ACCT
Cost Behavior
Learning Objectives
Introduction
W
I
n Chapter 5, we focus our attention on the behavior of costs. As
L
production volume changes, some costs may increase or decrease
and other costs may remain stable, but specific costs S
behave in predictable ways as volume changes. This concept of predictable
O cost behavior
based on volume is very important to the effective use of accounting
N
information for managerial decision making.
,
I
LO1 Describe the nature and behavior
of fixed and variable costs.
LO2
Use regression analysis and the
high/low method to define and analyze
mixed costs.
LO3 Illustrate the impact of income
taxes on costs and decision making.
LO4
Fixed and Variable Costs
J
A
Fixed costs are costs that remain the same in total, M
but vary per unit,
when production volume changes. Facility-level costs,
I such as rent, depreciation of a factory building, the salary of a plant manager, insurE
ance, and property taxes, are likely to be fixed costs. Summarizing this
LO1
After studying the material in this chapter,
you should be able to:
Identify the difference between
variable costing and absorption costing.
LO5
Identify the impact on the
income statement of variable costing and
absorption costing.
LO6
Recognize the benefits of using
variable costing for decision making.
cost behavior, fixed costs stay the same in total but vary when expressed
on a per-unit basis.
5
0
5 Behavior of Fixed Costs
Exhibit 5-1 The
1
$
B
U
$10,000
92
$2.00
$1.33
0
2,500 5,000 7,500
Volume
Fixed Cost in Total
0
2,500 5,000 7,500
Volume
Fixed Cost per Unit
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
© Cengage Learning 2013
$4.00
Cost behavior How costs
react to changes in production
volume or other levels of activity.
Fixed costs Costs that remain the same
in total when production volume increases
or decreases but that vary per unit.
$
CHAPTER
5
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L
S
O
N
,
© Henner Frankenfeld/Bloomberg via Getty Images
ACCT
J
A
M
I
E
Understanding how costs behave with changes in
production is crucial for managers of an organization.
5
0
5
Rent is a good example. If the cost to rent a factory building is $10,000 per year and 5,000
1 is $2.00 ($10,000 ÷ 5,000). If production
units of product are produced, the rent per unit
volume decreases to 2,500 units per year, the cost
B per unit will increase to $4.00 ($10,000 ÷
2,500). If production volume increases to 7,500 units, the cost per unit decreases to $1.33
U
($10,000 ÷ 7,500). However, the total rent remains $10,000 per year (see Exhibit 5-1).
On the other hand, variable costs vary in direct proportion to changes in production
volume but are constant when expressed as per-unit amounts. As production increases, variable costs increase in direct proportion to the change in volume; as production decreases,
variable costs decrease in direct proportion to the
change in volume. Examples include direct material,
Variable costs Costs that stay
direct labor (if paid per unit of output), and other unitthe same per unit, but change in total, as
level costs, such as factory supplies, energy costs to run
production volume increases or decreases.
factory machinery, and so on.
Chapter 5: Cost Behavior
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93
Consider the behavior of direct material costs as
production increases and decreases. If the production
of a standard classroom desk requires $20 of direct
materials (wood, hardware, and so on), the total direct material costs incurred will increase or decrease
proportionately with increases and decreases in production volume. If 5,000 desks are produced, the total
direct material cost will be $100,000 (5,000 × $20). If
production volume is increased to 7,500 units (a 50 percent increase), direct material costs will also increase
50 percent, to $150,000 (7,500 × $20). However, the
cost per unit is still $20. Likewise, if production volume
is decreased to 2,500 desks, direct material costs will
decrease by 50 percent, to $50,000. But once again, the
cost per unit remains $20 (see Exhibit 5-2).
Within the relevant range, fixed
costs are constant in total and
vary per unit, and variable costs
vary in total and are constant
per unit.
Relevant range The normal range of
production that can be expected for a particular
product and company.
94
Volume
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
© Cengage Learning 2013
Cost
© Cengage Learning 2013
as production increases. For example, utility costs per
kilowatt-hour may decrease at higher levels of electricity use (and production). Managerial accountants
typically get around this problem by assuming that the
relationship between cost and
volume is linear within the relExhibit 5-2 The Behavior of Variable Costs
W
evant range of production. In
other words, the cost per unit
I
$
$
is assumed to remain constant
L
$150,000
over the relevant range. The
S
relevant range is the normal
$100,000
range of production that can be
O
$20.00
expected for a particular prodN
$50,000
uct and company. The relevant
,
range can also be viewed as
0
0
the volume of production for
2,500 5,000 7,500
2,500 5,000 7,500
Volume
Volume
which the fixed and variable
J
Variable Cost per Unit
Variable Cost in Total
cost relationships hold true.
As you can see in Exhibit 5-3,
A
within this narrower range of
M
A current trend in manufacturing is to automate—
production, a curvilinear cost can be approximated by
to replace direct factory labor with robotics and otherI
a linear relationship between the cost and volume.
automated machinery and equipment. This trend has theE
effect of increasing fixed costs (depreciation)
and decreasing variable costs (direct labor).
Exhibit
5 5-3 Curvilinear Costs and the Relevant Range
Although there are many advantages to automation, the impact of automation on the employee
0
work force and on day-to-day decisions made
5
by managers must not be ignored.
1
Strictly speaking, a cost that varies in diRelevant
Curvilinear
rect proportion to changes in volume requires
B
Range
Function
a linear (straight-line) relationship between
U
the cost and volume. However, in reality, costs
may behave in a curvilinear fashion. Average
Straight-Line Approximation
costs or cost per unit may increase or decrease
MAKING IT REAL
Direct Labor as a Fixed Cost
F
W
I
L
Step Costs
S
The classification of costs is not always a simpleO
process.
Some costs vary but only with relatively largeNchanges
in production volume. Batch-level costs related to mov,
ing materials may vary with the number of batches
of
© Jessica Rinaldi/Reuters/Landov
or years, U.S. car manufacturers have had contracts with
their workers’ unions that
require the companies to pay their
assembly-line workers even when
they are not on the assembly line.
These contracts essentially transform
direct labor costs into fixed costs.
More recently, as the recession has
resulted in idle assembly lines, Toyota has done likewise. However, unlike the U.S. companies, which often
send their workers home, at Toyota
the workers might attend training
classes, repair and maintain equipment, or brainstorm in an eﬀort to
identify new cost-savings or qualityimprovement initiatives.
Source: “Toyota Keeps Idled Workers Busy Honing Their Skills,” by Kate Linebaugh, The Wall Street Journal, October 13, 2008.
product produced but not with every unit of product.
Product-level costs associated with quality control
J inspections may vary when new products are introduced.
A costs.
Costs like these are sometimes referred to as step
In practice, step costs may look like and be treated
M as either variable costs or fixed costs. Although step costs are
I
technically not fixed costs, they may be treated as such
E range
if they remain constant within a relatively wide
of production. Consider the costs of janitorial services
within a company. As long as production is below 7,500
5
desks, the company will hire one janitor with salary
and fringe benefits totaling $25,000. The cost0is fixed
as long as production remains below 7,500 units.
5 But if
desk production exceeds 7,500, increasing the amount
1
of waste and cleanup needed, it may be necessary to hire
B
a second janitor at a cost of another $25,000. However,
within a relevant range of production between
U 7,501
and 15,000 units, the cost is essentially fixed ($50,000).
costs are relevant in production decisions because they
vary with the level of production. Likewise, fixed costs
are generally not relevant, because they typically do not
change as production changes. However, variable costs
can remain the same between two alternatives, and fixed
costs can vary between alternatives. For example, if the
direct material cost of a product is the same for two competing designs, the material cost is not a relevant factor
in choosing a design. However, other qualitative factors
relating to the material, such as durability, may still be
relevant. Likewise, fixed costs can be relevant if they vary
between alternatives. Consider rent paid for a facility to
store inventory. Although the rent is a fixed cost, it is
relevant to a decision to reduce inventory storage costs
through just-in-time production techniques if the cost
of the rent can be avoided (by subleasing the space, for
example) by choosing one alternative over another.
The Cost Equation
Expressing the link between costs and production volume as an algebraic equation is useful. The equation for
a straight line is
y = a + bx
Relevant Costs and Cost Behavior
As mentioned in Chapter 1, relevant costs are those
which are avoidable or can be eliminated by choosing one
alternative over another. Relevant costs are also known
as differential, or incremental, costs. In general, variable
Step costs Costs that vary with activity in steps and may
look like and be treated as either variable costs or fixed costs;
step costs are technically not fixed costs but may be treated as such if
they remain constant within a relevant range of production.
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
95
The a in the equation is the point where the line intersects the vertical (y) axis (the y-intercept), and b is the
slope of the line. In Exhibit 5-4, if y = total direct material
costs and x = units produced, then y = $0 + $20x. The
y-intercept is zero and the slope of the line is 20. For
It can be misleading to always
view variable costs as relevant
and fixed costs as irrelevant.
Exhibit 5-4 Fixed and Variable Costs
Y
$100,000
Costs
Variable costs
(direct material)
$50,000
$10,000
0
0
2,500
5,000
Volume
W Fixed costs (rent)
I
L
S
OX
7,500
N
,
every one-unit increase (decrease) in production (x),
J
direct material costs increase (decrease) by $20. You
can see that direct material costs are variable becauseA
they stay the same on a per-unit basis but increase inM
total as production increases. Likewise, we can express
I
the fixed-cost line as an equation. If y = cost of rent and
x = units produced, then y = $10,000 + $0x. In thisE
case, the y-intercept is $10,000 and the slope is zero.
In other words, fixed costs are $10,000 at any level of
5
production within the relevant range.
0
5
1
LO2 Mixed Costs
B
he presence of mixed costs presents a unique chal-U
T
lenge because they include both a fixed and a variable component. Consequently, it is difficult to predict
Mixed costs Costs that include both a fixed and
a variable component, making it diﬃcult to predict the
behavior of a mixed cost as production changes, unless the cost is
first separated into its fixed and variable components.
96
© Cengage Learning 2013
$150,000
the behavior of a mixed cost as
production changes, unless the
cost is first separated into its
fixed and variable components.
A good example of a mixed
cost is the overhead costs of
KenCor Pizza Emporium. Overhead typically has both a fixed
and a variable component.
For example, rent and insurance paid by KenCor would be
fixed components of overhead,
whereas utilities and supplies
would likely be variable costs.
In the first seven weeks of
operations, KenCor incurred
the following overhead costs:
Week
1 (Start-up)
Total
Overhead
Cost
Pizzas
Costs
per Unit
0
$ 679
N/A
2
423
1,842
$4.35
3
601
2,350
3.91
4
347
1,546
4.46
5
559
2,250
4.03
6
398
1,769
4.44
7
251
1,288
5.13
Is the overhead cost a fixed, variable, or mixed cost?
Clearly, the cost is not fixed, because it changes each
week. However, is it a variable cost? Although the cost
changes each week, it does not vary in direct proportion to changes in production. In addition, remember
that variable costs remain constant when expressed per
unit. In this case, the amount of overhead cost per pizza
changes from week to week. A cost that changes in total
and also changes per unit is a mixed cost. As you can see
in Exhibit 5-5, a mixed cost looks somewhat like a variable cost. However, the cost does not vary in direct proportion to changes in the level of production (you can’t
draw a straight line through all the data points), and if
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
Exhibit 5-5 Mixed Costs
2,000
1,500
1,000
0
Overhead
0
100
200
300
400
500
600
700
Pizzas
Wto the
a line were drawn through the data points back
and the number of pizzas produced in the next 12 months
y-axis, we would still incur overhead cost at aI produc(see Exhibit 5-6). As you can see, because the overhead
tion volume of zero. Like a fixed cost, a mixed cost has
cost varies in total and on a per-unit basis, it must be a
L
a component that is constant regardless of production
mixed cost. A graph of the data is shown in Exhibit 5-7.
S
volume.
Once we know that a cost is mixed, we areO
Exhibit 5-6 Overhead Costs per Pizza
left with the task of separating the mixed cost
N
into its fixed and variable components. However,
Month
Pizzas
Overhead
Per Pizza
it is not clear how much of the overhead cost,
1
2,100
$
8,400
$4.00
is fixed and how much is variable. In the next
2
2,600
10,100
3.88
section, we will demonstrate the use of a statistiJ
3
2,300
8,800
3.83
cal tool called regression analysis to estimate the
4
2,450
9,250
3.78
fixed and variable components of a mixed cost. A
A variety of tools can be used to estimate theM
5
2,100
8,050
3.83
fixed and variable components of a mixed cost.
6
2,175
8,200
3.77
When we separate a mixed cost into its variableI
7
1,450
6,950
4.79
and fixed components, what we are really doingE
8
1,200
6,750
5.63
is generating the equation for a straight line, with
9
1,350
7,250
5.37
the y-intercept estimating the fixed cost and the
10
1,750
7,300
4.17
5
slope estimating the variable cost per unit.
11
1,550
7,250
4.68
Continuing our example of KenCor Pizza0
12
2,050
7,950
3.88
Emporium, we see that after the initial seven5
week start-up period, the company’s accountant
compiles data regarding the total overhead cost1
B
U
Regression Analysis
© iStockphoto.com/Todd Smith
A statistical technique used to estimate the fixed and
variable components of a mixed cost is called least
squares regression. Regression analysis uses statistical
Regression analysis The procedure that uses
statistical methods (least squares regression) to fit a cost line
(called a regression line) through a number of data points.
Chapter 5: Cost Behavior
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97
© Cengage Learning 2013
500
© Cengage Learning 2013
Overhead Costs
$2,500
Exhibit 5-7 Overhead Costs for KenCor Pizza
$11,000
10,000
9,000
8,000
Costs
7,000
6,000
5,000
4,000
2,000
1,000
0
0
200
400
600
800
W
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L
S
1,000 1,200 1,400 1,600 1,800 2,000 2,200 2,400 2,600
O Pizzas
N
,
methods to fit a cost line (called a regression line)
through a number of data points. Note that althoughJ
the data points in our example do not lie along a
A
straight line, regression analysis statistically finds the
line that minimizes the sum of the squared distancesM
from each data point to the line (hence the name leastI
squares regression).
E
Using a Spreadsheet Program to Perform Regression
Analysis Using a spreadsheet program to produce re-
gression results is a relatively simple process. We are5
going to use Microsoft Excel in this example, but all0
spreadsheet programs are similar. The first step is to
5
enter the actual values for our mixed cost (called the
dependent variable in regression analysis because1
the amount of cost is dependent on production) and theB
related volume of production (called the independent
U
variable because it drives the cost of the dependent
Dependent variable The variable in
regression analysis that is dependent on changes in the
independent variable.
Independent variable The variable in regression analysis that
drives changes in the dependent variable.
98
2,800
© Cengage Learning 2013
3,000
variable) into a spreadsheet, using one column for each
variable. Employing data from KenCor Pizza Emporium for overhead costs incurred and pizzas produced
for the first 12 months of operations, we see the data
shown in the Excel spreadsheet in Exhibit 5-8.
The next step in Excel (see Exhibit 5-9) is to click
on the Data tab and choose data analysis from the
Analysis ribbon. From the data analysis screen, scroll
down, highlight regression, and either double-click or
choose OK.
The regression screen will prompt you to choose a
number of options. The first step is to input the y range.
The y range will be used to identify the dependent
variable (overhead costs), found in column C of your
spreadsheet. You can either type in the range of cells or
simply highlight the cells in the spreadsheet (be sure not
to include the column heading), and click on the icon in
the y-range box. The next step is to select the x range
for the independent variable (volume of pizzas). Once
again, you can enter the cells directly or highlight the
cells in the second column of your spreadsheet.
After inputting the appropriate y and x ranges, your
Excel spreadsheet should look like the example shown
in Exhibit 5-10. Click OK, and the regression model
summary output appears as shown in Exhibit 5-11.
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
Exhibit 5-8 Regression Analysis—Step 1
5
0
5
1
B
U
Regression Analysis—Step 2
© Cengage Learning 2013
J
Exhibit 5-9
A
M
I
E
© Cengage Learning 2013
W
I
L
S
O
N
,
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
99
W
I
L
S
O
N
,
© Cengage Learning 2013
Exhibit 5-10 Regression Analysis—Step 2 (continued)
Exhibit 5-11 Regression Analysis—Summary Output
5
0
5
1
B
U
100
© Cengage Learning 2013
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Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
Total overhead cost = Fixed cost + (Variable cost/unit × Volume)
Total overhead cost = $3,998.25 + ($2.09 × Volume)
Graphically, the line for the total overhead costs
can be expressed as shown in the following illustration:
$
Costs
Slope
$3,998.25
W
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L
S
O
N
,
Volume of Pizzas J
A
M
We can use the preceding equation to help predict the total amount of overhead costs thatI will be
incurred for any number of pizzas within E
the rele-
vant range. The relevant range is that range of activity within which management expects to operate, or
5 is usethe range in which the equation in question
ful or meaningful. Our predictions should be0limited
to those activity levels within the relevant range. On
5
the basis of last year’s data, KenCor expects to produce between 1,200 and 2,600 pizzas each1month.
Next month, KenCor expects to produce 1,750
B pizzas. Using the regression equation, KenCor estimates
U
total overhead costs to be $7,655.75 ($3,998.25 +
[$2.09 × 1,750 pizzas]).
Regression Statistics The regression statistics section
at the top of Exhibit 5-11 provides useful diagnostic
tools. The multiple R (called the correlation coefficient)
is a measure of the proximity of the data points to the
regression line. In addition, the sign of the statistic
(+ or −) tells us the direction of the correlation between
the independent and dependent variables. In this
case, there is a positive correlation between the number of pizzas produced and the total overhead costs.
R square (often represented as R2 and called the
coefficient of determination) is a measure of goodness
of fit (how well the regression line “fits” the data). An
R2 of 1.0 indicates a perfect correlation between the
independent and dependent variables in the regression equation; in other words, 100 percent of the data
points are on the regression line. R2 can be interpreted
as the proportion of dependent-variable variation that
is explained by changes in the independent variable. In
this case, the R2 of 0.8933 indicates that over 89 percent of the variation in overhead costs is explained by
increasing or decreasing pizza production.
A low value of R2 may indicate
that the chosen independent variable is not a very reliable predictor
Total
of the dependent variable or that
overhead cost
other independent variables may
$2.09 = Variable
have an impact on the dependent
cost per unit
variable. For example, the outside
temperature and other environFixed cost
mental factors might affect overhead costs incurred by KenCor.
The presence of outliers in
the data may also result in low
R2 values. Outliers are simply extreme observations—that is, observations so far from the normal
activity that they may not be representative of normal
business levels (they are outside of the relevant range).
Under the least squares method, a regression line may
be pulled disproportionately toward the outlier and
result in misleading estimates of fixed and variable
costs and measures of goodness of fit.
© Cengage Learning 2013
How is the summary output interpreted? First, note
toward the bottom of Exhibit 5-11 that the estimated
coefficient (value) of the intercept (the y-intercept) is
3,998.25 and the estimated coefficient (value) of the
x variable (the slope) is 2.09. This means that the fixedcost component of our mixed overhead cost is estimated
to be $3,998.25 and the variable-cost component is estimated to be $2.09 per pizza.
Using the least squares regression results, we can
compute the regression line for overhead costs at KenCor
Pizza Emporium:
Estimating Regression Results with the
High/Low Method
If we did not have access to a computer regression program or for some reason did not want to use this tool,
we could estimate the regression equation by using a
simpler technique called the high/low method. The
R square (R2) A measure of goodness of fit (how well the
regression line “fits” the data).
Chapter 5: Cost Behavior
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101
high/low method uses only two data points (related
to the high and low levels of activity) and mathematically derives an equation for a straight line intersecting
those two data points. Though technically inferior to
regression analysis (which uses all the data points),
from a practical perspective the high/low method can
often provide a reasonable estimate of the regression
equation.
In Exhibit 5-6, the high level of activity occurred
in month 2, when 2,600 pizzas were produced and
$10,100 of overhead cost was incurred. The low
level of activity occurred in month 8, when only
1,200 pizzas were produced and overhead costs totaled $6,750. The slope of the line connecting those
two points can be calculated by dividing the difference between the costs incurred at the high and low
levels of activity by the difference in volume (number of pizzas) at those levels. Remember, the slopeW
of a line is calculated as the change in cost over theI
change in volume, in this case the difference in cost to
L
produce pizzas over the difference in volume of pizzas made. As with the regression equation, the slopeS
of the line is interpreted as the variable-cost compo-O
nent of the mixed cost:
Change in cost
= Variable cost per unit
Change in volume
N
,
J
Inserting the data for KenCor Pizza Emporium, we
A
find that the variable cost is $2.39 per unit ($10,100 −
$6,750) ÷ (2,600 − 1,200). This result compares withM
our regression estimate of $2.09. We then solve forI
the fixed-cost component by calculating the total variE
able cost incurred at either the high or the low level
of activity and subtracting the variable costs from the
total overhead cost incurred at that level. Mathemati-5
cally, if
Total overhead costs = Fixed costs +
( Variable cost per unit × number of pizzas)
then
0
5
1
B
U
Total overhead costs − Variable costs = Fixed costs
At the high level of activity, total overhead costs
are $10,100 and variable costs equal $6,214 (2,600
pizzas × $2.39 per pizza). Therefore, the fixed-cost
component of overhead costs is estimated to be $3,886
(total overhead costs of $10,100, less variable costs of
102
$6,214), and the total overhead cost is estimated to be
$3,886 + ($2.39 × number of pizzas produced).
Why is this equation different from the least squares
regression equation? Regression is a statistical tool that
fits the “best” line through all 12 data points, whereas
the high/low method mathematically derives a straight
line between just two of the data points. By using the two
points at the highest and lowest levels of activity, we are
forcing a line between those points without regard to the
remaining data points. If one or both of the points we selected is unusual (an outlier), the result will be a cost line
that is skewed and therefore may not be a good measure
of the fixed and variable components of the mixed cost.
In the case of KenCor Pizza Emporium, let’s see
how the high/low estimate would affect our prediction
of total overhead costs next month, when 1,750 pizzas
will be produced. Using the high/low estimate of the
cost equation, we would predict total overhead costs of
$8,068.50 ($3,886 + [$2.39 × 1,750 pizzas]). This result compares with our estimate of $7,655.75 using the
cost equation generated from the regression analysis.
Given the simplicity of generating regression equations with spreadsheet packages and handheld calculators, the need for using the high/low method for
computing cost equations in practice is questionable.
However, it remains an easy-to-use tool for estimating
cost behavior.
The Impact of Income Taxes
on Costs and Decision Making
LO3
W
e always need to consider tax laws and the
impact income and other taxes have on costs,
revenues, and decision making. Just as an individual
should consider the impact of income taxes on a decision whether to hold or sell a stock, managers must
consider the impact of taxes for a variety of decisions.
The first key to understanding the impact of taxes on
costs and revenues is the recognition that many costs
of operating businesses are deductible for income tax
purposes and that most business revenues are taxable.
After-Tax Costs and Revenues
Consider an example in which your current taxable
cash revenue is $100 and tax-deductible cash expenses
equal $60. As shown in Exhibit 5-12, taxable income
therefore equals $40. If the income tax rate is 40 percent, $16 of income taxes will be paid, leaving you with
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
Managers must
consider the
impact of taxes
when making
decisions.
Revenue
$100
$100
Expense
− 60
− 80
Taxable income
$ 40
$ 20
Tax (rate = 40%)
− 16
− 8
After-tax cash flow
$ 24
$ 12
© Yuri Arcurs/ShutterStock.com
Increase
Revenue by $20
$120
J
A
M
I
E
$24 cash after tax. Now consider the impact of spending
an additional $20 on tax-deductible expenditures. This
reduces your taxable income to $20. With a 405percent
income tax rate, $8 of income taxes will be paid
0 instead
of $16 (you saved $8 of income tax) and you will be left
5
with $12 after tax. Even though you spent an additional
$20, your cash flow decreased by only $12 1
($24 less
$12). Mathematically, the after-tax cost of a tax-deductB
ible cash expenditure can be found by subtracting the
U
income tax savings from the before-tax cost or by simply
multiplying the before-tax amount by (1 − tax rate):
After-tax cost = Pretax cost × (1 − tax rate)
So, if the before-tax cost is $20 and the income tax rate is
40 percent, the after-tax cost is $12 ($12 = $20 × [1 −
0.40]). In this case, the impact of income taxes is to reduce
− 60
$ 60
− 24
$ 36
© Cengage Learning 2013
Exhibit 5-12
W
I
L
S
O
The Impact of Income Taxes on Cash Flow
N
Increase
,
Current
Spending by $20
the “real” cost of a tax-deductible
expense to the business and to increase cash flow.
Income taxes also have an impact on cash revenues received by
a business. Continuing our original
example in Exhibit 5-12, if taxable
cash revenue increases by $20, taxable income will increase to $60
($120 − $60). After payment of
$24 of income taxes, you will be
left with $36 of cash. An increase
in revenue of $20 increases your cash
flow by only $12 ($36 − $24). Why?
Because the $20 is taxable and results in
the payment of an additional $8 of income
tax ($20 × 0.40). Mathematically, the formula to find the after-tax benefit associated
with a taxable cash revenue is analogous
to the formula for after-tax cost. The aftertax benefit of a taxable cash receipt can be
found by subtracting the additional income
tax to be paid from the before-tax receipt
or by simply multiplying the pretax receipt
by (1 − tax rate):
After-tax benefit = Pretax receipts × (1 − tax rate)
So, if the before-tax receipt is $20 and the tax rate is
40 percent, the after-tax benefit is $12 ($12 = $20 ×
[1 − 0.40]). In this case, the impact of income taxes is
to decrease cash flow to the business.
Before- and After-Tax Income
In a similar fashion, managers can calculate the impact
of income taxes on income. If we have an income tax
rate of 40 percent and operating income of $1,000,000,
we will have a tax liability of $400,000 (40 percent of
the $1,000,000) and be left with $600,000 of after-tax
income. This is exactly the same thing that happens
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
103
to our paychecks as individuals. If an individual earns
$1,000 per week and faces a 30 percent income tax
rate, the individual’s take-home pay (after considering
income tax withholding) is only $700. Mathematically,
After-tax income = Pretax income × (1 − tax rate)
Although tax laws are highly complex and computing tax
due is rarely as simple as applying one rate to income,
estimating the impact of income tax and other taxes on
cash receipts and disbursements is important in managerial decision making.
A Comparison of
Absorption Costing and
Variable Costing
LO4
Variable Costing
E
In Chapter 2, a system of product costing was intro-J
duced in which all manufacturing costs, fixed and
A
variable, were treated as product costs. Product costs
include the costs of direct materials, direct labor, and allM
manufacturing overhead (both fixed and variable). YouI
will recall that product costs attach to the product and
E
are expensed only when the product is sold. Commonly
called absorption costing, or full costing, this method is
required both for external financial statements prepared5
under generally accepted accounting principles (GAAP)
Variable (direct) costing A method of
costing in which product costs include the costs
of direct materials, direct labor, and variable
overhead; fixed overhead is treated as a period
cost; variable costing is consistent with CVP’s
focus on cost behavior.
104
Exhibit 5-13 provides a summary of the two costing
methods. As you can see, the only difference between
absorption and variable costing is the treatment of fixed
overhead. Under absorption costing, fixed overhead is
treated as a product cost, added to the cost of the product and expensed only when the product is sold. Under
variable costing, fixed overhead is treated as a period
cost and is expensed when incurred. The impact of this
difference on reported income becomes evident when
a company’s production and sales are different (that is,
when the number of units produced is greater than or
less than the number of units sold).
Because absorption costing treats fixed overhead
as a product cost, if units of production remain unsold
at year’s end, fixed overhead remains attached to those
units and is included on the balance sheet as an asset
as part of the cost of inventory. With variable costing,
all fixed overhead is expensed each period, regardless of the level of production or sales. Consequently,
when production is greater than sales and inventories
increase, absorption costing will result in higher net
income than variable costing.
0
5
1 Absorption and Variable Costing
Exhibit 5-13
B
Absorption Costing
U
Product
Costs
Period
Costs
Direct materials
Direct labor
Variable overhead
Fixed overhead
Variable Costing
Product
Costs
Period
Costs
Direct materials
Selling, general,
and administrative
costs
Direct labor
Selling, general,
and administrative
costs
Variable overhead
Fixed overhead
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
© Cengage Learning 2013
W
I
L
arlier in this chapter, we introduced the concept ofS
cost behavior—that is, how costs behave in relation to production volume—and described the behaviorO
of fixed and variable costs.
N
,
Absorption Costing
Absorption (full) costing A
method of costing in which product
costs include the costs of direct
materials, direct labor, and fixed and
variable overhead; required for external
financial statements and for income tax
reporting.
and for income tax reporting. Selling, general, and administrative costs, also called period costs, are expensed
immediately in the period in which they are incurred.
In contrast, variable costing, or direct costing, treats
only variable product costs (the costs of direct materials, direct labor, and variable manufacturing overhead) as product costs and treats fixed manufacturing
overhead as a period cost (along with selling, general,
and administrative costs). Variable costing is more consistent with the focus of cost–volume–profit analysis
(discussed in Chapter 6) on differentiating fixed from
variable costs, and it provides useful information for internal decision making that is often not apparent when
using absorption costing.
The only difference between
absorption and variable
costing is the treatment of
fixed overhead.
The Impact of Absorption
Costing and Variable Costing
on the Income Statement
LO5
L
N
,
Product Costs
Absorption Costing
Direct material
Variable Costing
$0.30
Direct material
Direct labor
0.35
Direct labor
Variable overhead
0.10
Variable overhead
Fixed overhead
0.30
Total per unit
$1.05
Total per unit
J $0.30
A 0.35
M 0.10
I
E $0.75
The only difference between the two methods is
5 units),
$0.30 of fixed overhead ($30,000 ÷ 100,000
0
which is treated as a product cost under absorption
costing and a period cost under variable costing.
5
Year 1 Income Comparison
1
B
unitsU
that
Let’s assume that in year 1 all 100,000
are
produced are sold. Then how much income would be
reported under each method? To answer this question,
remember that, under absorption costing, fixed manufacturing overhead costs are expensed as part of cost of goods
sold. Under variable costing, fixed manufacturing overhead costs are deducted as a fixed period cost. Regardless,
when all units produced are sold, the net operating income
reported under each method would be the same.
Year 1 Comparison of Absorption and Variable Costing
(100,000 Units Produced and Sold)
Absorption Costing
Sales
Less: Cost of goods sold
Gross profit
Less: S&A costs
Net operating income
Variable Costing
$200,000
105,000
$ 95,000
15,000
$ 80,000
Sales
Less: Variable costs
Contribution margin
Less: Fixed costs
$200,000
80,000
$120,000
40,000
Net operating income $ 80,000
Year 2 Income Comparison
Let’s suppose that in the next year LuLu’s
Lockets produces 100,000 units (for
the same costs) but, because of a very
slow Christmas season, sells only
80,000 units. In this case, the
variable-costing method would
expense the entire $30,000 of
fixed manufacturing overhead
as a period cost, whereas the
absorption-costing method
would expense only $24,000
(80,000 units sold × $0.30
per unit). When production
exceeds sales, absorption
costing will report higher net
operating income than variable costing will. Part of the
$30,000 of fixed overhead (20,000 unsold units × $0.30
per unit, or $6,000) remains in inventory until those units
are sold. The question for Elise is which method more
closely represents what actually happened in the second
year, when production exceeded sales. Fixed overhead
does not change with changes in sales volume, so variable costing seems to report a more accurate picture
of the company’s actual costs. Variable costing allows
Elise to look at the contribution of each item sold to the
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
105
© Scott Rothstein/Shutterstock.com
uLu’s Lockets is a custom jeweler manufacturing
unique lockets. LuLu’s CFO, Elise, is concerned
about choosing the best costing method (variable vs.
absorption) to allow her to make the best decision regarding management compensation and to more easily
understand the impact of production volume on the
income statement. LuLu’s Lockets produces 100,000
units each year, with the following per-unit costs: direct material of $0.30, direct labor of $0.35, and variable overhead of $0.10 per unit. Fixed manufacturing
overhead costs are $30,000. The company W
also has
variable selling and administrative costs of $0.05 per
I
unit sold and fixed selling and administrative costs of
L
$10,000.
The selling price of each locket is $2. The
Scost of
one unit of product under absorption costing and variO
able costing is calculated as follows:
(100,000 Units Produced and 80,000 Units Sold)
Absorption Costing
Sales
Variable Costing
$160,000
Less: Cost of goods sold*
Gross profit
84,000
$ 76,000
Less: S&A costs
14,000
Net operating income
$ 62,000
Sales
$160,000
Less: Variable costs
Contribution margin
64,000
$ 96,000
40,000
Less: Fixed costs
†
Net operating income
$ 56,000
* Cost of goods sold includes $24,000 (80,000 × $0.30) of fixed
manufacturing overhead.
†
Fixed costs include $30,000 of fixed manufacturing overhead.
company’s overall profit, whereas absorption costing distorts that analysis by including fixed manufacturing over-W
head in the sales data when, in fact, that cost is incurred
I
regardless of the sales volume.
L
S
Year 3 Income Comparison
O
In Year 3, LuLu’s Lockets holds production constant at
100,000 units, but increases sales to 120,000 units (theN
20,000 units left over from Year 2 were sold, in addition,
to all of the production for the third year). In this case,
under variable costing, $30,000 of fixed manufacturing
overhead would be expensed as a period cost. Under ab-J
sorption costing, the $30,000 would be expensed alongA
with an additional $6,000 related to the 20,000 units
produced in Year 2 and sold in Year 3 (20,000 units ×M
$0.30 per unit = $6,000). When units sold exceed unitsI
produced, variable costing will report higher net operat-E
ing income than will absorption costing. Remember from
our previous discussion of cost behavior that fixed costs
5
Year 3 Comparison of Absorption and Variable Costing 0
5
(100,000 Units Produced and 120,000 Units Sold)
1
Absorption Costing
Variable Costing
B
Sales
$240,000 Sales
$240,000
U
Less: Cost of goods sold *
126,000 Less: Variable costs
96,000
Gross profit
$114,000
Less: S&A costs
16,000
Net operating income
$ 98,000
Contribution margin
Less: Fixed costs
†
Net operating income
* Cost of goods sold includes $36,000 (120,000 × $0.30) of fixed
manufacturing overhead.
† Fixed costs include $30,000 of fixed manufacturing overhead.
106
$144,000
40,000
$104,000
remain constant from year to year regardless of sales volume. Absorption costing delays the expensing of a portion
of the fixed cost incurred in Year 2 until all units are sold in
Year 3. By contrast, variable costing results in the expensing of fixed costs in the year in which they are incurred.
Note that, over the three-year period, the total income is the same under each method. Why? Because
when units produced are equal to units sold, the net operating income reported under each method is the same.
Although production was greater than sales in Year 2
and sales were greater than production in Year 3, over
the three-year period the company produced and sold
300,000 units.
Year 1
Year 2
Year 3
Total
Production
100,000
100,000
100,000 300,000
Sales
100,000
80,000
120,000 300,000
Absorption Costing
Sales
$200,000 $160,000 $240,000 $600,000
Less: Cost of goods
sold
105,000
Gross margin
84,000
126,000 315,000
$ 95,000 $ 76,000 $114,000 $285,000
Less: S&A costs
15,000
14,000
16,000
45,000
Net operating income $ 80,000 $ 62,000 $ 98,000 $240,000
Variable Costing
Sales
$200,000 $160,000 $240,000 $600,000
Less: Variable costs
80,000
Contribution margin
Less: Fixed costs
64,000
96,000 240,000
$120,000 $ 96,000 $144,000 $360,000
40,000
40,000
40,000 120,000
Net operating income $ 80,000 $ 56,000 $104,000 $240,000
To summarize (see Exhibit 5-14), in Year 1, when
units sold equaled units produced, net operating income
was the same under both costing methods. In Year 2,
when units produced exceeded units sold, absorption
costing reported higher net operating income than variable costing did. In Year 3, when units sold exceeded
units produced, variable costing reported higher net
operating income than absorption costing did.
Exhibit 5-14 Production, Sales, and Income Under
Absorption Costing and Variable Costing
When Production
Sales
Absorption Income
Variable Income
When Production
Sales
Absorption Income
Variable Income
When Production
Sales
Absorption Income
Variable Income
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
© Cengage Learning 2013
Year 2 Comparison of Absorption and Variable Costing
Variable costing is consistent with
CVP’s focus on differentiating fixed
and variable costs and provides
useful decision-making information
that is often not apparent when
using absorption costing.
Variable Costing and
Decision Making
LO6
T
he use of absorption costing for internal decision making can result in less-than-optimal
decisions. For example, consider the case of the unemployed executive who offered his services to a
manufacturing company for only $1 per year in salary and a bonus equal to 50 percent of any increase
in net income generated for the year. Reviewing the
absorption-costing income statement for the previous
year, he learned that although 10,000 units of product
were produced and sold, the company had the capacity to produce 20,000 units. In addition, variable production costs were $40 per unit, variable selling and
W sold,
administrative (S&A) costs were $10 per unit
fixed manufacturing overhead costs were Iequal to
$300,000 ($30 per unit produced), and fixed selling
L
and administrative costs were equal to $100,000. As
shown here, the previous year’s net operatingSincome
was $100,000:
O
N
Absorption Costing Income (10,000 Units Produced)
,
Sales (10,000 units)
Less: Cost of goods sold *
Gross profit
Less: S&A costs
Net operating income
* Includes $300,000 (10,000 units
overhead.
$1,000,000
J700,000
$ A
300,000
200,000
M
$ 100,000
I
$30) of fixed manufacturing
E
5
By increasing production to 20,000 units, the allo0
cation of fixed manufacturing overhead is reduced
to
$15 per unit ($300,000 20,000 units $15).
Re5
member that, under absorption costing, fixed over1
head is a product cost and is expensed only when
B of
the product is sold. Therefore, only $150,000
fixed overhead costs will be expensed. The remaining
U
$150,000 of fixed manufacturing overhead costs is included in inventory and is reported as an asset on the
balance sheet. The cost of goods sold is reduced to
$550,000, and net income is increased by $150,000,
to $250,000. The manager is entitled to a bonus of
$75,000, whereas the company is saddled with 10,000
units of unsold inventory and the attendant costs of
storing and insuring it!
Absorption Costing Income (20,000 Units Produced)
Sales (10,000 units)
$1,000,000
Less: Cost of goods sold *
550,000
Gross profit
$ 450,000
Less: S&A costs
200,000
Net operating income
$ 250,000
* Includes $150,000 (10,000 units × $15) of fixed costs.
If income had been measured with a variable costing approach, net operating income would be the same
each year and the manager would not have been able to
pull off his scheme.
Variable Costing Income
(10,000 units produced)
Sales (10,000 units)
Variable costs
Contribution margin
Fixed costs
(20,000 units produced)
$1,000,000
500,000
$ 500,000
400,000
Net operating income $ 100,000
Sales (10,000 units)
Variable costs
Contribution margin
Fixed costs
$1,000,000
500,000
$ 500,000
400,000
Net operating income $ 100,000
So, where are the costs that resulted from the increased
production? Under variable costing, those production
costs are attached to the inventory and are on the balance sheet as inventory. The fixed costs, under variable
costing, are expensed each period in total, regardless of
the level of production.
Problems like these are less common in a just-intime (JIT) environment, in which inventory levels are
minimized and companies strive to produce only enough
products to meet demand.
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
107
Choosing the Best Method for
Performance Evaluation
For external reporting purposes, managers have no
choice but to use absorption costing, as it is required
by GAAP. Managers are also required to use absorption
costing for filing annual income tax returns. However,
for internal decision making, variable costing is often the
best choice. If income is used to evaluate the performance
of a manager of a division or segment of a company, it
seems logical that the measure of income should reflect
managerial effort and skill. If sales decrease from one period to another with no changes in production or other
factors, it seems logical that income should decrease as
it does under variable costing. In contrast, increasing income by increasing production with no corresponding
increase in sales (as is possible with absorption costing)
is counterintuitive. All other things being equal, increasesW
in sales should result in increases in income and decreasesI
in sales should result in decreases in income.
L
So, using variable costing for internal decision making
removes the impact of changing production levels on in-S
come. Accordingly, calculations of income are more likelyO
to reflect managerial skill rather than simply an increase in
N
production. If a manager’s compensation package is based
on net income, using absorption costing may motivate,
that manager to increase production simply to increase
income. Under variable costing, managers are more likely
J
to make optimal production volume decisions.
STUDY
A
M
I
E
TOOLS
Variable costing offers many
benefits that focus on managerial
performance and cost behavior.
Advantages of Variable Costing
Absorption costing is required by GAAP and must be
used whenever a company provides financial statements
to individuals outside the company. However, for internal management purposes, variable costing would seem
to be a better choice. Variable costing has the following
advantages:
•
•
•
•
•
Changes in production and inventory levels do not
affect the calculation of profits.
Variable costing focuses attention on relevant product costs. That is, attention is focused on variable
product costs, which can be avoided, rather than on
fixed product costs, which are often unavoidable.
Under variable costing, cost behavior is emphasized
and fixed costs are separated from variable costs on
the income statement.
Variable costing is consistent with variance analysis, an important tool used to manage a business.
Variable costing income is more closely aligned with
a company’s cash flows.
5
5
0
© Learning Objective and Key Concept Reviews
5
© Key Definitions and Formulas
1
Online (Located at www.cengagebrain.com)
B
© Flash Cards and Crossword
U Puzzles
Chapter review card
© Games and Quizzes
© Zingerman’s Deli Video and E-Lectures
© Homework Assignments (as directed by your instructor)
108
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
BRIEF EXERCISES
1. Understanding Fixed Costs and Variable
Costs LO1
Cost behavior is fundamentally important concept
to managerial accounting. The following statements
describe various aspects of cost behavior:
a. Facility-level costs include production labor, raw
materials, and utilities.
b. Fixed costs vary in direct proportion to changes
in production volume, but are constant when
expressed on a per-unit basis.
c. The normal range of production expected for
a particular product and company is called the
relevant range.
d. Assumptions about the behavior of fixed and
variable costs are expected to hold inside and
outside the relevant range.
e. Costs that vary, but only with relatively large
W
changes in production volume, are often called
I
step costs.
f. The cost equation y = a + bx can be used to
L
describe fixed costs, but not variable costs.
S
Required
Indicate whether each of the preceding statements
O
is true or false.
N
2. Mixed Costs Using High/Low Method LO2
,
PG Phones accumulated the following production
and overhead cost data for the past five months
related to its production of cell phones:
J
January
February
March
April
May
Production (cell phones)
13,600
11,500
12,750
14,300
13,250
Overhead Cost
A
$34,500
M
29,500
30,100
I
35,940
E
32,650
Required
A. Use the high/low method to calculate the5variable cost per unit and fixed costs for PG Phones.
0
B. What are estimated total costs for production of
13,000 cell phones?
5
1
Decisions frequently have income tax implications
B
for a business. The following table includes data
U
about mutually exclusive income tax scenarios:
3. The Impact of Income Taxes LO3
Before-Tax Revenue
?
$78,000
125,000
Before-Tax Cost
$60,000
?
96,000
Tax Rate
30%
?
20%
Tax Rate
15%
25%
?
After-Tax Revenue
$63,000
58,500
?
After-Tax Cost
?
$60,000
62,400
Required
Calculate the missing values for each of the
preceding transactions.
4. Absorption Costing vs. Variable
Costing LO4
The difference between absorption costing and
variable costing is relatively straightforward, but students often have difficulty mastering the material.
Item
Direct materials
Variable manufacturing overhead
Fixed selling and
administrative costs
Direct labor
Fixed manufacturing overhead
Variable selling and
administrative costs
Absorption
Costing
Variable
Costing
Required
Label each of the preceding items as to whether it is
treated as a product cost or a period cost for absorption costing and variable costing.
5. Calculating Unit Cost under Absorption
Costing and Variable Costing LO5
Companies use absorption costing and variable costing for different purposes. Understanding the difference in unit cost that results from these methods is
necessary for sound decision making. The following
production, cost, and pricing data are available:
Units in beginning inventory
Units produced
Units sold
Sales price per unit
Variable costs per unit:
Direct materials
Direct labor
Manufacturing overhead
Selling and administrative
Fixed costs in total:
Manufacturing overhead
Selling and administrative
0
12,000
10,500
$22
$7
4
2
1
$36,000
50,000
Required
Calculate the cost per unit, using absorption costing
and variable costing.
6. Comparing Income under Absorption
and Variable Costing LO6
Refer to the data in Brief Exercise 5.
Required
Calculate the net operating income for the company, using absorption costing and variable costing.
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
109
10. Mixed Costs and the Cost Equation LO1
EXERCISES
7. Cost Behavior LO1
Baby Toys Co. produces fine porcelain dolls that are
sold in exclusive gift shops. The controller and sales
manager are discussing possible price increases and
have started looking at various costs to consider
their potential impact on price. The following are
several of the costs they are discussing:
a. Advertising
b. Packaging (each doll is carefully packaged in a
nicely designed collectible carton)
c. Supervisors’ salaries
d. Fabric used in production (each doll is adorned in
unique fabrics)
e. Assembly labor
f. Mortgage payment on the production facility
g. Production facility utilities
h. Quality assurance (each doll is carefully inspected)
W
Required
I
Assist the controller and sales manager by indicating
whether each of the preceding costs is most likely a L
fixed cost (FC ) or a variable cost (VC ).
S
8. Calculation of Total Costs LO1
O
Doors and Keys, Inc., provides custom creation of
door locks for expensive homes. The company has N
recently become concerned about its ability to plan ,
and control costs. Howard Lockwood, the company’s
founder, believes that he can summarize the company’s monthly cost with a simple formula that apJ
pears as “Cost = $12,800 + $25.00 per labor hour.”
A
Required
If Doors and Keys’s employees work 850 hours in a M
single month, calculate an estimate of the company’s
I
total costs.
9. Cost Behavior Analysis LO1
Sisters Erin Joyner and Teresa Hayes have started
separate companies in the same city. Each company
provides party-planning services for weddings,
birthday parties, holiday parties, and other occasions. Erin and Teresa graduated from Upper State
University and completed a managerial accounting
course, so they both understand the importance of
managing their company’s costs. On the one hand,
Erin has estimated her cost equation to be “Total
cost = $4,000 + $40 per planning hour.” On the
other hand, Teresa has estimated her cost equation
to be “Total cost = $250 + $60 per planning hour.”
E
5
0
5
1
B
U
Carla Janes and Associates incurred total costs of
$10,000 to produce 500 custom mirrors. A total of
550 direct labor hours was required for the production of the mirrors. Direct labor is variable and costs
$10 per hour.
Required
How much fixed cost did Carla Janes and Associates
incur?
11. Cost Behavior: Step Costs LO1
Sara Ouellette has leased a new automobile under a
special lease plan. If she drives the car 1,000 miles or
less during a one-month period, the lease payment
is $250. If the mileage ranges between 1,001 and
1,500 miles, the lease payment becomes $300. If the
mileage ranges between 1,501 and 2,000 miles, the
lease payment rises to $350.
Required
A. What type of cost is the lease?
B. If Sara drives the car only between 1,200 and
1,400 miles per month, then what type of cost
does the lease effectively become?
12. Fixed and Variable Cost Behavior LO1
Killy’s Baskets has the following current-year costs:
Variable costs
Fixed costs
$6 per unit
$7,000
Killy and a key supplier have entered into an
arrangement that will result in a per-unit decrease
in Killy’s variable cost of $0.50 next year. Rental
space will also be reduced, thereby decreasing fixed
costs by 10 percent.
Required
A. If the company makes these changes, what is the
new cost equation?
B. Given the new cost equation, determine
estimated total costs if production remains at
12,000 units.
13. Regression Analysis: Calculation of Total
Cost LO2
Valentine is a manufacturer of fine chocolates.
Recently, the owner, Melinda Gross, asked her
controller to perform a regression analysis on
production costs. Melinda believes that pounds of
chocolate produced drive all of the company’s production costs. The controller generated the following regression output:
Required
A. What could explain such a difference in the cost
equations?
B. If each sister works a total of 135 planning hours,
what total costs would each report?
110
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
R Square
0.50688
Standard Error 1.43764
Analysis of Variance
DF Sum of Squares Mean Square
Regression
1
418.52992
481.52992
Residual
197
407.16375
2.06682
F = 202.49935
Signif. F = 0.0000
Variables in the Equation
Variable Coefficients Standard Error t Stat P-Value
Pounds
7.940
0.055794
14.230 0.0000
Intercept
204.070
0.261513
20.780 0.4361
Required
Calculate an estimated total cost, assuming that
Valentine manufactures 5,000 pounds of
chocolate.
14. Mixed Costs Using High/Low Method LO2
Gregory’s Gems accumulated the following production and overhead cost data for the pastW
five
months:
I
January
February
March
April
May
Production (units)
10,600
10,500
11,500
12,500
11,000
Overhead Cost
L
$40,250
S
40,000
44,250
O
45,500
N
43,750
,
Required
A. Use the high/low method to calculate the variable cost per unit and fixed costs for Gregory’s
J
Gems.
B. What are estimated total costs for production
A of
12,000 units?
M
15. Mixed Costs Using High/Low Method LO2
I
Captain Co. used the high/low method to derive the
E to
cost formula for electrical power cost. According
the cost formula, the variable cost per unit of activity is $3 per machine hour. Total electrical power
cost at the high level of activity was $7,600 5
and was
$7,300 at the low level of activity. The high level of
0
activity was 1,200 machine hours.
5
1
16. Calculate Variable Cost Using High/LowB
Method LO2
U
Required
Calculate the low level of activity.
Delia, Inc., is preparing a budget for next year and
requires a breakdown of the cost of steam used
in its factory into fixed and variable components.
The following data on the cost of steam used and
direct labor hours worked are available for the last
six months:
July
August
September
October
November
December
Cost of Steam
$ 15,850
13,400
16,370
19,800
17,600
18,500
Direct Labor Hours
3,000
2,050
2,900
3,650
2,670
2,650
$101,520
16,920
Required
A. Use the high/low method to calculate the estimated variable cost of steam per direct labor hour.
B. Prepare a graph of the cost of steam and the
direct labor hours. Show labor hours on the x-axis
and cost on the y-axis. What can you observe
from the graph you prepared? (Hint: Set the
minimum y-axis value to $11,000.)
17. Impact of Income Taxes LO3
Ben Rakusin is contemplating an expansion of his
business. He believes he can increase revenues by
$9,000 each month if he leases 1,500 additional
square feet of showroom space. Rakusin has found
the perfect showroom. It leases for $4,000 per
month. Ben’s tax rate is 30 percent.
Required
What estimated after-tax income will Rakusin earn
from his expansion?
18. Impact of Income Taxes LO3
Most business transactions have tax consequences.
Understanding the after-tax effects of transactions is
fundamentally important. Consider the following:
Before-Tax Revenue
$100,000
200,000
135,000
Before-Tax Cost
$25,000
50,000
35,000
Tax Rate
40%
20%
35%
Tax Rate
40%
20%
35%
After-Tax Revenue
?
?
?
After-Tax Cost
?
?
?
Required
Calculate the after-tax revenue or after-tax cost for
each of the preceding transactions.
19. Impact of Income Taxes LO3
Barnett Corporation anticipates net operating
income (before tax) of $1,200,000 this year. The
company is considering signing an equipment lease
that would result in a $175,000 deductible expense
this year. The company’s tax rate is 35 percent.
Required
A. What are the tax expense and net income after
taxes for the anticipated net income without the
lease of the equipment?
B. What are the tax expense and net income after
taxes if the equipment is leased?
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
111
20. Variable Costing: Calculation of Unit
Variable Cost LO4, 5
Yankee Doodle Dandy Candy Company manufactures a single product, an awesome chocolate bar.
Last year, the company produced 4,000 bars and sold
3,500 of them. Yankee Doodle Dandy had no candy
bars at the beginning of the year. The company has
the following costs:
Variable costs per unit:
Production
Selling and administrative
Fixed costs in total:
Production
Selling and administrative
$ 4.00
$ 1.00
$12,000
$ 8,000
W
I
Munn Bicycle Company manufactures bicycles
L
specifically for college campuses. The bicycles sell
for $100 and are very sturdy, with built-in saddle- S
bags on the rear designed to carry backpacks.
O
Selected data for last year’s operations are as
follows:
N
Units in beginning inventory
0
,
22. Absorption Costing: Calculation of Unit
Variable Cost LO5
20,000
18,000
2,000J
A
$40
20M
5I
2
E
$250,000
$100,0005
Lisa’s Lockets manufactures a single product, a diamond locket. Last year, the company produced
4,000 lockets and sold 3,500 of them. They had no
lockets at the beginning of the year. The company
has the following costs:
$12,000
$ 8,000
Required
Calculate the unit product cost, assuming that the
company uses absorption costing.
Refer to the data in Exercise 21.
21. Absorption Costing vs. Variable Costing
LO4, 5, 6
Required
A. What is the product cost per bicycle if the company uses absorption costing?
B. What is the product cost per bicycle if the company uses variable costing?
$ 4.00
$ 1.00
23. Absorption Costing vs. Variable Costing:
Calculation of Net Operating Income
LO4, 5, 6
Required
Calculate the unit product cost, assuming that the
company uses variable costing.
Units produced
Units sold
Units in ending inventory
Variable costs per unit:
Direct materials
Direct labor
Variable manufacturing overhead
Variable selling and administrative
Fixed costs:
Fixed manufacturing overhead
Fixed S&A
Variable costs per unit:
Production
Selling and administrative
Fixed costs in total:
Production
Selling and administrative
0
5
1
B
U
Required
A. Prepare income statements for each costing
method.
B. Explain the difference between the two income
statements.
C. If, in the next year of operation, 20,000 units are
produced and 21,000 units are sold, what would
the net operating income be under each costing
method? Explain the difference. (Assume that
there is no change in the variable cost per unit
or the fixed costs.)
24. Absorption Costing vs. Variable Costing:
Calculation of Net Operating Income
LO4, 5, 6
Posey Manufacturing has the following cost information available for the most current year.
Direct materials
Direct labor
Variable manufacturing overhead
Variable S&A costs
Fixed manufacturing overhead
Fixed S&A costs
$6.00 per unit
$4.00 per unit
$2.00 per unit
$1.00 per unit
$80,000
$25,000
During the year, Posey produced 12,500 units, out of
which 11,000 were sold for $60 each.
Required
A. Produce an income statement using variable
costing.
B. Produce an income statement using absorption
costing.
C. If Posey needs to take one of these income statements to the bank to apply for a loan, which one
should he use? Why?
D. For internal decision making, which income statement would be more useful? Why?
25. Absorption Costing vs. Variable Costing
LO4, 5
McIntyre Manufacturing produces a single product.
Last year, the company produced 20,000 units, out
of which 18,000 were sold. There were no units in
112
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
beginning inventory. The company had the following costs:
Variable costs per unit:
Production
S&A
Fixed costs (total):
Production
S&A
$ 10.00
$ 4.00
$40,000
$20,000
Required
A. Calculate McIntyre’s product cost per unit, assuming that the company uses variable costing.
B. Calculate McIntyre’s product cost per unit, assuming that the company uses absorption costing.
C. Calculate McIntyre’s total period cost, assuming
that the company uses variable costing.
D. Calculate McIntyre’s total period cost, assuming
that the company uses absorption costing.
E. Explain the differences in product cost and period
cost between the two costing methods. W
I
L
Kristi Bostock started Bostock Boutique three years
S she
ago. Her business has grown handsomely, and
now produces and sells thousands of items each
O
year. Selected operational and financial data are
N
as follows:
Units in beginning inventory
0
,
26. Variable Costing: Calculation of Net
Operating Income LO5
Units produced
Units sold
Selling price per unit
Variable costs per unit:
Direct materials
Direct labor
Manufacturing overhead
Selling and administrative
Fixed costs in total:
Manufacturing overhead
Selling and administrative
20,000
19,000
J$ 100
A
$
M
I
E
12.00
25.00
3.00
2.00
$500,000
5$600,000
0
Required
Calculate Bostock Boutique’s net operating income,
5
assuming that the company uses variable costing.
1
27. Absorption Costing: Calculation of Net
B
Operating Income LO5
Refer to the data in Exercise 26.
U
Required
Calculate Bostock Boutique’s net operating income,
assuming that the company uses absorption costing.
28. Absorption Costing vs. Variable Costing:
Calculation of Net Operating Income LO5, 6
Simmons Products has the following cost information available for the most recent year.
Direct materials
Direct labor
Variable manufacturing overhead
Variable S&A costs
Fixed manufacturing overhead
Fixed S&A costs
$4.00 per unit
$3.00 per unit
$2.00 per unit
$1.00 per unit
$25,000
$10,000
During the year, Simmons produced 5,000 units, out
of which 4,600 units were sold for $30 each.
Required
A. Calculate Simmons’s net operating income, assuming that the company uses variable costing.
B. Calculate Simmons’s net operating income, assuming that the company uses absorption costing.
29. Variable Costing and Absorption Costing:
Calculation of Net Operating Income LO5, 6
Graham Warner started Warner’s Watches four years
ago. His business has grown handsomely, and he
now produces and sells thousands of watches each
year. Selected operational and financial data are as
follows:
Units in beginning inventory
Units produced
Units sold
Selling price per unit
Variable costs per unit:
Direct materials
Direct labor
Manufacturing overhead
Selling and administrative
Fixed costs in total:
Manufacturing overhead
Selling and administrative
0
25,000
20,000
$
100
$ 10.00
30.00
4.00
1.00
$400,000
$300,000
Required
A. Calculate Warner’s Watches’s net operating
income, using variable costing.
B. Calculate Warner’s Watches’s net operating
income, using absorption costing.
30. Variable Costing and Absorption Costing:
Calculation of Net Operating Income LO5, 6
Gumby’s Gum produces large amounts of gum each
year. This year, Gumby’s produced 45,000 packs of
gum but sold only 42,000 of the packs. Each pack
sells for $1.50. Selected operational and financial
data are as follows:
Variable costs per unit:
Production
S&A
Fixed costs in total:
Production
S&A
Chapter 5: Cost Behavior
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$ 0.50
0.10
$6,000
$3,000
113
Required
A. Calculate Gumby’s net operating income, using
variable costing.
B. Will operating income be higher or lower if calculated with absorption costing?
C. By how much?
PROBLEMS
33. Regression vs. High/Low Method LO1, 2
Tools Are Us Corporation produces toolboxes used
by construction professionals and homeowners.
The company is concerned that it does not have
an understanding of its utility consumption. The
company’s president, George, has asked the plant
manager and cost accountant to work together
to get information about utilities cost. The two of
them accumulated the following data for the past
14 months (production volume is presented in units):
31. Variable Costing and Absorption
Costing: Calculation of Net
Operating Income LO5, 6
Entel Corporation creates an accounting computer
program. This year, Entel Corporation produced
20,000 units of its program and sold 22,000 units.
Each unit sells for $250. Selected operational and
financial data are as follows:
Variable costs per unit:
Direct materials
Direct labor
Manufacturing overhead
Selling and administrative
Fixed costs per unit:
Manufacturing overhead
Selling and administrative
$ 15.00
40.00
5.00
W
2.00
I
$200,000L
$150,000
S
Required
O
A. Calculate Entel’s net operating income, using
absorption costing.
N
B. Will operating income be higher or lower if cal,
culated with variable costing?
C. By how much?
J
A
M
Tammond Tire Manufacturing produces truck tires.
Current market conditions indicate a significant I
increase in demand in 2013 for their tires. In anticiE
pation of that increase, the CEO has ordered the
32. Absorption Costing vs. Variable
Costing: Benefits and Calculation
of Net Operating Income LO5, 6
production plants to increase production by
25 percent in 2012. Because sales are projected to
remain stable in 2012, that will result in a 25 percent increase in inventory levels by the end
of 2012.
Required
Discuss the impact on operating income in 2012,
using variable and absorption costing. What
causes the difference? Tammond Tire is required
to provide the bank with financial statements at
the end of each year. What do you think the bank
will think of the 2012 income statement? If the
market projections prevail and sales increase by
25 percent in 2013, what will be the impact on
the 2013 income statement, using both costing
methods?
114
5
0
5
1
B
U
January
February
March
April
May
June
July
August
September
October
November
December
January
February
Production
113,000
114,000
90,000
110,000
112,000
101,000
104,000
105,000
115,000
97,000
98,000
98,000
112,000
107,000
Utility Cost
$1,712
1,716
1,469
1,600
1,698
1,691
1,700
1,721
1,619
1,452
1,399
1,403
1,543
1,608
Required
A. Use the high/low method to determine the company’s utility cost equation.
B. What would be the expected utility cost of
producing 120,000 units? (The relevant range is
85,000 to 125,000 units of production.)
C. Using the data shown and a spreadsheet program, perform a regression analysis. Discuss
any differences in the results and the potential
impact on decision making.
34. Regression Analysis Interpretation LO1, 2
Global Office Services & Supplies sells various products and services in the greater Wentworth area.
Duplicating is one of its most popular services for
corporate customers and individuals alike. Selected
data from the Duplicating Department for the previous six months are as follows:
January
February
March
April
May
June
Number of
Copies Made
20,000
25,000
27,000
22,000
24,000
30,000
Duplicating
Department’s Costs
$1,700
1,950
2,100
1,800
1,900
2,400
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
Regression output based on the previous data is as
follows:
Coefficient of intercept
R square
Number of observations
X coefficient (independent variable)
280.79
0.967696
6
0.0687
Required
A. What is the variable cost per copy for Global
Office Services & Supplies?
B. What is the fixed cost for the Duplicating
Department?
C. Given the limited regression output shown,
what cost formula should be used to compute an
estimate of future total costs in the Duplicating
Department?
D. If 26,000 copies are made next month, what total
cost would be predicted?
E. On the basis of the information given, how accurate will the cost formula developed in response
W
to question C be at predicting total Duplicating
Department costs each month?
I
35. Basic Cost Behavior, High/Low Method L
LO1, 2
S
Simon and Garfunkel operate separate, but related,
businesses in the same town. The two haveO
been
debating which of them has the least amount
N of
fixed costs. Simon, because he has always come
,
first, believes his business has lower fixed costs
than Garfunkel’s business. Of course, Garfunkel
disagrees, saying that his business has lower fixed
J
costs. The two have accumulated the following
activity and cost data and have asked that you help
A
them resolve their debate:
Simon’s Business Data
Units
Produced
1,000
1,500
Utilities
$10,000
12,500
Rent
$15,000
15,000
M
I Indirect
ELabor
$13,000
15,600
5
0Indirect
Rent
Labor
5$22,000
$21,000
1 88,000
21,000
B
Required
A. Classify each of Simon’s and Garfunkel’s expenses
U
Garfunkel’s Business Data
Units
Utilities
Produced
Expense
2,000
$24,250
8,000
66,250
as a fixed, variable, or mixed cost.
B. Calculate the total-cost formula for each business. Which business has lower fixed costs?
C. If Simon produces 1,300 units, what would his
total costs be?
D. If Garfunkel produces 1,300 units, what would his
total costs be?
36. Regression Analysis LO1, 2
Same Day Delivery wants to determine the cost
behavior pattern of maintenance costs for its delivery vehicles. The company has decided to use linear
regression to examine the costs. The previous year’s
data regarding maintenance hours and costs are as
follows:
January
February
March
April
May
June
July
August
September
October
November
December
Hours of Activity
480
320
400
300
500
310
320
520
490
470
350
340
Maintenance Costs
$4,200
3,000
3,600
2,820
4,350
2,960
3,030
4,470
4,260
4,050
3,300
3,160
Required
A. Perform a regression analysis on the given data.
What maintenance costs should be budgeted for
a month in which 420 maintenance hours will be
worked?
B. What is the percentage of the total variance that
can be explained by your analysis?
C. Use the high/low method to estimate a cost formula for Same Day. How similar is your high/low
solution to the regression solution?
37. Regression Analysis LO1, 2
Pine Side Hospital wants to determine the cost
behavior pattern of maintenance costs for its X-ray
machines. The hospital has decided to use linear
regression to examine the costs. The previous year’s
data regarding maintenance hours and costs are as
follows:
January
February
March
April
May
June
July
August
September
October
November
December
Hours of Activity
500
450
300
375
425
520
410
380
440
390
400
330
Maintenance Costs
$3,950
3,800
3,220
3,380
3,700
4,000
3,650
3,400
3,780
3,470
3,590
3,310
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
115
Required
A. Perform a regression analysis on the given data.
What maintenance costs should be budgeted for
a month in which 430 maintenance hours will be
worked?
B. What is the percentage of the total variance that
can be explained by your analysis?
C. Use the high/low method to estimate a cost formula for Pine Side. How similar is your high/low
solution to the regression solution?
38. Regression Analysis: Impact of Outliers
LO1, 2
Chris Gill founded Gill’s Grill over 20 years ago. The
business has grown so much and been so successful
that Chris is now considering selling franchises. Chris
knows that potential franchisees will want access to
certain operational data. Gill’s Grill is probably best
known for its incredible “potato flats,” a french fry–
like item served with a special secret sauce. Chris is concerned that some of the potato flats data are unusual W
and out of the ordinary. The following production
I
data related to “potato flats” have been compiled:
Pounds
Food
of Potatoes
Preparation Costs
January
20,000
$17,000
February
25,000
11,000
March
27,000
27,000
April
22,000
18,000
May
24,000
30,000
June
30,000
24,000
July
22,000
18,000
August
23,000
18,500
September
34,000
26,000
Regression Output
Coefficient of intercept
4,104.372
R square
0.244367
X coefficient
0.672073
L
S
O
N
,
J
A
M
I
E
Required
5
A. Should Chris remove some of the data? In other
words, are any of the months unusual relative to the0
others? If so, identify likely outliers from the data
and state reasons that you would remove them. 5
B. Do you think removing the data points would
1
change the regression output? Perform a regresB
sion analysis to find out the correct answer.
39. Cost Behavior, High/Low Method LO1, 2
U
Ullrich Framing is well known for the quality of its picture framing. Lucinda Ullrich, the company’s president,
believes that the number of linear feet of framing used
is the best predictor of framing costs for her company.
She asked her assistant to look into the matter, and he
accumulated the following data:
116
January
February
March
April
May
June
Linear Feet
of Framing
20,000
25,000
27,000
22,000
24,000
30,000
Number
of Mats
7,100
8,120
8,500
8,400
8,300
10,600
Framing
Costs
$17,000
19,500
21,000
18,000
19,000
24,000
Required
A. Use the high/low method to develop a total
cost formula for Ullrich Framing. You will need
to perform two separate calculations, one for
number of feet of framing and one for number
of mats.
B. Compare the cost formulas developed in question
A. Why are there differences?
C. On what basis should Ullrich select a formula to
predict framing costs? Would you recommend
that Ullrich rely on the results of the high/low
method?
40. Absorption Costing vs. Variable
Costing: Benefits and Calculation of
Net Operating Income LO4, 5, 6
HD Inc. produces a variety of products for the
computing industry. CD burners are among its
most popular products. The company’s controller,
Katie Jergens, spoke to the company’s president
at a meeting last week and told her that the
company was doing well, but that the financial
picture depended on how product costs and net
operating income were calculated. The president
did not realize that the company had options in
regard to calculating these numbers, so she asked
Katie to prepare some information and be ready
to meet with her to talk more about this issue. In
preparing for the meeting, Katie accumulated the
following data:
Units produced
Units sold
Fixed manufacturing overhead
Direct materials per unit
Direct labor per unit
Variable manufacturing overhead per unit
100,000
95,000
$300,000
$55.00
$25.00
$15.00
Required
A. Compute the cost per unit, using absorption
costing.
B. Compute the cost per unit, using variable costing.
C. Compute the difference in net operating income between the two methods. Which costing method results in the higher net operating
income?
D. Assume that production was 100,000 units and
sales were 100,000 units. What would be the
difference in net operating income between the
two methods?
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
E. Which method is required by generally accepted
accounting principles?
41. Absorption Costing vs. Variable Costing:
Benefits and Calculation of Net Operating
Income LO4, 5, 6
Boots R Us produces a variety of products for the
fashion industry. Cowboy-type boots are among its
most popular products. The company’s controller
spoke to the company’s president at a meeting last
week and told her that the company was doing
well, but that the financial picture depended on
how product costs and net operating income were
calculated. The president did not realize that the
company had options with regard to calculating
these numbers, so she asked the controller to prepare some information and be ready to meet with
her to talk more about this issue. In preparing
for the meeting, the controller accumulated the
following data:
Beginning inventory
Units produced
Units sold
Fixed manufacturing overhead
Direct materials per unit
Direct labor per unit
Variable manufacturing overhead per unit
W
25,000
I 100,000
L105,000
S$400,000
$25.00
O $35.00
N $15.00
,
Required
A. Compute the cost per unit, using absorption
costing.
B. Compute the cost per unit, using variableJcosting.
C. Compute the difference in net operating income
A
between the two methods. Which costing
method results in the higher net operating
M
income?
D. Assume that production was 100,000 units
I and
sales were 70,000 units. What would be the difEthe
ference in net operating income between
two methods? Which costing method shows the
greater net operating income?
E. Assume that production was 100,000 units5
and
sales were 100,000 units. What would be the
0
difference in net operating income between the
5
two methods?
F. Which method is required by generally accepted
1
accounting principles?
B
42. Absorption vs. Variable Costing: Benefits
U
and Calculation of Net Operating Income
LO4, 5, 6
Oliver, Inc., produces an oak rocking chair that is
designed to ease back problems. The chairs sell for
$200 each. Results from last year’s operations are as
follows:
Inventory and production data:
Units in beginning inventory
Units produced during the year
Units sold during the year
Variable costs (unit):
Direct materials
Direct labor
Variable manufacturing overhead
Variable selling and administrative
Fixed costs:
Fixed manufacturing overhead
Fixed selling and administrative
0
20,000
18,000
$ 70.00
20.00
15.00
10.00
$500,000
$530,000
Required
A. Compute the unit product cost for one rocking
chair, assuming that the company uses variable
costing.
B. Prepare an income statement based on variable
costing.
C. Compute the unit product cost for one rocking
chair, assuming that the company uses absorption
costing.
D. Prepare an income statement based on absorption costing.
E. Compare the two income statements. What
causes the net operating income to differ?
F. If the company produced 18,000 chairs and sold
20,000 chairs (assume that the additional 2,000
chairs were in the beginning inventory), what
would be the impact on the two income statements? In other words, which method provides
the higher net operating income?
CASES
43. Decision Focus: Comprehensive
Regression Analysis LO1, 2
Last Minute Cruise Co. has been operating for
more than 20 years. The company has recently undergone several major management changes and
needs accurate information to plan new cruises.
You have been retained as a consultant to provide
a cruise-planning model. The company’s accounting department provided you with the data that
follow regarding last year’s average costs for 12
cruises on the MS Robyn, a cruise ship that has a
maximum capacity of 525 passengers and a crew
of 250. All cruises on the MS Robyn are for either 7
or 10 days. The total cost shown includes all costs
of operating the ship (fuel, maintenance, depreciation, etc.) as well as meals, entertainment, and
crew costs.
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
117
Cruise
1
2
3
4
5
6
7
8
9
10
11
12
Days
7
7
7
7
7
7
10
10
10
10
10
10
Passengers
455
420
473
510
447
435
445
495
480
505
471
439
Total Cost
$315,010
297,525
317,595
326,615
314,510
310,015
365,015
370,015
367,035
375,000
367,500
365,090
Required
A. Using the number of passengers as the independent variable, perform a regression analysis to
develop the total-cost formula for a cruise.
B. How accurate is the model calculated in questionW
A? (Hint: Look at how much variance in total cost
I
is explained by the number of passengers.)
C. What are the total fixed costs per cruise? (Round
L
your answer to the nearest cent.)
D. What are the variable costs per passenger?
S
(Round your answer to the nearest cent.)
O
E. What other independent variable might Last
Minute Cruise Co. use to predict total cruise
N
costs? Using regression analysis, develop another
total-cost formula based on the new indepen- ,
dent variable.
F. Using the best planning model you can develop
from the data provided, what is the estimated J
cost of a 10-day cruise at full capacity of 525
passengers? (Round your answer to the nearest A
cent.)
M
44. Decision Focus: Comprehensive
Regression Analysis LO1, 2, 3
I
E
Perlman-Douglas, a major retailing and mail-order
operation, has been in business for the past 10
years. During that time, the mail-order operations 5
have grown from a sideline to more than 80 percent
of the company’s annual sales. Of course, the com- 0
pany has suffered growing pains. There were times
5
when overloaded or faulty computer programs resulted in lost sales. And, hiring and scheduling tem- 1
porary employees to augment the permanent staff
B
during peak periods has always been a problem.
Gail Lobanoff, manager of mail-order opera- U
tions, has developed procedures for handling most
problems. However, she is still trying to improve the
scheduling of temporary employees to take telephone orders from customers. Under the current
118
system, Lobanoff keeps a permanent staff of 60
employees who handle the basic workload. On
the basis of her estimate of the upcoming week’s
telephone volume, she determines the number of
temporary employees needed. The permanent employees are paid an average of $10 per hour plus 30
percent fringe benefits. The temporary employees
are paid $7 per hour with no fringe benefits. The
full-time employees are seldom sent home when
volume is light, and they are not paid for hours
missed. Temporary employees are paid only for their
hours worked. Perlman-Douglas normally has three
supervisors who earn $1,000 per month, but one additional supervisor is hired when temporary employees are used.
Lobanoff has decided to try regression analysis
as a way to improve the prediction of total costs of
processing telephone orders. By summarizing the
daily labor hours into monthly totals for the past
year, she was able to determine the number of labor
hours incurred each month. In addition, she summarized the number of orders that had been processed
each month. After entering the data into a spreadsheet, Lobanoff ran two regressions. Regression
1 related the total hours worked (permanent and
temporary employees) to the total cost of operating
the phone center. Regression 2 related the number
of orders taken to the total cost. The data used and
regression output are as follows:
Month
Total Cost Total Hours Number of Orders
January
$134,000
9,600
10,560
February
133,350
9,550
10,450
March
132,700
9,500
10,200
April
134,000
9,600
10,700
May
133,675
9,575
10,400
June
139,900
10,100
10,700
July
143,820
10,500
11,100
August
140,880
10,200
10,450
September
137,940
9,900
10,200
October
153,620
11,500
12,200
November
163,420
12,500
12,900
December
150,680
11,200
11,490
Regression equation: TC = FC + VC (hours) or TC =
FC + VC (orders), where TC = total cost, FC = fixed
cost, and VC = variable cost per hour or order.
Intercept (FC)
X Variable (VC)
R square
Regression 1
36,180.42
10.21475
0.997958
Regression 2
21,595.15
10.95427
0.890802
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
Required
A. What is the total-cost formula for each of the
preceding regressions? State each formula, using
costs that are rounded to the nearest cent.
B. Gail Lobanoff estimates that 12,470 orders will be
received and 12,000 hours will be worked during
January. Use each cost formula you developed
in question A to predict the total cost of operating the phone center. Round your answers to the
nearest dollar.
C. Gail needs to select one of the models for use in
predicting total phone center costs for next year’s
monthly budget.
(1) What are the objectives in selecting a prediction model?
(2) What options are available to Gail? That is,
what other independent variables might be
used to predict the costs of the phone center?
45. Absorption Costing versus Variable
Costing: Benefits and Calculation of
Net Operating Income LO4, 5, 6
W
I
Crystal Glass is a producer of heirloom-quality
L and
glassware. The company has a solid reputation
is widely regarded as a model corporate citizen.
S
You have recently been hired as a staff accountant
at a time when the company is experiencingO
rapid
growth and is looking for a substantial increase in
N also
its line of credit at the local bank. Crystal Glass
is planning on trying to take the company public
,
in the next three to five years. At the present time,
the company is a closely held family-owned business. One of your first jobs is to review the current
J
month’s income statement for accuracy. The income
statement appears as follows:
A
Crystal Glass, Inc.
Statement of Income
For the Year Ended October 31, 2011
Sales revenue
$12,008,450
Variable costs
8,475,361
Contribution margin
Fixed costs
3,533,089
1,845,902
Net operating income
$ 1,687,187
You are given the following additional information:
Variable costs:
Manufacturing
$6,356,521
S&A
$2,118,840
Fixed costs:
Manufacturing
$1,476,722
S&A
$369,180
Beginning inventory
250,000 units
Production
500,000 units
Sales
600,000 units
Required
A. What type of costing method is used by Crystal
Glass?
B. Does the method comply with GAAP? If not,
what costing method should be used? What
would net operating income be?
C. Could the statements be misleading to the bank?
Why or why not?
D. What are your options as the new staff accountant? Who are the stakeholders affected?
M
I
E
5
0
5
1
B
U
Chapter 5: Cost Behavior
9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization.
119

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