Question

Fast Spirit Calendars imprints calendars with college names. The company has fixed expenses of $1,095,000 each month plus variable expenses of $ 6.50 per carton of calendars. Of the variable expense, 72% is cost of goods sold, while the remaining 28% relates to variable operating expenses. The company sells each carton of calendars for $ 16.50. Read the requirements. Requirements: 1.Compute the number of cartons of calendars that Fast Spirit Calendars must sell each month to breakeven. Begin by stating the basic income statement equation. 2.Compute the dollar amount of monthly sales that the company needs in order to earn $338,000 in operating income (round the contribution margin ratio to two decimal places). 3.Prepare the company’s contribution margin income statement for June for sales of 460,000 cartons of calendars. 4. What is June’s margin of safety (in dollars)? What is the operating leverage factor at this level of sales, and by what percentage will operating income change if July’s sales volume is 12% higher? Prove your answer with detailed explanations.

Answer 1

Fixed expenses = $1,095,000

Variable expenses = $6.50 per carton of calendar

Selling price = $16.50 per carton of calendar

Contribution per carton = Selling price per carton - Variable expenses per carton

= 16.50 - 6.50

= $10

1. Number of carton of calendars to be sold to break even = Fixed expenses/Contribution per carton

= 1,095,000/10

= 109,500

2. Contribution margin ratio = Contribution per carton/Selling price per carton

= 10/16.50

= 60.60%

Desired income = $338,000

Sales (in dollars) needed to get a desired income = (Fixed expenses + Desired income)/Contribution margin ratio

= (1,095,000 + 338,000)/60.60%

= 1,433,000/60.60%

= $2,364,686

3. Income statement for June

Sales (460,000 x 16.50)	7,590,000
Less: Variable expenses (460,000 x 6.50)	- 2,990,000
Contribution	4,600,000
Less : Fixed expenses	-1,095,000
Earnings before interest and tax	3,505,000

4. Break even sales units = 109,500

Hence, break even sales ( in $) = 109,500 x 16.50

= $1,806,750

Margin of safety = Actual sales - Break even sales

= 7,590,000 - 1,806,750

= $5,783,250

Operating leverage = Contribution/EBIT

= 4,600,000/3,505,000

= 1.31

Operating leverage = % change in EBIT/% change in sales

1.31 = % change in EBIT/ 12%

Hence, % increase in operating income (EBIT) = 1.31 X 12

= 15.73

Proof

July's sales volume =7,590,000 x 112%

= $8,500,800

Income statement for July

Sales	8,500,800
Less: Variable expenses (39.40% of sales)	- 3,349,315
Contribution	5,151,485
Less : Fixed expenses	-1,095,000
Earnings before interest and tax	4,056,485

Increase in EBIT = 4,056,485 - 3,505,000

= $551,485

Hence % increase in EBIT = 551,485/3,505,000

= 15.73