Milden Company has an exclusive franchise to purchase a product from the manufac
ID: 2587319 • Letter: M
Question
Milden Company has an exclusive franchise to purchase a product from the manufacturer and distribute it on the retail level. As an aid in planning, the company has decided to start using a contribution format income statement. To have data to prepare such a statement, the company has analyzed its expenses and has developed the following cost formulas: Cost Cost Formula Cost of good sold $34 per unit sold Advertising expense $190,000 per quarter Sales commissions 7% of sales Shipping expense ? Administrative salaries $100,000 per quarter Insurance expense $11,000 per quarter Depreciation expense $70,000 per quarter Management has concluded that shipping expense is a mixed cost, containing both variable and fixed cost elements. Units sold and the related shipping expense over the last eight quarters follow: Quarter Units Sold Shipping Expense Year 1: First 36,000 $ 180,000 Second 38,000 $ 195,000 Third 43,000 $ 237,000 Fourth 39,000 $ 200,000 Year 2: First 37,000 $ 190,000 Second 40,000 $ 205,000 Third 54,000 $ 252,000 Fourth 51,000 $ 228,000 Milden Company’s president would like a cost formula derived for shipping expense so that a budgeted contribution format income statement can be prepared for the next quarter. Required: 1. Using the high-low method, estimate a cost formula for shipping expense based on the data for the last eight quarters above. 2. In the first quarter of Year 3, the company plans to sell 43,000 units at a selling price of $67 per unit. Prepare a contribution format income statement for the quarter. (Do not round your intermediate calculations.)
Explanation / Answer
Answer (1)
Given information
Quarter
Units Sold
Shipping Expense ($)
Year 1
First
36,000
180,000
Second
38,000
195,000
Third
43,000
237,000
Fourth
39,000
200,000
Year 2
First
37,000
190,000
Second
40,000
205,000
Third
54,000
252,000
Fourth
51,000
228,000
Solution:
Units Sold
Shipping Expense ($)
Highest activity level
54,000
252,000
Lowest activity level
36,000
180,000
In high low method of cost formula is given by a linear relationship, (In this given question as shipping expenses is a mixed cost, containing both variable and fixed cost elements, their amounts are calculated as under):
Y = a + b X
Where, ‘a’ is fixed cost element of shipping expenses
‘b’ is variable Cost per Unit (for shipping expenses)
Variable cost per unit (b) is calculated using the following formula:
Variable cost per unit = y2- y1 / x2-x1
Where,
y2 is the shipping expenses at highest level of activity;
y1 is the shipping expenses at lowest level of activity;
x2 are the units sold at highest level of activity; and
x1 are the units sold at lowest level of activity
Putting values in the formula:
Variable cost per unit (b) = ($252,000-$180,000) / (54,000-36,000)
= $ 72,000 / 18,000
= $ 4 per unit
Fixed cost element (a) is calculated using the following formula:
Fixed cost element (a) = y2 – (b x2)
= $ 252,000- (4 * 54000)
= $ 252,000- $ 216,000
= $ 36,000
Cost formula for shipping expenses is Y = $ 36,000 + 4 X (Answer)
Answer (2)
Milden Company
Contribution format Income statement
For the first quarter of Year 3
Particulars
Amount ($)
Amount ($)
Sales (43,000 units *$ 67 per unit)
2,881,000
Variable expenses:
Sales commission (7 % of sales)
201,670
Shipping expenses (Variable portion $ 4 * 43,000 units )
172,000
Cost of goods sold ($ 34 per unit)
1,462,000
Total Variable expenses
1,835,670
Contribution margin (Sales – total variable expenses)
1,045,330
Fixed expenses:
Advertising expense
190,000
Administrative salaries
100,000
Insurance expense
11,000
Depreciation expense
70,000
Shipping expenses (Fixed portion)
36000
Total Fixed expenses
407,000
Net operating income (Contribution – total fixed expenses)
638,330
Note:
The expenses which are given as amount per quarter (Like Advertising, Administrative, Salaries, Insurance and Depreciation) are taken as fixed expenses as they do not change with units. While sales commission and cost of goods sold changes with units, so they are variable expenses.
Shipping expenses is a mixed cost, containing both variable and fixed cost elements (For calculation of fixed and variable elements refer answer 1)
Quarter
Units Sold
Shipping Expense ($)
Year 1
First
36,000
180,000
Second
38,000
195,000
Third
43,000
237,000
Fourth
39,000
200,000
Year 2
First
37,000
190,000
Second
40,000
205,000
Third
54,000
252,000
Fourth
51,000
228,000