Managerial Accounting

Chapter 5: Cost Behavior and Cost-Volume-Pro t Analysis Search

Chapter 5: Exercises

SHORT-ANSWER QUESTIONS, EXERCISES, AND PROBLEMS

Short-Answer Questions
➢ Name and describe four cost behavior patterns.
➢ Describe two methods of determining the xed and variable components of mixed costs.
➢ What is meant by the term break-even point?
➢ What are two ways in which the break-even point can be expressed?
➢ What is the relevant range?
➢ What is the formula for calculating the break-even point in sales revenue?
➢ What formula is used to solve for the break-even point in units?
➢ How can the break-even formula be altered to calculate the number of units that must be sold to achieve a desired level of income?
➢ Why might a business wish to lower its break-even point? How would it go about lowering the break-even point?
➢ What e ect would you expect the mechanization and automation of production processes to have on the break-even point?
➢ Real world question Assume your college is considering hiring a lecturer to teach a special class in communication skills. Identify at least
two costs that college administrators might consider in deciding whether to hire the lecturer and add the class.
➢ Real world question Two enterprising students are considering renting space and opening a class video recording service. They would
hire camera operators to record large introductory classes. The students taking the classes would be charged a fee to rent and view the
video on their laptops or smart phones. Identify as many costs of this business as you can and indicate which would be variable and which
would be xed.
Exercises
Exercise A Name and match the types of cost behavior with the appropriate diagram below:Exercise B Research Inc., performs laboratory
tests. Use the high-low method to determine the xed and variable components of a mixed cost, given the following observations:

Volume (number of tests) Total cost

4,800 $6,000

19,200 9,600

Exercise C Compute the break-even point in sales dollars if xed costs are $200,000 and the total contribution margin is 20%
of revenue.

Exercise D Barney Company makes and sells stu ed animals. One product, Michael Bears, sells for $28 per bear. Michael
Bears have xed costs of $100,000 per month and a variable cost of $12 per bear. How many Michael Bears must be produced
and sold each month to break even?

Exercise E
Peter Garcia Meza is considering buying a company if it will break even or earn net income on revenues of $80,000 per month.
The company that Peter is considering sells each unit it produces for $5. Use the following cost data to compute the variable
cost per unit and the xed cost for the period. Calculate the break-even point in sales dollars. Should Peter buy this company?

Volume (units) Cost

8,000 $70,000

68,000 190,000

Exercise F Never Late Delivery currently delivers packages for $9 each. The variable cost is $3 per package, and xed costs
are $60,000 per month. Compute the break-even point in both sales dollars and units under each of the following independent
assumptions. Comment on why the break-even points are di erent.

. The costs and selling price are as just given.

. Fixed costs are increased to $75,000.

. Selling price is increased by 10%. (Fixed costs are $60,000.)

. Variable cost is increased to $4.50 per unit. (Fixed costs are $60,000 and selling price is $9.)

Exercise G Best Eastern Motel is a regional motel chain. Its rooms rent for $100 per night, on average. The variable cost is $40
a room per night. Fixed costs are $5,000,000 per year. The company currently rents 200,000 units per year, with each unit
de ned as one room for one night. Should this company undertake an advertising campaign resulting in a $500,000 increase
in xed costs per year, no change in variable cost per unit, and a 10% increase in revenue (resulting from an increase in the
number of rooms rented)? What is the margin of safety before and after the campaign?

Exercise H Fall-For-Fun Company sells three products. Last year’s sales were $600,000 for parachutes, $800,000 for hang
gliders, and $200,000 for bungee jumping harnesses. Variable costs were: parachutes, $400,000; hang gliders, $700,000;
and bungee jumping harnesses, $100,000. Fixed costs were $240,000. Find (a) the break-even point in sales dollars and (b)
the margin of safety.

Exercise I Early Horizons Day Care Center has xed costs of $300,000 per year and variable costs of $10 per child per day. If it
charges $25 a child per day, what will be its break-even point expressed in dollars of revenue? How much revenue would be
required for Early Horizons Day Care to earn $100,000 net income per year?

Problems

Problem A Assume the local franchise of Togorio Sandwich Company assigns you the task of estimating total maintenance
cost on its delivery vehicles. This cost is a mixed cost. You receive the following data from past months:

Month Units Costs

March 8,000 $14,000

April 10,000 14,960

May 9,000 15,200

June 11,000 15,920

July 10,000 15,920

August 13,000 16,880

September 14,000 18,080

October 18,000 19,280

November 20,000 21,200

. Using the high-low method, determine the total amount of xed costs and the amount of variable cost per unit. Draw the
cost line.

. Prepare a scatter diagram, plot the actual costs, and visually t a linear cost line to the points. Estimate the amount of
total xed costs and the amount of variable cost per unit.

Problem B

. Using the preceding graph, label the relevant range, total costs, xed costs, break-even point, and pro t and loss areas.

. At 8,000 units, what are the variable costs, xed costs, sales, and contribution margin amounts in dollars?

. At 8,000 units, is there net income or loss? How much?

Problem C
The management of Bootleg Company wants to know the break-even point for its new line hiking boots under each of the
following independent assumptions. The selling price is $50 pair of boots unless otherwise stated. (Each pair of boots is one
unit.)

. Fixed costs are $300,000; variable cost is $30 per unit.

. Fixed costs are $300,000; variable cost is $20 per unit.

. Fixed costs are $250,000; variable cost is $20 per unit.

. Fixed costs are $250,000; selling price is $40; and variable cost is $30 per unit.

Compute the break-even point in units and sales dollars for each of the four independent case.

Problem D Refer to the previous problem. Bootleg Company’s sales are $1,100,000. Determine the margin (safety in dollars for
cases (a) through (d).

Problem E Using the data in the Bootleg Company problem (a through d), determine the level of sales dollars required achieve
a net income of $125,000.

Problem F Bikes Unlimited, Inc., sells three types of bicycles. It has xed costs of $258,000 per month. The sales and variable
costs of these products for April follow:

Bikes

Racing Mountain Touring

Sales $1,00,000 $1,500,000 $2,500,000

Variable costs 700,000 900,000 1,250,000

Compute the break-even point in sales dollars.

Problem G a. Assume that xed costs of Celtics Company are $180,000 per year, variable cost is $12 per unit, and selling price
is $30 per unit. Determine the break-even point in sales dollars.

. Hawks Corporation breaks even when its sales amount to $89,600,000. In 2010, its sales were $14,400,000, and its
variable costs amounted to $5,760,000. Determine the amount of its xed costs.

. The sales of Niners Corporation last year amounted to $20,000,000, its variable costs were $6,000,000, and its xed
costs were $4,000,000. At what level of sales dollars would the Niners Corporation break even?

. What would have been the net income of the Niners Corporation in part (c), if sales volume had been 10% higher but
selling prices had remained unchanged?

. What would have been the net income of the Niners Corporation in part (c), if variable costs had been 10% lower?

. What would have been the net income of the Niners Corporation in part (c), if xed costs had been 10% lower?

. Determine the break-even point in sales dollars for the Niners Corporation on the basis of the data given in (e) and then
in (f).

Answer each of the preceding questions.

Problem H After graduating from college, M. J. Orth started a company that produced cookbooks. After three years, Orth
decided to analyze how well the company was doing. He discovered the company has xed costs of $1,200,000 per year,
variable cost of $14.40 per cookbook (on average), and a selling price of $26.90 per cookbook (on average).

How many units (that is, cookbooks) must be sold to break even? How many units will the company have to sell to earn
$48,000?

Problem I The operating results for two companies follow:

Sierra Olympias

Sales (20,000) units $1,920,000 $1,920,000

Variable costs 480,000 1,056,000

Contribution margin 1,440,000 864,000

Fixed costs 960,000 384,00

Net income 480,000 480,000

. Prepare a cost-volume-pro t chart for Sierra Company, indicating the break-even point, the contribution margin, and the
areas of income and losses.

. Compute the break-even point of both companies in sales dollars and units.

. Assume that without changes in selling price, the sales of each company decline by 10%. Prepare income statements
similar to the preceding statements for both companies.

Problem J Soundo , Inc., a leading manufacturer of electronic equipment, decided to analyze the pro tability of its new
portable compact disc (CD) players. On the CD player line, the company incurred $2,520,000 of xed costs per month while
selling 20,000 units at $600 each. Variable cost was $240 per unit.

Recently, a new machine used in the production of CD players has become available; it is more e cient than the machine
currently being used. The new machine would reduce the company’s variable costs by 20%, and leasing it would increase xed
costs by $96,000 per year.

. Compute the break-even point in units assuming use of the old machine.

. Compute the break-even point in units assuming use of the new machine.

. Assuming that total sales remain at $12,000,000 and that the new machine is leased, compute the expected net
income.

. Should the new machine be leased? Why?

Problem K Surething CD Company reports sales of $720,000, variable costs of $432,000, and xed costs of $108,000. If the
company spends $72,000 on a sales promotion campaign, it estimates that sales will be increased by $270,000.

Determine whether the sales promotion campaign should be undertaken. Provide calculations.

Alternate problems

Alternate problem A Hear Right Company has identi ed certain variable and xed costs in its production of hearing aids.
Management wants you to divide one of its mixed costs into its xed and variable portions. Here are the data for this cost:

Month Units Costs

January 20,800 $57,600

February 20,000 54,000

March 22,000 58,500

April 25,600 57,600

May 28,400 58,500

June 30,000 62,100

July 32,800 63,900

August 35,600 68,400

September 37,600 72,000

October 40,000 77,400

. Using the high-low method, determine the total amount of xed costs and the amount of variable cost per unit. Draw the
cost line.

. Prepare a scatter diagram, plot the actual costs, and visually t a linear cost line to the points. Estimate the amount of
total xed costs and the variable cost per unit.

Alternate problem B

. Using the preceding graph, label the relevant range, total costs, xed costs, break-even point, and pro t and loss areas.

. At 18,000 units, what would sales revenue, total costs, xed and variable costs be?

. At 18,000 units, would there be a pro t or loss? How much?

Alternate problem C Je erson Company has a plant capacity of 100,000 units, at which level variable costs are $720,000.
Fixed costs are expected to be $432,000. Each unit of product sells for $12.

. Determine the company’s break-even point in sales dollars and units.

. At what level of sales dollars would the company earn net income of $144,000?

. If the selling price were raised to $14.40 per unit, at what level of sales dollars would the company earn $144,000?

Alternate problem D
a. Determine the break-even point in sales dollars and units for Cowboys Company that has xed costs of $63,000, variable
cost of $24.50 per unit, and a selling price of $35.00 per unit.

. Wildcats Company breaks even when sales are $280,000. In March, sales were $670,000, and variable costs were
$536,000. Compute the amount of xed costs.

. Hoosiers Company had sales in June of $84,000; variable costs of $46,200; and xed costs of $50,400. At what level of
sales, in dollars, would the company break even?

. What would the break-even point in sales dollars have been in (c) if variable costs had been 10% higher?

. What would the break-even point in sales dollars have been in (c) if xed costs had been 10% higher?

. Compute the break-even point in sales dollars for Hoosiers Company in (c) under the assumptions of (d) and (e) together.

Answer each of the preceding questions.

Alternate problem E See Right Company makes contact lenses. The company has a plant capacity of 200,000 units. Variable
costs are $4,000,000 at 100% capacity. Fixed costs are $2,000,000 per year, but this is true only between 50,000 and
200,000 units.

. Prepare a cost-volume-pro t chart for See Right Company assuming it sells its product for $40 each. Indicate on the
chart the relevant range, break-even point, and the areas of net income and losses.

. Compute the break-even point in units.

. How many units would have to be sold to earn $200,000 per year?

Alternate problem F Mr Feelds Cookies has xed costs of $360,000 per year. It sells three types of cookies. The cost and
revenue data for these products follow:

Cookies

Cream cake Goo ll Sweet tooth

Sales $64,000 $95,0000 $131,000

Variable costs 38,400 55,100 66,000

Compute the break-even point in sales dollars.

Beyond the numbers—Critical thinking

Business decision case A Quality Furniture Company is operating at almost 100% of capacity. The company expects sales to
increase by 25% in 2011. To satisfy the demand for its product, the company is considering two alternatives: The rst alternative
would increase xed costs by 15% but not a ect variable costs. The second alternative would not a ect xed costs but increase
variable costs to 60% of the selling price of the company’s product.

This is Quality Furniture Company’s condensed income statement for 2010:

Sales $3,600,000

Costs:

Variable $1,620,000

Fixed 330,000 1,950,000

Income before taxes $1,650,000

. Determine the break-even point in sales dollars for 2011 under each of the alternatives.

. Determine projected income for 2011 under each of the alternatives.

. Which alternative would you recommend? Why?

Business decision case B When the Weidkamp Company’s plant is completely idle, xed costs amount to $720,000. When the
plant operates at levels of 50% of capacity or less, its xed costs are $840,000; at levels more than 50% of capacity, its xed
costs are $1,200,000. The company’s variable costs at full capacity (100,000 units) amount to $1,800,000.

. Assuming that the company’s product sells for $60 per unit, what is the company’s break-even point in sales dollars?

. Using only the data given, at what level of sales would it be more economical to close the factory than to operate it? In
other words, at what level would operating losses approximate the losses incurred if the factory closed down
completely?

. Assume that Weidkamp Company is operating at 50% of its capacity and decides to reduce the selling price from $60
per unit to $36 per unit to increase sales. At what percentage of capacity must the company operate to break even at
the reduced sales price?

Business decision case C Monroe Company has recently been awarded a contract to sell 25,000 units of its product to the
federal government. Monroe manufactures the components of the product rather than purchasing them. When the news of the
contract was released to the public, President Mary Monroe, received a call from the president of the McLean Corporation, Carl
Cahn. Cahn o ered to sell Monroe 25,000 units of a needed component, Part J, for $15.00 each. After receiving the o er,
Monroe calls you into her o ce and asks you to recommend whether to accept or reject Cahn’s o er.

You go to the company’s records and obtain the following information concerning the production of Part J.

Costs at current production

level (200,000 units)

Direct labor $1,248,000

Direct materials 576,000

Manufacturing overhead 600,000

Total cost $2,424,000

You calculate the unit cost of Part J to be $12.12 or ($2,424,000/200,000). But you suspect that this unit cost may not hold true
at all production levels. To nd out, you consult the production manager. She tells you that to meet the increased production
needs, equipment would have to be rented and the production workers would work some overtime. She estimates the
machine rental to be $60,000 and the total overtime premiums to be $108,000. She provides you with the following
information:

Costs at current production

level (225,000 units)

Direct labor $1,404,000

Direct materials 648,000

Manufacturing overhead
828,000
(including equipmental rental and overtime premiums)

Total cost $2,880,000

The production manager advises you to reject Cahn’s o er, since the unit cost of Part J would be only $12.80 or
($2,880,000/225,000 units) with the additional costs of equipment rental and overtime premiums. This amount still is less than
the $15.00 that Cahn would charge. Undecided, you return to your o ce to consider the matter further.

. Using the high-low method, compute the variable cost portion of manufacturing overhead. (Remember that the costs of
equipment rental and overtime premiums are included in manufacturing overhead. Subtract these amounts before
performing the calculation).

. Compute the total costs to manufacture the additional units of Part J. (Note: include overtime premiums as a part of
direct labor.)

. Compute the unit cost to manufacture the additional units of Part J.

. Write a report recommending that Monroe accept or reject Cahn’s o er.

Business decision case D Refer to the “A broader perspective: Major television networks are nding it harder to break even”
discussion of cost-volume-pro t analysis for television networks. Write a memo to your instructor describing how the networks
can reduce their break-even points.

Group project E In teams of two or three students, develop a cost-volume-pro t equation for a new business that you might
start. Examples of such businesses are a portable espresso bar, a pizza stand, a campus movie theater, a package delivery
service, a campus-to-airport limousine service, and a T-shirt printing business.

Your equation should be in the form: Pro ts = (Price per unit X Volume) – (Variable cost per unit X Volume) – Fixed costs per
period. Pick a period of time, say one month, and project the unit price, volume, unit variable cost, and xed costs for the
period. From this information, you will be able to estimate the pro ts—or losses—for the period. Select one spokesperson for
your team to tell the class about your proposed business and its pro ts or losses. Good luck, and have fun.

Group project F
Refer to “A broader perspective: Even colleges use CVP” discussion of how cost-volume-pro t analysis is used by colleges. In
teams of two or three students, write a memo to your instructor de ning step costs and explain why the step costs identi ed in
the case are classi ed as such. Also include in your memo how the school might lower its break-even point.

Group project G In teams of two or three students, address the following questions:

Why would a company consider increasing automation and decreasing the use of labor if the result would be an
increase in the break-even point?

Would an increase in automation increase xed costs over the short-run, long-run, or both?

Write a memo to your instructor that addresses both questions. Be sure to explain your answers.

Using the Internet—A view of the real world

Visit the website for Intel Corporation, a high technology manufacturing company.

http://www.intel.com

Go to the company’s most recent nancial statements and review the consolidated statement of income. What additional
information, if any, would you need to perform cost-volume-pro t analysis? Why is this information excluded from Intel’s income
statement?

Visit the website for Wal-Mart Corporation, a retail company.

http://www.walmart.com

Go to the company’s most recent nancial statements and review the statement of income. What additional information, if any,
would you need to perform cost-volume-pro t analysis? Why is this information excluded from Wal-Mart Corporation’s income
statement?

level (225,000 units)Direct labor$1,404,000Direct materials648,000

Manufacturing overhead

(including equipmental rental and overtime premiums)

828,000Total cost$2,880,000

The production manager advises you to reject Cahn’s o er, since the unit cost of Part J would be only $12.80 or ($2,880,000/225,000
units) with the additional costs of equipment rental and overtime premiums. This amount still is less than the $15.00 that Cahn would
charge. Undecided, you return to your o ce to consider the matter further.

. Using the high-low method, compute the variable cost portion of manufacturing overhead. (Remember that the costs of
equipment rental and overtime premiums are included in manufacturing overhead. Subtract these amounts before performing the
calculation).
. Compute the total costs to manufacture the additional units of Part J. (Note: include overtime premiums as a part of direct labor.)
. Compute the unit cost to manufacture the additional units of Part J.
. Write a report recommending that Monroe accept or reject Cahn’s o er.

LICENSES AND ATTRIBUTIONS

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