Lancer Audio produces a high end DVD player that sells for $1,250. Total operati

Question

Lancer Audio produces a high end DVD player that sells for $1,250. Total operating expenses for July were as follows:

Month Units produced and sold Cost
August 125 $112,670
September 145 121,990
October 150 129,500
November 160 131,500
December 165 139,700
January 140 117,400
February 145 125,600
March 135 115,400
April 130 116,140
May 135 119,220
June 145 121,700
July 140 119,050

Required

A. Use the high-low method to estimate fixed and variable costs.
B. Based on these estimates, calculate the break-even level of sales in units.
C. Calculate the margin of safety for the coming August assuming estimated sales of 160 units.
D. Estimate total profit assuming production and sales of 160 units.
E. Comment on the limitations of the high-low method in estimating costs for Lancer Audio.

Explanation / Answer

a.Use the high-low method to estimate fixed and variable costs.
                          
                                Units          Cost
High                          165        $139,700
Low                        125        $112,670
Difference                   40          $27,030
Variable cots per unit
$27,030 / 40                            $675.75

Fixed costs = $139,700 - (165 x $675.75) = $28,202
Alternatively,
Fixed costs = $112,670 - (125 x $675.75) = $28,202

b.Based on these estimates, calculate the break-even level of sales in units.
   Contribution per unit = $1,250 - $675.75 = $574.25
   BEP(units) = $28,202 / $574.25 = 50 units

c.Calculate the margin of safety for the coming August assuming estimated sales of 160 units.
     Total sales 160 x $1,250          $200,000
      Less : Break even sales
              ($28,202 + $108,120)     $136,322
     Margin of safety                      $63,778

d.Estimate total profit assuming production and sales of 160 units.
      Contribution 160 x $574.25     $91,880
      Less : Fixed costs                  $28,202
         Total profit                        $63,678

e.Comment on the limitations of the high-low method in estimating costs for Lancer Audio.
    1) High-low method does not provide us with a measure of “goodness-of-fit
    2) Relies on only two points, and the selection of those two points requires judgment (that is, it discards
        most of the data).

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