Gary Gs is a small company that currently operates in Knoxville, TN and has a single product stadium seat cushions bearing the University of Tennessee logo. Eventually Gary wants to expand and sell this product for other university and professional sports teams, and to add other merchandise. In the meantime, Gary is having a little difficulty understanding margins, and operating income and product mix. Ill never understand this accounting stuff, Gary yelled, waving the income statement he had just received from his accountant in the morning mail. last month we sold 1,000 stadium seat cushions and earned $6,850 in operating income. This month, when we sold 1,500, I thought wed make $10,275. But this income statement shows an operating income of $12,100! How can I ever make plans if I cant predict my income? Im going to give Cathy one last chance to explain this to me, he declared as he picked up the phone to call Cathy, his accountant. Will you try to explain this operating income thing to me one more time please? Gary asked Cathy. After I saw last months income statement, I though each cushion we sold generated $6.85 in net income; now this month, each one generates $8.07! There was no change in the price we paid for each cushion, and we didnt change our selling price, so I dont understand how this happened. If I had known I was going to have $12,100 in operating income, I would have looked more seriously at adding to our product line. Taking a deep breath, Cathy replied, Sure, Gary. Id be happy to explain how you made so much more operating income than you were expecting.

Additional Information:

Contribution per unit: 10.5

Break Even Point: 348 Units

Break Even Point in Sales: $8,700

1. Using the following income statements, prepare a contribution margin income statement

for October.

2. Gary isn't happy with the projected income statement you showed him for a sales level

of 500 cushions. He wants to know how many seat cushions he will need to sell to earn

$3,700 in operating income.

3. Gary is evaluating two options to increase the number of cushions sold next month. First,

he believes he can increase sales by advertising in the university newspaper. Gary can

purchase a package of 12 ads over the next month for a total of $1,200. He believes the

ads will increase the number of stadium seat cushions sold from 500 to 960. A second

option would be to reduce the selling price. Gary believes a 10% decrease in the price

will result in 1,000 cushions sold. Which plan should Gary implement? At what level of

sales would he be indifferent between the two plans?

4. Just after Gary completed an income projection for 1,200 stadium seat cushions, his

supplier called to inform him of a 20% increase in the cost of the cushions that Gary

purchases, effectively immediately. Gary knows that he cannot pass the entire increase on

to his customers but thinks he can pass on half of it while only experiencing a 5%

decrease in units sold. Should Gary respond to the increase in cost of goods sold with an

increase in price?

5. Refer back to the original information. Gary has decided to add stadium blankets to his

product line. He has found a supplier who will provide the blankets for $32, and he plans

to sell them for $55. All other variable costs currently incurred for selling the stadium

seat cushions will also be incurred for selling blankets. Additional fixed costs of $350 per

month will be incurred if the blankets are taken on as a product line. Gary believes he can

sell one blanket for every three stadium seat cushions. How many blankets and seat

cushions will Gary need to sell each month in order to break even?

September October Sales Cost of Goods Sold Gross Profit Rent Expense Wages Expenses Shipping expense Utilities expense Advertising expense Insurance expense Operating income $25,000 10,000 15,000 1,500 3,500 1.250 750 750 400 $6,850 $37,500 15,000 22,500 1.500 5.000 1,875 750 875 400 $12.100 September October Sales Cost of Goods Sold Gross Profit Rent Expense Wages Expenses Shipping expense Utilities expense Advertising expense Insurance expense Operating income $25,000 10,000 15,000 1,500 3,500 1.250 750 750 400 $6,850 $37,500 15,000 22,500 1.500 5.000 1,875 750 875 400 $12.100