 Hello and welcome to this session in which you would look at the margin of safety. What is the margin of safety? Simply put the margin of safety is the access. It's the additional of budgeted or actual sales Above the break even volume of sales dollars. Simply put we have a break even point And what's the break even point break even point when your profit? Equal to zero. It means you have no profit and no loss and below zero is a loss Above zero is a profit. So this is so you compute your break even at what point your sales Will break even in terms of profit. This is the break even so we're computing is the access How much are you above your break even point? Are you this much above or is it this much above or is it this much above now? The further you are positively from the break even point the better off you are now If you don't remember how to compute the break even point which is we looked at the in the prior session This is part of your CVP cost volume profit analysis Simply put to find your break even and dollars which is sales dollars You will take your fixed cost Dividing your fixed cost by the contribution margin percentage if you need to do this Please look at the prior session in this lesson. Well, simply put what would what would the drop in sales V? Before we incur a loss simply put we're looking to find out how much sales we can lose Before we hit that zero profit. That's basically what it is And it's computed by taking the total budget if we're preparing the budget or the actual sales and we Subtract this from the break even so first you have to have your break even in sales Once you have you have your break even you would compare that to your total or actual budget again We can also compute the margin of safety in terms of a percentage So rather than giving you a sale a dollar amount, I'll tell you, you know Your sales can drop up to 10% The best way to look at this is to actually look at an example But to compute the margin of safety in terms of percentage You will take the margin of safety in dollars, which you computed here Margin of safety in dollars and you'll divide it by the total budgeted or actual sales dollar It's pretty straightforward concept. Let's take a look at this example real quick then we'll work the question If you remember this Contribution margin income statement for Adam company selling 400 tablets and at 400 tablets We know each tablet is selling for 500 the total sales is 200 the variable expenses are 300 400 times 400 units times $300 variable cost per unit 120 gives us a contribution margin of 80. We have fixed cost of 80 Therefore not operating income equal to zero simply put we have break even in sales is 200,000 and we know that our gross the contribution margin percentage 200 divided by 500 is 40 percent now Let's assume our sales our projected sales our budgeted sales is 250 well 250 minus 200,000 we say our margin of safety is $50,000. What does that mean? It means so this is the budgeted or actual. This is budgeted or actual So if we know if we think we can have 250 or $50,000 above the break-even point We can also compute this compute this in terms of percentage by taking 50,000 the break even in dollar Dividing it by the budgeted or the actual 250 and we find out that that percentage equal to 20% So simply put your sales can drop 20% Before you start to incur a loss if it drops 20% you will go down to you will go back to Zero profit zero profit this point here Now the best way again to illustrate this is to look at an actual example What you would see in the actual on an actual exam in an actual quiz to understand this concept And by the way, this question is from farhat lectures calm If you're watching you're most likely an accounting students or a CPA candidate or a CMA candidate Those questions are on my website Please subscribe so you can have access to questions in addition to the lectures It will help you tremendously invest in yourself. Don't shortchange yourself. Okay, assume A company is operating with a relevant range during 2021 using the following contribution margin income statement provided by the company We have sales 9,000 unit at 270,000 variable expenses at 189 Contribution margin 81,000 fixed expenses 70,000 350 net operating income is 10,000 650 what is the margin of safety For the year so what's the margin of safety for this company? Well to know the margin of safety We have to compare we have to compare this number which is 270,000 to what to the break even point. What is the break even point? Well, we have to compute the break even point. How do we compute the break even point? Fixed cost divided by the contribution margin percentage. We know the fixed cost is how much we know the fixed cost is 70 70,000 350. What's the contribution margin percentage? Well, hopefully, you know how to do this It's the contribution margin dividing by sales, so let's take a look at this and see how much is the contribution margin percentage which is you see Get the calculator stuck a little bit here Let's take a look at it. I have two of them Okay, so it's gonna be 781081 divided by 270 Which is the contribution margin percentage is point three or thirty percent now what we're gonna do We're gonna take this we're gonna perform this computation and that's gonna give us what that's gonna give us the break even in sales, so 70,000 350 divided by point three that's gonna give us 234 500 so this is break even in sales now if you want to go ahead and Try it yourself to make sure your net operating profit equal to zero you can now What is the break even in terms of percentage? That's what we're looking for. Well, first we have to find out What's the difference between 270 and 234 500? So let's take a look at this 270 minus 234 500 will give us our margin of safety our margin of Safety, this is the dollar amount equal to 35,500 the question is in terms of percentage well We're gonna take this number divided by the projected sales, which is 35 500 divided by 270 divide this number by 200 and 35 500 divide Dividing that's one more time 35 500 divide in it by 270 and that's gonna give us 13.148 which is 13.15 Browning which is this number here therefore the answer is C Again at the end of this recording if you're not a subscriber subscribe so you can practice more multiple choice questions more Exercises to reinforce this concept. Good luck study hard and of course stay safe