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Solutions To Week 3 Practice Text Exercises
Solutions To Week 3 Practice Text Exercises
Suppose that the cost of products sold is the only variable cost; selling, general, and
administrative
expenses are fixed with respect to sales.
Assume that Procter & Gamble had a 10% increase in sales in 2007 and that there was no
change
in costs except for increases associated with the higher volume of sales. Compute the
predicted 2007
operating income for Procter & Gamble and its percentage increase. Explain why the
percentage
increase in income differs from the percentage increase in sales.
Expected volume is 600,000 units per month, with each unit selling for $3.10. Capacity is
800,000
units.
1. Compute the budgeted profit at the expected volume of 600,000 units under both the
old and the
new production environments.
2. Compute the budgeted break-even point under both the old and the new production
environments.
3. Discuss the effect on profits if volume falls to 500,000 units under both the old and the
new production
environments.
4. Discuss the effect on profits if volume increases to 700,000 units under both the old
and the new
production environments.
5. Comment on the riskiness of the new operation versus the old operation.
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3. A fall in volume will be more devastating under the new system because the
high fixed costs will not be affected by the fall in volume:
5. Changes in volume affect profits in the new environment (a high fixed cost,
low variable cost environment) more than they affect profits in the old
environment. Therefore, profits in the old environment are more stable and
less risky. The higher risk new environment promises greater rewards
when conditions are favorable, but also leads to greater losses when
conditions are unfavorable, a more risky situation.
When you have completed your spreadsheet, answer the following questions:
1. What are the break-even points in units and dollars under proposal A?
2. How did the increased selling price under proposal B impact the break-even points in
units and dollars compared to the break-even points calculated under proposal A?
3. Why did the change in variable cost under proposal C not impact the break-even points
in units and dollars as significantly as proposal B did?
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Chapter 2 Decision Guideline
Phonetronix
Cost-Volume-Profit (CVP) Analysis
9/25/2009
3-38 Mixed Cost, Choosing Cost Drivers, and High-Low and Visual-Fit
Methods
Cedar Rapids Implements Company produces farm implements. Cedar Rapids is in the
process of
measuring its manufacturing costs and is particularly interested in the costs of the
manufacturing
maintenance activity, since maintenance is a significant mixed cost. Activity analysis
indicates that
maintenance activity consists primarily of maintenance labor setting up machines using
certain supplies.
A setup consists of preparing the necessary machines for a particular production run of a
product.
During setup, machines must still be running, which consumes energy. Thus, the costs
associated
with maintenance include labor, supplies, and energy. Unfortunately, Cedar Rapid’s cost
accounting
system does not trace these costs to maintenance activity separately. Cedar Rapids
employs two fulltime maintenance mechanics to perform maintenance. The annual salary
of a maintenance mechanic is $25,000 and is considered a fixed cost. Two plausible cost
drivers have been suggested: “units produced” and “number of setups.”
Data had been collected for the past 12 months and a plot made for the cost driver—units
of production.
The maintenance cost figures collected include estimates for labor, supplies, and energy.
Cory Fielder, controller at Cedar Rapids, noted that some types of activities are performed
each time
a batch of goods is processed rather than each time a unit is produced. Based on this
concept, he has
gathered data on the number of setups performed over the past 12 months. The plots of
monthly maintenance costs versus the two potential cost drivers follow on page 122.
1. Find monthly fixed maintenance cost and the variable maintenance cost per driver unit
using
the visual-fit method based on each potential cost driver. Explain how you treated the
April
data.
The April observation should be ignored since it does not represent a typical
month -- it is an example of an outlier. Other examples would be strikes,
abnormal downtime, or scheduled plant closings.
2. Find monthly fixed maintenance cost and the variable maintenance cost per driver unit
using the
high-low method based on each potential cost driver.
The high-low method uses only the highest and lowest activity levels. Note
that using a scatter diagram, the high-low method can be used without
knowing the exact figures. Fixed cost can be easily estimated using a
straight edge and should be about $11,500 based on Units Produced and
$7,500 based on Number of Setups. Variable costs are estimated using the
following computations:
3. Which cost driver best meets the criteria for choosing cost functions? Explain.
Both cost drivers appear, on the surface, to be plausible. However, if maintenance
activity is primarily associated with a “batch-level” activity such as setups, the setup
driver is preferred. Of the three costs associated with maintenance activity, supplies
and energy are probably variable, so salaries are the primary fixed costs. The
monthly salary of two mechanics is $4,167 [(2 x $25,000)/12]. The cost function
based on setups estimates fixed costs of about $5,200 (visual-fit method). This is
much more plausible than the $15,200 estimate based on units of production.
Students may inquire as to the use of “setup time” as an alternative to number of
setups. Setup time is an acceptable alternative that is often used when setup times
differ among different products. Another consideration is data availability. Setup
times by product may not be easily obtained or maintained.
Just looking at the two graphs, a linear cost function seems to fit the second
graph much better than the first. Reliability of cost drivers is measured by
the coefficient of determination, R-Squared. In the regressions used in
requirement 1, only 21% of the past year’s variability in maintenance costs
can be explained by changes in the volume of units produced, whereas 85%
of past fluctuations in maintenance costs can be explained by the number of
setups performed. This confirms the visual observation.