Chapter 20, Problem 1STQ

To determine

Find effect on semi-variable costs for 10% decrease in the current year sales of Incorporation R compared to last year sales.

Answer to Problem 1STQ

a) Decrease in total, but increase as a percentage of net sales.

Explanation of Solution

Semi-variable costs: These costs are fixed up to certain level of activity; over that level costs will change according to the change in the activity (less proportionate to that activity).

Total semi variable costs will increase/(decrease) along with the increase/(decrease) in the activity due to variable cost element. But semi variable costs percentage will increase less than proportionate to the increase / (decrease) in the activity because of fixed cost element.

For example:

Assume that the last year sales are $100,000 and semi variable cost are $20,000 (50% fixed, that is $10,000 variable component and $10,000 is the fixed component). Percentage of sales for semi-variable costs is 20%$\left(\$20,000÷\$100,000\right)$.

During the current year, 10% sales are decreased when compared to the last year. Then, the current year sales are $90,000$\left(\$100,000-\left[\$100,000\times 10\%\right]\right)$. The semi-variable costs (variable component) are also decreased by 10% due to a decrease in the sales. The current year’s semi variable costs are $19,000 ($9,000 is variable component and $10,000 is the fixed component). The percentage of sales for semi-variable costs is increased from 20% to 21%$\left(\$19,000÷\$90,000\right)$.

The above explanation is matching with the option (a) Decrease in total, but increase as a percentage of net sales. Thus, option (a) is the suitable answer. Options (b), (c), and (d) are incorrect answers.