Chapter 1, Problem 1.21P

a.

To determine

Introduction:

Traditional income statements: Normally, this type of statement is prepared in a manufacturing concern. It is based on cost of goods sold and selling and administrative expenses.

Contribution income statements: When net operating income has to be calculated in terms of fixed and variable behaviors, contribution income statements have to be prepared.

To prepare: A traditional format income statement for August.

Answer to Problem 1.21P

The traditional income statement for August is as follows:

MP INC.
TRADITIONAL INCOME STATEMENT FOR AUGUST
Particulars	Amount (in dollars ($))	Amount (in dollars (S))
Sales ( Note a)		125000
Cost of goods sold (Note b)		98000
Gross margin (Note c)		27000
Selling and administrative expenses:
Administrative expenses (Note e)	5000
Selling expenses (Note e)	14000	19000
Net operating income (Note f)		8000

Explanation of Solution

Average Cost price per unit=$2450

Average selling price per unit=$3125

Sale and delivery of pianos in August=40

Particular	Amount
Selling:
Advertising	$700
Sales salaries and commissions	$950
Delivery of pianos to customers	$3
Utilities	$350
Depreciation	$800
Administrative:
Executive salary	$2500
Insurance	$400
Clerical	$1000
Depreciation of office equipment	$300

With the help of the given information, we have to calculate the following:

1. Calculation of Sales:

  $\begin{array}{l}Sales=Sellingpriceperunit\times numberofunitsold\\ \Rightarrow \$3125\times 40=\$125000.\end{array}$

2. Calculation of cost of goods sold:

  $\begin{array}{l}Costofgoodssold=Costpriceperunit\times numberofunitsold\\ \Rightarrow \$2450\times 40=\$98000\end{array}$

3. Calculation of gross margin:

  $\begin{array}{l}Grossmargin=Sales-Costofgoodssold\\ \Rightarrow \$125000-\$98000=\$27000\end{array}$

4. Calculation of selling expenses:

To calculate the selling expenses, we have to calculate the following:

  $\begin{array}{l}Salescommission=Sales\times commissionrate\\ \Rightarrow \$125000\times 8\%\\ \Rightarrow \$125000\times \frac{8}{100}=\$10000\end{array}$

Sales salaries = $950 per month (given)

The total sales salaries consist of sales salaries + commission given.

Therefore, total sales salaries would be $\$950+\$10000=\$10950$ .

Let us calculate the cost incurred on delivery of pianos.

  $\begin{array}{l}DeliveryofPianos=Sellingcostperpiano\times Numberofunitssold\\ \Rightarrow \$30\times 40=\$1200\end{array}$

Therefore, when we add all the values we get the selling expense

  $\begin{array}{l}Salesexpenses=Advertising+Salessalaries\&commission+DeliveryofPianos+\\ Utilities+DepreciationofSalesfacilities\end{array}$

By substituting the required values, we get

  $\begin{array}{l}\Rightarrow \$700+\$10950+\$1200+\$350+\$800\\ \Rightarrow \$14000\end{array}$

5. Calculation of Administrative expenses:

We are been told that clerical staff get salaries which includes their salary + commission. We are given the monthly fixed salaries. We are asked to calculate the commissions given to clerical staff:

  $\begin{array}{l}Clerical=CostofClericalpermonth\times (Numberofunitssold\times Costperpiano)\\ \Rightarrow \$1000+(40\times \$20)\\ \Rightarrow \$1000+\$800=\$1800\end{array}$

Let us now calculate the Administrative expenses:

  $\begin{array}{l}Administrativeexpenses=Executivesalaries+insurance+clerical+depreciationof\\ officeequipment+totalfixedadministrativeexpenses\\ \Rightarrow \$2500+\$400+\$1800+\$300=\$5000\end{array}$

f)Net operating income: With the help of the formula given below, we can calculate the net operating income:

  $\begin{array}{l}Netoperatingincome=Grossmargin-sellingandadministrativeexpenses\\ \Rightarrow \$27000-(\$14000+\$5000)\\ \Rightarrow \$27000-\$19000\\ \Rightarrow \$8000\end{array}$

Since we have all the required values, let us now prepare a Traditional income statement of MP Inc.

b.

To determine

Introduction:

Traditional income statements: Normally, this type ofstatements is prepared in a manufacturing concern. It is based cost of goods sold and selling and administrative expenses.

Contribution income statements: When net operating income has to be calculated in terms of fixed and variable behaviors, contribution income statements have to be prepared.

Requirement 2 To prepare: A contribution format income statement for August.

Answer to Problem 1.21P

The contribution income statement is follows:

MP INC.
CONTRIBUTION INCOME STATEMENT FOR AUGUST
Particulars	Per unit amount (in dollars ($))	Amount (in dollars ($))
Sales ( Note f)	3125	125000
Variable Expenses:
Cost of goods sold (Note g)	2450	98000
Sales commission (Note h)	250	10000
Clerical expenses (Note j) expenses:	20	800
Delivery of Pianos (Note i)	30	1200
Total variable expenses	2750	110000
Contribution Margin (Sales-Variable expenses)	275	15000
Fixed expenses:
Advertising		700
Sales commission		950
Executive salaries		2500
Utilities		350
Depreciation of sales facilities		800
Depreciation of office equipment		300
Clerical salary		1000
Insurance		400
Total fixed expenses		7000
Net Income		8000

Explanation of Solution

Average Cost price per unit=$2450

Average selling price per unit=$3125

Sale and delivery of pianos in August=40

Particular	Amount
Selling:
Advertising	$700
Sales salaries and commissions	$950
Delivery of pianos to customers	$3
Utilities	$350
Depreciation	$800
Administrative:
Executive salary	$2500
Insurance	$400
Clerical	$1000
Depreciation of office equipment	$300

Here, we are asked the state the per unit cost of all the variables. So let us consider the calculations in (1) to calculate the per unit cost.

f) Calculation of Sales:

  $\begin{array}{l}Sales=Sellingpriceperunit\times numberofunitsold\\ \Rightarrow \$3125\times 40=\$125000.\end{array}$

If Sales is $125000, per unit cost will $3125.

g) Calculation of cost of goods sold:

  $\begin{array}{l}Costofgoodssold=Costpriceperunit\times numberofunitsold\\ \Rightarrow \$2450\times 40=\$98000\end{array}$

If cost of goods sold is $98000, then per unit cost will be $2450.

h) Calculation of selling expenses per unit cost:

To calculate the selling expenses per unit cost, we have to calculate the following:

  $\begin{array}{l}Salescommission=Sales\times commissionrate\\ \Rightarrow \$125000\times 8\%\\ \Rightarrow \$125000\times \frac{8}{100}=\$10000\end{array}$

  $\begin{array}{l}Perunit=\frac{Salescommissionsalary}{Numberofunitssold}\\ \Rightarrow \frac{\$10000}{40}=\$250\end{array}$

Therefore, the sales commission per unit cost would be $250.

i) Calculation of cost incurred on delivery of pianos:

  $\begin{array}{l}DeliveryofPianos=Sellingcostperpiano\times Numberofunitssold\\ \Rightarrow \$30\times 40=\$1200\end{array}$

Therefore, per unit cost of delivery of pianos would be $30.

j) Calculation of Administrative expenses:

We are asked to calculate the variable cost incurred on commissions given to clerical staff:

  $\begin{array}{l}Clerical=Numberofunitssold\times Costperpiano\\ \Rightarrow 40\times \$20\\ \Rightarrow \$800\end{array}$

Therefore, the unit cost of clerical commission would be $20.

Using the above values, let us now prepare a contribution statement of MP Inc. for August. The statement shows the value in total and the per cost values also.

c.

To determine

Introduction:

Traditional income statements: Normally, this type ofstatements is prepared in a manufacturing concern. It is based cost of goods sold and selling and administrative expenses.

Contribution income statements: When net operating income has to be calculated in terms of fixed and variable behaviors, contribution income statements have to be prepared.

To analyze: The reason for the statement misleading everyone when the fixed cost is shown on a per-unit basis.

Answer to Problem 1.21P

The fixed cost incurred will not change according the volume of production or any other activity. That is the reason why per unit cost of fixed expenses is not calculated.

Explanation of Solution

Given information:

Average Cost price per unit=$2450

Average selling price per unit=$3125

Sale and delivery of pianos in August=40

Particular	Amount
Selling:
Advertising	$700
Sales salaries and commissions	$950
Delivery of pianos to customers	$3
Utilities	$350
Depreciation	$800
Administrative:
Executive salary	$2500
Insurance	$400
Clerical	$1000
Depreciation of office equipment	$300

As of now, we have prepared an income statement under the traditional format and contribution format. In the contribution income statement, we have calculated the per-unit cost of certain variables but we have considered fixed expenses as a total. When the income statement is observed, we find the fixed cost is misleading the management stating that fixed costs are similar to variable cost. Fixed costs are not incurred unit wise as the basic concept behind fixed cost is that it never changes in proportion to the volume of production or other activities. Here, whatever may be the sales of pianos, the fixed cost incurred will not change. Once fixed, it remains fixed until a new fixed price is assigned to the variable. That is the reason why per unit cost of fixed expenses is not calculated. Consolidated fixed expenses are considered as a fixed cost in contribution format.