Question 1: Contribution Margin vs. Gross Margin
FongFone Ltd. manufactures cell phones, which are priced at $250. Mr. Fong, the president of
FongFone, has come to you for help in terms of the company’s cost structure. You are troubled
because the data produced by the accounting system of Fong...
FongFone Ltd. manufactures cell phones, which are priced at $250. Mr. Fong, the president of
FongFone, has come to you for help in terms of the company’s cost structure. You are troubled
because the data produced by the accounting system of FongFone do not distinguish between
variable and fixed costs.
After some analysis, you have identified various cost behaviour patterns. You have determined
that the margin of safety is $75,000 and sales in break-even units are 2,700; your analysis was
made easier by the fact that it is FongFone’s policy not to carry any inventories. Instead, the
company finishes pending orders sometime in December and gives employees vacations that end
in early January of the following year.
You have also collected the following information for the 2017 fiscal year:
2017
Direct labour $ 170,000
Direct material 210,000
Variable manufacturing overhead 80,000
Gross margin % 22.50%
Contribution margin % 30.00%
Income Tax Rate 25.00%
REQUIRED:
A. Calculate the following costs for 2017:
1. Sales in dollars
2. Variable Selling and Administrative Expenses
3. Fixed Manufacturing Overhead
4. Fixed Selling and Administrative Expenses
5. Earnings (Income) Before Taxes
B. Determine the sales volume in dollars and in units that FongFone must achieve to earn a
$36,000 income after taxes. Calculate the degree of operating leverage. If sales increase by
8%, what is the impact on the operating income?
, Solutions:
A
1. Sales in dollar
Sales – SalesBE = MOS Sales – 2,700 x $250 = $75,000
Sales = $750,000
2. Variable Selling and Administrative Expenses
Total VC = 70% of Sales = 70% x $750,000 = $525,000
Total VC = DL + DM + VMOH + VS&A
$525,000 = $170,000 + $210,000 + $80,000 + VS&A
VS&A = $65,000
3. Fixed Manufacturing Overhead
Cost of Goods Sold = DL + DM + VMOH +FMOH = 77.5% of Sales
77.5% x $750,000 = $170,000 + $210,000 + $80,000 + FMOH
FMOH = $121,250
4. Fixed Selling and Administrative Expenses
FC = FMOH + FS&A
SalesBE = FC ÷ CM%
$675,000 = FC ÷ 30%
FC = $202,500
$202,500 = $121,250 + FS&A
FS&A = $81,250
5. Earnings (Income) Before Taxes
S – VC – FC = EBT
$750,000 – $525,000 – $202,500 = $22,500
B
1. Sales volume in dollars and in units to earn a $36,000 income after taxes.
SalesTI = {FC + [EAT ÷ (1-Tx)]} ÷ CM%
EBT = EAT ÷ (1-Tx) = $36,000 ÷ 0.75 = $48,000
FC + EBT = $202,500 + $48,000 = $250,500
SalesTI = $250,500 ÷ 30% = $835,000
$835,000 ÷$250 = 3,340
2. Calculate the degree of operating leverage. If sales increase by 8%, what is the impact on
the operating income?
CM ÷ EBT = $250,500 ÷ $48,000 = 5.219
8% x 5.219 = 41.75%
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