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Exam 2: Cost Behavior, operating Leverage, and Profitability Analysis

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Question 71

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The variable cost per unit increases in direct proportion to the activity base.

A) True
B) False

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Question 72

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Production during the current year for California Manufacturing,a producer of high security bank vaults,was at its highest point in the month of June when 80 units were produced at a total cost of $800,000.The lowest point in production was in January when only 20 units were produced at a cost of $440,000.The company is preparing a budget for the current year and needs to project expected fixed cost for the budget year.Using the high-low method,the projected amount of fixed cost per month is:

A) $120,000
B) $320,000
C) $480,000
D) $360,000

E) A) and C)
F) B) and C)

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Question 73

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A cost that is considered variable for one activity base may be considered fixed for a different activity base.

For the last two years BRC Company had net income as follows: $\begin{array} { | l | c | c | } \hline & \text { Year 1 } & \text { Year 2 } \\\hline \text { Net Income } & \$ 160,000 & \$ 200,000 \\\hline\end{array}$ What was the percentage change in income from Year 1 to Year 2?

A cost that contains both fixed and variable elements is referred to as a:

Descriptions of cost behavior as fixed or variable pertain to a particular range of activity.

Grant Company and Lee Company compete in the same market.The following budgeted income statements illustrate their cost structures. $\begin{array}{lrr}&\text { Grant } & \text { Lee } \\&\text { Company } & \text { Company }\\ \text { Number of customers } & 200 & 200 \\\text { Sales revenue }(200 \times \$ 150) & \$ 30,000& \$ 30,000 \\\text { Less variable costs } & 6,000& 18,000\\\text { Contribution margin } & \$ 24,000 & \$ 12,000 \\\text { Less fixed costs } & 19,000 & 7,000 \\\text { Net income } & \$ 5,00 0& \$ 5,000\end{array}$ Required: (a)If Grant Company lowers its price to $135,it will lure 80 customers away from Lee Company.Prepare Grant's income statement based on 280 customers. (b)If Lee Company lowers its price to $135 (assuming that Grant Company is still charging $150 per customer),Lee would lure 80 customers away from Grant.Prepare Lee's income statement based on 280 customers. (c)Which of the companies would benefit more from lowering its sales price to attract more customers,and why?

Quick Change and Fast Change are competing oil change businesses.Both companies have 5,000 customers.The price of an oil change at both companies is $20.Quick Change pays its employees on a salary basis,and its salary expense is $40,000.Fast Change pays its employees $8 per customer served.Suppose Quick Change is able to lure 1,000 customers from Fast Change by lowering its price to $18 per vehicle.Thus,Quick Change will have 6,000 customers and Fast Change will have only 4,000 customers. Select the correct statement from the following.

The following income statements are provided for Li Company's last two years of operation: $\begin{array}{lrr}&\text { Year 1}&\text { Year 2}\\\text { Number of units produced and sold } & 3,500 & 3,000 \\\text { Sales revenue } & \$ 101,500& \$ 87,000 \\\text { Cost of goods sold } & 68,000& 60,000 \\\text { Gross margin } & 33,500& 27,000 \\\text { General, selling, and administrative expenses } & 13,000& 12,00 0 \\\text { Net income } & \$ 20,500 & \$ 15,000\end{array}$ Assuming that cost behavior did not change over the two-year period,what is the amount of the company's variable cost of goods sold per unit?

The magnitude of operating leverage for Perkins Corporation is 4.5 when sales are $100,000.If sales increase to $110,000,profits would be expected to increase by what percent?

Executive management at Ballard Books is very optimistic about the chain's ability to achieve significant increases in sales in each of the next five years.The company will most benefit if management creates a:

Variable costs will become fixed outside the relevant range.

How does total fixed cost behave when volume increases?

In the graph below,which depicts the relationship between units produced and total cost,the dotted line depicts which type of total cost?

What advantages does the regression method of cost estimation offer,compared to the high-low and scattergraph methods of estimating mixed costs?

In the graph below,which depicts the relationship between units produced and total cost,the dotted line depicts which type of total cost?

A company with a completely fixed cost structure will have operating leverage of 1.

Assume that wages expense is a variable cost and that the relevant range is 10,000 to 15,000 labor hours.Within that range,the cost is $15 per hour.What can you assume about wages expense outside this range?

Former NFL coach Joe Gibbs is highly sought after as a guest speaker.His fee can run as high as $150,000 for a single two-hour appearance.Recently,he was asked to speak at a seminar offered by the National Sports in Education Foundation (NSEF).Due to the charitable nature of the organization,Mr.Gibbs offered to speak for $100,000.NSEF planned to invite 350 guests who would each make a $500 contribution to the organization.The Foundation's executive director was concerned about committing so much of the organization's cash to this one event.So instead of the $100,000 fee she countered with an offer to pay Mr.Gibbs 50% of the revenue received from the seminar and no other payments. Required: (a)Classify the two offers in terms of cost behavior (fixed vs.variable). Scenario A,NSEF pays Gibbs a $100,000 fee: Scenario B,NSEF pays Gibbs 50% of revenue: (b)Compute the budgeted income (assuming there are no other expenses)under each of the following scenarios: 1)NSEF agrees to pay the $100,000 fee,and 350 guests actually attend the seminar; and 2)NSEF pays Mr.Gibbs 50% of revenue,and 350 guests attend the seminar. (c)For each scenario ($100,000 fee vs.50% of revenue),compute the percentage increase in profit that would result if the Foundation is able to increase attendance by 20 percent over the original plan (to a total of 420).(Round the percentages to the nearest whole numbers.) (d)For each scenario,compute NSEF's cost per contributor if 350 attend and if 420 contributors attend.(Round the cost per contributor to two decimal points.) (e)Summarize the impact on risk and profits of shifting the cost structure from fixed to variable costs.

Contribution margin income statements for two competing companies are provided below: $\begin{array}{lrr}&\text { Yin Company } & \text { Yang Company }\\ \text { Revenue} &\$750,000&\$750,000\\ \text { Less variable costs } &300,000&525,000\\ \text { Contribution margin} &\$450,000&\$225,000\\ \text {Less fixed costs } &405,000&108,000\\ \text {Net income } &\$45,000&\$45,000\\\end{array}$ Required: (1)Show each company's cost structure by inserting the percentage of the company's revenue represented by each item on the contribution income statement. (2)Compute each company's magnitude of operating leverage. (3)Using the operating leverage measures computed in requirement 2,determine the increase in each company's net income (percentage and amount)if each company experiences a 10 percent increase in sales. (4)Assume that sales are expected to continue to increase for the foreseeable future,which company probably has more desirable cost structure? Why?