1. EXERCISE 2–2Classifying Manufacturing Costs[LO2–2]
The PC Works assembles custom computers from components
supplied by various manufacturers. The company is very small,
and its assembly shop and retail sales store are housed in a
single facility in a Redmond, Washington, industrial park.
Listed below are some of the costs that are incurred at the
company.
Required:
For each cost, indicate whether it would most likely be
classified as direct labor, direct materials, manufacturing
overhead, selling, or an administrative cost.
1. The cost of a hard drive installed in a computer.
2. The cost of advertising in the Puget Sound Computer User
newspaper.
3. The wages of employees who assemble computers from
components.
4. Sales commissions paid to the company’s salespeople.
5. The wages of the assembly shop’s supervisor.
6. The wages of the company’s accountant.
7. Depreciation on equipment used to test assembled computers
before release to customers.
8. Rent on the facility in the industrial park.
EXERCISE 2–3 Classification of Costs as Product or Period
Cost[LO2–3]
Suppose that you have been given a summer job as an intern at
Issac Aircams, a company that manufactures sophisticated spy
cameras for remote-controlled military reconnaissance aircraft.
The company, which is privately owned, has approached a bank
for a loan to help it finance its growth. The bank requires
financial statements before approving such a loan. You have
been asked to help prepare the financial statements and were
given the following list of costs:
1. Depreciation on salespersons’ cars.

2. 2. Rent on equipment used in the factory.
3. Lubricants used for machine maintenance.
4. Salaries of personnel who work in the finished goods
warehouse.
5. Soap and paper towels used by factory workers at the end of
a shift.
6. Factory supervisors’ salaries.
7. Heat, water, and power consumed in the factory.
8. Materials used for boxing products for shipment overseas.
(Units are not normally boxed.)
9. Advertising costs.
10. Workers’ compensation insurance for factory employees.
11. Depreciation on chairs and tables in the factory lunchroom.
12. The wages of the receptionist in the administrative offices.
13. Cost of leasing the corporate jet used by the company’s
executives.
14. The cost of renting rooms at a Florida resort for the annual
sales conference.
15. The cost of packaging the company’s product.
Required:
Classify the above costs as either product costs or period costs
for the purpose of preparing the financial statements for the
bank.
EXERCISE 2–4 Fixed and Variable Cost Behavior [LO 2–4]
Espresso Express operates a number of espresso coffee stands in
busy suburban malls. The fixed weekly expense of a coffee
stand is $1,200 and the variable cost per cup of coffee served is
$0.22.
Required:
1. Fill in the following table with your estimates of total costs
and cost per cup of coffee at the indicated levels of activity for
a coffee stand. Round off the cost of a cup of coffee to the
nearest tenth of a cent.
Cups of Coffee Served in a Week

3. 2,000
2,100
2,200
Fixed cost. . . . . . . . . . . . . . . . . . . . . . . . . .
?
?
?
Variable cost. . . . . . . . . . . . . . . . . . . . . . . .
?
?
?
Total cost . . . . . . . . . . . . . . . . . . . . . . . . . .
?
?
?
Average cost per cup of coffee served . . . . . .
?
?
?
2. Does the average cost per cup of coffee served increase,
decrease, or remain the same as the number of cups of coffee
served in a week increases? Explain.
EXERCISE 2–5 High-Low Method [LO 2–5]
The Cheyenne Hotel in Big Sky, Montana, has accumulated

4. records of the total electrical costs of the hotel and the number
of occupancy-days over the last year. An occupancy-day
represents a room rented out for one day. The hotel’s business
is highly seasonal, with peaks occurring during the ski season
and in the summer.
Month
Occupancy-Days
Electrical
Costs
January. . . . . . . . . . . . . .
1,736
$4,127
February. . . . . . . . . . . . .
1,904
$4,207
March. . . . . . . . . . . . . . .
2,356
$5,083
April. . . . . . . . . . . . . . . .
960
$2,857
May . . . . . . . . . . . . . . . .
360
$1,871
June. . . . . . . . . . . . . . . .
744
$2,696
July . . . . . . . . . . . . . . . .
2,108
$4,670
August . . . . . . . . . . . . . .
2,406
$5,148
September . . . . . . . . . . .
840

5. $2,691
October. . . . . . . . . . . . . .
124
$1,588
November . . . . . . . . . . . .
720
$2,454
December . . . . . . . . . . . .
1,364
$3,529
Required:
1. Using the high-low method, estimate the fixed cost of
electricity per month and the variable cost of electricity per
occupancy-day. Round off the fixed cost to the nearest whole
dollar and the variable cost to the nearest whole cent.
2. What other factors other than occupancy-days are likely to
affect the variation in electrical costs from month to month?
EXERCISE 2–10 Cost Behavior; Contribution Format Income
Statement [LO 2–4, LO 2–6]
Harris Company manufactures and sells a single product. A
partially completed schedule of the company’s total and per unit

6. costs over the relevant range of 30,000 to 50,000 units produced
and sold annually is given below:
Units Produced and Sold
30,000
40,000
50,000
Total costs:
Variable costs. . . . . . . . . . . .
$180,000
?
?
Fixed costs. . . . . . . . . . . . . .
300,000
?
?
Total costs. . . . . . . . . . . . . . .
$480,000
?
?
Cost per unit:
Variable cost. . . . . . . . . . . . .
?
?
?
Fixed cost. . . . . . . . . . . . . . .
?
?
?

7. Total cost per unit. . . . . . . . . .
?
?
?
Required:
1. Complete the schedule of the company’s total and unit costs
above.
2. Assume that the company produces and sells 45,000 units
during the year at a selling price of $16 per unit. Prepare a
contribution format income statement for the year.
EXERCISE 3–1 Preparing a Contribution Format Income
Statement [LO3–1]
Whirly Corporation’s most recent income statement is shown
below:
Total
Per Unit
Sales (10,000 units). . . . . . . . . . . . . . . . . . . . . . .
$350,000
$35.00
Variable expenses. . . . . . . . . . . . . . . . . . . . . . . . .
200,000
20.00
Contribution margin. . . . . . . . . . . . . . . . . . . . . . .
150,000
$15.00
Fixed expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . .
135,000
Net operating income. . . . . . . . . . . . . . . . . . . . .
$ 15,000

8. Required:
Prepare a new contribution format income statement under each
of the following conditions (consider each case independently):
1. The sales volume increases by 100 units.
2. The sales volume decreases by 100 units.
3. The sales volume is 9,000 units.
EXERCISE 3–4 Computing and Using the CM Ratio [LO3–3]
Last month when Holiday Creations, Inc., sold 50,000 units,
total sales were $200,000, total variable expenses were
$120,000, and fixed expenses were $65,000.
Required:
1. What is the company’s contribution margin (CM) ratio?
2. Estimate the change in the company’s net operating income if
it were to increase its total sales by $1,000.
EXERCISE 3–5 Changes in Variable Costs, Fixed Costs, Selling
Price, and Volume [LO3–4]
Data for Hermann Corporation are shown below:
Per
Unit
Percent
of Sales
Selling price. . . . . . . . . . . . . . . . . . . .
$90
100%
Variable expenses. . . . . . . . . . . . . . . .
63
70%
Contribution margin . . . . . . . . . . . . . .
$27
30%

9. Fixed expenses are $30,000 per month and the company is
selling 2,000 units per month.
Required:
Page 102
1. The marketing manager argues that a $5,000 increase in the
monthly advertising budget would increase monthly sales by
$9,000. Should the advertising budget be increased?
2. Refer to the original data. Management is considering using
higher-quality components that would increase the variable
expense by $2 per unit. The marketing manager believes that the
higher-quality product would increase sales by 10% per month.
Should the higher-quality components be used?
EXERCISE 3–7 Compute the Level of Sales Required to Attain
a Target Profit [LO3–6]
Lin Corporation has a single product whose selling price is
$120 and whose variable expense is $80 per unit. The
company’s monthly fixed expense is $50,000.
Required:
1. Using the equation method, solve for the unit sales that are
required to earn a target profit of $10,000.
2. Using the formula method, solve for the unit sales that are
required to earn a target profit of $15,000.
EXERCISE 3–8 Compute the Margin of Safety [LO3–7]
Molander Corporation is a distributor of a sun umbrella used at
resort hotels. Data concerning the next month’s budget appear
below:
Selling price. . . . . . . . . . . . . . . . .
$30 per unit
Selling price. . . . . . . . . . . . . . . . .

10. $30 per unit
Variable expenses. . . . . . . . . . . . .
$20 per unit
Fixed expenses. . . . . . . . . . . . . . . .
$7,500 per month
Unit sales. . . . . . . . . . . . . . . . . . . .
1,000 units per month
Required:
1. Compute the company’s margin of safety.
2. Compute the company’s margin of safety as a percentage of
its sales.
EXERCISE 3–13 Using a Contribution Format Income
Statement [LO3–1, LO3–4]
Miller Company’s most recent contribution format income
statement is shown below:
Total
Per Unit
Sales (20,000 units). . . . . . . . . . . . . . . . . . . . . .
$300,000
$15.00
Variable expenses. . . . . . . . . . . . . . . . . . . . . . . .
180,000
9.00
Contribution margin. . . . . . . . . . . . . . . . . . . . . .
120,000

11. $ 2.00
Fixed expenses. . . . . . . . . . . . . . . . . . . . . . . . . . .
70,000
Net operating income. . . . . . . . . . . . . . . . . . . . .
$ 50,000
Required:
Prepare a new contribution format income statement under each
of the following conditions (consider each case independently):
1. The number of units sold increases by 15%.
2. The selling price decreases by $1.50 per unit, and the number
of units sold increases by 25%.
3. The selling price increases by $1.50 per unit, fixed expenses
increase by $20,000, and the number of units sold decreases by
5%.
4. The selling price increases by 12%, variable expenses
increase by 60 cents per unit, and the number of units sold
decreases by 10%.
CASE 3-33 Cost Structure; Break-Even and Target Profit
Analysis [LO3–4, LO3–5, LO3–6]
Pittman Company is a small but growing manufacturer of
telecommunications equipment. The company has no sales force
of its own; rather, it relies completely on independent sales
agents to market its products. These agents are paid a sales

12. commission of 15% for all items sold.
Barbara Cheney, Pittman’s controller, has just prepared the
company’s budgeted income statement for next year. The
statement follows:
Pittman Company Budgeted Income Statement For the Year
Ended December 31
Sales. . . . . . . . . . . . . . . . . . .
$16,000,000
Manufacturing expenses:
Variable. . . . . . . . . . . . . . . . . . . . .
$7,200,000
Fixed overhead. . . . . . . . . . . . . . .
2,340,000
9,540,000
Gross margin. . . . . . . . . . . . . . . . .
6,460,000
Selling and administrative expenses:
Commissions to agents. . . . . . . . . . . . . . .
2,400,000
Fixed marketing expenses. . . . . . . . . . . .
1,20,000*
Fixed administrative expenses. . . . . . .
1,800,000
4,320,000
Net operating income . . . . . . . . . . . . . .

13. 2,140,000
Fixed interest expenses . . . . . . . . . . .
540,000
Income before income taxes. . . . . . . . . .
1,600,000
Income taxes (30%). . . . . . . . . . . . . . . . .
480,000
Net income. . . . . . . . . . . . . . . . . . . . . .
$ 1,120,000
‘Primarily depreciation on storage facilities
As Barbara handed the statement to Karl Vecci, Pittman’s
president, she commented, “I went ahead and used the agents’
15% commission rate in completing these statements, but we’ve
just learned that they refuse to handle our products next year
unless we increase the commission rate to 20%.”
“That’s the last straw,” Karl replied angrily. “Those agents have
been demanding more and more, and this time they’ve gone too
far. How can they possibly defend a 20% commission rate?”
“They claim that after paying for advertising, travel, and the
other costs of promotion, there’s nothing left over for profit,”
replied Barbara.
“I say it’s just plain robbery,” retorted Karl. “And I also say it’s
time we dumped those guys and got our own sales force. Can
you get your people to work up some cost figures for us to look
at?”
“We’ve already worked them up,” said Barbara. “Several
companies we know about pay a 7.5% commission to their own
salespeople, along with a small salary. Of course, we would
have to handle all promotion costs, too. We figure our fixed
expenses would increase by $2,400,000 per year, but that would
be more than offset by the $3,200,000 (20% × $16,000,000) that
we would avoid on agents’ commissions.”

14. The breakdown of the $2,400,000 cost follows:
Salaries:
Sales manager. . . . . . . . . . . . . . . .
$ 100,000
Salespersons. . . . . . . . . . . . . . . .
600,000
Travel and entertainment. . . .
400,000
Advertising. . . . . . . . . . . . . . . .
1,300,000
Total. . . . . . . . . . . . . . . . . . . .
$2,400,000
“Super,” replied Karl. “And I noticed that the $2,400,000 is just
what we’re paying the agents under the old 15% commission
rate.”
“It’s even better than that,” explained Barbara. “We can
actually save $75,000 a year because that’s what we’re having
to pay the auditing firm now to check out the agents’ reports. So
our overall administrative expenses would be less.”
“Pull all of these numbers together and we’ll show them to the
executive committee tomorrow,” said Karl. “With the approval
of the committee, we can move on the matter immediately.”
Required:
1. Compute Pittman Company’s break-even point in dollar sales
for next year assuming:
· a. The agents’ commission rate remains unchanged at 15%.
· b. The agents’ commission rate is increased to 20%.
· c. The company employs its own sales force.
2. Assume that Pittman Company decides to continue selling
through agents and pays the 20% commission rate. Determine
the volume of sales that would be required to generate the same
net income as contained in the budgeted income statement for
next year.
3. Determine the volume of sales at which net income would be
equal regardless of whether Pitt-man Company sells through

15. agents (at a 20% commission rate) or employs its own sales
force.
4. Compute the degree of operating leverage that the company
would expect to have on December 31 at the end of next year
assuming:
· a. The agents’ commission rate remains unchanged at 15%.
· b. The agents’ commission rate is increased to 20%.
· c. The company employs its own sales force.
Use income before income taxes in your operating leverage
computation.
5. Based on the data in requirements 1-4 above, make a
recommendation as to whether the company should continue to
use sales agents (at a 20% commission rate) or employ its own
sales force. Give reasons for your answer.
(CMA, adapted)