Question

Bubba's Western Wear is a western hat retailer in Lubbock, Texas. Although Bubba's carries numerous styles of western hats, each hat has approximately the same price and invoice (purchase) cost, as shown in the following table. Sales personnel receive a commission to encourage them to be more aggressive in their sales efforts. Currently, the Lubbock economy is really humming, and sales growth at Bubba's has been great. The business is very competitive, however, and Bubba, the owner, has relied on his knowledgeable and courteous staff to attract and retain customers who otherwise might go to other western wear stores. Because of the rapid growth in sales, Bubba is also finding the management of certain aspects of the business more difficult, such as restocking inventory and hiring and training new salespeople. $ 80.00 27.50 27.50 55.00 Sales price Per unit variable expenses Purchase cost Sales commissions Total per unit variable costs Total annual fixed expenses Advertising Rent Salaries Total fixed expenses $257,500 228,000 360, 500 $846,000 Required: 1. Calculate the annual breakeven point, both in terms of units and in terms of sales dollars. 2. If Bubba's sells 35,000 hats, what is its before-tax income or loss? Support your answer by preparing a contribution income statement 3. If Bubba's sells 48,000 hats, what is its margin of safety (MOS) and MOS ratio? 4. Bubba is considering the elimination of sales commissions completely and increasing salaries by $309,000 annually. What would be the new breakeven point in units? What would be the before-tax income or loss if 35,000 hats are sold with the new salary plan?

Answer questions 1 to 4 for Bubba's Western Wear.

Answer 1

1. Annual break-even point in units = Fixed Costs/(Sales price per unit-Variable cost per unit) = $846,000 / ($80 - $55) = 33,840 hats Annual break-even point in Sales Dollars = Sales price per unit x Break-even point in units = 33,840 units x $80 = $2,707,200 2. Contribution income statement Particulars Amount Sales (35,000 hats x $80) $2,800,000 Variable expenses (35,000 hats x $55) $1,925,000 Contribution margin $875,000 Fixed expenses $846,000 Net Income before tax $29,000 3. Margin of Safety = Actual Sales - Break-even Point = 48,000 hats - 33,840 hats = 14,160 hats MOS ratio = [(Actual Sales - Break-even Point) / Actual Sales] x 100 = [(48,000 hats - 33,840 hats) / 48,000 hats] x 100 = 29.5%

4. New break-even point in units = Fixed Costs/(Sales price per unit - Variable cost per unit) = $1,155,000 / ($80 - $27.50) = 22,000 hats According to new plan income statement Particulars Amount Sales (35,000 hats x $80) $2,800,000 Variable expenses (35,000 hats x $27.50) $962,500 Contribution margin $1,837,500 Fixed expenses $1,155,000 Net Income before tax $682,500
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