Techniques For Estimating Fixed and Variable Costs

Chapter 4
Techniques for Estimating Fixed and Variable Costs

True/False

1. The contribution margin statement groups costs by their function.

2. The contribution margin is the amount that contributes toward recovering fixed costs and earning a
profit.

3. The contribution margin is well suited to evaluate short-term decision options.

4. Most firms rely on future data to estimate their cost structure.

5. Capacity costs are controllable in the short term.

6. We obtain the data for the account classification method from the contribution margin statement.

7. Because account classification requires us to examine each account in detail, it often provides
inaccurate estimates.

8. The major disadvantage of the account classification method is that it uses few observations of
aggregate cost data to estimate total fixed and variable costs.

9. With advances in computer and information technologies, the account classification task may still be
a daunting task.

10. The account classification is both time-consuming and subjective in nature.

11. The high-low method uses two observations of aggregate cost data to estimate total fixed costs and
the unit variable cost.

12. Using the high-low method, managers use the two observations pertaining to the highest and
lowest activity levels because these values are most likely to define any abnormal costs.

13. An advantage of using the high-low method is that we can apply it if we know only total revenues,
total costs, and activity volume.

14. The high-low method avoids the need to classify individual cost items as fixed or variable.

15. Using the high-low method, we know the true cost line.

16. The regression analysis method of estimating fixed and variable costs uses all available observations
to come up with a line that best “fits” the data.

17. The regression analysis method results in the least error between the estimated and true total cost
line.
Balakrishnan/Managerial Accounting, 2e

18. A disadvantage of using the regression analysis method is that it provides only one statistic to
evaluate the data.

19. R-square will always lie between negative one and positive one.

20. A major drawback of using regression analysis is that the technique makes a number of assumptions
about the data, and accounting data sometimes do not satisfy these assumptions.

21. The “segmented” contribution margin statement is one way firms modify the contribution margin
statement to reflect GAAP.

22. Contribution margin equals revenues less variable costs.

23. When constructing segmented statements, we use the term segment in a narrow sense.

24. Fixed costs are relevant for decisions involving increasing or decreasing production volumes.

25. Common fixed costs do not relate to any product in particular but to the entire business.

26. On many repetitive projects, the amount of labor time required decreases with every succeeding
unit.

27. The “doubling approach” says that as the production volume doubles, the average time required
decreased by a fixed percentage.

Multiple Choice

28. In the short run:

A. Most fixed costs are controllable
B. Most fixed costs are not controllable
C. Most variable costs are not controllable
D. Both fixed costs and variable costs are controllable
E. Neither fixed costs nor variable costs are controllable

29. A useful step for estimating controllable costs is:

A. Separating product costs from administrative costs.
B. Separating contribution costs from product costs.
C. Separating variable costs from fixed costs.
D. Separating variable costs from product costs.
E. Separating fixed costs from product costs.

30. If fixed costs are $15,000, profit before income taxes is $55,000, revenues are $160,000, variable
costs are $90,000, contribution margin is:
A. $105,000.
B. $90,000.
C. $70,000.
 Techniques For Estimating Fixed and Variable Costs

D. $55,000.

31. The term “contribution margin” denotes:

A. The value attained by subtracting variable and fixed costs from revenues.
B. The value attained by subtracting variable and fixed costs from net income.
C. The value attained by subtracting fixed costs from revenues.
D. The value attained by subtracting variable costs from revenues.

32. Contribution margin statements:

A. Can be utilized to evaluate the effect of possible activity changes on profit before taxes.
B. Cannot be utilized to evaluate the effect of possible activity changes if those changes also
change fixed costs.
C. Will not provide an alert if cost behaviors vary from those expected.
D. Identify variable and fixed costs but will not address changes in revenues.

33. The major disadvantage of the account classification method is

A. While some cost items will exactly correspond to a fixed or variable cost, other cost items will
not.
B. The difficulty associated with implementing it.
C. Small companies may have an expansive account list making the task hard.
D. Incorrectly classifying costs could lead to minor errors in cost estimates.

34. Account classification involves systematically:

A. Classifying a company’s list of revenue accounts into fixed and variable categories.
B. Classifying a company’s list of accounts into asset, liability, shareholders’ equity, revenue, and
expense accounts.
C. Classifying a company’s list of cost accounts into fixed and variable categories.
D. Classifying a company’s list of accounts into revenue and expense accounts only.

35. The change in variable costs is calculated as:

A. The sum of the variable costs divided by the volume of activities which is then multiplied by the
change in activity levels.
B. The sum of the variable costs multiplied by the change in activity levels.
C. The sum of the variable costs divided by the activity levels which is then multiplied by the
change in volume of activities.
D. The sum of the variable revenues divided by the volume of activities which is then multiplied by
the change in activity levels.

36. Bill and Ted recently opened a plumbing business. The business currently has $500 monthly
depreciation for its two trucks as its only fixed costs. During the first month, the company had 10
service calls each earning $99 revenue per call and variable costs amounting to $20 per call for
plumbing supplies and gas. How much is Bill and Ted’s contribution margin for its first month?
A. $990
B. $790
C. $490
D. $700
Balakrishnan/Managerial Accounting, 2e

37. Spudz Toys estimated production of 2,000 stuffed dogs each with a selling price of $8.00. If the
variable cost per stuffed dog is $2.00 and fixed costs are $5,000, what is estimated profit?
A. $7,000
B. $16,000
C. $12,000
D. $11,000

38. The contribution margin statement:

A. Focuses on revenues and fixed costs which can be controlled in the short-term.
B. Focuses on revenues and variable costs which can be controlled in the short-term.
C. Focuses on net income and fixed costs which can be controlled in the short-term.
D. Focuses on net income and variable costs which can be controlled in the short-term.

39. The sections of a contribution margin statement in proper order are:

A. Profit before taxes, fixed costs, contribution margin, variable costs, and revenues.
B. Revenues, fixed costs, contribution margin, variable costs, and profit before taxes.
C. Profit before taxes, variable costs, contribution margin, fixed costs, and revenues.
D. Revenues, variable costs, contribution margin, fixed costs, and profit before taxes.

40. Contribution margin denotes:

A. The amount that remains after subtracting costs of goods sold from revenue.
B. The amount that remains after subtracting fixed costs from revenue.
C. The amount that remains after subtracting fixed costs from costs of goods sold.
D. The amount that remains after subtracting variable costs from revenue.
E. The amount that remains after subtracting variable costs from costs of goods sold.

41. The contribution margin statement focuses attention on:

A. Revenues and variable costs.
B. Revenues and fixed costs.
C. Revenues and costs of goods sold.
D. Revenues only.
E. Revenues and total costs.

42. Which of the following is not a technique used to construct contribution margin statements?
A. Account classification
B. Capacity analysis
C. High-low method
D. Regression analysis
E. All of the above are techniques used to construct contribution margin statements.

43. Account classification involves categorizing cost accounts as:

A. Product costs and administrative costs.
B. Contribution costs and product costs.
C. Variable costs and fixed costs.
D. Variable costs and product costs.
E. Fixed costs from product costs.
 Techniques For Estimating Fixed and Variable Costs

44. The high-low method:

A. Utilizes the average and the mean values of costs to determine fixed and variable costs.
B. Utilizes the high and low values of aggregate costs to estimate total fixed costs and the unit
variable costs.
C. Utilizes regression analysis to estimate total fixed costs and the unit variable costs.
D. Requires cost items to be specifically classified as fixed costs or variable costs to be utilized.

45. The high-low method:

A. Provides a true fixed cost line and a true variable cost line.
B. Provides a true fixed cost line and an estimated variable cost line.
C. Provides an estimated fixed cost line and a true variable cost line.
D. Provides an estimated fixed cost line and an estimated variable cost line.

46. The high-low method requires:

A. The identification of fixed costs so variable costs can be estimated.
B. The identification of variable costs so fixed costs can be estimated.
C. The use of all data levels within the timeframe.
D. Two activity levels within the timeframe.

47. The manager at Bob’s Sunset Grill is trying to understand the contribution margin for the current
month’s results. Which of the following most correctly reflects what the manager can learn using
the account classification method?
A. The manager can only determine the fixed cost impact.
B. The manager can only determine the variable cost impact.
C. The manager can determine contribution margin without determining the behavior of the costs.
D. Subjectivity is needed to completely determine the nature of each cost.

48. The high-low method provides:

A. An exact value for variable and fixed costs.
B. An estimate of both the variable and the fixed costs.
C. An exact value for the fixed costs and an estimate of the variable costs.
D. An estimate of the fixed costs and an exact value of the variable costs.

49. An advantage of estimating variable costs by the account classification method is

A. It is less demanding than other methods
B. It provides statistical analysis
C. It is easy to implement.
D. It can provide very accurate estimates.
E. None of the above is an advantage.

50. Many firms do not choose to use the account classification method because:
A. It is time consuming to implement.
B. It is subjective in nature.
C. It does not provide very accurate estimates.
D. Both a and b.
E. Both b and c.
Balakrishnan/Managerial Accounting, 2e

51. Using the account classification method, estimating the change in variable costs involve three steps.
Which of the following is correct?
A. I. Sum the costs classified as fixed to obtain the total fixed costs for the most recent
period.
II. Multiply the amount in (I) by the volume of activity for the corresponding period to
estimate the unit fixed cost.
III. Divide (2) by the change in activity to estimate the total controllable cost.
B. I. Sum the costs classified as fixed to obtain the total fixed costs for the most recent
period.
II. Divide the amount in (I) by the volume of activity for the corresponding period to
estimate the unit fixed cost.
III. Multiply (2) by the change in activity to estimate the total controllable cost.
C. I. Sum the costs classified as variable to obtain the total variable costs for the most recent
period.
II. Multiply the amount in (I) by the volume of activity for the corresponding period to
estimate the unit variable cost.
III. Divide (2) by the change in activity to estimate the total controllable cost.
D. I. Sum the costs classified as variable to obtain the total variable costs for the most recent
period.
II. Divide the amount in (I) by the volume of activity for the corresponding period to
estimate the unit variable cost.
III. Multiply (2) by the change in activity to estimate the total controllable cost.

52. Which of the following statements is not true?

A. Using the account classification method requires us to examine each cost account in detail.
B. Using the account classification method frequently requires considerable knowledge and
experience.
C. Using the account classification method may be a daunting task for very large firms that offer a
wide range of products and have expansive account lists.
D. Using the account classification method requires us to use statistical analysis.
E. All of the above are correct statements.

53. Which of the following are concerns with using the high-low method?
A. It yields only rough estimates of fixed costs and unit variable cost.
B. Unusual cost deviations in the high and low observations affect the high-low estimates and
could increase estimation error significantly.
C. Applying the high-low method requires considerable knowledge and experience.
D. Both A and B.
E. All of the above are concerns with using the high-low method.

54. When provided data in an Excel format, regression analysis:

A. Will provide total fixed costs as the Coefficient/Intercept and total variable costs as
Coefficient/# of members.
B. Will provide total fixed costs as the Coefficient/Intercept and unit variable costs as Coefficient/#
of members.
C. Will provide individual member fixed costs as the Coefficient/Intercept and individual variable
costs as Coefficient/# of members.
 Techniques For Estimating Fixed and Variable Costs

D. Will provide total fixed costs as the Coefficient/Intercept and unit variable costs as p-value/# of
members.

55. Regression analysis:

A. Determines it has a good fit with high R-Square values near 1 and high confidence p-values with
values near 1.
B. Determines it has a good fit with high R-Square values near 0 and high confidence p-values with
values near 1.
C. Determines it has a good fit with high R-Square values near 0 and high confidence p-values with
values near 0.
D. Determines it has a good fit with high R-Square values near 1 and high confidence p-values with
values near 0.

56. Regression analysis:

A. Extracts the minimum amount of information from the data provided to answer the relevant
questions.
B. Extracts the maximum amount of information from the data provided to answer the relevant
questions.
C. Has no major drawbacks due to the complexity of the Excel function effectiveness.
D. Requires the high and low data to be specifically identified to improve its accuracy.

57. Segmented contribution margin statements can:

A. Be utilized to present both product and region information.
B. Only be utilized to present product or region information.
C. Requires the use of high-low or regression analysis modeling for information.
D. Not be utilized by small companies with few products or services.

58. Which of the following is correct with regard to using regression analysis to estimate fixed and
variable costs?
A. Using the p-value of .05 versus .01 indicates a much better confidence in an estimate.
B. Regression makes a number of assumptions about the data used in its analysis.
C. Regression is usually limited to one or fewer observations.
D. There will always be x, y, and z coordinates using regression analysis.

59. With regression analysis,

A. An R-square value close to zero is desired and a lower p-value indicates a higher confidence.
B. An R-square value close to one is desired and a lower p-value indicates a lower confidence.
C. An R-square value close to one is desired and a lower p-value indicates a higher confidence.
D. An R-square value close to zero is desired and a lower p-value indicates a lower confidence.

60. Trish’s Quilt Connection is an on-line company specializing in high-quality quilt frames and
accessories. Trish does not charge customers shipping charges for quilt frame orders. She has
provided the following information;

Month Quilt Frames Sold Shipping Costs

January 1,075 $ 8,800
February 780 $ 8,000
March 1,150 $ 9,000
Balakrishnan/Managerial Accounting, 2e

April 1,280 $10,000

Using the high-low method, estimate Trish’s total variable and fixed costs are at if she sells 1,280
frames:
A. Total variable cost=$5,120; Total Fixed Cost $4,880
B. Total variable cost=$320; Total Fixed Cost $9,680
C. Total variable cost=$10,000; Total Fixed Cost $0
D. Total variable cost=$2,000; Total Fixed Cost $8,000
E. Total variable cost=$7,500; Total Fixed Cost $500

61. Scatter plots help us:

A. Determine the appropriate technique to use to estimate fixed and variable costs.
B. Obtain a visual confirmation of the relation between the chosen activity and the cost.
C. Uncover data points that do not appear to conform to the general pattern emerging from other
data points.
D. A and B only.
E. A, B, and C.

62. For any volume of activity, total costs are:

A. Fixed costs + (Unit variable costs x Volume of activity).
B. Fixed costs + (Total variable costs/volume of activity).
C. Variable costs + (Unit fixed costs x Volume of activity).
D. Variable cost + (Total fixed costs/volume of activity).
E. None of the above.

63. Which of the following equations can be used to calculate the unit variable cost using the high-low
method?
Total costs HIGH ACTIVITY LEVEL – Total costs LOW ACTIVITY LEVEL
A. Unit variable cost =
Activity level HIGH – Activity level LOW
Total costs HIGH ACTIVITY LEVEL – Fixed costs LOW ACTIVITY LEVEL
B. Unit variable cost =
Activity level HIGH – Activity level LOW
Sales HIGH ACTIVITY LEVEL – Fixed costs LOW ACTIVITY LEVEL Activity
C. Unit variable cost =
level HIGH – Activity level LOW
Sales HIGH ACTIVITY LEVEL – Total costs LOW ACTIVITY LEVEL Activity
D. Unit variable cost =
level HIGH – Activity level LOW
E. None of the above.

64. Relevant range is defined as:

A. The proportion of total costs that are fixed and variable.
B. A statistical method that uses the normal range of operations to estimate fixed and variable
costs.
C. A non-statistical method that uses the normal range of operations to estimate fixed and variable
costs.
D. A firm’s normal range of operations in which we expect a stable relation between activity and
cost.
E. None of the above.

65. Which of the following is a drawback of using regression analysis?

 Techniques For Estimating Fixed and Variable Costs

A. It is difficult to implement.
B. It makes a number of assumptions about the data, and accounting data sometimes do not
satisfy these assumptions.
C. It is not a well-defined statistical method.
D. It provides only one statistic to evaluate the data.
E. None of the above are drawbacks of using regression analysis.

66. P-value:
A. Is not useful in interpreting the results of regression analysis.
B. Indicates the goodness-of-fit.
C. Is a residual number obtained when using the high-low method.
D. Indicates the confidence that the coefficient estimates reliably differ from zero.
E. Both b and c.

67. Regression analysis is:

A. The proportion of total costs that are fixed and variable.
B. A statistical method for estimating fixed and variable costs.
C. A non-statistical method that uses the normal range of operations to estimate fixed and variable
costs.
D. A firm’s normal range of operations in which we expect a stable relation between activity and
cost.
E. None of the above.

68. Which of the following statements is not true?

A. The high-low method is a non-statistical method; regression analysis is a statistical method.
B. The high-low method and regression analysis use only two observations to estimate fixed and
variable costs.
C. The mechanics of regression analysis are complex; the mechanics of the high-low method are
simple.
D. Both A and B are untrue.
E. A, B and C are untrue.

69. Segment (product) margin is calculated by:

A. Subtracting common fixed costs from its contribution margin.
B. Subtracting variable costs traceable to that product from contribution margin.
C. Subtracting fixed costs traceable to that product from its contribution margin.
D. Summing all contribution margins, and then subtracting common fixed costs.
E. None of the above.

70. Common fixed costs:

A. Are also referred to as facility-level costs.
B. Do not relate to any product in particular but to the entire business.
C. Are not controllable at the product level.
D. Both a and b.
E. a, b, and c.

71. Segmented contribution margin statements:

A. Require that all cost be associated with a product or region.
Balakrishnan/Managerial Accounting, 2e

B. Cannot be utilized to determine sales value per unit or costs per unit.
C. Can present common fixed costs.
D. Cannot be utilized in the decision process of special pricing.

72. Segmented contribution margin statements:

A. Can combine one or more products or regions into a single column presentation.
B. Can present individual product information for a single region.
C. Can be tailored to the requirements of the company.
D. All of the possibilities, A, B, and, C, are correct answers.

73. Miami Furniture manufactures two different types of recliners, a swivel recliner and a fixed recliner.
Which of the following will the company use in order to calculate segment margin for either
recliner?
A. Product profit before tax less contribution margin
B. Contribution margin less traceable variable costs
C. Contribution margin less traceable fixed costs
D. Sales minus fixed costs

74. Segmented contribution margin statement:

A. Will show if discontinuing a segment will change total fixed costs.
B. Will not show the total variable or fixed costs of the company.
C. Not help in the evaluation of special pricing sales opportunities.
D. Cannot be utilized to provide individual item revenue and costing data.

75. Which of the following statements is not true concerning the segmented contribution margin
statement?
A. The contribution margin statement may be organized by product.
B. The statement begins with sales volume and revenue.
C. The statement does not present cost of goods sold.
D. Variable and fixed costs are shown separately.
E. All of the above statements are true.

76. In a contribution margin statement, profit before taxes is calculated by:

A. Subtracting common fixed costs from segment (product) margin.
B. Subtracting traceable fixed costs from contribution margin.
C. Subtracting variable costs from contribution margin.
D. Subtracting contribution margin from Segment (product) margin.
E. Subtracting common fixed costs from contribution margin.

77. Which of the following is not an example of a segment?

A. Product.
B. Customer.
C. Geographical region.
D. A Store
E. All of the above could be segments of a firm.

78. Which of the following might be reasons why labor time is decreased with every succeeding unit
produced?
 Techniques For Estimating Fixed and Variable Costs

A. As people gain experience, they produce each unit more efficiently.

B. On the first unit, a worker may consult the blueprint, eventually he or she will simply remember
where and how to install a part.
C. As a worker becomes more comfortable with a machine, he or she will take less time to operate
the required steps of operation.
D. Both A and B.
E. A, B and C are reasons why labor time is decreased.

79. The “doubling approach” says:

A. As production volume increases, machine time eventually doubles because of maintenance
requirements.
B. As production volume doubles, labor time also doubles.
C. As production volume doubles, if labor efficiency does not double, the product should be
discontinued.
D. As production volume doubles, the average time required decreased by a fixed percentage.
E. None of the above.

Problems

1. Jerry’s Manufacturing Company provides you with the following income statement.

Jerry’s Manufacturing Company

Income Statement for Current Year
Revenue $250,000
Cost of Goods Sold 125,000
Gross Margin $125,000
Administrative Costs 45,000
Selling Costs 55,000
Profit $ 25,000

Jerry’s provides the following information for the current year:

Fixed manufacturing overhead costs $22,000

Variable manufacturing overhead costs $-0-
Variable selling costs 3% of revenue
Fixed administrative costs $45,000

Required:
Prepare an income statement in the contribution margin format.
Balakrishnan/Managerial Accounting, 2e

2. User Friendly Computer Company, in addition to its retail sales, conducts night classes in computer
technology. User Friendly has provided you the following information:

Anticipated new class offerings 3

Anticipated new students 60
Anticipated revenue $650 per student
Student-related variable costs $125 per student
Salary for new instructors $2,000 per class
Administrative costs $300 per instructor
Maintenance on building $15,000 per year

Required:
Using account classification, construct a Contribution Margin Statement.

3. Michael’s Specialty Woodworking Shop specializes in custom rod racks for fishing rods. Michael’s
business has flourished since he opened two years ago. His hand made rod racks with drawers for
accessories have been a favorite of his customers. Michael believes the average cost of supplies to
make the racks and his cost structure has remained the same during his first two years of operations
and believes they will remain steady in the future. Michael’s condensed income statements for his
first two years of operation is shown below:

Year 1 Year 2
Number of racks sold 750 1,100
Total revenue $187,500 $275,000
Total costs 75,000 98,800
Profit before Taxes $112,500 $176,200

Required:
a. Use the high-low method to estimate Michael’s Specialty Woodworking Shop’s annual cost
equation (i.e., use the data from years 1 and 2 to estimate Michael’s annual fixed costs and
variable cost per rack).

b. Michael has been asked to participate in a national “Outdoor Sports Extravaganza”. If he

participates, he will have to pay $1,000 booth fee as his only additional expense. Michael
believes that she will be able to sell at least 30 additional racks during the event. By how much
is Michael’s Specialty Woodworking Shop’s profit expected to change if Michael participates in
the Outdoor Sports Extravaganza.

4. Cindy’s Boutique is trying to derive a cost equation that predicts its monthly inventory-handling
costs. Cindy estimates the following two equations using regression analysis:

Equation #1

Inventory-handling costs per month = $15,000 + ($0.02 x value of inventory handled)

R-square = 27.3%
Both coefficients have p-values of 0.05 or lower
 Techniques For Estimating Fixed and Variable Costs

Equation #2:

Inventory handling costs per month = $8,000 + ($5.20 x number of inventory items handled)
R-square = 38.2%
Both coefficients have p-values of 0.01 or lower

Required:
Which of the two equations do you believe better predicts Cindy’s monthly inventory handling
costs?

5. Outdoor Toys manufactures and sells two lines of trampolines: rabbit (for younger children) and
kangaroo (for older children and adults). The following data pertain to Outdoor Toy’s most recent
year of operation:

Outdoor Toys
Income Statement for the Current Year
Revenues $1,350,000
Cost of Goods Sold 565,000
Gross Margin $785,000
Selling,& Administrative Costs 700,000
Profit Before Taxes $ 85,000

Outdoor Toys also provides the following information:

Rabbit Kangaroo
Number of Trampolines Sold 2,800 4,000
Price per Trampoline $125 $250
Variable Manufacturing Cost per
$40 $80
Trampoline
Traceable Fixed Manufacturing Cost $150,000 $150,000
Traceable Selling & Administrative Costs $100,000 $150,000

The remainder of fixed costs is common to both products.

Required:

Create a monthly contribution margin statement by product for Outdoor Toys.

Balakrishnan/Managerial Accounting, 2e

End of chapter content

Short Answer
1. Why is the traditional income statement, used for financial reporting, often not helpful for
decision making?

2. What is the contribution margin?

3. How does the format for the contribution margin statement differ from the format for the
GAAP-based income statement?

4. Does the contribution margin change proportionally with activity volume?

5. How does the organization of data in a contribution margin statement help firms make better
decisions?

6. What are the three techniques used to estimate costs?

7. What three steps are followed under the account classification method to estimate the change
in variable costs?

8. List one advantage and one disadvantage of the account classification method.

9. Which two observations are used by the high low method?

10. List one advantage and one disadvantage of the high-low method.

11. In contrast to the high-low method, how many observations does regression analysis use to
estimate fixed and variable costs?

12. What are two statistics that help us evaluate the results from regression analysis?

13. What is the relevant range?

14. What is a segment margin? How does it differ from a contribution margin?

15. List three possible ways in which a company might wish to segment its contribution margin
income statement.
 Techniques For Estimating Fixed and Variable Costs

Short Essays
1. Why might investors prefer an income statement in the gross margin format even though
managers might prefer to organize the data in the contribution margin format?

2. Why is the contribution margin statement more useful for making short-term decisions than it is
for long-term decisions?

3. How can plotting the data help improve cost estimation?

4. Why is account classification a preferred method for estimating costs when submitting a
proposal for grant funding? For example, a not-for-profit organization might apply to the Gates
Foundationfor a program grant.

5. A manager might not be as confident in her ability to estimate costs for large, one-of-a-kind
projects as for smaller decisions that are of a routine nature. Yet, we might prefer account
classification for large projects and mechanical methods such as the high low method for
smaller, routine decisions. Explain this seeming inconsistency.

6. As discussed in the chapter, the accuracy of the cost estimates derived using the high-low
method depends crucially on picking the “right” observations. How can you visually verify that
the high and low data points are “representative?”

7. “It is important to remove outliers in the high low method because we only use two
observations. Removing extreme observations that might not skew results is not as important
when using regressions because an outlier is only one of many observations.” True or False?
Explain.

8. Going back to obtain historical data from many years is one way to increase the number of data
points we use in a regression. What are the potential issues with this approach?

9. How could we include batch- and product-level activities in regression analysis? Is it appropriate
to interpret the intercept as “facility-level costs?”

10. Gyms such as Hercules often offer both individual and family memberships. For example, a
family membership would give access up to four individuals, but the family membership will cost
less than four individual memberships. How does this feature affect the estimation methods
described in this chapter? What additional assumptions, if any, do we need to implement these
methods?

11. Does it make sense to construct a contribution margin statement by customer? Why or why
not? What kinds of decisions might such a statement facilitate?

12. If a firm drops a product line, it will lose the revenue from that product. This loss is controllable
and direct with respect to the decision to keep or drop the product. Dropping a product might
also affect the sales of the firm’s other products. Give two examples—one where the spillover
effect increases the revenue from other products and one where the spillover effect decreases
the revenue from other products. Are these spillover effects controllable and direct to the
decision to drop the product?
Balakrishnan/Managerial Accounting, 2e

13.
Exercises

1. The following is the income statement from Ajax Corporation, a merchandising firm.
Ajax Corporation Income Statement for the Most Recent Year
Revenue $1,525,000
Cost of goods sold 900,000
Transport in 24,500
Gross margin $600,500
Administration costs 220,000
Selling costs 240,000
Profit $140,500

You learn that $18,000 in transport in represents fixed costs, and Ajax pays its sales persons a
commission of 6%. That is, a person selling $1,000 worth of items would earn a commission of $60.

Required:
Prepare an income statement in the contribution margin format.

solution

Revenue 1,525,000 $
cogs-variable 900000 $ FIXED 0
Transportation-variable 6500 $ FIXED 18000

Variable commission 91,500 $ fixed 148500

admin
contribution 527,000 $ fix 220000

profit 140,500 $

2. Dean Previts is considering increasing the number admitted into an MBA program from 400 to 450.
He anticipates that the increase will add eight sections in total. Staffing ratios have usually run about
1 staff person per 50 students.

Required:
Using account classification, estimate the increase in the following costs because of the decision to
increase enrollment.
Student related variable costs $2,500 per student per year
Faculty related costs $150,000 per faculty member.

Each professor teaches four sections per year.

Administration costs $60,000 per full time employee
Building maintenance 150,000 per year
 Techniques For Estimating Fixed and Variable Costs

Solution:
Student related variable cost: 2500*50=125000$
Faculty related variable cost=1*150000=150000$
Administration cost=1*60000=60000$
Total variable cost=335000$