Chapter 2: Second Half

The magnitude of operating leverage for Blue Ridge Corporation is 3.5 when sales are $200,000 and net income is $36,000. If sales decrease by 6%, net income is expected to decrease by what amount? Multiple Choice $2,160 $7,560 $3,420 $1,260

$7,560 Explanation: Decrease in net income = Net income × Percentage decrease in sales × Magnitude of operating leverage Decrease in net income = $36,000 × 0.06 × 3.5 = $7,560

The manager of Kenton Company stated that 45% of its total costs were fixed. The manager was describing the company's: Multiple Choice operating leverage. contribution margin. cost structure. cost averaging.

cost structure.

Pickard Company pays its sales staff a base salary of $4,500 a month plus a $3.00 commission for each product sold. If a salesperson sells 800 units of product in January, the employee would be paid: Multiple Choice $6,900. $4,500. $2,300. $2,700.

$6,900. Explanation: Total cost = Fixed cost + Variable cost Total cost = $4,500 + (800 units × $3.00 per unit) = $6,900

Select the incorrect statement regarding cost structures. Multiple Choice Highly leveraged companies will experience greater profits than companies less leveraged when sales increase. The more variable cost, the higher the fluctuation in income as sales fluctuate. When sales change, the amount of the corresponding change in income is affected by the company's cost structure. Faced with significant uncertainty about future revenues, a low leverage cost structure is preferable to a high leverage cost structure.

The more variable cost, the higher the fluctuation in income as sales fluctuate. Explanation Shifting the cost structure from fixed to variable reduces not only the level of risk but also the potential for profits. As a result, the more variable cost, the lower the fluctuation in income as sales fluctuate.

A cost that contains both fixed and variable elements is referred to as a: Multiple Choice mixed cost. hybrid cost. relevant cost. nonvariable cost.

mixed cost.

In order to prepare a contribution format income statement, costs must be separated into: Multiple Choice manufacturing and selling, general, and administrative costs. cost of goods sold and operating expenses. variable and fixed costs. mixed, variable and fixed costs.

variable and fixed costs.

The magnitude of operating leverage for Forbes Corporation is 1.8 when sales are $200,000 and net income is $24,000. If sales increase by 5%, what is net income expected to be? Multiple Choice $25,200 $26,160 $24,667 $43,200

$26,160 Explanation: Expected net income = Net income + (Net income × Percentage increase in sales × Magnitude of operating leverage) Expected net income = $24,000 + ($24,000 × 0.05 × 1.8) = $26,160

Carson Corporation's sales increase from $500,000 to $600,000 in the current year. What is the percentage change in sales? Multiple Choice 20% 25% 22% 16.7%

20% Explanation: % change = (Alternative measure − Base measure) ÷ Base measure% change = ($600,000 − $500,000) ÷ $500,000 = 20%

For the last two years BRC Company had net income as follows: Year 1Year 2 Net Income $160,000 | $200,000 What was the percentage change in income from Year 1 to Year 2? Multiple Choice 20% increase 20% decrease 25% increase 25% decrease

25% increase Explanation: % change = (Alternative measure − Base measure) ÷ Base measure% change = ($200,000 − $160,000) ÷ $160,000 = 25%

The following income statement is provided for Grant, Inc. Sales revenue (1,500 @ $30 per unit)$45,000 Variable costs (1,500 @ $14 per unit) 21,000 Fixed costs 16,000 Net income$8,000 What is this company's magnitude of operating leverage? Multiple Choice 0.33 1.31 2.00 3.00

3.00 Explanation Magnitude of operating leverage = Contribution margin ÷ Net incomeMagnitude of operating leverage = ($45,000 − $21,000) ÷ $8,000 = 3.00

The magnitude of operating leverage for Perkins Corporation is 4.5 when sales are $100,000. If sales increase to $110,000, profits would be expected to increase by what percent? Multiple Choice 4.5% 14.5% 45% 10%

45% Explanation Percentage increase in net income = Percentage increase in sales × Magnitude of operating leverage Percentage increase in net income = [($110,000 − $100,000) ÷ $100,000] × 4.5 = 45%

Companies A and B are in the same industry and are identical except for cost structure. At a volume of 50,000 units, the companies have equal net incomes. At 60,000 units, Company A's net income would be substantially higher than B's. Based on this information, Multiple Choice Company A's cost structure has more variable costs than B's. Company A's cost structure has higher fixed costs than B's. Company B's cost structure has higher fixed costs than A's. At a volume of 50,000 units, Company A's magnitude of operating leverage was lower than B's.

Company A's cost structure has higher fixed costs than B's. Explanation: When sales change, the amount of the corresponding change in net income is directly influenced by the company's cost structure. The more fixed cost, the greater the fluctuation in net income. Since Company A's net income is substantially higher than Company B's when both companies experience an equal increase in sales, Company A has a fixed cost structure while Company B has a variable cost structure.

Taste of the Town, Inc. operates a gourmet sandwich shop. The company orders bread, cold cuts, and produce several times a week. If the cost of these items remains constant per customer served, the cost is said to be: Multiple Choice Variable Fixed Opportunity Mixed

Variable Explanation: Variable cost per unit remains constant within the relevant range.

Operating leverage exists when: Multiple Choice a company utilizes debt to finance its assets. management buys enough of the company's shares of stock to take control of the corporation. the organization makes purchases on credit instead of paying cash. small percentage changes in revenue produce large percentage changes in profit.

small percentage changes in revenue produce large percentage changes in profit. Explanation: Operating leverage is the cost structure condition that produces a proportionately larger percentage change in net income for a given percentage change in revenue. Business managers apply operating leverage to magnify small changes in revenue into dramatic changes in profitability.

Hard Nails and Bright Nails are competing nail salons. Both companies have the same number of customers. Both charge the same price for a manicure. The only difference is that Hard Nails pays its manicurists on a salary basis (i.e., a fixed cost structure) while Bright Nails pays its manicurists on the basis of the number of customers they serve (i.e., a variable cost structure). Both companies currently make the same amount of net income. If sales of both salons increase by an equal amount, Hard Nails: Multiple Choice will earn a higher profit than Bright Nails. will earn a lower profit than Bright Nails. will earn the same amount of profit as Bright Nails. The answer cannot be determined from the information provided.

will earn a higher profit than Bright Nails. Explanation: When sales change, the amount of the corresponding change in net income is directly influenced by the company's cost structure. The more fixed cost, the greater the fluctuation in net income. Since Hard Nails has a fixed cost structure while Bright Nails has a variable cost structure, if sales of both salons increase by an equal amount, Hard Nails will earn a higher profit than Bright Nails.

Wham Company sells electronic squirrel repellants for $60. Variable costs are 60% of sales and total fixed costs are $40,000. What is the firm's magnitude of operating leverage if 2,000 units are sold? Multiple Choice 0.17 6.00 2.25 None of these

6.00 Explanation: Net income = Sales − Variable expenses − Fixed expenses Net income = ($60 × 2,000 units) − ($60 × 0.60 × 2,000 units) − $40,000 = $48,000 − $40,000 = $8,000 Magnitude of operating leverage = Contribution margin ÷ Net income Magnitude of operating leverage = $48,000 ÷ $8,000 = 6.00

Select the correct statement regarding fixed costs. Multiple Choice There is a contradiction between the term "fixed cost per unit" and the behavior pattern implied by the term. Fixed cost per unit is not fixed. Total fixed cost remains constant when volume changes. All of these are correct statements.

All of these are correct statements. Explanation The total amount of a fixed cost does not change when volume changes. In contrast, fixed cost per unit is not fixed. It changes as the volume changes. The fixed cost per unit decreases when volume increases and the fixed cost per unit increases when volume decreases.

Select the incorrect statement regarding the relevant range of volume. Multiple Choice Total fixed costs are expected to remain constant. Total variable costs are expected to vary in direct proportion with changes in volume. Variable cost per unit is expected to remain constant. Total cost per unit is expected to remain constant.

Total cost per unit is expected to remain constant. Explanation: Within the relevant range, the total cost per unit will decrease as volume increases.

Mark Company, Inc. sells electronics. The company generated sales of $45,000. Contribution margin is $20,000 and net income is $4,000. Based on this information, the magnitude of operating leverage is: Multiple Choice 2.25 11.25 5.00 6.25

5.00 Explanation: Magnitude of operating leverage = Contribution margin ÷ Net incomeMagnitude of operating leverage = $20,000 ÷ $4,000 = 5.0

Select the correct statement from the following. Multiple Choice A fixed cost structure offers less risk (i.e., less earnings volatility) and higher opportunity for profitability than does a variable cost structure. A variable cost structure offers less risk and higher opportunity for profitability than does a fixed cost structure. A fixed cost structure offers greater risk but higher opportunity for profitability than does a variable cost structure. A variable cost structure offers greater risk but higher opportunity for profitability than does a fixed cost structure.

A fixed cost structure offers greater risk but higher opportunity for profitability than does a variable cost structure. Explanation: Shifting the cost structure from fixed to variable reduces not only the level of risk but also the potential for profits.

Select the incorrect statement regarding the contribution margin income statement. Multiple Choice The contribution margin approach for the income statement is unacceptable for external reporting. Contribution margin represents the amount available to cover product costs and thereafter to provide profit. The contribution margin approach requires that all costs be classified as fixed or variable. Assuming no change in fixed costs, a $1 increase in contribution margin will result in a $1 increase in profit.

Contribution margin represents the amount available to cover product costs and thereafter to provide profit. Explanation The contribution margin represents the amount available to cover fixed expenses and thereafter to provide company profits.

Frazier Company sells women's ski jackets. The average sales price is $275 and the variable cost per jacket is $175. Fixed Costs are $1,350,000. If Frazier sells 15,000 jackets, the contribution margin will be: Multiple Choice $2,775,000 $1,500,000 $2,250,000 $150,000

Explanation Contribution margin = Revenues − Variable expenses Contribution margin = ($275 × 15,000 jackets) − ($175 × 15,000 jackets) = $1,500,000

Which of the following costs typically include both fixed and variable components? Multiple Choice Direct materials Direct labor Factory overhead None of these

Factory overhead

Mug Shots operates a chain of coffee shops. The company pays rent of $15,000 per year for each shop. Supplies (napkins, bags, and condiments) are purchased as needed. The managers of each shop are paid a salary of $2,500 per month and all other employees are paid on an hourly basis. The cost of rent relative to the number of customers in a particular shop and relative to the number of customers in the entire chain of shops is which kind of cost, respectively? Multiple Choice Variable cost and fixed cost Fixed cost and fixed cost Fixed cost and variable cost Variable cost and variable cost

Fixed cost and fixed cost Explanation: The behavior pattern of a particular cost may be either fixed or variable, depending on the context. In this context, the total cost of rent remains the same relative to the number of customers in a particular shop and also remains the same relative to the number of customers in the entire chain of shops. As such, in both situations, the rent is a fixed cost.

Select the incorrect statement regarding fixed and variable costs. Multiple Choice Fixed cost per unit remains constant as the number of units increases. Total variable cost is represented by a straight line sloping upward from the origin when total variable cost is graphed versus number of units. The concept of relevant range applies to both fixed costs and variable costs. The terms "fixed" and "variable" refer to the behavior of total cost.

Fixed cost per unit remains constant as the number of units increases.

Which of the following items would not be found on a contribution format income statement? Multiple Choice Fixed cost Variable cost Gross margin Net income

Gross margin Explanation: Gross margin is a subtotal calculated by subtracting cost of goods sold from sales. Gross margin is listed on an income statement prepared under GAAP for external reporting. However, for internal purposes, companies use a contribution margin approach. The contribution margin income statement subtracts variable costs from sales to arrive at the contribution margin, then subtracts fixed costs to arrive at net income.

The activity director for City Recreation is planning an activity. She is considering alternative ways to set up the activity's cost structure. Select the incorrect statement from the following. Multiple Choice If the director expects a low turnout, she should use a fixed cost structure. If the director expects a large turnout, she should attempt to convert variable costs into fixed costs. If the director shifts the cost structure from fixed to variable, the level of risk decreases. If the director shifts the cost structure from fixed to variable, the potential for profits will be reduced.

If the director expects a low turnout, she should use a fixed cost structure. Explanation: A manager who expects revenues to increase should use a fixed cost structure. On the other hand, if future sales growth is uncertain or if the manager believes revenue is likely to decline, a variable cost structure makes more sense. Shifting the cost structure from fixed to variable reduces not only the level of risk but also the potential for profits.

Select the incorrect statement regarding the relationship between cost behavior and profits. Multiple Choice A pure variable cost structure offers higher potential rewards. A pure fixed cost structure offers more security if volume expectations are not achieved. In a pure variable cost structure, when revenue increases by $1, so do profits. In a pure fixed cost structure, the unit selling price and unit contribution margin are equal.

In a pure fixed cost structure, the unit selling price and unit contribution margin are equal. Explanation Recall that contribution margin equals sales revenue minus variable costs. As such, in a pure fixed cost structure, because variable costs are zero, the unit selling price equals the unit contribution margin. Shifting the cost structure from fixed to variable reduces not only the level of risk but also the potential for profits.

Southern Food Service operates six restaurants in the Atlanta area. The company pays rent of $20,000 per year for each shop. The managers of each shop are paid a salary of $4,200 per month and all other employees are paid on an hourly basis. Relative to the number of hours worked, total compensation cost for a particular shop is which kind of cost? Multiple Choice Mixed cost Fixed cost Variable cost None of these

Mixed cost Explanation: The total compensation cost is comprised of the cost of the manager salaries, which is a fixed monthly cost, and the cost of the other employees, which is a variable cost based on the hours worked. A cost that contains both fixed and variable elements is referred to as a mixed cost.

Quick Change and Fast Change are competing oil change businesses. Both companies have 5,000 customers. The price of an oil change at both companies is $20. Quick Change pays its employees on a salary basis, and its salary expense is $40,000. Fast Change pays its employees $8 per customer served. Suppose Quick Change is able to lure 1,000 customers from Fast Change by lowering its price to $18 per vehicle. Thus, Quick Change will have 6,000 customers and Fast Change will have only 4,000 customers.Select the correct statement from the following. Multiple Choice Quick Change's profit will increase while Fast Change's profit will fall. Fast Change's profit will fall but it will still earn a higher profit than Quick Change. Profits will decline for both Quick Change and Fast Change. Quick Change's profit will remain the same while Fast Change's profit will decrease.

Quick Change's profit will increase while Fast Change's profit will fall. Explanation Net income = Sales revenue − Variable cost − Fixed cost Before the price change:Quick Change: Net income = (5,000 × $20 per unit) − $0 − $40,000 = $60,000 Fast Change: Net income = (5,000 × $20 per unit) − (5,000 × $8 per unit) − $0 = $60,000 After the price change:Quick Change: Net income = (6,000 × $18 per unit) − $0 − $40,000 = $68,000 Fast Change: Net income = (4,000 × $20 per unit) − (4,000 × $8 per unit) − $0 = $48,000

Select from the following the incorrect statement regarding contribution margin. Multiple Choice Sales − Fixed costs = Contribution margin Net income + Total fixed costs = Contribution margin At the breakeven point (where the company has neither profit nor loss), Total fixed costs = Total contribution margin Total sales revenue times the contribution margin percentage = Total contribution margin

Sales − Fixed costs = Contribution margin Explanation: Contribution margin = Revenues − Variable expenses

The results below represent what form of cost behavior? Year 1 Year 2 Units 4,500 4,800 Total Cost$11,250 $12,000 Multiple Choice Fixed Cost Variable Cost Mixed Cost Opportunity Cost

Variable Cost Explanation: Cost per unit in Year 1: $11,250 ÷ 4,500 units = $2.50 Cost per unit in Year 2: $12,000 ÷ 4,800 units = $2.50 When the volume increases, the cost per unit of stayed the same; as such, the cost is a variable cost.

Cool Runnings operates a chain of frozen yogurt shops. The company pays $5,000 of rent expense per month for each shop. The managers of each shop are paid a salary of $3,000 per month and all other employees are paid on an hourly basis. Relative to the number of shops, the cost of rent is which kind of cost? Multiple Choice Variable cost Fixed cost Mixed cost Opportunity cost

Variable cost Explanation: The behavior pattern of a particular cost may be either fixed or variable, depending on the context. In this context, the total cost of rent increases proportionately with the number of shops while cost per shop remains constant. The rent is therefore variable relative to the number of shops.

Java Joe operates a chain of coffee shops. The company pays rent of $20,000 per year for each shop. Supplies (napkins, bags, and condiments) are purchased as needed. The manager of each shop is paid a salary of $3,000 per month, and all other employees are paid on an hourly basis. Relative to the number of customers for a shop, the cost of supplies is which kind of cost? Multiple Choice Fixed cost Variable cost Mixed cost Relevant cost

Variable cost Explanation: When the volume increases, the total cost of supplies increases; when volume decreases, the total decreases; as such, the cost of supplies is a variable cost.

Rock Creek Bottling Company pays its production manager a salary of $6,000 per month. Salespersons are paid strictly on commission, at $1.50 for each case of product sold. For Rock Creek Bottling Company, the cost of the salespersons' commissions is an example of: Multiple Choice a fixed cost. a variable cost. a mixed cost. none of these

a variable cost. Explanation: Since the salespersons are paid strictly on commission, at $1.50 for each case of product sold, the total cost of the salespersons' commissions would increase as the sales volume increases. As such, this cost would be classified as a variable cost.

Whether a cost behaves as a fixed cost or as a variable cost depends upon the: Multiple Choice activity based used. cost structure of the company. industry. significance of the dollar amount of the cost.

activity based used.

The excess of revenue over variable costs is referred to as: Multiple Choice gross profit gross margin contribution margin manufacturing margin

contribution margin

Wu Company incurred $40,000 of fixed cost and $50,000 of variable cost when 4,000 units of product were made and sold.If the company's volume doubles, the total cost per unit will: Multiple Choice stay the same. decrease. double as well. increase but will not double.

decrease. Explanation: Current cost per unit:Total cost per unit = (Fixed cost + Variable cost) ÷ Number of units Total cost per unit = ($40,000 + $50,000) ÷ 4,000 units = $22.50 per unit Cost per unit when volume doubles:Total cost per unit = [$40,000 + ($50,000 × 2)] ÷ (4,000 units × 2) = $17.50 per unit

Fixed cost per unit: Multiple Choice decreases as production volume decreases. is not affected by changes in the production volume. decreases as production volume increases. increases as production volume increases.

decreases as production volume increases Explanation: The total amount of a fixed cost does not change when volume changes. In contrast, fixed cost per unit is not fixed. It changes as the volume changes. The fixed cost per unit decreases when volume increases and the fixed cost per unit increases when volume decreases.

Executive management at Ballard Books is very optimistic about the chain's ability to achieve significant increases in sales in each of the next five years. The company will most benefit if management creates a: Multiple Choice low operating leverage cost structure. medium operating leverage cost structure. high operating leverage cost structure. no operating leverage cost structure.

high operating leverage cost structure. Explanation: The higher the proportion of fixed cost to total costs, the greater the operating leverage. A manager who expects revenues to increase should use a fixed cost structure. While the variable cost structure reduces risk, it also limits the opportunity to benefit from operating leverage.

All of the following would be considered a fixed cost for a bottled water company except: Multiple Choice rent on warehouse facility. depreciation on its manufacturing equipment. hourly wages for machine operators. property taxes on its factory building.

hourly wages for machine operators.

Larry's Lawn Care incurs significant gasoline costs. This cost would be classified as a variable cost if the total gasoline cost: Multiple Choice varies inversely with the number of hours the lawn equipment is operated. is not affected by the number of hours the lawn equipment is operated. increases in direct proportion to the number of hours the lawn equipment is operated. None of these are correct.

increases in direct proportion to the number of hours the lawn equipment is operated. Explanation: The gasoline cost would be classified as variable if the total gasoline cost increases when the volume increases and the total gasoline cost decreases when the volume decreases.

Craft, Inc. normally produces between 120,000 and 150,000 units each year. Producing more than 150,000 units alters the company's cost structure. For example, fixed costs increase because more space must be rented, and additional supervisors must be hired. The production range between 120,000 and 150,000 is called the: Multiple Choice differential range. median range. relevant range. leverage range.

relevant range.