Virginia Company, a merchandising firm, operated five sales offices last year at a total cost of $500,000, of which $70,000 represented fixed costs. Virginia has determined that total costs are significantly influenced by the number of sales offices operated. Last year's costs and number of sales offices can be used as the basis for predicting annual costs. What would be the budgeted cost for the coming year if Virginia were to operate seven sales offices? (CPA adapted)

a. $586,000

b. $602,000

c. $700,000

d. $672,000

d. $672,000

Explanation:

In order to find the total budgeted cost of seven sales offices we need to break down the total cost of five sales offices and separate variable and fixed costs. The formula for total cost is as follows:

Total Cost = variable cost + fixed cost.

First we compute variable cost per sales office then calculate total variable costs of seven offices and add them up to find total budgeted cost.

The total cost of five sales offices = $500000 of which $70000 is fixed cost.

If we rearrange the formula of total cost we get total variable cost as follows:

$500000 = total variable cost + $70000

Total variable cost = $500000 - $70000

TVC = $430000

Now we calculate variable cost per sales office as follows;

Variable cost/sales office = $430000: 5

Variable cost/sales office = $86000

Now that we have variable cost per sales office and fixed cost, we calculate total budgeted cost of seven sales offices.

(Remember! Fixed costs are period costs and don't change as a result of increase in output therefore fixed costs will remain constant for the period.)

Lets calculate budgeted cost for the coming year.

TC = (VC * UNITS) + FIXED COST

Total Budgeted cost of seven sales offices = ($86000*7) + $70000

TC = $672000