Chapter 3

Cost Behaviour: Analysis and Use

Exercise 3-1 (15 minutes)

1. Smoothies Served
in a Week
2,100 2,800 3,500
Fixed cost................................ $2,500 $2,500 $2,500
Variable cost ($0.75 per cup)..... 1,575 2,100 2,625
Total cost................................. $4,075 $4,600 $5,125
Cost per smoothie served *....... $1.94 $1.64 $1.46
* Total cost ÷ smoothies served in a week

2. The average cost of a smoothie declines as the number of smoothies

served increases because the fixed cost is spread over more units.
Exercise 3-2 (30 minutes)
1. The completed scattergram is presented below:

$31,000
$30,000
$29,000
$28,000
Admitting Costs

$27,000
$26,000
$25,000
$24,000
$23,000
2,000 2,200 2,400 2,600 2,800 3,000 3,200 3,400 3,600 3,800 4,000
Patients Admitted

2. It appears that admitting costs are strongly related to the number of patients admitted. As
the number of patients admitted increases there is a very linear increase in admitting costs.
Exercise 3-4 (20 minutes)
The Rhythm Shop
Income Statement—Acoustic Guitar Department
For the Quarter Ended March 31
Sales................................................................ $1,600,000
Variable expenses:
Cost of goods sold ($400 per guitar × $800,000
2,000 guitars*)............................................
Selling expenses ($75 per guitar × 2,000 150,000
guitars).......................................................
Administrative expenses (25% × 50,000 1,000,000
$200,000)...................................................
Contribution margin.......................................... 600,000
Fixed expenses:
Selling expenses (400,000-150,000)................250,000
Administrative expenses(75% x 200,000).........150,000 400,000
Operating income.............................................. $ 200,000
 *$1,600,000 sales ÷ $800 per guitar = 2,000 guitars.

2. Since 2,000 guitars were sold and the contribution margin totaled
$600,000 for the quarter, the contribution of each guitar toward fixed
expenses and profits was $300 ($600,000 ÷ 2,000 guitars = $300 per
guitar). Another way to compute the $300 is:
Selling price per guitar........................ $800
Less variable expenses:
Cost per guitar................................ $400
Selling expenses.............................. 75
Administrative expenses
($50,000 ÷ 2,000 guitar)............... 25 500
Contribution margin per guitar............ $300

Exercise 3-4 (continued)

3. If the Rhythm Shop sells 100 more guitars in the quarter ending
June 30, than they did for the quarter ending March 31, profits
will increase by:

100 x $300* per guitar = $30,000

*$800 selling price - $500 total variable cost per guitar

Total operating income for the quarter ended June 30 will be:

Operating income for the Quarter ended March 31 $200,000

Contribution margin from additional unit sales 30,000
Total operating income** $230,000

** Check:
2,100 guitars sold x $300/guitar $630,000
Less fixed expenses 400,000
Total operating income $230,000
Exercise 3-7 (20 minutes)

1. Kilometers Total Annual

Driven Cost*
High level of activity......................... 105,000 $11,970
Low level of activity.......................... 70,000 9,380
Change........................................... 35,000 $ 2,590
* 105,000 kilometers × $0.114 per kilometer = $11,970
70,000 kilometers × $0.134 per kilometer = $9,380

Variable cost per kilometer:

Fixed cost per year:

Total cost at 105,000 kilometers..................... $11,970
Less variable portion:
105,000 kilometers × $0.074 per kilometer. . 7,770
Fixed cost per year........................................ $ 4,200

2. Y = $4,200 + $0.074X

3. Fixed cost......................................................... $ 4,200

Variable cost:
80,000 kilometers × $0.074 per kilometer........ 5,920
Total annual cost............................................... $10,120
Exercise 3-8 (20 minutes)

1. Blood Tests Costs

High activity level (February)........ 3,500 $14,500
Low activity level (June)............... 1,500 8,500
Change....................................... 2,000 $ 6,000

Variable cost per blood test:

Change in cost = $6,000 = $3 per blood test
Change in activity 2,000 blood tests

Fixed cost per month:

Blood test cost at the high activity level................. $14,500
Less variable cost element:
3,500 blood tests × $3.00 per test..................... 10,500
Total fixed cost.................................................... $ 4,000
The cost formula is $4,000 per month plus $3.00 per blood test
performed or, in terms of the equation for a straight line:
Y = $4,000 + $3.00X
where X is the number of blood tests performed.
2. Expected blood test costs when 2,300 tests are performed:
Variable cost: 2,300 blood tests × $3.00 per test....... $6,900
Fixed cost............................................................... 4,000
Total cost................................................................ $10,900
Problem 3-11 (45 minutes)
1.
Home Entertainment
Income Statement
For the Month Ended April 30
Sales (150 televisions × $1,500 per set)............. $225,000
Cost of goods sold
(150 televisions × $900 per set)...................... 135,000
Gross margin.................................................... 90,000
Selling and administrative expenses:
Selling expenses:
Advertising.................................................. $ 950
Delivery of televisions
(150 televisions × $40 per set)................... 6,000
Sales salaries and commissions
[$2,900 + (4% × $225,000)]..................... 11,900
Utilities........................................................ 400
Depreciation of sales facilities....................... 3,000
Total selling expenses..................................... 22,250
Administrative expenses:
Executive salaries......................................... 8,000
Depreciation of office equipment................... 500
Clerical
[$1,500 + (150 televisions × $40 per set)].. 7,500
Insurance.................................................... 400
Total administrative expenses.......................... 16,400
Total selling and administrative expenses............ 38,650
Operating income.............................................. $ 51,350
Problem 3-11 (continued)
2. Home Entertainment
Income Statement
For the Month Ended April 30
Total Per Unit
Sales (150 televisions × $1,500 per set)............. $225,000 $1,500
Variable expenses:
Cost of goods sold
(150 televisions × $900 per set)................... 135,000 900
Delivery of televisions
(150 televisions × $40 per set)..................... 6,000 40
Sales commissions (4% × $225,000)............... 9,000 60
Clerical (150 televisions × $40 per set)............ 6,000 40
Total variable expenses................................ 156,000 1,040
Contribution margin.......................................... 69,000 $ 460
Fixed expenses:
Advertising..................................................... 950
Sales salaries................................................. 2,900
Utilities.......................................................... 400
Depreciation of sales facilities.......................... 3,000
Executive salaries........................................... 8,000
Depreciation of office equipment..................... 500
Clerical.......................................................... 1,500
Insurance...................................................... 400
Total fixed expenses.......................................... 17,650
Operating income.............................................. $ 51,350

3. Fixed costs remain constant in total but vary on a per unit basis with
changes in the activity level. For example, as the activity level
increases, fixed costs decrease on a per unit basis. Showing fixed
costs on a per unit basis on the income statement make them appear
to be variable costs. That is, management might be misled into
thinking that the per unit fixed costs would be the same regardless of
how many televisions were sold during the month. For this reason,
fixed costs should be shown only in totals on a contribution-type
income statement.
Problem 3-12 (45 minutes)
1. Traditional income statement
Haaki Shop, Inc.
Traditional Income Statement
Quarter ended May 31
Sales................................................................ $800,000
Cost of goods sold
($80,000 + $320,000 – $100,000)................... 300,000
Gross margin.................................................... 500,000
Selling and administrative expenses:
Selling expenses (($50 per unit × 2,000
surfboards*) + $150,000)............................ 250,000
Administrative expenses (($20 per unit × 2,000
units) + $120,000)....................................... 160,000 410,000
Operating income.............................................. $ 90,000

*$800,000 sales ÷ $400 per surfboard = 2,000 surfboards.

2. Contribution format income statement

Haaki Shop, Inc.
Contribution Format Income Statement
Quarter ended May 31
Sales................................................................ $800,000
Variable expenses:
Cost of goods sold
($80,000 + $320,000 – $100,000)................ $300,000
Selling expenses
($50 per unit × 2,000 surfboards)................. 100,000
Administrative expenses
($20 per unit × 2,000 surfboards)................. 40,000 440,000
Contribution margin.......................................... 360,000
Fixed expenses:
Selling expenses............................................. 150,000
Administrative expenses.................................. 120,000 270,000
Operating income.............................................. $ 90,000
Exercise 3-12 (continued)

3. Since 2,000 surfboards were sold and the contribution margin totaled
$360,000 for the quarter, the contribution of each surfboard toward
fixed expenses and profits was $180 ($360,000 ÷ 2,000 surfboards =
$180 per surfboard).

Alternate calculation:
Selling price $400 – $220 variable costs (production $150* + Selling
$50 + admin $20) = $180

*($300,000 ÷ 2,000)
Problem 3-14 (45 minutes)
1. The completed scattergram follows:

24,000
Chart Title
21,000

18,000

15,000

12,000
Repair Cost

9,000

6,000

3,000

0
0 30 60 90 120 150 180 210 240 270

Jobs

Repair costs appear to be closely related to the number of jobs

completed each month. The data points all fall quite close to the trend
line added to the plot and suggest the relationship between repair costs
and jobs is approximately linear.
Problem 3-14 (continued)

2. High-low method:
Number of Repair
Jobs Costs
High activity level.............. 260 $24,000
Low activity level............... 80 9,600
Change............................. 180 $14,400
Variable cost per job:
Change in cost = $14,400 = $80 per job
Change in activity 180 jobs

Fixed cost: Total repair cost at high activity level........ $24,000

Less variable element:
260 jobs × $80 per job.......................... 20,800
Fixed cost element................................... $ 3,200
Therefore, the cost formula is: Y = $3,200 + $80X.

3. The formula developed in part 2 probably should not be used to predict costs for a 600-job
month because that level of activity appears to be well outside of the relevant range. The next
closest activity level is only 260 jobs (May), which is less than half of the number of jobs the manager
wants to predict costs for. Both fixed and variable costs could increase if the level of activity is 600
jobs. For example, additional mechanics may need to be hired, more repair equipment may be
needed and facilities may need to be expanded (even temporarily) to accommodate an increase of
that magnitude.
Problem 3-15 (45 minutes)
1. Maintenance cost at the 90,000 machine-hour level of activity can be
isolated as follows:
Level of Activity
60,000 MHs 90,000 MHs
Total factory overhead cost......... $174,000 $246,000
Deduct:
Utilities cost @ $0.80 per MH*. 48,000 72,000
Supervisory salaries................. 21,000 21,000
Maintenance cost....................... $105,000 $153,000
*$48,000 ÷ 60,000 MHs = $0.80 per MH

2. High-low analysis of maintenance cost:

Machine- Maintenance
Hours Cost
High activity level..................... 90,000 $153,000
Low activity level..................... 60,000 105,000
Change................................... 30,000 $ 48,000
Variable rate:
Total fixed cost:
Total maintenance cost at the high activity level... $153,000
Less variable cost element
(90,000 MHs × $1.60 per MH)......................... 144,000
Fixed cost element............................................ $ 9,000
Therefore, the cost formula for maintenance is $9,000 per month plus
$1.60 per machine-hour or
Y = $9,000 + $1.60X.
Problem 3-15 (continued)

3. Variable Cost per

Machine-Hour Fixed Cost
Utilities cost.................... $0.80
Supervisory salaries cost.. $21,000
Maintenance cost............ 1.60 9,000
Total overhead cost......... $2.40 $30,000
Thus, the cost formula would be: Y = $30,000 + $2.40X.

4. Total overhead cost at an activity level of 75,000 machine-hours:

Fixed costs................................................. $ 30,000
Variable costs: 75,000 MHs × $2.40 per MH. 180,000
Total overhead costs................................... $210,000