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Porter Insurance Company has three lines of insurance: automobile, property, and life. The life insurance segment has been losing money for the past five quarters, and Leah Harper, Porter’s controller, has done an analysis of that segment. She has discovered that the commission paid to the agent for the first year the policy is in place is 55 percent of the first-year premium. The second-year commission is 20 percent, and all succeeding years a commission equal to 5 percent of premiums is paid. No salaries are paid to agents; however, Porter does advertise on television and in magazines. Last year, the advertising expense was $500,000. The loss rate (payout on claims) averages 50 percent. Administrative expenses equal $450,000 per year. Revenue last year was $10,000,000 (premiums). The percentage of policies of various lengths is as follows:
Experience has shown that if a policy remains in effect for more than two years, it is rarely cancelled.
Leah is considering two alternative plans to turn this segment around. Plan 1 requires spending $250,000 on improved customer claim service in hopes that the percentage of policies in effect will take on the following distribution:
Total premiums would remain constant at $10,000,000, and there are no other changes in fixed or variable cost behavior.
Plan 2 involves dropping the independent agent and commission system and having potential policyholders phone in requests for coverage. Leah estimates that revenue would drop to $7,000,000. Commissions would be zero, but administrative expenses would rise by $1,200,000, and advertising (including direct mail solicitation) would increase by $1,000,000.
Required:
- 1. Prepare a variable-costing income statement for last year for the life insurance segment of Porter Insurance Company.
- 2. What impact would Plan 1 have on income?
- 3. What impact would Plan 2 have on income?
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Chapter 18 Solutions
Cornerstones of Cost Management (Cornerstones Series)
- Porter Insurance Company has three lines of insurance: automobile, property, and life. The life insurance segment has been losing money for the past five quarters, and Leah Harper, Porters controller, has done an analysis of that segment. She has discovered that the commission paid to the agent for the first year the policy is in place is 55 percent of the first-year premium. The second-year commission is 20 percent, and all succeeding years a commission equal to 5 percent of premiums is paid. No salaries are paid to agents; however, Porter does advertise on television and in magazines. Last year, the advertising expense was 500,000. The loss rate (payout on claims) averages 50 percent. Administrative expenses equal 450,000 per year. Revenue last year was 10,000,000 (premiums). The percentage of policies of various lengths is as follows: Experience has shown that if a policy remains in effect for more than two years, it is rarely cancelled. Leah is considering two alternative plans to turn this segment around. Plan 1 requires spending 250,000 on improved customer claim service in hopes that the percentage of policies in effect will take on the following distribution: Total premiums would remain constant at 10,000,000, and there are no other changes in fixed or variable cost behavior. Plan 2 involves dropping the independent agent and commission system and having potential policyholders phone in requests for coverage. Leah estimates that revenue would drop to 7,000,000. Commissions would be zero, but administrative expenses would rise by 1,200,000, and advertising (including direct mail solicitation) would increase by 1,000,000. Required: 1. Assume Fred holds the policy for one year and then drops it. What is his contribution to Porters operating income? 2. Assuming Fred holds the policy for three years, what is his contribution to Porters operating income in the second and third years? Over a three-year period? What implications does this hold for Porters efforts to retain policyholders?arrow_forwardAdorable Company owns a car dealership that it uses for servicing a car under warranty. The company’s past experience with warranty claims is as follows: 50% of the cars sold in a year have zero defect, 30% of the cars sold in a year have normal defect, and 20% of the cars sold in a year have significant defect. The cost of rectifying the normal defect is P10,000 while the significant defect is P30,000. The company sold 500 cars in 2021.How much is the amount of provision for warranty in 2021?arrow_forwardA company sells flood insurance to homeowners for $230 per year. It estimates there is a 1.2% chance of any house flooding in a year. When a house floods, the company's average payout is $17,600 (though the company keeps the $230 in any case). What is the company's expectation for each policy sold?arrow_forward
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- Hopewell sells a line of goods under a six-month warranty. Any defect arising during that period is repaired free of charge. Hopewell has calculated that if all the goods sold in the last six months of the year required repairs the cost would be $2 million. If all of these goods had more serious faults and had to be replaced the cost would be $6 million. The normal pattern is that 80% of goods sold will be fault-free, 15% will require repairs and 5% will have to be replaced. What is the amount of the provision required?arrow_forwardBrecha Hogan is president of Hogan Company, a manufacturer of toys for children. For the past 10 years, the company has sold its product to both wholesale and retail dealers of toys in the northeast United States. Over the years, the company has come to know its customers well. While all sales are made on credit, few credit losses have occurred. The company’s experience has shown that an annual provision for uncollectible accounts of 0.3 of 1 percent of sales is adequate in the old territory.Early in 20X1, Hogan Company decided to expand and develop a new sales base in the southeastern United States. Hogan was pleased when credit sales of $870,000 were achieved in the new territory during the year. To achieve this level of sales and get a foothold in the new territory, though, credit was allowed to some customers with lower credit ratings than had been granted in the past. Given its liberal credit policies in the new territory Hogan estimates that the provision in the new territory…arrow_forward.Pirates PLC sells a line of goods under a six-month warranty. Any defect arising during that period is repaired free of charge. Pirates PLC has calculated that if all the goods sold in the last six months of the year required repairs the cost would be $2 million. If all of these goods had more serious faults and had to be replaced the cost would be $6 millionThe normal pattern is that 80% of goods sold will be fault-free, 15% will require repairs and 5% will have to be replaced. What is the amount of the provision required? Select one alternative: $1.6 million $6 million $2 million $0.6 millionarrow_forward
- Vaughn Inc. has been using the services of San Bernadino Brokerage Company (SBBC) for the past six months. SBBC has informed Vaughn Inc. that the geometric mean monthly return was 6.6 percent and that over the past six months Vaughn Inc. earned 15.6 percent, 18.6 percent, -22.6 percent, 13.6 percent, -7.6 percent, and an unknown amount in the last month. Determine the missing return. (Round intermediate calculations to 6 decimal places, e.g. 1.251125 and the final answer to 4 decimal places, e.g. 14.5125 %) Missing return %arrow_forwardTrust is an insurance company and it has 10000 cars insured for crash accident. The company's record for the past 10 years shows that on average 3% of cars have crashed each year. Compute the expected number of cars to be crashed per year? What is the objective risk of Trust company? Assume that birr 500000 is the amount of compensation payments Trust will cover for the insured if accident happened, what is the maximum and minimum amount of birr Trust company is expected to pay?arrow_forwardCal’s Carpentry is considering outsourcing its accountsreceivable function. Currently, Cal employs two full-time clerksand one part-time clerk to manage accounts receivable. Each fulltime clerk has an annual salary of $36,000 plus fringe benefitscosting 30 percent of their salary. The part-time clerk makes$18,000 per year but has no fringe benefits. Total salary plus fringecost is $111,600. Cal estimates that each account receivable incursa $10 variable cost. The Small Business Accounts ReceivablesGroup (SBARG) specializes in handling accounts receivable forsmall- to medium-size companies. Doris Roberts from SBARGhas offered to do the accounts receivable for Cal’s Carpentry ata fixed cost of $75,000 per year plus $30 per account receivable.Next year, Cal expects to have 2000 accounts receivable.(a) Calculate the cost for Cal’s Carpentry to continue doingaccounts receivable in-house.(b) Calculate the cost for Cal’s Carpentry to use SBARG tohandle the accounts receivable.(c) If the fixed…arrow_forward
- Cornerstones of Cost Management (Cornerstones Ser...AccountingISBN:9781305970663Author:Don R. Hansen, Maryanne M. MowenPublisher:Cengage Learning
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