Cost Behavior and Cost-Volume-Profit Analysis

Located on Swiftcurrent 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 Native 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 canoe and paddles for use in self­guided tours of Swiftcurrent 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:

Required:
1. High­Low Cost Estimation Method
a. Use the high­low method to estimate the per­unit variable costs and total fixed costs for the canoe product line.
Variable cost per unit
$
Total fixed cost

$

b. Use the high­low method to estimate the per­unit variable costs and total fixed costs for the paddle product line.
Variable cost per unit
$
Total fixed cost

$

2. Cost­Volume­Profit Analysis, Single­Product Setting
Use CVP analysis to calculate the break­even point in units for

a. The canoe product line only (i.e., single­product setting)
BE units
canoes
b. The paddle product line only (i.e., single­product setting)
BE units
paddles
3. Cost­Volume­Profit Analysis, Multiple­Product 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 this multiple­product 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 break­even point in units for both the canoe and paddle product lines combined (i.e., the multiple­
product setting).
Canoe BE units
canoes
Paddle BE units

paddles

4. Cost Classification
a. Classify the manufacturing costs, marketing costs, and customer service hotline costs either as production
expenses or period expenses.
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b. For the period expenses, further classify them into either selling expenses or general and administrative expenses.
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5. Sensitivity Cost­Volume­Profit Analysis and Production Versus Period Expenses, Multiple­Product 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 high­low 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, and if required, round the number of packages in intermediate calculations up to the nearest
whole number (for example, 10.1 would round up to 11).
Canoe target income units
canoes
Paddle target income units

paddles

6. Margin of Safety
Calculate the margin of safety (both in units and in sales dollars) for Many Glacier Hotel, assuming the same facts as
in Requirement 3, and assuming it sells 700 canoes and 2,500 paddles next year.
total MOS units above total BE units
$ MOS in sales dollars

Cost System Choices, Budgeting, and Variance Analyses for Sacred Heart Hospital
The Two Cost Systems
Sacred Heart Hospital (SHH) faces skyrocketing nursing costs, all of which relate to its two biggest nursing service
lines—the Emergency Room (ER) and the Operating Room (OR). SHH’s current cost system assigns total nursing
costs to the ER and OR based on the number of patients serviced by each line. Total hospital annual nursing costs for
these two lines are expected to equal $300,000. The table below shows expected patient volume for both lines.

Required:
1. Using the current cost system, calculate the hospital­wide rate based on number of patients.
$ per patient
2. Calculate the amount of nursing costs that the current cost system assigns to the ER and to the OR.
The nursing cost, assigned to the ER
$
The nursing cost, assigned to the OR

$

3. Using the results from Requirement 2, calculate the cost per OR nursing hour under the current cost system.
$ per OR hour
After discussion with several experienced nurses, Jack Bauer (SHH’s accountant) decided that assigning nursing
costs to the two service lines based on the number of times that nurses must check patients’ vital signs might more
closely match the underlying use of costly hospital resources. Therefore, for comparative purposes, Jack decided to
develop a second cost system on his computer that assigns total nursing costs to the ER and OR based on the
number of times nurses check patients’ vital signs. This system is referred to as the “vital­signs costing system”. The
earlier table also shows data for vital signs checks for lines.
4. Using the vital­signs costing system, calculate the hospital­wide rate based on the number of vital signs checks.
$ per vital signs check
5. Calculate the amount of nursing costs that the vital­signs costing system assigns to the ER and to the OR.
The vital­signs cost, assigned to the ER
$
The vital­signs cost, assigned to the OR

$

6. Using the results from Requirement 5, calculate the cost per OR nursing hour under the vital­signs costing
system.
$ per OR hour
Budgeting and Variance Analysis
In an effort to better plan for and control OR costs, SHH management asked Jack to calculate the flexible budget
variance (i.e., flexible budget costs­actual costs) for OR nursing costs, including the price variance and efficiency
variance that make up the flexible budget variance for OR nursing costs. Given that Jack is interested in comparing
the reported costs of both systems, he decided to prepare the requested OR variance analysis for both the current
cost system and the vital signs costing system. In addition, Jack chose to use each cost system’s estimate of the cost
per OR nursing hour as the standard cost per OR nursing hour. Jack collected the following additional information for
use in preparing the flexible budget variance for both systems:
Actual number of surgeries performed = 950
Standard number of nursing hours allowed for each OR surgery = 5
Actual number of OR nursing hours used = 5,000
Actual OR nursing costs = $190,000
If there is no variance, enter “0” and select “No variance” from the dropdown.
7. For the OR service line, use the information above and the cost per OR nursing hour under the current cost system
to calculate the
a.
flexible budget variance. (Hint: Use your answer to Requirement 3 as the standard cost per OR nursing hour
for the current cost system.)
$
b.
price variance.
$
c.
efficiency variance.

$
8. For the OR service line, use the information above and the cost per OR nursing hour under the vital signs cost
system to calculate the
a.
flexible budget variance. (Hint: Use your answer to Requirement 6 as the standard cost per OR nursing hour
for the vital signs cost system.)
$
b.
price variance.
$
c.
efficiency variance.
$
Discussion of Reported Costs and Variances from the Two Systems
9. Consider SHH’s need to control its skyrocketing costs, Jack’s discussion with experienced nurses regarding their
use of hospital resources, and the reported costs that you calculated from each cost system. Based on these
considerations, which cost system (current or vital signs) should Jack choose? Briefly explain the reasoning behind
your choice.
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10. What does each of the calculated variances suggest to Jack regarding actions that he should or should not take
with respect to investigating and improving each variance? Also, briefly explain why the variances differ between the
two cost systems.
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Relevant Costing, Cost­Based Pricing, Cost Behavior, and Net Present Value Analysis for NoFat
Special Sales Offer Relevant Analysis
NoFat manufactures one product, olestra, and sells it to large potato chip manufacturers as the key ingredient in
nonfat snack foods, including Ruffles, Lays, Doritos, and Tostitos brand products. For each of the past 3 years, sales
of olestra have been far less than the expected annual volume of 125,000 pounds. Therefore, the company has
ended each year with significant unused capacity. Due to a short shelf life, NoFat must sell every pound of olestra
that it produces each year. As a result, NoFat’s controller, Allyson Ashley, has decided to seek out potential special
sales offers from other companies. One company, Patterson Union (PU)—a toxic waste cleanup company—offered
to buy 10,000 pounds of olestra from NoFat during December for a price of $2.20 per pound. PU discovered through
its research that olestra has proven to be very effective in cleaning up toxic waste locations designated as Superfund
Sites by the U.S. Environmental Protection Agency. Allyson was excited, noting that “This is another way to use our
expensive olestra plant!”
The annual costs incurred by NoFat to produce and sell 100,000 pounds of olestra are as follows:



In addition, Allyson met with several of NoFat’s key production managers and discovered the following information:
 The special order could be produced without incurring any additional marketing or customer service costs.
NoFat owns the aging plant facility that it uses to manufacture olestra.





NoFat incurs costs to set up and clean its machines for each production run, or batch, of olestra that it
produces. The total set­up costs shown in the previous table represent the production of 20 batches during the year.
NoFat leases its plant machinery. The lease agreement is negotiated and signed on the first day of each
year. NoFat currently leases enough machinery to produce 125,000 pounds of olestra.
PU requires that an independent quality team inspects any facility from which it makes purchases. The
terms of the special sales offer would require NoFat to bear the $1,000 cost of the inspection team.
Required:
1. Conduct a relevant analysis of the special sales offer by calculating the following:
a. The relevant revenues associated with the special sales offer
$
b. The relevant costs associated with the special sales offer
$
c. The relevant profit associated with the special sales offer (Enter loss, if any, as negative amount.)
$
2. Based solely on financial factors, explain why NoFat should accept or reject PU’s special sales offer.
NoFat should PU’s special sales offer.
Explain.
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3. Describe at least one qualitative factor that NoFat should consider, in addition to the financial factors, in making its
final decision regarding the acceptance or rejection of the special sales offer.
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Cost­Based Pricing
Assume that NoFat rejected PU’s special sales offer because the $2.20 price suggested by PU was too low. In
response to the rejection, PU asked NoFat to determine the price at which it would be willing to accept the special
sales offer. For its regular sales, NoFat sets prices by marking up variable costs by 10%.
4. If Allyson decides to use NoFat’s 10% mark­up pricing method to set the price for PU’s special sales offer,
a. Calculate the price that NoFat would charge PU for each pound of olestra. Round your answer to the nearest cent.
$ per unit
b. Calculate the relevant profit that NoFat would earn if it set the special sales price by using its mark­up pricing
method. Enter loss, if any, as negative amount. (Hint: Use the estimate of relevant costs that you calculated in
response to Requirement 1b.)
$
c. Explain why NoFat should accept or reject the special sales offer if it uses its mark­up pricing method to set the
special sales price.
NoFat should PU’s special sales offer.
Explain.
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

Incorporating a Long­Term Horizon into the Decision Analysis
Assume that Allyson’s relevant analysis reveals that NoFat would earn a positive relevant profit of $10,000 from the
special sale (i.e., the special sales alternative). However, after conducting this traditional, short­term relevant
analysis, Allyson wonders whether it might be more profitable over the long­term to downsize the company by
reducing its manufacturing capacity (i.e., its plant machinery and plant facility). She is aware that downsizing requires
a multiyear time horizon because companies usually cannot increase or decrease fixed plant assets every year.
Therefore, Allyson has decided to use a 5­year time horizon in her long­term decision analysis. She has identified the
following information regarding capacity downsizing (i.e., the downsizing alternative):
 The plant facility consists of several buildings. If it chooses to downsize its capacity, NoFat can immediately
sell one of the buildings to an adjacent business for $30,000.
If it chooses to downsize its capacity, NoFat’s annual lease cost for plant machinery will decrease to $9,000.
Therefore, Allyson must choose between these two alternatives: Accept the special sales offer each year and earn a
$10,000 relevant profit for each of the next 5 years or reject the special sales offer and downsize as described above.

5. Assume that NoFat pays for all costs with cash. Also, assume a 10% discount rate, a 5­year time horizon, and all
cash flows occur at the end of the year. Use an NPV approach to discount future cash flows to present value. To
determine NPV, use the Exhibit to locate the present value of $1 to be multiplied by the cash inflow in Year 1.
a. Calculate the NPV of accepting the special sale with the assumed positive relevant profit of $10,000 per year (i.e.,
the special sales alternative). Round your answer to the nearest dollar.
$
b. Calculate the NPV of downsizing capacity as previously described (i.e., the downsizing alternative). Round your
answer to the nearest dollar.
$
c. Based on the NPV of Calculations a and b, identify and explain which of these two alternatives is best for NoFat to
pursue in the long term.
The is best for NoFat to pursue in the long term.
Explain.
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