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 Cost Formula

Selling:
Advertising ......................................... $955 per month
Delivery of pianos ............................... $61 per piano sold
Sales salaries and commissions............. $4,823 per month, plus 4% of sales
Utilities ............................................... $633 per month
Depreciation of sales facilities .............. $4,944 per month
Administrative:
Executive salaries ................................ $13,490 per month
Depreciation of office equipment .......... $943 per month
Clerical ............................................... $2,499 per month, plus $37 per piano sold
Insurance ........................................... $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... $300 flat fee

Next 15,000 gallons............... $0.004 per gallon used
Next 15,000 gallons............... $0.008 per gallon used
Next 15,000 gallons............... $0.012 per gallon used
Etc....................................... 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 straight-line 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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1-2 Introduction to Managerial Accounting, 6th edition
PROBLEM 116B Variable 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.

Variable or Fixed
Direct or Indirect with Respect to the
Cost of Particular Number of Seniors
Direct or Indirect Seniors Served by Served by the
Cost of the Meals- the Meals-On- Meals-On-Wheels
On-Wheels Program Wheels Program Program
Description Direct Indirect Direct Indirect Variable Fixed
Example: The
cost of polio
immunization
tablets ......... X X X

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Chapter 1 B Problems 1-3
PROBLEM 117B High-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:

Level of Activity
Low High
Machine-hours ............................. 47,700 63,600
Total factory overhead costs ......... 248,560 pesos 277,180 pesos

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) ................... 62,010 pesos

Rent (fixed) .......................................... 135,000
Maintenance (mixed) ............................. 51,550
Total factory overhead costs .................. 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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1-4 Introduction to Managerial Accounting, 6th edition
PROBLEM 118B Cost 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 May June

Sales in units ................................................... 1,800 3,200 4,800

Sales revenue ................................................... 313,200 556,800 835,200

Cost of goods sold ........................................... 120,600 214,400 321,600
Gross margin ................................................... 192,600 342,400 513,600
Selling and administrative expenses:
Shipping expense ......................................... 41,300 58,100 77,300
Advertising expense ..................................... 70,000 70,000 70,000
Salaries and commissions ........................... 104,400 157,600 218,400
Insurance expense ....................................... 9,900 9,900 9,900
Depreciation expense ................................... 42,300 42,300 42,300
Total selling and administrative expenses ....... 267,900 337,900 417,900
Net operating income (loss) ............................. (75,300) 4,500 95,700

(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 119B High-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:

Number Power
Month of Ingots Cost
January 111 $5,782
February 91 $4,782
March 81 $4,682
April 101 $5,282
May 131 $6,282
June 121 $5,882
July 71 $4,282
August 61 $3,482
September 44 $3,682
October 34 $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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1-6 Introduction to Managerial Accounting, 6th edition
PROBLEM 120B High-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 Total Overhead Cost

March ...................................... 53,000 $190,500
April ......................................... 43,000 $166,500
May ......................................... 63,000 $214,500
June ........................................ 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) ............................... $ 51,600

Supervisory salaries (fixed) ................. 49,000
Maintenance (mixed) .......................... 65,900
Total overhead cost ............................ $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 121B Cost 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.

Manufacturing
Variable or Selling Administrative (Product) Cost
Cost Item Fixed Cost Cost Direct Indirect
Direct labor ..................................................................
V X
Executive salaries .........................................................
F X
Factory rent .................................................................
F X

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1-8 Introduction to Managerial Accounting, 6th edition
PROBLEM 122B High-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 Formula

Cost of goods sold ................................ $26 per unit sold
Advertising expense .............................. $183,000 per quarter
Sales commissions ................................ 7% of sales
Administrative salaries .......................... $93,000 per quarter
Shipping expense .................................. ?
Depreciation expense ............................ $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 ............................... 29,000 $173,000
Second ....................... 31,000 $188,000
Third ........................... 36,000 $230,000
Fourth ......................... 32,000 $193,000
Year 2:
First ............................... 30,000 $183,000
Second ....................... 33,000 $198,000
Third ........................... 47,000 $245,000
Fourth ......................... 44,000 $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) $431,000

Administrative office salaries $111,000
Factory supervision $67,000
Sales commissions $64,000
Depreciation, factory building $101,000
Depreciation, administrative office equipment $2,000
Indirect materials, factory $19,000
Factory labor (cutting and assembly) $87,000
Advertising $97,000
Insurance, factory $6,000
Administrative office supplies (billing) $4,000
Property taxes, factory $16,000
Utilities, factory $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 Behavior Selling or Product Cost

Cost Item Variable Fixed Admin. Direct Indirect
Cost
Direct materials used (wood, $431,000 $431,000
glass)
Administrative office salaries $111,000 $111,000

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