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Subject Topic: Contribution Margin/Margin of Safety Post ReplyPost New Topic
  
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rami837cpa
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Posted: 14 Nov 2010 at 14:42 | IP Logged Quote rami837cpa

I'm confused.  Can someone help me understand this?

65. CPA-03707 ARE Nov 95 #43 Page 42
Product Cott has sales of $200,000, a contribution margin of 20%, and a margin of safety of $80,000.
What is Cott's fixed cost?
a. $16,000
b. $24,000
c. $80,000
d. $96,000

CPA-03707 Explanation
Choice "b" is correct. Margin of safety equals actual (or budgeted) sales less breakeven sales. Since the
margin of safety is $80,000 and sales are $200,000, breakeven sales must be $120,000 ($200,000 −
$80,000).
Breakeven sales $120,000
Contribution margin rate 20%
Contribution margin $ 24,000
At breakeven, fixed cost equals contribution margin, or $24,000.

While I see how they got to the $24,000 per the calculation above, I cannot understand how margin of safety is $80,000 when the contribution margin is 20% of sales.  So at $200,000 sales the contribution margin is $40,000 (20% of sales). 

So how is the margin of safety $80,000 (Total sales (in dollars) − breakeven sales (in dollars) = margin of safety (in dollars)) when contribution margin is only $40,000?  Isn't breakeven sales total fixed cost + total variable cost, which would make it 24,000 + 120,000 = 144,000?  So margin of safety would be 200,000 - (24,000 + 120,000)= 56,000.

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OZZMAN
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Posted: 14 Nov 2010 at 22:23 | IP Logged Quote OZZMAN

rami:

I think the question is really presented backwards in order to "stump" us. You are really solving for fixed costs, which is what should have been given. 

I would approach it in this fashion:  Given you already arrived correctly at the fixed cost of $24,000 (which is the answer) and the B/E % is known to be 20%, the breakeven sales are $120,000 (also given).  So if the problem asked to solve for the margin of safety you would solve it as I indicated below. In the problem given you are basically solving the problem "backwards".  Instead of solving for margin of safety, you are solving for "fixed costs".

             $ 24,000 / .20 = $120,000

             $ 200,000 - $ 120,000 = $80,000

 

Hope this helps....

 

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orlando1145
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Posted: 15 Nov 2010 at 18:15 | IP Logged Quote orlando1145

Rami:

I believe your mistake is in the breakeven formula

BE= FIXED COST/COST MARGIN

24,000 / .20 = $120,000$120,000

The margin safety is given so:

Total Sales - Break Even = $80,000

$200,000 - $120,000 =80,000$80,000
given
$200,000 given

I hope it helps
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