Question

Erin Shelton, Inc., wants to earn a target profit of $860,000 this year. The company’s fixed costs are expected to be $1,120,000 and its variable costs are expected to be 60 percent of sales. Erin Shelton, Inc., earned $760,000 in profit last year.

Required:

1. Calculate break-even sales for Erin Shelton, Inc.

2. Prepare a contribution margin income statement on the basis break-even sales.

3. Calculate the required sales to meet the target profit of $860,000.

4. Prepare a contribution margin income statement based on sales required to earn a target profit of $860,000.

5. When the company earns $860,000 of net income, what is its margin of safety and margin of safety as a percentage of sales?

	Break-Even Sales

	Contribution Margin Income Statement Contribution Margin Profit

• Cost of Goods Sold
• Fixed Costs
• Gross Margin
• Interest Expense
• Net Income After Taxes
• Net Operating Income
• Sales
• Variable Costs

Calculate the required sales to meet the target profit of $860,000.

	Target Sales

• 	Contribution Margin Income Statement Contribution Margin Profit

• 
  Margin of Safety
• Margin of Safety as a Percentage of Sales %

Answer 1

Fixed cost of company = $ 1120000

variable cost = 60% of sales

PV Ratio = 1 - variable cost ratio

= 1-0.60

= 0.40 or 40%

1. Calculation of Break-even sales of Erin shelton, Inc

BEP = Total fixed cost/(selling price - variable cost)

= 1120000/(100%-60%)

= 1120000/40%

= $ 2800000

2. Preparation of contribution margin income statement on the break-even sales-

Erin Shelton Inc. Contribution margin income statement Particulars Amount $ Sales 2800000 less variable cost (60% of sales) (60%*2800000) 1680000 Contribution Margin 1120000 less Fixed cost 1120000 Net profit/EBIT 0

3. Calculation of the required sales to meet the target profit of $860000 -

Required sales = (Fixed cost + Target profit)/P/V ratio

= (1120000 + 860000)/40%

= 1980000/40%

= $ 4950000

4. Preparation of a contribution margin income statement based on sales required to earn a target profit of $860,000 -

Erin Shelton Inc. Contribution margin income statement Particulars Amount $ Sales 4950000 less variable cost (60% of sales) (60%*4950000) 2970000 Contribution Margin 1980000 less Fixed cost 1120000 Net profit/EBIT 860000

5. When the company earns $860,000 of net income, Computation of its margin of safety and margin of safety as a percentage of sales -

Margin of safety = sales at net income of 860000 - BEP Sales

= 4950000(as calculated in part 4) - 2800000 ( as calculated in part 1)

= $ 2150000

Margin of safety ratio = (Actual sales revenue at target proft of 860000 - BEP sales revenue)/ Actual sales revenue at target proft of 860000

= (4950000 - 2800000)/4950000

= 2150000/4950000

= 43.43%

Please check with your answer and let me know.