Cost Behavior, High-Low Method, Pricing Decision
Fonseca, Ruiz, and Dunn is a large, local accounting firm located in a southwestern city. Carlos Ruiz, one of the firm’s founders, appreciates the success his firm has enjoyed and wants to give something back to his community. He believes that an inexpensive accounting services clinic could provide basic accounting services for small businesses located in the barrio. He wants to price the services at cost.
Since the clinic is brand new, it has no experience to go on. Carlos decided to operate the clinic for 2 months before determining how much to charge per hour on an ongoing basis. As a temporary measure, the clinic adopted an hourly charge of $25, half the amount charged by Fonseca, Ruiz, and Dunn for professional services.
The accounting services clinic opened on January 1. During January, the clinic had 120 hours of professional service. During February, the activity was 150 hours. Costs for these two levels of activity usage are as follows:
Required:
- 1. Classify each cost as fixed, variable, or mixed, using hours of professional service as the activity driver.
- 2. Use the high-low method to separate the mixed costs into their fixed and variable components. (Note: Round variable rates to two decimal places and fixed amounts to the nearest dollar.)
- 3. Luz Mondragon, the chief paraprofessional of the clinic, has estimated that the clinic will average 140 professional hours per month. If the clinic is to be operated as a nonprofit organization, how much will it need to charge per professional hour ? How much of this charge is variable? How much is fixed? (Note: Round answers to two decimal places.)
- 4. CONCEPTUAL CONNECTION Suppose the accounting center averages 170 professional hours per month. How much would need to be charged per hour for the center to cover its costs ? Explain why the per-hour charge decreased as the activity output increased. (Note: Round answers to two decimal places.)
1.
Categorize the activities into fixed cost, variable cost or mixed cost.
Explanation of Solution
Cost:
Cost can be defined as the cash and cash equivalent which is incurred against the products or its related services which will benefit the organization in the future. There are two types of costs that are fixed and variable costs. Combination of fixed and variable is referred to as mixed cost.
Serial Number | Activities | Categorize |
1 | Senior accountant | Fixed cost |
2 | Office assistant | Fixed cost |
3 | Internet and software subscriptions | Mixed cost |
4 | Consulting by senior partner | Variable cost |
5 | Depreciation | Fixed cost |
6 | Supplies | Mixed cost |
7 | Administration | Fixed cost |
8 | Rent | Fixed cost |
9 | Utilities | Mixed cost |
Table (1)
2.
Divide the mixed costs into fixed and variable components with the help of high-low method.
Explanation of Solution
High Low Method:
The method in which, high and low points of data are used to classify the mixed cost into fixed and variable cost known as high low method. This is one among the three costs of separation methods.
Use the following formula to calculate the value of variable rate of internet and software subscriptions:
Substitute $850 for high receiving cost, $700 for low receiving cost, 150 for high professional hours and 120 for low professional hours in the above formula.
Therefore, variable rate is $5.00 per hour.
Use the following formula to calculate the fixed cost for a month of internet and software subscriptions:
Substitute $850 for high receiving cost, $5.00 for variable rate and 150 for high professional hours in the above formula.
Therefore, fixed cost for a month is $100.
Use the following formula to calculate the value of variable rate of supplies:
Substitute $1,100 for high receiving cost, $905 for low receiving cost, 150 for high professional hours and 120 for low professional hours in the above formula.
Therefore, variable rate is $6.5 per hour.
Use the following formula to calculate the fixed cost for a month of supplies:
Substitute $1,100 for high receiving cost, $6.50 for variable rate and 150 for high professional hours in the above formula.
Therefore, fixed cost for a month is $125.
Use the following formula to calculate the value of variable rate of utilities:
Substitute $365 for high receiving cost, $332 for low receiving cost, 150 for high professional hours and 120 for low professional hours in the above formula.
Therefore, variable rate is $1.10 per hour.
Use the following formula to calculate the fixed cost for a month of utilities:
Substitute $365 for high receiving cost, $1.10 for variable rate and 150 for high professional hours in the above formula.
Therefore, fixed cost for a month is $200.
3.
Calculate the value of total cost and charge per hour. Also, calculate the fixed cost and variable cost.
Explanation of Solution
Use the following formula to calculate the value of fixed cost per hour:
Substitute $9,025 for total cost and 140 for professional hours in the above formula.
Therefore, the value of fixed cost per hour is $64.46.
Use the following formula to calculate the value of variable cost per hour:
Substitute $5 for variable rate of internet subscriptions, $10 for consulting by senior partner, $6.50 for supplies and 1.10 for utilities in the above formula.
Therefore, the value of variable cost per hour is $22.60.
Use the following formula to calculate the value of total clinic cost:
Substitute $9,025 for fixed cost and $22.60 for variable rate and 140 for professional hours in the above formula.
Therefore, the value of total clinic cost is $12,189.
Use the following formula to calculate the value of charge per hour:
Substitute $12,189 for total clinic cost, 140 for professional hours and $22.60 for variable rate in the above formula.
Therefore, the value of charge per hour is $87.06.
Working Note:
Total Cost is calculated by adding the values of all the activities that is $9,025
4.
Calculate the value of charge per hour when the number of professional hours is 170 hours.
Explanation of Solution
Use the following formula to calculate the value of charge per hour:
Substitute $9,025 for fixed cost, 170 for professional hours and $22.60 for variable rate in the above formula.
Therefore, the value of charge per hour is $75.69.
The charge per hour decreases because fixed cost is divided by the large amount of professional hours.
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Chapter 3 Solutions
CENGAGENOWV2 FOR MOWEN/HANSEN/HEITGER S
- Cost Information and Ethical Behavior, Service Organization Jean Erickson, manager and owner of an advertising company in Charlotte, North Carolina, arranged a meeting with Leroy Gee, the chief accountant of a large, local competitor. The two are lifelong friends. They grew up together in a small town and attended the same university. Leroy is a competent, successful accountant but is having some personal financial difficulties after some of his investments turned sour, leaving him with a 15,000 personal loan to pay offjust when his oldest son is starting college. Jean, on the other hand, is struggling to establish a successful advertising business. She had recently acquired the rights to open a branch office of a large regional advertising firm headquartered in Atlanta, Georgia. During her first 2 years, she was able to build a small, profitable practice. However, the chance to gain a significant foothold in Charlotte hinged on the success of winning a bid to represent the state of North Carolina in a major campaign to attract new industry and tourism. The meeting she had scheduled with Leroy concerned the bid she planned to submit. Jean: Leroy, Im at a critical point in my business venture. If I can win the bid for the states advertising dollars, Ill be set. Winning the bid will bring 600,000 to 700,000 of revenues into the firm. On top of that, I estimate that the publicity will bring another 200,000 to 300,000 of new business. Leroy: I understand. My boss is anxious to win that business as well. It would mean a huge increase in profits for my firm. Its a competitive business, though. As new as you are, I doubt that youll have much chance of winning. Jean: Youre forgetting two very important considerations. First, I have the backing of all the resources and talent of a regional firm. Second, I have some political connections. Last year, I was hired to run the publicity side of the governors campaign. He was impressed with my work and would like me to have this business. I am confident that the proposals I submit will be very competitive. My only concern is to submit a bid that beats your firm. If I come in with a lower bid and good proposals, the governor can see to it that I get the work. Leroy: Sounds promising. If you do win, however, there will be a lot of upset people. After all, they are going to claim that the business should have been given to local advertisers, not to some out-of-state firm. Given the size of your office, youll have to get support from Atlanta. You could take a lot of heat. Jean: True. But I am the owner of the branch office. That fact alone should blunt most of the criticism. Who can argue that Im not a local? Listen, with your help, I think I can win this bid. Furthermore, if I do win it, you can reap some direct benefits. With that kind of business, I can afford to hire an accountant, and Ill make it worthwhile for you to transfer jobs. I can offer you an up-front bonus of 15,000. On top of that, Ill increase your annual salary by 20%. That should solve most of your financial difficulties. After all, we have been friends since day oneand what are friends for? Leroy: Jean, my wife would be ecstatic if I were able to improve our financial position as quickly as this opportunity affords. I certainly hope that you win the bid. What kind of help can I provide? Jean: Simple. To win, all I have to do is beat the bid of your firm. Before I submit my bid, I would like you to review it. With the financial skills you have, it should be easy for you to spot any excessive costs that I may have included. Or perhaps I included the wrong kind of costs. By cutting excessive costs and eliminating costs that may not be directly related to the project, my bid should be competitive enough to meet or beat your firms bid. 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RegionalOne Bank Bid: Checking accounts: 5 monthly maintenance fee per account to be waived for Kicker 0.20 foreign debit/credit 0.30 earned for each deposit 3.80 per returned check Credit card fees: 0.50 per item Wire transfers: 10 to domestic bank accounts, 55 to foreign bank accounts Line of credit: Yes, this amount is available: interest charged at prime plus 2% subject to a 6.5% minimum interest rate Internet banking services? Yes, full online banking available: one-time setup fee for each account waived for Kicker 20 monthly fee for software module The loan officer assigned to the potential Kicker account had 2 years of experience with large business banking. Another branch of the bank had expertise in the audio industry and would be willing to help as needed. This bank was the first one to submit a bid. Required: 1. Calculate the predicted monthly cost of banking with each bank. Round answers to the nearest dollar. 2. 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