Brief Exercise 20.3
City Ambulance Service estimates the monthly cost of responding to emergency calls to be $19,500, plus $110 per call.
In a month in which the company responds to 125 emergency calls, determine the estimated:
Total cost of responding to emergency calls.
Total Cost = Fixed cost + (Variable cost per call * Number of calls)
Total Cost =$19,500 + $(110*125 calls)
Total Cost = $33,250
Average cost of responding to emergency calls.
Average cost of responding to emergency calls = Total cost / No. of emergency calls.
Average cost = $33,250/125
Average cost = $266
Assume that in a given month, the number of emergency calls was unusually low. Would you expect the average cost of responding to emergency calls during this month to be higher or lower than in other months?
Delegate your assignment to our experts and they will do the rest.
If the number of emergency calls are unusually low in a given month, then the average cost of responding to emergency calls during that month will be higher. This is largely due to fixed cost. The fixed cost per unit increases given that the number of emergency calls are low in a given month.
For instance, if there are 120 calls in a month, then the average cost = $19,500/120 +$110 = $272.5 showing an increase in average cost.
Exercise 20.1
Listed below are nine technical accounting terms introduced in this chapter: Variable costs, Relevant range, Contribution margin, Break-even point, fixed costs, Semi-variable costs, economies of scale, sales mix, and unit contribution margin. Each of the following statements may (or may not) describe one of these technical terms. For each statement, indicate the accounting term described, or answer "None" if the statement does not correctly describe any of the terms.
The level of sales at which revenue exactly equals costs and expenses. Break-even Point.
Costs that remain unchanged despite changes in sales volume. Fixed costs.
The span over which output is likely to vary and assumptions about cost behavior generally remain valid. Relevant Range.
Sales revenue less variable costs and expenses. Contribution margin .
Unit sales price minus variable cost per unit. Unit contribution margin.
The reduction in unit cost achieved from a higher level of output. Economies of scale.
Costs that respond to changes in sales volume by less than a proportionate amount. Semi-variable Costs.
Operating income less variable cost. None
Exercise 20.2
The following information is available regarding the total manufacturing overhead of Bursa Mfg. Co. for a recent four-month period:
Machine-Hours Manufacturing Overhead
Jan. 5,500 $311,500
Feb. 3,200 224,000
Mar. 4,900 263,800
Apr. 2,800 184,600
Use the high-low method to determine:
The variable element of manufacturing overhead costs per machine-hour.
Machine-Hours Manufacturing Overhead
Jan. 5,500 $311,500
Apr. 2,800 184,600
$2,700 $126,900
Variable cost = difference between cost/difference between hours
Variable cost = $126,900/2,700 = $47
The fixed element of monthly overhead cost.
Fixed cost = Total cost – variable cost
Fixed cost = $311,500 – ($47*5,500 hours)
Fixed cost = $53,000
Bursa expects machine-hours in May to equal 5,300. Use the cost relationships determined in part a to forecast May's manufacturing overhead costs.
Total cost = Fixed cost + Variable cost
Total cost = $53,000 + ($47 * 5,300 hours)
Total cost = $302,100
Suppose Bursa had used the cost relationships determined in part a to estimate the total manufacturing overhead expected for the months of February and March. By what amounts would Bursa have over- or underestimated these costs?
For February:
Total cost = Fixed cost + variable cost
Total cost = $53,000 + ($47 * 3,200 hours)
Total cost = $203,400
Cost estimated by Bursa mfg. = $224,00
Overestimate=$224,000-$203,400
Overestimate = $20,600
For March:
Total cost = Fixed cost + variable cost
Total cost = $53,000 + ($47 * 4,900 hours)
Total cost = $283,300
Cost estimated by Bursa mfg. = $263,00
Overestimate=$283,300 - $263,800
Overestimate = $19,500
Exercise 20.8
Arrow Products typically earns a contribution margin ratio of 25% and has current fixed costs of $80,000. Arrow's general manager is considering spending an additional $20,000 to do one of the following:
1. Start a new ad campaign that is expected to increase sales revenue by 5%.
2. License a new computerized ordering system that is expected to increase Arrows contribution margin ratio to 30%.
Sales revenue for the coming year was initially forecast to equal $1,200,000 (that is without implementing either of the above options)
For each option how much will projected operating income increase or decrease relative to initial predications?
The operating margin will be calculated under both the options and compared with the initially predicted net operating income after adopting any of the options to determine the increase or decrease. The calculation of operating income under both the options was as:
| Ad Campaign: | |
| Sales (1,200,000*(1+.05)) | 1,260,000 |
| Contribution (1,260,000*25%) | 315,000 |
| Less Fixed Cost (80,000 + 20,000) | 100,000 |
| Net Operating Income | $215,000 |
Thus, projected operating income will decrease by $5,000 ($215,000 - $220,000) if the ad campaign is chosen.
| Ordering System: | |
| Sales | 1,200,000 |
| Contribution (1,200,000*30%) | 360,000 |
| Less Fixed Cost (80,000 + 20,000) | 100,000 |
| Net Operating Income | $260,000 |
| Operating Income Under Initial Prediction: | |
| Sales | 1,200,000 |
| Contribution (1,200,000*25%) | 300,000 |
| Less Fixed Cost (80,000 + 20,000) | 80,000 |
| Net Operating Income | $220,000 |
Thus, projected operating income will increase by $40,000 ($260,000 - $220,000) if the ad campaign is chosen.
By what percentage would sales revenue need to increase to make the ad campaign as attractive as the ordering system?
The total value of sales required to earn the net operating income of $260,000 is first calculated.
Desired Sales = (Fixed Cost + Desired Income)/Contribution Ratio
Desired Sales = (100,000 + 260,000)/25% = $1,440,000
The percentage increase in revenue would be calculated as follows:
(Desired Sales - Estimated Sales)/Estimated Sales = (1,440,000 - 1,200,000)/ (1,200,000) *100
Percentage increase in revenue = 20%
An increase in sales revenue of 20% would be required to make the ad campaign equally attractive to the ordering system.
Exercise 20.9
EasyWriter manufactures an erasable ballpoint pen, which sells for $1.75 per unit. Management recently finished analyzing the results of the company's operations for the current month. At a break-even point of 40,000 units the company's total variable costs are $50,000 and its total fixed costs amount to $20,000:
Calculate the contribution margin per unit.
Contribution margin per unit = Fixed cost/sales volume
Contribution margin per unit = 20000/40000
Contribution margin per unit = $0.50 .
Calculate the company's margin of safety if monthly sales total 45,000 units.
Margin of safety = Annual sales Volume – Break even sales volume
Margin of safety = 45,000 units – 40,000 units
Margin of safety = 5,000 units.
Estimate the company's monthly operating loss if it sells only 38,000 units.
Total sales value = No. of units * rate = 38,000 units *$1.75 = $66,500.
Contribution margin ratio = Contribution margin per unit/unit selling price = 28.57%
Operating loss = (Sales volumes (in dollars))*contribution margin ratio) – Fixed cost.
Operating income(loss) = ($66,500 * 28.57%) – $20,000.
Operating income(loss) = $1,000.95
Compute the total cost per unit at a production level of (1) 40,000 pens per month and (2) 50,000 pens per month. Explain the reason for the change in the unit costs.
Cost per unit = variable cost per unit + Fixed cost per unit
1) 40000 pens
Variable cost = 50000/40000 = 1.25 (this will not change no matter how many we manufacture)
Fixed cost = 20000/40000 = 0.50
Cost per unit: $1.75
2) 50000
Variable cost = 1.25
Fixed cost = 20000/50000 = 0.40
Cost per unit: $1.65
Chapter 21:
Exercise 21.1
Listed below are seven technical accounting terms introduced or emphasized in this chapter. Opportunity cost, sunk cost, out-of-pocket cost, split-off point, joint products, relevant information, incremental analysis. Each of the following statements may (or may not) describe one of these technical terms. For each statement, indicate the accounting term described.
a. Examination of differences between costs to be incurred and revenue to be earned under different courses of action. Incremental analysis .
b. A cost incurred in the past that cannot be changed as a result of future actions. Sunk cost .
c. Costs and revenue that are expected to vary, depending on the course of action decided on. Relevant information.
d. The benefit forgone by not pursuing an alternative course of action. Opportunity cost.
e. Products made from common raw materials and shared production processes. Joint products
f. A cost yet to be incurred that will require future payment and may vary among alternative courses of action. Out-of-pocket .
g. The point at which manufacturing costs are split equally between ending inventory and cost of goods sold. Split-off point .
Problem 21.1A
D. Lawrence designs and manufactures fashionable men's clothing. For the coming year, the company has scheduled production of 40,000 suede jackets. Budgeted costs and further information was given to answer the following questions.
a. Using incremental revenue and incremental costs, compute the expected effect of accepting this special order on D. Lawrence’s operating income.
Incremental revenue on special order = 10,000 jackets x $80 = $8,00,000
Add the decrease in sales commission ($20 - $5) x 10000 jackets = $1,50,000
Incremental revenue $9,50,000
Incremental Expenses Variable expenses totally = 10,000 jackets x ($50 + $20) = $700,000 Incremental Operating Income = $950,000 - $700,000 = $250,000
The company’s income will increase by $250,000 if it accepts the order.
b. Briefly discuss other factors that you believe D. Lawrence’s management should consider in deciding whether to accept the special order.
Financial factors to be considered when making the decision include; incremental costs and revenue, costs, out-of-pocket costs, and sunk costs. Non-financial factors to be considered include legal issues, ethical considerations, reputation effects, and environment impacts.
Problem 21.4A
Optical Instruments produces two models of binoculars. Information for each model was given to answer the following questions.
Prepare a schedule showing the contribution margin per machine-hour for each product.
| Model 100 | Model 101 | |
| Sale Price | 200 | 135 |
| Less : Variable Cost | ||
| Direct Material | 51 | 38 |
| Direct Labour | 33 | 30 |
| Variable Manufacturing O/H | 36*2/3=24 | 18*2/3=12 |
| Variable Selling Exp | 30 | 15 |
| Total Variable Cost | 138 | 95 |
| Contribution Margin | 62 | 40 |
| Machine Hour Per Unit | 2 | 1 |
| Contribution Margin Per Machine Hour | 31 | 40 |
The contribution margin per hour for model 100 is $31 while that for Model 101 is $40 .
Explain your recommendation as to which of the two products should be disconnected.
The contribution margin per hour for model 100 is low while that of model 101 is high. It is thus advisable to discontinue Module 100 which gives less contribution margin per hour.
Problem 21.7A
Kelp Company produces three joint products from seaweed. At the split-off point, three basic products emerge: Sea Tea, Sea Paste, and Sea Powder. Each of these products can either be sold at the split-off point or be processed further. If they are processed further, the resulting products can be sold as delicacies to health food stores. Cost and revenue information is as follows: Product Pounds Sales Value Final Sales Value Additional Cost Sea Tea 9,000 $60,000 $90,000 $35,000 Sea Paste 4,000 $80,000 $160,000 $50,000 Sea Powder 2,000 $70,000 $85,000 $14,000 a.) Which products should Kelp process beyond the split-off point?
Sea Tea: (90000 – 35000) = $55000 vs Sales value at split off $60000
Incremental Cost = 60000 – 55000 = $5000
Sea Paste: (160000 – 50000) = $110000 vs Sales value at split off $80000
Incremental benefit = 110000 – 80000 = $30000
Sea Powder: (85000 – 14000) = $71000 vs Sales value at split off $70000
Incremental benefit = 71000 – 70000 = $1000
Kelp should process products that have a net incremental benefit which is Sea Paste and Sea Power. b.) At what price per pound would it be advantageous for Kelp Company to sell Sea Paste at the split-off point rather than process it further?
In order for Kelp Company to sell Sea Paste at the split-off point and for it to be advantageous, the total revenue must be at least greater than the total net benefit to process further, which is $110000. Thus, price per pound = 110000/4000 = $27.50
