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Exam 2: Cost Behavior, Operating Leverage, and Profitability Analysis

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Question 51

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Assuming that cost behavior did not change over the two-year period, what is the amount of the company's variable cost of goods sold per unit?

A) $12.00 per unit
B) $16.00 per unit
C) 22.00 per unit
D) none of these

E) A) and D)
F) B) and D)

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Question 52

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What is an activity base, and how does the activity base relate to a variable cost?

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An activity base is a ...

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Question 53

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Operating leverage exists when:

Wham Company sells electronic squirrel repellants for $60. Variable costs are 60% of sales and total fixed costs are $40,000. What is the firm's magnitude of operating leverage if 2,000 units are sold?

If a company shifts its cost structure by decreasing fixed costs and increasing variable costs, it will lower both the level of risk and its potential for profits.

The following income statements are provided for two companies operating in the same industry: $\begin{array}{|l|c|c|}\hline&\text { Felix Company}& \text {Jinx Company }\\\hline\text { Reverule } & \$ 200,000 & \$ 200,000 \\\hline \text { Variable costs } & (25,000) & (70,000) \\\hline \text { Contribution margin } & 175,000 & 130,000 \\\hline \text { Fixed costs } & (70,000) & (25,000) \\\hline \text { Net income } & \$ 105,000 & \$ 105,000\\\hline\end{array}$ Assuming sales increase by $1,000, select the correct statement from the following:

The following information is given regarding driving lessons provided by Arrive Alive Company over several spans of time: Select the incorrect statement from the following. $\begin{array} { | l | r | r | r | } \hline & { \text { Length of Time } } \\\hline & \text { TODAY } & \text { ONE YEAR } & \text { FIVE YEARS } \\\hline \text { Total cost of lessons } & \$ 600 & \$ 110,000 & \$ 508,000 \\\hline \text { Number of lessons } & 50 & 10,000 & 55,000 \\\hline\end{array}$

Select the incorrect statement regarding the use of average unit costs.

Select the correct statement from the following.

Grant Company and Lee Company compete in the same market. The following budgeted income statements illustrate their cost structures. $\begin{array}{|l|c|c|}\hline &\text { Grant Company } &\text { Lee Company }\\\hline \text { Number of customers } & 200 & 200 \\\hline \text { Sales revenue }(200 \times \$ 150) & \$ 30,000 & \$ 30,000 \\\hline \text { Less variable costs } & 6,000 & 18,000 \\\hline \text { Contribution margin } & \$ 24,000 & \$ 12,000 \\\hline \text { Less fixed costs } & 19,000 & 7,000 \\\hline \text { Net income } & \$ 5,000 & \$ 5,000 \\\hline\end{array}$ Required: (a) If Grant Company lowers its price to $135, it will lure 80 customers away from Lee Company. Prepare Grant's income statement based on 280 customers.(b) If Lee Company lowers its price to $135 (assuming that Grant Company is still charging $150 per customer), Lee would lure 80 customers away from Grant. Prepare Lee's income statement based on 280 customers.(c) Which of the companies would benefit more from lowering its sales price to attract more customers, and why?

The contribution margin format income statement is not widely used for external financial reporting, but is allowed by GAAP.

A cost that is considered variable for one activity base may be considered fixed for a different activity base.

How does fixed cost per unit behave when volume decreases?

Former NFL coach Joe Gibbs is highly sought after as a guest speaker. His fee can run as high as $150,000 for a single two-hour appearance. Recently, he was asked to speak at a seminar offered by the National Sports in Education Foundation (NSEF). Due to the charitable nature of the organization, Mr. Gibbs offered to speak for $100,000. NSEF planned to invite 350 guests who would each make a $500 contribution to the organization. The Foundation's executive director was concerned about committing so much of the organization's cash to this one event. So instead of the $100,000 fee she countered with an offer to pay Mr. Gibbs 50% of the revenue received from the seminar and no other payments.Required: (a) Classify the two offers in terms of cost behavior (fixed vs. variable).Scenario A, NSEF pays Gibbs a $100,000 fee: Scenario B, NSEF pays Gibbs 50% of revenue: (b) Compute the budgeted income (assuming there are no other expenses) under each of the following scenarios: 1) NSEF agrees to pay the $100,000 fee, and 350 guests actually attend the seminar; and 2) NSEF pays Mr. Gibbs 50% of revenue, and 350 guests attend the seminar.(c) For each scenario ($100,000 fee vs. 50% of revenue), compute the percentage increase in profit that would result if the Foundation is able to increase attendance by 20 percent over the original plan (to a total of 420). (Round the percentages to the nearest whole numbers.)(d) For each scenario, compute NSEF's cost per contributor if 350 attend and if 420 contributors attend. (Round the cost per contributor to two decimal points.)(e) Summarize the impact on risk and profits of shifting the cost structure from fixed to variable costs.

If managers of a company do not understand the behavior of its costs, they are likely to make poor decisions about the company's operations.

The magnitude of operating leverage for Blue Ridge Corporation is 3.5 when sales are $200,000 and net income is $36,000. If sales decrease by 6%, net income is expected to decrease by what amount?

In the graph below, which depicts the relationship between units produced and total cost, the dotted line depicts which type of total cost?

Contribution margin income statements for two competing companies are provided below: $\begin{array}{|l|l|l|}\hline &{\text { Yin Company }} & \text { Yang Company } \\\hline \text { Revenue } & \$ 750,000 & \$ 750,000 \\\hline \text { Less variable costts }&300,000&525,000 \\\hline \text { Contribution margin } &\$450,000&\$225,000\\\hline \text { Less fixed costs } &405,000&180,000\\\hline \text { Net income }&\$45,000&\$45,000\\\hline\end{array}$ Required: 1) Show each company's cost structure by inserting the percentage of the company's revenue represented by each item on the contribution income statement.2) Compute each company's magnitude of operating leverage.3) Using the operating leverage measures computed in requirement 2, determine the increase in each company's net income (percentage and amount) if each company experiences a 10 percent increase in sales.4) Assume that sales are expected to continue to increase for the foreseeable future, which company probably has more desirable cost structure? Why?

Based on the following cost data, items labeled (a) and (b) in the table below are which of the following amounts, respectively? $\begin{array} { | l | r | r | } \hline \text { Number of units: } & 1,500 & 3,000 \\\hline \text { Total cost: } & & \\\hline \text { Variable } & \$ 7,500 & \$ 15,000 \\\hline \text { Fixed } & \$ 6,000 & \$ 6,000 \\\hline & & \\\hline \text { Cost per unit: } & & \\\hline \text { Variable } & \$ 5 & \text { (a) } \\\hline \text { Fixed } & \$ 4 & \text { (b) } \\\hline\end{array}$

Blackstock Company manufactures digital cameras. Indicate whether the cost is a product cost or period cost AND whether its cost behavior is fixed, variable, or mixed by placing X's in the appropriate boxes. As an example, commissions paid to sales staff would be classified as a period cost and variable. $\begin{array} { | l | l | l | l | } \hline & { \text { Cost Behavior } } \\\hline \text { Cost } & \text { Fixed } & \text { V ariable } & \text { Mixed } \\\hline \text { Insur ance on executive offices } & & & \\\hline \text { Lens caps for digital cameras } & & & \\\hline \text { Depreciation on manuf acturing equipment } & & & \\\hline \text { Shipping cost to defiver products to customers } & & & \\\hline \text { Salary of compary president } & & & \\\hline \text { Wages of assembly workers } & & & \\\hline \text { Product advertising } & & & \\\hline \begin{array} { l } \text { Utilities: electricity to nun machines and for } \\\text { heat and lights in factory }\end{array} & & & \\\hline\end{array}$