Question

Hudson Co. reports the contribution margin income statement for 2017.

HUDSON CO.
Contribution Margin Income Statement
For Year Ended December 31, 2017
Sales (10,700 units at $300 each)	$	3,210,000
Variable costs (10,700 units at $240 each)		2,568,000
Contribution margin	$	642,000
Fixed costs		504,000
Pretax income	$	138,000

Exercise 21-17 Target income and margin of safety (in dollars) LO C2

1. Assume Hudson Co. has a target pretax income of $161,000 for 2018. What amount of sales (in dollars) is needed to produce this target income?
2. If Hudson achieves its target pretax income for 2018, what is its margin of safety (in percent)? (Round your answer to 1 decimal place.)

Answer 1

Ans. 1	First of all, we need to calculate the contribution margin ratio.
	Contribution margin ratio =   Contribution margin / Sales * 100
	$642,000 / $3,210,000 * 100
	20%
	Dollar sales for target profit   =   (Fixed expense + Target profit) / Contribution margin ratio
	($504,000 + $161,000) / 20%
	$665,000 / 20%
	$3,325,000
Ans. 2	Margin of safety in dollars is the difference between actual sales and break even sales in dollars.
	We have actual sales and break even sales in dollars can be calculated by the following way:
	Break even point in dollar sales =   Fixed cost / Contribution margin ratio
	$504,000 / 20%
	$2,520,000
	Margin of safety in percentage = (Actual sales - Break even sales) / Actual sales * 100
	($3,210,000 - $2,520,000) / $3,210,000 * 100
	$690,000 / $3,210,000 * 100
	21.5%