Each of the following statements may (or may not) describe one of these technical terms. For each statement, indicate the accounting term described, or answer “None” if the statement does not correctly describe any of the terms.
a. The level of sales at which revenue exactly equals costs and expenses. Break-even point. b. Costs remain unchanged despite changes in sales volume. Fixed Costs. c. The span over which output is likely to vary and assumptions about cost behavior generally remain valid. Relevant Range. d. Sales revenue less variable costs and expenses. Contribution margin. e. Unit sales price minus variable cost per unit. Unit contribution margin. f. The reduction in unit cost achieved from a higher level of output. Economics of scale. g. Costs the respond to changes in sales volume by less than a proportionate amount. Semi variable costs. h. Operating income less variable costs. “None”.
Exercise 20.7 – Using Cost-Volume-Profit Formulas
Exercise 21.2 – Home Depot’s Financial Statements: Incremental, Sunk, and Opportunity Costs Read the footnote in Appendix A referring to Home Depot’s decision to close all of its remaining big box stores in China. Write a short paragraph identifying the incremental, sunk and opportunity costs associated with this decision. Assume that any cost savings will be invested elsewhere in more productive stores.
Incremental costs relate to the difference in costs between alternative courses of action and incremental revenues. The incremental costs that would be that would occur from either remodeling or closing Home Depot an existing location would include cost of materials, overhead from the actual physical remodel, labor that includes employee pay for rearranging and moving merchandise during a remodel if it occurred, designing and planning costs. Opportunity costs are important factors when it comes to decision making because they define the costs of taking some action in terms of the value foregone or that’s given up due to a particular action taken place. Opportunity costs of remolding would include profits on lost sales if the store is closed during remodeling, loss of current sales due to decrease in customer traffic (due to excessive noise, smell, dirt and inconveniences.
Stores could potentially lose profit if they are not able to stock the full line of products or keep items stocked during a remodel. Whereas a sunk cost is an outlay that has been irrevocably incurred at some time in the past; sunk costs cannot be changed no matter what course of action is taken and are irrelevant for purposes of decision making involving the future. Sunk costs related to either remodeling of the store that would need to be taken into consideration include original costs of the current store (decorations, paint, shelves, displays, carpet) and designs that will need to be replaced or removed during either remodeling or closing.
Exercise 21.6 – Incremental Analysis: Make or Buy Decision The cost to Swank Company of manufacturing 15,000 units of a particular part is $135,000, of which $60,000 is fixed and $75,000 is variable. The company can buy the part from an outside supplier for $6 per unit. Fixed costs will remain the same regardless of Swank’s decision. Should the company buy the part or continue to manufacture it? Prepare a comparative schedule in the format illustrated in Exhibit 21-6.
It would be more beneficial for the company to manufacture the part rather than buy it from an outside provider.
Brief Exercise 22.9 – Flows of Costs through Manufacturing Accounts The President of Cold Moo Ice Cream Company, a chain of ice cream stores in the Midwest, was unhappy with the actual six-month profit figures for the company recently prepared by the CFO. The president asked the CFO for a profit breakdown, by store, of the actual six-month results. When the President received the report, he was extremely upset and called the CFO, into his office. The President stated, “These reports show that each store in the chain is profitable, but our company results are unprofitable! How can this be?” The CFO pointed out that each store was allowed to set prices for ice cream based on its cost structure. However, the stores’ cost structures did not include headquarters costs of the costs of advertising and delivery of products.
What are the three characteristics for operating a successful responsibility accounting system? Consider whether the accounting system at Cold Moo Ice Cream Company includes the three characteristics of a successful responsibility accounting system. How could the responsibility accounting system at Cold Moo be improved?
As the Textbook states, “measuring performance along the lines of management responsibility is an important function. A responsibility accounting system holds individual managers accountable for the performance of the business centers under their control and provides top management with information useful in identifying strengths and weaknesses among units throughout the organization.” The three characteristics of a successful operating accounting system will include budgets, will measure the performance, and contain timely performance reports. “Budgets serve as performance targets for each subunit in an organization. The accounting system will measure the performance of each responsibility center, and timely performance reports are prepared that compare the actual performance of each center with the amounts budgeted.”
When reports are preformed frequently, it allows center managers to be able to keep their performances on target, and helps with the evaluation of the managers. It does not appear hat Cold Moo Ice Cream is following the timely reports method of the accounting system, which is essential to ensuring the financial information is accurate as possible, and to improve this aspect should be more intertwined with the actual budget and more accurately present how the performance of the store is measured.
To do so the responsibility income statement should also be presented, this contains not only the operating results of a particular part of a business but also the revenue and expenses of each profit center within that part, which could be extremely important to see how those centers within the same area measure and stack up against one another. For the responsibility income statement to be informative and useful it should essentially and efficiently be able to detail Variable Costs, Contribution Margin, Fixed Costs, Traceable Fixed Costs and Common Fixed Costs.
In addition, fixed costs that are common to both product lines amount to $125,000.00.
a. Prepare Chocolatiers’ responsibility income statement for the current month. Report the responsibility margin for each product line and income from operations for the company as a whole. Also include columns showing all dollar amounts as percentages of sales.
b. According to the analysis performed in part a, which product line is more profitable? Should the common fixed costs be considered when determining the profitability of individual product lines? Why or why not? According the analysis in part a, the solid product line is more profitable. When determining profitability of any product line, common fixed costs should not be considered. Only the costs that are directly traceable to the product lines should be included. Common fixed costs are not directly traceable to any product, as they are arbitrarily allocated in proportion to a chosen factor, for example, machine hour or square feet of a certain space occupied.
c. Chocolatiers has $15,000.00 to be used in advertising for one of the two product lines and expects that the expenditure will result in additional sales of $50,000.00. How should the company decide which product line to advertise?
The effects of this campaign will typically be in both sales and variable costs, and therefore the company should select the product line based on which product will have the highest contribution margin ratio, which is the percentage of sales, service revenues or selling price that remains after all variable costs and variable expenses have been covered. This method takes into consideration the limited time frame of the advertising campaign, where fixed costs will most likely not be affected.