MPA703 Management Accounting

Semester 2, 2019
Assignment

Question 1

“I don't understand this cost report at all,” exclaimed Jeff Mahoney, the newly appointed administrator
of Valley General Hospital. “Our administrative costs in the new pediatrics clinic are all over the map.
One month the report shows $7,000, and the next month it's $13,900. What's going on?”

Mahoney's question was posed to Megan McDonough, the hospital's director of cost management. “The
main problem is that the clinic has experienced some widely varying patient loads in its first year of
operation. There seems to be some confusion in the public's mind about what services we offer in the
clinic. When do they come to the clinic? When do they go to the emergency room? That sort of thing. As
the patient load has varied, we've frequently changed our clinic administrative staffing.”

Mahoney continued to puzzle over the report. “Could you pull some data together, Megan, so we can
see how this cost behaves over a range of patient loads?”

“You'll have it this afternoon,” McDonough responded. Later that morning, she gathered the following
data:

Month Patient Load Administrative cost

January……………………………………………… 400…………………………………………………….. $ 6000
February…………………………………………… 500………………………………………………………. 7000
March………………………………………………… 1400…………………………………………………….. 13900
April………………………………………………….. 900………………………………………………………. 9200
May…………………………………………………… 1300…………………………………………………….. 11900
June……………………………………………………. 1000……………………………………………………. 10000
July…………………………………………………….. 700………………………………………………………… 9400
August……………………………………………… 300…………………………………………………………. 4100
September………………………………………… 1100………………………………………………….. 10200
October……………………………………………… 1500…………………………………………………… 16100
November………………………………………… 600………………………………………………………. 8300
December………………………………………….. 1200……………………………………………………… 11100
McDonough does not believe the first year's widely fluctuating patient load will be experienced again in
the future. She has estimated that the clinic's relevant range of monthly activity in the future will be 600
to 1,200 patients.

Required:

1. Draw a scatter diagram of the clinic's administrative costs during its first year of operation.

2. Visually fit a curvilinear cost line to the plotted data.

3. Mark the clinic's relevant range of activity on the scatter diagram.

4. Visually fit a semivariable-cost line to approximate the curvilinear cost behavior pattern within the
clinic's relevant range.  

5. Estimate the fixed- and variable-cost components of the visually fit semivariable-cost line.

6. Use an equation to express the semivariable-cost approximation of the clinic's administrative costs.

7. What is your prediction of the clinic's administrative cost during a month when 750 patients visit the
clinic? When 350 patients visit? Which one of your visually fit cost lines did you use to make each of
these predictions? Why?

8. Use the high-low method to estimate the cost behavior for the clinic's administrative costs. Express
the cost behavior in formula form (Y = a+ bX). What is the variable cost per patient? Compare your
results with part 6 above.

[2 + 2 + 2 + 2 + 4 + 2 + 5 + 7 = 26 Marks]
Question 2

Pittman Company is a small but growing manufacturer of telecommunications equipment. The company
has no sales force of its own; rather, it relies completely on independent sales agents to market its
products. These agents are paid a commission of 15% of selling price for all items sold.

Barbara Cheney, Pittman's controller, has just prepared the company's budgeted income statement for
next year. The statement follows:

Pittman Company
Budgeted Income Statement
For the Year Ended December 31

Sales………………………………………………………………………………. $ 16,000,000
Manufacturing cost:
Variable…………………………………………………………………… $ 7,200,000
Fixed overhead………………………………………………………. 2,340,000 9,540,000
Gross margin…………………………………………………………………. 6,460,000
Selling and administrative cost:
Commissions to agents……………………………………………. 2,400,000
Fixed marketing cost………………………………………………. 120,000*
Fixed administrative cost…………………………………………. 1,800,000 4,320,000
Net operating income…………………………………………………… 2,140,000
Fixed interest cost………………………………………………………… 540,000

Income before income tax……………………………………………… 1,600,000

Income taxes (30%) ………………………………………………………… 480,000

Net income……………………………………………………………………. $ 1,120,000

_________________
*Primarily depreciation on storage facilities.
As Barbara handed the statement to Karl Vecci, Pittman's president, she commented, “I went ahead and
used the agents' 15% commission rate in completing these statements, but we've just learned that they
refuse to handle our products next year unless we increase the commission rate to 20%.” “That's the
last straw,” Karl replied angrily. “Those agents have been demanding more and more, and this time
they've gone too far. How can they possibly defend a 20% commission rate?”

“They claim that after paying for advertising, travel, and the other costs of promotion, there's nothing
left over for profit,” replied Barbara.

“I say it's just plain robbery,” retorted Karl. “And I also say it's time we dumped those guys and got our
own sales force. Can you get your people to work up some cost figures for us to look at?”

“We've already worked them up,” said Barbara. “Several companies we know about pay a 7.5%
commission to their own salespeople, along with a small salary. Of course, we would have to handle all
promotion costs, too. We figure our fixed costs would increase by $2,400,000 per year, but that would
be more than offset by the $3,200,000 (20% × $16,000,000) that we would avoid on agents'
commissions.”

The breakdown of the $2,400,000 cost follows:

Salaries:
Sales manager …………………………………………… $ 100,000
Salespersons ………………………………………………. 600,000
Travel and Entertainment ………………………………………. 400,000
Advertising ……………………………………………………………… 1,300,000
Total ……………………………………………………………………… $ 2,400,000

“Super,” replied Karl. “And I noticed that the $2,400,000 is just what we're paying the agents under
the old 15% commission rate.”

“It's even better than that,” explained Barbara. “We can actually save $75,000 a year because that's
what we're having to pay the auditing firm now to check out the agents' reports. So our overall
administrative costs would be less.”

“Pull all of these numbers together and we'll show them to the executive committee tomorrow,” said
Karl. “With the approval of the committee, we can move on the matter immediately.”

Required:
1. Compute Pittman Company's break-even point in sales dollars for next year assuming:

a. The agents' commission rate remains unchanged at 15%.

b. The agents' commission rate is increased to 20%.
c. The company employs its own sales force.

2. Assume that Pittman Company decides to continue selling through agents and pays the 20%
commission rate. Determine the volume of sales that would be required to generate the same net
income as contained in the budgeted income statement for next year.

3. Determine the volume of sales at which net income would be equal regardless of whether Pitt-man
Company sells through agents (at a 20% commission rate) or employs its own sales force.

4. Compute the degree of operating leverage that the company would expect to have on December 31
at the end of next year assuming:

a. The agents' commission rate remains unchanged at 15%.

b. The agents' commission rate is increased to 20%.
c. The company employs its own sales force.
Use income before income taxes in your operating leverage computation.

5. Based on the data in (1) through (4) above, make a recommendation as to whether the company
should continue to use sales agents (at a 20% commission rate) or employ its own sales force. Give
reasons for your answer.

Answers
Question 1

(1) Draw a scatter diagram of the clinic’s administrative cost during its first year.

Month Patient load Administrative cost

     
January 400 6000
February 500 7000
March 1400 13900
April 900 9200
May 1300 11900
June 1000 10000
July 700 9400
August 300 4100
September 1100 10200
October 1500 16100
November 600 8300
December 1200 11100

Administrative Cost
17000
16000
15000
14000
13000
12000
11000
Administrative cost

10000
9000
8000
7000
6000
5000
4000
3000
2000
1000
0
150 300 450 600 750 900 1050 1200 1350 1500 1650

Patient Load
(2) Visually fit a curvilinear cost line to the plotted data.

Administrative Cost
17000
16000
15000
14000
13000
12000
Administrative cost

11000
10000
9000
8000
7000
6000
5000
4000
3000
2000
1000
0
150 300 450 600 750 900 1050 1200 1350 1500 1650

Patient Load

------- Visually fitted curvilinear

cost line
(3) Mark the clinic’s relevant range of activity on the scatter diagram.

Administrative Cost
17000
16000
15000
14000
13000
12000
Administrative cost

11000
10000
9000
8000
7000
6000
5000
4000
3000
2000
1000
0
150 300 450 600 750 900 1050 1200 1350 1500 1650

Patient Load

------- Visually fitted curvilinear ------ Relevant range ------- Curvilinear line
cost line

*Workings
 From the visually fit curvilinear cost line we can assume that the fixed cost of the
administrative department is approximately $ 2,700 approx.
  To find out the variable cost at any activity level

= Total admin.cost of the month – fixed cost

Eg : Variable cost of the month of December
= Total admin.cost for December – Fixed cost
= $ 11,100 - $2,700
= $ 8,400

Variable cost of administrative department (For the month of December) is

approximately $8,400

The connection between the cost of the administrative department and the number of
patients visited Valley general hospital in the month can be mathematically shown by
using the following equation.

Y = a + bx

Where ;

Y – Administrative cost
a - Fixed cost
b - Variable cost per patient
x – No. of patients

We will have to find out the variable cost per patient (for the month of December)
= Variable cost of December
No. of patients for December

= $8,400
1200

Variable cost per patient = $ 7 approx.

For December

We can express the cost behavior for visually fit curvilinear cost line using following
equation
 Y = $2700+ $7.00x

(4) Visually fit a semi variable-cost line to approximate the curvilinear cost behavior pattern
within the clinic’s relevant range.

Administrative Cost
17000
16000
15000
14000
13000
12000
11000
Administrative cost

10000
9000
8000
7000
6000
5000
4000
3000
2000
1000
0
150 300 450 600 750 900 1050 1200 1350 1500 1650

Patient Load

--- Semi variable cost line --- Relevant range ---curvilinear line
(5) Estimate the fixed and variable cost components of the visually fit semi variable cost line

Administrative Cost
17000
16000
15000
14000
13000
12000
11000
Administrative cost

10000
9000
8000
7000
6000
5000
4000
3000
2000
1000
0
150 300 450 600 750 900 1050 1200 1350 1500 1650

Patient Load

 From the visually fit semi variable cost line we can assume that the fixed cost of
the administrative department is approximately $ 6,000.

 To find out the variable cost at any activity level

= Total admin.cost of the month – fixed cost

Eg : Variable cost of the month of December

= Total admin.cost for December – Fixed cost
= $ 11,100 - $6,000
 = $ 5,100

Variable cost of administrative department (For the month of December) is

approximately $5,100

(6) Use an equation to express the semi variable cost approximation of the clinic’s
administrative cost.

The connection between the cost of the administrative department and the number of
patients visited Valley general hospital in the month can be mathematically shown by
using the following equation.

Y = a + bx

Where ;

Y – Administrative cost
a - Fixed cost
b - Variable cost per patient
x – No. of patients

We will have to find out the variable cost per patient (for the month of December)
= Variable cost of December
No. of patients for December

= $5,100
1200

Variable cost per patient = $ 4.25 approx.

For December

We can express the cost behavior for visually fit semi variable cost line using following
equation

Y = $6000+ $4.25x
(7) What is your prediction of the clinic’s administrative cost during a month
a. When 750 patients visit the clinic
b. When 350 patients visit
c. Which one of your visually fit cost lines did you use to make each of these
predictions and why ?

 The equation for visually fit curvilinear cost line is :

(from the workings under question no. 3)

Y = $2700+ $7.00x

 The equation for visually fit semi variable cost line is :

Y = $6000+ $4.25x

a. For 750 patients

Clinic’s administrative cost = 6000 + 4.25x
= 6000 + (4.25* 750)
= $ 9187.5 approx.

To find out the cost of administrative department at 750 patients we have used visually fit
semi variable cost line. This line is used because 750 patients fall between the relevant
range (600 – 1200). When it comes to any number of patients below 600 are ignored
when calculating administrative cost.
 b. For 350 patients
Clinic’s administrative cost = 2700 + 7x
= 2700 + (7* 350)
= $ 5,150 approx.

To find out the cost of administrative department at 350 patients we have used visually fit
curvilinear cost line. This line is used because 350 patients fall below the relevant range
(600 – 1200). Due to relevant range number of patients will not differ from one month to
another.

(8) Use high-low method to estimate the cost behavior for the clinic’s administrative cost.
Express the cost behavior in formula form (Y=a+bX). What is the variable cost per
patient? Compare your results with part 6 above.

Variable cost per patient = Total cost of highest activity – Total cost of lowest activity
Highest activity level – Lowest activity level

= $ 16,100 - 4,100
1,500 - 300
= 12,000
1,200
= $ 10 per patient

Fixed cost = Total cost – (No. of patients * variable cost per patient )

Fixed cost( from highest level) = 16,100 – (1,500*10)

= $ 1,100

Fixed cost( from lowest level) = 4,100 – (300*10)

= $ 1100

Y = $ 1100 + 10x
Question 2

(1) Compute Pittman company’s break-even point in sales dollars for next year assuming;

a. The agents’ commission rate remains unchanged at 15%

15% Commission %
($)
Sales =16,000,000 100%

Variable expenses:

Manufacturing cost =7,200,000

Commission =16,000,000 x 15%

= $2,400,000

Total variable cost = Manufacturing cost + Commission 60%

= 7,200,000 + 2,400,000
= $9,600,000

Contribution Margin = Total sales revenue – Total variable cost 40%

= 16,000,000 – 9,600,000
= $6,400,000

Fixed Expenses:

Manufacturing cost = 2,340,000

Marketing cost = 120,000
Administrative cost = 1,800,000
Fixed interest cost = 540,000
+______________
Total Fixed cost = $4,800,000
 Income before} = 1,600,000
income taxes

Income tax (30%) = 480,000

_____________
Net income = $ 1,120,000

Break- even point = Total fixed Cost________

Contribution Margin Ratio
(Total Contribution Margin / Total Sales)

= ___4,800,000__________
(6,400,000 / 16,000,000)

= __4,800,000__
0.4

= $ 12,000,000

b. The agents’ commission rate is increased to 20%

20% Commission %
($)
Sales =16,000,000 100%

Variable expenses:

Manufacturing cost =7,200,000

Commission =2,400,000 x 20/15

= $3,200,000

Total variable cost = Manufacturing cost + Commission 65%

= 7,200,000 + 3,200,000
= $10,400,000
 Contribution Margin = Total sales revenue – Total variable cost 35%
= 16,000,000 – 10,400,000
= $5,600,000

Fixed Expenses:

Manufacturing cost = 2,340,000

Marketing cost = 120,000
Administrative cost = 1,800,000
Fixed interest cost = 540,000
+_______________
Total Fixed cost = $4,800,000

Income before} = Contribution Margin – Total fixed cost

income taxes = 5,600,000 – 4,800,000
=$ 800,000

Income tax (30%) = 800,000 x 30%

= $240,000

Net income = Income before income taxes – Income tax (30%)

= 800,000 – 240,000
= $560,000

Break- even point = Total fixed Cost______

Contribution Margin Ratio
(Total Contribution Margin / Total Sales)

= ___4,800,000__________
(5,600,000 / 16,000,000)

= __4,800,000__
0.35

= $ 13,714,285.71
c. The company employs its own sales force (7.5%)
7.5% Commission %
($)
Sales =16,000,000 100%

Variable expenses:

Manufacturing cost =7,200,000

Commission =2,400,000 x 7.5/15

= $1,200,000

Total variable cost = Manufacturing cost + Commission 52.5%

= 7,200,000 + 1,200,000
= $8,400,000

Contribution Margin = Total sales revenue – Total variable cost 47.5%

= 16,000,000 – 8,400,000
= $7,600,000

Fixed Expenses:

Manufacturing cost = $2,340,000

Marketing cost = Fixed marketing cost + Promotion handling

Cost (Increased fixed cost)
= 120,000 + 2,400,000
= $2,520,000

Administrative cost = Administrative cost – Auditing firm charges

 = 1,800,000 – 75,000
= 1,725,000

Fixed interest cost = 540,000

+________________
Total Fixed cost = $7,125,000

Income before} = Contribution Margin – Total fixed cost

income taxes = 7,600,000 – 7,125,000
= $475,000

Income tax (30%) = 475,000 x 30%

= $142,500

Net income = Income before income taxes – Income tax (30%)

= 475,000 – 142,500
= $332,500

Break- even point = Total Fixed Cost_______

Contribution Margin Ratio
(Total Contribution Margin / Total Sales)

= ___7,125,000__________
(7,600,000 / 16,000,000)

= __4,800,000__
0.475

= $ 15,000,000

(2) Company decides to continue selling though agents and pay 20% commission rate,
determine the volume of sales that would be required to generate the same net income as
contained in the budgeted income statement for next year.
 Dollar sales to attain target = Target income before taxes + Total fixed cost
Contribution margin ratio

= 1,600,000 + 4,800,000
0.35

= $ 18,285,714.29

(3) Determine the volume of sales at which net income would be equal regardless of whether
Pittman company sells through agents a) at a 20% commission rate or b) employs its own
sales forces.

X = Total sales revenue

Total variable cost per unit = Total variable cost

Total sales revenue

a) 20% Commission rate

Total variable cost per unit = 10,400,000

16,000,000
= $ 0.65 per unit

b) Own sales force (7.5%)

Total variable cost per unit = 8,400,000

16,000,000
= $ 0.525 per unit

0.65x + 4,800,000 = 0.525x + 7,125,000 (Variable cost per unit + Total fixed cost)
0.65x – 0.525x = 7,125,000 – 4,800,000
0.125x = 2,325,000
0.125 0.125

X = $18,600,000
⸫ The required volume of sales will be $ 18,600,000

(4) Compute the degree of operating leverage that the company would expect to have on
December 31st at the end of next year assuming :

Degree of Operating Leverage = Contribution Margin

Operating profit (EBIT)
EBIT – Earnings before income tax

a) The agents’ commission rate remains unchanged at 15%

DOL = 6,400,000
1,600,000
= $4

b) The agents’ commission rate is increased to 20%

DOL = 5,600,000
800,000
= $7

c) The company employs its own sales force 7.5%

DOL = 7,600,000
475,000
= $ 16