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EXAM REVIEW UNIT II - CHAPTERS 4, 5, & 6

Study Suggestions
Review your class notes, homework exercises and problems. Review Summary, Review Problem and Glossary at the end of each chapter. Use your Study Guide, especially Multiple Choice and True & False questions Review the resource materials and practice quizzes and exams available on the Textbook Website: http://highered.mcgraw-hill.com/sites/0073048836/information_center_view0/ Additional review materials are available online at sites such as: http://www.cliffsnotes.com/WileyCDA/Section/id-305261.html

Key Terms and Concepts to Know

Chapter 4 Systems Design: Process Costing
Differences and similarities between job order and process costing. Flow of product costs through the inventory accounts and intocost of goods sold. Each production department has a unique Production Report and separate workin-process inventory account. Journal entries required in a Process Cost system. Concept of "Equivalent Units" and how to calculate equivalent units Prepare a Production Report consisting of: Quantity Schedule Equivalent Units Cost per Equivalent Unit Cost Reconciliation/Assignment

Chapter 5 - Cost Behavior: Analysis And Use

Variable costs o Effect of a change in volume of total and per unit variable costs o Relationship between variable cost and the activity base. o True variable costs versus step variable costs. o Effect of the relevant range on the behavior of variable costs. Fixed cots o Effect of a change in volume of total and per unit fixed costs o Effect of the relevant range on the behavior of fixed costs.
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o Committed versus discretionary fixed costs. Mixed costs o Have properties of both variable and fixed costs. o Effect of a change in volume of total and per unit mixed costs o Analysis of mixed costs high-low method and scattergraph (quick-and-dirty) methods. Contribution approach income statement.

Chapter 6 - Cost-Volume-Profit Relationships

CVP analysis is based on the interactions among the following five elements: o Price or revenue of products o Volume or level of activity o Per units variable costs o Total fixed costs. o Mix of products sold (CVP analysis requires an assumption about sales mix) Contribution Margin o Difference between gross margin and contribution margin o Understand the relationship among: Revenue, variable cost and contribution margin per unit Why fixed costs and operating income per unit are never used. Total revenue, variable cost, contribution margin and fixed costs Level of activity versus number of units sold o Contribution Margin is the remaining amount of sales dollars available to cover fixed expenses and profit. o Contribution Margin in Dollars = Sales Revenue - Variable Expenses. o Contribution Margin per unit = Selling Price per unit Variable Expense per unit or total contribution margin / units sold o Contribution Margin Ratio (%) = Contribution Margin / Sales o Break-Even Point: At the Break-even Point: o Profit or operating income equals 0. o Total revenue equals total costs. o Total contribution margin equals fixed expenses. The break-even point is measured in sales dollars and/or units sold. The break-even point may be calculated using either the Equation Method or the Contribution Margin Method: Equation Method : In Units Sold: sales $/unit X units sold = variable expenses $/unit X units sold + fixed expenses + profit of 0 In Sales Dollars: sales % = variable expenses % + fixed expenses + profit of 0

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Contribution Margin Method: In Units Sold: (Fixed Expenses + Profit of 0) Contribution Margin per unit In Sales Dollars: Fixed expenses + Profit of 0) Contribution Margin ratio Calculate the break-even point in total sales dollars and total units sold for both single-product and multi-product companies. Sales mix, the relative combination in which a company's products are sold, is assumed to be constant for these companies. Calculate the sales dollars and units sold necessary to achieve a target profit using the break-even formulas above and substituting the target profit for the breakeven profit of 0. Understand how the revenue function, variable, fixed and total cost functions and the break-even point shift on the CVP graph when revenue and/or cost assumptions are changed Calculate the margin of safety. Margin of Safety is the excess of budgeted or actual sales over the break-even volume of sales. o Margin of safety in dollars = Total sales - Break-even sales o Margin of safety percentage = Margin of safety in dollars / Total sales Calculate the degree of leverage (leverage factor) o Operating Leverage is a way to measure, at a given level of sales, how a percentage change in sales volume will affect profits. o Use the leverage factor to calculate the percent change in operating income for given a percent change in sales o Explain how leverage changes when sales increase or decrease. o Degree of operating leverage = Contribution margin / Net income

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SAMPLE PROBLEMS
Problem 1 - Production Report The Rodman Paint Company manufactures products that go through two departments, mixing and filling. The company uses the weighted average method to compute unit costs. The following information is from the mixing department for the month of May: Amount Completed Gallons Materials Conversion Work in process, May 1 70,000 5/7 3/7 Started into production 460,000 Work in process, May 31 80,000 3/4 5/8 Costs in the beginning work in process inventory and costs added during May were: Conversion Materials Work in process, May 1 $35,000 $17,000 Costs added during May 391,000 282,000 Required: Prepare a production report for the mixing department for May. Problem 2 Process Costing Yoder Company uses the weighted-average method in its process costing system. The following data pertain to operations in the first processing department for a recent month when 750,000 units were put into production: Work-in-process, beginning Units in process 40,000 Stage of completion with respect to materials 70% Stage of completion with respect to conversion 60% Material cost $8,600 Conversion cost $4,800 Units in process 40,000 Costs added to production during the month: Materials cost $223,000 Conversion cost $149,000 Work-in-process, ending Units in process 30,000 Stage of completion with respect to materials 40% Stage of completion with respect to conversion 30% Required: a) How many units were completed and transferred to the next department during the month?
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b) What was the cost per equivalent unit of production for materials during the month? c) How much cost, in total, was assigned to the ending work in process inventory? Problem 3 High-Low Method and Contribution income Statement The Belfour Company is a manufacturer of a single product Belfour's income statements for the last two years are given below: Last Year This Year Units sold 300,000 240,000 Sales revenue $1,500,000 $1,200,000 740,000 Less: Cost of goods sold 800,000 Gross margin 700,000 460,000 420,000 Less: Operating expenses 450,000 Net Income 250,000 40,000 The company's cost of goods sold and operating expenses are mixed costs. Required: a) Using the high-low method, separate the cost of goods sold and operating expenses into their variable and fixed elements. Determine the cost formula for each type of cost. b) Prepare a contribution-format income statement for this year. c) Calculate the anticipated net income if units sold is 280,000.

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Problem 4 - CVP Relationships The Berman Company manufactures and sells a single product . The company's sales and expenses for last month were: Per Unit Percentage Total Sales $500,000 $25 100% 10 40% Less: Variable expenses 200,000 Contribution margin 300,000 15 60% Less: Fixed expenses 270,000 Net income $ 30,000 Required: a) Calculate the monthly break-even point in units sold and in sales dollars. o using the equation method o using the contribution margin method o verify the answer by preparing a contribution income statement b) Without any computations, what is the contribution margin at the break-even point? c) How many units would have to be sold each month to earn a minimum target net income of $60,000? d) Verify your answer by preparing a contribution income statement at the target level of sales. e) Refer to the original data above. Compute the company's margin of safety in both dollars and percentage. f) Refer to the original data above. o What is the company's Contribution Margin Ratio? o If monthly sales increase by $25,000 and there is no change in fixed expenses, by how much would net income be expected to increase? g) Refer to the original data above. If the company were able to reduce its variable expenses by $1 per unit, o what would be the new monthly break-even point in units and sales dollars? o verify the answer by preparing a contribution income statement. h) Compute the company's degree of operating leverage. If sales increase by 10% how much should net income increase?

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Problem 5 Contribution Margin and Income University Store, Inc.s first quarter income statement is presented below: Sales Cost of Goods Sold Gross Margin Less: Operating Expenses: Selling Expenses Administrative Expenses Net Income $800,000 560,000 240,000 $100,000 110,000 210,000 $ 30,000

On average, a book sells for $40.00. Variable selling expenses are $3.00 per book; the remaining selling expenses are fixed. The variable administrative expenses are 5% of sales; the remainder of the administrative expenses are fixed. Required: a) Calculate the contribution margin and contribution margin ratio for the first quarter. b) Prepare a contribution format income statement for the first quarter. c) Determine the cost formula for operating expenses. d) If 25,000 books are sold during the second quarter, calculate the companys expected contribution margin. Problem 6 Operating Leverage Pricher Corporations income statement for last year appears below: Sales $2,000,000 Cost of goods sold: Direct materials $500,000 Direct labor (variable) 150,000 Variable manufacturing overhead 50,000 1,300,000 Fixed manufacturing overhead 600,000 Gross Profit 700,000 Selling and administrative expenses Variable 100,000 300,000 Fixed 200,000 Operating Income 400,000 Required: a) Calculate the breakeven point. b) Calculate the degree of operating leverage. c) If sales and units sold double next year, calculate the degree of leverage.
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Sample True / False Questions

1. Process costing often combines direct materials and direct labor into a single category called conversion costs. True False 2. The process costing production report is used to determine how much manufacturing cost to transfer from Finished Goods Inventory to Cost of Goods Sold. True False 3. The number of beginning units in process plus the number of ending units in process should equal the number of units started plus the number of units completed. True False 4. The total cost of Work in Process incurred in one department during the period must be split between costs transferred to the next department and costs transferred to Finished Goods. True False 5. Under process costing, the amount of under- or overapplied conversion cost should be transferred to Work in Process Inventory at the end of the period. True False 6. The relevant range is the range in which costs remain variable. True False 7. A fixed cost will stay constant on a per unit basis as the volume increases. True False 8. Step costs are fixed over some range of activity and then increase like a variable cost. True False 9. The equation for a mixed cost is total fixed costs + variable cost per unit units of activity. True False 10. Contribution margin is calculated as sales revenue less variable costs. True False

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11. Total contribution margin is equal to total fixed costs at the break-even point. True False 12. Target units are calculated as fixed costs plus target profit divided by the unit contribution margin. True False 13. To determine the number of units needed to earn a target profit, divide the target contribution margin by the contribution margin per unit. True False 14. Managers can use cost-volume-profit analysis to evaluate changes in price. True False 15. The degree of operating leverage can be multiplied by a change in sales to determine change in profit. True False

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Sample Multiple Choice Questions

1. Davis Company uses the weighted-average method in its process costing system. The beginning inventory in department 1 consisted of 80,000 units, 100% complete with respect to materials and 25% complete with respect to conversion. The beginning work in process balance was $226,000. During the month, 150,000 units were transferred out of the department. The costs per equivalent unit of production were $2.00 for materials and $3.50 for conversion costs. The value of the units completed and transferred out of the department was: a) $681,000 b) $765,000 c) $821,000 d) $825,000 2. When the activity level is expected to decline within the relevant range, how would each of the following change? Fixed costs Variable costs per unit per unit a) Increase Increase b) Increase No change c) No change No change d) No change Increase 3. Utility costs at TSMC are a mixture of fixed and variable components. Utility costs average $0.40 per hour at an activity level of 9,000 machine hours and $0.25 per hour at an activity level of 18,000 machine hours. What are the expected total utility costs if the company works 13,000 machine hours? a) $4,225 b) $5,200 c) $4,000 d) $3,250 4. Clerical processing costs in the billing department of Shuma Services average $0.50 per account processed at an activity level of 32,000 accounts. Processing costs total $12,500 when only 22,000 accounts are processed. At a budgeted level of 25,000 accounts: a) Processing costs are expected to total $8,750 b) Fixed processing costs are expected to be $10,400 c) The variable processing costs are expected to be $0.35 per account processed d) Processing costs are expected to total $14,975

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5. Bad News Bears Inc. expected to sell 150,000 baseball games during the month of June. Junes budgeted income statement was: Revenue $2,400,000 Variable Expenses 1,425,000 Fixed manufacturing overhead expenses 250,000 Fixed selling & administrative expenses 500,000 Net Income 225,000 Actual June sales were 180,000 games. What should the net income have been according to the flexible budget? a) $450,000 b) $270,000 c) $420,000 d) $510,000 6. Sales and contribution margin ratios for Tri-Plex Inc.s three products are: Product X Product Y Product Z Sales $20,000 $40,000 $100,000 CM Ratio 45% 40% 15% The contribution margin ratio for the company as a whole would be: a) 25% b) 75% c) 33.3% d) it is impossible to determine from the data given 7. White Company has provided the following financial information: Breakeven units sold 1,000 Variable costs per unit $500 Total fixed costs $150,000 How much will be contributed to net income by the 1,001st unit sold? a) $650 b) $500 c) $150 d) $0 8. Conversion costs include: a) all costs of production. b) raw materials and direct labor. c) direct labor and manufacturing overhead. d) raw materials and manufacturing overhead.

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9. Which of the following is not included when reconciling the number of physical units using weighted average process costing? a) Units started b) Ending units in process c) Cost of goods sold d) Units completed 10. How would the number of units worked on during a period be calculated using weighted average process costing? a) Add beginning units in process and units completed b) Add beginning units in process and ending units in process c) Add units completed and ending units in process d) Add units started and units completed 11. Willow Companys beginning inventory for January consisted of 1,000 units that were 60% completed. During January, 10,000 units were started into the process and 10,500 units were completed. How many units were in ending inventory on January 31? a) 1,500 b) 1,000 c) 500 d) 100 12. NeoCon Inc. uses a process costing system in which direct materials are added at the beginning of the process and conversion costs are incurred uniformly throughout the process. Beginning inventory for January consisted of 1,000 units that were 40% completed. During the month, 10,000 units were started into the process. At the end of the month, the inventory consisted of 500 units that were 70% completed. What would be the equivalent units for direct materials cost using the weighted average method? a) 10,000 b) 10,450 c) 10,850 d) 11,000 13. It would not be necessary to translate physical units into equivalent units if a) the FIFO method were used instead of the weighted average method. b) direct materials were all added at the beginning of the process. c) direct labor and manufacturing overhead were combined into a single category called conversion costs. d) all units worked on during the period were completed during the period.

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14. Doggy Inc. uses a process costing system in which direct materials are added at the beginning of the process and conversion costs are incurred uniformly throughout the process. Beginning inventory for January consisted of 1,000 units and 10,000 units were started into the process during January. On January 31, the inventory consisted of 500 units. Equivalent units for conversion costs were 10,850. What was the percentage of completion for conversion costs in the January 31 work in process inventory? a) 70% b) 80% c) 90% d) 100% 15. Under the weighted average method of process costing, which of the following formulas is used to calculate the cost per equivalent unit? a) (Ending Inventory + Current Costs)/Physical Units b) (Beginning Inventory + Current Costs)/Physical Units c) (Ending Inventory + Current Costs)/Equivalent Units d) (Beginning Inventory + Current Costs)/Equivalent Units 16. Two Gulps uses process costing to account for the production of canned energy drinks. Direct materials are added at the beginning of the process and conversion costs are incurred uniformly throughout the process. Equivalent units have been calculated to be 12,000 units for materials and 10,000 units for conversion costs. Beginning inventory consisted of $7,000 in materials and $4,000 in conversion costs. April costs were $36,000 for materials and $40,000 for conversion costs. Ending inventory work in process inventory was 4,000 units which were 100% complete for materials, 50% for conversion. The value of ending inventory using the weighted average method would be a) $15,966.60 b) $23,133.20 c) $31,933.20 d) $65,000.00

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17. Jonas and Partners, a law firm, worked on a total of 1,000 cases this month, 800 of which were completed during the period. The remaining cases were 40% complete. The firm incurred $180,000 in direct labor and overhead costs during the period, and had $4,800 in direct labor and overhead costs in beginning inventory. Using the weighted average method, what was the total cost of cases completed during the period? a) $16,800 b) $17,520 c) $168,000 d) $175,200 18. A cost driver a) is the same as a fixed cost. b) is an activity that causes total costs to change. c) Is relevant only for automobile manufacturing companies. d) is a method of calculating mixed costs. 19. If sales revenue increases by 80%, variable costs will a) decrease in total. b) increase in total. c) decrease on a per unit basis. d) increase on a per unit basis. 20. Which of the following is a variable cost? a) A cost that is $20,000 when production production is 70,000. b) A cost that is $20,000 when production production is 70,000. c) A cost that is $20,000 when production production is 70,000. d) A cost that is $40,000 when production production is 70,000. is 50,000 and $20,000 when is 50,000 and $28,000 when is 50,000 and $40,000 when is 50,000 and $40,000 when

21. If sales revenue increases by 45%, fixed costs will a) decrease in total. b) increase in total. c) decrease on a per unit basis. d) increase on a per unit basis.

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22. Astra Inc. incurs three different production costs. Average units costs for each are as follows: Cost A Cost B Cost C Production = 10,000 units $20.00 $15.00 $12.00 Production = 40,000 units $5.00 $11.25 $12.00 What type of cost are each of these three costs? a) Cost A is fixed, Cost B is mixed, Cost C is variable. b) Cost A is fixed, Cost B is variable, Cost C is mixed. c) Cost A is variable, Cost B is mixed, Cost C is fixed. d) Cost A is variable, Cost B is fixed, Cost C is mixed. 23. The intercept of the cost line on a scattergraph represents a) fixed cost per unit. b) total fixed cost. c) variable cost per unit. d) sales price per unit. 24. Ajax uses the high-low method of estimating costs. Ajax had total costs of $50,000 at its lowest level of activity, when 5,000 units were sold. When, at its highest level of activity, sales equaled 12,000 units, total costs were $78,000. Ajax would estimate variable cost per unit as a) $10.00 b) $6.50 c) $4.00 d) $7.53 25. Ajax uses the high-low method of estimating costs. Ajax had total costs of $50,000 at its lowest level of activity, when 5,000 units were sold. When, at its highest level of activity, sales equaled 12,000 units, total costs were $78,000. Ajax would estimate fixed costs as a) $28,000 b) $30,000 c) $64,000 d) $128,000

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26. Foster, which uses the high-low method, reported total costs of $24 per unit at its lowest activity level, when production equaled 10,000 units. When production doubled, at its highest activity level, the total cost per unit dropped to $15. Foster would estimate variable cost per unit as a) $9 b) $6 c) negative $9 d) negative $0.0009 27. Ajax uses the high-low method of estimating costs. Ajax had total costs of $50,000 at its lowest level of activity, when 5,000 units were sold. When, at its highest level of activity, sales equaled 12,000 units, total costs were $78,000. What would Ajax estimate its total cost to be if sales equaled 8,000 units? a) $32,000 b) $52,000 c) $62,000 d) $80,000 28. The formula for break-even point in terms of units is a) Total variable costs/Unit contribution margin b) Total fixed costs/Contribution margin ratio c) Total fixed costs/Unit contribution margin d) Total variable costs/Total fixed costs 29. The a) b) c) d) formula for break-even point in terms of revenue is Total variable costs/Contribution margin ratio Total fixed costs/Contribution margin ratio Total fixed costs/Unit contribution margin Total variable costs/Total fixed costs

30. Alfred Corp has a selling price of $15, variable costs of $10 per unit, and fixed costs of $25,000. How many units must be sold to break-even? a) 5,000 b) 10,000 c) 2,500 d) 1,667

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31. Piazza Corp has sales of $400,000, a contribution margin ratio of 40%, and a profit of $40,000. If 20,000 units were sold, what is the break-even point in units? a) 12,000 b) 8,000 c) 20,000 d) 15,000 32. Last month Kallina Company had a $30,000 profit on sales of $250,000. Fixed costs are $60,000 a month. How much would sales have to decrease for Calico to break even? a) $90,000 b) $83,333 c) $166,667 d) $280,000 33. Last month Kironina Company had a $60,000 loss on sales of $300,000. Fixed costs are $120,000 a month. What sales revenue is needed for Calico to break even? a) $360,000 b) $480,000 c) $600,000 d) $420,000 34. Perisia, Inc. has fixed costs of $200,000 and a contribution margin ratio of 40%. How much sales revenue must be earned for a profit of $50,000? a) $125,000 b) $500,000 c) $625,000 d) $1,000,000 35. Bench Corp has sales of $300,000, a contribution margin ratio of 30%, and a target profit of $30,000. If 20,000 units were sold, what is the variable cost per unit? a) $15.00 b) $10.50 c) $4.50 d) $2.00

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36. Pearl Company sold 20,000 units, had variable costs of $12 per unit, fixed costs of $100,000, and profits of $60,000. What is the selling price per unit? a) $8 b) $17 c) $20 d) $32 37. Degree of operating leverage is used to a) calculate sales change given profit change. b) calculate profit change given sales change. c) calculate break-even sales given sales change. d) calculate break-even sales given profit change.

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SOLUTIONS TO SAMPLE PROBLEMS

Problem 1 - Production Report Units to be accounted for: Work in process, May 1 Started into production Total units to be accounted for Units accounted for: Transferred to filling Work in process, May 31 Total units accounted for Costs to be accounted for: Work in process, May 1 Costs added during the month Total Cost Equivalent units (from above) Unit cost Costs accounted for: Transferred to filling: 450,000 units x $1.433 each Work in process, May 31: Materials at $0.835 per EU Conversion at $0.598 per EU Total work in process, May 31 Total costs accounted for Alternate Solution: Costs accounted for as follows: Transferred to filling: Materials at $0.835 per EU Conversion at $0.598 per EU Work in process, May 31: Materials at $0.835 per EU Conversion at $0.598 per EU Total work in process, May 31 Total costs accounted for Total 70,000 460,000 530,000 450,000 80,000 530,000 $52,000 673,000 $725,000 $1.433 Materials Conversion

Equivalent Units 450,000 450,000 60,000 50,000 510,000 500,000 $ 35,000 391,000 $426,000 510,000 $0.835 $ 17,000 282,000 $299,000 500,000 $0.598

$645,000 50,100 29,900 80,000 $725,000 Total

450,000 60,000

450,000 50,000

Materials $375,750

Conversion $269,100

$644,850 50,100 29,900 80,000 $725,000

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$425,850

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Problem 2 Process Cost a) Beginning work-in-process Started into production Units to account for less: Ending work-in-process Transferred out b) Transferred out Ending work-in-process: Materials @ 40% Conversion @ 30% Equivalent units Beginning work-in-process Costs added Total costs Equivalent units per above Cost per equivalent unit c) Equivalent units Cost per equivalent unit Cost assigned to ending work-in-process

40,000 750,000 790,000 30,000 760,000 Materials 760,000 12,000 772,000 $8,600 223,000 231,600 772,000 $.30 12,000 $.30 $3,600 9,000 769,000 $4,800 149,000 153,800 769,000 $.20 9,000 $.20 $1,800 $5,400 Conversion 760,000 Total

Problem 3 High-Low Method and Contribution income Statement a) Cost of goods sold: Activity Cost High level of activity $800,000 300,000 240,000 Low level of activity 740,000 Change $ 60,000 60,000 Variable cost per unit = $60,000 / 60,000 units = $1.00 per unit Fixed costs = $800,000 - $1.00 x 300,000 = $500,000 OR Fixed costs = $740,000 - $1.00 x 240,000 = $500,000 Equation: Y = 500,000 + 1X

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Operating expenses: Activity Cost High level of activity $450,000 300,000 240,000 Low level of activity 420,000 Change $ 30,000 60,000 Variable cost per unit = $30,000 / 60,000 units = $.50 per unit Fixed costs = $450,000 - $.50 x 300,000 = $300,000 OR Fixed costs = $420,000 - $.50 x 240,000 = $300,000 Equation: Y = 300,000 + .5X b) The company's income statement for this year using the contribution format. Sales Revenue $1,500,000 Less: Variable expenses Cost of goods sold 300,000 450,000 Operating expenses 150,000 Contribution margin 1,050,000 Less: Fixed expenses: Cost of goods sold 500,000 Operating expenses 300,000 Net income $250,000 c) The companys anticipated income if units sold is 280,000. Sales Revenue $1,400,000 Less: Variable expenses Cost of goods sold 280,000 420,000 Operating expenses 140,000 Contribution margin 980,000 Less: Fixed expenses: Cost of goods sold 500,000 Operating expenses 300,000 Net income $180,000 Problem 4 - CVP Relationships a) Monthly break-even point in units and sales dollars: Units Sales Dollars Equation method: X =.40X + $270,000 $25X = $10X + $270,000 .6X = $270,000 $15X = $270,000 X = $450,000 X = 18,000 units
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CM method: Proof:

$270,000 / .6 = $450,000

$270,000 / $15 = 18,000 units

18,000 units X $25 = $450,000 Income statement: Sales Less: Variable expenses Contribution margin less: Fixed expenses Net income $450,000 180,000 270,000 270,000 $0

b) The contribution margin is $270,000, equal to the fixed expenses c) Target level of sales: (270,000 + 60,000) / 15 = 22,000 units 22,000 units X $25 = $550,000 d) Income statement: Sales $550,000 Less: Variable expenses 220,000 Contribution margin 330,000 less: Fixed expenses 270,000 Net income $ 60,000 e) Margin of safety: $500,000 - $450,000 = $50,000 $50,000 / $500,000 = .10 or 10% f) Contribution margin ratio is 60% (300,000 / 500,000 = .60 or 60%) Net income should increase by $15,000 (60% of $25,000) g) New contribution margin is $16 per unit ($25.00-($10.00-$1.00)) New break-even point is $270,000 / $16 = 16,875 units x $25.00 = $421,875 Proof: Sales $421,875 Less: Variable expenses 151,875 Contribution margin 270,000 less: Fixed expenses 270,000 Net income $0 h) Degree of operating leverage is 10; ($300,000 / $30,000=10)
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Net income should increase by 100%; (10 X 10% = 100%) Proof: Compare original data with income statement in d) above. Sales increased 10% from $500,000 to $550,000 and net income increased 100%, from $30,000 to $60,000. Problem 5 Contribution Margin and Income $ per Unit % Units sold 1 Sales $40.00 100.0 Variable expenses: Cost of goods sold 28.00 70.0 Selling 3.00 7.5 5.0 Administrative 2.00 Contribution margin a) 7.00 17.5 Fixed expenses: Selling Administrative Operating income b) c) Cost formula: Y = 110,000 + 33.00X Problem 6 Operating Leverage Sales Direct materials Direct labor (variable) Variable manufacturing overhead Variable selling and administrative Contribution margin $2,000,000 $500,000 150,000 50,000 100,000 Total $ 20,000 $800,000 560,000 60,000 40,000 140,000 40,000 70,000 $30,000 Total $ d) 25,000 $1,000,000 700,000 75,000 50,000 175,000 40,000 70,000 $65,000

800,000 1,200,000

a) CM ratio = 1,200,000 / 2,000,000 = 60% Breakeven point = 300,000 / 60% = $500,000 b) Degree of leverage = 1,200,000 / 400,000 = 3 c) Degree of leverage = (1,200,000 + 1,200,000) / (400,000 + 1,200,000) = 1.5

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Solutions to True / False Problems

1. False because direct labor and manufacturing overhead are often combined into a single category called conversion costs. 2. False because the production report is used to determine how much manufacturing cost to transfer out of Work in Process Inventory and into the next processing department. 3. False because the number of beginning units in process plus the number of units started should equal the number of units completed plus the number of ending units in process. 4. False because the total cost of Work in Process incurred during the period must be split between costs transferred to the next department and costs remaining in the current department as Work in Process Inventory. 5. False because the amount of under- or overapplied conversion cost should be transferred to Cost of Goods Sold at the end of the period. 6. False because the relevant range is the range of activity over which assumptions about cost behavior hold true. 7. False because fixed costs remain constant in total and decrease per unit as volume increases. 8. False because step costs are fixed over a certain range of activity and increase in a step-like manner when the next range of activity is reached. 9. True 10. True 11. True 12. True 13. False because the number of units needed to earn a target profit equals total fixed costs plus profit divided by the contribution margin per unit. 14. True 15. True

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Solutions to Multiple Choice Questions

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. D B C C C A C C C C C D D A D B C B B B C A B C B B C C B A D B C C B C B

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