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1 Chapter 22 Helena Company reports the following total costs at two levels of production. 10,000 Units 20,000 Units Direct materials \$20,000 \$40,000 Maintenance 8,000 10,000 Direct labor 17,000 34,000 Indirect materials 1,000 2,000 Depreciation 4,000 4,000 Utilities 3,000 5,000 Rent 6,000 6,000 Classify each cost as variable, fixed, or mixed. Variable costs: Direct materials, direct labor, and indirect materials are variable costs. Fixed costs: Depreciation and rent are fixed costs. Mixed costs: Maintenance and utilities are mixed costs. Related exercise material: BE22-1, BE22-2, E22-1, E22-2, E22-3, and Byrnes Company accumulates the following data concerning a mixed cost, using units produced as the activity level. Units Produced Total Cost March 9,800 \$14,740 April 8,500 13,250 May 7,000 11,100 June 7,600 12,000 July 8,100 12,460 (a) Compute the variable and fixed cost elements using the high-low method. (b) Estimate the total cost if the company produces 6,000 units. (a) Variable cost: (\$14,740 2 \$11,100) 4 (9, ,000) 5 \$1.30 per unit Fixed cost: \$14,740 2 \$12,740 (\$ ,800 units) 5 \$2,000 or \$11,100 2 \$9,100 (\$ ,000) 5 \$2,000 (b) Total cost to produce 6,000 units: \$2,000 1 \$7,800 (\$ ,000) 5 \$9,800 Related exercise material: BE22-3, BE22-4, E22-1, E22-2, E22-3, and Types of Costs Recall that a variable cost varies in total directly and proportionately with each change in activity. Recall that a fixed cost remains the same in total with each change in activity. Recall that a mixed cost changes in total but not proportionately with each change in activity. High-Low Method Determine the highest and lowest levels of activity. Compute variable cost per unit as: Change in total costs 4 High 2 Low activity level 5 Variable cost per unit. Compute fixed cost as: Total cost 2 (Variable cost per unit 3 Units produced) 5 Fixed cost.

2 Break-Even Analysis Apply the formula: Sales 5 Variable costs 1 Fixed costs 1 Net income. Apply the formula: Fixed costs 4 Contribution margin per unit 5 Break-even point in units. Margin of Safety; Required Sales Know the formulas. Recognize that variable costs change with sales volume; fixed costs do not. Avoid computational errors. Lombardi Company has a unit selling price of \$400, variable costs per unit of \$240, and fixed costs of \$180,000. Compute the break-even point in units using (a) a mathematical equation and (b) contribution margin per unit. (a) The formula is \$400Q 5 \$240Q 1 \$180,000. The break-even point in units is 1,125 (\$180,000 4 \$160). (b) The contribution margin per unit is \$160 (\$400 2 \$240). The formula therefore is \$180,000 4 \$160, and the break-even point in units is 1,125. Related exercise material: BE22-5, BE22-6, E22-4, E22-5, E22-6, E22-7, E22-8, and Mabo Company makes calculators that sell for \$20 each. For the coming year, management expects fixed costs to total \$220,000 and variable costs to be \$9 per unit. (a) Compute break-even point in units using the mathematical equation. (b) Compute break-even point in dollars using the contribution margin (CM) ratio. (c) Compute the margin of safety percentage assuming actual sales are \$500,000. (d) Compute the sales required in dollars to earn net income of \$165,000 using the mathematical equation. (a) Sales 5 Variable costs 1 Fixed costs 1 Net income \$20Q 5 \$9Q 1 \$220,000 1 \$0 \$11Q 5 \$220,000 Q 5 20,000 units (b) Contribution margin per unit 5 Unit selling price 2 Unit variable costs \$11 5 \$20 2 \$9 Contribution margin ratio 5 Contribution margin per unit 4 Unit selling price 55% 5 \$11 4 \$20 Break-even point in dollars 5 Fixed cost 4 Contribution margin ratio 5 \$220, % 5 \$400,000 Actual sales Break-even sales (c) Margin of safety 5 Actual sales \$500,000 2 \$400,000 5 \$500, % (d) Required sales 5 Variable costs 1 Fixed costs 1 Net income \$20Q 5 \$9Q 1 \$220,000 1 \$165,000 \$11Q 5 \$385,000 Q 5 35,000 units 35,000 units 3 \$20 5 \$700,000 required sales Related exercise material: BE22-6, BE22-7, BE22-8, E22-5, E22-6, E22-7, E22-8, E22-9, E22-10, E22-11, E22-12, E22-13, and 22-4.

3 COMPREHENSIVE B.T. Hernandez Company, maker of high-quality flashlights, has experienced steady growth over the last 6 years. However, increased competition has led Mr. Hernandez, the president, to believe that an aggressive campaign is needed next year to maintain the company s present growth. The company s accountant has presented Mr. Hernandez with the following data for the current year, 2012, for use in preparing next year s advertising campaign. Cost Schedules Variable costs Direct labor per flashlight \$ 8.00 Direct materials 4.00 Variable overhead 3.00 Variable cost per flashlight \$15.00 Fixed costs Manufacturing \$ 25,000 Selling 40,000 Administrative 70,000 Total fixed costs \$135,000 Selling price per flashlight \$25.00 Expected sales, 2012 (20,000 flashlights) \$500,000 Mr. Hernandez has set the sales target for the year 2013 at a level of \$550,000 (22,000 flashlights). (Ignore any income tax considerations.) (a) What is the projected operating income for 2012? (b) What is the contribution margin per unit for 2012? (c) What is the break-even point in units for 2012? (d) Mr. Hernandez believes that to attain the sales target in the year 2013, the company must incur an additional selling expense of \$10,000 for advertising in 2013, with all other costs remaining constant. What will be the break-even point in dollar sales for 2013 if the company spends the additional \$10,000? (e) If the company spends the additional \$10,000 for advertising in 2013, what is the sales level in dollars required to equal 2012 operating income? to Comprehensive (a) Expected sales \$500,000 Less: Variable cost (20,000 flashlights 3 \$15) \$300,000 Fixed costs 135, ,000 Projected operating income \$ 65,000 (b) Selling price per flashlight \$25 Variable cost per flashlight 15 Contribution margin per unit \$10 (c) Fixed costs 4 Contribution margin per unit 5 Break-even point in units \$135,000 4 \$ ,500 units Know the formulas. Recognize that variable costs change with sales volume; fixed costs do not. Avoid computational errors.

4 (d) Fixed costs 4 Contribution margin ratio 5 Break-even point in dollars \$145, % 5 \$362,500 Fixed costs (from 2012) \$135,000 Additional advertising expense 10,000 Fixed costs (2013) \$145,000 Contribution margin per unit (b) \$10 Contribution margin ratio 5 Contribution margin per unit 4 Unit selling price 40% 5 \$10 4 \$25 (e) Required sales 5 (Fixed costs 1 Target net income) 4 Contribution margin ratio \$525,000 5 (\$145,000 1 \$65,000) 4 40% Review Classify types of costs. (SO 1, 3) Compute costs using high-low method and estimate total cost. (SO 3) Compute break-even point in units. (SO 6) Compute margin of safety percentage and required sales. (SO 8, 9) 22-1 Wyoming Company reports the following total costs at two levels of production. 5,000 Units 10,000 Units Indirect labor \$ 3,000 \$ 6,000 Property taxes 7,000 7,000 Direct labor 27,000 54,000 Direct materials 22,000 44,000 Depreciation 4,000 4,000 Utilities 3,000 5,000 Maintenance 9,000 11,000 Classify each cost as variable, fixed, or mixed Blakely Company accumulates the following data concerning a mixed cost, using units produced as the activity level. Units Produced Total Cost March 10,000 \$18,000 April 9,000 16,650 May 10,500 18,750 June 8,800 16,200 July 9,500 17,100 (a) Compute the variable and fixed cost elements using the high-low method. (b) Estimate the total cost if the company produces 8,500 units Lombardi Company has a unit selling price of \$250, variable cost per unit of \$160, and fixed costs of \$135,000. Compute the break-even point in units using (a) a mathematical equation and (b) contribution margin per unit Wales Company makes radios that sell for \$30 each. For the coming year, management expects fixed costs to total \$200,000 and variable costs to be \$20 per unit. (a) Compute the break-even point in dollars using the contribution margin (CM) ratio. (b) Compute the margin of safety percentage assuming actual sales are \$750,000. (c) Compute the sales required in dollars to earn net income of \$120,000.

6 (a) Compute the current break-even point in units, and compare it to the break-even point in units if Kay s ideas are used. (b) Compute the margin of safety ratio for current operations and after Kay s changes are introduced. (Round to nearest full percent.) (c) Prepare a CVP income statement for current operations and after Kay s changes are introduced. Would you make the changes suggested? Compute break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in business environment. (SO 5, 6, 7, 8) Prepare income statements under absorption and variable costing. (SO 10) P22-5B Perkins Corporation has collected the following information after its first year of sales. Net sales were \$2,000,000 on 100,000 units; selling expenses \$400,000 (30% variable and 70% fixed); direct materials \$600,000; direct labor \$340,000; administrative expenses \$500,000 (30% variable and 70% fixed); manufacturing overhead \$480,000 (20% variable and 80% fixed). Top management has asked you to do a CVP analysis so that it can make plans for the coming year. It has projected that unit sales will increase by 20% next year. (a) Compute (1) the contribution margin for the current year and the projected year, and (2) the fixed costs for the current year. (Assume that fixed costs will remain the same in the projected year.) (b) Compute the break-even point in units and sales dollars. (c) The company has a target net income of \$374,000. What is the required sales in dollars for the company to meet its target? (d) If the company meets its target net income number, by what percentage could its sales fall before it is operating at a loss? That is, what is its margin of safety ratio? (e) The company is considering a purchase of equipment that would reduce its direct labor costs by \$140,000 and would change its manufacturing overhead costs to 10% variable and 90% fixed (assume total manufacturing overhead cost is \$480,000, as above). It is also considering switching to a pure commission basis for its sales staff. This would change selling expenses to 80% variable and 20% fixed (assume total selling expense is \$400,000, as above). Compute (1) the contribution margin and (2) the contribution margin ratio, and recompute (3) the break-even point in sales dollars. Comment on the effect each of management s proposed changes has on the break-even point. *P22-6B Azul Metal Company produces the steel wire that goes into the production of paper clips. In 2012, the first year of operations, Azul produced 50,000 miles of wire and sold 45,000 miles. In 2013, the production and sales results were exactly reversed. In each year, selling price per mile was \$60, variable manufacturing costs were 20% of the sales price, variable selling expenses were \$8.00 per mile sold, fixed manufacturing costs were \$1,200,000, and fixed administrative expenses were \$230,000. (a) Prepare comparative income statements for each year using variable costing. (b) Prepare comparative income statements for each year using absorption costing. (c) Reconcile the differences each year in income from operations under the two costing approaches. (d) Comment on the effects of production and sales on net income under the two costing approaches. Waterways Continuing Problem (Note: This is a continuation of the Waterways Problem from Chapters 19 through 21.) WCP22 The Vice President for Sales and Marketing at Waterways Corporation is planning for production needs to meet sales demand in the coming year. He is also trying to determine how the company s profits might be increased in the coming year. This problem asks you to use cost-volume-profit concepts to help Waterways understand contribution margins of some of its products and to decide whether to mass-produce certain products. Go to the book s companion website, to see the completion of this problem.

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