CHAPTER COST-VOLUME-PROFIT ANALYSIS: ADDITIONAL ISSUES SUMMARY OF QUESTIONS BY OBJECTIVES AND BLOOM’S TAXONOMY Item SO BT Item SO BT Item SO BT Item SO BT Item SO BT 5 6 C K K K K AP 25 26 a 27 a 28 a 29 a 30 7 8 C K K K K K 88 89 90 91 92 a 93 a 94 a 95 a 96 a 97 a 98 a 99 a 100 a 101 a 102 a 103 a 104 a 105 a 106 5 5 6 6 6 6 6 7 7 C K K K K K K K K K K K K K K AP AP AP AP a 107 108 a 109 a 110 a 111 a 112 a 113 a 114 a 115 a 116 a 117 a 118 a 119 a 120 a 121 a 122 a 123 a 124 a 125 7 7 7 7 7 7 7 8 8 AP K K C K K K AP AP AP AP C C C K K C K K a AP AP a AP 7 AP AP AP a 8 AP AP 7 K K K True-False Statements 1 2 3 K K K K K K 10 11 12 3 3 K AP AP K K K 13 14 15 16 17 18 4 5 C C K K K K 19 20 a 21 a 22 a 23 a 24 a a Multiple Choice Questions 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 1 1 1 1 1 1 2 2 2 K K K AP AP AP AP K K AP AP AP K AP AP AP AP AP AP 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 2 2 2 2 2 3 3 3 3 AP K AP AP AP K K AP AP AP K C AP AP AP AP AP AP AP 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 3 3 3 4 4 5 5 5 AP AP C C AP AP AP C C K AP AP K C C K AP AP C a Brief Exercises 126 127 3 AP AP 128 129 4 AP AP a 130 131 AP AP a 132 133 134 Exercises 135 136 137 3 AP AP AP 138 139 140 4 AN AN AP 141 142 a 143 a 6 AP K AP a 144 145 a 146 a Completion Statements 149 150 151 a K K K 152 153 154 K K K 155 156 a 157 a 6 This topic is dealt with in an Appendix to the chapter K K K a 158 159 a 160 a 147 148 a 6-2 Test Bank for ISV Managerial Accounting, Fourth Edition SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE Item Type Item Type 31 TF TF MC 32 33 34 MC MC MC 43 TF TF MC 44 45 46 MC MC MC TF TF TF TF TF 10 11 60 61 62 TF TF MC MC MC 12 13 TF TF 14 15 TF TF 16 17 18 19 TF TF TF TF 20 81 82 83 TF MC MC MC 21 22 23 TF TF TF 93 94 95 MC MC MC 24 25 26 27 103 TF TF TF TF MC 104 105 106 107 108 MC MC MC MC MC 28 29 TF TF 30 121 TF MC Item Type Item Type Item Study Objective 35 MC 38 MC 41 36 MC 39 MC 42 37 MC 40 MC 149 Study Objective 47 MC 50 MC 53 48 MC 51 MC 54 49 MC 52 MC 55 Study Objective 63 MC 68 MC 73 64 MC 69 MC 74 65 MC 70 MC 75 66 MC 71 MC 126 67 MC 72 MC 127 Study Objective 76 MC 78 MC 80 77 MC 79 MC 128 Study Objective 84 MC 88 MC 92 85 MC 89 MC 130 86 MC 90 MC 140 87 MC 91 MC 141 Study Objective 6a 96 MC 99 MC 102 97 MC 100 MC 131 98 MC 101 MC 132 Study Objective 7a 109 MC 114 MC 119 110 MC 115 MC 120 111 MC 116 MC 133 112 MC 117 MC 134 113 MC 118 MC 144 Study Objective 8a 122 MC 124 MC 147 123 MC 125 MC 148 Note: TF = True-False MC = Multiple Choice C = Completion BE = Brief Exercise The chapter also contains four Short-Answer Essay questions Type Item Type Item Type 59 150 MC C 139 153 Ex C 157 C MC MC C MC MC MC 56 57 58 MC MC MC MC MC MC BE BE 135 136 137 151 152 Ex Ex Ex C C MC BE 129 138 BE Ex MC BE Ex Ex 154 155 C C MC BE BE 142 143 156 Ex Ex C MC MC BE BE Ex 145 146 158 159 Ex Ex C C Ex Ex 160 C Ex = Exercise Cost-Volume-Profit Analysis: Additional Issues 6-3 CHAPTER STUDY OBJECTIVES Describe the essential features of a cost-volume-profit income statement The CVP income statement classifies costs and expenses as variable or fixed and reports contribution margin in the body of the statement Apply basic CVP concepts Contribution margin is the amount of revenue remaining after deducting variable costs It can be expressed as a per unit amount or as a ratio The breakeven point in units is fixed costs divided by contribution margin per unit The break-even point in dollars is fixed cost divided by the contribution margin ratio These formulas can also be used to determine units or sales dollars needed to achieve target net income, simply by adding target net income to fixed costs before dividing by the contribution margin Margin of safety indicates how much sales can decline before the company is operating at a loss It can be expressed in dollar terms or as a percentage Explain the term sales mix and its effects on break-even sales Sales mix is the relative proportion in which each product is sold when a company sells more than one product For a company with a small number of products, break-even sales in units is determined by using the weighted-average unit contribution margin of all the products If the company sells many different products, then calculating the break-even point using unit information is not practical Instead, in a company with many products, break-even sales in dollars is calculated using the weighted-average contribution margin ratio Determine sales mix when a company has limited resources When a company has limited resources, it is necessary to find the contribution margin per unit of limited resource This amount is then multiplied by the units of limited resource to determine which product maximizes net income Understand how operating leverage affects profitability Operating leverage refers to the degree to which a company’s net income reacts to a change in sales Operating leverage is determined by a company’s relative use of fixed versus variable costs Companies with high fixed costs relative to variable costs have high operating leverage A company with high operating leverage will experience a sharp increase (decrease) in net income with a given increase (decrease) in sales The degree of operating leverage can be measured by dividing contribution margin by net income a Explain the difference between absorption costing and variable costing Under absorption costing, fixed manufacturing costs are product costs Under variable costing, fixed manufacturing costs are period costs a Discuss net income effects under absorption costing versus variable costing If production volume exceeds sales volume, net income under absorption costing will exceed net income under variable costing by the amount of fixed manufacturing costs included in ending inventory that results from units produced but not sold during the period If production volume is less than sales volume, net income under absorption costing will be less than under variable costing by the amount of fixed manufacturing costs included in the units sold during the period that were not produced during the period a Discuss the merits of absorption versus variable costing for management decision making The use of variable costing is consistent with cost-volume-profit analysis Net income under variable costing is unaffected by changes in production levels Instead, it is closely tied to changes in sales The presentation of fixed costs in the variable costing approach makes it easier to identify fixed costs and to evaluate their impact on the company’s profitability 6-4 Test Bank for ISV Managerial Accounting, Fourth Edition TRUE-FALSE STATEMENTS The CVP income statement classifies costs as variable or fixed and computes a contribution margin In CVP analysis, cost includes manufacturing costs but not selling and administrative expenses When a company is in its early stages of operation, its primary goal is to generate a target net income The margin of safety tells a company how far sales can drop before it will be operating at a loss Sales mix is a measure of the percentage increase in sales from period to period Sales mix is not important to managers when different products have substantially different contribution margins The weighted-average contribution margin of all the products is computed when determining the break-even sales for a multi-product firm If Conan Corporation sells two products with a sales mix of 75% : 25%, and the respective contribution margins are $100 and $300, then weighted-average unit contribution margin is $150 If fixed costs are $100,000 and weighted-average unit contribution margin is $50, then the break-even point in units is 2,000 units 10 Net income can be increased or decreased by changing the sales mix 11 The break-even point in dollars is variable costs divided by the weighted-average contribution margin ratio 12 When a company has limited resources, management must decide which products to make and sell in order to maximize net income 13 When a company has limited resources to manufacture products, it should manufacture those products which have the highest contribution margin per unit 14 If a company has limited machine hours available for production, it is generally more profitable to produce and sell the product with the highest contribution margin per machine hour 15 According to the theory of constraints, a company must identify its constraints and find ways to reduce or eliminate them 16 Cost structure refers to the relative proportion of fixed versus variable costs that a company incurs 17 Operating leverage refers to the extent to which a company’s net income reacts to a given change in fixed costs Cost-Volume-Profit Analysis: Additional Issues a 6-5 18 The degree of operating leverage provides a measure of a company’s earnings volatility 19 If O’Brien Company has a margin of safety ratio of 60, it could sustain a 60 percent decline in sales before it would be operating at a loss 20 A company with low operating leverage will experience a sharp increase in net income with a given increase in sales 21 Variable costing is the approach used for external reporting under generally accepted accounting principles a 22 The difference between absorption costing and variable costing is the treatment of fixed manufacturing overhead a 23 Selling and administrative costs are period costs under both absorption and variable costing a 24 Manufacturing cost per unit will be higher under variable costing than under absorption costing a 25 Some fixed manufacturing costs of the current period are deferred to future periods through ending inventory under variable costing a 26 When units produced exceed units sold, income under absorption costing is higher than income under variable costing a 27 When units sold exceed units produced, income under absorption costing is higher than income under variable costing a 28 When absorption costing is used for external reporting, variable costing can still be used for internal reporting purposes a 29 When absorption costing is used, management may be tempted to overproduce in a given period in order to increase net income a 30 The use of absorption costing facilitates cost-volume-profit analysis Answers to True-False Statements Item Ans T F F T F Item 10 Ans F T T T T Item 11 12 13 14 15 Ans F T F T T Item 16 17 18 19 20 Ans T F T T F Item a 21 a 22 a 23 a 24 a 25 Ans F T T F F Item a 26 a 27 a 28 a 29 a 30 Ans T F T T F 6-6 Test Bank for ISV Managerial Accounting, Fourth Edition MULTIPLE CHOICE QUESTIONS 31 Cost-volume-profit analysis is the study of the effects of a changes in costs and volume on a company’s profit b cost, volume, and profit on the cash budget c cost, volume, and profit on various ratios d changes in costs and volume on a company’s profitability ratios 32 The CVP income statement classifies costs a as variable or fixed and computes contribution margin b by function and computes a contribution margin c as variable or fixed and computes gross margin d by function and computes a gross margin 33 Contribution margin is the amount of revenue remaining after deducting a cost of goods sold b fixed costs c variable costs d contra-revenue 34 Buerhrle’s CVP income statement included sales of 2,000 units, a selling price of $100, variable expenses of $60 per unit, and fixed expenses of $44,000 Contribution margin is a $200,000 b $120,000 c $80,000 d $36,000 35 Buerhrle’s CVP income statement included sales of 2,000 units, a selling price of $100, variable expenses of $60 per unit, and fixed expenses of $44,000 Net income is a $200,000 b $80,000 c $76,000 d $36,000 36 For Dye Company, at a sales level of 5,000 units, sales is $75,000, variable expenses total $40,000, and fixed expenses are $21,000 What is the contribution margin per unit? a $2.80 b $7.00 c $8.00 d $15.00 37 If contribution margin is $200,000, sales is $300,000, and net income is $30,000, then variable and fixed expenses are a b c d Variable $100,000 $100,000 $170,000 $500,000 Fixed $270,000 $170,000 $100,000 $270,000 Cost-Volume-Profit Analysis: Additional Issues 38 6-7 In a CVP income statement, cost of goods sold is generally a completely a variable cost b completely a fixed cost c neither a variable cost nor a fixed cost d partly a variable cost and partly a fixed cost 39 In a CVP income statement, a selling expense is generally a completely a variable cost b completely a fixed cost c neither a variable cost nor a fixed cost d partly a variable cost and partly a fixed cost 40 Vazquez Company’s cost of goods sold is $350,000 variable and $200,000 fixed The company’s selling and administrative expenses are $250,000 variable and $300,000 fixed If the company’s sales is $1,400,000, what is its contribution margin? a $300,000 b $800,000 c $850,000 d $900,000 41 Vazquez Company’s cost of goods sold is $350,000 variable and $200,000 fixed The company’s selling and administrative expenses are $250,000 variable and $300,000 fixed If the company’s sales is $1,400,000, what is its net income? a $300,000 b $800,000 c $850,000 d $900,000 42 Garland’s CVP income statement included sales of 3,000 units, a selling price of $100, variable expenses of $60 per unit, and net income of $50,000 Fixed expenses are a $70,000 b $120,000 c $180,000 d $300,000 43 The contribution margin ratio is a sales divided by contribution margin b sales divided by fixed expenses c sales divided by variable expenses d contribution margin divided by sales 44 For Danks Company, sales is $500,000, variable expenses are $310,000, and fixed expenses are $140,000 Danks’ contribution margin ratio is a 10% b 28% c 38% d 62% 6-8 Test Bank for ISV Managerial Accounting, Fourth Edition 45 For Contreras Company, sales is $1,000,000, fixed expenses are $300,000, and the contribution margin per unit is $72 What is the break-even point? a $1,388,889 sales dollars b $416,667 sales dollars c 13,889 units d 4,167 units 46 For Garland Company, sales is $1,000,000, fixed expenses are $300,000, and the contribution margin ratio is 36% What is net income? a $60,000 b $108,000 c $252,000 d $360,000 47 For Garland Company, sales is $1,000,000, fixed expenses are $300,000, and the contribution margin ratio is 36% What are the total variable expenses? a $192,000 b $360,000 c $640,000 d $1,000,000 48 In 2008, Masset sold 3,000 units at $500 each Variable expenses were $350 per unit, and fixed expenses were $200,000 What was Masset’s 2008 net income? a $250,000 b $450,000 c $1,050,000 d $1,500,000 49 In 2008, Masset sold 3,000 units at $500 each Variable expenses were $350 per unit, and fixed expenses were $200,000 The same selling price, variable expenses, and fixed expenses are expected for 2009 What is Masset’s break-even point in sales dollars for 2009? a $666,667 b $1,333,333 c $1,500,000 d $2,142,857 50 In 2008, Masset sold 3,000 units at $500 each Variable expenses were $350 per unit, and fixed expenses were $200,000 The same selling price, variable expenses, and fixed expenses are expected for 2009 What is Masset’s break-even point in units for 2009? a 1,333 b 3,000 c 4,285 d 6,667 51 The required sales in units to achieve a target net income is a (sales + target net income) divided by contribution margin per unit b (sales + target net income) divided by contribution margin ratio c (fixed cost + target net income) divided by contribution margin per unit d (fixed cost + target net income) divided by contribution margin ratio Cost-Volume-Profit Analysis: Additional Issues 6-9 52 For Jon Company, sales is $1,000,000, fixed expenses are $300,000, and the contribution margin ratio is 36% What is required sales in dollars to earn a target net income of $200,000? a $555,556 b $833,333 c $1,388,889 d $2,777,778 53 Jenks Corporation reported sales of $2,000,000 last year (100,000 units at $20 each), when the break-even point was 80,000 units Jenks’ margin of safety ratio is a 20% b 25% c 80% d 120% 54 For Bobby Company, sales is $1,000,000 (5,000 units), fixed expenses are $300,000, and the contribution margin per unit is $80 What is the margin of safety in dollars? a $50,000 b $250,000 c $450,000 d $700,000 55 Margin of safety in dollars is a expected sales divided by break-even sales b expected sales less break-even sales c actual sales less expected sales d expected sales less actual sales 56 The margin of safety ratio is a expected sales divided by break-even sales b expected sales less break-even sales c margin of safety in dollars divided by expected sales d margin of safety in dollars divided by break-even sales 57 In 2008, McDougal sold 3,000 units at $500 each Variable expenses were $350 per unit, and fixed expenses were $195,000 The same variable expenses per unit and fixed expenses are expected for 2009 If McDougal cuts selling price by 4%, what is McDougal’s break-even point in units for 2009? a 1,300 b 1,354 c 1,440 d 1,500 58 In 2008, Thornton sold 3,000 units at $500 each Variable expenses were $250 per unit, and fixed expenses were $150,000 The same selling price is expected for 2009 Thornton is tentatively planning to invest in equipment that would increase fixed costs by 20%, while decreasing variable costs per unit by 20% What is Thornton’s break-even point in units for 2009? a 600 b 720 c 750 d 900 - 10 Test Bank for ISV Managerial Accounting, Fourth Edition 59 In 2008, Logan sold 1,000 units at $500 each, and earned net income of $40,000 Variable expenses were $300 per unit, and fixed expenses were $160,000 The same selling price is expected for 2009 Logan’s variable cost per unit will rise by 10% in 2009 due to increasing material costs, so they are tentatively planning to cut fixed costs by $10,000 How many units must Logan sell in 2009 to maintain the same income level as 2008? a 882 b 1,000 c 1,056 d 1,118 60 Sales mix is a the relative percentage in which a company sells its multiple products b the trend of sales over recent periods c the mix of variable and fixed expenses in relation to sales d a measure of leverage used by the company 61 In a sales mix situation, at any level of units sold, net income will be higher if a more higher contribution margin units are sold than lower contribution margin units b more lower contribution margin units are sold than higher contribution margin units c more fixed expenses are incurred d weighted-average unit contribution margin decreases 62 Konerko Company sells two types of computer chips The sales mix is 30% (Q-Chip) and 70% (Q-Chip Plus) Q-Chip has variable costs per unit of $30 and a selling price of $50 Q-Chip Plus has variable costs per unit of $35 and a selling price of $65 The weightedaverage unit contribution margin for Konerko is a $23 b $25 c $27 d $50 63 Iguchi Company sells 2,000 units of Product A annually, and 3,000 units of Product B annually The sales mix for Product A is a 40% b 60% c 67% d cannot determine from information given 64 Konerko Company sells two types of computer chips The sales mix is 30% (Q-Chip) and 70% (Q-Chip Plus) Q-Chip has variable costs per unit of $30 and a selling price of $50 Q-Chip Plus has variable costs per unit of $35 and a selling price of $65 Konerko’s fixed costs are $540,000 How many units of Q-Chip would be sold at the break-even point? a 6,000 b 7,043 c 10,000 d 14,000 Cost-Volume-Profit Analysis: Additional Issues a Solution 131 (3–5 min.) Direct materials Direct labor Variable manufacturing overhead Total product costs under variable costing a - 23 $25,000 31,000 38,000 $94,000 BE 132 Huskie Company produces footballs It incurred the following costs this year: Direct materials Direct labor Fixed manufacturing overhead Variable manufacturing overhead Fixed selling and administrative expenses Variable selling and administrative expenses $25,000 31,000 22,000 38,000 23,000 14,000 Instructions What are the total product costs for the company under absorption costing? a Solution 132 (3–5 min.) Direct materials Direct labor Fixed manufacturing overhead Variable manufacturing overhead Total product costs under absorption costing a $ 25,000 31,000 22,000 38,000 $116,000 BE 133 During 2008, Nowak Corporation produced 60,000 units and sold 55,000 for $10 per unit Variable manufacturing costs were $4 per unit Annual fixed manufacturing overhead was $120,000 ($2 per unit) Variable selling and administrative costs were $1 per unit sold, and fixed selling and administrative costs were $30,000 Instructions Prepare a variable costing income statement a Solution 133 (5–7 min.) Sales (55,000 × $10) Variable cost of goods sold (55,000 × $4) Variable selling and administrative expenses (55,000 × $1) Contribution margin Fixed manufacturing overhead Fixed selling and administrative expenses Net income $550,000 $220,000 55,000 120,000 30,000 275,000 275,000 150,000 $125,000 - 24 a Test Bank for ISV Managerial Accounting, Fourth Edition BE 134 During 2008, Nowak Corporation produced 60,000 units and sold 55,000 for $10 per unit Variable manufacturing costs were $4 per unit Annual fixed manufacturing overhead was $120,000 ($2 per unit) Variable selling and administrative costs were $1 per unit sold, and fixed selling and administrative costs were $30,000 Instructions Prepare an absorption costing income statement a Solution 134 (5–7 min.) Sales (55,000 × $10) Cost of goods sold (55,000 × $6) Gross margin Variable selling and administrative expenses (55,000 × $1) Fixed selling and administrative expenses Net income $550,000 330,000 220,000 $55,000 30,000 85,000 $135,000 EXERCISES Ex 135 Trail King manufactures mountain bikes It has fixed costs of $5,360,000 Trail King’s sales mix and contribution margin per unit is shown as follows: Sales Mix 20% 55% 25% Destroyer Voyager Rebel Contribution Margin $120 $ 60 $ 40 Instructions Compute the number of each type of bike that the company would need to sell in order to break even under this product mix Solution 135 Destroyer Voyager Rebel (8–12 min.) Sales Mix 20% 55% 25% × × × × Contribution Margin $120 $ 60 $ 40 Weighted-Average Contribution Margin $24 $33 $10 $67 Total break-even sales = $5,360,000 ÷ $67 = 80,000 bikes Destroyer Voyager Rebel Sales Mix 20% 55% 25% × × × 80,000 80,000 80,000 = = = 16,000 bikes 44,000 bikes 20,000 bikes Cost-Volume-Profit Analysis: Additional Issues - 25 Ex 136 Account-Able Company provides primarily two lines of service: accounting and tax Accountingrelated services represent 60% of its revenue and provide a contribution margin ratio of 30% Tax services represent 40% of its revenue and provide a 45% contribution margin ratio The company’s fixed costs are $9,000,000 Instructions (a) Calculate the revenue from each type of service that the company must achieve to break even (b) The company has a desired net income of $1,800,000 What amount of revenue would Account-Able earn from tax services if it achieves this goal with the current sales mix? Solution 136 (10–15 min.) (a) Accounting Tax Contribution Margin Ratio 30% 45% Sales Mix 60% 40% Weighted-Average Contribution Margin Ratio 18% 18% 36% Total break-even sales = $9,000,000 ÷ 36 = $25,000,000 Accounting Tax Sales Mix 60% × 40% × $25,000,000 = $15,000,000 $25,000,000 = $10,000,000 (b) Sales to achieve target net income = ($9,000,000 + $1,800,000) ÷ 36 = $30,000,000 Tax Sales Mix 40% × $30,000,000 = $12,000,000 Ex 137 Mad City Flash Company sells computers and video game systems The business is divided into two divisions along product lines Variable costing income statements for the current year are presented below: Computers VG Systems Total Sales $700,000 $300,000 $1,000,000 Variable costs 420,000 210,000 630,000 Contribution margin $280,000 $ 90,000 370,000 Fixed costs 259,000 Net income $ 111,000 Instructions (a) Determine the sales mix and contribution margin ratio for each division (b) Calculate the company’s weighted-average contribution margin ratio (c) Calculate the company’s break-even point in dollars (d) Determine the sales level, in dollars, for each division at the break-even point - 26 Test Bank for ISV Managerial Accounting, Fourth Edition Solution 137 (15–20 min.) (a) Sales mix: Computers: VG Systems Contribution margin ratio: Computers: VG Systems: $700,000 ÷ ($700,000 + $300,000) = 70% $300,000 ÷ ($700,000 + $300,000) = 30% $280,000 ÷ $700,000 = 40% $ 90,000 ÷ $300,000 = 30% (b) Weighted-average contribution margin ratio = (70% × 40%) + (30% × 30%) = 37% (c) Break-even point in dollars = $259,000 ÷ 37 = $700,000 (d) Sales dollars at break-even point: Computers: $700,000 × 70 = $490,000 VG Systems: $700,000 × 30 = $210,000 Ex 138 Movie House Company has 4,000 machine hours available to produce either Product 22 or Product 44 The cost accounting department developed the following unit information for each product: Product 22 Product 44 Sales price $20 $40 Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Machine time required 15 minutes 60 minutes Instructions Management wants to know which product to produce in order to maximize the company’s income Taking into consideration the constraints under which the company operates, prepare a report to show which product should be produced and sold Solution 138 (10–12 min.) Contribution margin per unit Sales price Variable costs Direct material Direct labor Variable overhead Contribution margin Machine hours required: Product 22 $20 $5 12 $ 1/4 hr Contribution margin per unit of limited resource: ($8 ÷ 25) $ 32 ($25 ÷ 1) Machine hours available × 4,000 Contribution margin $128,000 The company should produce and sell Product 22 Product 44 $40 $8 15 $25 hr $ 25 × 4,000 $100,000 Cost-Volume-Profit Analysis: Additional Issues - 27 Ex 139 PHR Company manufactures and sells two products Relevant per unit data concerning each product are given below: Product Standard Deluxe Selling price $50 $75 Variable costs $24 $30 Machine hours Instructions (a) Compute the contribution margin per unit of limited resource for each product (b) If 1,000 additional machine hours are available, which product should be manufactured? Solution 139 (6–8 min.) (a) Product Contribution margin per unit Machine hours required Contribution margin per unit of limited resource Standard $26 ÷2 $13 Deluxe $45 ÷3 $15 (b) The Deluxe product should be manufactured because it results in the highest contribution margin per machine hour: $15 × 1,000 = $15,000 Ex 140 The following CVP income statements are available for Antique Company and Contemporary Company Antique Company Contemporary Company Sales revenue $700,000 $700,000 Variable costs 350,000 140,000 Contribution margin 350,000 560,000 Fixed costs 150,000 360,000 Net income $200,000 $200,000 Instructions (a) Compute the degree of operating leverage for each company (b) Assume that sales revenue decreases by 20% Prepare a CVP income statement for each company Solution 140 (a) (15–20 min.) Contribution Margin Antique $350,000 Contemporary $560,000 ÷ ÷ ÷ Net Income $200,000 $200,000 = = = Degree of Operating Leverage 1.75 2.80 - 28 Test Bank for ISV Managerial Accounting, Fourth Edition Solution 140 (cont.) (b) Sales revenue Variable costs Contribution margin Fixed costs Net income Antique Company $560,000* 280,000** 280,000 150,000 $130,000 Contemporary Company $560,000* 112,000*** 448,000 360,000 $ 88,000 *$700,000 ì **($350,000 ữ $700,000) ì $560,000 ***($140,000 ữ $700,000) ì $560,000 Ex 141 An investment banker is analyzing two companies that specialize in the production and sale of gourmet cappuccino and chai mixes Fireside Company uses a labor-intensive approach and Stirring Moments Company uses a mechanized system Variable costing income statements for the two companies are shown below: Fireside $1,000,000 650,000 350,000 150,000 $ 200,000 Sales Variable costs Contribution margin Fixed costs Net Income Stirring Moments $1,000,000 300,000 700,000 500,000 $ 200,000 The investment banker is interested in acquiring one of these companies However, she is concerned about the impact that each company’s cost structure might have on its profitability Instructions (a) Calculate each company’s degree of operating leverage (b) Determine the effect on each company’s net income if sales decrease by 10% and if sales increase by 20% Do not prepare income statements Solution 141 (8–10 min.) (a) Fireside St Moments Contribution Margin $350,000 $700,000 ÷ ÷ ÷ (b) Fireside St Moments Fireside St Moments % Change in Sales (10%) (10%) 20% 20% × × × × × Net Income $200,000 $200,000 = = = Degree of Operating Leverage 1.75 3.50 1.75 3.50 Degree of Operating Leverage 1.75 3.50 = = = % Change in Net Income (17.5%) (35.0%) = = 35.0% 70.0% Cost-Volume-Profit Analysis: Additional Issues a - 29 Ex 142 Indicate with a check mark whether each of the following would be a product cost or a period cost under an absorption or a variable system for Carson Company Absorption Product Period Variable Product Period a Direct materials _ _ _ _ b Direct labor _ _ _ _ c Factory utilities _ _ _ _ d Factory rent _ _ _ _ e Indirect labor _ _ _ _ f Factory supervisor salaries _ _ _ _ g Factory maintenance (variable) _ _ _ _ h Factory depreciation _ _ _ _ i Sales salaries _ _ _ _ j Sales commissions _ _ _ _ a Solution 142 a b c d e f g h i j a (10–15 min.) Direct materials Direct labor Factory utilities Factory rent Indirect labor Factory supervisor salaries Factory maintenance (variable) Factory depreciation Sales salaries Sales commissions Absorption Product Period           Variable Product Period  _  _  _ _  _ _  _ _ _ _ Ex 143 Fresh Air Products Company manufactures and sells a variety of camping products Recently the company opened a new plant to manufacture a deluxe portable cooking unit Cost and sales data for the first month of operations are shown below: Manufacturing Costs Fixed Overhead Variable overhead Direct labor Direct material $120,000 $3 per unit $12 per unit $30 per unit Beginning inventory Units produced Units sold units 12,000 11,000 Test Bank for ISV Managerial Accounting, Fourth Edition - 30 a Ex 143 (cont.) Selling and Administrative Costs Fixed Variable $200,000 $4 per unit sold The portable cooking unit sells for $110 Management is interested in the opening month’s results and has asked for an income statement Instructions Assume the company uses absorption costing Calculate the production cost per unit and prepare an income statement for the month of June, 2008 a Solution 143 (8–12 min.) Direct materials Direct labor Variable overhead Fixed overhead ($120,000 ÷ 12,000) Total cost Per Unit $30 12 10 $55 Fresh Air Products Company Income Statement (Absorption Costing) For the Month Ending June 30, 2008 Sales (11,000 × $110) Less: Cost of goods sold (11,000 × $55) Gross profit Less: Selling and administrative costs Variable (11,000 × $4) Fixed Net income a $1,210,000 605,000 605,000 $ 44,000 200,000 244,000 $ 361,000 Ex 144 Momentum Bikes Company manufactures a basic road bicycle Production and sales data for the most recent year are as follows (no beginning inventory): Variable production costs Fixed production costs Variable selling and administrative costs Fixed selling and administrative costs Selling price Production Sales $90 per bike $500,000 $22 per bike $520,000 $200 per bike 20,000 bikes 18,000 bikes Instructions (a) Prepare a brief income statement using absorption costing (b) Compute the amount to be reported for inventory in the year-end absorption costing balance sheet Cost-Volume-Profit Analysis: Additional Issues a Solution 144 (a) (8–12 min.) Sales (18,000 × $200) Less: Cost of goods sold (18,000 × $115*) Gross profit Less: selling and administrative costs [(18,000 $22) + $520,000] Net income *Variable production costs Fixed production costs ($500,000 ÷ 20,000) Total cost of goods sold per unit (b) a - 31 $3,600,000 2,070,000 1,530,000 916,000 $ 614,000 $ 90 per bike 25 per bike $115 per bike (20,000 – 18,000) × $115 = $230,000 Ex 145 Momentum Bikes Company manufactures a basic road bicycle Production and sales data for the most recent year are as follows (no beginning inventory): Variable production costs Fixed production costs Variable selling and administrative costs Fixed selling and administrative costs Selling price Production Sales $90 per bike $500,000 $22 per bike $520,000 $200 per bike 20,000 bikes 18,000 bikes Instructions (a) Prepare a brief income statement using variable costing (b) Compute the amount to be reported for inventory in the year-end variable costing balance sheet a Solution 145 (a) (b) (8–12 min.) Sales (18,000 × $200) Less: Variable costs Variable cost of goods sold (18,000 × $90) Variable selling and admin costs (18,000 × $22) Contribution margin Less: Fixed costs Fixed production costs Fixed selling and administrative costs Net income (20,000 – 18,000) × $90 = $180,000 $3,600,000 $1,620,000 396,000 500,000 520,000 2,016,000 1,584,000 1,020,000 $ 564,000 - 32 a Test Bank for ISV Managerial Accounting, Fourth Edition Ex 146 Dolan Company produces sporting equipment In 2008, the first year of operations, Dolan produced 25,000 units and sold 22,000 units In 2009, the production and sales results were exactly reversed In each year, selling price was $100, variable manufacturing costs were $40 per unit, variable selling expenses were $8 per unit, fixed manufacturing costs were $540,000, and fixed administrative expenses were $200,000 Instructions (a) Compute the net income under variable costing for each year (b) Compute the net income under absorption costing for each year (c) Reconcile the differences each year in income from operations under the two costing approaches a Solution 146 (20–25 min.) (a) 2008: [22,000 × ($100 – $40 – $8)] – ($540,000 + $200,000)] = $404,000 2009: [25,000 × ($100 – $40 – $8)] – ($540,000 + $200,000)] = $560,000 (b) 2008: [22,000 × ($100 – $40 – $21.60)] – ($200,000 + ($22,000 × $8)] = $468,800 2009: {[25,000 × $100) – [3,000 × ($40 + $21.60)] – [22,000 × ($40 + $24.55)]} – [$200,000 + (25,000 × $8)] = $495,200 (c) The variable costing and the absorption costing income can be recorded as follows: a 2008 variable costing income Fixed manufacturing costs deferred at 12/31/08 under absorption costing (3,000 × $21.60) 2008 absorption costing income $404,000 2009 variable costing income Fixed manufacturing costs expensed in 2009 under absorption costing (3,000 × $21.60) 2009 absorption costing income $560,000 64,800 $468,800 (64,800) $495,200 Ex 147 McCartney Pumps is a division of UK Controls Corporation The division manufactures and sells a pump that is used in a wide variety of applications During the coming year, it expects to sell 30,000 units for $20 per unit George Harrison, division manager, is considering producing either 30,000 or 50,000 units during the period Other information is presented in the schedule below: Division Information – 2008 Beginning inventory Expected sales in units Selling price per unit Variable manufacturing cost per unit Fixed manufacturing overhead costs (total) Fixed manufacturing overhead costs per unit Based on 30,000 units ($300,000 ÷ 30,000) Based on 50,000 units ($300,000 ÷ 50,000) Manufacturing cost per unit Based on 30,000 units ($7 variable + $10 fixed) Based on 50,000 units ($7 variable + $6 fixed) Selling and administrative expenses (all fixed) 30,000 $20 $7 $300,000 $10 $6 $17 $13 $25,000 Cost-Volume-Profit Analysis: Additional Issues a - 33 Ex 147 (cont.) Instructions (a) Prepare and absorption costing income statement with one column showing the results if 30,000 units are produced and one column showing the results if 50,000 units are produced (b) Why is income different for the two production levels when sales is 30,000 units either way? a Solution 147 (a) (15–20 min.) McCartney Pumps Division Income Statement (Absorption Costing) For the Year Ended 2008 30,000 Produced 50,000 Produced Sales (30,000 units × $20) $600,000 $600,000 Cost of goods sold 510,000 (30,000 × $17) 390,000 (30,000 × $13) Gross profit 90,000 210,000 Fixed selling and admin expenses 25,000 25,000 Net income $ 65,000 $185,000 (b) a Net income is $120,000 higher when 50,000 units are produced because under absorption costing, $120,000 of fixed manufacturing costs (20,000 × $6) are deferred to the next year Ex 148 McCartney Pumps is a division of UK Controls Corporation The division manufactures and sells a pump that is used in a wide variety of applications During the coming year, it expects to sell 30,000 units for $20 per unit George Harrison, division manager, is considering producing either 30,000 or 50,000 units during the period Other information is presented in the schedule below: Division Information – 2008 Beginning inventory Expected sales in units 30,000 Selling price per unit $20 Variable manufacturing cost per unit $7 Fixed manufacturing overhead costs (total) $300,000 Fixed manufacturing overhead costs per unit Based on 30,000 units ($300,000 ÷ 30,000) $10 Based on 50,000 units ($300,000 ÷ 50,000) $6 Manufacturing cost per unit Based on 30,000 units ($7 variable + $10 fixed) $17 Based on 50,000 units ($7 variable + $6 fixed) $13 Selling and administrative expenses (all fixed) $25,000 Instructions Prepare a variable costing income statement with one column showing the results if 30,000 units are produced and one column showing the results if 50,000 units are produced - 34 a Test Bank for ISV Managerial Accounting, Fourth Edition Solution 148 (15–20 min.) McCartney Pumps Division Income Statement (Variable Costing) For the Year Ended 2008 Sales (30,000 units × $20) Variable cost of goods sold (30,000 × $7) Contribution margin Fixed manufacturing overhead Fixed selling and administrative expenses Net income 30,000 Produced $600,000 210,000 390,000 300,000 25,000 $ 65,000 50,000 Produced $600,000 210,000 390,000 300,000 25,000 $ 65,000 Cost-Volume-Profit Analysis: Additional Issues - 35 COMPLETION STATEMENTS 149 The income statement classifies cost as variable or fixed and computes a contribution margin 150 _ tells a company how far sales can drop before it will be operating at a loss 151 _ is the relative percentage in which a company sells its multiple products 152 When more than one product is sold, the break-even point can be determined by dividing fixed expenses by _ 153 When a company has , management must decide which products to make and sell in order to maximize net income 154 _ refers to the relative proportion of fixed versus variable costs that a company incurs 155 The _ provides a measure of a company’s earnings volatility and can be used to compare companies a 156 Under _ all manufacturing costs are charged to, or absorbed by, the product a 157 Fixed manufacturing costs are treated as period costs under a 158 When production exceeds sales, a portion of the _ is deferred to a future period as part of the cost of ending inventory under absorption costing, but not under variable costing a 159 When units produced exceed units sold, income under absorption costing is _ than income under variable costing a 160 Management may be tempted to overproduce in a given period in order to increase net income if _ is used for internal decision making Answers to Completion Statements 149 150 151 152 153 154 CVP Margin of safety Sales mix weighted-average unit contribution limited resources Cost structure 155 156 a 157 a 158 a 159 a 160 a degree of operating leverage absorption costing variable costing fixed manufacturing overhead higher absorption costing - 36 Test Bank for ISV Managerial Accounting, Fourth Edition SHORT-ANSWER ESSAY QUESTIONS S-A E 161 A CVP income statement is frequently prepared for internal use by management Describe the features of the CVP income statement that make it more useful for management decision-making than the traditional income statement that is prepared for external users Solution 161 Several features of the CVP income statement make it more useful for internal decision-making The CVP income statement classifies costs as either fixed or variable, rather than by function Being able to identify the behavior of costs in this manner can aid management in controlling those costs Also, the CVP income statement shows the contribution margin, rather than a gross profit This helps management establish the extent to which their sales are able to cover their fixed costs, and to analyze the impact on net income of changes in sales or costs S-A E 162 Jacob Andrews, president of Video Adventure, has heard about operating leverage and asks you to explain this term What is operating leverage? How does a company increase its operating leverage? Solution 162 Operating leverage refers to the change in net income that a company experiences when there is a change in net sales revenue Companies that have higher fixed costs relative to variable costs have higher operating leverage In that case, the company’s profits will increase rapidly when sales revenue increases, but decrease rapidly when sales revenue decreases A company can increase its operating leverage by increasing its reliance on fixed costs, with a corresponding decrease in variable costs a S-A E 163 Define variable costing and absorption costing What are some of the benefits to a manager from using variable costing instead of absorption costing for internal decision making? a Solution 163 Variable costing is a system for determining product costs that is used primarily for making managerial decisions This system determines product costs by considering only direct materials, direct labor, and variable manufacturing overhead In contrast, absorption costing is used by some managers and also for external reporting Under absorption costing, product costs include direct materials, direct labor, and both fixed and variable manufacturing overhead costs Some of the benefits to a manager from using variable costing instead of absorption costing for internal decision-making include: variable costing already has to be used when constructing a contribution margin income statement, variable costing puts greater focus on cost behaviors, fixed expenses not get tied up in inventory under variable costing, variable costing is better Cost-Volume-Profit Analysis: Additional Issues - 37 suited for cost-volume-profit analysis, variable costing produces income statements that are closer to net cash flows than absorption costing, and the method ties in with standard costing and flexible budgeting more effectively a S-A E 164 How differences in production and sales levels affect income under absorption and variable costing? a Solution 164 If production equals sales in any given period, the net incomes under both absorption and variable costing will be equal Under this scenario, fixed manufacturing overhead will not differ, because the direct cost expense under variable costing will be equal to the product cost component of fixed overhead under absorption costing If production exceeds sales, absorption costing net income will be greater than variable costing net income Absorption costing net income is higher because some fixed manufacturing overhead costs will be deferred in the inventory account until the products are sold, whereas under variable costing, all fixed manufacturing overhead costs will be expensed If sales exceed production, absorption costing net income will be less than variable costing net income Absorption costing net income is less because some fixed manufacturing overhead costs from the previous period will now be expensed when the older product is sold, whereas under variable costing, only fixed manufacturing overhead costs of the current period will be expensed ... fixed costs by 20%, while decreasing variable costs per unit by 20% What is Thornton’s break-even point in units for 2009? a 600 b 720 c 750 d 900 - 10 Test Bank for ISV Managerial Accounting, ...6-2 Test Bank for ISV Managerial Accounting, Fourth Edition SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE Item Type Item Type 31 TF TF MC 32 33... a 22 a 23 a 24 a 25 Ans F T T F F Item a 26 a 27 a 28 a 29 a 30 Ans T F T T F 6-6 Test Bank for ISV Managerial Accounting, Fourth Edition MULTIPLE CHOICE QUESTIONS 31 Cost-volume-profit analysis