Question

Solomon Modems, Inc. makes modem cards that are used in notebook computers. The company completed the following transactions during year 1. All purchases and sales were made with cash.

1. Acquired $890,000 of cash from the owners.
2. Purchased $340,000 of manufacturing equipment. The equipment has a $44,000 salvage value and a four-year useful life.
3. The company started and completed 6,400 modems. Direct materials purchased and used amounted to $54 per unit.
4. Direct labor costs amounted to $39 per unit.
5. The cost of manufacturing supplies used amounted to $18 per unit.
6. The company paid $64,000 to rent the manufacturing facility.
7. Solomon sold all 6,400 units at a cash price of $190 per unit.
8. The sales staff was paid a $13.00 per unit sales commission.
9. Paid $53,000 to purchase equipment for administrative offices. The equipment was expected to have a $4,400 salvage value and a three-year useful life.
10. Administrative expenses consisting of office rental and salaries amounted to $80,100.

Required

1. Use the following partially completed form to prepare an income statement using the contribution margin format.

2. Determine the break-even point in units and in dollars.

3. Assume that next year’s sales are budgeted to be the same as the current year’s sales. Determine the margin of safety expressed as a percentage.

Answer 1

a.

SOLOMON MODEMS INC. Income Statement
Sales (6,400*$190)		$1,216,000
Less: Variable cost:
Direct material (6,400*$54)	$345,600
Direct labor (6,400*$39)	249,600
Manufacturing supplies (6,400*$18)	115,200
Sales commission (6,400*$13)	83,200
Total variable cost		793,600
Contribution margin		422,400
Less: Fixed cost:
Depreciation on manufacturing equipment ($340,000-44,000/4)	74,000
Rent on manufacturing facility	64,000
Depreciation on administrative offices equipment ($53,000-4,400)/3	16,200
Administrative expenses	80,100
Total fixed cost		234,300
Net income/(loss)		$188,100

b.

Break even points in units = Total fixed cost / Contribution per unit

Contribution margin per unit = $422,400/6,400 = $66

Break even points in units = $234,300 / $66 = 3,550 units

Break even points in dollars = 3,550*$190 = $674,500

c

Margin of safety = Current sales - Break even sales / Current sales * 100

Margin of safety = $1,216,000 - 674,500 / 1,216,000 * 100 = 44.53%