Question

3.        Cost Classification: The Lee’s have provided you with the following costs and relevant information that are assumed for year 20XY.

A. Classify each of the costs (a. through j.) below under C. as a variable cost or a fixed cost.

B. Explain the importance of distinguishing between variable and fixed costs.

C. Prepare a budgeted income statement, assuming 600 units to be produced and sold, a per unit selling price of $85, an income tax rate of 28% and the following information.

a.         Cost of goods sold of $35 per unit

b.         Labor = $400/month

•           One part-time employee will be hired to take care of packaging and shipping. This employee will be paid $10 per hour. He or she is estimated to work 40 hours total per month.

c.         Advertising fees = $3,000

d.         Bank fees = $200

e.         Phone/internet = $150 per month

f.          Shipping = $3 per unit

g.         Utilities = $100 per month

h.         Office Supplies = $900

i.          Conference Exhibitor Fee = $3000

j.          Travel Expenses for Conference (e.g. airfare, meals, taxi) = $1200

4.         Net Present Value: The Lees are considering adding a new piece of equipment that will speed up the process of building the bobble heads. The cost of the piece of equipment is $42000. It is expected that the new piece of equipment will lead to cash flows of $17000, $29000, and $40000 over the next 3 years. If the appropriate discount rate is 12%, what is the NPV of this investment? Explain the findings.

5. Budget Preparation: The Lees believe that production and sales could double after being on Shark Tank which is scheduled in December of 20XY. They want to be prepared for this. Based on the budgeted income statement calculated above for 20XY, create a new budgeted income for 20XZ assuming that the production and sales is double the level of 20XY.

6. Incremental Analysis: If production does increase dramatically after their presentation on Shark Tank, the Lees will need more space for production. They have two options. Option 1 is to rent out a spacious warehouse nearby. If they pursue this option, there rent will be $1200 per month and utilities are estimated to cost an additional $350 per month. Their second option, Option 2, is to rent a smaller storefront space that is also nearby. The storefront rent is $1350 per month. However, utilities will likely only cost an additional $150 per month. They want to compare their options over one year’s time (since each rental contract is a 1 year commitment). What is the incremental analysis if the Lees choose Option 1 over Option 2?

Answer 1

You have asked multiple unrelated questions in the same post. As if the same was not enough, your questions have multiple sub parts. I have addressed all the sub parts of the first one. Please post the balance questions separately one by one.

Q - 3

Part (A)

Classification of the cost:

Let's understand the nature of fixed costs and variable costs:

Fixed costs: As the name suggests, fixed cost remains unchanged for a specific period of time (also called Relevant Range). For example: Insurance premium of an equipment will be fixed for a specific duration irrespective of the usage. Since total fixed costs remain constant with respect to production volume; fixed cost per unit decreases with the increase in production volume.

Variable costs: Variable costs are directly linked to the cost drivers (production volume / activity levels) and any change in the cost driver within relevant range brings proportionate change in the variable costs. Cost driver can be production volume or activity related driver such as no. of machine set-ups, no. of batches etc. Total variable costs increase with production level however, variable cost per unit remains constant over a relevant range. For example: Material cost, labour cost, equipment running expenses.

Based on this the classification are here:

a. Variable
b. Fixed
c. fixed
d.fixed
e. fixed
f. variable
g. fixed
h. fixed
i. fixed
j. fixed

Part (B)

Measurement of costs accurately remains a challenging topic as they can be measured accurately only after they have been incurred (after the budgeting period), but then that will be too late.

We need to make budget, forecast and preject the net income beforehand, sometimes before even taking up the job. Hence, we need to make a plan, a projected statement. How will we be able to measure the costs in the plan if we don't know the behavior of the cost, whether they go up or down with the activity, whether they are avoidable or not, whether they are committed or not.

Hence, we need to distinguish between variable and fixed costs to better plan our profits and net income.

• Variable costs can be estimated fairly accurately at the beginning once we make an assumption about activity levels or production volumes.
• Out of fixed costs, costs which are committed can be also estimated accurately thus leaving problems only with estimating the discretionary costs.

Part (C)

BUDGETED INCOME STATEMENT
Particulars	$
Sales Revenue (85 x 600)	51,000
[-] Sales Return	-
Net Sales Revenue	51,000
[-] Cost of Goods Sold (35 x 600)	21,000
GROSS PROFIT (A)	30,000
Operating Expenses (Income)
Labour (400 x 12)	4,800
Part time employee ($10 x 40 x 12)	4,800
Advertising	3,000
Bank fees	200
Phone internet (150 x 12)	1,800
Shipping ($3 x 600)	1,800
Utilities (100 x 12)	1,200
Office Supplies	900
Conference Exhibitor Fee	3,000
Travel Expenses	1,200
Total Operating expenes (B) (Sum of all above)	22,700
OPERATING PROFIT (EBIT) (C ) = (A) - (B)	7,300
[-] Income Tax @ 28% (D) = (C ) x 28%	2,044
NET INCOME	5,256