Mastery Problem: Cost-Volume-Profit Analysis

Cost Behavior

Cover-to-Cover Company is a manufacturer of shelving for books. The company has compiled the following cost data, and wants your help in determining the cost behavior. After reviewing the data, complete requirements (1) and (2) that follow.

1. Determine whether the costs in the table are variable, fixed, mixed, or none of these.

2. For each cost, determine the fixed portion of the cost, and the per-unit variable cost. If there is no amount or an amount is zero, enter "0". Recall that, for N = Number of Units Produced, Total Costs = (Variable Cost Per Unit x N) + Fixed Cost. Complete the following table with your answers. Round variable portion of cost (per unit) answers to two decimal places.

High-Low

Biblio Files Company is the chief competitor of Cover-to-Cover Company in the bookshelf business. Biblio Files is analyzing its manufacturing costs, and has compiled the following data for the first six months of the year. After reviewing the data, answer questions (1) through (3) that follow.

1. From the data previously provided, help Biblio Files Company estimate the fixed and variable portions of its total costs using the high-low method. Recall that Total Costs = (Variable Cost Per Unit x Number of Units Produced) + Fixed Cost. Complete the following table.

2. With your Total Fixed Cost and Variable Cost per Unit from the high-low method, compute the total cost for the following values of N (Number of Units Produced).

3. Why does the total cost computed for 4,360 units not match the data for January?

a. The high-low method is accurate only for months in which production is at full capacity.

b. The high-low method only gives accurate data when fixed costs are zero.

c. The high-low method gives a formula for the estimated total cost and may not match levels of production other than the highest and lowest.

d. The high-low method gives accurate data only for levels of production outside the relevant range.

Contribution Margin

Review the contribution margin income statements for Cover-to-Cover Company and Biblio Files Company on their respective Income Statements. Complete the following table from the data provided on the income statements. Each company sold 81,800 units during the year.

Income Statement - Cover-to-Cover

Income Statement - Biblio Files

Sales Mix

Biblio Files Company is making plans for its next fiscal year, and decides to sell two new types of bookshelves, Basic and Deluxe. The company has compiled the following estimates for the new product offerings.

The company is interested in determining how many of each type of bookshelf would have to be sold in order to break even. If we think of the Basic and Deluxe products as components of one overall enterprise product called “Combined,” the unit contribution margin for the Combined product would be $2.31. Fixed costs for the upcoming year are estimated at $330,330. Recall that the totals of all the sales mix percents must be 100%. Determine the amounts to complete the following table.

Target Profit

Refer again to the income statements for Cover-to-Cover Company and Biblio Files Company on their respective Income Statement. Note that both companies have the same sales and net income. Answer questions (1) - (3) that follow, assuming that all data for the coming year is the same as the current year, except for the amount of sales.

1. If Cover-to-Cover Company wants to increase its profit by $30,000 in the coming year, what must their amount of sales be?
$

2. If Biblio Files Company wants to increase its profit by $30,000 in the coming year, what must their amount of sales be?
$

3. What would explain the difference between your answers for (1) and (2)?

a. Biblio Files Company has a higher contribution margin ratio, and so more of each sales dollar is available to cover fixed costs and provide operating income.

b. Cover-to-Cover Company’s contribution margin ratio is lower, meaning that it’s more efficient in its operations.

c. The companies have goals that are not in the relevant range.

d. The answers are not different; each company has the same required sales amount for the coming year to achieve the desired target profit.

(Deriving SR Cost Curves) In this problem, we’ll work through deriving short-run total cost and marginal cost functions from a production function. Such cost functions show how costs vary when quantity changes (you’re typical cost curves from intro to micro!). A firm has a production function ?? = 0.25????^0.5, the rental rate of capital is $100, and the wage rate is $25. In the short-run, capital is fixed at 100 units.

a. What is the firm’s short-run production function, q(L)? In one sentence, explain what this tells you.

b. What is the short-run demand for labor as a function of quantity, q(L) ? In one sentence, explain what this tells you.

c. Write the firm’s cost as a function of labor, ??(L) ? In one sentence, explain what this tells you.

d. Use what you found in (b) and (c) to derive the firm’s short-run cost function, ??(q) . In one sentence, explain what this tells you.

e. What is the firm’s short-run marginal cost function, ????(q) . In one sentence, explain what this tells you.

f. If the firm produces 125 units, what will be its total cost and marginal cost?

Learned Corporation has provided the following information:

Required:

a. For financial reporting purposes, what is the total amount of product costs incurred to make 5,000 units?
b. For financial reporting purposes, what is the total amount of period costs incurred to sell 5,000 units?
c. If the selling price is $24.10 per unit, what is the contribution margin per unit sold? (Round your answer to 2 decimal places.)
d. If 6,000 units are produced, what is the total amount of direct manufacturing cost incurred?
e. If 6,000 units are produced, what is the total amount of indirect manufacturing costs incurred?

1. What is meant by “cost structure?” Explain how a company's cost structure affects its break-even point. In your opinion, what is the best level of cost structure? Explain
2. J. P. Alexander claims that the relevant range concept is important only for variable costs. Explain the relevant range concept.  Do you agree with J. P.'s claim? Explain
3. What are the principal differences between activity-based costing (ABC) and traditional product costing? Which is the preferred method? Explain.

Factory Overhead Cost Variance Report

Tannin Products Inc. prepared the following factory overhead cost budget for the Trim Department for July of the current year, during which it expected to use 10,000 hours for production:

Tannin has available 14,000 hours of monthly productive capacity in the Trim Department under normal business conditions. During July, the Trim Department actually used 9,000 hours for production. The actual fixed costs were as budgeted. The actual variable overhead for July was as follows:

Construct a factory overhead cost variance report for the Trim Department for July. Enter all amounts as positive numbers. If an amount box does not require an entry, leave it blank. Round your interim computations to the nearest cent, if required.

2. How does the envelope relationship relate short run average cost and long run average cost?

     
Additional data for each of the product lines follow:     

    
Required

Determine the total cost and cost per unit for each product line, assuming that an ABC system is used to allocate overhead costs. Determine the combined cost of all three product lines.

Lower-of-Cost-or-Market Inventory

On the basis of the following data:

Determine the value of the inventory at the lower of cost or market. Assemble the data in the form illustrated in Exhibit 9.

Discuss both the full-cost pricing strategy and the marginal-cost pricing strategy and explain how each would apply to your health care clinic. How would target costing affect your business?