Deck 11: Cost Behavior, Operating Leverage, and Profitability Analysis

Question 1

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?

A) Variable cost
B) Fixed cost
C) Mixed cost
D) Opportunity cost

Answer 1

A
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.

Question 2

Based on the following cost data, items labeled (a) and (b) in the table below are which of the following amounts, respectively?

A) (a) = $3.00; (b) = $3.00
B) (a) = $5.00; (b) = $4.00
C) (a) = $2.50; (b) = $2.00
D) (a) = $5.00; (b) = $2.00

Answer 2

D
Explanation: (a) Total cost of $15,000 ÷ 3,000 units = $5 per unit
(b) Total cost of $6,000 ÷ 3,000 units = $2 per unit

Question 3

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 increases to 5,000 units, the total cost per unit will be:

A) $18.00.
B) $20.00.
C) $20.50.
D) $22.50.

Answer 3

C
Explanation: Variable cost per unit = Total variable cost ÷ Number of units
Variable cost per unit = $50,000 ÷ 4,000 units = $12.50 per unit
Total cost per unit = Fixed cost per unit + Variable cost per unit
Total cost per unit = ($40,000 ÷ 5,000 units) + $12.50 per unit = $20.50 per unit

Question 4

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 increases to 5,000 units, the company's total costs will be:

A) $100,000
B) $90,000
C) $102,500
D) $80,000

Question 5

If the company's volume doubles, the company's total cost will:

A) stay the same.
B) double as well.
C) increase but will not double.
D) decrease.

Question 6

Fixed cost per unit:

A) decreases as production volume decreases.
B) is not affected by changes in the production volume.
C) decreases as production volume increases.
D) increases as production volume increases.

Question 7

Operating leverage exists when:

A) a company utilizes debt to finance its assets.
B) management buys enough of the company's shares of stock to take control of the corporation.
C) the organization makes purchases on credit instead of paying cash.
D) small percentage changes in revenue produce large percentage changes in profit.

Question 8

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,

A) Company A's cost structure has more variable costs than B's.
B) Company A's cost structure has higher fixed costs than B's.
C) Company B's cost structure has higher fixed costs than A's.
D) At a volume of 50,000 units, Company A's magnitude of operating leverage was lower than B's.

Question 9

Select the correct statement regarding fixed costs.

A) There is a contradiction between the term "fixed cost per unit" and the behavior pattern implied by the term.
B) Fixed cost per unit is not fixed.
C) Total fixed cost remains constant when volume changes.
D) All of these are correct statements.

Question 10

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:

A) $6,900
B) $4,500
C) $2,300
D) $2,700

Question 11

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:

A) a fixed cost.
B) a variable cost.
C) a mixed cost.
D) none of these

Question 12

Select the incorrect statement regarding the relationship between cost behavior and profits.

A) A pure variable cost structure offers higher potential rewards.
B) A pure fixed cost structure offers more security if volume expectations are not achieved.
C) In a pure variable cost structure, when revenue increases by $1, so do profits.
D) In a pure fixed cost structure, the unit selling price and unit contribution margin are equal.

Question 13

Two different costs incurred by Ruiz Company exhibit the following behavior pattern per unit: Cost #1 and Cost #2 exhibit which of the following cost behavior patterns, respectively?

A) Fixed and variable
B) Variable and variable
C) Fixed and fixed
D) Variable and fixed

Question 14

Larry's Lawn Care incurs significant gasoline costs. This cost would be classified as a variable cost if the total gasoline cost:

A) varies inversely with the number of hours the lawn equipment is operated.
B) is not affected by the number of hours the lawn equipment is operated.
C) increases in direct proportion to the number of hours the lawn equipment is operated.
D) none of the above.

Question 15

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?

A) Fixed cost
B) Variable cost
C) Mixed cost
D) Relevant cost

Question 16

Based on the following cost data, what conclusions can you make about the costs of Product A and Product B?

A) The cost of Product A is a fixed cost and the cost of Product B is a variable cost.
B) The cost of Product A is a variable cost and the cost of Product B is a fixed cost.
C) The costs of Product A and Product B are both variable costs.
D) The costs of Product A and Product B are both mixed costs.

Question 17

Select the correct statement regarding fixed costs.

A) Because they do not change, fixed costs should be ignored in decision making.
B) The fixed cost per unit decreases when volume increases.
C) The fixed cost per unit increases when volume increases.
D) The fixed cost per unit does not change when volume decreases.

Question 18

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 production manager's salary is an example of:

A) a variable cost.
B) a mixed cost.
C) a fixed cost.
D) none of these

Question 19

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:

A) stay the same.
B) decrease.
C) double as well.
D) increase but will not double.

Question 20

For the last two years BRC Company had net income as follows: What was the percentage change in income from Year 1 to Year 2?

A) 20% increase
B) 20% decrease
C) 25% increase
D) 25% decrease

Question 21

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?

A) 4.5%
B) 14.5%
C) 45%
D) 10%

Question 22

Which of the following items would not be found on a contribution format income statement?

A) Fixed cost
B) Variable cost
C) Gross margin
D) Net income

Question 23

The following income statement is provided for Vargas, Inc. What is this company's magnitude of operating leverage?

A) 3.07
B) 0.33
C) 3.00
D) 1.67

Question 24

Select the correct statement from the following.

A) A fixed cost structure offers less risk (i.e., less earnings volatility) and higher opportunity for profitability than does a variable cost structure.
B) A variable cost structure offers less risk and higher opportunity for profitability than does a fixed cost structure.
C) A fixed cost structure offers greater risk but higher opportunity for profitability than does a variable cost structure.
D) A variable cost structure offers greater risk but higher opportunity for profitability than does a fixed cost structure.

Question 25

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?

A) 0.17
B) 6.00
C) 2.25
D) none of these

Question 26

The following income statement is provided for Grant, Inc. What is this company's magnitude of operating leverage?

A) 0.33
B) 1.31
C) 2.00
D) 3.00

Question 27

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?

A) $25,200
B) $26,160
C) $24,667
D) $43,200

Question 28

Based on the income statements of the three following retail businesses, which company has the highest operating leverage?

A) Alpha Company
B) Beta Company
C) Gamma Company
D) They all have same operating leverage

Question 29

Which of the following equations can be used to compute a firm's magnitude of operating leverage?

A) Net income ÷ Sales
B) Fixed costs ÷ Contribution margin
C) Contribution margin ÷ Net income
D) Net income ÷ Contribution margin

Question 30

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?

A) $2,160
B) $7,560
C) $3,420
D) $1,260

Question 31

In order to prepare a contribution format income statement, costs must be separated into:

A) manufacturing and selling, general, and administrative costs.
B) cost of goods sold and operating expenses.
C) variable and fixed costs.
D) mixed, variable and fixed costs.

Question 32

Select the incorrect statement regarding the contribution margin income statement.

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

Question 33

Select the incorrect statement regarding cost structures.

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

Question 34

The excess of revenue over variable costs is referred to as:

A) gross profit
B) gross margin
C) contribution margin
D) manufacturing margin

Question 35

Based on the income statements shown below, which division has the cost structure with the highest operating leverage?

A) Bottled Water.
B) Fruit Juices.
C) Soft Drinks.
D) The three divisions have identical operating leverage.

Question 36

The following income statement is provided for Ramirez Company for the current year: What amount was the company's contribution margin?

A) $50,000
B) $22,000
C) $52,000
D) $60,000

Question 37

The following income statements are provided for two companies operating in the same industry: Assuming sales increase by $1,000, select the correct statement from the following:

A) Felix's net income will be more than Jinx's.
B) Only Felix will experience an increase in profit.
C) Felix's net income will increase by $250.
D) Jinx's net income will increase by 6%.

Question 38

The manager of Kenton Company stated that 45% of its total costs were fixed. The manager was describing the company's:

A) operating leverage.
B) contribution margin.
C) cost structure.
D) cost averaging.

Question 39

Select from the following the incorrect statement regarding contribution margin.

A) Sales - Fixed costs = Contribution margin
B) Net income + Total fixed costs = Contribution margin
C) At the breakeven point (where the company has neither profit nor loss), Total fixed costs = Total contribution margin
D) Total sales revenue times the contribution margin percentage = Total contribution margin

Question 40

The following information is provided for Southall Company: What is this company's contribution margin?

A) $30,000
B) $17,500
C) $45,000
D) $67,500

Question 41

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:

A) Variable
B) Fixed
C) Opportunity
D) Mixed

Question 42

At its $60 selling price, Atlantic Company has sales of $15,000, variable manufacturing costs of $4,000, fixed manufacturing costs of $1,000, variable selling and administrative costs of $2,000 and fixed selling and administrative costs of $1,000. What is the company's contribution margin per unit?

A) $26
B) $28
C) $44
D) $36

Question 43

Based on the following operating data, the operating leverage is:

A) 0.18
B) 5.50
C) 1.22
D) 12.5

Question 44

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:

A) differential range.
B) median range.
C) relevant range.
D) leverage range.

Question 45

Which of the following costs typically include both fixed and variable components?

A) Direct materials
B) Direct labor
C) Factory overhead
D) None of these

Question 46

A cost that contains both fixed and variable elements is referred to as a:

A) mixed cost.
B) hybrid cost.
C) relevant cost.
D) nonvariable cost.

Question 47

The following information is for Gable, Inc. and Harlowe, Inc. for the recent year. What total amount of net income will Harlowe, Inc. earn if it experiences a 10 percent increase in revenue?

A) $180, 000
B) $80,000
C) $260,000
D) $20,000

Question 48

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:

A) 2.25
B) 11.25
C) 5.00
D) 6.25

Question 49

Carson Corporation's sales increase from $500,000 to $600,000 in the current year. What is the percentage change in sales?

A) 20%
B) 25%
C) 22%
D) 16.7%

Question 50

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?

A) Mixed cost
B) Fixed cost
C) Variable cost
D) None of these

Question 51

The following income statement was produced when volume of sales was at 400 units. If volume reaches 500 units, net income will be:

A) $625
B) $1,800
C) $700
D) None of the above

Question 52

The following information is for Gable, Inc. and Harlowe, Inc. for the recent year. Based on the above data, which company has a higher operating leverage?

A) Gable, Inc.
B) Harlowe, Inc.
C) Operating leverage is the same for both companies
D) Cannot be determined

Question 53

All of the following would be considered a fixed cost for a bottled water company except:

A) Rent on warehouse facility
B) Depreciation on its manufacturing equipment
C) Hourly wages for machine operators
D) Property taxes on its factory building

Question 54

Whether a cost behaves as a fixed cost or as a variable cost depends upon the:

A) activity based used.
B) cost structure of the company.
C) industry
D) significance of the dollar amount of the cost.

Question 55

Select the incorrect statement regarding the relevant range of volume.

A) Total fixed costs are expected to remain constant.
B) Total variable costs are expected to vary in direct proportion with changes in volume.
C) Variable cost per unit is expected to remain constant.
D) Total cost per unit is expected to remain constant.

Question 56

Martin Company currently produces and sells 40,000 units of product at a selling price of $12. The product has variable costs of $6 per unit and fixed costs of $150,000. The company currently earns a total contribution margin of:

A) $280,000
B) $200,000
C) $240,000
D) $90,000

Question 57

Pierce Company's break-even point is 12,000 units. Its product sells for $25 and has a $10 variable cost per unit. What is the company's total fixed cost amount?

A) $250,000
B) $180,000
C) $120,000
D) Fixed costs cannot be computed with the information provided.

Question 58

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?

A) Variable cost and fixed cost
B) Fixed cost and fixed cost
C) Fixed cost and variable cost
D) Variable cost and variable cost

Question 59

Consider the following information: Based on the above information, select the correct statement.

A) Cost of goods sold is a mixed cost.
B) Salary cost is a mixed cost.
C) Depreciation cost is a variable cost.
D) If the company sells 20 units for $540 each, it will incur a loss of $200.

Question 60

The results below represent what form of cost behavior?

A) Fixed Cost
B) Variable Cost
C) Mixed Cost
D) Opportunity Cost

Question 61

Which of the following statements regarding Company A is incorrect?

A) If Company A has fixed costs of $720,000, a selling price of $50 per unit, and contribution margin of $30 per unit, its break-even point in units is 36,000 units.
B) If Company A has fixed costs of $720,000, a selling price of $50 per unit, and contribution margin of $30 per unit, its variable expenses must be $20 per unit.
C) If Company A has fixed costs of $720,000, a selling price of $50 per unit, and contribution margin of $30 per unit, once it has covered its fixed costs, net income will increase by $30 for each additional unit sold.
D) Both if Company A has fixed costs of $720,000, a selling price of $50 per unit, and contribution margin of $30 per unit, its break-even point in units is 36,000 units and if Company A has fixed costs of $720,000, a selling price of $50 per unit, and contribution margin of $30 per unit, its variable expenses must be $20 per unit are incorrect.

Question 62

Company A has break-even sales of 90,000 units and budgeted sales of 99,000 units. What is the margin of safety as expressed as a percentage?

A) 9.00%
B) 10.0%
C) 9.09%
D) None of these answers is correct.

Question 63

Rocky Mountain Bottling Company produces a soft drink that is sold for a dollar. At production and sales of 800,000 units, the company pays $600,000 in production costs, half of which are fixed costs. At that volume, general, selling, and administrative costs amount to $250,000 of which $70,000 are fixed costs. What is the amount of contribution margin per unit?

A) $0.40
B) $0.5375
C) $0.25
D) None of these is correct.

Question 64

Newton Company currently produces and sells 4,000 units of a product that has a contribution margin of $6 per unit. The company sells the product for a sales price of $20 per unit. Fixed costs are $18,000. The company is considering investing in new technology that would decrease the variable cost per unit to $8 per unit and double total fixed costs. The company expects the new technology to increase production and sales to 9,000 units of product. What sales price would have to be charged to earn a $99,000 desired profit assuming the investment in technology is made?

A) $22
B) $23
C) $15
D) $13

Question 65

Burke Company has a break-even of $600,000 in total sales. Assuming the company sells its product for $50 per unit, what is its margin of safety in units if sales total $850,000?

A) 5,000 units
B) 250,000 units
C) 12,000 units
D) 17,000 units

Question 66

Once sales reach the break-even point, each additional unit sold will:

A) increase fixed cost by a proportionate amount.
B) reduce the margin of safety.
C) increase the company's operating leverage.
D) increase profit by an amount equal to the per unit contribution margin.

Question 67

Phan Company has not reported a profit in five years. This year the company would like to narrow its loss to $7,500. Assuming its selling price is $36.50 per unit and its variable costs per unit are $24, how many units must be sold to achieve its target given that total fixed costs are $60,000?

A) 2,188
B) 1,439
C) 4,200
D) 1,600

Question 68

Zeus, Inc. produces a product that has a variable cost of $9.50 per unit. The company's fixed costs are $40,000. The product sells for $12.00 a unit and the company desires to earn a $20,000 profit. What is the volume of sales in units required to achieve the target profit? (Do not round intermediate calculations.)

A) 24,000 units
B) 16,000 units
C) 17,000 units
D) 4,000 units

Question 69

Billings Company has developed the following budgeted income statement: The Company is experimenting with new engineering techniques and believes it can reduce variable cost to $4.50 per unit and significantly improve the product. The innovations would double fixed costs but the company expects to be able to increase sales to 3,500 units. If this strategy is pursued the company's budgeted net income will:

A) decrease by $4,250.
B) increase by $4,850.
C) increase by $13,250.
D) decrease by $4,150.

Question 70

A product has a contribution margin of $2.50 per unit and a selling price of $25 per unit. Fixed costs are $20,000. Assuming new technology increases the unit contribution margin by 50 percent but increases total fixed costs by $13,750, what is the new breakeven point in units?

A) 3,667 units
B) 3,333 units
C) 13,500 units
D) 9,000 units

Question 71

Columbus Industries makes a product that sells for $25 a unit. The product has a $5 per unit variable cost and total fixed costs of $9,000. At budgeted sales of 2,000 units, the margin of safety ratio is:

A) 22.5%.
B) 10%.
C) 77.5%.
D) None of these.

Question 72

At the break-even point:

A) Sales would be equal to total costs.
B) Contribution margin would be equal to total fixed costs.
C) Sales would be equal to fixed costs.
D) Both sales would be equal to total costs and contribution margin would be equal to total fixed costs are correct.

Question 73

During the current year, Fairview Corporation sold 100,000 units of its product for $20 each. The variable cost per unit was $14, and Fairview's margin of safety was 40,000 units. What was the amount of Fairview's total fixed costs?

A) $240,000
B) $560,000
C) $840,000
D) $360,000

Question 74

The margin of safety ratio can be defined as the:

A) Excess of budgeted sales over break-even sales divided by break-even sales.
B) Excess of budgeted sales over break-even sales divided by budgeted sales.
C) Excess of budgeted sales over fixed costs divided by budgeted sales.
D) Excess of budgeted sales over variable costs divided by budgeted sales.

Question 75

Rose Corporation sells backpacks. Variable costs for this product are $30 per unit, and the sales price per unit is $50 per unit. Total fixed costs amount to $100,000. How many backpacks does Rose need to sell to achieve a desired profit of $60,000?

A) 2,000 units
B) 5,000 units
C) 5,333 units
D) 8,000 units

Question 76

Falls Company has a contribution margin of $32 per unit and fixed costs of $500,000, and it desires to earn a profit of $100,000. What is the sales volume in units required to achieve this desired profit?

A) 3,125 units
B) 18,750 units
C) 15,625 units
D) 12,500 units

Question 77

During the current year, Winchester Company sold 80,000 units at a selling price of $20 per unit. Variable cost per unit was $15, and Winchester's net income for the year was $40,000. What was the amount of Winchester's fixed costs?

A) $360,000
B) $440,000
C) $1,160,000
D) $400,000

Question 78

Mitchell Company sells its product for $100 per unit. The company's accountant provided the following cost information: What is the company's break-even point in units?

A) 1,000
B) 750
C) 2,600
D) 4,000

Question 79

M and M, Inc. produces a product that has a variable cost of $3.00 per unit. The company's fixed costs are $30,000. The product is sold for $5.00 per unit and the company desires to earn a target profit of $20,000. What is the amount of sales that will be necessary to earn the desired profit?

A) $75,000
B) $50,000
C) $83,333
D) $125,000

Question 80

Chesterfield Corporation has been operating well above its break-even point. What will happen to Chesterfield's margin of safety if the variable cost per unit increases?

A) The break-even point would decrease, and the margin of safety would decrease.
B) The break-even point would decrease, and the margin of safety would increase.
C) The break-even point would increase, and the margin of safety would decrease.
D) The break-even point would increase, and the margin of safety would increase.