Question

Lurvey ​Men's Clothing's revenues and cost data for 2017 are as​ follows: LOADING...​(Click the icon to view the​ data.) Mr. Lurvey​, the owner of the​ store, is unhappy with the operating results. An analysis of other operating costs reveals that it includes $ 25 comma 000 variable​ costs, which vary with sales​ volume, and $ 5 comma 000 ​(fixed) costs

Revenue 500,000

cost of goods sold 250,000

gross margin 250,000

operating cost

salaries fixed 130,000

sales commissions (10% of sales) 50,000

depreciation on eqip. and fixtures 13,000 283,000

operating income (loss) (33,000)

store rent (5000 per month) 60,000

other operating cost 30,000   

1. Compute the contribution margin of Lurvey ​Men's Clothing.

2. Compute the contribution margin percentage.

3. Mr. Lurvey estimates that he can increase units​ sold, and hence revenues by 20​% by incurring additional advertising costs of $ 9 comma 000. Calculate the impact of the additional advertising costs on operating income.

4. What other actions can Mr. Lurvey take to improve operating​ income?

Answer 1

For better understanding Below is the income statement Lurvey clothings

Particulars	$	$
Revenue		500,000
Less : cost of goods sold		250,000
Gross margin		250,000
Operating expenses
Salaries	130,000
Sales commission	50,000
Depreciation on equipment and furniture	13,000
Store rent	60,000
Other operating costs	30,000
Total operating expenses		283,000
Operating income ( loss) [ GROSS MARGIN - TOTAL OPERATING EXPENSES ]		(33,000)

1) Contribution margin = net sales or revenue from operations - total variable expenses

net sales = $ 500,000

Total variable expenses = COGS + sales commission

Total variable expenses = $ 250,000 + $ 50,000 = $ 300,000

Contribution margin = $ 500,000 - $ 300,000 = $ 200,000

2) Contribution margin percentage = [contribution margin / net sales or revenue from operations ] X 100 %

Contribution margin percentage = [$ 200,000 / $ 500,000] X 100 % = 40%

3) Estimated Revenue = $ 500,000 X 120% = $ 600,000

Estimated Cost of goods sold remain same = $ 250,000

Estimated Gross margin  = $ 600,000 - $ 250,000 = $ 350,000

Estimated total operating expenses = $ 283,000 + $ 9,000 = $ 292,000

Estimated net operating income = estimated gross margin  - estimated total operating expenses

Estimated net operating income = $ 350,000 - $ 292,000 = $ 58,000

So, by additional operating cost of $ 9,000 company can able to make an operating profit of $ 58,000.

4) Apart from advertisement, following are the suggestion for improving operating income :

1) Increase production output if product has market demand , which reduces the per unit cost of fixed operating expenses on quantity produced and sold.

2) Sales commission percentage can be increased by certain percentage ( 5% to 10% more) , for the next slab of increment in sales. Like, up-to first 100 units of sales , sales commission provided @ 10% on sales and above 100 units of sales , allowable sales commission @ 20% ( 10% + additional 10%) on additional sales. Because now company is enjoying 40% of PV ratio.

Note: In this question other operating expenses considered as fixed cost, because no sufficient information is there to treat it as variable cost. Generally other operating expenses are office expenses that are not directly related with production and sales of goods and services ,thus considered as fixed cost .