Question

Magnificent Modems, Inc, makes modem cards that are used in notebook computers. The company completed the following transactions during year 1, All purchases and sales were made with cash. 1. Acquired $750,000 of cash from the owners, 2. Purchased $270,000 of manufacturing equipment. The equipment has a $30,000 salvage value and a four-year useful life. 3. The company started and completed 5,000 modems. Direct materials purchased and used amounted to $40 per unit. 4. Direct labor costs amounted to $25 per unit. 5. The cost of manufacturing supplies used amounted to $4 per unit. 6. The company paid $50,000 to rent the manufacturing facility. 7. Magnificent sold all 5,000 units at a cash price of $120 per unit. 3. The sales staff was paid a $6 per unit sales commission. P. Paid $39,000 to purchase equipment for administrative offices. The equipment was expected to have a $3,000 salvage value and a three-year useful life. D. Administrative expenses consisting of office rental and salaries amounted to $71,950. red Prepare an income statement using the contribution margin format. Determine the break-even point in units and in dollars. Assume that next year's sales are budgeted to be the same as the current year's sales. Determine the margin of safety expressed as a percentage.

Answer 1

Solution

(1)

Magnificent Modems, Inc.
Income Statement (Contribution Margin Approach)
Sales Revenue
(5000 x 120)	$      6,00,000.00
Less: Variable Overheads (Refer Note 1)	$     -3,75,000.00
Contribution	$      2,25,000.00
Less: Fixed Overheads (Refer Note 2)	$     -1,93,950.00
Income	$          31,050.00

Working Notes:

Note 1:

Variable Overheads
Direct Materials
(5000 x 40)	$   2,00,000.00
Direct Labor
(5000 x 25)	$   1,25,000.00
Cost of Manufacturing Supplies
(5000 x 4)	$       20,000.00
Sales Commission
(5000 x 6)	$       30,000.00
Total Variable Overheads	$   3,75,000.00

Note 2:

Fixed Overheads
Depreciation on Manufacturing Equipment
[(270,000 - 30,000) x 1/4]	$        60,000.00
Rent of Manufacturing Facility	$        50,000.00
Depreciation on Equipment
[(39,000 - 3,000) x 1/3]	$        12,000.00
Administrative Rentals and Salaries	$        71,950.00
Total Fixed Overheads	$    1,93,950.00

(2)

Fixed Overheads = $ 193,950
Contribution = $ 225,000
Units Sold = 5000
Contribution per unit = $ (225,000 / 5000) =  $ 45.00
Sales Revenue = $ 600,000
Contribution Margin Rate = (225,000 / 600,000) x 100 = 37.50%

Therefore,
Break-even point (Units) = Fixed Overhead / Contribution per unit
Or, 193950 / 45
Or, 4310
Break-even point in Units = 4310

Break-even point (Value) = Fixed Overhead / Contribution Margin Rate
Or, 193950 / 37.50%
Or, 193950 / 0.375
Or, 517200
Break-even point in Value = $ 517,200

(3)

Margin of Safety = [(Current Sales - Break-even Sales) / Current Sales] x 100
Or, [(600,000 - 517,200) / 600,000] x 100
Or, 13.80%

Therefore, the margin of safety will be 13.80%