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High-low methods, accounting analysis, CVP, and leverage

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EXERCISE4-5. High-Low Method

Campus Copy & Printing wants to predict copy machine repair expense at different levels of copying activity (number of copies made). The following data have been gathered: (see attached)

Required
Determine the fixed and variable components of repair expense using the high-low
method. Use copies made as the measure of activity.

EXERCISE 4-8. Account Analysis

Reef Office Supplies is interested in estimating
the cost involved in hiring new employees. The following information is available regarding
the costs of operating the Human Resource department at Reef Office Supplies
in May when there were 50 new hires.

Human Resource Department
May
Staff salaries $25,000
Manager salary 7,000
Office supplies 200
Depreciation of office equipment 300
Share of building cost (based
on square feet occupied by
Human Resources) 1,500
Total $34,000

Required
a. Use account analysis to determine fixed cost per month and variable cost per new
hire.
b. The company is planning to hire 60 employees in June. Estimate the total cost of
Human Resources for June..
c. What is the expected incremental cost associated with hiring 10 more employees
than were hired in May?

EXERCISE 4-12. CVP Analysis, Profit Equation

Clyde's Marina has estimated that fixed costs per month
are $240,000 and variable cost per dollar of sales is $0.60.

Required
a. What is the break-even point per month in sales?
b. What level of sales is needed for a monthly profit of $60,000?
c. For the month of July, the marina anticipates sales of $1,200,000: What is the expected level of profit?

EXERCISE 4-17. Operating Leverage
(see attached for data)
Required
a. Calculate profit as a percent of sales in the prior year.
b. Suppose sales in the current year increase by 20 percent. Calculate profit as a percent
of sales for the new level of sales and explain why the percent is greater than the
one calculated in Part a.

EXERCISE 4-18. Constraints

Dvorak Music produces two durable music stands:

Stand A Stand B
Selling price $80 $70
Less variable costs 20 40
Contribution margin $60 $30

Stand Arequires 5 labor hours and standB requires 2 labor hours. The company has
only 320 available labor hours per week. Further, the company can sell all it can produce
of either product.

Required
a. Which stand(s) should the company produce?
b. What would be the incremental benefit of obtaining 10 additional labor hours?

PROBLEM 4-12. Multiproduct CVP

Fidelity Multimedia sells audio and video equipment
and car stereo products. After performing a study of fixed and variable costs in the
prior year, the company prepared a product-line profit statement as follows:

Fidelity Multimedia
Profitability Analysis
For the Year Ended December 31,2007
Audio Video Car Total
Sales $3,000,000 $1,800,000 $1,200,000 $6,000,000
Less variable costs:
Cost of merchandise 1,800,000 1,260,000 600,000 3,660,000
Salary part-time staff 120,000 80,000 30,000 230,000
Total variable costs 1,920,000 1,340,000 630,000 3,890,000
Contribution margin 1,080,000 460,000 570,000 2,110,000
Less direct fixed costs:
Salary, full-time staff 300,000 250,000 210,000 760,000
Less common fixed costs:
Advertising 110,000
Utilities 20,000
Other administrative costs 560,000
Total common fixed costs 690,000
Profit $660,000

Required
a. Calculate the contribution margin ratios for the audio, video, and car product lines.
b. What would be the effect on profit of a $100,000 increase in sales of audio equipment
compared with a $100,000 increase in sales of video equipment, or a $100,000
increase in sales of car equipment? Based on this limited information, which product
line would you recommend expanding?
c. Calculate the break-even level of sales for the company as a whole.
d. Calculate sales needed to achieve a profit of $1,500,000 assuming the current mix.
e. Determine the sales of audio, video, and car products in the total sales amount calculated
for Part d.

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EXERCISE4-5. HIGH-LOW METHOD
Campus Copy & Printing wants to predict copy machine repair expense at different levels of copying activity (number of copies made). The following data have been gathered:

Required
Determine the fixed and variable components of repair expense using the high-low method. Use copies made as the measure of activity.

TUTORIAL
The high-low technique is a cost apportionment technique that utilizes two extremes: high and low in separating costs.
Cost Activity
High $10,000.00 800,000
Low $4,000.00 200,000
Difference = 10,000 - 4,000 $6,000.00 600,000

Variable cost = 6,000/600,000 $0.01
Fixed cost = $10,000 - ($0.01 * 800,00) or $4,000 - ($0.01*200,000) $2,000.00

EXERCISE 4-8. ACCOUNT ANALYSIS
Reef Office Supplies is interested in estimating the cost involved in hiring new employees. The following information is available regarding the costs of operating the Human Resource department at Reef Office Supplies in May when there were 50 new hires.
Human Resource Department
May
Staff salaries $25,000
Manager salary 7,000
Office supplies 200
Depreciation of office equipment 300
Share of building cost (based
on square feet occupied by
Human Resources) 1,500
Total $34,000

Required
a. Use account analysis to determine fixed cost per month and variable cost per new hire.
Human Resource Department
May
Staff salaries $25,000 Variable
Manager salary 7,000 Fixed
Office supplies 200 Variable
Depreciation of office equipment 300 Fixed
Share of building cost (based
on square feet occupied by
Human Resources) 1,500 Fixed
Total $34,000

Employee 50
Per unit
Total fixed cost 8,800
Variable cost 25,200 504.00 =25,200/50
b. The company is planning to hire 60 employees in June. Estimate the total cost of Human Resources for June.
Total cost = fixed cost + (variable cost * total employees) = 25,200 + (504 * (60 + 50)) = 80,640

c. What is the expected incremental cost associated with hiring 10 more employees than were hired in May?
Employees
Cost at May 50 50,400
Cost with new staff 60 55,440
Incremental cost 5,040

EXERCISE 4-12. CVP ANALYSIS, PROFIT EQUATION
Clyde's Marina has ...

Solution Summary

The expert examines the high-low methods for accounting analysis, CVP and leverages.

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2-48 CVP and Financial Statements for a Mega-Brand Company
Procter & Gamble Company is a Cincinnati-based company that produces household products under
brand names such as Gillette, Bounty, Crest, Folgers, and Tide. The company's 2006 income statement
showed the following (in millions):

Net sales $68,222
Costs of products sold $33,125
Selling, general, and administrative expense $21,848
Operating income $13,249

Suppose that the cost of products sold is the only variable cost; selling, general, and administrative expenses are fixed with respect to sales.
Assume that Procter & Gamble had a 10% increase in sales in 2007 and that there was no change in costs except for increases associated with the higher volume of sales.
Compute the predicted 2007 operating income for Procter & Gamble and its percentage increase. Explain why the percentage increase in income differs from the percentage increase in sales.

2-61 CVP in a Modern Manufacturing Environment
A division of Hewlett-Packard Company changed its production operations from one where alarge labor force assembled electronic components to an automated production facility dominated by computer-controlled robots. The change was necessary because of fierce competitive pressures. Improvements in quality, reliability, and flexibility of production schedules were necessary just to match the competition. As a result of the change, variable costs fell and fixed costs increased, as shown in the following assumed budgets:

Expected volume is 600,000 units per month, with each unit selling for $3.10. Capacity is 800,000
units.
1. Compute the budgeted profit at the expected volume of 600,000 units under both the old and the
new production environments.
2. Compute the budgeted break-even point under both the old and the new production environments.
3. Discuss the effect on profits if volume falls to 500,000 units under both the old and the new production
environments.
4. Discuss the effect on profits if volume increases to 700,000 units under both the old and the new
production environments.
5. Comment on the riskiness of the new operation versus the old operation.

2-65 CVP and Break-Even
Goal: Create an Excel spreadsheet to perform CVP analysis and show the relationship
between price, costs, and break-even points in terms of units and dollars. Use the results to answer questions about your findings.

Scenario: Phonetronix is a small manufacturer of telephone and communications devices. Recently, company management decided to investigate the profitability of cellular phone production. They have three different proposals to evaluate. Under all the proposals, the fixed costs for the new phone would be $110,000. Under proposal A, the selling price of the new phone would be $99 and the variable cost per unit would be $55. Under proposal B, the selling price of the phone would be $129 and the variable cost would remain the same. Under proposal C, the selling price would be $99 and the variable cost would be $49. When you have completed your spreadsheet, answer the following questions:

1. What are the break-even points in units and dollars under proposal A?
2. How did the increased selling price under proposal B impact the break-even points in
units and dollars compared to the break-even points calculated under proposal A?
3. Why did the change in variable cost under proposal C not impact the break-even points in units and dollars as significantly as proposal B did?

Step-by-Step:
1. Open a new Excel spreadsheet.
2. In column A, create a bold-faced heading that contains the following:
Row 1: Chapter 2 Decision Guideline
Row 2: Phonetronix
Row 3: Cost-Volume-Profit (CVP) Analysis
Row 4: Today's Date
3. Merge and center the four heading rows across columns A through D.
4. In Row 7, create the following bold-faced, right-justified column headings:
Column B: Proposal A
Column C: Proposal B
Column D: Proposal C
Note: Adjust cell widths when necessary as you work.
5. In Column A, create the following row headings:
Row 8: Selling price
Row 9: Variable cost
Row 10: Contribution margin
Row 11: Contribution margin ratio
Skip a row
Row 13: Fixed cost
Skip a row
Row 15: Break-even in units
Skip a row
Row 17: Break-even in dollars
6. Use the scenario data to fill in the selling price, variable cost, and fixed cost amounts
for the three proposals.
7. Use the appropriate formulas from this chapter to calculate contribution margin,
contribution margin ratio, break-even in units, and break-even in dollars.
8. Format all amounts as:

9. Change the format of the selling price, contribution margin, fixed cost, and break-even in dollars amounts to display a dollar symbol.
10. Change the format of both contribution margin headings to display as indented:

11. Change the format of the contribution margin amount cells to display a top border,
using the default line style.
Border tab: Icon: Top Border
12. Change the format of the contribution margin ratio amounts to display as a percentage
with two decimal places.
Number tab: Category: Percentage
Decimal places: 2
13. Change the format of all break-even headings and amounts to display as bold-faced.
14. Activate the ability to use heading names in formulas under Tools → Options:
Calculation tab: Check the box: Accept labels in formulas
15. Replace the cell-based formulas with "word-based" equivalents for each formula used
in Proposal A.
Example: Contribution margin for proposal B would be:
= ('Selling price' 'Proposal B') − ('Variable cost' 'Proposal B')
Note: The tic marks used in the example help avoid naming errors caused by data having similar titles (i.e., "contribution
margin" and "contribution margin ratio"). The parentheses help clarify groupings.
Help: Ask the Answer Wizard about "Name cells in a workbook."
Select "Learn about labels and names in formulas" from the right-hand panel.
16. Save your work to a disk, and print a copy for your files.

3-38 Mixed Cost, Choosing Cost Drivers, and High-Low and Visual-Fit Methods
Cedar Rapids Implements Company produces farm implements. Cedar Rapids is in the process of measuring its manufacturing costs and is particularly interested in the costs of the manufacturing maintenance activity, since maintenance is a significant mixed cost. Activity analysis indicates that maintenance activity consists primarily of maintenance labor setting up machines using certain supplies. A setup consists of preparing the necessary machines for a particular production run of a product. During setup, machines must still be running, which consumes energy. Thus, the costs associated with maintenance include labor, supplies, and energy. Unfortunately, Cedar Rapid's cost accounting system does not trace these costs to maintenance activity separately. Cedar Rapids employs two fulltime maintenance mechanics to perform maintenance. The annual salary of a maintenance mechanic is $25,000 and is considered a fixed cost. Two plausible cost drivers have been suggested: "units produced" and "number of setups." Data had been collected for the past 12 months and a plot made for the cost driver?units of production. The maintenance cost figures collected include estimates for labor, supplies, and energy. Cory Fielder, controller at Cedar Rapids, noted that some types of activities are performed each time a batch of goods is processed rather than each time a unit is produced. Based on this concept, he has gathered data on the number of setups performed over the past 12 months. The plots of monthly maintenance costs versus the two potential cost drivers follow.
1. Find monthly fixed maintenance cost and the variable maintenance cost per driver unit using the visual-fit method based on each potential cost driver. Explain how you treated the April data.
2. Find monthly fixed maintenance cost and the variable maintenance cost per driver unit using the high-low method based on each potential cost driver.
3. Which cost driver best meets the criteria for choosing cost functions? Explain.

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