Whirly corporation’s contribution format income statement for the most recent month is shown below:

EXERCISE 2–2 Classifying Manufacturing Costs [LO 2–2]

The PC Works assembles custom computers from components supplied by various manufacturers. The company is very small, and its assembly shop and retail sales store are housed in a single facility in a Redmond, Washington, industrial park. Listed below are some of the costs that are incurred at the company.

Required:

For each cost, indicate whether it would most likely be classified as direct labor, direct materials, manufacturing overhead, selling, or an administrative cost.

1. The cost of a hard drive installed in a computer.

2. The cost of advertising in the Puget Sound Computer User newspaper.

3. The wages of employees who assemble computers from components.

4. Sales commissions paid to the company’s salespeople.

5. The wages of the assembly shop’s supervisor.

6. The wages of the company’s accountant.

7. Depreciation on equipment used to test assembled computers before release to customers.

8. Rent on the facility in the industrial park.

EXERCISE 2–3 Classification of Costs as Product or Period Cost [LO 2–3]

Suppose that you have been given a summer job as an intern at Issac Aircams, a company that manufactures sophisticated spy cameras for remote-controlled military reconnaissance aircraft. The company, which is privately owned, has approached a bank for a loan to help it finance its growth. The bank requires financial statements before approving such a loan. You have been asked to help prepare the financial statements and were given the following list of costs:

1. Depreciation on salespersons’ cars.

2. Rent on equipment used in the factory.

3. Lubricants used for machine maintenance.

4. Salaries of personnel who work in the finished goods warehouse.

5. Soap and paper towels used by factory workers at the end of a shift.

6. Factory supervisors’ salaries.

7. Heat, water, and power consumed in the factory.

8. Materials used for boxing products for shipment overseas. (Units are not normally boxed.)

9. Advertising costs.

10. Workers’ compensation insurance for factory employees.

11. Depreciation on chairs and tables in the factory lunchroom.

12. The wages of the receptionist in the administrative offices.

13. Cost of leasing the corporate jet used by the company’s executives.

14. The cost of renting rooms at a Florida resort for the annual sales conference.

15. The cost of packaging the company’s product.

Required:

Classify the above costs as either product costs or period costs for the purpose of preparing the financial statements for the bank.

EXERCISE 2–4 Fixed and Variable Cost Behavior [LO 2–4]

Espresso Express operates a number of espresso coffee stands in busy suburban malls. The fixed weekly expense of a coffee stand is $1,200 and the variable cost per cup of coffee served is $0.22.

Required:

1. Fill in the following table with your estimates of total costs and cost per cup of coffee at the indicated levels of activity for a coffee stand. Round off the cost of a cup of coffee to the nearest tenth of a cent.

Cups of Coffee Served in a Week

2,000

2,100

2,200

Fixed cost. . . . . . . . . . . . . . . . . . . . . . . . . .

?

?

?

Variable cost. . . . . . . . . . . . . . . . . . . . . . . .

?

?

?

Total cost . . . . . . . . . . . . . . . . . . . . . . . . . .

?

?

?

Average cost per cup of coffee served . . . . . .

?

?

?

2. Does the average cost per cup of coffee served increase, decrease, or remain the same as the number of cups of coffee served in a week increases? Explain.

EXERCISE 2–5 High-Low Method [LO 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 . . . . . . . . . . . . . .

 2,406

$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.

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

EXERCISE 2–10 Cost Behavior; Contribution Format Income Statement [LO 2–4, LO 2–6]

Harris Company manufactures and sells a single product. A partially completed schedule of the company’s total and per unit costs over the relevant range of 30,000 to 50,000 units produced and sold annually is given below:

Units Produced and Sold

30,000

40,000

50,000

Total costs:

 Variable costs. . . . . . . . . . . .

$180,000

?

?

 Fixed costs. . . . . . . . . . . . . .

300,000

    ?  

    ?  

Total costs. . . . . . . . . . . . . . .

$480,000

    ?  

    ?  

Cost per unit:

 Variable cost. . . . . . . . . . . . .

?

?

?

 Fixed cost. . . . . . . . . . . . . . .

    ?  

    ?  

    ?  

Total cost per unit. . . . . . . . . .

    ?  

    ?  

    ?  

Required:

1. Complete the schedule of the company’s total and unit costs above.

2. Assume that the company produces and sells 45,000 units during the year at a selling price of $16 per unit. Prepare a contribution format income statement for the year.

EXERCISE 3–1 Preparing a Contribution Format Income Statement [LO3–1]

Whirly Corporation’s most recent income statement is shown below:

Total

Per Unit

Sales (10,000 units). . . . . . . . . . . . . . . . . . . . . . .

$350,000

$35.00

Variable expenses. . . . . . . . . . . . . . . . . . . . . . . . .

200,000

20.00

Contribution margin. . . . . . . . . . . . . . . . . . . . . . .

150,000

$15.00

Fixed expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . .

135,000

Net operating income. . . . . . . . . . . . . . . . . . . . .

$ 15,000

Required:

Prepare a new contribution format income statement under each of the following conditions (consider each case independently):

1. The sales volume increases by 100 units.

2. The sales volume decreases by 100 units.

3. The sales volume is 9,000 units.

EXERCISE 3–4 Computing and Using the CM Ratio [LO3–3]

Last month when Holiday Creations, Inc., sold 50,000 units, total sales were $200,000, total variable expenses were $120,000, and fixed expenses were $65,000.

Required:

1. What is the company’s contribution margin (CM) ratio?

2. Estimate the change in the company’s net operating income if it were to increase its total sales by $1,000.

EXERCISE 3–5 Changes in Variable Costs, Fixed Costs, Selling Price, and Volume [LO3–4]

Data for Hermann Corporation are shown below:

Per Unit

Percent of Sales

Selling price. . . . . . . . . . . . . . . . . . . .

$90

100%

Variable expenses. . . . . . . . . . . . . . . .

63

70%

Contribution margin . . . . . . . . . . . . . .

$27

30%

Fixed expenses are $30,000 per month and the company is selling 2,000 units per month.

Required:

Page 102

1. The marketing manager argues that a $5,000 increase in the monthly advertising budget would increase monthly sales by $9,000. Should the advertising budget be increased?

2. Refer to the original data. Management is considering using higher-quality components that would increase the variable expense by $2 per unit. The marketing manager believes that the higher-quality product would increase sales by 10% per month. Should the higher-quality components be used?

EXERCISE 3–7 Compute the Level of Sales Required to Attain a Target Profit [LO3–6]

Lin Corporation has a single product whose selling price is $120 and whose variable expense is $80 per unit. The company’s monthly fixed expense is $50,000.

Required:

1. Using the equation method, solve for the unit sales that are required to earn a target profit of $10,000.

2. Using the formula method, solve for the unit sales that are required to earn a target profit of $15,000.

EXERCISE 3–8 Compute the Margin of Safety [LO3–7]

Molander Corporation is a distributor of a sun umbrella used at resort hotels. Data concerning the next month’s budget appear below:

Selling price. . . . . . . . . . . . . . . . .

$30 per unit

Selling price. . . . . . . . . . . . . . . . .

$30 per unit

Variable expenses. . . . . . . . . . . . .

$20 per unit

Fixed expenses. . . . . . . . . . . . . . . .

$7,500 per month

Unit sales. . . . . . . . . . . . . . . . . . . .

1,000 units per month

Required:

1. Compute the company’s margin of safety.

2. Compute the company’s margin of safety as a percentage of its sales.

EXERCISE 3–13 Using a Contribution Format Income Statement [LO3–1, LO3–4]

Miller Company’s most recent contribution format income statement is shown below:

Total

Per Unit

Sales (20,000 units). . . . . . . . . . . . . . . . . . . . . .

$300,000

$15.00

Variable expenses. . . . . . . . . . . . . . . . . . . . . . . .

180,000

9.00

Contribution margin. . . . . . . . . . . . . . . . . . . . . .

120,000

$ 2.00

Fixed expenses. . . . . . . . . . . . . . . . . . . . . . . . . . .

70,000

Net operating income. . . . . . . . . . . . . . . . . . . . .

$ 50,000

Required:

Prepare a new contribution format income statement under each of the following conditions (consider each case independently):

1. The number of units sold increases by 15%.

2. The selling price decreases by $1.50 per unit, and the number of units sold increases by 25%.

3. The selling price increases by $1.50 per unit, fixed expenses increase by $20,000, and the number of units sold decreases by 5%.

4. The selling price increases by 12%, variable expenses increase by 60 cents per unit, and the number of units sold decreases by 10%.

CASE 3-33 Cost Structure; Break-Even and Target Profit Analysis [LO3–4, LO3–5, LO3–6]

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 sales commission of 15% 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 expenses:

Variable. . . . . . . . . . . . . . . . . . . . .

$7,200,000

Fixed overhead. . . . . . . . . . . . . . .

2,340,000

9,540,000

Gross margin. . . . . . . . . . . . . . . . .

6,460,000

Selling and administrative expenses:

Commissions to agents. . . . . . . . . . . . . . .

2,400,000

Fixed marketing expenses. . . . . . . . . . . .

1,20,000*

Fixed administrative expenses. . . . . . .

1,800,000

4,320,000

Net operating income . . . . . . . . . . . . . .

2,140,000

Fixed interest expenses . . . . . . . . . . .

540,000

Income before income taxes. . . . . . . . . .

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 expenses 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 expenses 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 dollar sales 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 requirements 1-4 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.

(CMA, adapted)