Question

Problem 5A-7 Cost Behavior; High-Low Method; Contribution Format Income Statement [LO5-10]

Morrisey & Brown, Ltd., of Sydney is a merchandising company that is the sole distributor of a product that is increasing in popularity among Australian consumers. The company’s income statements for the three most recent months follow:

Morrisey & Brown, Ltd. Income Statements For the Three Months Ended September 30
	July				August				September
Sales in units		6,000				6,500				7,000
Sales	$	570,000			$	617,500			$	665,000
Cost of goods sold		342,000				370,500				399,000
Gross margin		228,000				247,000				266,000
Selling and administrative expenses:
Advertising expense		26,200				26,200				26,200
Shipping expense		58,000				61,600				65,200
Salaries and commissions		110,000				116,800				123,600
Insurance expense		8,450				8,450				8,450
Depreciation expense		17,900				17,900				17,900
Total selling and administrative expenses		220,550				230,950				241,350
Net operating income	$	7,450			$	16,050			$	24,650

Required:

1. By analyzing the data from the company's income statements, classify each of its expenses (including cost of goods sold) as either variable, fixed, or mixed.

2. Using the high-low method, separate each mixed expense into variable and fixed elements. Express the variable and fixed portions of each mixed expense in the form Y = a + bX.

3. Redo the company’s income statement at the 7,000-unit level of activity using the contribution format.

Answer 1

1. By analyzing the data from the company's income statements, classify each of its expenses (including cost of goods sold) as either variable, fixed, or mixed.

Cost	Cost Behavior
Cost of Goods Sold	Variable
Advertising Expense	Fixed
Shipping Expense	Mixed
Salaries and Commissions	Mixed
Insurance Expense	Fixed
Depreciation Expense	Fixed

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2.

Using the high-low method, separate each mixed expense into variable and fixed elements. Express the variable and fixed portions of each mixed expense in the form Y = a + bX.

	Shipping Expense	Salaries and Commission
High (a)	65,200	123,600
Low (b)	$58,000	$110,000
Difference in Cost (c=A-B)	$7,200	$13,600
Difference in Sales Volume(d)	1,000 units	1,000 units
Variable Cost per Unit (E=c/d)	$ 7.20 per unit	$ 13.60 per unit
Fixed Cost per month (total cost-variable cost)	$14,800	$28,400

	variable	Fixed		Formula (to calc cost "Y" at any level)
Shipping Expense	$ 7.20 per unit	14,800		Y=$14,800 + $7.2 per unit
Salaries and commissions	$ 13.60 per unit	28,400		Y=$28,400 + $13.6 per unit

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3.

Redo the company’s income statement at the 7,000-unit level of activity using the contribution format.

Morrissey and Brown Ltd.
Contribution Margin Income Statement
Activity Level : 7,000 units
Sales Revenue ( 7000 x $ 95)		$665,000
Less Variable Costs:
Cost of Goods Sold ( 7,000 x $ 57)	399,000
Shipping Expense ( 7,000 x $ 7.2)	50,400
Salaries and Commissions ( 7,000 x $ 13.6)	95,200	544,600
Contribution Margin		$120,400
Less: Fixed Cost
Advertising	26,200
Insurance	8,450
Shipping	14,800
Salaries and Commissions	28,400
Depreciation	17,900
Total Fixed Costs		95,750
Net Operating Income		$24,650