Question

Island Novelties, Inc., of Palau makes two products—Hawaiian Fantasy and Tahitian Joy. Each product’s selling price, variable expense per unit, and annual sales volume are as follows:

	Hawaiian Fantasy			Tahitian Joy
Selling price per unit	$	20		$	125
Variable expense per unit	$	13		$	50
Number of units sold annually		15,000			5,100

Fixed expenses total $325,000 per year.

Required:

1. Assuming the sales mix given above, do the following:

a. Prepare a contribution format income statement showing both dollar and percent columns for each product and for the company as a whole.

b. Compute the company's break-even point in dollar sales. Also, compute its margin of safety in dollars and its margin of safety percentage.

2. The company has developed a new product called Samoan Delight that sells for $45 each and that has variable expenses of $27 per unit. If the company can sell 12,500 units of Samoan Delight without incurring any additional fixed expenses:

a. Prepare a revised contribution format income statement that includes Samoan Delight. Assume that sales of the other two products does not change.

b. Compute the company’s revised break-even point in dollar sales. Also, compute its revised margin of safety in dollars and margin of safety percentage.

Answer 1

1-a.
Island Novelties, Inc.
Contribution Income Statement
	Hawaiian Fantasy		Tahitian Joy		Total
	Amount	%	Amount	%	Amount	%
Sales	300000	100%	637500	100%	937500	100%
Variable expenses	195000	65%	255000	40%	450000	48%
Contribution margin	105000	35%	382500	60%	487500	52%
Fixed expenses					325000
Net operating income					162500

1-b.
Break-even point in dollars = Fixed expenses / Contribution margin ratio of company = 325000 / 52%	625000
Margin of safety in dollars = Sales - Break even point in dollars = 937500 - 625000	312500
Margin of safety percentage = Margin of safety in dollars / Sales = 312500 / 937500	33.3%

2-a.
Island Novelties, Inc.
Contribution Income Statement
	Hawaiian Fantasy		Tahitian Joy		Samoan Delight		Total
	Amount	%	Amount	%	Amount	%	Amount	%
Sales	300000	100.0%	637500	100.0%	562500	100.0%	1500000	100.0%
Variable expenses	195000	65.0%	255000	40.0%	337500	60.0%	787500	52.5%
Contribution margin	105000	35.0%	382500	60.0%	225000	40.0%	712500	47.5%
Fixed expenses							325000
Net operating income							387500

2-b.
Break-even point in dollars = Fixed expenses / Contribution margin ratio of company = 325000 / 47.5%	684211
Margin of safety in dollars = Sales - Break even point in dollars = 1500000 - 684211	815789
Margin of safety percentage = Margin of safety in dollars / Sales = 815789 / 1500000	54.4%