akmen

Using the High-Low Method to Estimate Variable and Fixed Costs

Located on Switcurrent Lake in Glacier National Park, Many Glacier Hotel was built in 1915 by the Great Northern Railway. In an effort to supplement its lodging revenue, the hotel decided in 2003 to begin manufacturing and selling small wooden canoes decorated with symbols hand painted by Nativa Americans living near the park. Due to the great success of the canoes, the hotel began manufacturing and selling paddles as well in 2006. Many hotel guests purchase a canoes and paddles for use in self-guided tours of Swirfcurrent Lake. Because production of the two products began in different years, the canoes and paddles are produced in separate production facilities and employ different laborers. Each canoe sells for $500, and each paddle sells for $50. A 2006 fire destroyed the hotel’s accounting records. However, a new system put into place before the 2007 season provides the following aggregated data for the hotel’s canoe and paddle manufacturing and marketing activities.

Manufacturing Data:

Year	Number of Canoes Manufactured	Total Canoe Manufacturing Costs	Year	Number of Paddles Manufactured	Total Paddle Manufacturing Costs
2012	250	$106,000	2012	900	$38,500
2011	275	115,000	2011	1,200	49,000
2010	240	108,000	2010	1,000	42,000
2009	310	122,000	2009	1,100	45,500
2008	350	130,000	2008	1,400	56,000
2007	400	140,000	2007	1,700	66,500

Marketing Data

Year	Number of Canoes Sold	Total Canoe Marketing Costs	Year	Number of Paddles Sold	Total Paddle Marketing Costs
2012	250	$45,000	2012	900	$7,500
2011	275	47,500	2011	1,200	9,000
2010	240	44,000	2010	1,000	8,000
2009	310	51,000	2009	1,100	8,500
2008	350	55,000	2008	1,400	10,000
2007	400	60,000	2007	1,700	11,500

Required:

1.      High-Low Cost Estimation Method

a.       Use the high-low method to estimate the per-unit variable costs and total fixed costs for the canoe product line.

Variable Cost per unit:            Manufacturing            : $140,000 – $108,000  = $200

                                                                                      400 - 240

                                                           Marketing        : $60,000 - $44,000       = $100

                                                                                                400-240

          Total Variable Cost per unit = $300

          Total Fixed Cost:         Manufacturing            : $ 140,000 – ($200 x 400) = $60,000

                                                Marketing        : $ 60,000 – ($100 x 400)   = $20,000

          Total Fixed Cost   = $ 80,000

b.      Use the high-low method to estimate the per-unit variable costs and total fixed costs for the paddle product.

Variabe Cost per unit: Manufacturing            : $ 66,500 – $ 38,500  = $35

                                                                                      1,700 - 900

                                                 Marketing                   : $11,500 - $7,500       = $5

                                                                                                1,700 - 900

          Total Variable Cost per unit = $40

          Total Fixed Cost: Manufacturing                     : $ 66,500 – ($35 x 1,700) = $ 7,000

                                        Marketing                           : $ 11,500 – ($5 x 1,700)   = $ 3,000

          Total Fixed Cost = $ 10,000

2.      Cost-Volume-Profit Analysis, Single-Product Setting

Use CVP analysis to calculate the break-even points in units for

a.       The canoe product line only (i.e., single-product setting)

Break-Even Units: $ 80,000 = 400 units

                                    $ 200

b.      The paddle product line only (i.e., single-product setting)

Break-Even Units: $ 10,000 = 1,000 units

                                     $ 10

3.      Cost-Volume-Profit Analysis, Multiple-Product Setting

The hotel’s accounting system data show an average sales mix of approximately 300 canoes and 1,200 paddles each season. Significantly more paddles are sold relative to canoes because some inexperienced canoe guests accidentally break one or more paddles, while other guests purchase additional paddles as presents for friends and relatives. In addition, for thiss multiple-product CVP analysis, assume the existence of an additional $30,000 of common fixed costs for a customer service hotline used for both canoe and paddle customers. Use CVP analysis to calculate the break-even points in units for both the canoe and paddle product lines combined (i.e., the multiple-product setting).

Sales Mix: 1 : 4

Weighted Average Contribution Margin: Canoe $300 x 300 = $ 90,000

                                                                   Paddle $40 x 1,200 = $ 48,000

                                                                   ($90,000+$48,000)/1500 units = $92

Break-Even Units Combined: $ 80,000 + $ 30,000 = 1,196 units

                                                              $ 92

       Break-Even Per Product: Canoe:1/4 x 1,196 units = 299 units

                                                Paddles: 3/4 x 1,196 = 897 units.

4.      Cost classification

a.       Classify the manufacturing costs, marketing costs, and customer service hotline costs either as production expenses or period expenses.

Manufacturing Costs = Production Expenses

Marketing Costs = Period Expense

Customer Service Hotline = Period Expenses

b.      For the period expenses, further classify them into either selling expenses or general and administrative expenses

Marketing Costs = Selling expenses

Customer Service Hotline = General & Admin Expenses

5.      Sensitivity Cost-Volume-Profit Analysis and Production Versus Period Expenses, Multiple-Product Setting

If both the variable and fixed production expenses (refer to your answer to Requirement 1) associated with the canoe product line increased by 5% (beyond the estimate from the high-low analysis), how many canoes and paddles would need to be sold in order to earn a target income of $96,000? Assume the same sales mix and additional fixed costs as in Requirement 3.

Sales Mix: 1 : 4

New Weighted Average Contribution Margin:

Canoe  $ 315 x 300  = $ 94,500

                 Paddle $ 42 x 1,200 = $ 50,400

                              ($94,500+$50,400)/1500 units = $ 96, 6

Units to be sold: Total Fixed Cost + Target Income/Contribution Margin per unit

                            = ($ 115,500 + $ 96,000)/$ 96,6

                            = 2190 units

Canoe  = 1/4 x 2190 =  548 units

Paddle = 3/4 x 2190 = 1642 units

6.      Magin of safety

Calculate the hotel’s margin of safety (both in units and in sales dollars) for Many Glacier Hotel, assuming the same facts as in Requirement 3, and it sells 700 canoes and 2,500 paddles next year.

For canoe:

            Margin of safety per unit: 700 – 400 = 300 units

            Margin of safety in sales: $500 (700) - $500 (400) = $150,000

For paddle:

            Margin of safety per unit: 2,500 – 1,000 = 1,500 units

            Margin of safety in sales: $50 (2,500) - $50 (1,000) = $ 75,000