Question

Assume that you are part of the accounting team for Best Industries. The company has only one product that sells for $40 per unit. Best estimates total fixed costs to be $9,000. Best estimates direct materials cost of $8.00 per unit, direct labor costs of $10.00 per unit, and variable overhead costs of $2.00 per unit. The CEO would like to see what the gross margin and operating income will be if 700 units are sold in the next period. Prepare a contribution margin income statement.

Sales -

Less: Variable Costs -

Contribution Margin -

Less: Fixed costs -

Operating Income -

Further analysis of Best Industries’s fixed costs revealed that the company actually faces annual fixed overhead costs of $9,800 and annual fixed selling and administrative costs of $4,200. Variable cost estimates are correct: direct materials cost, $8.00 per unit; direct labor costs, $10.00 per unit; and variable overhead costs, $2.00 per unit. At this time, the selling price of $40 will not change. Complete the following formulas for the revised fixed costs. Enter the ratio as a percentage.

Contribution Margin per Unit = $_________ - $__________ = $_________

Contribution Margin Ratio = $________ = __________% / ___________%

Units Sold at Break-Even Point = __________ units

Assume that the number of units that Best sold exceeded the break-even point by one (1).

How much would operating income be?
$_____________

What would operating income be if the units sold exceeded the break-even point by five (5) units?
$________________

Answer 1

Contribution margin statement, contribution margin per unit and contribution margin ratio:

1. Contribution Margin Statement Particulars Amount Calculation Sales Revenue $ 28,000 (700 X $40) Less: Variable Costs 1. Direct Material $ 5,600 (700 X $8) 2. Direct Labor $ 7,000 (700 x $10) 3. Variable Overhead $ 1,400 |(700 X $2) Total Variable Cost $ 14,000 Contribution Margin $ 14,000 (28,000 - 14,000) Less: Fixed Cost $ 9,000 Operating Income $ 5,000 (14,000 - 9,000) 2. Contribution Margin Per Unit: - Contribution margin per unit = Selling price per unit - Variable cost per unit Contribution margin per unit = $40 - ($8 + $10 +$2) - Contribution margin per unit = $20 -3. Contribution Margin Ratio: Contribution Margin Ratio = (Contribution margin per unit/Selling price per unit) X 100 Contribution Margin Ratio = ($20/$40) X 100 Contribution Margin Ratio = 50%

Break-even point and Operating Income in case of units sold over break-even point:

4. Break-even point in units: Breakeven units = Fixed costs/Contribution per unit Breakeven units = ($9,800 + $4,200)/$20 Breakeven units = 700 units 5. Operating Income if 1 unit sold over break-even point: Additional contribution earned = Contribution per unit X Additional unit over BEP Additional contribution earned = $20 X 1 = $20 Operating Income = $5,000 + $20 Operating Income = $5,020 5. Operating Income if 5 units sold over break-even point: Additional contribution earned = $20 X 5 = $100 Operating Income = $5,000 + $100 Operating Income = $5,100