1-14B Contribution Format versus Traditional Income Statement (LO5)

CHECK FIGURE
(2) Net operating income: $65,674
House of Pianos, Inc., purchases pianos from a well-known manufacturer and sells
them at the retail level. The pianos sell, on the average, for $3,300 each. The
average cost of an piano from the manufacturer is $1,492. The costs that the
company incurs in a typical month are presented below:
Costs
Selling:
Advertising .........................................
Delivery of pianos ...............................
Sales salaries and
commissions.............
Utilities ...............................................
Depreciation of sales
facilities ..............
Administrative:
Executive
salaries ................................
Depreciation of office
equipment ..........
Clerical ...............................................
Insurance ...........................................

Cost Formula
$955 per month
$61 per piano sold
$4,823 per month, plus 4% of sales
$633 per month
$4,944 per month
$13,490 per month
$943 per month
$2,499 per month, plus $37 per piano
sold
$719 per month

During November, the company sold and delivered 60 pianos.

Required:
1. Prepare a traditional income statement for September.
2. Prepare a contribution format income statement for September. Show costs and
revenues on both a total and a per unit basis down through contribution margin.
3. Refer to the income statement you prepared in (2) above. Why might it be
misleading to show the fixed costs on a per unit basis?

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Chapter 1 B Problems

1-1

PROBLEM 1-15B Identifying Cost Behavior Patterns (LO3)

In Problem 1-15A in the text are a number of graphs displaying cost behavior
patterns that might be found in a companys cost structure. The vertical axis on
each graph represents total cost, and the horizontal axis represents level of activity
(volume).
Required:
1. For each of the following situations, identify the graph from Problem 1-15A in the
text that illustrates the cost behavior pattern involved. Any graph may be used
more than once.
a. City water bill, which is computed as follows:
First 200,000 gallons or
less................................
Next 15,000 gallons..........
Next 15,000 gallons..........
Next 15,000 gallons..........
Etc....................................

$300 flat fee

$0.004 per gallon used
$0.008 per gallon used
$0.012 per gallon used
Etc.

b. Use of a machine under a lease, where a minimum charge of $2,500 is paid

for up to 100 hours of machine time. After 100 hours of machine time, an
additional charge of $4 per hour is paid up to a maximum charge of $4,000
per period.
c. Cost of raw materials used.
d. Rent on a factory building donated by the city, where the agreement calls for
a fixed fee payment unless 500,000 labor-hours or more are worked, in which
case no rent need be paid.
e. Depreciation of equipment, where the amount is computed by the straightline method. When the depreciation rate was established, it was anticipated
that the obsolescence factor would be greater than the wear and tear factor.
f. Rent on a factory building donated by the county, where the agreement calls
for rent of $350,000 less $1 for each direct labor-hour worked in excess of
100,000 hours, but a minimum rental payment of $50,000 must be paid.
g. Salaries of maintenance workers, where one maintenance worker is needed
for every 200 hours of machine-hours or less (that is, 0 to 200 hours requires
one maintenance worker, 201 to 400 hours requires two maintenance
workers, etc.)
h. Electricity bill -- a flat fixed charge, plus a variable cost after a certain
number of kilowatt-hours are used.
i. Cost of raw materials, where the cost starts at $10.00 per unit and then
decreases by 5 cents per unit for each of the first 100 units purchased, after
which it remains constant at $4.00 per unit.
2. How would knowledge of cost behavior patterns such as those above be of help
to a manager in analyzing the cost structure of his or her company?
(CPA, adapted)
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Introduction to Managerial Accounting, 6th edition

PROBLEM 116BVariable and Fixed Costs; Subtleties of Direct and Indirect

Costs (LO3, LO6)
Madison Seniors Care Center is a non-prot organization that provides a variety of
health services to the elderly. The center is organized into a number of
departments, one of which is the meals-on-wheels program that delivers hot meals
to seniors in their homes on a daily basis. Below are listed a number of costs of the
center and the meals-on-wheels program.
Example: The cost of groceries used in meal preparation.
a. The cost of leasing the meals-on-wheels van.
b. The cost of incidental supplies such as salt, pepper, napkins, and so on.
c. The cost of gasoline consumed by the meals-on-wheels van.
d. The rent on the facility that houses Madison Seniors Care Center, including the
meals-on-wheels program.
e. The salary of the part-time manager of the meals-on-wheels program.
f. Depreciation on the kitchen equipment used in the meals-on-wheels program.
g. The hourly wages of the caregiver who drives the van and delivers the meals.
h. The costs of complying with health safety regulations in the kitchen.
i. The costs of mailing letters soliciting donations to the meals-on-wheels program.
Required:
For each cost listed above, indicate whether it is a direct or indirect cost of the
meals-on-wheels program, whether it is a direct or indirect cost of particular seniors
served by the program, and whether it is variable or xed with respect to the
number of seniors served. Use the below form for your answer.

Description
Example: The
cost of polio
immunizatio
n
tablets .......
..

Direct or Indirect
Cost of the
Meals-On-Wheels
Program
Indirec
Direct
t

Direct or Indirect
Cost of Particular
Seniors Served
by the Meals-OnWheels Program
Indirec
Direct
t

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Chapter 1 B Problems

Variable or Fixed
with Respect to
the Number of
Seniors Served
by the Meals-OnWheels Program
Variabl
e
Fixed

1-3

PROBLEM 117BHigh-Low Method; Predicting Cost (LO3, LO4)

CHECK FIGURE
(3) Total cost: 257,146 pesos
Armondo SA is an Argentinian manufacturing company whose total factory
overhead costs fluctuate somewhat from year to year according to the number of
machine-hours worked in its production facility. These costs (in Argentinian pesos)
at high and low levels of activity over recent years are given below:

Machine-hours .............................
Total factory overhead costs .........

Level of Activity
Low
High
47,700
63,600
248,56 pesos
277,18 pesos
0
0

The factory overhead costs above consist of indirect materials, rent, and
maintenance. The company has analyzed these costs at the 47,700 machine-hours
level of activity as follows:
Indirect materials (variable) ...................
Rent (fixed) ..........................................
Maintenance (mixed) .............................
Total factory overhead costs ..................

62,010 pesos
135,000
51,550
248,560 pesos

For planning purposes, the company wants to break down the maintenance cost
into its variable and fixed cost elements.
Required:
1. Estimate how much of the factory overhead cost of 277,180 pesos at the high
level of activity consists of maintenance cost. (Hint: To do this, it may be helpful
to first determine how much of the 277,180 pesos cost consists of indirect
materials and rent. Think about the behavior of variable and fixed costs.)
2. Using the high-low method, estimate a cost formula for maintenance.
3. What total overhead costs would you expect the company to incur at an
operating level of 52,470 machine-hours?

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Introduction to Managerial Accounting, 6th edition

PROBLEM 118BCost Behavior; High-Low Method; Contribution Format

Income Statement (LO3, LO4, LO5)
CHECK FIGURE
(2) Shipping expense: Y = 19,700 + 12X
Arnall Ltd., a British merchandising company, is the exclusive distributor of a
product that is gaining rapid market acceptance. The companys revenues and
expenses (in British pounds) for the last three months are given below:
Arnall Ltd.
Comparative Income Statements
For the Three Months Ended June 30
April
Sales in
units ...................................................
Sales
revenue ...................................................
Cost of goods
sold ...........................................
Gross
margin ...................................................
Selling and administrative expenses:
Shipping
expense .........................................
Advertising
expense .....................................
Salaries and
commissions ...........................
Insurance
expense .......................................
Depreciation
expense ...................................
Total selling and administrative
expenses .......
Net operating income
(loss) .............................

1,800
313,200

May
3,200

June
4,800

556,800

835,200

120,600

214,400

321,600

192,600

342,400

41,300

58,100

77,300

70,000

70,000

70,000

104,400

157,600

218,400

9,900

9,900

9,900

42,300

42,300

267,900

337,900

417,900

(75,300)

4,500

95,700

513,600

42,300

(Note: Arnall Ltd.s income statement has been recast in the functional format
common in the United States. The British currency is the pound, denoted by .)
Required:
1. Identify each of the companys expenses (including cost of goods sold) as either
variable, fixed, or mixed.
2. Using the high-low method, separate each mixed expense into variable and fixed
elements. State the cost formula for each mixed expense.
3. Redo the companys income statement at the 4,800-unit level of activity using
the contribution format.
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Chapter 1 B Problems

1-5

PROBLEM 119BHigh-Low and Scattergraph Analysis (LO4)

CHECK FIGURE
(1) Y = $780 + $42X
Tristan Wire Company heats copper ingots to very high temperatures by placing the
ingots in a large heat coil. The heated ingots are then run through a shaping
machine that shapes the soft ingot into wire. Due to the long heat-up time, the coil
is never turned off. When an ingot is placed in the coil, the temperature is raised to
an even higher level, and then the coil is allowed to drop to the waiting
temperature between ingots. Management needs to know the variable cost of
power involved in heating an ingot and the fixed cost of power during waiting
periods. The following data on ingots processed and power costs are available:
Month
January
February
March
April
May
June
July
August
September
October

Number
of
Ingots
111
91
81
101
131
121
71
61
44
34

Power
Cost
$5,782
$4,782
$4,682
$5,282
$6,282
$5,882
$4,282
$3,482
$3,682
$2,208

Required:
1. Using the high-low method, estimate a cost formula for power cost. Express the
formula in the form Y = a + bX.
2. Prepare a scattergraph by plotting ingots processed and power cost on a graph.
Draw a straight line though the two data points that correspond to the high and
low levels of activity. Make sure your line intersects the Y-axis.
3. Comment on the accuracy of your high-low estimates assuming a least-squares
regression analysis estimated the total fixed costs to be $1,438.20 per month
and the variable cost to be $37.783 per ingot. How would the straight line that
you drew in requirement 2 differ from a straight line that minimizes the sum of
the squared errors?

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Introduction to Managerial Accounting, 6th edition

PROBLEM 120BHigh-Low Method; Predicting Cost (LO3, LO4)

CHECK FIGURE
(4) Total cost: $178,500
Harvest Companys total overhead cost at various levels of activity are presented
below:
Month

Machine-Hours

March ...................................
...
April ......................................
...
May ......................................
...
June ......................................
..

53,000

Total Overhead
Cost
$190,500

43,000

$166,500

63,000

$214,500

73,000

$238,500

Assume that the overhead cost above consists of utilities, supervisory salaries, and
maintenance. The breakdown of these costs at the 43,000 machine-hour level of
activity is as follows:
Utilities
(variable) ...............................
Supervisory salaries
(fixed) .................
Maintenance
(mixed) ..........................
Total overhead
cost ............................

$ 51,600
49,000
65,900
$166,500

The company wants to break down the maintenance cost into its variable and fixed
cost elements.
Required:
1. Estimate how much of the $238,500 of overhead cost in June was maintenance
cost. (Hint: To do this, it may be helpful to first determine how much of the
$238,500 consisted of utilities and supervisory salaries. Think about the behavior
of variable and fixed costs within the relevant range.)
2. Using the high-low method, estimate a cost formula for maintenance.
3. Express the companys total overhead cost in the form Y = a x bX.
4. What total overhead cost would you expect to be incurred at an activity level of
48,000 machine-hours?

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Chapter 1 B Problems

1-7

PROBLEM 121BCost Classification (LO2, LO3, LO)

Listed below are costs found in various organizations.
1. Property taxes, factory.
2. Boxes used for packaging detergent produced by the company.
3. Salespersons commissions.
4. Supervisors salary, factory.
5. Depreciation, executive autos.
6. Wages of workers assembling computers.
7. Insurance, nished goods warehouses.
8. Lubricants for production equipment.
9. Advertising costs.
10. Microchips used in producing calculators.
11. Shipping costs on merchandise sold.
12. Magazine subscriptions, factory lunchroom.
13. Thread in a garment factory.
14. Billing costs.
15. Executive life insurance.
16. Ink used in textbook production.
17. Fringe benets, assembly-line workers.
18. Yarn used in sweater production.
19. Wages of receptionist, executive ofces.
Required:
Prepare an answer sheet with column headings as shown below. For each cost item,
indicate
whether it would be variable or xed with respect to the number of units produced
and sold; and then whether it would be a selling cost, an administrative cost, or a
manufacturing cost. If it is a manufacturing cost, indicate whether it would typically
be treated as a direct cost or an indirect cost with respect to units of product. Three
sample answers are provided for illustration.

Cost Item
Direct labor ...............
Executive salaries .....
Factory rent ..............

Variable or
Fixed
V
F
F

Selling
Cost

Administrative
Cost

Manufacturing
(Product) Cost
Direct
Indirect
X

X
X

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Introduction to Managerial Accounting, 6th edition

PROBLEM 122BHigh-Low Method; Contribution Format Income Statement

(LO4, LO5)
CHECK FIGURE
(1) Y = $57,000 + $4X
McKenzie Company has decided to use a contribution format income statement for
internal planning purposes. The company has analyzed its expenses and has
developed the following cost formulas:
Cost
Cost of goods sold ................................
Advertising expense ..............................
Sales commissions ................................
Administrative salaries ..........................
Shipping expense ..................................
Depreciation expense ............................

Cost Formula
$26 per unit sold
$183,000 per quarter
7% of sales
$93,000 per quarter
?
$63,000 per quarter

Management has concluded that shipping expense is a mixed cost, containing both
variable and fixed cost elements. Units sold and the related shipping expense over
the last eight quarters are given below:
Quarter

Units Sold

Shipping
Expense

Year 1:
First ...............................
Second .......................
Third ...........................
Fourth .........................
Year 2:
First ...............................
Second .......................
Third ...........................
Fourth .........................

29,000

$173,000

31,000
36,000
32,000

$188,000
$230,000
$193,000

30,000

$183,000

33,000
47,000
44,000

$198,000
$245,000
$221,000

Management would like a cost formula derived for shipping expense so that a
budgeted contribution format income statement can be prepared for the next
quarter.
Required:
1. Using the high-low method, estimate a cost formula for shipping expense.
2. In the first quarter of Year 3, the company plans to sell 35,000 units at a selling
price of $56 per unit. Prepare a contribution format income statement for the
quarter.

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Chapter 1 B Problems

1-9

PROBLEM 123B Cost Classification and Cost Behavior (LO2, LO3, LO6)
Shulmans Company manufactures a beautiful bookcase that enjoys widespread
popularity. The company has a backlog of orders that is large enough to keep
production going indefinitely at the plants full capacity of 3,900 bookcases per
year. Annual cost data at full capacity follow:
Direct materials used (wood and glass)
Administrative office salaries
Factory supervision
Sales commissions
Depreciation, factory building
Depreciation, administrative office
equipment
Indirect materials, factory
Factory labor (cutting and assembly)
Advertising
Insurance, factory
Administrative office supplies (billing)
Property taxes, factory
Utilities, factory

$431,000
$111,000
$67,000
$64,000
$101,000
$2,000
$19,000
$87,000
$97,000
$6,000
$4,000
$16,000
$44,000

Required:
1. Prepare an answer sheet with the column headings shown below. Enter each cost
item on your answer sheet, placing the dollar amount under the appropriate
headings. As examples, this has been done already for the first two items in the
list above. Note that each cost item is classified in two ways: first, as either
variable or fixed with respect to the number of units produced and sold; and
second, as either a selling and administrative cost or a product cost. (If the item
is a product cost, it should also be classified as either direct or indirect as shown.)

Cost Item
Direct materials used
(wood, glass)
Administrative office
salaries

Cost Behavior
Variable
Fixed

Selling
or
Admin.
Cost

$431,00
0

Product Cost
Direct
Indirect
$431,00
0

$111,00
0

$111,00
0

2. Total the dollar amounts in each of the columns in (1) above. Compute the
average product cost per bookcase.
3. Due to a recession, assume that production drops to only 2,000 bookcases per
year. Would you expect the average product cost per bookcase to increase,
decrease, or remain unchanged? Explain. No computations are necessary.

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1-10

Introduction to Managerial Accounting, 6th edition

4. Refer to the original data. The presidents next-door neighbor has considered
making himself a bookcase and has priced the necessary materials at a building
supply store. He has asked the president whether he could purchase a bookcase
from the Shulmans Company at cost, and the president has agreed to let him
do so.
a. Would you expect any disagreement between the two men over the price the
neighbor should pay? Explain. What price does the president probably have in
mind? The neighbor?
b. Because the company is operating at full capacity, what cost term used in the
chapter might be justification for the president to charge the full, regular price
to the neighbor and still be selling at cost? Explain.

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Chapter 1 B Problems

1-11