Question

Kingbird, Inc. manufactures souvenirs and sells the products to souvenir shops across Canada. Lisa McKay is the new owner, and is concerned about the low margins. She would like to find a way to improve the company’s profitability. The accountant provides her the following financial information: sales are $306,000, of which 60% is cost of goods sold. Cost of goods sold consists of direct materials (20%), direct labour (30%), and fixed manufacturing overhead (50%). Operating expenses consist of variable expenses (40%) and fixed expenses (60%). Kingbird pays a 40% tax rate and the net income is $14,100. To reduce the company’s operating risks, McKay would like to review the company’s operations from another perspective. She would like to know how much the company needs to generate in order to break-even. Based on the current cost structure, how sensitive is the profit to a sale volume increase of 5%.

Prepare an income statement in the gross margin format. Kingbird, Inc. Gross Margin Income Statement

Answer 1

Cost of goods sold and its division:
Total sales						306000
Cost of goods sold as % of sales						60%
Cost of goods sold in $						183600
Material (20% of 183600)						36720
Labour (183600*30%)						55080
Fixed manufacturing Oh (183600*50%)						91800
Computation of Operating expense and its allocation;
Net income						14100
Tax rate						40%
Net income before tax (14100/60%)						23500
Gross Profit (sales -Cost of goods sold)						122400
	(306000-183600)
Operating expense (Gross profit- Net income before tax)						98900
Variable operating expenses			(98900*40%)			39560
Fixed operating expense			(98900*60%)			59340
Gross margin income Statement:
Sales revenue				306000
Less: Cost of goods sold
Material				36720
Labour				55080
Manufacturing Oh				91800
Total cost of goods ssold				183600
Gross margin				122400
Less: Operating expense
Variable expenses				39560
Fixed expenses				59340
Total Operating expenses				98900
Net income before tax				23500
Less: Tax @ 40%				9400
After tax net income				14100
Contribution Margin Income Statement:
Sales revennue				306000
Less: variable cost
Material				36720
labour				55080
variable operating expense				39560
Total Variable cost				131360
Contribution margin				174640
Less: Fixed cost
Fixed manufacturing oH				91800
Fixed operating expenses				59340
Total fixed cost				151140
Net income before tax				23500
Less: Tax @ 40%				9400
After tax income				14100
CM ratio = Contribution / Sales *100
		174640 /306000 *100 = 57.07%
Break even sales = Total fixed cost / CM ratio
		151140 /57.07 % = $ 264833
margin of safety = Actual sales - Break even sales
		306000 -264833 = 41167
Degree of Operating leverage = Contribution/ Net income before tax
			174640 /23500 = 7.43 times