Research and Application 6-34, page 278
1. From looking at the income statement presented on page 50, is prepared using an absorption format. Then on page 33 it is prepared using a contribution format. The annual report says that the contribution format income statement shown on page 33 is used for internal reporting purposes; but, Benetton has chosen to include it in the annual report anyway. The contribution format income statement treats all cost of sales as variable costs. The selling, general and administrative expenses shown on the absorption income statement have been broken down into variable and fixed components in the contribution format income statement.
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387 | 0.374 |
|Breakeven in euros |€1,126 |€1,239 |
The break-even point in 2004 is lower than in 2003 because Benetton’s fixed costs in 2004 are lower than in 2003 and its contribution margin ratio in 2004 is higher than in 2003.
4. The target profit calculation is as follows:
| |2004 |
|Total fixed costs + target profit |€736 |
|Contribution margin ratio | 0.387 |
|Sales needed to achieve target profit |€1,900 |
5. The margin of safety calculations are as follows:
| |2004 |2003 |
|Actual sales |€1,686 |€1,859 |
|Breakeven sales |1,126 |1,239 |
|Margin of safety |€560 |€620 |
The margin of safety has declined because the drop in sales from 2003 to 2004 (€173) exceeds the decrease in breakeven sales from 2003 to 2004 (€113).
6. The degree of operating leverage is calculated as follows:
| |2004 |
|Contribution margin |€653 |
|Income from operations | €217 |
|Degree of operating leverage (rounded) |3 |
A 6% increase in sales would result in income from operations of:
| |2004 |
|Revised sales (€1,686 ×1.06) |€1,787 |
|Contribution margin ratio |0.387 |
|Contribution margin |692 |
|Fixed general and administrative expenses | 436 |
|Income from operations |€256 |
The degree of operating leverage can be used to determine that a 6% increase in sales translates into an 18% increase in income from operations (6% × 3 = 18%). Rather than preparing a revised contribution format income statement to ascertain the new income from operations, the computation could be performed as follows: