Question

Contribution Margin, Break-Even Sales, Cost-Volume-Profit Chart, Margin of Safety, and Operating Leverage

Belmain Co. expects to maintain the same inventories at the end of 20Y7 as at the beginning of the year. The total of all production costs for the year is therefore assumed to be equal to the cost of goods sold. With this in mind, the various department heads were asked to submit estimates of the costs for their departments during the year. A summary report of these estimates is as follows:

		Estimated Fixed Cost			Estimated Variable Cost (per unit sold)
Production costs:
	Direct materials				$50.00
	Direct labor				30.00
	Factory overhead	$350,000			6.00
Selling expenses:
	Sales salaries and commissions	340,000			4.00
	Advertising	116,000
	Travel	4,000
	Miscellaneous selling expense	2,300			1.00
Administrative expenses:
	Office and officers' salaries	325,000
	Supplies	6,000			4.00
	Miscellaneous administrative expense	8,700			1.00
	Total	$1,152,000			$96.00

It is expected that 12,000 units will be sold at a price of $240 a unit. Maximum sales within the relevant range are 18,000 units.

Required:

1. Prepare an estimated income statement for 20Y7.

Belmain Co.
Estimated Income Statement
For the Year Ended December 31, 20Y7
Sales			$
Cost of goods sold:
Direct materials		$
Direct labor
Factory overhead
Total cost of goods sold
Gross profit			$
Expenses:
Selling expenses:
Sales salaries and commissions	$
Advertising
Travel
Miscellaneous selling expense
Total selling expenses		$
Administrative expenses:
Office and officers' salaries	$
Supplies
Miscellaneous administrative expense
Total administrative expenses
Total expenses
Income from operations			$

Feedback

1. Use the absorption costing format.

Learning Objective 2, Learning Objective 3, Learning Objective 4, and Learning Objective 5.

2. What is the expected contribution margin ratio?
%

3. Determine the break-even sales in units and dollars.

Units	units
Dollars	$1,920,000

4. Construct a cost-volume-profit chart on your own paper. What is the break-even sales?
$1,920,000

5. What is the expected margin of safety in dollars and as a percentage of sales?

Dollars	$
Percentage (If required, round the percent to one decimal place, e.g. 15.4%.)		%

6. Determine the operating leverage.

Answer 1

1.

Belmain Co. Estimated Income Statement For the year ended December 31, 20Y7
Sales			$ 2,880,000
Cost of Goods Sold
Direct Materials		$ 600,000
Direct Labor		360,000
Factory Overhead		422,000
Total Cost of Goods Sold			1,382,000
Gross Profit			$ 1,498,000
Expenses
Selling Expenses
Sales Salaries and Commissions	$ 388,000
Advertising	116,000
Travel	4,000
Miscellaneous Selling Expenses	14,300
Total Selling Expenses		522,300
Administrative Expenses
Offie and Officer's Salaries	325,000
Supplies	54,000
Miscellaneous Administrative Expenses	20,700
Total Administrative Expenses		399,700
Total Expenses			922,000
Income from Operations			$ 576,000

2.

Selling Price per Unit	$ 240
Variable Cost per Unit	96
Contribution Margin per Unit	144
Contribution Margin Ratio	60 %

3.

Break-even Units	8,000 units
Break-even Dollars	$ 1,920,000

Break-even units = Total Fixed Costs / Contribution Margin per Unit = $ 1,152,000 / $ 144 = 8,000 units

Break-even dollar sales = Total Fixed Costs / Contribution Margin Ratio = $ 1,152,000 / 60 % = $ 1,920,000.

5.

Margin of Safety in Dollars	$ 960,000
Margin of Safety as a Percentage of Sales	33.3 %

Margin of Safety = Actual Sales - Break-even Sales = $ 2,880,000 - $ 1,920,000 = $ 960,000

Margin of Safety Percentage = ( Actual Sales - Break-even Sales ) / Actual Sales * 100 = $ ( 2,880,000 - 1,920,000 ) / 2,880,000 * 100 = 33.3 %

6. Degree of Operating Leverage = Contribution Margin / Operating Income = ( 12,000 x $ 144 ) / $ 576,000 = 3