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Integrative Exercise
Cost Behavior and Cost-Volume-Profit Analysis for Many Glacier Hotel

Using the High-Low Method to Estimate Variable and Fixed Costs

Located on Swiftcurrent Lake in Glacier National Park, Many Glacier Hotel was built in 1915 by the Great Northern Railway. In an effort to supplement its lodging revenue, the hotel decided in 20X1 to begin manufacturing and selling small wooden canoes decorated with symbols hand painted by Native Americans living near the park. Due to the great success of the canoes, the hotel began manufacturing and selling paddles as well in 20X3. Many hotel guests purchase a canoe and paddles for use in self-guided tours of Swiftcurrent Lake. Because production of the two products began in different years, the canoes and paddles are produced in separate production facilities and employ different laborers. Each canoe sells for $500, and each paddle sells for $50. A 20X3 fire destroyed the hotel’s accounting records. However, a new system put into place before the 20X4 season provides the following aggregated data for the hotel’s canoe and paddle manufacturing and marketing activities:

Manufacturing Data:

Year

Number of
Canoes
Manufactured

Total Canoe
Manufacturing
Costs

 

Year

Number of
Paddles
Manufactured

Total Paddle
Manufacturing
Costs

20X9

 

250

 

 

$103,000

 

 

20X9

 

900

 

 

$38,500

 

20X8

 

275

 

 

128,000

 

 

20X8

 

1,200

 

 

49,000

 

20X7

 

240

 

 

108,000

 

 

20X7

 

1,000

 

 

44,000

 

20X6

 

310

 

 

114,000

 

 

20X6

 

1,100

 

 

45,500

 

20X5

 

350

 

 

141,500

 

 

20X5

 

1,400

 

 

52,000

 

20X4

 

400

 

 

140,000

 

 

20X4

 

1,700

 

 

66,500

 

Marketing Data:

Year

Number of
Canoes
Sold

Total Canoe
Marketing
Costs

 

Year

Number of
Paddles
Sold

Total Paddle
Marketing
Costs

20X9

 

250

 

 

$45,000

 

 

20X9

 

900

 

 

$7,500

 

20X8

 

275

 

 

43,000

 

 

20X8

 

1,200

 

 

9,000

 

20X7

 

240

 

 

44,000

 

 

20X7

 

1,000

 

 

8,000

 

20X6

 

310

 

 

51,000

 

 

20X6

 

1,100

 

 

8,500

 

20X5

 

350

 

 

62,000

 

 

20X5

 

1,400

 

 

10,000

 

20X4

 

400

 

 

60,000

 

 

20X4

 

1,700

 

 

11,500

 

Required:

1.  High-Low Cost Estimation Method

a. Use the high-low method to estimate the per-unit variable costs and total fixed costs for the canoe product line.

Variable cost per unit

$fill in the blank 1

Total fixed cost

$fill in the blank 2

b. Use the high-low method to estimate the per-unit variable costs and total fixed costs for the paddle product line.

Variable cost per unit

$fill in the blank 3

Total fixed cost

$fill in the blank 4

2.  Cost-Volume-Profit Analysis, Single-Product Setting
Use CVP analysis to calculate the break-even point in units for

a. The canoe product line only (i.e., single-product setting)

BE units

fill in the blank 5  canoes

b. The paddle product line only (i.e., single-product setting)

BE units

fill in the blank 6  paddles

3.   Cost-Volume-Profit Analysis, Multiple-Product Setting

The hotel’s accounting system data show an average sales mix of approximately 300 canoes and 1,200 paddles each season. Significantly more paddles are sold relative to canoes because some inexperienced canoe guests accidentally break one or more paddles, while other guests purchase additional paddles as presents for friends and relatives. In addition, for this multiple-product CVP analysis, assume the existence of an additional $30,000 of common fixed costs for a customer service hotline used for both canoe and paddle customers. Use CVP analysis to calculate the break-even point in units for both the canoe and paddle product lines combined (i.e., the multiple-product setting).

Canoe BE units

fill in the blank 7  canoes

Paddle BE units

fill in the blank 8  paddles

4.  Cost Classification

a. Classify the manufacturing costs, marketing costs, and customer service hotline costs either as production costs or period costs.

All manufacturing costs are 

 costs. All marketing costs and customer hotline costs are 

 costs

b. For the period costs, further classify them into either selling expenses or general and administrative expenses.

Marketing costs are selling oriented; therefore, the marketing period costs would be further classified as 

. Customer hotline costs relate to the customer service section of the value chain and would be further classified as 

.

5.   Sensitivity Cost-Volume-Profit Analysis and Production Versus Period Costs, Multiple- Product Setting

If both the variable and fixed production costs (refer to your answer to Requirement 1) associated with the canoe product line increased by 5% (beyond the estimate from the high-low analysis), how many canoes and paddles would need to be sold in order to earn a target income of $96,000? Assume the same sales mix and additional fixed costs as in Requirement 3.

Canoe target income units

fill in the blank 13  canoes

Paddle target income units

fill in the blank 14  paddles

6.   Margin of Safety

Calculate the hotel’s margin of safety (both in units and in sales dollars) for Many Glacier Hotel, assuming the same facts as in Requirement 3, and assuming that it sells 700 canoes and 2,500 paddles next year.
fill in the blank 15 total MOS units above total BE units

$fill in the blank 16 MOS in sales dollars

Contribution Margin, Break-Even Units, Break-Even Sales, Margin of Safety, Degree of Operating Leverage

Aldovar Company produces a variety of chemicals. One division makes reagents for laboratories. The division’s projected income statement for the coming year is:

Sales (203,000 units @ $70)

$14,210,000

Total variable cost

8,120,000

Contribution margin

$6,090,000

Total fixed cost

4,945,500

Operating income

$1,144,500

Required:

1.  Compute the contribution margin per unit, and calculate the break-even point in units. Calculate the contribution margin ratio and use it to calculate the break-even sales revenue. (Note: Round contribution margin ratio to four significant digits, and round the break-even sales revenue to the nearest dollar.)

Unit contribution margin

$fill in the blank 1

 

Break-even point in units

fill in the blank 2

 

Contribution margin ratio

fill in the blank 3

 

Break-even sales revenue

$fill in the blank 4

 

2.  The divisional manager has decided to increase the advertising budget by $250,000. This will increase sales revenues by $1 million. By how much will operating income increase or decrease as a result of this action? Use your answers from part 1 to determine the amount.
$fill in the blank 5  

3.  Suppose sales revenues exceed the estimated amount on the income statement by $1,500,000. Without preparing a new income statement, by how much are profits underestimated? Use your answers from part 1 to determine the amount.
$fill in the blank 7

4.  Compute the margin of safety based on the original income statement. Round your answer to the nearest dollar.
$fill in the blank 8

5.  Compute the degree of operating leverage based on the original income statement. Round your answer to two decimal places.
fill in the blank 9

If sales revenues are 8% greater than expected, what is the percentage increase in operating income? Round your answer to four decimal places before converting to a percentage. For example, 0.88349 would be rounded to 0.8835 and entered as 88.35%.
fill in the blank 10 %


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Scattergraph, High-Low Method, and Predicting Cost for a Different Time Period from the One Used to Develop a Cost Formula

Farnsworth Company has gathered data on its overhead activities and associated costs for the past 10 months. Tracy Heppler, a member of the controller’s department, has convinced management that overhead costs can be better estimated and controlled if the fixed and variable components of each overhead activity are known. One such activity is receiving raw materials (unloading incoming goods, counting goods, and inspecting goods), which she believes is driven by the number of receiving orders. Ten months of data have been gathered for the receiving activity and are as follows:

  Month

 

Receiving Orders

 

Receiving Cost

1

 

1,000

 

$18,000

2

 

700

 

15,000

3

 

1,500

 

28,000

4

 

1,200

 

17,000

5

 

1,300

 

25,000

6

 

1,100

 

21,000

7

 

1,600

 

29,000

8

 

1,400

 

24,000

9

 

1,700

 

27,000

10

 

900

 

16,000

Required:

1.  On your own paper, prepare a scattergraph based on the 10 months of data. Based on this, does the relationship appear to be linear?

2.  Using the high-low method, select a cost formula for the receiving activity.

Using the cost formula, what is the predicted cost of receiving for a month in which 1,450 receiving orders are processed?
$fill in the blank 3

3.   Prepare a cost formula for the receiving activity for a quarter. Based on this formula, what is the predicted cost of receiving for a quarter in which 4,650 receiving orders are anticipated?
$fill in the blank 4

Prepare a cost formula for the receiving activity for a year. Based on this formula, what is the predicted cost of receiving for a year in which 18,000 receiving orders are anticipated?
$fill in the blank 5

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Method of Least Squares, Predicting Cost for Different Time Periods from the One Used to Develop a Cost Formula

Farnsworth Company has gathered data on its overhead activities and associated costs for the past 10 months. Tracy Heppler, a member of the controller’s department, has convinced management that overhead costs can be better estimated and controlled if the fixed and variable components of each overhead activity are known. One such activity is receiving raw materials (unloading incoming goods, counting goods, and inspecting goods), which she believes is driven by the number of receiving orders. Ten months of data have been gathered for the receiving activity and are as follows:

  Month

 

Receiving Orders

 

Receiving Cost

1

 

1,000

 

$18,000

2

 

700

 

15,000

3

 

1,500

 

28,000

4

 

1,200

 

17,000

5

 

1,300

 

25,000

6

 

1,100

 

21,000

7

 

1,600

 

29,000

8

 

1,400

 

24,000

9

 

1,700

 

27,000

10

 

900

 

16,000

Assume that Tracy has used the method of least squares on the receiving data and has gotten the following results:

Intercept

3,212

Slope

15.15

Required:

1.  Using the results from the method of least squares, what is the cost formula for the receiving activity?

2.  Using the cost formula, what is the predicted cost of receiving for a month in which 1,450 receiving orders are processed? (Note: Round your answer to the nearest dollar.)
$fill in the blank 2

3. Prepare a cost formula for the receiving activity for a quarter. Based on this formula, what is the predicted cost of receiving for a quarter in which 4,650 receiving orders are anticipated? Round your answer to the nearest dollar.
$fill in the blank 3

Prepare a cost formula for the receiving activity for a year. Based on this formula, what is the predicted cost of receiving for a year in which 18,000 receiving orders are anticipated? Round your answer to the nearest dollar.
$fill in the blank 4

Feedback

Variable-Costing and Absorption-Costing Income

Borques Company produces and sells wooden pallets that are used for moving and stacking materials. The operating costs for the past year were as follows:

Variable costs per unit:

 

Direct materials

$ 2.85

Direct labor

$ 1.92

Variable overhead

$ 1.60

Variable selling

$ 0.90

Fixed costs per year:

 

Fixed overhead

$180,000

Selling and administrative

$ 96,000

During the year, Borques produced 200,000 wooden pallets and sold 204,300 at $9 each. Borques had 8,200 pallets in beginning finished goods inventory; costs have not changed from last year to this year. An actual costing system is used for product costing.

Required:

1. What is the per-unit inventory cost that is acceptable for reporting on Borques’s balance sheet at the end of the year?

$fill in the blank 1

How many units are in ending inventory?

fill in the blank 2 units

What is the total cost of ending inventory?

$fill in the blank 3

2. Calculate absorption-costing operating income.

$fill in the blank 4

3. What would the per-unit inventory cost be under variable costing? Round your answer to the nearest cent.

$fill in the blank 5

Does this differ from the unit cost computed in Requirement 1?

4. Calculate variable-costing operating income.

$fill in the blank 7

5. Suppose that Borques Company had sold 196,700 pallets during the year. What would absorption-costing operating income have been?

$fill in the blank 8

What would variable-costing operating income?

$fill in the blank 9

(Appendix 3A) Scattergraph, High-Low Method, Method of Least Squares, Use of Judgment

The management of Wheeler Company has decided to develop cost formulas for its major overhead activities. Wheeler uses a highly automated manufacturing process, and power costs are a significant manufacturing cost. Cost analysts have decided that power costs are mixed. The costs must be broken into their fixed and variable elements so that the cost behavior of the power usage activity can be properly described. Machine hours have been selected as the activity driver for power costs. The following data for the past 8 quarters have been collected:

Quarter

 

Machine Hours

Power Cost

1

 

20,000

 

$26,000

2

 

25,000

 

38,000

3

 

30,000

 

42,500

4

 

22,000

 

37,000

5

 

21,000

 

34,000

6

 

18,000

 

29,000

7

 

24,000

 

36,000

8

 

28,000

 

40,000

Note: For the following requirements, round the fixed cost to the nearest dollar, round the variable rates to three decimal places, and the R2 to two decimal places.

Required:

1.  Prepare a scattergraph by plotting power costs against machine hours. Does the scattergraph show a linear relationship between machine hours and power cost?

2.  Using the high and low points (i.e., the high-low method), compute a power cost formula. (Note: Round variable rate to three decimal places.)

Total power cost = $fill in the blank 2 + ( $fill in the blank 3 x Number of machine hours )

3.   Use the method of least squares to compute a power cost formula. Evaluate the coefficient of determination.

Variable rate (to two decimal places)

$fill in the blank 4

per machine hour

Fixed cost (to the nearest dollar)

$fill in the blank 5

 

Coefficient of determination (R2) (to one decimal place).

fill in the blank 6

%

4.  Conceptual Connection: Rerun the regression, and drop the point (20,000, $26,000) as an outlier. Compare the results from this regression to those for the regression in Requirement 3. Which is better?

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(Appendix 3A) Separating Fixed and Variable Costs, Service Setting

Louise McDermott, controller for the Galvin plant of Veromar Inc., wanted to determine the cost behavior of moving materials throughout the plant. She accumulated the following data on the number of moves (from 100 to 800 in increments of 100) and the total cost of moving materials at those levels of moves:

Number of Moves

 

        Total Cost

100

 

$ 3,000

  

200

 

4,650

  

300

 

3,400

  

400

 

8,500

  

500

 

10,000

  

600

 

12,600

  

700

 

13,600

  

800

 

14,560

  

Required:

1.  Prepare a scattergraph based on the data above. Use cost for the vertical axis and number of moves for the horizontal. Based on an examination of the scattergraph, does there appear to be a linear relationship between the total cost of moving materials and the number of moves?

2.  Compute the cost formula for moving materials by using the high-low method. Calculate the predicted cost for a month with 550 moves by using the high-low formula. (Note: Round the answer for the variable rate to three decimal places and the answer for total fixed cost and total cost to the nearest dollar.)

Variable rate

$fill in the blank 2 per move

Fixed cost

$fill in the blank 3

Total cost

$fill in the blank 4

3.  Conceptual Connection: Compute the cost formula for moving materials using the method of least squares. (Note: For the method of least squares, round the variable rate to two decimal places and total fixed cost and total cost to the nearest dollar.) Using the regression cost formula, what is the predicted cost for a month with 550 moves?

Variable rate

$fill in the blank 5 per move

Fixed cost

$fill in the blank 6

Total cost

$fill in the blank 7

4. Evaluate the cost formula using the least squares coefficients.Could it be improved?

Normally, we would prefer the least squares method since the data appear to be 

. However, the third observation may be an outlier. If the third observation (300 moves and $3,400 of cost) is dropped, the R² rises to 99%. The new cost formula would be: Total Cost = $1,411 + ($17.28 × Number of Moves)

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Show Me How

Creating and Using a Cost Formula

Big Thumbs Company manufactures portable flash drives for computers. Big Thumbs incurs monthly depreciation costs of $15,800 on its plant equipment. Also, each drive requires materials and manufacturing overhead resources. On average, the company uses 16,250 ounces of materials to manufacture 6,500 flash drives per month. Each ounce of material costs $3.00. In addition, manufacturing overhead resources are driven by machine hours. On average, the company incurs $45,500 of variable manufacturing overhead resources to produce 6,500 flash drives per month.

In your calculations, round variable rate per flash drive to the nearest cent. If required, round final answers to the nearest cent.

Required:

1.  Create a formula for the monthly cost of flash drives for Big Thumbs.

Total cost of flash drives = 

 + ( 

 x Number of flash drives)

Total cost of flash drives = $fill in the blank 3 + ($fill in the blank 4 x Number of flash drives)

2.  If the department expects to manufacture 6,000 flash drives next month, what is the expected fixed cost (assume that 6,000 units is within the company’s current relevant range)?
$fill in the blank 5

What is the total variable cost (assume that 6,000 units is within the company’s current relevant range)?
$fill in the blank 6

What is the total manufacturing cost (i.e., both fixed and variable) (assume that 6,000 units is within the company’s current relevant range)?
$fill in the blank 7

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Show Me How

Using High-Low to Calculate Fixed Cost, Calculate the Variable Rate, and Construct a Cost Function

Pizza Vesuvio makes specialty pizzas. Data for the past 8 months were collected:

Month

Labor Cost($)

Employee Hours

 

January

 

9,390

 

 

400

 

February

 

6,900

 

 

470

 

March

 

7,431

 

 

500

 

April

 

8,040

 

 

370

 

May

 

9,687

 

 

430

 

June

 

8,390

 

 

340

 

July

 

11,500

 

 

560

 

August

 

7,400

 

 

310

Pizza Vesuvio’s controller wants to calculate the fixed and variable costs associated with labor used in the restaurant.

In your calculations, round the variable rate per employee hour to the nearest cent. If required, round your final answers to the nearest cent.

Required:

1.  Using the high-low method, calculate the variable rate.
$fill in the blank 1 per employee hour

2.  Using the high-low method, calculate the fixed cost of labor.
$fill in the blank 2

3.  Using the high-low method, construct the cost formula for total labor cost.

Total labor cost = $fill in the blank 3 + ($fill in the blank 4 × Employee hours)


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