REGUNAYAN, Marco Paul C.

AC17 – Management Accounting Part 1

CBET – 01 – 602P Prof. Rowell C. Marasigan

Final Examination Chapters 5 & 6

Answer the following items:

Chapter 5

Item #10. Describe the four steps of the high-low method and how these steps are used to estimate costs.
The first step of the high-low method is to identify the high and low activity levels from the data set. Note
that we are identifying the high and low activity level (units produced) rather than the high and low dollar/peso
levels (total production costs) because choosing the high and low total production costs can result in incorrect
high and low points.
Second, calculate the variable cost per unit (v). The goal here is to calculate the slope of the line using the
high and low points identified in step 1.
Third step, calculate the total fixed cost (f). The goal of step 3 is to calculate a value for total fixed cost.
Simply select the high or low activity level, and fill in the data to solve for total fixed costs.
And the last step, state the results in equation form Y = f + vX. After getting from step 2 the variable cost
per unit and from step 3 the total fixed cost, thus, we can state the equation used to estimate total costs.

Item #12. Describe the five steps of the scattergraph method and how these steps are used to estimate costs.
The first step of the scattergraph method is to plot the data points for each period on a graph. This step
requires that each data point be plotted on a graph. The x-axis (horizontal axis) reflects the level of activity (units
produced in this example), and the y-axis (vertical axis) reflects the total production cost.
Second, visually fit a line to the data points and be sure the line touches one data point. Once the data
points are plotted as described in step 1, draw a line through the points touching one data point and extending to
the y-axis. The goal here is to minimize the distance from the data points to the line to make the line as close to
the data points as possible.
Third step, estimate the total fixed costs (f). The total fixed costs are simply the point at which the line
drawn in step 2 meets the y-axis. Remember, the line meets the y-axis when the activity level (units produced in
this example) is zero. Fixed costs remain the same in total regardless of level of production, and variable costs
change in total with changes in levels of production.
Fourth, calculate the variable cost per unit (v). The goal of step 4 is to calculate a value for variable cost
per unit. Simply use the data point the line intersects and fill in the data to solve for v (variable cost per unit).
And lastly, state the results in equation form Y = f + vX. After getting from step 3 the variable cost per
unit and from step 4 the total fixed cost, thus, we can state the equation used to estimate total costs.

Item #15. How does the contribution margin income statement differ from the traditional income statement?
A traditional income statement separates product costs (those incurred in the process of manufacturing a
product) from period costs (those incurred in the process of selling products as opposed to manufacturing them),
whereas a contribution margin income statement separates variable costs from fixed costs.
A traditional income statement employs absorption or full costing, which includes both variable and fixed
manufacturing costs when calculating cost of goods sold. The contribution margin income statement, on the other
hand, employs variable costing, which means that fixed manufacturing costs are assigned to overhead costs and
are thus excluded from product costs.

Item #17. Describe the term relevant range. Why is it important to stay within the relevant range when
estimating costs?
The relevant range is a term that describes the range of activity (in this case, units of production) for
which cost behavior patterns are likely to be accurate. It is the cost accountant's responsibility to determine the
relevant range and to communicate to management that estimates for activity outside of the relevant range must
be carefully analyzed for accuracy.
 When estimating costs, it is critical to identify the relevant range because if a cost estimate is made for
an activity outside of the relevant range, total fixed costs and per unit variable costs may differ from those
described in the cost equation.

Woodworks, Inc.
Woodworks, Inc., produces cabinet doors. Manufacturing overhead costs tend to fluctuate from one
month to the next, and management would like to accurately estimate these costs for planning and decision-
making purposes.
The accounting staff at Woodworks recommends that costs be broken down into fixed and variable
components. Because the production process is highly automated, most of the manufacturing overhead costs are
related to machinery and equipment. The accounting staff believes the best starting point is to review historical
data for costs and machine hours:

Reporting Period (Month) Total Costs Machine Hours

January $278,000 1,550
February 280,000 1,570
March 266,000 1,115
April 290,000 1,700
May 262,000 1,110
June 269,000 1,225
July 275,000 1,335
August 286,000 1,660
September 250,000 1,000
October 253,000 1,020
November 260,000 1,025
December 281,000 1,600

These data were entered into a computer regression program, which produced the following output:
Coefficients
y-intercept 210,766
x variable 45.31

Required:
a. Use the four steps of the high-low method to estimate total fixed costs per month and the variable cost
per machine hour. State your results in the cost equation form Y = f + vX by filling in the dollar
amounts for f and v.
Step 1. Identify the high and low activity levels from the data set.
The highest level of activity (level of production) occurred in the month of April (1,700 machine
hours; $290,000 total costs), and the lowest level of activity occurred in the month of September (1,000
machine hours; $250,000 total costs).
Step 2. Calculate the variable cost per unit (v).
𝐶𝑜𝑠𝑡 𝑎𝑡 ℎ𝑖𝑔ℎ𝑒𝑠𝑡 𝑙𝑒𝑣𝑒𝑙−𝐶𝑜𝑠𝑡 𝑎𝑡 𝑙𝑜𝑤𝑒𝑠𝑡 𝑙𝑒𝑣𝑒𝑙 $290,000− $250,000
Unit variable cost (v) = 𝐻𝑖𝑔ℎ𝑒𝑠𝑡 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦 𝑙𝑒𝑣𝑒𝑙−𝐿𝑜𝑤𝑒𝑠𝑡 𝑎𝑐𝑡𝑖𝑣𝑖𝑡𝑦 𝑙𝑒𝑣𝑒𝑙 = = $57.14
1,700−1,000
Step 3. Calculate the total fixed cost (f).
Y = f + vX
Y = f + $57.14X
$290,000 = f + ($57.14x1,700)
$290,000 = f + $97,138
$290,000 - $97,138 = f
$192,862 = Total fixed costs (f)
Step 4. State the results in equation form Y = f + vX.
Y = $192,862 + $57.14X
b. Use the five steps of the scattergraph method to estimate total fixed costs per month, and the variable
cost per machine hour. State your results in the cost equation form Y = f + vX by filling in the dollar
amounts for f and v.
Step 1. Plot the data points for each period on a graph.
295,000

290,000

285,000

280,000

275,000

270,000

265,000

260,000

255,000

250,000

245,000
0 200 400 600 800 1,000 1,200 1,400 1,600 1,800

Step 2. Visually fit a line to the data points and be sure the line touches one data point.
Total Costs
295,000

290,000

285,000

280,000

275,000

270,000

265,000

260,000

255,000

250,000

245,000
0 200 400 600 800 1,000 1,200 1,400 1,600 1,800

Step 3. Estimate the total fixed costs (f).

The graph indicates total fixed costs of approximately $248,000.
Step 4. Calculate the variable cost per unit (v).
Y = f + vX
Y = $210,766 + vX
$286,000 = $210,766 + v1,660
$286,000 - $210,766 = v1,660
$75,234 = v1,660
$45.32 = v
Step 5. State the results in equation form Y = f + vX.
Y = $210,766 + $45.32X
c. Use the regression output given to develop the cost equation Y = f + vX by filling in the dollar
amounts for fand v.
Y = $210,766 + $45.31X

d. Use the results of the high-low method (a), scattergraph method (b), and regression analysis (c), to
estimate costs for 1,500 machine hours. (You will have three different answers—one for each
method.) Which approach do you think is most accurate and why?
a. High-low Method
Y = $192,862 + $57.14X
Y = $192,862 + $57.14(1,500)
Y = $192,862 + $85,710
Y = $278,572
b. Scattergraph Method
Y = $210,766 + $45.32X
Y = $210,766 + $45.32(1,500)
Y = $210,766 + $67,980
Y = $278,746
c. Regression Analysis
Y = $210,766 + $45.31X
Y = $210,766 + $45.31(1,500)
Y = $210,766 + $67,965
Y = $278,731
Regression analysis tends to be most accurate because it provides a cost equation that best fits
the line to the data points. However, the goal of most companies is to get close—the results do not need
to be perfect.

e. Management likes the regression analysis approach and asks you to estimate costs for 5,000 machine
hours using this approach (the company plans to expand by opening another facility and hiring
additional employees). Calculate your estimate, and explain why your estimate might be misleading.
Regression Analysis:
Y = $210,766 + $45.31X
Y = $210,766 + $45.31(5,000)
Y = $210,766 + $226,550
Y = $437,316
Chapter 6

Item #6. Distinguish between contribution margin per unit and contribution margin ratio.
The contribution margin per unit is the difference between the selling price and the variable cost per unit,
and the contribution margin ratio is the ratio of the contribution margin to the selling price per unit.
The contribution margin per unit is the amount each unit sold contributes to covering fixed costs and
increasing profit. We calculate it by subtracting variable costs per unit (V) from the selling price per unit (S).
The contribution margin ratio (often called contribution margin percent) is the contribution margin as a
percentage of sales. It measures the amount each sales dollar contributes to covering fixed costs and increasing
profit. The contribution margin ratio is the contribution margin per unit divided by the selling price per unit.

Item #7. What does the term margin of safety mean? How might management use this information?
The margin of safety is the excess of projected sales over the break-even point. The margin of safety
represents the amount by which sales can fall before the company incurs a loss. It signals to the management the
risk of loss that may happen as the business is subjected to changes in sales, especially when a significant number
of sales are at risk of decline or unprofitability. A low percentage of margin of safety might cause a business to
cut expenses while a high spread of margin assures a company that it is protected from sales variability.

Item #11. What is sensitivity analysis and how might it help those performing cost-volume-profit analysis?
Sensitivity analysis shows how the cost-volume-profit model will change with changes in any of its
variables. Although the focus is typically on how changes in variables affect profit, accountants often analyze the
impact on the break-even point and target profit as well.
Cost-volume-profit analysis can be used to conduct a sensitivity analysis, which shows what will happen
if the sales price, units sold, variable cost per unit, or fixed costs change. Companies use this type of analysis to
consider possible scenarios that assist them in planning.

Item #16. Describe the difference between absorption costing and variable costing.
Absorption costing includes all the costs associated with the manufacturing of a product, while variable
costing only includes the variable costs directly incurred in production but not any of the fixed costs.
The only difference between absorption costing and variable costing is in the treatment of fixed
manufacturing overhead. Using absorption costing, fixed manufacturing overhead is reported as a product cost.
Using variable costing, fixed manufacturing overhead is reported as a period cost summarizes the similarities
and differences between absorption costing and variable costing.

Wall Tech Company

Wall Tech Company produces wood siding. The company has no finished goods inventory at the beginning of
year 1. The following information pertains to Wall Tech Company.
Required:

a. All 200,000 units produced during year 1 are sold during year 1.
1. Prepare a traditional income statement assuming the company uses absorption costing.
Sales Revenue $6,000,000
Less: Cost of Goods Sold 4,000,000
Gross Margin $2,000,000
Less: Selling & Administrative Costs 1,200,000
Operating Profit $800,000

2. Prepare a contribution margin income statement assuming the company uses variable costing.
Sales $6,000,000
Less: Variable Cost:
Cost of Goods Sold $3,000,000
Selling & Administrative Cost 400,000
Total Variable Cost 3,400,000
Contribution Margin $2,600,000
Less: Fixed Cost:
Cost of Goods Sold $1,000,000
Selling & Administrative Cost 800,000
Total Fixed Cost 1,800,000
Operating Profit $800,000

b. Although 200,000 units are produced during year 2, only 170,000 units are sold during the year. The
remaining 30,000 units are in finished goods inventory at the end of year 2.
1. Prepare a traditional income statement assuming the company uses absorption costing.
Sales Revenue $5,100,000
Less: Cost of Goods Sold 3,400,000
Gross Margin $1,700,000
Less: Selling & Administrative Costs 1,140,000
Operating Profit $560,000

2. Prepare a contribution margin income statement assuming the company uses variable costing.
Sales $5,100,000
Less: Variable Cost:
Cost of Goods Sold $2,550,000
Selling & Administrative Cost 340,000
Total Variable Cost 2,890,000
Contribution Margin $2,210,000
Less: Fixed Cost:
Cost of Goods Sold $1,000,000
Selling & Administrative Cost 800,000
Total Fixed Cost 1,800,000
Operating Profit $410,000
 c. Although 200,000 units are produced during year 3, a total of 230,000 units are sold during the year.
The 30,000 units remaining in inventory at the end of year 2 are sold during year 3.
1. Prepare a traditional income statement assuming the company uses absorption costing.
Sales Revenue $6,900,000
Less: Cost of Goods Sold 4,600,000
Gross Margin $2,300,000
Less: Selling & Administrative Costs 1,260,000
Operating Profit $1,040,000

2. Prepare a contribution margin income statement assuming the company uses variable costing.
Sales $6,900,000
Less: Variable Cost:
Cost of Goods Sold $3,450,000
Selling & Administrative Cost 460,000
Total Variable Cost 3,910,000
Contribution Margin $2,990,000
Less: Fixed Cost:
Cost of Goods Sold $1,000,000
Selling & Administrative Cost 800,000
Total Fixed Cost 1,800,000
Operating Profit $1,190,000

d. Analyze the results in years 1 through 3 (requirements a through c).

Year 1: The operating profit for both traditional income statement and contribution margin income
statement are the same with the amount of $800,000.
Year 2: The operating profit under traditional (absorption costing) is greater than the operating profit
under contribution margin (variable costing), $560,000 and $410,000 respectively, with a difference of
$150,000.
Year 3: The operating profit under traditional (absorption costing) is less than the operating profit under
contribution margin (variable costing), $1,040,000 and $1,190,000 respectively, with a difference of
$150,000.

Performance Sports (letter D only)

Performance Sports produces inflatable rafts used for river rafting. Sales have grown slowly over the years, and
cost increases are causing Performance Sports to incur losses. Financial data for the most recent year are shown.

Members of the management group at Performance Sports arrived at these three possible courses of action to
return the company to profitability (each scenario is independent of the others):
1. Increase the sales price for each raft by 10 percent, which will cause a 5 percent drop in sales volume.
Although sales volume will drop 5 percent, the group believes the increased sales price will more than
offset the drop in rafts sold.
 2. Decrease the sales price for each raft by 10 percent, which will cause an 8 percent increase in sales
volume. Although the sales price will drop by 10 percent, the group believes an increase in rafts sold
will more than offset the sales price reduction.
3. Increase advertising costs by $200,000, which will increase sales volume by 15 percent. Although fixed
selling and administrative costs will increase by $200,000, the group believes the increase in rafts sold
will more than offset the increase in advertising costs.
Required:
d. Calculate the projected operating profit (loss) for the option assigned, and determine whether the
option is acceptable.
1. If adopt option 1, increase sales price by 10% and therefore sales volume will decrease by 5%.
Present Sales Price $2,000
Increased Sales Price ($2,000 x 1.10) $2,200
Present Sales Volume 1,300 units
Decreased Sales Volume ($1,300 x 0.95) 1,235 units
Variable cost per unit will remain same and fixed cost in total will remain same irrespective of
number of units.

Financial Data
Sales P2,717,000 (1,235 units x $2,200)
Variable Cost:
Cost of Goods Sold $988,000 (1,235 units x $800)
Selling & Admin. Cost 370,500 (1,235 units x $300)
Total Variable Cost 1,358,500
Contribution Margin P1,358,500
Fixed Cost:
Cost of Goods Sold $800,000
Selling & Admin. Cost 400,000
Total Fixed Cost 1,200,000
Operating Profit $158,500

2. If adopt option 2, decrease sales price by 10% and therefore the sales volume will increase by
8%.
Present Sales Price $2,000
Increased Sales Price ($2,000 x 0.90) $1,800
Present Sales Volume 1,300 units
Decreased Sales Volume (1,300 x 1.08) 1,404 units

Financial Data
Sales P2,527,200 (1,404 units x $1,800)
Variable Cost:
Cost of Goods Sold $1,123,200 (1,404 units x $800)
Selling & Admin. Cost 421,200 (1,404 units x $300)
Total Variable Cost 1,544,400
Contribution Margin P982,800
Fixed Cost:
Cost of Goods Sold $800,000
Selling & Admin. Cost 400,000
Total Fixed Cost 1,200,000
Operating Loss $(217,200)
3. If adopt option 3, increase in fixed advertisement expenses by $200,000 which will increase sales
volume by 15%.
Present Sales Price $2,000
Present Sales Volume 1,300 units
Increased Sales Volume (1,300 x 1.15) 1,495 units

Financial Data
Sales P2,990,000 (1,495 units x $2,000)
Variable Cost:
Cost of Goods Sold $1,196,000 (1,495 units x $800)
Selling & Admin. Cost 448,500 (1,495 units x $300)
Total Variable Cost 1,644,500
Contribution Margin P1,345,500
Fixed Cost:
Cost of Goods Sold $800,000
Selling & Admin. Cost 600,000 ($400,000 + 200,000)
Total Fixed Cost 1,400,000
Operating Loss $(54,500)

As there is operating loss in option 2 and 3, and operating profit in option 1 therefore
option 1 should be accepted.