Bthma2e ch06 SM

Chapter 6
Cost Behavior
Quick Check
Answers: QC-1. a QC-2. c QC-3. d QC-4. b QC-5. a QC-6. b QC-7. d QC-8. C QC-9. a QC-10. c
Managerial Accounting 2e Solutions Manual
30
Short Exercises
(5-10 min.)
S 6-1
Cost A is a variable cost. The cost is constant on a per unit basis and increases in total as volume increases. Cost B is a fixed cost. The cost is constant in total, and decreases on a per unit basis as volume increases. Cost C is mixed. It is not constant in total, and it is not constant on a per unit basis.
31
(10 min.)
S 6-2
On each of the following graphs, the y-axis is Total Cost and the x-axis is Volume of Activity
a. Step
d. Mixed
b. Fixed e. Variable (Any curved line)

Y
c. Curvilinear
Chapter 6 Cost Behavior 32
(5-10 min.)
S 6-3
Total fixed cost = $3.00 / basketball 12,000 basketballs Total fixed cost = $36,000 Since a volume of 15,000 basketballs is in the same relevant range, the total fixed costs will remain constant at $36,000
Number of Basketballs produced
Therefore, the new fixed cost per basketball will be: Total fixed cost Number of basketballs produced $36,000 Fixed cost per basketball = 15,000 Fixed cost per basketball = $2.40 Fixed cost per basketball =
33
(5-10 min.) a. Fixed y=f Where y = total fixed cost f = fixed amount over a period of time (vertical intercept)
S 6-4
b. Mixed y = vx + f Where y v x f = = = = total mixed cost variable cost per unit of activity (slope) volume of activity fixed amount over a period of time (vertical intercept)
c. Variable y = vx Where y = total variable cost v = variable cost per unit of activity (slope) x = volume of activity
Chapter 6
Cost Behavior
34
(5-10 min.) Find the answer to Ritter Razors questions by:
S 6-5
1) finding the companys cost equation, and then 2) using the cost equation to predict total costs at a different volume. First, determine the firms cost equation: Total costs = variable component + fixed component y = vx + f $100,000 = $40,000 = f $60,000 Also, since: vx v (20,000) v = $40,000 when x = 20,000 = $40,000 = $2.00 per package of razors = f
Therefore, the production cost equation is: y = $2.00x + $60,000 Predict total costs for other volumes in the same relevant range using the cost equation found above: y y y
35
= = =
($2.00 per package 25,000 packages) + $60,000 $50,000 + $60,000 $110,000
Total production costs are predicted to be $110,000 when 25,000 packages of razors are produced. (5-10 min.) Req. 1 a. Call for 20 minutes $5.00 + (20 $0.35) $5.00 + $7.00 = $12.00
b.
S 6-6
Call for 40 minutes $5.00 + (40 $0.35) $5.00 + $14.00 = $19.00
c.
Call for 80 minutes $5.00 + (80 $0.35) $5.00 + $28.00 = $33.00
Req. 2
Chapter 6
Cost Behavior
36
37
(5-10 min.) a. Depreciation on equipment used to cut wood enclosures....... b. Wood for speaker enclosures. c. Patents on crossover relays d. Crossover relays. e. Grill cloth.. f. Glue g. Quality inspectors salary.
S 6-7
Fixed Variable Fixed Variable Variable Variable Fixed
Chapter 6
Cost Behavior
38
(10-15 min.) Req. 1

Scatterplot of Operating expenses and number of oil changes
$40,000 $35,000 $30,000 $25,000 $20,000 $15,000 $10,000 $5,000 $0 0 500 1000 1500 2000 2500 3000 3500 4000 Number of oil changes
S 6-8
Req. 2 There appears to be a very strong relationship between the companys operating expenses and the number of oil changes it performs. We can tell this because the scatterplot of the data almost falls in a straight line (it is very linear). If there were no relationship, or if the relationship was weak, the scatterplot of data points would appear almost random. Additionally, since all of the data points fall in the same linear pattern, there do not appear to be any outliers.
39 Managerial Accounting 2e Solutions Manual
Monthly operating expenses
(continued) Req. 3
S 6-8
The operating expenses appear to be mixed costs. If the operating expenses were purely fixed, the data points would fall in a horizontal, rather than sloped line. If the operating expenses were purely variable, the data points would fall in a sloped line as they do now, but the slope of the data points would intersect the graphs origin. If we visually connect the data points, it appears that a sloped line connecting the data points would intersect the y- axis at about $10,000, rather than the origin.
Req. 4 Lube-for-Less could only perform 4,000 oil changes per month if it expanded its existing facility. (Its current facility can only accommodate 3,600 oil changes per month). The companys operating expenses may change significantly as a result. Therefore, the current relationship between monthly operating expenses and number of oil changes performed each month
Chapter 6
Cost Behavior
40
should not be used to project total monthly operating expenses at a volume of 4,000 oil changes.
41
(5-10 min.)
S 6-9
The highest volume of oil changes (3,500) occurred in May while the lowest volume of oil changes (2,700) occurred in February. Therefore, we use those two data points in the highlow method: Step 1) Find the slope (the variable cost component): y (high) y (low) x (high) x (low) = ($37,700 $32,100) (3,500 2,700 oil changes)
$7.00
Step 2) Find the vertical intercept (the fixed cost component) by plugging the slope into a cost equation, using either May or February data: Using May data: y = vx + f: $37,700 = ($7.00 / oil change 3,500 oil changes) + f f = $13,200
Chapter 6
Cost Behavior
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(continued) Using February data:

y = vx + f: $32,100 = ($7.00 / oil change 2,700 oil changes) + f f = $13,200
S 6-9
The fixed cost portion of the operating expenses is $13,200.
Using a variable cost of $7.00 per oil change and fixed operating costs of $13,200, we would project monthly operating expenses to be $38,400: Total monthly operating expenses = ($7.00 / oil change 3,600 oil changes) + $13,200 = $38,400
43
(5-10 min.) Step 1) Find the slope (the variable cost component): y (high) y (low) x (high) x (low) = ($27,500 $25,000) (900 800 labor hours)
S 6-10
$25.00
Step 2) Find the vertical intercept (the fixed cost component) by plugging the slope into a cost equation, using either high point or low point data: Using high point data: y $25,000 $25,000 f = = = = vx + f: ($25.00 / labor hour 800 labor hours) + f $22,500 + f $5,000
Using low point data:

y = vx + f:
$27,500 = ($25.00 / labor hour 900 labor hours) + f $27,500 = $20,000 + f f = $5,000 The fixed cost portion of the overhead is $5,000. Using a variable cost of $25.00 per labor hour and fixed costs of $5,000, we would expect total MOH to be $25,625:
Total expected overhead cost = ($25.00 / labor hour 825 labor hours) + $5,000 = $25,625
45
(15 min.)
S 6-11
The process of identifying cost behaviors and building cost equation models that are useful for predictions is more involved than the intern believes. Thats because cost equations are only as good as the data and method used to build them. The intern has not considered any of the following: 1. More than two months of historical data should be collected. Cost behavior patterns are difficult to assess from simply two data points. 2. One or both of the most recent months may have been outliers. If so, they should not be used in building the cost equation. 3. If the business is seasonal, using data from two adjoining months may not result in a cost equation that is representative of the rest of the year. 4. The data should first be plotted to see if a relationship exists between the costs and activity selected. Plotting the data will also help determine whether outliers are present. 5. The high-low method may not render the best cost equation, because the method only relies on two data points. If possible, the intern should use regression analysis based on several months (or years) worth of data. The R-square statistic will let the intern know how representative the cost equation is of the data. 6. Before making predictions based on the equation, the intern should consider whether the equation should be adjusted for inflation. 7. Predictions should only be made for volumes in the same relevant range. If the volume is outside of the current relevant range, cost behavior patterns may be different.
Chapter 6
Cost Behavior
46
Student answers may vary.
(5-10 min.)
S 6-12
1. There appears to be a fairly strong relationship between the number of room-nights rented per month and the monthly utilities cost. We can tell this because most of the data points fall in a tight, linear pattern, resembling something close to a straight line. 2. Most of the data falls in the same general pattern. However, the highest and lowest volume data points appear to be somewhat off-line from the rest of the data points. Whether these points are outliers or not, is a matter of judgment since they are not extremely different than the rest of the data points. In fact, these curved ends might suggest that the cost behaves in a curvilinear fashion. Management may wish to check this data to make sure it is accurate before proceeding with any further analysis. 3. Using the high-low method will result in a slightly skewed cost equation. The high-low method results in a cost equation for the straight line connecting the highest and lowest volume data points. Since the low volume data point is slightly high, while the high-volume data point is slightly low, the line connecting these data points will be flatter than a line representing the rest of the data points. As a result, management may overestimate the fixed portion of the cost equation, and underestimate the variable portion of the cost equation.
47
(5-10 min.)
S 6-13
1. Generally speaking, regression analysis results in more accurate cost equations than does the high-low method. Regression analysis uses all of the data to form the line and cost equation that best fits all of the data points. However, the high-low method only uses the highest and lowest volume data points to form the line and cost equation. In the scatter plot, the low volume data point is slightly high, while the high-volume data point is slightly low compared to the other data points. As a result, the high-low line will be flatter than the regression line (which is generated based on all data points). 2. The R-square statistic tells how well the line and cost equation fits the data. The highest possible value, 1, occurs only if the data points fall in a perfectly straight line. The lowest value, 0, occurs if the data points are extremely random. Therefore, an R-square of 0.939 is very high, and indicates that the regression line fits the data quite well. 3. Because an R-square of 0.939 is very high, and indicates that the regression line fits the data quite well, a manager should be quite confident in using the regression cost equation to predict utilities costs for other volumes within the same relevant range.
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Cost Behavior
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(5-10 min.) a) y = $0.89x + $9,942.83
S 6-14
where x = volume of activity of the potential cost driver b) Management probably should use this equation to predict costs. The R-square statistic can range from a high of 1.00 to a low of zero. In this case, the R-square is quite high (.86), indicating there is a fairly strong relationship between the potential cost driver and the firms operating costs. In other words, the potential cost driver explains most of the variability in total operating costs.
49
(10-15 min.) Pams Quilt Shoppe Income Statement Month Ended February 28 Sales revenue (80 $350) Less: Cost of goods sold (80 $250) Gross profit Less: Operating expenses: Sales commissions (5% $28,000) Payroll costs Lease Operating income
S 6-15
$28,000 (20,000) 8,000 (1,400) (1,200) (1,000) $ 4,400
Pams Quilt Shoppe Contribution Margin Income Statement Month Ended February 28 Sales revenue (80 $350) $28,000 Less: Variable costs: Cost of goods sold (80 $250) (20,000) Sales commissions (5% $28,000) (1,400) Contribution margin 6,600 Less: Fixed costs: Payroll costs (1,200) Lease (1,000) Operating income $ 4,400
Chapter 6
Cost Behavior
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(10-15 min.) Sportade Income Statement (Variable Costing) Month Ended April 30
Sales revenue (11,000 $30) Deduct: Variable expenses: Variable cost of goods sold: Beginning finished goods inventory (2,000 $11) Variable cost of goods manufactured (10,000 $11) Variable cost of goods available for sale Ending finished goods inventory (1,000 $11) Variable cost of goods sold Sales commission expense (11,000 $2.50) Contribution margin Deduct: Fixed expenses: Fixed manufacturing overhead Fixed marketing and administrative expenses Operating income
S 6-16
$330,000
$ 22,000 110,000 132,000 11,000 121,000 27,500 (148,500) 181,500 50,000 25,000
(75,000) $106,500
51
(15 min.) Req. 1 Sportade Income Statement (Absorption Costing) Month Ended April 30
Sales revenue (11,000 $30) Deduct: Cost of goods sold: Beginning finished goods inventory (2,000 $16) Cost of goods manufactured (10,000 $16) Cost of goods available for sale Ending finished goods inventory (1,000 $16) Cost of goods sold Gross profit Deduct: Operating expenses: Marketing and administrative expenses [(11,000 $2.50) + $25,000] Operating income
S 6-17
$330,000 $ 32,000 160,000 192,000 16,000 (176,000) 154,000
(52,500) $101,500
Req. 2 Absorption costing income is $5,000 lower than variable costing income. The difference stems from two offsetting forces. Variable costing expenses all fixed manufacturing overhead in the period incurred. But absorption costing expenses fixed manufacturing overhead in the period when the related units are sold. Thus, absorption costing shifts the timing when the fixed manufacturing overhead is expensed. In this case:
(continued) Req. 2 (continued)
S 6-17
Absorption costing deferred $10,000 of March fixed manufacturing overhead in the 2,000 units of Marchs ending inventory ($5 2,000). Under absorption costing, this $10,000 of Marchs fixed overhead are not expensed until April when the units are sold. This extra expense charged in April decreases Aprils absorption costing operating income by $10,000. Absorption costing deferred $5,000 of April fixed manufacturing overhead in the 1,000 units of Aprils ending inventory ($5 1,000). Under absorption costing, these $5,000 of Aprils fixed overhead are not expensed until May when the units are sold. This deferral of Aprils fixed manufacturing overhead costs increases Aprils absorption costing operating income by $5,000. The net effect of the two forces is that Aprils operating income decreased by $5,000 ($10,000 decrease less $5,000 increase), relative to variable costing where there is no shifting of fixed manufacturing overhead from period to period.
Students responses will probably be less complete. The solution here is intended to provide a basis for class discussion.
53
Exercises (Group A)
(15 min.)
(a) Variable Expenses Cost $100 (thou- $ 80 sands) $ 60 $ 40 $ 20 0 2 4 6 8 10 Volume (thousands of units) $50 Cost $40 (thou- $30 sands) $20 $10 0 2 4 6 8 10 Volume (thousands of units) (b) Mixed Expenses Cost $40 (thou- $30 sands) $20 $10 0 2 4 6 8 10 Volume (thousands of units)
E 6-18A
(c) Fixed Expenses
Chapter 6
Cost Behavior
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(5-10 min.)
a. Graph 1 b. Graph 5
E 6-19A
c. Graph 8 d. Graph 1
e. Graph 3 f. Graph 11 g. h. i. j. Graph 2 Graph 7 Graph 9 Graph 2
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(15 min.)
E 6-20A
a. Fixed costs remain constant in total over a wide range of volume. b. R-square is often referred to as the goodness of fit statistic.
c. Variable costs and mixed costs increase in total as volume increases. Note: Step costs could also be included in (c). d. Graphs of variable costs always begin at the origin.
e. Account analysis uses the managers judgment to determine the cost behavior of various accounts. f. Step costs remain constant in total over small ranges of activity. g. Fixed costs and mixed costs increase on a per unit basis as volume decreases. High-low method uses only two historical data points to determine the cost line and cost equation. Variable costs remain constant on a per unit basis. When graphing cost equations, total costs are always shown on the y-axis.
h.
i. j.
k. The average cost per unit should not be used to predict total costs at various volumes unless it is a strictly variable cost.
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l. Regression analysis uses all historical data points provided to determine the cost equation. m. Committed fixed costs are the result of previous management decisions and are not usually controllable in the short-run.
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(15 min.)
E 6-21A
Use the two pieces of information provided to find total fixed costs and the variable cost per unit within the relevant range: Total fixed costs Total fixed costs Total fixed costs = number of garments fixed cost per garment at a given level = 3,500 $2.00 = $7,000
Total variable costs = number of garments variable cost per garment $2,625 = 3,500 variable cost per garment $0.75 = variable cost per garment
Total fixed costs will remain constant at $7,000 at all volumes within the relevant range. The variable cost per unit will remain constant at $0.75 per garment across the relevant range. The following predictions are made using this information:
2,000 garments $1,500 7,000 $8,500 $0.75 3.50 3,500 garments $2,625 7,000 $9,625 $0.75 2.00
Chapter 6
Total variable costs Total fixed costs Total operating costs Variable cost per garment Fixed cost per garment
5,000 garments $ 3,750 7,000 $10,750 $0.75 1.40

Cost Behavior 58
Average cost per garment
$4.25
$2.75
$2.15
59
(continued)
E 6-21A
2) The average cost per garment changes as volume changes, due to the fixed component of the dry cleaners costs. The fixed cost per unit decreases as volume increases, while the variable cost per unit remains constant. 3) If Dan Perreth uses the average cost per unit at full capacity ($2.15) to predict total costs for a volume of 2,000 units, he will predict total costs to be $4,300 ($2.15 2,000 garments). Since his actual costs at this volume will be $8,500, he will have underestimated total costs by $4,200.
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(15 min.) Perreth Dry Cleaners Projected Income Statement Month Ended March 31 Dry cleaning revenue (4,252 $7) Less: Operating costs [$7,000 + (4,252 $0.75)] Operating income
E 6-22A
$29,764 (10,189) $19,575
Perreth Dry Cleaners Projected Contribution Margin Income Statement Month Ended March 31 Dry cleaning revenue (4,252 $7) $29,764 Less: Variable costs: (4,252 $0.75) (3,189) Contribution margin 26,575 Less: Fixed costs: (7,000) Operating income $19,575
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(15 min.) Req. 1
E 6-23A
The highest volume of machine hours (1,400) occurred in June while the lowest volume of machine hours (1,000) occurred in March. Therefore, we use those two data points in the high-low method. Find the slope (the variable cost component): y (high) y (low) x (high) x (low) = ($4,200 $3,500) (1,400 1,000 machine hours)
$1.75
Req. 2 Find the vertical intercept (the fixed cost component) by plugging the slope into a cost equation, using either high point or low point data: Using high point (June) data: y $4,200 $4,200 f = = = = vx + f: ($1.75 / MH 1,400 MHs) + f $2,450 + f $1,750
Using low point (March) data:

y = vx + f:
$3,500 = ($1.75 / MH 1,000 MHs) + f $3,500 = $1,750 + f f = $1,750 The fixed cost portion of the utilities is $1,750. (continued)
E 6-23A
Req. 3 Using a variable cost of $1.75 per machine hour and fixed costs of $1,750, we would expect total utilities costs to be $3,990. Total expected utilities cost: = ($1.75 / MH 1,280 MHs) + $1,750 = $3,990
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(15 min.) a) Average cost per unit $26.43 $26,430
E 6-24A
= Total cost number of units = Total cost 1,000 units = Total cost
b) Use a mixed cost equation to determine the variable cost per unit: Total cost = Variable cost component + fixed cost component y = vx + f $26,430 = v (1,000) + $18,000 $8,430 = v (1,000) $8.43 = v The variable cost per unit is $8.43
c)
= $8.43 x + $18,000 where x= number of mailboxes
d) If the plant manager forecasts costs using the average cost per unit, his forecast for 1,200 mailboxes would be: $31,716 = 1,200 $26.43 average cost per mailbox
e) If the plant manager forecasts total costs using the cost equation, his forecast for 1,200 mailboxes would be: $28,116 = ($8.43 1,200) + $18,000
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(continued)
E 6-24A
f) The plant managers forecast would be $3,600 ($31,716 $28,116) too high if he uses the average cost per unit to predict costs. The average cost per unit is based on a mixed cost that will change as volume changes. If the manager uses the average cost to predict costs, he is erroneously assuming that the average cost per unit does not change at different volumes. (In essence, he is assuming the average cost behaves as a variable cost.) The manager should use the cost equation to predict costs since it correctly takes into account the variable and fixed components of producing mailboxes.
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(5-10 min.)
a. b.
E 6-25A
FIXED: Apartment rental$500 per month FIXED: Local phone service with unlimited local calls $19.99 per month
c.
MIXED: Cell phone plan where the first 700 minutes are included for $39.99 / month and every minute thereafter costs 30 cents.
d. e. f. g.
VARIABLE: Utilities at $0.475 per kilowatt hour FIXED: Car payment$350 per month FIXED: Car Insurance$250 per month VARIABLE: Gas$2.59 per gallon and your car averages 25 miles per gallon
h.
MIXED: Cable TV$50 per month for 120 channels plus $4.99 per pay-per-view movie
i. j. k.
VARIABLE: Commuter rail tickets$2.00 per ride MIXED: Student activity pass$100 plus $5 per event VARIABLE: Campus meal plan$3.00 per meal
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(10-15 min.) Req. 1
E 6-26A
Excel will render the following scatter plot if students do not force the axes back to the origin:
Relationship of Van Operating Costs to Miles Driven

6000 5800 5600 5400 5200 5000 4800 14000 Van Operating Costs
14500
15000
15500
16000
16500
17000
17500
Miles Driven
If students force the axes back to the origin, Excel will render the following scatter plot:
Relationship of Van Operating Costs to Miles Driven

7000 6000 5000 4000 3000 2000 1000 0 0 5000 10000 Miles Driven 15000 20000 Van Operating Costs
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(continued) Req. 2
E 6-26A
The data does not appear to contain any outliers. All data points fall in the same general pattern.
Req. 3 There appears to be a very strong relationship between van operating costs and miles driven. We can tell this because the data points fall in a fairly tight, linear pattern.
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(10-15 min.)
E 6-27A
The month with the highest volume is February and the month with the lowest volume is July. The high-low method uses only these two months to determine the cost equation. Step 1) Find the slope:
Rise y (high) y (low) = = Run x (high) x (low) ($5,680 $4,880) (17,300 14,100) miles = $0.25 per mile
Step 2) Find the vertical intercept (the fixed cost component) by plugging the slope into a cost equation, using either the February or July data. Using February data: y = vx + f $5,680 = ($0.25 per mile 17,300 miles) + f f = $1,355 Or, Using July data: y = vx + f $4,880 = ($0.25 per mile 14,100 miles) + f f = $1,355 Step 3) Write the cost equation: y = $0.25 x + $1,355 where y = monthly van operating costs x = number of miles driven Predict monthly operating costs when volume is 15,000 miles
y = ($0.25 15,000) + $1,355 y = $5,105
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(20-30 min.) Req. 1 The Excel regression output looks like this:
SUMMARY OUTPUT Regression Statistics Multiple R 0.946215 R Square 0.895322 Adjusted R Square 0.874387 Standard Error 124.9883 Observations 7 ANOVA df Regression Residual Total 1 5 6 Coefficient s Intercept X Variable 1 931.2314 0.281064 SS 668089.6 78110.42 746200 Standard Error 678.874 0.042979 MS 668089. 6 15622.0 8 F 42.7657 1
E 6-28A
Significanc eF 0.001252
t Stat 1.37172 9 6.53955
P-value 0.22849 8 0.00125 2
Lower 95% -813.87 0.170583
Upper 95% 2676.33 3 0.39154 6
Lower 95.0%
-813.87
0.170583
Req. 2 Based on the Excel output, Flower Powers van operating cost equation is: y = $0.28 x + $931.23
where y = monthly van operating costs x = miles driven This equation found by looking at the X variable 1 coefficient (.281064) and the intercept coefficient (931.2314) on the Excel output.
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(continued) Req. 3
E 6-28A
The R-square is 0.895 (rounded). The r-square indicates that the cost equation explains 89.5% of the variability in the data. In other words, it fits the data quite well. Flower Power should feel confident using this cost equation to predict total costs at other volumes within the same relevant range. Req. 4 At a volume of 15,000 miles, Flower Power could expect the following van operating costs: y y = = ($0.28 per mile 15,000 miles) + $931.23 $5,131.23
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(5-10 min.) Req. 1
E 6-29A
Based on the Excel output, Flower Powers van operating cost equation is: y = $0.28 x + $826.04 where y = monthly van operating costs x = miles driven This equation found by looking at the X variable 1 coefficient (.28) and the intercept coefficient (826.04) on the Excel output. Req. 2 The R-square is 0.92. The r-square indicates that the cost equation explains 92% of the variability in the data. In other words, it fits the data quite well. Flower Power should feel confident using this cost equation to predict total costs at other volumes within the same relevant range.
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Req. 3 At a volume of 16,000 miles, Flower Power could expect the following van operating costs: y y = = ($0.28 per mile 16,000 miles) + $826.04 $5,306.04 (10-20 min.) Req. 1
E 6-30A
Relationship of pancake volume to operating costs

3000 2500 2000 1500 1000 500 0 0 500 1000 1500 2000 2500 3000 3500 4000 4500 Pancake Volume Operating Costs
Note: If students used Excel, they may not have forced the vertical axis to show the origin. If so, their scatter plot will look different.
Req. 2
The data appears to be sound. There are no data points that look abnormal compared to the other data points.
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(continued) Req. 3
E 6-30A
Operating costs appear to be a mixed cost. If they were strictly fixed, the data points would fall in a horizontal straight line. If they were strictly variable, they would fall in a sloped straight line which would be angled towards the origin. The data points appear to be sloped towards a vertical intercept of about $1,500. In other words, the data appears to be a mixed cost with a fixed portion of about $1,500.
Req. 4 There does appear to be a linear relationship between pancake volume and operating costs. However, the relationship does not appear to be very strong. If it were a stronger relationship, the data points would fall into more of a tight, straight line.
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(5-10 min.) Req. 1
E 6-31A
Step 1) The month with the highest volume is August (3,900 pancakes) and the month with the lowest volume is September (3,200 pancakes). Therefore, use only these two months to determine the cost equation. Step 1) Find the slope: y (high) y (low) x (high) x (low) = ($2,390 $2,320) (3,900 3,200 pancakes)
= $0.10 per pancake
Step 2) Find the vertical intercept (the fixed cost component) by plugging the slope into a cost equation, using either August or September data: Using August data: y = vx + f: $2,390 = ($0.10 / pancake 3,900 pancakes) + f f = $2,000 Alternatively, using September data: y = vx + f $2,320 = ($0.10 / pancake 3,200 pancakes) + f f = $2,000 Step 3) Write the cost equation: y = $0.10 x + $2,000
where y = total monthly operating costs x = number of pancakes
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(continued) Req. 2
E 6-31A
2) Predict total monthly operating costs when 4,000 pancakes are served: y Y = ($0.10 4,000) + $2,000 = $2,400
Req. 3 3) Daves current volume ranges from 3,200 3,900 pancakes. If Dave sells 10,000 pancakes one month, he might be operating outside of his current relevant range. Dave should not predict costs using the current cost equation for any volumes that fall outside of his relevant range since cost behavior may change at higher volumes.
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(10-20 min.) Req. 1

SUMMARY OUTPUT Regression Statistics Multiple R 0.664645 R Square 0.441753 Adjusted R Square 0.302191 Standard Error 98.47448 Observations 6 ANOVA df Regression Residual Total 1 4 5 Coefficient s 1410.526 0.276984 SS 30694.44 38788.89 69483.33 Standard Error 558.5437 0.155686 MS 30694.44 9697.223 F 3.165281 Significanc eF 0.149837
E 6-32A
Intercept X Variable 1
t Stat 2.525363 1.779124
P-value 0.064985 0.149837
Lower 95% -140.24 -0.15527
Upper 95% 2961.292 0.709237
Lower 95.0% -140.24 -0.15527
Upper 95.0% 2961.292 0.709237
y = $1,410.53 + $0.28 (rounded) x Where: y = Daves monthly operating costs x = pancake volume Req. 2 The R-square is only 0.44. This indicates that the regression line and cost equation do not fit the data very well. Dave should use this cost equation with great caution, realizing that it will not do a very good job of predicting future monthly operating costs within the same relevant range.
(10-20 min.) Req. 1
E 6-33A
The fixed cost per month for Daves is $1,423.60. This is the Intercept Coefficient found in the Excel output.
Req. 2 The variable cost per pancake is $0.31. This is the X Variable 1 Coefficient found in the Excel output.
Req. 3 Daves cost equation using the fixed and variable components from requirements 1 and 2 would be: y = $0.31x + $1,423.60 Where: y = Daves monthly operating costs x = pancake volume To predict total monthly operating costs when 3,700 pancakes are served we input 3,700 as x in our cost equation: y y = ($0.31 3,700) + $1,423.60 = $2,570.60
83
Therefore, we would expect our total costs to be $2,570.60 at a production level of 3,700 pancakes.
(15 min.)
E 6-34A
The owner can use the high-low method to estimate the apartment operating cost behavior. Since only two months of data are given, these are the two months that will be used for the high-low method. 90% occupancy 500 unit complex = 450 apartments occupied 80% occupancy 500 unit complex = 400 apartments occupied
Step 1) Find the slope:

y (high) y (low) x (high) x (low) ($200,000 $197,000) (450 400) occupied apartments $60 per occupied apartment
Step 2) Find the vertical intercept (the fixed cost component) y $200,000 f Or, y $197,000 f = = = = = = vx + f ($60 450 occupied apartments) + f 173,000 vx + f ($60 400 occupied apartments) + f 173,000
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Step 3) Write the cost equation: y = $60 x + $173,000 where y = monthly operating costs x = number of occupied apartments
(continued)
E 6-34A
Use the cost equation to predict total operating costs when occupancy is at 60%. First calculate how many apartments are occupied at a 60% occupancy rate: 60% occupancy 500 unit complex = 300 apartments occupied
y y
= =
($60 300) + $173,000 $191,000
Total operating costs will be about $191,000 when the apartments are 60% occupied. Unfortunately for the owner, most of his costs are fixed and will continue to exist even if occupancy rates fall substantially.
85
(10-20 min.)
E 6-35A
Precious Pets Contribution Margin Income Statement For the Year Ended December 31 Sales revenue Variable expenses: Cost of goods sold 665,000 Variable selling and marketing expenses 27,400 Variable web site maintenance expenses 14,000 Other variable operating expenses 1,700 Total variable expenses Contribution margin Fixed expenses: Fixed selling and marketing expenses 33,600 Fixed web site maintenance
Chapter 6
$987,000
708,100 278,900
Cost Behavior
86
expenses Other fixed operating expenses Total fixed expenses Operating income
42,000 15,300 90,900 $188,000
87
(continued) Calculations for selling and marketing expenses: Total selling and marketing expenses Variable freight-out Remaining selling and marketing expenses
E 6-35A
$ 61,000 (19,000) $ 42,000
Variable: Fixed:
$42,000 20% = $8,400 + $19,000 (freight out) = $27,400 $42,000 80% = $33,600
Calculations for web site maintenance expenses: Variable: Fixed: $56,000 25% = $14,000 $56,000 75% = $42,000
Calculations for other operating expenses: Variable: Fixed: $17,000 10% = $1,700 $17,000 90% = $15,300
Chapter 6
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88
(15-20 min.) Req. 1
E 6-36A
Charleston Carriage Company Contribution Margin Income Statement For the Month Ended April 30 Sales revenue (12,960 85% $20.00) + (12,960 15% $12.00) $243,648 Variable expenses: Fee paid to city (15% $243,648) $36,547 Complimentary postcards (12,960 $0.50) 6,480 Brokerage fee (12,960 60% $1.00) 7,776 Carriage driver wages (12,960 $3.00) 38,880 Total variable expenses 89,683 Contribution margin $153,965 Fixed expenses: Leasing and boarding horses $45,000 Non-carriage driver payroll expense 7,500 Depreciation expense 2,000 Other fixed operating expenses 7,000 Total fixed expenses 61,500 Operating income $ 92,465
89
(continued) Req. 2
E 6-36A
If passenger volume increases by 10% in May, we would expect revenue and all variable expenses to increase by 10%. This is because revenues and variable costs change in direct proportion to changes in volume. As a result, the contribution margin would also increase by 10%. However, assuming that a 10% increase in volume is still in the same relevant range, we would expect all fixed costs to remain at their present level.
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90
(15 min.)
E 6-37A
Req. 1 Rays Conventional (Absorption Costing) Income Statement Year Ended December 31
Sales revenue (185,000 $35) Less: Cost of goods sold: Beginning finished goods inventory Cost of goods manufactured (200,000 $25*) Cost of goods available for sale Ending finished goods inventory (15,000 $25) Cost of goods sold Gross profit Operating expenses [(185,000 $5) + $250,000] Operating income $6,475,000 $ 0 5,000,000 5,000,000 (375,000) 4,625,000 1,850,000 1,175,000 $ 675,000
__________ *Variable manufacturing expense per unit of $15 plus $10 fixed manufacturing expense per unit ($2,000,000 fixed manufacturing overhead / 200,000 units produced.)
91
E 6-37A
Rays Contribution Margin (Variable Costing) Income Statement Year Ended December 31 Sales revenue (185,000 $35) $6,475,000 Variable expenses: Variable cost of goods sold: Beginning finished goods inventory $ 0 Variable cost of goods manufactured (200,000 $15) 3,000,000 Variable cost of goods available for sale 3,000,000 Ending finished goods inventory (15,000 $15) (225,000) Variable cost of goods sold 2,775,000 Sales commission expense (185,000 $5) 925,000 3,700,000 Contribution margin 2,775,000 Fixed expenses: Manufacturing overhead $2,000,000 Operating expenses 250,000 2,250,000 Operating income $ 525,000
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92
(continued) Req. 2
E 6-37A
Absorption costing operating income is higher than variable costing operating income. This is because absorption costing defers 15,000 goggles $10 fixed manufacturing overhead per goggle = $150,000 of fixed manufacturing overhead as an asset in ending inventory. In contrast, variable costing expenses all the fixed manufacturing overhead during the year. Variable costing expenses $150,000 more costs during the year, so variable costing operating income is $150,000 less than absorption costing income ($675,000 $525,000).
Req. 3 Rays managers can use the contribution margin income statement format to evaluate the sales promotion. Increase in contribution margin (15,000 $225,000 $15)*.... Increase in fixed expenses....................... (150,000) Increase in operating income.............................. $ 75,000 Rays should go ahead with the promotion. *Contribution margin per unit: Sale price.......................................... Variable manufacturing cost.................. Variable operating cost.......................
$35 $15 5 (20)
Contribution margin per unit..............
$ 15
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Exercises (Group B)
(15 min.)
(a) Variable Expenses Cost $100 Cost (thou- $ 80 (thousands) $ 60 sands) $ 40 $ 20 0 2 4 6 8 10 Volume (thousands of units) $50 $40 $30 $20 $10 0 2 4 6 8 10 Volume (thousands of units) (b) Mixed Expenses Cost $40 (thou- $30 sands) $20 $10
E 6-38B
(c) Fixed Expenses
0 2 4 6 8 10 Volume (thousands of units)
95
(5-10 min.)
a. Graph 9 b. Graph 1
E 6-39B
c. Graph 2 d. Graph 3
e. Graph 8 f. Graph 2 g. h. i. j. Graph 11 Graph 1 Graph 7 Graph 5
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96
(15 min.)
a.
E 6-40B
The managers judgment is used to determine the cost behavior of various accounts when using the Account analysis method of cost estimation. Total costs are always shown on the y-axis in cost equations graphs. The Average cost per unit should not be used to predict total costs at various volumes unless it is strictly a/an Variable cost. As volume increases, Variable costs and Mixed costs increase in total. Committed fixed costs are the result of previous management decisions and are not usually controllable in the short run. Fixed costs remain constant in total over a wide range of volume. Step costs remain constant in total over small ranges of activity. Graphs of Variable costs always begin at the origin. One of the disadvantages of the High-low method is that it uses only two historical data points to determine the cost line and cost equation. The goodness-of-fit statistic is also known as the _R-square_. Variable costs remain constant on a per unit basis.
b.
c.
d.
e.
f. g. h. i.
j. k
97
l.
All historical data points provided are used when performing a Regression analysis to determine the cost equation. As volume decreases, Fixed costs and Mixed costs increase on a per unit basis.
m.
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(15 min.)
E 6-41B
Use the two pieces of information provided to find total fixed costs and the variable cost per unit within the relevant range: Total fixed costs Total fixed costs Total fixed costs = number of garments fixed cost per garment at a given level = 4,500 $2.20 = $9,900
Total variable costs = number of garments variable cost per garment $3,375 = 4,500 variable cost per garment $0.75 = variable cost per garment
Total fixed costs will remain constant at $9,900 at all volumes within the relevant range. The variable cost per unit will remain constant at $0.75 per garment across the relevant range. The following predictions are made using this information:
3,000 garments $2,250 9,900 $12,150 $0.75 3.30 4,500 garments $3,375 9,900 $13,275 $0.75 2.20 6,000 garments $ 4,500 9,900 $14,400 $0.75 1.65
Total variable costs Total fixed costs Total operating costs Variable cost per garment Fixed cost per garment
99
Average cost per garment
$4.05
$2.95
$2.40
Chapter 6
Cost Behavior
100
(continued)
E 6-41B
2) The average cost per garment changes as volume changes, due to the fixed component of the dry cleaners costs. The fixed cost per unit decreases as volume increases, while the variable cost per unit remains constant. 3) If Dan Pillard uses the average cost per unit at full capacity ($2.40) to predict total costs for a volume of 3,000 units, he will predict total costs to be $7,200 ($2.40 3,000 garments). Since his actual costs at this volume will be $12,150, he will have underestimated total costs by $4,950.
101
(15 min.) Pillard Dry Cleaners Projected Income Statement Month Ended March 31 Dry cleaning revenue (4,280 $8) Less: Operating costs [$9,900 + (4,280 $0.75)] Operating income
E 6-42B
$34,240 (13,110) $21,130
Pillard Dry Cleaners Projected Contribution Margin Income Statement Month Ended March 31 Dry cleaning revenue (4,280 $8) $34,240 Less: Variable costs: (4,280 $0.75) (3,210) Contribution margin 31,030 Less: Fixed costs: (9,900) Operating income $21,130
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(15 min.) Req. 1
E 6-43B
The highest volume of machine hours (1,440) occurred in June while the lowest volume of machine hours (1,040) occurred in March. Therefore, we use those two data points in the high-low method. Find the slope (the variable cost component): y (high) y (low) x (high) x (low) = ($4,086 $3,590) (1,440 1,040 machine hours)
$1.24
Req. 2 Find the vertical intercept (the fixed cost component) by plugging the slope into a cost equation, using either high point or low point data: Using high point (June) data: y $4,086 $4,086 f
103
= = = =
vx + f: ($1.24 / MH 1,440 MHs) + f $1,786 + f $2,300
Using low point (March) data:

y = vx + f:
$3,590 = ($1.24 / MH 1,040 MHs) + f $3,590 = $1,290 + f f = $2,300 The fixed cost portion of the utilities is $2,300. (continued)
E 6-43B
Req. 3 Using a variable cost of $1.24 per machine hour and fixed costs of $2,300, we would expect total utilities costs to be about $3,800. Total expected utilities cost: = ($1.24 / MH 1,220 MHs) + $2,300 = $3,813
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(15 min.) a) Average cost per unit $23.43 $32,802
E 6-44B
= Total cost number of units = Total cost 1,400 units = Total cost
b) Use a mixed cost equation to determine the variable cost per unit: Total cost = Variable cost component + fixed cost component y = vx + f $32,802 = v (1,400) + $15,000 $17,802 = v (1,400) $12.72 = v The variable cost per unit is $12.72
c)
= $12.72 x + $15,000 where x= number of mailboxes
d) If the plant manager forecasts costs using the average cost per unit, his forecast for 1,700 mailboxes would be: $39,831 = 1,700 $23.43 average cost per mailbox
e) If the plant manager forecasts total costs using the cost equation, his forecast for 1,700 mailboxes would be: $36,624
105
= ($12.72 1,700) + $15,000
Chapter 6
Cost Behavior
106
(continued)
E 6-44B
f) The plant managers forecast would be $3,207 ($39,831 $36,624) too high if he uses the average cost per unit to predict costs. The average cost per unit is based on a mixed cost that will change as volume changes. If the manager uses the average cost to predict costs, he is erroneously assuming that the average cost per unit does not change at different volumes. (In essence, he is assuming the average cost behaves as a variable cost.) The manager should use the cost equation to predict costs since it correctly takes into account the variable and fixed components of producing mailboxes.
107
(5-10 min.)
a.
E 6-45B
MIXED: Satellite TV - $40 per month for 150 channels plus $2.99 per pay-per-view movie
b. c. d.
VARIABLE: Bus ticket - $1 per ride FIXED: Condo rental - $750 per month MIXED: Phone service - $19.99 per month plus $0.05 per minute for long distance
e. f. g.
MIXED: Student activity pass - $50 plus $5 per event VARIABLE: Campus meal plan - $3 per meal VARIABLE: Pay-as-you-go cell phone plan - $0.20 per minute
h.
MIXED: Utilities - $20 per month plus $0.475 per kilowatt hour
i.
FIXED: Car payment - $400 per month VARIABLE: Gas - $2.79 per gallon and your car averages 45 miles per gallon
j.
k.
FIXED: Car insurance - $175 per month
Chapter 6
Cost Behavior
108
(10-15 min.) Req. 1
E 6-46B
Excel will render the following scatter plot if students do not force the axes back to the origin:
Relationship of van operating costs to miles driven

Van operating costs 6000 5500 5000 4500 4000 13000 14000 15000 16000 17000 18000
Miles driven
If students force the axes back to the origin, Excel will render the following scatter plot:
Relationship of van operating costs to miles driven

6000 5000 4000 3000 2000 1000 0 0 5000 10000 Miles driven 15000 20000 Van operating costs
109
(continued) Req. 2
E 6-46B
The data does not appear to contain any outliers. All data points fall in the same general pattern.
Req. 3 There appears to be a very strong relationship between van operating costs and miles driven. We can tell this because the data points fall in a fairly tight, linear pattern.
Chapter 6
Cost Behavior
110
(10-15 min.)
E 6-47B
The month with the highest volume is February and the month with the lowest volume is July. The high-low method uses only these two months to determine the cost equation. Step 1) Find the slope:
Rise y (high) y (low) = = Run x (high) x (low) ($5,350 $4,590) (17,500 13,500) miles = $0.19 per mile
Step 2) Find the vertical intercept (the fixed cost component) by plugging the slope into a cost equation, using either the February or July data. Using February data: y = vx + f $5,350 = ($0.19 per mile 17,500 miles) + f f = $2,025 Or, Using July data: y = vx + f $4,590 = ($0.19 per mile 13,500 miles) + f f = $2,025 Step 3) Write the cost equation: y = $0.19 x + $2,025 where y = monthly van operating costs x = number of miles driven Predict monthly operating costs when volume is 14,500 miles
y = ($0.19 14,500) + $2,025 y = $4,780
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(20-30 min.) Req. 1 The Excel regression output looks like this:
SUMMARY OUTPUT Regression Statistics Multiple R 0.866984 R Square 0.751662 Adjusted R Square 0.701994 Standard Error 181.5471 Observations 7 ANOVA df 1 5 6 Coefficient s 1964.2867 0.204931 SS 498803.1 66470.85 677882 Standard Error 826.8944 0.052678 MS 498803.1 13294.17 F 15.13387 Significance F 0.01152
E 6-48B
Regression Residual Total
T Stat 2.375498 3.890228
P-value 0.063518 0.01152
Lower 95% -161.313 0.069517
Upper 95% -4089.886 0.340345
Lower 95.0% -161.313 0.069517
Upper 95.0% -4089.886 0.340345
Req. 2 Based on the Excel output, Tulip Times van operating cost equation is: y = $0.20 x + $1,964.29 where y = monthly van operating costs x = miles driven
113
This equation found by looking at the X variable 1 coefficient (.204931) and the intercept coefficient (1964.2867) on the Excel output.
Chapter 6
Cost Behavior
114
(continued) Req. 2
E 6-48B
The R-square is 0.752 (rounded). The r-square indicates that the cost equation explains 75.2% of the variability in the data. An Rsquare between .50 and .80 means that the manager should use the cost equation with caution.
Req. 3 At a volume of 14,500 miles, Tulip Time could expect the following van operating costs: y y = = ($0.20 per mile 14,500 miles) + $1,964.29 $4,864.29
115
(5-10 min.) Req. 1
E 6-49B
Based on the Excel output, Tulip Times van operating cost equation is: y = $0.29 x + $678.76 where y = monthly van operating costs x = miles driven This equation found by looking at the X variable 1 coefficient (.29) and the intercept coefficient (678.76) on the Excel output. Req. 2 The R-square is 0.72. The r-square indicates that the cost equation explains 72% of the variability in the data. In other words, it fits the data quite well. Tulip Time should feel confident using this cost equation to predict total costs at other volumes within the same relevant range.
Chapter 6
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116
Req. 3 At a volume of 15,500 miles, Tulip Time could expect the following van operating costs: y y = = ($0.29 per mile 15,500 miles) + $678.76 $5,173.76 (10-20 min.) Req. 1
E 6-50B
Op era tin g co sts

$3,000 $2,500 $2,000 $1,500 $1,000 $500 $0 0
Relationship of pancake volume to operating costs
1000
2000
3000
4000
5000
Pancake volume
Note: If students used Excel, they may not have forced the vertical axis to show the origin. If so, their scatter plot will look different.
117
Req. 2 The data appears to be sound. There are no data points that look abnormal compared to the other data points.
Chapter 6
Cost Behavior
118
(continued) Req. 3
E 6-50B
Operating costs appear to be a mixed cost. If they were strictly fixed, the data points would fall in a horizontal straight line. If they were strictly variable, they would fall in a sloped straight line which would be angled towards the origin. The data points appear to be sloped towards a vertical intercept of about $1,500. In other words, the data appears to be a mixed cost with a fixed portion of about $1,500.
Req. 4 There does appear to be a linear relationship between pancake volume and operating costs. However, the relationship does not appear to be very strong. If it were a stronger relationship, the data points would fall into more of a tight, straight line.
119
(5-10 min.) Req. 1
E 6-51B
Step 1) The month with the highest volume is August (4,200 pancakes) and the month with the lowest volume is September (3,600 pancakes). Therefore, use only these two months to determine the cost equation. Step 1) Find the slope: y (high) y (low) x (high) x (low) = ($2,530 $2,440) (4,200 3,600 pancakes)
= $0.15 per pancake
Step 2) Find the vertical intercept (the fixed cost component) by plugging the slope into a cost equation, using either August or September data: Using August data: y = vx + f: $2,530 = ($0.15 / pancake 4,200 pancakes) + f f = $1,900 Alternatively, using September data: y = vx + f $2,440 = ($0.15 / pancake 3,600 pancakes) + f f = $1,900 Step 3) Write the cost equation: y = $0.15 x + $1,900
where y = total monthly operating costs x = number of pancakes
121
(continued) Req. 2
E 6-51B
2) Predict total monthly operating costs when 4,000 pancakes are served: y Y = ($0.15 4,500) + $1,900 = $2,575
Req. 3 3) Cliffs current volume ranges from 3,600 4,200 pancakes. If Cliff sells 12,000 pancakes one month, he might be operating outside of his current relevant range. Cliff should not predict costs using the current cost equation for any volumes that fall outside of his relevant range since cost behavior may change at higher volumes.
Chapter 6
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122
(10-20 min.) Req. 1

SUMMARY OUTPUT Regression Statistics Multiple R 0.566678 R Square 0.321124 Adjusted R Square 0.151405 Standard Error 100.7011 Observations 6 ANOVA df Regression Residual Total 1 4 5 Coefficient s 1322.732 0.289617 SS 19187.16 40562.84 59750 Standard Error 816.9133 0.210549 MS 19187.16 10140.71 F 1.892092 Significanc eF 0.24097
E 6-52B
t Stat 1.619183 1.375533
P-value 0.180721 0.24097
Lower 95% -945.383 -0.29496
Upper 95% 3590.847 0.874196
Lower 95.0% -945.383 -0.29496
Upper 95.0% 3590.847 0.874196
y = $1,322.73 + $0.29 (rounded) x Where: y = Cliffs monthly operating costs x = pancake volume Req. 2 The R-square is only 0.32. This indicates that the regression line and cost equation do not fit the data very well. Dave should use this cost equation with great caution, realizing that it will not do a very good job of predicting future monthly operating costs within the same relevant range.
123
(10-20 min.) Req. 1
E 6-53B
The fixed cost per month for Cliffs is $1,626.18. This is the Intercept Coefficient found in the Excel output.
Req. 2 The variable cost per pancake is $0.22. This is the X Variable 1 Coefficient found in the Excel output.
Req. 3 Cliffs cost equation using the fixed and variable components from requirements 1 and 2 would be: y = $0.22x + $1,626.18 Where: y = Cliffs monthly operating costs x = pancake volume To predict total monthly operating costs when 4,200 pancakes are served we input 4,200 as x in our cost equation: y y = ($0.22 4,200) + $1,626.18 = $2,550.18
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Therefore, we would expect our total costs to be $2,550.18 at a production level of 4,200 pancakes.
(15 min.)
E 6-54B
The owner can use the high-low method to estimate the apartment operating cost behavior. Since only two months of data are given, these are the two months that will be used for the high-low method. 90% occupancy 750 unit complex = 675 apartments occupied 80% occupancy 750 unit complex = 600 apartments occupied

y (high) y (low) x (high) x (low) ($216,825 $212,400) (675 600) occupied apartments $59 per occupied apartment
Step 2) Find the vertical intercept (the fixed cost component) y $216,825 f Or, y $212,400 f = = = = = = vx + f ($59 675 occupied apartments) + f 177,000 vx + f ($59 600 occupied apartments) + f 177,000
125
Step 3) Write the cost equation: y = $59 x + $177,000 where y = monthly operating costs x = number of occupied apartments
(continued)
E 6-54B
Use the cost equation to predict total operating costs when occupancy is at 60%. First calculate how many apartments are occupied at a 60% occupancy rate: 60% occupancy 750 unit complex = 450 apartments occupied
y y
= =
($59 450) + $177,000 $203,550
Total operating costs will be about $203,550 when the apartments are 60% occupied. Unfortunately for the owner, most of his costs are fixed and will continue to exist even if occupancy rates fall substantially.
Chapter 6
Cost Behavior
126
(10-20 min.)
E 6-55B
Pretty Pets Contribution Margin Income Statement For the Year Ended December 31 Sales revenue $1,011,000 Variable expenses: Cost of goods sold 671,000 Variable selling and marketing expenses 28,520 Variable web site maintenance expenses 15,000 Other variable operating expenses 1,780 Total variable expenses 716,300 Contribution margin 294,700 Fixed expenses: Fixed selling and marketing expenses 32,480 Fixed web site maintenance
expenses Other fixed operating expenses Total fixed expenses Operating income
45,000 16,020 93,500 $201,200
Chapter 6
Cost Behavior
128
(continued) Calculations for selling and marketing expenses: Total selling and marketing expenses Variable freight-out Remaining selling and marketing expenses
E 6-55B
$ 61,000 (20,400) $ 40,600
Variable: Fixed:
$40,600 20% = $8,120 + $20,400 (freight out) = $28,520 $40,600 80% = $32,480
Calculations for web site maintenance expenses: Variable: Fixed: $60,000 25% = $15,000 $60,000 75% = $45,000
Calculations for other operating expenses: Variable: Fixed: $17,800 10% = $1,780 $17,800 90% = $16,020
129
(15-20 min.) Req. 1
E 6-56B
Counton Carriage Company Contribution Margin Income Statement For the Month Ended April 30 Sales revenue (12,970 85% $26.00) + (12,970 15% $18.00) $321,656 Variable expenses: Fee paid to city (15% $321,656) $48,248 Complimentary postcards (12,970 $0.75) 9,728 Brokerage fee (12,970 60% $1.20) 9,338 Carriage driver wages (12,970 $3.00) 38,910 Total variable expenses 106,224 Contribution margin $215,432 Fixed expenses: Leasing and boarding horses $48,000 Non-carriage driver payroll expense 7,500 Depreciation expense 2,900 Other fixed operating expenses 7,250 Total fixed expenses 65,650 Operating income $149,782
Chapter 6
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130
(continued) Req. 2
E 6-56B
If passenger volume increases by 18% in May, we would expect revenue and all variable expenses to increase by 18%. This is because revenues and variable costs change in direct proportion to changes in volume. As a result, the contribution margin would also increase by 18%. However, assuming that a 18% increase in volume is still in the same relevant range, we would expect all fixed costs to remain at their present level.
131
(15 min.)
E 6-57B
Req. 1 Swim Clearly Conventional (Absorption Costing) Income Statement Year Ended December 31
Sales revenue (200,000 $42) Less: Cost of goods sold: Beginning finished goods inventory Cost of goods manufactured (215,000 $29*) Cost of goods available for sale Ending finished goods inventory (15,000 $29) Cost of goods sold Gross profit Operating expenses [(200,000 $5) + $265,000] Operating income $8,400,000 $ 0 6,235,000 6,235,000 (435,000) 5,800,000 2,600,000 1,265,000 $1,335,000
__________ *Variable manufacturing expense per unit of $20 plus $9 fixed manufacturing expense per unit ($1,935,000 fixed manufacturing overhead / 215,000 units produced.)
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E 6-57B
Swim Clearly Contribution Margin (Variable Costing) Income Statement Year Ended December 31 Sales revenue (200,000 $42) $8,400,000 Variable expenses: Variable cost of goods sold: Beginning finished goods inventory $ 0 Variable cost of goods manufactured (215,000 $20) 4,300,000 Variable cost of goods available for sale 4,300,000 Ending finished goods inventory (15,000 $20) (300,000) Variable cost of goods sold 4,000,000 Sales commission expense (200,000 $5) 1,000,000 5,000,000 Contribution margin 3,400,000 Fixed expenses: Manufacturing overhead $1,935,000 Operating expenses 265,000 2,200,000 Operating income $1,200,000
133
(continued) Req. 2
E 6-57B
Absorption costing operating income is higher than variable costing operating income. This is because absorption costing defers 15,000 goggles $9 fixed manufacturing overhead per goggle = $135,000 of fixed manufacturing overhead as an asset in ending inventory. In contrast, variable costing expenses all the fixed manufacturing overhead during the year. Variable costing expenses $135,000 more costs during the year, so variable costing operating income is $135,000 less than absorption costing income ($1,335,000 $1,200,000).
Req. 3 Swim Clearlys managers can use the contribution margin income statement format to evaluate the sales promotion. Increase in contribution margin (15,000 $255,000 $17)*.... Increase in fixed expenses....................... (145,000) Increase in operating income.............................. $110,000 Swim Clearly should go ahead with the promotion. *Contribution margin per unit: Sale price.......................................... Variable manufacturing cost.................. Variable operating cost.......................
Chapter 6
$42 $20 5
Cost Behavior
(25)
134
Contribution margin per unit..............
$ 17
Problems (Group A) P 6-58A
(45-60 min.) Req. 1
Bergs manufacturing overhead appears to be a mixed cost. If it were a fixed cost, it would remain constant each month. If it were a variable cost, it would remain constant on a per-unit (of activity) basis. Both Bergs MOH per DL hour and MOH per unit produced vary with volume. As in Bergs case, manufacturing overhead usually includes both fixed and variable components.
Req. 2
135
Berg's Overhead
600000 500000
Cost
400000 300000 200000 100000 0 0 5000 10000 15000 DL hours 20000 25000 30000
Chapter 6
Cost Behavior
136
(continued) Req. 3
P 6-58A
Berg's Overhead
600000 500000
Cost
400000 300000 200000 100000 0 0 1000 2000 3000 4000 5000 6000 7000
Units
Req. 4 There does not appear to be any outlier in the graph depicting MOH costs vs. DL hours. However, in the graph of MOH costs vs. units, September may be a potential outlier. The graph dips substantially at this data point (volume of 4,200 units and cost of $419,010). On the other hand, the data may be sound. Management should check into September data before
continuing with the analysis.
137
(continued) Req. 5
P 6-58A
The month with the highest number of DL hours is November while the month with the lowest number of DL hours is September. Use only these two months to determine Bergs MOH cost equation:

y (high) y (low) ($527,000 $425,000) = = $12.75 per DL hour x (high) x (low) (27,000 19,000) DL hours
Step 2) Find the vertical intercept (fixed cost component): Using November data: y = vx + f $527,000 = ($12.75 per DL hour 27,000 DL hours) + f f = $182,750 Or, using September data: y = vx + f $425,000 = ($12.75 per DL hour 19,000 DL hours) + f f = $182,750
Step 3) Write the cost equation: y = $12.75 x + $182,750 where y = monthly MOH costs
x = number of DL hours
(continued) Req. 6
P 6-58A
Use the cost equation to predict total operating costs if 24,000 DL hours are incurred:
y y
= ($12.75 per DL hour 24,000 DL hours) + $182,750 = $488,750
Total manufacturing overhead costs will be about $488,750 if 24,000 DL hours are incurred.
139
(30-40 min.) Req. 1

SUMMARY OUTPUT Regression Statistics Multiple R 0.982244 R Square 0.964804 Adjusted R Square 0.956005 Standard Error 8879.809 Observations 6 ANOVA df 1 4 5 Coefficient s 191235.4 12.20372 SS MS 8.65E + 09 8.65E + 09 3.15E + 08 78850999 8.69E + 09 Standard Error 26741.2 1.16544 F 109.65 Significance F 0.00047
P 6-59A
T Stat 7.151339 10.47134
P-value 0.002023 0.00047
Lower 95% 116989.9 8.96794
Upper 95% 265480.9 15.4395
Lower 95.0% 116989.9 8.96794
Upper 95.0% 265480.9 15.4395
Based on the regression output, the manufacturing overhead cost equation is: y = $12.20 x + $191,235.42 where y = monthly MOH costs x = number of DL hours The R-square is very high at .965 (rounded); therefore projections should be fairly accurate. If 24,000 DL hours are incurred, total manufacturing overhead costs are projected to be: y = $12.20 (24,000) + $191,235.42
y = $484,035.42
141
(continued) Req. 2
SUMMARY OUTPUT Regression Statistics Multiple R 0.757995 R Square 0.574556 Adjusted R Square 0.468195 Standard Error 30872.91 Observations 6 ANOVA df 1 4 5 Coefficient s 326296.4 34.83775 SS 5.15E+09 3.81E+09 8.69E+09 Standard Error 62538.63 14.98909 MS 5.15E+09 9.53E+08 F 5.40 Significance F 0.080763
P 6-59A
T Stat 5.217517 2.324207
P-value 0.006438 0.080763
Lower 95% 152661.3 -6.77863
Upper 95% 499931.5 76.45412
Lower 95.0% 152661.3 -6.77863
Upper 95.0% 499931.5 76.45412
Based on the regression output, the manufacturing overhead cost equation is: y = $34.84 x + $326,296.41 (figures rounded) where y = monthly MOH costs x = number of units produced Projecting MOH at 5,000 units yields: y = $34.84 (5,000) + $326,296.41 y = $500,496.41
Chapter 6
Cost Behavior
142
The R-square is much lower (.575) than it was using DL hours as the cost driver (.965). Therefore, the cost equation using DL hours is the more accurate cost equation.
143
(continued) Req. 3
P 6-59A
September appeared to be a possible outlier on the graph (P658A requirement 4). After removing Septembers data from the data set, the resulting regression analysis yields the following output:
T Stat 8.563332 3.937295
P-value 0.003347 0.029189
Lower 95% 207104.5 6.97272
Upper 95% 452082.3 65.76677
Lower 95.0% 207104.5 6.97272
Upper 95.0% 452082.3 65.76677
Based on the regression output, the manufacturing overhead cost equation is: y = $36.37 + $329,593.36 (figures rounded) where y = monthly MOH costs x= number of units produced Projecting MOH at 5,000 units yields: y = $36.37 (5,000) + $329,593.36 y = $511,443.36
The R-square (.8379) is much higher with the potential outlier (September) removed.
145
(continued) Req. 4
P 6-59A
We have the most confidence in the cost equation that uses DL hours as the cost driver. The R square value for that equation (found in Req. 1) was the highest (.965) indicating a very strong relationship between the number of DL hours and MOH costs.
Chapter 6
Cost Behavior
146
(15-20 min.) Req. 1 Kelseys Ice Cream Shoppe Income Statement For the Month Ended June 30 Sales revenue (9,000 $3.00) Cost of goods sold (9,000 $0.55*) Gross profit Operating expenses: Lease expense $1,800 Depreciation expense 250 Other operating expenses 2,500 Total operating expenses Operating income
P 6-60A
$27,000 (4,950) $22,050
(4,550) $17,500
*$15 per tub 30 servings = $0.50 for ice cream + $0.05 per ice cream cone = $0.55
147
(continued) Req. 2 Kelseys Ice Cream Shoppe Contribution Margin Income Statement For the Month Ended June 30 Sales revenue (9,000 $3.00) Variable expenses Cost of goods sold (9,000 0.55*) $4,950 Other variable operating expenses 625a Total variable expense Contribution margin Fixed expenses: Lease expense $1,800 Depreciation expense 250 Other fixed operating expenses 1,875b Total fixed expenses Operating income $2,500 25% variable = $625 b $2,500 75% fixed = $1,875
a
P 6-60A
$27,000
(5,575) $21,425
(3,925) $17,500
Chapter 6
Cost Behavior
148
(30-45 min.)
P 6-61A
Sales: Violins produced (units) 2,000 Less: Ending inventory (units) (600) Violins sold (units)* 1,400 sales price per violin $112.50 Total sales revenue $157,500 *Since this was the first month of operation, there would be no beginning inventory. Variable Manufacturing Costs: Direct materials used Direct labor Variable manufacturing overhead Total variable manufacturing costs Units produced Variable manufacturing cost per unit Fixed Manufacturing Costs: Fixed manufacturing overhead Units produced Fixed manufacturing cost per unit Period Costs: Variable selling and administrative Fixed selling and administrative
$ 80,000 50,000 30,000 $160,000 2,000 $ 80
$40,000 2,000 $ 20
$10,000 15,000
The difference between absorption and variable costing is the treatment of fixed manufacturing overhead. Under absorption costing, it is treated as a product cost. Under variable costing, it is treated as a period cost. Therefore, under absorption costing, the inventoriable product cost per unit is $100 ($80
variable + $20 fixed), whereas under variable costing, the inventoriable product cost per unit is $80.
Chapter 6
Cost Behavior
150
(continued) 1. Gross Profit Sales Less: Cost of goods sold (1,400 violins $100) Gross profit
P 6-61A
$157,500 140,000 $ 17,500
2. Contribution Margin Sales Less: Variable cost of goods sold (1,400 violins $80) Less: Variable selling and administrative Contribution margin $ 157,500 (112,000) (10,000) $ 35,500
3. Total Expenses Shown Below the Gross Profit Line All selling and administrative expenses: Variable selling and administrative Fixed selling and administrative Total period expenses
$10,000 15,000 $25,000
4. Total Expenses Shown Below the Contribution Margin Line All fixed expenses: Fixed manufacturing Fixed selling and administrative Total fixed expenses
$40,000 15,000 $55,000
Chapter 6
Cost Behavior
152
(continued)
P 6-61A
5. Dollar Value of Ending Inventory under Absorption Costing Units in ending inventory Inventoriable cost per unit Dollar value of ending inventory 600 $100 $60,000
6. Dollar Value of Ending Inventory under Variable Costing Units in ending inventory Inventoriable cost per unit Dollar value of ending inventory 600 $80 $48,000
7. Operating income will be $12,000 higher under absorption costing than it is under variable costing. In this case, both income statements report an operating losshowever that loss is $12,000 less under absorption costing. Under absorption costing, $12,000 more [($60,000 absorption ending inventory $48,000 variable costing ending
inventory) OR (600 violins $20 fixed manufacturing cost per violin)] is trapped on the balance sheet rather than expensed as part of cost of goods sold in the current period. This $12,000 of cost will flow through the absorption income statement when the violins are sold.
(25-35 min.) Req. 1

January
P 6-62A
February
Absorption Variable Absorption Variable Costing Costing Costing Costing
Variable manufacturing expenses Fixed manufacturing expenses. Total...........................
$4.00 .50a $4.50
$4.00 $4.00
$4.00 .70a $4.70
$4.00 $4.00
Fixed overhead = per meal In January: =
Fixed manufacturing overhead Number of meals produced
$700 1,400
= $0.50 per meal In February: = $700 1,000
= $0.70 per meal
Chapter 6
Cost Behavior
154
(continued) Req. 2a Marios Foods Income Statement (Absorption Costing) Month Ended January 31
P 6-62A
Sales revenue (1,000 $7) Less: Cost of goods sold: Beginning finished goods inventory $ 0 Cost of goods manufactured (1,400 $4.50) 6,300 Cost of goods available for sale 6,300 a Ending finished goods inventory (400 $4.50) (1,800) Cost of goods sold Gross profit Less: Operating expenses: Marketing and administrative expenses [(1,000 $1) + $600] Operating income
$7,000
(4,500) 2,500
(1,600) $ 900
Beginning inventory.......... Units produced........ Units available............. Units sold........................ Ending inventory............
Units 0 1,400 1,400 (1,000) 400
155
(continued) Req. 2a (continued) Marios Foods Income Statement (Absorption Costing) Month Ended February 28
P 6-62A
Sales revenue (1,200 $7) Less: Cost of goods sold: Beginning finished goods inventory $1,800b Cost of goods manufactured (1,000 $4.70) 4,700 Cost of goods available for sale 6,500 c d Ending finished goods inventory (200 $4.70) (940) Cost of goods sold Gross profit Less: Operating expenses: Marketing and administrative expenses [(1,200 $1) + $600] Operating income
b
$8,400
(5,560) 2,840
(1,800) $1,040
Ending inventory in Januarys absorption costing income statement.
Units c Beginning inventory....... 400 Units produced........... 1,000 Units available................ 1,400 Units sold........................ (1,200) Ending inventory............... 200
d
Under FIFO, ending inventory is costed at the current periods cost ($4.70).
(continued) Req. 2b Marios Foods Income Statement (Variable Costing) Month Ended January 31
Sales revenue (1,000 $7) Less: Variable expenses: Beginning finished goods inventory Variable cost of goods manufactured (1,400 $4) Variable cost of goods available for sale Ending finished goods inventory (400 $4) Variable cost of goods sold Sales commission expense (1,000 $1) Total variable expenses Contribution margin Less: Fixed expenses: Fixed manufacturing overhead Fixed marketing and administrative expenses Total fixed expenses Operating income
P 6-62A
$7,000 $ 0
5,600 5,600 (1,600) 4,000 1,000 (5,000) 2,000 700 600 (1,300) $ 700
157
(continued) Req. 2b (continued) Marios Foods Income Statement (Variable Costing) Month Ended February 28
d
P 6-62A
$8,400 $1,600d 4,000 5,600 (800) 4,800 1,200 (6,000) 2,400 700 600 (1,300) $1,100
Ending inventory in Januarys variable costing income statement.
Chapter 6
Cost Behavior
158
(continued) Req. 3
P 6-62A
In January, absorption costing operating income exceeds variable costing income. This is because production exceeds sales. Absorption costing defers some of Januarys fixed manufacturing overhead costs in the 400 units of ending inventory. These costs will not be expensed until those units are sold. Deferring some of Januarys fixed manufacturing overhead costs to the future increases Januarys absorption costing income. In February, absorption costing operating income is less than variable costing operating income. This is because fewer units are produced than are sold. As inventory declines, Januarys fixed manufacturing overhead costs that absorption costing assigned to that inventory are expensed in February. This decreases Februarys absorption costing income.
Students should be able to provide responses similar to those above. The additional explanation below is included for instructors who wish to provide a more detailed explanation of
159
the source of the difference between absorption and variable costing incomes.
Chapter 6
Cost Behavior
160
(continued) Req. 3 (continued) January:
P 6-62A
Absorption costing assigns $0.50 of fixed manufacturing overhead to each unit. There are 400 units in ending inventory, so absorption costing defers 400 $0.50 = $200 of January fixed overhead costs. Thus, absorption costing income is $200 higher than variable costing income in January.
February: Marios Foods uses FIFO, so absorption costing expenses the $200 of Januarys fixed overhead that was assigned to the 400 units of Februarys beginning inventory. This reduces
Februarys absorption costing income by $200. However, at the end of February, 200 units of Februarys production remain in ending inventory. At Februarys $0.70 fixed overhead cost per unit, absorption costing defers 200 $0.70 = $140 of February fixed manufacturing costs to the future. Combining both effects, absorption costing operating income is $60 ($200 $140) lower than variable costing income.
Problems (Group B)
Req. 1 Carmichaels manufacturing overhead appears to be a mixed cost. If it were a fixed cost, it would remain constant each month. If it were a variable cost, it would remain constant on a per-unit (of activity) basis. Both Carmichaels MOH per DL hour and MOH per unit produced vary with volume. As in Carmichaels case, manufacturing overhead usually includes both fixed and variable components.
Req. 2
Carmichael's Overhead
600000 500000 Cost 400000 300000 200000 100000 0 0 5000 10000 15000 20000 25000 30000 35000 DL hours
Chapter 6
Cost Behavior
162
163
(continued) Req. 3
P 6-63B
Carmichael's Overhead
600000 500000 Cost 400000 300000 200000 100000 0 0 1000 2000 3000 4000 Units 5000 6000 7000
Req. 4 There does not appear to be any outlier in the graph depicting MOH costs vs. DL hours. However, in the graph of MOH costs vs. units, September may be a potential outlier. The graph dips substantially at this data point (volume of 4,230 units and cost of $435,000). On the other hand, the data may be sound. Management should check into September data before
continuing with the analysis.
Chapter 6
Cost Behavior
164
(continued) Req. 5
P 6-63B
The month with the highest number of DL hours is November while the month with the lowest number of DL hours is September. Use only these two months to determine Bergs MOH cost equation:

y (high) y (low) ($562,000 $435,000) = = $12.70 per DL hour x (high) x (low) (30,000 20,000) DL hours
Step 2) Find the vertical intercept (fixed cost component): Using November data: y = vx + f $562,000 = ($12.70 per DL hour 30,000 DL hours) + f f = $181,000 Or, using September data: y = vx + f $435,000 = ($12.70 per DL hour 20,000 DL hours) + f f = $181,000
Step 3) Write the cost equation: y = $12.70 x + $181,000 where y = monthly MOH costs
x = number of DL hours
(continued) Req. 6
P 6-63B
Use the cost equation to predict total operating costs if 25,500 DL hours are incurred:
y y
= ($12.70 per DL hour 25,500 DL hours) + $181,000 = $504,850
Total manufacturing overhead costs will be about $504,850 if 25,500 DL hours are incurred.
Chapter 6
Cost Behavior
166
(30-40 min.) Req. 1

SUMMARY OUTPUT Regression Statistics Multiple R 0.99658 R Square 0.993172 Adjusted R Square 0.991465 Standard Error 4661.843 Observations 6 ANOVA df 1 4 5 Coefficient s 174684.8 12.81195 SS MS 1.26E + 10 1.26E + 10 86931129 21732782 1.27E + 10 Standard Error 12670.48 0.531169 F 581.79 Significance F 1.75E-05
P 6-64B
T Stat 13.78676 24.12031
P-value 0.00016 1.75E-05
Lower 95% 139505.9 11.33719
Upper 95% 209863.7 14.28671
Lower 95.0% 139505.9 11.33719
Upper 95.0% 209863.7 14.28671
Based on the regression output, the manufacturing overhead cost equation is: y = $12.81 x + $174,684.79 where y = monthly MOH costs x = number of DL hours The R-square is very high at .993 (rounded); therefore projections should be fairly accurate. If 25,500 hours are incurred, total manufacturing overhead costs are projected to be: y = $12.81 (25,500) + $174,684.79
y = $501,339,79
Chapter 6
Cost Behavior
168
(continued) Req. 2
P 6-64B
T Stat 4.980487 3.470088
P-value 0.007595 0.025582
Lower 95% 125428.3 9.421494
Upper 95% 441434 84.84438
Lower 95.0% 125428.3 9.421494
Upper 95.0% 441434 84.84438
Based on the regression output, the manufacturing overhead cost equation is: y = $47.13 x + $283,431.18 (figures rounded) where y = monthly MOH costs x = number of units produced Projecting MOH at 5,200 units yields: y = $47.13 (5,200) + $283,431.18 y = $528,507.18
169
The R-square is much lower (.7506) than it was using DL hours as the cost driver (.9932). Therefore, the cost equation using DL hours is the more accurate cost equation.
Chapter 6
Cost Behavior
170
(continued) Req. 3
P 6-64B
September appeared to be a possible outlier on the graph (P658A requirement 4). After removing Septembers data from the data set, the resulting regression analysis yields the following output:
T Stat 11.9658 8.540854
P-value 0.001256 0.003372
Lower 95% 209988.2 30.63501
Upper 95% 362157.1 67.02429
Lower 95.0% 209988.2 30.63501
Upper 95.0% 362157.1 67.02429
Based on the regression output, the manufacturing overhead cost equation is: y = $48.83 x + $286,072.69 (figures rounded) where y = monthly MOH costs x= number of units produced Projecting MOH at 5,200 units yields: y = $48.83 (5,200) + $286,072.69 y = $539,988.69
The R-square (.9605) is much higher with the potential outlier (September) removed.
Chapter 6
Cost Behavior
172
(continued) Req. 4
P 6-64B
We have the most confidence in the cost equation that uses DL hours as the cost driver. The R square value for that equation (found in Req. 1) was the highest (.993) indicating a very strong relationship between the number of DL hours and MOH costs.
173
(15-20 min.) Req. 1 Marys Ice Cream Shoppe Income Statement For the Month Ended June 30 Sales revenue (9,100 $4.00) Cost of goods sold (9,100 $0.70*) Gross profit Operating expenses: Lease expense $2,050 Depreciation expense 210 Other operating expenses 2,000 Total operating expenses Operating income
P 6-65B
$36,400 (6,370) $30,030
(4,260) $25,770
*$14 per tub 28 servings = $0.50 for ice cream + $0.20 per ice cream cone = $0.70
Chapter 6
Cost Behavior
174
(continued) Req. 2 Marys Ice Cream Shoppe Contribution Margin Income Statement For the Month Ended June 30 Sales revenue (9,100 $4.00) Variable expenses Cost of goods sold (9,100 0.70*) $6,370 Other variable operating expenses 500a Total variable expense Contribution margin Fixed expenses: Lease expense $2,050 Depreciation expense 210 Other fixed operating expenses 1,500b Total fixed expenses Operating income $2,000 25% variable = $500 b $2,000 75% fixed = $1,500
a
P 6-65B
$36,400
(6,870) $29,530
(3,760) $25,770
175
(30-45 min.)
P 6-66B
Sales: Violins produced (units) 2,100 Less: Ending inventory (units) (550) Violins sold (units)* 1,550 sales price per violin $122.50 Total sales revenue $189,875 *Since this was the first month of operation, there would be no beginning inventory. Variable Manufacturing Costs: Direct materials used Direct labor Variable manufacturing overhead Total variable manufacturing costs Units produced Variable manufacturing cost per unit Fixed Manufacturing Costs: Fixed manufacturing overhead Units produced Fixed manufacturing cost per unit Period Costs: Variable selling and administrative Fixed selling and administrative
$ 87,200 60,000 25,000 $172,200 2,100 $ 82
$44,100 2,100 $ 21
$8,000 13,900
The difference between absorption and variable costing is the treatment of fixed manufacturing overhead. Under absorption costing, it is treated as a product cost. Under variable costing, it is treated as a period cost. Therefore, under absorption costing, the inventoriable product cost per unit is $103 ($82
variable + $21 fixed), whereas under variable costing, the inventoriable product cost per unit is $82.
177
(continued) 1. Gross Profit Sales Less: Cost of goods sold (1,550 violins $103) Gross profit
P 6-66B
$189,875 159,650 $ 30,225
2. Contribution Margin Sales Less: Variable cost of goods sold (1,550 violins $82) Less: Variable selling and administrative Contribution margin $ 189,875 (127,100) (8,000) $ 54,775
3. Total Expenses Shown Below the Gross Profit Line All selling and administrative expenses: Variable selling and administrative Fixed selling and administrative Total period expenses
$8,000 13,900 $21,900
4. Total Expenses Shown Below the Contribution Margin Line All fixed expenses: Fixed manufacturing Fixed selling and administrative Total fixed expenses
Chapter 6 Cost Behavior
$44,100 13,900 $58,000

178
179
(continued)
P 6-66B
5. Dollar Value of Ending Inventory under Absorption Costing Units in ending inventory Inventoriable cost per unit Dollar value of ending inventory 550 $103 $56,650
6. Dollar Value of Ending Inventory under Variable Costing Units in ending inventory Inventoriable cost per unit Dollar value of ending inventory 550 $82 $45,100
7. Operating income will be $11,550 higher under absorption costing than it is under variable costing. In this case, both income statements report an operating losshowever that loss is $11,550 less under absorption costing. Under absorption costing, $11,550 more [($56,650 absorption ending inventory $45,100 variable costing ending
inventory) OR (550 violins $21 fixed manufacturing cost per violin)] is trapped on the balance sheet rather than expensed as part of cost of goods sold in the current period. This $11,550 of cost will flow through the absorption income statement when the violins are sold.
(25-35 min.) Req. 1

January
P 6-67B
February
Absorption Variable Absorption Variable Costing Costing Costing Costing
Variable manufacturing expenses Fixed manufacturing expenses. Total...........................
$5.00 .35a $5.35
$5.00 $5.00
$5.00 .50a $5.50
$5.00 $5.00
Fixed overhead = per meal In January: =
Fixed manufacturing overhead Number of meals produced
$700 2,000
= $0.35 per meal In February: = $700 1,400
= $0.50 per meal
181
(continued) Req. 2a Martys Entrees Income Statement (Absorption Costing) Month Ended January 31
P 6-67B
Sales revenue (1,400 $9) $12,600 Less: Cost of goods sold: Beginning finished goods inventory $ 0 Cost of goods manufactured (2,000 $5.35) 10,700 Cost of goods available for sale 10,700 a Ending finished goods inventory (600 $5.35) (3,210) Cost of goods sold (7,490) Gross profit 5,110 Less: Operating expenses: Marketing and administrative expenses [(1,400 $1) + $500] (1,900) Operating income $ 3,210
Beginning inventory.......... Units produced........ Units available............. Units sold........................ Ending inventory............
Units 0 2,000 2,000 (1,400) 600
Chapter 6
Cost Behavior
182
(continued) Req. 2a (continued) Martys Entrees Income Statement (Absorption Costing) Month Ended February 28
P 6-67B
Sales revenue (1,800 $9) $16,200 Less: Cost of goods sold: Beginning finished goods inventory $3,210 Cost of goods manufactured (1,400 $5.50) 7,700 Cost of goods available for sale 10,910 c d Ending finished goods inventory (200 $5.50) (1,100 ) Cost of goods sold (9,810) Gross profit 6,390 Less: Operating expenses: Marketing and administrative expenses [(1,800 $1) + $500] (2,300) Operating income $4,090
b
Ending inventory in Januarys absorption costing income statement.
Units c Beginning inventory....... 600 Units produced........... 1,400 Units available................ 2,000 Units sold........................ (1,800) Ending inventory............... 200
d
Under FIFO, ending inventory is costed at the current periods cost ($5.50).
183
Chapter 6
Cost Behavior
184
(continued) Req. 2b Martys Entrees Income Statement (Variable Costing) Month Ended January 31
P 6-67B
$12,600 $ 0
10,000 10,000 (3,000) 7,000 1,400 (8,400) 4,200 700 500 (1,200) $ 3,000
185
(continued) Req. 2b (continued) Martys Entrees Income Statement (Variable Costing) Month Ended February 28
d
P 6-67B
$16,200 $3,000d 7,000 10,000 (1,000) 9,000 1,800 (10,800) 5,400 700 500 (1,200) $4,200
Ending inventory in Januarys variable costing income statement.
Chapter 6
Cost Behavior
186
(continued) Req. 3
P 6-67B
In January, absorption costing operating income exceeds variable costing income. This is because production exceeds sales. Absorption costing defers some of Januarys fixed manufacturing overhead costs in the 600 units of ending inventory. These costs will not be expensed until those units are sold. Deferring some of Januarys fixed manufacturing overhead costs to the future increases Januarys absorption costing income. In February, absorption costing operating income is less than variable costing operating income. This is because fewer units are produced than are sold. As inventory declines, Januarys fixed manufacturing overhead costs that absorption costing assigned to that inventory are expensed in February. This decreases Februarys absorption costing income.
Students should be able to provide responses similar to those above. The additional explanation below is included for instructors who wish to provide a more detailed explanation of
187
the source of the difference between absorption and variable costing incomes.
Chapter 6
Cost Behavior
188
(continued) Req. 3 (continued) January:
P 6-67B
Absorption costing assigns $0.35 of fixed manufacturing overhead to each unit. There are 600 units in ending inventory, so absorption costing defers 6400 $0.350 = $210 of January fixed overhead costs. Thus, absorption costing income is $210 higher than variable costing income in January.
February: Martys Entrees uses FIFO, so absorption costing expenses the $210 of Januarys fixed overhead that was assigned to the 600 units of Februarys beginning inventory. This reduces
Februarys absorption costing income by $210. However, at the end of February, 200 units of Februarys production remain in ending inventory. At Februarys $0.50 fixed overhead cost per unit, absorption costing defers 200 $0.50 = $100 of February fixed manufacturing costs to the future. Combining both effects, absorption costing operating income is $110 ($210 $100) lower than variable costing income.
Chapter 6
Cost Behavior
190
Decision Cases
(15 min.) DATE: TO: __________ Herbert Kohler, Chairman of the Board, American Faucet Students name
C6-68
FROM:
SUBJECT: Definition of operating income for Toni Moens bonus contract I suggest that we base Toni Moens bonus contract on variable costing operating income rather than absorption costing operating income. If we base her bonus on absorption costing income, we will give Moen conflicting signals. Our recent decision to adopt just-in-time means that American Faucet should reduce inventory. However, if we base Moens bonus on absorption costing income, we will give her an incentive to increase inventory. As vice president of manufacturing operations, Moen could build up ending inventory. Under absorption costing, this inventory buildup defers current period fixed manufacturing
191
overhead to the future, which increases current period operating income. Moen would have an incentive to build up
(continued)
C6-68
inventory to increase income and thus her bonus. This is clearly inconsistent with our just-in-time philosophy. In contrast, variable costing expenses all the fixed
manufacturing overhead in the period incurred. Variable costing operating income is unaffected by changes in inventories, so a bonus based on variable costing income would not give Moen an incentive to build inventory.
Note: Most students will probably suggest the bonus be based on variable costing income. However, an equally acceptable alternative is to use absorption costing income, but implement strict inventory controls that prevent an inventory buildup.
Chapter 6
Cost Behavior
192
(75-90 min.) Req. 1
C6-69
Braunhauss manufacturing overhead appears to be a mixed cost. If it were a fixed cost, it would remain constant in total each month. If it were a variable cost, it would remain constant on a per unit (of activity) basis. Both Braunhauss MOH per processing hour and MOH per case vary with volume. As in Braunhauss case, manufacturing overhead usually includes both fixed and variable components.
Req. 2
193
Braunhaus Brewery Overhead

35,000 30,000 25,000 Cost 20,000 15,000 10,000 5,000 0 0 100 200 300 400 500 600 700 800 Processing Hours
Chapter 6
Cost Behavior
194
(continued) C6-69 Req. 3

Braunhaus Brewery Overhead
35,000 30,000 25,000 Cost 20,000 15,000 10,000 5,000 0 0 2000 4000 Cases 6000 8000 10000
Req. 4 There does not appear to be any outlier in the graph depicting MOH costs vs. processing hours. However, in the graph of MOH costs vs. cases, June may be a potential outlier. The data point (volume of 5,600 cases and MOH cost of $29,750) appears out of line with the other data points. On the other hand, the data may be sound. Management should check into June data before continuing with the analysis.
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(continued) Req. 5
C6-69
The month with the highest number of processing hours is June while the month with the lowest volume of processing hours is March. Use only these two months to determine the manufacturing overhead cost equation: Step 1) Find the slope:
y (high) y (low) ($29,750 $24,500) $25 per processing = = hour x (high) x (low) (710 500) processing hours
Step 2) Find the vertical intercept (fixed cost component) using either June or March data: Using June data: y = vx + f $29,750 = ($25 per hour 710 hours) + f f = $12,000 Or, using March data: y = vx + f $24,500 = ($25 per hour 500 hours) + f f = $12,000
Step 3) Write the cost equation: y = $25 x + $12,000 where y = monthly manufacturing overhead costs
x = processing hours
197
continued)
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Req. 6 Use the cost equation to predict manufacturing overhead costs when 550 processing hours are incurred:
y y = ($25 per processing hour 550 processing hours) + $12,000 = $25,750
Total manufacturing overhead costs will be about $25,750 when 550 processing hours are incurred.
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(continued) Req. 7
SUMMARY OUTPUT Regression Statistics Multiple R 0.88923 R Square 0.79073 Adjusted R Square 0.738412 Standard Error 985.1906 Observations 6 ANOVA df 1 4 5 Coefficient s 14265.86 22.3297 SS 14669681 3882402 18552083 Standard Error 3578.987 5.743713 MS 14669681 970600.5 F 15.11403 Significance F 0.017725
C6-69
T Stat 3.986005 3.887676
P-value 0.016319 0.017725
Lower 95% 4329 6.382560
Upper 95% 24202.74 38.2768
Lower 95.0% 4329 6.382560
Upper 95.0% 24202.74 38.2768
Based on the regression output, the manufacturing overhead cost equation is: y = $22.33 x + $14,266 (rounded) where y = monthly manufacturing overhead costs x = number of processing hours The R-square is fairly high at .7907 (rounded); therefore projections should be fairly accurate. If 550 processing hours are incurred, total manufacturing overhead costs are projected to be: y = ($22.33 550 processing hours) + $14,266
y = $26,548 (rounded)
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(continued) Req. 8
SUMMARY OUTPUT Regression Statistics Multiple R 0.454219 R Square 0.206315 Adjusted R Square 0.007894 Standard Error 1918.627 Observations 6 ANOVA df 1 4 5 Coefficient s 22541.32 0.814232 SS 3827569 14724514 18552083 Standard Error 5499.205 0.798504 MS 3827569 3681128 F 1.039782 Significance F 0.365528
C6-69
T Stat 4.099014 1.019697
P-value 0.014865 0.365528
Lower 95% 7273.045 -1.40278
Upper 95% 37809.56 3.031235
Lower 95.0% 7273.045 -1.40278
Upper 95.0% 37809.56 3.031235
Based on the regression output, the manufacturing overhead cost equation is: y = $0.81 x + $22,541 (figures rounded) where y = monthly manufacturing overhead costs x = number of cases Projecting MOH at 6,000 cases yields: y = ($0.81 6,000 cases) + $22,541 y = $27,401
201
The R-square is very low (.2063), meaning it doesnt fit the data very well. Therefore, the cost equation using processing hours is the more accurate cost equation.
Chapter 6
Cost Behavior
202
(continued) Req. 9
C6-69
June appeared to be an outlier on the graph (Reqs. 3 and 4). After removing Junes data from the data set, the resulting regression analysis yields the following output:
SUMMARY OUTPUT Regression Statistics Multiple R 0.912161 R Square 0.832038 Adjusted R Square 0.77605 Standard Error 924.0782 Observations 5 ANOVA df 1 3 4 Coefficient s 15180.24 1.781836 SS 12690239 2561761 15252000 Standard Error 3289.284 0.462212 MS 12690239 853920.4 F 14.86115 Significance F 0.030836
T Stat 4.615058 3.855016
P-value 0.019143 0.030836
Lower 95% 4712.256 0.31087
Upper 95% 25648.2 3.252804
Lower 95.0% 4712.256 0.31087
Upper 95.0% 25648.2 3.252804
Based on the regression output, the manufacturing overhead cost equation is: y = $1.78 x + $15,180 (figures rounded) where y = monthly manufacturing overhead costs x = number of cases Projecting MOH at 6,000 cases yields: y = ($1.78 6,000 cases) + $15,180 y = $25,860
The R-square (.83) is much higher with the potential outlier (June) removed.
Chapter 6
Cost Behavior
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(continued) Req. 10
C6-69
The R square value was the highest (.83) in the regression analysis that used number of cases as the cost driver, but only when the potential outlier (June) was removed from the data set. The R square was almost as high (.79) in the regression that used processing hours as the cost driver. Since there didnt appear to be any outliers when processing hours were used, management might lean towards being most confident in the cost equation using number of processing hours.
205
Discussion & Analysis

1. Briefly describe an organization with which you are familiar. Describe a situation when a manager in that organization could use cost behavior information and how the manager could use the information. The manager of Starbucks needs to understand how costs behave so that he/she can make sound decisions, such as budgeting. For instance, the manager would need to know that the depreciation of the coffee machines is a committed fixed cost and that it will remain constant over a certain period of time. The manager needs to understand that the cost of coffee behaves differently. The coffee used is a variable cost. The more drinks prepared, the more coffee is used. 2. How are fixed costs similar to step fixed costs? How are fixed costs different from step fixed costs? Give an example of a step fixed cost and describe why that cost is not considered to be a fixed cost. Fixed and step costs are similar in that they remain constant over a certain range of activity. Step costs are fixed over a small range of activity and then jump to a different level with moderate changes in volume. Rent is an example of a fixed cost where the total cost of rent does not change no matter how much volume changes. The salary for an additional professor who must be hired because a department is expanding past the range where existing faculty can cover classes is an example of a step fixed cost. 3. Describe a specific situation when a scatter plot could be useful to a manager. The manager of a printing firm could use a scatter plot to analyze the monthly telephone expenses for a year to determine how much
of the expense is fixed and how much is variable. A scatter plot graphs cost and volume data so that managers can visualize the relationship between the two. They are also useful because they allow managers to identify outliers (abnormal data points). 4. What is a mixed cost? Give an example of a mixed cost. Sketch a graph of this example. A mixed cost contains both variable cost and fixed cost components. The expense for a cell phone is often mixed because there is a fixed amount for a certain number of minutes and an additional per minute charge if the minutes exceed the limit. 5. Compare discretionary fixed costs to committed fixed costs. Think of an organization with which you are familiar. Give two examples of discretionary fixed costs and two examples of committed fixed costs which that organization may have. Explain why the costs you have chosen as examples fit within the definitions of discretionary fixed costs and committed fixed costs. Discretionary fixed costs are controllable in the short run where managers have little or no control over committed fixed costs in the short run. Advertising and R&D are examples of discretionary fixed costs because they can be increased or decreased in the short run by managers. Rent and depreciation are examples of committed fixed costs because they can only be changed in the long run. 6. Define the terms independent variable and dependent variable, as used in regression analysis. Illustrate the concepts of independent variables and dependent variables by selecting a cost a company would want to predict and what activity it might use to predict that cost. Describe the independent variable and the dependent variable in that situation.
The dependent variable is the amount you want to predict and is based on the amounts of the independent variables. For example, a company would like to know the total cost of paid compensation for their salespeople (dependent variable). The total cost would be based on their base salary and their commission percentage of sales revenue (independent variables). 7. Define the term relevant range. Why is it important to managers? The relevant range is the band of volume where total fixed costs and variable costs per unit remain constant. It is important to managers in understanding that cost behavior may change if they are making decisions that are outside the range. 8. Describe the term R-square. If a regression analysis for predicting manufacturing overhead using direct labor hours as the dependent variable has an R-square of .40, why might this be a problem? Given the low R-square value, describe the options a manager has for predicting manufacturing overhead costs. Which option do you think is the best option for the manager? Defend your answer. R-square is the goodness-of-fit statistic that tells how well the regression line fits the data points. The higher the R-square, the stronger the relationship between cost and volume. Generally an Rsquare over .80 indicates that the cost equation is very reliable for predicting costs at other volumes within the relevant range. An Rsquare of .40 is low and indicates that the manager should try using a different activity base for cost analysis because the current measure of volume is only weakly related to the costs. The manager could also the high-low method to plan for costs at different volumes. Of the two methods, regression analysis usually
gives better predictions because it uses more historical data where the high-low method only uses two data points.
9. Over the past year, a companys inventory has increased significantly. The company uses absorption costing for financial statements, but internally, the company uses variable costing for financial statements. Which set of financial statements will show the highest operating income? What specifically causes the difference between the two sets of financial statements? The absorption costing financial statements will show higher operating income than the variable costing statements. The difference between the two sets of statements is caused by absorption costing deferring a portion of fixed manufacturing overhead to the balance sheet in ending inventory. In variable costing statements, total fixed manufacturing overhead is expensed as a period cost. 10. A company has adopted a lean production philosophy and, as a result, has cut its inventory levels significantly. Describe the impact on the companys external financial statements as a result of this inventory reduction. Also describe the impact of the inventory reduction on the companys internal financial statements which are prepared using variable costing. The reduction in inventory will affect the balance sheet in that the three inventory accounts, raw materials, work in process, and finished goods, will have little to no balances. The costs of inventory will be expensed in the same period that they were incurred because the entire inventory that was produced was sold. The difference in operating income between the absorption and the variable costing statements will be zero or minimal.
209
Application & Analysis

Cost Behavior in Real Companies Basic Discussion Questions
1. Describe the company you selected and the products or services it provides. McGraw Hill is a publisher of textbooks. It provides both printed and ebooks, online resources for students and instructors, and customer service. 2. List ten costs that this company would incur. Include costs from a variety of departments within the company, including human resources, sales, accounting, production (if a manufacturer), service (if a service company), and others. Make sure that you have at least one cost from each of the following categories: fixed, variable, and mixed. Development of new texts/editions Training for customer service representatives Sales commissions Development of online resources such as narrated slides Advertising Handling textbook orders Accounting salaries Cost of paper/ink Depreciation of binding machinery Shipping costs 3. Classify each of the costs you listed as either fixed, variable, or mixed. Justify why you classified each cost as you did. Mixed includes salaried editors (fixed) and authors advances
Fixed scheduled training sessions Variable per book amount Mixed salaried employees and outside contractors Fixed a discretionary amount not tied to activity levels Variable dependent on the number of books ordered Fixed salaried employees Variable dependent on the number of books printed Fixed committed cost of machinery Variable dependent on the amount of book shipped
4. Describe a potential cost driver for each of the variable and mixed costs you listed. Explain why each cost driver would be appropriate for its associated cost. Revision/new book projects Scheduled training sessions Number of books sold Online resource projects Educational institutions targeted Orders received Accounting department employees Orders received Time Orders received
5. Discuss how easy or difficult it was for you to decide whether each cost was fixed, variable, or mixed. Describe techniques a company could use to determine whether a cost is fixed, variable, or mixed. Any cost that stays constant over a wide range of volumes is fixed. If a cost rises in direct proportion to increases in volume, it can be recognized as a variable cost. For mixed costs, a company can
use scatter plots, the high-low method, and regression analysis to determine the fixed and variable components. CMA-1. c CMA-2. d
Chapter 6
Cost Behavior
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Chapter 6

Managerial Accounting 2e Solutions Manual

Managerial Accounting 2e Solutions Manual

b. Fixed e. Variable (Any curved line)

Number of Basketballs produced

Managerial Accounting 2e Solutions Manual

(5-10 min.) Find the answer to Ritter Razors questions by:

($2.00 per package 25,000 packages) + $60,000 $50,000 + $60,000 $110,000

Managerial Accounting 2e Solutions Manual

Call for 40 minutes $5.00 + (40 $0.35) $5.00 + $14.00 = $19.00

Call for 80 minutes $5.00 + (80 $0.35) $5.00 + $28.00 = $33.00

Managerial Accounting 2e Solutions Manual

Fixed Variable Fixed Variable Variable Variable Fixed

(10-15 min.) Req. 1

Monthly operating expenses

Managerial Accounting 2e Solutions Manual

(continued) Using February data:

The fixed cost portion of the operating expenses is $13,200.

Managerial Accounting 2e Solutions Manual

Using low point data:

Managerial Accounting 2e Solutions Manual

Student answers may vary.

Managerial Accounting 2e Solutions Manual

(5-10 min.) a) y = $0.89x + $9,942.83

Managerial Accounting 2e Solutions Manual

$28,000 (20,000) 8,000 (1,400) (1,200) (1,000) $ 4,400

Managerial Accounting 2e Solutions Manual

$330,000 $ 32,000 160,000 192,000 16,000 (176,000) 154,000

(continued) Req. 2 (continued)

Managerial Accounting 2e Solutions Manual

(c) Fixed Expenses

e. Graph 3 f. Graph 11 g. h. i. j. Graph 2 Graph 7 Graph 9 Graph 2

Managerial Accounting 2e Solutions Manual

Managerial Accounting 2e Solutions Manual

5,000 garments $ 3,750 7,000 $10,750 $0.75 1.40

Average cost per garment

Managerial Accounting 2e Solutions Manual

$29,764 (10,189) $19,575

Managerial Accounting 2e Solutions Manual

(15 min.) Req. 1

Using low point (March) data:

Managerial Accounting 2e Solutions Manual

(15 min.) a) Average cost per unit $26.43 $26,430

= $8.43 x + $18,000 where x= number of mailboxes

Managerial Accounting 2e Solutions Manual

Managerial Accounting 2e Solutions Manual

(10-15 min.) Req. 1

Relationship of Van Operating Costs to Miles Driven

Relationship of Van Operating Costs to Miles Driven

Managerial Accounting 2e Solutions Manual

y = ($0.25 15,000) + $1,355 y = $5,105

Managerial Accounting 2e Solutions Manual

t Stat 1.37172 9 6.53955

P-value 0.22849 8 0.00125 2

Lower 95% -813.87 0.170583

Upper 95% 2676.33 3 0.39154 6

Managerial Accounting 2e Solutions Manual

(5-10 min.) Req. 1

Managerial Accounting 2e Solutions Manual

Relationship of pancake volume to operating costs

Managerial Accounting 2e Solutions Manual

(5-10 min.) Req. 1