Chapter IE, Problem 1IE

INTEGRATION EXERCISE I Different Costs for Different Purposes, Cost-Volume-Profit-Relationships

Hixson Company manufactures and sells one product for $34 per unit. The company maintains no beginning or ending inventories and its relevant range of production is 20,000 units to 30,000 units. When Hixson produces and sells 25,000 units, its unit costs are as follows:

Required:

1. For financial accounting purposes. what is the total amount of product costs incurred to make 25.000 units? What is the total amount of period costs incurred to sell 25.000 units?

If 24.000 units are produced,what is the variable manufacturing cost per unit produced? What is the average fixed manufacturing cost per unit produced?

If 26.000 units arc produced, what is the variable manufacturing cost per unit produced? What is the average fixed manufacturing cost per unit produced?

If 27.000 units are produced. what are the total amounts of direct and indirect manufacturing costs incurred to support this level of production?

What total incremental manufacturing cost will Hixson incur if it increases production from 25,000 to 25,001 units?

What is Hixson’s contribution margin per unit? What is its contribution margin ratio?

What is Hixson’s Break-Even point in unit sales? What is its Break-Even point in dollar sales?

How much will Hixson’s net operating income increase if it can grow production and sales from 25.000 units to 26.500 units?

What is Hixson’s margin of safety at a sales volume of 25000 units?

What is Hixson degree of operating leverage at a sales volume of 25,000 units?

To determine

Product cost Product cost include all the costs or expenses that are directly related to product. These costs are incurred only during the production process. For example- cost incurred for direct material, direct labor, etc.

Period cost Period costs are the expenses that are incurred even when there is no production. These costs are not related to products but to passage of time. For example, depreciation expense, advertising expense, etc.

To calculate: Total amount of product cost and period cost incurred to produce 25,000 units.

Answer to Problem 1IE

Total product cost for manufacturing 25,000 units is $500,000 and total period cost is $275,000.

Explanation of Solution

Calculation of product cost for 25,000 units will be as follows:

Particulars		Amount (in $)
Direct materials	(25,000 * $8)	200,000
Direct labors	(25,000 * $5)	125,000
Manufacturing overheads (variable)	(25,000 * $1)	25,000
Manufacturing overheads (fixed)	(25,000 * $6)	150,000
Total product cost		500,000

Calculation of period cost for 25,000 units will be as follows:

Particulars		Amount (in $)
Selling expense (fixed)	(25,000 * $3.5)	87,500
Administration expense (fixed)	(25,000 * $2.5)	62,500
Sales commission	(25,000 * $4)	100,000
Administrative expense	(25,000 * $1)	25,000
Total product cost		275,000

For 25,000 units, total product cost is $500,000 and total period cost is $275,000.

To determine

Variable cost per unit This is the total variable cost that a company incurs to produce one unit. This is calculated by the division of total variable cost and the number of manufactured units. Variable cost per unit remains the same.

Average fixed manufacturing cost per unit This shows fixed manufacturing cost incurred for one unit. This is calculated by the division of total fixed manufacturing expenses and total units.

To calculate: Per unit variable manufacturing cost and average fixed manufacturing cost for 24,000 units.

Answer to Problem 1IE

Variable manufacturing cost is calculated as $14 per unit and fixed manufacturing overhead is $6.25 per unit.

Explanation of Solution

For 24,000 units, Variable manufacturing cost per unit will be calculated as:

Particulars	Amount (in S)
Direct material (per unit)	8
Direct labor (per unit)	5
Manufacturing overhead (variable) (per unit)	1
Variable manufacturing cost (per unit)	14

Fixed manufacturing cost per unit will be calculated as:

Particulars	Amount (in $)
Total fixed manufacturing overheads (shown in sub part 1)	150,000
Total units	24,000 units
Per unit fixed manufacturing cost (total cost / units)	6.25

Variable manufacturing cost per unit is $14.00 and per unit fixed manufacturing overhead is $6.25.

To determine

Variable manufacturing cost per unit This is the total variable cost that a company incurs to manufacture one unit. This is calculated by the division of total variable cost and the number of manufactured units. Variable cost per unit remains the same.

Fixed manufacturing cost per unit This shows fixed manufacturing cost incurred for one unit. This is calculated by the division of total fixed manufacturing expenses and total units.

To calculate: For 26,000 units per unit variable and fixed manufacturing costs.

Answer to Problem 1IE

Variable manufacturing cost is calculated as $14 per unit and fixed manufacturing overhead is $5.77 per unit.

Explanation of Solution

For 26,000 units, Variable manufacturing cost per unit will be calculated as:

Particulars	Amount (in S)
Direct material (per unit)	8.00
Direct labor (per unit)	5.00
Manufacturing overhead (variable) (per unit)	1.00
Total variable manufacturing cost (per unit)	14.00

Note: Variable cost per unit remains the same, irrespective of the number of units produced.

Fixed manufacturing cost per unit for 26,000 units will be calculated as:

Particulars	Amount (in $)
Total fixed manufacturing overheads (shown in sub part 1)	150,000
Total units	26,000 units
Per unit fixed manufacturing cost (total cost / units)	5.77

Note: Total fixed cost incurred by the company does not change.

Variable manufacturing cost per unit is $14.00 and fixed manufacturing overhead per unit is $5.77.

To determine

Direct manufacturing cost Direct cost covers all the costs that are directly associated with a product. For example, costs related to direct material, labor, etc.

Indirect manufacturing cost Indirect cost covers all the costs that are not directly associated with a product but help in operating in a more efficient way. For example, supervision cost, advertising cost, etc.

To calculate: Total direct and indirect manufacturing costs for 27,000 units.

Answer to Problem 1IE

Total direct manufacturing cost for 27,000 units is $351,000 and total indirect manufacturing cost is $177,000.

Explanation of Solution

For 27,000 units, total direct manufacturing cost will be calculated as:

Particulars	Amount (in $)
Direct material (27,000 * $8)	216,000
Direct labor (27,000 * $5)	135,000
Total direct manufacturing cost	351,000

For 27,000 units, total indirect manufacturing cost will be calculated as:

Particulars	Amount (in $)
Manufacturing overhead (variable) (27,000 * $1)	27,000
Manufacturing overhead (fixed)	150,000
Total indirect manufacturing cost	177,000

For 27,000 units, total direct manufacturing expense is $351,000 and total indirect manufacturing expense is $177,000.

To determine

Incremental manufacturing cost Incremental cost refers to the additional cost that a company incurs by producing one addiyional unit.

To calculate: Total incremental manufacturing cost that the company would incur if number of units change from 25,000 to 25,001.

Answer to Problem 1IE

Incremental cost that the company will incur by increasing one unit is $14.

Explanation of Solution

Calculation for incremental cost will be done as follows:

Particulars	For 25,000 units	For 25,001 units
Direct material ($8)	200,000	200,008
Direct labor ($5)	125,000	125,005
Manufacturing overhead (variable) (1)	25,000	25,001
Manufacturing overhead (fixed) (fixed cost does not change in total)	150,000	150,000
Total	500,000	500,014

So, incremental cost when company changes the number of units from 25,000 to 25,001 is $14 (500,014 − 500,000).

To determine

Contribution margin Contribution margin represents the portion of sales, which does not include any amount of variable costs. This portion of sale includes only fixed costs and profit. It is calculated by deducting total variable cost from sale price or by adding amount of fixed costs and profit.

To calculate: Per unit contribution margin and contribution margin ratio of the company.

Answer to Problem 1IE

Contribution margin is $15 per unit and Contribution margin ratio is 44.1%.

Explanation of Solution

Contribution margin per unit is calculated by the following formula:

  $\text{Contribution margin (p}\text{.u) = Selling price (p}\text{.u) - Total variable cost (p}\text{.u) }$

Selling price is given as $34 per unit and total variable cost per unit will be calculated as:

Particulars	Amount (in S)
Direct material (per unit)	8.00
Direct labor (per unit)	5.00
Manufacturing overhead (variable) (per unit)	1.00
Sales commission	4.00
Variable administration expense	1.00
Total variable manufacturing cost (per unit)	19.00

So, contribution margin per unit will be:

  $\begin{array}{l}\text{Contribution margin (p}\text{.u) = Selling price (p}\text{.u) - Total variable cost (p}\text{.u) }\\ \text{ = \$34 - \$19 }\\ \text{ = \$15}\end{array}$

Formula to calculate contribution margin ratio is:

  $\text{Contribution margin ratio = }\frac{\text{Contribution margin (p}\text{.u)}}{\text{Selling}\text{price}}$

Contribution margin ratio will be:

  $\begin{array}{l}\text{Contribution margin ratio = }\frac{\text{Contribution margin (p}\text{.u)}}{\text{Selling}\text{price}}\\ \text{ = }\frac{\$15}{\$34}\\ \text{ = 0}\text{.441 or 44}\text{.1\%}\end{array}$

So, contribution is $15 per unit and contribution margin ratio is 44.1%.

To determine

Break even point It is that level of sales at which, cost incurred by a company is exactly equal to the revenue earned. It is known as the level of no profit or no loss as, at this level company does not earn any profit and covers all of its costs.

To calculate:Break-even point in units and in sales.

Answer to Problem 1IE

Break-even point in units is calculated as 20,000 units and in sales, it is calculated as $680,000.

Explanation of Solution

Calculation for total fixed cost:

Particulars	Amount (in S)
Fixed manufacturing cost	150,000
Fixed selling expense	87,500
Fixed administrative expense	62,500
Total fixed costs	300,000

Now, break even point (in units) will be calculated as:

  $\begin{array}{l}\text{Break even point (in units) = }\frac{\text{Total fixed costs}}{\text{Contribution (per unit)}}\\ \text{ = }\frac{\$300,000}{\$15}\\ \text{ = 20,000 units }\end{array}$

Break even point (in sales) will be:

  $\begin{array}{l}\text{Break even point (in sales) = BEP units }\times \text{ Selling price (p}\text{.u) }\\ \text{ = 20,000 }\times \text{ \$34 }\\ \text{ = \$680,000 }\end{array}$

Break even point in units is 20,000 units and break even point in sales $680,000.

To determine

Net operating income It is the net income generated by a company and it is obtained after deducting both types of costs, variable and fixed, from the sale value.

To calculate:Increase in net operating income when units increase from 25,000 units to 26,500 units.

Answer to Problem 1IE

Net operating income will increase by $22,500.

Explanation of Solution

Net operating income is calculated by deducting amount of total fixed cost from contribution (in rupees).

Calculation for increase in net operating income will be done as follows:

Particulars	For 25,000 units	For 26,500 units
Contribution margin per unit	$15	$15
Total units	25,000	26,500
Total contribution in rupees	$375,000	$397,500
Total fixed cost (computed in sub part 7)	$300,000	$300,000
Net operating income	$75,000	$97,500

So, increase in net operating income of the company number of units increase from 25,000 to 26,500 is $22,500 ($97,500 − 75,000).

To determine

Margin of safety Margin of safety represents the sales made by a company in addition to its break-even level. It is calculated by deducting break even sales from the actual sales made.

To calculate:Margin of safety at 25,000 units.

Answer to Problem 1IE

Margin of safety at 25,000 unit is $170,000.

Explanation of Solution

Margin of safety is calculated by deducting break even sales from the total actual sales. So, it will be calculated as:

Particulars	Amount (in $)
Total sales (25,000 * 34)	850,000
Less: Break-even point (in sales) (computed in sub part 7)	680,000
Margin of safety	170,000

So, margin of safety is $170,000.

To determine

Operating leverage Operating leverage measures the degree by which operating income for a company will increase with an increase in its revenue.

To calculate:Degree of operating leverage at 25,000 units.

Answer to Problem 1IE

Operating leverage at 25,000 units is 5.0.

Explanation of Solution

Degree of operating leverage is obtained by dividing contribution margin and net operating income. So, Calculation for degree of operating leverage will be done as follows:

  $\begin{array}{l}\text{Degree of operating leverage = }\frac{\text{Contribution margin}}{\text{Net}\text{operating}\text{income}}\\ \text{ = }\frac{\$375,000}{\$75,000}\\ \text{ = 5}\text{.0}\end{array}$

So, degree of operating leverage, at 25,000 units, is 5.0.

Note: contribution margin and net operating income both are calculated in sub part 8.