Question

Frieden Company's contribution format income statement for last month is shown below: Sales (36,000 units) Variable expenses $1,440,000 1,080,000 Contribution margin Fixed expenses 360,000 288,000 Operating income $ 72,000 Competition is intense, and Frieden Company's profits vary considerably from one year to the next. Management is exploring opportunities to increase profitability. Required: 1. Frieden's management is considering a major upgrade to the manufacturing equipment, which would result in fixed expenses increasing by $360,000 per month. However, variable expenses would decrease by $10 per unit. Selling price would not change Prepare two contribution format income statements, one showing current operations and one showing how operations would appear if the upgrade is completed. Show an Amount column, a Per Unit column, and a Percentage column on each statement.

Answer 1

FRIEDEN COMPANY Contribution Margin Income Statement Present Proposed Amount Per Unit % Amount Per Unit % Sales $ 14,40,000 $ 40 100% $ 14,40,000 $ 40 Variable Expenses $ 10,80,000 $ 30 75% $ 7,20,000 $ 20 Contribution Margin $ 3,60,000 $ 10 | 25% $ 7,20,000 $ 20 | Fixed Expenses $ 2,88,000 $ 6,48,000 Net Operating Income $ 72,000 $ 72,000 100% 50% 50%

Degree of operating leverage = Contribution Net Operating Income a. Present Degree of operating leverage = $ $ 3,60,000 72,000 5 Degree of operating leverage = b. Proposed | Degree of operating leverage = $ 72,000 10 3 Degree of operating leverage = Break even point in dollars = Total Fixed Costs Contribution Margin Ratio

5 Break even point in dollars = Total Fixed Costs Contribution Margin Ratio 5 3 a. Present Break even point in dollars = $ 2,88,000 25% 11,52,000 Break even point in dollars = $ 2 b. Proposed Break even point in dollars = $ 6,48,000 50% 12,96,000 Break even point in dollars = $

28 Margin of Safety in dollars = Actual Sales - Break Even Sales 30 a. Present 31 Margin of Safety in dollars = 32 Margin of Safety in dollars = $14,40,000 - $1,152,000 $ 2,88,000 34 b. Proposed 35 Margin of Safety in dollars = 36 Margin of Safety in dollars = $1,440,000 - $1,296,000 $ 1,44,000

B Margin of Safety in Percentage = Margin of Safety *100 Current Sales m. 1 a. Present 2 Margin of Safety in Percentage = $ $ 3 2,88,000 *100 14,40,000 20% 4 Margin of Safety in Percentage = 5 b. Proposed 7 Margin of Safety in Percentage = $_ $ 1,44,000 *100 14,40,000 10% Margin of Safety in Percentage =

3-a Units Sales 36,000 units per month Frieden management will be indifferent between doing the major upgrade. 3-b No Frieden should not proceed with the major upgrade 3-c In this case, the indifference point it the same as the current level of sales at which point the upgrade will not have an impact on operating income. So Friedens should not proceed to upgrade 4-a Operating Income $ 17,000 Increase (36,000 * 15%) * $10-$37,000) 4-b Yes