Question

Gilmore Corp started in business on 1/1/2014. The company produces golf clubs which it expects to sell for $80 per unit. The accountant has produced the following forecast income statement for 2014 using absorption costing:

Gilmore Corp: Absorption costing income statement for 2014	$
Sales revenue (5,000 clubs @ $80 per unit	400,000
Variable cost of goods sold: direct materials & labor (5,000 clubs @ $26 per unit)	(130,000)
Fixed cost of goods sold*	(20,000)
Gross profit	250,000
Variable sales commissions ($12 for each club sold)	(60,000)
Administrative salaries	(70,000)
Fixed advertising expenses	(30,000)
Shipping and handling expense (5,000 clubs @ $2 per unit)	(10,000)
Net income	80,000

* The fixed cost of goods sold is an allocation for the company’s fixed manufacturing overheads. The total fixed manufacturing overhead for 2014 is estimated at $20,000 and is allocated to products using the total units produced. The company expects to produce and sell 5,000 clubs during 2014.   

Required:
a) Using the information above, prepare a revised income statement for 2014 using a contribution margin-based “variable costing” format (hint: you need to identify contribution margin by reclassifying costs according to whether they are variable or fixed in nature).

b) Using your answer from part a), calculate Gilmore’s operating leverage.

c) Using your operating leverage calculation from part b), determine the total net income that Gilmore will earn if sales revenue increases by 30%

d) Using the original question data, calculate the company’s contribution margin per unit

e) Calculate the company’s break-even point in units and total sales dollars.

f) How many units must be sold during 2014 to earn a net income of $40,000?

Answer 1

SOLUTION

A.

Particulars	Amount ($)
Revenue	400,000
Less : Variable cost	(200,000)
Contribution margin	200,000
Less : Fixed Cost	(120,000)
Net Income	80,000

Variable cost = Variable cost of goods sold + Variable sales commissions + Shipping and handling expense

= 130,000 + 60,000 + 10,000 = 200,000

Fixed Cost = Fixed cost of goods sold + Administrative salaries + Fixed advertising expenses

= 20,000 + 70,000 + 30,000 = 120,000

B. Operating Leverage = Contribution / (Contribution - Fixed cost)

= 200,000 / (200,000 - 120,000) = 2.5

C. Total Income if sales is increased by 30% = 80,000 + 1500 ( 80 - 40 )

= 140,000

D. Company's contribution margin per unit = Contribution margin / Units

= 200,000 / 5000 = $40

E. Company's breakeven point in units = Fixed cost / Contribution per unit

= 120,000 / 40 = 3,000 units

F. Number of units to be sold-

Let X be the number of units

Therefore, X ( 80 - 40 ) -120,000 = 40,000

40X - 120,000 = 40,000

X = 4000

Therefore 4,000 units must be sold to earn a net income of $40,000.