Names: Lucman, Achmadjan Subject & Block: BUSE-3 Block A

Balt, Princess Nadjah

Jack and Jill are the owners of the Midway Processing Company and the Greasy Manufacturing
Company, respectively. These companies manufacture and sell the same product, and
competition between the two owners has always been friendly. Cost and profit data have been
freely exchanged. Uniform selling prices have been set by market conditions.

Jack and Jill differ markedly in their management thinking. Operations at Midway are highly
mechanized, and the direct labor force is paid on a fixed-salary basis. Greasy uses manual hourly
paid labor for the most part and pays incentive bonuses. Midway’s salesmen are paid a fixed
salary, whereas Greasy’s salesmen are paid small salaries plus commissions. Mr. Jill takes pride
in his ability to adapt his costs to fluctuations in sales volume and has frequently chided Mr. Jack
on Midway’s “inflexible overhead.”

During 2002, both firms reported the same profit on sales of P100,000. However, when
comparing results at the end of 2003, Mr. Jill was startled by the following results:

Midway Greasy
2002 2003 2002 2003
Sales Revenue 100,000 120,000 100,000 150,000
Costs and Expenses 90,000 94,000 90,000 130,000
Net Income 10,000 26,000 10,000 20,000
Return on Sales 10% 21.67% 10% 13.50%

On the assumption that operating inefficiencies must have existed, Jill and his accountant made a
thorough investigation of costs but could not uncover any evidence of costs that were out of line.
At a loss to explain the lower increase in profits on a much higher increase in sales volume, they
have asked you to prepare an explanation.

You find that fixed costs and expenses recorded over the two-year period were as follows:

Midway – 70,000 each year

Greasy – 100,000 each year
Required:
• Redo the income statements emphasizing contribution margin.

Midway Processing Company

Income Statement
For the Year Ended December 31, 2002

Unit Price Percentage

Sales P 100,000 50 (100,000/2,000) 100%
Less: Variable Costs 20,000 10 (20,000/2,000) 20%
Contribution Margin 80,000 40 (80,000/2,000) 80%
Less: Fixed Costs 70,000
Net Income P 10,000

Assume: 2, 000 units produced and sold

Midway Processing Company

Income Statement
For the Year Ended December 31, 2003

Unit Price By Percentage

Sales P 120,000 50 (120,000/2,400) 100%
Less: Variable Costs 24,000 10 (24,000/2,400) 20%
Contribution Margin 96,000 40 (96,000/2,400) 80%
Less: Fixed Costs 70,000
Net Income P 26,000

Assume: 2,400 units produced and sold

A P20,000 increase in sales revenue results in a P16,000 increase in Contribution Margin.

*20,000 x .80 (CMR) = 16,000

Greasy Manufacturing Company

Income Statement
For the Year Ended December 31, 2002

Unit Price By Percentage

Sales P 100,000 50 (100,000/2,000) 100%
Less: Variable Costs 20,000 10 (20,000/2,000) 20%
Contribution Margin 80,000 40 (80,000/2,000) 80%
Less: Fixed Costs 100,000
Net Income (P 20,000)

Assume: 2,000 units produced and sold

 Greasy Manufacturing Company
Income Statement
For the Year Ended December 31, 2003

Unit Price By Percentage

Sales P 150,000 50 (150,000/3,000) 100%
Less: Variable Costs 30,000 10 (30,000/3,000) 20%
Contribution Margin 120,000 40 (120,000/3,000) 80%
Less: Fixed Costs 100,000
Net Income P 20,000

Assume: 3,000 units produced and sold

A P50,000 increase in sales revenue results in a P40,000 increase in Contribution Margin.

*50,000 x .80 (CMR) = 40,000

• Calculate breakeven point for each company.

Midway Processing Company

Break Even Point (in units) = Fixed Costs

Contribution Margin per unit
= 70,000
40
= 1,750 units

Break Even Point (in peso) = Fixed Costs

Contribution Margin Ratio
= 70,000
.80
= P 87,500

At 1,750 units sold or P87,500 sales revenue, the point needed to cover total costs, the Midway
Processing Company would be able to have a break even where there is no profit or no loss. Or
the sales revenue is just equal to total costs.

Greasy Manufacturing Company

Break Even Point (in units) = Fixed Costs

Contribution Margin per unit
= 100,000
40
= 2,500 units
Break Even Point (in peso) = Fixed Costs
Contribution Margin Ratio
= 100,000
.80
= P 125,000

At 2,500 units sold or P125,000 sales revenue, the point needed to cover total costs, the Greasy
Manufacturing Company would be able to have a break even where there is no profit or no loss.
Or the sales revenue is just equal to total costs.

• Calculate the volume of sales that Greasy would have to have had in 2003 to achieve
the profit of P26,000 realized by Midway in 2003.

Target Sales (in peso) = Fixed Costs + Desired Income

Contribution Margin Ratio
= 100,000+26,000
.80
= P 157,500

Target Sales (in units) = Fixed Costs + Desired Income

Contribution Margin per unit
= 100,000+26,000
40
= P 3,150

Using the expected sales price and target sales volumes, we can estimate the revenue levels need
to achieve. Selling 3,150 units or P157,500 sales revenue will result in an Operating Income of
P26,000. To prove, let us compute for the Net Income at 3,150 units.

Greasy Manufacturing Company

Income Statement
For the Year Ended December 31, 2003

Unit Price By Percentage

Sales P 157,500 50 (157,500/3,150) 100%
Less: Variable Costs 31,500 10 (31,500/3,150) 20%
Contribution Margin 126,000 40 (126,000/3,150) 80%
Less: Fixed Costs 100,000
Net Income P 26,000
 • If Greasy reached the target profit of P26,000, compute for the margin of safety in
units.

Margin of Safety (in peso) = Actual Sales – Break Even Point (in peso)
= P157,500 – P125,000
= P 32,500

Margin of Safety (in units) = Actual Sales – Break Even Point (in unit)
= 3,150 – 2,500
= 650

It is a safety cushion that protects a business against a loss, a higher MOS reduces the risk of
business losses. Thus, P32,500 is an important figure for any business because it tells the
management how much reduction in revenue will result to break even.

• Calculate the volume of sales that Midway would have to have had in 2003 to achieve a
target profit of above P50,000.

Target Sales (in peso) = Fixed Costs + Desired Income

Contribution Margin Ratio
= 70,000+50,040
.80
= P 150,050

Target Sales (in units) = Fixed Costs + Desired Income

Contribution Margin per unit
= 70,000+50,040
40
= P 3,001

Using the expected sales price and target sales volumes, we can estimate the revenue levels need
to achieve. Selling 3,001 units or P150,050 sales revenue will result in an Operating Income of
P50,040. To prove, let us compute for the Net Income at 3,001 units.

Midway Processing Company

Income Statement
For the Year Ended December 31, 2003

Unit Price By Percentage

Sales P 150,050 50 (150,050/3,001) 100%
Less: Variable Costs 30,010 10 (30,010/3,001) 20%
Contribution Margin 120,040 40 (120,040/3,001) 80%
Less: Fixed Costs 70,000
Net Income P 50,040
 • If Midway reach the target profit of above P50,000, compute for the margin of safety.

Margin of Safety (in peso) = Actual Sales – Break Even Point (in peso)
= P150,050 – P87,500
= P 62,550

Margin of Safety (in units) = Actual Sales – Break Even Point (in unit)
= 3,001 – 1,750
= 1,251

It is a safety cushion that protects a business against a loss, a higher MOS reduces the risk of
business losses. Thus, P62,550 is an important figure for any business because it tells the
management how much reduction in revenue will result to break even.