Question

Lone Mountain Extraction, which mines ore in Idaho, uses a calendar year for both financial-reporting and tax purposes. The following selected costs were incurred in December, the low point of activity, when 1,800 tons of ore were extracted:

Straight-line depreciation	$	44,000
Charitable contributions*		13,000
Mining labor/fringe benefits		387,000
Royalties		121,000
Trucking and hauling		380,385

*Incurred only in December.

Peak activity of 3,100 tons occurred in June, resulting in mining labor/fringe benefit costs of $666,500, royalties of $173,000, and trucking and hauling outlays of $495,385. The trucking and hauling outlays exhibit the following behavior:

Less than 1,800 tons	$	322,885
From 1,800–2,299 tons		380,385
From 2,300–2,799 tons		437,885
From 2,800–3,299 tons		495,385

Lone Mountain Extraction uses the high-low method to analyze costs.

Required:

1.	Classify the five costs listed in terms of their behavior: variable, step-variable, committed fixed, discretionary fixed, step-fixed, or semivariable.

          

Straight-line depreciation
Charitable contributions
Mining labor/fringe benefits
Royalties
Trucking and hauling

2.	Calculate the total cost for next February when 2,100 tons are expected to be extracted.

          

Total Cost

3-a.	Is hauling 1,800 tons with respect to Lone Mountain’s trucking/hauling cost behavior cost effective?
	Yes No

3-b.	Given the current scenario at what number of units cost effectiveness can be achieved?

           

Number of Units

4.	In times of economic difficulties, the management will cut which type of fixed costs?
	Discretionary fixed costs. Committed fixed costs.

5.	Speculate as to why the company’s charitable contribution cost arises only in December. Choose the most relevant reason from the given options.
	To demonstrate social responsibility. To claim tax deduction. To promote business.

Answer 1

Lone Mountain Requirement 1 Straight-line depreciation - committed fixed Charitable contributions - discretionary fixed Mining labor/fringe benefits - variable Royalties - semi variable Trucking and hauling - step fixed The per-ton mining labor/fringe benefit cost is constant at both volume levels presented, which is characteristic of a variable cost. $387,000 = 1,800 tons = $215 per ton $666,500 - 3,100 tons = $215 per ton Royalties have both a variable and a fixed component, making it a semivariable (mixed) cost. Variable royalty cost = Difference in cost + Difference in tons = ($173,000-$121,000) =(3,100 -1,800) = $52,000 -1,300 tons = $40 per ton Fixed royalty cost: Total royalty cost Less: Variable cost at $40 per ton Fixed royalty cost June December (3100 tons) (1800 tons) 173000 121000 124000 72000 49000 49000 Requirement 2 Total cost for 2,100 tons: 44000 451500 Depreciation Charitable contributions Mining labor/fringe benefits at $215 per ton Royalties: Variable at $40 per ton Fixed Trucking and hauling Total 84000 49000 380385 1008885

Requirement 3 Hauling 1,800 tons is not particularly cost effective. Lone Mountain Extraction will incur a cost of $380,385 if it needs 1,800 tons hauled or, for that matter, 2,299 tons. The company would be better off if it had 1,799 tons hauled, saving outlays of $57,500. In general, with this type of cost function, effectiveness is maximized if a firm operates on the right-most portion of a step, just prior to a jump in cost. Requirement 4 A committed fixed cost results from an entity's ownership or use of facilities and its basic organizational structure. Examples of such costs include property taxes, depreciation, rent, and management salaries. Discretionary fixed costs, on the other hand, arise from a decision to spend a particular amount of money for a specific purpose. Outlays for research and development, advertising, and charitable contributions fall in this category. In times of severe economic difficulties, a company's management will often try to cut discretionary fixed costs. Such costs are more easily altered in the short run and do not have as significant long-term ramifications for a firm as do more long-lasting actions. While it's true that cutting expenditures on advertising or R&D can often have adverse long-term consequences, other cuts could have even more significant negative consequences in the future. The decision to close a manufacturing facility, for example, could reduce property taxes, rent, and/or depreciation. However, that decision may result in a significant long-run change in operations that may be difficult to overturn when economic conditions rebound. Requirement 5 Lone Mountain Extraction uses a calendar year for tax-reporting purposes. At year-end, it may have ample funds available and decide to make donations to charitable causes. Such contributions are deductible in computing the company's tax obligation to the government. Tax deductions reduce taxable income and, therefore, produce a tax savings for the firm.