Question

the accountant's Company

Income Statement

For the Year Ended December 31, 2018

Sales                                                               $8,500,000

Manufacturing Expenses

Variable                                $3,250,000

Fixed overhead                       640,000       3,890,000

Gross Margin                                                  $4,610,000

Selling and administrative expenses

Commissions                           $580,000

Fixed marketing expenses       300,000

Fixed admin expenses               450,000      1,330,000

Net Operating Income                                     $3,280,000

Fixed Interest expenses                                       230,000    

Income before Taxes                                      $3,050,000     

Income Taxes (21%)                                            640,500

Net Income                                                     $2,409,500

1.Restate the income statement in a contribution margin format.

2.Compute the break-even point in sales dollars given the current structure.

3.Compute the operating leverage at the 2018 level of sales.

4.Compute the margin of safety in both dollars and percentage for the 2018 level of sales.

Your company is considering out-sourcing the sales and marketing to an agency specializing in these types of sales. The outsourcing would remove the commissions, reduce the marketing by $270,000, and reduce the fixed administrative expenses by $35,000. The out-sourcing firm, Jangler Marketing, will charge a fee of 14% of sales. Jangler requires a 3-year contract. Jangler believes that it can increase sales by 10% for 2019 and 13% each year after (2020 and 2021). The company believes that with its current sales and marketing staff, sales will increase by 8% for 2019 and 9% in each year after (2020 and 2021).

1.Prepare contribution format projected income statements for 2019, 2020 & 202a assuming the company hires Jangler Marketing.

2.Prepare contribution format projected income statements assuming the outsourcing is rejected.

Answer 1

Solution 1:

Income Statement - Dec'31 2018 - Contribution Margin format
Particulars		Amount
Sales		$8,500,000.00
Variable Cost:
Variable manufacturing expense	$3,250,000.00
Selling commissions	$580,000.00	$3,830,000.00
Contribution (Sales - VC)		$4,670,000.00
Fixed Cost:
Fixed Overhead	$640,000.00
Fixed Marketing Expense	$300,000.00
Fixed Admin Expense	$450,000.00	$1,390,000.00
Earning before interest and taxes (EBIT) (Contribution - Fixed Cost)		$3,280,000.00
Interest Expense		$230,000.00
Earning before taxes (EBT)		$3,050,000.00
Income taxes (21%)		$640,500.00
Earning after taxes		$2,409,500.00

Solution 2:

Contributon margin ratio = Contribution / Sales = $4,670,000 / $8,500,000 = 54.94%

Fixed expense = Operating fixed cost + Fixed interest cost = $1,390,000 + $230,000 = $1,620,000

Break even Sales = Fixed Expenses / Contribution margin = $1,620,000 / 54.94% = $2,948,671

Solution 3:

Operating leverage = Contribution / EBIT = $4,670,000/$3,280,000 = 1.42

Solution 4:

Margin of Safety (In dollar) = Current level Sale - Break even sales = $8,500,000 - $2,948,671 = $5,551,329

Margin of Safety (In % of current sale) = (Current level sales - Break even sales) / Current level Sale * 100

= $5,551,329 / 8,500,000*100 = 65.31%