Exam 2: Cost Behavior, Operating Leverage, and Profitability Analysis

Income statements for three companies are provided below: Company A Company B Company C Sales (20 units) \ 1,000 \1 ,000 \1 ,000 Less variable costs 600 300 - Less fixed costs 200 500 800 Net income \ 200 \2 00 \ 200 Required: (a) Prepare new income statements for the firms assuming each sells one additional unit (i.e. each firm sells 21 units)(b) Briefly describe the effect of cost structure on profitability.

Assume that management uses the regression method to separate a mixed cost into its fixed and variable components. Briefly describe the significance of the R Square (R²) when interpreting the reliability of cost estimates that result.

Based on the income statements shown below, which division has the cost structure with the highest operating leverage? Soft Drinks Bottled Water Frust Juices Revenue \ 50,000 \ 50,000 \ 50,000 Variable costs (10,000) (5000) (30,000) Contribution margin 40,000 45,000 20,000 Fixed costs (30,000) (40,000) (10,000) Net income \ 10,000 \ 5,000 \ 10,000

Companies with low operating leverage will experience lower profits when sales increase than will companies with higher operating leverage.

Pickard Company pays its sales staff a base salary of $4,500 a month plus a $3.00 commission for each product sold. If a salesperson sells 800 units of product in January, the employee would be paid:

Select the correct statement regarding fixed costs.

Contribution margin can only be determined if costs are separated into product and period costs.

If a company had a pure variable cost structure, what would be the relationship between contribution margin and net income, and what would be the magnitude of operating leverage?

An advantage of using the scattergraph method over the high-low method is that all points of data are used in determining the cost line.

Maryland Novelties Company produces and sells souvenir products. Monthly income statements for two activity levels are provided below: Unit volumes 20,000 units 30,000 units Revenue \ 150,000 \ 225,000 Less cost of goods sold 60,000 90,000 Gross margin \ 90,000 \ 135,000 Less operating expenses Salaries and commissions 20,000 25,000 Advertising expenses 30,000 30,000 Administrative expenses 12,500 12,500 Total operating expenses 62,500 67,500 Net income \4 27,500 \6 7,500 Required: 1) Identify the mixed expense(s).2) Use the high-low method to separate the mixed costs into variable and fixed components.3) Prepare a contribution margin income statement at the 20,000-unit level.

Contribution margin represents the amount available to cover fixed expenses and then provide company profits.

Complete the following table to indicate your understanding of fixed and variable cost behavior by inserting one of the following responses in each box: "Remain constant," "Increase," or "Decrease." When Activity Increases When Activity Decre ase s Unit fixed costs Total fixed costs Unit variable costs Total variable costs

One way that computing an average cost per unit facilitates management decision making is that managers are provided more timely and more relevant cost information.

Two different costs incurred by Ruiz Company exhibit the following behavior pattern per unit: Units Sold 50 100 150 200 Cost \# 1 \ 300 per unit \ 150 per unit \ 100 per unit \ 75 per unit Cost \# 2 \ 2 per unit \ 2 per unit \ 2 per unit \ 2 per unit Cost #1 and Cost #2 exhibit which of the following cost behavior patterns, respectively?

What is meant by the phrase, "relevant range?" How does the concept of relevant range affect fixed costs?

If a profitable company has both fixed and variable costs, its operating leverage will always be greater than 1.

Production during the current year for California Manufacturing, a producer of high security bank vaults, was at its highest point in the month of June when 80 units were produced at a total cost of $800,000. The lowest point in production was in January when only 20 units were produced at a cost of $440,000. The company is preparing a budget for the current year and needs to project expected fixed cost for the budget year. Using the high-low method, the projected amount of fixed cost per month is:

Assume that Microsoft and Sony both plan to introduce a new hand-held video game. Microsoft plans to use a heavily automated production process to produce its product while Sony plans to use a labor-intensive production process. The following revenue and cost relationships are provided: Microsoft Game Sony Game Selling price per unit 150 150 Variable costs per unit Direct materials \2 7.00 \ 27.00 Direct labor 7.50 30.0 Overhead 7.50 30.00 Selling and administrative 3.00 3.00 Annual fixed costs Overhead \ 600,000 \2 40,000 Selling and administrative 135,000 135,000 Required: (a) Compute the contribution margin per unit for each company.(b) Prepare a contribution income statement for each company assuming each company sells 8,000 units.(c) Compute each firm's net income if the number of units sold increases by 10%.(d) Which firm will have more stable profits when sales change? Why?

ETutor is an online tutoring service provider that is particularly popular with college students. The company is interested in estimating the fixed and variable components of its tutoring services costs. The manager believes that these costs are driven by the number of hours of tutoring services provided. The following information was gathered for the last six months of business: Required: Month Number of Hours Tutoring costs January 25,000 \ 308,000 February 41,000 420,000 March 29,000 352,000 April 31,000 373,000 May 34,000 378,000 June 18,000 252,000 1) Compute the average tutoring cost per hour for the six-month period. (Round the average tutoring cost per hour to two decimal points.)2) Use the high-low method to estimate the total fixed cost and the variable cost per hour. (Round the variable cost per hour to two decimal points.)3) Name one advantage and one disadvantage of the high-low method.4) Describe the scattergraph method that can be used to analyze mixed costs.

Larry's Lawn Care incurs significant gasoline costs. This cost would be classified as a variable cost if the total gasoline cost: