Question

1. Merry, the Knight is a bookstore specializing in J. R. R. Tolkien and other fantasy literature. Recently, the bookstore has taken on a side business in New Zealand, package tours of the places where the filming for the movie trilogy took place. The first two years results follow, being a peak and lull year, and about the high and low ends of operating capacity: 2017 3500 $17,500,000 2018 4500 $ 22,500,000 Year Sales in units (tours) Sales Revenue ($5,000 per tour) Expenses Travel costs Meals and lodging Guide salaries, and expenses Insurance Advertising $ 2,950,000 5,250,000 4,950,000 1,500,000 2,000,000 $ 3,450,000 6,750,000 5,650,000 1,500,000 2,000,000 Net Operating Income $ 850,000 $ 3,150,000 The budget is being written up for the 2019 season, and the expected number of tours sold is 4200. In order to estimate net operating income for 2019, an analysis of the costs of doing business so far needs to be done. Assuming that the last two years costs can be used (they are typical), identify each of the company's expenses as either a pure variable, a mixed, or a fixed expense. Using the hi-lo method, separate each of the mixed expenses into fixed and variable elements. Redo the company's expense totals (for all the expenses separately) at the 4200 units sales level, and use it to estimate net operating income. Finally, a manager asked the accounting staff, at 6000 units sold, what would you estimate the total travel costs at? Respond appropriately

Answer 1

Expenses	Identification
Travel costs	Mixed expense
Meal and lodging	Variable expense
Guide salaries, and expenses	Mixed expense
Insurance	Fixed expense
Advertising	Fixed expense

Travel costs

Using High low method fixed and variable expenses are

Variable costs= Change in costs/Change in units

= $(3450000-2950000)/(4500-3500)

= $500000/1000

Variable cost per unit= $500 per unit

Fixed cost= Total cost-Variable cost

= $3450000-($500*4500)= $1200000

Meals and lodging

2017= $5250000/3500= $1500

2018= $6750000/4500= $1500

As the cost per unit of meals and lodging are same that means meals and lodging is a variable expense

Guide, salaries and expenses

Using High low method fixed and variable expenses are

Variable costs= Change in costs/Change in units

= $(5650000-4950000)/(4500-3500)

Variable cost= $700 per unit

Fixed cost= Total cost-Variable cost

= $5650000-($700*4500)= $2500000

Insurance and advertising

As in both the years, Insurance and advertising expenses are same that means they both are fixed expenses.

Computation of total expenses at 4200 unit sales

Variable expenses:
Travel costs ($500*4200)	$2100000
Meals and lodging ($1500*4200)	6300000
Guide salaries, and expenses ($700*4200)	2940000
Total variable expenses		11340000
Fixed expenses:
Travel costs	$1200000
Guide salaries, and expenses	2500000
Insurance	1500000
Advertising	2000000
Total fixed expenses		7200000
Total expenses at 4200 unit sales		$18540000

Calculation of Net operating income at 4200 unit sales

Sales ($5000*4200)	$21000000
Less: Variable costs	(11340000)
Contribution margin	9660000
Less: Fixed expenses	(7200000)
Net operating income	$2460000

Total travel costs at 6000 units sold= Variable cost+Fixed cost

Variable cost at 6000 units sold= Travel costs

= $500*6000= $3000000

Fixed cost= Travel costs

= $1200000

Total travel costs at 6000 units sold= $3000000+1200000= $4200000