Reference no: EM132843435

Question - John Ranton, president and founder of Running Mate, could hardly contain his excitement over the operating results for his company's second year of operations. Running Mate is an online retailer of a GPS running watch that records distance, time, speed, heart rate, and a number of other statistics. Ranton's company does not manufacture the watches, but instead purchases them directly from the manufacturer based in China and resells them through its online shopping site. During the first two years of operation, Ranton decided to hold the selling price of the watch constant at $100 per unit in an effort to attract business. He was also able to negotiate a deal with the supplier to hold Running Mate's cost per watch constant at $80 per unit for the two years.

Operating expenses for each of the first two years of operation consist only of advertising expenses and the salaries paid to the website designer/administrator and the company's bookkeeper. Because Ranton is busy with his numerous other business ventures, the bookkeeper also looks after the day-to-day operations of Running Mate and has sole signing authority to make expenditures on the company's behalf. To motivate his website designer to create a website that is easy to use and appealing to customers, Ranton decided to pay her a commission equal to 1% of annual sales in both 2017 and 2018. The salaries paid to the website administrator and the bookkeeper were the same in both years and totalled $92,000. Annual advertising expenses of $8,000 were also the same in both years.

After reviewing the operating results for 2017 (shown below), Ranton roughly calculated the expected sales and expenses for 2018 based on anticipated sales of 10,000 watches at a price of $100 per unit and a cost of $80 per unit. He calculated expected operating expenses in 2018 based on the 2017 cost per unit of $13.50 ($108,000 ÷ 8,000). Based on his calculations (shown below), Ranton expected a 25% improvement in 2018 operating income, in keeping with the increase in unit sales. So, when Running Mate's bookkeeper provided Ranton with the actual results shown below for 2018, he was thrilled. Operating income had improved 44% compared to 2017 on sales growth of 25%.

Ranton has always been an entrepreneur at heart but has no formal training in financial accounting or management accounting. He has always had the bookkeeper to make annual financial statements.

Required -

When Ranton calculated the expected operating expenses for 2018, he made a commonly seen error. In terms of cost behaviour, what was the nature of the error?

To illustrate the error, in Excel, draw a small graph showing cost behaviour.

Recalculate the 2018 expected and actual results based on your understanding of the operations of Running Mate. Present your calculations in a similar format to the above table.

Make another table to compare your results to the actual numbers prepared by the bookkeeper. Do you have any questions for the bookkeeper?

Prepare the expected results for 2019, based on the following new information. Unit sales 12,000; new advertising $10,000 per year, new combined salaries, $94,000. Ranton expects the selling price and the imported cost of the watches to remain the same.

Draw line chart of the actual 2017 and 2018 results and the expected 2019 results with unit sales on the horizontal axis and dollars on the vertical axis. Use a solid green line for sales dollars, a dashed red line for fixed expenses, and a dotted blue line for variable expenses.