Chapter 19 – Kimmel Accounting 5e
Challenge Exercises
CE 19-1 (based on EX 19-5 Kimmel Accounting 5e – page 1023)
Booth Company had sales in 2014 of $1,875,000 on 75,000 units. Variable costs totaled $1,125,000 and
fixed costs totaled $500,000.
A new raw material is available that will decrease the variable costs per unit by 20% (or $3.00).
However, to process the new raw material, fixed operating costs will increase by $125,000.
Management feels that two-thirds of the decline in the variable costs per unit should be passed on to
customers in the form of a sales price reduction. The marketing department expects that this sales price
reduction will result in a 4% increase in the number of units sold.
Instructions
(a)
Prepare a projected CVP income statement for 2014 (1) assuming the changes have not been
made, and (2) assuming that changes are made as described.
(b)
Before Booth Company had the chance to implement usage of the new raw material, new
industry specifications were announced and result in the following changes for the Booth
Company. Variable costs will increase by 15% per unit and fixed costs will increase by $50,000.
Management feels that a $3 per unit price increase is needed to accommodate the cost
increases. However, this will result in a 10% decrease in units sold. Prepare a CVP income
statement assuming these changes have been made.
(c)
The marketing department suggests implementing an advertising promotion that would
increase variable costs by $.50 per unit but would retain the original sales volume of 75,000
units. Prepare a CPV income statement with these changes. Do you recommend
implementation of the advertising program? Why or why not?
CE 19-2 (based on EX 19-15 Kimmel Accounting 5e – page 1025)
Tasty Time Cafeteria operates cafeteria food services in public buildings in the Midwest. Tasty Time is
contemplating a major change in its cost structure. Currently, all of their cafeteria lines are staffed with
hourly wage employees who hand serve the food to customers. Benson Riggs, Tasty Time’s owner, is
considering replacing the employees with an automated self-service system. However, before making
the change, Benson would like to know the consequences of the change, since the volume of business
varies significantly from location to location. Shown below are the CVP income statements for each
alternative.
Sales
Variable costs
Contribution margin
Fixed Costs
Net Income
Personal Service
System
$2,500,000
1,875,000
$ 625,000
125,000
$ 500,000
Automated Self-Service
System ______
$2,500,000
1,125,000
$1,375,000
875,000
$ 500,000
Instructions
(a)
Determine the degree of operating leverage for each alternative.
(b)
Which alternative would produce the higher net income if sales increased by $250,000?
(c)
Using the margin of safety ratio, determine which alternative could sustain the greater decline
in sales before operating at a loss.
(d)
Tasty Time’s vice president of finance has offered another option. He suggests a different
system that combines personal service at key points in the cafeteria line with a less expensive
automated self -service system for the other items. The financial information on this system is
given below:
Sales
Variable costs
Contribution margin
Fixed Costs
Net Income
(1)
(2)
(3)
(4)
Blended Service
System
$2,500,000
1,500,000
$ 1,000,000
500,000
$ 500,000
Determine the degree of operating leverage for this option.
How much would net income increase if sales increased by $250,000?
Using the margin of safety ratio, how large of a decline in sales could this option sustain
before operating at a loss.
Which option do you recommend for Tasty Time Cafeteria?