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Chapter 21: Problem 5

Intuit Inc. develops and sells software products for the personal finance market, including popular titles such as Quicken and TurboTax \(^{\circledast}\). Classify each of the following costs and expenses for this company as either variable or fixed to the number of units produced and sold: a. Shipping expenses b. Property taxes on general offices c. Straight-line depreciation of computer equipment d. Salaries of human resources personnel e. President's salary f. Advertising g. Sales commissions h. CDs i. Packaging costs j. Salaries of software developers k. Wages of telephone order assistants 1\. User's guides

Short Answer

Expert verified
Fixed: b, c, d, e, f, j; Variable: a, g, h, i, k, l.

Step by step solution

01

Understanding Fixed Costs

Fixed costs are expenses that do not change with the level of production or sales volume. These costs remain constant regardless of how many units are produced or sold.
02

Identifying Fixed Costs

Let's categorize the fixed costs: - Property taxes on general offices (b): These taxes are fixed regardless of output. - Straight-line depreciation of computer equipment (c): Depreciation is a fixed expense as it does not change with production. - Salaries of human resources personnel (d): Typically, these salaries do not fluctuate with production levels. - President's salary (e): This salary is a fixed cost that is not tied to production. - Advertising (f): Usually, a set budget regardless of how much product is sold. - Salaries of software developers (j): These are generally fixed as they might be paid the same regardless of workload.
03

Understanding Variable Costs

Variable costs change in direct proportion to the number of units produced or sold. The more units produced, the higher the variable costs.
04

Identifying Variable Costs

Let's categorize the variable costs: - Shipping expenses (a): These increase with the number of units sold. - Sales commissions (g): Typically a percentage of sales, so they rise with more sales. - CDs (h): The cost is directly related to the number of units produced and sold. - Packaging costs (i): Directly tied to how much product is manufactured and sold. - Wages of telephone order assistants (k): If based on the number of calls/orders received, they can be variable. - User鈥檚 guides (l): Cost varies with the number of products sold, as each product might have a guide.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Variable Costs in Accounting
Variable costs are those expenses that change based on the level of production or sales activity. In other words, the more you produce or sell, the higher these costs will be. Imagine you are in charge of shipping expenses for a software company. Every time a software package is sold, the cost of shipping it to a customer will increase. Some common examples of variable costs include:
  • Shipping expenses: As sales increase, so do the costs of delivering products to customers.
  • Sales commissions: These are often a percentage of each sale, so the more you sell, the higher the total commission payout will be.
  • Cost of CDs: In software companies, if they sell downloadable software and also provide CDs, the more they sell, the more CDs are produced, which increases costs.
  • Packaging costs: More products sold means more packaging used.
  • User鈥檚 guides: Each product might come with a guide; selling more products increases these costs.
Variable costs are essential to understand because they affect profit margins directly. Keeping track of these costs helps a business forecast how much it must sell to cover its expenses.
Fixed Costs in Accounting
Fixed costs are expenses that remain constant, regardless of how much a company produces or sells. For example, let's say you run a software company out of an office building. The property taxes on that office remain the same whether you sell one or one thousand software packages. Key examples of fixed costs include:
  • Property taxes: These do not fluctuate with production levels and are due regardless of sales.
  • Straight-line depreciation: This method of depreciation allocates an equal amount of the asset鈥檚 cost over its useful life, remaining consistent year after year.
  • Salaries of human resources personnel: These staff members are usually on a fixed payroll, independent of how many products the company sells.
  • President鈥檚 salary: Often contractually fixed, this does not vary with sales volume.
  • Advertising expenses: A set budget may be allocated annually, which doesn鈥檛 change based on the number of units sold.
  • Salaries of software developers: Many developers are salaried employees, meaning their compensation isn鈥檛 tied to the number of products sold.
Understanding fixed costs is critical in managing and planning a company's finances as these costs need to be paid regardless of the business鈥檚 sales performance.
Variable and Fixed Costs in the Software Industry
The software industry has unique characteristics when it comes to cost structures. Given the digital nature of many products, distinguishing between fixed and variable costs helps maintain profitability.
  • Fixed Costs: For a software company, fixed expenses are made up mostly of salaries (development and management), office costs like rent and utilities, and capital investments such as technological infrastructure.
  • Variable Costs: In contrast, CDs, packaging for physical copies, and cloud service expenses (which increase based on user data) are typical variable costs. Additionally, marketing efforts that ramp up or down based on sales targets can become more variable over time.
The software industry must carefully balance these costs because software products can sometimes have low variable costs. In fact, once software is developed, distributing additional copies may incur minimal extra expenses, increasing profit margins rapidly once fixed costs are covered.
Accounting Education Basics
An essential part of accounting education involves learning how to classify costs. It's important for students to distinguish between fixed and variable costs to make informed financial decisions and forecasts.

The Goals of Accounting Education

Accounting courses aim to:
  • Teach the ability to analyze and categorize different cost types.
  • Ensure students understand the impact of these costs on a company鈥檚 finances.
  • Help students learn strategies to manage and minimize costs.
  • Prepare students for real-world scenarios where making quick, accurate financial decisions is crucial.
By mastering cost classification and other fundamental concepts, accounting students are well-prepared to contribute to an organization鈥檚 costing strategies and financial planning. Having a grasp of how variable and fixed costs interact helps students develop the analytic skills necessary for success in any financial management role.

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Most popular questions from this chapter

a. Bert Company budgets sales of \(\$ 1,250,000\), fixed costs of \(\$ 450,000\), and variable costs of \(\$ 200,000\). What is the contribution margin ratio for Bert Company? b. If the contribution margin ratio for Ernie Company is \(40 \%\), sales were \(\$ 750,000\), and fixed costs were \(\$ 225,000\), what was the income from operations?

a. If Fama Company, with a break-even point at \(\$ 360,000\) of sales, has actual sales of \(\$ 480,000\), what is the margin of safety expressed (1) in dollars and (2) as a percentage of sales? b. If the margin of safety for Watkins Company was \(25 \%\), fixed costs were \(\$ 1,200,000\), and variable costs were \(75 \%\) of sales, what was the amount of actual sales (dollars)?

For the current year ending March 31 , Jwork Company expects fixed costs of \(\$ 440,000\), a unit variable cost of \(\$ 50\), and a unit selling price of \(\$ 75\). a. Compute the anticipated break-even sales (units). b. Compute the sales (units) required to realize income from operations of \(\$ 90,000\).

Media outlets such as ESPN and Fox Sports often have Web sites that provide in-depth coverage of news and events. Portions of these Web sites are restricted to members who pay a monthly subscription to gain access to exclusive news and commentary. These Web sites typically offer a free trial period to introduce viewers to the Web site. Assume that during a recent fiscal year, ESPN.com spent \(\$ 1,800,000\) on a promotional campaign for the ESPN.com Web site that offered two free months of service for new subscribers. In addition, assume the following information: \(\begin{array}{ll}\text { Number of months an average new customer stays with the } & \\ \text { service (including the two free months) } & 25 \text { months } \\ \text { Revenue per month per customer subscription } & \$ 10.00 \\\ \text { Variable cost per month per customer subscription } & \$ 2.00\end{array}\) Determine the number of new customer accounts needed to break even on the cost of the promotional campaign. In forming your answer, (1) treat the cost of the promotional campaign as a fixed cost, and (2) treat the revenue less variable cost per account for the subscription period as the unit contribution margin.

Currently, the unit selling price of a product is \(\$ 280\), the unit variable cost is \(\$ 230\), and the total fixed costs are \(\$ 525,000\). A proposal is being evaluated to increase the unit selling price to \(\$ 300\). a. Compute the current break-even sales (units). b. Compute the anticipated break-even sales (units), assuming that the unit selling price is increased and all costs remain constant.
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