Question

PR 21-6A Contribution margin, break-even sales, cost-volume-profit chart, OBJ. 2, 3, 4, 5 margin of safety, and operating leverage Wolsey Industries Inc. expects to maintain the same inventories at the end of 2016 as at the beginning of the year. The total of all production costs for the year is therefore assumed to be equal to the cost of goods sold. With this in mind, the various department heads were asked to submit estimates of the costs for their departments during the year. A summary report of these estimates is as follows: Estimated Estimated Variable Cost Fixed Cost (per unit sold) Production costs: Direct materials.... Direct labor ..... Factory overhead.. $200,000 Selling expenses: Sales salaries and commissions... 110,000 Advertising. 40,000 Travel ........................ 12,000 Miscellaneous selling expense 7,600 Administrative expenses: Office and officers' salaries ... 132,000 Supplies..... 10,000 Miscellaneous administrative expense 13.400 Total $525.000 It is expected that 21,875 units will be sold at a price of $160 a unit. Maximum sales within the relevant range are 27,000 units. Instructions 1. Prepare an estimated income statement for 2016. 2. What is the expected contribution margin ratio? 3. Determine the break-even sales in units and dollars. 4. Construct a cost-volume-profit chart indicating the break-even sales. 5. What is the expected margin of safety in dollars and as a percentage of sales? 6. Determine the operating leverage

Answer 1

1.

Prepare an estimated income statement for 2016 as follows:

$3.500.000 Wolsey Industries Inc. Estimated Income statement For the year Ended December 31, 2016 Sales (21,875 units $160) Less: Cost of goods sold Direct material (21.875 x $46) $1,006,250 Direct Labor (21.875 x $40) $875.000 Factory overhead [(21875 $20) + $200,000] $637,500 $2,518,750 Operating Income $981,250

Less: Expenses: Sales salaries and commissions [(21875 x $8) + $110,000] Miscellaneous selling expenses [(21875 $1) + $7,600] $285.000 $29,475 $314.475 Less: Administration expense: Supplies expense [(21875 x $4) + $10,000] Miscellaneous administration expenses [(21875 x $1) + $13,400] || $97.500 $35,275 $132.775 Less: Fixed expense: Advertising expense Travel expense Office and salary expense $40,000 $12.000 $132.000 $184.000 Net Operating Income $350.000

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Compute Expected contribution margin ratio as follows: Contribution margin per unit Expected contribution margin ratio= Selling price per unit _(Selling price-Variable cost) per unit Selling price per unit _($160-$120) $160 = 0.25

Compute Breakeven sales in units and dollars as follows: Fixed cost BEP(Units)=- Contribution margin per unit $525.000 $40 = 13,125 units Fixed cost BEPDollars)== Contribution margin ratio $525.000 0.25 = $2.100,000

Compute margin of safety: MOS(dollars)=Total Sales -Break even sales =$3,500,000-$2.100.000 = $1,400,000 MOS(%of sales) - Margin of safety sales Total sales $1,400,000 $3,500,000 = 40% Compute operating Leverage: EBIT Operating Leverage = EBT $875.000 $350000 = 2.5

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