Question

Problem 5A-7 Cost Behavior; High-Low Method; Contribution Format Income Statement [LO5-10]

Morrisey & Brown, Ltd., of Sydney is a merchandising company that is the sole distributor of a product that is increasing in popularity among Australian consumers. The company’s income statements for the three most recent months follow:

Morrisey & Brown, Ltd. Income Statements For the Three Months Ended September 30
	July				August				September
Sales in units		7,750				8,250				8,750
Sales	$	775,000			$	825,000			$	875,000
Cost of goods sold		465,000				495,000				525,000
Gross margin		310,000				330,000				350,000
Selling and administrative expenses:
Advertising expense		28,200				28,200				28,200
Shipping expense		89,500				94,500				99,500
Salaries and commissions		140,000				147,500				155,000
Insurance expense		7,200				7,200				7,200
Depreciation expense		21,600				21,600				21,600
Total selling and administrative expenses		286,500				299,000				311,500
Net operating income	$	23,500			$	31,000			$	38,500

Required:

1. By analyzing the data from the company's income statements, classify each of its 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. Express the variable and fixed portions of each mixed expense in the form Y = a + bX.

3. Redo the company’s income statement at the 8,750-unit level of activity using the contribution format.

Answer 1

1)	Expenses				Classification
	cost of goods sold				Variable
	Advertising expense				fixed
	shipping expense				mixed
	Salaries and commission				mixed
	insurance expense				fixed
	Depreciation expense				fixed
2)	High low method
	shipping expense
			units	cost
	high		8,750	99,500
	low		7,750	89,500
	difference		1,000	10,000
	variable expense per unit 10000/1000 = $10
	fixed expense = 99500-8750*10             =				12000
	Salaries and commission
			units	cost
	high		8,750	155,000
	low		7,750	140,000
	difference		1,000	15,000
	Variable expense per unit = 15000/1000=$15
	fixed expense = 155000-8750*15				23750
	cost formula
			Variable cost		Fixed cost	Formula
	shipping expense		10	per unit	12,000	Y=	12,000	+	10	per unit
	Salaries & commission		15	per unit	23,750	Y=	23,750	+	15	per unit
3)	Sales in units				8750
	Sales				875,000
	Variable expense
	Cost of goods sold			525,000
	Shipping expense			87,500
	Salaries and commission			131250
					743,750
	Contribution margin				131,250
	Fixed expense
	Advertising expense			28,200
	Shipping expense			12,000
	Salaries & commission			23,750
	insurance expense			7,200
	Depreciation expense			21,600
					92,750
	Net income				38,500