Question

APPLY THE CONCEPTS: Target income (number of units sold)

Suppose a business has pricing and cost information as follows::

Price and Cost Information	Amount
Selling Price per Unit	$10.00
Variable Cost per Unit	$5.00
Total Fixed Cost	$100

For the upcoming period, the company wishes to generate operating income of $400. Given the cost and pricing structure for the company’s product, how many units must the company sell to attain its target income?

Remember that the basic equation for calculating operating income is as follows:

Operating Income

=

(Unit Price x Units Sold)

-

(Variable Cost per Unit x Units Sold)

-

Fixed Cost

Step 1: Replace the operating income in the equation with your company’s target income, and insert your cost and pricing information into the equation, as well:

$

=

($ x Units Sold)

-

($ x Units Sold)

-

$

Step 2: Rearrange the equation to isolate units to one side of the equation:

Number of Units to Earn Target Income =	Fixed Cost + Target Income
	Unit selling price - Variable Cost per Unit

Number of Units to Earn Target Income =	$ + 400
	$ - $

Number of Units to Earn Target Income =  units

Step 3: Create a contribution margin income statement to check your previous work. Enter all amounts as positive numbers.

Sales		$
Total variable expense
	Total contribution margin	$
Total fixed expense
	Operating income	$

Feedback

Carry each value shown into each equation and compute the result.

APPLY THE CONCEPTS: Target income (sales revenue)

Another useful method for figuring out the type of performance your company will need to reach a target income is by using sales revenue. Rather than using the number of units, this method uses total sales revenue. In companies for which the total set of goods produced and sold is more varied, this would be the preferred method, as opposed to a business in which only one product is sold. Assume a company has pricing and cost information as follows:

Price and Cost Information	Amount
Selling Price per Unit	$20
Variable Cost per Unit	$10
Total Fixed Cost	$12,000

For the upcoming period, the company wishes to generate operating income of $75,000. Given the cost and pricing structure for the company’s product, how much sales revenue must it generate to attain its target income?

Step 1: Calculate the contribution margin ratio:

The contribution margin ratio is the contribution margin in proportion to the selling price on a per-unit basis.

Contribution Margin Ratio =	(Selling Price – Variable Cost)
	Selling Price

Note: The contribution margin ratio is calculated to one decimal place.)

Contribution Margin Ratio =	($ – $10)	=
	$

Step 2: Calculate the sales revenue required to attain the target income:

Sales Dollars =	(Target Income + Fixed Cost)
	Contribution Margin Ratio

Sales Dollars =	( $ + $12,000)	=	$

Step 3: Create a contribution margin income statement, to check your previous work. Enter all amounts as positive numbers.

Sales		$
Total variable expense
	Total contribution margin
Total fixed expense
	Operating income

Feedback

Carry each value shown into each equation and compute the result.

To complete the income statement, carry down your calculated target sales dollars and use the contribution margin ratio to calculate total contribution margin. The total variable expense will be the difference between these two values.

APPLY THE CONCEPTS: Margin of Safety
Margin of safety can allow you to see how much padding there is for your company between profit and loss. If this number is great, it may indicate that your company is performing very well. If this number is small, it may be worth looking into possible remediation. Consider the following pricing and cost information:

Price and Cost Information	Amount
Selling Price per Unit	$500
Variable Cost per Unit	$350
Total Fixed Cost	$50,000

For the upcoming period, the company projects that it will sell 5,000 units. Considering that the company has a unit break-even point of 333.33 units, what is the margin of safety in terms of both units and sales revenue? Round your answers to two decimal places, if necessary.

Margin of Safety in Units =  -  =

Margin of Safety in Sales Revenue = $ - $ = $

Answer 1

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