Question

Johnson Company has collected the following information after its first year of sales. Sales were $1,700,000 on 85,000 units; selling expenses $250,000 (40% variable and 60% fixed); direct materials $720,800; direct labor $250,000; administrative expenses $270,000 (20% variable and 80% fixed); and manufacturing overhead $336,000 (70% variable and 30% fixed). Top management has asked you to do a CVP analysis so that it can make plans for the coming year. It has projected that unit sales will increase by 10% next year.

Compute (1) the contribution margin for the current year and the projected year, and (2) the fixed costs for the current year. (Assume that fixed costs will remain the same in the projected year).

(1) Contribution margin for current year $______________

Contribution margin for projected year $_______________

(2) Fixed costs for current year $___________________

Compute the break-even point in units and sales dollars for the first year.

Break-even point ____________ units

Break-even point $_______________

The company has a target net income of $180,000. What is the required sales in dollars for the company to meet its target?

Sales dollars required for target net income $____________________

If the company meets its target net income number, by what percentage could its sales fall before it is operating at a loss? That is, what is its margin of safety ratio?

Margin of safety ratio_________%

The company is considering a purchase of equipment that would reduce its direct labor costs by $100,000 and would change its manufacturing overhead costs by 30% variable and 70% fixed (assume total manufacturing overhead cost is $336,000 as above). It is also considering switching to a pure commission basis for its sales staff. This would change selling expenses to 90% variable and 10% fixed (assume total selling expense is $250,000 as above). Compute (1) the contribution margin and (2) the contribution margin ratio, and recompute (3) the break-even point in sales dollars.

1. Contribution margin $_______________

2. Contribution margin ratio_____________________

3. Break-even point $_____________________

Answer 1

Solution:

Requirement: 1 & 2 :

Contribution margin statement Current Yr. Projected Yr. $1,700,000 1,870,000 Sales Revenue Variable costs: Sellling exp 110,000 100,000 Direct material 720,800 792,880 Direct labor 250,000 275,000 Administrative exp 54,000 59,400 Manf. OH 235,200 258,720 Total variable costs Contribution margin (1,360,000) (1,496,000) 340,000 $ 374,000 Fixed cost current yr. Sellling exp Administrative exp 150,000 216,000 Manf. OH 100,800 $466,800 Fixed costs for the current year

3. Break even point in units = Fixed costs / Contribution margin per unit

= $466,800 / ($340,000/85,000)

= 116,700 units

Break even point in sales dollars = Fixed costs / Contribution margin ratio

= 466,800 / ($340,000 / 1,700,000)

= $466,800 / 0.20

= $2,334,000

4. Required Sales in dollars for target net income = (Fixed cost + Target NI) / Contribution margin ratio

= ($466,800 + 180,000) / 0.20

= $3,234,000

5. Margin of safety ratio = (Sales - BEP sales) / Sales

   = ($3,234,000 - 2,334,000 ) / $3,234,000

= 27.83% (rounded off to 2 decimal places)

or 28% if rounded off to 0 decimal place