Variable Cost

Scenario 1

Energy Cost Energy Cost per unit

Production units
100 $100 $100/100 = $1.00
200 $200 $200/200 = $1.00
300 $325 $325/300 = $1.08
400 $425 $425/400 = $1.06
500 $515 $515/500 = $1.03

Criteria:
Total cost increases with level of activity
Unit Cost is constant over the relevant range

Verdict: This is NOT a variable cost because both criteria are not met. Cost per unit does not
remain constant across the relevant range.

Scenario 2

Energy Cost Energy Cost per unit

Production units
100 $100 $100/100 = $1.00
200 $200 $200/200 = $1.00
300 $300 $300/300 = $1.00
400 $400 $400/400 = $1.00
500 $500 $500/500 = $1.00

Verdict: This is a variable cost because both criteria are met. Cost per unit remains constant
across the relevant range AND total cost increases with the level of output.

Rounding Decimals
Number with greater then 2 decimal Correct rounding to 2 places Reason
places
1.21056 1.21 Since the 3rd decimal is less than 5,
the second decimal does not
change
2.30785 2.31 Since the 3rd decimal is >4 , the
second decimal increases by 1
3.11548 3.12
5.55055 5.55
10.29503 10.30 Since the 3rd decimal is >4, the
second decimal increases by 1.
So .29 becomes .30
Question 1

Mishoe Corporation has provided the following contribution format income statement. Assume that
the following information is within the relevant range.
 
     
Sales (1,000 units) $ 50,000
Variable expenses   32,500
Contribution margin   17,500
Fixed expenses   12,250
Net operating income $ 5,250

 
The break-even point in unit sales is closest to: (Round your intermediate calculations to 2
decimal places.)

Solution:

     
Selling price per unit ($50,000 ÷ 1,000 units) $50.00
Variable cost per unit ($32,500 ÷ 1,000 units)  32.50
Unit contribution margin $17.50

Formula Approach:

BE Units = Fixed Cost / CMu

Fixed Cost = $12,250

BEu = 12,250/17.50 = 700 units

Question 2

How much will a company's net operating income change if it undertakes an advertising campaign
given the following data:
 
       
Cost of advertising campaign $ 25,000  
Variable expense as a percentage of sales   42%
Increase in sales $ 60,000  

Solution:

CM ratio = 1 – Variable expense ratio = 1 – 0.42 = 0.58

Increase in net operating income = CM ratio × Increase in sales – Increase in fixed expenses
= (0.58 × $60,000) – $25,000 = $34,800 – $25,000 = $9,800

Question 3
Mio Canoe Livery rents canoes and transports canoes and customers to and from their canoe trip on
a local river. The trip is priced at $20 per person and has a CM ratio of 30%. Mio's fixed expenses
are $84,000. Last year, sales were $400,000 and profit was $36,000. How many units need to be
sold to break-even, and how many need to be sold to earn a profit of $42,000?

Solution:

Dollar sales to break even = Fixed expenses ÷ CM ratio

= $84,000 ÷ 0.30 = $280,000
Unit sales to break even = $280,000 ÷ $20 per person = 14,000 persons
 
Dollar sales to attain a target profit = (Target profit + Fixed expenses) ÷ CM ratio
= ($42,000 + $84,000) ÷ 0.30 = $420,000
Unit sales to attain a target profit = $420,000 ÷ $20 per person = 21,000 persons