Costs and Net Operating Income
Exchange Corp. is a company that acts as a facilitator in tax-favored real estate swaps. Such swaps, know as 1031 exchanges, permit participants to avoid some or all of the capital gains taxes that would otherwise be due. The bookkeeper for the company has been asked to prepare a report for the company to help its owner/manager analyze performance. The first such report appears below:
Note that the revenues and costs in the above report are unit revenues and costs. For example, the average office expense is $135 per exchange completed on the planning budget; whereas, the average actual office expense is $112 per exchange completed.
Legal and search fees is a variable cost; office expenses is a mixed cost; and equipment depreciation, rent, and insurance are fixed costs. In the planning budget, the fixed component of office expenses was $5,200.
All of the company’s revenues come from fees collected when an exchange is completed.
Required:
1. Evaluate the report prepared by the bookkeeper.
2. Prepare a performance report that would help the owner/manager assess the performance of the company in May.
3. Using the report you created, evaluate the performance of the company in May.
SOLUTION:
1. The report prepared by the bookkeeper compares average budgeted per unit revenues and costs to average actual per unit revenues and costs. This approach implicitly assumes that all costs are strictly variable; only variable costs should be constant on a per unit basis. The average fixed cost should decrease as the level of activity increases and should increase as the level of activity decreases. In this case, the actual level of activity was greater than the budgeted level of activity. As a consequence, the average cost per unit for any cost that is fixed or mixed (such as office expenses, equipment depreciation, rent, and insurance) should decline and show a favorable variance. This makes it difficult to interpret the variance for a mixed or fixed cost.
Note that the revenues and costs in the above report are unit revenues and costs. For example, the average office expense is $135 per exchange completed on the planning budget; whereas, the average actual office expense is $112 per exchange completed.
Legal and search fees is a variable cost; office expenses is a mixed cost; and equipment depreciation, rent, and insurance are fixed costs. In the planning budget, the fixed component of office expenses was $5,200.
All of the company’s revenues come from fees collected when an exchange is completed.
Required:
1. Evaluate the report prepared by the bookkeeper.
2. Prepare a performance report that would help the owner/manager assess the performance of the company in May.
3. Using the report you created, evaluate the performance of the company in May.
SOLUTION:
1. The report prepared by the bookkeeper compares average budgeted per unit revenues and costs to average actual per unit revenues and costs. This approach implicitly assumes that all costs are strictly variable; only variable costs should be constant on a per unit basis. The average fixed cost should decrease as the level of activity increases and should increase as the level of activity decreases. In this case, the actual level of activity was greater than the budgeted level of activity. As a consequence, the average cost per unit for any cost that is fixed or mixed (such as office expenses, equipment depreciation, rent, and insurance) should decline and show a favorable variance. This makes it difficult to interpret the variance for a mixed or fixed cost.