Chapter 5
Cost Behavior: Analysis and Use
Solutions to Questions
5-1
a. Variable cost: A variable cost remains constant on a per unit basis, but changes in total in direct relation to changes in volume.
b. Fixed cost: A fixed cost remains constant in
total, but if expressed on a per unit basis,
varies inversely with changes in volume.
c. Mixed cost: A mixed cost contains both variable and fixed cost elements.
5-2
a. Unit fixed costs decrease as volume increases.
b. Unit variable costs remain constant as volume increases.
c. Total fixed costs remain constant as volume
increases.
d. Total variable costs increase as volume increases.
5-3
a. Cost behavior: Cost behavior is the way in
which costs change in response to changes
in some underlying activity, such as sales
volume, production volume, or orders processed.
b. Relevant range: The relevant range is the
range of activity within which assumptions
relative to variable and fixed cost behavior
are valid.
5-4
An activity base is a measure of whatever causes the incurrence of a variable cost.
Examples of activity bases include units produced, units sold, letters typed, beds in a hospital, meals served in a cafe, service calls made,
etc.
5-5
(See the exhibit below.)
a. Variable cost: A variable cost remains constant on a per unit basis, but increases or
decreases in total in direct relation to
changes in activity.
b. Mixed cost: A mixed cost is a cost that contains both variable and fixed cost elements.
c. Step-variable cost: A step-variable cost is a
cost that is incurred in large chunks, and
which increases or decreases only in response to fairly wide changes in activity.
Mixed Cost
Variable Cost
Cost
Step-Variable Cost
Activity
5-6
The linear assumption is reasonably
valid providing the cost formula is used only
within the relevant range.
5-7
A discretionary fixed cost is one that has
a fairly short planning horizon—usually a year.
Such costs arise from annual decisions by management to spend in certain fixed cost areas,
such as advertising, research, and management
development. A committed fixed cost is one that
has a long planning horizon—generally many
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Introduction to Managerial Accounting, 4th Edition
years. Such costs relate to a company’s investment in facilities, equipment, and basic
organization. Once such costs have been incurred, a company becomes “locked in” to the
decision for many years.
5-8
a. Committed
b. Discretionary
c. Discretionary
d. Committed
e. Committed
f. Discretionary
5-9
Yes. As the anticipated level of activity
changes, the level of fixed costs needed to support operations may also change. Fixed costs
may often be adjusted in broad steps, rather
than being absolutely fixed at one level for all
ranges of activity.
5-10 The major disadvantage of the high-low
method is that it uses only two points in determining a cost formula and these two points are
likely to be less than typical since they represent
extremes of activity.
5-11 The quick-and-dirty method, the highlow method, and the least-squares regression
method can be used to analyze mixed costs. The
least-squares regression method is generally
considered to be most accurate, since it derives
the fixed and variable elements of a mixed cost
by means of statistical analysis. The quick-anddirty method is relatively crude and subjective.
The high-low method utilizes only two data
points, making it the least accurate of the three
methods.
5-12 A mixed cost can be expressed in the
form Y = a + bX, where the a term represents
the fixed cost element and the b term represents the variable cost element per unit of activity.
5-13 The fixed cost element is represented by
the point where the line intersects the vertical
axis on the graph. The variable cost per unit is
represented by the slope of the line.
5-14 The term “least-squares regression”
means that the sum of the squares of the deviations from the plotted points on a graph to the
regression line is smaller than could be obtained
from any other line that could be fitted to the
data.
5-15 The contribution approach to the income
statement organizes costs by behavior, first deducting variable expenses to obtain the contribution margin, and then deducting fixed expenses
to obtain net operating income. The traditional
approach organizes costs by function, such as
production, selling, and administration. Within a
functional area, fixed and variable costs are intermingled.
5-16 The contribution margin is total sales
revenue less total variable expenses.
5-17 The basic difference between absorption
and variable costing is due to the accounting for
fixed manufacturing overhead. Under absorption
costing, fixed manufacturing overhead is accounted for as a product cost and hence is an
asset until products are sold. Under variable
costing, fixed manufacturing overhead is accounted for as a period cost and is charged in
full against the current period’s income.
5-18 Selling and administrative expenses are
accounted for as period costs under both variable costing and absorption costing.
5-19 Under absorption costing, fixed manufacturing overhead costs are included in product
costs, along with direct materials, direct labor,
and variable manufacturing overhead. If some of
the units are not sold by the end of the period,
then they are carried into the next period as inventory. The fixed manufacturing overhead cost
attached to the units in ending inventory follow
the units into the next period as part of their
inventory cost. When the units carried over as
inventory are finally sold, the fixed manufacturing overhead cost that has been carried over
with the units is included as part of that period’s
cost of goods sold.
5-20 If production exceeds sales, absorption
costing will usually show higher net operating
income than variable costing. When production
exceeds sales, inventories increase and under
absorption costing part of the fixed manufacturing overhead cost of the current period is deferred in inventory to the next period. In contrast, under variable costing all of the fixed
manufacturing overhead cost of the current period is charged immediately against income as a
period cost.
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173
5-21 If fixed manufacturing overhead cost is
released from inventory, then inventory levels
must have decreased and therefore production
must have been less than sales.
5-22 Under absorption costing it is possible to
increase net operating income simply by increasing the level of production without any increase
in sales. If production exceeds sales, units are
added to inventory. These units carry a portion
of the current period’s fixed manufacturing overhead costs into the inventory account, thereby
reducing the current period’s reported expenses
and causing net operating income to increase.
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Introduction to Managerial Accounting, 4th Edition
Brief Exercise 5-1 (20 minutes)
1.
Fixed cost ..................................
Variable cost ..............................
Total cost ..................................
Cost per cup of coffee served * ..
Cups of Coffee Served
in a Week
1,800
1,900
2,000
$1,100
468
$1,568
$0.871
$1,100
494
$1,594
$0.839
$1,100
520
$1,620
$0.810
* Total cost ÷ cups of coffee served in a week
2. The average cost of a cup of coffee declines as the number of cups of
coffee served increases because the fixed cost is spread over more cups
of coffee.
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175
Brief Exercise 5-2 (45 minutes)
1. The completed scattergraph is presented below:
16,000
14,000
12,000
Total Cost
10,000
8,000
6,000
4,000
2,000
0
0
2,000
4,000
6,000
8,000
10,000
Units Processed
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Introduction to Managerial Accounting, 4th Edition
Brief Exercise 5-2 (continued)
2. (Students’ answers will vary considerably due to the inherent
imprecision and subjectivity of the quick-and-dirty scattergraph method
of estimating variable and fixed costs.)
The approximate monthly fixed cost is $6,000—the point where the
straight line intersects the cost axis.
The variable cost per unit processed can be estimated as follows using
the 8,000-unit level of activity, which falls on the straight line:
Total cost at the 8,000-unit level of activity ...........
Less fixed costs ...................................................
Variable costs at the 8,000-unit level of activity .....
$14,000
6,000
$ 8,000
$8,000 ÷ 8,000 units = $1 per unit.
Observe from the scattergraph that if the company used the high-low
method to determine the slope of the line, the line would be too steep.
This would result in underestimating the fixed cost and overestimating
the variable cost per unit.
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177
Brief Exercise 5-3 (30 minutes)
1.
Month
High activity level (August) ..
Low activity level (October) .
Change ...............................
OccupancyDays
3,608
186
3,422
Electrical
Costs
$8,111
1,712
$6,399
Variable cost = Change in cost ÷ Change in activity
= $6,399 ÷ 3,422 occupancy-days
= $1.87 per occupancy-day
Total cost (August) .....................................................
Variable cost element
($1.87 per occupancy-day × 3,608 occupancy-days) .
Fixed cost element .....................................................
$8,111
6,747
$1,364
2. Electrical costs may reflect seasonal factors other than just the variation
in occupancy days. For example, common areas such as the reception
area must be lighted for longer periods during the winter. This results in
seasonal effects on the fixed electrical costs.
Additionally, fixed costs are affected by the number of days in a
month. In other words, costs like the costs of lighting common areas
are variable with respect to the number of days in the month, but are
fixed with respect to how many rooms are occupied during the month.
Other, less systematic, factors may also affect electrical costs such as
the frugality of individual guests. Some guests turn off lights when they
leave a room. Others do not.
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Introduction to Managerial Accounting, 4th Edition
Brief Exercise 5-4 (30 minutes)
1.
The Haaki Shop, Inc.
Income Statement—Surfboard Department
For the Quarter Ended May 31
Sales ................................................................
Variable expenses:
Cost of goods sold
($150 per surfboard × 2,000 surfboards*).....
Selling expenses
($50 per surfboard × 2,000 surfboards) ........
Administrative expenses (25% × $160,000) .....
Contribution margin...........................................
Fixed expenses:
Selling expenses .............................................
Administrative expenses ..................................
Net operating income ........................................
$800,000
$300,000
100,000
40,000
150,000
120,000
440,000
360,000
270,000
$ 90,000
*$800,000 sales ÷ $400 per surfboard = 2,000 surfboards.
2. Since 2,000 surfboards were sold and the contribution margin totaled
$360,000 for the quarter, the contribution of each surfboard toward
covering fixed costs and toward earning of profits was $180 ($360,000
÷ 2,000 surfboards = $180 per surfboard). Another way to compute the
$180 is:
Selling price per surfboard.................
Variable expenses:
Cost per surfboard .........................
Selling expenses ............................
Administrative expenses
($40,000 ÷ 2,000 surfboards) ......
Contribution margin per surfboard .....
$400
$150
50
20
220
$180
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179
Brief Exercise 5-5 (45 minutes)
1. a. The unit product cost under absorption costing would be:
Direct materials ................................................................
Direct labor ......................................................................
Variable manufacturing overhead ......................................
Total variable costs ...........................................................
Fixed manufacturing overhead ($160,000 ÷ 20,000 units) ..
Unit product cost ..............................................................
$18
7
2
27
8
$35
b. The absorption costing income statement:
Sales (16,000 units × $50 per unit) .......................... $800,000
Cost of goods sold (16,000 units × $35 per unit) ...... 560,000
Gross margin........................................................... 240,000
Selling and administrative expenses
[(16,000 units × $5 per unit) + $110,000] .......... 190,000
Net operating income .............................................. $ 50,000
2. a. The unit product cost under variable costing would be:
Direct materials ...................................
Direct labor .........................................
Variable manufacturing overhead .........
Unit product cost .................................
$18
7
2
$27
b. The variable costing income statement:
Sales (16,000 units × $50 per unit) ..............
$800,000
Less variable expenses:
Variable cost of goods sold
(16,000 units × $27 per unit) ................. $432,000
Variable selling expense
(16,000 units × $5 per unit) ...................
80,000 512,000
Contribution margin .....................................
288,000
Less fixed expenses:
Fixed manufacturing overhead ................... 160,000
Fixed selling and administrative expense .... 110,000 270,000
Net operating income ..................................
$ 18,000
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Introduction to Managerial Accounting, 4th Edition
Brief Exercise 5-6 (30 minutes)
1.
Beginning inventories
(units) ..............................
Ending inventories (units) ....
Change in inventories
(units) ..............................
Variable costing net
operating income ..............
Add: Fixed manufacturing
overhead cost deferred in
inventory under
absorption costing (10
units × $450 per unit; 40
units × $450 per unit) .......
Deduct: Fixed
manufacturing overhead
cost released from
inventory under
absorption costing (30
units × $450 per unit) .......
Absorption costing net
operating income ..............
Year 1
Year 2
Year 3
180
150
150
160
160
200
(30)
10
40
$292,400
$269,200
$251,800
4,500
18,000
$273,700
$269,800
13,500
$278,900
2. Since absorption costing net operating income was greater than variable
costing net operating income in Year 4, inventories must have increased
during the year and hence fixed manufacturing overhead was deferred
in inventories. The amount of the deferral is just the difference between
the two net operating incomes or $27,000 = $267,200 – $240,200.
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181
Exercise 5-7 (30 minutes)
1.
High activity level ................
Low activity level .................
Change ...............................
Miles
Driven
Total
Annual
Cost*
120,000 $13,920
80,000 10,880
40,000 $ 3,040
* 120,000 miles × $0.116 per mile = $13,920
80,000 miles × $0.136 per mile = $10,880
Variable cost per mile:
Change in cost
$3,040
=
=$0.076 per mile
Change in activity 40,000 miles
Fixed cost per year:
Total cost at 120,000 miles ..................
Less variable cost element:
120,000 miles × $0.076 per mile .......
Fixed cost per year ..............................
$13,920
9,120
$ 4,800
2. Y = $4,800 + $0.076X
3. Fixed cost ...............................................................
Variable cost: 100,000 miles × $0.076 per mile ........
Total annual cost .....................................................
$ 4,800
7,600
$12,400
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Introduction to Managerial Accounting, 4th Edition
Exercise 5-8 (60 minutes)
1.
High activity level ............
Low activity level .............
Change ..........................
Units Shipped
8
2
6
Shipping Expense
$3,600
1,500
$2,100
Variable cost element:
Change in cost
$2,100
=
=$350 per unit
Change in activity 6 units
Fixed cost element:
Shipping expense at the high activity level ...................
Less variable cost element ($350 per unit × 8 units) ....
Total fixed cost...........................................................
$3,600
2,800
$ 800
The cost formula is $800 per month plus $350 per unit shipped or
Y = $800 + $350X,
where X is the number of units shipped.
2. a. See the scattergraph on the following page.
b. (Note: Students’ answers will vary due to the imprecision and
subjective nature of this method of estimating variable and fixed
costs.)
Total cost at 5 units shipped per month [a point
falling on the line in (a)]......................................
Less fixed cost element (intersection of the Y axis) .
Variable cost element ............................................
$2,600
1,100
$1,500
$1,500 ÷ 5 units = $300 per unit.
The cost formula is $1,100 per month plus $300 per unit shipped or
Y = $1,100 + 300X,
where X is the number of units shipped.
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183
Exercise 5-8 (continued)
2. a. The scattergraph appears below:
4,000
3,500
Total Shipping Expense
3,000
2,500
2,000
1,500
1,000
500
0
0
1
2
3
4
5
6
7
8
9
10
Units Shipped
3. The cost of shipping units is likely to depend on the weight and volume
of the units shipped and the distance traveled as well as on the number
of units shipped. In addition, higher cost shipping might be necessary to
meet a deadline.
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Introduction to Managerial Accounting, 4th Edition
Exercise 5-9 (30 minutes)
1. Sales (40,000 units × $33.75 per unit) ..........
Less variable expenses:
Variable cost of goods sold
(40,000 units × $16 per unit*) ................
Variable selling and administrative expenses
(40,000 units × $3 per unit) ....................
Contribution margin......................................
Less fixed expenses:
Fixed manufacturing overhead....................
Fixed selling and administrative expenses ...
Net operating income ...................................
* Direct materials ..............................
Direct labor ....................................
Variable manufacturing overhead ....
Total variable manufacturing cost ....
$1,350,000
$640,000
120,000
250,000
300,000
760,000
590,000
550,000
$ 40,000
$10
4
2
$16
2. The difference in net operating income can be explained by the $50,000
in fixed manufacturing overhead deferred in inventory under the
absorption costing method:
Variable costing net operating income ...........................
Add: Fixed manufacturing overhead cost deferred in
inventory under absorption costing: 10,000 units × $5
per unit in fixed manufacturing overhead cost .............
Absorption costing net operating income .......................
$40,000
50,000
$90,000
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185
Exercise 5-10 (30 minutes)
1.
High activity level (February) ........
Low activity level (June) ...............
Change ........................................
X-rays Taken
7,000
3,000
4,000
X-ray Costs
$29,000
17,000
$12,000
Variable cost per X-ray:
Change in cost
$12,000
=
=$3.00 per X-ray
Change in activity 4,000 X-rays
Fixed cost per month:
X-ray cost at the high activity level .......................
Less variable cost element:
7,000 X-rays × $3.00 per X-ray ..........................
Total fixed cost....................................................
$29,000
21,000
$ 8,000
The cost formula is $8,000 per month plus $3.00 per X-ray taken or, in
terms of the equation for a straight line:
Y = $8,000 + $3.00X
where X is the number of X-rays taken.
2. Expected X-ray costs when 4,600 X-rays are taken:
Variable cost: 4,600 X-rays × $3.00 per X-ray ...........
Fixed cost ...............................................................
Total cost ................................................................
$13,800
8,000
$21,800
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Introduction to Managerial Accounting, 4th Edition
Exercise 5-11 (45 minutes)
Cost of X-Rays
1. The scattergraph appears below.
32,000
30,000
28,000
26,000
24,000
22,000
20,000
18,000
16,000
14,000
12,000
10,000
8,000
6,000
4,000
2,000
0
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
Number of X-Rays Taken
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187
Exercise 5-11 (continued)
2. (Note: Students’ answers will vary considerably due to the inherent lack
of precision and subjectivity of the quick-and-dirty method.)
Total costs at 5,000 X-rays per month [a point falling
on the line in (1)] .................................................
Less fixed cost element (intersection of the Y axis) ...
Variable cost element ..............................................
$23,000
6,500
$16,500
$16,500 ÷ 5,000 X-rays = $3.30 per X-ray.
The cost formula is therefore $6,500 per month plus $3.30 per X-ray
taken. Written in equation form, the cost formula is:
Y = $6,500 + $3.30X,
where X is the number of X-rays taken.
3. The high-low method would not provide an accurate cost formula in this
situation, since a line drawn through the high and low points would
have a slope that is too flat. Consequently, the high-low method would
overestimate the fixed cost and underestimate the variable cost per
unit.
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Introduction to Managerial Accounting, 4th Edition
Exercise 5-12 (20 minutes)
(Note: All currency values are in thousands of rupees.)
1. Under absorption costing, all manufacturing costs (variable and fixed)
are included in product costs.
Direct materials ..................................
Direct labor ........................................
Variable manufacturing overhead ........
Fixed manufacturing overhead
(R600,000 ÷ 10,000 units) ...............
Unit product cost ................................
R120
140
50
60
R370
2. Under variable costing, only the variable manufacturing costs are
included in product costs.
Direct materials ..................................
Direct labor ........................................
Variable manufacturing overhead ........
Unit product cost ................................
R120
140
50
R310
Note that selling and administrative expenses are not treated as product
costs under either absorption or variable costing; that is, they are not
included in the costs that are inventoried. These expenses are always
treated as period costs and are charged against the current period’s
revenue.
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189
Exercise 5-13 (45 minutes)
(Note: All currency values are in rupees.)
1. 2,000 units × R60 per unit fixed manufacturing overhead = R120,000
2. The variable costing income statement appears below:
Sales .................................................
Less variable expenses:
Variable cost of goods sold
(8,000 units × R310 per unit) ........
Variable selling and administrative
expenses
(8,000 units × R20 per unit) ..........
Contribution margin ............................
Less fixed expenses:
Fixed manufacturing overhead ..........
Fixed selling and administrative
expenses ......................................
Net operating income .........................
R4,000,000
R2,480,000
160,000
2,640,000
1,360,000
600,000
400,000
1,000,000
R 360,000
The difference in net operating income between variable and absorption
costing can be explained by the deferral of fixed manufacturing
overhead cost in inventory that has taken place under the absorption
costing approach. Note from part (1) that R120,000 of fixed
manufacturing overhead cost has been deferred in inventory to the next
period. Thus, net operating income under the absorption costing
approach is R120,000 higher than it is under variable costing.
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Introduction to Managerial Accounting, 4th Edition
Exercise 5-14 (30 minutes)
1. The company’s variable cost per unit would be:
$150,000
=$2.50 per unit.
60,000 units
Taking into account the difference in behavior between variable and
fixed costs, the completed schedule would be:
Units produced and sold
Total costs:
Variable costs ..........
Fixed costs ..............
Total costs ...............
Cost per unit:
Variable cost ............
Fixed cost ................
Total cost per unit ....
*Given.
60,000
80,000
100,000
$150,000 *
360,000 *
$510,000 *
$200,000
360,000
$560,000
$250,000
360,000
$610,000
$2.50
6.00
$8.50
$2.50
4.50
$7.00
$2.50
3.60
$6.10
2. The company’s income statement in the contribution format would be:
Sales (90,000 units × $7.50 per unit) ............................
Variable expenses (90,000 units × $2.50 per unit) .........
Contribution margin .....................................................
Fixed expenses ............................................................
Net operating income ...................................................
$675,000
225,000
450,000
360,000
$ 90,000
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191
Problem 5-15A (60 minutes)
1.
The Fun Store, Inc.
Income Statement
For the Month of October
Sales (450 units × $40 per unit) .........................
Cost of goods sold
(450 units × $9 per unit) .................................
Gross margin .....................................................
Selling and administrative expenses:
Selling expenses:
Advertising ...................................................
Sales salaries and commissions
[$800 + (5% ×$18,000)]............................
Delivery of toys (450 units × $6 per unit) .......
Utilities .........................................................
Depreciation of sales facilities ........................
Total selling expenses ......................................
Administrative expenses:
Executive salaries ..........................................
Insurance .....................................................
Clerical [$500 + (450 units × $5 per unit)] .....
Depreciation of office equipment ...................
Total administrative expenses ...........................
Total selling and administrative expenses.............
Net operating income .........................................
$18,000
4,050
13,950
$1,000
1,700
2,700
700
900
7,000
3,500
500
2,750
600
7,350
14,350
$ (400)
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Introduction to Managerial Accounting, 4th Edition
Problem 5-15A (continued)
2.
The Fun Store, Inc.
Income Statement
For the Month of October
Sales (450 units × $40 per unit) ........................
Variable expenses:
Cost of goods sold (450 units × $9 per unit) ....
Sales commissions (5% × $18,000) .................
Delivery of toys (450 units × $6 per unit) ........
Clerical (450 units × $5 per unit) .....................
Total variable expenses......................................
Contribution margin...........................................
Fixed expenses:
Advertising .....................................................
Sales salaries..................................................
Utilities ..........................................................
Depreciation of sales facilities ..........................
Executive salaries ...........................................
Insurance .......................................................
Clerical ...........................................................
Depreciation of office equipment .....................
Total fixed expenses ..........................................
Net operating income ........................................
Total
$18,000
4,050
900
2,700
2,250
9,900
8,100
Per Unit
$40
9
2
6
5
22
$18
1,000
800
700
900
3,500
500
500
600
8,500
$ (400)
3. Total fixed costs remain constant, but per unit fixed costs change with
the activity level. For example, as the activity level increases, a per unit
fixed cost will decrease. Showing fixed costs on a per unit basis make
them appear to be variable costs. That is, management might be misled
into thinking that the per unit fixed costs would be the same regardless
of how many toys were sold during the month. For this reason, fixed
costs should be shown only in totals on a contribution format income
statement.
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193
Problem 5-16A (30 minutes)
1. a. Change in cost:
Monthly operating costs at 85% occupancy:
340 beds × 85% = 289 beds;
289 beds × 30 days × $40 per bed-day ...................
Monthly operating costs at 70% occupancy (given) .....
Change in cost ...........................................................
$346,800
339,150
$ 7,650
Change in activity:
85% occupancy (340 beds × 85% × 30 days) ..........
70% occupancy (340 beds × 70% × 30 days) ..........
Change in activity ....................................................
8,670
7,140
1,530
Variable cost =
=
Change in cost
Change in activity
$7,650
=$5.00 per bed-day
1,530 bed-days
b. Monthly operating costs at 85% occupancy (above) .....
Less variable costs
289 beds × 30 days × $5.00 per bed-day .................
Fixed operating costs per month .................................
2. 340 beds × 80% = 272 beds occupied.
Fixed costs......................................................................
Variable costs: 272 beds × 30 days × $5.00 per bed-day ..
Total expected costs ........................................................
$346,800
43,350
$303,450
$303,450
40,800
$344,250
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194
Introduction to Managerial Accounting, 4th Edition
Problem 5-17A (60 minutes)
1. High-low method:
High activity level ......
Low activity level .......
Change .....................
Variable cost =
Number
of Scans
100
10
90
Utilities
Cost
$7,490
4,880
$2,610
Change in cost
$2,610
=
=$29.00 per scan
Change in activity 90 scans
Fixed cost:
Total cost at high activity level ........
Less variable element:
100 scans × $29.00 per scan .......
Fixed cost element .........................
$7,490
2,900
$4,590
Therefore, the cost formula is: Y = $4,590 + $29.00X.
2. Scattergraph method (see the scattergraph on the following page):
(Note: Students’ answers will vary according to their placement of the
regression line.)
The straight line intersects the cost axis at about $4,500. The variable
cost can be estimated as follows:
Total cost at 50 scans (a point that falls on the
regression line) ......................................................
Less the fixed cost element.......................................
Variable cost element at 50 scans (total) ...................
$6,000
4,500
$1,500
$1,500 ÷ 50 scans = $30.00 per scan.
Therefore, the cost formula is: Y = $4,500 + $30.00X.
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Solutions Manual, Chapter 5
195
Problem 5-17A (continued)
The completed scattergraph:
$8,000
$7,000
Total Utilities Cost
$6,000
$5,000
$4,000
$3,000
$2,000
$1,000
$0
0
20
40
60
80
100
120
Number of Scans
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196
Introduction to Managerial Accounting, 4th Edition
Problem 5-18A (45 minutes)
1. The unit product cost under the variable costing method is computed as
follows:
Direct materials ....................................
Direct labor ..........................................
Variable manufacturing overhead ..........
Unit product cost ..................................
$ 8
10
2
$20
With this figure, the variable costing income statements can be
prepared:
Sales .........................................................
Less variable expenses:
Variable cost of goods sold (20,000 units
x $20 per unit; 30,000 units x $20 per
unit) .....................................................
Variable selling and administrative (20,000
units x $3 per unit; 30,000 units x $3
per unit) ...............................................
Total variable expenses ...............................
Contribution margin ....................................
Less fixed expenses:
Fixed manufacturing overhead ..................
Fixed selling and administrative expenses .
Total fixed expenses ...................................
Net operating income (loss) ........................
Year 1
Year 2
$1,000,000
$1,500,000
400,000
600,000
60,000
460,000
540,000
90,000
690,000
810,000
350,000
250,000
600,000
$ (60,000) $
350,000
250,000
600,000
210,000
2. The reconciliation of absorption and variable costing follows:
Year 1
Year 2
Variable costing net operating income (loss) . $ (60,000) $ 210,000
Add: Fixed manufacturing overhead cost
deferred in inventory under absorption
costing (5,000 units × $14 per unit) ..........
70,000
Deduct: Fixed manufacturing overhead cost
released from inventory under absorption
costing (5,000 units × $14 per unit) ..........
(70,000)
Absorption costing net operating income ...... $ 10,000 $ 140,000
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Solutions Manual, Chapter 5
197
Problem 5-19A (45 minutes)
1.
a. 10
b. 4
c. 6
d. 1
e. 9
f. 2
g. 11
h. 3
i. 7
2. Without a knowledge of underlying cost behavior patterns, it would be
difficult if not impossible for a manager to properly analyze the firm’s
cost structure. The reason is that not all costs behave in the same way.
One cost might move in one direction as a result of a particular action,
and another cost might move in an opposite direction. Unless the
behavior pattern of each cost is clearly understood, the impact of a
firm’s activities on its costs will not be known until after the activity has
occurred.
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198
Introduction to Managerial Accounting, 4th Edition
Problem 5-20A (60 minutes)
1. Cost of goods sold...................
Advertising..............................
Shipping .................................
Salaries and commissions ........
Insurance ...............................
Depreciation ...........................
Variable
Fixed
Mixed
Mixed
Fixed
Fixed
2. Analysis of the mixed costs:
High activity level ...........
Low activity level ............
Change ..........................
Units
7,400
6,500
900
Shipping
Expense
P75,600
67,500
P 8,100
Salaries and
Commissions
P34,400
30,800
P 3,600
Variable cost element:
Variable cost =
Shipping:
Change in cost
Change in activity
P8,100
=P9.00 per unit.
900 units
Salaries and commissions:
P3,600
=P4.00 per unit.
900 units
Fixed cost element:
Cost at high level of activity ........
Less variable cost element:
7,400 units × P9.00 per unit .....
7,400 units × P4.00 per unit .....
Fixed cost element......................
Shipping
Expense
P75,600
66,600
P 9,000
Salaries and
Commissions
P34,400
29,600
P 4,800
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Solutions Manual, Chapter 5
199
Problem 5-20A (continued)
The cost formulas are:
Shipping:
P9,000 per month plus P9.00 per unit
or
Y = P9,000 + P9.00X.
Salaries and commissions:
P4,800 per month plus P4.00 per unit
or
Y = P4,800+ P4.00X.
3.
Compania Maritima S.A.
Income Statement
For the Month Ended June 30
Sales (7,000 units × P40 per unit) .......................
Variable expenses:
Cost of goods sold (7,000 units × P12 per unit) .
Shipping (7,000 units × P9 per unit) .................
Salaries and commissions
(7,000 units × P4 per unit) ............................
Contribution margin............................................
Fixed expenses:
Advertising ......................................................
Shipping..........................................................
Salaries and commissions .................................
Insurance ........................................................
Depreciation ....................................................
Net operating income .........................................
P280,000
P84,000
63,000
28,000
5,000
9,000
4,800
4,000
2,500
175,000
105,000
25,300
P 79,700
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200
Introduction to Managerial Accounting, 4th Edition
Problem 5-21A (60 minutes)
1. a. The unit product cost under absorption costing:
Direct materials ..............................................................
Direct labor ....................................................................
Variable manufacturing overhead ....................................
Fixed manufacturing overhead ($640,000 ÷ 40,000 units)
Unit product cost ............................................................
$15
7
2
16
$40
b. The absorption costing income statement is:
Sales (35,000 units × $60 per unit) ..................... $2,100,000
Cost of goods sold (35,000 units × $40 per unit)
1,400,000
Gross margin .....................................................
700,000
Selling and administrative expenses
[(35,000 units x $2 per unit) + $560,000].........
630,000
Net operating income ......................................... $ 70,000
2. a. The unit product cost under variable costing is:
Direct materials ................................................ $15
Direct labor ......................................................
7
Variable manufacturing overhead ......................
2
Unit product cost .............................................. $24
b. The variable costing income statement is:
Sales (35,000 units × $60 per unit) ................
$2,100,000
Less variable expenses:
Variable cost of goods sold
(35,000 units × $24 per unit) ................... $840,000
Variable selling expense
(35,000 units × $2 per unit) .....................
70,000
910,000
Contribution margin .......................................
1,190,000
Less fixed expenses:
Fixed manufacturing overhead ..................... 640,000
Fixed selling and administrative expense ...... 560,000 1,200,000
Net operating loss .........................................
$ (10,000)
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Solutions Manual, Chapter 5
201
Problem 5-21A (continued)
3. The difference in the ending inventory relates to a difference in the
handling of fixed manufacturing overhead costs. Under variable costing,
these costs have been expensed in full as period costs. Under
absorption costing, these costs have been added to units of product at
the rate of $16 per unit ($640,000 ÷ 40,000 units produced = $16 per
unit). Thus, under absorption costing a portion of the $640,000 fixed
manufacturing overhead cost of the month has been added to the
inventory account rather than expensed on the income statement:
Added to the ending inventory
(5,000 units × $16 per unit) ......................................... $ 80,000
Expensed as part of cost of goods sold
(35,000 units × $16 per unit) ....................................... 560,000
Total fixed manufacturing overhead cost for the month .... $640,000
Since $80,000 of fixed manufacturing overhead cost has been deferred
in inventory under absorption costing, the net operating income
reported under that costing method is $80,000 higher than the net
operating income under variable costing, as shown in parts (1) and (2)
above.
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202
Introduction to Managerial Accounting, 4th Edition
Problem 5-22A (75 minutes)
1.
Direct materials cost @ $4.00 per unit .
Direct labor cost @ $8.00 per unit .......
Manufacturing overhead cost* ............
Total manufacturing costs ...................
Add: Work in process, beginning .........
Deduct: Work in process, ending .........
Cost of goods manufactured ...............
January—Low
12,000 Units
$ 48,000
96,000
107,000
251,000
5,000
256,000
6,000
$250,000
April—High
15,000 Units
$ 60,000
120,000
113,000
293,000
16,000
309,000
9,000
$300,000
*Computed by working upwards through the statements.
2.
Units
Produced
Cost
Observed
April—High activity level ..............
15,000
$113,000
January—Low activity level ..........
12,000
107,000
Change ..........................................................................
3,000
$ 6,000
Variable cost =
Change in cost
$6,000
=
= $2.00 per unit
Change in activity 3,000 units
Total cost at the high activity level .................
Less variable cost element
(15,000 units × $2.00 per unit) ..................
Fixed cost element .......................................
$113,000
30,000
$ 83,000
Therefore, the cost formula is: $83,000 per month, plus $2.00 per unit
produced or
Y = $83,000 + $2.00X,
where X represents the number of units.
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Solutions Manual, Chapter 5
203
Problem 5-22A (continued)
3. The cost of goods manufactured if 13,500 units are produced:
Direct materials cost
(13,500 units × $4.00 per unit) ..........................
$ 54,000
Direct labor cost (13,500 units × $8.00 per unit) ...
108,000
Manufacturing overhead cost:
Fixed portion ..................................................... $83,000
Variable portion (13,500 units × $2.00 per unit) ..
27,000 110,000
Total manufacturing cost ......................................
272,000
Add: Work in process, beginning ...........................
0
272,000
Deduct: Work in process, ending ...........................
0
Cost of goods manufactured .................................
$272,000
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204
Introduction to Managerial Accounting, 4th Edition
Problem 5-23A (60 minutes)
1. Maintenance cost at the 20,000 machine-hour level of activity can be
isolated as follows:
Level of Activity
5,000 MHs 20,000 MHs
Total factory overhead cost ........
Deduct:
Utilities cost @ $2.40 per MH*.
Supervisory salaries ................
Maintenance cost ......................
$80,000
$138,500
12,000
13,000
$55,000
48,000
13,000
$ 77,500
*$12,000 ÷ 5,000 MHs = $2.40 per MH
2. High-low analysis of maintenance cost:
High activity level ....................
Low activity level .....................
Change ...................................
Machine- Maintenance
Hours
Cost
20,000
5,000
15,000
$77,500
55,000
$22,500
Variable cost:
Change in cost
$22,500
=
=$1.50 per MH.
Change in activity 15,000 MHs
Total fixed cost:
Total maintenance cost at the high activity level ...............
$77,500
Less variable cost element
(20,000 MHs × $1.50 per MH) ......................................
30,000
Fixed cost element .........................................................
$47,500
Therefore, the cost formula for maintenance is: $47,500 per month plus
$1.50 per machine-hour or
Y = $47,500 + $1.50X,
where X represents machine-hours.
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Solutions Manual, Chapter 5
205
Problem 5-23A (continued)
3.
Maintenance cost ..............
Utilities cost ......................
Supervisory salaries cost ....
Totals ...............................
Variable
Cost per
MachineHour
$1.50
2.40
$3.90
Fixed
Cost
$47,500
13,000
$60,500
Thus, the cost formula would be: Y = $60,500 + $3.90X.
4. Total overhead cost at an activity level of 17,000 machine-hours:
Fixed cost .....................................................
Variable cost: 17,000 MHs × $3.90 per MH .....
Total overhead cost .......................................
$ 60,500
66,300
$126,800
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206
Introduction to Managerial Accounting, 4th Edition
Problem 5-24A (60 minutes)
1. Maintenance cost at the 5,000 direct labor-hour level of activity can be
isolated as follows:
Total factory overhead cost .................
Deduct:
Indirect materials @ ¥2,000 per
DLH* ............................................
Rent ................................................
Maintenance cost ...............................
Level of Activity
4,000 DLHs
5,000 DLHs
¥15,250,000
¥17,625,000
8,000,000
5,000,000
¥ 2,250,000
10,000,000
5,000,000
¥ 2,625,000
* ¥8,000,000 ÷ 4,000 DLHs = ¥2,000 per DLH
2. High-low analysis of maintenance cost:
High activity level ............
Low activity level .............
Change ...........................
Direct LaborHours
5,000
4,000
1,000
Maintenance
Cost
¥2,625,000
2,250,000
¥ 375,000
Variable cost element:
Change in cost
¥375,000
=
= ¥375 per DLH
Change in activity 1,000 DLHs
Fixed cost element:
Total cost at the high activity level .....................
Less variable cost element
(5,000 DLHs × ¥375 per DLH) ........................
Fixed cost element ...........................................
¥2,625,000
1,875,000
¥ 750,000
Therefore, the cost formula for maintenance is: ¥750,000 per year plus
¥375 per direct labor-hour or
Y = ¥750,000 + ¥375X
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Solutions Manual, Chapter 5
207
Problem 5-24A (continued)
3. Total factory overhead cost at 4,800 direct labor-hours would be:
Indirect materials
(4,800 DLHs × ¥2,000 per DLH) ............
¥ 9,600,000
Rent .......................................................
5,000,000
Maintenance:
Variable cost element
(4,800 DLHs × ¥375 per DLH) ............ ¥1,800,000
Fixed cost element ...............................
750,000
2,550,000
Total factory overhead cost ......................
¥17,150,000
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208
Introduction to Managerial Accounting, 4th Edition
Teamwork in Action
The costs necessary to manufacture chocolate chip cookies might include,
but would not be limited to, the following:
Product Components and Costs
Ingredients (such as flour,
chocolate chips, sugar, salt, etc.) .
Packages .......................................
Corrugated shipping boxes .............
Assembly line workers (mixers,
bakers, packagers, etc.) ..............
Depreciation on building ................
Depreciation on machinery .............
Insurance ......................................
Factory supplies .............................
Lubricants .....................................
Property taxes on building ..............
Supervisors ...................................
Telephone .....................................
Utilities (electricity, water, etc.) ......
(1)
(2)
Type of
Product Cost
Type of
Cost Behavior
Direct materials Variable
Direct materials Variable
Direct materials Variable
Direct labor
Overhead
Overhead
Overhead
Overhead
Overhead
Overhead
Overhead
Overhead
Overhead
Variable (1)
Fixed
Fixed (2)
Fixed
Mixed
Variable
Fixed
Fixed (if salaried)
Mixed
Mixed
Assumed; however, see related discussion of whether direct labor is
a variable or fixed cost in the text.
The depreciation may be wholly or partially variable if the machinery
wears out through use.
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Solutions Manual, Chapter 5
209
Communicating in Practice (45 minutes)
Note to the instructor: The issues raised in this assignment will challenge
your students to think about the application of the concepts covered in this
chapter.
Date:
To:
From:
Subject:
Current Date
Jasmine Lee
Student’s Name
Cost Estimate
You must consider cost behavior when estimating future costs, such as the
cost of catering a cocktail party. A variable cost is a cost whose total dollar
amount varies in direct proportion to changes in the activity level (in your
case, the number of guests). A fixed cost is a cost whose total dollar
amount remains constant within a relevant range of activity. A mixed cost
is one that contains both variable and fixed cost elements.
Food and beverage and labor are examples of variable costs. These costs
increase in total as the number of guests increases. On the other hand,
overhead cost is an example of a mixed cost. It has both variable and fixed
cost elements. The costs of hiring and writing paychecks for temporary
workers is an example of a variable cost, while the annual office rent and
administrative salaries are examples of fixed costs.
Before you make a decision about what to bid on this event, you should
remove the amount of fixed overhead from your total estimated cost per
guest to arrive at your total estimated variable cost per guest. To do this,
you need to break your overhead cost down into its variable and fixed
components. There are a variety of methods that you can use to break
down this mixed cost.
Finally, you noted that you are not willing to lose money on the fundraising cocktail party. Because this cocktail party will not require you to
incur any additional fixed expenses, your bid just needs to cover your
variable costs in order for the party to be profitable. As such, any bid
amount that exceeds your total variable cost per guest will generate a
profit. This will be less than the $31.32 total cost since that amount
includes fixed costs.
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210
Introduction to Managerial Accounting, 4th Edition
Analytical Thinking Case (60 minutes)
1. The completed scattergraph for the number of units produced as the
activity base is presented below:
5,000
4,500
Janitorial Labor Cost
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
0
20
40
60
80
100
120
140
Units Produced
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Solutions Manual, Chapter 5
211
Analytical Thinking Case (continued)
2. The completed scattergraph for the number of workdays as the activity
base is presented below:
5,000
4,500
Janitorial Labor Cost
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
0
2
4
6
8
10
12
14
16
18
20
22
24
Number of Janitorial Workdays
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Introduction to Managerial Accounting, 4th Edition
Analytical Thinking Case (continued)
3. The number of workdays should be used as the activity base rather
than the number of units produced. There are several reasons for this.
First, the scattergraphs reveal that there is a much stronger relationship
(i.e., higher correlation) between janitorial costs and number of
workdays than between janitorial costs and number of units produced.
Second, from the description of the janitorial costs, one would expect
that variations in those costs have little to do with the number of units
produced. Two janitors each work an eight-hour shift—apparently
irrespective of the number of units produced or how busy the company
is. Variations in the janitorial labor costs apparently occur because of
the number of workdays in the month and the number of days the
janitors call in sick. Third, for planning purposes, the company is likely
to be able to predict the number of working days in the month with
much greater accuracy than the number of units that will be produced.
Note that the scattergraph in part (1) seems to suggest that the
janitorial labor costs are variable with respect to the number of units
produced. This is false. Janitorial labor costs do vary, but the number of
units produced isn’t the cause of the variation. However, since the
number of units produced tends to go up and down with the number of
workdays and since the janitorial labor costs are driven by the number
of workdays, it appears on the scattergraph that the number of units
drives the janitorial labor costs to some extent. Analysts must be careful
not to fall into this trap of using the wrong measure of activity as the
activity base just because it appears there is some relationship between
cost and the measure of activity. Careful thought and analysis should go
into the selection of the activity base.
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Solutions Manual, Chapter 5
213
Research and Application
1. Blue Nile succeeds first and foremost because of its operational
excellence customer value proposition. Page 3 of the 10-K says “we
have developed an efficient online cost structure … that eliminates
traditional layers of diamond wholesalers and brokers, which allows us
to generally purchase most of our product offerings at lower prices by
avoiding markups imposed by those intermediaries. Our supply solution
generally enables us to purchase only those diamonds that our
customers have ordered. As a result, we are able to minimize the costs
associated with carrying diamond inventory.” On page 4 of the 10-K,
Blue Nile’s growth strategy hinges largely on increasing what it calls
supply chain efficiencies and operational efficiencies. Blue Nile also
emphasizes jewelry customization and customer service, but these
attributes do not differentiate Blue Nile from its competitors.
2. Blue Nile faces numerous business risks as described in pages 8-19 of
the 10-K. Students may mention other risks beyond those specifically
mentioned in the 10-K. Here are four risks faced by Blue Nile with
suggested control activities:
 Risk: Customer may not purchase an expensive item such as a
diamond over the Internet because of concerns about product quality
(given that customers cannot see the product in person prior to
purchasing it.)
Control activities: Sell only independently certified diamonds and
market this fact heavily. Also, design a web site that enables
customers to easily learn more about the specific products that they
are interested in purchasing.
 Risk: Customers may avoid Internet purchases because of fears that
security breaches will enable criminals to have access to their
confidential information.
Control activities: Invest in state-of-the-art encryption technology
and other safeguards.
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Introduction to Managerial Accounting, 4th Edition
Research and Application (continued)
 Risk: Because Blue Nile sells luxury products that are often
purchased on a discretionary basis, sales may decline significantly in
an economic downturn as people have access to less disposable
income.
Control activities: Expand product offerings and expand the number
of geographic markets served.
 Risk: The financial reporting process may fail to function properly
(e.g., it may not comply with the Sarbanes-Oxley Act of 2002) as the
business grows.
Control activities: Implement additional financial accounting systems
and internal control over those systems.
Blue Nile faces various risks that are not easily reduced through control
activities. Three such examples include:
 If Blue Nile is required by law to charge sales tax on purchases it will
reduce Blue Nile’s price advantage over bricks-and-mortar retailers
(see page 17 of the 10-K).
 Restrictions on the supply of diamonds would harm Blue Nile’s
financial results (see page 9 of the 10-K).
 Other Internet retailers, such as Amazon.com, could offer the same
efficiencies and low price as Blue Nile, while leveraging their stronger
brand recognition to attract Blue Nile’s customers (see page 10 of
the 10-K).
3. Blue Nile is a merchandiser. The first sentence of the overview on page
3 of the 10-K says “Blue Nile Inc. is a leading online retailer of high
quality diamonds and fine jewelry.” While Blue Niles does some
assembly work to support its “Build Your Own” feature, the company
essentially buys jewelry directly from suppliers and resells it to
customers. In fact, Blue Nile never takes possession of some of the
diamonds it sells. Page 4 of the 10-K says “our diamond supplier
relationships allow us to display suppliers’ diamond inventories on the
Blue Nile web site for sale to consumers without holding the diamonds
in our inventory until the products are ordered by customers.” This
sentence suggests that items are shipped directly from the supplier to
the consumer.
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Solutions Manual, Chapter 5
215
Research and Application (continued)
4. There is no need to calculate any numbers to ascertain that cost of
sales is almost entirely a variable cost. Page 25 of the 10-K says “our
cost of sales consists of the cost of diamonds and jewelry products sold
to customers, inbound and outbound shipping costs, insurance on
shipments and the costs incurred to set diamonds into ring, earring and
pendant settings, including labor and related facilities costs.” The
overwhelming majority of these costs are variable costs. Assuming the
workers that set diamonds into ring, earring, and pendant settings are
not paid on a piece rate, the labor cost would be step-variable in
nature. The facilities costs are likely to be committed fixed in nature;
however, the overwhelming majority of the cost of sales is variable.
Similarly, there is no need to calculate any numbers to ascertain that
selling, general and administrative expense is a mixed cost. Page 25 of
the 10-K says “our selling, general and administrative expenses consist
primarily of payroll and related benefit costs for our employees,
marketing costs, credit card fees and costs associated with being a
publicly traded company. These expenses also include certain facilities,
fulfillment, customer service, technology and depreciation expenses, as
well as professional fees and other general corporate expenses.” At the
bottom of page 25, the 10-K says “the increase in selling, general and
administrative expenses in 2004 was due primarily to…higher credit
card processing fees based on increased volume.” This indicates that
credit card processing fees is a variable cost. At the top of page 26 of
the 10-K it says “the decrease in selling, general and administrative
expenses as a percentage of sales in 2004 resulted primarily from our
ability to leverage our fixed cost base.” This explicitly recognizes that
selling, general and administrative expense includes a large portion of
fixed costs.
Examples of the various costs include:
 Variable costs: cost of sales, credit card processing fees
 Step-variable costs: diamond setting labor, fulfillment labor
 Discretionary fixed costs: marketing costs, employee training costs
 Committed fixed costs: general corporate expenses, facilities costs
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Introduction to Managerial Accounting, 4th Edition
Research and Application (continued
5. The data needed to complete the table as shown below is found on page 49 of the 10-K:
Net sales ..................
Cost of sales .............
Gross profit ...............
Selling, general and
administrative
expense .................
Operating income ......
Quarter
1
$35,784
27,572
8,212
5,308
$ 2,904
High Quarter (‘04 Q4) ......
Low Quarter (’04 Q3) .......
Change ............................
2004
Quarter Quarter
2
3
$35,022
27,095
7,927
$33,888
26,519
7,369
5,111
$ 2,816
5,033
$ 2,336
Quarter
4
$64,548
50,404
14,144
7,343
$ 6,801
2005
Quarter
1
Quarter 2
$44,116
34,429
9,687
$43,826
33,836
9,990
6,123
$ 3,564
6,184
$ 3,806
Selling, General,
and
Net sales Administrative
$64,548
$33,888
$30,660
$7,343
$5,033
$2,310
Variable cost = $2,310/$30,660 = 0.075342 per dollar of revenue
Fixed cost estimate (using the low level of activity):
$5,033 − ($33,888 × 0.075342) = $2,480 (rounded up)
The linear equation is: Y = $2,480 + 0.075342X, where X is revenue.
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Solutions Manual, Chapter 5
217
Research and Application (continued)
6. The contribution format income statement using the high-low method
for the third quarter of 2005 would be as follows:
2005
Third Quarter
Net sales .........................................
$45,500
Cost of sales .................................... $35,128
Variable selling, general and
administrative ...............................
3,428 38,556
Contribution margin .........................
6,944
Fixed selling, general and
administrative ...............................
2,480
Operating income ............................
$ 4,464
The contribution format income statement using least-squares
regression for the third quarter of 2005 would be as follows:
2005
Third Quarter
Net sales .........................................
$45,500
Cost of sales .................................... $35,128
Variable selling, general and
administrative ...............................
3,422 38,550
Contribution margin .........................
6,950
Fixed selling, general and
administrative ...............................
2,627
Operating income ............................
$ 4,323
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Introduction to Managerial Accounting, 4th Edition
Research and Application (continued)
7. Blue Nile’s cost structure is heavily weighted towards variable costs.
Less than 10% of Blue Nile’s costs are fixed. Blue Nile’s cost of sales as
a percentage of sales is higher than bricks-and-mortar retailers. Page 22
of the 10-K says “As an online retailer, we do not incur most of the
operating costs associated with physical retail stores, including the costs
of maintaining significant inventory and related overhead. As a result,
while our gross profit margins are lower than those typically maintained
by traditional diamond and fine jewelry retailers, we are able to realize
relatively higher operating income as a percentage of net sales. In
2004, we had a 22.2% gross profit margin, as compared to gross profit
margins of up to 50% by some traditional retailers. We believe our
lower gross profit margins result from lower retail prices that we offer
to our customers.”
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