COST BEHAVIOR & TERMINOLOGY

ACCOUNTING & COST MANAGEMENT

TEM: 303
 COST CLASSIFICATIONS IN MANUFACTURING
COMPANIES

Purpose of Cost classifications

classification
Preparing an income • Product costs (Manufacturing cost)
statement and balance • Direct materials
sheet • Direct labor
• Manufacturing overhead
• Period costs (non manufacturing
costs)
• Marketing and selling costs
• Administrative costs
Predicting changes in cost • Variable costs
due to changes in activity • Fixed costs

Assigning costs to cost • Direct costs

objects • Indirect costs

Making decisions • Differential costs

• Sunk costs
• Opportunity costs
 MANUFACTURING COSTS
Manufac
Direct Direct turing
Materials Labor Overhea
d

The
Product

Manufacturing costs are usually grouped into three main

categories: direct materials, direct labor, and
manufacturing overhead. These costs are incurred to
make a product.
 DIRECT MATERIALS
Direct materials are raw materials that become an integral
part of the finished product and whose costs can be
conveniently traced to it.

Costing of Material:
Company A produced 1,000 tables. To produce 1,000 tables,
the company incurred costs of:
$12,000 on wood
$100 for a bag of nails to hold the tables together
Total material costs: $12,000 (direct material) [$100
(indirect material)]
Per Unit Direct Material Cost= $ 12,000/1000 tables= $12
 DIRECT LABOR
Direct labor consists of that portion of labor cost that can be easily traced
to a product. Direct labor is sometimes referred to as “touch labor,” since
it consists of the costs of workers who “touch” the product as it is being
made.

Examples include mechanics & worker work in manufacturing a car

engine, worker employed in assembly of electronic parts.

Costing of Labor:
Company A produced 1,000 tables. To produce 1,000 tables, the company
incurred costs of:
$2,000 on wages for carpenters and $500 on wages for security guards to
overlook the manufacturing facility
Total labor costs: $2,000 (direct labor) [$500 (indirect labor)]
Per Unit Direct Labor Cost= $2000/1000 tables= $2
 MANUFACTURING OVERHEAD
Manufacturing overhead includes all manufacturing costs except
direct materials and direct labor. These costs cannot be easily
traced to specific units produced (also called indirect
manufacturing cost, factory overhead, and factory burden).

Manufacturing overhead= indirect material + indirect labor +

other expenses

Company A produced 1,000 tables. To produce 1,000 tables, the company incurred
costs of:

•$500 on wages for security guards to overlook the manufacturing facility

•$100 for a bag of nails to hold the tables together
•$500 for factory rent and utilities

•Total Manufacturing Overhead cost: $500 (Indirect Labor) + $ 100 (Indirect Material)
+ $ 500 (rent & utility-other cost)= $1100
•Per Unit Manufacturing Overhead (OH) Cost= $ 1100/1000= $ 1.1
 MANUFACTURING OVERHEAD
Indirect materials Indirect labor
Other Cost
MANUFACTURING OVERHEAD
 NON-MANUFACTURING COST (PERIOD COST)
Also called selling, general & administrative cost (SGA- cost)

Marketing & Selling costs include all costs necessary to get customer orders and
deliver the finished product into the hands of the customer. These costs are also
referred to as order-getting and order-filling costs.

General & Administrative costs include all executive (staff), organizational, and
clerical costs associated with the general management of an organization.

Administrati
ve Costs

Executive and clerical

compensation/ salary,
Organizational expenses
 Do it

A bicycle company has these costs: tires, salaries of employees who put tires on the
wheels, factory building depreciation, lubricants, spokes, salary of factory manager,
handlebars, and salaries of factory maintenance employees. Classify each cost as direct
materials, direct labor, or overhead.

Direct material Direct labor

Manufacturing overhead
 Tires  salaries of employees
 Lubricants
 Spokes who put tires on the  Factory depreciation
 Handlebars wheels  Factory manager salary
 Factory maintenance employees
salary
CLASSIFY DIFFERENT COST
 ANOTHER CLASSIFICATION OF COST
Two more cost categories are often used in discussions of manufacturing

• Prime cost is the sum of direct materials cost and direct labor cost
• Conversion cost is the sum of direct labor cost and manufacturing
overhead cost.
The term conversion cost is used to describe direct labor and
manufacturing overhead because these costs are incurred to convert
materials into the finished product.
Direct Direct Manufacturin
Material Labor g
Overhead

Prime Conversio
Cost n
Cost
Product cost= Direct materials +Direct labor + Manufacturing overhead
= $69,000 +$35,000 + $14,000
= $118,000

Period cost =Selling expenses +Administrative expenses

=$29,000 +$50,000
= $79,000

Conversion cost = Direct labor + Manufacturing overhead

= $35,000 + $14,000
= $49,000

Prime cost = Direct materials + Direct labor

= $69,000 + $35,000
= $104,000
COMPARISON OF MERCHANDISING & MANUFACTURING

MERCHANDISER MANUFACTURER
S... S...
⮚ BUY FINISHED ⮚ BUY RAW
GOODS. MATERIALS.
⮚ SELL FINISHED ⮚ PRODUCE AND
GOODS. SELL FINISHED
MegaLoMart GOODS.
 Cost of goods sold & cost of goods manufactured

• Cost of goods manufactured (COGM) • Cost of goods sold (COGS)

• The cost of goods manufactured (COGM), also • The cost of goods sold calculates the
called cost of goods completed, calculates the total value of inventory (goods) that
total value of inventory (goods) that was was produced during the period and
produced during the period and is ready for already sold.
sale • COGS= beginning finished goods
• COGM= Beginning WIP inventory cost+ total inventory cost + cost of goods
manufacturing cost- ending WIP manufactured (COGM) or purchase of
inventory cost finished goods – ending finished goods
inventory cost
• Total manufacturing cost= direct material cost +
direct labor cost + manufacturing overhead cost • Merchandising companies only have
cogs but manufacturing companies
may have both COGM & COGS
PRODUCT COST FLOWS
PRODUCT COST FLOWS
PRODUCT COST FLOWS
PRODUCT COST FLOWS
PRODUCT COST FLOWS
Beginning raw materials inventory was $32,000. During the month, $276,000 of raw material
was purchased. A count at the end of the month revealed that $28,000 of raw material was still
present. What is the cost of direct material used?
A. $276,000
B. $272,000
C. $280,000
D. $ 2,000
Beginning work in process was $125,000. Manufacturing costs incurred for the month were
$835,000. There were $200,000 of partially finished goods remaining in work in process
inventory at the end of the month. What was the cost of goods manufactured during the
month?

A.$1,160,000
B. $ 910,000
C. $ 760,000
D.CANNOT BE DETERMINED.
Beginning finished goods inventory was $130,000. The cost of goods manufactured for
the month was $760,000. And the ending finished goods inventory was $150,000. What
was the cost of goods sold for the month?
A. $ 20,000.
B. $740,000.
C. $780,000.
D. $760,000.

$130,000 + $760,000 = $890,000

$890,000 - $150,000 = $740,000
 Assigning cost to cost objects

Direct costs Indirect costs

• Costs that can be • Costs that cannot be

easily and easily and
conveniently traced to conveniently traced
a unit of product or to a unit of product
other cost object. or other cost object.
• Examples: direct • Example:
material and direct manufacturing
labor overhead
COST CLASSIFICATION FOR DECISION MAKING

It is important to realize that every decision

involves a choice between at least two
alternatives.

To make decisions, it is essential to

have a grasp on three concepts:
Differential costs,
Opportunity costs, and
Sunk costs.
DIFFERENTIAL COST AND REVENUE
Differential costs is a difference in cost between any two alternatives.
Differential costs can be either fixed or variable. A difference in revenue
between two alternatives is called differential revenue.

Example: You have a job paying $1,500 per

month in your hometown. You have a job
offer in a neighboring city that pays $2,000
per month. The commuting cost to the city is
$300 per month.
Differential Differential cost
revenue is: is:
$2,000 – $1,500 = $300
$500
Which project to
select?
 OPPORTUNITY COST

The potential benefit that is given up

when one alternative is selected over
another.

Example: If you were not attending college, you

could be earning $15,000 per year. Your
opportunity cost
of attending college for one year is $15,000.
 SUNK COSTS

SUNK COSTS HAVE ALREADY BEEN INCURRED AND CANNOT

BE CHANGED NOW OR IN THE FUTURE.

Example: You bought an automobile that cost

$10,000 two years ago. The $10,000 cost is
sunk because whether you drive it, park it,
rent it, or sell it, you cannot change that
$10,000 cost.
 IDLE TIME COST
Machine Power Material
Breakdowns Failures Shortages
The labor costs incurred during idle
time are ordinarily treated as
manufacturing overhead.

OVERTIME COST
The overtime cost for all factory workers are usually
considered to be part of manufacturing overhead.
This is done to avoid penalizing particular products
or customer orders simply because they happen to
fail to be completed end of the daily production
schedule.
 LABOR FRINGE BENEFITS
Labor fringe benefit costs are employment-related
costs paid by an employer, such as insurance
programs, retirement plans, provident funds, home
rent, medical allowance, transport allowance,
entertainment allowance etc.

These costs often add up to 30 to 40 percent of an

employee’s basic pay.

Some companies Other companies treat

include all of these fringe benefit
costs in expenses of direct
manufacturing laborers as additional
overhead. direct labor costs.
• Explicit and implicit costs
• A firm’s cost of production include explicit costs and implicit
costs.

• Explicit costs are input costs that require a direct outlay of

money by the firm. Ex: travel expenses, the cost of a hotel room,
and costs related to entertainment.

• Implicit costs are input costs that do not require an outlay of

money by the firm. Ex: not paying rent on the self-owned
property,
 Product costing need knowledge of cost behavior

Cost behavior pattern helps to determine cost for different materials

•Cost behavior provides proper information about fixed & variable cost associated with the
product
•In case of mixed cost this cost behavior provides accurate proportion of fixed & variable cost
•During product costing what will be the variable cost per unit.
•How fixed cost is affecting the existing selling price & profit that also can be observed by cost
behavior
 COST CLASSIFICATIONS FOR PREDICTING COST BEHAVIOR

How a cost will react to

changes in the level of
activity within the
relevant range.

– Total variable costs

change when activity
changes.
– Total fixed costs remain
unchanged when activity
changes.

A manager may want to estimate the impact

that a 5% increase in sales would have an
impact on the company’s total electric bill.
Cost behavior refers to how a cost will react to
changes in the level of activity within the
relevant range.
 VARIABLE COST

A variable cost varies directly in proportion to

changes in the level of activity.
Your total texting bill is based on how many texts you send.

Total Texting Bill

Number of Texts
Sent
 VARIABLE COST PER UNIT
Although variable costs change in total as the activity
level rises and falls, variable cost per unit is
constant.
The cost per text sent is constant at 5 cents per text.

Cost Per Text Sent

Number of Texts
Sent
 EXAMPLES OF VARIABLE COSTS
Merchandising companies – cost of goods sold.
Manufacturing companies – direct materials,
direct labor, and variable overhead.
Merchandising and manufacturing companies –
Sales commissions, shipping costs.
 TRUE VARIABLE COST

Direct material is a true or proportionately variable cost because the

amount used during a period will vary in direct proportion to the
level of production activity.
Cost

Volume
 STEP-VARIABLE COSTS

A resource that is cost incurable only in large

range (such as maintenance workers) and whose
costs increase or decrease only in response to
fairly wide changes in activity is known as a step-
variable cost.
Cost

Volume
 STEP-VARIABLE COSTS

Small changes in the level of production are not

likely to have any effect on the number of
maintenance workers employed.
Cost

Volume
 STEP-VARIABLE COSTS

Only fairly wide changes in the activity level will

cause a change in the number of maintenance
workers employed
Cost

Volume
 FIXED COST
• A fixed cost is constant within the relevant range. In other words, fixed costs do not
change for changes in activity that fall within the “relevant range.”

• For example, your monthly contract fee for your cell phone is a fixed amount for a certain
number of minutes. The monthly contract fee does not change based on the number of
calls you make.

Phone Contract
Monthly Cell

Fee

Number of Minutes
Used
Within Monthly Plan
 FIXED COST PER UNIT
• A fixed cost is inversely related to activity—the per unit cost decreases when
activity rises and increases when activity falls.

• For example, the average fixed cost per cell phone call made decreases as
more calls are made in the month.

Fixed cost per phone

call
Calls made per month
 TYPES OF FIXED COSTS

Committed Discretionary
Long-term, cannot be May be altered in the short-
significantly reduced in the term by current
short term. managerial decisions

Examples Examples
investment in buildings Advertising and
& equipment, Research and
insurance expense,
federal tax Development
COST CLASSIFICATIONS FOR
PREDICTING COST BEHAVIOR
 MIXED COSTS (ALSO CALLED SEMI VARIABLE COSTS)

A mixed cost contains both variable and fixed

elements. Consider the example of utility cost.

Y
Total Utility Cost

ost
d c
i xe
l m
ota
T Variable
Cost per KW
X Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge
 MIXED COSTS (ALSO CALLED SEMI VARIABLE COSTS)

Y
Total Utility Cost

ost
d c
ixe
l m
ota
T Variable
Cost per KW
X Fixed Monthly
Activity (Kilowatt Hours)
Utility Charge
 MIXED COSTS – AN EXAMPLE

If your fixed monthly utility charge is $40, your

variable cost is $0.03 per kilowatt hour, and your
monthly activity level is 2,000 kilowatt hours, what is
the amount of your utility bill?
THE HIGH-LOW METHOD-MIXED COST
Assume the following hours of maintenance work
and the total maintenance costs for six months.
THE HIGH-LOW METHOD

The variable cost

per hour of
maintenance is
equal to the
change in cost
divided by the
change in hours.
$2,400
=
300
$8.00/hour
THE HIGH-LOW METHOD

The Cost Equation for Maintenance

Y = a +bX
 Sales salaries and commissions are $10,000 when
80,000 units are sold, and $14,000 when 120,000
units are sold. Using the high-low method, what is
the value of variable cost per unit & fixed portion of
sales salaries and commission?
A. $0.08 per unit
B. $0.10 per unit
c. $0.12 per unit
D. $0.125 per unit
$4,000 ÷ 40,000 units
= $0.10 per unit
 Sales salaries and commissions are $10,000 when
80,000 units are sold, and $14,000 when 120,000
units are sold. Using the high-low method, what is
the value of variable cost per unit & fixed portion of
sales salaries and commission?
A. $2000
B. $2500
C. $1500
D. $1800
ABSORPTION AND VARIABLE COSTING

Absorption Costing/ Variable Costing/

Full Costing marginal Costing

Direct Materials
Product
Product Direct Labor
Costs
Costs Variable Manufacturing Overhead

Fixed Manufacturing Overhead

Period
Period Variable Selling and Administrative Expenses
Costs
Costs Fixed Selling and Administrative Expenses
 UNIT COST COMPUTATIONS

Harvey company produces a single

product
with the following information
available:
 UNIT COST COMPUTATIONS

UNIT PRODUCT COST IS DETERMINED AS

FOLLOWS:

Under absorption costing, selling and administrative

expenses are
always treated as period expenses and deducted
from revenue as incurred.
 CVP ANALYSIS
Cost-volume-profit (cvp) analysis is the study about
• The effects of changes of costs and volume on a company’s profits.
•Cost-volume-profit (cvp) analysis is important in profit planning.
•It also is a critical factor in management decisions.

Assumption of cvp analysis:

1. Selling price is constant. The price of a product or service will not change as volume
changes.
2. Costs are linear and can be accurately divided into variable and fixed elements. The variable
element is constant per unit, and the fixed element is constant in total over the entire relevant
range.
3. In multiproduct companies, the sales mix is constant.
4. In manufacturing companies, inventories do not change. The number of units produced equals
the number of units sold.
 BASICS OF COST-VOLUME-PROFIT ANALYSIS
• Let's look at a hypothetical contribution income statement for DBL Group.
The selling price of per unit product is $ 500. VARIABLE PRICE IS $300

• Notice the emphasis on cost behavior. Variable costs are separate from
fixed costs.

Contribution Margin (CM) ($ 100000) is the amount remaining

from sales revenue after variable expenses have been deducted.
Net income ($ 20000) is the remaining from contribution margin
after fixed expenses have been deducted
THE CONTRIBUTION APPROACH
Sales, variable expenses, and contribution margin can
also be expressed on a per unit basis. If this company
sells an additional unit, $200 additional CM will be
generated to cover fixed expenses and profit.
THE CONTRIBUTION APPROACH
Each month, DBL must generate at least
$80,000 in total CM to break even.
THE CONTRIBUTION APPROACH
If company sells 400 units in a month, it will be operating
at the break-even point.

40
0
THE CONTRIBUTION APPROACH
If company sells one more bike (401 bikes),
net
Operating income will increase by $200.

40
1
 CVP RELATIONSHIPS IN GRAPHIC FORM
The relationship among revenue, cost, profit and volume can be expressed graphically by
preparing a cvp graph.
Dbl developed contribution margin income statements at 300, 400, and 500 units sold.
We will use this information to prepare the cvp graph.
 CVP GRAPH

Dollars

Total Expenses
Fixed Expenses

Units
 CVP GRAPH

Total Sales
Dollars

Total Expenses
Fixed Expenses

Units
 CVP GRAPH

Break-even point
(400 units or $200,000 in sales)
r e a
fit A
P ro
Dollars

re a
s A
L o s

Units
CONTRIBUTION MARGIN RATIO

The contribution margin ratio is:

Total CM
CM Ratio =
Total sales
for the company the ratio is:
$80,000
= 40%
$200,000
Each $1.00 increase in sales results in a
total contribution margin increase of 40¢.
 CONTRIBUTION MARGIN RATIO

Or, in terms of units, the contribution margin

ratio Unit
is: CM
CM Ratio =
Unit selling price

For the company the ratio is:

$200 = 40%
$500
Coffee klatch is an espresso stand in a
downtown office building. The average selling
price of a cup of coffee is $1.49 and the
average variable expense per cup is $0.36.
The average fixed expense per month is
$1,300. 2,100 cups are sold each month on
average. What is the cm ratio for coffee
klatch?
A. 1.319
B. 0.758
C. 0.242
D. 4.139
 Changes in fixed costs and sales volume
What is the profit impact if company can increase unit sales from
500 to 540 by increasing the monthly advertising budget by
$80,000 + $10,000$10,000?
advertising = $90,000

Sales increased by $20,000, but net operating

income decreased by $2,000.
 Changes in fixed costs and sales volume
What is the profit impact if COMPANY can use higher quality raw materials,
thus increasing variable costs per unit by $10, to generate an increase
in unit sales from 500 to 580?
580 units × $310 variable cost/unit = $179,800

Sales increase by $40,000, and net operating income

increases by $10,200.
 Changes in fixed costs and sales volume
What is the profit impact if company (1) cuts its selling price
$20 per unit, (2) increases its advertising budget by $15,000
per month, and (3) increases sales from 500 to 650 units per
month?

Sales increase by $62,000, fixed costs increase by

$15,000, and net operating income increases by $2,000.
 BREAK-EVEN ANALYSIS

BREAK-EVEN ANALYSIS CAN BE APPROACHED IN TWO WAYS:

1. EQUATION METHOD
2. CONTRIBUTION MARGIN METHOD
At the break-even point
EQUATION METHOD profits equal zero
Profits = (Sales – Variable expenses) – Fixed expenses
Sales = Variable expenses + Fixed expenses + Profits
 Equation method
●We calculate the break-even point as
follows:
Sales = variable expenses + fixed expenses + profits

$500q = $300q + $80,000 + $0

Where:
Q = number of bikes sold
$500 = unit selling price
$300 = unit variable expense
$80,000 = total fixed expense
 EQUATION METHOD

●WE CALCULATE THE BREAK-EVEN POINT

AS FOLLOWS:
Sales = Variable expenses + Fixed expenses + Profits

$500Q = $300Q + $80,000 + $0

$200Q = $80,000
Q = $80,000 ÷ $200 per bike
Q = 400 bikes
 CONTRIBUTION MARGIN METHOD

The contribution margin method has

two key equations.

Break-even point Fixed expenses

=
in units sold CM per unit

Break-even point in Fixed expenses

total sales dollars = CM ratio
 CONTRIBUTION MARGIN METHOD

Let’s use the contribution margin method to calculate

the break-even point in total sales dollars

Break-even point in Fixed expenses

total sales dollars = CM ratio

$80,000 = $200,000 break-even sales

40%
 Coffee klatch is an espresso stand in a
downtown office building. The average selling
price of a cup of coffee is $1.49 and the
average variable expense per cup is $0.36.
The average fixed expense per month is
$1,300. 2,100 cups are sold each month on
average. What is the break-even sales in
units? Fixed expenses
Break-even =
a. 872 cups CM per Unit
$1,300
B. 3,611 cups =
C. 1,200 cups
$1.49/cup - $0.36/cup
= $1,300
D. 1,150 cups
$1.13/cup
= 1,150 cups
Coffee klatch is an espresso stand in a
downtown office building. The average selling
price of a cup of coffee is $1.49 and the
average variable expense per cup is $0.36. The
average fixed expense per month is $1,300.
2,100 cups are sold each month on average.
What is the break-even sales in dollars?
A. $1,300
B. $1,715 Break-even Fixed expenses
=
C. $1,788 sales CM Ratio
$1,300
D. $3,129 =
0.758
= $1,715
 TARGET PROFIT ANALYSIS
Suppose Ranold company wants to know how many
units must be sold to earn a profit of $100,000.
CVP EQUATION
METHOD
Sales = Variable expenses + Fixed expenses +
Profits
$500Q = $300Q + $80,000 + $100,000

$200Q = $180,000

Q = 900 bikes
 CONTRIBUTION MARGIN
METHOD

Unit sales to attain Fixed expenses + Target profit

=
the target profit CM per unit

$80,000 + $100,000
= 900 bikes
$200/bike
Coffee klatch is an espresso stand in a downtown
office building. The average selling price of a cup
of coffee is $1.49 and the average variable
expense per cup is $0.36. The average fixed
expense per month is $1,300. How many cups of
coffee would have to be sold to attain target
profits of $2,500 per month?Unit sales
= Fixed expenses + Target profit
A. 3,363 cups to attain Unit CM
B. 2,212 cups target profit $1,300 + $2,500
C. 1,150 cups
=
$1.49 - $0.36
D. 4,200 cups = $3,800
$1.13
= 3,363 cups
 Margin of safety
Margin of safety is defined as the difference between total
sales & break-even sales.

Margin of safety = Total sales – break-even sales

In case of prev. Example of dbl group, total sales = 500 unit & break even sales
= 400 unit

So, margin of safety= 500-400= 100 unit

Margin of safety percentage = 100/500= 20%

Coffee klatch is an espresso stand in a downtown
office building. The average selling price of a cup
of coffee is $1.49 and the average variable
expense per cup is $0.36. The average fixed
expense per month is $1,300. 2,100 cups are sold
each month on average. What is the margin of
safety?
A. 3,250 cups
B. 950 cups Margin of safety = Total sales – Break-even sales
C. 1,150 cups
= 2,100 cups – 1,150 cups
D. 2,100 cups
= 950 cups
or
Margin of safety 950 cups
= 2,100 cups = 45%
percentage
 OPERATING LEVERAGE
A measure of how sensitive net operating income is to
percentage changes in sales.

Degree of Contribution margin

=
operating leverage Net operating income

$100,000 = 5
$20,000
 Operating Leverage

With an operating leverage of 5, if the company increases its sales

by 10%, net operating income would increase by 50%.

Percent increase in sales 10%

Degree of operating leverage × 5
Percent increase in profits 50%

Here’s the verification!

 Operating Leverage
Actual sales Increased
(500) sales (550)
Sales $ 250,000 $ 275,000
Less variable expenses 150,000 165,000
Contribution margin 100,000 110,000
Less fixed expenses 80,000 80,000
Net operating income $ 20,000 $ 30,000

10% increase in sales from

$250,000 to $275,000 . . .
. . . results in a 50% increase in
income from $20,000 to $30,000.
 MATH PRACTICE
Voltar company manufactures and sells a specialized cordless
telephone for high electromagnetic radiation environments.
The company’s contribution format income statement for
the most recent year is given below:
Management is anxious to increase the company’s profit and
has asked for an analysis of a number of items.
Required:
1. Compute the company’s CM ratio and variable expense
ratio.
2. Compute the company’s break-even point in both units and
sales dollars. Use the equation method.
3. Assume that sales increase by $400,000 next year. If cost
behavior patterns remain unchanged, by how much will the
company’s contribution margin increase? Use the CM ratio
to compute your answer.
4. Refer to the original data. Assume that next year
management wants the company to earn a profit of at least
$90,000. How many units will have to be sold to meet this
target profit?
5. Refer to the original data. Compute the company’s margin
of safety in both dollar and percentage form.
6. a. Compute the company’s degree of operating leverage at the present
level of sales.
b. Assume that through a more intense effort by the sales staff, the company’s
sales increase by 8% next year. By what percentage would you expect net
operating income to increase? Use the degree of operating leverage to
obtain your answer.
c. Verify your answer to ( b ) by preparing a new contribution format income
statement showing an 8% increase in sales.

7. In an effort to increase sales and profits, management is considering the

use of a higher- quality speaker. The higher-quality speaker would increase
variable costs by $3 per unit, but management could eliminate one quality
inspector who is paid a salary of $30,000 per year. The sales manager
estimates that the higher-quality speaker would increase annual sales by at
least 20%.

a. Assuming that changes are made as described above, prepare a projected

contribution format
income statement for next year. Show data on a total, per unit, and
percentage basis.
b. Compute the company’s new break-even point in both units and dollars of
Thank you for your patience