Question

Problem 6-27 Sales Mix; Break-Even Analysis; Margin of Safety [LO6-7, LO6-9]

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		$	100
Variable expense per unit	$	13		$	40
Number of units sold annually		22,000			6,600

Fixed expenses total $506,000 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 $55 each and that has variable expenses of $44 per unit. If the company can sell 10,000 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.
Island Novelties, Inc.
Contribution Income Statement
	Hawaiian Fantasy		Tahitian Joy		Total
	Amount	%	Amount	%	Amount	%
Sales	440000	100%	660000	100%	1100000	100%
Variable expenses	286000	65%	264000	40%	550000	50%
Contribution margin	154000	35%	396000	60%	550000	50%
Fixed expenses					506000
Net operating income					44000

1-b.
Break-even point in dollars = Fixed expenses / Contribution margin ratio of company = 506000 / 50%	1012000
Margin of safety in dollars = Sales - Break even point in dollars = 1100000 - 1012000	88000
Margin of safety percentage = Margin of safety in dollars / Sales = 88000 / 1100000	8.0%

2-a.
Island Novelties, Inc.
Contribution Income Statement
	Hawaiian Fantasy		Tahitian Joy		Samoan Delight		Total
	Amount	%	Amount	%	Amount	%	Amount	%
Sales	440000	100.0%	660000	100.0%	550000	100.0%	1650000	100.0%
Variable expenses	286000	65.0%	264000	40.0%	440000	80.0%	990000	60.0%
Contribution margin	154000	35.0%	396000	60.0%	110000	20.0%	660000	40.0%
Fixed expenses							506000
Net operating income							154000

2-b.
Break-even point in dollars = Fixed expenses / Contribution margin ratio of company = 506000 / 40.0%	1265000
Margin of safety in dollars = Sales - Break even point in dollars = 1650000 - 1265000	385000
Margin of safety percentage = Margin of safety in dollars / Sales = 385000 / 1650000	23.3%