Financial and Managerial Accounting Study Set 1

Business

Quiz 20 :
Cost Behavior and Cost-Volume-Profit Analysis

Quiz 20 :
Cost Behavior and Cost-Volume-Profit Analysis

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Ethics and professional conduct in business Edward Seymour is a financial consultant to Cornish Inc., a real estate syndicate. Cornish Inc. finances and develops commercial real estate (office buildings). The completed projects are then sold as limited partnership interests to individual investors. The syndicate makes a profit on the sale of these partnership interests. Edward provides financial information for the offering prospectus, which is a document that provides the financial and legal details of the limited partnership offerings. In one of the projects, the bank has financed the construction of a commercial office building at a rate of 10% for the first four years, after which time the rate jumps to 15% for the remaining 20 years of the mortgage. The interest costs are one of the major ongoing costs of a real estate project. Edward has reported prominently in the prospectus that the break-even occupancy for the first four years is 65%. This is the amount of office space that must be leased to cover the interest and general upkeep costs over the first four years. The 65% break-even is very low and thus communicates a low risk to potential investors. Edward uses the 65% break-even rate as a major marketing tool in selling the limited partnership interests. Buried in the fine print of the prospectus is additional information that would allow an astute investor to determine that the break-even occupancy will jump to 95% after the fourth year because of the contracted increase in the mortgage interest rate. Edward believes prospective investors are adequately informed as to the risk of the investment. Comment on the ethical considerations of this situation.
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Ethical Considerations
An ethical consideration involves an act of informing a prospective investor about all possible information in the prospectus. Further, it involves highlighting all the major risk factors in the prospectus in a simple language.
The act of Edward Seymour shall be considered unethical. This is due to following reasons -:
1. All risk information is not highlighted;
2. The information on increased project cost is not given in simple language thereby misleading small investors.

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Describe how total variable costs and unit variable costs behave with changes in the level of activity.
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Total variable costs vary in direct proportion to changes in the level of activity.
Unit variable costs remain the same with changes in the level of activity.

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Classify costs Following is a list of various costs incurred in producing replacement automobile parts. With respect to the production and sale of these auto parts, classify each cost as either variable, fixed, or mixed. 1. Oil used in manufacturing equipment 2. Plastic 3. Property taxes, $165,000 per year on factory building and equipment 4. Salary of plant manager 5. Cost of labor for hourly workers 6. Packaging 7. Factory cleaning costs, $6,000 per month 8. Metal 9. Rent on warehouse, $10,000 per month plus $25 per square foot of storage used 10. Property insurance premiums, $3,600 per month plus $0.01 for each dollar of property over $1,200,000 11. Straight-line depreciation on the production equipment 12. Hourly wages of machine operators 13. Electricity costs, $0.20 per kilowatt-hour 14. Computer chip (purchased from a vendor) 15. Pension cost, $1.00 per employee hour on the job
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The costs which alter with the change in production are called variable costs. The costs which remain constant despite of change in production are called fixed costs.
All costs cannot be segregated into fixed or variable. Some costs are semi- variable or mixed in nature; that is variable as well as fixed.
Table showing classification of costs
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High-low method The manufacturing costs of Lightfoot Industries for three months of the year follow: img Using the high-low method, determine (a) the variable cost per unit and (b) the total fixed cost. The manufacturing costs of Carrefour Enterprises for the first three months of the year follow: img Using the high-low method, determine (a) the variable cost per unit and (b) the total fixed cost.
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Classify costs Seymour Clothing Co. manufactures a variety of clothing types for distribution to several major retail chains. The following costs are incurred in the production and sale of blue jeans: a. Shipping boxes used to ship orders b. Consulting fee of $200,000 paid to industry specialist for marketing advice c. Straight-line depreciation on sewing machines d. Salesperson's salary, $10,000 plus 2% of the total sales e. Fabric f. Dye g. Thread h. Salary of designers i. Brass buttons j. Legal fees paid to attorneys in defense of the company in a patent infringement suit, $50,000 plus $87 per hour k. Insurance premiums on property, plant, and equipment, $70,000 per year plus $5 per $30,000 of insured value over $8,000,000 l. Rental costs of warehouse, $5,000 per month plus $4 per square foot of storage used m. Supplies n. Leather for patches identifying the brand on individual pieces of apparel o. Rent on plant equipment, $50,000 per year p. Salary of production vice president q. Janitorial services, $2,200 per month r. Wages of machine operators s. Electricity costs of $0.10 per kilowatt-hour t. Property taxes on property, plant, and equipment Instructions Classify the preceding costs as either fixed, variable, or mixed. Use the following tabular headings and place an X in the appropriate column. Identify each cost by letter in the cost column. img
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Classify costs Cromwell Furniture Company manufactures sofas for distribution to several major retail chains. The following costs are incurred in the production and sale of sofas: a. Fabric for sofa coverings b. Wood for framing the sofas c. Legal fees paid to attorneys in defense of the company in a patent infringement suit, $25,000 plus $160 per hour d. Salary of production supervisor e. Cartons used to ship sofas f. Rent on experimental equipment, $50 for every sofa produced g. Straight-line depreciation on factory equipment h. Rental costs of warehouse, $30,000 per month i. Property taxes on property, plant, and equipment j. Insurance premiums on property, plant, and equipment, $25,000 per year plus $25 per $25,000 of insured value over $16,000,000 k. Springs l. Consulting fee of $120,000 paid to efficiency specialists m. Electricity costs of $0.13 per kilowatt-hour n. Salesperson's salary, $80,000 plus 4% of the selling price of each sofa sold o. Foam rubber for cushion fillings p. Janitorial supplies, $2,500 per month q. Employer's FICA taxes on controller's salary of $180,000 r. Salary of designers s. Wages of sewing machine operators t. Sewing supplies Instructions Classify the preceding costs as either fixed, variable, or mixed. Use the following tabular headings and place an X in the appropriate column. Identify each cost by letter in the cost column. img
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Break-even sales, contribution margin "For a student, a grade of 65 percent is nothing to write home about. But for the airline... [industry], filling 65 percent of the seats... is the difference between profit and loss. The [economy] might be just strong enough to sustain all the carriers on a cash basis, but not strong enough to bring any significant profitability to the industry For the airlines..., the emphasis will be on trying to consolidate routes and raise ticket prices... " Source: Edwin McDowell, "Empty Seats, Empty Beds, Empty Pockets," The New York Times , January 6, 1992, p. C3. The airline industry is notorious for boom and bust cycles. Why is airline profitability very sensitive to these cycles? Do you think that during a down cycle the strategy to consolidate routes and raise ticket prices is reasonable? What would make this strategy succeed or fail? Why?
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Which of the following costs would be classified as variable and which would be classified as fixed, if units produced is the activity base? a. Direct materials costs b. Electricity costs of $0.35 per kilowatt-hour
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Identify cost graphs The following cost graphs illustrate various types of cost behavior: img For each of the following costs, identify the cost graph that best illustrates its cost behavior as the number of units produced increases: a. Total direct materials cost b. Electricity costs of $1,000 per month plus $0.10 per kilowatt-hour c. Per-unit cost of straight-line depreciation on factory equipment d. Salary of quality control supervisor, $20,000 per month e. Per-unit direct labor cost
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Contribution margin Michigan Company sells 10,000 units at $100 per unit. Variable costs are $75 per unit, and fixed costs are $125,000. Determine (a) the contribution margin ratio, (b) the unit contribution margin, and (c) income from operations. Weidner Company sells 22,000 units at $30 per unit. Variable costs are $24 per unit, and fixed costs are $40,000. Determine (a) the contribution margin ratio, (b) the unit contribution margin, and (c) income from operations.
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Break-even sales under present and proposed conditions BeeGee Company, operating at full capacity, sold 150,000 units at a price of $116 per unit during the current year. Its income statement is as follows: img The division of costs between variable and fixed is as follows: img Management is considering a plant expansion program for the following year that will permit an increase of $3,625,000 in yearly sales. The expansion will increase fixed costs by $1,000,000 but will not affect the relationship between sales and variable costs. Instructions 1. Determine the total variable costs and the total fixed costs for the current year. 2. Determine (a) the unit variable cost and (b) the unit contribution margin for the current year. 3. Compute the break-even sales (units) for the current year. 4. Compute the break-even sales (units) under the proposed program for the following year. 5. Determine the amount of sales (units) that would be necessary under the proposed program to realize the $4,400,000 of income from operations that was earned in the current year. 6. Determine the maximum income from operations possible with the expanded plant. 7. If the proposal is accepted and sales remain at the current level, what will the income or loss from operations be for the following year? 8. Based on the data given, would you recommend accepting the proposal? Explain.
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Break-even sales under present and proposed conditions Howard Industries Inc., operating at full capacity, sold 64,000 units at a price of $45 per unit during the current year. Its income statement is as follows: img The division of costs between variable and fixed is as follows: img Management is considering a plant expansion program for the following year that will permit an increase of $900,000 in yearly sales. The expansion will increase fixed costs by $212,500 but will not affect the relationship between sales and variable costs. Instructions 1. Determine the total fixed costs and the total variable costs for the current year. 2. Determine (a) the unit variable cost and (b) the unit contribution margin for the current year. 3. Compute the break-even sales (units) for the current year. 4. Compute the break-even sales (units) under the proposed program for the following year. 5. Determine the amount of sales (units) that would be necessary under the proposed program to realize the $692,500 of income from operations that was earned in the current year. 6. Determine the maximum income from operations possible with the expanded plant. 7. If the proposal is accepted and sales remain at the current level, what will the income or loss from operations be for the following year? 8. Based on the data given, would you recommend accepting the proposal?
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Break-even analysis Somerset Inc. has finished a new video game, Snowboard Challenge. Management is now considering its marketing strategies. The following information is available: img Two managers, James Hamilton and Thomas Seymour, had the following discussion of ways to increase the profitability of this new offering: James: I think we need to think of some way to increase our profitability. Do you have any ideas? Thomas: Well, I think the best strategy would be to become aggressive on price. James: How aggressive? Thomas: If we drop the price to $60 per unit and maintain our advertising budget at $15,000,000, I think we will generate total sales of 2,000,000 units. James: I think that?s the wrong way to go. You're giving too much up on price. Instead, I think we need to follow an aggressive advertising strategy. Thomas: How aggressive? James: If we increase our advertising to a total of $25,000,000, we should be able to increase sales volume to 1,400,000 units without any change in price. Thomas: I don't think that?s reasonable. We?ll never cover the increased advertising costs. Which strategy is best: Do nothing? Follow the advice of Thomas Seymour? Or follow James Hamilton's strategy?
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Describe how total fixed costs and unit fixed costs behave with changes in the level of activity.
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Identify activity bases For a major university, match each cost in the following table with the activity base most appropriate to it. An activity base may be used more than once or not used at all. img
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Break-even point Santana sells a product for $115 per unit. The variable cost is $75 per unit, while fixed costs are $65,000. Determine (a) the break-even point in sales units and (b) the breakeven point if the selling price were increased to $125 per unit. Elrod Inc. sells a product for $75 per unit. The variable cost is $45 per unit, while fixed costs are $48,000. Determine (a) the break-even point in sales units and (b) the breakeven point if the selling price were increased to $95 per unit.
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Break-even sales and cost-volume-profit chart For the coming year, Cleves Company anticipates a unit selling price of $100, a unit variable cost of $60, and fixed costs of $480,000. Instructions 1. Compute the anticipated break-even sales (units). 2. Compute the sales (units) required to realize a target profit of $240,000. 3. Construct a cost-volume-profit chart, assuming maximum sales of 20,000 units within the relevant range. 4. Determine the probable income (loss) from operations if sales total 16,000 units.
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Break-even sales and cost-volume-profit chart For the coming year, Culpeper Products Inc. anticipates a unit selling price of $150, a unit variable cost of $110, and fixed costs of $800,000. Instructions 1. Compute the anticipated break-even sales (units). 2. Compute the sales (units) required to realize income from operations of $300,000. 3. Construct a cost-volume-profit chart, assuming maximum sales of 40,000 units within the relevant range. 4. Determine the probable income (loss) from operations if sales total 32,000 units.
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Variable costs and activity bases in decision making The owner of Warwick Printing, a printing company, is planning direct labor needs for the upcoming year. The owner has provided you with the following information for next year's plans: img Each color on the banner must be printed one at a time. Thus, for example, a four-color banner will need to be run through the printing operation four separate times. The total production volume last year was 800 banners, as follows: img As you can see, the four-color banner is a new product offering for the upcoming year. The owner believes that the expected 1,000-unit increase in volume from last year means that direct labor expenses should increase by 125% (1,000 4 800). What do you think?
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In applying the high-low method of cost estimation to mixed costs, how is the total fixed cost estimated?
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