Question

Island Novelties, Inc., of Palau makes two products—Hawaiian Fantasy and Tahitian Joy. Each product's selling price, variable expense per unit and annual sales volume are as follows:

	Hawaiian Fantasy			Tahitian Joy
Selling price per unit	$	20		$	150
Variable expense per unit	$	12		$	30
Number of units sold annually		37,000			7,400

Fixed expenses total $912,000 per year.

Required:

1. Assuming the sales mix given above, do the following:

a. Prepare a contribution format income statement showing both dollar and percent columns for each product and for the company as a whole.

b. Compute the company's break-even point in dollar sales. Also, compute its margin of safety in dollars and its margin of safety percentage.

2. The company has developed a new product called Samoan Delight that sells for $40 each and that has variable expenses of $32 per unit. If the company can sell 22,500 units of Samoan Delight without incurring any additional fixed expenses:

a. Prepare a revised contribution format income statement that includes Samoan Delight. Assume that sales of the other two products does not change.

b. Compute the company’s revised break-even point in dollar sales. Also, compute its revised margin of safety in dollars and margin of safety percentage.

Answer 1

1.

a

	Hawaiian Fantacy		Tahitian Joy		Total
		%		%		%
Sales	$740,000 (37,000*$20)	100	$1,110,000 (7,400*$150)	100	$1,850,000	100
Variable expenses	444,000 (37,000*$12)	60	222,000 (7,400*$30)	20	666,000	36
Contribution margin	296,000	40	888,000	80	1,184,000	64
Fixed expenses					912,000
Net income					$272,000

b

Break even point in dollars = Fixed cost / Contribution margin ratio

Break even point in dollars = $912,000/64% = $1,425,000

Margin of safety in dollars = Sales-break even sales

Margin of safety in dollars = $1,850,000-1,425,000 = $425,000

Margin of safety in percentage = Margin of safety in dollars / Sales*100

Margin of safety in percentage = $425,000 / 1,850,000 *100 = 23% (rounded off)

2.

a

	Samoan Delight		Hawaiian Fantacy		Tahitian Joy		Total
		%		%		%		%
Sales	$900,000 (22,500*$40)	100	$740,000 (37,000*$20)	100	$1,110,000 (7,400*$150)	100	$2,750,000	100
Variable expenses	720,000 (22,500*$32)	80	444,000 (37,000*$12)	60	222,000 (7,400*$30)	20	1,386,000	50.4
Contribution margin	180,000	20	296,000	40	888,000	80	1,364,000	49.6
Fixed expenses							912,000
Net income							$452,000

b

Break even point in dollars = Fixed cost / Contribution margin ratio

Break even point in dollars = $912,000/49.6% = $1,838,709.68

Margin of safety in dollars = Sales-break even sales

Margin of safety in dollars = $2,750,000-1,838,709.68 = $911,290.32

Margin of safety in percentage = Margin of safety in dollars / Sales*100

Margin of safety in percentage = $911,290.32 / 2,750,000 *100 = 33.14% (rounded off)