Angel Dela Pena 3rd year BSBA-HRM

Exercise 2-5.

The Cheyenne Hotel in Big Sky, Montana, has accumulated records of the total
electrical costs of the hotel and the number of occupancy-days over the last year. An
occupancy-day represents a room rented out for one day. The hotel’s business is highly
seasonal, with peaks occurring during the ski season and in the summer.

Month Occupancy - Days Electrical Costs

January, 1,736 - $4,127

February, 1,904 - $4,207
March, 2,356 - $5,083
April, 960 - $2,857
May, 360 - $1,871
June, 744 - $2,696
July 2,108 - $4,670
August, 406 - $5,148
September, 840 - $2,691
October, 124 - $1,588
November, 720 - $2,454
December, 1,364 - $3,529

Required: 1

Using the high-low method, estimate the fixed cost of electricity per month and the
variable cost of electricity per occupancy-day. Round off the fixed cost to the nearest
whole dollar and the variable cost to the nearest whole cent.

Answer: Occupancy Days Electrical Cost

High Activity level (august) 2,406 $5,148

Low Activity Level (October) 124 1,588

Change 2,282 $3,560

Variable Cost = Change in cost /Change in activity

= $3,560/2,282 occupancy days

= $1.56 per occupancy day

Total Cost (August) $5,148

Variable cost element

($1.56 per occupancy day x 2406 occupancy days) 3,753

Fixed cost element $1,395

Required 2.

What other factors other than occupancy-days are likely to affect the variation in
electrical costs from month to month?

Answer:

Common areas such as the reception needs more time to be lighted during in the winter
compared to the winter. Fixed cost will be affected by the number of days in a month.

Exercise 2-6.

Traditional and Contribution Format Income Statements [LO2–6] Cherokee Inc. is a

merchandiser that provided the following information:

Amount Number of units sold 20,000

Selling price per unit $30

Variable selling expense per unit $4

Variable administrative expense per unit $2

Total fixed selling expense $40,000

Total fixed administrative expense $30,000

Beginning merchandise inventory $24,000

Ending merchandise inventory $44,000

Merchandise purchases $180,000

Required 1:
Prepare a traditional income statement.

Cherokee, Inc.

Traditional Income Statement

Sales ($30 per unit x 20,000 units) $600,000

Cost of good sold

($24,000 + $180,000 -$44,000) 160,000

Gross Margin 440,000

Selling and administrative expenses:

Selling expenses

($4per unit x 20,000 units) + $40,000) 120,000

Administrative expenses

($2 per unit x 20,000 units)+$30,000) 70,000 190,000

Net operating income $250,000

Required: 2

Prepare a contribution format income statement

Contribution format income statement

Chekoree, Inc.

Contribution format Income statement

Sales $600,000

Variable expenses: cost of goods sold

($24,000+$180,000-$44,000) $160,000

Selling expenses ($4 per unit x 20,000 units) 80,000

Administrative expenses

($2 per unit xx 20,000 units) 40,000 280,000

Contribution margin 320,000

Fixed expense 40,000

Administrative expense 30,000 70,000

Net operating income $250,000

Exercise 2-7.

Differential, Opportunity, and Sunk Costs [LO2–7]

Northwest Hospital is a full-service hospital that provides everything from major surgery
and emergency room care to outpatient clinics. The hospital’s Radiology Department is
considering replacing an old inefficient X-ray machine with a state-of-the-art digital X-ray
machine. The new machine would provide higher quality X-rays in less time and at a
lower cost per X-ray. It would also require less power and would use a colour laser
printer to produce easily readable X-ray images. Instead of investing the funds in the
new X-ray machine, the Laboratory Department is lobbying the hospital’s management
to buy a new DNA analyser. Required: For each of the items below, indicate by placing
an X in the appropriate column whether it should be considered a differential cost, an
opportunity cost, or a sunk cost in the decision to replace the old X-ray machine with a
new machine. If none of the categories apply for a particular item, leave all columns
blank. Item Differential Cost Opportunity Cost Sunk Cost Ex. Cost of X-ray film used in
the old machine X

1. Cost of the old X-ray machine.

2. The salary of the head of the Radiology Department.
3. The salary of the head of the Pediatrics Department.
4. Cost of the new color laser printer.
5. Rent on the space occupied by Radiology.
6. The cost of maintaining the old machine.
7. Benefits from a new DNA analyzer.
8. Cost of electricity to run the X-ray machines.

Answer: Differential Opportunity Sunk

Item cost cost cost

1. Cost of the old X-ray machine x

2. The salary of the head of the Radiology

Department

3. The salary of the head of the Pediatrics

Department.

4. Cost of the new color laser printer x

5. Rent on the space occupied by Radiology.

6. The cost of maintaining the old machine. x

7. Benefits from a new DNA analyzer x

8. Cost of electricity to run the X-ray machines x

Exercise 2-8.

Cost Behavior; High-Low Method [LO2–4, LO2–5] Hoi Chong Transport, Ltd., operates
a fleet of delivery trucks in Singapore. The company has determined that if a truck is
driven 105,000 kilometers during a year, the average operating cost is 11.4 cents per
kilometer. If a truck is driven only 70,000 kilometers during a year, the average
operating cost increases to 13.4 cents per kilometer.

Required 1:

Using the high-low method, estimate the variable and fixed cost elements of the annual
cost of the truck operation.

1. Kilometers driven Total annual cost

High level of activity 105,000 11,790

Low level of activity 70,000 9,380

Change 35,000 2,590

105,000 kilometers x $0.144 per kilometer = $11,970

70,000 kilometers x $0.134 per kilometer=$9,380

Variable cost per kilometer;

Change in cost = $2,590 = $0.074 per kilometer

Change in activity - 35,000 kilometers

Fixed cost per year:

Total cost at 105,000 kilometers $11,970

Less variable portion

105,000 kilometer x $0.074 per kilometer 7,770

Fixed cost per year $4,200

Required 2.

Express the variable and fixed costs in the form Y   5   a   1   bX.

Y = $4200+ $0.074X

Required 3.

If a truck were driven 80,000 kilometers during a year, what total cost would you expect
to be incurred?

Fixed cost $4,200

Variable cost

80,000 kilometers x $0.074 per kilometer 5,920

Total annual cost $10,120

Exercise 2-15.
Classification of Costs as Variable or Fixed and as Product or Period [LO2–3, LO2–4]
Below are listed various costs that are found in organizations.

1. Hamburger buns in a Wendy’s outlet.

2. Advertising by a dental office.
3. Apples processed and canned by Del Monte.
4. Shipping canned apples from a Del Monte plant to customers.
5. Insurance on a Bausch & Lomb factory producing contact lenses.
6. Insurance on IBM’s corporate headquarters.
7. Salary of a supervisor overseeing production of printers at Hewlett-Packard.
8. Commissions paid to automobile salespersons.
9. Depreciation of factory lunchroom facilities at a General Electric plant.
10. Steering wheels installed in BMWs.

Required 1.

Classify each cost as being either variable or fixed with respect to the number of units
produced and sold. Also classify each cost as either a selling and administrative cost or
a product cost.

Prepare your answer sheet as shown below. Place an X in the appropriate columns to
show the proper classification of each cost. Cost Item Period (Selling and
Administrative) Variable Fixed Cost Product Cost

Cost behavior Administrative Product

Cost Item Variable Fixed Cost Cost

1. Hamburger buns at a x x
Wendy's outlet
2. Advertising by a x x
Dental office
3. Apples processed and x x
canned by Del Monte.
4. Shipping canned apples x x
From a Del Monte plant to
Customers.

5. Insurance on a Bausch x x
& Lomb factory
producing contact lenses.
6. Insurance on IBM’s x x
corporate headquarters
7. Salary of a supervisor x x
overseeing
production of printers at
Hewlett-Packard.
8. Commissions paid x x
to automobile
salespersons
9. Depreciation of x x
factory lunchroom
facilities at a
General Electric plant.
10. Steering wheels x x
installed in BMWs

Exercise 2-22.

High-Low and Scatter graph Analysis [LO2–4, LO2–5] Pleasant View Hospital of British
Columbia has just hired a new chief administrator who is anxious to employ sound
management and planning techniques in the business affairs of the hospital.
Accordingly, she has directed her assistant to summarize the cost structure of the
various departments so that data will be available for planning purposes. The assistant
is unsure how to classify the utilities costs in the Radiology Department because these
costs do not exhibit either strictly variable or fixed cost behavior. Utilities costs are very
high in the department due to a CAT scanner that draws a large amount of power and is
kept running at all times. The scanner can’t be turned off due to the long warm-up
period required for its use. When the scanner is used to scan a patient, it consumes an
additional burst of power. The assistant has accumulated the following data on utilities
costs and use of the scanner since the first of the year.

Month Number of Scans Utilities Cost

January . . . . . . . . . . . . . . . . . . . . 60 $2,200 February . . . . . . . . . . . . . . . . . . 70 $2,600

March . . . . . . . . . . . . . . . . . . . . 90 $2,900 April . . . . . . . . . . . . . . . . . . . . 120 $3,300
May . . . . . . . . . . . . . . . . . . . . . . 100 $3,000 June . . . . . . . . . . . . . . . . . . . . 130 $3,600
July . . . . . . . . . . . . . . . . . . . . . . 150 $4,000 August . . . . . . . . . . . . . . . . . . 140 $3,600
September . . . . . . . . . . . . . . . . . 110 $3,100 October . . . . . . . . . . . . . . . . . . 80 $2,500
The chief administrator has informed her assistant that the utilities cost is probably a
mixed cost that will have to be broken down into its variable and fixed cost elements by
use of a scatter graph. The assistant feels, however, that if an analysis of this type is
necessary, then the high-low method should be used, since it is easier and quicker. The
controller has suggested that there may be a better approach.

Required 1.

Using the high-low method, estimate a cost formula for utilities. Express the formula in
the form Y  5  a  1 bX. (The variable rate should be stated in terms of cost per scan.)

High low method:

Number of scans Utilities Cost

High level of activity 150 $4000

Low level of activity 60 2200

Change 90 $1800

Change in cost $1800

Variable rate: = =$20 per can

Change in Activity 90 scans

Fixed cost : Total cost at high level of activity ...... $4000

Less variable element:

150 cans x $20 per scan ........ 3000

Fixed cost element $1000

Therefore, the cost formula is : Y=$1000 + $20X

Required 2.
Prepare a scatter graph by plotting the number of scans and utility 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.

Utility Cost
$3,500

$3,000

$2,500

$2,000 Utility Cost

Linear (Utility Cost)

$1,500

$1,000

$500

$0
0 1 2 3 4 5 6 7 8 9

PROBLEM 2-A–4

Least-Squares Regression Method; Scatter graph; Cost Behavior [LO2–4, LO2–8]

Professor John Morton has just been appointed chairperson of the Finance Department
at Westland University. In reviewing the department’s cost records, Professor Morton
has found the following total cost associated with Finance 101 over the last several
terms: Term Number of Sections Offered Total Cost Fall, last year 4 $10,000 winters,
last year. 6 $14,000 summer, last year 2 $7,000 Fall, this year. . . . . . 5 $13,000 Winter,
this year 3 $9,500 Professor Morton knows that there are some variable costs, such as
amounts paid to graduate assistants, associated with the course. He would like to have
the variable and fixed costs separated for planning purposes.

Required 1.
Prepare a scatter graph plot. (Place total cost on the vertical axis and number of
sections offered on the horizontal axis.) 2. Using the least-squares regression method,
estimate the variable cost per section and the total fixed cost per term for Finance 101.
Express these estimates in the linear equation form Y   5   a   1   bX. 3. Assume that
because of the small number of sections offered during the Winter Term this year,
Professor Morton will have to offer eight sections of Finance 101 during the Fall Term.
Compute the expected total cost for Finance 101. Can you see any problem with using
the cost formula from (2) above to derive this total cost figure? Explain.

Total Cost
$16,000

$14,000

$12,000

$10,000
Total Cost
$8,000 Linear (Total Cost)

$6,000

$4,000

$2,000

$0
1.5 2 2.5 3 3.5 4 4.5 5 5.5 6 6.5

Expected Total cost would be:

Fixed cost $3,700

Variable Cost (8 section x $1,750 per section) 14,000

Total Cost $17,700

The problem with using the cost formula from (2) to derive total cost is that an activity
level 8 sections may lie outside the relevant range, the range of activity within which the
fixed cost is approximate $3,700 per term and the variable cost is approximately $1,750
per section offered. These approximations appear to be reasonably accurate with the
range of 2 to 6 sections, but the may be invalid outside the range.