Answer:
1. Break-even sales = $2,200,000
2. Net Income = $0
3. Sales = $3,800,000
4. See explanation section
5. Margin of safety = $1,600,000
Margin of safety (%) = 42.11%
Explanation:
Requirement 1.
We know,
Break-even sales = Fixed expense ÷ Contribution Margin Ratio
Given,
Expected Fixed expense = $1,320,000
Contribution Margin Ratio = Contribution Margin ÷ Sales Revenue
As we do not have contribution margin and Sales Revenue, we have to use variable costs that is expected to be 40% of sales. Therefore,
Contribution Margin Ratio = Sales (%) - variable costs (%) = 100% - 40% = 60%
Therefore, Break-even sales = $1,320,000 ÷ 60%
Break-even sales = $1,320,000 ÷ 60%
Therefore, Break-even sales = $2,200,000
Requirement 2.
Erin Shelton, Inc.
Contribution Margin Income Statement format
For the year ended, December 31, Current year
Sales Revenue $2,200,000 (<em>Requirement 1</em>)
<u>Less: Variable expense (40% of sales) 880,000</u>
Contribution Margin $1,320,000
<u>Less: Fixed Expense 1,320,000</u>
Net operating Income 0
In break-even sales, total fixed expense = total contribution margin, therefore, no income or loss.
Requirement 3.
We know,
This year, To attain profit, sales = (Fixed expense + Target Profit) ÷ Contribution Margin Ratio
Given,
Expected Fixed expense = $1,320,000
Target Profit = $960,000
Contribution Margin Ratio = Contribution Margin ÷ Sales Revenue
As we do not have contribution margin and Sales Revenue, we have to use variable costs that is expected to be 40% of sales. Therefore,
Contribution Margin Ratio = Sales (%) - variable costs (%) = 100% - 40% = 60%
Therefore, To attain profit, sales = ($1,320,000 + $960,000) ÷ 60%
To attain profit, sales = $2,280,000 ÷ 60%
Therefore, To attain profit, sales = $3,800,000
Requirement 4.
Using To attain profit, sales = $3,800,000 (From Requirement 3) to find the net operating income
Erin Shelton, Inc.
Contribution Margin Income Statement format
For the year ended, December 31, Current year
Sales Revenue $3,800,000 (<em>Requirement 3</em>)
<u>Less: Variable expense (40% of sales) 1520,000</u>
Contribution Margin $2,280,000
<u>Less: Fixed Expense 1,320,000</u>
Net operating Income $960,000
Requirement 5.
We know,
Margin of safety = (Current sales - Break-even sales)
<em>From Requirement 1, we get, Break-even sales = $2,200,000</em>
<em>From Requirement 3, we get, Current sales = $3,800,000</em>
Margin of safety = $3,800,000 - $2,200,000
Therefore, Margin of safety = $1,600,000
Margin of safety as percentage = [(Current sales - Break-even sales) ÷ Current sales] × 100
Margin of safety = ($1,600,000 ÷ $3,800,000) × 100
or, Margin of safety = 0.42105 × 100
Margin of safety = 42.11%
