Question

Apple offers extended service contracts that provide repair coverage for its products. As you complete the following requirements, assume that Apple’s repair services department uses many of the company’s existing resources, such as its facilities, repair machinery, and computer systems.

Required

1. Identify several of the variable, mixed, and fixed costs that Apple’s repair services department is likely to incur in carrying out its services.
2. Assume that Apple’s repair service revenues are expected to grow by 25% in the next year. How would we expect the costs identified in part 1 to change, if at all?
3. Based on the answer to part 2, can Apple use the contribution margin ratio to predict how income will change in response to increases in Apple’s repair service revenues?

Short answer

1. Apple’s repair service will include material and labor as variable cost, office rent, depreciation and salary to supervisor as fixed expense, and expenses related to utilities such as electricity, telephone expenses are part of mixed expenses.
2. It is difficult to forecast how much the variable expenses will rise
3. Apple cannot use contribution margin ratio.

Step-by-step solution

Meaning of Contribution margin

The contribution margin is the sum of sales revenue left over after covering the business entity's fixed costs. The inconsistency between sales income and variable costs is what determines it.

(1) Identifying several variables.

Apple's repair services division is divided as follows:

1. Variables: Parts required to fix electronic equipment (raw material), labor costs, and indirect materials utilised.
2. Mixed: In the form of utility-related costs incurred.
3. Fixed: It comprises managerial salaries and facility rental fees.

(2) Evaluating the costs identified in part 1 to change.

The total of the variable expenses will rise along with the mixed costs as revenues rise. The sum of fixed costs shouldn't change. It is difficult to forecast how much the variable expenses will rise because the "product" (Apple repair services) can vary based on the repairs required by each customer.

(3) Explaining whether Apple can use contribution margin.

Apple cannot apply a straightforward contribution margin ratio calculation to predict the increase in profits with an increase in sales dollars or the number of customers serviced since variable costs are unlikely to increase with volume increases by a constant amount. The services were the same for all clients, and variable cost increases may also be steady. But sometimes variable costs incurred may change depending on the fault in the equipment. In this case, simply calculating the contribution margin ratio would not be helpful.