Question

Problem 3.55 Culver, Inc. manufactures souvenirs and sells the products to souvenir shops across Canada. Lisa McKay is the new owner, and is concerned about the low margins. She would like to find a way to improve the company's profitability. The accountant provides her the following financial information: sales are $246,000, of which 50% is cost of goods sold. Cost of goods sold consists of direct materials (20%), direct labour (30%), and fixed manufacturing overhead (50%). Operating expenses consist of variable expenses (40%) and fixed expenses (60%). Culver pays a 40% tax rate and the net income is $15,720. To reduce the company's operating risks, McKay would like to review the company's operations from another perspective. She would like to know how much the company needs to generate in order to break-even. Based on the current cost structure, how sensitive is the profit to a sale volume increase of 5%. Prepare an income statement in the gross margin format. Culver, Inc. Gross Margin Income Statement LINK TO TEXT LINK TO TEXT LINK TO TEXT LINK TO TEXT

Answer 1

Solution:

Income statement in gross margin format:

Culver, Inc. Gross Margin Income Statement Sales revenue 246,000 Cost of goods sold Direct materials 24,600 Direct labour 36,900 Fixed manufacturing OH 61,500 Total cost of goods sold 123,000 Gross Margin 123,000 Operating expenses: Variable expense 38,720 Fixed expense 58,080 Total operating expense 96,800 Net Income before tax 26,200 Income tax expense 10,480 Net Income 15,720 %24 %24

Income statement in contribution margin format:

Culver, Inc. Contribution Margin Income Statement Sales revenue Variable expense: 246,000 Direct materials 24,600 Direct labour 36,900 Variable exp. Total variable expenses Contribution Margin 38,720 100,220 145,780 Fixed expense: Fixed manufacturing OH 61,500 Fixed operating exp. Total fixed expense 58,080 119,580 Net Income before tax 26,200 Income tax expense 10,480 Net Income 15,720 %24

Sales Break-even = Fixed costs / contribution margin ratio

= $119,580 / (145,780/246,000)

= $119,580 / 0.5926 = $201,788 (rounded off)

Margin of safety = Sales - Sales break even = $246,000 - 201,788 = $44,212

Degree of operating leverage = Contribution margin / (Cont. margin - fixed cost)

= $145,780 / ($145,780 - 119,580)

= 5.56