Principles of managerial accounting

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timer Asked: Mar 28th, 2017

Question Description

Richardson Corporation plans to increase its advertising budget by 20% next year. The company currently spends $15,000 on advertising costs. In addition to advertising, Richardson spends $50,000 per year for other fixed costs and $10 per unit for variable costs. If Richardson anticipates producing 30,000 units next year, what will be next year's total costs?

A. Calculate total estimated costs for next year.

Preferred Products has the following cost information available for 2012:

Direct materials

$4.00 per unit

Direct labor

$3.00 per unit

Variable manufacturing overhead

$2.00 per unit

Variable selling and administrative costs

$1.00 per unit

Fixed manufacturing overhead

$25,000

Fixed selling and administrative costs

$10,000

During 2012, Preferred produced 5,000 units out of which 4,600 units were sold for $30 each.

2. Calculate Preferred's net operating income assuming the company uses variable costing.

3. Calculate Preferred's net operating income assuming the company uses absorption costing.

You can earn a maximum of 75 points for the entire Complete section assignment in each of the five units. The Complete section is due each Sunday at midnight. Complete responses should meet or exceed the required word count if applicable. The minimum word count will need to exceed 150 words for each question unless otherwise stated. You must show your work if the question required a numerical answer.


PLEASE EXPLAIN HOW YOU CALCULATED THE ANSWER AND USE THE READING MATERIAL

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 W I 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 9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization. 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 9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization. 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 I 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 J A M I E 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 I 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 9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization. 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 9781305323339, Managerial ACCT2, Second Edition, Sawyers/Jackson/Jenkins - © Cengage Learning. All rights reserved. No distribution allowed without express authorization. $ 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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