Managerial Accounting and Decision Making

2015-16Term 3
Quiz 1 (Classes 1-4)
Answer ALL THREE questions. Questions are equally weighted. You have 45 minutes to take this quiz.
Question 1
Zap, Inc., manufactures an organic insecticide marketed and sold via television infomercials. Each ZAP
kit sells for a base price of $20 plus a $2 charge for shipping and handling fees. Zaps contribution margin
ratio (based on the $22 total revenue per kit) is 60%. In addition, Zap expects to break even if it sells
17,500 ZAP kits per month.
Required: Suppose Zap introduces an offer for free shipping and handling. Thus, the consumer would
obtain a kit for $20 only. How many additional kits must ZAP sell each month to break even?
(Hint: Calculate total fixed costs with the current structure. Compute unit contribution with the new
pricing. Compute the number of units needed to breakeven. Compare quantities.)
Solution
The contribution margin ratio =

( Price - Unit variable cost ) .

Price

With Zaps information, we have the contribution margin ratio

=

( $22.00 - Unit variable cost ) = 0.60.

$22.00

Therefore, unit variable cost is $8.80 for each ZAP kit.

Because Zap, Inc., breaks even at 17,500 kits, it must be the case that
17,500 (22.00 8.80) Fixed costs = 0, which yields Fixed costs = $231,000
The free shipping and handling offer reduces Zaps revenue per ZAP kit to $20.00. With the knowledge
acquired in parts [a] and [b] (i.e., the variable cost per ZAP kit and Zaps monthly fixed costs,
respectively), we can calculate Zaps breakeven volume as:

$0 = (Unit contribution margin Breakeven volume) Fixed costs.

or, $0 = [($20.00 $8.80) Breakeven volume] $231,000
Breakeven number of kits (Breakeven volume) = 20,625.
Additional kits sold = 20,625 17,500 = 3,125

Question 2
Select Auto Imports is a regional auto dealership that specializes in selling high-end imported luxury
automobiles. Select Auto Imports sells both new and pre-owned (used) cars. Financial data for the most
recent year of operations are as follows:
New Cars
$1,500,000
750,000
$750,000

Revenue
Variable costs
Contribution margin
Common Fixed costs
Profit before taxes

Used Cars
$500,000
200,000
$300,000

Total
$2,000,000
950,000
$1,050,000
840,000
$210,000

Auto Imports expects that the same revenue mix will continue for the foreseeable future.
Required: What level of (total) revenue is required to ensure that Select Auto Imports earns an after-tax
profit of $735,000 for the coming year? Assume that Select Auto pays taxes at the rate of 30% on profit
before taxes.

Solution
In this setting, we must use the weighted contribution margin ratio approach given the absence
of unit-level data. Accordingly:
Profit before taxes = (RevenueN Contribution margin rationN) +
(RevenueU Contribution margin ratioU) Fixed costs,
The subscripts N and U stand for new and used. Additionally, we know that
$1,500,000/$2,000,000, or 75% of the revenue is from new cars, and $500,000/$2,000,000, or
25% of the revenue is from used cars.
Further, we can calculate the contribution margin ratio for each product using the product-level
financial data. We have:
(Contribution margin ratio)N =

1,500,000 750,000
= .50.
1,500,000

(Contribution margin ratio)U =

500,000 200,000
= .60.
500,000

Thus, the weighted contribution margin ratio = (.50 .75) + (.60 .25) = .525.
We can now write Selects profit in terms of the weighted contribution margin ratio and total
revenues:
Profit before taxes = (.525 Total revenue) $840,000.
Given that, Profit after taxes = $735,000 and Effective tax rate = 30%
Thus the Profit before taxes = $(735,000 / (1-0.3)) = $1,050,000
To answer the question, we plug in our desired profit in the equation for profit developed in
part [a]. We now have:
$1,050,000 = (.525 Total revenue) $840,000.
Solving, we find:
Total revenue = $3,600,000. This translates into $3,600,000 .75 = $2,700,000 in new auto
sales and $3,600,000 .25 = $900,000 in used auto sales.

Question 3
Xenon Corporation makes a number of industrial products. Xenon estimates annual factory overhead at
$1,500,000, materials cost at $600,000, and labor cost at $1,000,000. In addition, Xenon considers onethird of its overhead to be variable and the remainder as fixed.
Xenon analyzes its fixed overhead and determines that $240,000 relates to materials and the remainder
relates to labor-related expenses. Xenon allocates materials-related fixed overhead using materials cost
as the allocation basis and labor-related fixed overhead using labor cost as the allocation basis. Xenon
allocates variable overhead using labor cost as the allocation basis.
One of Xenons products, a pump, requires $12 in materials and $30 in labor. Each pump sells for $90
and incurs variable selling expenses of $5 per pump.
Required: Determine the contribution margin and the gross margin per pump.
Solution
Contribution margin is price less all variable costs. For Xenon, variable costs include materials, labor, and
variable overhead. We know the cost of materials and labor but need allocations to determine the cost
of variable overhead.
Total variable overhead costs

= 1/3 of total overhead = 1/3 $1,500,000 = $500,000.

Dividing through by the total labor cost, we have:

Variable overhead per labor $ = $500,000/$1,000,000 = $0.50/labor $.
Because the pump has $30 of labor cost, Xenon will allocate $30 $0.50 = $15 toward variable
overhead.
Collecting this information, we have:
Sales Price
Less: Materials
Labor
Variable overhead
Less: Variable Selling Costs
Equals: Contribution margin

$90.00 per unit

12.00
30.00
15.00
5.00
28.00 per unit

Given
Given
Given
$30.00 $0.50 / labor $
Given

Gross Margin is price less all manufacturing related costs, including variable and fixed overhead. We
know the cost of materials and labor but need allocations to determine the cost of variable and fixed
overhead.
From part [a], we know that variable overhead rate is $0.50 per labor $.
Total fixed overhead costs

= 2/3 of total overhead = 2/3 $1,500,000 = $1,000,000.

Now, Xenon has to compute two separate fixed overhead rates, corresponding to the two cost pools.
We have:
Costs

Denominator

Rate

Volume
Materials related pool
Labor related pool

$240,000
$760,000

$600,000
$1,000,000

$0.40 / materials $
$0.76 / labor $

Using these rates, we compute:

Less:

Equals:

Sales Price
Materials & components
Labor
Variable overhead
Fixed overhead (materials)
Fixed overhead (labor)
= Inventoriable cost
Gross Margin

Per Pump
$90.00
12.00
30.00
15.00
4.80
22.80

Given
Given
Given
$30.00 $0.50 / labor $
$12.00 $0.40 / material $
$30.00 $0.76 / labor $

84.60
$5.40

Cost of goods sold (COGS) is the direct cost attributable to the production of the goods sold by a
company. This amount includes the cost of the materials used in creating the good along with the direct
labor costs used to produce the good. It excludes indirect expenses such as distribution costs and sales
force costs. Therefore variable selling expenses of $5 per pump will not be included.