Question

Valencia Manufacturing Company manufactures and sells musical gadgets. The business earned Operating Income of $220,000 in 2018, when selling price per unit was $200, and the president of Valencia is under pressure to increase operating income in 2019. Data for variable cost per unit and total fixed costs were as follows:

Variable expenses per unit:                Direct Material	$40
Direct Labour	$32
Variable Manufacturing Overhead	$18
Fixed expenses:                      Fixed Manufacturing Overhead	$190,000
Fixed Selling Costs	$115,000
Fixed Administrative Costs	$135,000

Required:

(a)          Using the equation method, calculate the number of units sold in 2018.    

(b)          Given the sales units calculated in Part (a), prepare a contribution margin income statement for the year ended December 31, 2018, detailing the composition of total fixed costs and clearly showing contribution and net income.                                                                          

(c)          Calculate Valencia’s break-even point in units and in sales dollars.             

(d)          Calculate the margin of safety in units and in sales dollars.                          

(e)          The management of Valencia Manufacturing Company is desirous of increasing operating income by 20% in 2019. They expect per unit data and total fixed costs to remain the same in 2018. Determine the number of units that must be sold to earn this target operating profit. Is this a realistic goal?                                                                                                               

(f)           Assume that as a result of reorganizing the production process, Valencia Manufacturing Company was able to reduce direct material cost per unit by $5 due to a change in the quality of raw material used in the production process but the expected sales of 6,000 units would decrease by 5% and total fixed costs are expected to increase by $94,000. What must the new selling price per unit be if the company wishes to meet the target operating profit for 2019?  

(g)          You have just begun your summer internship at Valencia Manufacturing. To expand sales, the business is considering paying a commission to its sales team. You have been asked to compute 1) the new break-even sales figure, and 2) the operating profit if sales increase by 10% under the new sales commission plan. She is confident that you can handle the task, because you learned CVP analysis in your accounting class.

You collected your data, performed your analysis and submitted a memo to your manager, who was very pleased with the work done. Your report indicated that the new sales commission plan would result in a significant increase in operating income but only a small increase in break-even sales.

A few days after, you realized that you made an error in the CVP analysis, as the sales personnel’s $88,000 monthly salaries were inadvertently left out and you therefore did not include this fixed marketing cost in your computations. You are not sure what to do, as you are afraid that Valencia might not offer you permanent employment after the internship.

How would your error affect breakeven sales and operating income under the proposed sales commission plan? After considering all factors, should you inform your manager or simply keep quiet?                                                                                                                        

Answer 1