Cost Volume Profit Analysis

EXERCISES
I. THEORIES AND CONCEPTS
1. A cost formula may not be valid outside the relevant range of
activity.

2. The planning horizons for committed fixed costs and

discretionary fixed costs are generally the same.

3. The high-low method is generally less accurate than the least-

squares regression method for analyzing the behavior of
mixed costs.
4. The contribution approach to the income statement classifies
costs by behavior rather than by function.

5. On an income statement prepared by the traditional

approach, costs are organized and presented according to
function.
I. THEORIES AND CONCEPTS
1. A cost formula may not be valid outside the relevant range of activity.
TRUE

2. The planning horizons for committed fixed costs and discretionary fixed
costs are generally the same.
FALSE (committed-managers has no control about the cost, whereas,
discretionary, managers has

3. The high-low method is generally less accurate than the least-squares

regression method for analyzing the behavior of mixed costs. TRUE

4. The contribution approach to the income statement classifies costs by

behavior rather than by function.
TRUE

5. On an income statement prepared by the traditional approach, costs are

organized and presented according to function. TRUE
6. The profit in cost-volume-profit equations is the same as the
net operating income on a contribution income statement.

7. At the break-even point, variable expenses and fixed

expenses are equal.

8. All other things the same, a decrease in variable expense per

unit will reduce the break-even point.

9. If the sales mix changes, the average contribution margin

ratio is likely to change as well.
6. The profit in cost-volume-profit equations is the same as the net
operating income on a contribution income statement. TRUE

7. At the break-even point, variable expenses and fixed expenses are

equal. Contribution margin = to fixed costs
FALSE

8. All other things the same, a decrease in variable expense per unit will
reduce the break-even point.
TRUE

9. If the sales mix changes, the average contribution margin ratio is likely to
change as well.
TRUE
11. Which costs will change with a decrease in activity
within the relevant range?
A. Total fixed costs and total variable cost.
B. Unit fixed costs and total variable cost.
C. Unit variable cost and unit fixed cost.
D. Unit fixed cost and total fixed cost.

12. The linear equation Y = a + bX is often used to express

cost formulas. In this equation:
A. the b term represents variable cost per unit of activity.
B. the a term represents variable cost in total.
C. the X term represents total cost.
D. the Y term represents total fixed cost.
11. Which costs will change with a decrease in activity
within the relevant range?
A. Total fixed costs and total variable cost.
B. Unit fixed costs and total variable cost.
C. Unit variable cost and unit fixed cost.
D. Unit fixed cost and total fixed cost.

12. The linear equation Y = a + bX is often used to express

cost formulas. In this equation:
A. the b term represents variable cost per unit of activity.
B. the a term represents variable cost in total.
C. the X term represents total cost.
D. the Y term represents total fixed cost.
13. An example of a discretionary fixed cost is:
A. insurance.
B. taxes on real estate.
C. management training.
D. depreciation of buildings and equipment.

14. Once the break-even point is reached:

A. the total contribution margin changes from negative to
positive.
B. net operating income will increase by the unit contribution
margin for each additional item sold.
C. variable expenses will remain constant in total.
D. the contribution margin ratio begins to decrease=1
13. An example of a discretionary fixed cost is:
A. insurance.
B. taxes on real estate.
C. management training.
D. depreciation of buildings and equipment.

14. Once the break-even point is reached:

A. the total contribution margin changes from negative to
positive.
B. net operating income will increase by the unit contribution
margin for each additional item sold.
C. variable expenses will remain constant in total.
D. the contribution margin ratio begins to decrease=1
15. To obtain the break-even point in terms of PESO sales,
total fixed expenses are divided by which of the following?
A. Variable expense per unit.
B. Variable expense per unit/Selling price per unit.
C. Fixed expense per unit.
D. (Selling price per unit - Variable expense per
unit)/Selling price per unit.

16. The ratio of fixed expenses to the unit contribution

margin is the:
A. break-even point in unit sales.
B. profit margin.
C. contribution margin ratio.
D. margin of safety.
15. To obtain the break-even point in terms of dollar sales,
total fixed expenses are divided by which of the following?
A. Variable expense per unit.
B. Variable expense per unit/Selling price per unit.
C. Fixed expense per unit.
D. (Selling price per unit - Variable expense per
unit)/Selling price per unit.

16. The ratio of fixed expenses to the unit contribution

margin is the:
A. break-even point in unit sales.
B. profit margin.
C. contribution margin ratio.
D. margin of safety.
PROBLEM SOLVING

1. Brooklyn sells a single product to wholesalers. The company's

budget for the upcoming year revealed anticipated unit sales of
31,600, a selling price of $20, variable cost per unit of $8, and total
fixed costs of $360,000. Brooklyn's safety margin in units is:
A. (13,400).
B. 0.
C. 1,600.
D. 13,600.
E. an amount other than those above.

Break-even Sales:
Fixed Costr $ 360,000
Contribution margin per unit 12
Break-even units 30,000
Anticipated Sales in units 31,600
Margin of safety in units 1,600
.2. Danielle sells a single product at $20 per unit. The firm's most recent income
statement revealed unit sales of 100,000, variable costs of $800,000, and fixed
costs of $400,000. If a $4 drop in selling price will boost unit sales volume by
20%, the company will experience:
A. no change in profit because a 20% drop in sales price is balanced by a 20%
increase in volume.
B. an $80,000 drop in profit. D. a $240,000 drop in profit.
C. a $400,000 drop in profit. E. a change in profit other than those above.
Current
Sales (100,000) $ 2,000,000 $ 20
Variable Cost 800,000 8
$ 1,200,000 $ 12
Fixed Cost 400,000
Operating Income $ 800,000

Changes
Drop in Selling Price ($20-4) $ 16.00
New Sales Volume 20% 120,000
New Sales $ 1,920,000
Variable Cost 960,000
Contribution Margin $ 960,000
Fixed Cost 400,000
Opeating Income $ 560,000
Drop in Profit $ 240,000
3. Grime-X is studying the profitability of a change in operation and has
gathered the following information:

Should Grime-X make the change?

A. Yes, the company will be better off by $6,000.
B. No, because sales will drop by 3,000 units.
C. No, because the company will be worse off by $4,000.
D. No, because the company will be worse off by $22,000.
E. It is impossible to judge because additional information is needed.
 Current Anticipated
9,000 6,000
$ 144,000 $ 16 132,000 $ 22
90,000 10 72,000 12
Contribution Margin $ 54,000 $ 6 $ 60,000 $ 10
Fixed Cost 38,000 48,000
$ 16,000 $ 12,000
Drop in Operating Income $ 4,000
4. Edmonco Company produced and sold 45,000 units of a single product
last year, with the following results:

Edmonco's operating leverage factor was:

A. 4.
B. 5.
C. 6.
D. 7.
E. 8.
Sales $ 1,350,000
Variable Cost:
Manufecturing cost $ 585,000
Selling Cost 40,500
Administrative 184,500 810,000
Contribution Margin $ 540,000
Fixed Cost:
Manufacturing ₱ 270,000
Selling Cost 54,000
Administrative 108,000 432,000
$ 108,000
Degree of Operating Leveragew
Contribution Margin $ 540,000
Operating Income $ 108,000
5
5. At an activity level of 10,000 units, variable costs totaled $35,000 and
fixed costs totaled $20,800. If 16,000 units are produced and this activity
is within the relevant range, then:
A. total cost would equal $89,280.
B. total unit cost would equal $4.80.
C. fixed cost per unit would equal $5.58.
D. total costs would equal $55,800.

Variable Cost (10,000) $ 35,000 $ 3.50

Fixed Cost 20,800 2.08
Total Cost $ 55,800 $ 5.58

At 16,000 units:
Variable Cost $ 56,000 $ 3.50
Fixed Cost 20,800 1.30
Total Cost $ 76,800 $ 4.80
6. Reddy Company has the following cost
formulas for overhead.

Cost Cost Formula

Indirect materials $2,000 plus $.40 per machinehour
Maintenance $1,500 plus $0.60 per machine hour
Machine set up $0.30 per machine hour
Utilities $200 plus $0.10 per machine hour
Depreciation $800

Based on these cost formulas, the total overhead cost at 600

machine hours is expected to be
A. $4,500
B. $5,200
C. $5,620
D. $5,340
6.
7. Electrical costs at one of Gotch Corporation's factories are listed below:

Management believes that electrical cost is a mixed cost that depends on machine-
hours. Using the high-low method to estimate the variable and fixed components of
this cost, these estimates would be closest to:
A. $0.15 per machine-hour; $35,115 per month
B. $9.11 per machine-hour; $1,249 per month
C. $9.43 per machine-hour; $35,406 per month
D. $6.57 per machine-hour; $10,728 per month
Highest level $ 35,694 3,800
Lowest level 35,044 3,701
Change $ 650 99
Variable Cost per unit ($650/99) $ 6.57
Fixed Cost= Total Cost - Variable Cost
Total Cost $ 35,694
Variable cost ($6.97 x 3,800) 24,966
Fixed cost $ 10,728
. 8. Forest Corporation has prepared the following budgeted data based on
a sales forecast of $3,000,000:

What would be the amount of dollar sales at the break-even point?

A. $1,125,000
B. $2,000,000
C. $2,650,000
D. $1,750,000
Break-even in total sales dollars = Fixed expenses Contribution margin ratio
= $700,000 35% = $2,000,000
 9.
Ringstaff Corporation produces and sells a single product. Data concerning that product
appear below:

The company is currently selling 7,000 units per month. Fixed expenses are $615,000 per
month. The marketing manager believes that a $21,000 increase in the monthly advertising
budget would result in a 180 unit increase in monthly sales. What should be the overall effect
on the company's monthly net operating income of this change?
A. increase of $600
B. decrease of $600
C. decrease of $21,000
D. increase of $21,600
Increase in net operating income: $225,600 - $225,000 = $600
 10
Harist Corporation sold 5,000 units in May. Sales were $400,000, variable expenses were
$240,000, and fixed expenses were $120,000. If the company increases its selling price by
10%, how many units would have to be sold in June to generate a profit of $40,000?
A. 4,200 Sales (5,000 units) $ 400,000 $ 80 $ 88
B. 4,500 Variable expenses 240,000 48 48
C. 4,000 Contribution margin $ 160,000 $ 32 $ 40
D. 5,000 Fixed expenses 120,000
Operating Income $ 40,000

Fixed Cost $ 120,000

Target Profit 40,000
Total $ 160,000
÷Contribution margin per unit 40
Number of units 4,000

Proof:
Sales (4,000 x $88) $ 352,000
Variable Expenses (4,000 x $48) 192,000
Contribution margin $ 160,000
Fixed Expenses 120,000
Operating Income $ 40,000