Question 1

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:

Accepted Answer

A high operating leverage cost structure would be the best choice in this scenario because it allows the company to benefit greatly from increases in sales. This is because a high operating leverage cost structure means that a significant portion of the company's costs are fixed, such as rent and salaries, and do not change as the company's sales increase. Therefore, any additional revenue generated from increased sales goes directly to the company's bottom line, resulting in higher profits.

Question 2

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

Accepted Answer

In order to prepare a contribution format income statement, costs must be separated into variable and fixed costs. This is because the contribution format income statement focuses on the contribution margin, which is the difference between sales revenue and variable costs. The fixed costs are deducted separately from the contribution margin to determine the net income. Separating the costs into manufacturing and selling, general, and administrative costs or cost of goods sold and operating expenses would not provide the necessary information for a contribution format income statement. Mixed costs can be separated into variable and fixed components for purposes of the income statement, so they would fall under the variable and fixed cost categories.

Question 3

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,

Accepted Answer

Company A's net income increasing more than Company B's at a higher volume indicates that Company A has higher fixed costs and lower variable costs. This is because fixed costs are spread over more units, reducing the cost per unit and increasing profitability as sales volume increases.

Question 4

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

Accepted Answer

In a pure fixed cost structure, the unit selling price and unit contribution margin may not be equal. The unit contribution margin is calculated by subtracting the variable costs from the selling price per unit. However, the selling price per unit may include both variable and fixed costs, so it does not necessarily equal the unit contribution margin.

Question 5

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

Accepted Answer

The excess of revenue over variable costs is known as contribution margin, which is the amount that contributes towards covering fixed costs and generating profits. A is incorrect, as gross profit is the excess of revenue over COGS (cost of goods sold), while B and D are not correct terms used in accounting.

Question 6

The following income statements are provided for two companies operating in the same industry: $\begin{array}{c}
\begin{array}{l}
\
\text {Revenue}\
 \text {Variable costs}\
\text { Contribution margin }\
\text {Fixed costs}\
 \text {Net income}\
\end{array}  
\begin{array}{lll}
\text { Felix Company  }\
\$200,000\
(25,000)\
175,000\
(70,000)\
\$105,000 
\end{array}
\begin{array}{c}
\text {Jinx Company}\
\$  200,000 \
 (70,000) \
130,000 \
 (25,000) \
 \$ 10 5,000
\end{array}

\end{array}$
 Assuming sales increase by $1,000,select the correct statement from the following:

Accepted Answer

CFelix Company has a higher contribution margin ratio due to lower variable costs, meaning an increase in sales will result in a higher increase in net income compared to Jinx Company. For Felix, the variable cost is 12.5% of sales ($25,000/$200,000), so a $1,000 increase in sales would increase net income by $875 ($1,000 - 12.5% of $1,000). For Jinx, the variable cost is 35% of sales ($70,000/$200,000), so a $1,000 increase in sales would increase net income by $650 ($1,000 - 35% of $1,000). Therefore, Felix's net income will increase more than Jinx's, making statements A and C correct.

Question 7

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

Accepted Answer

The manager's statement about the portion of fixed costs in the company's total costs indicates the company's cost structure.

Question 8

Select the incorrect statement regarding the contribution margin income statement.

Accepted Answer

B) is incorrect because the contribution margin represents the amount available to cover fixed costs and thereafter to provide profit, not product costs. Product costs are already accounted for in the calculation of the contribution margin, which is sales revenue minus variable costs.

Question 9

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

Accepted Answer

Gross margin is typically found on a traditional income statement, not on a contribution format income statement. The contribution format specifically separates costs into variable and fixed, focusing on contribution margin rather than gross margin.

Question 10

For the last two years BRC Company had net income as follows: $$\begin{array} { | l | c | c | } 
\hline & \text { Year 1 } & \text { Year 2 } \
\hline \text { Net Income } & \$ 160,000 & \$ 200,000 \
\hline
\end{array}$$ What was the percentage change in income from Year 1 to Year 2?

Accepted Answer

To find the percentage change in income, we use the formula:
Percentage change = (Year 2 income - Year 1 income) / Year 1 income x 100%
Using the given values, we get:
Percentage change = (150,000 - 120,000) / 120,000 x 100%
Percentage change = 25%
Therefore, the percentage change in income from Year 1 to Year 2 is a 25% increase.

Question 11

Select the incorrect statement regarding cost structures.

Accepted Answer

The statement "The more variable cost, the higher the fluctuation in income as sales fluctuate" is incorrect because it is actually the higher fixed costs (not variable costs) that lead to greater fluctuations in income as sales fluctuate. Variable costs change with sales volume, which tends to stabilize income, whereas fixed costs remain constant regardless of sales volume, leading to greater income fluctuation with changes in sales.

Question 12

The following information is provided for Southall Company: $\begin{array}{lr}
\text { Sales revenue } & \$ 125,000 \
\text { Variable manufacturing costs } & 42,500 \
\text { Fixed manufacturing costs } & 37,500 \
\text { Variable selling and administrative costs } & 15,000 \
\text { Fixed selling and administrative costs } & 12,500
\end{array}$ What is this company's contribution margin?

Accepted Answer

The contribution margin is calculated as Sales Revenue minus Variable Costs (both manufacturing and selling & administrative). So, $125,000 - $42,500 (Variable manufacturing costs) - $15,000 (Variable selling and administrative costs) = $67,500.

Question 13

Select the correct statement from the following.

Accepted Answer

A fixed cost structure involves higher fixed costs and lower variable costs, leading to greater risk due to the need to cover fixed costs regardless of sales volume. However, it also offers a higher opportunity for profitability because once fixed costs are covered, the incremental profit from each additional unit sold is higher.

Question 14

The following income statement is provided for Ramirez Company for the current year: $\begin{array}{lr}
\text { Sales revenue (2,500 units } \times \$ 40 \text { per unit) } & \$ 100,000\
\text { Cost of goods sold (variable; } 2,500 \text { units } \times \$ 16 \text { per unit) } & (40,000) \
\text { Cost of goods sold (fixed) } & \underline{ (8,000)}\
\text { Gross margin } & 52,000 \
\text { Administrative salaries } & (12,000) \
\text { Depreciation } & (8,000) \
\text { Supplies }(2,500 \text { units } \times \$ 4 \text { per unit) } & \underline{ (10,000) }\
\text { Net income } &  \underline{\$ 22,000}
\end{array}$ What amount was the company's contribution margin?

Accepted Answer

The answer of The following income statement is provided for...

Question 15

Select from the following the incorrect statement regarding contribution margin.

Accepted Answer

The correct formula for contribution margin is Sales - Variable Costs, not Sales - Fixed Costs. Fixed costs are not subtracted to find the contribution margin; instead, they are considered later in the calculation of net income.

Question 16

Operating leverage exists when:

Accepted Answer

Operating leverage refers to the degree to which a company's fixed costs are used in its operations. When a company has high fixed costs relative to its variable costs, small changes in revenue can have a magnified effect on profit. This is because the company's fixed costs are spread over a smaller revenue base, resulting in higher profit margins. Therefore, option D is the correct choice as it accurately describes operating leverage.

Question 17

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.

Accepted Answer

If the director expects a low turnout, using a fixed cost structure is risky because fixed costs remain constant regardless of the number of participants, potentially leading to losses.

Question 18

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?

Accepted Answer

The answer of Cool Runnings operates a chain of frozen...

Question 19

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

Accepted Answer

The magnitude of operating leverage is calculated as the contribution margin divided by net income, which measures how a percentage change in sales will affect operating income.

Question 20

Based on the income statements shown below,which division has the cost structure with the highest operating leverage? $\begin{array}{c}
\begin{array}{l}
\
\text {Revenue}\
 \text {Variable costs}\
\text { Contribution margin }\
\text {Fixed costs}\
 \text {Net income}\
\end{array}  
\begin{array}{lll}
\text { Soft Drinks }\
\$50,000\
(10,000)\
40,000\
(30,000)\
\%10,000 
\end{array}
\begin{array}{c}
\text { Bottled Water }\
\$  50,000 \
 (5,000) \
 45,000 \
 (40,000) \
 \$  5,000
\end{array}
\begin{array}{lll}
\text { Fruit Juices }\
\$50,000\
(30,000)\
20,000\
(10,000)\
\$10,000
\end{array}
\end{array}$

Accepted Answer

Bottled Water division has the highest contribution margin ratio of 63% which implies that 63% of every dollar of sales revenue is available to cover fixed costs and to generate operating income. This high contribution margin ratio indicates that the Bottled Water division has a higher operating leverage than the other two divisions, which means that a small change in sales can have a significant impact on the operating income of the Bottled Water division. On the other hand, the Fruit Juices and Soft Drinks divisions have lower contribution margin ratios of 44% and 40%, respectively, indicating a lower operating leverage. Therefore, the best choice is A) Bottled Water.

Quiz 2: Cost Behavior, operating Leverage, and Profitability Analysis