Managerial Accounting Services-Review

Cost-Volume-Profit, Sales Mix, Operating leverage, Absorption and

Variable Costing

1. Distinguish between variable and fixed costs. Variable costs are costs that vary in total
directly and proportionately with changes in the activity index. Fixed costs are costs that
remain the same in total regardless of changes in the activity index.

2. Explain the significance of the relevant range. The relevant range is the range of activity
in which a company expects to operate during a year. It is important in CVP analysis
because the behavior of costs is assumed to be linear throughout the relevant range.

3. Explain the concept of mixed costs. Mixed costs increase in total but not proportionately
with changes in the activity level. For purposes of CVP analysis, mixed costs must be
classified into their fixed and variable elements. One method that management may use to
classify these costs is the high-low method.

4. List the five components of cost-volume-profit analysis. The five components of CVP
analysis are (a) volume or level of activity, (b) unit selling prices, (c) variable cost per unit,
(d) total fixed costs, and (e) sales mix.

5. Indicate what contribution margin is and how it can be expressed. Contribution margin
is the amount of revenue remaining after deducting variable costs. It is identified in a CVP
income statement, which classifies costs as variable or fixed. It can be expressed as a total
amount, as a per unit amount, or as a ratio.

6. Identify the three ways to determine the break-even point. The break-even point can be
(a) computed from a mathematical equation, (b) computed by using a contribution margin
technique, and (c) derived from a CVP graph.
7. Give the formulas for determining sales required to earn target net income. The
general formula for required sales is: Required sales = Variable costs + Fixed costs + Target
net income. Two other formulas are: Required sales in units = (Fixed costs + Target net
income) ÷ Contribution margin per unit, and Required sales in dollars = (Fixed costs + Target
net income) ÷ Contribution margin ratio.

8. Define margin of safety, and give the formulas for computing it. Margin of safety is
the difference between actual or expected sales and sales at the break-even point. The
formulas for margin of safety are: Actual (expected) sales – Break-even sales = Margin of
safety in dollars; Margin of safety in dollars ÷ Actual (expected) sales = Margin of safety
ratio.

9. Explain the term sales mix and its effects on break-even sales. Sales mix is the
relative proportion in which each product is sold when a company sells more than one
product. For a company with a small number of products, break-even sales in units is
determined by using the weighted-average unit contribution margin of all the products. If
the company sells many different products, then calculating the break-even point using
unit information is not practical. Instead, in a company with many products, break-even
sales in dollars is calculated using the weighted-average contribution margin ratio.

10. Understand how operating leverage affects profitability. Operating leverage refers to
the degree to which a company’s net income reacts to a change in sales. Operating
leverage is determined by a company’s relative use of fixed versus variable costs.
Companies with high fixed costs relative to variable costs have high operating leverage.
A company with high operating leverage will experience a sharp increase (decrease) in
net income with a given increase (decrease) in sales. The degree of operating leverage
can be measured by dividing contribution margin by net income.

11. Explain the difference between absorption costing and variable costing. Under
absorption costing, fixed manufacturing costs are product costs. Under variable costing,
fixed manufacturing costs are period costs.

12. Discuss net income effects under absorption costing versus variable costing. If
production volume exceeds sales volume, net income under absorption costing will
exceed net income under variable costing by the amount of fixed manufacturing costs
included in ending inventory that results from units produced but not sold during the period.
If production volume is less than sales volume, net income under absorption costing will

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 be less than under variable costing by the amount of fixed manufacturing costs included
in the units sold during the period that were not produced during the period.

Theories

1. For an activity base to be useful in cost behavior analysis,

a. the activity should always be stated in dollars.
b. there should be a correlation between changes in the level of activity and changes in
costs.
c. the activity should always be stated in terms of units.
d. the activity level should be constant over a period of time.
2. A variable cost is a cost that
a. varies per unit at every level of activity.
b. occurs at various times during the year.
c. varies in total in proportion to changes in the level of activity.
d. may or may not be incurred, depending on management's discretion.
3. A cost which remains constant per unit at various levels of activity is a
a. variable cost.
b. fixed cost.
c. mixed cost.
d. manufacturing cost.
4. An increase in the level of activity will have the following effects on unit costs for variable
and fixed costs:
Unit Variable Cost Unit Fixed Cost
a. Increases Decreases
b. Remains constant Remains constant
c. Decreases Remains constant
d. Remains constant Decreases
5. A fixed cost is a cost which
a. varies in total with changes in the level of activity.
b. remains constant per unit with changes in the level of activity.
c. varies inversely in total with changes in the level of activity.
d. remains constant in total with changes in the level of activity.
6. Fixed costs normally will not include
a. property taxes.
b. direct labor.
c. supervisory salaries.
d. depreciation on buildings and equipment.
7. Cost behavior analysis applies to
a. retailers.
b. wholesalers.
c. manufacturers.
d. all entities.
8. If a firm increases its activity level,
a. costs should remain the same.
b. most costs will rise.
c. no costs will remain the same.
d. some costs will change, others will remain the same.
9. Which of the following is not a cost classification?
a. Mixed
b. Multiple
c. Variable
d. Fixed
10. Changes in activity have a(n) _________ effect on fixed costs per unit.
a. positive
b. negative
c. inverse
d. neutral

11. Cost-volume-profit analysis is the study of the effects of

a. changes in costs and volume on a company’s profit.
b. cost, volume, and profit on the cash budget.
c. cost, volume, and profit on various ratios.
d. changes in costs and volume on a company’s profitability ratios.

12. Margin of safety in dollars is

a. expected sales divided by break-even sales.

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 b. expected sales less break-even sales.
c. actual sales less expected sales.
d. expected sales less actual sales.
13. Sales mix is
a. the relative percentage in which a company sells its multiple products.
b. the trend of sales over recent periods.
c. the mix of variable and fixed expenses in relation to sales.
d. a measure of leverage used by the company.

14. A shift from high-margin sales to low-margin sales

a. may decrease net income, even though there is an increase in total units sold.
b. will always decrease net income.
c. will always increase net income.
d. will always increase units sold.

15. What is the key factor in determining sales mix if a company has limited resources?
a. Contribution margin per unit of limited resource
b. The amount of fixed costs per unit
c. Total contribution margin
d. The cost of limited resources

16. Which of the following statements is not true?

a. Operating leverage refers to the extent to which a company’s net income reacts to a
given change in sales.
b. Companies that have higher fixed costs relative to variable costs have higher operating
leverage.
c. When a company’s sales revenue is increasing, high operating leverage is good
because it means that profits will increase rapidly.
d. When a company’s sales revenue is decreasing, high operating leverage is good
because it means that profits will decrease at a slower pace than revenues decrease.

17. Only direct materials, direct labor, and variable manufacturing overhead costs are
considered product costs when using
a. full costing.
b. absorption costing.
c. variable costing.
d. product costing.

18. Under absorption costing and variable costing, how are fixed manufacturing costs treated?
Absorption Variable
a. Product Cost Product Cost
b. Product Cost Period Cost
c. Period Cost Product Cost
d. Period Cost Period Cost

19. Variable costing

a. is used for external reporting purposes.
b. is required under GAAP.
c. treats fixed manufacturing overhead as a period cost.
d. is also known as full costing.

20. Fixed selling expenses are period costs

a. under both absorption and variable costing.
b. under neither absorption nor variable costing.
c. under absorption costing, but not under variable costing.
d. under variable costing, but not under absorption costing.

Problem Solving
Case 1
Dollywood Corporation accumulates the following data concerning a mixed cost, using miles as
the activity level.
Miles Driven Total Cost Miles Driven Total Cost
January 10,000 $15,000 March 9,000 $12,500
February 8,000 $14,500 April 7,500 $12,000
Compute the variable and fixed cost elements using the high-low method.

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Case 2
Sandel Company makes 2 products, footballs and baseballs. Additional information follows:
Footballs Baseballs
Units 4,000 2,500
Sales $60,000 $25,000
Variable costs 36,000 7,000
Fixed costs 9,000 9,000
Net income $15,000 $ 9,000

Profit per unit $3.75 $3.60

Sandel has unlimited demand for both products. Therefore, which product should Sandel tell his
sales people to emphasize?

Case 3
Determine the missing amounts.

Contribution Margin Contribution

Unit Selling Price Unit Variable Costs
per Unit Margin Ratio
1. $300 $195 A. B.
2. $600 C. $150 D.
3. E. F. $480 40%

Case 4
Kipling Company has sales of $1,500,000 for the first quarter of 2013. In making the sales, the
company incurred the following costs and expenses.
Variable Fixed
Product costs $500,000 $550,000
Selling expenses 100,000 75,000
Administrative expenses 80,000 67,000

Calculate net income under CVP for 2013.

Case 5
Cannon Co. has a unit selling price of $500, variable cost per unit $300, and fixed costs of
$210,000.
Compute the break-even point in units and in sales dollars.

Case 6
Oakbrook, Inc. reported actual sales of $2,000,000, and fixed costs of $350,000. The contribution
margin ratio is 25%.

Compute the margin of safety in dollars and the margin of safety ratio.

Case 7
The following monthly data are available for Fortner Industries which produces only one product
which it sells for $18 each. Its unit variable costs are $8, and its total fixed expenses are $16,000.
Actual sales for the month of May totaled 2,000 units.

Case 8
At break-even point, a company sells 1,200 widgets. Its selling price is $6 per widget, variable
cost is $2 per widget, and its fixed cost is $4 per widget.

If it sells 200 additional widgets, determine the company’s incremental profit.

Case 9
Sandburg Manufacturing manufactures a single product. Annual production costs incurred in the
manufacturing process are shown below for the production of 2,000 units. The Utilities and
Maintenance are mixed costs. The fixed portions of these costs are $300 and $200, respectively.
Costs Incurred
Production in Units 2,000 4,000

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Production Costs
a. Direct Materials $ 4,000 ?
b. Direct Labor 16,000 ?
c. Utilities 1,000 ?
d. Rent 3,000 ?
e. Indirect Labor 4,200 ?
f. Supervisory Salaries 1,500 ?
g. Maintenance 900 ?
h. Depreciation 2,500 ?

Calculate the expected costs to be incurred when production is 4,000 units. Use your knowledge
of cost behavior to determine which of the other costs are fixed or variable.

Case 10
Bill Braddock is considering opening a Fast ‘n Clean Car Service Center. He estimates that the
following costs will be incurred during his first year of operations: Rent $9,200, Depreciation on
equipment $7,000, Wages $16,400, Motor oil $2.00 per quart. He estimates that each oil change
will require 5 quarts of oil. Oil filters will cost $3.00 each. He must also pay The Fast ‘n Clean
Corporation a franchise fee of $1.10 per oil change, since he will operate the business as a
franchise. In addition, utility costs are expected to behave in relation to the number of oil changes
as follows:
Number of Oil Changes Utility Costs
4,000 $ 6,000
6,000 $ 7,300
9,000 $ 9,600
12,000 $12,600
14,000 $15,000
Bill Braddock anticipates that he can provide the oil change service with a filter at $25 each.

(a) Using the high-low method, determine variable costs per unit and total fixed costs.
(b) Determine the break-even point in number of oil changes and sales dollars.
(c) Without regard to your answers in parts (a) and (b), determine the oil changes required to
earn net income of $20,000, assuming fixed costs are $32,000 and the contribution margin
per unit is $8.

Case 11
Jane Botosan operates a bed and breakfast hotel in a resort area near Lake Michigan.
Depreciation on the hotel is $60,000 per year. Jane employs a maintenance person at an annual
salary of $32,000 and a cleaning person at an annual salary of $24,000. Real estate taxes are
$10,000 per year. The rooms rent at an average price of $60 per person per night including
breakfast. Other costs are laundry and cleaning service at a cost of $10 per person per night and
the cost of food which is $5 per person per night.

(a) Determine the number of rentals and the sales revenue Jane needs to break even using the
contribution margin technique.
(b) If the current level of rentals is 3,500, by what percentage can rentals decrease before Jane
has to worry about having a net loss?
(c) Jane is considering upgrading the breakfast service to attract more business and increase
prices. This will cost an additional $3 for food costs per person per night. Jane feels she can
increase the room rate to $66 per person per night. Determine the number of rentals and the
sales revenue Jane needs to break even if the changes are made.

Case 12
Corris Co. accumulates the following data concerning a mixed cost, using miles as the activity
level.
Miles Driven Total Cost
January 10,000 $17,000
February 8,000 13,500
March 9,000 14,400
April 7,000 12,500
Compute the variable and fixed cost elements using the high-low method.

Case 13

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Moresan Co. gathered the following information on power costs and factory machine usage for
the last six months:

Month Power Cost Factory Machine Hours

January $24,400 13,900
February 29,200 17,600
March 29,000 16,800
April 22,340 13,200
May 19,900 11,600
June 14,900 6,600
Using the high-low method of analyzing costs, answer the following questions and show
computations to support your answers.
(a) What is the estimated variable portion of power costs per factory machine hour?
(b) What is the estimated fixed power cost each month?
(c) If it is estimated that 10,000 factory machine hours will be run in July, what is the
expected total power cost for July?

Case 14
Henderson Farms reports the following results for the month of November:
Sales (10,000 units) $600,000
Variable costs 420,000
Contribution margin 180,000
Fixed costs 110,000
Net income $ 70,000
Management is considering the following independent courses of action to increase net income.
1. Increase selling price by 5% with no change in total variable costs.
2. Reduce variable costs to 66 2 3 % of sales.
3. Reduce fixed costs by $10,000.
If maximizing net income is the objective, which is the best course of action?
Case 15
Marvin Co. had a net loss of $150,000 in 2012 when the selling price per unit was $20, the variable
costs per unit were $14, and the fixed costs were $600,000. Management expects per unit data
and total fixed costs to be the same in 2013. Management has set a goal of earning net income
of $150,000 in 2013.

(a) Compute the units sold in 2012.

(b) Compute the number of units that would have to be sold in 2013 to reach management's
desired net income level.
(c) Assume that Marvin Co. sells the same number of units in 2013 as it did in 2012. What would
the selling price have to be in order to reach the target net income? Use the mathematical
equation.

Case 16
In 2012, Stallman Co. had a break-even point of $800,000 based on a selling price of $10 per unit
and fixed costs of $240,000. In 2013, the selling price and variable costs per unit did not change,
but the break-even point increased to $850,000.
(a) Compute the variable cost per unit and the contribution margin ratio for 2012.
(b) Using the contribution margin ratio, compute the increase in fixed costs for 2013.

Case 17
Webber, Inc. developed the following information for its product:
Per Unit
Sales price $90
Variable cost 63
Contribution margin $27

Total fixed costs $1,080,000

Answer the following independent questions and show computations using the contribution
margin technique to support your answers.
1. How many units must be sold to break even?
2. What is the total sales that must be generated for the company to earn a profit of $60,000?

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3. If the company is presently selling 45,000 units, but plans to spend an additional $108,000 on
an advertising program, how many additional units must the company sell to earn the same
net income it is now making?
4. Using the original data in the problem, compute a new break-even point in units if the unit
sales price is increased 20%, unit variable cost is increased by 10%, and total fixed costs are
increased by $210,000.

Case 18
Werth & Garza Manufacturing's sales slumped badly in 2013 due to so many people purchasing
gifts online. The company's income statement showed the following results from selling 500,000
units of product: net sales $2,125,000; total costs and expenses $2,500,000; and net loss
$375,000. Costs and expenses consisted of the following:
Total Variable Fixed
Cost of goods sold $2,000,000 $1,300,000 $700,000
Selling expenses 200,000 50,000 150,000
Administrative expenses 300,000 150,000 150,000
$2,500,000 $1,500,000 $1,000,000
Management is considering the following alternative for 2013:
Purchase new automated equipment that will change the proportion between variable and
fixed expenses sold to 45% variable and 55% fixed.

(a) Compute the break-even point in dollars for 2013.

(b) Compute the break-even point in dollars under the alternative course of action.

Case 19
Erickson, Inc. makes student book bags that sell for $20 each. For the coming year, management
expects fixed costs to be $225,000. Variable costs are $15 per unit.

(a) Compute break-even sales in dollars using the mathematical equation.

(b) Compute break-even sales using the contribution margin ratio.
(c) Compute margin of safety ratio assuming actual sales are $1,200,000.
(d) Compute the sales required to earn net income of $150,000, using the mathematical
equation.

Case 20
Englehart, Inc. reports the following operating results for the month of August: Sales $400,000
(units 5,000); variable costs $280,000; and fixed costs $95,000. Management is considering the
following independent courses of action to increase net income.
1. Increase selling price by 10% with no change in total variable costs.
2. Reduce variable costs to 65% of sales.
3. Reduce fixed costs by $15,000.
Compute the net income to be earned under each alternative. Which course of action will produce
the highest net income?

Case 21
Archer Industries sells three different sets of sportswear. Sleek sells for $30 and has variable
costs of $18; Smooth sells for $50 and has variable costs of $30; Potent sells for $70 and has
variable costs of $45. The sales mix of the three sets is: Sleek, 50%; Smooth, 30%; and Potent,
20%.

What is the weighted-average unit contribution margin?

Case 22
Lazaro Inc. sells two product lines. The sales mix of the product lines is: Standard, 60%; and
Deluxe, 40%. The contribution margin ratio of each line is: Standard, 40%; and Deluxe, 45%.
Lazaro’s fixed costs are $1,995,000.

What is the dollar amount of Deluxe sales at the break-even point?

Case 23
Hunt, Inc. provided the following information concerning two products:

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 Product 12 Product 43
Contribution margin per unit $22 $18
Machine hours required for one unit 2 hours 1.5 hours

Compute the contribution margin per unit of limited resource for each product. Which product
should Hunt tell its sales personnel to “push” to customers?

Case 24
Marina Manufacturing is considering buying new equipment for its factory. The new equipment
will reduce variable labor costs but increase depreciation expense. Contribution margin is
expected to increase from $250,000 to $300,000. Net income is expected to remain the same at
$100,000.

Compute the degree of operating leverage before and after the purchase of the new equipment
and interpret your results.

Case 25
The degree of operating leverage for Gurney, Inc.. and Dough Company are 2.4 and 5.6
respectively. Both have net incomes of $60,000. Determine their respective contribution
margins.

Case 26
Kindle, Inc. manufactures cosmetic products that are sold through a network of sales agents. The
agents are paid a commission of 12.5% of sales. The income statement for the year ending
December 31, 2013, is as follow.
KINDLE, INC.
Income Statement
Year Ending December 31, 2013
Sales $130,000
Cost of goods sold
Variable $58,500
Fixed 14,350 72,850
Gross margin 57,150
Selling and marketing expenses
Commissions $16,250
Fixed costs 17,100 33,350
Operating income $ 23,800

The company is considering hiring its own sales staff to replace the network of agents. It will pay
its salespeople a commission of 10% and incur additional fixed costs of $13 million.

(a) Under the current policy of using a network of sales agents, calculate Kindle, Inc.'s break-
even point in sales dollars for the year 2013.
(b) Calculate the company's break-even point in sales dollars for the year 2013 if it hires its own
sales force to replace the network of agents.
(c) Calculate the degree of operating leverage at sales of $130 million if (1) Kindle, Inc. uses
sales agents, and (2) Kindle, Inc. employs its own sales staff.

Case 27
Qwik Service has over 200 auto-maintenance service outlets nationwide. It provides primarily two
lines of service: oil changes and brake repair. Oil change-related services represent 75% of its
sales and provide a contribution margin ratio of 20%. Brake repair represents 25% of its sales
and provides a 60% contribution margin ratio. The company's fixed costs are $12,000,000 (that
is, $60,000 per service outlet).

(a) Calculate the dollar amount of each type of service that the company must provide in order
to break even.
(b) The company has a desired net income of $45,000 per service outlet. What is the dollar
amount of each type of service that must be provided by each service outlet to meet its target
net income per outlet?

Case 28
Seaver Corporation manufactures mountain bikes. It has fixed costs of $4,140,000. Seaver’s
sales mix and contribution margin per unit is shown as follows:

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 Sales Mix Contribution Margin
Green 25% $120
Brown 45% $ 60
Blue 30% $ 40
Compute the number of each type of bike that the company would need to sell in order to break
even under this product mix.

Case 29
Hewitt Co. has 4,000 machine hours available to produce either Product 22 or Product 44. The
cost accounting department developed the following unit information for each product:
Product 22 Product 44
Sales price $25 $50
Direct materials 6 8
Direct labor 3 2
Variable manufacturing overhead 4 5
Fixed manufacturing overhead 3 5
Machine time required 15 minutes 60 minutes
Management wants to know which product to produce in order to maximize the company’s
income. Taking into consideration the constraints under which the company operates, prepare a
report to show which product should be produced and sold.

Case 30
Reynolds, Inc. manufactures and sells two products. Relevant per unit data concerning each
product are given below:
Product
Standard Deluxe
Selling price $50 $75
Variable costs $26 $33
Machine hours 2 3
(a) Compute the contribution margin per unit of limited resource for each product.
(b) If 1,000 additional machine hours are available, which product should be manufactured?

Case 31
Oscar Corporation produces and sells three products. Unit data concerning each product is
shown below.
Product
X Y Z
Selling price $200 $300 $250
Direct labor costs 45 75 60
Other variable costs 110 130 106
The company has 2,000 hours of labor available to build inventory in anticipation of the
company's peak season. Management is trying to decide which product should be produced.
The direct labor hourly rate is $15.

(a) Determine the number of direct labor hours per unit.

(b) Determine the contribution margin per direct labor hour.
(c) Determine which product should be produced and the total contribution margin for that
product.

Case 32
Shanahan Co. of Dublin, Ireland is contemplating a major change in its cost structure. Currently,
all of its drafting work is performed by skilled draftsmen. Mike Shanahan the owner, is considering
replacing the draftsmen with a computerized drafting system.
However, before making the change, Mike would like to know the consequences of the change,
since the volume of business varies significantly from year to year. Shown below are CVP income
statements for each alternative.
Manual System Computerized System
Sales $1,500,000 $1,500,000
Variable costs 1,200,000 900,000
Contribution margin 300,000 600,000
Fixed costs 150,000 450,000
Net income $150,000 $150,000
(a) Determine the degree of operating leverage for each alternative.

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(b) Which alternative would produce the higher net income if sales increased by $300,000?

Absorption and Variable Costing

Case 33
Cutting Edge Corp. produces sporting equipment. In 2012, the first year of operations, Cutting
Edge produced 25,000 units and sold 20,000 units. In 2013, the production and sales results were
exactly reversed. In each year, selling price was $100, variable manufacturing costs were $40 per
unit, variable selling expenses were $8 per unit, fixed manufacturing costs were $540,000, and
fixed administrative expenses were $200,000.
(a) Compute the net income under variable costing for each year.
(b) Compute the net income under absorption costing for each year.
(c) Reconcile the differences each year in income from operations under the two costing
approaches.

Case 34
On-Road Wheels, Inc. manufactures a basic road bicycle. Production and sales data for the most
recent year are as follows (no beginning inventory):
Variable production costs $90 per bike
Fixed production costs $400,000
Variable selling and administrative costs $22 per bike
Fixed selling and administrative costs $550,000
Selling price $200 per bike
Production 20,000 bikes
Sales 18,000 bikes

(a) Prepare a brief income statement using absorption costing.

(b) Compute the amount to be reported for inventory in the year-end absorption costing balance
sheet.
(c) Prepare a brief income statement using variable costing.
(d) Compute the amount to be reported for inventory in the year-end variable costing balance
sheet.

-END-

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