Question

(1)

Antioch Extraction, which mines ore in Montana, uses a calendar year for both financial-reporting and tax purposes. The following selected costs were incurred in December, the low point of activity, when 1,500 tons of ore were extracted:

Straight-line depreciation ..........................$ 25,000 Royalties .....................................$135,000

Charitable contributions* ...........................11,000 Trucking and hauling ...........................275,000

Mining labor/fringe benefits .......................345,000

*Incurred only in December.

Peak activity of 2,600 tons occurred in June, resulting in mining labor/fringe benefit costs of $598,000, royalties of $201,000, and trucking and hauling outlays of $325,000. The trucking and hauling outlays exhibit the following behavior:

Less than 1,500 tons ............................................................................................................................$250,000

From 1,500–1,899 tons ....................................................................................................................... 275,000

From 1,900–2,299 tons ........................................................................................................................300,000
From 2,300–2,699 tons ........................................................................................................................325,000

Antioch uses the high-low method to analyze costs.

To do:
1. Classify the five costs listed in terms of their behavior: variable, step-variable, committed fixed, discretionary fixed, step-fixed, or semivariable. Show calculations to support your answers for mining labor/fringe benefits and royalties.

2. Calculate the total cost for next February when 1,650 tons are expected to be extracted.
3. Comment on the cost-effectiveness of hauling 1,500 tons with respect to Antioch’s trucking/haul-ing cost behavior. Can the company’s effectiveness be improved? How?
4. Distinguish between committed and discretionary fixed costs. If Antioch were to experience severe economic difficulties, which of the two types of fixed costs should management try to cut? Why?
5. Speculate as to why the company’s charitable contribution cost arises only in December.

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Answer 1

1.

Straight-line depreciation—committed fixed

Charitable contributions—discretionary fixed

Mining labor/fringe benefits—variable

Royalties—semi variable

Trucking and hauling—step-fixed

The per-ton mining labor/fringe benefit cost is constant at both volume levels presented, which is characteristic of a variable cost.

$345,000 ÷ 1,500 tons = $230 per ton

$598,000 ÷ 2,600 tons = $230 per ton

Royalties have both a variable and a fixed component, making it a semi variable (mixed) cost.

Variable royalty cost = difference in cost ÷ difference in tons   

= ($201,000 – $135,000) ÷ (2,600 – 1,500)

  = $66,000 ÷ 1,100 tons

= $60 per ton

Fixed royalty cost:

June (2,600 tons) December (1,500 tons)

Total royalty cost………………………. $201,000 $135,000

Less: Variable cost at $60 per ton…..   156,000 90,000

Fixed royalty cost……………………… $ 45,000   $ 45,000

2.

Total cost for 1,650 tons:

Depreciation…………………………………………... $ 25,000

Charitable contributions……………………………. ----

Mining labor/fringe benefits at $230 per ton……. 379,500

Royalties:   

Variable at $60 per ton………………………….. 99,000

Fixed……………………………………………….. 45,000

Trucking and hauling……………………………….. 275,000

Total……………………………………………….. $823,500

3.

Hauling 1,500 tons is not very cost effective. Antioch will incur cost of $275,000 if it needs 1,500 tons hauled or, for that matter, 1,899 tons. The company would be better off if it had 1,499 tons hauled, saving outlays of $25,000. In general, with this type of cost function, effectiveness is maximized if a firm operates on the right-most portion of a step, just prior to a jump in cost.

4.

A committed fixed cost results from an entity’s ownership or use of facilities and its basic organizational structure. Examples of such costs include property taxes, depreciation, rent, and management salaries. Discretionary fixed costs, on the other hand, arise from a decision to spend a particular amount of money for a specific purpose. Outlays for research and development, advertising, and charitable contributions fall in this category.

In times of severe economic difficulties, management should try to cut discretionary fixed costs. Such costs are more easily altered in the short run and in some cases may not have significant long-term ramifications for a firm. The decision to close a manufacturing facility, for example, could reduce property taxes, rent, and/or depreciation. However, that decision may result in a significant long-run change in operations that may be difficult to overturn when economic conditions rebound.

5.   

Antioch uses a calendar year for tax-reporting purposes. At year-end, it may have ample funds available and decide to make donations to charitable causes. Such contributions are deductible in computing the company’s tax obligation to the government. Tax deductions reduce taxable income and, therefore, produce a tax savings for the firm.