Question

The following costs result from the production and sale of 12,000 CD sets manufactured by Gilmore Company for the year ended December 31, 2017. The CD sets sell for \(18 each. The company has a 25% income tax rate.

Variable manufacturing costs
Plastic for CD Sets	\)1,500
Wages of assembly workers	30,000
Labelling	3,000
Variable selling cost
Sales commission	6,000
Fixed manufacturing cost
Rent on factory	6,750
Factory cleaning services	4,520
Factory machine depreciation	20,000
Fixed selling and administrative cost
Lease of office equipment	1,050
System staff salaries	15,000
Administrative management salaries	120,000

Required

1. Prepare a contribution margin income statement for the company.

2. Compute its contribution margin per unit and its contribution margin ratio.

Analysis Component

3. Interpret the contribution margin and contribution margin ratio from part 2.

Short answer

1. The business entity is generating a net income of$6,135.
2. Contribution margin per unit:$14.625, contribution margin ratio: 0.8125.
3. $14.625 per unit is available from the sale of each unit to cover the fixed cost.

Step-by-step solution

Definition of Pre-Tax Income

Before making the tax adjustments, a business entity's net income generated from its operations is known as pre-tax income. The tax expenses are calculated over this income only.

Contribution margin income statement

Particular	Amount $	Amount $
Sales 12,000 CD sets @ $18 each		$216,000
Less: Variable cost
Plastic for CD Sets	$1,500
Wages of assembly workers	30,000
Labelling	3,000
Sales commission	6,000	(40,500)
Contribution margin		175,500
Less: Fixed cost
Rent on factory	6,750
Factory cleaning services	4,520
Factory machine depreciation	20,000
Lease of office equipment	1,050
System staff salaries	15,000
Administrative management salaries	120,000	(167,320)
Pre-tax income		8,180
Less: Income tax		(2,045)
Net income		$6,135

Contribution margin per unit and ratio

Particular	Amount $
Sales price	$18
Less: Variable cost per unit $\left(\frac{\$40,500}{12,000}\right)$	(3.375)
Contribution margin per unit	$14.625

$\begin{array}{rcl}\mathrm{Contribution}\mathrm{margin}\mathrm{ratio}& =& \frac{\mathrm{Contribution}\mathrm{margin}}{\mathrm{Sales}}\\ & =& \frac{\$175,500}{\$216,000}\\ & =& 0.8125\end{array}$

Interpretation of contribution margin per unit and ratio

The contribution margin per unit reflects that the sale of each unit generates $14.625 to cover the fixed cost of the business entity.

The contribution margin ratio reflects that 81.25% of total sales is available to cover the company’s fixed costs.