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Using variable costing, service company

Professional Pool Cleaning Service provides pool cleaning services to residential customers. The company has three employees, each assigned to specific customers. The company considers each employee’s territory as a business segment. The company incurs variable costs that include the employees’ wages, pool chemicals, and gas for the service vans. Fixed costs include depreciation on the service vans. Following is the income statement for the month of July:

Requirements

  1. Calculate the contribution margin ratio for each business segment.
  2. The business segments had the following numbers of customers: Birman, 60; Meech, 70; and Frond, 40. Compute the service revenue per customer, variable cost per customer, and contribution margin per customer for each business segment.
  3. Which business segment was most profitable? List some possible reasons why this segment was most profitable. How might the various reasons affect the company in the long term?

Short Answer

Expert verified
  1. The Contribution Margin ratio for Birman, Meech, and Frond is 50%, 30%, and 40%.
  2. Service revenue per customer for each business segment is $50.Variable cost per customer for Birman, Meech, and Frond is $25, $35, and $30 respectively.The contribution margin per customerfor Birman, Meech, and Frond is $25, $15, and $20.
  1. Birman's business segment is most profitable because of its lower variable cost. It may affect the organization in both positive or negative manner depending on the reason of low variable cost.

Step by step solution

01

Calculation of the contribution margin ratio for each business segment (1) 

Particulars

Birman

Meech

Frond

Service revenue

$3,000

$3,500

$2,000

Variable cost

$1,500

$2,450

$1,200

Contribution Margin

$1,500

$1,050

$800

Contribution margin ratio

50%

30%

40%

02

Calculation of average service revenue per customer, average variable cost per customer, and, average contribution margin per customer.(2) 

Particulars

Birman

Meech

Frond

Service revenue

$3,000/60 =$50

$3,500/70 =$50

$2,000/40 =$50

Variable cost

$1,500/60 =$25

$2,450/70 =$35

$1,200/40 =$30

Contribution Margin

$1,500/60 =$25

$1,050/70 =$15

$800/40

=$20

03

Profitability analysis (3)

Birman is the most profitable business segment because it has the highest contribution margin. It is the most profitable segment because it has the lowest variable cost per unit.The lowest variable cost may be because of low wages, poor quality of chemicals used for cleaning, etc. This leads to high employee turnover and dissatisfied customers which cause both financial and reputational loss. If it is because of efficient utilization of resources whether it's human resources or others it leads to high profitability.

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Most popular questions from this chapter

Calculating gross profit and operating income, absorption costing Calculate the gross profit and operating income for June using absorption costing

Use the following information for Short Exercises S21-4 and S21-5.

Dracut Company reports the following information for June:

Net Sales Revenue $ 755,000 Variable Cost of Goods Sold 240,000 Fixed Cost of Goods Sold 198,000 Variable Selling and Administrative Costs 168,000 Fixed Selling and Administrative Costs 79,000

Classifying costs Classify each cost by placing an X in the appropriate columns. The first cost is completed as an example.

Absorption Costing Variable Costing Product Cost Period Cost Product Cost Period cost

  1. Direct materials
  2. Direct labor
  3. Variable manufacturing overhead
  4. Fixed manufacturing overhead
  5. Variable selling and administrative costs
  6. Fixed selling and administrative cost

Preparing variable and absorption costing income statements Linda’s Foods produces frozen meals that it sells for \(7 each. The company computes a new monthly fixed manufacturing overhead allocation rate based on the planned number of meals to be produced that month. Assume all costs and production levels are exactly as planned. The following data are from Linda’s Foods’s first month in business:

January 2018

Units produced and sold:

Sales 1,000 meals

Production 1,200 meals

Variable manufacturing cost per meal \) 3

Sales commission cost per meal 1

Total fixed manufacturing overhead 660

Total fixed selling and administrative costs 500

Requirements:

  1. Compute the product cost per meal produced under absorption costing and under variable costing.
  2. Prepare income statements for January 2018 using: a. absorption costing. b. variable costing.
  3. Is operating income higher under absorption costing or variable costing in January?

Using variable and absorption costing, making decisions The 2018 data that follow pertain to Eli’s Electric Eyewear, a manufacturer of swimming goggles. (Eli’s Electric Eyewear had no beginning Finished Goods Inventory in January 2018.)

Number of goggles produced 245,000 Number of goggles sold 215,000 Sales price per unit \( 22Variable manufacturing cost per unit 8Sales commission cost per unit 5Fixed manufacturing overhead 1,470,000 Fixed selling and administrative costs 250,000 Requirements

1. Prepare both conventional (absorption costing) and contribution margin (variable costing) income statements for Eli’s Electric Eyewear for the year ended December 31, 2018.

2. Which statement shows the higher operating income? Why?

3. Eli’s ElectricEyewear’s marketing vice president believes a new sales promotion that costs \)60,000 would increase sales to 220,000 goggles. Should the company go ahead with the promotion? Give your reasoning.

When units produced equal units sold, how does operating income differ between variable costing and absorption costing?

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