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Cost Behavior and Cost-Volume-Profit Relationship

1. Brief Exercise 5-2 Scattergraph Analysis

The data below have been taken from the cost records of the Atlanta Processing Company. The data relate to the cost of operating one of the company`s processing facilities at various levels of activity:

MONTH UNITS PROCESSED TOTAL COST

January................................... 8,000 $14,000

February.................................. 4,500 $10,000

March...................................... 7,000 $12,500

April........................................ 9,000 $15,500

May........................................ 3,750 $10,000

June........................................ 6,000 $12,500

July......................................... 3,000 $8,500

August..................................... 5,000 $11,500

Required:

1. Prepare a scattergraph using the above data. Plot cost on the vertical axis and activity on the horizontal axis. Fit a line to your plotted points using a ruler.

2. Using the quick-and-dirty method, what is the approximate monthly fixed cost? The approximate variable cost per unit processed? Show your computations.

2. Problem 5-15A Contribution Format Versus Traditional Income Statement

The Fun Store, Inc., purchases very large and heavy toys from a large manufacturer and sells them at retail level. The toys cost, on average, $9 each from the manufacturer. The Fun Store, Inc., sells the toys to its customers at an average of $40 each. The selling and administrative costs that the company incurs in a typical month presented below: (see attached excel spreadsheet 5-15A)

During October, The Fun Store Inc., sold and delivered 450 toys.

Required:

1. Prepare an income statement for The Fun Store, Inc., for October. Use the traditional format, with costs organized by function.

2. Redo (1) above, using the contribution format, with costs organized by behavior. Show costs and revenues on both a total and a per unit basis down through contribution margin.

3. Refer to the income statement you prepared in (2) above. Why might it be misleading to show the fixed costs on a per unit basis?

3. Problem 5-16 High-Low Method; Predicting Cost

Black Forest Clinic contains 340 beds. The average occupancy rate is 85% per month. In other words, on average, 85% of the clinic`s beds are occupied by patients. At this level of occupancy, the clinic`s operating costs are $40 per occupied bed per day, assuming a 30-day month. This $40 cost contains both variable and fixed cost elements.

During November, the clinic`s occupancy rate was only 70%. A total of $339,150 in operating cost was incurred during the month.

Required:

1. Using the high-low method, estimate:

a. The variable cost per occupied bed on a daily basis.

b. The total fixed operating costs per month.

2. Assume an occupancy rate of 80% per month. What amount of total operating cost would you expect the clinic to incur?

Chapter 6

4. Problem 6-22A Basics of CVP Analysis

Marjolein & Co. distributes a designer alarm clock that sells for $20.00 per unit. Variable costs are $6.00 per unit and fixed costs total $210,000 per year.

Required:

Answer the following independent questions:

1. What is the product`s CM ratio?

2. Use the CM ratio to determine the break-even point in sales dollars.

3. Due to an increase in demand, the company estimates that sales will increase by $200,000 during the next year. By how much should net operating income increase (or net operating decrease), assuming that fixed costs do not change?

4. Assume that the operating results for last year were:

Sales......................................... $320,000

Variable expenses........................ 96,000

Contribution margin....................... 224,000

Fixed expenses........................... 210,000

Net operating expenses................. $14,000

a. Compute the degree of operating leverage at the current level of sales.

b. The president expects sales to increase by 5% next year. By what percentage should net operating income increase?

5. Refer to the original data. Assume that the company sold 20,000 units last year. The sales manager is convinced that an 8% reduction in the selling price, combined with a $24,000 increase in advertising, would cause annual sales in units to increase by one-fourth. Prepare two contribution format income statements, one showing the results of last year`s operations and one showing the results of operations if these changes are made. Would you recommend that the company do as the sales manager suggests?

5. Problem 6-23A Sales Mix; Break-Even Analysis; Margin of Safety

Jean Leeman & Co. of Texas makes two products, Mini and Giga. Present revenue, cost, and sales data for the two products follow:

Mini Giga

Selling price per unit................................ $5.00 $60.00

Variable expenses per unit....................... $2.00 $36.00

Number of units sold annually................... 108,000 9,000

Fixed expenses total $378,000 per year.

Required:

1. Assuming the sales mix given above, do the following:

a. Prepare a contribution format income statement showing both dollar and percent columns for each product and for the company as a whole.

b. Compute the break-even point in dollars for the company as a whole and the margin of safety in both dollars and percent.

2. The company has just developed a new product to be called Mega. Assume that the company could sell 36,000 units at $50.00 each. The variable expense would be $35.00 each. The company`s fixed expenses would not change.

a. Prepare another contribution format income statement, including sales of Mega (sales of the other two products would not change.)

b. Compute the company`s new break-even point in dollars and the new margin of safety in both dollars and percent.

3. The president of the company examines your figures and says, "There`s something strange here. Our fixed costs haven`t changed and you show greater total contribution margin if we add the new product, but you also show our break-even point going up. With greater contribution margin, the break-even point should go down, not up. You`ve made a mistake somewhere." Explain to the president what has happened.

6. Problem 6-26A Break-Even and Target Profit Analysis

Mugs and More sell a large variety of coffee mugs. Larry Hooper, the owner, is thinking of expanding his sales by hiring local high school students, on a commission basis, to sell coffee mugs bearing the name and mascot of the local high school.

These coffee mugs would have to be ordered from the manufacturer six weeks in advance, and they could not be returned because of the unique printing required. The coffee mugs would cost Mr. Hooper $3.00 each with a minimum order of 50 coffee mugs. Any additional coffee mugs would have to be ordered in increments of 50.

Since Mr. Hooper`s plan would not require any additional facilities, the only costs associated with the project would be the costs of the coffee mugs and the costs of the sales commissions. The selling price of the coffee mugs would be $6.00 each. Mr. Hooper would pay the students a commission of $1.00 for each mug sold.

Required:

1. To make the project worthwhile, Mr. Hooper would require a $700 profit for the first three months of the venture. What level of sales in units and in dollars would be required to reach this target net operating income? Show all computations.

2. Assume that the venture is undertaken and an order is placed for 50 coffee mugs. What would be Mr. Hooper`s break-even point in units and in sales dollars? Show computations and explain the reasoning behind your answer.

Building Your Skills

1. Analytical Thinking

Jasmine Park encountered her boss, Bobby Gompers, at the pop machine in the lobby. Bobby is the vice president of marketing at Down South Lures Corporation. Jasmine was puzzled by some calculations she had been doing, so she asked him:

Jasmine: "Bobby, I`m not sure how to go about answering the questions that came up at the meeting with the president yesterday."

Bobby: "What`s the problem?"

Jasmine: "The president wanted to know the break-even for each of the company`s products, but I am having trouble figuring them out."

Bobby: "I`m sure you can handle it, Jasmine. And, by the way, I need your analysis on my desk tomorrow morning 8:00 sharp so I can look at it before the follow-up meeting at 9:00."

Down South Lures makes three different fishing lures in its manufacturing facility in Alabama Data concerning these products appear below.

Frog Minnow Worm

Normal annual sales volume............................................... 100,000 200,000 300,000

Unit selling price................................... $2.00 $1.40 $0.80

Variable cost per unit ............................ $1.20 $0.80 $0.50

Total fixed expenses are $282,000 per year.

All three products are sold in highly competitive markets, so the company is unable to raise its prices without losing unacceptable numbers of customers.

The company has no work in process or finished goods inventories due to an extremely effective Lean Production system.

Required:

1. What is the company`s overall break-even point in total sales dollars?

2. Of the total fixed costs of $282,000, $18,000 could be avoided if the Frog lure product were dropped. The remaining fixed costs of $108,000 consist of common fixed costs such as administrative salaries and rent on the factory building that could be avoided only by going out of business entirely.

a. What is the break-even point in units for each product?

b. If the company sells exactly the break-even quantity of each product, what will be the overall profit of the company? Explain this result.