Case 5-1 Microimage Technology, Inc. :

MicroImage Technology, Inc. produces miniature digital color cameras that can be attached to endoscopes and other medical devices. The cameras sell for $215 per unit and are disposed of after each use. For 2014, the companys first full year of operation, the company had sales of 80,000 units and a net loss of $9,810,000, as follows:

MicroImage Technology, Inc.

Income Statement

for the Year ended December 31, 2014

Sales Revenue $17,200,000 Less: cost of goods sold 18,360,000 Gross Profit (loss) (1,160,000) Less: Selling and administrative expenses: Selling expense $3,750,000 Administrative expense 4,900,000 8,650,000 Net loss ($9,810,000) The company is closely held, with six major inventors. Early in the first quarter of 2015, Warren Logan, company CFO, was preparing to meet with them to present profitability estimates for the coming two years. He expected the meeting to be somewhat hostile. Two days before, he had received an email from one of the investors, Sanjay Patel:

Warren: I expected a net loss but not this big. And I certainly didnt expect a negative gross profit! It looks like the more we sell, the more well lose. I hope you come to the investor meeting next week with some explanations and some better numbers. SP.

In preparing for the meeting, Warren assembled the following information based on results for 2014: Units sold 80,000 Units produced 80,000 Selling price $215 Manufacturing costs:

Direct materials costs $1,280,000 Direct labor costs 1,200,000

Total direct manufacturing costs $2,480,000

Variable manufacturing overhead:

Equipment maintenance 160,000 Inspection costs 400,000 Miscellaneous variable manufacturing overhead 320,000 Total variable manufacturing overhead 880,000

Fixed manufacturing overhead:

Rent 1,800,000 Depreciation 5,000,000 Supervisory salaries 4,500,000 Miscellaneous fixed manufacturing overhead 3,700,000 Total fixed manufacturing costs 15,000,000 Total manufacturing costs $18,360,000

Operating Expenses:

Selling expenses

Variable selling expense:

Shipping $ 280,000 Commissions 800,000 Travel 120,000 Total variable selling expenses $1,200,000

Fixed selling expense: Salaries 1,900,000 Miscellaneous fixed selling expense 650,000 Total fixed selling expenses 2,550,000 Total selling expenses $ 3,750,000

Administrative expenses (all fixed)

Research and development $ 2,700,000 Administrative salaries 1,300,000 Miscellaneous administrative expense 900,000 . Total administrative expenses 4,900,000 Total operating expenses $8,650,000 Assumptions for 2015 1. The company will hire two additional sales managers at a base salary of $90,000 each. 2. R&D will be cut by $1,100,000. 3. Unit sales will increase by 30 percent. Assumptions for 2016

The company will hire one additional sales manager at a base salary of $90,000.

R&D will be increased by $600,172 over 2015.

Unit sales will increase by 60 percent over 2015. Required:

Recast the absorption costing income statement for 2014 into a variable costing format. Does it appear, as Sanjay Patel contends, that the more the company sells, the more it loses? Explain.

Warren Logan, CFO, has developed assumptions that he believes are reasonable for 2015 and 2016. Using these assumptions, prepare budgeted income statements for 2015 and 2016 using the variable costing method. Are the major investors likely to find forecasted profits encouraging? Explain.

Calculate the following for 2016: a. Unit contribution margin. b. Sales in dollars and units needed to breakeven. c. Margin of safety in units and dollars. d. Degree of operating leverage. Briefly explain and interpret the companys margin of safety and its degree of operating leverage.