Question

Lydo Cinema Chain based in Melbourne, owns three cinemas in the suburbs of Camberwell, South Yarra and Ringwood. It has prepared budgets for the coming year based upon a ticket price of $20.

	Particulars		Camberwell	South Yarra	Ringwood
	Budgeted revenue from ticket sales		1,500,000	1,250,000	750,000
	Costs:
	Film license		510,000	390,000	380,000
	Wages and salaries		295,000	265,000	175,000
	Overheads		495,000	395,000	345,000
	Total costs		1,300,000	1,050,000	900,000

Included in the overhead figures are the Head Office fixed costs that amount to $750,000, these have been allocated to each cinema based on budgeted ticket receipts. All other costs are variable. The top management is concerned about the Ringwood cinema and the fact that it is showing a budgeted loss and is considering closing the cinema and selling the site to a Property Developer.

Required:

1. Prepare marginal costing income statements to show contributions for each cinema and contribution and profit for the overall chain based on the original budget.

2. Prepare marginal costing income statements to show contributions for each cinema and contribution and profit for the overall chain assuming Ringwood cinema is closed.

3. Based on your calculations in requirement (b) above, do you think that Ringwood cinema should be closed? Justify your answer with appropriate explanation.

4. What is the contribution per ticket sale at each cinema?

5. What is the margin of safety in revenue for the chain at the budgeted level of activity if the Ringwood cinema is kept open?

6. What is the margin of safety in revenue for the chain at the budgeted level of activity if the Ringwood cinema is closed?

7. If the Ringwood cinema is kept open, management would like to increase its profitability. One suggestion is that ticket sales at Ringwood cinema can be increased by 60% by an advertising campaign directed at Ringwood that will add $20,000 to the chain's fixed costs. Do you think that the advertising campaign should be undertaken to improve the cinema's profitability? Give reasons for your decision.

Answer 1

Part a – marginal costing income statements to show contributions for each cinema and contribution and profit for the overall chain based on the original budget.

	Camberwell	South Yarra	Ringwood	Total
Budgeted Revenue from ticket sales	$1,500,000	$1,250,000	$750,000	$3,500,000
Variable Costs:
Film Licence	$510,000	$390,000	$380,000	$1,280,000
Wages and Salaries	$295,000	$265,000	$175,000	$735,000
Variable Overheads (Refer Note 1)	$173,571	$127,143	$184,286	$485,000
Total Variable Costs	$978,571	$782,143	$739,286	$2,500,000
Contribution Margin (Sales - Variable Costs)	$521,429	$467,857	$10,714	$1,000,000
Fixed Overhead Costs				$750,000
Profit				$250,000

Note 1 - Calculation of Variable Overhead

	Camberwell	South Yarra	Ringwood	Total
Total Overheads Cost (given) (A)	$495,000	$395,000	$345,000	$1,235,000
Allocation of Fixed Overheads based on budgeted ticket receipts
Budgeted Ticket Receipts	$1,500,000	$1,250,000	$750,000	$3,500,000
Allocation Ratio	0.428571	0.357143	0.214286
Multiply by: Fixed Overheads	$750,000	$750,000	$750,000
Allocated Fixed Overheads (B)	$321,429	$267,857	$160,714
Variable Overheads (A - B)	$173,571	$127,143	$184,286	$485,000

Part b – marginal costing income statements to show contributions for each cinema and contribution and profit for the overall chain assuming Ringwood cinema is closed

	Camberwell	South Yarra	Ringwood (Closed)	Total
Budgeted Revenue from ticket sales	$1,500,000	$1,250,000	$0	$2,750,000
Variable Costs:
Film Licence	$510,000	$390,000	$0	$900,000
Wages and Salaries	$295,000	$265,000	$0	$560,000
Variable Overheads (Refer Note 1)	$173,571	$127,143	$0	$300,714
Total Variable Costs	$978,571	$782,143	$0	$1,760,714
Contribution Margin (Sales - Variable Costs)	$521,429	$467,857	$0	$989,286
Fixed Overhead Costs				$750,000
Profit				$239,286

Part c –

No, Ringwood cinema should not be closed. Since the overall profit of the company will decrease from $250,000 to $239,286 If Ringwood is closed.

Part d – contribution per ticket sale at each cinema

	Camberwell	South Yarra	Ringwood
Budgeted Revenue from ticket sales	$1,500,000	$1,250,000	$750,000
Divide by: Per Ticket Price	$20	$20	$20
Number of Tickets Sold	75000	62500	37500
Contribution Margin (from Part a)	$521,429	$467,857	$10,714
Divide by: Number of Tickets	75000	62500	37500
Contribution Margin per ticket	$6.95	$7.49	$0.29

Part e – Margin of safety in revenue for the chain at the budgeted level of activity if the Ringwood cinema is kept open

Contribution Margin Ratio for overall company = Contirbution Margin (including Ringwood) / Sales Revenue * 100

= $1,000,000 / 3,500,000 * 100

= 28.571429%

Break Even Revenue for Lydo Cinema Chain = Total Fixed Costs $750,000 / Contribution Margin Ratio for overall company (28.571429%)

= $2,625,000

Margin of Safety = Total Revenue $3,500,000 – Break Even Revenue $2,625,000

= $875,000

Margin of Safety = $875,000

Part f – margin of safety in revenue for the chain at the budgeted level of activity if the Ringwood cinema is closed

Contribution Margin Ratio for overall company = Contirbution Margin (exluding Ringwood) / Sales Revenue * 100

= $989,286 / 2,750,000 * 100

= 35.974026%

Break Even Revenue for Lydo Cinema Chain = Total Fixed Costs $750,000 / Contribution Margin Ratio for overall company (35.974026%)

= $2,084,838

Margin of Safety = Total Revenue $2,750,000 – Break Even Revenue $2,084,838

= $665,162

Part g –

	Ringwood
Increase in ticket sale (37,500 Tickets * 60%)	22500
Multiply by: Contribution Margin per ticket (Rounded to 2 decimal places)	$0.29
Incremental Contribution Margni per ticket	$6,525
Less: Increased in Fixed Costs	$20,000
Incremental Profit / (Loss)	($13,475)

Do you think that the advertising campaign should be undertaken to improve the cinema's profitability ---- NO

The advertising campaign should NOT be undertaken, since there is a loss of $13,475 by this advertising campaign.

Note --- In calculating Variable Ovehead Costs and Break Even Sales contribution margin ratio the decimal places are not rounded off since it is not mentioned in the question.

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