The following costs result from the production and sale of 1,000 drum sets manufactured by Tight Drums Company for the year ended December 31, 2015. The drum sets sell for $500 each. The company has a 25% income tax rate. Variable production costs Plastic for casing $ 17,000Wages of assembly workers 82,000Drum stands 26,000Variable selling costs Sales commissions 15,000Fixed manufacturing costs Taxes on factory 5,000Factory maintenance 10,000Factory machinery depreciation 40,000Fixed selling and administrative costs Lease of equipment for sales staff 10,000Accounting staff salaries 35,000Administrative management salaries 125,000Compute its contribution margin per unit and its contribution margin ratio. Prepare a contribution margin income statement. Interpret the contribution margin and contrubition margin ratio.

a) Contribution margin is $360,000 and Net income is $101,250.

b) The portion of sales revenue that is not used to pay variable costs is $360,000. That is, the portion of the sales revenue that is left to pay for fixed costs and make a profit is $360,000.

c) The percentage of sales revenue that is left after deducting all the variable costs is 72%. In other words, 72% of sales revenue is left to pay for fixed costs and make a profit.

Explanation:

These can be calculated as follows:

a) Prepare a contribution margin income statement

Tight Drums Company

Contribution margin income statement

For the year ended December 31, 2015

Particulars                                                 $                        $

Sales revenue (1,000 * $500)                                       500,000

Variable costs      

    Plastic for casing                             (17,000)  

    Wages of assembly workers         (82,000)  

    Drum stands                               (26,000)    

    Sales commissions                        (15,000)  

Total variable cost                                                          (140,000)  

Contribution margin                                                      360,000

Fixed costs    

    Taxes on factory                              (5,000)  

    Factory maintenance                      (10,000)  

    Factory machinery depreciation    (40,000)      

    Lease of equip. for sales staff        (10,000)  

    Accounting staff salaries                (35,000)  

    Admin. management salaries       (125,000)  

Total Fixed cost                                                             (225.000)

Income before tax                                                            135,000

Tax (135,000 * 25%)                                                         (33,750)  

Net income                                                                     101,250  

b) Interpret the contribution margin

Contribution margin is sales revenue minus total variable cost.

From part a, contribution of $360,000 therefore implies that the portion of sales revenue that is not used to pay the variable costs is $360,000.

That is, the portion of the sales revenue that is left to pay for fixed costs and make a profit is $360,000.

c) Interpret the contribution margin ratio

Contribution margin ratio = Contribution margin / Sales revenue = $360,000 / $500,000 = 0.72, or 72%

This implies that 72% of sales revenue is left after deducting all the variable cost. In other words, 72% of sales revenue is left to pay for fixed costs and make a profit.

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