Question

Randy Reseller operates a small shop on the beach that sells a surfboard. After getting his April income statement he “Yelled I’ll never understand this accounting stuff. Last month (June) we sold 1,000 surfboards and earned $68,500 in operating income. This month (July) we sold 1,500. I thought we would make $102,750. However, his income statement for July shows a net income of $121,000. He is frustrated and says how can I ever make plans if I can’t predict my net income. That accountant has some explaining to do. I am giving her one more chance to explain this, as he dials his accountant Alex Figures. “Will you explain this operating income thing to me one more time?” Randy ask Alex. “After I saw last month’s income statement, I thought each surfboard we sold generated $68.50 in net income; now this month each one generates $80.67! There was no change in the price we paid for the surfboard, so I don’t understand how this happened. If I had known I was going to have $121,000 in operating income, I would have looked more seriously at adding to our product lines.

Required: 1. Assume Alex’s roll. Explain to Randy why his use of operating income per surfboard was in error Explanation assessed (Scale of 1 to 5) 1 2 3 4 5

2. Using the following income statements, prepare a contribution margin income statement for July. Hint, used the high-low method to separate the variable and fixed elements where necessary.

june July

sales revenue 250,000 375,000

cost of Good sold 100,000 150,000

Gross Profit 150,000 225000

Operating expences

Rent expence 1500 1500

Wages expence 35000 50000

Shipping expense 12500 18750

Utilities expense 7500 7500

Advertising expence 7500 8750

Insurance expence 4000 4000

Total operating expences 81500 104000

Operating income 68500 121000

3. Randy plans to sell 500 surfboards next month (August). How much operating income Randy expect to earn next month if he realizes his planned sales

4. Randy wasn’t happy with the projected income statements you prepared for him for a sales level of 500 surfboards. He wants to know how many surfboards he will need to sell to earn an operating income of $37,000. As a safety net, he also wants to know how many surfboards must he sell to break-even.

5. Randy is evaluating two options that would increase the number of surfboards sold next month. First, he believes he can increase sales by advertising on the local radio station. He can purchase 12 radio spots for the next month for a total of $12,000. He believes the increased advertising will increase the number of surfboard sold from 500 to 960. A second option would be to reduce the selling price. Randy believes a 10% decrease in price will result in 1,000 surf boards sold. Which plan should Randy implement. Show your calculations for both alternatives.

6. Just after Randy had completed an income projection for 1,200 surfboards, his supplier called to inform him that the cost of surfboards would be going up by 20%, effective immediately. That is, from $100 per unit to $120 per unit. Randy knows that he cannot pass the entire increase on to his customers, but he thinks he can pass on half of the increase while suffering only a 5% reduction in units sold. Should Randy pass the increase onto his customers. (Hint prepare two income statements; one with no increase in sales price and the other with the increase

Answer 1

1) Randy,

Operating income refers to the income that we earn after deducting cost of goods sold and all other operating related expenses. This is also known as Earnings Before Interest and Taxes. The formula to calculate Operating income is as given below:

Operating Income = Sales – Cost of Goods Sold – Operating Expenses

As you can see in the above formula, it is not only cost of surfboards that decide our operating income. There are many other costs such as rent expenses, utilities expenses, wages expenses, shipping cost etc., which have direct impact on Operating Income. Hence, in order to understand the operating income, we must look into the operating expenses as well. Since we have earned more than previous month proportionately, there must be some reduction in the operating expenses this month.

Operating income per unit After 1000 units = $12,100- $6850/ 1,500-1,000 = $5,250/500 =$10.5
So contribution per unit = $10.5
Is sales was 1,000 then contribution = $10.5 * 1,000 = $10,500
Fixed cost = Contribution - operating income = $10,500 - $6850 = $3,650

Projected income statement for 500 units= $10.5 * 500 - 3,650 = $1,600

Number of stuffet mascots = Fixed cost+profit /contribution per unit =$3,650+$3,700 / 10.5 = 700 stuffed mascots

Break even (units)= Fixed cost / contribution per unit = $3,650 / 10.5 = 348 stuffed mascots(approx).