Chapter 5

Cost Behavior: Analysis and Use

Solutions to Questions
5-1 a. Variable cost: The variable cost per unit is constant, but total variable cost changes in in direct proportion to changes in volume. b. Fixed cost: The total fixed cost is constant within the relevant range. The average fixed cost per unit varies inversely with changes in volume. c. Mixed cost: A mixed cost contains both variable and fixed cost elements. 5-2 a. nit fixed costs decrease as volume increases. b. nit variable costs remain constant as volume increases. c. Total fixed costs remain constant as volume increases. d. Total variable costs increase as volume increases. 5-3 a. !ost behavior: !ost behavior refers to the way in which costs change in response to changes in a measure of activity such as sales volume, production volume, or orders processed. b. "elevant range: The relevant range is the range of activity within which assumptions about variable and fixed cost behavior are valid. 5-4 An activity base is a measure of whatever causes the incurrence of a variable cost. #xamples of activity bases include units produced, units sold, letters typed, beds in a hospital, meals served in a cafe, service calls made, etc. 5-5 a. Variable cost: A variable cost remains constant on a per unit basis, but increases or decreases in total in direct relation to changes in activity. b. Mixed cost: A mixed cost is a cost that contains both variable and fixed cost elements. c. $tep%variable cost: A step%variable cost is a cost that is incurred in large chun&s, and which increases or decreases only in response to fairly wide changes in activity.

Mixed Cost Variable Cost

Cost

Step-Variable Cost

Activity

5-6 The linear assumption is reasonably valid providing that the cost formula is used only within the relevant range. 5-7 A discretionary fixed cost has a fairly short planning hori'on(usually a year. $uch costs arise from annual decisions by management to spend on certain fixed cost items, such as advertising, research, and management development. A committed fixed cost has

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -.0 Managerial Accounting, /1th #dition

a long planning hori'on(generally many years. $uch costs relate to a company2s investment in facilities, e3uipment, and basic organi'ation. 4nce such costs have been incurred, they are 5loc&ed in6 for many years.

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -.7 Managerial Accounting, /1th #dition

5a. !ommitted b. 8iscretionary c. 8iscretionary

d. !ommitted e. !ommitted f. 8iscretionary

regression line is smaller than could be obtained from any other line that could be fitted to the data. 5-13 4rdinary single least%s3uares regression analysis is used when a variable cost is a function of only a single factor. ,f a cost is a function of more than one factor, multiple regression analysis should be used to analy'e the behavior of the cost. 5-14 The contribution approach income statement organi'es costs by behavior, first deducting variable expenses to obtain contribution margin, and then deducting fixed expenses to obtain net operating income. The traditional approach organi'es costs by function, such as production, selling, and administration. >ithin a functional area, fixed and variable costs are intermingled. 5-15 The contribution margin is total sales revenue less total variable expenses.

5-! 9es. As the anticipated level of activity changes, the level of fixed costs needed to support operations may also change. Most fixed costs are ad:usted upward and downward in large steps, rather than being absolutely fixed at one level for all ranges of activity. 5-1" The high%low method uses only two points to determine a cost formula. These two points are li&ely to be less than typical because they represent extremes of activity. 5-11 The formula for a mixed cost is 9 ; a < b=. ,n cost analysis, the 5a6 term represents the fixed cost and the 5b6 term represents the variable cost per unit of activity. 5-12 ,n a least%s3uares regression, the sum of the s3uares of the deviations from the plotted points on a graph to the

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, !hapter 7 -.?

#$er%ise 5-1 @/7 minutesA / . Fixed cost............................ Variable cost........................ Total cost............................. Average cost per cup of coffee served D.................. Cups of Coffee Served in a Week 2,000 2,100 2,200 B/,-.. B/,-.. B/,-. . 00. 0?0C0 B/,?0. B/,??B/,?C 0 B..C-. B..EF/ B..E? 7

D Total cost G cups of coffee served in a wee& -. The average cost of a cup of coffee declines as the number of cups of coffee served increases because the fixed cost is spread over more cups of coffee.

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -.E Managerial Accounting, /1th #dition

#$er%ise 5-2 @1. minutesA /. The scattergraph appears below:

B?.,... 9

B7.,...

&ro%essin' Cost

B0.,...

B1.,...

B-.,...

B/.,...

B. .

= -,... 0,... ?,... C,... /.,... /-,... /0,... Units &rodu%ed

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, !hapter 7 -.C

#$er%ise 5-2 @continuedA -. @$tudents2 answers will vary considerably due to the inherent imprecision of the 3uic&%and%dirty method.A The approximate monthly fixed cost is B1.,...(the point where the line intersects the cost axis. The variable cost per unit processed can be estimated using the C,...%unit level of activity, which falls on the line: Total cost at an C,...%unit level of activity.... Hess fixed costs............................................. Variable costs at an C,...%unit level of activity........................................................ B/?,... G C,... units ; B- per unit Therefore, the cost formula is B1.,... per month plus B- per unit processed. 4bserve from the scattergraph that if the company used the high%low method to determine the slope of the regression line, the line would be too steep. This would result in underestimating fixed costs and overestimating the variable cost per unit. B0?,... 1.,... B/?,...

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -.F Managerial Accounting, /1th #dition

#$er%ise 5-3 @-. minutesA /. +igh activity level @AugustA....................... How activity level @4ctoberA..................... !hange........................... Occupanc y-Days -,0.? /-0 -,-CElectrical Costs B7,/0C /,7CC B1,7?.

Variable cost ; !hange in cost G !hange in activity ; B1,7?. G -,-C- occupancy%days ; B/.7? per occupancy%day Total cost @AugustA.............................................. B7,/0C Variable cost element @B/.7? per occupancy%day I -,0.? occupancy% daysA................................................................ 1,E71 Fixed cost element.............................................. B/,1F7 -. #lectrical costs may reflect seasonal factors other than :ust the variation in occupancy days. For example, common areas such as the reception area must be lighted for longer periods during the winter than in the summer. This will result in seasonal fluctuations in the fixed electrical costs. Additionally, fixed costs will be affected by the number of days in a month. ,n other words, costs li&e the costs of lighting common areas are variable with respect to the number of days in the month, but are fixed with respect to how many rooms are occupied during the month. 4ther, less systematic, factors may also affect electrical costs such as the frugality of individual guests. $ome guests will turn off lights when they leave a room. 4thers will not.

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, !hapter 7 -/.

#$er%ise 5-4 @-. minutesA /. The Alpine +ouse, ,nc. ,ncome $tatement($&i 8epartment For the Juarter #nded March 1/ $ales............................................................... Variable expenses: !ost of goods sold @-.. pairsD I B07. per pairA........................................................... $elling expenses @-.. pairs I B7. per pairA. Administrative expenses @-.K I B/.,...A... !ontribution margin........................................ Fixed expenses: $elling expenses LB1.,... M @-.. pairs I B7. per pairAN....... Administrative expenses @C.K I B/.,...A... Oet operating income...................................... DB/7.,... G BE7. per pair ; -.. pairs -. $ince -.. pairs of s&is were sold and the contribution margin totaled B0C,... for the 3uarter, the contribution of each pair of s&is toward covering fixed costs and toward earning of profits was B-0. @B0C,... G -.. pairs ; B-0. per pairA. Another way to compute the B-0. is: $elling price per pair.................... Variable expenses: !ost per pair.............................. $elling expenses........................ Administrative expenses @B-,... G -.. pairsA............... !ontribution margin per pair........ BE7. B07. 7. /. 7/. B-0. B/7.,.. . BF.,... /.,... -,... /.-,... 0C,... -.,... C,...

-C,... B -.,...

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -// Managerial Accounting, /1th #dition

#$er%ise 5-5 @-. minutesA /. The company2s variable cost per unit is: B/C.,... ;B? per unit. 1.,... units ,n accordance with the behavior of variable and fixed costs, the completed schedule is: Units produced and sold 0,000 !0,000 "0,000 B/C.,.. B1..,.. . B-0.,... . 1..,... 1..,... 1..,... B0C.,.. B?..,.. . B70.,... . B ?... /.... B/?... B ?... E.7. B/1.7. B ?... ?... B/-...

Total costs: Variable costs......... Fixed costs............. Total costs.............. !ost per unit: Variable cost.......... Fixed cost............... Total cost per unit...

-. The company2s income statement in the contribution format is: $ales @07,... units I B/? per unitA................ BE-.,... Variable expenses @07,... units I B? per unitA.............................................................. -E.,... !ontribution margin........................................ 07.,... Fixed expense................................................. 1..,... Oet operating income..................................... B/7.,...

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, !hapter 7 -/-

#$er%ise 5-6 @07 minutesA /. Units S#ipped C ? S#ipping E$pense B-,E.. /,-.. B/,7..

+igh activity level @PuneA. How activity level @PulyA.. . !hange........................... Variable cost element:

!hange in expense B/,7.. ; ;B-7. per unit. !hange in activity ? units Fixed cost element: $hipping expense at high activity level............. Hess variable cost element @B-7. per unit I C unitsA.............................................................. Total fixed cost.................................................. B-,E.. -,... BQE..

The cost formula is BE.. per month plus B-7. per unit shipped or 9 ; BE.. < B-7.=, where = is the number of units shipped. -. a. $ee the scattergraph on the following page. b. @Oote: $tudents2 answers will vary due to the imprecision of this method of estimating variable and fixed costs.A Total cost at 7 units shipped per month La point falling on the regression line in @aAN...... Hess fixed cost element @intersection of the 9 axisA.............................................................. Variable cost element...................................... B/,... G 7 units ; B-.. per unit The cost formula is B/,... per month plus B-.. per unit shipped or 9 ; B/,... < B-..= where = is the number of units shipped. B-,... /,... B/,...

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -/1 Managerial Accounting, /1th #dition

#$er%ise 5-6 @continuedA -. a. The scattergraph would be:

B1,... Shippin' #$pense B-,7.. B-,... B/,7.. B/,... B7.. B.

= . 0 ? C /. Units Shipped

1. The cost of shipping units is li&ely to depend on the weight and volume of the units and the distance traveled, as well as on the number of units shipped. ,n addition, higher cost shipping might be necessary to meet a deadline.

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, !hapter 7 -/0

#$er%ise 5-7 @-. minutesA /. +igh level of activity................... How level of activity.................... !hange....................................... %ilo&eter s Driven /.7,... E.,... 17,... 'otal (nnual Cost) B//,FE. F,1C. BQ-,7F.

/.7,... &ilometers I B..//0 per &ilometer ; B//,FE. E.,... &ilometers I B../10 per &ilometer ; BF,1C. Variable cost per &ilometer: !hange in cost B-,7F. ; ;B...E0 per &ilometer !hange in activity 17,... &ilometers Fixed cost per year: Total cost at /.7,... &ilometers.............. Hess variable portion: /.7,... &ilometers I B...E0 per &ilometer.............................................. Fixed cost per year.................................. -. 9 ; B0,-.. < B...E0= 1. Fixed cost.................................................... Variable cost: C.,... &ilometers I B...E0 per &ilometer.................................................. Total annual cost......................................... BQ0,-.. 7,F-. B/.,/-. B//,FE. E,EE. BQ0,-..

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -/7 Managerial Accounting, /1th #dition

#$er%ise 5/.

@-. minutesA Custodia l Supplies E$pense B/1,7.. E,7.. B ?,...

*uest Days +igh activity level @PulyA.......... /-,... How activity level @MarchA....... 0,... !hange................................... C,... Variable cost element:

!hange in expense B?,... ; ;B..E7 per guest%day !hange in activity C,... guest%days Fixed cost element: !ustodial supplies expense at high activity level............................................................ B/1,7.. Hess variable cost element: /-,... guest%days I B..E7 per guest%day. . F,... Total fixed cost.............................................. BQ0,7.. The cost formula is B0,7.. per month plus B..E7 per guest%day or 9 ; B0,7.. < B..E7= -. !ustodial supplies expense for //,... guest%days: Variable cost: //,... guest%days I B..E7 per guest%day........................................... B C,-7. Fixed cost............................................. 0,7.. Total cost.............................................. B/-,E7.

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, !hapter 7 -/?

#$er%ise 5-! @1. minutesA /. The scattergraph appears below:

9

B/?,... B/0,... Custodial Supplies Cost B/-,... B/.,... BC,... B?,... B0,... B-,... B.

= . -,... 0,... ?,... C,... /.,... /-,... /0,...

(uest-)ays

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -/E Managerial Accounting, /1th #dition

#$er%ise 5-! @continuedA -. @Oote: $tudents2 answers will vary considerably due to the inherent lac& of precision and sub:ectivity of the 3uic&%and%dirty method.A Total costs at E,7.. guest%days per month La point falling on the line in @/AN.......................... Hess fixed cost element @intersection of the 9 axisA................................................................. Variable cost element......................................... B?,... G E,7.. guest%days ; B..C. per guest%day The cost formula is therefore B1,E7. per month, plus B..C. per guest%day or 9 ; B1,E7. < B..C.=, where = is the number of guest%days. 1. The high%low method would not provide an accurate cost formula in this situation because a line drawn through the high and low points would have a slope that is too flat and would be placed too high, cutting the cost axis at about B0,7.. per month. The high and low points are not representative of all of the data in this situation. BF,E7. 1,E7. B?,...

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, !hapter 7 -/C

#$er%ise 5-1" @-. minutesA /. a. 8ifference in cost: Monthly operating costs at C.K occupancy: 07. beds I C.K ; 1?. bedsR 1?. beds I 1. days I B1- per bed%day.......... B107,?.. Monthly operating costs at ?.K occupancy @givenA............................................................. 1-?,E.. 8ifference in cost............................................... BQ/C,F.. 8ifference in activity: C.K occupancy @07. beds I C.K I 1. daysA. ?.K occupancy @07. beds I ?.K I 1. daysA. 8ifference in activity......................................... /.,C.. C,/.. -,E..

!hange in cost B/C,F.. ; ; BE per bed%day !hange in activity -,E.. bed%days b. Monthly operating costs at C.K occupancy @aboveA............................................................. Hess variable costs: 1?. beds I 1. days I BE per bed%day............. Fixed operating costs per month......................... -. 07. beds I E.K ; 1/7 beds occupied: B107,?. . E7,?.. B-E.,.. .

B-E.,.. Fixed costs.......................................................... . Variable costs: 1/7 beds I 1. days I BE per ??,/7 bed%day............................................................ . B11?,/7 Total expected costs............................................ .

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -/F Managerial Accounting, /1th #dition

&ro*le+ 5-11 @07 minutesA /. Marwic&2s Sianos, ,nc. ,ncome $tatement For the Month of August $ales @0. pianos I B1,/-7 per pianoA...... !ost of goods sold @0. pianos I B-,07. per pianoA............. *ross margin........................................... $elling and administrative expenses: $elling expenses: Advertising.......................................... $ales salaries and commissions LBF7. < @CK I B/-7,...AN............... 8elivery of pianos @0. pianos I B1. per pianoA............. tilities................................................ 8epreciation of sales facilities............. Total selling expenses............................ Administrative expenses: #xecutive salaries............................... ,nsurance............................................ !lerical LB/,... < @0. pianos I B-. per pianoAN.............................................. 8epreciation of office e3uipment........ Total administrative expenses............... Total selling and administrative expenses Oet operating income.............................. B/-7,.. . FC,.. . -E,... B E..

/.,F7. /,-.. 17. C.. /0,... -,7.. 0.. /,C.. 1.. 7,...

/F,.. . BQQ C,...

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, !hapter 7 --.

&ro*le+ 5-11 @continuedA -. Marwic&2s Sianos, ,nc. ,ncome $tatement For the Month of August +er 'otal +iano $ales @0. pianos I B1,/-7 per pianoA......... B/-7,... B1,/-7 Variable expenses: !ost of goods sold @0. pianos I B-,07. per pianoA.............. FC,... -,07. $ales commissions @CK I B/-7,...A........ /.,... -7. 8elivery of pianos @0. pianos I B1. per pianoA..................................................... /,-.. 1. !lerical @0. pianos I B-. per pianoA........ C.. -. Total variable expenses............................... //.,... -,E7. !ontribution margin.................................... /7,... BQ 1E7 Fixed expenses: Advertising............................................... E.. $ales salaries............................................ F7. tilities..................................................... 17. 8epreciation of sales facilities.................. C.. #xecutive salaries..................................... -,7.. ,nsurance.................................................. 0.. !lerical..................................................... /,... 8epreciation of office e3uipment.............. 1.. Total fixed expenses.................................... E,... Oet operating income................................. B C,... 1. Fixed costs remain constant in total but vary on a per unit basis inversely with changes in the activity level. As the activity level increases, for example, the fixed costs will decrease on a per unit basis. $howing fixed costs on a per unit basis on the income statement might mislead management into thin&ing that the fixed costs behave in the same way as the variable costs. That is, management might be misled into thin&ing that the per unit fixed costs would be the same regardless of how many pianos were sold during the month. For this reason, fixed costs generally are shown only in totals on a contribution format income statement.
) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. --/ Managerial Accounting, /1th #dition

&ro*le+ 5-12 @07 minutesA /. !ost of goods sold............. Advertising expense.......... $hipping expense.............. $alaries and commissions.. ,nsurance expense............. 8epreciation expense........ Variable Fixed Mixed Mixed Fixed Fixed Salaries and S#ipping Co&&issions E$pense E$pense AB1C,... ABF.,... 10,... EC,... AB 0,... AB/-,...

-. Analysis of the mixed expenses: Units 7,... 0,... /,...

+igh level of activity.. How level of activity... !hange...................... Variable cost element: Variable rate ;

!hange in cost !hange in activity AB0,... ; AB0 per unit /,... units AB/-,... ; AB/- per unit /,... units Salaries and Co&&issions E$pense ABF.,...

$hipping expense:

$alaries and commissions expense: Fixed cost element:

!ost at high level of activity........................... Hess variable cost element: 7,... units I AB0 per unit.............................. 7,... units I AB/- per
$olutions Manual, !hapter 7

S#ipping E$pense AB1C,...

-.,...

?.,...
---

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved.

unit.............................. Fixed cost element............ &ro*le+ 5-12 @continuedA

AB/C,...

AB1.,...

The cost formulas are: $hipping expense: AB/C,... per month plus AB0 per unit or 9 ; AB/C,... < AB0= $alaries and commissions expense: AB1.,... per month plus AB/- per unit or 9 ; AB1.,... < AB/-= 1. Morrisey T Urown, Htd. ,ncome $tatement For the Month #nded $eptember 1. $ales @7,... units I AB/.. per unitA. . Variable expenses: !ost of goods sold @7,... units I AB?. per unitA........ $hipping expense @7,... units I AB0 per unitA........... $alaries and commissions expense @7,... units I AB/- per unitA......... !ontribution margin............................ Fixed expenses: Advertising expense......................... $hipping expense............................. $alaries and commissions expense. . ,nsurance expense............................ 8epreciation expense....................... Oet operating income......................... AB7..,.. . AB1..,.. . -.,... ?.,... -/,... /C,... 1.,... ?,... /7,... 1C.,... /-.,...

F.,... AB 1.,...

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. --1 Managerial Accounting, /1th #dition

&ro*le+ 5-13 @1. minutesA a 1 / . . b ? . c . // e 0 . f. /. g . h . E i F .

d / .

-. >ithout an understanding of the underlying cost behavior patterns, it would be difficult, if not impossible, for a manager to properly analy'e the firm2s cost structure. The reason is that all costs don2t behave in the same way. 4ne cost might move in one direction as a result of a particular action, and another cost might move in an opposite direction. nless the behavior pattern of each cost is clearly understood, the impact of a firm2s activities on its costs will not be &nown until after the activity has occurred.

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, !hapter 7 --0

&ro*le+ 5-14 @07 minutesA /. +igh%low method: ,u&-er of Scans /7. ?. F. Utilities Cost B0,... -,-.. B/,C..

+igh level of activity................ How level of activity................ !hange.................. Variable rate:

!hange in cost B/,C.. ; ;B-. per scan !hange in activity F. scans B0,... 1,... B/,...

Fixed cost: Total cost at high level of activity.... Hess variable element: /7. scans I B-. per scan............. Fixed cost element..........................

Therefore, the cost formula is: 9 ; B/,... < B-.=. -. $cattergraph method @see the scattergraph on the following pageA: @Oote: $tudents2 answers will vary due to the inherent imprecision of the 3uic&%and%dirty method.A The line intersects the cost axis at about B/,-... The variable cost can be estimated as follows: Total cost at /.. scans @a point that falls on the lineA................................................................ Hess the fixed cost element............................... Variable cost element @totalA............................. B/,C.. G /.. scans ; B/C per scan Therefore, the cost formula is: 9 ; B/,-.. < B/C=. B1,... /,-.. B/,C..

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. --7 Managerial Accounting, /1th #dition

&ro*le+ 5-14 @continuedA The completed scattergraph:

B0,7.. B0,... B1,7.. B1,... B-,7.. B-,... B/,7.. B/,... B7.. B.

.otal Utilities Cost

= . -. 0. ?. C. /.. /-. /0. /?. ,u+*er o- S%ans

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, !hapter 7 --?

&ro*le+ 5-15 @1. minutesA /. Maintenance cost at the E7,... direct labor%hour level of activity can be isolated as follows: .evel of (ctivity "0,000 0",000 D./s D./s V/0,-7.,.. . V/E,?-7,...

Total factory overhead cost........... 8educt: ,ndirect materials W V/.. per 8H+D........................................ 7,...,... E,7..,... "ent........................................... ?,...,... ?,...,... Maintenance cost......................... V 1,-7.,... V 0,/-7,... D V7,...,... G 7.,... 8H+s ; V/.. per 8H+ -. +igh%low analysis of maintenance cost: Direct .a-or/ours E7,... 7.,... -7,... 1aintenance Cost V0,/-7,... 1,-7.,... V CE7,...

+igh level of activity. . . How level of activity. . . . !hange........................ Variable cost element:

!hange in cost VCE7,... ; ;V17 per 8H+ !hange in activity -7,... 8H+ Fixed cost element: Total cost at the high level of activity......... V0,/-7,... Hess variable cost element @E7,... 8H+s I V17 per 8H+A.................. -,?-7,... Fixed cost element..................................... V/,7..,... Therefore, the cost formula for maintenance is V/,7..,... per year plus V17 per direct labor%hour or 9 ; V/,7..,... < V17=

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. --E Managerial Accounting, /1th #dition

&ro*le+ 5-15 @continuedA 1. Total factory overhead cost at E.,... direct labor%hours is: ,ndirect materials @E.,... 8H+s I V/.. per 8H+A...... "ent.................................................. Maintenance: Variable cost element @E.,... 8H+s I V17 per 8H+A...... Fixed cost element......................... Total factory overhead cost............... V E,...,.. . ?,...,... V-,07.,.. .

1,F7.,.. /,7..,... . V/?,F7.,.. .

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, !hapter 7 --C

&ro*le+ 5-16 @07 minutesA /. 8irect materials cost W B? per unit......................................... 8irect labor cost W B/. per unit Manufacturing overhead costD. . Total manufacturing costs......... Add: >or& in process, beginning............................... 8educt: >or& in process, ending.................................... !ost of goods manufactured..... 1arc#2.o3 5,000 Units B 1?,... ?.,... EC,... /E0,... F,... /C1,... /7,... B/?C,... 4une2/ig# 6,000 Units B 70,... F.,... /.-,... -0?,... 1-,... -EC,... -/,... B-7E,...

D!omputed by wor&ing upwards through the statements. -. Pune(+igh level of activity..... March(How level of activity... !hange................................... Units +roduce d F,... ?,... 1,... Cost O-served B/.-,... EC,... BQ-0,...

!hange in cost B-0,... ; ; BC... per unit !hange in activity 1,... units Total cost at the high level of activity..... Hess variable cost element @BC... per unit I F,... unitsA.............. Fixed cost element................................. B/.-,... E-,... B 1.,...

Therefore, the cost formula is B1.,... per month plus BC... per unit produced or 9 ; B1.,... < BC...=

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. --F Managerial Accounting, /1th #dition

&ro*le+ 5-16 @continuedA 1. The cost of goods manufactured if E,... units are produced: 8irect materials cost @E,... units I B?... per unitA.............................................................. 8irect labor cost @E,... units I B/.... per unitA.............................................................. Manufacturing overhead cost: B 0-,... E.,...

B1.,.. Fixed portion................................................. . Variable portion @E,... units I BC... per unitA........................................................... 7?,... C?,... Total manufacturing costs............................... /FC,... Add: >or& in process, beginning..................... . /FC,... 8educt: >or& in process, ending..................... . B/FC,.. !ost of goods manufactured........................... .

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, !hapter 7 -1.

&ro*le+ 5-17 @07 minutesA /. Maintenance cost at the F.,... machine%hour level of activity can be isolated as follows: .evel of (ctivity 60,000 50,000 1/s 1/s B/E0,... B-0?,... 0C,... -/,... B/.7,... E-,... -/,... B/71,...

Total factory overhead cost. . . 8educt: tilities cost W B..C. per M+D.................................. $upervisory salaries............ Maintenance cost..................

DB0C,... G ?.,... M+s ; B..C. per M+ -. +igh%low analysis of maintenance cost: 1ac#ine 1aintenanc -/ours e Cost +igh activity level............... F.,... B/71,... How activity level................ ?.,... /.7,... !hange............................... 1.,... B 0C,... Variable rate: !hange in cost B0C,... ; ; B/.?. per M+ !hange in activity 1.,... M+s Total fixed cost: Total maintenance cost at the high activity B/71,.. level.......................................................... . Hess variable cost element @F.,... M+s I B/.?. per M+A................... /00,... Fixed cost element...................................... B F,... Therefore, the cost formula for maintenance is BF,... per month plus B/.?. per machine%hour or 9 ; BF,... < B/.?.=.

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -1/ Managerial Accounting, /1th #dition

&ro*le+ 5-17 @continuedA 1. 7aria-le Cost per 8i$ed 1ac#ine-/our Cost tilities cost................ B..C. $upervisory salaries cost.......................... B-/,... Maintenance cost....... /.?. F,... Total overhead cost.... B-.0. B1.,... Thus, the cost formula would be: 9 ; B1.,... < B-.0.=. 0. Total overhead cost at an activity level of E7,... machine% hours: Fixed costs........................................... Variable costs: E7,... M+s I B-.0. per M+............................................... Total overhead costs............................. BQ1.,... /C.,... B-/.,...

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, !hapter 7 -1-

Case 5-1

@F. minutesA

Oote to the instructor: This case re3uires the ability to build on concepts that are introduced only briefly in the text. To some degree, this case anticipates issues that will be covered in more depth in later chapters. /. ,n order to estimate the contribution to profit of the charity event, it is first necessary to estimate the variable costs of catering the event. The costs of food, beverages, and labor are all apparently variable with respect to the number of guests. +owever, the situation with respect to overhead expenses is less clear. A good first step is to plot the labor hour and overhead expense data in a scattergraph as shown below.

9 BF.,... BC.,... 1verhead #$penses BE.,... B?.,... B7.,... B0.,... B1.,... B-.,... B/.,... B. . -,... 0,... /a*or 0ours ?,... = C,...

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -11 Managerial Accounting, /1th #dition

Case 5-1

@continuedA

This scattergraph reveals several interesting points about the behavior of overhead costs: X The relation between overhead expense and labor hours is approximated reasonably well by a straight line. @+owever, there appears to be a slight downward bend in the plot as the labor hours increase. $uch increasing returns to scale is a common occurrence. $ee Ooreen T $oderstrom, 5Are overhead costs strictly proportional to activityY6 4ournal of (ccounting and Econo&ics, vol. /E, /FF0, pp. -77%-EC.A X The data points are all fairly close to the straight line. This indicates that most of the variation in overhead expenses is explained by labor hours. As a conse3uence, there probably wouldn2t be much benefit to investigating other possible cost drivers for the overhead expenses. X Most of the overhead expense appears to be fixed. Maria should as& herself if this is reasonable. Are there, in fact, large fixed expenses such as rent, depreciation, and her own salaryY The overhead expenses could be decomposed into fixed and variable elements using the high%low method, least%s3uares regression method, or even the 3uic&%and%dirty method based on the scattergraph. X The high%low method throws away most of the data and bases the estimates of variable and fixed costs on data for only two months. For that reason, it is a decidedly inferior method in this situation. Oevertheless, if the high%low method were used, the estimates would be computed as follows: Over#ea .a-or d /ours E$pense E,7.. BEE,... -,7.. 77,... 7,... B--,...

+igh level of activity.. How level of activity. . !hange...................... Variable cost ;

!hange in cost B--,... ; !hange in activity 7,... labor%hours

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved.

$olutions Manual, !hapter 7

-10

; B0.0. per labor%hour

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -17 Managerial Accounting, /1th #dition

Case 5-1

@continuedA

Fixed cost element ; Total cost M Variable cost element ; BEE,... M B0.0. per labor%hour I E,7.. labor%hours ; B00,... X ,n this situation, the 3uic&%and%dirty method based on the scattergraph is probably better than the high%low method and should give acceptable estimates of the fixed and variable components of overhead expenses. The estimates should be fairly close @within the inherent imprecision of the methodA to the estimates that would result from using least%s3uares regression. X sing statistical software, the least%s3uares regression method yields estimates of B1.F7 per labor hour for the variable cost and B0C,/-? per month for the fixed cost. The ad:usted " - is F?K. The total variable cost per guest is computed as follows: Food and beverages............................... Habor @..7 hour I B/.... per hourA........ 4verhead @..7 hour I B1.F7 per hourA.... Total variable cost per guest................... B/7... 7... /.FC B-/.FC

And the total contribution from /C. guests paying B1/ each is computed as follows: $ales @/C. guests I B1/... per guestA... Variable cost @/C. guests I B-/.FC per guestA................................................... !ontribution to profit.............................. B7,7C.... 1,F7?.0. B/,?-1.?.

Fixed costs are not included in the above computation because there is no indication that there would be any additional fixed costs incurred as a conse3uence of catering the coc&tail party. ,f additional fixed costs were incurred, they should be subtracted from revenues as well to determine the profit of the party. -. Assuming that no additional fixed costs are incurred as a result
) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, !hapter 7 -1?

of catering the charity event, any price greater than the variable cost per guest of roughly B-- would contribute to profits.

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -1E Managerial Accounting, /1th #dition

Case 5-1

@continuedA

1. >e would favor bidding slightly less than B1. to get the contract. Any bid above B-- would contribute to profits and a bid at the normal price of B1/ is unli&ely to land the contract. And apart from the contribution to profit, catering the event would show off the company2s capabilities to potential clients. The danger is that a price lower than the normal bid of B1/ might set a precedent for the future or it might embroil the company in a price war among caterers. +owever, the price need not be publici'ed and the lower price could be :ustified to future clients because this is a charity event. Another possibility would be for Maria to maintain her normal price but throw in additional services at no cost to the customer. >hether to compete based on price or service is a delicate issue that Maria will have to decide after getting to &now the personality and preferences of her customers.

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, !hapter 7 -1C

Case 5-1! @07 minutesA /. The scattergraph of direct labor cost versus the number of units produced is presented below:

$18,000 $16,000 $14,000 Direct Labor Cost $12,000 $10,000 $8,000 $6,000 $4,000 $2,000 $0

50

100

X 150

Thousands of Units Produced

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -1F Managerial Accounting, /1th #dition

Case 5-1! @continuedA -. The scattergraph of the direct labor cost versus the number of paid days is presented below:

$18,000 $16,000 $14,000 Direct Labor Cost $12,000 $10,000 $8,000 $6,000 $4,000 $2,000 $0

X 0 5 10 15 20 25 Number of Workdays
,u+*er o- &aid )ays

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, !hapter 7 -0.

Case 5-1! @continuedA 1. The number of paid days should be used as the activity base rather than the number of units produced. The scattergraphs reveal a much stronger relation @i.e., higher correlationA between direct labor costs and number of paid days than between direct labor costs and number of units produced. Variations in the direct labor costs apparently occur because of the number of paid days in the month and have little to do with the number of units that are produced. ,t appears that the direct labor costs are basically fixed with respect to how many units are produced in a month. This would happen if the direct labor wor&ers are treated as full%time employees who are paid even if there is insufficient wor& to &eep them busy. Moreover, for planning purposes, the company is li&ely to be able to predict the number of paid days in the month with much greater accuracy than the number of units that will be produced.

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -0/ Managerial Accounting, /1th #dition

2esear%h and Appli%ation 5-2" /. Ulue Oile succeeds first and foremost because of its operational excellence customer value proposition. Sage 1 of the /.%Z says 5we have developed an efficient online cost structure [ that eliminates traditional layers of diamond wholesalers and bro&ers, which allows us to generally purchase most of our product offerings at lower prices by avoiding mar&ups imposed by those intermediaries. 4ur supply solution generally enables us to purchase only those diamonds that our customers have ordered. As a result, we are able to minimi'e the costs associated with carrying diamond inventory.6 4n page 0 of the /.%Z, Ulue Oile2s growth strategy hinges largely on increasing what it calls supply chain efficiencies and operational efficiencies. Ulue Oile also emphasi'es :ewelry customi'ation and customer service, but these attributes do not differentiate Ulue Oile from its competitors. -. Ulue Oile faces numerous business ris&s as described in pages C%/F of the /.%Z. $tudents may mention other ris&s beyond those specifically mentioned in the /.%Z. +ere are four ris&s faced by Ulue Oile with suggested control activities: "is&: !ustomer may not purchase an expensive item such as a diamond over the ,nternet because of concerns about product 3uality @given that customers cannot see the product in person prior to purchasing itA. !ontrol activities: $ell only independently certified diamonds and mar&et this fact heavily. Also, design a web site that enables customers to easily learn more about the specific products that they are interested in purchasing. "is&: !ustomers may avoid ,nternet purchases because of fears that security breaches will enable criminals to have access to their confidential information. !ontrol activities: ,nvest in state%of%the%art encryption technology and other safeguards.

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, !hapter 7 -0-

2esear%h and Appli%ation 5-2" @continuedA "is&: Uecause Ulue Oile sells luxury products that are often purchased on a discretionary basis, sales may decline significantly in an economic downturn as people have access to less disposable income. !ontrol activities: #xpand product offerings and expand the number of geographic mar&ets served. "is&: The financial reporting process may fail to function properly @e.g., it may not comply with the $arbanes%4xley Act of -..-A as the business grows. !ontrol activities: ,mplement additional financial accounting systems and internal control over those systems. Ulue Oile faces various ris&s that are not easily reduced through control activities. Three such examples include: ,f Ulue Oile is re3uired by law to charge sales tax on purchases it will reduce Ulue Oile2s price advantage over bric&s%and%mortar retailers @see page /E of the /.%ZA. "estrictions on the supply of diamonds would harm Ulue Oile2s financial results @see page F of the /.%ZA. 4ther ,nternet retailers, such as Ama'on.com, could offer the same efficiencies and low price as Ulue Oile, while leveraging their stronger brand recognition to attract Ulue Oile2s customers @see page /. of the /.%ZA. 1. Ulue Oile is a merchandiser. The first sentence of the overview on page 1 of the /.%Z says 5Ulue Oile ,nc. is a leading online retailer of high 3uality diamonds and fine :ewelry.6 >hile Ulue Oiles does some assembly wor& to support its 5Uuild 9our 4wn6 feature, the company essentially buys :ewelry directly from suppliers and resells it to customers. ,n fact, Ulue Oile never ta&es possession of some of the diamonds it sells. Sage 0 of the /.%Z says 5our diamond supplier relationships allow us to display suppliers2 diamond inventories on the Ulue Oile web site for sale to consumers without holding the diamonds in our inventory until the products are ordered by customers.6 This sentence suggests that items are shipped directly from the supplier to the consumer.
) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -01 Managerial Accounting, /1th #dition

2esear%h and Appli%ation 5-2" @continuedA 0. There is no need to calculate any numbers to ascertain that cost of sales is almost entirely a variable cost. Sage -7 of the /.%Z says 5our cost of sales consists of the cost of diamonds and :ewelry products sold to customers, inbound and outbound shipping costs, insurance on shipments and the costs incurred to set diamonds into ring, earring and pendant settings, including labor and related facilities costs.6 The overwhelming ma:ority of these costs are variable costs. Assuming the wor&ers that set diamonds into ring, earring, and pendant settings are not paid on a piece rate, the labor cost would be step%variable in nature. The facilities costs are li&ely to be committed fixed in natureR however, the overwhelming ma:ority of the cost of sales is variable. $imilarly, there is no need to calculate any numbers to ascertain that selling, general and administrative expense is a mixed cost. Sage -7 of the /.%Z says 5our selling, general and administrative expenses consist primarily of payroll and related benefit costs for our employees, mar&eting costs, credit card fees and costs associated with being a publicly traded company. These expenses also include certain facilities, fulfillment, customer service, technology and depreciation expenses, as well as professional fees and other general corporate expenses.6 At the bottom of page -7, the /.%Z says 5the increase in selling, general and administrative expenses in -..0 was due primarily to[higher credit card processing fees based on increased volume.6 This indicates that credit card processing fees is a variable cost. At the top of page -? of the /.%Z it says 5the decrease in selling, general and administrative expenses as a percentage of sales in -..0 resulted primarily from our ability to leverage our fixed cost base.6 This explicitly recogni'es that selling, general and administrative expense includes a large portion of fixed costs. #xamples of the various costs include: Variable costs: cost of sales, credit card processing fees. $tep%variable costs: diamond setting labor, fulfillment labor. 8iscretionary fixed costs: mar&eting costs, employee training costs.
) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, !hapter 7 -00

 !ommitted fixed costs: general corporate expenses, facilities costs.

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -07 Managerial Accounting, /1th #dition

2esear%h and Appli%ation 5-2" @continuedA 7. The data needed to complete the table as shown below is found on page 0F of the /.%Z: 9uarte r1 B17,EC Oet sales.......................... 0 -E,7E !ost of sales.................... *ross profit...................... C,-/$elling, general and administrative expense.. 7,1.C B -,F. 4perating income............ 0 ,et sales B?0,70 C B11,CC C B1.,?? . 200! 200" 9uarte 9uarte 9uarte 9uarte 9uarte r2 r r! r1 r2 B17,.- B11,CC B?0,70 B00,// B01,CC C ? ? -E,.F -?,7/ 7.,0. 10,0- 11,C1 7 F 0 F ? E,F-E E,1?F /0,/00 F,?CE F,FF. 7,/// B -,C/ ? 7,.11 B -,11 ? E,101 B ?,C. / ?,/-1 B 1,7? 0 ?,/C0 B 1,C. ?

Selling, *eneral, and (d&inistrative BE,101 B7,.11 B-,1/.

+igh Juarter @-..0 J0A............................... How Juarter @-..0 J1A !hange........................

Variable cost ; B-,1/.\B1.,??. ; ...E710- per dollar of revenue Fixed cost estimate @using the low level of activityA:
) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, !hapter 7 -0?

B7,.11 ] @B11,CCC I ...E710-A ; B-,0C. @rounded upA The linear e3uation is: 9 ; B-,0C. < ...E710-=, where = is revenue.

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -0E Managerial Accounting, /1th #dition

2esear%h and Appli%ation 5-2" @continuedA ?. The contribution format income statement using the high%low method for the third 3uarter of -..7 would be as follows: -..7 Third Juarter Oet sales..................................... !ost of sales............................... Variable selling, general and administrative.......................... !ontribution margin.................... Fixed selling, general and administrative.......................... Oet operating income................. B17,/C 1,0C B07,7. . 1C,77 ? ?,F00 -,0C. B 0,0? 0

E. Ulue Oile2s cost structure is heavily weighted towards variable costs. Hess than /.K of Ulue Oile2s costs are fixed. Ulue Oile2s cost of sales as a percentage of sales is higher than bric&s and mortar retailers. Sage -- of the /.%Z says 5As an online retailer, we do not incur most of the operating costs associated with physical retail stores, including the costs of maintaining significant inventory and related overhead. As a result, while our gross profit margins are lower than those typically maintained by traditional diamond and fine :ewelry retailers, we are able to reali'e relatively higher operating income as a percentage of net sales. ,n -..0, we had a --.-K gross profit margin, as compared to gross profit margins of up to 7.K by some traditional retailers. >e believe our lower gross profit margins result from lower retail prices that we offer to our customers.6

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, !hapter 7 -0C

Appendi$ 5A /east-S3uares 2e'ression Co+putations

#$er%ise 5A-1 @07 minutesA The least%s3uares regression estimates of fixed and variable costs can be computed using any of a variety of statistical and mathematical software pac&ages or even by hand. The solution below uses Microsoft^ #xcel as illustrated in the text.

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -0F Managerial Accounting, /1th #dition

#$er%ise 5A-1 @continuedA The intercept provides the estimate of the fixed cost element, B/,1EE per month, and the slope provides the estimate of the variable cost element, B0..0 per rental return. #xpressed as an e3uation, the relation between car wash costs and rental returns is 9 ; B/,1EE < B0..0= where = is the number of rental returns. Oote that the "- is ..F., which is 3uite high, and indicates a strong linear relationship between car wash costs and rental returns.

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, Appendix 7A -7.

#$er%ise 5A-1 @continuedA >hile not a re3uirement of the exercise, it is always a good idea to plot the data on a scattergraph. The scattergraph can help spot nonlinearities or other problems with the data. ,n this case, the regression line @shown belowA is a reasonably good approximation to the relationship between car wash costs and rental returns.
$18,000 $16,000 $14,000 $12,000 $10,000 $8,000
t o h s W r a C

$6,000 $4,000 $2,000 $0 0 1,000 2,000 3,000 Rental Returns 4,000

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -7/ Managerial Accounting, /1th #dition

#$er%ise 5A-2 @1. minutesA /. Week / 1 0 7 ? Units :;< 0 1 C ? E 'otal Etc#ing Cost :=< $Fr/C $Fr/E $Fr-7 $Fr-. $Fr-0 $Fr/?

$tatistical software or a spreadsheet application such as #xcel can be used to compute the slope and intercept of the least% s3uares regression line for the above data. The results are: ,ntercept @fixed costA............ $lope @variable cost per unitA................................... " ......................................... $Fr/-.1$Fr/.70 ..F0

Therefore, the cost formula is $Fr/-.1- per month plus $Fr/.70 per unit etched or 9 ; $Fr/-.1- < $Fr/.70 Oote that the "- is ..F0, which means that F0K of the variation in etching costs is explained by the number of units etched. This is a very high "- and indicates a good fit. -. 9 ; $Fr/-.1- < $Fr/.70= 1. Total expected etching cost if 7 units are processed: Variable cost: 7 units I $Fr/.70 per unit................................................. Fixed cost.......................................... Total expected cost............................ $FrQE.E. /-.1$Fr-...-

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, Appendix 7A -7-

#$er%ise 5A-3 @1. minutesA /. 1ont# Panuary February March April May Pune Puly Units S#ipped :;< 1 ? 0 7 E C -

S#ipping E$pense :=< B/,C.. B-,1.. B/,E.. B-,... B-,1.. B-,E.. B/,-..

$tatistical software or a spreadsheet application such as #xcel can be used to compute the slope and intercept of the least% s3uares regression line for the above data. The results are: ,ntercept @fixed costA............ $lope @variable cost per unitA................................... " ......................................... BF// B-/C ..F-

Therefore, the cost formula is BF// per month plus B-/C per unit shipped or 9 ; BF// < B-/C= Oote that the "- is ..F-, which means that F-K of the variation in shipping costs is explained by the number of units shipped. This is a very high "- and indicates a good fit. -. Juic&%and%dirty scattergraph method......................................... +igh%low method............................. Heast%s3uares regression method. . . 7aria-le Cost per Unit B-.. B-7. B-/C 8i$ed Cost per 1ont# B/,... BE.. BF//

Oote that the high%low method gives estimates that are 3uite different from the estimates provided by least%s3uares regression.
) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -71 Managerial Accounting, /1th #dition

&ro*le+ 5A-4 @07 minutesA /. 'er& Fall, last year....... >inter, last year. $ummer, last year.................. Fall, this year....... >inter, this year. ,u&-er of Sections Offered :;< 0 ? 7 1

'otal Cost :=< B/.,... B/0,... BE,... B/1,... BF,7..

A spreadsheet application such as #xcel or a statistical software pac&age can be used to compute the slope and intercept of the least%s3uares regression line for the above data. The results are: ,ntercept @fixed costA............ $lope @variable cost per unitA................................... " ......................................... B1,E.. B/,E7. ..F?

Therefore, the variable cost is B/,E7. per section and the fixed cost is B1,E.. per term. Oote that the "- is ..F?, which means that F?K of the variation in cost is explained by the number of sections. This is a very high "- and indicates a very good fit. -. 9 ; B1,E.. < B/,E7.= 1. #xpected total cost would be: Fixed cost................................................. BQ1,E.. Variable cost @C sections I B/,E7. per sectionA.................................................. /0,... Total cost.................................................. B/E,E.. The problem with using the cost formula from @-A to derive total cost is that an activity level of C sections may lie outside the relevant range(the range of activity within which the fixed cost is approximately B1,E.. per term and the variable cost is
) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, Appendix 7A -70

approximately B/,E7. per section offered. These approximations appear to be reasonably accurate within the range of - to ? sections, but they may be invalid outside this range.

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -77 Managerial Accounting, /1th #dition

&ro*le+ 5A-4 @continuedA 0.

9 B/?,... B/0,... B/-,... .otal Cost B/.,... BC,... B?,... B0,... B-,... B. . / 1 0 7 ? ,u+*er o- Se%tions = E

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, Appendix 7A -7?

&ro*le+ 5A-5 @07 minutesA /. 9uarter 9ear /%/st -nd 1rd 0th 9ear -%/st -nd 1rd 0th Units Sold :000< :;< /. /? /C /7 // /E -. /1 S#ipping E$pense :=< B//F,... B/E7,... B/F.,... B/?0,... B/1.,... B/C7,... B-/.,... B/0E,...

$tatistical software or a spreadsheet application such as #xcel can be used to compute the slope and intercept of the least% s3uares regression line for the above data. The results are: ,ntercept @fixed cost per 3uarterA....... $lope @variable cost per thousand unitsA............................................... " ....................................................... $30,000 $9,000 0.998

Therefore the cost formula for shipping expense is B1.,... per 3uarter plus BF,... per thousand units sold @BF... per unitA or 9 ; B1.,... < BF...=, where = is the number of units sold. Oote that the "- is ..FFC, which means that FF.CK of the variation in shipping expense is explained by the number of units sold. This is an extremely high "- and indicates an excellent fit.

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -7E Managerial Accounting, /1th #dition

&ro*le+ 5A-5 @continuedA -. Milden !ompany Uudgeted ,ncome $tatement For the First Juarter, 9ear 1 $ales @/-,... units I B/.. per unitA. . . Variable expenses: !ost of goods sold @/-,... units I B17 unitA................ $ales commission @?K I B/,-..,...A.................................... $hipping expense @/-,... units I BF per unitA............ Total variable expenses........................ !ontribution margin............................. Fixed expenses: Advertising expense.......................... $hipping expense.............................. Administrative salaries...................... ,nsurance expense............................ 8epreciation expense........................ Total fixed expenses............................. Oet operating income.......................... B/,-..,.. . B0-.,.. . E-,... /.C,... ?..,.. . ?..,...

-/.,... 1.,... /07,... F,... E?,...

0E.,.. . BQ /1.,.. .

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, Appendix 7A -7C

&ro*le+ 5A-6 @1. minutesA /. The least%s3uares regression method: 1ont# Panuary February March April May Pune Puly August $eptembe r 4ctober ,u&-er of Scans :;< ?. E. F. /-. /.. /1. /7. /0. //. C. Utilities Cost :=< B-,-.. B-,?.. B-,F.. B1,1.. B1,... B1,?.. B0,... B1,?.. B1,/.. B-,7..

$tatistical software or a spreadsheet application such as #xcel or can be used to compute the slope and intercept of the least% s3uares regression line for the above data. The results are: ,ntercept @fixed costA............ $lope @variable cost per unitA................................... " ......................................... $1,171 $18.18 0.97

Therefore, the variable cost of power per scan is B/C./C and the fixed cost of power is B/,/E/ per month and the cost formula is: 9 ; B/,/E/ < B/C./C=. Oote that the "- is ..FE, which means that FEK of the variation in utilities cost is explained by the number of scans. This is a very high "- and indicates a very good fit. -. As shown in the graph in part @-A of problem 7%/0, the high and low points in this case fall in such a way they are not representative of all points of cost data. A regression line drawn through these two points would be too steep and thus result in an inaccurate cost formula. This is the ma:or defect in the high% low methodR although it is simple to apply, the manager must be careful in its use or misleading information may result.
) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -7F Managerial Accounting, /1th #dition

Case 5A-7 @F. minutesA /. 8irect labor%hour allocation base: V1,CEF,.. #lectrical costs @aA.......................... . 8irect labor%hours @bA..................... 0-C,.0. 8H+s Sredetermined overhead rate @aA G @bA................................................ VF..? per 8H+ V1,CEF,.. . 1?F,?.. M+s V/..7. per M+

Machine%hour allocation base: #lectrical costs @aA........................... Machine%hours @bA........................... Sredetermined overhead rate @aA G @bA.................................................

-. #lectrical cost for the shipyard :ob under the old costing system: Sredetermined overhead rate @aA......... VF..? per 8H+ 8irect labor%hours for the :ob @bA.......... 17. 8H+s #lectrical cost applied to the :ob @aA I @bA...................................................... V1,/E/ #lectrical cost for the shipyard :ob under the new AU! system: Sredetermined overhead rate @aA......... V/..7. per M+ Machine%hours for the :ob @bA............... -E. M+s #lectrical cost applied to the :ob @aA I @bA...................................................... V-,C17

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, Appendix 7A -?.

Case 5A-7 @continuedA 1. $cattergraph for electrical costs and machine%hours:

F.,... C.,... #le%tri%al Costs 5yen6 E.,... ?.,... 7.,... 0.,... 1.,... -.,... /.,... . . -,... 0,... ?,... C,... /.,... 4a%hine-0ours

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -?/ Managerial Accounting, /1th #dition

Case 5A-7 @continuedA $cattergraph for electrical costs and direct labor%hours:

F.,... C.,... E.,... #le%tri%al Costs 5yen6 ?.,... 7.,... 0.,... 1.,... -.,... /.,... . . -,... 0,... ?,... C,... /.,... )ire%t /a*or-0ours

,n general, the allocation base should actually cause the cost being allocated. ,f it doesn2t, costs will be incorrectly assigned to :obs. ,ncorrectly assigned costs are worse than useless for decision%ma&ing. Hoo&ing at the above scattergraph, electrical costs do not appear to be related to direct labor%hours. #lectrical costs do vary, but apparently not in response to changes in direct labor% hours. 4n the other hand, loo&ing at the scattergraph for machine%hours, there is some tendency for electrical costs to increase as the machine%hours increase. $o if one must choose between machine%hours and direct labor%hours as an
) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, Appendix 7A -?-

Case 5A-7 @continuedA allocation base, machine%hours seems to be the better choice. #ven so, it loo&s li&e little of the overhead cost is explained even by machine%hours. #lectrical cost has a large fixed component and much of the variation in the cost is unrelated to machine hours. 0. >ee& / >ee& >ee& 1 >ee& 0 >ee& 7 >ee& ? >ee& E >ee& C 1ac#ine /ours E,-.. C,-.. C,E.. E,-.. E,0.. C,C.. ?,0.. E,E.. Electrical Costs VEE,/.. VC0,0.. VC.,0.. VE7,7.. VC/,/.. VC1,1.. VEF,-.. VC7,7..

sing statistical software or a spreadsheet application such as #xcel to compute estimates of the intercept and the slope for the above data, the results are: ,ntercept @fixed cost per wee&A.......... $lope @variable cost per machine% hourA................................................ " ....................................................... V?1,7-C V-.-0 0.28

Therefore the cost formula for electrical costs is V?1,7-C per wee& plus V-.-0 per machine%hour, or 9 ; V?1,7-C < V-.-0 =, where = is machine%hours.
) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -?1 Managerial Accounting, /1th #dition

Oote that the "- is ..-C, which means that only -CK of the variation in electrical cost is explained by machine%hours. 4ther factors, discussed in part @?A below, are responsible for most of the variation in electrical costs from wee& to wee&.

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, Appendix 7A -?0

Case 5A-7 @continuedA 7. The shipyard :ob re3uires -E. machine%hours. At V-.-0 per machine%hour, the electrical cost actually caused by the :ob would be only V?.0.C.. This contrasts with the electrical cost of V1,/E/ under the old cost system and V-,C17 under the new AU! system. Uoth the old cost system and the new AU! system grossly overstate the electrical costs of the :ob. This is because under both cost systems, the large fixed electrical costs of V?1,7-C per wee& are allocated to :obs along with the electrical costs that actually vary with the amount of wor& being done. ,n practice, almost all categories of overhead costs pose similar problems. As a conse3uence, the costs of individual :obs are li&ely to be seriously overstated for decision%ma&ing purposes under both traditional and AU! systems. Uoth systems provide acceptable cost data for external reporting, but both provide potentially misleading data for internal decision%ma&ing unless suitable ad:ustments are made. ?. #lectricity is used for heating, cooling, and lighting the building as well as to run e3uipment. Therefore, consumption of electrical power is li&ely to be affected at least by the weather and by the time of the year as well as by how many hours the e3uipment is run. @Fewer daylight hours mean the lights have to be on longer.A

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. -?7 Managerial Accounting, /1th #dition

2esear%h and Appli%ation 5A/. sing least%s3uares regression, the estimates are as follows: $H4S# @variable costA ; ...E7-.? ,OT#"!#ST @fixed costA ; B-,?-E @rounded upA "- @goodness of fitA ; ..F? The cost formula is: 9 ; B-,?-E < ...E7-.?= These estimates differ from the high%low method because least s3uares regression uses all of the data rather than :ust the data pertaining to the high and low 3uarters of activity. -. The contribution format income statement using least%s3uares regression for the third 3uarter of -..7 would be as follows: -..7 Third Juarter Oet sales..................................... !ost of sales............................... Variable selling, general and administrative.......................... !ontribution margin.................... Fixed selling, general and administrative.......................... 4perating income....................... B17,/C 1,0B07,7. . 1C,77 . ?,F7. -,?-E B 0,11

) The Mc*raw%+ill !ompanies, ,nc., -./.. All rights reserved. $olutions Manual, Appendix 7A -??