Question

The Central Valley Company is a manufacturing firm that produces and sells a single product. The company’s revenues and expenses for the last four months are given below.

Central Valley Company
Comparative Monthly Income Statements
		March			April			May			June
Sales in units		6,800			6,300			7,050			7,300
Sales revenue	$	829,600		$	768,600		$	860,100		$	890,600
Less: Cost of goods sold		418,500			393,000			426,250			444,000
Gross margin		411,100			375,600			433,850			446,600
Less: Operating expenses
Shipping expense		76,000			71,000			79,250			80,000
Advertising expense		88,000			88,000			88,000			88,000
Salaries & commissions		192,800			176,500			193,250			198,500
Insurance expense		10,800			10,800			10,800			10,800
Depreciation expense		57,000			57,000			57,000			57,000
Total operating expenses		424,600			403,300			428,300			434,300
Net income	$	(13,500	)	$	(27,700	)	$	5,550		$	12,300

Required:

1. Management is concerned about the losses experienced during the spring and would like to know more about the cost behaviour. Develop a cost equation for each of the costs.

2. Using the cost equations, prepare a contribution margin income statement (in good form) for September when 7,200 units are expected to be sold.

Answer 1

1	Cost equation,Y=Fixed costs+(Variable cost per unit*Sales in units)
	Let's assume sales in units=X
	Cost of goods sold:
				March	April	May	June
	Sales in units		a	6800	6300	7050	7300
	Cost of goods sold		b	418500	393000	426250	444000
	Cost per unit		b/a	61.54412	62.38095	60.46099	60.82192
	Cost per unit varies.It means cost of goods sold is a mixed cost.
	Hence,Let's use high low method to segregate variable and fixed cost
	Under High low method,Consider the Highest and Lowest activity and then apply the following equation
	Variable cost per unit=Change in Total cost/Change in activity
	Highest activity=7300 units
	Lowest activity=6300 units
	Variable cost per unit=(444000-393000)/(7300-6300)=$ 51
	To find fixed cost, Apply variable cost per unit in highest or lowest activity
	Let's take lowest activity
	Fixed cost=393000-(6300*51)=$ 71700
	Cost formula,Y=71700+51X
	Shipping expense:
				March	April	May	June
	Sales in units		a	6800	6300	7050	7300
	Shipping expense		b	76000	71000	79250	80000
	Cost per unit		b/a	11.17647	11.26984	11.24113	10.9589
	Cost per unit varies.It means shipping expense is a mixed cost.
	Hence,Let's use high low method to segregate variable and fixed cost
	Under High low method,Consider the Highest and Lowest activity and then apply the following equation
	Variable cost per unit=Change in Total cost/Change in activity
	Highest activity=7300 units
	Lowest activity=6300 units
	Variable cost per unit=(80000-71000)/(7300-6300)=$ 9
	To find fixed cost, Apply variable cost per unit in highest or lowest activity
	Let's take lowest activity
	Fixed cost=71000-(6300*9)=$ 14300
	Cost formula,Y=14300+9X
	Advertising expense:
				March	April	May	June
	Sales in units		a	6800	6300	7050	7300
	Advertising expense		b	88000	88000	88000	88000
	Cost per unit		b/a	12.94118	13.96825	12.48227	12.05479
	Cost per unit varies.But total cost is always equal at $88000.
	It shows advertising expense is a fixed cost
	Cost formula,Y=$ 88000
	Salaries & commissions:
				March	April	May	June
	Sales in units		a	6800	6300	7050	7300
	Salaries & commissions		b	192800	176500	193250	198500
	Cost per unit		b/a	28.35294	28.01587	27.41135	27.19178