1. a. Under absorption costing, both variable and fixed manufacturing costs are included as a part of the cost of the product manufactured.
b. Under variable costing, only the variable manufacturing costs are included as a part of the cost of the product manufactured. The fixed manufacturing costs are treated as an expense of the period in which they are incurred.
2. Fixed factory overhead.
3. Included as part of the cost of product manufactured: (a), (d), (g).
4. a. Variable cost of goods sold.
b. Variable selling and administrative expenses.
c. Fixed costs.
5. In the variable costing income statement, the fixed manufacturing costs and the fixed selling and administrative expenses are reported in a special section for fixed costs and are deducted from the contribution margin.
6. The amount of income from operations determined by absorption costing will be more than the amount determined by variable costing. This effect on the magnitude of income is caused by the difference between the two methods in treating fixed factory overhead costs. Absorption costing allocates the fixed overhead costs to all goods produced during the period, while variable costing treats all the fixed overhead costs as an expense of the period. Thus, if the quantity of inventory at the end of the period is more than that at the beginning of the period, a portion of the fixed overhead costs for the period would be included in the ending inventory, with a corresponding effect on the amount of income.
7. All costs are controllable by someone within the business but not necessarily by the same level of management. For a specific level of management, noncontrollable costs are costs for which another level of management is responsible.
8. In the short run, income from operations is maximized if the revenue from the sale of the product exceeds the variable cost of making and selling the product. Under variable costing, these relevant costs are readily available.
9. Management might develop a contribution margin by sales territory report. Such a report can be used by management to identify profitable sales territories for directing sales efforts. Fixed costs, which may not be influenced by territory-related decisions, should be removed from the analysis.
10. Product profitability analysis can be used by management to set product prices, to emphasize promotional activity toward more profitable products or away from less profitable products, and to make decisions about keeping products or eliminating products from the product line.
11. Rewarding sales personnel on the basis of total sales will normally motivate the sales staff to expend their efforts promoting high-volume products, which will produce a large total amount of sales dollars. In some cases, more profit may be earned by promoting specialty products with lower sales volume but which have higher profit margins on each product sold. For example, grocery stores must generate a large volume of sales to earn the same profit as a jewelry store, because the profit margin for the grocery industry is low, while the profit margin for the jewelry industry is high. A better measure of sales performance is the total dollar contribution margin of each salesperson (total sales less variable cost of goods sold and variable selling expenses) to overall company profit.
12. A change in contribution margin can be
attributed to a change in the following factors as they affect sales and/or
variable costs: (1) quantity factor—the effect of a difference in the number of
units sold, assuming no
change in unit sales price or unit cost, and (2) unit price or unit cost
factor—the effect of a difference in unit sales price or unit cost on the
number of units sold.
13. The quantity factor for sales is computed as the difference between the actual quantity sold and the planned quantity sold, multiplied by the planned unit sales price.
14. The unit cost factor for variable cost of goods sold is computed as the difference between the actual unit cost and the planned
unit cost, multiplied by the actual quantity sold.
15.
Entertainment
companies will segment their profit reporting by major business lines, such as
in the case of Walt Disney Corporation: Theme Parks (Disney World), Movie Production
(Walt Disney Pictures), Television (ABC Network), Merchandising (Disney retail
stores), Cruise Lines, and Theatrical Productions. Other segments common to
entertainment companies include music, radio, and publishing.
Ex. 19–1 (Fin Man); Ex. 4–1 (Man)
a. The inventory valuation under the absorption costing concept would include the fixed manufacturing cost, as follows:
2,500 units × $43.75* = $109,375
*Direct materials...................................................................... $25.00
Direct labor.............................................................................. 11.10
Fixed factory overhead........................................................ 4.20
Variable factory overhead................................................... 3.45
Total.......................................................................................... $43.75
b. The inventory valuation under the variable costing concept would not include the fixed factory overhead cost, as follows:
2,500 units × $39.55* = $98,875
*Direct materials...................................................................... $25.00
Direct labor.............................................................................. 11.10
Variable factory overhead................................................... 3.45
Total.......................................................................................... $39.55
All of the fixed factory overhead cost would be included in the variable costing income statement. Thus, the absorption costing income statement would have a higher net income than would the variable costing income statement.
Ex. 19–2 (Fin Man); Ex. 4–2 (Man)
a.
LASER AUDIO INC.
Absorption Costing Income Statement
For the Month Ended May 31, 2006
Sales................................................................................................................... $1,900,000
Cost of goods sold (10,000 units × $127.60*).......................................... 1,276,000
Gross profit....................................................................................................... $ 624,000
Selling and administrative expenses ($260,000 + $100,000)............... 360,000
Income from operations................................................................................ $ 264,000
*Production costs per unit:
Direct materials per unit ($780,000/12,000 units).............................. $ 65.00
Direct labor per unit ($420,000/12,000 units)...................................... 35.00
Variable factory overhead per unit ($208,800/12,000 units)........... 17.40
Fixed factory overhead per unit ($122,400/12,000 units)................ 10.20
Total
production costs per unit....................................................... $127.60
b.
LASER AUDIO INC.
Variable Costing Income Statement
For the Month Ended May 31, 2006
Sales................................................................................................................... $ 1,900,000
Variable
cost of goods sold (10,000 units × $117.40* per unit)........... 1,174,000
Manufacturing margin................................................................................... $ 726,000
Variable
selling and administrative expenses......................................... 260,000
Contribution margin....................................................................................... $ 466,000
Fixed costs:
Fixed factory overhead costs.............................................. $122,400
Fixed selling and administrative expenses...................... 100,000 222,400
Income from operations.............................................................. $ 243,600
*$65 + $35 + $17.40 = $117.40
Ex. 19–2 (Fin Man); Ex. 4–2 (Man) Concluded
c. The difference between the absorption and variable costing income from operations of $20,400 ($264,000 – $243,600) can be explained as follows:
Increase in inventory............................................................ 2,000
Fixed factory overhead per unit......................................... × $10.20
Difference in income from operations.............................. $20,400
Under the absorption costing method, the fixed factory overhead cost included in the cost of goods sold is matched with the revenues. As a result, 2,000 units that were produced but unsold (inventory) include fixed factory overhead cost, which is not included in the cost of goods sold.
Under variable costing, all of the fixed factory overhead cost is deducted in the period in which it is incurred, regardless of the amount of inventory change. Thus, when inventory increases, the absorption costing income statement will have a higher income from operations than will the variable costing income statement.
a.
MILAN FASHIONS INC.
Absorption Costing Income Statement
For the Month Ended September 30, 2006
Sales................................................................................................................... $3,300,000
Cost of goods sold:
Beginning inventory (2,000 × $59.20).......................... $ 118,400
Cost of goods manufactured (28,000 × $60.00)........ 1,680,000
Cost
of goods sold....................................................................... 1,798,400
Gross profit..................................................................................... $1,501,600
Selling
and administrative expenses....................................... 867,000
Income from operations.............................................................. $ 634,600
Ex. 19–3 (Fin Man); Ex. 4–3 (Man) Concluded
b.
MILAN FASHIONS INC.
Variable Costing Income Statement
For the Month Ended September 30, 2006
Sales................................................................................................................... $3,300,000
Variable
cost of goods sold (30,000 units × $48.00 per unit)............... 1,440,000
Manufacturing margin................................................................................... $1,860,000
Variable
selling and administrative expenses......................................... 642,000
Contribution margin....................................................................................... $1,218,000
Fixed costs:
Fixed manufacturing costs.................................................. $336,000
Fixed selling and administrative expenses...................... 225,000 561,000
Income from operations.............................................................. $ 657,000
c. The difference between the absorption and variable costing income from operations of –$22,400 ($634,600 – $657,000) can be explained as follows:
Reduction in inventory......................................................... (2,000)
Fixed manufacturing cost per unit (at 100% capacity) × $11.20
Difference in income from operations.............................. $(22,400)
Under the absorption costing method, the fixed manufacturing cost included in the cost of goods sold is matched with the revenues. As a result, 2,000 units that were produced but unsold in August (beginning inventory for September) include fixed manufacturing cost, which is included in the cost of goods sold for September. Under variable costing, all of the fixed manufacturing cost is deducted in the period in which it is incurred, regardless of the amount of inventory change. Thus, when inventory decreases, the absorption costing income statement will have a lower income from operations than will the variable costing income statement.
Ex. 19–4 (Fin Man); Ex. 4–4 (Man)
a. =
=
= $27,000
b. =
=
= $39,000
EAST TEXAS PETROLEUM COMPANY
Variable Costing Income Statement
For the Month Ended April 30, 2006
Sales (3,700 units)........................................................................................... $88,800
Variable cost of goods sold:
Variable cost of goods manufactured............................... $46,6001
Less inventory, April 30 (300 units).................................... 3,4952
Variable cost of goods sold........................................... 43,105
Manufacturing margin................................................................. $45,695
Variable selling and administrative expenses....................... 7,000
Contribution margin..................................................................... $38,695
Fixed costs:
Fixed manufacturing costs.................................................. $17,400
Fixed selling and administrative expenses...................... 15,550 32,950
Income
from operations.............................................................. $ 5,745
1 $64,000 – $17,400 (total manufacturing cost less fixed manufacturing cost)
2 $46,600/$64,000 × $4,800 (the ratio of variable to total
manufacturing costs times
the value of the ending inventory under absorption costing); or
$46,600/4,000 units manufactured =
$11.65; $11.65 × 300 units = $3,495.
Ex. 19–6 (Fin Man); Ex. 4–6 (Man)
OLDE ENGLISH FURNITURE COMPANY
Absorption Costing Income Statement
For the Month Ended September 30, 2007
Sales (8,000 units)........................................................................................... $960,000
Cost of goods sold:
Cost of goods manufactured......................................... $592,2001
Less inventory, September 30 (1,400 units)............... 88,2002
Cost of goods sold........................................................... 504,000
Gross profit..................................................................................... $456,000
Selling
and administrative expenses....................................... 288,130
Income
from operations.............................................................. $167,870
1 $470,000 + $122,200 (total variable plus fixed manufacturing cost)
2 ($592,200/$470,000) × $70,000 (the ratio of total to variable manufacturing cost times the ending inventory valuation under variable costing); or $592,200/9,400 units manufactured = $63.00/unit; $63.00 × 1,400 units = $88,200.
a.
PROCTER & GAMBLE COMPANY
Variable Costing Income Statement (assumed)
(in millions)
Net sales............................................................................................................ $40,238
Variable
cost of products sold.................................................................... 15,000
Manufacturing margin................................................................................... $25,238
Variable
marketing, administrative, and other expenses..................... 6,900
Contribution margin....................................................................................... $18,338
Fixed costs:
Fixed manufacturing costs.................................................. $5,989
Fixed marketing, administrative, and other expenses.. 5,671 11,660
Income
from operations.............................................................. $ 6,678
b. If Procter & Gamble Company reduced its inventories during the period, then the cost of products sold would include fixed costs allocated to the beginning inventories. These would not be fixed costs of the current period. Thus, the total fixed costs of products sold on the absorption costing income statement would be higher, and the income from operations would be lower.
Ex. 19–8 (Fin Man); Ex. 4–8 (Man)
a. 1.
ADVANCED FILTERS INC.
Absorption Costing Income Statement
For the Month Ending March 31, 2006
8,000 Units 9,000 Units
Manufactured Manufactured
Sales..................................................................................... $680,000 $680,000
Cost of goods sold:
Cost of goods manufactured:
8,000 units × $76.501............................................. $612,000
9,000 units × $75.752............................................. 681,750
Less inventory, March 31 (1,000 units × $75.75). 75,750
Cost of goods sold............................................... $612,000 $606,000
Gross profit......................................................................... $ 68,000 $ 74,000
Selling and administrative expenses........................... 36,500 36,500
Income
from operations.................................................. $ 31,500 $ 37,500
1 Unit cost of goods manufactured:
Direct materials ($408,000 ÷ 8,000).............................. $51.00
Direct labor ($100,000 ÷ 8,000)..................................... 12.50
Variable factory overhead cost ($50,000 ÷ 8,000).... 6.25
Fixed factory overhead cost ($54,000 ÷
8,000)......... 6.75
Total unit cost................................................................... $76.50
2 Unit cost of goods manufactured:
Direct materials................................................................ $51.00
Direct labor........................................................................ 12.50
Variable factory overhead cost.................................... 6.25
Fixed factory overhead cost ($54,000 ÷ 9,000)......... 6.00
Total unit cost................................................................... $75.75
Ex. 19–8 (Fin Man); Ex. 4–8 (Man) Concluded
2.
ADVANCED FILTERS INC.
Variable Costing Income Statement
For the Month Ending March 31, 2006
8,000 Units 9,000 Units
Manufactured Manufactured
Sales..................................................................................... $680,000 $680,000
Variable cost of goods sold:
Variable cost of goods manufactured:
8,000 units × $69.751............................................. $558,000
9,000 units × $69.751............................................. $627,750
Less inventory, March 31 (1,000 units × $69.75). 69,750
Variable cost of goods sold............................... $558,000 $558,000
Manufacturing margin..................................................... $122,000 $122,000
Variable selling and administrative expenses2......... 24,300 24,300
Contribution margin......................................................... $ 97,700 $ 97,700
Fixed costs:
Fixed factory overhead cost.................................... 54,000 54,000
Fixed selling and administrative expenses.......... 12,200 12,200
Total fixed costs.......................................................... $ 66,200 $ 66,200
Income from operations.................................................. $ 31,500 $ 31,500
1 Unit variable cost of goods manufactured:
Direct materials ($408,000 ÷ 8,000)........................ $51.00
Direct labor ($100,000 ÷ 8,000)............................... 12.50
Variable factory overhead cost
($50,000 ÷ 8,000) 6.25
Total unit variable cost............................................. $69.75
2 Variable selling and administrative expenses are constant with constant sales levels.
b. If 9,000 units rather than 8,000 units are manufactured, the increase in income from operations of $6,000 under absorption costing is caused by the allocation of $54,000 of fixed factory overhead cost over a larger number of units. If 8,000 units are manufactured, the fixed factory overhead cost is $6.75 per unit ($54,000 ÷ 8,000) compared to $6.00 per unit ($54,000 ÷ 9,000) if 9,000 units are manufactured. Thus, the cost of goods sold is $6,000 less by the amount of $0.75/unit ($6.75 – $6.00) times the number of units sold, or $0.75 × 8,000 units = $6,000. The $6,000 difference can also be explained by the amount of fixed factory overhead cost included in the ending inventory if 9,000 units are manufactured ($6.00 per unit × 1,000 units).
Ex. 19–9 (Fin Man); Ex. 4–9 (Man)
a. Management’s decision and conclusion are incorrect. The profit will not be improved by $55,000, because the fixed costs used in manufacturing and selling ski boots will not be avoided if the line is eliminated. These fixed costs total $130,000 for the ski boot line. Thus, the actual profit will go down by $75,000 ($130,000 – $55,000) if the ski boot line is eliminated. This is shown in the variable costing income statements in (b). The absorption costing product profit reports should not be used for making this type of decision.
b.
ASPEN BOOT COMPANY
Product Income Statements—Variable Costing
For the Year Ended December 31, 2006
Hiking Fishing Ski
Boots Boots Boots
Revenues...................................................................... $ 590,000 $ 500,000 $ 430,000
Variable cost of goods sold..................................... 240,000 175,000 200,000
Manufacturing margin............................................... $ 350,000 $ 325,000 $ 230,000
Variable selling and administrative expenses..... 140,000 100,000 155,000
Contribution margin................................................... $ 210,000 $ 225,000 $ 75,000
Fixed costs:
Fixed manufacturing costs................................ 70,000 55,000 60,000
Fixed selling and administrative expenses.... 60,000 50,000 70,000
$ 130,000 $ 105,000 $ 130,000
Income from operations............................................ $ 80,000 $ 120,000 $ (55,000)
c. If the ski boot line were eliminated, then the contribution margin of the product line would also be eliminated. The fixed costs would not be eliminated. Thus, the profit of the company would actually decline by $75,000. Management should keep the line and attempt to improve the profitability of the product by increasing prices, increasing volume, or reducing costs. Alternatively, if the volume of the other two products were to increase, then the ski boot line could be eliminated and replaced with volume from the other two products.
Ex. 19–10 (Fin Man); Ex. 4–10 (Man)
a.
WHIRLPOOL CORPORATION
Variable Costing Income Statement (assumed)
(in millions)
Sales................................................................................................. $11,016.00
Variable cost of goods sold:
Beginning inventory (70% × $949)..................................... $ 664.30
Variable cost of goods manufactured............................... 6,000.001
Less: Ending inventory (70% × $928)............................... (649.60)
Variable cost of goods sold........................................... 6,014.70
Manufacturing margin................................................................. $ 5,001.30
Variable selling and administrative expenses....................... 1,098.002
Contribution margin..................................................................... $ 3,903.30
Fixed costs:
Fixed manufacturing costs ($243 + $2,200)..................... (2,443.00)
Fixed selling and administrative expenses
($162 + $600)...................................................................... (762.00)
Income from operations.............................................................. $ 698.30
1 Variable Cost of Goods Manufactured:
Cost of goods sold................................................................ $8,464
Plus: Dec. 31 inventory........................................................ 928
Less: Jan. 1 inventory ......................................................... (949)
Cost of goods manufactured............................................. $8,443
Less: Manufacturing depreciation
(60% × $405)........................................................... (243)
Other manufacturing fixed costs...................... (2,200)
Variable cost of goods manufactured.............................. $6,000
2 Variable selling and administrative expenses:
Selling and administrative expenses............................... $1,860
Less: Depreciation expense (40% × $405)..................... (162)
Other selling and administrative
...................................................... fixed expenses (600)
Variable selling and administrative expenses............... $1,098
Ex. 19–10 (Fin Man); Ex. 4–10 (Man) Concluded
b. The income from operations under the variable costing concept will not be the same as the income from operations under the absorption costing concept when the inventories either increase or decrease during the year. In this case, Whirlpool’s inventory decreased, meaning it sold more than it produced. As a result, the income from operations under the variable costing concept will be greater than the income from operations under the absorption costing concept. The reason is because the variable costing concept will deduct the fixed costs in the period that they are incurred, regardless of changes in inventory balances. In contrast, absorption costing will match costs with sales by allocating the fixed costs to the beginning and ending inventories. When sales exceed the cost of goods manufactured (when inventories decrease), fixed costs from the beginning inventory are included in cost of goods sold under absorption costing. Thus, more fixed costs will be included in cost of goods sold than were actually incurred during the period. This will result in a lower income from operations than would be reported under the variable costing concept.
The difference between the income from operations under the two concepts can be explained as follows:
Fixed cost portion of Jan. 1 inventory (30% × $949)............................. $284.70
Less:
Fixed cost portion of Dec. 31 inventory (30% × 928)................. 278.40
Difference
in income from operations....................................................... $ 6.30
Income from operations—variable costing.............................................. $ 698.30
Income
from operations—absorption costing........................................ 692.00
Difference.......................................................................................................... $ 6.30
Ex. 19–11 (Fin Man); Ex. 4–11 (Man)
Ballpoint Fountain
Pen Pen
Unit volume increase................................................................... 5,000 7,500
Contribution
margin per unit..................................................... × $1.70 × $4.20
Increase
in profitability................................................................ $ 8,500 $ 31,500
The increase in total profitability would be $40,000 ($8,500 + $31,500). Note that the income from operations per unit figures are not used in the analysis, since the fixed costs should be excluded in determining the incremental income from operations to be earned from the incremental sales. This is because the company has sufficient capacity for the additional production. Thus, fixed costs will not be affected by the decision.
a.
X-C TV INC.
Contribution Margin by Product
Table Top Console
Sales................................................................................................. $480,000 $600,000
Variable
cost of goods sold....................................................... 270,000 252,000
Manufacturing margin................................................................. $210,000 $348,000
Variable
selling and administrative expenses....................... 90,000 108,000
Contribution margin..................................................................... $120,000 $240,000
Contribution margin ratio........................................................... 25.00% 40.00%
b. The console line provides the largest total contribution margin and the largest contribution margin ratio. If the sales mix were shifted more toward the console line, the overall profitability of the company would increase.
The income from operations per unit is the same for each product. This appears to suggest that management would be indifferent between selling consoles or table tops. This is not the case. The console contribution margin per unit is more than three times that of the table top line; thus, management would prefer to sell consoles. This is because the total fixed costs within the relevant range will not vary with changes in the volume or mix of products sold.
Ex. 19–13 (Fin Man); Ex. 4–13 (Man)
a.
CYCLE SPORT, INC.
Contribution Margin by Territory
Netherlands France
Sales........................................................................................... $4,840,000 $4,020,000
Variable
cost of goods sold................................................. 1,920,000 1,860,000
Manufacturing margin........................................................... $2,920,000 $ 2,160,000
Variable
selling expenses..................................................... 2,000,000 1,300,000
Contribution
margin............................................................... $ 920,000 $ 860,000
Contribution
margin ratio..................................................... 19.01% 21.39%
b. The total contribution margin is slightly higher for the Netherlands, while the contribution margin ratio is slightly higher for France. This is because the Netherlands sells only touring bikes, which have a lower contribution margin ratio (19.01% vs. 25.00%)* but a higher contribution margin per unit ($115 vs. $100). In attempting to improve the company’s profitability, it is unlikely that changing the mix of products to the two territories will have much effect. The Netherlands will sell very few mountain bikes (they have no mountains), while France has a mixed terrain. However, there appears to be a number of profit opportunities. First, the touring bike has a manufacturing margin of $365 per unit, while the mountain bike’s is only $175 per unit. Why such a large difference? Maybe the mountain bike is underpriced or made in inefficient manufacturing processes. Second, the variable selling expense per unit for the touring bike is much higher than that of the mountain bike ($250 vs. $75). This suggests that the variable selling expenses per unit for the touring bike may be too high. It seems difficult to justify a near three-to-one difference in this expense. Reducing the variable selling expense for the touring bike in half, for example, would have a significant impact on the firm’s overall profitability.
* 19.01% = $115 ÷ $605
25.00% = $100 ÷ $400
Ex. 19–14 (Fin Man); Ex. 4–14 (Man)
a. 1.
HCA HARDWARE COMPANY
Contribution Margin by Salesperson
Connie M. Luis A. Barry L. Tamara T.
Sales....................................................... $406,000 $300,000 $320,000 $385,000
Variable
cost of goods sold............. 243,600 120,000 192,000 154,000
Manufacturing margin....................... $162,400 $180,000 $128,000 $231,000
Variable commission expense........ 32,480 36,000 38,400 30,800
Contribution margin........................... $129,920 $144,000 $ 89,600 $200,200
Contribution margin ratio................. 32.00% 48.00% 28.00% 52.00%
2. Tamara T. earns the highest contribution margin and has the highest contribution margin ratio. This is because she sells the most units, has a low commission rate, and sells a product mix with a high manufacturing margin (60% of sales, $33/$55). Luis A. also sells products with a high average manufacturing margin (60% of sales, $36/$60) but at a high commission rate. This accounts for the four percentage point difference in the contribution margin ratio between Tamara T. and Luis A. The other two salespersons sell products with lower average manufacturing margins (40% of sales). Combining this with the high commission rate causes Barry L. to have the poorest contribution margin ratio among the four salespersons. In addition, because Barry L. has the lowest sales volume, he also provides the lowest overall contribution margin. Again, the four percentage point difference between Barry L. and Connie M. is due to the difference in their commission rates.
b. 1.
HCA HARDWARE COMPANY
Contribution Margin by Territory
Northern Southern
Sales........................................................................................... $ 706,000 $ 705,000
Variable
cost of goods sold................................................. 363,600 346,000
Manufacturing margin........................................................... $ 342,400 $ 359,000
Variable
commission expense............................................
68,480 69,200
Contribution
margin............................................................... $ 273,920 $ 289,800
Contribution margin ratio..................................................... 38.80% 41.11%
Ex. 19–14 (Fin Man); Ex. 4–14 (Man) Concluded
2. Both regions have nearly the same total aggregate sales; however, they earn different contribution margins. The Southern region has the largest contribution margin ratio and a slightly higher total contribution margin. In the Southern region, the salesperson with the highest sales unit volume also has the highest contribution margin ratio (Tamara T.). The Southern region has the highest performance, even though it also has the salesperson with the lowest sales volume and contribution margin ratio (Barry L.). In the Northern region, both salespersons are performing similarly. The Northern region contribution margin is less than the Southern region because of the outstanding performance of Tamara T. Tamara T. is driving the Southern region’s performance.
a.
CATERPILLAR, INC.
Segment Contribution Margin (assumed)
(in millions, except ratio figures)
Europe/Africa/
Middle East Latin Power North
Asia/Pacific (EAME) America Products America
Sales........................................ $ 1,660.00 $ 2,828.00 $ 1,313.00 $ 5,736.00 $ 5,575.00
Variable
cost of goods sold.. 830.00 1,696.80 590.85 3,441.60 2,899.00
Manufacturing margin............ $ 830.00 $ 1,131.20 $ 722.15 $ 2,294.40 $ 2,676.00
Dealer commissions............... $ 132.80 $ 339.36 $ 105.04 $ 286.80 $ 446.00
Variable
promotion expenses 400.00 450.00 300.00 750.00
900.00
Variable
selling expenses..... $ 532.80 $ 789.36 $ 405.04 $ 1,036.80 $ 1,346.00
Contribution
margin............... $ 297.20 $ 341.84 $ 317.11 $ 1,257.60 $ 1,330.00
Contribution margin ratio...... 17.90% 12.09% 24.15% 21.92% 23.86%
b.
Europe/Africa/
Middle East Latin Power North
Asia/Pacific (EAME) America Products America
Manufacturing margin
as percent of sales........... 50.00% 40.00% 55.00% 40.00% 48.00%
Dealer commissions
as percent of sales........... (8.00) (12.00) (8.00) (5.00) (8.00)
Variable promotion expenses
as percent of sales........... (24.10) (15.91) (22.85) (13.08) (16.14)
Contribution margin ratio...... 17.90% 12.09% 24.15% 21.92% 23.86%
Ex. 19–15 (Fin Man); Ex. 4–15 (Man) Concluded
c. The Latin American segment has the highest contribution margin ratio. This is because this region has a low dealer commission as a percent of sales combined with the largest manufacturing margin. This may be due to the lower labor costs to manufacture and sell product in Latin America. North America also has a healthy contribution margin ratio. The manufacturing margin is about average as is the dealer commission rate. The variable promotion expenses as a percent of sales is better than average. North America may be able to generate more sales per promotional dollar because it is a part of the world that can afford a higher concentration of heavy equipment. EAME is the poorest performing segment in terms of contribution margin ratio. This is because the manufacturing margin is the lowest and dealer commissions are the highest. The high dealer commission is out of balance with the rest of the world. This may be the result of the high labor cost structure of Europe. Asia/Pacific performs about average with respect to manufacturing margin and dealer commissions; however, the variable promotion expenses as a percent of revenue are very high. This might be because Caterpillar competes head-to-head with Komatsu (a Japanese company) in this part of the world or must engage in heavy promotional effort to establish itself in this part of the world. Also, Asia/Pacific may not be able to afford the same concentration of heavy equipment as other regions, requiring greater promotional effort per dollar of sales. The Power Products are sold mostly to other manufacturers. As a result, each sale has more volume and requires less effort, so the commission rate is lower. This helps the Power Products segment perform well in light of a low manufacturing margin.
Ex. 19–16 (Fin Man); Ex. 4–16 (Man)
a.
Cable Television Infinity Entertainment
Video
Revenues............................. $4,727.00 $7,490.00 $3,755.00 $3,647.00 $5,566.00
Variable costs...................... 709.05 1,123.50 375.50 911.75 3,617.90
Contribution margin............ $4,017.95 $6,366.50 $3,379.50 $2,735.25 $1,948.10
Contribution margin ratio... 85% 85% 90% 75% 35%
b. The cable, television, infinity, and entertainment segments sell an information or media product that has a very small variable cost per unit. For example, the cable segment earns revenue monthly from each subscriber to MTV. However, the variable cost of each subscriber to MTV is rather small. The cost of programming MTV is essentially fixed, whether there are few or many subscribers. The same holds true for the television, infinity, and entertainment segments. The variable cost per ticket sold to a motion picture is rather small. The costs of producing and promoting a new film are essentially fixed to the number of tickets sold. The studio will have enough capacity to release a set number of films per year. The costs will be incurred regardless of the number of tickets sold. The same logic holds for the CBS television network and the radio stations. Much of their costs are fixed to the number of viewers and listeners. The video segment rents and sells products that do have a variable cost per unit. The cost of videotape and DVDs will increase as more units are rented and sold. The labor costs of running Blockbuster stores are probably semivariable to the volume. Thus, the video segment will have a much lower contribution margin ratio than the other segments.
c. The higher contribution margin ratios of the cable, television, infinity, and entertainment segments should not be interpreted that they are the most profitable. The fixed costs cannot be ignored. These segments will have high fixed costs. If the volume of business is not sufficient to exceed the break-even point, then the segments would be unprofitable. In the final analysis, the fixed costs should also be considered in determining the overall profitability of the segments. The contribution margin ratio shows how sensitive the profit will be to changes in volume. These segments increase their profitability rapidly with increases in audience volume, compared to the video segment.
Ex. 19–17 (Fin Man); Ex. 4–17 (Man)
NEW SOUND MUSIC COMPANY
Contribution Margin Analysis—Sales
For the Year Ended December 31, 2006
a. Increase in the amount of sales attributed to:
Quantity factor:
Increase in number of units sold in 2006 1,500
Planned sales price in 2006................... × $17.00 $25,500
Price factor:
Decrease in unit sales price in 2006.... ($1.50)
Number of units sold in 2006................. × 10,000 (15,000)
Net increase in amount of sales...................... $10,500
b. The sales will increase by $10,500. If the variable cost per unit were $6, and there were 1,500 more units than planned, then the variable cost will increase by $9,000 due to the quantity factor. Thus, the contribution margin will increase by $1,500 ($10,500 – $9,000) as a result of the price reduction.
HIGHLAND PRODUCTS INC.
Contribution Margin Analysis—Sales
For the Year Ended December 31, 2006
Increase in the amount of sales attributed to:
Quantity factor:
Decrease in number of units sold in 2006.................. (500)
Planned sales price in 2006........................................... × $155.00 $ (77,500)
Price factor:
Increase in unit sales price in 2006.............................. $10.00
Number of units sold in 2006......................................... × 13,400 134,000
Net
increase in amount of sales................................................ $ 56,500
Ex. 19–19 (Fin Man); Ex. 4–19 (Man)
HIGHLAND PRODUCTS INC.
Contribution Margin Analysis—Variable Costs
For the Year Ended December 31, 2006
Increase in the amount of variable cost of
goods sold attributed to:
Quantity factor:
Decrease in number of units sold in 2006... (500)
Planned variable cost per unit in 2006......... × $86.00 $ (43,000)
Price factor:
Increase in variable cost per unit in 2006.... $4.00
Number of units sold in 2006.......................... × 13,400
53,600
Net increase in amount of variable cost of
goods sold........................................................... $ 10,600
Decrease in the amount of variable selling and
administrative expenses attributed to:
Quantity factor:
Decrease in number of units sold in 2006... (500)
Planned variable selling and
administrative cost per unit in 2006.......... × $17.50 $ (8,750)
Price factor:
Decrease in variable selling and
administrative cost per unit in 2006.......... $(1.50)
Number of units sold in 2006.......................... × 13,400 (20,100)
Net decrease in amount of variable selling
and administrative expenses.......................... (28,850)
Net
decrease in amount of variable costs............ $ (18,250)
Ex. 19–20 (Fin Man); Ex. 4–20 (Man)
a.
ERUDITE UNIVERSITY
Contribution Margin and Income from Operations Report
For the Fall Term 2006
Revenue.................................................................................................................. $7,260,000
Registration, records, and marketing cost..................................................... $1,232,000
Instructional
costs................................................................................................ 4,554,000
Total variable costs.............................................................................................. $5,786,000
Contribution margin............................................................................................. $1,474,000
Depreciation on classrooms and equipment................................................ 890,000
Income from operations...................................................................................... $ 584,000
Supporting Calculations
Revenue: $110 × 66,000 credit hours
Registration, records, and marketing costs: $280 × 4,400 students
Instructional costs: $69 × 66,000 credit hours
Ex. 19–20 (Fin Man); Ex. 4–20 (Man) Concluded
b.
ERUDITE UNIVERSITY
Contribution Margin Analysis—Planned vs. Actual
For the Fall Term 2006
Increase in revenue attributed to:
Quantity factor:
Increase in the number of credit hours........ 18,000
Planned price...................................................... × $120 $2,160,000
Price factor:
Decrease in tuition............................................. $(10.00)
Number of credit hours.................................... × 66,000
(660,000)
Net increase in revenue........................................ $1,500,000
Increase in registration, records, and
marketing costs attributed to:
Quantity factor:
Increase in number of students enrolled..... 400
Planned unit cost .............................................. × $280
Net increase in food and beverage service
expenses.............................................................. (112,000)
Increase in instructional costs attributed to:
Quantity factor:
Increase in the number of credit hours........ 18,000
Planned unit cost .............................................. × $65 $1,170,000
Price factor:
Increase in the instructional cost
per credit hour............................................... $4
Number of credit hours.................................... × 66,000 264,000
Net increase in instructional costs.................... (1,434,000)
Decrease
in contribution margin............................ $ (46,000)
Ex. 19–21 (Fin Man); Ex. 4–21 (Man)
a.
COASTAL RAILROAD COMPANY
Contribution Margin Report by Route
For the Month Ended July 31, 2006
Atlanta/ Baltimore/ Pittsburgh/
Baltimore Pittsburgh Atlanta Total
Revenues........................................ $310,000 $812,000 $750,000 $1,872,000
Labor costs for loading and
unloading railcars............. 27,500 154,000 82,500 264,000
Fuel costs................................. 168,000 105,000 204,000 477,000
Train crew labor costs........... 98,000 61,250 119,000 278,250
Switchyard labor costs......... 17,500 98,000 52,500 168,000
Total variable costs.......... $311,000 $418,250 $458,000 $1,187,250
Contribution
margin..................... $ (1,000) $393,750 $292,000 $
684,750
Contribution margin ratio –0.32% 48.49% 38.93% 36.58%
Revenues: Revenue per rail car × Number of railcars
Labor costs for loading and unloading: $55 × Number of railcars
Fuel costs: $12 × Number of train-miles
Train crew labor costs: $7 × Number of train-miles
Switchyard labor costs: $35 × Number of railcars
b. The Atlanta/Baltimore route performs significantly worse than do the other two routes. A close examination of the operating statistics indicates that this route runs very few railcars, combined with fairly high total mileage. This combination suggests that the railroad is running many short trains on the railroad. That is, the railroad’s profitability is very sensitive to the size, or length, of the train in railcar terms. A short train costs nearly as much fuel and crewing costs as does a longer train. Thus, short trains will be inherently less profitable than longer trains. The other two routes have much better ratios of train-miles to railcars, indicating that their train sizes are larger.
Note to Instructors: Part (b) is somewhat subtle but a worthy discussion. The cost behavior issues discussed in (b) are common in service companies. For example, large classes in a university are inherently more profitable than small classes, dense data traffic on a telecommunication system is more profitable than less traffic, and faster table turns in a restaurant creates greater profitability than do slower turns, etc.
Ex. 19–22 (Fin Man); Ex. 4–22 (Man)
a. COASTAL RAILROAD COMPANY
Contribution Margin Report for Atlanta/Baltimore Route
For the Month Ended August 31, 2006
Revenues ($550 × 900 railcars)................................................................... $495,000
Labor costs for loading and unloading
railcars
($55 × 900 railcars).............................................................................. 49,500
Fuel costs ($12 × 14,000 train-miles).................................................... 168,000
Train crew labor costs ($7 × 14,000 train-miles)................................ 98,000
Switchyard labor costs ($35 × 900 railcars)....................................... 31,500
Total variable costs............................................................................ $ 347,000
Contribution margin....................................................................................... $148,000
Contribution margin ratio............................................................................. 29.90%
b. COASTAL RAILROAD COMPANY
Contribution Margin Analysis
For the Month Ended August 31, 2006
Increase in revenue attributed to:
Quantity factor:
Increase in the number of
railcars in August......................................... 400
Planned price...................................................... × $620 $248,000
Price factor:
Decrease price per railcar in August............ $(70)
Number of railcars sold in August................. × 900 (63,000)
Net increase in revenue......................................... $185,000
Increase in loading/unloading labor cost
attributed to:
Quantity factor:
Increase in the number of railcars
in August........................................................ 400
Planned unit cost in May.................................. ×$55.00
Net increase in loading/unloading labor cost.. (22,000)
Increase in switchyard labor costs attributed to:
Quantity factor:
Increase in the number of railcars
in August........................................................ 400
Planned unit cost in August............................ $35
Net increase in switchyard labor costs.............. (14,000)
Increase
in contribution margin................................. $ 149,000
Note to Instructors: If Exercise 19–21 was assigned, the increase in contribution margin can be reconciled. The $149,000 increase in the contribution margin is equal to the contribution margin for the route in part (a) of $148,000 less the ($1,000) contribution margin for the route in Exercise 19–21.
Prob. 19–1A (Fin Man); Prob. 4–1A (Man)
1. MIRACLE KITCHEN APPLIANCE COMPANY
Absorption Costing Income Statement
For the Month Ended August 31, 2007
Sales................................................................................................. $924,800
Cost of goods sold:
Cost of goods manufactured............................................... $639,000
Less inventory, August 31 (60 units ×
$450*).................. 27,000
Cost of goods sold........................................................... 612,000
Gross profit..................................................................................... $312,800
Selling
and administrative expenses....................................... 115,600
Income from operations.............................................................. $197,200
*$639,000 ÷ 1,420 units = $450
2. MIRACLE KITCHEN APPLIANCE COMPANY
Variable Costing Income Statement
For the Month Ended August 31, 2007
Sales................................................................................................. $924,800
Variable cost of goods sold:
Variable cost of goods manufactured............................... $539,600
Less inventory, August 31 (60 × $380*)............................. 22,800
Variable cost of goods sold........................................... 516,800
Manufacturing margin................................................................. $408,000
Variable selling and administrative expenses....................... 81,600
Contribution margin..................................................................... $326,400
Fixed costs:
Fixed manufacturing costs.................................................. $ 99,400
Fixed selling and administrative expenses...................... 34,000 133,400
Income from operations.............................................................. $193,000
*$539,600 ÷ 1,420 = $380
3. The income from operations reported under absorption costing exceeds the income from operations reported under variable costing by $4,200 ($197,200 – $193,000). This $4,200 is due to including $4,200 of fixed manufacturing cost in inventory under absorption costing [60 units × $70 ($99,400 ÷ 1,420)]. The $4,200 was thus deferred to a future month under absorption costing, while it was included as an expense of August (part of fixed costs) under variable costing.
Prob. 19–2A (Fin Man); Prob. 4–2A (Man)
1. ALBANY PRODUCTS INC.
Estimated Income Statement—Absorption Costing—Solvent
For the Month Ending October 31, 2007
Sales (2,400 units)......................................................................... $228,000
Cost of goods sold:
Direct materials........................................................................ $91,200
Direct labor............................................................................... 34,800
Variable manufacturing cost................................................ 28,080
Fixed manufacturing cost..................................................... 50,000
Cost of goods sold........................................................... 204,080
Gross profit..................................................................................... $ 23,920
Selling and administrative expenses:
Variable selling and administrative expenses................. $ 14,400
Fixed selling and administrative expenses...................... 24,500 38,900
Loss
from operations.................................................................. $ (14,980)
2. ALBANY PRODUCTS INC.
Estimated Income Statement—Variable Costing—Solvent
For the Month Ending October 31, 2007
Sales (2,400 units)......................................................................... $228,000
Variable cost of goods sold:
Direct materials........................................................................ $91,200
Direct labor............................................................................... 34,800
Variable manufacturing cost................................................ 28,080 154,080
Manufacturing margin................................................................. $ 73,920
Variable
selling and administrative expenses....................... 14,400
Contribution margin..................................................................... $ 59,520
Fixed costs:
Fixed manufacturing cost..................................................... $50,000
Fixed selling and administrative expenses...................... 24,500 74,500
Loss
from operations.................................................................. $ (14,980)
3. $74,500. The loss from operations from temporarily closing the portion of the plant associated with solvent would be $74,500 (fixed manufacturing cost of $50,000 plus fixed selling and administrative expenses of $24,500).
4. Production of solvent should be continued. Temporary suspension of production would result in an operating loss of $74,500 (from [3] above), compared with a loss from operations of $14,980 if production is continued. The savings of $59,520, measured by the excess of $74,500 over $14,980, is the amount reported as contribution margin on the variable costing income statement.
Prob. 19–3A (Fin Man); Prob. 4–3A (Man)
1. a. SOUND OFF SHIRT COMPANY
Absorption Costing Income Statement
For the Month Ended July 31, 2006
Sales................................................................................................. $450,000
Cost of goods sold:
Cost of goods manufactured............................................... $373,620
Less inventory, July 31 (3,000 units ×
$9.58*).................. 28,740
Cost of goods sold........................................................... $344,880
Gross profit..................................................................................... $105,120
Selling
and administrative expenses....................................... 30,600
Income
from operations.............................................................. $ 74,520
*$373,620 ÷ 39,000 = $9.58
b. SOUND OFF SHIRT COMPANY
Absorption Costing Income Statement
For the Month Ended August 31, 2006
Sales................................................................................................. $450,000
Cost of goods sold:
Inventory, August 1 (3,000 units × $9.58).......................... 28,740
Cost of goods manufactured............................................... $321,420
Cost of goods sold........................................................... $350,160
Gross profit..................................................................................... $ 99,840
Selling
and administrative expenses....................................... 30,600
Income
from operations.............................................................. $ 69,240
2. a. SOUND
OFF SHIRT COMPANY
Variable Costing Income Statement
For the Month Ended July 31, 2006
Sales................................................................................................. $450,000
Variable cost of goods sold:
Variable cost of goods manufactured............................... $339,300
Less inventory, July 31 (3,000 units ×
$8.70*).................. 26,100
Variable cost of goods sold........................................... 313,200
Manufacturing margin................................................................. $136,800
Variable
selling and administrative expenses....................... 18,000
Contribution margin..................................................................... $118,800
Fixed costs:
Fixed manufacturing costs.................................................. $ 34,320
Fixed selling and administrative expenses...................... 12,600 46,920
Income
from operations.............................................................. $ 71,880
*$339,300 ÷ 39,000 = $8.70
Prob. 19–3A (Fin Man); Prob. 4–3A (Man) Concluded
b. SOUND OFF SHIRT COMPANY
Variable Costing Income Statement
For the Month Ended August 31, 2006
Sales................................................................................................. $450,000
Variable cost of goods sold:
Inventory, August 1 (3,000 units × $8.70).......................... $ 26,100
Variable cost of goods manufactured............................... 287,100
Variable cost of goods sold........................................... 313,200
Manufacturing margin................................................................. $136,800
Variable
selling and administrative expenses....................... 18,000
Contribution margin..................................................................... $118,800
Fixed costs:
Fixed manufacturing costs.................................................. $ 34,320
Fixed selling and administrative expenses...................... 12,600 46,920
Income
from operations.............................................................. $ 71,880
3. a. For July, the income from operations reported under absorption costing exceeds the income from operations reported under variable costing by $2,640. This difference is due to including $2,640 of fixed manufacturing cost in inventory under absorption costing [3,000 units × $0.88 ($34,320 ÷ 39,000)]. The $2,640 was thus deferred to August under absorption costing, while it was included as an expense of July (part of fixed costs) under variable costing.
b. For August, the income from operations reported under absorption costing is less than the income from operations reported under variable costing by $2,640. This difference is due to including $2,640 of fixed manufacturing cost in the August 1 inventory under absorption costing (3,000 units × $0.88). Thus, this $2,640 was included in August’s cost of goods sold under absorption costing. Under variable costing, this $2,640 was included as an expense of July (part of the fixed costs) and thus is excluded from August’s income statement.
4. Sound Off Shirt Company was equally profitable in July and in August under the variable costing concept. Sales and the variable cost per unit were the same for both July and August. The difference in income reported under the absorption costing concept is due to allocating $2,640 of fixed manufacturing cost to the July 31 ending inventory.
Note: The combined income from operations reported for July and August ($143,760) is the same for both absorption costing and variable costing. This problem illustrates the need for management to exercise care in interpreting income from operations reported under absorption costing when large changes in inventory levels occur.
Prob. 19–4A (Fin Man); Prob. 4–4A (Man)
1. RIVER CITY BAND INSTRUMENT COMPANY
Salespersons’ Analysis
For the Year Ended December 31, 2007
Variable
Variable Cost Selling
of Goods Sold Expenses Contribution
Contribution as a Percent as a Percent Margin
Salesperson Margin of Sales of Sales Ratio
Alpert $ 100,000 60.0% 20.0% 20.0%
Armstrong 95,000 63.0 19.4 17.6
Goodman 170,000 54.2 17.5 28.3
Hirt 105,000 62.2 16.3 21.4
Kenny G. 110,000 58.3 18.8 22.9
Marsalis 125,000 57.1 19.0 23.8
Severinsen 100,000 60.0 21.8 18.2
2. Goodman has the highest contribution margin and contribution margin ratio for the year. This is because of two factors. First, Goodman has the smallest variable cost of goods sold as a percent of sales. This is probably due to selling a favorable mix of product that has high manufacturing margins as a percent of sales. Second, Goodman has the lowest variable selling expenses as a percent of sales. This could be due to a lower sales commission or selling support costs.
3. Other factors that should be considered in evaluating the performance of salespersons include rate of growth in sales for the current year compared with past years, years of experience for salespersons, size of sales territory, and actual sales compared with budgeted sales.
Prob. 19–5A (Fin Man); Prob. 4–5A (Man)
1. ALASKAN COAT COMPANY
Variable Costing Income Statement
For the Year Ended June 30, 2006
Size
S M L Total
Sales....................................................... $560,000 $620,000 $850,000 $ 2,030,000
Variable
cost of goods sold............. 250,000 300,000 350,000 900,000
Manufacturing margin....................... $310,000 $320,000 $500,000 $ 1,130,000
Variable
operating expenses........... 110,000 145,000 160,000 415,000
Contribution margin........................... $200,000 $175,000 $340,000 $ 715,000
Fixed costs:
Manufacturing costs...................................................................................... $ 320,000
Operating expenses....................................................................................... 290,000
Total fixed costs........................................................................................ $ 610,000
Income
from operations...................................................................................... $ 105,000
2. Annual income from operations would be reduced below its present level by $93,000 if Size M were to be discontinued (Proposal 2), as indicated below:
Contribution margin for Size M.................................................................. $175,000
Less reduction in fixed production costs and fixed operating
expenses ($50,000 + $32,000).................................................... 82,000
Reduction in annual income from
operations....................................... $
93,000
If Size M is discontinued, $175,000 of contribution margin would be forgone and only $82,000 in fixed costs would be saved, resulting in a decrease of $93,000 in income from operations.
Prob. 19–5A (Fin Man); Prob. 4–5A (Man) Concluded
3. ALASKAN COAT COMPANY
Variable Costing Income Statement—Proposal 3
Size
S L Total
Sales................................................................... $1,288,000 $850,000 $ 2,138,000
Variable
cost of goods sold......................... 575,000 350,000 925,000
Manufacturing margin................................... $ 713,000 $500,000 $ 1,213,000
Variable
operating expenses....................... 253,000 160,000 413,000
Contribution margin....................................... $ 460,000 $340,000 $ 800,000
Fixed costs:
Manufacturing costs...................................................................................... $ 320,000
Operating expenses (including $40,000
additional rent)...................... 330,000
Total fixed costs........................................................................................ $ 650,000
Income
from operations...................................................................................... $ 150,000
4. $45,000. A comparison of the amount of income from operations under present conditions, as indicated in (1), and under Proposal 3, as indicated in (3), suggest an increase of $45,000 if Proposal 3 is accepted, as illustrated below:
Income from operations, Proposal 3........................................................ $150,000
Income from operations, present
conditions......................................... 105,000
Increase in income from operations......................................................... $ 45,000
Alternatively, the $45,000 increase can be determined as follows:
Contribution margin, Size S, Proposal 3................................................. $460,000
Contribution margin, Size S, present
operations.................................. 200,000
Increase in contribution margin................................................................. $260,000
Less contribution margin, Size M, present operations $175,000
Additional rent........................................................................ 40,000 215,000
Increase in income from operations................................. $ 45,000
Prob. 19–6A (Fin Man); Prob. 4–6A (Man)
1. ALPHA INDUSTRIES INC.
Contribution Margin Analysis
For the Year Ended December 31, 2006
Increase in the amount of sales attributed to:
Quantity factory:
Decrease in number of units sold in 2006...... (1,000)
Planned sales price in 2006............................... × $40.00 $ (40,000)
Price factor:
Increase in unit sales price in 2006.................. $5.00
Number of units sold in 2006............................. × 9,000 45,000
Net increase in amount of sales.............................. $ 5,000
Decrease in the amount of variable cost of
goods sold attributed to:
Quantity factor:
Decrease in number of units sold in 2006...... (1,000)
Planned variable cost per unit in 2006............ × $17.00 $ (17,000)
Price factor:
Increase in variable cost per unit in 2006....... $1.00
Number of units sold in 2006............................. × 9,000
9,000
Net decrease in amount of variable cost of
goods sold.............................................................. $ (8,000)
Increase in the amount of variable selling
and administrative expenses attributed to:
Quantity factor:
Decrease in number of units sold in 2006...... (1,000)
Planned variable selling and
administrative cost per unit in 2006........... × $9.00 $ (9,000)
Price factor:
Increase in variable selling and
administrative cost per unit in 2006............ $3.00
Number of units sold in 2006............................. × 9,000 27,000
Net increase in variable selling and
administrative expenses..................................... $ 18,000
Net increase in amount of variable costs................... 10,000
Decrease
in contribution margin.................................. $ (5,000)
Prob.
19–6A (Fin Man); Prob. 4–6A (Man) Concluded
2. The president’s first statement appears correct taken at face value. The president is incorrect regarding variable cost of goods sold. The majority of the decrease in the variable cost of goods sold was due to the quantity factor. However, this decrease was offset by a $1.00 increase in the variable cost of goods sold per unit. The contribution margin improved, but some inefficiency reduced the expected amount of improvement from the quantity factor.
The president is correct in saying that an investigation of the increase in variable selling and administrative expenses is needed. The price factor increased by $3.00, which more than offset the favorable quantity factor, resulting in an overall decrease in the contribution margin. The increase in the variable selling and administrative expenses is probably due to the additional selling effort required in the face of price increases. It will probably be very difficult to improve the efficiency of this effort as prices go up. Therefore, the president’s suggestion is probably unwarranted. Increasing the price again will require even more selling effort to overcome this negative influence. In addition, there is a limit as to how much price increase the market will likely be able to accommodate.
Prob. 19–1B (Fin Man); Prob. 4–1B (Man)
1. CONNECTEX MODEM COMPANY
Absorption Costing Income Statement
For the Month Ended June 30, 2006
Sales................................................................................................. $787,750
Cost of goods sold:
Cost of goods manufactured............................................... $572,400
Less inventory, June 30 (350 units ×
$79.50*)................. 27,825
Cost of goods sold........................................................... 544,575
Gross profit..................................................................................... $243,175
Selling
and administrative expenses....................................... 85,625
Income from operations.............................................................. $157,550
*$572,400 ÷ 7,200 = $79.50
2. CONNECTEX MODEM COMPANY
Variable Costing Income Statement
For the Month Ended June 30, 2006
Sales................................................................................................. $787,750
Variable cost of goods sold:
Variable cost of goods manufactured............................... $532,800
Less inventory, June 30 (350 × $74.00*)............................ 25,900
Variable cost of goods sold........................................... 506,900
Manufacturing margin................................................................. $280,850
Variable
selling and administrative expenses....................... 65,075
Contribution margin..................................................................... $215,775
Fixed costs:
Fixed manufacturing costs.................................................. $ 39,600
Fixed selling and administrative expenses...................... 20,550 60,150
Income
from operations.............................................................. $ 155,625
*$532,800 ÷ 7,200 = $74.00
3. The income from operations reported under absorption costing exceeds the income from operations reported under variable costing by $1,925 ($157,550 – $155,625). This difference is due to including $1,925 of fixed manufacturing cost in inventory under absorption costing [350 units × $5.50 ($39,600 ÷ 7,200)]. The $1,925 was thus deferred to a future month under absorption costing, while it was included as an expense of June (part of fixed costs) under variable costing.
Prob. 19–2B (Fin Man); Prob. 4–2B (Man)
1. APHRODITE INC.
Estimated Income Statement—Absorption Costing—Shampoo
For the Month Ending February 28, 2006
Sales (48,000 units)...................................................................... $ 537,600
Cost of goods sold:
Direct materials........................................................................ $100,800
Direct labor............................................................................... 132,000
Variable manufacturing cost................................................ 57,600
Fixed manufacturing cost..................................................... 240,000
Cost of goods sold........................................................... 530,400
Gross profit..................................................................................... $ 7,200
Selling and administrative expenses:
Variable selling and administrative expenses................. $ 81,600
Fixed selling and administrative expenses...................... 42,000 123,600
Operating
loss............................................................................... $ (116,400)
2. APHRODITE INC.
Estimated Income Statement—Variable Costing—Shampoo
For the Month Ending February 28, 2006
Sales (48,000 units)...................................................................... $ 537,600
Variable cost of goods sold:
Direct materials........................................................................ $100,800
Direct labor............................................................................... 132,000
Variable manufacturing cost................................................ 57,600 290,400
Manufacturing margin................................................................. $ 247,200
Variable
selling and administrative expenses....................... 81,600
Contribution margin..................................................................... $ 165,600
Fixed costs:
Fixed manufacturing cost..................................................... $240,000
Fixed selling and administrative expenses...................... 42,000 282,000
Operating loss............................................................................... $ (116,400)
3. $282,000. The operating loss from temporarily closing the portion of the plant associated with shampoo would be $282,000 (fixed manufacturing cost of $240,000 plus fixed selling and administrative expenses of $42,000). This assumes that the variable costs are all avoidable.
4. Production of shampoo should be continued. Temporary suspension of production would result in an operating loss of $282,000 (from [3] above), compared with an operating loss of $116,400 if production is continued. The savings of $165,600, measured by the excess of $282,000 over $116,400, is the amount reported as contribution margin on the variable costing income statement.
Prob. 19–3B (Fin Man); Prob. 4–3B (Man)
1. a.
HOLIDAY BAKERY INC.
Absorption Costing Income Statement
For the Month Ended May 31, 2006
Sales................................................................................................. $35,000
Cost of goods sold:
Cost of goods baked............................................................. $21,600
Less inventory, May 31 (200 units ×
$7.20*)..................... 1,440
Cost of goods sold........................................................... 20,160
Gross profit..................................................................................... $ 14,840
Selling
and administrative expenses....................................... 4,340
Income
from operations.............................................................. $ 10,500
*$21,600 ÷ 3,000 units = $7.20
b.
HOLIDAY BAKERY INC.
Absorption Costing Income Statement
For the Month Ended June 30, 2006
Sales................................................................................................. $35,000
Cost of goods sold:
Inventory, June 1 (200 units × $7.20)................................. $ 1,440
Cost of goods baked............................................................. 19,240
Cost of goods sold........................................................... 20,680
Gross profit..................................................................................... $ 14,320
Selling
and administrative expenses....................................... 4,340
Income
from operations.............................................................. $ 9,980
Prob. 19–3B (Fin Man); Prob. 4–3B (Man) Continued
2. a.
HOLIDAY BAKERY INC.
Variable Costing Income Statement
For the Month Ended May 31, 2006
Sales................................................................................................. $35,000
Variable cost of goods sold:
Variable cost of goods baked.............................................. $17,700
Less inventory, May 31 (200 units ×
$5.90*)..................... 1,180
Variable cost of goods sold........................................... 16,520
Manufacturing margin................................................................. $ 18,480
Variable
selling and administrative expenses....................... 3,360
Contribution margin..................................................................... $ 15,120
Fixed costs:
Fixed manufacturing costs.................................................. $ 3,900
Fixed selling and administrative expenses...................... 980 4,880
Income
from operations.............................................................. $ 10,240
*$17,700 ÷ 3,000 = $5.90
b.
HOLIDAY BAKERY INC.
Variable Costing Income Statement
For the Month Ended June 30, 2006
Sales................................................................................................. $ 35,000
Variable cost of goods sold:
Inventory, June 1 (200 units × $5.90)................................. $ 1,180
Variable cost of goods baked.............................................. 15,340
Variable cost of goods sold........................................... 16,520
Manufacturing margin................................................................. $ 18,480
Variable
selling and administrative expenses....................... 3,360
Contribution margin..................................................................... $ 15,120
Fixed costs:
Fixed manufacturing costs.................................................. $ 3,900
Fixed selling and administrative expenses...................... 980 4,880
Income
from operations.............................................................. $ 10,240
Prob. 19–3B (Fin Man); Prob. 4–3B (Man) Concluded
3. a. For May, the income from operations reported under absorption costing exceeds the income from operations reported under variable costing by $260. This difference is due to including $260 of fixed baking cost in inventory under absorption costing [200 units × $1.30, ($3,900 ÷ 3,000)]. The $260 was thus deferred to June under absorption costing, while it was included as an expense of May (part of fixed costs) under variable costing.
b. For June, the income from operations reported under absorption costing is less than the income from operations reported under variable costing by $260. This difference is due to including $260 of fixed baking cost in the June 1 inventory under absorption costing (200 units × $1.30). Thus, this $260 was included in June’s cost of goods sold under absorption costing. Under variable costing, this $260 was included as an expense of May (part of the fixed costs) and thus is excluded from June’s income statement.
4. Holiday Bakery Inc. was equally profitable in May and in June under the variable costing concept. Sales and the variable cost per unit were the same for both May and June. The difference in income reported under the absorption costing concept is due to allocating $260 of fixed baking cost to the May 31 ending inventory.
Note: The combined income from operations reported for May and June ($20,480) is the same for both absorption costing and variable costing. This problem illustrates the need for management to exercise care in interpreting income from operations reported under absorption costing when large changes in inventory levels occur.
Prob. 19–4B (Fin Man); Prob. 4–4B (Man)
1.
WESTERN WEAR DEPOT, INC.
Salespersons’ Analysis
For the Year Ended June 30, 2007
Variable
Variable Cost Selling
of Goods Sold Expenses Contribution
Contribution as a Percent as a Percent Margin
Salesperson Margin of Sales of Sales Ratio
Cooper $ 110,000 48.6% 20.0% 31.4%
Eastwood 135,000 47.6 20.2 32.1
Ladd 140,000 50.0 22.0 28.0
Marvin 145,000 47.9 21.9 30.2
Newman 110,000 47.6 26.2 26.2
Redford 200,000 44.4 18.5 37.0
Wayne 160,000 45.9 21.4 32.7
2. Redford has the highest contribution margin and contribution margin ratio for the year. This is because of two factors. First, Redford had the smallest variable cost of goods sold as a percent of sales. This is probably due to selling a favorable mix of product that has high manufacturing margins as a percent of sales. Second, Redford has the lowest variable selling expenses as a percent of sales. This could be due to a lower sales commission or selling support costs.
3. Other factors that should be considered in evaluating the performance of salespersons include rate of growth in sales for the current year compared with past years, years of experience for salespersons, size of sales territory, and actual sales compared with budgeted sales.
Prob. 19–5B (Fin Man); Prob. 4–5B (Man)
1.
AUDITORIUM SEATING COMPANY
Variable Costing Income Statement
For the Year Ended January 31, 2006
Size
S M L Total
Sales................................................. $1,040,000 $ 1,250,000 $ 1,100,000 $ 3,390,000
Variable
cost of goods sold....... 560,000 780,000 625,000 1,965,000
Manufacturing margin................. $ 480,000 $ 470,000 $ 475,000 $ 1,425,000
Variable
operating expenses..... 120,000 145,000 120,000 385,000
Contribution margin..................... $ 360,000 $ 325,000 $ 355,000 $ 1,040,000
Fixed costs:
Manufacturing costs...................................................................................... $ 865,000
Operating expenses....................................................................................... 107,000
Total fixed costs........................................................................................ $ 972,000
Income
from operations...................................................................................... $ 68,000
2. Annual income from operations would be reduced below its present level by $165,000 if Size M were to be discontinued (Proposal 2), as indicated below:
Contribution margin for Size M.................................................................. $325,000
Less reduction in fixed production costs and fixed operating
expenses ($140,000 +
$20,000).................................................. 160,000
Reduction in annual income from
operations....................................... $165,000
If Size M is discontinued, $325,000 of contribution margin would be forgone and only $160,000 in fixed costs would be saved, resulting in a decrease of $165,000 in income from operations.
Prob. 19–5B (Fin Man); Prob. 4–5B (Man) Concluded
3.
AUDITORIUM SEATING COMPANY
Variable Costing Income Statement—Proposal 3
Size
S L Total
Sales......................................................................... $ 2,600,000 $ 1,100,000 $ 3,700,000
Variable cost of goods sold............................... 1,400,000 625,000 2,025,000
Manufacturing margin......................................... $ 1,200,000 $ 475,000 $ 1,675,000
Variable operating expenses............................. 300,000 120,000 420,000
Contribution margin............................................. $ 900,000 $ 355,000 $ 1,255,000
Fixed costs:
Manufacturing costs...................................................................................... $ 865,000
Operating expenses (including $80,000 additional salary).................. 187,000
Total fixed costs.............................................................................................. $ 1,052,000
Income from operations...................................................................................... $ 203,000
4. $135,000. A comparison of the amount of income from operations under present conditions, as indicated in (1), and under Proposal 3, as indicated in (3), suggest an increase of $135,000 if Proposal 3 is accepted, as illustrated below:
Income from operations, Proposal 3........................................................ $203,000
Income from operations, present
conditions......................................... 68,000
Increase in income from operations......................................................... $135,000
Alternatively, the $135,000 increase can be determined as follows:
Contribution margin, Size S, Proposal 3................................................. $900,000
Contribution margin, Size S, present
operations.................................. 360,000
Increase in contribution margin................................................................. $540,000
Less contribution margin, Size M, present operations... $325,000
Additional salaries.................................................................... 80,000 405,000
Increase in income from operations....................................... $ 135,000
Prob. 19–6B (Fin Man); Prob. 4–6B (Man)
1.
SIGNAL ELECTRONICS COMPANY
Contribution Margin Analysis
For the Year Ended December 31, 2006
Increase in the amount of sales attributed to:
Quantity factor:
Increase in number of units sold in 2006..... 500
Planned sales price in 2006............................ × $120.00 $60,000
Price factor:
Decrease in unit sales price in 2006............. $(8.00)
Number of units sold in 2006.......................... × 5,500 (44,000)
Net increase in amount of sales........................... $ 16,000
Increase in the amount of variable cost of
goods sold attributed to:
Quantity factor:
Increase in number of units sold in 2006..... 500
Planned variable cost per unit in 2006......... × $65.00 $32,500
Price factor:
Decrease in variable cost per unit in 2006.. $(3.00)
Number of units sold in 2006.......................... × 5,500 (16,500)
Net increase in amount of variable cost of
goods sold........................................................... $16,000
Increase in the amount of variable selling and
administrative expenses attributed to:
Quantity factor:
Increase in number of units sold in 2006..... 500
Planned variable selling and
administrative cost per unit in 2006........ × $15.00 $ 7,500
Price factor:
Increase in variable selling and
administrative cost per unit in 2006........ $2.00
Number of units sold in 2006.......................... × 5,500 11,000
Net increase in variable selling and
administrative expenses.................................. $ 18,500
Net increase in amount of variable costs................ 34,500
Decrease
in contribution margin............................... $(18,500)
Prob. 19–6B (Fin Man); Prob. 4–6B (Man) Concluded
2. No, the president is not correct in saying that the variable cost of goods sold got out of control in 2006. The majority of the increase in the variable cost of goods sold was due to the quantity factor. Specifically, the increase of 500 units in the quantity of product sold increased the variable cost of goods sold by $32,500, based upon planned unit costs. Actually, the unit cost of the variable cost of goods sold decreased $3.00, which had a favorable effect of $16,500 on the contribution margin.
The president is correct in saying that an investigation of the increase in variable selling and administrative expenses is needed. Of the $18,500 increase in these expenses, only $7,500 was due to the quantity factor. The unit cost increase of $2.00 for selling and administrative expenses does raise concern. This increase may have been caused by additional selling expenses associated with the increased sales. The increase in selling and administrative expenses could also have been caused by increased marketing and advertising expenditures to promote the price decrease. Thus, the increase in sales may not have been caused entirely by the lowering of the unit sales price. If this is the case, the president should exercise caution in deciding to lower the selling price further to increase sales. In addition, the reduction in sales price does not generate sufficient volume to compensate for the quantity factor of the variable costs. Thus, reducing the price further will not likely be a successful strategy.