Grissom Company estimates that variable costs will be 60% of sales, and fixed co

Question

Grissom Company estimates that variable costs will be 60% of sales, and fixed costs will total $800,000. The selling price of the product is $4.00.

c) Compute the margin of safety in (1) dollars and (2) as a ration, assuming actual sales are $2.5 million.

Note: My calulations are as follows:
Actual(expected) sales-break-even sales=Margin of safety in Dollars
2,500,000-2,000,000=500,000

Margin of Safety in Dollars/Actual(Expected) Sales=Margin of Safety Ratio
500,000/2,500,000=20%

Please advise...Thank you

Explanation / Answer

The formula for calculating Margin of safety is

Margi of safety = Actual or Budgeted sales - Break even sales

But Break-Even sales = Fixed costs / Contribution margion ratio

Where Contribution margin ratio = Unit conribution margin / Unit selling price
                                                = (SP - VC) / SP
                                                = ($4 - $2.4) / $4
                                                = 0.4 or 40%
Where SP = selling price per unit            VC = Variable cost per unit

                Now Break-even sales = $800,000 / 0.4
                                                = $2,000,000

Therefore Margin of safety in dollars is

                  Margin of safety = $2,500,000 - $2,000,000
                                          = $500,000

Margin of safety ratio = Margin of safety in dollars / Actual or budgeted sales
                                = $500,000 / $2,500,000
                                = 0.2 or 20%

Therefore, your answer is correct.

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