Chapter 5, Problem 11F15

To determine

Margin of Safety: A margin of safety is the comfort zone between the budgeted sales and the break even sales where a company is safe from any losses.

The margin of safety in dollars and percentage

Answer to Problem 11F15

Solution:

1-a) The margin of safety in dollars is $ 5,000

1-b) The margin of safety in percentage is 25%

Explanation of Solution

A margin of safety is calculated by deducting the break-even sales in dollars from the budgeted sales in dollars of the company. The budgeted sale is an estimation of sales in dollars during a particular period which $20,000 as per exercise and the break-even sales in dollars is ascertained by dividing the fixed cost by contribution margin ratio $15,000. A contribution margin ratio is contribution margin expressed in percentage.

. Computation of Margin of Safety in dollars

  $\begin{array}{l}Marginofsafetyindollars=BudgetedSalesindollars–Break-EvenSalesindollars\hfill \\ =\$20,000 - \$15,000\hfill \\ =\$5,000\hfill \end{array}$

$$ $\begin{array}{l}ComputationofBreak-Evenpointindollarsales \\ Break-evenpointindollarsales=\frac{Fixedexpense}{Contributionmarginratio}\\ \begin{array}{l} =\frac{\$6,000}{0.4}\hfill \\ =\$15,000\hfill \end{array}\end{array}$

  $\begin{array}{l}*Contributionmarginratio=\frac{Contributionmargin}{Salesrevenue}\text{*}\text{100 }\hfill \\ =\frac{\$8,000}{\$20,000}*100\hfill \\ =40\%or0.4\hfill \\ \hfill \end{array}$

$$

Computation of Margin of Safety in percentage

  $\begin{array}{l}MarginofSafetyinpercentage=\frac{Marginofsafetyindollars}{Budgetedsalesindollars}*100\hfill \\ =\$5,000/\$20,000*100\hfill \\ =25\%\hfill \end{array}$

Given:

Sales (1,000 units )	$20,000
Variable expenses	$12,000
Contribution margin	$8,000
Fixed expenses	$6,000
Net operating income	$2,000

Conclusion

Hence it is concluded that the Oslo Company has Margin of Safety of $5,000 or 25% of sales revenue. It means that within the range of $5,000 the company is safe from incurring any loss from the sale of product. It provides the company a comfort of safety or time to take precautions to avoid any loss.