CHAPTER3

COSTANALYSIS

31CostClassification
(a)Committed
(b)Committed
(c)Discretionary,butinsomecompaniescouldbecommitted(Intel,
Microsoft,et.al.)
(d)Committed
(e)Discretionary
(f)Committed
(g)Discretionary
32LimitationsofHighLowMethod

Theprocedurewouldnotworkwellbecausethetwopointsusedto
determinethepatternofcostbehaviorareoutsidetherelevantrange.The
resultswillprobablyunderstatethefixedcomponentandoverstatethe
variablecomponent.Totalcostsatshutdown(allfixedcosts)arealmost
certainlylessthanfixedcostsintherelevantrangeandtotalcostsat100%
ofcapacitywillreflectinefficienciesfromsacrificingefficiencyto
increaseoutput.Thecompanywillhireinexperiencedworkers,expedite
deliveriesofmaterials,andtakeotheractionsthatwillincreasecosts.If
theycansellallthattheycanmake,thecompanywillbeveryprofitable,
andcostcontrolisnotlikelytobeahighpriority.
33MethodsofCostBehaviorAnalysis
Thehighlowmethodisquickandeasy,butusesonlytwoobservations
andsoisseriouslydeficient.Itassumesthatthetwoselectedpointsare
representative.Itgivesnoindicationofhowaccuratepredictionsare
likelytobe.
Thescatterdiagrammethodisbetterthanthehighlowmethod.Ituses
moreobservations,itallowsavisual,informalanalysisofgoodnessoffit,
anditallowsuserstospotoutliersorproblematicpatternsofcost(suchas
curvilinearbehaviororkinksthatindicatetwoormorecostfunctions).
Regressionanalysisgivesmorepreciseresultsthanscatterdiagrams,
givesformalmeasuresofgoodnessoffit,andpermitstheuseofmorethan
oneindependentvariable.Byitself,itdoesnotallowtheusertospot
outliersorproblematiccostpatterns.

31

34CostClassification
Itneedstobemadeclearwithrespecttowhatdecisionacostis
avoidable.Youmightwishtoaskforotherdecisionsortypesofdecisions
forwhicheachcostmightbeavoided.
(a)Avoidableanddirect
(b)Unavoidable,butdirect
(c)Avoidableanddirect
(d)Unavoidableandindirect
(e)UnavoidableandindirectThecostisavoidable,butnotwith
respecttodecisionsabouttheSouthCentralregion.
(f)Avoidableanddirect
Thepatternthatemergesisthatavoidablecostsaretypicallydirect,
indirectcostsusuallyunavoidable,butnotnecessarilyviceversa.Chapter
5discussessituationsinwhichindirect,commoncostsmightbeavoided,
essentiallywhendroppingasegmentsogreatlyreducesworkloadthata
servicedepartmentmightbereduced.

35CostClassification
BDirectnessandAvoidability
(a)Avoidableanddirect
(b)Unavoidableandindirect
(c)Unavoidable,butdirect
(d)Unavoidableandindirect
(e)Avoidableanddirect
(f)Unavoidableandindirect
36AccuracyofPredictions(5minutes)
Indirectlaborismucheasier.Theobservationsliealongalinewhile
suppliescostiswidelydispersed.Ifacostlinewerefittedvisuallyin
eachgraphandcostspredictedbasedontheformulaforthatline,theactual
costsofsupplieswillbefartherfromthatlinethantheactualcostsof
indirectlabor.
37MixedCosts(10minutes)
1.$64,230fixed,$0.57perhourvariable
$90,450$85,890=$4,560/8,000=$0.57perhourvariable
component
46,00038,000
Fixedcost=totalcosttotalvariablecost
Usingthehighvolume,
Fixedcost=totalcosttotalvariablecost
=$90,450(46,000x$0.57)
=$90,450$26,220
=$64,230
Usingthelowvolume,

32

=$85,890(38,000x$0.57)
=$85,890$21,660
=$64,230
2.$89,880$64,230+($0.57x45,000hours)
3.Thecontrollerwantstobeabletopredictcosts,andalsomusttakepart
indecisionsaboutpricing,whethertoacceptparticulartypesofbusiness,
andothers.
38CostBehavior(10minutes)
1.Variablecomponent=costathighvolumecostatlowvolume
highvolumelowvolume
=$29,840$21,150=$8,690/$220,000=0.0395,or3.95%
$560,000$340,000
Fixedcomponent=Totalcostvariablecost,usingthehighvolume,
F=$29,840(0.0395x$560,000)
F=$29,840$22,120
F=$7,720
2.Exceloutputfollows.
SUMMARYOUTPUT
RegressionStatistics
MultipleR
0.783200
RSquare
0.613403
AdjustedRSquare
0.558175
StandardError
1,829.53
Observations
9

Intercept
MonthlyService
Revenues

Standard
Coefficients
Error
tStat Pvalue Lower95%
Upper95%
11,928.34 3,946.01 3.023 0.019 2,597.52 21,259.17
0.02902 0.00871 3.333 0.013 0.00843 0.04960

Theresultsarequitedifferent.Theregressionlineis$11,928+0.029x
salesasopposedto$7,720+0.0395xsales.Thefixedcomponentishigher
andthevariablecomponentlowerthanthehighlowmethodgives.Thehigh
andlowobservationsappeartobenonrepresentativeoftheentireset.Of
course,itsrelianceontwoobservationsisamajorweaknessofthehighlow
method.
3.Theequationisreasonablygood.Anr2of.613andastandarderrorof
$1,830aredecentmeasuresofgoodnessoffit.The95%confidenceinterval
forthevariablecostdoesnotincludezero.Giventhatservicerevenues
averagenearly$450,000,theaveragepredictedcostwillbeabout$25,000,so
68%ofobservationsshouldbewithin$1,830,orabout7.4%.
39CostAnalysis,HighLowMethod(20minutes)

33

1.
Costof
GoodsSoldSellingAdministrative
Costathighvolume$54,000$8,800$9,400
Costatlowvolume48,0008,5009,200
Changeincost$6,000$300$200
Dividedbychangeinvolume$10,000$10,000$10,000
Equalsvariablecostpercentage60%3%2%
Totalcostatsalesof$90,000$54,000$8,800$9,400
Variablecostportion($90,000x
variablecostpercentage)54,0002,7001,800
Fixedportionofcost$$6,100$7,600
2.IncomeStatement
Sales$100,000
Variablecosts:
Costofgoodssoldat60%$60,000
Sellingexpensesat3%3,000
Administrativeexpensesat2%2,000
Totalvariablecostsat65%65,000
Contributionmarginat35%35,000
Fixedcosts:
Selling$6,100
Administrative7,600
Totalfixedcosts13,700
Income$21,300

NotetotheInstructor:Studentswillusedifferentformatsin
requirement2.Somemightfindonlythetotalforeachcomponentandplace
onlythattotalonthestatement.Alternativesoffertheopportunityto
discusstheideaofpreparingstatementsandinternalreportsinaformmost
likelytobeunderstoodandusefultotheirreaders.Thepointtobemadeis
thatinformationprovidedbyaccountantsdoesnotfulfillitsfunctionifthe
managersreceivingitcannotuseittofulfilltheirfunctions.Auseful
analogyof"differentreportsfordifferentpeople"isfoundinfinancial
accounting,wheretheformatschangeforreportstostockholders,themany
governmentalunits,regulatoryagencies,tradeassociations,etc.
Youmightwishtomakethepointthat,foranonmanufacturingcompany,
costofgoodssoldshouldbewhollyvariable(notmixed,asitcanbefora
manufacturer).Ofcourse,costofsalesmightnotbeexactlythesame
percentageofsalesfromperiodtoperiodevenifsellingpricesare
constant.Changesinthepercentageofcostofsalestosalesbetweentwo
periodscouldresultfromachangeinpurchasepricesorsalesmix(covered
inChapter4).
310UnderstandingRegressionResults(1015minutes)
Thememorandumshouldcontainthefollowingmajorpoints.

Theequationtellsusthatparttimeconsultantscosthasafixed
componentof$101,187permonthandavariablecomponentof$0.0898per
dollarofconsultingrevenue.Therefore,topredictthecost,wemultiply
expectedrevenueby$0.0898andadd$101,187.Forexample,at$900,000,

Y=$101,187+($0.0898x$900,000)=$182,007

34


Theslopetellsusthevariablecomponentofthecost,sowecanuseit
todeterminetheprobableincrease(ordecrease)incoststhatwould
accompanyanincrease(ordecrease)inbusiness.
Thecoefficientofdetermination,r2of0.6266,or62.66%,isthe
percentageofthevariationinparttimeconsultantscostthatisassociated
withchangesinrevenue.Thevalueisrelativelyhighforsuchdataandso
indicatesthatthefitisgood.
Thestandarderroroftheestimate,tellsushowcloseourpredictions
arelikelytobetotheactualresults.Inthiscase,weexpectpredictions
tobewithin$9,329about68%ofthetime,andwithin$18,658(2x$9,329)
about95%ofthetime.(Thisisabitroughanddoesnottellusthe
confidenceintervalforasinglepredictionbutfortheaverage.Thispoint
isprobablynotimportanttomostclasses.)
Itisalsohelpfultounderstandwhattheresultsdonottellyou.The
equationisnotnecessarilythebestavailable.Someotherfactormight
predictbetter.Multipleregressionwithsomeotherfactorsmightgive
betterresultsintheformofahigherrsquaredandalowerstandarderror.
Theintercept,$101,187,isnottheestimateoftotalcostatzero
revenue.Thedatawerecollectedintherangeof$800,000to$1,200,000,and
itisunsafetoextrapolateoutsidethatrange.
NotetotheInstructor:Studentsoftenaskwhatagoodvalueisforr2.
Thebestanswer,thatitdependsonthedata,isnottoosatisfying.Anything
above.50isprobablyquitegoodforcostdatainacomplicatedenvironment.
Evaluatingthestandarderrorrequiresexaminingtherelationshipofthe
errortothetotalcost.Forinstance,at$1,000,000hours(midpointof
range)predictedcostis$190,987.Thestandarderrorof$9,329isabout5%
ofpredictedcost,whichisaprettygoodfit.
311InterpretingBehaviorPatterns(1015minutes)
1.Thefirststepistodeterminejustwhatthebehavioris.Thefirstset
ofobservationsshowsarelativelylowfixedcostandarapidlyincreasing
totalcost.Thisindicatesthatvariablecostisrelativelyhigh.The
secondsegmentshowsajumpabovethelevelofthefirstsegment,witha
flatteningofthetotalcostline,indicatingadeclineinvariablecostper
unitofactivity.Thethirdsegmentshowsmuchthesame:ajumpinthe
levelofcosts,withafurtherflatteringoftheslopeofthecostline.
Onepossibleexplanationfortheobservedbehavioristhat"variable"
costsperunitdropasvolumeincreases,withincreasesinstepvariable
costsaccountingforthejumps.Ifthecostweretotalmanufacturingcost,a
possibleexplanationisthatmaterialsweresubjecttoquantitydiscountsand
werealargeproportionoftotalcosts,withjumpsincostoccurringbecause
ofstepvariablecostssuchassupervision.
Anotherpossibleexplanationisthatthecompanyhasthreealternative
methodsofproduction,withincreasingamountsofmachinerycausingthejumps
incostandincreasedefficiencyintheuseoflaborandmaterialscausing
theflatteningsofthecostlines.Itisunlikelythatthefirmcould
actuallyoperatefromnearzerotonearfullcapacityinthismanneratshort
notice,unlessthemachinerycouldberentedatshortnotice.Hence,the
costbehaviorunderthisexplanationshouldbeviewedasrelativelylong
term.

35

2.Planningforthecostsshouldberelativelysimpleiftherangewithin
whichthecompanyexpectstooperatewasrelativelycertain.Threedifferent
lineswouldbedrawnandusedinprediction,dependingontherangeinwhich
volumewasexpectedtooccur.Asinglelinecouldnotbeagoodpredictor.
312HighLowMethodforManufacturingCompany(20minutes)
1.Costofsales:30%ofsales$$variable,$340.0fixed
S&Aexpenses:20%ofsales$$variable,$150.0fixed
CostofSalesS&AExpenses
Costathighvolume$688.0$382.0
Costatlowvolume670.0370.0
Differences$18.0$12.0
Dividedbydifferenceinsales$60.0$60.0
Variablecomponents30%20%
Costathighvolume$688.0$382.0
Lessvariablecost:
$1,160.0x30%348.0
$1,160.0x20%______232.0
Fixedcomponents$340.0$150.0
2.AprilMay
Sales$1,100.0$1,160.0
Variablecosts:
Manufacturingat30%$330.0$348.0
S&Aat20%220.0550.0232.0580.0
Contributionmargin550.0580.0
Fixedcosts:
Manufacturing340.0340.0
S&A150.0490.0150.0490.0
Income$60.0$90.0

Severalcommentsapplyhere.First,somestudentsdonotunderstandthat
recastingincomestatementsdoesnotchangeprofit,onlytheformofthe
statement.Second,thecontributionmarginformatallowsustodoCVP
analysis,whichwecouldnotwiththefunctionalincomestatements.Wecan,
forexample,determinethebreakevenpointbecauseweknowthatcontribution
marginis50%(100%30%20%)andtotalfixedcostsare$490.0:
$490.0/50%=$980.0
Wecanalsocalculatesalesvolumesrequiredfortargetprofitsanddoother
planningthatisimpossiblewithoutknowledgeofcostbehavior.

313Relationships(15minutes)
1.(b)$600,000$400,000+$200,000
(a)$2.00$8sellingpriceless$6contributionmarginper
unit($600,000/100,000)
(c)$230,000$200,000currentincome+additionalcontribution
marginof$30,000(5,000x$6),or105,000x$6=
$630,000totalcontributionmarginless$400,000fixed
costs=$230,000

36

2.(d)$250,000$50,000/20%
(c)25,000units$250,000/$10
(b)$6$10x(100%40%)
(a)$50,000($250,000x40%)$50,000profit
3.(c)$60,000$400,000x15%
(a)10,000
Sales$400,000
Totalcontributionmargin($60,000+$90,000)150,000
Variablecosts$250,000
Variablecostperunit$25
Numberofunitssold($250,000/$25)10,000
(b)$15$150,000CM/10,000units
314PerUnitAnalysis(1015minutes)
1.$432,000,$5.40x80,000.Youmightwanttoreemphasizethatfixedcosts
comeintotal,notperunit,andthatthismultiplicationisnecessary
becauseyoumustworkbackwards.
2.85,000units
Totalfixedcosts$432,000
Desiredprofit180,000
Totalrequiredcontributionmargin$612,000
Dividedbycontributionmarginperunit($12$4.80)$7.20
Unitsrequired85,000
3.$13.54perunit
Desiredincome$180,000
Fixedcostsfromrequirement1432,000
Requiredtotalcontributionmargin$612,000
Dividedbyexpectedunitvolume70,000units
Equalsrequiredperunitcontributionmargin$8.74
rounded
Plusexpectedvariablecostperunit4.80
Requiredprice$13.54
4.$9,600increaseinprofit.Eitherthetotalorincrementalapproaches
couldbeusedhere.Usingthetotalapproach,
Expectedtotalcontributionmargin($7.20x83,000)$597,600
Expectedfixedcosts($432,000+$12,000)444,000
Expectedtotalprofit153,600
Profitexpectedwithoutadditionalexpenditure(80,000x$1.80)144,000
Increaseinprofit$9,600
Usingtheincrementalapproach,
Additionalcontributionmargin($7.20x3,000units)$21,600
Addedfixedcosts12,000
Increaseinprofit$9,600
NotetotheInstructor:Youmightwishtoasktheclasshowmanyadditional
unitsthecompanymustselltomaketheadvertisingcampaignjustpayfor
itself.Thecalculationissimilartothatofanindifferencepoint,oreven
ofabreakevenpoint.
$12,000/$7.20=1,667units

37

Because1,667iswellbelowtheexpected3,000units,thecompanyisprobably
welladvisedtogoahead.Hadtheindifferencepointbeen,say,2,800units,
areasonablemanagermightbelievethattheriskistoogreatbecausea
relativelysmallshortfallwouldwipeouttheadditionalprofit.
315PercentageIncomeStatement(1520minutes)
1.$80,000$800,000x10%
2.$160,000fixedcosts,$533,333breakevenpoint,($160,000/30%)and
$266,667marginofsafety($800,000$533,333)
Variablecostsare70%ofsalescostofsalesof60%plus10%commissionso
contributionmarginis30%.Tofindfixedcosts,
Totalcostsat$800,000sales$800,000$80,000profit$720,000
Totalvariablecosts($800,000x70%)560,000
Totalfixedcosts$160,000
3.$50,000
Contributionmargin($700,000x30%)$210,000
Fixedcosts160,000
Profit$50,000
Or,thedecreasedsalesof$100,000decreaseprofitby$30,000($100,000x
30%CM%),from$80,000to$50,000.
4.5.55%Theeasiestwaytoapproachthisrequirementistousethebasic
profitequation.Costofsalesremainsat$480,000,($800,000x60%).
S$480,000.1S$160,000=$120,000
.9S=$760,000
S=$844,444
Percentageincrease=5.55%($44,444/$800,000)
Asproof,
Sales$844,444
Costofsales,asbefore480,000
Grossmargin364,444
Commission($844,444x10%)84,444
Contributionmargin280,000
Fixedcosts160,000
Profit$120,000
316CostBehaviorGraphs(15minutes)
UnofficialanswerstothisCPAproblemareasfollows:
1.C2.F3.K4.B5.A6.D7.J8.EorH
9.L(Item9isdifferentfromtheoriginalCPAproblem.)10.G
Manyoftheanswersassumethattheuseofthecostelementisatleast
partlyvariablewithproduction.Item3isanexample.Thecostofwateras
theuseofwaterincreasesisdescribedbygraphK.Itisassumedthat
increasesinproductioncauseproportionalincreasesintheamountofwater
consumed.Itispossible,butunlikely,thattheuseofwaterisrelatively
constantwhateverproductionis.Itisalsopossiblethat1,000,000gallons
ormoreisthebaseamount,withadditionalwaterbeingrelatedto
production.

38

NotetotheInstructor:Althoughwedidnotshowtheverticalsegments
ofstepvariablecostsinthetext,studentshavehadlittledifficultywith
costgraphssuchasitem7.YoumightwishtopointoutthatgraphJis
technicallyincorrectbecausethecostisdiscontinuous,jumpingfromone
leveltoanother.Thisposesnorealprobleminapracticalsituation
becausetheportionsofdiscontinuityarequitesmall.Inthiscase,a
singlemachinehouratthebreakingpointgivesthejumps,anditisunlikely
thatanycompanycouldbesopreciseinitshiringpractices.
SomestudentswillwonderwhythesecondsegmentofthelineingraphH
(item8)tiltsupwardinsteadofbeingparalleltothehorizontalaxis.The
reasonseemstobethatalthoughthelaborforceis"constantinnumber,"it
couldbechangingincompositionbecauseofturnover.Itisalsopossible
thatsomeworkersearnannualwagesoflessthan$8,500.GraphEisagood
answerif(a)thereisnoturnoverandallworkersearningmorethan$8,500.
317CVPReview(20minutes)
1.183sweaters,rounded($5,000+$6,000)/($100$40)=$11,000/$60
Usethehighlowmethodtodeterminefixedandvariablecosts:
At150units,costsare(150x$100)$4,000=$11,000
At200units,costsare(200x$100)$7,000=$13,000
Variablecosts=($13,000$11,000)/(200150)=$40
Fixedcosts=$13,000($40x200)=$5,000
2.$113.33rounded
Salesvariablecostsfixedcosts=profit
(Sx150)($40x150)$5,000=$6,000
(S$40)=$11,000/150
S=$40+73.33
3.150sweaters,sameasnowSomealertstudentswillseethatthe
supplierreceives$40eitherwayatthe$100price.Somewillgothrough
calculationssuchasthefollowing.
$100$30(10%x$100)=$60newcontributionmargin,sameasnow
($5,000+$4,000)/$60=150
Theproposedagreementgivesthesupplierthesametotalcompensationatthe
$100sellingprice.Athighersellingpricesthesupplierwilltakealarger
share.Inalllikelihood,Miawillraisepricesinthefuture,makingthe
proposedarrangementmoreattractivetothesupplier,lessattractivetoMia.

318ProfitImprovementAlternatives(15to25minutes)
To:LeslieMeriwether
From:Student
Date:Today
Subj:Profitimprovement
Wecanachieveourtargetprofitby(a)increasingsellingprice,(b)
decreasingvariablecost,(c)decreasingfixedcosts,and(d)increasingsales
volume.Therequiredchangesintheseitemsappearbelow:
(a)Increasesellingpriceto$10.60,anincreaseof$0.60perunit.

39

Withnochangeinfixedorvariablecosts,a$60,000increaseinprofit
($100,000desiredvs.$40,000earnedlastyear)requiresa$60,000increase
incontributionmarginatavolume(currentlevel)of100,000.Hence,an
increaseof$0.60($60,000/100,000)isnecessary.
Competitionwilldeterminewhetherwecanachievetheexpectedvolumewith
thehigherprice.
(b)Reducevariablecostperunitto$5.40,adecreaseof$0.60perunit.
Thelogichereisthesameasinrequirement(a).Contributionmargin
mustincreaseby$0.60perunit,andwithaconstantsellingpriceof$10
theperunitvariablecostmustdecline$0.60from$6.
Wemightchangesupplierstoreducevariablecosts,butsuchastepcould
reducethequalityoftheproduct.Weshouldlookforactivities/costs
thatdonotaddvaluetotheproduct.
(c)Fixedcostsmustdecreaseby$60,000,to$300,000.
Ifprofitistoincrease$50,000andcontributionmarginistoremainthe
same,fixedcostsmustbereducedbyanamountequaltothedesired
increaseinprofit.
Wecaneasilyreducesomefixedcosts,butagainthequestioniswhetherwe
mightrunintootherdifficulties.Wecanalwaysreducediscretionarycosts
suchasadvertising,butperhapsatthecostofreducedsales.Wecouldcut
othercoststhatmightharmusinthelongrun.Suchcostsincludeemployee
trainingandmaintenance.
(d)Increasesalesto115,000,anincreaseof15%.
Hereagain,ifprofitistoincrease$60,000withoutachangeinfixedcosts,
totalcontributionmarginmustalsoincreasebythatamount.Ifselling
price($10)andvariablecostperunit($6)remainconstant,contribution
marginremainsat$4,anditwillrequire15,000moreunits($60,000/$4)to
producethedesiredincreaseinprofit.
Increasingunitsaleswithoutincreasingcostscouldbedifficult.An
expandingmarketwouldhelp,aswouldbetterservicetoourcustomersanda
higherqualityproduct.Achievingtheseimprovementswithoutincreasing
costsmightnotbepossible.
319InterpretingData(1015minutes)
Theassistantmerelyconnectedthehighandlowpointswithhisline,not
consideringtheinterveningobservations.Moreover,thehighandlowpoints
areatvolumesfarremovedfromtheotherobservations,soweshouldquestion
whethertheyarewithintherelevantrange.Becausethecostismaintenance,
wemightevenexpectarelativelyhigherthannormalcostatlowactivity
becausethereisthenmoretimeforperformingthework.Similarly,atthe
highpointwemightexpectlowerthannormalcostsbecauseoftheinability
toperformworkthen,aswellasmanagers'unwillingnesstotakelimosinfor
serviceduringapeakperiod.
Theassistant'slineshowsobservationsinalmostequalnumbersaboveand
below,butthelinewouldfitthemajority(allbutthehighandlow)ofthe
observationsbetterifitweretiltedupandpusheddownonthevertical
axis.Alinehittingtheverticalaxisat$100andwithaslopeof$1.55fits

310

nicely.At500hours,thecostisabout$875.Thislineignorestheextreme
points.Iftheextremepointsaretobeconsidered,thelinewouldtiltless
andthefixedcostcomponentwouldbehigherthan$100.Puttingacoupleof
alternativesontheboardwillhelpstudentsseethedifferencesthatwould
arisefromdifferinginterpretationsoftheparticularobservations.

320DeltaAirlinesCVPRelationships(20minutes)
1.Thekeyistofindrevenuesandcostsatbreakeventobeabletousethe
highlowmethod.
Revenueandcostatbreakeven=$14,881($16,741/.729)x.648
So,$15,003$14,881=$122=6.56%variablecomponent
$16,741$14,881$1,860
2.Thefixedcomponentis$13,905million,$14,881($14,881x$0.0656)
3.$1,953million
Revenue,$16,741/.729x.739$16,971
Operatingexpenses
Variableat6.56%$1,113
Fixed13,905
Totaloperatingexpenses15,018
Operatingincome$1,953
4.Thelessonisthatanairline,oranyothercompanywithveryhighfixed
costsandlowvariablecosts,livesanddiesbyvolume.Thecalculationin
requirement3showsthateachpercentagepointaddsover$215million($1,953
$1,738=$215)tooperatingincome.Ofcourse,eachdropreducesoperating
incomebythesameamount.

311

321UsingMultipleRegression(20minutes)
1.$75,992$49,272+($1.78x12,000)+($2.68x2,000)
2.$30.90,calculatedasfollows:
Materials$6.00
Labor,2hoursx$1020.00
Variablemanufacturingoverhead(2.0x$1.78)+(.50x$2.68)4.90
Totalvariablecost$30.90
3.$5.89
Reducedlabor,$10x.50$5.00
Reducedvariableoverhead$1.78x.500.89
Totalreduction$5.89
NotetotheInstructor:Youmightexpandontheimportantideathat,as
item3shows,whenacompanyreduceslabortime,itreducesnotonlylabor
costbutalsoanyvariablemanufacturingoverheaddrivenbydirectlabor
time.

322UnderstandingRegressionResults(15minutes)

1.$209,345,$118,645+($0.907x100,000)
2.No,becausezerohoursisoutsidetherelevantrange.Thispointisvery
important,yetoftenoverlooked.Itisnotsafetopredictcostsbelow
75,000norabove140,000hours.
3.$40.815(45x$0.907)perbatchof100,or$0.40815perunit
4.Thisquestionreferstomeasuresofgoodnessoffit.Ther 2of79.25%
indicatesquiteagoodfitbecause79.25%ofthevariationinpowercostis
associatedwithchangesinmachinehours.Thespecificrequirementofthe
questiongetsatthemeaningofthestandarderror.Actualcostshouldbe
within$9,497ofpredictedcostabout68%ofthetimeandwithin$18,994(2x
$9,497)about95%ofthetime.At100,000hours,$18,994isonly9.1%of
predictedcostofover$209,345(part1).
5.No.Therecouldbeanothersimpleregressionequationoramultiple
regressionequationthatpredictsbetter.Onlyifthecorrelationis
perfect,r2=1,Standarderror=zero,canyousaythatthereisnonebetter.
323ReviewProblem,IncludingIncomeTaxes(3540minutes)
1.$10($500,000sales/50,000units)
2.$2.50($10sellingprice$7.50variablecost)
variablecost=$375,000/50,000units=$7.50
3.24,000units($60,000fixedcosts/$2.50contributionmargin
4.$7,500(3,000unitsx$2.50contributionmarginperunit)
5.48,000units($60,000targetprofit+$60,000fixedcosts)/$2.50
6.$400,000$60,000fixedcosts/(25%contributionmargin10%ROS)
7.54,000units

312

Desiredaftertaxprofit$45,000
Dividedby60%=pretaxprofit$75,000
Fixedcosts60,000
Requiredcontributionmargin$135,000
Dividedby$2.50unitCM=54,000units
8.60,000units
Desiredaftertaxreturn9%
Dividedby60%=pretaxreturn15%
Sales=$60,000/(25%15%)
=$600,000
$600,000/$10sellingprice=60,000units
9.$10.20perunit
Desiredaftertaxprofit$45,000
Dividedby1taxrate0.60
Requiredpretaxprofit$75,000
Fixedcosts60,000
Requiredcontributionmargin$135,000
Dividedbyunitvolume50,000
Equalsrequiredunitcontributionmargin$2.70
Plusvariablecost7.50
Sellingprice$10.20
10.$10.36perunit,letP=sellingprice
50,000P(50,000x$7.50)$60,000=0.16Px50,000
P=$10.357
11.$625,000
Contributionmargin,$10.00($7.50+$0.50)$2.00
Contributionmarginpercentage,$2/$1020%
Requiredcontributionmargin,$60,000+$65,000$125,000
Dividedby20%equalsrequiredsales$625,000
324CostFormula,HighLowMethod(5minutes)
Thevariablecostrateisabout5.2%ofsales,andfixedcostsareabout
$412.

SalesWages
High$18,100$1,350
Low5,050675
Difference$13,050$675
Changeincostdividedbychangeinvolume($675/$13,050)=5.2%rounded
Substituting5.2%inthetotalcostformulaatthelowvolumelevel:
Fixedcosts+Variablecosts=Totalcosts
F+(5.2%x$5,050)=$675
F=$412rounded
NotetotheInstructor:Thisrelativelysimpleproblememphasizesthree
importantpoints.First,theobservationsusedincalculatingthevariable
andfixedcomponentsofamixedcostarethehighandlowpointsforthe
independentvariable,notforthedependentvariable.(Students
misunderstandingthispointwillusesalesvolumesof$1,950and$15,040.)
Second,thepointstobeusedmustbewithintherelevantrange.(Students
misunderstandingthispointwillusesalesvolumesof$1,950and$18,100.)

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Thethird,andmoregeneral,pointdemonstratedbythisproblemisthe
needtounderstandthefactsofthesituation.Agraspofthefactsis
necessaryifthestudentistoquestionwhethertheobservationsforsales
volumesof$2,000,$17,000,and$18,000areoutsidetherelevantrange,given
thatthelowandhighcostobservationsoccurat$1,950and$18,100.Inthis
case,theownercallsinparttimehelpbasedontheestimateofsalesfor
thecomingweek,anditistobeexpectedthattheowner'sestimatesare
sometimesoffbyawidemargin.Errorsinestimatesresultinwagesbeing
higherorlowerthanpredictedusingaformulabasedonactualsales.Thus,
whenactualsaleswere$15,040,theownermighthaveexpectedmuchlarger
volumeinoneormoreweeksandcommittedtomoreparttimehelp(whohadto
bepaid!).Similarly,thefactsgivenabouttheperiodwith$1,950sales
suggestthatthatlevelofvolumeisbelowtherelevantrangeandshouldbe
disregarded.

325FixedCostsandDecisions(25Minutes)
Thisisastraightforwardproblemthatallowsyoutodiscussseveral
importantpointsatanearlystageinthecourse.Theideaofopportunity
costandlossofsalesaretreatedinChapter5,buttheintroductionhereof
thesepointsisrelativelysimple.Moreover,youneednotevenusetheterm
opportunitycostinconnectionwiththisproblem.
Consideringonlyquantitativeissues,Keithisbetteroffstayingopen.
Anincomestatementassumingthatheclosesshowsthefollowing.
Rentonbuilding$1,550
Depreciationonfixtures600
Utilities,minimum450
Netloss$2,600
Addingthe$2,600losstothe$350profitthathecouldearnstaying
open,Keithis$2,950betteroffremainingopen.
ThefinalrecommendationdependsonwhatKeithmeansby"netatleast
$2,500forthemonth."Ifhemeansthathewantstobeatleast$2,500
betteroffstayingopen,heshouldstayopen,butifhemeansthathewants
toshowaprofitof$2,500,heshouldclose.
WhatevertheintentionofKeith'sstateddecisioncriterion,heshouldbe
advisedtorecognizetheeffectofaonemonthclosingontheprofitfora
fullyear.Thatis,thecosttohimofclosingis$2,950,notjustthe$350
profitgivenup.Moreover,Keithmighthavereasontobelievethatclosing
couldaffectfuturesales.Somesemiregularcustomersmightfindanother
restauranttheylikebetter.Somemightbeputoffbytheclosingandstay
awaylongerthantheirnormalintervals.

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326AlternativeCostStructures

AMovieCompany(30minutes)
NotetotheInstructor:Thisproblemcanbeansweredeitherbycomputing
profitsateachlevelofadmissionsorbyusingthebreakevenpointsfrom
problem243.
1.(a)Blockbusters:
Normalcontract

$180million

$200million

Revenues(40%)
$72,000,000
Variablecosts
3,600,000
Contributionmargin
68,400,000
Fixedcosts
65,000,000
Profit

$3,400,000

$80,000,000
4,000,000
76,000,000
65,000,000
$11,000,000

Specialcontract

$180million

$200million

Revenues(40%)
Variablecosts
Contributionmargin
Fixedcosts
Profit

$72,000,000
14,400,000
57,600,000
50,000,000
$7,600,000

$80,000,000
16,000,000
64,000,000
50,000,000
$14,000,000

Ineithercase,Blockbusterswillpreferthespecialcontract.As
problem243,requirement3showed,thespecialcontractwillbepreferredby
Blockbustersonlywhenrevenuestotheproducerarelessthan$100million.
(b)Driftwillpreferthenormalcontract.At$180million,thenormal
contractwouldpayDrift$23.6million($20millionsalary+3.6million
variable)whilethespecialcontractwouldpayDrift$19.4million.At$200
millionDriftspaywouldbe$24millionunderthenormalcontractand$21
millionunderthespecialcontract.
2.(a)Blockbusterswillpreferthenormalcontract.
Revenues
Variablecosts
Contributionmargin
Fixedcosts
Profit

Normal
$120,000,000
6,000,000
114,000,000
65,000,000
$49,000,000

Special
$120,000,000
24,000,000
96,000,000
50,000,000
$46,000,000

(b)Driftwillpreferthespecialcontract.Thenormalcontractwouldpay
$26millionwhilethespecialcontractwouldpay$29million.
327RegressionAnalysis(15minutes)
Thepointhereisthatobservationsaresowidelyscatteredthatthe
regressionequationisvirtuallyworthless.Ther2is0.019.Because
regressionanalysisalwaysgivesanequation(unlesstheindependentvariable
hasthesamevalueforeveryobservation),peoplesometimescountonitmore
thanisdesirable.ThefollowingExceloutputprovidesrelevantmeasures.

SUMMARYOUTPUT

315

RegressionStatistics
MultipleR
0.137572
RSquare
0.018926
AdjustedRSquare
(0.121227)
StandardError
48,652.19
Observations
9

Intercept
UnitsProduced

Standard
Coefficients
Error
tStat Pvalue Lower95%
Upper95%
262,203.39 74,407.37 3.524 0.010 86,258.05 438,148.73
13.1961 35.9103 0.367 0.724 (71.7181) 98.1104

Noticealsothatwithastandarderroroftheregressionequationof$48,652,
the68%confidenceintervalisverywide.Thevariable,UnitsProduced,is
notstatisticallysignificant.
328CVPAnalysiswithChangesinCosts(2025minutes)
1.$200,000(350,000x[$20$8])$4,000,000
2.$21Theincreaseinmaterialcostis$1.00($4.00x25%),sotheprice
increasemustcovertheincreaseinvariablecosts.Somestudentswill
simplyaddthe$12perunitcontributionmargintothenewperunitvariable
costof$9toarriveatthe$21price.Somestudentswillsolvefrom
scratch.
Sales=$4,000,000+(350,000x$9)+$200,000=$7,350,000
$7,350,000/350,000=$21
3.(a)$22.50($9.00/40%)Thecurrentcontributionmarginpercentageis
60%,($20$8)/$20,sothevariablecostratiois40%.Thenewvariable
costis$9,sothesellingpriceis$9dividedby40%.
Somestudentswillhavetroublewiththispart,whichisnotexplicitly
illustratedinthetext.However,allitrequiresisunderstandingthat100%
minusthecontributionmarginpercentageisthevariablecostpercentage.
(b)Profitwillbehigherbecausecontributionmarginperunitwillbe
higher($22.50x60%=$13.50,ratherthan$12).Thisrequirementemphasizes
thatcontributionmarginperunitandcontributionmarginpercentageare
different.Assumingnochangeinunitvolume,ifpricesareincreasedsoas
tomaintaintheperunitcontributionmargin,profitismaintainedatthe
previouslevel.Ifpricesareincreasedsoastomaintainthecontribution
marginpercentage,perunitcontributionmarginincreasesandsoprofit
increases.
329CostStructuresandAverageCosts(25minutes)

1.Sally:100,000x($10$9)=$100,000
Sam:200,000x($10$9)=$200,000
2.Computations:
SallySam
Totalcostsat200,000units
200,000x$6$1,200,000

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200,000x$9$1,800,000
Totalcostsat100,000units
100,000x$9900,000
Totalcostsat80,000units
80,000x($10+$0.50)840,000
Changesintotalcosts$300,000$960,000
Changesinvolume100,000120,000
Unitvariablecosts$3$8
Totalvariablecostsat200,000units
200,000x$3$600,000
200,000x$8$1,600,000
Totalfixedcosts
$1,200,000$600,000$600,000
$1,800,000$1,600,000$200,000
Contributionmargin
$10$3$7
$6$4$2
3.Sally:$600,000/($10$3)=85,714
Sam:$200,000/($10$8)=100,000
4.Sincethesellingpriceisthesameforeachdivision,theywillshow
equalprofitswhentheyhaveequalcosts.LettingVrepresentthevolume,
SallySam
$600,000+$3xV=$200,000+$8xV
$400,000=$5xV
80,000=V
Sincethisvolumeislessthanthebreakevenforeitherdivision,thisisthe
saleslevelwheretheywillshowequallosses.Atvolumesgreaterthan
80,000,Sallywillshowahigherprofit.
330AvoidableCosts(20to25minutes)
1.TheequationpreparedbyHalton'sfriendisincorrectunlessHalton
purchasesandsellsexactly200arrangements(sothattherearenolossesas
aresultofpurchasedbutunsoldarrangements).Ineffect,theequation
ignoresHalton'spurchasingsituation.Haltonturnsanormallyvariablecost
intoafixed(andunavoidable)costbecausehecannotsellunitsaftera
week.CVPanalysisassumessaleabilityofpurchasedunits.
NotetotheInstructor:Beforegoingontothenextquestion,itmight
beusefultoexploretheimplicationsofacceptingtheproposedequation,
evenforplanningpurposes.Forexample,thenatureoftheproductissuch
thatsomewillbelessdesirablethanothersbytheendoftheweek,sothat
lateintheweeksalesmightnotbeasexpected.(And,ofcourse,ifthe
productisnotarrangementsbutgroupsofflowersofvarioustypes,itis
certainlypossiblethattheflowersavailableforarrangingattheendofthe
weekwillnotbeappropriateforthesalesopportunitiesavailableatthat
time.)Animportantpointtorememberisthatwearedealingwithaverage
datahere(purchaseandsalesprices),whichsuggestssomeneedtoprovide
leewayinplanning.And,inadditiontothepreviousconsiderations,Halton
shouldrecognizethatifhebuysandsells200arrangements,hecouldlose
thecontributionmarginfromsalesordersthathecannotmeet.
2.Thepurchasecostofthearrangements(ortheflowers,asthecasemay
be)cannotbereadilyclassified.Onceaspecificquantityhasbeenbought,
thetotalpurchasecostbecomesanunavoidablefixedcost,thevariablecost

317

persalebecomeszero,andcontributionmarginequalssellingprice.
3.About234unitsif300unitsarepurchasedand267if400arepurchased.
IncorporatingtheideaexpressedintheNotetotheInstructorfor
requirement1,thepurchasecostbecomesanotherfixedcostandthetarget
salesvolumescanbecomputedasfollows:
Ifpurchasesare300,
targetsalesvolume=$3,000+($10x300)+$1,000=234units,rounded
$30$0
Ifpurchasesare400,
targetsalesvolume=$3,000+($10x400)+$1,000=267units,rounded
$30$0
Anotherapproachistorelyonthebasicideathatrevenuescosts=profit.
Usingthissimpleapproach:

Ifpurchasesare300,andlettingQ=thenumberofunitssold:
$30Q$10Q$3,000$10(300Q)=$1,000Q=234units
Ifpurchasesare400,andlettingQ=numberofunitssold:
$30Q$10Q$3,000$10(400Q)=$1,000Q=267units
InlinewiththecommentsofferedundertheNotetotheInstructorin
requirement1,somestudentsmightwellaskwhyHaltondoesnotjustorder
200unitstoavoidtheproblemofunsoldunits.Theissueis,ofcourse,
balancingriskandreward,andariskof$10(onaverage)forapotential
rewardof$30(again,onaverage)islikelytobequiteattractive.
331CostEstimationServiceBusiness(35minutes)

Thepatternofbehavior,asshowninthescatterdiagram,isthatthe
costisrelativelyconstantfrom2,800to3,500hours.Itthenrisesata
rateofabout$1.80to$1.95.
Severalreasonscouldexplainthebehavior.Becausewehaveno
observationsbelow2,800hours,wedonotknowwhetherthe$3,000orsocost
thatweseefrom2,800to3,500hoursisfixedorastepinafunctionofa
stepvariablecost.ItmightbethatJarviskeepsasteadyparttimeforce
untilhefindsthatvolumeisrisingandhethenneedstoaddworkersor
increasethehoursoftheexistingones.

318

Calculatedvariablecostratesindifferentranges:

RangeRate
3,5004,800$1.77($5,400$3,100)/(4,8003,500)
4,8005,2001.95($6,180$5,400)/(5,2004,800)
5,2005,6001.80($6,900$6,180)/(5,6005,200)
3,5005,6001.81($6,900$3,100)/(5,6003,500)
Theratesarefairlyconstant,indicatingthatapatterndoesexistover
theupperrangeofvolume.
Cost

$7,000
x

6,000x
x

5,000

4,000
x
x
3,000xx
__________________________________________________________
1,0002,0003,0004,0005,0006,000
Hours
332CVPAnalysisforanAirline(25minutes)

1.20,000passengersor53.33%ofcapacityof37,500
Fixedcosts:
Overallpermonth$130,000
Flightcostsat250flights(250x$4,000)1,000,000
Totalfixedcosts1,130,000
Desiredprofit70,000
Requiredcontributionmargin$1,200,000
DividedbyperpassengerCM($66$6)$60
Numberofpassengersrequired20,000
Dividedbycapacity(250x150)37,500
Equalspercentageofcapacityrequired53.33%

2.16,667passengersor55.56%ofcapacityof30,000
Fixedcosts:
Overallpermonth$130,000
Flightcostsfor200flights(200x$4,000)800,000
Total930,000
Desiredprofit70,000
Requiredcontributionmargin$1,000,000
DividedbyperpassengerCM($66$6)$60
Numberofpassengersrequired16,667
Dividedbycapacity(200x150)30,000
Equalspercentageofcapacity55.56%

3.Flightcostsareanexampleofacostthatvarieswithanactivityother
thansales.Theflightcostisfixedfromthepointofviewofaspecific

319

flight,butisvariablewiththenumberofflights.
4.Themostobviouscharacteristicoftheairline'scoststructureisthe
highleveloffixedcosts.Forsuchcompanies,volumeisthekeyto
successfuloperations.Forexample,withthedatagiveninrequirement1,
thebreakevenpointis18,833passengers,or50.22%ofcapacity.

[$130,000+(250x4,000)]/($66$6)

Thus,anincreaseofslightlyoverthreepercentagepoints(53.33%50.22%)
incapacityutilizationproducesa$70,000changeinprofit.Thisisan
increaseofonly1,167passengers.Anotherincreaseof1,167passengers
doublesprofitto$140,000.
NotetotheInstructor:Apointofparticularinterestinthisproblem
isthebehaviorofflightcosts,whicharevariablebutnotwithsales.Note
alsothatthenumberofplanesavailablehasnodirectbearingonthe
problem.Somestudentstrytoincorporatethatnumberintheirsolution,at
firstasadeterminateofcapacity.Theparticularplaneusedforoneofthe
200or250flightshasnobearingonthecostsorcapacity.Thetotalfixed
costisaffectedbythenumberofplanesownedtoprovidethecapacity
expressedasthenumberofflights.
333PromotionalCampaign(20minutes)
1.$5,850,000
SubscriptionrevenuetoAjax20,000,000x15%x$35x25%$26,250,000
Costs$10,000,000+$10,400,00020,400,000
Profit$5,850,000
2.11.66%Ajaxhasacontributionmarginper$35orderof$8.75($35x
25%).Thebreakevenpointinnumberofordersis2,331,429
($20,400,000/$8.75),or11.66%responserate(2,331,429/20,000,000).
NotetotheInstructor:Youmightwanttomentionthattheprizemoney
inthesegiveawaysispaidoveralengthytime,often20years.Youmight,
evenbeforecoveringChapter8,asktheclasswhateffectthedelayedpayment
hasontheprofitabilityofthecampaign.Thoughtheyhavenotyetstudied
thetimevalueofmoney,moststudentswillseethatthecampaignwouldbe
moreprofitablebecauseAjaxcaninvestthemoneyforalongtime.

334BrainTeaser

CalculatingContributionMarginPercentage(1025
minutes)
1.40%(1minusthe60%variablecostpercentagecomputedbelow)
First,convertthe6%aftertaxROStoal0%beforetaxROS[6%/(1
40%)],whichmeansthattotalcostsare90%(110%)ofcurrentsales.
Knowingthemarginofsafetyandthat,atthebreakevenpoint,totalcosts
equaltotalsales,thebasicfactsare:
SalesTotalCosts=Profit
CurrentsalesS90%S10%S
Breakevensales75%S75%S0
Thismatrixcanbeconvertedtothetypicalhighlowmatrixas:

320

SalesTotalCosts
Highvolume1.00.90
Lowvolume.75.75
Difference.25.15
Changeintotalcostdividedbychangeinvolume=.15/.25=60%
2.$36,000Again,convertingtheaftertax6%ROStoa10%beforetaxROS,
andapplyingthebasicformulasregardingsales,costs,andbreakeven,the
basicfactsare:

SalesTotalCosts=Profit
Currentsales$120,000$108,000$12,000
Breakevensales75%
ofcurrentsales90,00090,0000
Difference$30,000$18,000$12,000
Changeintotalcostdividedbychangeinvolume=$l8,000/$30,000=60%
Applyingthevariablecostpercentagetothecurrentsalesvolume(thebreak
evenvolumecouldalsobeused,ofcourse):
Totalcosts=variablecosts+fixedcost
$108,000=(60%x$120,000)+fixedcost
$108,000$72,000=fixedcost
$36,000=fixedcost

335CostStructureandRisk(20minutes)

Monthly5Years
Annualsales$250,000$250,000
Variablecosts100,000100,000
Contributionmargin150,000150,000
Fixedcosts:
12x$6,00072,000
12x$5,20062,400
Annualprofit$78,000$87,600
Ifsalesandvariablecostsmaterializeasforecast,Gladackwillearn
$9,600moreannuallyunderthefiveyearlease.However,theacceptanceof
theproduct(andhencetheproduct'susefullife)isalsorelevant.
If,forexample,theproductstopssellingafterfouryears,thecompany
willbeunabletoavoidthelastyear'sleasepaymentof$62,400,whilethe
addedprofitunderthefiveyearleasewillbeonly$38,400($9,600x4
years).Thepresidentshouldthereforebeinterestedindeterminingthe
indifferencepoint,howlongtheproductwouldhavetoselltoequatethe
costsandprofitsunderthetwochoices.Thecalculations,withM=the
numberofmonthsthecompanymustusethemachineare:
CostofMonthtoMonthLeaseCostofFiveYearLease
$6,000M=$5,200x12x5
M=52
Thus,ifthecompanyusesthemachinefor52months,itshowsthesame
totalcostandtotalprofitundereitheralternative.Atthispointyou
mightwishtobringupthetimevalueofmoney,sayingthatevenifthe
companyusesthemachineforexactly52months,itisbetteroffwiththe
yearyearleasebecauseitscashpaymentsaredelayedunderthatchoice.
Thatis,thecompanysaves$800permonthfor52months,atotalof$41,600.

321

Itpaysthe$41,600duringthelasteightmonthsat$5,200permonth,sothat
thepresentvalueofthesavingsofthefiveyearleaseispositive.The52
monthperiodisonlyeightmonthsshortoffiveyears,sobytakingthefive
yearleasethecompanyisacceptingtheriskthattheproductwillbe
profitablefornearlytheentirelifeofthelease.Thelowerthe
indifferencepoint,themoreattractivethefiveyearlease.
Thecommitmentforthefiveyearperiodcutsbothways.Thereisno
guaranteethattheleasewillremainat$6,000permonthforthefiveyears
underthemonthlyoption.Thelessorcouldraisetherentatanytime,as
theproblemstates(thelessorcancancelthelease,whichamountstosaying
thatitcouldalsoraisetherent).Thus,thefiveyearleasedoesprotect
thecompanyagainsttheriskofincreasedrent.
NotetotheInstructor:Thisisagoodproblemtopointoutthe
uncertaintieswithwhichbusinesspeoplemustregularlydeal.Herethe
presidentisfacinguncertaintyregardingconsumeracceptanceandatthesame
timemustdealonlywithestimatesofrevenuesandvariablecosts.Ifa
decisionisbasedonthebestinformationavailableatthetime,the
presidentneednotregretthechoice.Ifsubsequentinformationdoesnot
agreewithreasonableestimatesatthetimeofthedecision,itisthe
estimatesthatwerewrong(or"bad"),notthedecision.
336LossperUnit(20minutes)
1.$4perunit.Thetotallossat40,000unitsis$120,000($3x40,000)
andat50,000unitsis$80,000($1.60x50,000).Thechangeinthelossis
$40,000,which,whendividedby10,000units,gives$4perunit.
2.$280,000.Atsalesof40,000units,totalcontributionmarginis
$160,000(40,000x$4)andthelossis$120,000.Fixedcostsaretherefore
$280,000greaterthancontributionmargin.At50,000units,contribution
marginis$200,000($4x50,000),andthelossis$80,000,alsogiving
$280,000forfixedcosts.
3.70,000units($280,000/$4)
337CVPAnalysisMeasuresofVolume(30minutes)
Thisproblemfocusesonidentifyingameasureofsalesvolumethatis
suitableforuseinCVPanalysis.Requirement3willgivemanystudentsa
greatdealoftroubleandaffordsanopportunitytodiscussalternativeways
toexpressrevenuesandcosts.
1.At100loavespermonththecompanywillearn$12,000,selling450,000
boardfeetofgoodoutput(5,000x90%x100loaves).

322

Revenue:
Goodoutput(450,000bd.ft.x$.30)$135,000
Scrap(50,000x$.11)5,500
Totalrevenue($1,405perloaf)140,500
Variablecosts:
Priceofloaf($900x100)$90,000
Cuttingcosts($175x100)17,500
Totalvariablecosts107,500
Contributionmargin($330perloaf)$33,000
Fixedcosts21,000
Income$12,000
2.63.6loaves($21,000/$330contributionmarginperloaf)
Itistheoreticallypossibleforthecompanytoprocesspartofaloaf
becausetheproductionprocesscouldbeviewedasmoreorlesscontinuous.A
loafcouldbe35%orsoprocessedattheendofamonth.Suchananswer
wouldbecalculatedanywayifloavesperdaywereaskedfor,with22working
daysinamonth.
3.Therearealternativewaystoapproachthispart.Theeasiestisto
dividecontributionmarginperloafof$330(requirement1)by4,500good
boardfeetperloaf,giving$.0733contributionpergoodboardfoot.Itis
alsopossibletoworkdirectlywithboardfeet.Itiseasiertotreatscrap
salesasvariablecostreductions,thanasrevenue.
Revenuepergoodboardfoot$0.3000
Variablecostperloaf$1,075
Lessscrapsalesperloaf(500x$.11)55
Netvariablecost1,020
Dividedby4,500goodboardfeet0.2267
Contributionmarginperboardfoot$0.0733
Thesalesofgoodboardfeetrequiredtoearn$15,000are491,132[($21,000+
$15,000)/$.0733].
338MeasuresofVolume(50minutes)
Thefirststepistoscanthedatatoidentifylikelycorrelations.
Thus,sellingexpensesaremoreprobablyrelatedtosalesthantolabor
hours,andthelasttwolistedobservationsconfirmthisintuitive
conclusion.
ThefollowingresultsarefromExcelspreadsheets.
Productioncosts=$5,397+$7.50perlaborhour

r2=.991,StdError=$238
Sellingexpenses=$1,997+$0.101persalesdollar

r2=.998,StdError=$52
Administrativeexpenses=$2,681+$0.058persalesdollar

r2=.918,StdError=$208
Thefitsareallexcellent,indicatingthatwehavetherightdrivers.We
testedotherpossiblecombinations.Ther2forproductioncostsagainst
salesis.18:forsellingexpensesagainstlaborhoursitis.38.Fitsof

323

othercombinations,suchassellingexpensestoDLHarelow.Wehaveonly
sixobservations(tokeepdataentrytoaminimum),sowecannotbeashappy
aswewouldwith25orso,butwithsuchgoodfitswehaveequationsthat
shouldpredictwell.Wemustguardagainstregressingeverythinginsighton
everythingelse,alwaysatemptationwhenwehaveadatarichenvironmentand
virtuallyunlimitedcomputingcapability.
339SelectingaRegressionEquation(1015minutes)
Thememoshouldmakethefollowingpoints.
Theequationusingmachinehourswillprovidebetterpredictionsthan
theoneusingdirectlaborhours.Laborhoursisnotastatistically
significantvariable(noticethe95%confidenceintervalincludesavalueof
zero).Moreover,theequationusingmachinehourswillgivereasonable
resultsandsoweshoulduseit.
LaborHoursMachineHours
Standarderror$19,272$10,105
r2.24.79
variablecostsignificant?noyes
Themachinehourequationisbetterontheimportantmeasuresof
goodnessoffit.Weshouldgetreasonablepredictionsusingthemachinehour
equation.
Wemightdoevenbetterbyusingbothvariablesinamultipleregression
analysis.Ifwedo,wemusttakecaretocheckformulticollinearity.If
machinehoursandlaborhoursarethemselvescorrelated,wewouldhavea
problem.
340ValueAddingandNonValueAddingActivitiesandCosts(30minutes)
Thisassignmentisvirtuallythesameas114,exceptthat114asks
aboutdifferencesbetweenacompany'soperationsandJIToperations.
MULwarehousesmaterialsandcomponents.AJITmanufacturerordersstock
asneeded,eliminatingthehandlingandstorage.MULgoestogreatlengths
togetthebestpricesonmaterialsandcomponents.AJITmanufactureris
moreconcernedaboutqualityandmeetingdeliveryschedules.MULdealswith
manysuppliers,whileaJITmanufacturerdealswithrelativelyfew.
MULinspectsallincomingshipments.Instead,likeaJITmanufacturer
itshouldstopinspectingonceitdeterminesthatavendordeliversdefect
freecomponents.MULalsoinspectsfordeteriorationbeforeitputs
componentsintoprocess.Keepinglowerinventorieswouldeliminatethis
activity.
MULmaintainsinventoriesatworkstations,haslongsetuptimes,and
considerablemovingofgoodsduringproduction.Theseactivitiescouldbe
eliminatedbypayingmoreattentiontoqualitysothattherewouldbenoneed
toholdinventoriesatstations.Usingmanufacturingcellswouldreduce
(perhapseliminate)setuptimesandeliminatemovingsemifinishedproduct
aroundthefactory.
MULinspectsattheendofproduction.Italsomakes10%moreunitsthan
neededasabufferagainstdefects.Thecompany'sworkerscouldinstead
inspectproductcontinually,makingitpossibletokeeplittleinventoryand

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eliminateseparateinspection.

MULtriestotracedefects,whichaddsnovalue.Ifitsworkers
inspectedcontinuallyitwouldnothavethatactivity.

MUL'scycletimesarehigh.ItcouldreducethembyadoptingJIT
principles,asindicatedabove.

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