Managerial Accounting: E6-15 Imagen Arquitectonica of Tijuana, Mexico

Managerial Accounting
Imagen Arquitectonica of Tijuana, Mexico is contemplating a major change in its cost structure. Currently, all of its drafting work is performed by skilled draftsmen. Alfredo Ayala, Imagen's owner, is considering replacing the draftsmen with a computerized drafting system. However, before making the change Alfredo would like to know the consequences of the change, since the volume of business varies significantly from year to year. Shown below are CVP income statements for each alternative.
Manual System Computerized System
Sales 1,500,000 1,500,000
Variable costs 1,200,000 600,000
Contribution margin 300,000 900,000
Fixed costs 60,000 660,000
Net income 240,000 240,000

a. Determine the degree of operating leverage for each alternative
b. Which alternative would produce the higher net income if sales increase by $100,000.
c. Using the margin of safety ratio, determine which alternative could sustain the greater decline in sales before operating at a loss.
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