Question

ANALYSIS AND INTERPRETATION PROBLEMS AIP 2.1 Variable and Fixed Costs LO 7 Dellana Lab operates four blood testing labs in Boston. The four labs are identical. They employ the same production technology, process the same types of blood tests, and buy raw materials from the same companies at the same prices. Wage rates are also the same at the four labs. In reviewing operating results for November, the newly hired assistant controller, Matt Paige, became quite confused over the numbers: Lab A Lab B Lab C Lab D Number of blood tests 50,000 55,000 60,000 65,000 Revenue ($000s) $500 $550 $600 $650 Less: Variable costs (195) (298) (352) Fixed costs (300) (300) (300) Profit (Loss) $ 5 $ 8 $ 2 $ (2) (242) (300) Upon further study, Matt learned that each plant had a fixed overhead of $300.000. Matt remembered from his management accounting class that as volume increases, average fixed per unit falls, Lab D had much lower average fixed costs per blood test than labs A and B. Matt, therefore, expected lab D to be more profitable than A and B. But the numbers show just the opposite. Write a concise but clear memo to Matt that will resolve his confusion.

Answer 1

			Lab A	Rate per unit		Lab B	Rate per unit		Lab C	Rate per unit		Lab D	Rate per unit
Number of biood tests			50,000			55,000			60,000			65,000
Revenue($000s)			500	10.00		550	10.00		600	10.00		650	10.00
Less:
Variable costs			-195	-3.90		-242	-4.40		-298	-4.97		-352	-5.42
Fixed costs			-300	-6.00		-300	-5.45		-300	-5.00		-300	-4.62
Profit (Loss)			5	0.10		8	0.15		2	0.03		-2	-0.03

For further understanding we expanded data to find out rate per unit.

Matt is correct that higher the volume means lower fixed cost per unit. But we cannot ignore Variable cost per unit. Lab D has highest Variable cost per unit of $5.42. Hence it turned in to negative profits.

For maximising profit, we suppose to maximise volume but our variable cost per unit should not increase for that intension.