Question

Peggy Grear just fulfilled a dream as she completed her first season as the owner of a rafting company. Unfortunately, her operation was not profitable in its first year of operation.  She has enough savings to get her through another season or two, but she realizes that she will have to start making a profit or give up the dream. Her company’s income statement for the first year of operation follows.

Grear Rafting Company

Income Statement

For the Year Ended December 31, 2015

Revenue $1,048,000

Rental Cost of Rafts and Camping Equipment (208,600)

Meals Provided to Rafters (314,400)

Advertising Expenses (50,000)

Compensation Paid to Guides (471,600)

Salary of Office Manager (16,500)

T-Shirts and Hats Provided to Rafters. (31,440)

Office Utility Expense (3,850)

  Net Income (Loss) $48,390

The rafts and equipment are rented on an annual basis.  Additional rafts and equipment are NOT available, nor is an allowance provided for early returns.  Guides are paid on a commission basis.  The rafting trip is for seven (7) days.  Ms. Grear’s company served 1,048 rafters during the year.  

1. Identify which of the costs are variable relative to the number of rafters.
2. Identify which of the costs are fixed relative to the number of rafters.
3. Define a product cost and identify which of the costs are product costs.
4. Define a period cost and identify which of the costs are period costs.
5. Restate the Income Statement in a contribution format using GOOD form.  (Be sure to specify the current number of rafters.)
6. What number of rafters would be required to breakeven?
7. What actions could Ms. Grear take to improve profitability of her company? (There are several obvious changes.)  Would these actions affect breakeven and how?

Answer 1

Solutions

Variable cost relative to the numbers of rafters

Variable Cost	Total	Per Unit
Meals provided to Rafters	3,14,400	314400/1048 = 300
Compensation paid to Guide	4,71,600	471600/1048 = 450
T-shirts & hats to Rafter	31,440	31440/1048 = 30
Total	8,17,440	780

Fixed cost relative to the numbers of rafters

Fixed Cost	Total
Rental cost of Rafts and Camping Equipment	2,08,600
Advertising Expenses	50,000
Salary of Office Manager	16,500
Office Utility Expenses	3,850
	2,78,950

Product cost : - Product cost refers to the costs incurred to create a product. These costs include direct labor, direct material, consumable production supplies and factory overhead.

Product Cost	Total
Meals provided to Rafters	314400
Compensation paid to Guide	471600
T-shirts & hats to Rafter	31440

Period cost :- A period cost is any cost that cannot be capitalized into prepaid expenses, inventory, or fixed assets. A period costs is more closely associated with the passage of time than with a transactional event. Examples of period costs are : Selling expenses , Advertising expense etc.

Period cost	Total
Rental cost of Rafts and Camping Equipment	2,08,600
Advertising Expenses	50,000
Salary of Office Manager	16,500
Office Utility Expenses	3,850
	2,78,950

Income statement in Contribution format for 1048 Rafters :-

Particulars	Total	Per Unit
Revenue	10,48,000	1048000/1048 = 1000
Less: Variable cost	-8,17,440	817440/1048 = 780
Contribution	2,30,560	230560/1048 = 220
Less: Fixed Cost	(2,78,950)
Profit/ (Loss)	(48 390)

Numbers of rafters required to breakeven

Break even in numbers = Fixed cost / Contribution per unit

278950/220 = 1268 rafters

Actions taken to improve profitability

a) Increase in selling price

Increase in selling price will lead to increase in contribution which ultimately bring down break even and increase profit margin.

b) Increase in numbers of rafters

Increase in numbers of rafters will lead to increase in profitability, but there is no change in break even point as contribution per unit is same.