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What is cost stickiness? Why do managers need to be aware of cost stickiness?

Short Answer

Expert verified

Answer

Variable cost and contribution margin have an inverse connection.

Step by step solution

01

Meaning of cost stickiness

When the ratio of increase in cost due to increased sales is higher than the ratio of decrease in cost to reduce in sales is known as cost stickiness.

02

Why do managers need to be aware of cost stickiness?

Due to cost stickiness, costs can behave differently than expected from their CVP analysis; that’s why managers need to be aware of cost stickiness.

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Most popular questions from this chapter

Computing margin of safety

Robbie’s Repair Shop has a monthly target profit of \(31,000. Variable costs are 20%of sales, and monthly fixed costs are \)19,000.

Requirements

1. Compute the monthly margin of safety in dollars if the shop achieves its income goal.

2. Express Robbie’s margin of safety as a percentage of target sales.

3. Why would Robbie’s management want to know the shop’s margin of safety?

You have just begun your summer internship at Omni Instruments. The company supplies sterilized surgical instruments for physicians. To expand sales, Omni is considering paying a commission to its sales force. The controller, Matthew Barnhill, asks you to compute: (1) the new breakeven sales figure, and (2) the operating profit if sales increase 15% under the new sales commission plan. He thinks you can handle this task because you learned CVP analysis in your accounting class.

You spend the next day collecting information from the accounting records, performing the analysis, and writing a memo to explain the results. The company president is pleased with your memo. You report that the new sales commission plan will lead to a significant increase in operating income and only a small increase in breakeven sales.

The following week, you realize that you made an error in the CVP analysis. You overlooked the sales personnel’s $2,800 monthly salaries, and you did not include this fixed selling cost in your computations. You are not sure what to do. If you tell Matthew Barnhill of your mistake, he will have to tell the president. In this case, you are afraid Omni might not offer you permanent employment after your internship.

Requirements

1. How would your error affect breakeven sales and operating income under the proposed sales commission plan? Could this cause the president to reject the sales commission proposal?

2. Consider your ethical responsibilities. Is there a difference between (a) initially making an error and (b) subsequently failing to inform the controller?

3. Suppose you tell Matthew Barnhill of the error in your analysis. Why might the consequences not be as bad as you fear? Should Barnhill take any responsibility for your error? What could Barnhill have done differently?

4. After considering all the factors, should you inform Barnhill or simply keep quiet?

Question: Use the following information to complete Short Exercises S20-10 through S20-15.

Funday Park competes with Cool World by providing a variety of rides. Funday Park sells tickets at \(70 per person as a one-day entrance fee. Variable costs are \)42 per person, and fixed costs are $170,800 per month.

Compute Funday Park’s contribution margin ratio. Carry your computation to two decimal places. Use the contribution margin ratio approach to determine the sales revenue Funday Park needs to break even

Question: Gilbert’s Steel Parts produces parts for the automobile industry. Thecompany has monthly fixed costs of \(640,220 and a contribution margin of85% of revenues.

Requirements

1. Compute Gilbert’s monthly breakeven sales in dollars. Use the contributionmargin ratio approach.

2. Use contribution margin income statements to compute Gilbert’s monthlyoperating income or operating loss if revenues are \)500,000 and if they are$1,050,000.

3. Do the results in Requirement 2 make sense given the breakeven sales youcomputed in Requirement 1? Explain.

Calculating breakeven point for two products, margin of safety, andoperating leverage

The contribution margin income statement of Delectable Donuts for May 2018follows:

DELECTABLE DONUTS

Contribution Margin Income Statement

Month Ended May 31, 2018

Net Sales Revenue

\(125,000

Variable cost

Cost of goods sold

\)32,100

Selling cost

17,400

Administrative cost

500

\(50,000

Contribution Margin

\)75,000

Fixed cost

Selling cost

\(37,800

Administrative cost

12,600

\)50,400

Operating income

\(24,600

Delectable sells five dozen plain donuts for every dozen custard-filled donuts. A dozenplain donuts sells for \)4.00, with a variable cost of \(1.60 per dozen. A dozen custardfilled donuts sells for \)8.00, with a variable cost of $3.20 per dozen.

Requirements

1. Calculate the weighted-average contribution margin.

2. Determine Delectable’s monthly breakeven point in dozens of plain donuts and custard-filled donuts. Prove your answer by preparing a summary contribution nmargin income statement at the breakeven level of sales. Show only two categories of costs: variable and fixed.

3. Compute Delectable’s margin of safety in dollars for May 2018.

4. Compute the degree of operating leverage for Delectable Donuts. Estimate thenew operating income if total sales increase by 20%. (Round the degree of operating leverage to four decimal places and the final answer to the nearest dollar.Assume the sales mix remains unchanged.)

5. Prove your answer to Requirement 4 by preparing a contribution marginincome statement with a 20% increase in total sales. (The sales mix remainsunchanged.)

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