a. Assuming that Solution to Review Problem 1. changes are made as described above, prepare a Because the fixed expenses are not expected to change, net operating income will increase by the projected entire $100,000 increase in contribution margin computed above. contribution Equation method: format income Formula method: statement for next year. Show data on a total, per unit, and percentage basis. b. Compute the company's new If sales increase by 8%, then 21,600 units (20,000 × 1.08 = 21,600) will be sold next year. The new point contribution format income statement would be as follows: in both units and dollars of Thus, the $84,000 expected net operating income for next year represents a 40% increase over the sales. Use $60,000 net operating income earned during the current year: the formula method. Note from the income statement that the increase in sales from 20,000 to 21,600 units has c. Would you increased both total sales and total variable expenses. recommend that the A 20% increase in sales would result in 24,000 units being sold next year: 20,000 units × 1.20 = changes be 24,000 units. made? Note that the change in per unit variable expenses results in a change in both the per unit contribution margin and the CM ratio. Yes, on these data the changes should be made. The changes increase the company's net operating income from the present $60,000 to $78,000 per year. Although the changes also result in a higher break-even point (17,500 units as compared to the present 16,000 units), the company's margin of safety actually becomes greater than before: Margin of safety in dollars = Total sales Break–even sales – = $ 1,440,000 $ 1,050,000 = $ 390,000 – As shown in (5) on the prior page, the company's present margin of safety is only $240,000. Thus, several benefits will result from the proposed changes. THE FOUNDATIONAL 15 Oslo Company prepared the following contribution format income statement based on a sales volume of 1,000 units (the relevant range of production is 500 units to 1,500 units):
a. Assuming that changes are made as described above, prepare a projected contribution format income statement for next year. Show data on a total, per unit, and percentage basis. b. Compute the company's new point in both units and dollars of sales. Use the formula method. c. Would you recommend that the changes be made? Solution to Review Problem 1. Because the fixed expenses are not expected to change, net operating income will increase by the entire $100,000 increase in contribution margin computed above. Equation method: Formula method: If sales increase by 8%, then 21,600 units (20,000 × 1.08 = 21,600) will be sold next year. The new contribution format income statement would be as follows: Thus, the $84,000 expected net operating income for next year represents a 40% increase over the $60,000 net operating income earned during the current year: Note from the income statement that the increase in sales from 20,000 to 21,600 units has increased both total sales and total variable expenses. A 20% increase in sales would result in 24,000 units being sold next year: 20,000 units × 1.20 = 24,000 units. Note that the change in per unit variable expenses results in a change in both the per unit contribution margin and the CM ratio. Yes, on these data the changes should be made. The changes increase the company's net operating income from the present $60,000 to $78,000 per year. Although the changes also result in a higher break-even point (17,500 units as compared to the present 16,000 units), the company's margin of safety actually becomes greater than before: Margin of safety in dollars = Total sales – Break–even sales = $ 1,440,000 – $ 1,050,000 = $ 390,000 As shown in (5) on the prior page, the company's present margin of safety is only $240,000. Thus, several benefits will result from the proposed changes. THE FOUNDATIONAL 15 Oslo Company prepared the following contribution format income statement based on a sales volume of 1,000 units (the relevant range of production is 500 units to 1,500 units):
chap05-Rev.-F15-Ex.docx