Question

(URGENT) An extract from the income statement of PoMA Ltd for the previous year is given below:                                                                                                            

                                                                                Rs.                         

Sales (50,000 units)                                         1,000,000

Direct materials                                                350,000                

Direct labor cost (50,000 hours)                 200,000                

Fixed manufacturing overhead                  240,000

Variable manufacturing overhead            50,000

Administration overheads                           180,000                

Selling and distribution overhead             120,000                

                                                                                                               

The directors are keen to improve revenue and productivity and are considering various options.             You are the management accountant and are requested to compute the following:                                

                                                               

a. If salesmen are paid commission of 10% of sales, how many units must be sold to achieve breakeven point.                    

                                                               

b. By how much does profit change (increase or decrease) if the selling price is reduced by 10% resulting in an estimated increase in sales volume (in number of units) by 30%.                                                           

                                                               

c. By how much does profit change (increase or decrease) if the direct labor rate is increased from Rs.4 to Rs.5 per hour. This increase is expected to increase production and sales by 20% without affecting the hours worked. However, advertising costs will increase by Rs.50,000.                                

                                                               

d. How many units must be sold in order to achieve a target profit margin of 10% on sales (profit/salesx100) assuming that advertising costs will increase by Rs.300,000 and selling price will increase by 20%                                                                                                            

                                                               

e. What is the Margin of Safety at the sales volume derived in part d above (express as percentage of sales)                                                   

Answer 1

Part a –

units must be sold to achieve breakeven point
Total Fixed Costs (Refer Note 1)	540,000
Divide by: Contribution Margin Per Unit (Refer note 1)	6
Units must be sold to achieve breakeven point	90,000	Units

Note 1 –

Calculation of Contribution Margin per unit and in percentage
	Total	Per Unit
Sales (50,000 units)	1,000,000	20.00
Variable Costs:
Direct materials	350,000	7.00
Direct labor cost (50,000 hours)	200,000	4.00
Variable manufacturing overhead	50,000	1.00
Variable Sales Commission (10% of Sales)	100,000	2.00
Total Variable Costs	700,000	14.00
Contribution Margin (Sales - total variable cost)	300,000	6.00
Total Fixed Costs
Fixed manufacturing overhead	240,000
Administration overheads (assumed fixed)	180,000
Selling and distribution overhead (assumed fixed)	120,000
Total Fixed Costs	540,000

Part b –

	Current	Proposed
	Total	Per Unit	Total	Per Unit
Sales (Current 50,000 units; Proposed 50,000*1.3 = 65,000 Units)	1,000,000	20.00	1,170,000	18
Variable Costs:
Direct materials	350,000	7.00	455,000	7.00
Direct labor cost (50,000 hours)	200,000	4.00	260,000	4.00
Variable manufacturing overhead	50,000	1.00	65,000	1.00
Total Variable Costs	600,000	12.00	780,000	12.00
Contribution Margin (Sales - total variable cost)	400,000	8.00	390,000	6.00
Total Fixed Costs
Fixed manufacturing overhead	240,000		240,000
Administration overheads (assumed fixed)	180,000		180,000
Selling and distribution overhead (assumed fixed)	120,000		120,000
Total Fixed Costs	540,000		540,000
Net Profit /(loss)	-140,000		-150,000

Profit will decrease by $10,000

Part c –

	Current	Proposed
	Total	Per Unit	Total	Per Unit
Sales (Current 50,000 units; Proposed 50,000*1.2 = 60,000 Units)	1,000,000	20.00	1,200,000	20.000
Variable Costs:
Direct materials	350,000	7.00	420,000	7.00
Direct labor cost (50,000 hours)	200,000	4.00	300,000	5.00
Variable manufacturing overhead	50,000	1.00	60,000	1.00
Total Variable Costs	600,000	12.00	780,000	13.00
Contribution Margin (Sales - total variable cost)	400,000	8.00	420,000	7.00
Total Fixed Costs
Fixed manufacturing overhead	240,000		240,000
Administration overheads (assumed fixed)	180,000		230,000
Selling and distribution overhead (assumed fixed)	120,000		120,000
Total Fixed Costs	540,000		590,000
Net Profit /(loss)	-140,000		-170,000

Profit will decrease by $30,000

Part d –

Units must be sold to achieve target profit Rs 120,000
Total Fixed Costs (Refer Note 1)	840,000
Plus: Target Profit	120,000
Total Contribution Margin Required	960,000
Divide by: Contribution Margin Per Unit	12
Units must be sold to achieve breakeven point	80,000	Units

Note 2 -

Target Profit = 10% of Sales 1,200,000 = 120,000

Total Fixed Costs = 540,000 + Increase in advertising cost 300,000 = 840,000

	Total	Per Unit
Sales (Current 50,000 units)	1,200,000	24.00
Variable Costs:
Direct materials	350,000	7.00
Direct labor cost (50,000 hours)	200,000	4.00
Variable manufacturing overhead	50,000	1.00
Total Variable Costs	600,000	12.00
Contribution Margin (Sales - total variable cost)	600,000	12.00

Part e –

Margin of Safery = Total Sales 1,200,000 – Break Even Sales (refer working below) 1,680,000

No Margin of safety.

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