Question

Use the following data to construct an income statement for Cheryl’s posters:

Sales price                              $20 per unit

Variable Cost                          $10 per unit

Fixed costs                             $5,000

Sales in Units                          1,000

Required:  

1. Calculate the Earnings before Interest and Taxes (EBIT) for Cheryl’s Posters using the data provided above.

2. Prepare two pro forma income statements assuming:

a 50% increase in sales  (1,500)

a 50% decrease in sales  (500)

3. What is the impact on earnings before interest and taxes (EBIT) of the 50% increase/decrease in sales?

4. Explain using the concept of leverage.

Answer 1

Income statement for existing situation

Sales Unit	1000
Sales Value	$20,000.00
Less: Variable operating cost	$10,000.00
Contribution	$10,000.00
Less: Fixed operating Cost	$5,000
EBIT	$5,000.00

Income statement when 50% increase in sales i.e. 1500

Sales Unit	1500.00
Sales Value	$30,000.00
Less: Variable operating cost	$15,000.00
Contribution	$15,000.00
Less: Fixed operating Cost	$5,000
EBIT	$10,000.00

Income statement when 50% Decrease in sales i.e. 500

Sales Unit	500
Sales Value	$10,000.00
Less: Variable operating cost	$5,000.00
Contribution	$5,000.00
Less: Fixed operating Cost	$5,000
EBIT	$0.00

The earning is increasing or decreasing on increase or decrease of sales unit earning is double when it's sales unit increase by 50% or 1500 unit and other hand earning goes down to zero when it's sales unit decrease by 50% or 500 unit.

I hope this clear your doubt.

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