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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

Computing unit product cost, absorption costing Calculate the unit product cost using absorption costing. Round your answer to the nearest cent.

Use the following information for Short Exercises S21-2 and S21-3.

Martin Company had the following costs:

Units produced 320 units Direct materials $ 71 per unit Direct labor 40 per unit Variable manufacturing overhead 13 per unit Fixed manufacturing overhead 7,360 per year Variable selling and administrative costs 22 per unit

Fixed selling and administrative costs 1,920 per year

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.

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

Using Excel for variable costing

Download an Excel template for this problem online in MyAccountingLab or athttp://www.pearsonhighered.com/Horngren. Tiger Mountain Gelato incurs thefollowing costs for its premium ice cream in May 2018:

Direct materials cost per pint $ 2.50 perpint

Direct labor cost per pint 0.75 per pint

Variable manufacturing overhead cost per pint 0.25 per pint

Fixed manufacturing overhead costs 6,000 per month

Total fixed selling and administrative costs 5,000 per month

Sales price per pint 8.00 per pint

Pints of gelato produced 12,000 pints

Pints of gelato sold 11,500 pints

There were no beginning inventories, so Tiger Mountain Gelato has 500 pintsin ending Finished Goods Inventory (12,000 pints produced less 11,500 pintssold).

Requirements

1. Calculate Tiger Mountain Gelato’s product cost per pint under absorptioncosting and variable costing.

2. Calculate the balance in Finished Goods Inventory on May 31, 2018, usingabsorption costing and variable costing.

3. Prepare income statements in good form for Tiger Mountain Gelato for May2018 using absorption costing and variable costing.

4. Reconcile the differences between operating incomes and Finished GoodsInventory balances between the two-costing method

: Before you begin this assignment, review the Tying It All Together feature in the chapter. CF Industries Holdings, Inc. is one of the largest manufacturers and distributors of nitrogen fertilizer and other nitrogen products in the world. The corporation often produces and stores large amounts of inventory during periods of low demand to ensure that there is enough product to meet the demand of peak seasons. Assume that one line of fertilizer (with no beginning Finished Goods Inventory) had the following data during a time period of low demand:

Sales price $ 20.00 per case Variable manufacturing costs 4.00 per case Fixed manufacturing costs 100,000 per quarter Variable selling and administrative costs 2.00 per case Fixed selling and administrative costs 45,000 per quarter Given that the time period has low demand, assume the company produced 1,000,000 cases but only sold 250,000 cases.

Requirement

1. Prepare the income statement for the quarter using variable costing.

2. Prepare the income statement for the quarter using absorption costing.

3. Why, if at all, is there a difference between operating income under the two methods?

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