Exercise 22.1
The following are nine technical accounting terms introduced or emphasized in this chapter: Responsibility margin, transfer price, common fixed costs, contribution margin, cost-plus transfer price, traceable fixed costs, performance margin, product costs, committed fixed costs. Each of the following statements may (or may not) describe one of these terms.
a. The costs deducted from contribution margin to determine responsibility margin. Traceable fixed costs. b. Cost to produce plus a predetermined markup. Cost-plus transfer price. c. Fixed costs that are readily controllable by the manager. None, the statement describes controllable fixed costs. d. A subtotal in a responsibility income statement, equal to responsibility margin plus committed fixed costs. Contribution margin . e. The subtotal in a responsibility income statement that is most useful in evaluating the short run effect of various marketing strategies on the income of the business. Performance margin. f. The subtotal in a responsibility income statement that comes closest to indicating the change in income from operation that would result from closing a particular part of the business. Responsibility margin. g. The amount used in recording products or services supplied by one business unit to another. Transfer price.
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Exercise 22.2
Video World owns and operates a national chain of video game arcades. Indicate whether Video World would evaluate of the following as an investment center, a profit center (other than an investment center), or a cost center. Briefly explain the reason for your answer.
An individual video arcade within a chain of video arcades. Investment Center. Each arcade will generate profit and should have an identifiable asset base.
A snack bar within one of the company. A profit Center. It will share common assets with other profit centers in each arcade and will not be evaluated as an investment center.
A particular video game within one of the company’s arcades. A profit Center. However, in case the company’s investment in each game is viewed as its asset base and the common assets it shares with other games in the arcade are ignored, then the company could consider each game as an investment center.
The security officers at each arcade location. A cost center. Security officers do not contribute any profit to the company.
Problem 22.2A
Regal Flair Enterprises has two product lines: jewelry and women’s apparel. Cost and revenue data for each product line for the current month are as follows.
Jewelry Apparel
sales..............................................................$800,000 $450,000 variable costs as a percentage of sales.......... 55% 28% fixed costs traceable to product lines……….$200,000 $250,000 In addition to the costs shown above, the company incurs monthly fixed costs of $100,000 common to both product lines. a. Prepare regal flair enterprise’s responsibility income statement for the current month. Report the responsibility margin for each product line and income from operations for the company as a whole. Also include columns showing all dollar amounts as percentages of sales.
REGAL FLAIR ENTERPRISES |
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Responsibility Income Statement |
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For the Current Month |
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| Entire Company | Jewelry Line | Apparel Line | ||||
| Dollars | Percent | Dollars | Percent | Dollars | Percent | |
| Sales | 1,250,000 | 100% | 800,000 | 100% | 450,000 | 100% |
| Variable costs | 566,000 | 45.28% | 440000 | 55% | 126000 | 28% |
| Contribution margin | 684,000 | 54.72% | 360,000 | 45% | 324,000 | 72% |
| Fixed costs traceable to product lines | 450,000 | 36.00% | 200,000 | 25.00% | 250,000 | 55.56% |
| Product responsibility margin | 234,000 | 18.72% | 160,000 | 20% | 74,000 | 16% |
| Common fixed costs | 100,000 | 8.00% | ||||
| Income from operations | 134,000 | 10.72% | ||||
b. Assume that a marketing survey shows that a $75,000 monthly advertising campaign focused on either product line should increase that product line's monthly sales by approximately $150,000.
| Jewel | Apparel | |
| Expected increase in contribution margin | ||
| Jewelry ($150,000 *45%) | $67,500 | |
| Apparel ($150,000 *72%) | $108,000 | |
| Less: Increase in advertising expenditures | $75,000 | $75,000 |
| Expected increase (decrease) in operating income | $(7,500) | $33,000 |
Do you recommend this additional advertising for either or both product lines? show computations to support our conclusions.
It is recommended to make the additional advertising expenditure only on the apparel line since its contribution margin is positive.
c. Management is considering expanding one of the company's two product lines. an investment of given dollar amount is expected to increase the sales of the expanded product line by $300,000. it is also expected to increase the traceable fixed cost of the expanded product line by 75 percent.
| Jewel | Apparel | |
| Expected increase in contribution margin | ||
| Jewelry ($300,000 *45%) | $135,500 | |
| Apparel ($300,000 *72%) | $216,000 | |
| Less: Increase in advertising expenditures(75%) | $75,000 | $187,500 |
| Expected increase (decrease) in operating income | $(15,000) | $28,500 |
Based on this information, which product line do you recommend expanding? explain the basis for your conclusion.
The Apparel line is recommended for expanding because it has a higher increase in operating income.
Exercise 22.1A
You have just been hired as the controller of Land’s End Hotel. The hotel prepares monthly
With a group of students:
separately evaluate the points raised by each of the two managers
Points raised by Robert Chamberlain: The current approach understates the profitability of his department. By developing a reputation as a fine restaurant, the dining room has significantly increased its revenue. When vacancies go up, rental revenue goes down and the dining room becomes charged with a greater percentage of overall operating costs. His suggestion was that fixed costs relating to the hotel should be allocated among the profit centers based on the number of square feet occupied by each department.
Points raised by Debra Mettenburg: She points out that the lounge is very big, because it is designed for hotel guests to read, relax, and watch the sunset.
Suggest an approach to allocating the hotel’s fixed costs among the various profit centers.
Fixed cost. This cost remains constant irrespective of increase or decrease in sales volume or service level. Examples are depreciation of the building, insurance policies, property taxes, management salaries, and rentals of the buildings.
It is better to follow activity based costing to allocate fixed costs. Through this method costs will be allocated based on the cost drivers activity. However, here they are allocating fixed costs to each profit center based on the revenue they are generated.
Suggested method: Apportion the total fixed cost into directly related and general fixed cost. Based on that apportionment, allocate the fixed cost which is 100% related to the concern profit center and general fixed cost in a revenue contribution basis.
