Question One - Cost Behaviour, High-Low Method, Pricing Decision
Fonseca, Ruiz, and Dunn is a large, local accounting firm located in downtown Toronto. Carlos Ruiz, one of the firm's founders, appreciates the success his firm has enjoyed and wants to give something back to his community. He believes that an inexpensive accounting services clinic could provide basic accounting services for small businesses located in a working-class neighbourhood. He wants to price the services at cost.
Since the clinic is brand new, it has no experience to go on. Cabs decided to operate the clinic for two months before determining how much to charge per hour on an ongoing basis. As a temporary measure, the clinic adopted an hourly charge of $25, half the amount charged by Fonseca, Ruiz, and Dunn for professional services.
The accounting services clinic opened on January 1. During January, the clinic had 120 hours of professional service. During February, the activity was 150 hours. Costs for these two levels of activity usage are as follows:
120 Professional Hours ($) 150 Professional Hours ($)
Salaries:
Senior accountant 2,500 2,500
Office assistant 1,200 1,200
Internet and software
subscriptions 700 850
Consulting by senior partner 1,200 1,500
Depreciation (equipment) 2,400 2,400
Supplies 905 1,100
Administration 500 500
Rent (offices) 2,000 2,000
Utilities 332 365
Required:
1. Classify each cost as fixed, variable, or mixed, using hours of professional service as the activity driver.
2. Use the high-low method to separate the mixed costs into their fixed and variable components.
3. Luz Montage, the chief paraprofessional of the clinic, has estimated that the clinic will average 140 professional hours per month. If the clinic is to be operated as a not-for-profit organization, how much will it need to charge per professional hour? How much of this charge is variable? How much is fixed?
4. Suppose the accounting centre averages 170 professional hours per month. How much would need to be charged per hour for the centre to cover its costs? Explain why the per-hour charge decreased as the activity output increased.
Question Two - Variable and Fixed Costs, Cost Formula, High-Low Method
Li Ming Yuan and Tiffany Shaden are the department heads for the accounting department and human resources department respectively at a Montreal textile firm. They have just returned from an executive meeting at which the necessity of cutting costs and gaining efficiency has been stressed. After talking with Tiffany and some of her staff members, as well as his own staff members, Li Ming discovered that there were a number of costs associated with the claims processing activity. These costs included the salaries of the two paralegals who worked full-time on claims processing; the salary of the accountant who cut the cheques; the cost of claims forms, cheques, envelopes, and postage; and depreciation on the office equipment dedicated to the processing. Some of the paralegals' time is spent in the routine processing of uncontested claims, but much time is spent on the claims that have incomplete documentation or are contested. The accountant's time appears to vary with the number of claims processed.
Li Ming was able to separate the costs of processing claims from the costs of running the departments of accounting and human resources. He gathered the data on claims processing cost and the number of claims processed per month for the past six months. These data are as follows:
Month Claims Processing Cost ($) Number of Claims Processed
February 34,907 5,700
March 31,260 4,900
April 37,950 6,100
May 38,250 6,500
June 44,895 7,930
July 44,055 7,514
Required:
1. Classify the claims processing costs that Li Ming identified as variable and fixed
2. What is the independent variable The dependent variable.
3. Use the high-low method to find the fixed cost per month and the variable rate. What is the cost formula?
4. Suppose that an outside company bids on the claims processing business The bid price is $4.60 per claim. If Tiffany expects 75,600 claims next year, should she out- source the claims processing or continue to do it in house?