Problem 14 - Accounting Principles

Question

Cournot Company sells 100,000 wrenches for \(\$ 12\) a unit. Fixed costs are \(\$ 300,000\), and net income is \(\$ 200,000\). What should be reported as variable expenses in the CVP income statement? (a) \(\$ 700,000\). (c) \(\$ 500,000\). (b) \(\$ 900,000\). (d) \(\$ 1,000,000\).

Step-by-Step Solution

Answer

(a) $700,000.

Step 1: Calculate Total Sales Revenue

Total sales revenue can be calculated by multiplying the number of wrenches sold by the price per unit. So, the total sales revenue = 100,000 wrenches \( \times 12 \) = \( \$ 1,200,000 \).

Step 2: Calculate Total Costs

Net income is derived from subtracting total costs from total sales revenue. Total costs = Total sales revenue - Net income.\[\text{Total Costs} = \\( 1,200,000 - \\) 200,000 = \$ 1,000,000\]

Step 3: Determine Total Variable Expenses

To find total variable expenses, subtract fixed costs from total costs. \[\text{Variable Expenses} = \text{Total Costs} - \text{Fixed Costs} = \\( 1,000,000 - \\) 300,000 = \$ 700,000\]

Step 4: Compare to Given Options

The calculated variable expenses, \( \\( 700,000 \), match option (a). Thus, the variable expenses reported in the CVP income statement should be \( \\) 700,000 \).

Key Concepts

Fixed Costs

Fixed costs are a fundamental part of cost-volume-profit analysis. They are the expenses that do not change regardless of how many units you produce or sell. In Cournot Company's case, their fixed costs are reported as \(300,000. This means that whether they sell one wrench or one hundred thousand wrenches, the costs that fall under this category remain constant.
\[\text{Fixed Costs} = \\)300,000\]
Fixed costs typically include expenditures like rent, salaries of permanent staff, and insurance. These are costs that a company must pay regardless of its level of production or sales activity. It is critical for businesses to accurately identify their fixed costs to better understand their breakeven point and profitability.

Variable Expenses

Variable expenses vary directly with the level of production or sales. They are the costs that increase or decrease with the business activity volume. In the Cournot Company scenario, they need to find out how much of their total production costs are variable.
To calculate variable expenses, we first looked at the total costs, which include both fixed and variable expenses. With a total of \(1,000,000 in costs and known fixed costs of \)300,000, the variable expenses can be calculated as:
\[\text{Variable Expenses} = \text{Total Costs} - \text{Fixed Costs} = \\(1,000,000 - \\)300,000 = \\(700,000\]
The value of \)700,000 represents the expenses directly linked to the units produced and sold. This would include costs like raw materials, direct labor, and other variable factors. Understanding variable expenses helps businesses adjust operations and manage profits effectively.

Net Income

Net income, often referred to as the bottom line, is the profit a company makes after all expenses have been deducted from total revenues. For Cournot Company, with sales of 100,000 wrenches at \(12 each, the net income is provided as \)200,000.
To find net income, subtract the total costs from total sales revenue. In this situation, this calculation is:
\[\text{Net Income} = \text{Total Sales Revenue} - \text{Total Costs} = \\(1,200,000 - \\)1,000,000 = \$200,000\]
Net income signifies the financial health of a company. A positive net income suggests that the company is running profitably, whereas a negative value indicates losses. For students analyzing such problems, understanding net income allows insights into the economic efficiency and viability of business operations.