Question

PROBLEM 3-16 Cost Behaviour: High-Low Method; Contribution Format Income Statement LOL. LO26.03 Skate World is a merchandising company that sells skateboards both at its retail store and its online store. Results for the most recent three months are shown below. July August September Sales in units 4.000 4.500 5,000 Sales S400.000 $450,000 $500,000 Cost of goods sold 270.000 240.000 160.000 200.000 200.000 Gross margin 180.000 Selling and administrative expenses Advertising expense 21,000 21.000 34,000 21,000 36,000 Shipping expense 38,000 Salaries and commissions 78.000 84.000 90,000 Insurance expense 6,000 6,000 6,000 Depreciation expense 15.000 15.000 Total selling and administrative 15.000 154.000 S6,000 162.000 $18,000 170,000 30,000 Operating income Required: 1. Identify each of the company's expenses (including cost of goods sold) as either variable, fixed, or mixed. 2. Using the high-low method, separate each mixed expense into variable and fixed elements. State the cost formula for each mixed expense 3. Redo the company's income statement for September using the contribution format

Answer 1

1. Expenses that remain fixed irrespective of the number of units produced are fixed expenses. Cost of goods sold is considered as variable expense.

Expenses are identified as below:

Cost of goods sold : Variable

Advertising expense: Fixed

Shipping expense: Mixed

Salaries & commission: Mixed

Insurance expense: Fixed

Depreciation expense: Fixed

2. We need to segregate the mixed expense into fixed and variable expenses. From the above classification, we can see that shipping expense and salaries & commission are mixed expenses.We will classify them into fixed and variable as per below:

Shipping expense:

Expense at 4000 units = 34000

Expense at 4500 units = 36000

Variable shipping expense = Change in expense / Change in units

Variable shipping expense = 36000 - 34000 / 4500 - 4000

Variable shipping expense = 2000 / 500 = 4 per unit

Total variable shipping expense for 4000 units = 4000 * 4 = 16000

Total fixed shipping expense for 4000 units = 34000 - 16000 = 18000

Total variable  shipping expense for 4500 units = 4500 * 4 = 18000

Total variable shipping expense for 5000 units = 5000 * 4 = 20000

Required cost formula is:

Cost formula = Fixed expense + Variable expense per unit * No. of units sold

Cost formula = 18000 + 4x

where, x is number of units sold

Salaries & commission expense:

Expense at 4000 units = 78000

Expense at 4500 units = 84000

Variable salaries & commission expense = Change in expense / Change in units

Variable salaries & commission expense = 78000 - 84000 / 4500 - 4000

Variable salaries & commission expense = 6000 / 500 = 12 per unit

Total variable salaries & commission expense for 4000 units = 4000 * 12 = 48000

Total fixed salaries & commission expense for 4000 units = 78000 - 48000 = 30000

Total variable salaries & commission expense for 4500 units = 4500 * 12 = 54000

Total salaries & commission expense for 5000 units = 5000 * 12 = 60000

Required cost formula is:

Cost formula = Fixed expense + Variable expense per unit * No. of units sold

Cost formula = 30000 + 12x

where, x is number of units sold

3. We will now prepare the contribution format income statement. In the contribution format income statement, we will take the variable parts and fixed parts of expenses separately.

Contribution format income statement:

Description	July	August	September
Sales in units	4000	4500	5000
Sales	$400000	$450000	$500000
Less: Variable expenses
Cost of goods sold	240000	270000	300000
Shipping expense	16000	18000	20000
Salaries & commission	48000	54000	60000
Contribution margin	96000	108000	120000
Less: Fixed expenses
Advertising expense	21000	21000	21000
Shipping expense	18000	18000	18000
Salaries & commission	30000	30000	30000
Insurance expense	6000	6000	6000
Depreciation expense	15000	15000	15000
Operating income	6000	18000	30000