Thursday 27 June 2013

Frankel Ltd., a British merchandising company, is the exclusive distributor of a product that is gaining rapid market acceptance. The company’s revenues and expenses (in British pounds) for the last three months are given below:

Frankel Ltd., a British merchandising company, is the exclusive distributor of a product that is gaining rapid market acceptance. The company’s revenues and expenses (in British pounds) for the last three months are given below:

Frankel Ltd.
Comparative Income Statements
For the Three Months Ended June 30
April May June
  Sales in units 3,000 3,750 4,500






  Sales revenue £ 420, 000    £ 525,000     £ 630,000  
  Cost of goods sold
168,000  
210,000 252,000



  Gross margin 252,000 315,000 378,000



  Selling and administrative expenses:
       Shipping expense 44,000   50,000   56,000  
       Advertising expense 70,000   70,000   70,000  
       Salaries and commissions 107,000   125,000   143,000  
       Insurance expense 9,000   9,000   9,000  
       Depreciation expense 42,000 42,000 42,000



  Total selling and administrative expenses 272,000 296,000 320,000



  Net operating income (loss) £  (20,000) £  19,000 £  58,000







(Note: Frankel Ltd.’s income statement has been recast in the functional format common in the United States. The British currency is the pound, denoted by £.)

Required:
1. Identify each of the company’s expenses (including cost of goods sold) as either variable, fixed, or mixed.

  Expenses Classification
  Cost of goods sold Variable
  Shipping expense Mixed
  Advertising expense Fixed
  Salaries and commissions Mixed
  Insurance expense Fixed
  Depreciation expense Fixed


2. Using the high-low method, separate each mixed expense into variable and fixed elements. State the cost formula for each mixed expense. (Omit the "£" sign in your response.)
     
Variable Cost        Fixed Cost Formula
  Shipping expense £    per unit £   Y = £ + £  X  
  Salaries and commissions £   per unit £   Y = £ + £  X  


3.
Redo the company’s income statement at the 4,500-unit level of activity using the contribution format. (Input all amounts as positive values except losses which should be indicated by a minus sign. Omit the "£" sign in your response.)

Frankel Ltd.
Income Statement
For the Month Ended June 30
  Sales revenue £  
  Variable expenses:
       Cost of goods sold £
       Shipping expense
       Sales commissions  


  Contribution margin  
  Fixed expenses:
       Shipping expense
       Advertising expense
       Sales salaries
       Insurance expense
       Depreciation expense  


  Net operating income £  





Explanation: 2. 
Analysis of the mixed expenses:

Units Shipping
Expense
Salaries and Commissions
  High level of activity    4,500     £56,000     £143,000  
  Low level of activity    3,000      44,000     107,000



  Change    1,500    £12,000    £ 36,000







  
Variable cost element:

Variable cost per unit  =
Change in cost
Change in activity  

Shipping expense:
=
£12,000
 = £8 per unit
1,500 units

Salaries and commissions:
£36,000
  = £24 per unit
1,500 units

Fixed cost element:

Shipping Expense Salaries and Commissions
  Cost at high level of activity £ 56,000     £ 143,000   
  Less variable cost element:
      4,500 units × £8 per unit 36,000    
      4,500 units × £24 per unit
108,000  




  Fixed cost element £ 20,000    £ 35,000  










The cost formulas are:
Shipping expense: £20,000 per month plus £8 per unit or
  Y = £20,000 + £8X.
Salaries and Commissions: £35,000 per month plus £24 per unit or
  Y = £35,000 + £24X.

3.
Cost of goods sold: (4,500 units × £56 per unit) = £252,000
Shipping expense: (4,500 units × £8 per unit) = £36,000
Sales commissions: (4,500 units × £24 per unit) = £108,000

A number of graphs displaying cost behavior patterns are shown below. The vertical axis on each graph represents total cost and the horizontal axis represents the level of activity (volume).

A number of graphs displaying cost behavior patterns are shown below. The vertical axis on each graph represents total cost and the horizontal axis represents the level of activity (volume).
Picture

Consider the cost behavior patterns of each of the following situations:
a. Electricity bill—a flat fixed charge, plus a variable cost after a certain number of kilowatt-hours are used.
b. City water bill, which is computed as follows:

   
  First 1,000,000 gallons or less $1,000 flat fee
  Next 10,000 gallons $0.003 per gallon used
  Next 10,000 gallons $0.006 per gallon used
  Next 10,000 gallons $0.009 per gallon used
  Etc. Etc.


c.
Depreciation of equipment, where the amount is computed by the straight-line method. When the depreciation rate was established, it was anticipated that the obsolescence factor would be greater than the wear and tear factor.
d. Rent on a factory building donated by the city, where the agreement calls for a fixed fee payment unless 200,000 labor-hours or more are worked, in which case no rent need be paid.
e.
Cost of raw materials, where the cost starts at $7.50 per unit and then decreases by 5 cents per unit for each of the first 100 units purchased, after which it remains constant at $2.50 per unit.
f.
Salaries of maintenance workers, where one maintenance worker is needed for every 1,000 hours of machine-hours or less (that is, 0 to 1,000 hours requires one maintenance worker, 1,001 to 2,000 hours requires two maintenance workers, etc.).
g.
Cost of raw material used.
h.
Rent on a factory building donated by the county, where the agreement calls for rent of $100,000 less $1 for each direct labor-hour worked in excess of 200,000 hours, but a minimum rental payment of $20,000 must be paid.
i.
Use of a machine under a lease, where a minimum charge of $1,000 is paid for up to 400 hours of machine time. After 400 hours of machine time, an additional charge of $2 per hour is paid up to a maximum charge of $2,000 per period.

Required:
1. For each of the above situations, identify the graph that illustrates the cost behavior pattern involved.

Situation Graph  
a.     6
b.     11
c.     1
d.     4
e.     2
f.     10
g.     3
h.     7
i.     9


2. Would a knowledge of cost behavior patterns such as those above be of help to a manager in analyzing the cost structure of his or her company?
   
  Yes


Explanation:

The most recent financial statements for Fleury Inc., follow. Interest expense will remain constant; the tax rate and the dividend payout rate will also remain constant. Costs, other expenses, current assets, fixed assets and accounts payable increase spontaneously with sales.

The most recent financial statements for Fleury Inc., follow. Interest expense will remain constant; the tax rate and the dividend payout rate will also remain constant. Costs, other expenses, current assets, fixed assets and accounts payable increase spontaneously with sales.

FLEURY, INC.
2011 Income Statement
  Sales       $ 755,000  
  Costs         590,000  
  Other expenses         11,000  
       

 
  Earnings before interest and taxes       $ 154,000  
  Interest paid         12,000  
       

 
  Taxable income       $ 142,000  
  Taxes (40%)         56,800  
       

 
  Net income       $ 85,200  
       



 
  Dividends $ 34,080        
  Addition to retained earnings   51,120        


FLEURY, INC.
Balance Sheet as of December 31, 2011
Assets   Liabilities and Owners’ Equity  
  Current assets         Current liabilities      
    Cash $ 21,440       Accounts payable $ 55,600  
    Accounts receivable   33,760       Notes payable   14,800  
         

 
    Inventory 70,720       Total $ 70,400
 

   

 
      Total $ 125,920     Long-term debt $ 138,000  
          Owners’ equity      
  Fixed assets           Common stock and paid-in surplus $ 124,000  
    Net plant and equipment $ 240,000       Retained earnings   33,520  
 

   

 
              Total $ 157,520  
         

 
  Total assets $ 365,920     Total liabilities and owners’ equity $ 365,920  
 



   



 

  
Complete the pro forma income statements below. (Input all amounts as positive values.)
   
FLEURY INC.
Pro Forma Income Statement
  15 % Sales Growth   20 % Sales Growth   25 % Sales Growth
  Sales $     $     $  
  Costs          
  Other expenses          
 
   
   
 
  EBIT $     $     $  
  Interest          
 
   
   
 
  Taxable income $     $     $  
  Taxes          
 
   
   
 
  Net income $     $     $  
 

   

   

 
     Dividends $
$ $
     Add to RE


Calculate the EFN for 15, 20 and 25 percent growth rates. (Negative amount should be indicated by a minus sign.)

  15% 20% 25%
  EFN $   $   $  



Explanation: