Question

Q1) The Buffet Company produces and sells Parrot-head t-shirts. Income statements for two activity levels are provided below:

Unit Volumes	40,000	60,000
Revenue	$300,000	$450,000
Less cost of goods sold	120,000	180,000
Gross margin	$180,000	$270,000
Less operating expenses:
Salaries and commissions	$40,000	$ 50,000
Advertising expenses	$60,000	$ 60,000
Administrative expenses	$25,000	$ 25,000
Total operating expenses	$125,000	$135,000
Net income	$55,000	$ 135,000

Required:

1. Identify the mixed expenses.
2. Use the high-low method to separate the mixed costs into variable and fixed components.
3. Prepare a contribution margin income statement at the 50,000 unit level.

__________________________________________________________________________________________________________________________

Q2) The Mean Cleaning Machine (MCM) Company and the Acme Cleaning Service provide janitorial services to commercial and residential customers in a major metropolitan area. MCM pays its employees $10 per hour for commercial jobs and $12.50 per hour for residential jobs. Acme pays its workers salaries. Acme’s total labor costs run $200,000 per year. Both companies charge their commercial customers an average of $15 per hour and the residential customers $25 per hour.

Required:

1. Prepare a contribution margin income statement for each company assuming they provide 15,000 hours of service to commercial customers and 4,000 hours of service to residential customers during the period and incurred no other expenses than those mentioned above.
2. A new service has recently entered the market specializing in residential cleaning at substantial lower rates. Both MCM and Ace are contemplating getting out of the residential business. Prepare a contribution margin income statement for each company assuming they do exit the residential business.
3. Which company will fare better if the residential business is eliminated? Why?

Answer 1

Answer to Question No. 1

Part 1.

Salaries and Commissions are mixed expenses, whereas Cost of Goods sold is a variable expense and Advertising Expenses and Administrative Expenses are Fixed Expenses.

Part 2.

As per High- Low method,
Variable Cost per Unit = (y2 – y1)/ (x2 – x1)
Total Cost at the Highest level of activity (y2) = $50,000
Total Cost at the Lowest level of activity (y1) = $40,000
Units at the Highest level of activity (x2) = 60,000 Units
Units at the Lowest level of activity (x1) = 40,000 Units

Variable Cost per Unit = ($50,000 - $40,000) / (60,000 – 40,000)
Variable Cost per Unit = $0.50

Total Cost = a + bx

Total Cost at an activity level of 40,000 (x) units = $40,000
$40,000 = a + ($0.50 * 40,000)
a = $20,000

Therefore, Variable Cost per Unit is $0.50 and Fixed Cost is $20,000.

Part 3.