Horngren's Cost Accounting A Managerial Emphasis, 9th Canadian Edition By Srikant Datar, Madhav Raja by ACADEMIAMILL

INSTRUCTOR’S SOLUTIONS MANUAL Horngren’s Cost Accounting A Managerial Emphasis

Ninth Canadian Edition Srikant M. Datar Madhav V. Rajan Louis Beaubien Steve Janz

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CHAPTER 1 THE ACCOUNTANT’S VITAL ROLE IN DECISION MAKING MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

SHORT-ANSWER QUESTIONS 1-1

Management accounting measures, analyzes, and reports financial and nonfinancial information to internal managers making internal decisions to improve performance. The reporting and analyses are not restricted by generally accepted accounting principles (GAAP) based on either International Financial Reporting Standards (IFRS) or Canadian Accounting Standards for Private Exterprise (ASPE). Financial accounting measures, analyzes, and reports primarily financial information to external parties who own the corporate assets, such as investors, government agencies, and banks. Methods of identification and classification of business transactions, measurement of their economic effect, analyses, and reporting in financial statements must comply with standards set by the Chartered Professional Accountants of Canada (CPA Canada). Other differences include (1) management accounting emphasizes the future (not the past), and (2) management accounting is designed specifically to influence the behaviour of managers and other employees (rather than primarily reporting economic events).

1-2

In Canada, financial accounting is constrained by GAAP. Companies listed on stock exchanges must comply with IFRS. Other companies must comply with ASPE when reporting to external parties. Management accounting is not restricted to these principles. The result is:     

management accountants can charge interest on owners’ capital to help judge a division’s performance, even though such a charge is not allowed under GAAP management accountants can classify, measure, and include the value of internally developed assets and liabilities not recognized under GAAP management accountants can use measurement methods of the value of assets or liabilities not permitted under GAAP management accountants can change the method of revenue and expense recognition, which is not permitted under GAAP, and management accountants assess the quality of information provided based on how well it reflects the economic reality of a real business process, not a standard.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

1-3

Management accountants help formulate strategy by identifying relevant information about the sources of competitive advantage—usually the cost, productivity, or efficiency advantage of their company relative to competitors. Alternatively, management accountants can analyze the benefits to customers and the costs to the company of adding features to further customize more distinctive products or services. These data will assist in setting an appropriate premium price for distinctive value-added attributes as determined by the customer.

1-4      

The business functions in the value chain are

Research and development—generating and experimenting with ideas related to new products, services, or processes. Design of products, services, and processes—the detailed planning and engineering of products, services, or processes. Production—acquiring, coordinating, and assembling resources to produce a product or deliver a service. Marketing—promoting and selling products or services to customers or prospective customers. Distribution—delivering products or services to customers. Customer service—providing after-sale support to customers.

1-5

The “supply chain” is a coordinated flow of goods, services, and information from each initial source of materials and services to the delivery of products to consumers, whether or not the supply activities occur in the purchasing or in other organizations. Cost management is most effective when it integrates and coordinates activities across all suppliers in the supply chain as well as across each business function in the purchasing company’s value chain. Business functions can be restructured to be more cost-effective.

1-6

This statement is wrong. Management accountants also analyze revenues from products, services, and customers relative to their costs to assess the profitability of types of products, services, and customers. Management accountants also examine the business environment and report relevant information on the intensity of competition. Cost information is only one part of the relevant internal and external information identified, analyzed, and reported by management accountants.

1-7

Management accountants help a management team identify performance measures that are important to maintain or increase profitability. Important measures include features, quality, and timely delivery as determined by customers. For-profit companies use these data to evaluate the balance of costs and benefits—both financial and nonfinancial—and provide relative assurance that proposed changes will not impair profitability. Initiatives include TQM, relieving bottleneck constraints, or providing faster customer service.

Chapter 1: The Accountant’s Vital Role in Decision Making

1-8

The five-step decision-making process is (1) identify the problem and uncertainties, (2) obtain relevant information, (3) make predictions about the future, (4) decide on one of the available alternatives, and (5) implement the decision, evaluate performance, and learn. Often the most important information required to provide certainty around predictions is missing, which is why rigorous and disciplined decision making is important to success.

1-9

Planning decisions include (a) selecting organization goals, (b) predicting results under various alternative ways of achieving those goals, (c) deciding how to attain the desired goals, and (d) communicating the goals and how to attain them to the entire organization. Good planning decisions indicate how rigorous and disciplined the management team is at making unbiased business decisions in the best interests of improving organizational profit. Control decisions require the assessment of actual compared to planned or predicted outcomes and include (a) identifying performance outcomes and how to measure them, (b) obtaining timely and high-quality feedback, (c) assessing how to improve actual performance, and (d) acting differently to improve the implementation of planning decisions. Good control decisions indicate how well a management team learns from its actual experience.

1-10 The three guidelines for management accountants are 1. Employ a cost–benefit approach. 2. Recognize behavioural and technical considerations. 3. Identify relevance and understand that decisions require “different costs for different purposes.”

1-11 Agree. A successful management accountant requires general business skills (such as understanding the strategy of an organization) and people skills (such as motivating other team members) as well as technical skills (such as computer knowledge, calculating costs of products, and supporting planning and control decisions).

1-12 The new controller could reply in one or more of the following ways: (a) Demonstrate to the plant manager how he or she could make better decisions if the plant controller was viewed as a resource rather than a busybody. The plant controller is the best person to show how the plant manager will benefit because his or her time and resources can be saved by bringing the plant controller into the decision-making process. (b) Demonstrate to the plant manager a good knowledge of the technical aspects of the plant. This approach often requires research on customer preferences, potential for growth in demand, plant-specific production or service processes, people, and suppliers. It certainly will involve spending time on the plant floor speaking to plant personnel to learn from their practical experience.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

(c) Show the plant manager examples of the new plant controller’s past successes in working with line managers in other plants. Examples could include:  assistance in reducing the plant manager’s time to prepare the budget,  assistance in analyzing problem situations and evaluating financial and nonfinancial aspects of different alternatives, and  assistance in submitting successful capital budget requests. (d) Seek assistance from the corporate controller to highlight to the plant manager the importance of many tasks undertaken by the new plant controller. This approach is a last resort but may be necessary in some cases.

1-13 Steps to take when established written policies provide insufficient guidance are (a) Discuss the problem with the immediate superior (except when it appears that the superior is involved). (b) Clarify relevant ethical issues by confidential discussion with an impartial adviser. (c) Consult your own lawyer about legal obligations and rights arising from ethical conflicts.

EXERCISES 1-14 (10 min.) 1. 2. 3. 4. 5. 6. 7. 8. 9.

Terminology.

timely, reliable technical Control ethical guidelines Management accounting cost–benefit Strategy Value chain Corporate social responsibility

1-15 (10 min.)

Cost, management, and financial accounting.

1. Once a transaction has occurred, financial accountants classify the transaction according to IFRS or ASPE standards and GAAP. This information is then communicated to external parties in a standardized way. Management accountants use financial accounting information, knowing the relevance and reliability of these data. The basic financial accounting information can be analyzed and reported by management accountants using a variety of techniques most appropriate to the management decision being made. These analyses will filter relevant costs and inform an internal decision maker.

Chapter 1: The Accountant’s Vital Role in Decision Making

2. All accountants are members of a profession and are bound by professional duty to act with integrity. Their duty is to report estimates of the financial outcomes from doing business, which do not materially misstate the economic value of the company.

1-16 (10 min.)

Strategy.

1. Managers assess the internal strengths and weaknesses of their company relative to their competitors. In addition, managers also gather relevant information about other external parties upon whom the company depends, such as customers, suppliers, financing, and the existence of substitute products. The purpose is to evaluate how a management team can control and deploy internal resources to best counter external threats from its environment and profit from external opportunities. By matching the intensity of competition in the environment with the unique competitive strengths of a company, management teams can select the best strategy. 2. Strategy requires managers to examine how the company and its goals fit with the external environment over which the company has no control. Strategic decisions are made for the longterm guidance and coordination of activities. Operating decisions are made with a focus on internal strengths and weaknesses. Operating decisions are made in the short term to achieve expected performance levels.

1-17 (15 min.) 1. 2. 3. 4. 5. 6. 7. 8.

Production Distribution Marketing Marketing Marketing Production Design of products, services, or processes Customer service

1-18 (15 min.) 1. 2. 3. 4. 5. 6. 7. 8.

Value chain and classification of costs, fast food restaurant.

Value chain and customer expectations.

Design Marketing Customer service Research and development Marketing Production Marketing Distribution

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

1-19 (10 min.) 1. 2. 3. 4. 5.

Planning Control Control Planning Planning

1-20 (15 min.) 1. 2. 3. 4. 5. 6. 7.

Five-step decision-making role of relevant accounting information.

Obtain information. Make predictions about the future. Identify the problem and uncertainties. Implement the decision, evaluate performance, and learn. Make predictions about the future (again). Decide on one of the available alternatives. Obtain information.

1-21 (15 min.) 1. 2. 3. 4. 5. 6. 7.

Planning and control decisions.

Five-step decision-making process, service firm.

Obtain information. Identify the problem and uncertainties. Make predictions about the future. Implement the decision, evaluate performance, and learn. Make predictions about the future Obtain information. Decide on one of the available alternatives.

PROBLEMS 1-22 (20 min.)

Strategic decisions and management accounting.

1. The strategies the companies are following in each case are: a Low-price strategy b. Differentiated-product strategy c. Low-price strategy d. Differentiated-product strategy

Chapter 1: The Accountant’s Vital Role in Decision Making

2. Examples of information the management accountant can provide for each strategic decision follow. a. Cost to manufacture and sell the cell phone Productivity, efficiency, and cost advantages relative to competition Prices of competitive smart mobile devices Sensitivity of target customers to price and quality The production capacity of Yello Phones relative to its competitors b. Cost to develop, produce, and sell new software Premium price that customers would be willing to pay due to product uniqueness Price of basic software Price of closest competitive software Cash needed to develop, produce, and sell new software c. Cost of producing the “store brand” lip gloss Productivity, efficiency, and cost advantages relative to competition Prices of competitive products Sensitivity of target customers to price and quality How the market for lip gloss is growing d. Cost to produce and sell new line of gourmet bologna Premium price that customers would be willing to pay due to product uniqueness Price of basic meat product Price of closest competitive product

1-23 (15 min.)

Planning and control decisions.

The plan or budget communicates the financial goals the organization will achieve, while control arises from feedback on how well the plan has been achieved and reasons why the plan has not been achieved. a. Annual financial statements communicate what was achieved. The annual report is a standardized control report on financial performance. It is feedback on what the organization accomplished. b. Internal periodic reports of financial performance are control reports. c. The report of losses suffered from a storm is a financial report that is a control report. Externally the insurer will use the report to estimate the amounts it will reimburse Softmoc according to the insurance contract. Internally the managers will use the report to modify their plan and generate the most appropriate response to an unanticipated event. The actual event will also initiate review of the adequacy of the insurance coverage relative to its cost. These new data will be used in subsequent plans for future insurance coverage and its cost. d. Weekly reports of the total quantity of particular shoes sold are feedback. They are control reports internally because a comparison can be made with the plan to determine if the plan was achieved and if not, why not. They are control reports for the supplier for the same reasons. e. Studies of new business development opportunities communicate planned costs and revenue. Copyright © 2022 Pearson Canada Inc. 1-7

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

1-24 (30 min.)

Accountants’ guidelines and roles in a company.

This problem raises plenty of thought-provoking questions. There are no easy answers. Generalizing is impossible, based on the unique facts of this case. 1. It appears that Whisler mistrusts the performance analyses. However, the important thing seems to be that Whilser has no confidence in the accountants who seem intrusive and unqualified to identify and measure performance for two stated reasons: (a) the responsibility is Whisler’s, not the accountants’; and (b) Whisler has experienced problems in performance first hand. He understands the complexity of a real situation. Whisler has maintained a day-to-day relationship with line personnel in Division C. 2. Bergstrom needs to establish trust now, not later, that the work being done by his performance-analysis staff will reflect the economic reality of Whisler’s performance. It may be that different performance measures will improve their relationship and the benefits to Whisler from using the reports. Then Whisler can concentrate on remedies with confidence they are likely to work. Bergstrom can help Whisler understand that performance measurement and analysis is a support, not a line function, intended to relieve Whisler of routine tasks. Centralizing performance measurement will help standardize, simplify, and predict the likely outcomes of any remedies Whisler implements. Bergstrom can also let Whisler know the benefits of appropriate standardization of performance measures across divisions when strategic decisions must be made. Whisler needs reassurance that his job security and remuneration is protected when uncontrollable factors cause performance shortfalls. 3. Two approaches within the existing organization reporting relationships would be: (a) Placing higher priority on having his performance-analysis staff view the division personnel as important customers and actively seeking out ways to increase customer satisfaction. (b) Encouraging greater use of teams in which division personnel and corporate control personnel are members. Hopefully, mutual respect will increase by this close interaction. A more extreme approach would be to change the organization’s reporting relationships and staff assignments. For example, each division manager could have his or her own performance-analysis staff member as part of the plant controller’s group. Or, a matrix reporting relationships could be implemented.

1-25 (35 min.)

Professional ethics and end-of-year actions.

1. The possible motivations for the snack-foods division president wanting to take end-of-year actions include:  Management incentives. Gourmet Foods may have a division bonus scheme based on oneyear reported division earnings. Efforts to front-end load revenue into the current year or transfer costs into the next year can increase this bonus.

Chapter 1: The Accountant’s Vital Role in Decision Making



Promotion opportunities and job security. Top management of Gourmet Foods likely will view those division managers that deliver high reported earnings growth rates as being the best prospects for promotion. Division managers who deliver “unwelcome surprises” may be viewed as less capable. Retain division autonomy. If top management of Gourmet Foods adopts a “management by exception” approach, divisions that report sharp reductions in their earnings growth rates may attract a sizable increase in top management oversight.

2. Several of the “end-of-year actions” clearly are in conflict and should be viewed as unacceptable by Taylor: (b) The fiscal year-end should be closed on midnight of December 31. “Extending” the close falsely reports next year’s sales as this year’s sales. (c) Altering shipping dates is falsification of the accounting reports. (f) Advertisements run in December should be charged to the current year. The advertising agency is facilitating falsification of the accounting records of Gourmet Foods as well as falsifying its own records. The other “end-of-year actions” occur in many organizations and may fall into the “grey” to “acceptable” area. However, much depends on the circumstances surrounding each one: (a) If the independent contractor does not do maintenance work in December, there is no transaction regarding maintenance to record. The responsibility for ensuring packaging equipment is well maintained is that of the plant manager. The division controller probably can do little more than observe the absence of a December maintenance charge. (d) In many organizations sales are heavily concentrated in the final weeks of the fiscal year. If the double bonus is approved by the division marketing manager, the division controller can do little more than observe the extra bonus paid in December. (e) If advertising is reduced in December, the advertising cost in December will be reduced. There is no record falsification here. (g) Much depends on the means of “persuading” carriers to accept the merchandise. For example, if an under-the-table payment is involved, it is clearly unethical. If, however, the carrier receives no extra consideration and willingly agrees to accept the assignment, the transaction appears ethical. Each of the (a), (d), (e), and (g) “end-of-year actions” may well disadvantage Gourmet Foods in the long run. The divisional controller is well advised to raise this issue in meetings with the division president. However, if Gourmet Foods has a rigid set of line/staff distinctions, the division president is the one who bears primary responsibility for justifying division actions to senior corporate officers. 3. If Taylor believes that Ryan wants her to engage in unethical behaviour, she should first raise her concerns directly with Ryan. If Ryan is unwilling to change his request, Taylor should discuss her concerns with the corporate controller of Gourmet Foods. She could also initiate a confidential discussion with an other impartial adviser, or her own lawyer. Taylor also may well ask for a transfer from the snack foods division if she perceives that Ryan is unwilling to Copyright © 2022 Pearson Canada Inc. 1-9

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

listen to pressure brought by the corporate controller, CFO, or even president of Gourmet Foods. In the extreme, she may want to resign if the corporate culture of Gourmet Foods is to reward division managers who take “end-of-year actions” that Taylor views as unethical and possibly illegal.

1-26 (35 min.)

Professional ethics and earnings management.

1. The possible motivations for Harvest Day Corporation’s CEO to “manage” earnings include:  Manage the stock price. Harvest Day’s CEO wants to meet the forecasted earnings number of $1.34 per share because the CEO believes that the stock price will drop if actual earnings fall short of the forecast.  Job security. The CEO may be concerned that the board of directors may have a poor view of him if he delivers “unwelcome surprises.” Depending on how much the stock falls, they may even consider dismissing him.  Management incentives. The bonuses of top management and the CEO may be based on earnings. If earnings decrease, smaller or no bonuses may be paid. If top management and the CEO have stock options, the value of these options will be adversely affected if the stock price falls. 2. Several of the “end-of-year actions” clearly are in conflict and should be viewed as unacceptable: (a) Subscriptions cancelled in December should be recorded in December itself and not delayed until January. (c) Subscription revenue received in December in advance for magazines that will be sent out in January is a liability. Showing it as revenue falsely reports next year’s revenue as this year’s revenue. (d) Office supplies purchased in December should be recorded as an expense of the current year and not as an expense of the next year. (e) Booking advertising revenues that relate to January in December falsely reports next year’s revenue as this year’s revenue. The other “end-of-year actions” occur in many organizations and may fall into the “grey” to “acceptable” area. However, much depends on the circumstances surrounding each one: (b) If the software on office computers is not updated until January, there is no transaction or expense to record in December. The responsibility for ensuring that the software is updated is that of the chief information technology officer. The controller can do little more than observe the absence of a December software update and question whether this will have an adverse long-term impact on Harvest Day. (f) If building repairs are not done in December, there is no transaction to record in December. There is no record falsification here. The decision regarding when to do building repairs is made by the operations manager. (g) Many companies switch their depreciation policy from one method to another. Harvest Day could argue that straight-line depreciation better represents the decrease in the economic Copyright © 2022 Pearson Canada Inc. 1-10

Chapter 1: The Accountant’s Vital Role in Decision Making

value of the asset compared to the declining-balance method. Straight-line depreciation may also be more in line with what its competitors do. If, however, Harvest Day changes to straight-line depreciation with the sole purpose of reducing expenses to meet its earnings goal, such behaviour would be unacceptable. The standards of ethical behaviour require management accountants to communicate information fairly and objectively, and to carry out duties ethically. 3. Harvest Day’s controller should directly raise these concerns with the CEO. If the CEO refuses to change his request, the controller should raise these issues with the audit committee and the board of directors. The controller could also initiate a confidential discussion with an other impartial adviser, or his/her own attorney. In the extreme, the controller may want to resign if the corporate culture of Harvest Day is to reward executives who take “end of fiscal year actions” that the controller views as unethical and possibly illegal. It was precisely actions along the lines of (a), (c), (d), and (e) that caused Betty Vinson, an accountant at WorldCom, to be indicted for falsifying WorldCom’s books and misleading investors.

1-27 (10 min.)

Professional ethics and corporate governance.

1. Segato’s ethical responsibilities are well summarized in the CPA’s “Code of Professional Conduct”. The key area related to Segato’s current dilemma is integrity. Segato should refuse to book the $240,000 of sales until the goods are shipped. Both financial accounting and management accounting principles maintain that sales are not complete until the title is transferred to the buyer. The job of the accountant is to report in a way that reflects the economic reality of what has actually happened. 2. Segato should refuse to follow Maloney’s orders. If Maloney persists, the incident should be reported to the corporate controller. Support for line management should be wholehearted, but it never requires unethical conduct.

1-28 (30 min.)

Professional ethics and corporate governance.

1. Companies with “codes of conduct” frequently have a “supplier clause” that prohibits their employees from accepting “material” (in some cases, any) gifts from suppliers. The motivations include: 



Integrity/conflict of interest. Suppose Michaels recommends that a Horizon 1-2-3 product subsequently be purchased by SXSW. His recommendation could be because he felt he owed Horizon an obligation as his trip to the Cancun conference was fully paid by Horizon. The appearance of a conflict of interest. Even if the Horizon 1-2-3 product is the superior one at that time, other suppliers likely will have a different opinion. They may believe the way to sell products to SXSW is via “fully paid junkets to resorts.” Those not wanting to do business this way may downplay future business activities with SXSW even though SXSW may gain much from such activities. Some executives view the meeting as “suspect” from the start given the Caribbean location and its “rest and recreation” tone.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Pros of attending the user meeting include:    

Able to interact with other current users as well as possible purchasers and obtain their opinions. Able to influence the future product development plans of Horizon in a way that will benefit SXSW. An example is Horizon’s subsequently developing software modules tailored to food-product companies. Saves SXSW money. Visiting suppliers and their customers typically costs money whereas Horizon is paying for the Cancun conference. Able to learn more about the software products of Horizon.

Cons of attending the user meeting include:  

The ethical issues raised in requirement 1. Negative morale effects on other SXSW employees who do not get to attend the Cancun conference. These employees may reduce their trust and respect for Michaels’s judgment, arguing he has been on a “supplier-paid vacation.”

Conditions on attending which SXSW might impose are: • Sizable part of time in Cancun has to be devoted to business rather than recreation. • Decision on which SXSW executive attends is not made by the person who attends (this reduces the appearance of a conflict of interest). • Person attending (Michaels) does not have final say on purchase decision (this reduces the appearance of a conflict of interest). • SXSW executives should only go when a new major purchase is being contemplated (to avoid the conference becoming a regular “vacation”). A conference board publication on corporate ethics asked executives about a comparable situation: • 76% said SXSW and Michaels face an ethical consideration in deciding whether to attend.  71% said Michaels should not attend as the payment of expenses is a “gift” within the meaning of a credible corporate ethics policy. 3. Pros of having a written code. The Conference Board outlines the following reasons why companies adopt codes of ethics: a. b. c. d.

Signals commitment of senior management to ethics. Promotes public trust in the credibility of the company and its employees. Signals the managerial professionalism of its employees. Provides guidance to employees as to how difficult problems are to be handled. If the code is adhered to, employees will avoid many actions that are unethical or appear to be unethical. e. Drafting of the policy (and its redrafting in the light of ambiguities) can assist management in anticipating and preparing for ethical issues not yet encountered. Copyright © 2022 Pearson Canada Inc. 1-12

Chapter 1: The Accountant’s Vital Role in Decision Making

Cons of having a written code include: a. Can give appearance that all issues have been covered. Issues not covered may appear to be “acceptable” even when they are not. b. Can constrain the entrepreneurial activities of employees. Forces people to always “behave by the book.” c. Cost of developing code can be “high” if it consumes a lot of employee time.

1-29 (40 min.)

Global company, ethical challenges.

1. It is clear that bribes are illegal according to domestic laws. It is not clear from the case whether bribes are illegal in Vartan. However, knowledgeable people in global business would attest to the fact that it is virtually impossible to find any country in the world that specifically sanctions bribery. The major point, however, that deserves discussion is: Should ZenTel engage in any unethical activities even if they are not illegal? It is difficult to make a generalization about all shareholders of the company. It is, however, safe to assume that not all shareholders would want to keep their investment in a company that is engaged in unethical and/or illegal activities. There is historical evidence to substantiate this point: When apartheid laws were in effect in South Africa, many investors divested shares of companies doing business in South Africa. Apart from the ethical issues, it should also be noted that bribery can be very costly in some parts of the world. Bribes may not generate revenues sufficient enough to offset their cost. 2. Apparently Hank thinks that local culture and common practice are one and the same. This, in fact, is not the case. There are many common practices in developing countries that are against the native culture. Specifically, bribery often leads to decisions that are not made on the basis of the merits of the alternative selected. This results in misallocation of meagre resources of the developing country. Misallocation of resources has adverse effects on the economy of a country and the living standard of its population. The negative impact is intensified in developing countries because they can least afford the misallocation of resources. As it applies to local common practice, multinational companies make some small allowances but draw a hard line against paying the $1 million “commission.” In 2010, the UK enacted legislation that requires multinational companies to prevent bribery and similar legislation also came into effect in the United States in January 2011 and in Canada in October of the same year. 3. ZenTel might have an articulated corporate policy against such payments to get the message across that regardless of laws, the top management would not tolerate any bribery payments made by its employees. A strong and consistent message from the top often has a noticeable effect on the corporate culture and employee behaviour.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4. If this contract is of great importance to ZenTel’s global strategy, it is likely that this kind of issue will come up again as ZenTel expands into very diverse cultures, and the company should tackle it head on and make a policy decision against offering bribes. Steve Cheng should discuss the situation with the top management at ZenTel and re-affirm his goal to get the Vartan contract by legal means. He could seek the help of the Canadian commercial attaché in Vartan to continue a dialogue with Vartan’s deputy minister of communications. He could propose other creative, legal changes to ZenTel’s bid, even at the cost of reducing the profitability of the current project. Concessions such as training programs, schools, and other public works projects may be legal, get the attention of the Vartan government, and raise ZenTel’s profile both at home and abroad. In the worst case, if the Vartan government does not agree to any of the creative, legal “extras” that ZenTel can provide in order to win the contract, Cheng should report this to ZenTel’s management and be willing to walk away from the Vartan project.

CHAPTER 2 AN INTRODUCTION TO COST TERMS AND PURPOSES MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

SHORT-ANSWER QUESTIONS 2-1

A cost object is anything for which a separate measurement of costs is desired. Examples include a product, a service, a project, a customer, a brand category, an activity, a department, and a program.

2-2

Direct costs of a cost object are related directly to the particular cost object and can be traced to it in an economically feasible way. Indirect costs of a cost object are costs that arise from common costs shared among distinct types of cost objects and cannot be traced to each type of cost object in an economically feasible way.

2-3

When direct costs are traced to a particular cost object, the resources used are unique to the distinct type of cost object and can be accurately assigned to it. When costs of resources shared unequally among distinct types of cost objects are allocated, managers are less certain whether the cost allocation base, a measure of direct resources consumed, accurately measures the benefit or value added to the distinct type of cost object from its share of common resources consumed. Managers prefer to use more accurate costs in their decisions.

2-4 1. 2. 3. 4.

Factors affecting the classification of a cost as direct or indirect include:

the materiality of the cost in question available information-gathering technology design of operations the type of costing system in use.

2-5

A cost driver is a variable that causes a change in total cost, measured throughout a specific time. A change in the quantity of a cost driver used results in a change in the level of total costs. For example, the number of tires per vehicle is a driver of the total cost of tires for each vehicle.

2-6

The relevant range is the range over which the changes in the quantity of the cost driver used have a causal relationship with changes in total cost. Relevant range is important to accurately defining cost behaviour as a linear cost function. Linear cost functions are applied when examining cost–volume–profit (CVP) relationships as long as the volume levels are within the relevant range.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2-7

The usefulness of a unit cost or rate per unit of resource used depends on whether the causal relationship is true, for example, with fully variable costs. The rate per unit for variable costs is computed by dividing some total cost of the resource used (the numerator) by a corresponding quantity of units of a resource used (the denominator). But when total cost is fully or partially fixed it is wrong to use a constant rate per unit. There is no direct causal relationship between a fixed cost, which is constant, and any quantity of any cost object, either input or output. The fixed cost in the numerator is unchanged but the fixed cost rate will vary as the denominator quantity changes.

2-8

Manufacturing companies purchase materials and components and convert them into various finished goods; pharmaceutical, automotive, and textile companies are examples. Merchandising-sector companies purchase and then sell tangible products without changing their basic form; retailing or distribution companies are examples. Service-sector companies produce and provide services or intangible products to their customers; for example, service-sector companies provide engineering design, legal advice, and audits.

2-9

Manufacturing companies typically have one or more of the following three types of inventory: 1. Direct materials inventory. Direct materials on site and awaiting use in the production process. 2. Work-in-process inventory. Goods partially converted from direct materials to goods available for sale, but not yet finished. This is also called work in progress (WIP). 3. Finished goods inventory. Goods completed and available for sale but not yet sold.

2-10 No. Service sector companies have no inventories and, hence, no inventoriable costs. 2-11 Overtime premium is the wage rate paid to workers (for both direct labour and indirect labour) in excess of their straight-time wage rates. Idle time is a sub-classification of indirect labour that represents wages paid for unproductive time caused by lack of orders, machine breakdowns, material shortages, poor scheduling, and the like.

2-12 Either a product or a service cost is the sum of the costs assigned to it for a specific purpose. Purposes for computing a product cost include:   

Pricing and product mix decisions, which should include the costs of all value-chain functions Contracting with government agencies, which will be defined by a contract and may include only total costs of the production business function in the value chain Preparing GAAP-compliant financial statements for external reporting

Chapter 2: An Introduction to Cost Terms and Purposes

2-13 Financial accountants classify the actual or historical costs of business transactions during a specific time period in a standardized way. The costs are accumulated for only transactions in a specific classification in general ledger accounts. Management accountants are free to reclassify the reliable costs in general ledger accounts by distinguishing and including only those costs that are relevant to identifying and solving a specific cost-management problem.

EXERCISES 2-14 (10 min.) 1. 2. 3. 4. 5. 6. 7. 8.

Terminology.

Conversion costs fixed cost Inventoriable costs Prime costs Period costs variable cost Indirect Relevant cost

2-15 (15 min.)

Inventoriable costs versus period costs.

1. Spring water purchased for resale by Sobeys—inventoriable cost of a merchandising company. It becomes part of cost of goods sold when the mineral water is sold. 2. Electricity used at a Toyota assembly plant—inventoriable cost of a manufacturing company. It is part of the manufacturing overhead that is included in the manufacturing cost of a truck finished good. 3. Depreciation on Google’s computer equipment—period cost of a service company. Google has no inventory of goods for sale and, hence, no inventoriable cost. 4. Electricity for Sobeys store aisles—period cost of a merchandising company. It is a cost that benefits the current period and is not traceable to goods purchased for resale. 5. Depreciation on Toyota’s assembly testing equipment—inventoriable cost of a manufacturing company. It is part of the manufacturing overhead that is included in the manufacturing cost of a truck finished good. 6. Salaries of Sobeys marketing personnel—period cost of a merchandising company. It is a cost that is not traceable to goods purchased for resale. It is presumed not to benefit future periods (or at least not to have sufficiently reliable evidence to estimate such future benefits). 7. Water consumed by Google’s engineers—period cost of a service company. Google has no inventory of goods for sale and, hence, no inventoriable cost. 8. Salaries of Google’s marketing personnel—period cost of a service company. Google has no inventory of goods for sale and, hence, no inventoriable cost.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2-16 (15–20 min.) Classification of costs, service sector. Cost object: Cost variability:

Each individual focus group With respect to the number of focus groups

There may be some debate over classifications of individual items, especially with regard to cost variability. Cost Item A B C D E F G H

D or I D I I I D I D I

V or F V F Va F V F V Vb

aSome students will note that phone call costs are variable when each call has a separate charge.

It may be a fixed cost if Buyer Research has a flat monthly charge for a line, irrespective of the amount of usage. bGasoline costs are likely to vary with the number of focus groups. However, vehicles likely serve multiple purposes, and detailed records may be required to examine how costs vary with changes in one of the many purposes served.

2-17 (15–20 min.) Classification of costs, merchandising sector. Cost object: Cost variability:

Gaming section of store With respect to changes in the number of games sold

There may be some debate over classifications of individual items. Debate about cost variability is more likely. Cost Item A B C D E F G H

D or I D I D I I I I D

V or F F F V F F V or F F V

Chapter 2: An Introduction to Cost Terms and Purposes

2-18 (15–20 min.) Classification of costs, manufacturing sector. Cost object: Cost variability:

Type of car assembled (Corolla or Geo Prism) With respect to changes in the number of cars assembled

There may be some debate over classifications of individual items. Debate about cost variability is more likely. Cost Item A B C D E F G H

2-19 (10 min.)

D or I D I D D D I D I

V or F V F F F V V or F V F

Variable costs, fixed costs, total costs.

Plan A:

100 minutes × $0.10 = $10.00 300 minutes × $0.10 = $30.00 500 minutes × $0.10 = $50.00

Plan B:

100 minutes = $16.00 300 minutes = $16.00 500 minutes = $16.00 + $10.00 (200 minutes × $0.05) = $26.00

Plan C:

100 minutes = $20.00 300 minutes = $20.00 500 minutes = $20.00 + $0.80 (20 minutes × $0.04) = $20.80

If Compo plans to make 100 minutes of long-distance calls each month, she should choose Plan A; for 300 minutes, choose Plan B; for 500 minutes, choose Plan C.

2-20 (10 min.)

Total costs and unit costs.

1. Total cost, $4,800. Unit cost per person, $4,800 ÷ 400 = $12 2. Total cost, $4,800. Unit cost per person, $4,800 ÷ 4,000 = $1.20 4. The main lesson of this problem is to alert the student early in the course to the desirability of thinking in terms of total costs rather than unit costs wherever feasible. Changes in the number of cost driver units will affect total variable costs but not total fixed costs. In our example, it would be perilous to use either the $12.00 or the $1.20 unit cost to predict the total cost because the total costs are not affected by the attendance. Instead, the student association should use the

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

$4,800 total cost. Obviously, if the musical group agreed to work for, say, $4.80 per person, such a unit variable cost could be used to predict the total cost.

2-21 (15 min.)

Total and unit costs, decision making.

1. Total Manufacturing Costs

60,000 50,000

Fixed Costs

40,000 Variable Costs

30,000 20,000

Total Manufacturing Costs

10,000 0 0

5,000

10,000

Number of Flanges

The variable cost is $1 per flange for materials, and $2 per flange ($20 per hour divided by 10 flanges per hour) for direct manufacturing labour. The inventoriable (manufacturing) cost per unit for 5,000 flanges is $3 × 5,000 + $20,000 = $35,000. Average (unit) cost = $35,000 ÷ 5,000 units = $7 per unit. This is below Fred’s selling price of $8.25 per flange. However, in order to make a profit, Graham’s Glassworks also needs to cover the period (non-manufacturing) costs of $10,000, or $10,000 ÷ 5,000 = $2 per unit. Thus, total costs, both inventoriable (manufacturing) and period (non-manufacturing), for the flanges is $7 + $2 = $9. Graham’s Glassworks cannot sell below Fred’s price of $8.25 and still make a profit on the flanges. Alternatively, At Fred’s price of $8.25 per flange: Revenue $8.25 × 5,000 = $41,250 Variable costs $3.00 × 5,000 = 15,000 Fixed costs 30,000 Operating loss $(3,750) Graham’s Glassworks cannot sell below $8.25 per flange and make a profit. At Fred’s price of $8.25 per flange, the company has an operating loss of $3,750.

Chapter 2: An Introduction to Cost Terms and Purposes

2. If Graham’s Glassworks produces 10,000 units, the total inventoriable cost will be: $3 × 10,000 + $20,000 = $50,000. Average (unit) inventoriable (manufacturing) cost will be $50,000 ÷ 10,000 units = $5 per flange Unit total cost including both inventoriable and period costs will be ($50,000 + $10,000) ÷ 10,000 = $6 per flange, and Graham’s Glassworks will be able to sell the flanges for less than Fred and still make a profit. Alternatively, At Fred’s price of $8.25 per flange: Revenue $8.25 × 10,000 = $82,500 Variable costs $3.00 × 10,000 = 30,000 Fixed costs 30,000 Operating income $22,500 Graham’s Glassworks can sell at a price below $8.25 per flange and still make a profit. The company earns operating income of $22,500 at a price of $8.25 per flange. The company will earn operating income as long as the price exceeds $6.00 per flange. The reason the unit cost decreases significantly is that inventoriable (manufacturing) fixed costs and fixed period (nonmanufacturing) costs remain the same regardless of the number of units produced. So, as Graham’s Glassworks produces more units, fixed costs are spread over more units, and cost per unit decreases. This means that if you use unit costs to make decisions about pricing, and which product to produce, you must be aware that the unit cost only applies to a particular level of output.

2-22 (15–20 min.) Variable costs and fixed costs. 1. Variable cost per ton of beach sand mined Subcontractor Government tax Total Fixed costs per month 0 to 100 tons of capacity per day 101 to 200 tons of capacity per day 201 to 300 tons of capacity per day

$ 80 per ton 50 per ton $130 per ton = = =

$150,000 $300,000 $450,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

The concept of relevant range is potentially relevant for both graphs. However, the question does not place restrictions on the unit variable costs. The relevant range for the total fixed costs is from 0 to 100 tons; 101 to 200 tons; 201 to 300 tons, and so on. Within these ranges, the total fixed costs do not change in total. 3. Tons Mined per Day (1) (a) 180 (b) 220

Tons Mined per Month (2) = (1) × 25 4,500 5,500

Fixed Unit Cost per Ton (3) = FC ÷ (2) $300,000 ÷ 4,500 = $66.67 $450,000 ÷ 5,500 = $81.82

Variable Unit Cost per Ton (4) $130 $130

Total Unit Cost per Ton (5) = (3) + (4) $196.67 $211.82

The unit cost for 220 tons mined per day is $211.82, while for 180 tons it is only $196.67. This difference is caused by the fixed cost increment from 101 to 200 tons being spread over an increment of 80 tons, while the fixed cost increment from 201 to 300 tons is spread over an increment of only 20 tons.

2-23 (20 min.)

Variable costs, fixed costs, relevant range.

1. Since the production capacity is 5,000 jaw breakers per month, the current annual relevant range of output is 0 to 60,000 jaw breakers (5,000 jaw breakers × 12 months). 2. Current annual fixed manufacturing costs within the relevant range are $1,000 × 12 = $12,000 for rent and other overhead costs, plus $6,000 ÷ 10 = $600 for depreciation, totaling $12,600. The variable costs, the materials, are 10 cents per jaw breaker, or $3,600 (= $0.10 per jaw breaker × 3,000 jaw breakers per month × 12 months) for the year. 3. If demand changes from 3,000 to 6,000, MegMunchies Ltd. will need a second machine. Assuming the company buys a second machine identical to the first machine, it will increase capacity from 5,000 jaw breakers per month to 10,000. The annual relevant range will be between 0 and 120,000 jaw breakers (10,000 jaw breakers × 12 months).

Chapter 2: An Introduction to Cost Terms and Purposes

Assume the second machine costs $6,000 and is depreciated using straight-line depreciation over 10 years and zero residual value, just like the first machine. This will add $600 of depreciation per year. Fixed costs for next year will increase to $13,200. Total fixed costs for next year equal $600 (depreciation on first machine) + $600 (depreciation on second machine) + $12,000 (rent and other fixed overhead costs). The variable cost per jaw breaker next year will be 90% × $0.10 = $0.09. Total variable costs equal $0.09 per jaw breaker × 72,000 jaw breakers = $6,480.

2-24 (20 min.) 1. (a) (b) (c) (d)

Using unit costs for making decisions.

$120,000 ÷ 2,000 = $60.00 per package $120,000 ÷ 6,000 = $20.00 per package $120,000 ÷ 10,000 = $12.00 per package [$120,000 + (10,000 × $9.60)] ÷ 20,000 = $216,000 ÷ 20,000 = $10.80 per package

The unit cost to ECG decreases on a per-unit basis due to the first $120,000 payment being a fixed cost. The $9.60 amount per package beyond 10,000 units is a variable cost. The cost function is:

2. ECG should not use any of the unit costs in requirement 1 when predicting total costs. Up to 10,000 units, the total cost is a fixed amount. Beyond 10,000 units, the total cost is a combination of a fixed amount plus a per-unit (beyond 10,000 unit) variable amount. The total costs at different volume levels cannot be predicted by using the unit cost at a specific volume level. The total cost should be predicted by combining the total fixed costs and total variable costs rather than by multiplying a unit cost amount by the predicted number of packages sold.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2-25 (20 min.) Computing cost of goods manufactured and cost of goods sold. Schedules: Cost of Goods Manufactured and Cost of Goods Sold Schedule of Cost of Goods Manufactured For the Year Ended December 31, 2022 (in thousands) Direct materials used Direct manufacturing labour costs Indirect manufacturing costs: Property tax on plant building Plant utilities Depreciation of plant building Depreciation of plant equipment Plant repairs and maintenance Indirect manufacturing labour costs Indirect materials used Miscellaneous plant overhead Manufacturing costs incurred during the year Add beginning work in process inventory, Jan. 1 Total manufacturing costs to account for Deduct ending work in process inventory, Dec. 31 Cost of goods manufactured

$104,400 40,800 $ 3,800 20,400 10,800 13,200 19,200 27,600 13,200 5,800

Schedule of Cost of Goods Sold For the Year Ended December 31, 2022 (in thousands) Beginning finished goods, Jan. 1 Cost of goods manufactured (above) Cost of goods available for sale Ending finished goods, Dec. 31 Cost of goods sold

$ 32,400 252,000 284,400 40,800 $243,600

114,000 259,200 24,000 283,200 31,200 $252,000

Chapter 2: An Introduction to Cost Terms and Purposes

2-26 (20 min.) Computing cost of goods purchased and cost of sales. (a) Marvin Department Store Schedule of Cost of Goods Purchased For the Year Ended December 31, 2022 (in thousands) Purchases Add transportation-in

$175,000 8,000 183,000

Deduct: Purchase return and allowances Purchase discounts Cost of goods purchased

$4,200 8,750

12,950 $170,050

(b) Marvin Department Store Schedule of Cost of Sales For the Year Ended December 31, 2022 (in thousands) Beginning merchandise inventory, Jan. 1 Cost of goods purchased (above) Cost of goods available for sale Ending merchandise inventory, Dec. 31 Cost of sales

$ 27,000 170,050 197,050 37,000 $160,050

2-27 (10–15 min.) Cost drivers and functions. 1. Function 1. Accounting 2. Human resources 3. Data processing 4. Research and development 5. Purchasing 6. Distribution 7. Billing

Representative Cost Driver Number of transactions processed Number of employees Hours of computer processing unit (CPU) Number of research scientists Number of purchase orders Number of deliveries made Number of invoices sent

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Function 1. Accounting 2. Human resources 3. Data processing 4. Research and development 5. Purchasing 6. Distribution 7. Billing

Representative Cost Driver Number of journal entries made Salaries and wages of employees Number of computer transactions Number of new products being developed Number of different types of materials purchased Distance traveled to make deliveries Number of credit sales transactions

PROBLEMS 2-28 (20 min.)

Labour cost, overtime, and idle time.

1. (a) Total cost of hours worked at regular rates 42 hours × 12 per hour 42 hours × 12 per hour 43 hours × 12 per hour 40 hours × 12 per hour Minus idle time (5.2 hours × $12 per hour) Direct manufacturing labour costs (b) Idle time = 5.2 hours × 12 per hour = (c) Overtime and holiday premium. Week 1: Overtime (42–40) hours × Premium, $6 per hour Week 2: Overtime (42–40) hours × Premium, $6 per hour Week 3: Overtime (43–40) hours × Premium, $6 per hour Week 4: Holiday 8 hours × Premium, $12 per hour Total overtime and holiday premium (d) Total earnings in May Direct manufacturing labour costs Idle time Overtime and holiday premium Total earnings

$ 504.00 504.00 516.00 480.00 2,004.00 62.40 $1,941.60 $

62.40

12.00 12.00 18.00 96.00 $ 138.00

$1,941.60 62.40 138.00 $2,142.00

2. Idle time caused by equipment breakdowns and scheduling mix-ups is an indirect cost of the jobs because it is not related to a specific job.

Chapter 2: An Introduction to Cost Terms and Purposes

Overtime premium caused by the heavy overall volume of work is also an indirect cost because it is not related to a particular job that happened to be worked on during the overtime hours. If, however, the overtime is the result of a demanding “rush job,” the overtime premium is a direct cost of that job.

2-29 (30 min.)

Comprehensive problem on unit costs, product costs.

1. If 2 kilograms of direct materials are used to make each unit of finished product, 100,000 units  2 kg, or 200,000 kg, were used at $0.70 per kilogram of direct materials ($140,000 ÷ 200,000 kg). (The direct materials costs of $140,000 are direct materials used, not purchased.) Therefore, the ending inventory of direct materials is 2,000 kg  $0.70 = $1,400 2.

Manufacturing Costs for 100,000 units Variable Direct materials costs Direct manufacturing labour costs Plant energy costs Indirect manufacturing labour costs Other indirect manufacturing costs Cost of goods manufactured

$140,000 30,000 5,000 10,000 8,000 $193,000

Fixed

Total

– – – 16,000 24,000 $40,000

$140,000 30,000 5,000 26,000 32,000 $233,000

Average unit manufacturing cost: $233,000 ÷ 100,000 units = $2.33 per unit Finished goods inventory in units: $20,970 (given) ÷ $2.33 per unit = 9,000 units 3.

Units sold in 2022

= Beginning inventory + Production – Ending inventory = 0 + 100,000 – 9,000 = 91,000 units Selling price per unit in 2022: $436,800 ÷ 91,000 = $4.80 per unit Revenue (91,000 units sold  $4.80) Cost of units sold: Beginning finished goods, Jan. 1 Cost of goods manufactured Cost of goods available for sale Ending finished goods, Dec. 31 Gross margin Operating costs: Marketing, distribution, and customer-service costs Administrative costs Operating income

$436,800 $ 0 233,000 233,000 20,970

162,850 50,000

212,030 224,770

212,850 $ 11,920

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Note: Although not required, the full set of unit variable costs are: Direct materials costs Direct manufacturing labour costs Plant energy costs Indirect manufacturing labour costs

$1.40 0.30 0.05

= $1.93 per unit manuf’d (100,000)

0.10 Other indirect manufacturing costs 0.08 Marketing, distribution, and customer-service costs

2-30 (30 min.)

1.35

} per unit sold (91,000)

Budgeted income statement of comprehensive income (continuation of 2-29).

Target ending finished goods, Dec. 31, 2023 Forecasted sales for 2023 Total finished goods required in 2023 Beginning finished goods, Jan. 1, 2023 Finished goods production required in 2023

Revenue (122,000 units sold  $4.80) Cost of units sold: Beginning finished goods, Jan. 1, 2023 Cost of goods manufactured Cost of goods available for sale Ending finished goods, Dec. 31, 2023 Gross margin Operating costs: Marketing, distn., and customer-service costs Administrative costs Operating income

12,000 units 122,000 units 134,000 units 9,000 units 125,000 units $585,600 $ 20,970b 281,250a 302,220b 27,000c

204,700b 50,000b

275,220 310,380

254,700d $ 55,680

Supporting Computations a) Manufacturing Costs for 125,000 Units Direct materials costs Direct manufacturing labour costs Plant energy costs Indirect manufacturing labour costs

Variable $175,000b 37,500b 6,250 12,500b

Fixed $ – – – 16,000

Total $175,000 37,500 6,250 28,500

Chapter 2: An Introduction to Cost Terms and Purposes

Other indirect manufacturing costs 10,000b 24,000 34,000 Cost of goods manufactured $241,250b $40,000 $281,250 b) Direct materials costs = 250,000 kg  $0.70/kg = $175,000. c) The average unit manufacturing costs in 2023 is $281,250 ÷ 125,000 units = $2.25. Finished goods, December 31, 2023 = 12,000  $2.25 = $27,000. d) Variable mktg., distn., and customer-service costs, 122,000  $1.35 $164,700 Fixed marketing, distribution., and customer-service costs 40,000 Fixed administrative costs 50,000 $254,700

2-31 (30–40 min.) Cost of goods manufactured. 1.

Canseco Company Schedule of Cost of Goods Manufactured For the Year Ended December 31, 2022 (in thousands) Direct materials costs: Beginning inventory, Jan. 1 Purchases of direct materials Cost of direct materials available for use Ending inventory, Dec. 31 Direct materials used Direct manufacturing labour costs Indirect manufacturing costs: Indirect manufacturing labour costs Plant insurance Depreciation—plant building and equipment Repairs and maintenance—plant Manufacturing costs incurred during the year Add beginning work in process inventory, Jan. 1 Total manufacturing costs to account for Deduct ending work in process inventory, Dec. 31 Cost of goods manufactured

$ 24,000 80,000 104,000 29,000 $ 75,000 22,000 $17,000 10,000 12,000 6,000

45,000 142,000 19,000 161,000 20,000 $141,000

Canseco Company Statement of Comprehensive Income For the Year Ended December 31, 2022 (in thousands) Revenue Cost of goods sold: Beginning finished goods, Jan. 1 Cost of goods manufactured (Requirement 1)

$325,000 $ 18,000 141,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Cost of goods available for sale Ending finished goods, Dec. 31 Gross margin Operating costs: Marketing, distribution, and customer-service General and administrative Operating income

2-32 (30 min.)

159,000 21,000

138,000 $187,000

$ 97,000 24,000

121,000 $ 66,000

Flow of inventoriable costs. (in millions) $ 90 360 450 375 $ 75

Direct materials inventory, Aug. 1, 2022 Direct materials purchased Direct materials available Deduct direct materials used Direct materials inventory, Aug. 31, 2022

Total manufacturing overhead costs Subtract: Variable manufacturing overhead costs Fixed manufacturing overhead costs

$480 250 $ 230

Total manufacturing costs Deduct: Direct materials used Manufacturing overhead Direct manufacturing labour costs

$1,600

$375 480

Work-in-process inventory, Aug. 1, 2022 Total manufacturing costs

855 $ 745

Deduct cost of goods manufactured (moved into FG) Work-in-process inventory Aug. 31, 2022

$ 200 1,600 1,800 1,650 $ 150

Finished goods inventory Aug. 1, 2022 Cost of goods manufactured (moved from WIP) Goods available for sale

$ 200 1,650 $1,850

Goods available for sale in August (from req. 5) Deduct cost of goods sold Finished goods inventory, Aug. 31, 2022

$1,850 1,700 $ 150

Chapter 2: An Introduction to Cost Terms and Purposes

2-33 (25–30 min.) Statement of comprehensive income and schedule of cost of goods manufactured. Powell Corporation Statement of Comprehensive Income For the Year Ended December 31, 2022 (in millions) Revenue Cost of goods sold: Beginning finished goods, Jan. 1 Cost of goods manufactured (below) Cost of goods available for sale Ending finished goods, Dec. 31 Gross margin Marketing, distribution, and customer-service costs Operating income

$1,140 $ 70 762 832 55

777 363 288 $ 75

Powell Corporation Schedule of Cost of Goods Manufactured For the Year Ended December 31, 2022 (in millions) Direct materials costs: Beginning inventory, Jan. 1 Purchases of direct materials Cost of direct materials available for use Ending inventory, Dec. 31 Direct materials used Direct manufacturing labour costs Indirect manufacturing costs: Indirect manufacturing labour Plant supplies used Plant utilities Depreciation—plant, building, and equipment Plant supervisory salaries Miscellaneous plant overhead Manufacturing costs incurred during the year Add beginning work in process inventory, Jan. 1 Total manufacturing costs to account for Deduct ending work in process, Dec. 31 Cost of goods manufactured

$ 15 390 405 20 $ 385 120 60 12 36 96 6 42

252 757 10 767 5 $ 762

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2-34 (15–20 min.) Interpretation of statements (continuation of 2-33). 1. The schedule of costs of goods manufactured in 2-33 can become a schedule of cost of goods manufactured and sold simply by including the beginning and ending finished goods inventory figures in the supporting schedule, rather than directly in the body of the income statement. Note that cost of goods manufactured refers to the cost of goods brought to completion (finished) during the accounting period, whether they were started before or during the current accounting period. Some of the manufacturing costs incurred are held back as costs of the ending work in process; similarly, the costs of the beginning work in process inventory become a part of the cost of goods manufactured for 2022. 2. The sales manager’s salary would be charged as a marketing cost as incurred by both manufacturing and merchandising companies. It is basically an operating cost that appears below the gross margin line on an income statement. In contrast, an assembler’s wages would be assigned to the products worked on. Thus, the wages cost would be charged to Work in Process and would not be expensed until the product is transferred through Finished Goods Inventory to Cost of Goods Sold as the product is sold. 3. The direct–indirect distinction can be resolved only with respect to a particular cost object. For example, in defense contracting, the cost object may be defined as a contract. Then, a plant supervisor’s salary may be charged directly and wholly to that single contract. 4. Direct materials used Depreciation

= =

$385,000,000 ÷ 1,000,000 units $ 96,000,000 ÷ 1,000,000 units

= $385 per unit = $96 per unit

5. Direct materials unit cost would be unchanged at $385. Depreciation unit cost would be $96,000,000 ÷ 1,200,000 = $80 per unit. Total direct materials costs would rise by 20% to $462,000,000 (= $385 per unit × 1,200,000 units), whereas total depreciation would be unaffected at $96,000,000. 6. Unit costs are averages, and they must be interpreted with caution. The $385 direct materials unit cost is valid for predicting total costs because direct materials is a variable cost; total direct materials costs indeed change as output levels change. However, fixed costs like depreciation must be interpreted quite differently from variable costs. A common error in cost analysis is to regard all unit costs as one—as if all the total costs to which they are related are variable costs. Changes in output levels (the denominator) will affect total variable costs, but not total fixed costs. Graphs of the two costs may clarify this point; it is safer to think in terms of total costs rather than in terms of unit costs.

2-35 (30 min.)

Prime costs version conversion costs.

1. Prime costs are: purchases of direct materials; direct manufacturing labour. Conversion costs are: plant utilities; indirect manufacturing labour; depreciation—plant, building, and equipment; miscellaneous manufacturing overhead; plant supplies used; and property taxes on plant. Copyright © 2022 Pearson Canada Inc. 2-18

Chapter 2: An Introduction to Cost Terms and Purposes

Chan Corporation Statement of Comprehensive Income For the Year Ended December 31, 2022 (in millions) Revenue Cost of goods sold: Beginning finished goods, Jan. 1 Cost of goods manufactured (below) Cost of goods available for sale Ending finished goods, Dec. 31 Gross margin Marketing, distribution, and customer-service costs Operating income

$420.00 $ 48.00 244.80 292.80 14.40

278.40 141.60 108.00 $ 33.60

Chan Corporation Schedule of Cost of Goods Manufactured For the Year Ended December 31, 2022 (in millions) Direct material costs: Beginning inventory, Jan. 1 Direct materials purchased Cost of direct materials available for use Ending inventory, Dec. 31 Direct materials used Direct manufacturing labour costs Indirect manufacturing costs: Plant supplies used Property taxes on plant Plant utilities Indirect manufacturing labour costs Depreciation—plant, building, and equipment Miscellaneous manufacturing overhead costs Manufacturing costs incurred during the year Add beginning work in process inventory, Jan. 1 Total manufacturing costs to account for Deduct ending work in process inventory, Dec. 31 Cost of goods manufactured (to income statement)

$ 36.00 96.00 132.00 6.00 $126.00 48.00 7.20 1.20 6.00 24.00 10.80 12.00

61.20 235.20 12.00 247.20 2.40 $244.80

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2-36 Statement of comprehensive income. 1.

Beagle-grove Company Statement of Comprehensive Income For the Year Ended December 31, 2022 Revenue Cost of goods sold: Beginning finished goods, Jan. 1 Cost of goods manufactured (see below) Cost of goods available for sale Ending finished goods, Dec. 31 Gross margin Operating costs: Marketing and promotion Marketing salaries Shipping costs Customer-service costs Operating income

$1,360,000 $ 100,000 960,000 1,060,000 150,000

$ 60,000 100,000 70,000 100,000

910,000 $ 450,000

330,000 $ 120,000

Beagle-grove Company Schedule of Cost of Goods Manufactured For the Year Ended December 31, 2022 Direct material costs: Beginning inventory, Jan. 1 Direct materials purchased during the year Cost of direct materials available for use Ending inventory, Dec. 31 Direct materials used

$ 40,000 460,000 500,000 50,000 $ 450,000

(V) Direct manufacturing labour costs Indirect manufacturing costs: Sandpaper Materials–handling costs Lubricants and coolants Miscellaneous indirect manufacturing labour Plant leasing costs Depreciation—plant equipment Property taxes on plant equipment Fire and casualty insurance on plant equipment Copyright © 2022 Pearson Canada Inc. 2-20

300,000 (V) 2,000 (V) 70,000 (V) 5,000 (V) 40,000 (V) 54,000 (F) 36,000 (F) 4,000 (F) 3,000 (F)

214,000

Chapter 2: An Introduction to Cost Terms and Purposes

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Manufacturing costs incurred during the year Add beginning work in process inventory, Jan. 1 Total manufacturing costs to account for Deduct ending work in process inventory, Dec. 31 Cost of goods manufactured (to income statement) 2. Direct materials unit cost

= Direct materials used ÷ Units produced = $450,000 ÷ 900,000 = $0.50

Plant leasing unit cost

= Plant leasing costs ÷ Units produced = $54,000 ÷ 900,000 = $0.06

964,000 10,000 974,000 14,000 $960,000

3. The direct materials costs are variable, so they would increase in total from $450,000 to $500,000 (= 1,000,000 × $0.50). However, their unit costs would be unaffected: $500,000 ÷ 1,000,000 units = $0.50. In contrast, the plant leasing costs of $54,000 are fixed, so they would not increase in total. However, if the plant leasing costs were assigned to units produced, the unit costs would decline from $0.060 to $0.054: $54,000 ÷ 1,000,000 = $0.054. 4. The explanation would begin with the answer to requirement 3. As a consultant, you should stress that unitizing (averaging) of costs that have different behaviour patterns can be misleading. A common error is to assume that a total unit cost, which is often a sum of variable unit costs and fixed unit costs, is an indicator that total costs change in a wholly variable way as the level of production output changes. You must be especially wary about unit fixed costs. Too often, unit fixed costs are erroneously regarded as being indistinguishable from unit variable costs. 5. DML is 33% (= $300,000 ÷ $910,000) of total COGS. This is a material amount based on the normal financial accounting guideline that suggests materiality thresholds of 5% to 10%. Because DML is material it should be classified as a prime rather than a conversion cost. Total conversion costs are $214,000; this is less than the DML. To include DML in the conversion cost would distort the relationship between the contribution to costs made by direct and those made by indirect costs. This would misrepresent the material and efficient causes of the cost of each output unit.

Chapter 2: An Introduction to Cost Terms and Purposes

2-37 (10 min.)

Inventory decision, opportunity costs.

1. Unit cost, orders of 20,000 Unit cost, order of 240,000 (0.96  $9.00)

$9.00 $8.64

Alternatives under consideration: (a) Buy 240,000 units at start of year. (b) Buy 20,000 units at start of each month. Average investment in inventory: (a) (240,000  $8.64) ÷ 2 (b) (20,000  $9.00) ÷ 2 Difference in average investment

$1,036,800 90,000 $ 946,800

Opportunity cost of interest forgone from 240,000-unit purchase at start of year = $946,800  0.10 = $94,680 2. No. The $94,680 is an opportunity cost rather than an incremental or outlay cost. No actual transaction records the $94,680 as an entry in the accounting system. 3. The following table presents the two alternatives:

Alternative A: Alternative B: Purchase Purchase 240,000 20,000 spark plugs at spark plugs beginning of at beginning year of each month Difference (1) (2) (3) = (1) – (2) Annual purchase-order costs (1  $200; 12  $200) Annual purchase (incremental) costs (240,000  $8.64; 240,000  $9) Annual interest income that could be earned if investment in inventory were invested (opportunity cost) (10%  $1,036,800; 10%  $90,000) Relevant costs

200 2,073,600

2,400 2,160,000

$ (2,200) (86,400)

103,680 $2,177,480

9,000 $2,171,400

94,680 6,080

Column (3) indicates that purchasing 20,000 spark plugs at the beginning of each month is preferred relative to purchasing 240,000 spark plugs at the beginning of the year because the opportunity cost of holding larger inventory exceeds the lower purchasing and ordering costs.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

If other incremental benefits of holding lower inventory such as lower insurance, materials handling, storage, obsolescence, and breakage costs were considered, the costs under Alternative A would have been higher, and Alternative B would be preferred even more.

COLLABORATIVE LEARNING CASES 2-38 (20–25 min.) Finding unknown balances. Let G = given, I = inferred Step 1:

Step 2:

Step 3:

CASE 1

CASE 2

Use gross margin formula Revenue Cost of goods sold Gross margin

$32,000 G A 20,700 I $11,300 G

$31,800 G 20,000 G C $11,800 I

Use schedule of cost of goods manufactured formula Direct materials used Direct manufacturing labour costs Indirect manufacturing costs Manufacturing costs incurred Add beginning work in process, Jan. 1, 2021 Total manufacturing costs to account for Deduct ending work in process, Dec. 31, 2021 Cost of goods manufactured

$ 8,000 G 3,000 G 7,000 G 18,000 I 0G 18,000 I 0G $18,000 I

$12,000 G 5,000 G D 6,500 I 23,500 I 800 G 24,300 I 3,000 G $21,300 I

Use cost of goods sold formula Beginning finished goods inventory, Jan. 1, 2021 Cost of goods manufactured Cost of goods available for sale Ending finished goods inventory, Dec. 31, 2021 Cost of goods sold

$ 4,000 G 18,000 I 22,000 I B 1,300 I $20,700 I

4,000 G 21,300 I 25,300 I 5,300 G $20,000 G

For case 1, do steps 1, 2, and 3 in order. For case 2, do steps 1, 3, and then 2.

Chapter 2: An Introduction to Cost Terms and Purposes

2-39 (20–25 min.) Labour-cost ethics, governance. 1. No. The direct manufacturing labour costs are not 20% or greater of total manufacturing costs. Direct manufacturing labour costs are $410,000 which are 16.4% of total manufacturing costs, $410,000 ÷ $2,500,000 = 16.4%. 2. Buyoung Kim can ask the controller to reclassify at least two of the costs that are currently reported as indirect manufacturing costs to direct manufacturing labour costs. The most logical are the fringe benefits and some of the overtime costs, particularly if it can be argued that some of the overtime was directly caused by jobs. The fringe benefits are logical because they are not only the largest, but can be argued to be a part of normal cost of manufacturing labour. Fringe benefits related to direct manufacturing labour costs together with some of the overtime premium could bring the total direct manufacturing labour cost over the minimum $500,000. Justification for reclassifying vacation and sick time is similar to that of fringe benefits—that it is a normal cost of labour since it is part of and can be traced to the direct manufacturing labourer’s payment. It is harder to justify reclassifying idle time, since it is difficult to identify a specific job that the idle time relates to. Idle time is also the smallest cost item. 3. The controller should not reclassify overhead costs as direct manufacturing labour costs just so the firm can reap tax benefits, particularly if the changes would violate the company’s policy of computing direct manufacturing labour costs. The idea of cost classification is to allow internal (and external) decision making by clarifying what each cost item represents. Also, if costs in only the Costa Melon plant are reclassified, it will be harder for XKY to evaluate the Costa Melon plant, when compared to XKY’s other plants. Nevertheless, some of the arguments presented in requirement 2 can be justified and could prompt a reevaluation of XKY’s direct manufacturing labour classifications.

2-40 (30 min.) Classifying costs for managerial decisions. 1. The three factors that Diamond should consider in pricing decisions are: Customers. The major customers (“guests” to Diamond) of the Galaxy are business travellers who predominantly stay on a Sunday-through-Thursday basis. Diamond should consider these issues: (a) Will some of the $180/$216-a-night customers staying Sunday through Thursday transfer their business to Friday or Saturday for reduced rates? If a sizable number of these customers can transfer their business to Friday or Saturday nights, Diamond should be reluctant to make sizable weekend price discounts. (b) Will a new set of customers be attracted to the Galaxy with a reduced weekend rate, people who would not be attracted at the $180/$216-a-night rates? (c) How will seasonality affect the business? Will there be more tourists, and therefore less need for a discount, at certain times of the year?

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

The business customers of Galaxy likely will understand cost–volume–profit relationships for hotels and not be offended at different rates for different days of the week. “Off-peak” pricing is an accepted convention in many industries (such as in telecommunications and airlines). Competitors. Many prestige hotels already offer sizable price discounts on weekends. Moreover, cuts of up to 50% are the nominal price discounts. The additional items included in weekend packages (such as breakfast or a bottle of champagne) add to the effective price discount. Costs. The variable costs of servicing each room are only $24 a night per single occupancy and $26.40 a night per double occupancy. Any room rate above these amounts will make a positive contribution to Galaxy’s operating income. It is an accepted convention that weekend rates at Vancouver’s prestige hotels will be lowered on Friday and Saturday nights. Diamond may want to offer moderate price reductions and add other discounted items in the weekend package. The approach may help maintain the policy of treating guests as “royalty.” A Finnish student commented that hotels in Finland provide customers who have a high volume of business in peak periods with complimentary rooms in the off-peak period. 2. The customers, competitors, and cost factors that apply to setting the rates for Grey Cup weekend include: Customers. The likely customers can be classified as: (a) long-term Galaxy hotel customers, and (b) other customers. Charging the market rate (even if it is $360 a night) is not likely to alienate other customers. Diamond’s problem lies with long-term customers. He may want to offer preferred reservations or “normal” weekday ($180/$216-a-night) rates to his regular customers on Grey Cup weekend. Competitors. Several four-star prestige hotels are already advertising $360 a night rates. Thus, Galaxy will not be viewed as the first to adopt an “aggressive price-gouging” approach. Hotels often increase their rates because of increased demand even when costs do not increase. It is unlikely that the Galaxy chain would be singled out for negative publicity from such a policy, especially if it made an effort to give preferential bookings and rates to its regular customers. Costs. The variable costs of servicing each room are the same as in the answer to requirement 1.

Chapter 2: An Introduction to Cost Terms and Purposes

2-41 (30 min.) Cost analysis, litigation risk, governance. 1. Reasons for Savage not wanting Nash to include the potential litigation costs include: (a) Genuine belief that the product has no risk of future litigation. Note that she asserts “she has total confidence in her medical research team.” (b) Concern that the uncertainties about litigation are sufficiently high to make any numerical estimate “meaningless.” (c) Concern that inclusion of future litigation costs would cause the board of directors to vote against the project. Savage may be “overly committed” to the project and wants to avoid showing information that prompts questions she prefers not be raised. (d) Avoid “smoking gun” memos being included in the project evaluation file. Savage may believe that if subsequent litigation occurs, the plaintiffs will “inappropriately” use a litigation cost line item as “proof” FY “knew the product had health problems” that were known to management at the outset.

2. Unit cost to FY Physician price Patient’s price FY’s margin Physician’s margin

No litigation $144.00 172.80 432.00 28.80 259.20

With litigation $276.00 331.20 432.00 55.20 100.80

The selling price would be $828 (= $276 × 3) to maintain the triple-the-cost target. The percentage decrease is: 61.11% [= (259.20 – 100.80) / 259.20]. Since each treatment is planned to cost patients $432, the new selling price of $331.20 will drop the doctors’ margin to only $100.80 from the planned margin of $259.20. This would probably result in the doctors not having much incentive to promote the product. In fact, it may be quite possible that the doctors may not attempt to prescribe the treatment at such low margin because of their own exposure to liability. 3. Nash has already registered his concern to Savage. The difficulty is that Savage asked Nash not to include the possible litigation in his presentation. If there is no record of this presentation, then Nash may have several concerns. (a) He may be accused at a later stage of not anticipating the costs of litigation. If litigation does occur, some people will try to distance themselves from the problems. It may be to Nash’s advantage to have a record of his early concerns. (Although plaintiffs may make Nash’s life very difficult if they get access to Nash’s files.) Nash may want to keep some record of his presentation to Savage.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

(b) He may be portrayed as not being a “team player” if he continues his objections. Savage may have to silence his concerns if he decides to stay at FY. (c) He may have difficult ethical objections with Savage’s behaviour. If he thinks she is acting unethically, his main options are to speak to her first (at least one time), speak to her supervisor (probably chairman of the company), or, as a final resort, resign.

CHAPTER 3 COST-VOLUME-PROFIT ANALYSIS MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

SHORT-ANSWER QUESTIONS 3-1

The assumptions underlying CVP analysis are:

1. Changes in the sales volume and production volume are identical. The ending balances of inventories are zero. 2. All costs are classified as fixed or variable with no mixed costs. 3. All cost behaviour is linear within the relevant volume range. 4. The unit selling price, unit variable costs, fixed costs, and sales volume are known. 5. Either the product sold or the product mix remains constant although the volume changes. 6. All revenues and costs can be added and compared without taking into account the time value of money.

3-2

Operating income is total revenues from operations for the accounting period minus total costs from operations: Operating income = Total revenues from operations – Total costs from operations Net income is operating income plus non-operating revenues (such as interest revenue) minus non-operating costs (such as interest cost) minus income taxes.

3-3

CVP certainly is simple, with its assumption of a single revenue driver, a single cost driver, and linear revenue and cost relationships. Whether these assumptions make it simplistic depends on the decision context. In some cases, these assumptions may be sufficiently accurate for CVP to provide useful insights.

3-4

An increase in the income tax rate does not affect the breakeven point. Operating income at the breakeven point is zero and thus no income taxes will be paid at this point.

3-5

Sensitivity analysis is a “what-if” technique that examines how a result will change if the original predicted data are not achieved or if an underlying assumption changes. The advent of spreadsheet software has greatly increased the ability to explore the effect of alternative assumptions at minimal cost. CVP is one of the most widely used software applications in the management accounting area.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3-6   

Manufacturing—substituting a robotic machine for hourly wage workers. Marketing—changing a sales force compensation plan from a percentage of sales dollars to a fixed salary. Customer service—hiring a subcontractor to do customer repair visits on an annual retainer basis rather than a per visit basis.

3-7   

Examples include:

Manufacturing—subcontracting a component to a supplier on a per unit basis to avoid purchasing a machine with a high fixed amortization cost. Marketing—changing a sales compensation plan from a fixed salary to a percentage of sales dollars basis. Customer service—hiring a subcontractor to do customer service on a per visit basis rather than an annual retainer basis.

3-8

Operating leverage describes the effects that fixed costs have on changes in operating income as changes occur in units sold and hence in contribution margin. Knowing the degree of operating leverage at a given level of sales helps managers calculate the effect of fluctuations in sales on operating incomes.

3-9

A company with multiple products can compute a breakeven point by assuming there is a constant mix of products at different levels of total revenue.

EXERCISES 3-10 (10 min.) 1. 2. 3. 4. 5. 6. 7. 8. 9.

Terminology

capital intensive Cost–volume–profit analysis breakeven point Operating leverage contribution margin contribution margin percentage gross margin sales mix margin of safety

Chapter 3: Cost-Volume-Profit Analysis

3-11 (15 min.)

CVP analysis computations.

Case

Unit Selling Price

Unit VC

Units Sold

TCM

Fixed Costs

$ 70

$ 25

20,000

$ 900,000

$ 700,000

$200,000

15,000

375,000

250,000

125,000

250

100

30,000

4,500,000

3,600,000

900,000

150

24,000

1,728,000

1,500,000

228,000

TCM = $900,000 = Q =

Q (USP – UVC) Q ($70 – $25) 20,000

TFC

= =

TCM – OI $900,000 – $200,000 = $700,000

OI $125,000 TCM

= = =

TCM – TFC TCM – $250,000 $375,000

TCM $375,000 $25 USP

= = = =

Q (USP – UVC) 15,000 (USP – $62) (USP – $62) $87

OI $900,000 TFC

= = =

TCM – TFC $4,500,000 – TFC $3,600,000

TCM $4,500,000 $150 UVC

= = = =

Q (USP – UVC) 30,000 ($250 – UVC) $250 – UVC $100

OI OI OI

= = =

TCM – TFC $1,728,000 – $1,500,000 $228,000

TCM $1,728,000 $72 UVC

= = = =

Q (USP – UVC) 24,000 ($150 – UVC) $150 – UVC $78

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3-12 (10 min.)

CVP computations.

1a.

Sales ($50 per unit × 300,000 units) Variable costs ($35 per unit × 300,000 units) Contribution margin

$15,000,000 10,500,000 $ 4,500,000

1b.

Contribution margin (from above) Fixed costs Operating income

$ 4,500,000 1,800,000 $ 2,700,000

2a.

Sales (from above) Variable costs ($23 per unit × 300,000 units) Contribution margin

$15,000,000 6,900,000 $ 8,100,000

2b.

Contribution margin Fixed costs Operating income

$ 8,100,000 3,400,000 $ 4,700,000

3. Operating income is expected to increase by $2,000,000 if Ms. Schoenen’s proposal is accepted. The management would consider other factors before making the final decision. It is likely that product quality would improve as a result of using state of the art equipment. Due to increased automation, probably many workers will have to be laid off. Patel’s management will have to consider the impact of such an action on employee morale. In addition, the proposal increases the company’s fixed costs dramatically. This will increase the company’s operating leverage and risk.

3-13 (10 min.)

CVP analysis, income taxes.

1. Monthly fixed costs = $60,000 + $70,000 + $10,000 = $140,000 Contribution margin per unit = $26,000 – $22,000 – $500 = $3,500 Monthly fixed costs $140, 000 Breakeven units per month = = = 40 cars Contribution margin per input $3,500 per car 2. Tax rate = 40% Target net income = $63,000 Target net income $63, 000 $63, 000 Target operating income =    $105, 000 1 tax rate (1 0.40) 0.60 Quantity of output units  Fixed costs  Target operating income required to be sold Contribution margin per unit



$140, 000  $105, 000  70 cars $3,500

Chapter 3: Cost-Volume-Profit Analysis

3-14 (20 min.)

CVP analysis, income taxes.

Variable cost percentage is $3.20  $8.00 = 40%

Let R = Revenues needed to obtain target net income $105,000 R – 0.40R – $450,000 = 1 0.30 0.60R = $450,000 + $150,000 R = $600,000  0.60 R = $1,000,000 Proof:

2.a. b.

Revenues Variable costs (at 40%) Contribution margin Fixed costs Operating income Income taxes (at 30%) Net income

$1,000,000 400,000 600,000 450,000 150,000 45,000 $ 105,000

Customers needed to earn net income of $105,000: Total revenues  Sales bill per customer: $1,000,000  $8 = 125,000 customers Customers needed to break even: Contribution margin per customer = $8.00 – $3.20 = $4.80 Breakeven number of customers = Fixed costs  Contribution margin per customer = $450,000  $4.80 per customer = 93,750 customers Using the shortcut approach: Change in net income

New net income

 Unit  Change in     =  contribution  (1 – Tax rate) number of customers   margin    = (150,000 – 125,000)  $4.80  (1 – 0.30) = $120,000  0.7 = $84,000 = $84,000 + $105,000 = $189,000

The alternative approach is: Revenues, 150,000  $8.00 Variable costs at 40% Contribution margin Fixed costs Operating income Income tax at 30% Net income

$1,200,000 480,000 720,000 450,000 270,000 81,000 $ 189,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3-15 (15 min.)

Gross margin and contribution margin.

1. Ticket sales ($20 × 500 attendees) Variable cost of dinner ($10a × 500 attendees) Variable invitations and paperwork ($1b × 500) Contribution margin Fixed cost of dinner Fixed cost of invitations and paperwork Operating profit (loss)

$10,000 5,000 500 4,500 6,000 2,500

8,500 $ (4,000)

a$5,000/500 attendees = $10/attendee b$500/500 attendees = $1/attendee

2. Ticket sales ($20 × 1,000 attendees) Variable cost of dinner ($10a × 1,000 attendees) Variable invitations and paperwork ($1b × 1,000) Contribution margin Fixed cost of dinner Fixed cost of invitations and paperwork Operating profit (loss)

$20,000 10,000 1,000 9,000 6,000 2,500

8,500 $ 500

3-16 CVP, not-for-profit 1.

Ticket sales per concert Variable costs per concert: Guest performers Marketing and advertising Total variable costs per concert Contribution margin per concert Fixed costs Salaries Lease payments ($4,000 × 12) Total fixed costs Less donations Net fixed costs

Breakeven point in units =

$ 4,500 $ 1,800 1,000 2,800 $ 1,700 $33,000 48,000 $81,000 30,000 $51,000

Net fixed costs $51, 00 = 30 concerts Contribution margin per concert $1, 700

Chapter 3: Cost-Volume-Profit Analysis

Check Donations Revenue ($4,500 × 30) Total revenue Less variable costs Guest performers ($1,800 × 30) Marketing and advertising ($1,000 × 30) Total variable costs Less fixed costs Salaries Mortgage payments Total fixed costs Operating income 2.

Ticket sales per concert Variable costs per concert: Guest performers Marketing and advertising Total variable costs per concert Contribution margin per concert Fixed costs Salaries ($33,000 + $25,500) Lease payments ($4,000 × 12) Total fixed costs Less donations Net fixed costs

Breakeven point in units =

$ 30,000 135,000 165,000 $54,000 30,000 84,000 $33,000 48,000 81,000 $ 0 $

4,500

2,800 1,700

$ 1,800 1,000

$58,500 48,000 $106,500 30,000 $ 76,500

Net fixed costs $76,500 = = 45 concerts Contribution margin per concert $1, 700

Check Donations Revenue ($4,500 × 45) Total revenue Less variable costs Guest performers ($1,800 × 45) Marketing and advertising ($1,000 × 45) Total variable costs

$ 30,000 202,500 232,500 $81,000 45,000

126,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Less fixed costs Salaries Lease payments Total fixed costs Operating income

$58,500 48,000 106,500 0

Operating Income if 41 concerts are held Donations Revenue ($4,500 × 41) Total revenue Less variable costs Guest performers ($1,800 × 41) Marketing and advertising ($1,000 × 41) Total variable costs Less fixed costs Salaries Lease payments Total fixed costs Operating income (loss)

$ 30,000 184,500 214,500 $73,800 41,000 114,800 $58,500 48,000 106,500 $ (6,800)

The Music Society would not be able to afford the new marketing director if the number of concerts were to increase to only 41 events. The addition of the new marketing director would require the Music Society to hold at least 45 concerts in order to breakeven. If only 41 concerts were held, the organization would lose $6,800 annually. The Music Society could look for other contributions to support the new marketing director’s salary or perhaps increase the number of attendees per concert if the number of concerts could not be increased beyond 41. 3.

Ticket sales per concert Variable costs per concert: Guest performers Marketing and advertising Total variable costs per concert Contribution margin per concert Fixed costs Salaries ($33,000 + $25,500) Lease payments ($4,000 × 12) Total fixed costs Deduct donations Net fixed costs

Breakeven point in units =

4,500

2,800 1,700

$ 1,800 1,000

$58,500 48,000 $106,500 47,000 $ 59,500

Chapter 3: Cost-Volume-Profit Analysis

Check Donations Revenue ($4,500 × 35) Total revenue Less variable costs Guest performers ($1,800 × 35) Marketing and advertising ($1,000 × 35) Total variable costs Less fixed costs Salaries Mortgage payments Total fixed costs Operating income

$ 47,000 157,500 204,500 $63,000 35,000 98,000 $58,500 48,000 106,500 $ 0

3-17 (35–40 min.) CVP analysis, changing revenues and costs. 1a.

SP UVC UCM FC

1b.

2a.

SP VCU UCM FC

2b.

= = = =

8% × $1,000 = $80 per ticket $35 per ticket $80 – $35 = $45 per ticket $22,000 a month $22,000 FC Q = = = 489 tickets (rounded up) $45 per ticket UCM

$22,000  $10,000 $32,000 FC  TOI = = = 712 tickets (rounded up) $45 per ticket $45 per ticket UCM = $80 per ticket = $29 per ticket = $80 – $29 = $51 per ticket = $22,000 a month $22,000 FC Q = = = 432 tickets (rounded up) $51 per ticket UCM

$22,000  $10,000 $32,000 FC  TOI = = = 628 tickets (rounded up) $51 per ticket $51 per ticket UCM

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3a.

SP VCU CMU FC

3b.

= = = =

$48 per ticket $29 per ticket $48 – $29 = $19 per ticket $22,000 a month FC $22,000 Q = = = 1,158 tickets (rounded up) UCM $19 per ticket FC  TOI UCM

$22,000  $10,000 $32,000 = = 1,685 tickets (rounded up) $19 per ticket $19 per ticket

The decreased commission significantly increases the breakeven point and the number of tickets required to yield a target operating income of $10,000. 4a.

The $10 delivery fee can be treated as either an extra source of revenue (as done below) or as a cost offset. Either approach increases CMU $10: SP VCU CMU FC

$58 (= $48 + $10) per ticket $29 per ticket $58 – $29 = $29 per ticket $22,000 a month FC $22,000 Q = = = ~ 759 tickets (rounded up) CMU $29 per ticket

4b.

= = = =

FC  TOI CMU

$22,000  $10,000 $32,000 = = 1,104 tickets (rounded up) $29 per ticket $29 per ticket

The $10 delivery fee results in a higher contribution margin, which reduces both the breakeven point and the tickets sold to attain operating income of $10,000.

Chapter 3: Cost-Volume-Profit Analysis

3-18 (20 min.)

Contribution margin, gross margin and margin of safety.

1. Mirabel Cosmetics Statement of Operating Income June Units sold Revenues Variable costs Variable manufacturing costs Variable marketing costs Total variable costs Contribution margin Fixed costs Fixed manufacturing costs Fixed marketing & administration costs Total fixed costs Operating income

15,000 $150,000 $65,000 10,000 75,000 75,000 $25,000 15,000 40,000 $ 35,000

2. Contribution margin (CM) per unit = $75,000/15,000 units = $5 per unit Breakeven quantity = Fixed Costs/CM per unit = $40,000/$5 per unit = 8,000 units Selling price = Revenues/Units sold = $150,000/15,000 units = $10 per unit Breakeven revenues = 8,000 units × $10 per unit = $80,000 Alternatively, Contribution margin percentage = CM/Revenues = $75,000/$150,000 = 50% Breakeven revenues = Fixed Costs/CM % = $40,000/0.50 = $80,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. Margin of safety = 15,000 units – 8,000 units = 7,000 units 4. Units sold Revenues (Units sold × Selling price = 9,000 × $10) Contribution margin (Revenues × CM percentage = $90,000 × 50%) Fixed costs Operating income Taxes (35% × $5,000) Net income

9,000 $90,000 $45,000 40,000 5,000 1,750 $ 3,250

3-19 CVP computations. 1. (a) 5,000,000 ($0.60 – $0.36) – $1,080,000

= $120,000

(b) 1,080,000 ÷ [($0.60 – $0.36) ÷ $0.60]

= $2,700,000

2. (a) 5,000,000 ($0.60 – $0.408) – $1,080,000

= $(120,000)

(b) [5,000,000 (1.1) ($0.60 – $0.36)] – [$1,080,000 (1.1)]

= $132,000

= $228,000

3. (a) $1,080,000 (1.1) ÷ ($0.60 – $0.36) (b) ($1,080,000 + $24,000) ÷ ($0.66 – $0.36)

= 4,950,000 units = 3,680,000 units

Chapter 3: Cost-Volume-Profit Analysis

3-20 (30 min.)

CVP, target operating income, service firm.

1. Revenue per child Variable costs per child Contribution margin per child Breakeven quantity =

2. Target quantity =

$640 240 $400

Fixed costs Contribution on margin per child $4,800  12 children $400

Fixed costs  Target operating income Contribution on margin per child $4,800  $10,800  39 children $400

3. Increase in rent ($3,500 – $2,100) Field trips Total increase in fixed costs Divide by the number of children enrolled Increase in fee per child

$1,400 2,500 $3,900 ÷ 39 $ 100

Therefore, the fee per child will increase from $640 to $740. Alternatively, New contribution margin per child =

$4,800  $3,900  $10,800  $500 39

New fee per child = Variable costs per child + New contribution margin per child = $240 + $500 = $740

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3-21 (25 min.) 1a.

Operating leverage.

Let Q denote the quantity of carpets sold Breakeven point under Option 1 $950Q  $760Q = $7,410 $190Q = $7,410 Q = $7,410  $190 = 39 carpets

1b.

Breakeven point under Option 2 $950Q  $760Q  (0.10  $950Q) 95Q Q

= = =

0 0 0

Operating income under Option 1 = $190Q  $7,410 Operating income under Option 2 = $95Q Find Q such that $190Q  $7,410 = $95Q $95Q = $7,410 Q = $7,410  $95 = 78 carpets Revenues = $950 × 78 carpets = $74,100 For Q = 78 carpets, operating income under both Option 1 ($190 × 78 – $7,410) and Option 2 ($95 × 78) = $7,410 For Q > 78, say, 79 carpets, Option 1 gives operating income = ($190  79)  $7,410 Option 2 gives operating income = $95  79 So Color Rugs will prefer Option 1.

= =

$7,600 $7,505

For Q < 78, say, 77 carpets, Option 1 gives operating income = ($190  77)  $7,410 Option 2 gives operating income = $95  77 So Color Rugs will prefer Option 2.

= =

$7,220 $7,315

Contribution margin Operating income Contribution margin per unit  Quanity of carpets sold = Operating income Under Option 1, contribution margin per unit = $950 – $760 = $190, so Operating income = $190  65  $7,410 = $4,940 $190  65 Degree of operating leverage = = 2.5 $4,940

3. Degree of operating leverage =

Chapter 3: Cost-Volume-Profit Analysis

Under Option 2, contribution margin per unit = $950 – $760 – 0.10  $950 = $95, so Operating income = $95  65  $0 = $6,175 $95  65 Degree of operating leverage = = 1.0 $6,175 4. The calculations in requirement 3 indicate that when sales are 65 units, a percentage change in sales and contribution margin will result in 2.5 times that percentage change in operating income for Option 1, but the same percentage change in operating income for Option 2 (because there are no fixed costs in Option 2). The degree of operating leverage at a given level of sales helps managers calculate the effect of fluctuations in sales on operating incomes.

3-22 (15 min.)

Contribution margin, decision making.

1. Revenues Deduct variable costs: Cost of goods sold Sales commissions Other operating costs Contribution margin

$600,000

2. Contribution margin percentage =

$198, 000 = 33% $600, 000

$300,000 72,000 30,000 $198,000

402,000

3. Incremental revenue (25% × $600,000) = $150,000 Incremental contribution margin (33% × $150,000) Incremental fixed costs (advertising) Incremental operating income

$49,500 8,000 $41,500

If Mr. Welch spends $8,000 more on advertising, the operating income will increase by $41,500, changing the operating loss of $(9,000) to an operating profit of $32,500 ($41,500 − $9,000). Proof (Optional): Revenues (125% × $600,000) $750,000 Cost of goods sold (50% of sales) 375,000 Gross margin 375,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Operating costs: Salaries and wages Sales commissions (12% of sales) Depreciation of equipment and fixtures Store rent Advertising Other operating costs: $30, 000   $750, 000  Variable  $600, 000  Fixed Operating income

$140,000 90,000 10,000 42,000 8,000 37,500 15,000

342,500 $ 32,500

4. To improve operating income, Mr. Wharton must find ways to decrease variable costs, decrease fixed costs, or increase selling prices.

3-23 CVP analysis, margin of safety. 1. Selling price Variable costs per unit: Contribution margin per unit (CMU) Breakeven point in units =

$3,000 2,000 $1,000

Fixed costs Contribution margin per unit

$400, 000 = 400 plans $1, 000 = 500* – 400 = 100 plans

Breakeven point in units = Margin of safety (units)

*$1,500,000 budgeted revenue ÷ $3,000 = 500 plans Breakeven revenues = $3,000 × 400 = $1,200,000 Margin of safety percentage = ($1,500,000 − $1,200,000) ÷ $1,500,000 = 20% 2a. Increase selling price to $4,000 Selling price Variable costs per unit: Contribution margin per unit (CMU) Fixed costs Contribution margin per unit $400,000 Breakeven point in units = = 200 plans $2,000 Breakeven revenues = $4,000 × 200 plans = $800,000

Breakeven point in units =

$4,000 2,000 $2,000

Chapter 3: Cost-Volume-Profit Analysis

At a revenue per customer of $4,000, budgeted revenues would increase to $2,000,000 ($4,000 × 500 plans). Margin of safety percentage = ($2,000,000 − $800,000) ÷ $2,000,000 = 60% This change will help Marketing Docs achieve its desired margin of safety of 45%. 2b. Selling price Variable costs per unit: Contribution margin per unit (CMU) Breakeven point in units =

Fixed costs Contribution margin per unit

Breakeven point in units =

$400,000 = 400 plans $1,000

$3,000 2,000 $1,000

Breakeven revenues = $3,000 × 400 plans = $1,200,000 Budgeted revenues = $1,500,000 × 1.05 = $1,575,000 Margin of safety percentage = ($1,575,000 − $1,200,000) ÷ $1,575,000 = 23.8% This change will not help Marketing Docs achieve its desired margin of safety of 45%. 2c. Selling price Variable costs per unit $2,000 – $200 (10% × 2,000): Contribution margin per unit (CMU)

$3,000 1,800 $1,200

Fixed costs = $400,000 × 1.05 = $420,000 Fixed costs Contribution margin per unit $420, 000 Breakeven point in units = = 350 plans $1, 200

Breakeven point in units =

Breakeven revenues = $3,000 × 350 plans = $1,050,000 Margin of safety percentage = ($1,500,000− $1,050,000) ÷ $1,500,000= 30% This change will not help Marketing Docs achieve its desired margin of safety of 45%. Each of the three options improves the margin of safety, but only option 2a exceeds the company’s desired margin of safety.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3-24 (30 min.)

CVP, international cost structure differences.

1a Selling Price VC-Manufacturing VC-Distribution Total Variable Costs Unit CM

1b 2.

India 49.00 6.00 23.00 29.00 20.00

$ $ $ $ $

China 49.00 8.60 18.40 27.00 22.00

$ $ $ $ $

Canada 49.00 19.00 7.00 26.00 23.00

$ $ $ $ $

Fixed Costs B/E point b/a (units) B/E point in revenues (Units  $49.00)

$7,000,000 350,000

$4,950,000 225,000

$10,350,000 450,000

$17,150,00

$11,025,000

$22,050,000

Volume Total CM (Volume  UCM) Less Fixed Costs Forecasted OI

1,100,000 $ 22,000,000 7,000,000 $ 15,000,000

1,100,000 $ 24,200,000 4,950,000 $ 19,250,000

1,100,000 $ 25,300,000 10,350,000 $ 14,950,000

China has the lowest breakeven point—it has the lowest fixed costs ($4,950,000) and its variable cost per unit ($27.00) is marginally lower than India. While Canada has a higher per unit CM, the fixed costs are more than double those of China. The higher fixed costs add risk to operating in Canada (leverage). 3.

China’s OI = $22.00 per unit less Fixed Costs of $4,950,000 Canada’s OI = $23.00 per unit less Fixed Costs of $10,350,000 $22.00X – $4,950,000 $5,400,000 X

= $23.00X – $10,350,000 = $1X = 5,400,000

Proof and India’s Operating Income at same sales volume Unit CM Volume Total CM Less Fixed Costs Forecasted OI

India 20.00 5,400,0000 108,000,000 7,000,000 $101,000,000 $

China 22.00 5,400,000 118,800,000 4,950,000 $113,850,000 $

(Note: India’s forecasted OI is lower at this volume)

Canada 23.00 5,400,0000 124,200,000 10,350,000 $113,850,000 $

Chapter 3: Cost-Volume-Profit Analysis

3-25 (25 min.)

CVP, Not for profit

Contributions Fixed costs Cash available to purchase land Divided by cost per hectare to purchase land Hectares of land SG can purchase

$19,000,000 1,000,000 $18,000,000 ÷3,000 6,000 hectares

Contributions ($19,000,000 – $5,000,000) Fixed costs Cash available to purchase land Divided by cost per hectare ($3,000 – $1,000) Hectares of land SG can purchase

$14,000,000 1,000,000 $13,000,000 ÷2,000 6,500 hectares

On financial considerations alone, SG should take the subsidy because it can purchase 500 more hectares (6,500 – 6,000). 3.

Let the decrease in contributions be $x. Cash available to purchase land = $19,000,000 – $x – $1,000,000 Cost to purchase land = $3,000 – $1,000 = $2,000 To purchase 6,000 hectares, we solve the following equation for x. 19, 000, x 1, 000, 000  6, 000 2, 000

18, 000, 000 x  6, 000  2, 000 18, 000, 000 x  12, 000, 000 X = $6,000,000 SG will be indifferent between taking the government subsidy or not if contributions decrease by $6,000,000.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3-26 (20 min.)

Orig. 1. 2. 3. 4. 5. 6. 7. 8.

CVP exercises.

Revenues

Variable Costs

$11,000,000G 11,000,000 11,000,000 11,000,000 11,000,000 11,550,000e 10,450,000g 12,100,000i 11,000,000

$7,500,000G 7,150,000 7,850,000 7,500,000 7,500,000 7,875,000f 7,125,000h 8,250,000j 7,125,000l

Contribution Margin $3,500,000 3,850,000a 3,150,000b 3,500,000 3,500,000 3,675,000 3,325,000 3,850,000 3,875,000

Fixed Costs $3,000,000G 3,000,000 3,000,000 3,150,000c 2,850,000d 3,000,000 3,000,000 3,300,000k 3,150,000m

Budgeted Operating Income $500,000 850,000 150,000 350,000 650,000 675,000 325,000 550,000 725,000

Gstands for given.

a$3,500,000 × 1.10; b$3,500,000 × 0.90; c$3,000,000 × 1.05; d$3,000,000 × 0.95; e$11,000,000 × 1.05; f$7,500,000 × 1.05; g$1,100,000 × 0.95; h$7,500,000 × 0.95; i$11,000,000 × 1.10; j$7,500,000 × 1.10; k$3,000,000 × 1.10; l$7,500,000 × 0.95; m$3,000,000 × 1.05 9. Alternative 1, a 10% increase in contribution margin holding revenues constant, yields the highest budgeted operating income because it has the highest increase in contribution margin without increasing fixed costs.

3-27 (40 min.) 1.

Alternative cost structures, uncertainty, and sensitivity analysis.

Contribution margin assuming fixed rental arrangement = $50 – $30 = $20 per bouquet Fixed costs = $5,000 Breakeven point = $5,000 ÷ $20 per bouquet = 250 bouquets Contribution margin assuming $10 per arrangement rental agreement = $50 – $30 – $10 = $10 per bouquet Fixed costs = $0 Breakeven point = $0 ÷ $10 per bouquet = 0

Let x denote the number of bouquets EB must sell for it to be indifferent between the fixed rent and royalty agreement. To calculate x we solve the following equation. $50x – $30x – $5,000 = $50x – $40x $20x – $5,000 = $10x $10x = $5,000 x = $5,000 ÷ $10 = 500 bouquets

Chapter 3: Cost-Volume-Profit Analysis

For sales between 0 to 500 bouquets, EB prefers the royalty agreement because in this range, $10x > $20x – $5,000. For sales greater than 500 bouquets, EB prefers the fixed rent agreement because in this range, $20x – $5,000 > $10x. 3.

If we assume the $5 savings in variable costs applies to both options, we solve the following equation for x. $50x – $25x – $5,000 = $50x – $35x $25x – $5,000 = $15x $10x = $5,000 x = $5,000 ÷ $10 per bouquet = 500 bouquets The answer is the same as in Requirement 2, that is, for sales between 0 to 500 bouquets, EB prefers the royalty agreement because in this range, $15x > $25x – $5,000. For sales greater than 500 bouquets, EB prefers the fixed rent agreement because in this range, $25 x – $5,000 > $15x.

Fixed rent agreement:

Bouquets Sold Revenue (1) (2) 200 200 × $50 = $10,000 400 400 × $50 = $20,000 600 600 × $50 = $30,000 800 800 × $50 = $40,000 1,000 1,000 × $50 = $50,000 Expected value of rent agreement

Fixed Costs (3) $5,000 $5,000 $5,000 $5,000 $5,000

Operating Variable Income Costs (Loss) (4) (5) = (2) – (3) – (4) 200 × $30 = $ 6,000 $ (1,000) 400 × $30 = $12,000 $ 3,000 600 × $30 = $18,000 $ 7,000 800 × $30 = $24,000 $11,000 1,000 × $30 = $30,000 $15,000

Probability (6)

0.20 0.20 0.20 0.20 0.20

Expected Operating Income (7) = (5) × (6) $ ( 200) 600 1,400 2,200 3,000 $7,000

Royalty agreement: Bouquets Variable Operating Sold Revenue Costs Income Probability (1) (2) (3) (4) = (2) – (3) (5) 200 200 × $50 = $10,000 200 × $40 = $ 8,000 $2,000 0.20 400 400 × $50 = $20,000 400 × $40 = $16,000 $4,000 0.20 600 600 × $50 = $30,000 600 × $40 = $24,000 $6,000 0.20 800 800 × $50 = $40,000 800 × $40 = $32,000 $8,000 0.20 1,000 1,000 × $50 = $50,000 1,000 × $40 = $40,000 $10,000 0.20 Expected value of royalty agreement

Expected Operating Income (6) = (4) × (5) $ 400 800 1,200 1,600 2,000 $6,000

EB should choose the fixed rent agreement because the expected value is higher than the royalty agreement. EB will lose money under the fixed rent agreement if EB sells less than 400 bouquets but this loss is more than made up for by high operating incomes when sales are high.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3-28 (20-30 min.) CVP, alternative cost structures. 1. Variable cost per unit = $10 Contribution margin per unit = Selling price –Variable cost per unit = $30 – $10 = $20 Fixed Costs: Manager’s salary ($72,000 × 0.5) ÷12 $3,000 per month Rent 1,000 per month Hourly employee wages (2 × 160 hours × $10) 3,200 per month Total fixed costs $7,200 per month Breakeven point = Fixed costs ÷ Contribution margin per unit = $7,200 ÷ $20 = 360 sunglasses (per month) Fixed costs + Target operating income Contribution margin per unit $7, 200  $5,300 =  625 sunglasses $20

2. Target number of sunglasses =

3. Contribution margin per unit = Selling price – Variable cost per sunglass = $30 – 0.15 × $30 – $10 = $15.50 Fixed costs = Manager’s salary + Rent = $3,000 + $1,000 = $4,000 Fixed costs  Target operating income Contribution margin per unit $4, 000  $5,300 =  600 sunglasses $15.50

Target number of sunglasses =

4. Let x be the number of sunglasses for which Classical Glasses is indifferent between paying a monthly rental fee for the retail space and paying a 10% commission on sales. Classical Glasses will be indifferent when the operating income under the two alternatives are equal. $30x − $10x – $7,200 = $30x – $10x − $30 (0.10)x − $6,200 $20x – $7,200 = $17x − $6,200 $3x = $1,000 x = 333 sunglasses (rounded) For sales between 0 and 333 sunglasses, Classical Glasses prefers to pay the 10% commission because in this range, $17x − $6,200 > $20x – $7,200. For sales greater than 333 sunglasses, the company prefers to pay the monthly fixed rent of $1,000 because $20x – $7,200 > $17x − $6,200.

Chapter 3: Cost-Volume-Profit Analysis

3-29

(40 min.)

Alternative cost structures, uncertainty, and sensitivity analysis.

1. Contribution margin per page assuming current fixed leasing agreement

= $0.20 – $0.05 – $0.10 = $0.05 per page

Fixed costs = $1,500 Breakeven point =

Fixed costs $1,500   30, 000 pages Contribution margin per page $0.05 per page

Contribution margin per page assuming $20 per 500 page commission agreement

= $0.20 – $0.04a – $0.05 – $.10 = $0.01 per page

Fixed costs = $0 Breakeven point =

Fixed costs $0   0 pages Contribution margin per page $0.01 per page

(i.e., Corporate Printing Company makes a profit no matter how few pages it sells) a$20 ÷ 500 pages = $0.04 per page

2. Let x denote the number of pages Corporate Printing must sell for it to be indifferent between the fixed leasing agreement and commission based agreement. To calculate x we solve the following equation. $0.20x – $0.05x – $0.10x – $1,500 = $0.20x – $0.04x – $0.05x – $0.10x $0.05x – $1,500 = $0.01x $0.04x = $1,500 x = $1,500 ÷ $0.04 = 37,500 pages For sales between 0 to 37,500 pages, Corporate Printing prefers the commission-based agreement because in this range, $0.01x > $0.05x – $1,500. For sales greater than 37,500 pages, Corporate Printing prefers the fixed leasing agreement because in this range, $0.05x – $1,500 > $.01x.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. Fixed leasing agreement

Pages Sold (1) 20,000 30,000 40,000 50,000 60,000

Revenue (2) 20,000 × $.20 = $ 4,000 30,000 × $.20 = $ 6,000 40,000 × $.20 = $ 8,000 50,000 × $.20 = $10,000 60,000 × $.20 = $12,000

Variable Costs (3) 20,000 × $.15 = $3,000 30,000 × $.15 = $4,500 40,000 × $.15 = $6,000 50,000 × $.15 = $7,500 60,000 × $.15 = $9,000

Operating Income (Loss) (5) = (2) – (3) – (4) $ (500) $ 0 $ 500 $1,000 $1,500

Fixed Costs (4) $1,500 $1,500 $1,500 $1,500 $1,500

Probability (6) 0.20 0.20 0.20 0.20 0.20

Expected value of fixed leasing agreement Commission-based leasing agreement:

Expected Operating Income (7) = (5) × (6) $(100) 0 100 200 300

$ 500

Pages Variable Sold Revenue Costs (1) (2) (3) 20,000 20,000 × $.20 = $ 4,000 20,000 × $.19 = $ 3,800 30,000 30,000 × $.20 = $ 6,000 30,000 × $.19 = $ 5,700 40,000 40,000 × $.20 = $ 8,000 40,000 × $.19 = $ 7,600 50,000 50,000 × $.20 = $10,000 50,000 × $.19 = $ 9,500 60,000 60,000 × $.20 = $12,000 60,000 × $.19 = $11,400 Expected value of commission based agreement

Operating Income (4) = (2) – (3) $200 $300 $400 $500 $600

Probability (5) 0.20 0.20 0.20 0.20 0.20

Expected Operating Income (6) = (4) × (5) $ 40 60 80 100 120 $400

Corporate Printing should choose the fixed cost leasing agreement because the expected value is higher than under the commission-based leasing agreement. The range of sales is high enough to make the fixed leasing agreement more attractive.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

PROBLEMS 3-30 (30 min.)

Sales mix, new and upgrade customers.

1. SP VCU CMU

New Upgrade Customers Customers $195 $115 65 35 $130 $ 80

The 60%/40% sales mix implies that, in each bundle, 3 units are sold to new customers and 2 units are sold to upgrade customers. Contribution margin of the bundle = 3  $130 + 2  $80 = $390 + $160 = $550 $16,500, 000 Breakeven point in bundles = = 30,000 bundles $550 Breakeven point in units is: Sales to new customers: 30,000 bundles  3 units per bundle 90,000 units Sales to upgrade customers: 30,000 bundles  2 units per bundle 60,000 units Total number of units to breakeven 150,000 units Alternatively, Let S = Number of units sold to upgrade customers 1.5S = Number of units sold to new customers Revenues – Variable costs – Fixed costs = Operating income [$195 (1.5S) + $115S] – [$65 (1.5S) + $35S] – $16,500,000 = OI $407.5S – $132.5S – $16,500,000 = OI Breakeven point is 150,000 units when OI = $0 because $275S = S = 1.5S = BEP =

$16,500,000 60,000 units sold to upgrade customers 90,000 units sold to new customers 150,000 units

Check Revenues ($195  90,000) + ($115  60,000) Variable costs ($65  90,000) + ($35  60,000) Contribution margin Fixed costs Operating income

$24,450,000 7,950,000 16,500,000 16,500,000 $ 0

Chapter 3: Cost-Volume-Profit Analysis

When 170,000 units are sold, mix is: Units sold to new customers (60%  170,000) Units sold to upgrade customers (40%  170,000) Revenues ($195  102,000) + ($115  68,000) Variable costs ($65  102,000) + ($35  68,000) Contribution margin Fixed costs Operating income

3a.

102,000 68,000 $27,710,000 9,010,000 18,700,000 16,500,000 $ 2,200,000

At New 40%/Upgrade 60% mix, each bundle contains 2 units sold to new customers and 3 units sold to upgrade customers. Contribution margin of the bundle = 2  $130 + 3  $80 = $260 + $240 = $500 $16,500, 000 Breakeven point in bundles = = 33,000 bundles $500 Breakeven point in units is: Sales to new customers: 33,000 bundles × 2 unit per bundle 66,000 units Sales to upgrade customers: 33,000 bundles × 3 unit per bundle 99,000 units Total number of units to breakeven 165,000 units Alternatively, Let S = Number of units sold to new customers then 1.5S = Number of units sold to upgrade customers [$195S + $115 (1.5S)] – [$65S + $35 (1.5S)] – $16,500,000 = OI 367.5S – 117.5S = $16,500,000 250S = $16,500,000 S = 66,000 units sold to new customers 1.5S = 99,000 units sold to upgrade customers BEP = 165,000 units Check Revenues ($195  66,000) + ($115  99,000) $24,255,000 Variable costs ($65  66,000) + ($35  99,000) 7,755,000 Contribution margin 16,500,000 Fixed costs 16,500,000 Operating income $ 0

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3b.

At New 80%/ Upgrade 20% mix, each bundle contains 4 units sold to new customers and 1 unit sold to upgrade customers. Contribution margin of the bundle = 4  $130 + 1  $80 = $520 + $80 = $600 $16,500, 000 Breakeven point in bundles = = 27,500 bundles $600 Breakeven point in units is: Sales to new customers: 27,500 bundles  4 units per bundle 110,000 units 27,500 bundles  1 unit per bundle Sales to upgrade customers: 27,500 units Total number of units to breakeven 137,500 units

Alternatively, Let S = Number of units sold to upgrade customers then 4S= Number of units sold to new customers [$195 (4S) + $115S] – [$65 (4S) + $35S] – $16,500,000 = OI 895S – 295S = $16,500,000 600S = $16,500,000 S = 27,500 units sold to upgrade customers 4S = 110,000 units sold to new customers 137,500 units Check Revenues ($195  110,000) + ($115  27,500) Variable costs ($65  110,000) + ($35  27,500) Contribution margin Fixed costs Operating income 3c.

$24,612,500 8,112,500 16,500,000 16,500,000 $ 0

As Chartz increases its percentage of new customers, which have a higher contribution margin per unit than upgrade customers, the number of units required to break even decreases:

Requirement 3(a) Requirement 1 Requirement 3(b)

New Upgrade Breakeven Customers Customers Point 40% 60% 165,000 60 40 150,000 80 20 137,500

Chapter 3: Cost-Volume-Profit Analysis

3-31 (30 min.)

Uncertainty and expected costs.

1. Monthly Number of Orders 300,000 500,000 700,000

Cost of Current System $2,000,000 + $55(300,000) = $18,500,000 $2,000,000 + $55(500,000) = $29,500,000 $2,000,000 + $55(700,000) = $40,500,000

Monthly Number of Orders 300,000 500,000 700,000

Cost of Partially Automated System $6,000,000 + $45(300,000) = $19,500,000 $6,000,000 + $45(500,000) = $28,500,000 $6,000,000 + $45(700,000) = $37,500,000

Monthly Number of Orders 300,000 500,000 700,000

Cost of Fully Automated System $14,000,000 + $25(300,000) = $21,500,000 $14,000,000 + $25(500,000) = $26,500,000 $14,000,000 + $25(700,000) = $31,500,000

2. Current System Expected Cost: $18,500,000 × 0.25 = $ 4,625,000 29,500,000 × 0.45 = 13,275,000 40,500,000 × 0.30 = 12,150,000 $30,050,000 Partially Automated System Expected Cost: $19,500,000 × 0.25 = $ 4,875,000 28,500,000 × 0.45 = 12,825,000 37,500,000 × 0.30 = 11,250,000 $28,950,000 Fully Automated System Expected Cost: $21,500,000 × 0.25 = $ 5,375,000 26,500,000 × 0.45 = 11,925,000 31,500,000 × 0.30 = 9,450,000 $26,750,000 3. The fully automated system has the lowest expected cost. Before making a final decision, Kindmart should consider the impact of the different systems on its relationship with suppliers. The interface with Kindmart’s system may require that suppliers also update their systems. This could cause some suppliers to raise the cost of their merchandise. It could force other suppliers to drop out of Kindmart’s supply chain because the cost of the system change would be prohibitive. Kindmart may also want to consider other factors such as the reliability of different systems and the effect on employee morale if employees have to be laid off as it automates its systems.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3-32 (15-20 min.) CVP analysis, service firm. 1.

Revenue per package Variable cost per package Contribution margin per package

$9,200 6,340 $2,860

Breakeven (units) = Fixed costs ÷ Contribution margin per package = $1,287,000 ÷ $2,860 = 450 package tours 2.

Contribution margin ratio 

Contribution margin per package Selling price

= $2,860 ÷ $9,200 =31.09% Units needed to achieve target income = (Fixed costs + target OI) ÷ UCM = ($1,287,000 + $214,500) ÷ $2,860 = 525 packages Revenues to earn $214,500 OI or Revenue to achieve target income

= 525 tour packages  $9,200= $4,830,000 = (Fixed costs + target OI) ÷ CM ratio = ($1,287,000 + $214,500) ÷ .3109 = $4,829,527 (rounding difference)

Fixed costs = $1,287,000 + $40,500 = $1,327,500 Breakeven (units) 

Fixed costs Contribution margin per unit

Contribution margin per unit = $1,327,500 ÷ 450 = $2,950 per tour package Desired variable cost per tour package = $9,200 – $2,950 = $6,250 Because the current variable cost per unit is $6,340 the unit variable cost will need to be reduced by $90 to achieve the breakeven point calculated in requirement 1. Alternative Method: If fixed cost increases by $40,500 then total variable costs must be reduced by $40,500 or $40,500/450 or $90 per package tour.

Chapter 3: Cost-Volume-Profit Analysis

3-33 (40 min.)

Multiproduct CVP and decision making.

1. Faucet filter: Selling price Variable cost per unit Contribution margin per unit

$90 25 $65

Pitcher/filter: Selling price Variable cost per unit Contribution margin per unit

$110 20 $ 90

Each bundle contains two faucet models and three pitcher models. So contribution margin of a bundle = 2 × $65 + 3 × $90 = $400 Breakeven Fixed costs $1, 200, 000 point in =   3, 000 bundles Contribution margin per bundle $400 bundles

Breakeven point in units of faucet models and pitcher models is: Faucet models: 3,000 bundles × 2 units per bundle = 6,000 units Pitcher models: 3,000 bundles × 3 units per bundle = 9,000 units Total number of units to breakeven 15,000 units Breakeven point in dollars for faucet models and pitcher models is: Faucet models: 6,000 units × $90 per unit = $ 540,000 Pitcher models: 9,000 units × $110 per unit = 990,000 Breakeven revenues $1,530,000 Alternatively, weighted average contribution margin per unit = Breakeven point =

$1,200,000  15, 000 units $80

2  15,000 units = 6,000 units 5 3 Pitcher-cum-filter:  15, 000 units  9, 000 units 5 Breakeven point in dollars Faucet filter: 6,000 units × $90 per unit $ 540,000 Pitcher/filter: 9,000 units × $110 per unit 990,000 Total $1,530,000 Faucet filter:

(2  $65) + (3  $90) = $80 5

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Faucet filter: Selling price Variable cost per unit Contribution margin per unit Pitcher/filter:

$90 20 $70

Selling price Variable cost per unit Contribution margin per unit

$110 10 $100

Each bundle contains two faucet models and three pitcher models. So contribution margin of a bundle = 2 × $70 + 3 × $100 = $440 Breakeven $1, 200, 000  $208, 000 Fixed costs point in =   3, 200 bundles Contribution margin per bundle $440 bundles Breakeven point in units of faucet models and pitcher models is: Faucet models: 3,200 bundles × 2 units per bundle = 6,400 units Pitcher models: 3,200 bundles × 3 units per bundle = 9,600 units Total number of units to breakeven 16,000 units

Breakeven point in dollars for faucet models and pitcher models is: Faucet models: 6,400 bundles × $90 per unit = $ 576,000 Pitcher models: 9,600 bundles × $110 per unit = 1,056,000 Breakeven revenues $1,632,000

Alternatively, weighted average contribution margin per unit = Breakeven point =

$1,200,000 + $208,000  16, 000 units $88

2  16,000 units = 6,400 units 5 3 Pitcher-cum-filter:  16, 000 units  9, 600 units 5 Breakeven point in dollars: Faucet filter: 6,400 units × $90 per unit $ 640,000 Pitcher/filter: 9,600 units × $110 per unit 1,056,000 Total $1,632,000 Faucet filter:

(2  $70) + (3  $100) = $88 5

Chapter 3: Cost-Volume-Profit Analysis

3. Let x be the number of bundles for Crystal Clear Products to be indifferent between the old and new production equipment. Operating income using old equipment = $400x – $1,200,000 Operating income using new equipment = $440x – $1,200,000 – $208,000 At point of indifference: $400x – $1,200,000 = $440x – $1,408,000 $440x – $400x = $1,408,000 – $1,200,000 $40x = $208,000 x = $208,000 ÷ $40 = 5,200 bundles Faucet models = 5,200 bundles × 2 units per bundle = 10,400 units Pitcher models = 5,200 bundles × 3 units per bundle = 15,600 units Total number of units 26,000 units Let x be the number of bundles,

When total sales are less than 26,000 units (5,200 bundles), $400x $1,200,000 > $440x $1,408,000, so Crystal Clear Products is better off with the old equipment. When total sales are less than 26,000 units (5,200 bundles), $440x $1,408,000 > $400x $1,200,000, so Crystal Clear Products is better off buying the new equipment.

At total sales of 24,000 units (4,800 bundles), Crystal Clear Products should keep the old production equipment. Check $400 × 4,800 – $1,200,000 = $720,000 is greater than $440 × 4,800 – $1,408,000 = $704,000.

3-34 (20 min.)

CVP analysis, income taxes, sensitivity.

1a. To breakeven, Thompson Engine Company must sell 1,112 units. This amount represents the point where revenues equal total costs. Let Q denote the quantity of engines sold. Revenue = Variable costs + Fixed costs $7,000Q = $2000Q + $5,560,000 $5,000Q = $5,560,000 Q = 1,112 units

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Breakeven can also be calculated using contribution margin per unit. Contribution margin per unit = Selling price – Variable cost per unit = $7,000 – $2,000 = $5,000 Breakeven = Fixed Costs  Contribution margin per unit = $5,560,000  $5,000 = 1,112 units 1b. To achieve its net income objective, Thompson Engine Company must sell 1,412 units. This amount represents the point where revenues equal total costs plus the corresponding operating income objective to achieve net income of $900,000. Revenue = Variable costs + Fixed costs + [Net income ÷ (1 – Tax rate)] $7,000Q = $2,000Q + $5,560,000 + [$900,000  (1  0.40)] $7,000Q = $2,000Q + $5,560,000 + $1,500,000 Q = 1,412 units 2. Alternative b will help Thompson Engine Company achieve its net income objective of $900,000. Alternative b, where variable costs are reduced by $750 and selling price is reduced by $800 resulting in 1,130 additional units being sold through the end of the year, yields the highest net income of $920,100. Calculations for the three alternatives are shown below. Alternative a Revenues Variable costs Operating income Net income

= = = =

($7,000  300) + ($5,950a  1,400) = $10,430,000 $2,000  1,700b = $3,400,000 $10,430,000 $3,400,000  $5,560,000 = $1,470,000 $1,470,000  (1  0.40) = $882,000

a$7,000 – ($7,000 × 0.15);

Alternative b Revenues Variable costs Operating income Net income a$7,000 – 800;

= = = =

b300 units + 1,400 units.

($7,000  300) + ($6,200a  1,130) = $9,106,000 ($2,000  300) + (1,250b  1,130) = $2,012,500 $9,106,000  $2,012,500  $5,560,000 = $1,533,500 $1,533,500  (1  0.40) = $920,100

b$2,000 – $750.

Alternative c Revenues Variable costs Operating income Net income

= = = =

($7,000  300) + ($5,250a  1,500) = $9,975,000 $2,000  1,800b = $3,600,000 $9,975,000 $3,600,000  $5,282,000c = 1,093,000 $1,093,000  (1  0.40) = $655,800

a$7,000 – ($7,000 0.25);

b300 units + 1,500nits;

c$5,560,000 – ($5,560,000  0.05)

Chapter 3: Cost-Volume-Profit Analysis

3-35 (30–40 min.) CVP analysis, income taxes. 1. Revenues – Variable costs – Fixed costs

Target net income 1 Tax rate

Let X = Net income for 2021 X 1 0.40 X $770,000 – $407,000 – $214,500 = 0.60 $462,000 – $244,200 – $128,700 = X X = $89,100

22,000($35.00) – 22,000($18.50) – $214,500 =

Alternatively, Operating income = Revenues – Variable costs – Fixed costs = $770,000 – $407,000 – $214,500 = $148,500 Income taxes = 0.40 × $148,500 = $59,400 Net income = Operating income – Income taxes = $148,500 – $59,400 = $89,100 2. Let Q = Number of units to break even $35.00Q – $18.50Q – $214,500 = 0 Q = $214,500  $16.50 = 13,000 units

3. Let X = Net income for 2022 X 1 0.40 X $875,000 – $462,500 – $231,000 = 0.60 X $181,500 = 0.60 X = $108,900

25,000($35.00) – 25,000($18.50) – ($214,500 + $16,500) =

4. Let Q = Number of units to break even with new fixed costs of $146,250 $35.00Q – $18.50Q – $231,000 = 0 Q = $231,000  $16.50 = 14,000 units Breakeven revenues = 14,000  $35.00 = $490,000 5. Let S = Required sales units to equal 2021 net income $35.00S – $18.50S – $231,000 =

$89,100 0.60

$16.50S = $379,500 S = 23,000 units Revenues = 23,000 units  $35 = $805,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

6. Let A = Amount spent for advertising in 2022 $108,450 0.60 $875,000 – $462,500 – $214,500 – A = $180,750 $875,000 – $857,750 = A A = $17,250

$875,000 – $462,500 – ($214,500 + A) =

3-36 (20 min.)

CVP, shoe stores.

1. UCM (SP – UVC = $30 – $21) a. Breakeven units (FC ÷ UCM = $360,000 ÷ $9 per unit) b. Breakeven revenues (Breakeven units × SP = 40,000 units × $30 per unit) 2. Pairs sold Revenues, 35,000 × $30 Total cost of shoes, 35,000 × $19.50 Total sales commissions, 35,000 × $1.50 Total variable costs Contribution margin Fixed costs Operating income (loss) 3. Unit variable data (per pair of shoes) Selling price Cost of shoes Sales commissions Variable cost per unit Annual fixed costs Rent Salaries, $200,000 + $81,000 Advertising Other fixed costs Total fixed costs UCM, $30 – $19.50 a. Breakeven units, $441,000 ÷ $10.50 per unit b. Breakeven revenues, 42,000 units × $30 per unit

$9.00 40,000 $1,200,000

35,000 $1,050,000 682,500 52,500 735,000 315,000 360,000 $ (45,000) $ $

30.00 19.50 0 19.50

60,000 281,000 80,000 20,000 $ 441,000 $

10.50 42,000 $1,260,000

Chapter 3: Cost-Volume-Profit Analysis

4. Unit variable data (per pair of shoes) Selling price Cost of shoes Sales commissions Variable cost per unit Total fixed costs UCM, $30 – $21.30 a. Breakeven units = $360,000 ÷ $8.70 per unit b. Breakeven revenues = 41,380 units × $30 per unit 5. Pairs sold Revenues (50,000 pairs × $30 per pair) Total cost of shoes (50,000 pairs × $19.50 per pair) Sales commissions on first 40,000 pairs (40,000 pairs × $1.50 per pair) Sales commissions on additional 10,000 pairs: [10,000 pairs × ($1.50 + $0.30 per pair)] Total variable costs Contribution margin Fixed costs Operating income

30.00 19.50 1.80 $ 21.30 $ 360,000 $

8.70 41,380 (rounded up) $1,241,400 50,000 $1,500,000 $ 975,000 60,000 18,000 $1,053,000 $ 447,000 360,000 $ 87,000

Alternative approach: Breakeven point in units = 40,000 pairs Store manager receives commission of $0.30 on 10,000 (= 50,000 – 40,000) pairs. Contribution margin per pair beyond breakeven point of 10,000 pairs = $8.70 (= $30 – $21 – $0.30) per pair. Operating income = 10,000 pairs × $8.70 contribution margin per pair = $87,000.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3-37 (30 min.)

CVP, shoe stores (continuation of 3-36). Salaries + Commission Plan

No. of CM units sold per Unit (1) 40,000 42,000 44,000 46,000 48,000 50,000 52,000 54,000 56,000 58,000 60,000 62,000 64,000 66,000

(2) $9.00 9.00 9.00 9.00 9.00 9.00 9.00 9.00 9.00 9.00 9.00 9.00 9.00 9.00

Operating Income

CM per Unit

(3) = (1) × (2) (4) (5) = (3) – (4) $360,000 $360,000 0 378,000 360,000 18,000 396,000 360,000 36,000 414,000 360,000 54,000 432,000 360,000 72,000 450,000 360,000 90,000 468,000 360,000 108,000 486,000 360,000 126,000 504,000 360,000 144,000 522,000 360,000 162,000 540,000 360,000 180,000 558,000 360,000 198,000 576,000 360,000 216,000 594,000 360,000 234,000

(6) $10.50 10.50 10.50 10.50 10.50 10.50 10.50 10.50 10.50 10.50 10.50 10.50 10.50 10.50

Fixed Costs

Higher Fixed Salaries Only CM (7) = (1) × (6) $420,000 441,000 462,000 483,000 504,000 525,000 546,000 567,000 588,000 609,000 630,000 651,000 672,000 693,000

Operating Income

Difference in favour of higherfixed-salary-only

(8) (9) = (7) – (8) $441,000 $ (21,000) 441,000 0 441,000 21,000 441,000 42,000 441,000 63,000 441,000 84,000 441,000 105,000 441,000 126,000 441,000 147,000 441,000 168,000 441,000 189,000 441,000 210,000 441,000 231,000 441,000 252,000

(10) = (9) – (5) $(21,000) (18,000) (15,000) (12,000) (9,000) (6,000) (3,000) 0 3,000 6,000 9,000 12,000 15,000 18,000

Fixed Costs

Chapter 3: Cost-Volume-Profit Analysis

See preceding table. The new store will have the same operating income under either compensation plan when the volume of sales is 54,000 pairs of shoes. This can also be calculated as the unit sales level at which both compensation plans result in the same total costs: Let Q = unit sales level at which total costs are same for both plans: $19.50Q + $360,000 + $81,000 = $21Q + $360,000 $1.50 Q = $81,000 Q = 54,000 pairs

When sales volume is above 54,000 pairs, the higher-fixed-salaries plan results in lower costs and higher operating incomes than the salary-plus-commission plan. So, for an expected volume of 55,000 pairs, the owner would be inclined to choose the higher-fixed-salaries-only plan. But it is likely that sales volume itself is determined by the nature of the compensation plan. The salary-plus-commission plan provides a greater motivation to the salespeople, and it may well be that for the same amount of money paid to salespeople, the salary-pluscommission plan generates a higher volume of sales than the fixed-salary plan.

Let TQ = Target number of units For the salary-only plan: $30.00TQ – $19.50TQ – $441,000 = $168,000 $10.50TQ = $609,000 TQ = $609,000 ÷ $10.50 TQ = 58,000 units For the salary-plus-commission plan: $30.00TQ – $21.00TQ – $360,000 = $168,000 $9.00TQ = $528,000 TQ = $528,000 ÷ $9.00 TQ = 58,667 units (rounded up) The decision regarding the salary plan depends heavily on predictions of demand. For instance, the salary plan offers the same operating income at 58,000 units as the commission plan offers at 58,667 units.

WalkRite Shoe Company Operating Income Statement for year 2022 Revenues (48,000 pairs × $30) + (2,000 pairs × $18) Cost of shoes, 50,000 pairs × $19.50 Commissions = Revenues × 5% = $1,476,000 × 0.05 Contribution margin Fixed costs Operating income

$1,476,000 975,000 73,800 427,200 360,000 $ 67,200

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3-38 (30 min.)

Uncertainty and expected costs.

1. Monthly Number of Orders 300,000 400,000 500,000 600,000 700,000

Cost of Current System $1,000,000 + $40(300,000) = $13,000,000 $1,000,000 + $40(400,000) = $17,000,000 $1,000,000 + $40(500,000) = $21,000,000 $1,000,000 + $40(600,000) = $25,000,000 $1,000,000 + $40(700,000) = $29,000,000

Monthly Number of Orders 300,000 400,000 500,000 600,000 700,000

Cost of Partially Automated System $5,000,000 + $30(300,000) = $14,000,000 $5,000,000 + $30(400,000) = $17,000,000 $5,000,000 + $30(500,000) = $20,000,000 $5,000,000 + $30(600,000) = $23,000,000 $5,000,000 + $30(700,000) = $26,000,000

Monthly Number of Orders 300,000 400,000 500,000 600,000 700,000

Cost of Fully Automated System $10,000,000 + $20(300,000) = $16,000,000 $10,000,000 + $20(400,000) = $18,000,000 $10,000,000 + $20(500,000) = $20,000,000 $10,000,000 + $20(600,000) = $22,000,000 $10,000,000 + $20(700,000) = $24,000,000

Current System Expected Cost:

$13,000,000 × 0.1 = $ 1,300,000 17,000,000 × 0.25 = 4,250,000 21,000,000 × 0.40 = 8,400,000 25,000,000 × 0.15 = 3,750,000 29,000,000 × 0.10 = 2,900,000 $20,600,000 Partially Automated System Expected Cost: $14,000,000 × 0.1 17,000,000 × 0.25 20,000,000 × 0.40 23,000,000 × 0.15 26,000,000 × 0.10

= $ 1,400,000 = 4,250,000 = 8,000,000 = 3,450,000 = 2,600,000 $19,700,000

Chapter 3: Cost-Volume-Profit Analysis

Fully Automated System Expected Cost: $16,000,000 × 0.1 = $ 1,600,000 18,000,000 × 0.25 = 4,500,000 20,000,000 × 0.40 = 8,000,000 22,000,000 × 0.15 = 3,300,000 24,000,000 × 0.10 = 2,400,000 $19,800,000 3.

Dawmart should consider the impact of the different systems on its relationship with suppliers. The interface with Dawmart’s system may require that suppliers also update their systems. This could cause some suppliers to raise the cost of their merchandise. It could force other suppliers to drop out of Dawmart’s supply chain because the cost of the system change would be prohibitive. Dawmart may also want to consider other factors such as the reliability of different systems and the effect on employee morale if employees have to be laid off as it automates its systems.

3-39 (20 min.) 1.

Gross margin and contribution margin.

Ticket sales ($24  525 attendees) Variable cost of dinner ($12a  525 attendees) Variable invitations and paperwork ($1b  525) Contribution margin Fixed cost of dinner Fixed cost of invitations and paperwork Operating profit (loss)

$12,600 6,300 525

6,825 5,775

9,000 1,975

10,975 $ (5,200)

a$6,300/525 attendees = $12/attendee b$525/525 attendees = $1/attendee

Ticket sales ($24 × 1,050 attendees) Variable cost of dinner ($12 × 1,050 attendees) Variable invitations and paperwork ($1 × 1,050) Contribution margin Fixed cost of dinner Fixed cost of invitations and paperwork Operating profit (loss)

$25,200 12,600 1,050 9,000 1,975

13,650 11,550 10,975 $ 575

3-40 (20–25 min.) Revenue mix, two products. 1.

Sales of standard and deluxe carriers are in the ratio of 150,000:50,000. So for every 1 unit of deluxe, 3 (=150,000 ÷ 50,000) units of standard are sold. Contribution margin of the bundle = 3  $6 + 1  $12 = $18 + $12 = $30 Breakeven point in bundles =

$1, 200, 000 = 40,000 bundles $30

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Breakeven point in units is: Standard carrier: 40,000 bundles × 3 units per bundle Deluxe carrier: 40,000 bundles × 1 unit per bundle Total number of units to breakeven

120,000 units 40,000 units 160,000 units

Alternatively, Let Q = Number of units of Deluxe carrier to break even 3Q = Number of units of Standard carrier to break even Revenues – Variable costs – Fixed costs = Zero operating income $20(3Q) + $30Q – $14(3Q) – $18Q – $1,200,000 = $60Q + $30Q – $42Q – $18Q = $30Q = Q = 3Q =

0 $1,200,000 $1,200,000 40,000 units of Deluxe 120,000 units of Standard

The breakeven point is 120,000 Standard units plus 40,000 Deluxe units, a total of 160,000 units. 2a.

Unit contribution margins are: Standard: $20 – $14 = $6; Deluxe: $30 – $18 = $12 If only Standard carriers were sold, the breakeven point would be: $1,200,000  $6 = 200,000 units.

2b.

If only Deluxe carriers were sold, the breakeven point would be: $1,200,000  $12 = 100,000 units

Operating income 

Contribution margin Contribution margin  Fixed costs of Standard of Deluxe

= 180,000($6) + 20,000($12) – $1,200,000 = $1,080,000 + $240,000 – $1,200,000 = $120,000 Sales of standard and deluxe carriers are in the ratio of 180,000:20,000. So for every 1 unit of deluxe, 9 (180,000 ÷ 20,000) units of standard are sold. Contribution margin of the bundle = 9  $6 + 1  $12 = $54 + $12 = $66 Breakeven point in bundles =

$1, 200, 000 = 18,182 bundles (rounded up) $66

Breakeven point in units is: Standard carrier: 18,182 bundles × 9 units per bundle Deluxe carrier: 18,182 bundles × 1 unit per bundle Total number of units to breakeven

163,638 units 18,182 units 181,820 units

Chapter 3: Cost-Volume-Profit Analysis

Alternatively, Let Q 9Q

= =

Number of units of Deluxe product to break even Number of units of Standard product to break even

$20(9Q) + $30Q – $14(9Q) – $18Q – $1,200,000 = 0 $180Q + $30Q – $126Q – $18Q = $1,200,000 $66Q = $1,200,000 Q = 18,182 units of Deluxe (rounded up) 9Q = 163,638 units of Standard The breakeven point is 163,638 Standard + 18,182 Deluxe, a total of 181,820 units. The major lesson of this problem is that changes in the sales mix change breakeven points and operating incomes. In this example, the budgeted and actual total sales in number of units were identical, but the proportion of the product having the higher contribution margin declined. Operating income suffered, falling from $300,000 to $120,000. Moreover, the breakeven point rose from 160,000 to 181,820 units.

3-41 (30 min.) 1.

Choosing between compensation plans, operating leverage.

We can recast Marston’s income statement to emphasize contribution margin, and then use it to compute the required CVP parameters. Marston Corporation Statement of Comprehensive Income For the Year Ended December 31, 2022 Using Sales Agents $26,000,000

Revenues Variable Costs Cost of goods sold—variable Marketing commissions Contribution margin Fixed Costs Cost of goods sold—fixed Marketing—fixed Operating income

$11,700,000 4,680,000 2,870,000 3,420,000

Contribution margin percentage ($9,620,000 ÷ 26,000,000; $11,700,000 ÷ $26,000,000) Breakeven revenues ($6,290,000 ÷ 0.37; $8,370,000 ÷ 0.45) Degree of operating leverage ($9,620,000 ÷ $3,330,000; $11,700,000 ÷ $3,330,000)

16,380,000 $9,620,000 6,290,000 $3,330,000

Using Own Sales Force $26,000,000 $11,700,000 2,600,000 2,870,000 5,500,000

14,300,000 $11,700,000 8,370,000 $ 3,330,000

37%

45%

$17,000,000

$18,600,000

2.89

3.51

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

The calculations indicate that at sales of $26,000,000, a percentage change in sales and contribution margin will result in 2.89 times that percentage change in operating income if Marston continues to use sales agents and 3.51 times that percentage change in operating income if Marston employs its own sales staff. The higher contribution margin per dollar of sales and higher fixed costs gives Marston more operating leverage, that is, greater benefits (increases in operating income) if revenues increase but greater risks (decreases in operating income) if revenues decrease. Marston also needs to consider the skill levels and incentives under the two alternatives. Sales agents have more incentive compensation and hence may be more motivated to increase sales. On the other hand, Marston’s own sales force may be more knowledgeable and skilled in selling the company’s products. That is, the sales volume itself will be affected by who sells and by the nature of the compensation plan. Variable costs of marketing = 15% of Revenues Fixed marketing costs = $5,500,000

Operating income = Revenues 

Variable Fixed Variable  Fixed  marketing  marketing manuf. costs manuf. costs costs costs

Denote the revenues required to earn $3,330,000 of operating income by R, then: R – 0.45R – $2,870,000 – 0.15R – $5,500,000 = $3,330,000 R – 0.45R – 0.15R = $3,330,000 + $2,870,000 + $5,500,000 0.40R = $11,700,000 R = $11,700,000  0.40 = $29,250,000

3-42 (20-25 min.) Special-order decision. 1.

Time spent on manufacturing bottles = 750,000 bottles ÷ 100 bottles per hour = 7,500 hours So 10,000 – 7,500 = 2,500 hours available for toys.

Moulded plastic toy requires: 100,000 units ÷ 40 units per hour = 2,500 hours, so MPC has enough capacity to accept the toys order. Additional income from accepting the order is: Revenue $3.40  100,000 Variable costs 2.70  100,000 Contribution margin Fixed costs Additional income

$340,000 270,000 70,000 24,000 $ 46,000

So MPC should accept the order since it has enough excess capacity to make the 100,000 toys. 2.

Time spent on manufacturing bottles = 850,000 ÷ 100 = 8,500 hours So 10,000 – 8,500 = 1,500 hours available for toys.

Chapter 3: Cost-Volume-Profit Analysis

From requirement 1, the moulded plastic toy requires 2,500 hours and generates $46,000 in operating income. So if the toy offer is accepted, 1,000 hours (2,500 hours required – 1,500 hours available) of bottle making will be forgone, equal to 100,000 bottles (100 bottles/hr.  1,000 hrs.): Operating income from accepting Forgone contribution margin (100,000 bottles  $0.30)* Increase in operating income

$46,000 30,000 $16,000

So MPC should accept the special order. *CM = $0.55 – $0.25 = $0.30 Without considering the fixed costs for the toy mould, the contribution per machine-hour of the constrained resource for bottles and the special toy are as follows: Contribution margin per unit Multiplied by units made in 1 machine-hour Contribution margin per machine-hour

Bottles $0.30 100 $ 30

Toys $0.70 40 $ 28

This suggests that MPC should make as many bottles as it can rather than the special toys, because bottles generate a higher contribution margin per machine-hour. So if MPC used the 1,500 hours available to it for making toys after using the 8,500 hours to make bottles, it would be able to make 1,500  40 = 60,000 toys and earn operating income of: Contribution margin 60,000  $0.70 Fixed mould costs Increase in operating income

$42,000 24,000 $18,000

The contribution margin earned covers the fixed costs of the mould, so MPC should make 850,000 bottles and 60,000 toys. 3.

Time spent on manufacturing bottles = 900,000 ÷ 100 = 9,000 hours So 10,000 – 9,000 = 1,000 hours available for toys.

So if the toy offer is accepted, then 1,500 hours (2,500 hours required – 1,000 hours available) of bottle capacity will be forgone = 150,000 bottles Contribution from accepting toy offer Forgone profits on bottles 150,000  $0.30 Increase (decrease) in operating income

$ 46,000 (45,000) $ 1,000

So accept the special order.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3-43 (25 min.)

CVP, sensitivity analysis.

Contribution margin per corkscrew = $4 – 3 = $1 Fixed costs = $6,000 Units sold = Total sales ÷ Selling price = $40,000 ÷ $4 per corkscrew = 10,000 corkscrews 1. Sales increase 10% Sales revenues 10,000 × 1.10 × $4.00 Variable costs 10,000 × 1.10 × $3.00 Contribution margin Fixed costs Operating income

$44,000 33,000 11,000 6,000 $ 5,000

2. Increase fixed costs $2,000; Increase sales 50% Sales revenues 10,000 × 1.50 × $4.00 $60,000 Variable costs 10,000 × 1.50 × $3.00 45,000 Contribution margin 15,000 Fixed costs ($6,000 + $2,000) 8,000 Operating income $ 7,000 3. Increase selling price to $5.00; Sales decrease 20% Sales revenues 10,000 × 0.80 × $5.00 $40,000 Variable costs 10,000 × 0.80 × $3.00 24,000 Contribution margin 16,000 Fixed costs 6,000 Operating income $10,000 4. Increase selling price to $6.00; Variable costs increase $1 per corkscrew Sales revenues 10,000 × $6.00 $60,000 Variable costs 10,000 × $4.00 40,000 Contribution margin 20,000 Fixed costs 6,000 Operating income $14,000 Alternative 4 yields the highest operating income. If TOP is confident that unit sales will not decrease despite increasing the selling price, it should choose alternative 4.

3-44 (15-25 min.) Non-profit institution. 1.

Let Q = Number of visits Revenues – Variable costs – Fixed costs $850,000 – $16Q – $500,000 $16Q Q

= = = =

0 0 $350,000 21,875 visits

Chapter 3: Cost-Volume-Profit Analysis

Revenues – Variable costs – Fixed costs $765,000 – $16Q – $500,000 $16Q Q

= 0 = 0 = $265,000 = 16,562 visits (rounded down)

The reduction in service is more than the 10% reduction in the budget. Without restructuring operations, the quantity of service units must be reduced by 24.29% [= (21,875 – 16,562) ÷ 21,875] to stay within the budget. 3.

Let V = Variable cost per visit

$765,000 – 21,875V – $500,000 = 0 21,875V = $265,000 V = $12.11 ($12.114286)* Percentage drop: ($16 – $12.114286*) ÷ $16 = 24.29% Regarding requirements 2 and 3, note that the decrease in service can be measured by a formula: % reduction in service = (% budget change) ÷ (% variable cost) The variable cost percentage is ($16  21,875) ÷ $850,000 = $350,000 ÷ $850,000 = 41.1765%* % reduction in service = 10% ÷ 41.1765% = 24.29% *The extra decimal places are used to minimize the rounding difference. Most will round to two decimals for the money and to 24%.

3-45 (15–25 min.) Sales mix, three products. 1.

Sales of A, B, and C are in ratio 20,000 : 100,000 : 80,000. So for every 1 unit of A, 5 (100,000 ÷ 20,000) units of B are sold, and 4 (80,000 ÷ 20,000) units of C are sold. Contribution margin of the bundle = 1  $3 + 5  $2 + 4  $1 = $3 + $10 + $4 = $17 Breakeven point in bundles =

$255,000 = 15,000 bundles $17

Breakeven point in units is: Product A: 15,000 bundles × 1 unit per bundle Product B: 15,000 bundles × 5 units per bundle Product C: 15,000 bundles × 4 units per bundle Total number of units to breakeven

15,000 units 75,000 units 60,000 units 150,000 units

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Alternatively, Let Q = Number of units of A to break even 5Q = Number of units of B to break even 4Q = Number of units of C to break even Contribution margin – Fixed costs = Zero operating income

$3Q + $2(5Q) + $1(4Q) – $255,000 = 0 $17Q = $255,000 Q = 15,000 ($255,000 ÷ $17) units of A 5Q = 75,000 units of B 4Q = 60,000 units of C Total = 150,000 units Contribution margin: A: 20,000  $3 $ 60,000 B: 100,000  $2 200,000 C: 80,000  $1 80,000 Contribution margin $340,000 Fixed costs 255,000 Operating income $ 85,000 Contribution margin A: 20,000  $3 B: 80,000  $2 C: 100,000  $1 Contribution margin Fixed costs Operating income

$ 60,000 160,000 100,000 $320,000 255,000 $ 65,000

Sales of A, B, and C are in ratio 20,000 : 80,000 : 100,000. So for every 1 unit of A, 4 (80,000 ÷ 20,000) units of B and 5 (100,000 ÷ 20,000) units of C are sold. Contribution margin of the bundle = 1  $3 + 4  $2 + 5  $1 = $3 + $8 + $5 = $16 Breakeven point in bundles =

$255,000 = 15,938 bundles (rounded up) $16

Breakeven point in units is: Product A: 15,938 bundles × 1 unit per bundle Product B: 15,938 bundles × 4 units per bundle Product C: 15,938 bundles × 5 units per bundle Total number of units to breakeven

15,938 units 63,752 units 79,690 units 159,380 units

Chapter 3: Cost-Volume-Profit Analysis

Alternatively, Let Q = Number of units of A to break even 4Q = Number of units of B to break even 5Q = Number of units of C to break even Contribution margin – Fixed costs = Breakeven point $3Q + $2(4Q) + $1(5Q) – $255,000 $16Q Q 4Q 5Q Total

= 0 = $255,000 = 15,938 ($255,000 ÷ $16) units of A (rounded up) = 63,752 units of B = 79,690 units of C = 159,380 units

Breakeven point increases because the new mix contains less of the higher contribution margin per unit, product B, and more of the lower contribution margin per unit, product C.

3-46 (30 min.) Ethics, CVP analysis. 1.

Contribution margin percentage =

Revenues Variable costs Revenues

$5, 000, 000 $3, 250, 000 $5,000,000 $1,750,000 = = 35% $5,000,000 Fixed costs = Contribution margin percentage =

Breakeven revenues

= 2.

If variable costs are 55% of revenues, contribution margin percentage equals 45% (100%  55%) Breakeven revenues

$1,890,000 = $5,400,000 0.35

Fixed costs Contribution margin percentage

$1,890,000 = $4,200,000 0.45

Revenues $5,000,000 Variable costs (0.55  $5,000,000) 2,750,000 Fixed costs 1,890,000 Operating income $ 360,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Incorrect reporting of environmental costs with the goal of continuing operations is unethical. In assessing the situation, the specific “Guidelines for Ethical Behaviour” (described in Exhibit 1-7) accountants should consider are:

Clear reports using relevant and reliable information should be prepared. Preparing reports on the basis of incorrect environmental costs to make the company’s performance look better than it is violates competence standards. It is unethical for DiNunzo not to report environmental costs to make the plant’s performance look good.

An accountant has a responsibility to avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict. DiNunzo may be tempted to report lower environmental costs to please Kirby and Gibbs and save the jobs of his colleagues. This action, however, violates the responsibility for integrity.

An accountant is required to ensure that information should be fairly and objectively communicated and that all relevant information should be disclosed. From this standpoint, underreporting environmental costs to make performance look good would violate the standard of objectivity.

DiNunzo should indicate to Gibbs that estimates of environmental costs and liabilities should be included in the analysis. If Gibbs still insists on modifying the numbers and reporting lower environmental costs, DiNunzo should raise the matter with Kirby or one of Gibbs’s superiors. If after taking all these steps, there is continued pressure to understate environmental costs, DiNunzo should consider resigning from the company and not engage in unethical behaviour.

3-47 (20-25 min.)

Mini-case: Governance, CVP, cost analysis.

(a) USP UVC UCM FC Q

= = = = = = =

$68 $28.50 ($19.25 + $9.25) $39.50 $25,000,000 FC ÷ UCM $25,000,000 ÷ $39.50 632,912 monthly treatments (rounded up)

(b) USP UVC UCM FC Q

= = = = = = =

$68 $19.25 $48.75 $25,000,000 FC ÷ UCM $25,000,000 ÷ $48.75 512,821 monthly treatments (rounded up)

Chapter 3: Cost-Volume-Profit Analysis

Diba believes that the $9.25 per monthly visit should be included in the variable costs per visit. His argument is that a product like “Vital Hair” has a positive probability of attracting product litigation. By excluding any allowance for the possible event, the assumption is that it will be zero. Diba faces an integrity issue. His report to the executive committee will understate his expected cost estimates when he takes Kelly’s advice. One possibility Diba should have explored is reporting the $19.25 per treatment variable cost in the breakeven computations as well as including qualifications in the report about possible product litigation costs.

Diba likely has been placed in a compromised situation. He may feel Kelly deliberately set him up to avoid the $9.25 amount being reported to the executive committee. At a minimum, he should directly confront Kelly with his concerns. If she is unresponsive, he faces a very tough dilemma. His options are: (a) Stay in his current position and be more determined next time to have his concerns registered. (b) Report his concerns to Kelly’s immediate superior. (c) Resign. If he selects (a), it would be useful to show Kelly the Code of Professional Ethics and stress how her behaviour has put him in a difficult ethical situation.

3-48 (35 min.) Deciding where to produce. Selling price Variable cost per unit Manufacturing Marketing and distribution Contribution margin per unit (CMU) Fixed costs per unit Manufacturing Marketing and distribution Operating income per unit

Peona $150.00 $72.00 14.00 30.00 19.00

86.00 64.00 49.00 $ 15.00

CMU of normal production CMU of overtime production ($64 – $3; $48 – $8)

Modine $150.00 $88.00 14.00 15.00 14.50

102.00 48.00 29.50 $ 18.50

$64

$48

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

1. Annual fixed costs: P – ($49.00 × 400 units × 240 days) M – ($29.50 × 320 units × 240 days) Breakeven volume: P – ($4,704,000 ÷ $64) M – ($2,265,600 ÷ $48) 2. Units produced and sold Normal annual volume (units) (400 × 240; 320 × 240) Units over normal volume (overtime) CM from normal production units (normal annual volume × CMU normal production) (96,000 × $64; 76,800 × $48) CM from overtime production units (0; 19,200 × $40) Total contribution margin Total fixed costs Operating income Total operating income 3.

$4,704,000

$2,265,600

73,500 units

47,200 Units

96,000

96,000 0

76,800 19,200

$6,144,000

$3,686,400

0 6,144,000 4,704,000 $1,440,000

768,000 4,454,400 2,265,600 $2,188,800 $3,628,800

The optimal production plan is to produce 120,000 units at the Peona plant and 72,000 units at the Modine plant. The full capacity of the Peona plant, 120,000 units (= 400 units × 300 days), should be used because the contribution from these units is higher at all levels of production than is the contribution from units produced at the Modine plant. Contribution margin per plant: Peona, 96,000 × $64 Peona, 24,000 × ($64 – $3) Modine, 72,000 × $48 Total contribution margin Deduct total fixed costs Operating income

$ 6,144,000 1,464,000 3,456,000 11,064,000 6,969,600 $ 4,094,400

The contribution margin is higher when 120,000 units are produced at the Peona plant and 72,000 units at the Modine plant. As a result, operating income will also be higher in this case since total fixed costs for the division remain unchanged regardless of the quantity produced at each plant.

Chapter 3: Cost-Volume-Profit Analysis

COLLABORATIVE LEARNING PROBLEM 3-49 (25 Min.) (CVP analysis and revenue mix) 1.

Let A 5A 4A

= = =

Number of units of A to break even Number of units of B to break even Number of units of C to break even

$3.60A + $2.40(5A) + $1.20(4A) – $306,000 = 0 A = 15,000 units of A 5A = 75,000 units of B 4A = 60,000 units of C Total = 150,000 units 2.

Contribution margin: A: 20,000  $3.60 B: 100,000  $2.40 C: 80,000  $1.20

= = =

Contribution margin: A: 20,000  $3.60 B: 80,000  $2.40 C: 100,000  $1.20

= = =

$ 72,000 $240,000 $ 96,000 $408,000 Operating Income = $408,000 – $306,000 = $102,000 3.

$72,000 $192,000 $120,000 $384,000

Operating Income = $384,000 – $306,000 = $78,000 Let A = Number of units of A to break even 4A = Number of units of B to break even 5A = Number of units of C to break even $3.60A + $2.40(4A) + $1.20(5A) – $306,000 = 0 A 5A 4A Total

= 15,938 units of A = 63,752 units of B = 79,690 units of C = 159,380 units

CHAPTER 4 JOB COSTING MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

SHORT-ANSWER QUESTIONS 4-1

In a job costing system, shared indirect costs of customization are assigned to a distinct unit, batch, or product or service. In a process costing system there is little or no distinction among outputs. The cost of a product or service is obtained by using broad averages to assign costs to masses of similar outputs.

4-2

Separating manufacturing overhead (MOH) into more than one cost pool may allow for better representation of cost and benefit. Sometimes this type of refinement reveals direct cause and effect relationships between a single MOH cost pool and a single cost driver. Where indirect inputs are shared unequally among distinct types of products, refining a single MOH cost pool into several may improve the accuracy of output costing, pricing, and prediction of profitability.

4-3

An advertising campaign for Pepsi is likely to be very specific to that individual client. Job costing requires that all the specific aspects of each distinct job be identified. In contrast, the processing of chequing account deposits is similar for almost all transactions. Here, process costing can be used to compute the cost of each chequing account deposit.

4-4

The seven steps in job costing are: (1) identify the job that is the chosen cost object, (2) identify the direct costs of the job, (3) select the cost-allocation bases to use for allocating indirect costs to the job, (4) identify the indirect costs associated with each cost-allocation base, (5) compute the rate per unit of each cost-allocation base used to allocate indirect costs to the job, (6) compute the indirect costs allocated to the job, and (7) compute the total cost of the job by adding all direct and indirect costs assigned to the job.

4-5

Two major types of organizational elements that managers focus on in companies using job costing are (1) products or services (outputs), and (2) responsibility centres or departments (inputs).

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4-6

Three major source documents used in job-costing systems are (1) job cost record or job cost sheet, a document that records and accumulates all costs assigned to a specific job, (2) materials requisition record, a document used to charge job cost records and departments for the cost of direct materials used on a specific job, and (3) labour-time record, a document used to charge job cost records and departments for labour time used on a specific job.

4-7

The main concern with the source documents of job-cost records is the accuracy of the records. Problems of accuracy include recording either incorrect quantity or dollar amounts, materials recorded on one job being "borrowed" and used on other jobs, and the wrong job numbers being assigned to materials or labour inputs.

4-8

Two reasons for using annual budget periods are:

a) The numerator reason—the longer the time period, the lesser the influence of seasonal patterns, and b) The denominator reason—the longer the time period, the lesser the effect of variations in output levels on the allocation of fixed costs.

4-9

Actual costing and normal costing differ in their use of actual or budgeted direct- or indirect-cost rates:

Direct-cost rates Indirect-cost rates

Actual Costing

Normal Costing

Actual rates Actual rates

Actual rates Budgeted rates

Both costing methods use the actual quantity of the direct-cost input and the actual quantity of the cost-allocation base.

4-10 A construction firm can use job cost information (a) to determine the profitability of individual jobs, (b) to assist the bidding on future jobs, and (c) to evaluate professionals who are in charge of managing individual jobs.

4-11 The statement is false. In a normal costing system, the Manufacturing Overhead Control account will not, in general, equal the amounts in the Manufacturing Overhead Allocated account. The Manufacturing Overhead Control account aggregates the actual overhead costs incurred, while Manufacturing Overhead Allocated allocates overhead costs to jobs on the basis of a budgeted rate multiplied by the actual quantity of the cost-allocation base. Underallocation or overallocation of indirect (overhead) costs can arise because of: (a) Numerator reason—the actual overhead costs differ from the budgeted overhead costs, and (b) Denominator reason—the actual quantity used of the allocation base differs from the budgeted quantity.

Chapter 4: Job Costing

4-12 Debit entries to Work-in-Process Control represent increases in work in process. Examples of debit entries are: (a) direct materials used (credit to Materials Control), (b) direct manufacturing labour billed to job (credit to Wages Payable Control), and (c) manufacturing overhead allocated to job (credit Manufacturing Overhead Allocated).

4-13 Alternative ways to make end-of-period adjustments for underallocated or overallocated overhead are: a) Adjusted allocation approach: restating all entries for all jobs in the general ledger by using actual cost rates rather than budgeted cost rates. b) Proration based on the total amount of indirect costs allocated (before proration) in the ending balances of work in process, finished goods, and cost of goods sold or on total ending balances (before proration) in work in process, finished goods, and cost of goods sold. c) Year-end write-off to Cost of Goods Sold.

4-14 A service company might use budgeted costs rather than actual costs to compute direct labour rates because it may be difficult to trace some costs to jobs as they are completed.

4-15 Modern technology such as electronic data interchange (EDI) is helpful to managers because it provides them with quick and accurate product-cost information that facilitates the management and control of jobs.

EXERCISES 4-16 (10 min.) 1. 2. 3. 4. 5. 6. 7.

Terminology.

Proration actual cost allocation rate source document opportunity cost Cost tracing cost pool

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4-17 (10 min.) a. b. c. d. e. f. g. h. i. j. k.

Job costing, process costing.

Job costing Process costing Job costing Process costing (unless specialty) Job costing Process costing Job costing Job or process (depending on production) Process costing Process costing Job costing

4-18 (20 min.)

l. Job costing m. Process costing n. Job costing o. Job costing p. Job costing q. Job costing r. Process costing s. Job costing t. Process costing u. Job costing

Actual costing, normal costing, manufacturing overhead.

Budgeted manufacturing Budgeted manufacturing overhead costs  Budgeted direct manufacturing overhead rate 1. labour costs  $2, 210, 000 / $2, 600, 000  85% of Direct Labour Costs or $0.85 per $1 of Direct Labour

Actual manufacturing Actual manufacturing overhead costs  Actual direct manufacturing overhead rate labour costs  $2,311, 400 / $2,540, 000  91% of Direct Labour Costs or $0.91 per $1 of Direct Labour

Chapter 4: Job Costing

2. Costs of Job 626 under actual and normal costing follow: a. Actual Costing

b. Normal Costing

$ 48,000 27,000

24,570 $ 99,570

22,950 $ 97,950

Direct materials Direct manufacturing labour costs Manufacturing overhead costs $27,000  $0.91; $0.85 Total manufacturing costs of Job 626 3.

Total manufacturing overhead

allocated under nomral costing

Actual manufactring labour costs



Budgeted overhead rate

= $2,540,000  0.85 = $2,159,000 Underallocated manufactring overhead

Actual manufactring overhead costs

−

Manufactring overhead allocated

= $2,311,400 − $2,159,000 = $152,400 There is no under- or overallocated overhead under actual costing because overhead is allocated under actual costing by multiplying actual manufacturing labour costs and the actual manufacturing overhead rate. This, of course, equals the actual manufacturing overhead costs. All actual overhead costs are allocated to products. Hence, there is no under- or overallocated overhead. 4. Actual costing reflects the actual results incurred, while normal costing reflects expectations of the amount the overhead should be. Normal costing can be done in advance and thus can be used in pricing, planning, and cost management decisions.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4-19 (25 min.) Job costing; actual, normal, and variation from normal costing. 1. Actual direct-cost rate for professional labour = $68 per professional labour-hour Actual indirect-cost rate = $852,500/15,500 hours = $55 per professional labour-hour Budgeted direct-cost rate = $1,120,000/16,000 hours = $70 per professional labour-hour Budgeted indirect-cost rate = $800,000/16,000 hours = $50 per professional labour-hour (a) Actual Costing

(b) Normal Costing

Direct-Cost Rate

$68 (Actual rate)

$70 (Budgeted rate)

Indirect-Cost Rate

$55 (Actual rate)

$50 (Budgeted rate)

(b) Normal Costing $68  120 = $ 8,160 50  120 = 6,000 $14,160

2. Direct Costs Indirect Costs Total Job Costs

(a) Actual Costing $68  120 = $ 8,160 55  120 = 6,600 $14,760

All three costing systems use the actual professional labour time of 120 hours. The budgeted 110 hours for the Pierre & Company audit job is not used in job costing. However, Chirac may have used the 110 hour number in bidding for the audit. The actual costing figure of $14,760 exceeds the normal costing figure of $14,160 because the actual indirect-cost rate ($55) exceeds the budgeted indirect-cost rate ($50). The normal costing figure of $14,160 is less than the variation of normal costing (based on budgeted rates for direct costs) figure of $14,400, because the actual direct-cost rate ($68) is less than the budgeted direct-cost rate ($70).

Chapter 4: Job Costing

4-20 (30 min.)

Job costing: actual, normal, and budgeted costing.

1a. Actual costing Direct-cost rate = Actual professional labour costs ÷ Actual professional labour-hours = $1,320,000 ÷ 22,000 hours = $60 per professional hour Indirect-cost rate = Actual support costs ÷ Actual professional labour-hours = $2,400,000 ÷ 22,000 hours = $109.09 per professional hour 1b. Normal costing Budgeted professional hours = Budgeted hours per lawyer × Number of lawyers = 2,500 × 8 = 20,000 hours Direct-cost rate = Actual professional labour costs ÷ Actual professional labour-hours = $1,320,000 ÷ 22,000 hours = $60 per professional hour Indirect-cost rate = Budgeted support costs ÷ Budgeted professional labour-hours = $2,000,000 ÷ 20,000 hours = $100 per professional hour 1c. Variation from normal costing that uses budgeted rates for direct costs Budgeted direct-cost rate = $1,100,000 ÷ 20,000 hours = $55 per professional hour Indirect-cost rate = Budgeted support costs ÷ Budgeted professional labour-hours = $2,000,000 ÷ 20,000 hours = $100 per professional hour 2. The costs of Ari Roos’ will under each method follow: a. Actual Costing Direct costs 2,000 hours × $60 per hour Indirect costs 2,000 hours × $109.09 per hour Total costs

$120,000 218,180 $338,180

b. Normal Costing Direct costs 2,000 hours × $60 per hour Indirect costs 2,000 hours × $100 per hour Total costs

$120,000 200,000 $320,000

c. Variation from normal costing Direct costs 2,000 hours × $55 per hour Indirect costs 2,000 hours × $100 per hour Total costs

$110,000 200,000 $310,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4-21 (20–30 min.) Job costing, normal, and actual costing. Budgeted indirect costs $7, 200, 000  Budgeted direct labour-hours 150, 000 hours  $48 per direct labour-hour

1. Budgeted indirect-cost rate 

Actual indirect costs $6,888, 000  Actual direct labour-hours 164, 000 hours  $42 per direct labour-hour

Actual indirect-cost rate 

These rates differ because both the numerator and the denominator in the two calculations are different—one is based on budgeted numbers and the other is based on actual numbers.

2a. Normal costing Direct costs Direct materials Direct labour Indirect costs Assembly support ($48  850;  960) Total costs

2b.

Actual costing Direct costs Direct materials Direct labour Indirect costs Assembly support ($42  850;  960) Total costs

Laguna Model

Mission Model

$106,450 35,275 141,725

$127,604 40,320 167,924

40,800 $182,525

46,080 $214,004

$106,450 35,275 141,725

$127,604 40,320 167,924

35,700 $177,425

40,320 $208,244

Chapter 4: Job Costing

3. Normal costing enables Anderson to report a job cost as soon as the job is completed, assuming that both the direct materials and direct labour costs are known at the time of use. Once the 850 direct labour-hours are known for the Laguna Model (June 2022), Anderson can compute the $182,525 cost figure using normal costing. Anderson can use this information to manage the costs of the Laguna Model job as well as to bid on similar jobs later in the year. In contrast, Anderson has to wait until the December 2022 year-end to compute the $177,425 cost of the Laguna Model using actual costing. Although not required, the following overview diagram summarizes Anderson Construction’s job-costing system.

COSTS DIRECT

HOME RESIDENTIAL COST OBJECT:

BASE ALLOCATION COST

POOL COST INDIRECT

   

Materials Direct

Labor Manufacturing Direct

Direct Costs Indirect Costs

Labor-Hours Direct

Support Assembly

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4-22 (20–30 min.) Job costing, accounting for manufacturing overhead, budgeted rates. 1. An overview of the product costing system is



INDIRECT COST POOL



COST ALLOCATION BASE

Machining Department Manufacturing Overhead

Assembly Department Manufacturing Overhead

Machine-Hours

Direct Manuf. Labor Cost



Indirect Costs

COST OBJECT: PRODUCT



DIRECT COST

Direct Costs

Direct Materials

Direct Manufacturing Labor

Budgeted manufacturing overhead divided by the budgeted quantity of the allocation base: $1,500, 000 = $50 per machine-hour 30, 000 $5,100, 000 Assembly Department overhead: = 170% of direct manuf. labour costs $3,300, 000

Machining Department overhead:

2. Machining department overhead allocated, 2,800 hours  $50 Assembly department overhead allocated, 170%  $19,000 Total manufacturing overhead allocated to Job 494 3. Actual manufacturing overhead Manufacturing overhead allocated, $50  33,000 machine-hours 170%  $3,200,000 Underallocated (Overallocated)

$140,000 32,300 $172,300

Machining Dept.

Assembly Dept.

$1,800,000

$ 5,300,000

1,650,000 — $ 150,000

— 5,440,000 $ (140,000)

Chapter 4: Job Costing

4-23 (2025 min.) Job costing, consulting firm. 1. Budgeted indirect-cost rate for client support can be calculated as follows: Budgeted indirect-cost rate = $25,000,000 ÷ $20,000,000 = 125% of professional labour costs

INDIRECT COST POOL



Consulting Consulting Client Support Support support

Support COST ALLOCATION BASE



Professional Professional Labor LaborCosts Costs

COST OBJECT: JOB FOR CONSULTING CLIENT



Indirect Costs

DIRECT COSTS



Direct Costs

Professional Labor

2. At the budgeted revenues of $50,000,000 Frontier’s operating income of $5,000,000 equals 10% of revenues. Markup rate = 10% × $50,000,000 ÷ $20,000,000 = 25% of direct professional costs. 3. Budgeted costs Direct costs: Director, $200  9 $1,800 Partner, $100  24 2,400 Associate, $50  100 5,000 Assistant, $30  220 6,600 Indirect costs: Consulting support, 125%  $15,800 Total costs

$15,800 19,750 $35,550

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

As calculated in requirement 2, the bid price to earn a 10% income-to-revenue margin is 25% of direct professional costs. Therefore, Taylor should bid 250%  $15,800 = $39,500 for the Sentinel Communications job. Bid price to earn target operating income-to-revenue margin of 10% can also be calculated as follows: Let R = revenue to earn target income R − 0.10R = $35,550 0.90R = $35,550 R = $35,550 ÷ 0.90 = $39,500 Or Direct costs Indirect costs Operating income (0.10 × $39,500) Bid price

4-24 (45 min.) 1.

$15,800 19,750 3,950 $39,500

Job costing, journal entries.

Amounts in millions (1) Materials Control Accounts Payable Control (2) Work-in-Process Control Materials Control (3) Manufacturing Overhead Control Materials Control (4) Work-in-Process Control Manufacturing Overhead Control Wages Payable Control (5) Manufacturing Overhead Control Accumulated Depreciation (6) Manufacturing Overhead Control Various Liabilities (7) Work-in-Process Control Manufacturing Overhead Allocated* (8) Finished Goods Control Work-in-Process Control (9a) Cost of Goods Sold Finished Goods Control (9b) Accounts Receivable Control (or Cash) Revenue

240 240 198 198 24 24 127 21 148 23 23 10 10 75 75 374.6 374.6 369 369 540 540

Chapter 4: Job Costing

*Budgeted Manufacturing Overhead Rate

Allocated MOH

Budgeted MOH Cost Budgeted Machine Hours = $80,000,000 ÷ 1,000,000 = $80.00 per machine-hour = $80 × 937,500 = $75,000,000

The posting of entries to T-accounts is:

Bal. (1)

Bal.

Materials Control 5 (2) 240 (3)

(9a) (10)

Cost of Goods Sold 369.0 3.0

(10)

Manufacturing Overhead Allocated 75.0 (7)

75.0

240

Wages Payable Control (4)

148

Various Liabilities (6)

Revenue (9b)

540

198 24

Bal. (8) Bal.

Finished Goods Control 7.4 (9a) 374.6 13.0

(3) (4) (5) (6)

Manufacturing Overhead Control 24 (10) 21 23 10

369.0

Accounts Payable Control (1) Accumulated Amortization (5)

(9b)

Bal. (2) (4) (7) Bal.

Work-in-Process Control 1.6 (8) 198.0 127.0 75.0 27.0

Accounts Receivable Control 540

374.6

The ending balance of Work-in-Process Control is $27.0. 2. (10) Manufacturing Overhead Allocated Cost of Goods Sold Manufacturing Department Overhead Control

75.0 3.0 78.0

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4-25 (15 min.)

Job costing, unit cost, ending work in progress.

1. Direct manufacturing labour rate per hour Manufacturing overhead cost allocated per manufacturing labour-hour Direct manufacturing labour costs Direct manufacturing labour-hours ($275,000 ÷ $25; $209,000 ÷ $25) Manufacturing overhead cost allocated (11,000 × $22; 8,360 × $22) Job Costs May 2021 Direct materials Direct manufacturing labour Manufacturing overhead allocated Total costs 2. Number of pipes produced for Job M1 Cost per pipe ($592,000 ÷ 1,600) 3. Finished Goods Control Work-in-Process Control

$25 $22 Job M1 $275,000

Job M2 $209,000

11,000

8,360

$242,000

$183,920

Job M1 $ 75,000 275,000 242,000 $592,000

Job M2 $ 56,000 209,000 183,920 $448,920

1,600 $ 370 592,000 592,000

4. Rowan Company began May 2021 with no work-in-process inventory. During May, it started and finished M1. It also started M2, which is still in work-in-process inventory at the end of May. M2’s manufacturing costs up to this point, $448,920, remain as a debit balance in the Work-in-Process Inventory account at the end of May.

4-26 (40 min.) Job costing, journal entries, T-accounts, source documents. 1. (1) Direct Materials Control 124,000 Accounts Payable Control Source Document: Purchase Invoice, Receiving Report Subsidiary Ledger: Direct Materials Record, Accounts Payable

124,000

(2) Work-in-Process Controla 122,000 Direct Materials Control 122,000 Source Document: Material Requisition Records, Job Cost Record Subsidiary Ledger: Direct Materials Record, Work-in-Process Inventory Records by Job

Chapter 4: Job Costing

(3) Work in Process Control 80,000 Manufacturing Overhead Control 54,500 Wages Payable Control 134,500 Source Document: Labour Time Records, Job Cost Records Subsidiary Ledger: Manufacturing Overhead Records, Employee Labour Records, Work-inProcess Inventory Records by Jobs (4) Manufacturing Overhead Control 129,500 Salaries Payable or AP Control 20,000 Accounts Payable Control 9,500 Accumulated Depreciation Control 30,000 Rent Payable Control 70,000 Source Document: Depreciation Schedule, Rent Schedule, Maintenance wages due, Invoices for miscellaneous factory overhead items Subsidiary Ledger: Manufacturing Overhead Records (5) Work-in-Process Control Manufacturing Overhead Allocated

200,000 200,000 (80,000 × $2.50)

Source Document: Labour Time Records, Job Cost Record Subsidiary Ledger: Work-in-Process Inventory Records by Jobs (6) Finished Goods Controlb 387,000 Work-in-Process Control 387,000 Source Document: Job Cost Record, Completed Job Cost Record Subsidiary Ledger: Work-in-Process Inventory Records by Jobs, Finished Goods Inventory Records by Jobs (7) Cost of Goods Soldc 432,000 Finished Goods Control 432,000 Source Document: Sales Invoice, Completed Job Cost Record Subsidiary Ledger: Finished Goods Inventory Records by Jobs (8) Manufacturing Overhead Allocated Manufacturing Overhead Control Cost of Goods Sold Source Document: Prior Journal Entries

200,000 184,000 16,000

(9) Administrative Expenses 7,000 Marketing Expenses 120,000 Salaries Payable Control 30,000 Accounts Payable Control 90,000 Accumulated Depreciation, Office Equipment 7,000 Source Document: Depreciation Schedule, Marketing Payroll Request, Invoice for Advertising, Sales Commission Schedule.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Subsidiary Ledger: Employee Salary Records, Administration Cost Records, Marketing Cost Records. aMaterials used = Beginning DM inventory + Purchases - Ending DM inventory

= 9,000 + 124,000 - 11,000 = 122,000 bCost of goods manufactured = Beginning WIP inv. + Manufacturing cost - Ending WIP inv.

= 6,000 + (122,000 + 80,000 + 200,000) − 21,000 = 387,000 cCost of Goods Sold = Beginning FG inv. + Cost of goods manuf. − Ending FG inv.

= 69,000 + 387,000 − 24,000 = 432,000 2. T-accounts Bal. (1) Purchases Bal.

Direct Materials Control 9,000 (2) Materials used 124,000 11,000

Issues

122,000

Work-in-Process Control Bal. 6,000 (6) Cost of goods manufactured 387,000 (2) Direct materials used 122,000 (3) Direct manuf. labour (5) Manuf. overhead 80,000 allocated 200,000 Bal. 21,000 Bal. (6) Cost of goods manuf. Bal.

Finished Goods Control 69,000 (7) Cost of goods sold 387,000 24,000

(7)

Cost of Goods Sold 432,000 (8) Adjust for overallocation

Goods sold

432,000

16,000

416,000 (3) Indirect labour (4) Supplies (4) Miscellaneous (4) Amortization (4) Rent Bal. (8) To close

Manufacturing Overhead Control 54,500 (8) To close 20,000 9,500 30,000 70,000 0 Manufacturing Overhead Allocated 200,000 (5) Manuf. overhead allocated Bal.

184,000

200,000 0

Chapter 4: Job Costing

4-27 (2030 min.) Job costing; variation on actual, normal, and variation from normal costing. 1. Actual direct-labour hour rate =

$285, 000 = $25 per direct labour-hour 11, 400

$159, 600 = $14 per direct labour-hour 11, 400

Budgeted direct labor-hour rate =

$273, 000 = $26 per direct labour-hour 10,500

Budgeted indirect cost rate

$157, 000 = $15 per direct labour-hour 10,500

Actual indirect cost rate

Direct-Cost Rate Indirect-Cost Rate

(a) (b) Actual Normal Costing Costing $25 $25 (Actual rate) (Actual rate) $14 $15 (Actual rate) (Budgeted rate)

2. Creative Solutions should choose a job-costing system based on the direct cost information available to them. If Creative Solutions knows direct costs as the jobs are being done, I would recommend Creative Solutions use normal costing over actual costing by calculating a budgeted indirect cost rate to cost jobs. Normal costing enables Creative Solutions to use the budgeted indirect cost rate calculated at the beginning of the year to estimate the cost of a job as soon as the job is completed. Creative Solutions can use knowledge of job costs for ongoing uses, including pricing jobs, monitoring and managing costs, evaluating the success of the job, learning about what did and did not work, bidding on new jobs, and preparing interim financial statements. Under actual costing, Creative Solutions would only determine the cost of a job at the end of the year when actual indirect costs are known. To be useful, of course, the budgeted indirect cost rate and the allocated costs need to reasonably approximate the actual indirect cost rate and the actual costs, which is the case here. If Creative Solutions does not know direct costs as the jobs are being completed, I would recommend that Creative Solutions use the variation of normal costing that calculates a budgeted direct cost rate. This would allow Creative Solutions to estimate costs on a moretimely basis and gain all the benefits discussed earlier in the context of indirect costs. However, if Creative Solutions does use the variation of normal costing, it needs to continue to do a good job of estimating the budgeted direct cost rate. Currently, the budgeted direct cost rate ($26) is very close to the actual rate of $25 per direct labour-hour.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

(a) Actual Costing $25  79 = $1,975 $14  79 = 1,106 $3,081

Direct Costs Indirect Costs Total Job Costs

(b) Normal Costing $25  79 = $1,975 $15  79 = 1,185 $3,160

All three costing systems use the actual direct labour-hours of 79 hours. The budgeted 86 hours for the Greenville Day School job is not used in job costing. However, Creative Solutions may have used the budgeted number of hours in bidding for the job.

4-28 (30 min.) 1.

Proration of overhead.

Budgeted Budgeted manufacturing overhead cost manufacturing  Budgeted direct mfg. labour cost overhead rate 

$100, 000  50% of direct manufacturing labour cost $200, 000

2. Overhead allocated = 50% × Actual direct manufacturing labour cost = 50% × $220,000 = $110,000 Overallocated plant overhead = Actual plant overhead costs − Allocated plant overhead costs = $106,000 − $110,000 = –$4,000 Overallocated plant overhead = –$4,000 3a. All overallocated plant overhead is written off to cost of goods sold. Both work in process (WIP) and finished goods inventory remain unchanged.

Account WIP Finished Goods Cost of Goods Sold Total

Dec. 31 Balance (Before Proration) (1) $ 50,000 240,000 560,000 $850,000

Proration of $4,000 Overallocated Manuf. Overhead (2) $ 0 0 4,000 $4,000

Dec. 31, 2022 Balance (After Proration) (3) = (1) − (2) $ 50,000 240,000 556,000 $846,000

Chapter 4: Job Costing

3b. Overallocated plant overhead prorated based on ending balances:

Account WIP Finished Goods Cost of Goods Sold Total

Dec. 31 Balance (Before Proration) (1) $ 50,000

Balance as a Percent of Total (2) = (1) ÷ $850,000 0.0588

Proration of $4,000 Overallocated Manuf. Overhead (3) = (2) × $4,000 0.0588 × $4,000 = $235.20

Dec. 31, 2022 Balance (After Proration) (4) = (1) − (3) $49,764.80

240,000

0.2824

0.2824 × $4,000 = 1,129.60

238,870.40

560,000 $850,000

0.6588 1.0000

0.6588 × $4,000 = 2,635.20 $ 4,000

557,364.80 $ 846,000

3c. Overallocated plant overhead prorated based on 2022 overhead in ending balances:

Account WIP Finished Goods Cost of Goods Sold Total

Proration of $4,000 Overallocated Manuf. Overhead (4) = (3) × $4,000

Dec. 31, 2022 Balance (After Proration) (5) = (1) − (4)

0.0909

0.0909 × $4,000 = $363.60

$ 49,636.40

30,000b

0.2727

0.2727 × $4,000 =1,090.80

238,909.20

70,000c $110,000

0.6364 1.0000

0.6364 × $4,000 = 2,545.60 $ 4,000

557,454.40 $ 846,000

Dec. 31, Balance (Before Proration) (1)

Allocated MOH in Dec. 31, Balance (2)

$50,000

$ 10,000a

240,000 560,000 $850,000

Allocated MOH in Dec. 31 Balance as a % of Total (3) = (2) ÷ $110,000

a,b,cOverhead allocated = Direct manuf. labour cost × 50% = $20,000; 60,000; 140,000 × 50%

4. Writing off all of the overallocated plant overhead to Cost of Goods Sold (CGS) is usually warranted when CGS is large relative to Work-in-Process and Finished Goods Inventory and the overallocated plant overhead is immaterial. Both these conditions apply in this case. ROW should write off the $4,000 overallocated plant overhead to Cost of Goods Sold Account.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4-29 (3545 min.) Job costing, journal entries. Some instructors may also want to assign Exercise 4-30. It demonstrates the relationships of the general ledger to the underlying subsidiary ledgers and source documents. 2. An overview of the product costing system is:

INDIRECT COST POOL



COST ALLOCATION BASE

Manufacturing Overhead

Direct Manufacturing Labour Costs



Indirect Costs

COST OBJECT: PRINT JOB



DIRECT COST

Direct Costs

Direct Materials

Direct Manuf. Labour

2. & 3. This answer assumes COGS given of $4,020 does not include the writeoff of overallocated manufacturing overhead.

Chapter 4: Job Costing

(1) Materials Control Accounts Payable Control (2) Work-in-Process Control Materials Control (3) Manufacturing Overhead Control Materials Control (4) Work-in-Process Control Manufacturing Overhead Control Wages Payable Control (5) Manufacturing Overhead Control Accumulated Depreciation––buildings and manufacturing equipment (6) Manufacturing Overhead Control Miscellaneous accounts (7) Work-in-Process Control Manufacturing Overhead Allocated (1.60  $1,300 = $2,080) (8) Finished Goods Control Work-in-Process Control (9) Accounts Receivable Control (or Cash) Revenues (10) Cost of Goods Sold Finished Goods Control (11) Manufacturing Overhead Allocated Manufacturing Overhead Control Cost of Goods Sold

800 800 710 710 100 100 1,300 900 2,200 400 400 550 550 2,080 2,080 4,120 4,120 8,000 8,000 4,020 4,020 2,080

1,950 130

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. Bal. 1/1/2021 (1) Accounts Payable Control (Purchases)

800

Bal. 12/31/2021

Bal. 1/1/2021 (2) Materials Control (Direct materials) (4) Wages Payable Control (Direct manuf. labour) (7) Manuf. Overhead Allocated Bal. 12/31/2021

Bal. 1/1/2021 (8) WIP Control (Goods completed) Bal. 12/31/2021

500

(10) Finished Goods Control (Goods sold) Bal. 12/31/2021

Materials Control (2) Work-in-Process Control (Materials used) (3) Manufacturing Overhead Control (Materials used)

100

Work-in-Process Control (8) Finished Goods Control (Goods completed)

4,120

710 1,300 2,080 30 Finished Goods Control (10) Cost of Goods Sold

4,020

4,120 600 Cost of Goods Sold (11) Manufacturing Overhead 4,020 Allocated (Adjust for overallocation) 3,890

Manufacturing Overhead Control (3) Materials Control (Indirect (11) To close materials) 100 (4) Wages Payable Control (Indirect manuf. labour) 900 (5) Accum. Deprn. Control (Depreciation) 400 (6) Accounts Payable Control (Miscellaneous) 550 Bal. 0 (11) To close

710

130

1,950

Manufacturing Overhead Allocated 2,080 (7) Work-in-Process Control (Manuf. overhead allocated) Bal.

2,080 0

Chapter 4: Job Costing

4. Gross margin = Revenues − Cost of goods sold = $8,000 − $3,890 = $4,110. This is a very good profit margin of 51% ($4,110 ÷ $8,000) indicating that University of Chicago Press performed very well in 2021. (Gross margins above 30% are generally considered very good.) It also accurately budgeted for manufacturing overhead costs resulting in a very small overallocation.

4-30 (15 min.) 1.

Job costing, law firm.

Budgeted professional

Budgeted direct labour compensation per professional labour-hour direct-cost rate Budgeted direct labour-hours per professional = $104,000/1,600 = $65 per professional labour-hour Budgeted indirect cost rate

Budgeted total costs in the indirect-cost pool Budgeted total professional labour-hours = $2,200,000/[25  1,600 hours] = $2,200,000/40,000 = $55 per professional labour-hour

3. Direct costs: Professional labour, $65  100; $65  150 Indirect costs: Legal support, $55  100; $55  150

Richardson

Punch

$ 6,500

$ 9,750

5,500 $12,000

8,250 $18,000

4-31 (25–30 min.) Job costing with two direct cost and two indirect cost categories, law firm (continuation of 4-30). 1. Budgeted compensation/professional Budgeted hours of billable time per professional Budgeted direct-cost rate 2. Budgeted total costs Divided by budgeted quantity of allocation base Budgeted indirect cost rate

Professional Partner Labour $200,000

Professional Manager Labour $80,000

÷ 1,600 $125 per hour

÷ 1,600 $50 per hour

General Support $1,800,000 ÷ 40,000 hours $45 per hour

Administration Support $400,000 ÷ 8,000 hours $50 per hour

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Professional hours = 25 × 1,600 hours = 40,000 hours Partner hours = 5 × 1,600 hours = 8,000 hours 3. Direct costs: Professional partners, $125  60; $125  30 Professional manager, $50  40; $50  120 Direct costs Indirect costs: General support, $45  100; $45  150 Admin. support, $50  60; $50  30 Indirect costs Total costs 4.

Richardson $7,500 2,000

Punch $3,750 6,000

$ 9,500 4,500 3,000

$ 9,750 6,750 1,500

7,500 $17,000

8,250 $18,000

Richardson Single direct - Single indirect (from Problem 4–30) Multiple direct − Multiple indirect (from requirement 3 of Problem 4-31) Difference

Punch

$12,000

$18,000

17,000 $ 5,000 undercosted

18,000 $ 0 no change

The Richardson and Punch jobs differ in their use of resources. The Richardson job has a mix of 60% partners and 40% manager, while Punch has a mix of 20% partners and 80% managers. Thus, the Richardson job is a relatively high user of the more costly partnerrelated resources (both direct partner costs and indirect partner secretarial support). The refined-costing system increases the reported cost in Problem 4-31 for the Richardson job by 41.7% (from $12,000 to $17,000).

4-32 (15 min.)

Normal costing, overhead allocation, working backward.

1a. Manufacturing overhead allocated = 250% × Direct manufacturing labour costs $4,100,000 = 2.50 × Direct manufacturing labour costs Direct manufacturing labour costs =

$4,100, 000 = $1,640,000 2.50

Direct manufacturing Total manufacturing Cost of direct Manufacturing = + + cost materials used overhead allocated labor cost

$8,300,000 = Cost of direct materials used + $1,640,000 + $4,100,000 Cost of direct materials used = $2,560,000

Chapter 4: Job Costing

Beginning WIP +

Total Cost of goods = + Ending WIP manufacturing cost manuractured

Denote Work in process on 12/31/2021 by X $420,000 + $8,300,000 = $8,100,000 + X X = $620,000 Work-in-process inventory, 12/31/21 = $620,000.

4-33 (40 min.)

Disposition of overhead overallocation or underallocation, two indirect cost pools.

Budgeted manufacturing overhead cost rate for the Machining Department

Budgeted manufacturing overhead cost rate for the Assembly Department

Budgeted manufacturing overhead costs in the Machining Department Budgeted machine-hours in the Machining Department

$5,850,000 ÷ 90,000

$65 per machine-hour

Budgeted manufacturing overhead costs in the Assembly Department Budgeted direct manufacturing labour-hours in the Assembly Department

$7,812,000 ÷ 124,000

$63 per direct manufacturing labour-hour

2. Machining Department Total actual machine-hours = 69,000 + 6,900 + 16,100 = 92,000 machine-hours Manufacturing overhead allocated

= 92,000  $65 = $5,980,000

Over/Underallocated MOH =

Actual manufacturing Manufacturing overhead − overhead costs allocated

= $5,470,000 − $5,980,000 = $510,000 OVERALLOCATED

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Assembly Department Total actual direct = 83,200 + 12,800 + 32,000 = 128,000 manufacturing labour-hours

Manufacturing overhead allocated

= 128,000  $63 = $8,064,000

Over/Underallocated MOH

Actual manufacturing Manufacturing overhead − overhead costs allocated

= $8,234,000 − $8,064,000 = $170,000 UNDERALLOCATED 2. a. Write-off to Cost of Goods Sold leads to (i)

lower Cost of Goods Sold of $510,000 as a result of overallocation of manufacturing overhead in the Machining Department

(ii) higher Cost of Goods Sold of $170,000 as a result of underallocation of manufacturing overhead in the Assembly Department. Hence, Cost of Goods Sold = $21,600,000 − $510,000 + $170,000 = $21,260,000 b. Proration based on ending balances (before proration) in Work in Process, Finished Goods, and Cost of Goods Sold. Account balances in each account after proration follows:

Account (1)

Account Balance (2)

Proration of ($510,000) Overallocated Overhead in Machining Dept. (3)

Cost of Goods Sold

21,600,000 (67.50%)

0.675  ($510,000)

Finished Goods Work in Process

Proration of $170,000 Underallocated Overhead in Assembly Dept. (4)

Account Balance (after Proration) (5) = (2) + (3) + (4) $21,370,500

= ($344,250)

0.675  $170,000 = $114,750

2,800,000 (8.75%)

0.0875  ($510,000) = ($44,625)

0.0875  $170,000 = $14,875

$ 2,770,250

$7,600,000 (23.75%)

0.2375  ($510,000) = ($121,125)

0.2375  $170,000 = $40,375

$ 7,519,250

(32,000,000)

($510,000)

$170,000

$31,660,000

Chapter 4: Job Costing

c. Proration based on the overhead allocated (before proration) in the ending balances of Cost of Goods Sold, Finished Goods, and Work in Process for each Department follows. Machining Department

Account (1) Work in process Finished goods Cost of goods sold

Overhead Costs Allocated to Each Account in Machining Department Using Budgeted Machine-Hour Rate  Actual Machine-hours (2) $65  16,100 = $1,046,500 (17.5%) $65  6,900 = 448,500 (7.5%) $65  69,000 = 4,485,000 (75.0%) $5,980,000 100%

Proration of ($510,000) Overallocated Overhead (3) 0.175  ($510,000) = ($ 89,250) 0.075  ($510,000) = ($ 38,250) 0.75  ($510,000) = ($382,500) ($510,000)

Assembly Department

Account (1) Work in process Finished goods Cost of goods sold

Overhead Costs Allocated to Each Account in Assembly Department Using Budgeted Direct Manuf. Labour-hour Rate  Actual Direct Manuf. Labour-hours (2) $6332,000 = $2,016,000 (25%) $6312,800 = 806,400 (10%) $6383,200 = 5,241,600 (65%) $8,064,000 (100%)

Proration of $170,000 Underallocated Assembly Overhead (3) 0.25  $170,000 = $ 42,500 0.10  $170,000 = 17,000 0.65  $170,000 = 110,500 $170,000

Account balances in each account after proration of overallocated Machining Department costs and underallocated Assembly Department costs follow.

Account (1) Work in process Finished goods Cost of goods sold

Account Balance (before) Proration) (2) $ 7,600,000 2,800,000 21,600,000 $32,000,000

Prorated ($510,000) of Overallocated Machining Department Overhead (calculated earlier) (3) $ (89,250) (38,250) (382,500) $(510,000)

Prorated $170,000 of Underallocated Assembly Department Overhead (calculated earlier) (4) $ 42,500 17,000 110,500 $170,000

Account Balance (after Proration) (5) = (2) + (3) + (4) $ 7,553,250 2,778,750 21,328,000 $31,660,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. If the purpose is to report the most accurate inventory and cost of goods sold figures, the preferred method is to prorate based on the manufacturing overhead allocated amount in the inventory and cost of goods sold accounts (as in requirement 2c). Note, however, that prorating based on ending balances in Work in Process, Finished Goods, and Cost of Goods Sold (as in requirement 2b) yields a close approximation to the more accurate proration in requirement 2c. Also note that the write-off to Cost of Goods Sold method (as in requirement 2a) results in a difference of only $68,000 ($21,328,000 − $21,260,000) or less than 1% to the balance of Cost of Goods Sold. Furthermore, the Write Off to Cost of Goods Sold method is simpler than the other methods. Depending on the objectives of the disposal of over/underallocation, a manager may prefer any one of the methods over the other two.

4-34 (35 minutes) Journal entries, T-accounts, and source documents. 1. (1) Direct Materials Control 121,000 Accounts Payable Control 121,000 Source Document: Purchase Invoice, Receiving Report Subsidiary Ledger: Direct Materials Record, Accounts Payable (2) Work in Process Controla 112,400 Direct Materials Control 112,400 Source Document: Material Requisition Records, Job Cost Record Subsidiary Ledger: Direct Materials Record, Work-in-Process Inventory Records by Jobs (3) Work in Process Control 87,000 Manufacturing Overhead Control 54,400 Wages Payable Control 141,400 Source Document: Labour Time Sheets, Job Cost Records Subsidiary Ledger: Manufacturing Overhead Records, Employee Labour Records, Work-inProcess Inventory Records by Jobs (4) Manufacturing Overhead Control 207,100 Salaries Payable Control 46,000 Accounts Payable Control 9,100 Accumulated Depreciation Control 53,000 Rent Payable Control 99,000 Source Document: Depreciation Schedule, Rent Schedule, Maintenance wages due, Invoices for miscellaneous factory overhead items Subsidiary Ledger: Manufacturing Overhead Records

Chapter 4: Job Costing

(5) Work in Process Control 269,700 Manufacturing Overhead Allocated ($87,000 × $3.10) Source Document: Labour Time Sheets, Job Cost Record Subsidiary Ledger: Work-in-Process Inventory Records by Jobs

269,700

(6) Finished Goods Controlb 449,600 Work in Process Control 449,600 Source Document: Job Cost Record, Completed Job Cost Record Subsidiary Ledger: Work-in-Process Inventory Records by Jobs, Finished Goods Inventory Records by Jobs (7) Cost of Goods Soldc 478,600 Finished Goods Control Source Document: Sales Invoice, Completed Job Cost Record Subsidiary Ledger: Finished Goods Inventory Records by Jobs (8) Manufacturing Overhead Allocated Manufacturing Overhead Control ($54,400 + $207,100) Cost of Goods Sold Source Document: Prior Journal Entries

478,600

269,700 261,500 8,200

(9) Administrative Expenses 7,700 Marketing Expenses 136,000 Salaries Payable Control 39,000 Accounts Payable Control 97,000 Accumulated Depreciation, Office Equipment 7,700 Source Document: Depreciation Schedule, Marketing Payroll Request, Invoice for Advertising, Sales Commission Schedule. Subsidiary Ledger: Employee Salary Records, Administration Cost Records, Marketing Cost Records. aMaterials used =

Beginning direct Ending direct + Purchases − materials inventory materials inventory

= $9,400 + $121,000 − $18,000 = $112,400 Cost of Beginning WIP Manufacturing Ending WIP =   b goods manufactured inventory cost inventory

= $6,500 + ($112,400 + $87,000 + $269,700) − $26,000 = $449,600 cCost of goods sold = Beginning finished  Cost of goods Ending finished

goods inventory

manufactured

goods inventory

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. T-accounts Direct Materials Control Bal. 1/1/2021 9,400 (2) Work-in-Process Control (1) Accounts Payable Control (Materials used) (Purchases) 121,000 Bal. 12/31/2021 18,000 Bal. 1/1/2021 (2) Materials Control (Direct materials used) (3) Wages Payable Control (Direct manuf. labour) (5) Manuf. Overhead Allocated Bal. 12/31/2021 Bal. 1/1/2021 (6) WIP Control (Cost of goods manuf.) Bal. 12/31/2021 (7) Finished Goods Control (Goods sold) Bal. 12/31/2021

Work-in-Process Control 6,500 (6) Finished Goods Control (Cost of goods 112,400 manufactured)

449,600

87,000 269,700 26,000 Finished Goods Control 60,000 (7) Cost of Goods Sold

478,600

449,600 31,000 Cost of Goods Sold (8) Manufacturing Overhead 478,600 Allocated (Adjust for overallocation) 470,400

Manufacturing Overhead Control (3) Wages Payable Control (8) To close (Indirect manuf. labour) 54,400 (4) Salaries Payable Control (Maintenance) 46,000 (4) Accounts Payable Control (Miscellaneous) 9,100 (4) Accum. Deprn. Control (Depreciation) 53,000 (4) Rent Payable Control (Rent) 99,000 Bal. 0 (8) To close

112,400

8,200

261,500

269,700 0

Chapter 4: Job Costing

4-35 (25–30 min.) Job costing, ethics. Direct Materials Control 01/01/2022

12/31/2022

25,000

630,000

Work-in-Process Control 01/01/2022

280,000

650,000

Dir. Lbr

880,000

45,000

Dir .Matls

630,000

OH Alloc

1,408,000

12/31/2022

298,000

Finished Goods Control 2,900,000

01/01/2022

320,000

2,930,000

2,900,000 12/31/2022

290,000

1a. Direct Materials Control, 12/31/2022 $45,000 1b. Manufacturing Overhead Allocated, 2022 1.6 × $1,300,000 = $1,408,000 1c. Cost of Goods Sold, 2022 $2,930,000 2. Overhead overallocated = Manufacturing overhead allocated − Manufacturing overhead control = $1,408,000 − $1,300,000 = $108,000 overallocated 3. a. If the overallocated overhead is closed out to cost of goods sold, COGS decreases by $108,000: $2,930,000 − $108,000 = $2,822,000 Revenue $5,550,000 COGS 2,822,000 Selling and admin. expenses 2,720,000 Net operating income $ 8,000 b. If the overallocated overhead is prorated to work in process control, finished goods control, and cost of goods sold based on ending balances before proration, cost of goods sold will be adjusted as follows: Ending Balance Before Proration 12/31/2022 (1)

Proration of $108,000 of Overallocated Manufacturing Overhead (4) = (2) × (3)

Overallocated Manufacuring Overhead (3)

Account Balance as a Precent of Total (2) = (1)/3,518,000

WIP Control

298,000

8.4707%

108,000

9,148

Fin. Good Control

290,000

8.2433%

108,000

8,903

Cost of Goods sold

2,930,000 3,518,000

83.2860% 100%

108,000

89,949 108,000

$108,000 overallocated overhead × 83.3% = $89,964 is subtracted from COGS $2,930,000 − $89,964 = $2,840,036

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Revenue $5,550,000 COGS 2,840,036 Selling and admin. expenses 2,720,000 Net operating loss $ (10,036) 4. While technically the $18,036 difference in adjusted cost of goods sold may have been immaterial, the difference caused Anderson to report a profit in the first instance, and a loss in the second. Recall that the company is under pressure to report a profit in 2022 because it is preparing for an acquisition by a private equity firm. The circumstances cause the amount to be material. Further, Underwood may have been planning for this all along, when he increased the overhead allocation rate for 2022. The ethical issue is that he may have planned for an overallocation of overhead so that he would have the option of reducing cost of goods sold at the end of the year in order to increase earnings.

4-36 (35 min.)

General ledger relationships, under- and overallocation.

The solution assumes all materials used are direct materials. A summary of the T-accounts for Keezel Company before adjusting for under- or overallocation of overhead follows: Direct Materials Control 1-1-2021 Purchases 12-31-2021

Work-in-Process Control

42,000 Material used for 135,000 manufacturing 148,000 29,000

1-1-2021 82,000 Transferred to Direct materials 148,000 finished goods 705,000 Direct manuf. labour 285,000 Manuf. overhead allocated 380,000 12-31-2021 190,000

Finished Goods Control 1-1-2021 105,000 Cost of goods Transferred in sold from WIP 705,000 12-31-2021 110,000

Cost of Goods Sold 700,000

Manufacturing Overhead Control

Finished goods sold

700,000

Manufacturing Overhead Allocated

Manufacturing overhead costs 425,000

Manufacturing overhead allocated to work in process

1. From Direct Materials Control T-account, Direct materials issued to production = $148,000 that appears as a credit.

380,000

Chapter 4: Job Costing

2. Direct manufacturing labour-hours

Manufacturing overhead allocated

Direct manufacturing labor costs Direct manufacturing wage rate per hour = $285,000 ÷ $15 per hour = 19,000 hours Direct manufacturing Manufacturing =  labor hours overhead rate

= 19,000 hours × $20 per hour = $380,000 3. From the debit entry to Finished Goods T-account, Cost of jobs completed and transferred from WIP = $705,000 4. From Work-in-Process T-account, Work in process inventory = $82,000 + $148,000 + $285,000 + $380,000 –$705,000 on 12/31/2021 = $190,000 5. From the credit entry to Finished Goods Control T-account, Cost of goods sold (before proration) = $700,000 6.

Manufacturing overhead Debits to Manufacturing Credit to Manufacturing =  underallocated Overhead Control Overhead Allocated

= $425,000 − $380,000 = $45,000 underallocated 7. a. Write-off to Cost of Goods Sold will increase (debit) Cost of Goods Sold by $45,000. Hence, Cost of Goods Sold = $700,000 + $45,000 = $745,000. b. Proration based on ending balances (before proration) in Work in Process, Finished Goods, and Cost of Goods Sold. Account balances in each account after proration follows: Proration of $45,000 Account Balance Account Balance Underallocated (After Account (Before Proration) Manufacturing Overhead Proration) (1) (2) (3) (4) = (2) + (3) Work in Process $ 190,000 (19%) 0.19  $45,000 =$ 8,550 $ 198,550 Finished Goods 110,000 ( 11%) 0.11  $45,000 = 4,950 114,950 Cost of Goods Sold 700,000 (70%) 0.70  $45,000 = 31,500 731,500 $1,000,000 100% $45,000 $1,045,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

8. Keezel’s operating income using write-off to Cost of Goods Sold and Proration based on ending balances (before proration) follows: Write-off to Proration Based Cost of Goods Sold on Ending Balances Revenues Cost of goods sold Gross margin Marketing and distribution costs Operating income/(loss)

$1,550,000 745,000 805,000 810,000 $ (5,000)

$1,550,000 731,500 818,500 810,000 $ 8,500

9. If the purpose is to report the most accurate inventory and cost of goods sold figures, the preferred method is to prorate based on the manufacturing overhead allocated component in the inventory and cost of goods sold accounts. Proration based on the balances in Work in Process, Finished Goods, and Cost of Goods Sold will equal the proration based on the manufacturing overhead allocated component if the proportions of direct costs to manufacturing overhead costs are constant in the Work in Process, Finished Goods, and Cost of Goods Sold accounts. Even if this is not the case, the prorations based on Work in Process, Finished Goods, and Cost of Goods Sold will better approximate the results if actual cost rates had been used rather than the write-off to Cost of Goods Sold method. Another consideration in Keezel’s decision about how to dispose of underallocated manufacturing overhead is the effects on operating income. The write-off to Cost of Goods Sold will lead to an operating loss. Proration based on the balances in Work in Process, Finished Goods, and Cost of Goods Sold will help Keezel avoid the loss and show an operating income. The main merit of the write-off to Cost of Goods Sold method is its simplicity. However, accuracy and the effect on operating income favour the preferred and recommended proration approach.

4-37 (15 min.)

Proration of overhead with two indirect cost pools.

1. Fabrication department: Overhead allocated = $12 per machine-hour × 3,200 machine-hours = $38,400 Finishing department: Overhead allocated = $20 per direct manuf. labour-hour × 1,800 direct manuf. labour-hours = $36,000 2. Under- or overallocated overhead in each department and in total follows: Fabrication department: $42,600 actual overhead − $38,400 allocated = $4,200 underallocated Finishing department: $39,800 actual overhead − $36,000 allocated = $3,800 underallocated Total underallocated overhead = $4,200 + $3,800 = $8,000

Chapter 4: Job Costing

3. Underallocated overhead prorated based on ending balances

Account Work in Process Finished Goods Cost of Goods Sold Total

Account Balance (Before Proration) (1) $ 60,000 180,000 360,000 $600,000

Account Balance as a Percent of Total (2) = (1) ÷ $600,000 0.10 0.30 0.60 1.00

Proration of $8,000 Underallocated Overhead (3) = (2) × 8,000 0.10 × $8,000 = $ 800 0.30 × $8,000 = 2,400 0.60 × $8,000 = 4,800 $8,000

Account Balance (After Proration) (4) = (1) + (3) $ 60,800 182,400 364,800 $608,000

Because Adventure Designs is disposing of underallocated costs based on the ending balance in Work in Process, Finished Goods, and Cost of Goods Sold accounts, it does not have to allocate the underallocated overhead from each department separately. Had Adventure Designs disposed of the underallocated overhead based on the overhead allocated in the ending balances in each of the three accounts, it would have to dispose of the underallocated overhead in the Fabrication Department and the underallocated overhead in the Finishing Department separately. 4. The ending balance in Cost of Goods Sold would be $368,000 instead of $364,800 if the entire $8,000 amount of underallocated overhead was written off to Cost of Goods Sold account. Cost of Goods Sold would increase by 0.9% ($368,000 − $364,800) ÷ $364,800. Because this is an insignificant amount, it would be reasonable to use the simpler method of charging off to Cost of Goods Sold.

4-38 (2025 min.) Disposition of underallocated or overallocated overhead -- Advanced. 1. Budgeted manufacturing overhead read is $4,800,000 ÷ 80,000 hours = $60 per machinehour Manufacturing overhead Manufacturing overhead Manufacturing overhead   underallocated incurred allocated

 $4,900, 000 $4,500, 000*  $400, 000

*$60  75,000 actual machine-hours = $4,500,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

a. Write-off to Cost of Goods Sold

Account Balance (Before Proration) (2)

Account (1) Work in Process Finished Goods Cost of Goods Sold Total

750,000 1,250,000 8,000,000 $10,000,000

Write-off of $400,000 Underallocated Manufacturing Overhead (3) $

0 0 400,000 $400,000

Account Balance (After Proration) (4) = (2) + (3) $

750,000 1,250,000 8,400,000 $10,400,000

b. Proration based on ending balances (before proration) in Work in Process, Finished Goods, and Cost of Goods Sold. Proration of $400,000 Account Underallocated Balance Account Balance Manufacturing (After Account (Before Proration) Overhead Proration) (1) (2) (3) (4) = (2) + (3) Work in Process $ 750,000 (7.5%) 0.075  $400,000 = $ 30,000 $ 780,000 Finished Goods 1,250,000 (12.5%) 0.125  $400,000 = 50,000 1,300,000 Cost of Goods Sold 8,000,000 (80.0%) 0.800  $400,000 = 320,000 8,320,000 Total $10,000,000 100.0% $400,000 $10,400,000 c. Proration based on the allocated overhead amount (before proration) in the ending balances of Work in Process, Finished Goods, and Cost of Goods Sold. Account Balance (Before Proration) (2)

Account (1)

Allocated Overhead Included in the Account Balance (Before Proration) (3) (4)

Proration of $400,000 Underallocated Manufacturing Overhead (5)

Work in Process Finished Goods Cost of Goods Sold

750,000 1,250,000 8,000,000

$ 240,000 b 660,000 c 3,600,000

( 5.33%) (14.67%) (80.00%)

0.0533  $400,000 = $ 21,320 0.1467  $400,000 = 58,680 0.8000  $400,000 = 320,000

Total

$10,000,000

$4,500,000

100.00%

$400,000

a$60  4,000 machine-hours;

b$60  11,000 machine-hours;

c$60  60,000 machine-hours

Account Balance (After Proration) (6) = (2) + (5) $

771,320 1,308,680 8,320,000

$10,400,000

Chapter 4: Job Costing

3. Alternative (c) is theoretically preferred over (a) and (b). Alternative (c) yields the same ending balances in work in process, finished goods, and cost of goods sold that would have been reported had actual indirect cost rates been used. Chapter 4 also discusses an adjusted allocation rate approach that results in the same ending balances as does alternative (c). This approach operates via a restatement of the indirect costs allocated to all the individual jobs worked on during the year using the actual indirect cost rate. COLLABORATIVE LEARNING CASES

4-39 (35–40 min.) Normal job costing, unit costs. 1. Manufacturing overhead rate = Budgeted MOH Costs Budgeted Direct Labour-Hours .MOH Rate = $180,000/15,000 = $12 per DL hour 2. Ending work in process In reviewing the production, the only job that remains in process at the end of the year is Job 817. It had an opening balance (as of December 1) of: Direct materials Direct labour MOH allocated Total $6,250

$2,500 $2,400 $1,350

Beginning Balance Direct materials added Direct labour added MOH Allocated Ending balance

$6,250 $ 700 $1,440 $ 960 $9,350

[80 hours @ $12]

The total balance of ending work in process is $9,350 and relates to one job, Job 817. The unit cost of the job (to date) assuming there are 250 units in the job is $37.40 ($9,350/250).

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. Calculation of the cost of goods manufactured Beginning work in process Direct materials (Dec.) Direct labour (Dec.) MOH allocated Less ending WIP COGM

[$3,200+$6,250+$2,750] [$500+$700+$1,300+$1,250+$1,500] [$900+$1,440+$3,060+$3,960+$5,940] $12 × [50+80+170+220+330] (see above)

$12,200 $5,250 $15,300 $10,200 ($9,350) $33,600

During the month of December, jobs 815, 822, and 823 were all sold, since only job 824 remains in ending inventory. Dec. 31 Finished Goods Balance = Job 824 = $1,500 + $5,940 + (330×$12) = $11,400 Dec. 1 Finished Goods + COGM (Dec) − Dec 31 Finished Goods = COGS $0 + $33,600 –$11,400 = $22,200 The selling price is based on 200% of total manufacturing cost. Total Sales = $22,200 × 200% = $44,400 Gross Margin = Sales − Cost of Goods Sold Gross Margin = $44,400  $22,200 = $22,200 The following chart summarizes the jobs and classifies them into WIP, Finished Goods, and Cost of Goods Sold. WIP, Dec 1 DM DL OH Alloc. Bal Dec 31 WIP Fin. Good COGS

Job 815 $3,200 $ 500 $ 900 $ 600 $5,200 N/A N/A $5,200

Job 817 $6,250 $700 $1,440 $960 $9,350 $9,350 N/A N/A

Job 822 $2,750 $1,300 $3,060 $2,040 $9,150 N/A N/A $9,150

4. Under- or overallocated overhead for the year: Direct labour-hours worked to December 1 Additional DL hours worked in December Total DL hours worked in the year MOH allocated at $12 per DL hour

Job 823 N/A $1,250 $3,960 $2,640 $7,850 N/A N/A $7,850

13,750 850 14,600 $175,200

Job 824 N/A $ 1,500 $ 5,940 $ 3,960 $11,400 N/A $11,400 N/A

Total $12,200 $ 5,250 $15,300 $10,200 $42,950 $ 9,350 $11,400 $22,200

[50+80+170+220+330]

Under- or overallocated MOH = Actual MOH  Allocated MOH Under- or overallocated MOH = $204,800*  $175,200 = $29,600 Underallocated Manufacturing overhead is underallocated for the year by $29,600. *Should add $2,490 + $1,800 + $2,200 + $1,500 + $1,800 = $9,790 in December so that the actual OH for the year would then be $204,800 and the Underallocated amount would be $29,600.

Chapter 4: Job Costing

4-40 (35 min.) Job costing—service industry. 1. Gigs in Process (GIP) April 30, 2022

Author Irok ($570 + $110; $750 + $200) Bottom Rung ($250 + $310; $475 + $250) Rail Ride Total

Direct Materials Labour (1) (2) $ 680 $ 950

Overhead (3) = 120% × (2) $1,140

Total (4) $2,770

560 225 $1,465

870 300 $2,310

2,155 775 $5,700

Overhead (3) = 120% × (2)

Total (4)

$ 780 540 $1,320

$2,270 1,530 $3,800

725 250 $1,925

2. Cost of Completed Gigs (CCG) in April 2022 Direct Labour (2)

Materials (1)

Author Freke Out ($700 + $140; $550 + $100) Dish Towel Total

$ 840 540 $1,380

$ 650 450 $1,100

3. Overhead allocated = 1.20 × 1,250a = $1,500 Underallocated overhead = Actual overhead − Allocated overhead = $1,980 − 1,500 = $480 underallocated aTotal direct labour in April = $200 + $100 + $250 + $450 + $250 = $1,250

4a. Underallocated overhead is written off to CCG GIP inventory remains unchanged.

Account GIP CCG

April 30, 2022 Balance (Before Proration) (1) $5,700 3,800 $9,500

Underallocated Overhead of $480 written off to Cost of Completed Gigs (CCG) (2) $ 0 480 $480

April 30, 2022 Balance (After Proration) (3) = (1) + (2) $5,700 4,280 $9,980

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4b. Underallocated overhead is allocated based on the ending balances (before proration) in GIP and CCG April 30, 2022 Balance (Before Proration) Account (1) GIP $5,700 (60%) CCG 3,800 (40%) $9,500

April 30, 2022 Proration of $480 Balance Underallocated (After Overhead Proration) (2) (3) = (1) + (2) 0.60 × $480 = $ 288.00 $5,988.00 0.40 × $480 = 192.00 3,992.00 $ 480.00 $9,980.00

4c. Underallocated overhead prorated based on April overhead in ending balances Overhead April 30, 2022 Allocated in Overhead Allocated Balance April Included in April Included (Before in April 30, 2022 in April 30, 2022 as Proration) Balance a Percent of Total Account (1) (2) (3) = (2) ÷ $1,500 GIP $5,700 $ 840a 0.56 CCG 3,800 660b 0.44 $9,500 $1,500 1.00

Proration of $480 Underallocated Overhead (4) = (3) × $480 0.56 × $480 = $ 268.80 0.44 × $480 = 211.20 $ 480.00

April 30, 2022 Balance (After Proration) (5) = (1) + (4) $5,968.80 4,011.20 $9,980.00

aApril labour for Irok, Bottom Rung, and Rail Ride × 120%

= ($200 + $250 + $250) × 120% = $700 × 120% = $840 bApril labour for Freke Out and Dish Towel × 120%

= ($100 + $450) × 120% = $550 × 120% = $660 5. I would choose the method in 4c (proration based on overhead allocated) because this method results in account balances based on actual overhead allocation rates. The account balances before proration in GIP and CCG are significant, and underallocated overhead is material. Of course, the method chosen affects reported operating income. In the case of underallocated overhead, writing off to CCG results in lower operating income compared to proration and lower taxes. If overhead had been overallocated, proration would result in lower operating income and lower taxes. Despite the tax considerations, I would choose proration because it best represents Brady’s performance during a period. I would use the simpler method of write off to CCG only if the amount were immaterial or if it represents inefficiency. I would apply this method consistently from period to period.

CHAPTER 5 ACTIVITY-BASED COSTING AND MANAGEMENT MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

SHORT-ANSWER QUESTIONS 5-1

Cost smoothing (or traditional costing, broad averaging, “peanut-butter costing”) describes a costing approach that uses broad average cost allocation rates for assigning (or spreading, as in spreading peanut butter) the cost of shared resources to distinct types of cost objects when the use among the distinct types of cost objects is unequal. Broad averaging can lead to undercosting or overcosting of products or services.

5-2

Overcosting may result in competitors entering a market and taking market share for products that a company erroneously believes are low-margin or even unprofitable. Undercosting may result in companies selling products on which they are in fact losing money, when they erroneously believe them to be profitable.

5-3

Costing system refinement means making changes to a traditional costing system that reduces the use of one broad average to assign indirect costs of shared resources to cost objects. Reducing the use of one broad average is a refinement that requires increasing the number of indirect MOH cost pools from one to several. Three guidelines for refinement are 1. Classify as many of the total costs as direct costs as is economically feasible. 2. Expand the number of indirect cost pools until each of these pools is more homogenous and less mixed in the resource costs contained in the pool. 3. Use the cause-and-effect criterion, when possible, to identify the cost-driver for each new, homogeneous indirect-cost pool.

5-4

An activity-based costing (ABC) approach is a refinement to a costing system that defines the cost object as an activity. The same support activity can be done in many business functions in the value chain. The cost of these activities is the activity cost pool or numerator. The activity cost driver is the denominator which when divided into the activity cost pool equals activity cost driver rate. The activity cost driver may be a measure of benefit (such as purchase orders completed in a timely way) or a measure of input such as quality control hours consumed. What is essential is that change in the quantity of the activity cost driver explains most of the change in the total value of the activity cost pool.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

5-5

Four levels of a cost hierarchy are

(i) Output unit-level costs: costs of activities performed on each unit of a distinct type of output (ii) Batch-level costs: costs of activities related to a group of distinct units of homogeneous outputs. A batch may be 1,000 identical units of one distinct type of output that are distinguished from another batch of 1,000 identical units of a different distinct type of output in some meaningful and costly way. (iii) Product-sustaining or service-sustaining costs: costs of activities undertaken to support distinct types of products or services regardless of the number of units or batches in which the types of products or services are produced. (iv) Facility-sustaining costs: costs of intangible (unmeasurable) activities that cannot be traced to distinct types of units, batches, products, or services but support the organization as a whole.

5-6

It is important to classify costs into a cost hierarchy because costs saved at the facilities level can generate savings for all business functions in the value-chain. By identifying the level at which an activity is shared, the scope of potential savings is also identified. For example a unit-level cost saving will not affect a facility-sustaining cost. In practical terms, reducing the cost of a direct material input for a specific type of output cannot reduce the salary of the director of IT services.

5-7

An ABC system defines activities as the cost objects. The costs of these activities are accumulated throughout the hierarchy to compute the costs of products, and services, and so on. Simple costing systems have one or a few indirect cost pools that ignore the inaccuracies induced when there are many types of resource costs in one cost pool. ABC systems have multiple indirect cost pools, one for each type of resource used. An ABC approach uses the quantity of activity cost drivers as the allocation base or denominator for each indirect cost pool. A traditional cost system typically uses a quantity of a direct input as the cost allocation base. The ABC approach classifies as many indirect costs as direct costs as possible. This improves the management team’s understanding of cause and effect relationships and the accuracy of costing.

5-8 1. 2. 3. 4.

Four decisions for which ABC information is useful are

pricing and product mix decisions, cost reduction and process improvement decisions, product design decisions, and decisions for planning and managing activities.

5-9

No. Department indirect-cost rates are similar to activity-cost rates if (1) a single activity accounts for a sizable fraction of the department’s costs, or (2) significant costs are incurred because of different activities within a department but each activity has the same cost-allocation base, or (3) significant costs are incurred because of different activities with different costallocation bases within a department but different products use resources from the different activity areas in the same proportions.

Chapter 5: Activity-Based Costing and Management

5-10 “Tell-tale” signs that indicate when ABC systems are likely to provide the most benefits are as follows: 1. Significant amounts of indirect costs are allocated using only one or two cost pools. 2. All or most indirect costs are identified as output-unit-level costs (i.e., few indirect costs are described as batch-level, product-sustaining, or facility-sustaining costs). 3. Products make diverse demands on shared resources because of differences in volume, process steps, batch size, or complexity. 4. Products that a company is well suited to make and sell show small profits, whereas products that a company is less suited to produce and sell show large profits. 5. Operations staff has significant disagreements with the accounting staff about the costs of manufacturing and marketing products and services.

5-11 The main costs and limitations of ABC are the measurements necessary to implement the systems. It is hard for management teams to think about activities instead of jobs as a cost object. It is also hard for management teams to think about the scope of business functions affected by one activity and establish an activity hierarchy. Even basic ABC systems require many calculations to determine costs of products and services. Activity-cost rates often need to be updated regularly. Very detailed ABC systems are costly to operate and difficult to understand. Sometimes the allocations necessary to calculate activity costs result in activity-cost pools and quantities of cost-drivers being measured with error. When measurement errors are large, activity-cost information can be misleading. A common problem is that when accruals are used, the costs in the pool lead the full consumption of the activity. This means the quantity of the activity cost driver is understated relative to the value of the activity cost pool.

5-12 No, ABC systems are appropriate for service companies such as banks, railroads, hospitals, and accounting firms, as well as for merchandising companies such as retailers and distributors.

5-13 No. An activity-based system should be adopted only if its expected benefits exceed its expected costs. It is not always a wise investment. If the jobs, products, or services are alike in the way they use indirect resources of a company, then a simple costing system will suffice.

5-14 No. Increasing the number of indirect-cost pools does not guarantee increased accuracy of product or service costs. If the existing cost pool is already homogeneous, increasing the number of cost pools will not increase accuracy. If the existing cost pool is not homogeneous, accuracy will increase only if the increased cost pools themselves increase in homogeneity when compared to the single cost pool.

5-15 The new system will result in more accurate product costs which will influence pricing and product mix decisions. The new system can also be used to reduce product costs, which will lower selling prices. The new system can help managers make better decisions involving design. The new system can help managers plan for growth and distinguish value-added from non-valueadded activities. As a result, the customer will benefit from the new system.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

EXERCISES 5-16 (10 min.) Terminology. 1. One common refinement to a traditional or peanut butter costing system is called an activity-based costing system (ABC). 2. The single MOH cost pool is separated into different activity cost pools distinguished from one another by their measure of benefits provided, or the activity cost driver. 3. Benefits provided unequally to distinct types of outputs provide value-added to customers, for which customers are willing to pay. This is the basic concept that guides the approach to cost reduction and control called activity-based management (ABM). 4. The management team identifies and eliminates non-value added activity and its costs and reorganizes the value-added activity to minimize costs. 5. There are four levels of activities in a cost hierarchy. From narrowest to broadest in scope they are output, batch, product (or service), and facility-sustaining cost. 6. When a management team fails to develop a cost management system that reports faithfully the unequal benefits (and costs) of value-added activities there is a high risk of mispricing distinct types of outputs. If managers use cost plus pricing, an overcosted output will be priced too high and an undercosted product will be priced too low relative to the economic value-added. The result is preventable cross-subsidization of costs of the lower-priced by the higher-priced product.

5-17 (20 min.) 1. a. b.

c. d. e.

f. g.

Cost hierarchy.

Indirect manufacturing labour costs of $1,500,000 support direct manufacturing labour and are output unit-level costs. Direct manufacturing labour generally increases with output units, and so will the indirect costs to support it. Batch-level costs are costs of activities that are related to a group of units of a product rather than each individual unit of a product. Purchase order-related costs (including costs of receiving materials and paying suppliers) of $800,000 relate to a group of units of product and are batch-level costs. Cost of indirect materials of $450,000 generally changes with labour-hours or machinehours which are unit-level costs. Therefore, indirect material costs are output unit-level costs. Setup costs of $900,000 are batch-level costs because they relate to a group of units of product produced after the machines are set up. Costs of designing processes, drawing process charts, and making engineering changes for individual products, $900,000, are product-sustaining because they relate to the costs of activities undertaken to support individual products regardless of the number of units or batches in which the product is produced. Machine-related overhead costs (depreciation and maintenance) of $1,200,000 are output unit-level costs because they change with the number of units produced. Plant management, plant rent, and insurance costs of $950,000 are facility-sustaining costs because the costs of these activities cannot be traced to individual products or services but support the organization as a whole.

Chapter 5: Activity-Based Costing and Management

2. The complex boom box made in many batches will use significantly more batch-level overhead resources compared to the simple boom box that is made in a few batches. In addition, the complex boom box will use more product-sustaining overhead resources because it is complex. Because each boom box requires the same amount of machine-hours, both the simple and the complex boom box will be allocated the same amount of overhead costs per boom box if Teledor uses only machine-hours to allocate overhead costs to boom boxes. As a result, the complex boom box will be undercosted (it consumes a relatively high level of resources but is reported to have a relatively low cost) and the simple boom box will be overcosted (it consumes a relatively low level of resources but is reported to have a relatively high cost). 3. Using the cost hierarchy to calculate activity-based costs can help Teledor to identify both the costs of individual activities and the cost of activities demanded by individual products. Teledor can use this information to manage its business in several ways: a. Teledor can improve pricing and product mix decisions. Knowing the resources needed to manufacture and sell different types of boom boxes can help Teledor to price the different boom boxes and also identify which boom boxes are more profitable. It can then emphasize its more profitable products. b. Teledor can use information about the costs of different activities to improve processes and reduce costs of the different activities. Teledor could have a target of reducing costs of activities (setups, order processing, etc.) by, say, 3% and constantly seek to eliminate activities and costs (such as engineering changes) that its customers perceive as not adding value. c. Teledor management can identify and evaluate new designs to improve performance by analyzing how product and process designs affect activities and costs. d. Teledor can use its ABC systems and cost hierarchy information to plan and manage activities. What activities should be performed in the period and at what cost?

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

5-18 (50 min.)

Plant-wide, department, and activity-cost rates.

1. Basic Direct materials Forming $ 60,000 Assembly 5,000 Total 65,000 Direct manufacturing labour Forming 30,000 Assembly 15,000 Total Total direct costs

45,000 $110,000

Deluxe

Total

$35,000 10,000 45,000 20,000 25,000 45,000 $90,000

$200,000

Budgeted = ($48, 000  $32, 000  $40, 000  $120, 000 = $0.60 per dollar of direct cost overhead rate $200, 000 $200, 000

Basic

Deluxe

Total

Direct materials $ 65,000 Direct manuf. labour 45,000 Total direct cost 110,000 Allocated overhead ($0.60 × 110,000;90000) 66,000 Total costs $176,000 Unit cost ($176,000 ÷ 10,000; $144,000 ÷ 5,000) $17.60

$ 45,000 45,000 90,000 54,000 $144,000 $28.80

$110,000 90,000 200,000 120,000 $320,000

Chapter 5: Activity-Based Costing and Management

Budgeted Budgeted Forming Department overhead costs overhead rate- = 2. Forming Dept. Budgeted Forming Department direct manufacturing labour costs $48, 000  $32, 000 $30, 000  $20, 000 $80, 000 = = $1.60 per Forming Department direct manuf.-labour dollar $50, 000

Budgeted Budgeted Assembly Department overhead costs overhead rate- = Forming Dept. Budgeted Assembly Department direct manufacturing labour costs $40, 000 ($15, 000  $25, 000) $40, 000 = = $1 per Assembly Department direct manuf.-labour dollar $40, 000

Direct materials Direct manufacturing labour Total direct cost Allocated overhead Forming Dept.($1.60 × 30,000;20,000) Assembly Dept. ($1 × 15,000;25,000) Total costs Unit cost ($173,000÷10,000; $147,000÷5,000)

Basic $ 65,000 45,000 110,000

Deluxe $ 45,000 45,000 90,000

Total $110,000 90,000 200,000

48,000 15,000 $173,000 $17.30

32,000 25,000 $147,000 $29.40

80,000 40,000 $320,000

3. Number of batches of basic trophies = 10,000 ÷ 200 trophies per batch = 50 batches Number of batches of deluxe trophies = 5,000 ÷ 50 trophies per batch = 100 batches Total number of batches = 50 + 100 = 150 batches Forming Department Budgeted setup rate 

$48, 000 = $320 per batch 150 batches

Budgeted general overhead rate =

$32, 000 = $0.64 per direct manuf.-labour dollar $50, 000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Assembly Department Budgeted general overhead rate =

$40, 000 = $1 per direct manuf.-labour dollar $40, 000

Direct material costs Direct labour costs Total direct costs Forming Dept. overhead Set up $320 × 50; 100 General overhead $0.64 × $30,000; $20,000 Assembly Department overhead General overhead $1 × $15,000; $25,000 Total costs Unit cost ($160,200÷10,000; $159,800÷5,000) 4.

Basic $ 65,000 45,000 110,000

Deluxe $ 45,000 45,000 90,000

Total $110,000 90,000 200,000

16,000

32,000

48,000

19,200

12,800

32,000

15,000

25,000

40,000

$160,200 $16.02

$159,800 $31.96

$320,000

As Acclaim uses more refined cost pools, the costs of basic trophies decreases, and costs of deluxe trophies increases. This is because deluxe trophies use a higher proportion of cost drivers (batches of set ups and direct manufacturing labour costs) than basic trophies, whereas the direct costs (the allocation base used in the simple costing system) are slightly smaller for deluxe trophies compared to basic trophies. This results in deluxe trophies being undercosted and basic trophies overcosted in the simple costing system. Department costing systems increase the costs of deluxe trophies relative to basic trophies because the forming and assembly department costs are allocated based on direct manufacturing labour costs in the respective departments. When compared to basic trophies, deluxe trophies use direct manufacturing labour more intensively in each department compared to direct materials. I would recommend that Acclaim use the activity-based costing system because disaggregated information can improve decisions by allowing managers to see the details that help them understand how different aspects of cost influence total cost per unit. Even though the cost per unit of basic trophies and deluxe trophies does not change much, activity-based costing can help managers understand the drivers of different cost categories and use this information for pricing and product-mix decisions, cost reduction and processimprovement decisions, design decisions, and to plan and manage activities. However, too much detail can overload managers who don’t understand the data or what it means. Acclaim’s ABC system is intuitive and easy to understand. Also, managers looking at perunit data may be misled when considering costs that aren’t unit-level costs.

Chapter 5: Activity-Based Costing and Management

5-19 (20 min.)

Plantwide indirect cost rates.

1. Actual plantwide variable MOH rate based on machine-hours: 319,800 ÷ 4,000 = $79.95 per machine-hour United Holden Motors Motors Variable manufacturing overhead, allocated based on machine-hours ($79.95 × 125; $79.95 × 2,800; $79.95 × 1,075) $9,994 $223,860

Leland Motors

Total

$85,946

$319,800

2. Department Design Engineering Production

Variable MOH in 2022 $41,000 28,800 250,000

Total Driver Units 400 384 4,000

Design-related overhead, allocated on CAD-design hours (120 × $102.5; 195 × $102.5; 85 × $102.5) Engineering-related overhead, allocated on engineering hours (75 × $75; 65 × $75; 244 × $75) Production-related overhead, allocated on machinehours (125 × $62.5; 2,800 × $62.5; 1,075 × $62.5) Total Variable MOH

Rate $102.5 $ 75 $ 62.5

per CAD-design hour per engineering hour per machine-hour

United Motors

Holden Motors

Leland Motors

Total

$12,300

$ 19,988

$ 8,712

$ 41,000

5,625

4,875

18,300

28,800

7,812

175,000

67,188

250,000

$25,737 $199,863

$94,200 $319,800

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. a. Department rates (Requirement 2) b. Plantwide rate (Requirement 1) Ratio of (a) ÷ (b)

United Motors

Holden Motors

Leland Motors

$25,737

$199,863

$94,200

$ 9,994 2.58

$223,860 0.89

$85,946 1.10

The variable manufacturing overhead allocated to United Motors increases by 158% under the department rates, the overhead allocated to Holden decreases by about 11% and the overhead allocated to Leland increases by about 10%. The three contracts differ sizably in the way they use the resources of the three departments. The percentage of total driver units in each department used by the companies is: Department Design Engineering Production

Cost Driver CAD-design hours Engineering hours Machine-hours

United Motors 30% 20 3

Holden Motors 49% 17 70

Leland Motors 21% 63 27

The United Motors contract uses only 3% of total machine-hours in 2022, yet uses 30% of CAD design-hours and 20% of engineering hours. The result is that the plantwide rate, based on machine-hours, will greatly underestimate the cost of resources used on the United Motors contract. This explains the 158% increase in indirect costs assigned to the United Motors contract when department rates are used. In contrast, the Holden Motors contract uses less of design (49%) and engineering (17%) than of machine-hours (70%). Hence, the use of department rates will report lower indirect costs for Holden Motors than does a plantwide rate. Holden Motors was probably complaining under the use of the simple system because its contract was being overcosted relative to its consumption of MOH resources. United, on the other hand, was having its contract undercosted and underpriced by the simple system. Assuming that CP is an efficient and competitive supplier, if the new department-based rates are used to price contracts, United will be unhappy. CP should explain to United how the calculation was done, and point out United’s high use of design and engineering resources relative to production machine-hours. Discuss ways of reducing the consumption of those resources, if possible, and show willingness to partner with them to do so. If the price increase is going to be steep, perhaps offer to phase in the new prices. 4. Other than for pricing, CP can also use the information from the department-based system to examine and streamline its own operations so that there is maximum value added from all indirect resources. It might set targets over time to reduce both the consumption of each indirect resource and the unit costs of the resources. The department-based system gives CP more opportunities for targeted cost management.

Chapter 5: Activity-Based Costing and Management

5. It would not be worthwhile to further refine the cost system into an ABC system if there wasn’t much variation among contracts in the consumption of activities within a department. If, for example, most activities within the design department were, in fact, driven by CADdesign hours, then the more refined system would be more costly and no more accurate than the department-based cost system. Even if there were sufficient variation, considering the relative sizes of the three department cost pools, it may only be cost-effective to further analyze the production cost pool, which consumes 78% (= $250,000 ÷ $319,800) of the manufacturing overhead.

5-20 (10–15 min.) ABC, process costing. 1. Rates per unit cost driver. Activity Cost Driver Machining Machine-hours

Rate $360,000 ÷ (30,000 + 60,000) = $4 per machine hour

Set up

Production runs

$108,000 ÷ (45 + 45) = $1,200 per production run

Inspection

Inspection-hours

$117,000 ÷ (1,200 + 600) = $65 per inspection hour

Manufacturing overhead cost per unit: Machining: $4 × 30,000; 60,000 Set up: $1,200 × 45; $1,200 × 45 Inspection: $65 × 1,200; $65 × 600 Total manufacturing overhead costs Divide by number of units Manufacturing overhead cost per unit

Mathematical Financial $120,000 $240,000 54,000 54,000 78,000 39,000 $252,000 $333,000 ÷ 45,000 ÷90,000 $ 5.60 $ 3.70

2. Mathematical Financial Manufacturing cost per unit: Direct materials $180,000 ÷ 45,000 $360,000 ÷ 90,000 Direct manufacturing labour $90,000 ÷ 45,000 $180,000 ÷ 90,000 Manufacturing overhead (from requirement 1) Manufacturing cost per unit

$ 4.00 $4.00 2.00 5.60 $11.60

2.00 3.70 $9.70

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. Disaggregated information can improve decisions by allowing managers to see the details that help them understand how different aspects of cost influence total cost per unit. Managers can also understand the drivers of different cost categories and use this information for pricing and product-mix decisions, cost reduction and process-improvement decisions, design decisions, and to plan and manage activities. However, too much detail can overload managers who don’t understand the data or what it means. Also, managers looking at perunit data may be misled when considering costs that aren’t unit-level costs.

5-21 (15 min.)

Explain undercosting and overcosting of services.

1. Direct Professional Time Rate Number Support Services Amount per of Billed to Client Hour Hours Total Rate per hour Total Client (1) (2) (3) (4) = (2) × (3) (5) (6) = (4) × (5) (7) = (4) + (6) Winnipeg Dominion Wolfson Ku Anderson

$800 144 96

15 3 22

$12,000 432 2,112

30% 30% 30%

$3,600 130 634

$15,600 562 2,746 $18,908

2 8 30

$ 1,600 1,152 2,880

30% 30% 30%

$ 480 346 864

$ 2,080 1,498 3,744 $ 7,322

Tokyo Enterprises Wolfson Ku Anderson

$800 144 96

Amounts are rounded to the nearest dollar. 2. Direct Professional Time Support Services Rate Number Amount per of Billed to Client Hour Hours Total Rate per hour Total Client (1) (2) (3) (4) = (2) × (3) (5) (6) = (3) × (5) (7) = (4) + (6) Winnipeg Dominion Wolfson Ku Anderson

$800 144 96

15 3 22

$12,000 432 2,112

$60 60 60

$ 900 180 1,320

$12,900 612 3,432 $16,944

Tokyo Enterprises Wolfson $800 Ku 144 Anderson 96

2 8 30

$ 1,600 1,152 2,880

$60 60 60

$ 120 480 1,800

$ 1,720 1,632 4,680 $ 8,032

Chapter 5: Activity-Based Costing and Management

Amounts are rounded to the nearest dollar.

Winnipeg Dominion Tokyo Enterprises

Requirement 1 $18,908 7,322 $26,230

Requirement 2 $16,944 8,032 $24,976

Both clients use 40 hours of professional labour time. However, Winnipeg Dominion uses a higher proportion of Wolfson’s time (15 hours), which is more costly. This attracts the highest support-services charge when allocated on the basis of direct professional labour costs. 3. Assume that the Wolfson Group uses a cause-and-effect criterion when choosing the allocation base for support services. You could use several pieces of evidence to determine whether professional labour costs or hours is the driver of support-service costs: a. Interviews with personnel. For example, staff in the major cost categories in support services could be interviewed to determine whether Wolfson requires more support per hour than, say, Anderson. The professional labour costs allocation base implies that an hour of Wolfson’s time requires 8.33 (= $800  $96) times more support-service dollars than does an hour of Anderson’s time. b. Analysis of tasks undertaken for selected clients. For example, if computer-related costs are a sizable part of support costs, you could determine if there was a systematic relationship between the percentage involvement of professionals with high billing rates on cases and the computer resources consumed for those cases.

5-22 (25 min.)

ABC, cost hierarchy, service.

1. Output unit-level costs a. Direct-labour costs, $146,000 b. Equipment-related costs (rent, maintenance, energy, and so on), $350,000 These costs are output unit-level costs because they are incurred on each unit of materials tested, that is, for every hour of testing. Batch-level costs c. Setup costs, $430,000 These costs are batch-level costs because they are incurred each time a batch of materials is set up for either HT or ST, regardless of the number of hours for which the tests are subsequently run. Service-sustaining costs d. Costs of designing tests, $264,000. These costs are service-sustaining costs because they are incurred to design the HT and ST tests, regardless of the number of batches tested or the number of hours of test time.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Heat Testing (HT) Per Hour (2) = (1)  40,000 Total (1) hrs Direct labour costs (given) Equipment-related costs $5 per hour* × 40,000 hours $5 per hour* × 30,000 hours Setup costs $25 per setup-hour† × 13,600 setuphours $25 per setup-hour† × 3,600 setuphours Costs of designing tests $60 per hour** × 3,000 hours $60 per hour** × 1,400 hours Total costs

$100,000

$ 2.50

200,000

5.00

340,000

180,000 $820,000

Stress Testing (ST) Per Hour (4) = (3)  30,000 Total (3) hrs $ 46,000

$ 1.53

150,000

5.00

90,000

3.00

84,000 $370,000

2.80 $12.33

8.50

4.50 $20.50

*$350,000  (40,000 + 30,000) hours = $5 per test-hour †$430,000  (13,600 + 3,600) setup hours = $25 per setup-hour **$264,000  (3,000 + 1,400) hours = $60 per hour At a cost per test-hour of $17, the simple costing system undercosts heat testing ($20.50) and overcosts stress testing ($12.33). The reason is that heat testing uses direct labour, setup, and design resources per hour more intensively than stress testing. Heat tests are more complex, take longer to set up, and are more difficult to design. The simple costing system assumes that testing costs per hour are the same for heat testing and stress testing. 3. The ABC system better captures the resources needed for heat testing and stress testing because it identifies all the various activities undertaken when performing the tests and recognizes the levels of the cost hierarchy at which costs vary. Hence, the ABC system generates more accurate product costs. Vineyard’s management can use the information from the ABC system to make better pricing and product mix decisions. For example, it might decide to increase the prices charged for the more costly heat testing and consider reducing prices on the less costly stress testing. Vineyard should watch if competitors are underbidding Vineyard in stress testing and causing it to lose business. Vineyard can also use ABC information to reduce costs by eliminating processes and activities that do not add value, identifying and evaluating new methods to do testing that reduce the activities needed to do the tests, reducing the costs of doing various activities, and planning and managing activities.

Chapter 5: Activity-Based Costing and Management

5-23 (25 min.)

Allocation of costs to activities, unused capacity.

1. Indirect Resources Teachers’ salaries and benefits Principals’ salaries and benefits Facilities cost Office staff salaries and benefits Sports program staff salaries and benefits

Percentage of Costs Used by Each Activity Academic Sports Community Instruction Administration Training Relationships 60% 20% 8% 12% 10% 60% 5% 25% 35% 15% 45% 5% 5% 60% 10% 25% 35% 10% 45% 10%

Indirect Resources Teachers’ salaries and benefits Principals’ salaries and benefits Facilities cost Office staff salaries and benefits Sports program staff salaries and benefits Total

Actual Resource Cost Used by Each Activity Academic Sports Community Instruction Administration Training Relationships $2,400,000 $ 800,000 $ 320,000 $480,000 40,000 240,000 20,000 100,000 910,000 390,000 1,170,000 130,000 15,000 180,000 30,000 75,000 175,000 50,000 225,000 50,000 $3,540,000 $1,660,000 $1,765,000 $835,000

No. of students Cost per student Percent of total cost by activity

500 $7,080 45%

500 $ 3,320 21%

500 $3,530 23%

500 $1,670 11%

2021 Expenditures $4,000,000 400,000 2,600,000 300,000 500,000 $7,800,000 2021 Expenditures $4,000,000 400,000 2,600,000 300,000 500,000 $7,800,000 500 $15,600 100%

Instructor’s Solutions Manual for Cost Accounting, Eighth Canadian Edition

The overall cost of educating each student is $15,600. Of this, $7,080 (or 45%) is spent on academic instruction and $3,320 (or 21%) is spent on administration. 2. Cost of ice hockey program = $300,000 Total cost of activities w/o ice hockey program = $7,800,000 – $300,000 = $7,500,000 Per student cost of educational program w/o hockey = $7,500,000 ÷ 500 = $15,000 3. Net cost of ice hockey program with $1,000 fee = $300,000 – (30 × $1,000) = $270,000 Total cost of activities with ice hockey program fee = $7,500,000 + $270,000 = $7,770,000 Per student cost of educational program with hockey fee = $7,770,000 ÷ 500 = $15,540 Charging a fee helps a bit but the net cost of the ice hockey program is still high and significantly increases the cost of educating each student. 4. Academic instruction capacity Cost of academic instruction activity (from requirement 1 calculations) Cost of academic instruction per student at full utilization = $3,540,000 ÷ 600 Academic instruction resource costs used by current student population = 500 × $5,900 Cost of excess academic instruction capacity = $3,540,000 – $2,950,000

600 students $3,540,000 $5,900 $2,950,000 $ 590,000

Most of the costs at Heights Academy are fixed in the short run. So, Smith must try to recruit more students to the school. If, in the long run, it seems like the student population is going to be stable at around 500, he should plan how some of the excess capacity can be cut back so that the fixed school capacity is better utilized; that is, he should work to reduce the cost of excess capacity. One problem with that plan is that “cutting excess academic instruction capacity” may eventually mean reducing the number of sections in each grade and letting teachers go, and if this involves the loss of experienced teachers, that could cause long-term damage to the school. Unrelated to the excess capacity issue, but with the aim of improving the school’s economics, he should consider doing away with expensive activities like the ice hockey program which raises the cost per student substantially, even after a large fee is charged from students who choose to play the sport.

Chapter 5: Activity-Based Costing and Management

5-24 (30 min.)

Special order, activity-based costing.

1. Medal Plus’s operating income under the alternatives of accepting/rejecting the special order are:

Sales Variable costs: Direct materials Direct manufacturing labour Batch manufacturing costs Fixed costs: Fixed manufacturing costs Fixed marketing costs Total costs Operating income

Without One-TimeOnly Special Order 9,000 Units $1,800,000

With OneTime-Only Special Order 11,500 Units $2,220,000

Difference 2,500 Units $ 420,000

360,000 405,000 126,000

460,0001 517,5002 143,5003

100,000 112,500 17,500

325,000 224,000 1,440,000 $ 360,000

325,000 224,000 1,670,000 $ 550,000

— — 230,000 $ 190,000

1 Unit cost of direct materials = $360,000/9,000 = $40 per medal

$40 × 11,500 = $460,000 2 Unit cost of direct labour = $405,000/9,000 = $45 per medal $45 × 11,500 = $517,500 3 Batch costs $126,000 + (25 * $700) Alternatively, we could calculate the incremental revenue and the incremental costs of the additional 2,500 units as follows: Incremental revenue $168 × 2,500 $420,000 Incremental direct material costs 2,500 × $40 = 100,000 Incremental direct manufacturing labour costs 2,500 × $45 = 112,500 Incremental batch manufacturing costs $700 × 25 = 17,500 Total incremental costs 230,000 Total incremental operating income from accepting the special order $190,000 Medal Plus should accept the one-time-only special order if it has no long-term implications, because accepting the order increases Medal Plus’s operating income by $190,000. If, however, accepting the special order would cause the regular customers to be dissatisfied or to demand lower prices, then Medal Plus will have to trade off the $190,000 gain from accepting the special order against the operating income it might lose from regular customers.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Medal Plus has a capacity of 10,000 medals. Therefore, if it accepts the special one-time order of 2,500 medals, it can sell only 7,500 medals instead of the 9,000 medals that it currently sells to existing customers. That is, by accepting the special order, Medal Plus must forgo sales of 1,500 medals to its regular customers. Alternatively, Medal Plus can reject the special order and continue to sell 9,000 medals to its regular customers. Medal Plus’s operating income from selling 7,500 medals to regular customers and 2,500 medals under the one-time special order follows: Sales (7,500 × $200) + (2,500 × $168) Direct materials (10,000 * $40) Direct manufacturing labour (10,000 * $45) Batch manufacturing costs** (150 × $700) + (25 × $700) Fixed manufacturing costs Fixed marketing costs Total costs Operating income

$1,920,000 400,000 450,000 122,500 325,000 224,000 1,521,500 $ 398,500

**Medal Plus makes regular medals in batch sizes of 50. To produce 7,500 medals requires

150 (7,500 ÷ 50) batches. Accepting the special order will result in an increase in operating income of $38,500 ($398,500– $360,000). The special order should therefore be accepted. A more direct approach would be to focus on the incremental effects—the benefits of accepting the special order of 2,500 units versus the costs of selling 1,500 fewer units to regular customers. Increase in operating income from the 2,500-unit special order equals $190,000 (requirement 1). The loss in operating income from selling 1,500 fewer units to regular customers equals: Lost revenue $200 × 1,500 Savings in direct materials costs $40 × 1,500 Savings in direct manufacturing labour costs $45 × 1,500 Savings in batch manufacturing costs $700 × 30 Operating income lost

$ (300,000) 60,000 67,500 21,000 $ (151,500)

Accepting the special order will result in an increase in operating income of $38,500 ($190,000– $151,500). The special order should therefore be accepted. 3. Medal Plus should not accept the special order. Increase in operating income by selling 2,500 units under the special order (requirement 1) Operating income lost from existing customers ($11 × 9,000) Net effect on operating income of accepting special order The special order should therefore be accepted.

$ 190,000 (99,000) $ 91,000

Chapter 5: Activity-Based Costing and Management

5-25 (15–20 min.) ABC, wholesale, customer profitability. Customer 1 2 Gross sales $40,000 $20,000 Sales returns 8,000 3,000 Net sales 32,000 17,000 Cost of goods sold (75%of net sales) 24,000 12,750 Gross margin 8,000 4,250 Customer-related costs: Regular orders $30 × 30; 140; 55; 100 900 4,200 Rush orders $150 × 8; 46; 12; 45 1,200 6,900 Returned items $15 × 96; 24; 64; 32 1,440 360 Catalogs and customer support 1,200 1,200 Customer related costs 4,740 12,660 Contribution (loss) margin $ 3,260 $(8,410) Contribution (loss) margin as percentage of gross sales 8.2% (42.1%)

3 4 $110,000 $95,000 7,700 9,000 102,300 86,000 76,725 25,575

64,500 21,500

1,650

3,000

1,800

6,750

960 480 1,200 1,200 5,610 11,430 $ 19,965 $10,070 18.2%

10.6%

The analysis indicates that customers’ profitability (loss) contribution varies widely from (42.1%) to 18.2%. Immediate attention to Chain 2 is required which is currently showing a loss contribution. The chain has a disproportionate number of both regular orders and rush orders. Veritek should work with the management of Chain 2 to find ways to reduce the number of orders while maintaining or increasing the sales volume. If this is not possible, Veritek should consider dropping Chain 2 if it can save the customer-related costs. Chain 1 has a disproportionate number of the items returned as well as value of sale returns. The causes of these should be investigated so that the profitability contribution of Chain 1 could be improved.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

5-26 (30 min.)

ABC, retail product-line profitability.

1. The simple costing process reports the following: Baked Milk & Goods Fruit Juice Revenues $60,000 $66,500 Costs Cost of goods sold 41,000 51,000 Store support (30% of COGS) 12,300 15,300 Total costs 53,300 66,300 Operating income $ 6,700 $ 200 Operating income ÷ Revenues

Frozen Products Total $50,500 $177,000 32,000 9,600 41,600 $ 8,900

124,000 37,200 161,200 $ 15,800

0.30%

17.62%

8.93%

Baked Goods $60,000

Milk & Fruit Juice $66,500

Frozen Products $50,500

Total $177,000

41,000 4,180 9,120 3,230

51,000 2,280 4,560 2,850

32,000 1,330 2,736 380

124,000 7,790 16,416 6,460

2,310 59,840 $ 160

3,030 63,720 $ 2,780

1,194 37,640 $12,860

6,534 161,200 $ 15,800

0.27%

4.18%

25.47%

8.93%

Milk & Fruit Juice 24 60 150 20,200

Frozen Products 14 36 20 7,960

11.17%

2. The ABC system reports the following: Revenues Costs Cost of goods sold Ordering ($95 × 44; 24; 14) Delivery ($76 × 120; 60; 36) Shelf-stocking ($19 × 170; 150; 20) Customer support ($0.15 × 15,400; 20,200; 7,960) Total costs Operating income Operating income ÷ Revenues

These activity costs are based on the following: Activity Ordering Delivery Shelf-stocking Customer support

Cost Allocation Rate $95 per purchase order $76 per delivery $19 per hour $0.15 per item sold

Baked Goods 44 120 170 15,400

3. The rankings of products in terms of relative profitability are: Simple Costing System ABC System 1. Frozen products 17.62% Frozen products 2. Baked goods 11.17 Milk and fruit juice 3. Milk & fruit juice 0.30 Baked goods

25.47% 4.18 0.27

Chapter 5: Activity-Based Costing and Management

The percentage revenue, COGS, and activity costs for each product line are:

Revenues COGS Activity areas: Ordering Delivery Shelf-stocking Customer support

Baked Goods 33.90 33.06

Milk & Frozen Fruit Juice Products Total 37.57 28.53 100.00 41.13 25.81 100.00

53.66 55.55 50.00 35.36

29.27 27.78 44.12 46.37

17.07 16.67 5.88 18.27

100.00 100.00 100.00 100.00

The baked goods line drops sizably in profitability when ABC is used. Although it constitutes 33.06% of COGS, it uses a higher percentage of total resources in each activity area, especially the high-cost delivery activity area. In contrast, frozen products draw a much lower percentage of total resources used in each activity area than its percentage of total COGS. Hence, under ABC, frozen products are much more profitable. Milk and fruit juice uses a lower percentage of resources in some high-cost activity areas relative to COGS so its profitability improves under ABC than Fitzgerald Supermarkets may want to explore ways to increase sales of frozen products. It may also want to explore price increases on baked goods. SOLUTION Product-Costing Overviews of Fitzgerald Supermarkets PANEL A: SIMPLE COSTING SYSTEM PANEL B: ABC SYSTEM INDIRECT COST POOL COST ALLOCATION BASE COST OBJECT: PRODUCT LINE DIRECT COST

Ordering

Delivery

ShelfStocking

Customer Support

Number of Purchase Order

Number of Deliveries

Hours of Shelf-Stocking

Number of Items Sold

Indirect Costs Direct Costs

COGS

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

5-27 (30 min.)

ABC, product costing at banks, cross-subsidization.

1. Robinson Revenue Spread revenue on annual basis (2.5% ×; $2,600, $1,200, $40,000) Monthly fee charges ($35×; 0, 12, 0) Total revenue

Skerrett

$ 65.00 0.00 65.00

Costs Deposit/withdrawal with teller $4.00 × 45; 55; 10 180.00 Deposit/withdrawal with ATM $1.20 × 12; 24; 18 14.40 Deposit/withdrawal prearranged monthly: $0.80 × 0; 15; 60 0 Bank cheques written $11.25 × 10; 5; 4 112.50 Foreign currency drafts $12.50 × 4; 1; 7 50.00 Inquiries $2.50 × 12; 20; 11 30.00 Total costs 386.90 Operating income $(321.90)

Farrel

$ 30.00 $1,000.00

Total

$ 1,095.00

420.00 450.00

0.00 1,000.00

420.00 1,515.00

220.00

40.00

440.00

28.80

21.60

64.80

12.00

48.00

60.00

56.25

45.00

213.75

12.50

87.50

150.00

50.00 27.50 379.55 269.60 $ 70.45 $ 730.40

107.50 $1,036.05 $ 478.95

The assumption that the Robinson and Farrel accounts exceed $2,500 every month and the Skerrett account is less than $2,500 each month means the monthly charges apply only to Skerrett. 2. Cross-subsidization across individual Premier Accounts occurs when profits made on some accounts are offset by losses on other accounts. The aggregate profitability on the three customers is $478.95. The Farrel account is highly profitable ($730.40), while the Robinson account is sizably unprofitable. International Trust (IT) should be very concerned about the cross-subsidization. Competition likely would “understand” that high-balance low-activity type accounts (such as Farrel) are highly profitable. Offering free services to these customers is not likely to retain these accounts if other banks offer higher interest rates. Competition likely will reduce the interest rate spread IT can earn on the high-balance low-activity accounts they are able to retain.

Chapter 5: Activity-Based Costing and Management

3. Possible changes IT could make are: a. Offer higher interest rates on high-balance accounts to increase IT’s competitiveness in attracting and retaining these accounts. b. Introduce charges for individual services. The ABC study reports the cost of each service. IT has to decide if it wants to price each service at cost, below cost, or above cost. If it prices above cost, it may use advertising and other means to encourage additional use of those services by customers. c. Increase the minimum balance for unlimited use of services.

5-28 (30-40 min.) Choosing cost drivers, activity-based costing, activity-based management. 1. Direct materials—purses Direct materials—backpacks Direct manufacturing labour—purses Direct manufacturing labour—backpacks Setup Shipping Design Plant utilities and administration

Output unit-level costs Output unit-level costs Output unit-level costs Output unit-level costs Batch-level costs Batch-level costs Product-sustaining costs Facility-sustaining costs

2. Direct materials—purses Direct materials—backpacks Direct manufacturing labour—purses Direct manufacturing labour—backpacks Setup Shipping Design Plant utilities and administration

Number of purses Number of backpacks Number of purses Number of backpacks Number of batches Number of batches Number of designs Hours of production

Direct material and direct manufacturing labour are costs that can be easily traced to output, which in this case is the number of purses or backpacks produced. Setup and shipping are both a function of the number of batches produced. Design is related to the number of designs created for each product. Plant utilities and administration result from general activity level in the plant. Thus, hours of production seems to be an appropriate cost driver.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. Direct materials—purses Direct materials—backpacks Direct manufacturing labour—purses Direct manufacturing labour—backpacks Setup Shipping Design Plant utilities and administration

$319,155 ÷ 3,075 purses = $103.79 per purse $454,995 ÷ 6,175 backpacks = $73.68 per backpack $99,000 ÷ 3,075 purses = $32.20 per purse $113,000 ÷ 6,175 backpacks = $18.30 per backpack $64,000  200 batches = $320 per batch $73,000  200 batches = $365 per batch $169,000 ÷ 4 designs = $42,250 per design $221,000 ÷ 4,250 hours = $52 per hour

4. Direct materials Direct manufacturing labour Setup ($320 × 120; 80 batches) Shipping ($365 × 120; 80 batches) Design ($42,250 × 2; 2 designs) Plant utilities and administration ($52 × 1,665; 2,585 hours) Budgeted total costs Divided by number of backpacks/purses Budgeted cost per backpack/purse

Backpacks $454,995 113,000

Purses $319,155 99,000

Total $ 774,150 212,000

38,400

25,600

64,000

43,800

29,200

73,000

84,500

169,000

86,580 $821,275 ÷ 6,175 $ 133.00

134,420 $691,875 ÷ 3,075 $ 225.00

221,000 $1,513,150

5. Based on this analysis, more than 50% of product cost relates to direct material. Managers should determine whether the material costs can be reduced. Producing in small lots increases the setup and shipping costs. While both are relatively small components of product cost, management may want to evaluate ways to reduce the number of setups and the cost per setup. Of the indirect costs, the product and facility-sustaining costs are the highest. Management should review the design process for cost savings and examine why it takes so long to produce purses relative to backpacks.

Chapter 5: Activity-Based Costing and Management

PROBLEMS 5-29 (20-30 min.) Job costing with single direct-cost category, single indirect-cost pool, law firm.. 1. Pricing decisions at Marc and Associates are heavily influenced by reported cost numbers. Suppose Marc and Associates is bidding against another firm for a client with a job similar to that of Widnes Coal. If the costing system overstates the costs of these jobs, Marc and Associates may bid too high and fail to land the client. If the costing system understates the costs of these jobs, Marc and Associates may bid low, land the client, and then lose money in handling the case. 2.

St. Helen’s Glass

Total

$ 7,280

$ 6,720

$14,000

10,920 $18,200

10,080 $16,800

21,000 $35,000

Direct professional labour, $70 × 104; $70 × 96 Indirect costs allocated, $105 × 104; $105 × 96 Total costs to be billed

Widnes Coal

5-30 (20–25 min.) Job costing with multiple direct-cost categories, single indirect-cost pool, law firm (continuation of 5-29). 1. Indirect costs = $7,000 Total professional labour-hours = 200 hours (104 + 96) = $7,000 ÷ 200 = $35/hour 2. Direct costs: Direct professional labour, $70 × 104; $70 × 96 Research support labour Computer time Travel and allowances Telephones/faxes Photocopying Total direct costs Indirect costs allocated, $35 × 104; $35 × 96 Total costs to be billed

Widnes Coal

St. Helen’s Glass

Total

$ 7,280 1,600 500 600 200 250 10,430

$ 6,720 3,400 1,300 4,400 1,000 750 17,570

$14,000 5,000 1,800 5,000 1,200 1,000 28,000

3,640 $14,070

3,360 $20,930

7,000 $35,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Problem 5-31 Problem 5-32

Widnes Coal

St. Helen’s Glass

Total

$18,200 14,070

$16,800 20,930

$35,000 35,000

The Problem 5-30 approach directly traces $14,000 of general support costs to the individual jobs. In Problem 5-29, these costs are allocated on the basis of direct professional labour-hours. The averaging assumption implicit in the Problem 5-29 approach appears incorrect—for example, the St. Helen’s Glass job has travel costs more than seven times higher than the Widnes Coal case, despite having lower direct professional labour-hours.

5-31 (30 min.)

Job costing with multiple direct-cost categories, multiple indirect-cost pools, law firm (continuation of 5-29 and 5-30). Widnes Coal

Direct costs: Partner professional labour, $100 × 24; $100 × 56 $ 2,400 Associate professional labour, $50 × 80; $50 × 40 4,000 Research support labour 1,600 Computer time 500 Travel and allowances 600 Telephones/faxes 200 Photocopying 250 Total direct costs 9,550 Indirect costs allocated: Indirect costs for partners, $57.50 × 24; $57.50 × 56 1,380 Indirect costs for associates, $20 × 80; $20 × 40 1,600 Total indirect costs 2,980 Total costs to be billed $12,530 Comparison Single direct cost/ Single indirect cost pool Multiple direct costs/ Single indirect cost pool Multiple direct costs/ Multiple indirect cost pools

St. Helen’s Glass

Total

$ 5,600

$ 8,000

2,000 3,400 1,300 4,400 1,000 750 18,450

6,000 5,000 1,800 5,000 1,200 1,000 28,000

3,220

4,600

800 4,020 $22,470

2,400 7,000 $35,000

Widnes Coal

St. Helen’s Glass

Total

$18,200

$16,800

$35,000

$14,070

$20,930

$35,000

$12,530

$22,470

$35,000

Chapter 5: Activity-Based Costing and Management

The higher the percentage of costs directly traced to each case, and the greater the number of homogeneous indirect cost pools linked to the cost drivers of indirect costs, the more accurate the product cost of each individual case. The Widnes and St. Helen’s cases differ in how they use “resource areas” of Marc and Associates: Widnes St. Helen’s Coal Glass Partner professional labour 30.0% 70.0% Associate professional labour 66.7 33.3 Research support labour 32.0 68.0 Computer time 27.8 72.2 Travel and allowances 12.0 88.0 Telephones/faxes 16.7 83.3 Photocopying 25.0 75.0 The Widnes Coal case makes relatively low use of the higher-cost partners but relatively higher use of the lower-cost managers than does St. Helen’s Glass.

5-32 (25 min.)

Contrast the logic of two cost assignment systems.

1. Output unit-level costs: 1. Direct-labour costs, $288,000 2. Equipment-related costs (rent, maintenance, energy, and so on), $480,000 These costs are output unit-level costs because they are incurred on each unit of materials tested, that is, for every hour of testing. Batch-level costs: 3. Setup costs, $420,000 These costs are batch-level costs because they are incurred each time a batch of materials is setup for either HT or ST, regardless of the number of hours for which the tests are subsequently run. Service-sustaining costs: 4. Costs of designing tests, $252,000. These costs are service-sustaining costs because they are incurred to design the HT and ST tests, regardless of the number of batches tested or the number of hours of test time.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Heat Testing (HT) Per Hour Total (2) (1) = (1) ÷ 50,000 $ 216,000 $ 4.32

Direct labour costs (given) Equipment-related costs $6 per hour* × 50,000 hours 300,000 $6 per hour* × 30,000 hours Setup costs $24 per setup-hour† × 13,500 setup-hours 324,000 † $24 per setup-hour × 4,000 setup-hours Costs of designing tests $60 per hour** × 2,800 hours 168,000 $60 per hour** × 1,400 hours _________ Total costs $1,008,000

Stress Testing (ST) Per Hour Total (4) (3) = (3) ÷ 30,000 $ 72,000 $ 2.40

6.00 180,000

6.00

96,000

3.20

84,000 $432,000

2.80 $14.40

6.48

3.36 ___ $20.16

*$480,000 ÷ (50,000 + 30,000) hours = $6 per test-hour †$420,000 ÷ (13,500 + 4,000) setup hours = $24 per setup-hour **$252,000 ÷ (2,800 + 1,400) hours = $60 per hour At a cost per test-hour of $18, the existing costing system undercosts heat testing ($20.16) and overcosts stress testing ($14.40). The reason is that heat testing uses direct labour, setup, and design resources per hour more intensively than stress testing. Heat tests are more complex, take longer to set up, and are more difficult to design. The existing costing system assumes that testing costs per hour are the same for heat testing and stress testing. 3. The ABC system better captures the resources needed for heat testing and stress testing because it identifies all the various activities undertaken when performing the tests and recognizes the levels of the cost hierarchy at which costs vary. Halifax’s management can use the information from the ABC system to make better pricing and product mix decisions. For example, it might decide to increase the prices charged for the more costly heat testing and consider reducing prices on the less costly stress testing. Halifax should determine if competitors are underbidding Halifax in stress testing, and causing it to lose business. Halifax can also use ABC information to reduce costs by eliminating processes and activities that do not add value, identifying and evaluating new methods to do testing that reduce the activities needed to do the tests, reducing the costs of doing various activities, and planning and managing activities.

Chapter 5: Activity-Based Costing and Management

5-33 (30 min.)

Use ABC systems for ABM.

1. The previous costing system reports the following:

Revenue Costs Cost of goods sold Store support (30% of COGS) Total costs Operating income Operating income ÷ Revenue

Baked Goods $78,400

Milk & Fruit Juice $85,600

Frozen Products $72,400

Total $236,400

45,600 13,680 59,280 $19,120

56,400 16,920 73,320 $12,280

42,000 12,600 54,600 $17,800

144,000 43,200 187,200 $ 49,200

24.39%

14.35%

24.59%

20.81%

Baked Goods $78,400

Milk & Fruit Juice $85,600

Frozen Products $72,400

Total $236,400

45,600 3,600 9,408 4,392 3,720 66,720 $11,680

56,400 3,000 3,456 3,984 4,920 71,760 $13,840

42,000 1,560 2,688 576 1,896 48,720 $23,680

144,000 8,160 15,552 8,952 10,536 187,200 $ 49,200

14.90%

16.17%

32.7%

20.81%

Milk & Fruit Juice 25 36 166 20,500

Frozen Products 13 28 24 7,900

2. The ABC system reports the following:

Revenue Costs Cost of goods sold Ordering Delivery Shelf-stocking Customer support Total costs Operating income Operating income ÷ Revenue

These activity costs are based on the following: Activity Ordering Delivery Shelf-stocking Customer support

Cost Allocation Rate $120 per purchase order $96 per delivery $24 per hour $0.24 per item sold

Baked Goods 30 98 183 15,500

The rankings of products in terms of relative profitability are:

1. 2. 3.

Previous Costing System Frozen products 24.59% Baked goods 24.39 Milk & fruit juice 14.35

ABC System Frozen products Milk & fruit juice Baked goods

32.70% 16.17 14.90

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

The percentage revenue, COGS, and activity costs for each product line are:

Revenue COGS Activity areas: Ordering Delivery Shelf-stocking Customer support 3.

Milk & Fruit Juice 36.21 39.17

Frozen Products 30.63 29.16

Total 100.00 100.00

44.12 60.49 49.06 35.31

36.76 22.22 44.50 46.70

19.12 17.29 6.44 17.99

100.00 100.00 100.00 100.00

The baked goods line drops sizably in profitability when the ABC is used. Although it constitutes 31.67% of COGS, it uses a higher percentage of total resources in each activity area, especially the high cost delivery activity area. In contrast, frozen products draws a much lower percentage of total resources used in each activity area than its percentage of total COGS. Hence, under ABC, frozen products is much more profitable. Family Supermarkets may want to explore ways to increase sales of frozen products. It may also want to explore price increases on baked goods.

5-34 (30-40 min.) 1.

Baked Goods 33.16 31.67

Department and activity-cost rates, service sector.

Overhead costs = $20,610 + $247,320 + $196,180 + $134,350 = $598,460

Budgeted overhead $598, 460  $1.626 per DL $ = rate $368,040 X-rays

Ultrasound

CT scan

MRI

Total

$ 61,440

$105,600

$ 96,000

$ 105,000

$ 368,040

Depreciation

32,240

268,000

439,000

897,500

1,636,740

Materials

22,080

16,500

24,000

31,250

93,830

Allocated overhead*

99,901

171,706

156,096

170,730

598,433

Total budgeted costs

$215,661

$561,806

$715,096

$1,204,480

$2,697,043

Budgeted number of procedures

÷3,840

÷4,400

÷3,000

÷2,500

56.16

$ 127.68

$ 238.37

Technician labour

Budgeted cost per service

*Allocated overhead = Budgeted overhead rate × Technician labour costs

481.79

Chapter 5: Activity-Based Costing and Management

2. Budgeted Information X-rays

Ultrasound

CT scan

MRI

Total

Number of procedures

3,840

4,400

3,000

2,500

13,740

Cleaning minutes per procedure

×5

×15

×35

Total cleaning minutes

19,200

22,000

45,000

87,500

173,700

Number of procedures

3,840

4,400

3,000

2,500

13,740

×5

×15

×20

×45

19,200

66,000

60,000

112,500

Minutes for each procedure Total procedure minutes

Units of Cost Driver (3)

257,700

Activity

Budgeted Cost (1)

Cost Driver (2)

Administration

$ 20,610

Total number of procedures

Maintenance

$247,320

Total dollars of depreciation

$1,636,740 $0.151105 per dollar of depreciation

Sanitation

$196,180

Total cleaning minutes

173,700

$1.12942 per cleaning minute

Utilities

$134,350

Total procedure minutes

257,700

$0.52134 per procedure minute

X-rays $ 61,440 32,240 22,080

13,740

Ultrasound $105,600 268,000 16,500

Technician labour Depreciation Materials Allocated activity costs: Administration* 5,760 6,600 Maintenance** 4,872 40,496 † Sanitation 21,685 24,847 Utilities†† 10,010 34,408 Total budgeted cost $158,087 $496,451 Budgeted number of procedures ÷3,840 ÷4,400 Budgeted cost per service $ 41.17 $ 112.83 *($1.50 × 3,840; 4,400; 3,000; 2,500) **($0.151105 × $32,240; $268,000; $439,000; $897,500) † ($1.12942 × 19,200; 22,000; 45,000; 87,500) †† ($0.52134 × 19,200; 66,000; 60,000; 112,500)

Activity Rate (4) = (1) ÷ (3) $1.50 per procedure

CT scan $ 96,000 439,000 24,000

MRI $ 105,000 897,500 31,250

Total $ 368,040 1,636,740 93,830

4,500 66,335 50,824 31,280 $711,939 ÷3,000 $ 237.31

3,750 135,617 98,824 58,651 $1,330,592 ÷2,500 $ 532.24

20,610 247,320 196,180 134,350 $2,697,070

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Using the disaggregated activity-based costing data, managers can see that the MRI actually costs substantially more and x-rays and ultrasounds substantially less than the traditional system indicated. In particular, the MRI activity generates a lot of maintenance activity and sanitation activity. Managers should examine the use of these two activities to search for ways to reduce the activity consumption and ultimately its cost.

5-35 (30–40 min.) Activity-based costing, merchandising. 1.

Revenue Cost of goods sold Gross margin Other operating costs Operating income Gross margin %

General Supermarket Chains

Drugstore Chains

$3,725,000 3,600,000 $ 125,000

$3,175,000 3,027,000 $ 148,000

$1,960,000 1,805,000 $ 155,000

4.66%

7.91%

3.36%

Mom-and-Pop Single Stores

Total $8,860,000 8,432,000 $ 428,000 319,000 $ 109,000

The gross margin of Pharmacare Inc. was 4.83% (= $428,000 ÷ $8,860,000). The operating income margin of Pharmacare Inc. was 1.23% (= $109,000 ÷ $8,860,000). The per-unit cost driver rates are: 1. Customer purchase order processing, $85,000 ÷ 2,000 (150 + 360 + 1,490) orders 2. Line item ordering, $69,300 ÷ 21,000 (1,980 + 4,500 + 14,520) line items 3. Store delivery, $72,500 ÷ 1,450 (122 + 278 + 1,050) deliveries 4. Cartons shipped, $78,200 ÷ 78,200 (37,000 + 24,200 + 17,000) cartons 5. Shelf-stocking, $14,000 ÷ 700 (390 + 200 + 110) hours

= $42.5 per order = $3.3 per line item = $50 per delivery = $1 per carton = $20 per hour

Chapter 5: Activity-Based Costing and Management

The activity-based costing of each distribution market for August is: General Supermarket Chains 1. Customer purchase order processing ($42.5 × 150; 360; 1,490) 2. Line item ordering ($3.3 × 1,980; 4,500; 14,520) 3. Store delivery ($50 × 122; 278; 1,050) 4. Cartons shipped ($1 × 37,000; 24,200; 17,000) 5. Shelf-stocking ($20 × 390; 200; 110)

Drugstore Chains

Mom-andPop Single Stores

Total

$ 6,375

$15,300

$ 63,325

$ 85,000

6,534

14.850

47,916

69,300

6,100

13,900

52,500

72,500

37,000

24,200

17,000

78,200

7,800 $63,809

4,000 $72,250

2,200 $182,941

14,000 $319,000

The revised operating income statement is: General Supermarket Chains Revenue $3,725,000 Cost of goods sold 3,600,000 Gross margin 125,000 Operating costs 63,809 Operating income $ 61,191

Drugstore Chains $3,175,000 3,027,000 148,000 72,250 $ 75,750

Operating income margin 1.64%

2.39%

Mom-and-Pop Single Stores $1,960,000 1,805,000 155,000 182,941 ($ 27,941)

Total $8,860,000 8,432,000 428,000 319,000 $ 109,000

−1.43%

1.23%

4. The ranking of the three markets are: Using Gross Margin 1. Mom-and-Pop Single Stores 2. Drugstore Chains 3. General Supermarket Chains

7.91% 4.66% 3.36%

Using Operating Income 1. Drugstore Chains 2.39% 2. General Supermarket Chains 1.64% 3. Mom-and-Pop Single Stores -1.43%

The activity-based analysis of costs highlights how the Mom-and-Pop Single Stores use a larger amount of Pharmacare’s resources per revenue dollar than do the other two markets. The ratio of the operating costs to revenue across the three markets is: General Supermarket Chains Drugstore Chains Mom-and-Pop Single Stores

1.71% 2.28% 9.33%

($63,809 ÷ $3,725,000) ($72,250 ÷ $3,175,000) ($182,941 ÷ $1,960,000)

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

This is a classic illustration of the maxim that “all revenue dollars are not created equal.” The analysis indicates that the Mom-and-Pop Single Stores are the least profitable market. Pharmacare must work to increase profits in this market through: (1) a possible surcharge, (2) decreasing the number of orders, (3) offering discounts for quantity purchases, etc. A negative operating income is unacceptable. Other issues for Pharmacare to consider include: a. Choosing the appropriate cost drivers for each area. The problem gives a cost driver for each chosen activity area. However, it is likely that over time further refinements in cost drivers would occur. For example, not all store deliveries are equally easy to make, depending on parking availability, accessibility of the storage/shelf space to the delivery point, etc. Similarly, not all cartons are equally easy to deliver—their weight, size, or likely breakage component are factors that can vary across carton types. b. Developing a reliable data base on the chosen cost drivers. For some items, such as the number of orders and the number of line items, this information likely would be available in machine readable form at a high level of accuracy. Unless the delivery personnel have hand-held computers that they use in a systematic way, estimates of shelf-stocking time are likely to be unreliable. Advances in information technology likely will reduce problems in this area over time. c. Deciding how to handle costs that may be common across several activities. For example, (3) store delivery and (4) cartons shipped to stores have the common cost of the same trip. Some organizations may treat (3) as the primary activity and attribute only incremental costs to (4). Similarly, (1) order processing and (2) line item ordering may have common costs. d. Behavioural factors are likely to be a challenge to Flair. He must now tell those salespeople who specialize in Mom-and-Pop accounts that they have been less profitable than previously thought.

5-36 (30-40 min.) Choosing cost drivers, activity-based costing, activity-based management. 1. Direct materials—purses Direct materials—backpacks Direct manufacturing labour—purses Direct manufacturing labour—backpacks Setup Shipping Design

Output unit-level costs Output unit-level costs Output unit-level costs Output unit-level costs Batch-level costs Batch-level costs Product-sustaining costs

Plant utilities and administration

Facility-sustaining costs

Chapter 5: Activity-Based Costing and Management

2. Direct materials—purses Direct materials—backpacks Direct manufacturing labour—purses Direct manufacturing labour—backpacks Setup Shipping Design Plant utilities and administration

Number of bags Number of bags Number of bags Number of bags Number of batches Number of batches Number of designs Hours of production

Direct material and direct manufacturing labour are costs that can be easily traced to output, which in this case is the number of bags produced. Setup and shipping are both a function of the number of batches produced. Design is related to the number of designs created for each product. Plant utilities and administration result from the general activity level in the plant. Thus, hours of production seems to be an appropriate cost driver. 3. Direct materials—purses Direct materials—backpacks Direct manufacturing labour—purses Direct manufacturing labour—backpacks Setup Shipping Design Plant utilities and administration

$362,000 ÷ 3,150 purses = $114.92 per purse $427,000 ÷ 6,000 backpacks = $71.17 per backpack $98,000 ÷ 3,150 purses = $31.11 per purse $115,597 ÷ 6,000 backpacks = $19.27 per backpack $64,960 ÷ 203 = $320 per batch $72,065 ÷ 203 = $355 per batch $167,000 ÷ 5 = $33,400 per design $225,000 ÷ 4,160 hours = $54.0865 per hour

4. Direct materials Direct manufacturing labour Setup ($320 × 133; 70) Shipping ($355 × 133; 70) Design ($33,400 × 3; 2) Plant utilities and administration ($54.0865 × 1,560; 2,600) Budgeted total costs ÷ Number of bags Budgeted cost per bag

Backpacks $427,000 115,597 42,560 47,215 100,200

Purses $362,000 98,000 22,400 24,850 66,800

Total $ 789,000 213,597 64,960 72,065 167,000

84,375 $816,947 ÷ 6,000 $ 136.16

140,625 $714,675 ÷ 3,150 $ 226.88

225,000 $1,531,622

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

5. Based on this analysis, over 50% of product cost relates to direct material. Managers should determine whether the material costs can be reduced. Producing in small lots increases the setup and shipping costs. While both are relatively small components of product cost, management may want to evaluate ways to reduce the number of setups and the cost per setup. Of the indirect costs, the product- and facility-sustaining costs are the highest. Management should review the design process for cost savings and examine why it takes so long to produce purses relative to backpacks.

5-37 (25 min.)

Unused capacity, activity-based costing, activity-based management.

1. Number of batches Machine-hours

Basketballs 450 13,500

Volleyballs 300 10,500

Total 750 24,000

Setup cost per batch = $157,500 ÷ 750 batches = $210 per batch. Equipment and maintenance = $115,200 ÷ 24,000 machine-hours = $4.80 per machine-hour. Lease rent, insurance, utilities = $210,000 ÷ 14,000 sq. ft. of capacity = $15 per sq. ft. 2. Unused capacity = Total capacity −

Capacity used for Capacity used for − basketball production volleyball production

= 14,000 – 3,200 – 8,000 = 2,800 sq. ft. Cost of unused capacity = $15 per sq. ft × 2,800 sq. ft. = $42,000 3. Direct materials Direct manufacturing labour Setup ($210 × 450; 300) Equipment and maintenance ($4.80 × 13,500; 10,500) Lease rent, etc. ($15 × 3,200; 8,000) Budgeted total costs Divided by number of units Budgeted cost per unit

Basketballs $168,100 111,800

Volleyballs $303,280 100,820

Total $ 471,380 212,620

94,500

63,000

157,500

64,800

50,400

115,200

48,000 $487,200 ÷ 58,000 $ 8.40

120,000 $637,500 ÷ 85,000 $ 7.50

168,000 $1,124,700

3. Currently, Zarson’s only utilizes 80% of its available capacity. The excess capacity is currently costing Zarson’s $42,000 annually, so Zarson’s would need to consider using the excess capacity to expand production of either of the existing models, or add a new product line in the future. Zarson’s should only do so if there is available skilled labour and machine capacity, as well as demand for the product to justify higher costs and the capital investment needed. Zarson’s may also consider renting out the available space to a compatible outside user, with the option to take the space back if needed.

Chapter 5: Activity-Based Costing and Management

On the other hand having excess capacity might also be beneficial to Zarson’s. It allows the company to accept special orders if they are received and to reduce the confusion and complexity that occurs when a plant is operating at full capacity.

5-38 (50 min.)

ABC, implementation, ethics.

1. Plum Electronics should not emphasize the Maximum model and should not phase out the Mammoth model. Under activity-based costing, the Maximum model has an operating income percentage of less than 3%, while the Mammoth model has an operating income percentage of nearly 43%. Cost driver rates for the various activities identified in the activity-based costing (ABC) system are as follows: Soldering $ 1,036,200  1,570,000 = $ 0.66 per solder point Shipments 946,000  20,000 = 47.30 per shipment Quality control 1,364,000  77,500 = 17.60 per inspection Purchase orders 1,045,440  190,080 = 5.50 per order Machine power 63,360  192,000 = 0.33 per machine-hour Machine setups 825,000  30,000 = 27.50 per setup Plum Electronics Calculation of Costs of Each Model under Activity-Based Costing Direct materials ($228.80 × 22,000; $642.40 × 4,000) Direct manuf. labour ($13.20 × 1.5 hrs. × 22,000; $13.20 × 3.5hrs. × 4,000) Machine costs ($19.80 × 8 hrs. × 22,000; $19.80 × 4 hrs. × 4,000) Total direct costs Indirect costs Soldering ($0.66 × 1,185,000; $0.66 × 385,000) Shipments ($47.30 × 16,200; $47.30 × 3,800) Quality control ($17.60 × 56,200; $17.60 × 21,300) Purchase orders ($5.50 × 80,100; $5.50 × 109,980) Machine power ($0.33 × 176,000; $0.33 × 16,000) Machine setups ($27.50 × 16,000; $27.50 × 14,000) Total indirect costs Total costs

Mammoth $ 5,033,600

Maximum $2,569,600

435,600

184,800

3,484,800 8,954,000

316,800 3,071,200

782,100 766,260 989,120 440,550 58,080 440,000 3,476,110 $12,430,110

254,100 179,740 374,880 604,890 5,280 385,000 1,803,890 $4,875,090

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Profitability analysis Revenues Cost of goods sold Gross margin Per-unit calculations: Units sold Selling price ($21,780,000  22,000; $5,016,000  4,000) Cost of goods sold ($12,430,110  22,000; $4,875,090  4,000) Gross margin Gross margin percentage

Mammoth $21,780,000 12,430,110 $ 9,349,890

Maximum $5,016,000 4,875,090 $ 140,910

22,000

4,000

$990.00

$1,254.00

565.01 $424.99 42.9%

1,218.77 $ 35.23 2.8%

Total $26,796,000 17,305,200 $ 9,490,800

2. Plum’s simple costing system allocates all manufacturing overhead other than machine costs on the basis of machine-hours, an output unit-level cost driver. Consequently, the more machine-hours per unit that a product needs, the greater the manufacturing overhead allocated to it. Because Mammoth uses twice the number of machine-hours per unit compared to Maximum, a large amount of manufacturing overhead is allocated to Mammoth. The ABC analysis recognizes several batch-level cost drivers such as purchase orders, shipments, and setups. Maximum uses these resources much more intensively than Mammoth. The ABC system recognizes Maximum’s use of these overhead resources. Consider, for example, purchase order costs. The simple system allocates these costs on the basis of machine-hours. As a result, each unit of Mammoth is allocated twice the purchase order costs of each unit of Maximum. The ABC system allocates $440,550 of purchase order costs to Mammoth (equal to $20.02 [$440,550  22,000] per unit) and $604,890 of purchase order costs to Maximum (equal to $151.23 [$604,890  4,000] per unit). Each unit of Maximum uses 7.55 ($151.23  $20.02) times the purchases order costs of each unit of Mammoth. Recognizing Maximum’s more intensive use of manufacturing overhead results in Maximum showing a much lower profitability under the ABC system. By the same token, the ABC analysis shows that Mammoth is quite profitable. The simple costing system overcosted Mammoth and so made it appear less profitable. 3. Clark’s comments about ABC implementation are valid. When designing and implementing ABC systems, managers and management accountants need to trade off the costs of the system against its benefits. Adding more activities would make the system harder to understand and more costly to implement, but it would probably improve the accuracy of cost information, which, in turn, would help Plum make better decisions. Similarly, using inspection-hours and setup-hours as allocation bases would also probably lead to more accurate cost information, but it would increase measurement costs.

Chapter 5: Activity-Based Costing and Management

4. Activity-based management (ABM) is the use of information from activity-based costing to make improvements in a firm. For example, a firm could revise product prices on the basis of revised cost information. For the long term, activity-based costing can assist management in making decisions regarding the viability of product lines, distribution channels, marketing strategies, etc. ABM highlights possible improvements, including reduction or elimination of non-value-added activities, selecting lower cost activities, sharing activities with other products, and eliminating waste. ABM is an integrated approach that focuses management’s attention on activities with the ultimate aim of continuous improvement. As a wholecompany philosophy, ABM focuses on strategic, as well as tactical and operational activities of the company. 5. Incorrect reporting of ABC costs with the goal of retaining both the Mammoth and Maximum product lines is unethical. In assessing the situation, accountants should consider issues such as: 1. Clear reports using relevant and reliable information should be prepared. Preparing reports on the basis of incorrect costs in order to retain product lines violates competence standards. It is unethical for Jacobs to change the ABC system with the specific goal of reporting different product cost numbers that Clark favors. 2. An accountant has a responsibility to avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict. Jacobs may be tempted to change the product cost numbers to please Clark, the division president. This action, however, would violate the responsibility for integrity. 3. An accountant is required to ensure that information should be fairly and objectively communicated and that all relevant information should be disclosed. From this standpoint, underreporting environmental costs to make performance look good would violate the standard of objectivity. Jacobs should indicate to Clark that the product cost calculations are, indeed, appropriate. If Clark still insists on modifying the product cost numbers, Jacobs should raise the matter with one of Clark’s superiors. If, after taking all these steps, there is continued pressure to modify product cost numbers, Jacobs should consider resigning from the company rather than engage in unethical behaviour.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

MINI-CASE 5-39 (40–60 min.) Using ABC for activity-based management. 1. General Mills has identified two segments within the food-service channel: impulse locations and yogurt shops. The segments differ on three dimensions: 

 

The impulse segment, which sells 80% of the total cases in the food-service channel, orders mostly individual cases (95% of the 1,200,000 impulse segment cases are purchased as individual cases). The shop segment, on the other hand, orders 80% of its needs as full pallets and the rest as individual cases. This results in higher shipping costs to the impulse segment. The shop segment consumes only about 2.6% (90 of 3,450) of the merchandising kits, and the impulse segment consumes the rest. This results in higher merchandising costs to the impulse segment. The shop segment consumes only 1% of the sales time spent on frozen yogurt in the food-service channel, and the impulse segment consumes the rest. This results in higher selling costs to the impulse segment.

2. COGS:

Shipping:

Total is $14,250,000 (same for all cases) = $14,250,000 ÷ 1,500,000 cases = $9.50 per case Impulse: 1,200,000 cases at $9.50 = $11,400,000 Shops: 300,000 cases at $9.50 = $2,850,000 Total of $3,000,000 varies with individual cases ($2.25/case) or pallets ($75 each). Impulse: Pallets = 60,000 ÷ 75 cases = 800 pallets at $75 = $60,000 Individual cases = 1,140,000 cases at $2.25 = $2,565,000 Total: $2,625,000 Shops: Pallets = 240,000 ÷ 75 cases = 3,200 pallets at $75=$240,000 Individual cases = 60,000 cases at $2.25 = $135,000 Total: $375,000

Merchandising: $500 per kit Impulse: (3,450 – 90 kits) × $500 = 3,360 × $500 = $1,680,000 Shops: 90 kits × $500 = $45,000 SG&A:

$1,185,000 previously allocated based on sales dollars. After sales diaries analysis, total was adjusted to $3,900,000. Impulse: 99% × $3,900,000 = $3,861,000 Shops: 1% × $3,900,000 = $39,000

Chapter 5: Activity-Based Costing and Management

New Net Income Analysis: Category Impulse Location Sales in cases 1,200,000 Sales revenue $23,880,000 Less: Promotions (3,600,000) Net sales $20,280,000 Less: COGS (11,400,000) Less: Shipping (2,625,000) Gross margin $ 6,255,000 Less: Merchandising (1,680,000) Less: SG&A (3,861,000) Net income $ 714,000 Per case: $0.60

Yogurt Shops 300,000 $5,970,000 (900,000) $5,070,000 (2,850,000) (375,000) $1,845,000 (45,000) (39,000) $1,761,000 $5.87

Total 1,500,000 $29,850,000 (4,500,000) $25,350,000 (14,250,000) (3,000,000) $ 8,100,000 (1,725,000) (3,900,000) $ 2,475,000 $1.65

3. The SG&A allocation to each segment using the sales dollar allocation method was too low, inflating net income figures. Recommend allocation based on time (as determined from sales diaries). Marketing costs (price promotions, merchandising, shipping, and SG&A) now total $13,125,000, representing 44% of sales and 530% of net income. This implies that, if marketing support costs can be reduced without reducing sales, profit will increase by 5% for every 1% reduction. Impulse locations have higher marketing support costs, so emphasis on reducing those costs is important—less salesperson time, consolidating the multiple small orders into larger ones, smaller and less costly marketing kits that can be mailed instead of hand-delivered. Shops have largely been ignored by the sales force, but there is opportunity to boost these sales. Is it due to sales force lack of training? Either offer training or set up a separate sales force to specialize in this area. Maybe offer incentives to boost shop sales. Start charging for the marketing kits. The price promotions have been costly in this segment, so if they are removed, additional value must be perceived elsewhere, such as more sales force attention, new products, etc. General Mills should recognize that the shops segment has 20% of the sales yet 71% of the net income. Clearly, an opportunity exists to further boost this segment’s performance. In reality, the company shifted its emphasis away from the impulse segment to the shop segment, created a new marketing kit and sales team for shops, and rebuilt relationships it had neglected.

CHAPTER 6 MASTER BUDGET AND RESPONSIBILITY ACCOUNTING MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

SHORT-ANSWER QUESTIONS 6-1

The budgeting cycle includes the following elements:

a. Planning the performance of the organization as a whole and of its subunits. The entire management team agrees as to what is expected. b. Providing a frame of reference, a set of specific expectations against which the actual results can be compared. c. Investigating variations from the plans. If necessary, corrective action follows investigation. d. Planning again, considering feedback and changed conditions.

6-2

A master budget is a single comprehensive document that combines information from many individual budgeted statements. The term “master” refers to its being a comprehensive organization-wide set of budgets that coordinates all financial projections for a set period of time.

6-3

Plans can and sometimes should be changed if the feedback indicates an assumption used in the budget was wrong. If the feedback indicates the plan was reasonable, then it is necessary to understand the issues preventing the achievement of the planned results and implement an appropriate remedy.

6-4

Strategy, plans, and budgets are interrelated and affect one another. Strategy is a broad term that usually means selection of overall objectives. Strategic analysis underlies both long-run and short-run planning. In turn, these plans lead to the formulation of budgets. Budgets provide feedback to managers about the likely effects of their strategic plans. Managers use this feedback to revise their strategic plans.

6-5

Yes, budgeted performance is better than past performance for judging managers. Why? Mainly because inefficiencies included in past results can be detected and eliminated in budgeting. Also, new opportunities in the future, which did not exist in the past, may otherwise be ignored if past performance is used.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

6-6

A company that shares its own internal budget information with other companies can gain multiple benefits. One benefit is better coordination with suppliers, which can reduce the likelihood of supply shortages. Better coordination with customers can result in increased sales as demand by customers is less likely to exceed supply. Better coordination across the whole supply chain can also help a company reduce inventories and thus reduce the costs of holding inventories. Suppliers and customers become “partners in profit.” Here satisfied customers sell the final product to new customers.

6-7

A rolling budget is a budget or plan that is always available for a specified future period by adding a month, quarter, or year in the future as the month, quarter, or year just ended is dropped. For example, a 12-month rolling budget for the March 2021 to February 2022 period becomes a 12-month rolling budget for the April 2021 to March 2022 period the next month, and so on.

6-8 1. 2. 3. 4. 5. 6. 7. 8. 9.

The steps in preparing an operating budget are:

Prepare the revenue budget Prepare the production budget (in units) Prepare the direct materials usage budget and direct materials purchases budget Prepare the direct manufacturing labour budget Prepare the manufacturing overhead budget Prepare the ending inventories budget Prepare the cost of goods sold budget Prepare the nonproduction costs budget Prepare the budgeted operating income statement

6-9

The revenue budget is typically the cornerstone for budgeting because production (and hence costs) and inventory levels generally depend on the forecasted level of demand and revenue.

6-10 Sensitivity analysis adds an extra dimension to budgeting. It enables managers to examine how budgeted amounts change with changes in the underlying assumptions. This helps managers to monitor those assumptions that are most critical to a company attaining its budget and to make timely adjustments to plans when appropriate.

6-11 Padding is when budget figures are either inflated (in the case of expenses) or deflated (in the case of revenues) in order to make it easier to achieve them during the actual operations of the firm. This makes it easier for managers to meet their budget targets and earn performance bonuses. Senior managers should look at outside (external) data to see if the internal budgets are reasonable. Senior managers should also be familiar with the operations of the firms—this will make it easier for them to spot unreasonable budget estimates.

6-12 Non-output-based cost drivers can be incorporated into budgeting by the use of activitybased budgeting (ABB). ABB focuses on the budgeted cost of activities necessary to produce and sell products and services. Non-output-based cost drivers, such as the number of part numbers, number of batches, and number of new products, can be used with ABB.

Chapter 6: Master Budget and Responsibility Accounting

6-13 The choice of a responsibility centre type guides the variables to be included in the budgeting exercise. For example, if a revenue centre is chosen, the focus will be on variables that assist in forecasting revenue. Factors related to, say, costs of the investment base will be considered only if they assist in forecasting revenue.

6-14 Equal or across-the-board reductions is a strategy that penalizes honest business functions and rewards those that pad the budgets. The strategy produces a perverse incentive, rewarding the overstatement of budgeted costs and the understatement of budgeted revenue.

EXERCISES 6-15 (10 min.)

Terminology.

1. A cash cycle, also known as an operating cycle, is the movement of cash arising from business functions to inventories, to receivables, and back to cash when outputs are sold. 2. It is a self-liquidating cycle where all costs of a corporation are recovered when output is sold. 3. Budgetary slack is the practice of underestimating revenue and overestimating costs to make budget constraints less challenging. 4. Once the corporate budget is produced, all managers make a commitment to reach budget targets. They are responsible for controllable cost that must be at or below the budget constraint during each reporting time period. 5. Some companies produce a rolling budget that adds a reporting time period as one is completed. 6. An investment budget affects the flow in and out of cash either to make the investment or to pay to finance it.

6-16 (15 min.)

Responsibility and controllability.

1. (a) Salesperson (b) VP of sales Permit the salesperson to offer a reasonable discount to customers, but require that he/she clear bigger discounts with the VP. Also, base his/her bonus/performance evaluation not just on revenue generated, but also on margins (or, ability to meet budget). 2. (a) VP of sales (b) VP of sales VP of sales should compare budgeted sales with actuals, and ask for an analysis of all the sales during the quarter. Discuss with salespeople why so many discounts are being offered—and if they are really needed to close each sale. Are our prices too high (i.e., uncompetitive)? 3. (a) Manager, shipping department (b) Manager or director of operations (including shipping) The shipping department manager must report delays more regularly and request additional capacity in a timely manner. Operations manager should ask for a review of shipping capacity utilization, and consider expanding the department.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4. (a) HR department (b) Production supervisor The production supervisor should devise his or her own educational standards that all new plant employees are held to before they are allowed to work on the plant floor. Offer remedial in-plant training to those workers who show promise. Be very specific about the types of skills required when using the HR department to hire plant workers. Test the workers periodically for required skills. 5. (a) Production supervisor (b) Production supervisor Get feedback from the workers, analyze it, and act on it. Get extra coaching and training from experienced mentors. 6. (a) Maintenance department (b) Production supervisor First, get the requisite maintenance done on the machines. Make sure that the maintenance department head clearly understands the repercussions of poor maintenance. Discuss and establish maintenance standards that must be met (frequency of maintenance and tolerance limits, for example). Test and keep a log of the maintenance work.

Chapter 6: Master Budget and Responsibility Accounting

6-17 (15 min.)

Sales budget, service setting.

1. McGrath & Sons Radon Tests Lead Tests

2021 Volume 11,000 15,200

At 2021 Selling Prices $250 $200

Expected 2022 Change in Volume +10% −10%

Expected 2022 Volume 12,100 13,680

McGrath & Sons Sales Budget For the Year Ended December 31, 2022 Radon Tests Lead Tests

Selling Price $250 $200

Units Sold 12,100 13,680

Total Revenue $3,025,000 2,736,000 $5,761,000

2. McGrath & Sons Radon Tests Lead Tests

2021 Volume 11,000 15,200

Planned 2022 Selling Prices $250 $190

Expected 2022 Change in Volume +10% −5%

Expected 2022 Volume 12,100 14,440

McGrath & Sons Sales Budget For the Year Ended December 31, 2022 Radon Tests Lead Tests

Selling Price $250 $190

Units Sold 12,100 14,440

Total Revenue $3,025,000 2,743,600 $5,768,600

Expected revenue of $5,768,600 at the new 2022 prices are greater than the expected 2022 revenue of $5,761,000 if the prices are unchanged. So, if the goal is to maximize sales revenue and if Jim McGrath’s forecasts are reliable, the company should lower its price for a lead test in 2022.

6-18 (5 min.) Sales and production budget. Budgeted sales in units Add target ending finished goods inventory Total requirements Deduct beginning finished goods inventory Units to be produced

145,000 16,500 161,500 11,500 150,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

6-19 (5 min.)

Direct materials budget.

Direct materials to be used in production (bottles) Add target ending direct materials inventory (bottles) Total requirements (bottles) Deduct beginning direct materials inventory (bottles) Direct materials to be purchased (bottles)

6-20 (10 min.)

2,400,000 75,000 2,475,000 25,000 2,450,000

Budgeting material purchases. Finished Goods (units)

Budgeted sales Add target ending finished goods inventory Total requirements Deduct beginning finished goods inventory Units to be produced

52,250 29,400 81,650 27,300 54,350 Direct Materials (in litres)

Direct materials needed for production (54,350 × 3) Add target ending direct materials inventory Total requirements Deduct beginning direct materials inventory Direct materials to be purchased

6-21 (30 min.)

163,050 110,000 273,050 117,350 155,700

Revenues and production budget.

1. 12-ounce bottles 1-gallon units

Selling Price $0.30 1.60

Units Sold 6,000,000a 1,560,000b

Total Revenues $1,800,000 2,496,000 $4,296,000

a500,000 × 12 months = 6,000,000 b130,000 × 12 months = 1,560,000

2. Budgeted unit sales (12-ounce bottles) Add target ending finished goods inventory Total requirements Deduct beginning finished goods inventory Units to be produced

6,000,000 660,000 6,660,000 980,000 5,680,000

Chapter 6: Master Budget and Responsibility Accounting

3. Beginning Target = Budgeted +  Budgeted inventory sales ending inventory production = 1,560,000 + 300,000  1,200,000 = 660,000 1-gallon units

6-22 (30 min.)

Budgeting; direct material usage, manufacturing cost, and gross margin.

1. Direct Material Usage Budget in Quantity and Dollars Material Physical Units Budget Direct materials required for Blue Rugs (200,000 rugs × 36 skeins and 0.8 gal.) Cost Budget Available from beginning direct materials inventory: (a) Wool: 458,000 skeins Dye: 4,000 gallons To be purchased this period: (b) Wool: (7,200,000 – 458,000) skeins × $2 per skein Dye: (160,000 – 4,000) gal. × $6 per gal. Direct materials to be used this period: (a) + (b)

Wool

Dye

7,200,000 skeins

160,000 gal.

Total

961,800 $ 23,680

13,484,000 $14,445,800

2. Weaving budgeted $31, 620, 000 = = $2.55 per DMLH overhead rate 12, 400, 000 DMLH

Dyeing budgeted  $17, 280, 000 = $12 per MH  overhead rate =   1, 440, 000 MH

936,000 $ 959,680

$15,405,480

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. Budgeted Unit Cost of Blue Rug

Wool Dye Direct manufacturing labour Dyeing overhead Weaving overhead Total 10.2 machine hour per skein

Input per Unit of Output 36 skeins 0.8 gal. 62 hrs. 7.21 mach-hrs. 62 DMLH

Cost per Unit of Input $ 2 6 13 12 2.55

Total 72.00 4.80 806.00 86.40 158.10 $1,127.30

×36 skeins per rug = 7.2 machine-hrs. per rug.

4. Revenue Budget Selling Units Price Blue Rugs 200,000 $2,000 Blue Rugs 185,000 $2,000

Total Revenues $400,000,000 $370,000,000

5a. Sales = 200,000 rugs Cost of Goods Sold Budget From Schedule Total Beginning finished goods inventory $ 0 Direct materials used $ 15,405,480 Direct manufacturing labour ($806 × 200,000) 161,200,000 Dyeing overhead ($86.40 × 200,000) 17,280,000 Weaving overhead ($158.10 × 200,000) 31,620,000 225,505,480 Cost of goods available for sale 225,505,480 Deduct ending finished goods inventory 0 Cost of goods sold $225,505,480

Chapter 6: Master Budget and Responsibility Accounting

5b. Sales = 185,000 rugs Production = 200,000 rugs Cost of Goods Sold Budget From Schedule Beginning finished goods inventory Direct materials used Direct manufacturing labour ($806 × 200,000) Dyeing overhead ($86.40 × 200,000) Weaving overhead ($158.10 × 200,000) Cost of goods available for sale Deduct ending finished goods inventory ($1,127.30 × 15,000) Cost of goods sold

Total $

$ 15,405,480 161,200,000 17,280,000 31,620,000

225,505,480 225,505,480 16,909,500 $208,595,980

Some students assume that Xander will produce only 185,000 rugs to match 185,000 rugs that ar expected to be sold and carry no finished good inventory of the rugs. In this case the Cost of goods sold budget will be as follows. The Cost of Goods Sold budget is higher because the fixed overhead costs in the dyeing and weaving cost pools do not get “inventoried” in the closing inventory of rugs but are instead expensed in the current period. Sales = 185,000 rugs Cost of Goods Sold Budget for Producing 185,000 rugs From Schedule Beginning finished goods inventory Direct materials useda Direct manufacturing labour ($806 × 185,000) Variable dyeing overhead ($70.55b × 185,000) Fixed dyeing overheadc Variable weaving overhead ($119.15d × 185,000) Fixed weaving overheade Cost of goods available for sale Deduct ending finished goods inventory Cost of goods sold

Total $

$ 14,253,480 149,110,000 13,051,750 3,170,000 22,042,750 7,790,000

209,417,980 209,417,980 0 $209,417,980

a[$961,800 + (185,000 rugs×36 skeins−458,000)×$2] + [$23,680 + (185,000 rugs×0.8 gallons−4,000)×$6] bVariable dyeing overhead cost per rug = ($6,560,000 + $7,550,000) ÷ 200,000 rugs = $70.55 per rug cFixed dyeing overhead costs = $347,000 + $2,100,000 + $723,000 = $3,170,000 dVariable weaving overhead cost per rug = ($15,400,000 + $5,540,000 + $2,890,000) ÷ 200,000 rugs = $119.15 per rug eFixed weaving overhead costs = $1,700,000 + $274,000 + $5,816,000 = $7,790,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

6. Revenue Less: Cost of goods sold Gross margin

200,000 rugs sold $400,000,000 225,505,480 $174,494,520

185,000 rugs sold 200,000 rugs produced $370,000,000 208,595,980 $161,404,020

185,000 rugs sold 185,000 rugs produced $370,000,000 209,417,980 $160,582,020

7. If sales drop to 185,000 blue rugs, Xander should look to reduce fixed costs and produce less to reduce variable costs and inventory costs. 8. Top management can look for ways to increase (stretch) sales and improve quality, efficiency, and input prices to reduce costs in each cost category such as direct materials, direct manufacturing labour, and overhead costs. Top management can also use the budget to coordinate and communicate across different parts of the organization, create a framework for judging performance and facilitating learning, and motivate managers and employees to achieve “stretch” targets of higher revenues and lower costs.

6-23 (15-20 min.) Revenue, production, and purchases budget. 1. 985,000 motorcycles × 505,000 yen = 497,425,000,000 yen 2. Budgeted sales (units) Add target ending finished goods inventory Total requirements Deduct beginning finished goods inventory Units to be produced 3. Direct materials to be used in production, 948,000 × 2 Add target ending direct materials inventory Total requirements Deduct beginning direct materials inventory Direct materials to be purchased Cost per wheel in yen Direct materials purchase cost in yen

985,000 115,000 1,100,000 152,000 948,000 1,896,000 28,000 1,924,000 19,000 1,905,000 21,300 40,576,500,000

Note the relatively small inventory of wheels. In Japan, suppliers tend to be located very close to the major manufacturer. Inventories are controlled by just-in-time (JIT) and similar systems. Indeed, some direct materials inventories are almost nonexistent.

Chapter 6: Master Budget and Responsibility Accounting

6-24 (15-25 min.) Budgets for production and di rect manufacturing labour. All Frame Company Budget for Production and Direct Manufacturing Labour For the Quarter Ended March 31, 2022 January February Budgeted sales (units) 10,000 12,000 Add target ending finished goods inventory* (units) 16,000 12,500 Total requirements (units) 26,000 24,500 Deduct beginning finished goods inventory (units) 16,000 16,000 Units to be produced 10,000 8,500 Direct manufacturing labour-hours (DMLH) per unit × 2.0 × 2.0 Total hours of direct manufacturing labour time needed 20,000 17,000 Direct manufacturing labour costs: Wages ($10.00 per DMLH) $200,000 $170,000 Pension contributions ($0.50 per DMLH) 10,000 8,500 Workers’ compensation insurance ($0.15 per DMLH) 3,000 2,550 Employee medical insurance ($0.40 per DMLH) 8,000 6,800 Employment insurance (employer’s share) ($10.00 × 0.075 = $0.75 per DMLH) 15,000 12,750 Total direct manufacturing labour costs $236,000 $200,600

March 8,000 13,500 21,500 12,500 9,000 × 1.5 13,500

Quarter 30,000 13,500 43,500 16,000 27,500

$135,000 6,750 2,025 5,400

$505,000 25,250 7,575 20,200

10,125 $159,300

37,875 $595,900

50,500

*100% of the first following month’s sales plus 50% of the second following month’s sales. Note that the employee employment insurance levy of 7.5% is irrelevant. Such taxes are withheld from employees’ wages and paid to the government by the employer on behalf of the employees; therefore, the employee 7.5% amounts are not additional costs to the employer.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

6-25 (30 min.)

Cash flow analysis.

1. The cash that TabComp Inc. can expect to collect during April is calculated below: April cash receipts: April cash sales ($400,000 × .25) $100,000 April credit card sales ($400,000 × .30 × .96) 115,200 Collections on account: March ($480,000 × .45 × .70) 151,200 February ($500,000 × .45 × .28) 63,000 January (uncollectable–not relevant) 0 Total collections $429,400 2. a. The projected number of the MZB-33 computer hardware units that TabComp Inc. will order on January 25 is calculated as follows.

March sales Plus: Ending inventorya Total needed Less: Beginning inventoryb Projected purchases in units

MZB-33 Units 110 27 137 33 104

a0.30 × 90 unit sales in April b0.30 × 110 unit sales in March

b. Selling price = $2,025,000  675 units, or for March, $330,000 110 units = $3,000 per unit Purchase price per unit, 70% × $3,000 $ 2,100 Projected unit purchases × 104 Total MZB-33 purchases, $2,100 × 104 $218,400 3. Monthly cash budgets are prepared by companies such as TabComp Inc. in order to plan for their cash needs. This means identifying when both excess cash and cash shortages may occur. A company needs to know when cash shortages will occur so that prior arrangements can be made with lending institutions in order to have cash available for borrowing when the company needs it. At the same time, a company should be aware of when there will be excess cash available for investment or for repaying loans.

Chapter 6: Master Budget and Responsibility Accounting

6-26 (20-30 min.) Activity-based budgeting. 1. Activity Ordering $90 × 14; 24; 14 Delivery $82 × 12; 62; 19 Shelf-stocking $21 × 16; 172; 94 Customer support $0.18 × 4,600; 34,200; 10,750

Cost Hierarchy

Soft Drinks

Fresh Produce

Packaged Food

Total

Batch-level

$1,260

$ 2,160

$1,260

$ 4,680

Batch-level

984

5,084

1,558

7,626

Output-unit-level

336

3,612

1,974

5,922

828

6,156

1,935

8,919

$3,408

$17,012

$6,727

$27,147

13%

63%

Output-unit-level

Total budgeted indirect costs Percentage of total indirect costs (subject to rounding)

25%

2. Refer to the last row of the table in requirement 1. Fresh produce, which probably represents the smallest portion of COGS, is the product category that consumes the largest share (63%) of the indirect resources. Fresh produce demands the highest level of ordering, delivery, shelf-stocking, and customer support resources of all three product categories—it has to be ordered, delivered, and stocked in small, perishable batches, and supermarket customers often ask for a lot of guidance on fresh produce items. 3. An ABB approach recognizes how different products require different mixes of support activities. The relative percentage of how each product area uses the cost driver at each activity area is:

Activity Ordering Delivery Shelf-stocking Customer support

Cost Hierarchy Batch-level Batch-level Output-unit-level Output-unit-level

Soft Drinks 27% 13 6 9

Fresh Produce 46% 67 61 69

Packaged Food 27% 20 33 22

Total 100% 100 100 100

By recognizing these differences, YM managers are better able to budget for different unit sales levels and different mixes of individual product-line items sold. Using a single cost driver (such as COGS) assumes homogeneity in the use of indirect costs (support activities) across product lines which does not occur at YM. Other benefits cited by managers include: (1) better identification of resource needs, (2) clearer linking of costs with staff responsibilities, and (3) identification of budgetary slack.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

6-27 (20–30 min.) Kaizen approach to activity-based budgeting (continuation of 6-26). 1. Activity Ordering Delivery Shelf-stocking Customer support

Cost Hierarchy Batch-level Batch-level Output-unit-level Output-unit-level

Budgeted Cost-Driver Rates January February March $90.00 $89.82 $89.64 82.00 81.84 81.67 21.00 20.96 20.92 0.18 0.18 0.179

The March 2022 rates can be used to compute the total budgeted cost for each activity area in March 2022: Activity Ordering $89.64 × 14; 24; 14 Delivery $81.67 × 12; 62; 19 Shelf-stocking $20.92 × 16; 172; 94 Customer support $0.179 × 4,600; 34,200; 10,750 Total

Cost Hierarchy Batch-level

Soft Drinks

Fresh Produce

Packaged Food

Total

Batch-level

$1,255

$2,151

$1,255

$4,661

Output-unitlevel Output-unitlevel

980

5,064

1,552

7,596

335

3,598

1,966

5,899

823 $3,393

6,122 $16,935

1,924 8,869 $6,697 $27,025

2. A kaizen budgeting approach signals management’s commitment to systematic cost reduction. Compare the budgeted costs from Exercises 6-27 and 6-28.

Exercise 6-27 Exercise 6-28 (Kaizen)

Ordering $4,680 4,661

Delivery $7,626 7,596

ShelfStocking $5,922 5,899

Customer Support $8,919 8,869

The kaizen budget number will show unfavourable variances for managers whose activities do not meet the required monthly cost reductions. This likely will put more pressure on managers to creatively seek out cost reductions by working “smarter” within YM or by having “better” interactions with suppliers or customers. One limitation of kaizen budgeting, as illustrated in this question, is that it assumes small incremental improvements each month. It is possible that some cost improvements arise from large discontinuous changes in operating processes, supplier networks, or customer interactions. Companies need to highlight the importance of seeking these large discontinuous improvements as well as the small incremental improvements.

Chapter 6: Master Budget and Responsibility Accounting

PROBLEMS 6-28 (30–40 min.) Revenue and production budgets. This is a routine budgeting problem. The key to its solution is to compute the correct quantities of finished goods and direct materials. Use the following general formula:  Budgeted   Target   Budgeted      Beginning  production  ending  sales or    inventory       or purchases  inventory     materials used 

Fraser Corporation Revenue Budget For 2022 Units 60,000 40,000

Widget Thingamajig Projected sales 2.

Price $198 300

Total $ 11,880,000 12,000,000 $23,880,000

Fraser Corporation Production Budget (in units) For 2022 Budgeted sales in units Add target finished goods inventories, December 31, 2022 Total requirements Deduct finished goods inventories, January 1, 2022 Units to be produced

Widget 60,000

Thingamajig 40,000

27,000 87,000

11,000 51,000

22,000 65,000

10,000 41,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Fraser Corporation Direct Materials Purchases Budget (in quantities) for 2022

Direct materials to be used in production • Widget (budgeted production of 65,000 units times 4 kg of A, 2 kg of B) • Thingamajig (budgeted production of 41,000 units times 5 kg of A, 3 kg of B, 1 unit of C) Total Add target ending inventories, December 31, 2022 Total requirements in quantities Deduct beginning inventories, January 1, 2022 Direct materials to be purchased (quantities) 4.

Direct Materials B

260,000

130,000

—

205,000 465,000 36,000 501,000 32,000 469,000

123,000 253,000 32,000 285,000 29,000 256,000

41,000 41,000 7,000 48,000 6,000 42,000

Fraser Corporation Direct Materials Purchases Budget (in dollars) for 2022

Direct material A Direct material B Direct material C Budgeted purchases 5.

Budgeted Purchases (Quantities) 469,000 256,000 42,000

Expected Purchase Price per Unit $14 7 5

Total $6,566,000 1,792,000 210,000 $8,568,000

Fraser Corporation Direct Manufacturing Labour Budget for 2022

Widget Thingamajig Total

Budgeted Production (Units) 65,000 41,000

Direct Manufacturing Labour-Hours per Unit 2 3

Total Hours 130,000 123,000

Rate per Hour $15 19

Total $1,950,000 2,337,000 $4,287,000

Chapter 6: Master Budget and Responsibility Accounting

Fraser Corporation Budgeted Finished Goods Inventory At December 31, 2022

Widget: Direct materials costs: A, 4 kilograms at $14 B, 2 kilograms at $7 Direct manufacturing labour costs, 2 hours at $15 Manufacturing overhead costs at $24 per direct manufacturing labour-hour (2 hours) Budgeted manufacturing costs per unit Finished goods inventory of Widget $148 × 27,000 units Thingamajig: Direct materials costs: A, 5 kilograms at $14 B, 3 kilograms at $7 C, 1 each at $5 Direct manufacturing labour costs, 3 hours at $19 Manufacturing overhead costs at $24 per direct manufacturing labour-hour (3 hours) Budgeted manufacturing costs per unit Finished goods inventory of Thingamajig $225 × 11,000 units Budgeted finished goods inventory, December 31, 2022

$56 14

$ 70 30 48 $148

$3,996,000

$70 21 5

$ 96 57 72 $225

2,475,000 $6,471,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

6-29 (30 min.)

Budgeted income statement. Easecom Company Budgeted Operating Income Statement for the year (in thousands)

Revenue Equipment ($6,000 × 1.06 × 1.15) Maintenance contracts ($1,800 × 1.06) Total revenue Cost of goods sold ($4,600 × 1.03 × 1.06) Gross margin Operating costs: Marketing costs ($600 + $250) Distribution costs ($150 × 1.06) Customer maintenance costs ($1,000 + $130) Administrative costs Total operating costs Operating income

6-30 (40 min.)

$7,314 1,908 $9,222 5,022 4,200 850 159 1,130 900 3,039 $ 1,161

Budget schedules for a manufacturer.

1a. Revenues Budget Units sold Selling price Budgeted revenues

Broncos Blankets 140 $305 $42,700

Rams Blankets 195 $378 $73,710

Total $116,410

b. Production Budget in Units Budgeted unit sales Add budgeted ending fin. goods inventory Total requirements Deduct beginning fin. goods inventory Budgeted production

Broncos Blankets 140 24 164 14 150

Rams Blankets 195 29 224 19 205

Chapter 6: Master Budget and Responsibility Accounting

c. Direct Materials Usage Budget (units) Red wool Broncos blankets: 1. Budgeted input per f.g. unit 2. Budgeted production 3. Budgeted usage (1 × 2) Rams blankets: 4. Budgeted input per f.g. unit 5. Budgeted production 6. Budgeted usage (4 × 5) 7. Total direct materials usage (3 + 6) Direct Materials Cost Budget 8. Beginning inventory 9. Unit price (FIFO) 10. Cost of DM used from beginning inventory (8 × 9) 11. Materials to be used from purchases (7 – 8) 12. Cost of DM in March 13. Cost of DM purchased and used in March (11 × 12) 14. Direct materials to be used (10 + 13)

Black wool

Broncos Rams logo logo patches patches

5 150 750

– – –

1 150 150

– – –

6 205 1,230

– – –

1 205 205

750

1,230

150

205

40 $ 10

20 $ 14

50 $ 8

65 $ 7

$ 400

$ 280

$ 400

$ 455

710 $ 11

1,210 $ 13

100 $ 8

140 $ 9

$7,810

$15,730

$ 800

$1,260

$25,600

$8,210

$16,010

$1,200

$1,715

$27,135

Direct Materials Purchases Budget Red wool Budgeted usage (from line 7) Add target ending inventory Total requirements Deduct beginning inventory Total DM purchases Purchase price (March) Total purchases

Total

Black wool

Bronco s logos

Rams logos

750

1,230

150

205

30 780

20 1,250

30 180

235

40 740 $ 11 $8,140

20 1,230 $ 13 $15,990

50 130 $ 8 $1,040

65 170 $ 9 $1,530

Total

$26,700

$ 1,535

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

d. Direct Manufacturing Labour Budget

Units Produced

Direct Manuf. LabourHours per Output Unit

150 205

4 5

Budgeted

Broncos blankets Rams blankets

Total Hours 600 1,025 1,625

Hourly Rate $28 $28

Total $16,800 28,700 $45,500

e. Manufacturing Overhead Budget Variable manufacturing overhead costs (1,625 × $17) Fixed manufacturing overhead costs Total manufacturing overhead costs

$27,625 14,625 $42,250

Total manuf. overhead cost per hour = $42,250 ÷ 1,625 = $26 per direct manufacturing labour-hour Fixed manuf. overhead cost per hour = $ 14,625 ÷ 1,625 = $9 per direct manufacturing labour-hour f. Computation of unit costs of ending inventory of finished goods Broncos Rams Blankets Blankets Direct materials Red wool ($11 × 5, 0) $ 55 $ 0 Black wool ($13 × 0, 6) 0 78 Broncos logos ($8 × 1, 0) 8 0 Rams logos ($9 × 0, 1) 0 9 Direct manufacturing labour ($28 × 4, 5) 112 140 Manufacturing overhead Variable ($17 × 4, 5) 68 85 Fixed ($9 × 4, 5) 36 45 Total manufacturing cost $279 $357 Ending Inventories Budget Cost per Unit Units Total Direct Materials Red wool $ 11 30 $ 330 Black wool 13 20 260 Broncos logo patches 8 30 240 Rams logo patches 9 30 270 1,100 Finished Goods Broncos blankets 279 24 6,696 Rams blankets 357 29 10,353 17,049 Total $18,149 Copyright © 2022 Pearson Canada Inc. 6-20

Chapter 6: Master Budget and Responsibility Accounting

g. Cost of goods sold budget Beginning fin. goods inventory, March 1, 2021 ($1,960 + $2,945) $ 4,905 Direct materials used (from Dir. materials cost budget) $27,135 Direct manufacturing labour (Dir. manuf. labour budget) 45,500 Manufacturing overhead (Manuf. overhead budget) 42,250 Cost of goods manufactured 114,885 Cost of goods available for sale 119,790 Deduct ending fin. goods inventory, March 31, 2021 (Inventories budget) 17,049 Cost of goods sold $102,741 2. Areas where continuous improvement might be incorporated into the budgeting process: (a) Direct materials. Either an improvement in usage or price could be budgeted. For example, the budgeted usage amounts for the fabric could be related to the maximum improvement (current usage – minimum possible usage) of yards of fabric for either blanket. It may also be feasible to decrease the price paid, particularly with quantity discounts on things like the logo patches. (b) Direct manufacturing labour. The budgeted usage of 4 hours/5 hours could be continuously revised on a monthly basis. Similarly, the manufacturing labour cost per hour of $28 could be continuously revised down. The former appears more feasible than the latter. (c) Variable manufacturing overhead. By budgeting more efficient use of the allocation base, a signal is given for continuous improvement. A second approach is to budget continuous improvement in the budgeted variable overhead cost per unit of the allocation base. (d) Fixed manufacturing overhead. The approach here is to budget for reductions in the yearto-year amounts of fixed overhead. If these costs are appropriately classified as fixed, then they are more difficult to adjust down on a monthly basis.

6-31 (30–40 min.) Revenue and production budgets. This is a routine budgeting problem. The key to its solution is to compute the correct quantities of finished goods and direct materials. Use the following general formula:

Budgeted production  Target ending  Budgeted sales or  Beginning   or purchases =  inventory +  materials used – inventory          1.

Chen Corporation Revenues Budget for 2021 Thingone Thingtwo Budgeted revenues

Units 69,000 44,000

Price $160 258

Total $11,040,000 11,352,000 $22,392,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. The CEO would want to probe if the revenue budget is sufficiently stretched. Is the revenue growing faster than the market? Should the company increase marketing and advertising spending to grow sales? Would increasing the sales force or giving salespersons stronger incentives result in higher sales? 3.

Chen Corporation Production Budget (in units) for 2021 Budgeted sales in units Add target finished goods inventories, December 31, 2021 Total requirements Deduct finished goods inventories, January 1, 2021 Units to be produced

Thingone 69,000

Thingtwo 44,000

29,000 98,000

8,000 52,000

24,000 74,000

7,000 45,000

Chen Corporation Direct Materials Purchases Budget (in quantities) for 2021 Direct Materials A B C Direct materials to be used in production • Thingone (budgeted production of 74,000 units times 6 lbs. of A, 4 lbs. of B) 444,000 296,000 -• Thingtwo (budgeted production of 45,000 units times 7 lbs. of A, 5 lbs. of B, 3 lb. of C) 315,000 225,000 135,000 Total 759,000 521,000 135,000 Add target ending inventories, December 31, 2021 38,000 34,000 12,000 Total requirements in units 797,000 555,000 147,000 Deduct beginning inventories, January 1, 2021 36,000 31,000 9,000 Direct materials to be purchased (units) 761,000 524,000 138,000 Chen Corporation Direct Materials Purchases Budget (in dollars) for 2021

Direct material A Direct material B Direct material C Budgeted purchases

Budgeted Purchases (Units) 761,000 524,000 138,000

Expected Purchase Price per unit Total $13 $ 9,893,000 8 4,192,000 7 966,000 $15,051,000

Chapter 6: Master Budget and Responsibility Accounting

Chen Corporation Direct Manufacturing Labour Budget (in dollars) for 2021

Thingone Thingtwo Total 7.

Budgeted Production (Units) 74,000 45,000

Direct Manufacturing Labour-Hours per Unit 4 5

Rate Total per Hours Hour 296,000 $13 225,000 18

Total $3,848,000 4,050,000 $7,898,000

Chen Corporation Budgeted Finished Goods Inventory at December 31, 2021 Thingone: Direct materials costs: A, 6 pounds × $13 B, 4 pounds × $8 Direct manufacturing labour costs, 4 hours × $13 Manufacturing overhead costs at $24 per direct manufacturing labour-hour (4 hours × $24) Budgeted manufacturing costs per unit Finished goods inventory of Thingone $258 × 29,000 units Thingtwo: Direct materials costs: A, 7 pounds × $13 B, 5 pounds × $8 C, 3 each × $7 Direct manufacturing labour costs, 5 hours × $18 Manufacturing overhead costs at $24 per direct manufacturing labour-hour (5 hours × $24) Budgeted manufacturing costs per unit Finished goods inventory of Thingtwo $362 × 8,000 units Budgeted finished goods inventory, December 31, 2021

$78 32

$110 52 96 $258 $ 7,482,000

$91 40 21

$152

90 120 $362 2,896,000 $10,378,000

8. The CEO would want to ask the production manager why the target ending inventories have increased. Could production be more closely tailored to demand? Could the efficiency and productivity of direct materials and direct manufacturing labour be increased? Could direct materials inventory be reduced?

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

9. Preparing a budget helps Chen Corporation manage costs based on revenues and production needs, look for opportunities to increase efficiencies, reduce costs, particularly in areas where costs are high, coordinate and communicate across different parts of the organization, create a framework for judging performance and facilitating learning, and motivate managers and employees to achieve “stretch” targets of higher revenues and lower costs.

6-32 (60 min.)

Comprehensive operating budget.

1. Schedule 1: Revenues Budget for January 2022 Units Selling Price Total Revenues Snowboards 2,900 $650 $1,885,000 2. Schedule 2: Production Budget (in Units) for January 2022 Snowboards 2,900 200 3,100 500 2,600

Budgeted unit sales (Schedule 1) Add target ending finished goods inventory Total requirements Deduct beginning finished goods inventory Units to be produced

3. Schedule 3A: Direct Materials Usage Budget for January 2022 Physical Units Budget Wood: 2,600 × 9 b.f. Fiberglass: 2,600 × 10 yards To be used in production

Wood

Fiberglass

23,400 _______ 23,400

26,000 26,000

Cost Budget Available from beginning inventory Wood: 2,040 b.f. × $32.00 $ 65,280 Fiberglass: 1,040 b.f. × $8.00 To be used from purchases this period Wood: (23,400 – 2,040) × $34.00 726,240 Fiberglass: (26,000 – 1,040) × $9.00 Total cost of direct materials to be used $791,520

Total

8,320

224,640 $232,960

$1,024,480

Chapter 6: Master Budget and Responsibility Accounting

Schedule 3B: Direct Materials Purchases Budget for January 2022 Wood

Fiberglass

Physical Units Budget Production usage (from Schedule 3A) 23,400 Add target ending inventory 1,540 Total requirements 24,940 Deduct beginning inventory 2,040 Purchases 22,900 Cost Budget Wood: 22,900 × $34.00 Fiberglass: 27,000 × $9.00 Purchases

$778,600 ________ $778,600

Total

26,000 2,040 28,040 1,040 27,000

$243,000 $243,000

$1,021,600

4. Schedule 4: Direct Manufacturing Labour Budget for January 2022 Labour Category Manufacturing labour

Cost Driver Units 2,600

DML Hours per Driver Unit 5.00

Total Hours 13,000

Wage Rate $29.00

Total $377,000

5. Schedule 5: Manufacturing Overhead Budget for January 2022 At Budgeted Level of 13,000 Direct Manufacturing Labour-Hours Variable manufacturing overhead costs ($7.00 × 13,000) $ 91,000 Fixed manufacturing overhead costs 81,000 Total manufacturing overhead costs $172,000 $172, 000 = $13.23 per hour 13, 000 $172, 000 7. Budgeted manufacturing overhead cost per output unit: = $66 per output unit 2, 600 (rounded)

6. Budgeted manufacturing overhead rate:

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

8. Schedule 6A: Computation of Unit Costs of Manufacturing Finished Goods in January 2022

Direct materials Wood Fiberglass Direct manufacturing labour Total manufacturing overhead

Cost per Unit of Inputa

Inputsb

Total

$34.00 9.00 29.00

9.00 10.00 5.00

$306.00 90.00 145.00 66.00 $607.00

aCost is per board foot, yard, or per hour bInputs is the amount of each input per board

9. Schedule 6B: Ending Inventories Budget, January 31, 2022

Direct materials Wood Fiberglass Finished goods Snowboards Total Ending Inventory

Units

Cost per Unit

Total

1,540 2,040

$ 34.00 9.00

$ 52,360 18,360

200

607.00

121,400 $192,120

10. Schedule 7: Cost of Goods Sold Budget for January 2022 From Schedule Beginning finished goods inventory January 1, 2022, $374.80 × 500 Given Direct materials used 3A $1,024,480 Direct manufacturing labour 4 377,000 Manufacturing overhead 5 172,000 Cost of goods manufactured Cost of goods available for sale Deduct ending finished goods inventory, January 31, 2022 6B Cost of goods sold 11. Budgeted Income Statement for Skulas for January 2022 Revenues Schedule 1 Cost of goods sold Schedule 7 Gross margin Operating costs Variable marketing costs ($250 × 38) $ 9,500 Fixed nonmanufacturing costs 35,000 Operating income Copyright © 2022 Pearson Canada Inc. 6-26

Total $

187,400

1,573,480 1,760,880 121,400 $1,639,480 $1,885,000 1,639,480 245,520 44,500 $ 201,020

Chapter 6: Master Budget and Responsibility Accounting

12. The CEO would want to probe if the revenue budget is sufficiently stretched. Is the revenue growing faster than the market? Should the company increase marketing and advertising spending to grow sales? Would increasing the sales force or giving salespersons stronger incentives result in higher sales? The CEO would want to ask the production manager if production could be more closely tailored to demand? Could the efficiency and productivity of direct materials and direct manufacturing labour be increased? Could direct materials inventory be reduced? The CEO should set stretch targets that are challenging but achievable because creating some performance anxiety motivates employees to exert extra effort and attain better performance. A major rationale for stretch targets is the psychological motivation that comes from loss aversion—people feel the pain of loss more than the joy of success. Setting challenging targets motivates employees to reach these targets because failing to achieve a target is seen as failing. At no point should the pressure for performance push employees to engage in illegal or unethical practices. So, while setting stretch targets, the CEO must place great emphasis on adhering to codes of conduct and following appropriate norms and values. The CEO should also not set targets that are very difficult or impossible to achieve. Such targets demotivate employees because they give up on trying to achieve them. 13. Preparing a budget helps Skulas manage costs based on revenues and production needs, look for opportunities to increase efficiencies, reduce costs, particularly in areas where costs are high, coordinate and communicate across different parts of the organization, create a framework for judging performance and facilitating learning, and motivate management and employees to achieve “stretch” targets of higher revenues and lower costs.

6-33 (30 min.)

Cash budgeting, budgeted balance sheet. (Appendix)

1. Cash Collections from Receivables From sales in: December (60% × $1,650,000) $ 990,000 January (40% × $1,885,000) 754,000 Total $1,744,000 Cash Disbursements for Material Purchases For purchases in: December (50% × $820,000) January (50% × $1,021,600a) Total

$410,000 510,800 $920,800

a6-32, Schedule 3B

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Cash Disbursements for Fixed Overhead Costs Fixed manufacturing overhead ($81,000b – $64,000) Fixed nonmanufacturing overhead ($35,000c – $10,000) Total

$17,000 25,000 $42,000

b6-32, Schedule 5 c6-32, Budgeted Income Statement

Cash Budget for January 2022 Beginning cash balance

$ 124,000

Add receipts: Collection of receivables Total cash available

1,744,000 $1,868,000

Deduct disbursements: Material purchases Direct manufacturing labour Variable manufacturing overhead Fixed manufacturing overhead Variable marketing costs Fixed nonmanufacturing costs Cash dividends Total disbursements Ending cash balance

$ 920,800 377,000 91,000 17,000 9,500 25,000 160,000 1,600,300 $ 267,700

2. Yes. Skulas has a budgeted cash balance of $267,700 on January 31, 2022, after paying the dividend of $160,000 at the end of January. 3. Skulas’ managers prepare a cash budget in addition to the operating income budget to plan cash flows to ensure that the company has adequate cash to pay vendors, meet payroll, and pay operating expenses as these payments come due. Skulas could be very profitable on an accrual accounting basis, but the pattern of cash receipts from revenues might be delayed and result in insufficient cash being available to make scheduled payments for its expenses. Skulas’ managers may then need to initiate a plan to borrow money to finance any shortfall. Building a profitable operating plan does not guarantee that adequate cash will be available, so Skulas’ managers need to prepare a cash budget in addition to an operating income budget. 4. Budgeted Balance Sheet for Skulas as of January 31, 2022 Cash Accounts receivable (60% × $1,885,000) Inventory (6-32 Schedule 6B) Property, plant, and equipment (net) Total assets

$ 267,700 1,131,000 192,120 1,175,600 $2,766,420

Chapter 6: Master Budget and Responsibility Accounting

Accounts Payable Long-term liabilities Stockholders’ equity Total liabilities and stockholders’ equity

6-34 (60 min.)

$ 510,800 182,000 2,073,620 $2,766,420

Comprehensive problem with ABC costing.

1. Revenue Budget For the Month of April

Cat-allac Dog-eriffic Total

Units Selling Price Total Revenue 500 $160 $ 80,000 300 250 75,000 $155,000

2. Production Budget For the Month of April

Budgeted unit sales Add target ending finished goods inventory Total required units Deduct beginning finished goods inventory Units of finished goods to be produced

Product Cat-allac Dog-eriffic 500 300 35 15 535 315 15 30 520 285

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3a. Direct Material Usage Budget in Quantity and Dollars For the Month of April Material Plastic Metal Physical Units Budget Direct materials required for Cat-allac (520 units × 4 kg and 0.5 kg) 2,080 kg 260 kg Dog-errific (285 units × 6 kg and 1 kg) 1,710 kg 285 kg Total quantity of direct materials to be used 3,790 kg 545 kg Cost Budget Available from beginning direct materials inventory (under a FIFO cost-flow assumption) Plastic: 250 kg × $3.80/kg $ 950 Metal: 60 kg × $3/kg To be purchased this period Plastic: (3,790 – 250) kg × $4/kg 14,160 Metal: (545 – 60) kg × $3/kg __ ____ Direct materials to be used this period $15,110

Total

180

1,455 $ 1,635

$16,745

3b. Direct Material Purchases Budget For the Month of April Material Plastic Physical Units Budget To be used in production (requirement 3) Add target ending inventory Total requirements Deduct beginning inventory Purchases to be made

3,790 kg 380 kg 4,170 kg 250 kg 3,920 kg

Cost Budget Plastic: 3,920 kg × $4 Metal: 540 kg × $3 Purchases

$15,680 ______ $15,680

Metal

Total

545 kg 55 kg 600 kg 60 kg 540 kg

$ 1,620 $ 1,620

$ 17,300

Cat-allac Dog-errific Total

Direct Manufacturing Labour Costs Budget For the Month of April Output Units Produced DMLH Total Hourly Wage (requirement 2) per Unit Hours Rate 520 3 1,560 $10 285 5 1,425 10

Total $15,600 14,250 $29,850

Chapter 6: Master Budget and Responsibility Accounting

5. Machine Setup Overhead Cat-allac 520 ÷ 20 26 ×1.5 hrs. 39 hrs.

Units to be produced Units per batch Number of batches Setup time per batch Total setup time Budgeted machine setup costs

Dog-errific 285 ÷15 19 ×1.75 hrs. 33.25 hrs.

Total

72.25 hrs.

= $100 per setup hour × 72.25 hours = $7,225

Processing Overhead Budgeted machine-hours (MH) = (10 MH per unit × 520 units) + (18 MH per unit × 285 units) = 5,200 MH + 5,130 MH = 10,330 MH Budgeted processing costs = $5 per MH × 10,330 MH = $51,650 Inspection Overhead Budgeted inspection hours = (0.5 × 26 batches) + (0.6 × 19 batches) = 13 + 11.4 = 24.4 inspection hrs. Budgeted inspection costs = $16 per inspection hr. ×24.4 inspection hours = $390.40 Manufacturing Overhead Budget For the Month of April Machine setup costs $ 7,225 Processing costs 51,650 Inspection costs 390 Total costs $59,265

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

6. Unit Costs of Ending Finished Goods Inventory April 30 Product Cat-allac Dog-errific Cost per Input per Input per Unit of Unit of Input Output Total Unit of Output Total Plastic $ 4 4 kg $ 16.00 6 kg $ 24.00 Metal 3 0.5 kg 1.50 1 kg 3.00 Direct manufacturing labour 10 3 hrs. 30.00 5 hrs. 50.00 Machine setup 100 0.075 hrs.1 7.50 0.1167 hr1 11.67 Processing 5 10 MH 50.00 18 MH 90.00 Inspection Total

0.025 hr2

0.40 $105.40

0.04 hr.2

0.64 $179.31

139 setup hours ÷ 520 units = 0.075 hours per unit; 33.25 setup hours ÷ 285 units = 0.1167 hours per unit 213 inspection hours ÷ 520 units = 0.025 hours per unit; 11.4 inspection hours ÷ 285 units = 0.04 hours per

unit

Ending Inventories Budget April 30 Direct Materials Plastic Metals Finished goods Cat-allac Dog-errific Total ending inventory

Quantity

Cost per Unit

Total

380 55

$4 3

$1,520 165

35 15

$105.40 179.31

$3,689 2,690

$1,685

6,379 $8,064

7. Cost of Goods Sold Budget For the Month of April Beginning finished goods inventory, April, 1 ($1,500 + $5,580) Direct materials used (requirement 3) Direct manufacturing labour (requirement 4) Manufacturing overhead (requirement 5) Cost of goods manufactured Cost of goods available for sale Deduct: Ending finished goods inventory, April 30 (reqmt. 6) Cost of goods sold

$ 7,080 $16,745 29,850 59,265 105,860 112,940 6,379 $106,561

Chapter 6: Master Budget and Responsibility Accounting

8. Nonmanufacturing Costs Budget For the Month of April Salaries ($36,000 ÷ 2 × 1.05) $18,900 Other fixed costs ($36,000 ÷ 2) 18,000 Sales commissions ($155,000 × 1%) 1,550 Total nonmanufacturing costs $38,450 9. Budgeted Operating Income Statement For the Month of April Revenue $155,000 Cost of goods sold 106,561 Gross margin 48,439 Operating (nonmanufacturing) costs 38,450 Operating income $ 9,989

6-35 (25 min.)

Cash budget (continuation of 6-34). Cash Budget April 30

Cash balance, April 1 Add receipts Cash sales ($155,000 × 10%) Credit card sales ($155,000 × 90% × 97%) Total cash available for needs (x) Deduct cash disbursements Direct materials ($8,500 + ($17,300 × 50%)) Direct manufacturing labour Manufacturing overhead ($59,265 – $20,000 depreciation) Nonmanufacturing salaries Sales commissions Other nonmanufacturing fixed costs ($18,000 – $10,000 deprn) Machinery purchase Income taxes Total disbursements (y) Financing Repayment of loan 1 Interest at 12% ($2,000 × 12% × ) 12 Total effects of financing (z) Ending cash balance, April 30 (x) ─ (y) ─ (z)

$ 5,360 15,500 135,315 $156,175 $ 17,150 29,850 39,265 18,900 1,550 8,000 13,700 5,000 $133,415 $ 2,000 20 $ 2,020 $ 20,740

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

6-36 (15 min.)

Responsibility and controllability.

The time lost in the plant should be charged to the purchasing department. Certainly, the plant manager could not be asked to underwrite a loss which is due to failure of delivery over which he had no supervision. Although the purchasing agent may feel that he has done everything he possibly could, he must realize that, in the whole organization, he is the one who is in the best position to evaluate the situation. He receives an assignment. He may accept it or reject it. But if he accepts, he must perform. If he fails, the damage is evaluated. Everybody makes mistakes. The important point is to avoid making too many mistakes and also to understand fully that the extensive control reflected in “responsibility accounting” is the necessary balance to the great freedom of action that individual executives are given. Discussions of this problem have again and again revealed a tendency among students (and among accountants and managers) to “fix the blame”—as if the variances arising from a responsibility accounting system should pinpoint misbehaviour and provide answers. The point is that no accounting system or variances can provide answers. However, variances can lead to questions. In this case, in deciding where the penalty should be assigned, the student might inquire who should be asked—not who should be blamed. Classroom discussions have also raised the following diverse points: (a) Is the railway company liable? Yes, and they have liability insurance. (b) Costs of idle time are usually routinely charged to the production department. Should the information system be fine-tuned to reallocate such costs to the purchasing department? Both purchasing and the plant manager answer to either a business manager or an operations manager. The buck stops here. Some companies have the purchasing department answer directly to the plant manager, which would be a probable result of the above mistake. Give accountability to the plant manager as his/her authority warrants it. (c) How will the purchasing managers behave in the future regarding willingness to take risks? The text emphasizes the following: Beware of overemphasis on controllability. For example, a time-honoured theme of management is that responsibility should not be given without accompanying authority. Such a guide is a useful first step, but responsibility accounting is more far-reaching. The basic focus should be on information or knowledge, not on control. The key question is: “Who is the best informed?” Put another way, “Who is the person who can tell us the most about the specific item, regardless of ability to exert personal control?”

6-37 (15 min.)

Budgeting and governance.

1. The standards proposed by Maki are not challenging. In fact, she set the target at the level her department currently achieves. DM 2.95 kg × 100 units = 295 kg DL 19.2 min. × 100 units = 1,920 min ÷ 60 = 32 hrs. MT 9.9 min. × 100 units = 990 min. ÷ 60 = 16.5 hrs. Copyright © 2022 Pearson Canada Inc. 6-34

Chapter 6: Master Budget and Responsibility Accounting

2. Maki probably chose these standards so that her department would be able to make the goal and receive any resulting reward. With a little effort, her department can likely beat these goals. 3. As discussed in the chapter, benchmarking might be used to highlight the easy targets set by Maki. Perhaps the organization has multiple plant locations that could be used as comparisons. Alternatively, management could use industry averages. Also, management should work with Maki to better understand her department and encourage her to set more realistic targets. Finally, the reward structure should be designed to encourage increasing productivity, not beating the budget.

6-38 (60 min.) Comprehensive budgeting problem; activity-based costing, operating and financial budgets. 1a. Revenues Budget For the Month of June

Regular Deluxe Total

Units Selling Price Total Revenues 2,000 $120 $240,000 3,000 195 585,000 $825,000

b. Production Budget For the Month of June

Budgeted unit sales Add: target ending finished goods inventory Total required units Deduct: beginning finished goods inventory Units of finished goods to be produced

Product Regular Deluxe 2,000 3,000 400 600 2,400 3,600 250 650 2,150 2,950

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

c. Direct Material Usage Budget in Quantity and Dollars For the Month of June Material Cloth Wood Physical Units Budget Direct materials required for Regular (2,150 units × 1.3 yd.; 0 b.f.) Deluxe (2,950 units × 1.5 yds.; 2 b.f.) Total quantity of direct materials to be used

Total

2,795 yds. 0 b.f. 4,425 yds. 5,900 b.f. 7,220 yds. 5,900 b.f.

Cost Budget Available from beginning direct materials inventory (under a FIFO cost-flow assumption) To be purchased this period Cloth: (7,220 yd. – 610 yd.) × $5.25 per yd. Wood: (5,900 – 800) × $7.50 per b. f. Direct materials to be used this period

$ 3,219

$ 6,060

34,703 38,250 $44,310

$82,232

Material Cloth Wood

Total

$37,922

Direct Materials Purchases Budget For the Month of June

Physical Units Budget To be used in production Add: Target ending direct material inventory Total requirements Deduct: beginning direct material inventory Purchases to be made Cost Budget Cloth: (6,996 yds. × $5.25 per yd.) Wood: (5,395 ft × $7.50 per b.f.) Total

7,220 yds. 386 yds. 7,606 yds. 610 yds. 6,996 yds. $36,729 ______ $36,729

5,900 ft 295 ft 6,195 ft 800 ft 5,395 ft

$40,463 $40,463

$77,192

d. Direct Manufacturing Labour Costs Budget For the Month of June

Regular Deluxe Total

Output Units Produced 2,150 2,950

Direct Manufacturing Labour-Hours per Unit 5 7

Total Hourly Wage Hours Rate 10,750 $15 20,650 15 31,400

Total $161,250 309,750 $471,000

Chapter 6: Master Budget and Responsibility Accounting

e. Manufacturing Overhead Costs Budget For the Month of June Total Machine setup (Regular, 43 batchesa × 2 hrs./batch + Deluxe, 59 batchesb × 3 hrs./batch) × $18/hour Processing (31,400 DMLH × $1.80) Inspection [(2,150 + 2,950) pairs × $1.35 per pair] Total

$ 4,734 56,520 6,885 $68,139

aRegular: 2,150 pairs ÷ 50 pairs per batch = 43; bDeluxe: 2,950 pairs ÷ 50 pairs per batch = 59

Cloth Wood Direct manufacturing labour Machine setup Processing Inspection Total

Unit Costs of Ending Finished Goods Inventory For the Month of June Regular Deluxe Cost per Input per Input per Unit of Input Unit of Output Total Unit of Output Total $ 5.25 1.3 yd $ 6.83 1.5 yd $ 7.88 7.50 0 b.f. 0.00 2 b.f. 15.00 15.00 5 hr. 75.00 7 hrs. 105.00 18.00 0.04 hra 0.72 0.06 hrb 1.08 1.80 5 hrs 9.00 7 hrs 12.60 1.35 1 pair 1.35 1 pair 1.35 $92.90 $142.91

a2 hours per setup ÷ 50 pairs per batch = 0.04 hr. per unit b3 hours per setup ÷ 50 pairs per batch = 0.06 hr. per unit

Ending Inventories Budget June Direct Materials Cloth Wood Finished goods Regular Deluxe Total ending inventory

Quantity

Cost per unit

386 yards 295 b.f.

$5.25 7.50

$2,026.50 2,212.50

400 600

$ 92.90 142.91

$37,160 85,746

Total $ 4,239

122,906 $127,145

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

g. Cost of Goods Sold Budget For the Month of June Beginning finished goods inventory, June 1 ($23,250 + $92,625) Direct materials used (requirement c) Direct manufacturing labour (requirement d) Manufacturing overhead (requirement e) Cost of goods manufactured Cost of goods available for sale Deduct ending finished goods inventory, June 30 (requirement f) Cost of goods sold

$115,875 $ 82,232 471,000 68,139 621,371 737,246 122,906 $614,340

h. Nonmanufacturing Costs Budget For the Month of June Total Marketing and general administration 8% × $825,000 Shipping (5,000 pairs ÷ 40 pairs per shipment) × $15 Total

$66,000 1,875 $67,875

2. Cash Budget June 30 Cash balance, June 1 (from Balance Sheet) Add receipts Collections from May accounts receivable Collections from June accounts receivable ($825,000 × 60%) Total collection from customers Total cash available for needs (x) Deduct cash disbursements Direct material purchases in May Direct material purchases in June ($77,192 × 80%) Direct manufacturing labour Manufacturing overhead ($68,139 × 70% because 30% is depreciation) Nonmanufacturing costs ($67,875 × 90% because 10% is depreciation) Taxes Dividends Total disbursements (y) Financing Interest at 6% ($150,000 × 6% × 1 ÷ 12) (z) Ending cash balance, June 30 (x) – (y) – (z)

9,435 307,800 495,000

802,800 $812,235 $ 15,600 61,754 471,000 47,697 61,088 10,800 15,000 $682,939 $ 750 $128,546

Chapter 6: Master Budget and Responsibility Accounting

3. Budgeted Income Statement For the Month of June Revenues $825,000 Bad debt expense ($825,000 × 2%) 16,500 Net revenues Cost of goods sold Gross margin Operating (nonmanufacturing) costs $67,875 Interest expense (for June) 750 Net income

$808,500 614,340 194,160 68,625 $125,535

Budgeted Balance Sheet June 30 Assets Cash Accounts receivable ($825,000 × 40%) Less: allowance for doubtful accounts Inventories Direct materials Finished goods Fixed assets Less: accumulated depreciation ($136,335 + $68,139 × 30% + $67,875 × 10%)) Total assets

$ 128,546 $330,000 16,500

313,500

4,239 122,906

127,145

$870,000

Liabilities and Equity Accounts payable ($77,192 × 20%) Interest payable Long-term debt Common stock Retained earnings ($698,904 + $125,535 – $15,000)) Total liabilities and equity

163,564

706,436 $1,275,627 $

15,438 750 150,000 300,000 809,439 $1,275,627

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

MINI-CASE

6-39 (60 min.) Comprehensive budgeting problem; activity-based costing, operating and financial budgets. 1a. Revenue Budget For the Month of June Large Giant Total

Units Selling Price Total Revenue 3,000 $3 $ 9,000 1,800 4 7,200 $16,200

1b. Production Budget For the Month of June Budgeted unit sales Add: target ending finished goods inventory Total required units Deduct: beginning finished goods inventory Units of finished goods to be produced

Product Large Giant 3,000 1,800 300 180 3,300 1,980 200 150 3,100 1,830

1c. Direct Material Usage Budget in Quantity and Dollars For the Month of June Material Sugar Sticks Physical Units Budget Direct materials required for Large (3,100 units × 0.25 lb.; 1 stick) 775 lbs. 3,100 Giant (1,830 units × 0.50 lb.; 1 stick) 915 lbs. 1,830 Total quantity of direct materials to be used 1,690 lbs. 4,930 Cost Budget Available from beginning direct materials inventory (under a FIFO cost-flow assumption) To be purchased this period Sugar: (1,690 lbs. – 125 lbs.) × $0.50 per lb. Sticks: (4,930 – 350) × $0.30 per stick Direct materials to be used this period

$ 64

$ 105

783 ____ $847

1,374 $1,479

Total

$2,326

Chapter 6: Master Budget and Responsibility Accounting

Direct Materials Purchases Budget For the Month of June Material Sugar Sticks Physical Units Budget To be used in production Add: Target ending direct material inventory Total requirements Deduct: beginning direct material inventory Purchases to be made

1,690 lbs. 240 lbs. 1,930 lbs. 125 lbs. 1,805 lbs.

4,930 480 5,410 350 5,060

Cost Budget Sugar: (1,805 lbs. × $0.50 per lb.) Sticks: (5,060 × $0.30 per stick) Total

$903 ____ $903

$1,518 $1,518

Total

$2,421

1d. Direct Manufacturing Labour Costs Budget For the Month of June

Large Giant Total

Output Units Direct Manufacturing Produced Labour-Hours per Unit 3,100 0.20 1,830 0.25

Total Hours 620 457.5 1,077.5

Hourly Wage Rate $8 8

Total $4,960 3,660 $8,620

1e. Manufacturing Overhead Costs Budget For the Month of June Total Machine setup (Large 310 batchesa × 0.08 hrs./batch + Giant 183 batchesb × 0.09 hrs./batch) × $20/hour Processing (1,077.5 DMLH × $1.70) Total aLarge: 3,100 units ÷ 10 units per batch = 310 bGiant: 1,830 units ÷ 10 units per batch = 183

$ 825 1,832 $2,657

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

1f. Unit Costs of Ending Finished Goods Inventory For the Month of June

Sugar Sticks Direct manufacturing labour Machine setup Processing Total

Large Cost per Input per Unit of Input Unit of Output $ 0.50 0.25 lb 0.30 1 8.00 20.00 1.70

0.2 hr. 0.008 hr.a 0.2 hr

Total $0.125 0.30 1.60 0.16 0.34 $2.525

Giant Input per Unit of Output 0.50 lb. 1 0.25 hr. 0.009 hra 0.25 hr

Total $ 0.25 0.30 2.00 0.18 0.425 $3.155

a0.08 hour per setup ÷ 10 units per batch = 0.008 hr. per unit;

0.09 hour per setup ÷ 10 units per batch = 0.009 hr. per unit.

Ending Inventories Budget June Direct Materials Sugar Sticks Finished goods Large Giant Total ending inventory

Quantity

Cost per unit

Total

240 lbs. 480 sticks

$0.50 0.30

$120 144

300 180

$2.525 3.155

$758 568

$ 264

1,326 $1,590

1g. Cost of Goods Sold Budget For the Month of June Beginning finished goods inventory, June 1 ($500 + $474) Direct materials used (requirement c) Direct manufacturing labour (requirement d) Manufacturing overhead (requirement e) Cost of goods manufactured Cost of goods available for sale Deduct ending finished goods inventory, June 30 (requirement f) Cost of goods sold

$ 974 $2,326 8,620 2,657 13,603 14,577 1,326 $13,251

Chapter 6: Master Budget and Responsibility Accounting

1h. Nonmanufacturing Costs Budget For the Month of June Total Marketing and general administration 10% × 16,200

$1,620

2. Cash Budget June 30 Cash balance, June 30 Add receipts Collections from May accounts receivable Collections from June accounts receivable ($16,200 × 80% × 50%) Collections from June cash sales ($16,200 × 20%) Total collection from customers Total cash available for needs (x) Deduct cash disbursements Direct material purchases in May Direct material purchases in June ( $2,421 × 70%) Direct manufacturing labour Manufacturing overhead ( $2,657 × 60% because 40% is depreciation) Nonmanufacturing costs ( $1,620 × 70% because 30% is depreciation) Taxes Total disbursements (y) Financing Interest at 12% ($20,000 × 12% × 1 ÷ 12) (z) Ending cash balance, June 30 (x) ─ (y) ─ (z)

$ 587 4,704 6,480 3,240 14,424 $15,011 $ 696 1,695 8,620 1,594 1,134 500 $14,239 $ 200 $ 572

3. Budgeted Operating Income Statement For the Month of June Revenue Cost of goods sold Gross margin Operating (nonmanufacturing) costs Bad debt expense ($16,200 × 80% × 1%) Interest expense (for June) Net income

$16,200 13,251 2,949 $1,620 130 200

1,950 $ 999

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Budgeted Balance Sheet June 30 Assets Cash Accounts receivable ($16,200 × 80% × 50%)) Less: allowance for doubtful accounts Inventories Direct materials Finished goods Fixed assets Less: accumulated depreciation ($55,759 + 2,657 × 40% + 1,620 × 30%) Total assets

$ $ 6,480 130 $

572 6,350

264 1,326

1,590

$190,000 57,308

132,692 $141,204

Liabilities and Equity Accounts payable ($2,421 × 30%) Interest payable Long-term debt Common stock Retained earnings ($109,279 + $999) Total liabilities and equity

726 200 20,000 10,000 110,278 $141,204

6-40 (60 min.) University department, budget revision options. This exercise illustrates the difficulty of budgeting issues in universities. There are multiple stakeholders—student-athletes, student non-athletes, coaches, sports administrators, university faculty, university administrators, and alumni. Actions that benefit one type of stakeholder can “gore the ox” of other stakeholders. The general options that groups could examine are outlined below. Increasing Revenue There are at least two approaches to “increase” revenue: (a) Increase revenue from outside sources. For example, sell more tickets to football, basketball, etc. This is heavily driven by success. Medley’s concerns about academic standards likely will constrain Tax’s flexibility to recruit any athlete he believes to be a major star. Some universities have been innovative in terms of increasing cable television revenue from coverage of university sporting games. Tax could propose direct fundraising for the athletics department. This could run into problems with Medley, as she may require all fundraising to be coordinated at the university level. (b) Increase the “revenue” attributed to the athletics department. Tax could argue that a successful athletics program has many positive externalities for Maritime University, many of which increase MU revenue. •

Alumni are more likely to give money and other contributions when they are stimulated by being on campus to watch a nationally ranked team or viewing a successful MU team Copyright © 2022 Pearson Canada Inc. 6-44

Chapter 6: Master Budget and Responsibility Accounting

•

on television. Many universities use tickets to athletic events and invitations to related social functions as a thank-you to major donors. Athletics officials (especially nationally prominent coaches) are expected to assist Medley and her senior officers in promoting MU to potential donors, parents of future students, etc. For example, the coach of a number-one-ranked football team may attend over 50 dinners/functions a year on behalf of the university. Some of these dinners are “one-onone” with potential large donors. Merchandising revenue sold to alumni and other supporters is likely to increase when MU’s athletics teams achieve national success. These include sweaters, towels, and rings.

The current budgeting process gives zero recognition to these externalities, which may well exceed the projected $3.612 million deficit. Decreasing Costs Tax can always cut costs to meet any level Medley may impose. However, the ways to achieve any substantial reduction will be relatively painful. (a) Reduce scholarships (either number or amount) to students. This can take time to achieve bottom-line reductions as existing students may have three more years of scholarship remaining. Unless Tax cuts existing scholarships, he is restricted to cutting back on scholarships to new students. This option will be very painful. One consequence will be lower-quality levels of student athletes which will have implications for the sporting competitiveness of MU. The option of cutting back on already committed existing scholarships would be traumatic (but it has occurred). Tax could undertake across-the-board cuts or target the reductions to some sports. For example, sports that do not draw sizable crowds may be candidates for reduction. One difficulty here is that Tax is faced with both reducing total costs and increasing the relative percentage of scholarships to women. The scholarship breakdown is: Men’s Women’s Program Program Total Football 37 — 37 Basketball 21 11 32 Swimming 6 4 10 Other 4 2 6 Total 68 17 85 The largest percentage of scholarships are for the two highly successful programs—men’s football (37/85 = 44%) and men’s basketball (21/85 = 25%). There is little room for cutbacks in the second tier sports at MU. (b) Reduce sports sponsored by the athletics department. Cut out support for all but a few targeted sporting programs. This will cause morale problems for students in these sporting programs (such as rugby, soccer, and volleyball).

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

(c) Reduce salaries and other costs of the athletics department. The salary for Bill Madden is an obvious target for Tax’s cost reduction. However, Madden may have a multi-year contract that leaves MU little room for cost reduction. Moreover, if cost reduction is attempted, Madden may leave, which could have negative general effects on morale and university finances. Tax could approach alumni or sponsors to cover Madden’s salary and other costs. This would address Medley’s budget balance concerns but not her concern as to the level of Madden’s salary relative to leading academics’. Cost reductions could be achieved by reducing the number of assistant coaches and the number of support officials. The effect of these reductions on student morale and MU athletic achievements is difficult to measure. Gender Issues Based on dollar expenditures and scholarships, Medley has evidence to support her concerns. The men’s programs get the “lion’s share” of the expenditures and student scholarships. Men’s Women’s Program Program Costs $13.248 million $3.36 million Full student scholarships 68 17 Tax could respond by noting that the men’s programs have a lower deficit based on revenue minus assigned costs (in millions): Men’s Women’s Program Program Revenue $12.420 $ 0.936 Assigned costs 13.248 3.360 Contribution $(0.828) $(2.424) This lower deficit reflects, in part, the large revenue-drawing capacity of their successful men’s football and athletics departments. Medley’s demands for a balanced budget, more gender equality, and higher academic standards leaves Tax in an unenviable position.

CHAPTER 7 FLEXIBLE BUDGETS, VARIANCES, AND MANAGEMENT CONTROL: I MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

SHORT-ANSWER QUESTIONS 7-1

Static budget variance can mislead those assessing actual against pro forma performance indicators. The key issue is that when production and sales volume exceed pro forma amounts, an unfavourable cost variance analysis is an inevitable result of what is usually considered good news. Managers may waste valuable time investigating routine-cost behaviour.

7-2

Management by exception is the practice of concentrating on areas not operating as anticipated and giving less attention to areas operating as anticipated. Variance analysis helps managers identify areas not operating as anticipated. The larger the variance, the more likely an area is not operating as anticipated.

7-3

A favourable variance—denoted F—is a variance that increases operating income relative to the budgeted amount. An unfavourable variance—denoted U—is a variance that decreases operating income relative to the budgeted amount.

7-4

The key difference is the output level used to set the budget. A static budget is based on the level of output planned at the start of the budget period. A flexible budget is developed using budgeted revenues or cost amounts based on the level of output actually achieved in the budget period. The actual level of output is not known until the end of the budget period. Flexible budgets give managers more insight into the causes of variances than static budgets.

7-5 Step 1: Step 2: Step 3: Step 4: Step 5:

The steps in developing a flexible budget are: Determine the budgeted selling price per unit, the budgeted variable costs per unit, and the budgeted fixed costs. Determine the actual quantity of the revenue driver. Determine the flexible budget for revenue based on the budgeted unit revenue and the actual quantity of the revenue driver. Determine the actual quantity of the cost driver(s). Determine the flexible budget for costs based on the budgeted unit variable costs and fixed costs and the actual quantity of the cost driver(s).

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

7-6

Four reasons for using standard costs are: (i) (ii) (iii) (iv)

7-7     

cost management, pricing decisions, budgetary planning and control, and financial statement preparation.

Possible causes of a favourable materials rate variance are:

purchasing officer negotiated more skillfully than was planned in the budget, purchasing manager bought in larger lot sizes than budgeted, thus obtaining quantity discounts, materials rates decreased unexpectedly due to, say, industry oversupply, budgeted purchase rates were set without careful analysis of the market, and purchasing manager purchased lower quality materials.

7-8

Direct materials rate variances are often computed at the time of purchase while direct materials efficiency variances are often computed at the time of usage. Purchasing managers are typically responsible for rate variances, while production managers are typically responsible for usage variances.

7-9

Some possible reasons for an unfavourable direct manufacturing labour efficiency variance

are:    

the hiring and use of underskilled workers, inefficient scheduling of work so that the workforce was not optimally occupied, poor maintenance of machines resulting in a high proportion of non-value-added labour, unrealistic time standards.

Each of these factors would result in actual direct manufacturing labour-hours being higher than indicated by the standard work rate.

7-10 A process where the inputs are nonsubstitutable leaves workers no discretion as to the components to use. A process where the inputs are substitutable means there is discretion about the exact number and type of inputs or about the weighting of inputs.

7-11 The direct materials efficiency variance is a Level 3 variance. Further insight into this variance can be gained by moving to a Level 4 analysis where the effect of mix and yield changes are quantified. The mix variance captures the effect of a change in the relative percentage use of each input relative to that budgeted. The yield variance captures the effect of a change in the number of inputs required to obtain a given output relative to that budgeted.

Chapter 7: Flexible Budgets, Variances, and Management Control: I

7-12 Variance analysis, by providing information about actual performance relative to standards, can form the basis of continuous operational improvement. The underlying causes of unfavourable variances are identified, and corrective action taken where possible. Favourable variances can also provide information if the organization can identify why a favourable variance occurred. Steps can often be taken to replicate those conditions more often. As the easier changes are made, and perhaps some standards tightened, the harder issues will be revealed for the organization to act on—this is continuous improvement.

7-13 An individual business function, such as production, is interdependent with other business functions. Factors outside of production can explain why variances arise in the production area. For example:   

purchasing of lower quality materials that creates excess waste poor design of products or processes can lead to a sizable number of defects, and marketing personnel making promises for delivery times that require a large number of rush orders that create production-scheduling difficulties.

7-14 The plant supervisor likely has good grounds for complaint if the plant accountant puts excessive emphasis on using variances to pin blame. The key value of variances is to help understand why actual results differ from budgeted amounts and then to use that knowledge to promote learning and continuous improvement.

EXERCISES 7-15 Terminology. 1. The question is whether or not the actual results met expectations, exceeded expectations or failed to meet expectations and a variance analysis will respond to this question. A variance is the result of subtracting the budgeted or predicted outcome from the actual outcome. 2. A favourable (F) variance means the effect of the variance is to increase operating income. An unfavourable (U) variance means the effect of the variance is to decrease operating income. 3. A static budget variance simply fails to reflect the routine effect of changes in quantity produced and sold on the revenue and the variable costs. 4. A flexible budget does reflect the routine changes to be expected when the quantity produced and sold fluctuates from what was predicted. The flexible budget permits more fineness in the report of non-routine variances and management by exception. The flexible budget variance plus the sales volume variance equals the static budget variance. 5. When quantities of direct materials purchased and used differ from budget, the variance can be the result of either a rate variance (input rate variance) arising in an unexpected difference in the cost/unit or an efficiency variance arising from an unexpected difference in the quantity of the input used, or a combination of both. Copyright © 2022 Pearson Canada Inc. 7-3

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

6. When a direct materials input mix has substitutable inputs both the direct materials mix and the direct materials yield variance become important. 7. These elements of a Level 4 analysis permit the managers to assess how changes from what was expected affected the yield.

7-16 (20–30 min.) Flexible budget. Variance Analysis for Brabham Enterprises for August:

Units (tires) sold Revenues Variable costs Contribution margin Fixed costs Operating income

Actual Results (1) g 3,800 a $444,600 d 304,000 140,600 g 62,000 $ 78,600

Flexible-Budget Variances (2) = (1) – (3) 0 $ 7,600 F 11,400 U

Flexible Budget (3) 3,800 b $437,000 e 292,600

SalesVolume Variances (4) = (3) – (5) 200 U $23,000 U 15,400 F

Static Budget (5) g 4,000 c $460,000 f 308,000

3,800 U 2,000 F $1,800 U

144,400 g 64,000 $ 80,400

7,600 U 0 $ 7,600 U

152,000 g 64,000 $ 88,000

$1,800 U

$ 7,600 U

Total flexible-budget variance

$117 × 3,800 = $444,600 $115 × 4,000 = $460,000 e $77 × 3,800 = $292,600 g Given c

Total sales-volume variance

$9,400 U Total static-budget variance b $115 × 3,800 = $437,000 d Given. Unit variable cost = $304,000 ÷ 3,800 = $80 per tire f $77 × 4,000 = $308,000

2. The key information items are: Actual Units Unit selling price Unit variable cost Fixed costs

3,800 $ 117 $ 80 $ 62,000

Budgeted 4,000 $ 115 $ 77 $ 64,000

The total static-budget variance in operating income is $9,400 U. There is both an unfavourable total flexible-budget variance ($1,800) and an unfavourable sales-volume variance ($7,600).

Chapter 7: Flexible Budgets, Variances, and Management Control: I

The unfavourable sales-volume variance arises solely because actual units manufactured and sold were 200 less than the budgeted 4,000 units. The unfavourable flexible-budget variance of $1,800 in operating income is due primarily to the $3 increase in unit variable costs. This increase in unit variable costs is only partially offset by the $2 increase in unit selling price and the $2,000 decrease in fixed costs.

7-17 (15 min.)

Flexible budget.

The existing performance report is a Level 1 analysis, based on a static budget. It makes no adjustment for changes in output levels. The budgeted output level is 10,000 units––direct materials of $400,000 in the static budget ÷ budgeted direct materials cost per attaché case of $40. The following is a Level 2 analysis that presents a flexible-budget variance and a salesvolume variance of each direct cost category. Variance Analysis for Connor Company

Output units Direct materials Direct manufacturing labour Direct marketing labour Total direct costs

Actual Results (1) 8,800 $364,000 78,000 110,000 $552,000

FlexibleBudget Flexible Sales-Volume Variances Budget Variances (2) = (1) – (3) (3) (4) = (3) – (5) 0 8,800 1,200 U $12,000 U $352,000 $48,000 F 7,600 U 70,400 9,600 F 4,400 U 105,600 14,400 F $24,000 U $528,000 $72,000 F $24,000 U

Static Budget (5) 10,000 $400,000 80,000 120,000 $600,000

$72,000 F

Flexible-budget variance Sales-volume variance $48,000 F Static-budget variance

The Level 1 analysis shows total direct costs have a $48,000 favourable variance. However, the Level 2 analysis reveals that this favourable variance is due to the reduction in output of 1,200 units from the budgeted 10,000 units. Once this reduction in output is taken into account (via a flexible budget), the flexible-budget variance shows each direct cost category to have an unfavourable variance indicating less efficient use of each direct cost item than was budgeted, or the use of more costly direct cost items than was budgeted, or both.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Each direct cost category has an actual unit variable cost that exceeds its budgeted unit cost: Actual 8,800 $41.36 $8.86 $12.50

Units Direct materials Direct manufacturing labour Direct marketing labour

Budgeted 10,000 $40.00 $8.00 $12.00

Analysis of rate and efficiency variances for each cost category could assist in further identifying causes of these more aggregated (Level 2) variances.

7-18 (15 min.)

Direct Materials

Materials and manufacturing-labour variances.

Actual Costs Incurred (Actual Input Qty. × Actual Rate) $200,000

Actual Input Qty. × Standard Rate $214,000

Flexible Budget (Standard Input Qty. Allowed for Actual Output × Standard Rate) $225,000

$14,000 F $11,000 F Rate variance Efficiency variance $25,000 F Flexible-budget variance Direct Mfg. Labour

$90,000

$86,000 $4,000 U Rate variance

$80,000

$6,000 U Efficiency variance

$10,000 U Flexible-budget variance

7-19 (25 min.)

Rate and efficiency variances.

1. The key information items are: Output units (salads) Input units Cost per input unit

Actual 71,400 21,000 $1.10

Budgeted 70,000 20,000 $1.18

Doux Dulce budgets to obtain 3.50 (= 70,000 ÷ 20,000) kale salads from each kilogram of kale. The flexible-budget variance is $972 F.

Chapter 7: Flexible Budgets, Variances, and Management Control: I

Actual Results (1) 23,100a

Kale costs

FlexibleBudget Variance (2) = (1) – (3) $972 F

SalesFlexible Volume Budget Variance (3) (4) = (3) – (5) $24,072b $472 U

Static Budget (5) $23,600c

a21,000  $1.10 = $23,100 b71,400 ÷ 3.50  $1.18 = $24,072 c70,000 ÷ 3.50  $1.18 = $23,600

2. Actual Costs Incurred (Actual Input  Actual Price $23,100a

Actual Input  Budgeted Price $24,780b $1,680 F $708 U

Price variance

Flexible Budget (Budgeted Input Allowed for Actual Output Achieved  Budgeted Price) $24,072c

Efficiency variance $972 F

Flexible-budget variance a21,000  $1.10 = $23,100 b21,000  $1.18 = $24,780 (no inventory involved) c71,400 ÷ 3.50  $1.18 = $24,072

3. The favourable flexible-budget variance of $972 has two offsetting components: (a) favourable price variance of $1,680—reflects the $1.10 actual purchase cost being lower than the $1.18 budgeted purchase cost per kilogram. (b) unfavourable efficiency variance of $708—reflects the actual materials yield of 3.40 salads per kilogram of kale (71,400 ÷ 21,000 = 3.40) being less than the budgeted yield of 3.50 (70,000 ÷ 20,000 = 3.50) Overall, one explanation is that Doux Dulce purchased lower-quality kale at a lower cost per kilogram.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

7-20 (30-40 min.) Flexible budget and sales volume variances 1. and 2. Performance Report for Cascade, Inc., June

Units (pounds) Revenues Variable mfg. costs Contribution margin

Actual (1) 460,000 $2,626,600 1,651,400 $975,200

Flexible Budget Variances (2) = (1) – (3) — $ 41,400 U 41,400 U $ 82,800 U

Flexible Budget (3) 460,000 $2,668,000a 1,610,000b $1,058,000

$82,800 U Flexible-budget variance

Sales Volume Variances (4) = (3) – (5) 13,000 F $75,400 F 45,500 U $ 29,900 F

Static Budget (5) 447,000 $2,592,600 1,564,500 $1,028,100

$ 29,900 F Sales-volume variance

$52,900 U Static-budget variance aBudgeted selling price = $2,592,600 ÷ 447,000 lbs = $5.80 per lb.

Flexible-budget revenues = $5.80 per lb. × 460,000 lbs. = $2,668,000 bBudgeted variable mfg. cost per unit = $1,564,500 ÷ 447,000 lbs. = $3.50

Flexible-budget variable mfg. costs = $3.50 per lb. × 460,000 lbs. = $1,610,000

Static Budget Variance (6) = (1) – (5) 13,000 F $34,000 F 86,900 U $52,900 U

Static Budget Variance as % of Static Budget (7) = (6)  (5) 2.91% 1.31% 5.55% 5.15%

Chapter 7: Flexible Budgets, Variances, and Management Control: I

3. The selling price variance, caused solely by the difference in actual and budgeted selling price, is the flexible-budget variance in revenues = $41,400 U. 4. The flexible-budget variances show that for the actual sales volume of 460,000 pounds, selling prices were lower and costs per pound were higher. The favourable sales volume variance in revenues (because more pounds of ice cream were sold than budgeted) helped offset the unfavourable variable cost variance and shored up the results in June. Geller should be more concerned because the static-budget variance in contribution margin of $52,900 U is actually made up of a favourable sales-volume variance in contribution margin of $29,900, an unfavourable selling-price variance of $41,400 and an unfavourable variable manufacturing costs variance of $41,400. Adler should analyze why each of these variances occurred and the relationships among them. Could the efficiency of variable manufacturing costs be improved? The sales volume appears to have increased due to the lower average selling price per pound.

7-21 (30 min.)

Flexible-budget preparation and analysis.

1. Variance Analysis for Trustex Printers Inc. for September Level 1 Analysis

Units sold Revenue Variable costs Contribution margin Fixed costs Operating income

Actual Results (1) 10,000 a $252,000 d 70,000 182,000 150,000 $ 32,000

Static-Budget Static Variances Budget (2) = (1) – (3) (3) 5,000 U 15,000 c $ 48,000 U $300,000 50,000 F 120,000f 2,000 F 180,000 5,000 U 145,000 $ 3,000 U $ 35,000 $3,000 U

Total static-budget variance

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Level 2 Analysis

Units sold Revenue Variable costs Contribution margin Fixed costs Operating income

Actual Results (1) 10,000 a $252,000 d 70,000

FlexibleSales Budget Flexible Volume Static Variances Budget Variances Budget (2) = (1) – (3) (3) (4) = (3) – (5) (5) 0 10,000 5,000 U 15,000 b c $52,000 F $200,000 $100,000 U 300,000 e f 10,000 F 80,000 40,000 F 120,000

182,000 150,000

62,000 F 5,000 U

120,000 145,000

60,000 U 0

180,000 145,000

$ 32,000

$57,000 F

$(25,000) $60,000 U

$ 35,000

$57,000 F $60,000 U Total flexible-budget Total sales-volume variance variance $3,000 U Total static-budget variance a

10,000 × $25.20 = $252,000 b 10,000 × $20 = $200,000 c 15,000 × $20 = $300,000

10,000 × $7 = $70,000 10,000 × $8 = $80,000 f 15,000 × $8 = $120,000 e

3. Level 2 analysis breaks down the static-budget variance into a flexible-budget variance and a sales-volume variance. The primary reason for the static-budget variance being unfavourable ($3,000 U) is the reduction in unit volume from the budgeted 15,000 to an actual 10,000. One explanation for this reduction is the increase in selling price from a budgeted $20 to an actual $25.20. Operating management was able to reduce variable costs by $10,000 relative to the flexible budget. This reduction could be a sign of efficient management. Alternatively, it could be due to using lower-quality materials (which in turn adversely affected unit volume).

Chapter 7: Flexible Budgets, Variances, and Management Control: I

7-22 (30 min.)

Flexible budget, working backward.

1. Variance Analysis for The Clarkson Company for the year ended December 31. FlexibleBudget Variances (2) = (1) (3)

Flexible Budget (3)

130,000 0 $715,000 $260,000 F 515,000 255,000 U 200,000 5,000 F 140,000 20,000 U $ 60,000 $ 15,000 U

130,000 $455,000a 260,000b 195,000 120,000 $ 75,000

Actual Results (1)

Units sold Revenues Variable costs Contribution margin Fixed costs Operating income

Sales-Volume Variances (4) = (3) (5)

Static Budget (5)

10,000 F $35,000 F 20,000 U 15,000 F 0 $15,000 F

120,000 $420,000 240,000 180,000 120,000 $ 60,000

$15,000 U $15,000 F Total flexible-budget variance Total sales volume variance $0 Total static-budget variance a130,000 × $3.50 = $455,000; $420,000 ÷ 120,000 = $3.50 b130,000 × $2.00 = $260,000; $240,000 ÷ 120,000 = $2.00

2. Actual selling price: Budgeted selling price: Actual variable cost per unit: Budgeted variable cost per unit:

$715,000  130,000 420,000 ÷ 120,000 515,000 ÷ 130,000 240,000 ÷ 120,000

= = = =

$5.50 $3.50 $3.96 $2.00

3. A zero total static-budget variance may be due to offsetting total flexible-budget and total sales-volume variances. In this case, these two variances exactly offset each other: Total flexible-budget variance Total sales-volume variance

$15,000 Unfavourable $15,000 Favourable

A closer look at the variance components reveals some major deviations from plan. Actual variable costs increased from $2.00 to $3.96, causing an unfavourable flexible-budget variable cost variance of $255,000. Such an increase could be a result of, for example, a jump in direct material prices. Clarkson was able to pass most of the increase in costs onto their customers—actual selling price increased by 57% [($5.50 – $3.50) ÷ $3.50], bringing about an offsetting favourable flexible-budget revenue variance in the amount of $260,000. An increase in the actual number of units sold also contributed to more favourable results. The company should examine why the units sold increased despite an increase in direct material prices. For example, Clarkson’s customers may have stocked up, anticipating future increases in direct material prices. Alternatively, Clarkson’s selling price increases may have been lower than competitors’ price increases. Understanding the reasons why actual results differ from budgeted amounts can help Clarkson better manage its costs and pricing decisions in the future. The important lesson learned here is that a superficial examination of summary level data (Levels 0

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

and 1) may be insufficient. It is imperative to scrutinize data at a more detailed level (Level 2). Had Clarkson not been able to pass costs on to customers, losses would have been considerable.

7-23 (20–30 min.) Price and efficiency variances. 1. The key information items are: Output units (scones) Input units (kilograms pumpkin) Cost per input unit

Actual 59,200 16,000 $ 0.85

Budgeted 59,000 14,750 $ 0.92

Sunshine budgets to obtain 3 pumpkin scones from each kilogram of pumpkin. The flexible-budget variance is $16 F.

Pumpkin costs

Actual Results (1) $13,600a

FlexibleBudget Variance (2) = (1) – (3) $16 F

Flexible Budget (3) $13,616b

Sales-Volume Static Variance Budget (4) = (3) – (5) (5) $46 U $13,570c

a16,000 × $0.85 = $13,600 b59,200 × 0.25 × $0.92 = $13,616 c59,000 × 0.25 × $0.92 = $13,570

2. Actual Costs Incurred (Actual Input Qty. × Actual Price) $13,600a

Actual Input Qty. × Budgeted Price $14,720b

$1,120 F Price variance

Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) $13,616c

$1,104 U Efficiency variance

$16 F Flexible-budget variance a16,000 × $0.85 = $13,600 b16,000 × $0.92 = $14,720 c59,200 × 0.25 × $0.92 = $13,616

3. The favourable flexible-budget variance of $16 has two offsetting components: (a) favourable price variance of $1,120––reflects the $0.85 actual purchase cost being lower than the $0.92 budgeted purchase cost per kilogram. (b) unfavourable efficiency variance of $1,104––reflects the actual materials yield of 3.80 scones per kilogram of pumpkin (59,200 ÷ 16,000 = 3.70) being less than the budgeted yield of 4.00 (59,000 ÷ 14,750 = 4.00). The company used more pumpkins (materials) to make the scones than was budgeted.

Chapter 7: Flexible Budgets, Variances, and Management Control: I

One explanation may be that Sunshine purchased lower quality pumpkins at a lower cost per kilogram.

7-24 (30 min.)

Materials and manufacturing labour variances, standard costs with inventory.

1. Direct Materials Actual Costs Incurred (Actual Input Qty. × Actual Rate)

Actual Input Qty. × Budgeted Rate

(3,700 sq. m × $5.10) $18,870

(3,700 sq. m × $5.00) $18,500

$370 U Rate variance

Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate) (2,000 × 2 × $5.00) (4,000 sq. m × $5.00) $20,000

$1,500 F Efficiency variance $1,130 F

Flexible-budget variance The unfavourable materials rate variance may be unrelated to the favourable materials efficiency variance. For example, (a) the purchasing officer may be less skillful than assumed in the budget, or (b) there was an unexpected increase in materials rate per square metre due to reduced competition. Similarly, the favourable materials efficiency variance may be unrelated to the unfavourable materials rate variance. For example, (a) the production manager may have been able to employ higher-skilled workers, or (b) the budgeted materials standards were set too loosely. It is also possible that the two variances are interrelated. The higher materials input rate may be due to higher quality materials being purchased. Less material was used than budgeted due to the higher quality of the materials.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Direct Manufacturing Labour

Actual Costs Incurred (Actual Input Qty. × Actual Rate)

Actual Input Qty. × Budgeted Rate

(900 hrs. × $9.80) $8,820

(900 hrs. × $10.00) $9,000

Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate) (2,000 × 0.5 × $10.00) (1,000 hrs. × $10.00) $10,000

$180 F $1,000 F Rate variance Efficiency variance $1,180 F Flexible-budget variance The favourable labour rate variance may be due to, say, (a) a reduction in labour rates due to a recession, or (b) the standard being set without detailed analysis of labour compensation. The favourable labour efficiency variance may be due to, say, (a) more efficient workers being employed, (b) a redesign in the plant enabling labour to be more productive, or (c) the use of higher quality materials. 2.

Control Point Purchasing

Production

Actual Costs Incurred (Actual Input Qty. × Actual Rate) (6,000 sq. m × $5.10) $30,600

Actual Input Qty. × Budgeted Rate (6,000 sq. m × $5.00) $30,000

$600 U Rate variance (3,700 sq. m × $5.00) $18,500

Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate)

(2,000 × 2 × $5.00) $20,000

$1,500 F Efficiency variance Direct manufacturing labour variances are the same as in requirement 1.

Chapter 7: Flexible Budgets, Variances, and Management Control: I

7-25 (30 min.)

Journal entries and T-accounts. (continuation of 7-24)

For requirement 1 from Exercise 7-24: a. Direct Materials Control Direct Materials Rate Variance Accounts Payable Control To record purchase of direct materials.

18,500 370

b. Work-in-Process Control Direct Materials Efficiency Variance Direct Materials Control To record direct materials used.

20,000

18,870

1,500 18,500

c. Work-in-Process Control 10,000 Direct Manufacturing Labour Rate Variance Direct Manufacturing Labour Efficiency Variance Wages Payable Control To record liability for and allocation of direct labour costs. Direct Materials Control (a) 18,500 (b) 18,500

Work-in-Process Control (b) 20,000 (c) 10,000 Wages Payable Control (c) 8,820

Direct Materials Rate Variance (a) 370 Direct Manufacturing Labour Rate Variance (c) 180

180 1,000 8,820

Direct Materials Efficiency Variance (b) 1,500 Direct Manuf. Labour Efficiency Variance (c) 1,000

Accounts Payable Control (a) 18,870

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

For requirement 2 from Exercise 7-24: The following journal entries pertain to the measurement of price and efficiency variances when 6,000 sq. m of direct materials are purchased: a1. Direct Materials Control Direct Materials Rate Variance Accounts Payable Control To record direct materials purchased.

30,000 600

a2. Work-in-Process Control Direct Materials Efficiency Variance Direct Materials Control To record direct materials used.

20,000

Direct Materials Control (a1) 30,000 (a2) 18,500

Accounts Payable Control (a1) 30,600

30,600

1,500 18,500

Direct Materials Rate Variance (a1) 600

Work-in-Process Control (a2) 20,000

Direct Materials Efficiency Variance (a2) 1,500 The T-account entries related to direct manufacturing labour are the same as in requirement 1. The difference between standard costing and normal costing for direct cost items is: Standard Costs Normal Costs Direct Costs Standard rate(s) Actual rate(s) × Standard input × Actual input allowed for actual outputs achieved These journal entries differ from the normal costing entries because Work-in-Process Control is no longer carried at “actual” costs. Furthermore, Direct Materials Control is carried at standard unit rates rather than actual unit rates. Finally, variances appear for direct materials and direct manufacturing labour under standard costing but not under normal costing.

Chapter 7: Flexible Budgets, Variances, and Management Control: I

7-26 (20 min.)

Direct materials and direct manufacturing labour variances.

May Lots Direct materials Direct labour Total price variance Total efficiency variance

Actual Results (1) 325 $31,525.00 $ 9,009.00

Price Variance (2) = (1) – (3) $1,300.00 U $ 71.50 U $1,371.50 U

Actual Quantity × Budgeted Price (3)

Efficiency Variance (4) = (3) – (5)

$30,225.00a $ 8,937.50c

$3,022.50 U $812.50 F

Flexible Budget (5) 325 $27,202.50b $9,750.00d

$2,210.00 U

a6,500 metres × $4.65 per metre = $30,225 b325 lots × 18 metres per lot × $4.65 per metre = $27,202.50 c715 hours × $12.50 per hour = $8,937.50 d3250 lots × 2.4 hours per lot × $12.50 per hour = $9,750.00

Total flexible-budget variance for both inputs = $1,371.50 U + $2,210.00 U = $3,581.50 U Total flexible-budget cost of direct materials and direct labour = $27,202.50 + $9,750.00 = $36,952.50 Total flexible-budget variance as % of total flexible-budget costs = $3,581.50 ÷ $36,952.50 = 9.69% 2. It is unclear whether the excess use of materials will continue, or whether it was indeed a result of workers getting accustomed to the new fabric. The time required was indeed lower as predicted, but not nearly enough to overcome the unfavourable direct material efficiency variance. However, direct labour usage will probably decline even further as workers gain experience in working with the new material. The unfavourable direct labour price variance is insignificant and unlikely to be related to the change of material. Rugged Life may wish to continue to use the new material, especially in light of its superior quality and feel, but it may want to keep the following points in mind: 

The new material costs substantially more than the old ($4.85 versus $4.65 per metre). Its price is unlikely to come down even more within the coming year. Standard material price should be reexamined and possibly changed.



Rugged Life should continue to work to reduce direct materials and direct manufacturing labour usage.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

7-27 (30 min.)

Price and efficiency variances, journal entries.

1. Direct materials and direct manufacturing labour are analyzed in turn: Actual Costs Incurred (Actual Input Qty. × Actual Price) Direct Materials

(100,000 × $4.65a) $465,000

Actual Input Qty. × Budgeted Price Purchases Usage (100,000 × $4.50) $450,000

(98,055 × $4.50) $441,248

$15,000 U Price variance Direct Manufacturing Labour

Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price)

(4,900 × $31.5b) $154,350

(9,850 × 10 × $4.50) $443,250

$2,002 F Efficiency variance (9,850 × 0.5 × $30) or (4,925 × $30) $147,750

(4,900 × $30) $147,000 $7,350 U Price variance

$750 F Efficiency variance

a$465,000 ÷ 100,000 = $4.65 b$154,350 ÷ 4,900 = $31.5

2. Direct Materials Control Direct Materials Price Variance Accounts Payable or Cash Control

450,000 15,000 465,000

Work-in-Process Control Direct Materials Control Direct Materials Efficiency Variance

443,250

Work-in-Process Control Direct Manuf. Labour Price Variance Wages Payable Control Direct Manuf. Labour Efficiency Variance

147,750 7,350

441,248 2,002

154,350 750

3. Some students’ comments will be immersed in conjecture about higher prices for materials, better quality materials, higher grade labour, better efficiency in use of materials, and so forth. A possibility is that approximately the same labour force, paid somewhat more, is taking slightly less time with better materials and causing less waste and spoilage. A key point in this problem is that all of these efficiency variances are likely to be insignificant. They are so small as to be nearly meaningless. Fluctuations about standards are bound to occur in a random fashion. Practically, from a control viewpoint, a standard is a band or range of acceptable performance rather than a single-figure measure.

Chapter 7: Flexible Budgets, Variances, and Management Control: I

4. The purchasing point is where responsibility for price variances is found most often. The production point is where responsibility for efficiency variances is found most often. The Schuyler Corporation may calculate variances at different points in time to tie in with these different responsibility areas.

PROBLEMS 7-28 (30 min.)

Variance analysis, non-manufacturing setting.

1. Lightning Car Detailing Statement of Comprehensive Income Variances For the Month Ended June 30

Cars Detailed

Budget 200

Actual 225

Static Budget Variance 25 F

Revenue

$ 30,000

$ 39,375

$ 9,375 F

Variable costs: Costs of supplies Labour

1,500 5,600

2,250 6,000

750 U 400 U

Total variable costs

7,100

8,250

1,150 U

Contribution margin

22,900

31,125

8,225 F

Fixed costs

9,500

$ 13,400

$ 21,625

Operating income

$ 8,225 F

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. To compute flexible budget variances for revenues and the variable costs, first calculate the budgeted cost or revenue per car, and then multiply that by the actual number of cars detailed. Subtract the actual revenue or cost, and the result is the flexible budget variance. FBV(Revenue) = Actual revenue – (Actual number of cars  (Budgeted revenue/Budgeted number of cars)) = $39,375 – (225  ($30,000/200)) = $39,375 – $33,750 = $5,625 F FBV(Supplies) = Actual supplies expense – (Actual number of cars  (Budgeted cost of supplies/Budgeted number of cars)) = $2,250 – (225  ($1,500/200)) = $2,250 – $1,687.50 = $562.50 U FBV(Labour) = Actual labour expense – (Actual number of cars  (Budgeted cost of labour/Budgeted number of cars)) = $6,000 – (225  ($5,600/200)) = $6,000 – $6,300 = $300 F The flexible budget variance for fixed costs is the same as the static budget variance, and equals $0 in this case. Therefore, the overall flexible budget variance in income is given by aggregating the variances computed earlier, adjusting for whether they are favourable or unfavourable. This yields: FBV(Operating Income) = $5,625 F (–) $562.50 U (+) $300 F = $5,362.50 F 3. In addition to understanding the variances computed above, Stevie should attempt to keep track of the number of cars worked on by each employee, as well as the number of hours actually spent on each car. In addition, Stevie should look at the prices charged for detailing, in relation to the hours spent on each job.

Chapter 7: Flexible Budgets, Variances, and Management Control: I

4. This is a problem of two equations and two unknowns. The two equations relate to the number of cars detailed and the labour costs (the wages paid to the employees). X = number of cars detailed by long-term employee Y = number of cars detailed by both short-term employees (combined) Budget: X + Y 40X + 20Y

= 200 = 5,600

Substitution: 40X + 20(200-X) = 5,600 20X = 1600 X = 80 Y = 120

Actual: X + Y = 225 40X + 20Y = 6,000 Substitution: 40X + 20(225-X) = 6,000 20X = 1500 X = 75 Y = 150

Therefore the long-term employee is budgeted to detail 80 cars, and the new employees are budgeted to detail 60 cars each. Actually, the long-term employee details 75 cars (and grosses $3,000 for the month), and the other two wash 75 each and gross $1,500 apiece. 5. The two short-term employees are budgeted to earn gross wages of $18,000 per year: 150 ÷ 2 × 2 hrs × $10 = $1,500 × 12 months = $18,000 (if June is typical, and less if it is a highvolume month). If this is a part-time job for them, then that is fine. If it is full-time, and they only get paid for what they wash, the excess capacity may be causing motivation problems. Stevie needs to determine a better way to compensate employees to encourage retention. This should increase customer satisfaction, and potentially revenue, because longer-term employees do a more thorough job. In addition, rather than paying the same wage per car, Stevie might consider setting quality standards and improvement goals for all of the employees.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

7-29 (2030 min.) Materials and manufacturing labour variances, standard costs. 1. Direct Materials Actual Costs Incurred (Actual Input Qty. × Actual Price) (6,200 sq. metres. × $5.70) $35,340

Actual Input Qty. × Budgeted Price

Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price)

(2,200 × 3 × $5.50) (6,200 sq. metres. × $5.50) (6,600 sq. metres. × $5.50) $34,100 $36,300

$1,240 U Price variance

$2,200 F Efficiency variance

$960 F Flexible-budget variance The unfavourable materials price variance may be unrelated to the favourable materials efficiency variance. For example, (a) the purchasing officer may be less skillful than assumed in the budget, or (b) there was an unexpected increase in materials price per square metre due to reduced competition. Similarly, the favourable materials efficiency variance may be unrelated to the unfavourable materials price variance. For example, (a) the production manager may have been able to employ higher-skilled workers, or (b) the budgeted materials standards were set too loosely. It is also possible that the two variances are interrelated. The higher materials input price may be due to higher quality materials being purchased. Less material was used than budgeted due to the high quality of the materials. Direct Manufacturing Labour Actual Costs Incurred (Actual Input Qty. × Actual Price)

Actual Input Qty. × Budgeted Price

(920 hrs. × $10.70) $9,844

(920 hrs. × $10.50) $9,660

Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price) (2,200 × 0.5 × $10.50) (1,100 hrs. × $10.50) $11,550

$184 U $1,890 F Price variance Efficiency variance $1,706 F Flexible-budget variance The unfavourable labour price variance may be due to, say, (a) an increase in labour rates due to a booming economy, or (b) the standard being set without detailed analysis of labour compensation. The favourable labour efficiency variance may be due to, say, (a) more efficient workers being employed, (b) a redesign in the plant enabling labour to be more productive, or (c) the use of higher quality materials. Copyright © 2022 Pearson Canada Inc. 7-22

Chapter 7: Flexible Budgets, Variances, and Management Control: I

Control Point Purchasing

Actual Costs Incurred (Actual Input Qty. × Actual Price) (8,700 sq. metres.× $5.70) $49,590

Actual Input Qty. × Budgeted Price (8,700 sq. metres. × $5.50) $47,850

Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price)

$1,740 U Price variance

Production

(6,200 sq. yds.× $5.50) $34,100

(2,200 × 3 × $5.50) $36,300

$2,200 F Efficiency variance

Direct manufacturing labour variances are the same as in requirement 1.

7-30 (2025 min.) Journal entries and T-accounts (continuation of 7-29). For requirement 1 from Exercise 7-29: a. Direct Materials Control Direct Materials Price Variance Accounts Payable Control To record purchase of direct materials. b. Work-in-Process Control Direct Materials Efficiency Variance Direct Materials Control To record direct materials used.

34,100 1,240 35,340 36,300

c. Work-in-Process Control 11,550 Direct Manufacturing Labour Price Variance 184 Direct Manufacturing Labour Efficiency Variance Wages Payable Control To record liability for and allocation of direct labour costs.

2,200 34,100

1,890 9,844

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Direct Materials Control (a) 34,100 (b) 34,100 Work-in-Process Control (b) 36,300 (c) 11,550 Wages Payable Control (c) 9,844

Direct Materials Price Variance (a) 1,240

Direct Materials Efficiency Variance (b) 2,200

Direct Manufacturing Labour Price Variance (a) 184

Direct Manuf. Labour Efficiency Variance (c) 1,890

Accounts Payable Control (a) 35,340

For requirement 2 from Exercise 7-29: The following journal entries pertain to the measurement of price and efficiency variances when 8,700 sq. metres. of direct materials are purchased: a1. Direct Materials Control Direct Materials Price Variance Accounts Payable Control To record direct materials purchased.

47,850 1,740

a2. Work-in-Process Control Direct Materials Control Direct Materials Efficiency Variance To record direct materials used.

36,300

49,590

34,100 2,200

Direct Materials Control (a1) 47,850 (a2) 34,100

Direct Materials Price Variance (a1) 1,740

Accounts Payable Control (a1) 49,590

Work-in-Process Control (a2) 36,300

Direct Materials Efficiency Variance (a2) 2,200

Chapter 7: Flexible Budgets, Variances, and Management Control: I

The T-account entries related to direct manufacturing labour are the same as in requirement 1. The difference between standard costing and normal costing for direct cost items is: Direct Costs

Standard Costs Standard price(s) × Standard input allowed for actual outputs achieved

Normal Costs Actual price(s) × Actual input

These journal entries differ from the normal costing entries because Work-in-Process Control is no longer carried at “actual” costs. Furthermore, Direct Materials Control is carried at standard unit prices rather than actual unit prices. Finally, variances appear for direct materials and direct manufacturing labour under standard costing but not under normal costing.

7-31 (20–30 min.) Direct materials and manufacturing labour variances, solving unknowns. All given items are designated by an asterisk.

Direct Manufacturing Labour

Actual Costs Incurred (Actual Input Qty. × Actual Rate)

Actual Input Qty. × Budgeted Rate

Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate)

(1,900 × $21) $39,900

(1,900 × $20*) $38,000

(4,000* × 0.5* × $20*) $40,000

$1,900 U* Rate variance

Direct Materials

(13,000 × $5.25) $68,250*

Purchases (13,000 × $5*) $65,000

$2,000 F* Efficiency variance Usage (12,500 × $5*) $62,500

$3,250 U* Rate variance 1.

(4,000* × 3* × $5*) $60,000

$2,500 U* Efficiency variance

4,000 units × 0.5 hours/unit = 2,000 hours

2. Flexible budget – Efficiency variance = $40,000 – $2,000 = $38,000 Actual DMLH = $38,000 ÷ Budgeted rate of $20/hour = 1,900 hours 3. $38,000 + Rate variance, $1,900 = $39,900, the actual direct manuf. labour cost Actual rate = Actual cost ÷ Actual hours = $39,900 ÷ 1,900 hours = $21/hour

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4. Standard qty. of direct materials = 4,000 units × 3 kg/unit = 12,000 kg 5. Flexible budget + Dir. matls. effcy. var. = $60,000 + $2,500 = $62,500 Actual quantity of dir. matls. used = $62,500 ÷ Budgeted rate per kilogram = $62,500 ÷ $5/lb = 12,500 kg 6.

Actual cost of direct materials, $68,250 – Rate variance, $3,250 = $65,000 Actual qty. of direct materials purchased = $65,000 ÷ Budgeted rate, $5/kg = 13,000 kg

Actual direct materials rate = $68,250 ÷ 13,000 kg = $5.25 per kilogram

7-32 (30 min.)

Direct manufacturing labour and direct materials variances, missing data.

Direct mfg. labour

Actual Costs Incurred (Actual Actual Input Qty. Input Qty. × Actual Rate) × Budgeted Rate $368,000a $384,000b $16,000 F Rate variance

Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate) $360,000c

$24,000 U Efficiency variance

$8,000 U Flexible-budget variance aGiven (or 32,000 hours × $11.50/hour) b32,000 hours × $12/hour = $384,000 c6,000 units × 5 hours/unit × $12/hour = $360,000

2. Unfavourable direct materials efficiency variance of $12,500 indicates that more kilograms of direct materials were actually used than the budgeted quantity allowed for actual output. =

$12,500 efficiency variance $2 per kilogram budgeted rate

= 6,250 kg Budgeted kilograms allowed for the output achieved = 6,000 × 20 = 120,000 kilograms Actual kilograms of direct materials used = 120,000 + 6,250 = 126,250 kilograms Copyright © 2022 Pearson Canada Inc. 7-26

Chapter 7: Flexible Budgets, Variances, and Management Control: I

3. Actual rate paid per kilogram =

$292,500 150,000 = $1.95 per kilogram

Actual Costs Incurred (Actual Input × Actual Rate) $292,500a

Actual Input × Budgeted Rate $300,000b

$7,500 F Rate variance aGiven b150,000 kilograms × $2/kilogram = $300,000

7-33 (30 min.)

Flexible budget, direct materials and direct manufacturing labour variances.

Variance Analysis for Emerald Statuary for 2021 Actual Results

Units sold Revenues Direct materials Direct manufacturing labour Fixed costs Total costs Operating income

FlexibleBudget Variances

Flexible Budget

SalesVolume Variances

Static Budget

(1) (2) = (1) – (3) (3) (4) = (3) – (5) (5) 4,800a 0 4,800 2,200 U 7,000a $3,456,000b $192,000 F $3,264,000c $1,496,000 U $4,760,000d $ 392,700

$ 8,700 U $ 384,000e $ 176,000 F

$ 560,000f

878,400a 9,600 F 888,000g 407,000 F 1,295,000h a a 1,170,000 230,000 F 1,400,000 0 1,400,000a $2,441,100 $230,900 F $2,672,000 $ 583,000 F $3,255,000 $1,014,900 $422,900 F $ 592,000 $ 913,000 U $1,505,000 $422,900 F $913,000 U Flexible-budget variance Sales-volume variance $490,100 U Static-budget variance

aGiven b$720/unit × 4,800 units = $3,456,000 c$680/unit × 4,800 units = $3,264,000 d$680/unit × 7,000 units = $4,760,000 e$80/unit

× 4,800 units = $384,000 × 7,000 units = $560,000 g$185/unit × 4,800 units = $888,000 h$185/unit × 7,000 units = $1,295,000 f$80/unit

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Actual Incurred (Actual Input Qty. × Actual Price)

Actual Input Qty. × Budgeted Price

Flexible Budget (Budgeted Input Qty. Allowed for Actual Output × Budgeted Price)

$392,700a

$528,000b

$384,000c

Direct materials

$135,300 F Price variance

$144,000 U Efficiency variance $8,700 U Flexible-budget variance

Direct manufacturing labour

$878,400d

$915,000e

$888,000f

$36,600 F Price variance

$27,000 U Efficiency variance $9,600 F Flexible-budget variance

a66,000 kilograms × $5.95/kilogram = $392,700 b66,000 kilograms × $8/kilogram = $528,000 c4,800 statues × 10 kilograms/statue × $8/kilogram = 48,000 kilograms × $8/kilogram = $384,000 d18,300 hours × $48/hour = $878,400 e18,300 hours × $50/hour = $915,000 f4,800 statues × 3.7 hours/statue × $50/hour = 17,760 hours × $50/hour = $888,000

7-34 (30 min.)

Variance analysis, nonmanufacturing setting

1. This is a problem of two equations & two unknowns. The two equations relate to the number of offices cleaned and the labour costs (the wages paid to the employees). X = number of offices cleaned by the experienced employee Y = number of offices cleaned by the less experienced employees (combined) Budget:

X + Y = 140 $30X + $15Y = $3,360 Substitution: 30X + 15(140 – X) = 3,360 15X = 1,260 X= 84 offices Y=140 – 84 = 56 offices

Actual: X + Y = 160 $30X + $15Y = $4,200 Substitution: 30X + 15(160 – X) = 4,200 15X = 1,800 X = 120 offices Y= 160 – 120 = 40 offices

Budget: The experienced employee is budgeted to clean 84 offices (and earn $2,520), and the less experienced employees are budgeted to clean 28 offices each and earn $420 apiece. Actual: The experienced employee cleans 120 offices (and grosses $3,600 for the month), and the other two clean 20 offices each and gross $300 apiece. Copyright © 2022 Pearson Canada Inc. 7-28

Chapter 7: Flexible Budgets, Variances, and Management Control: I

Offices cleaned Revenues Variable costs Supplies Labour – Experienced Labour – Less experienced Total variable costs Contribution Margin Fixed costs Operating income

Actual Results (1) 160

FlexibleBudget Variances (2) = (1) – (3)

Flexible Budget (3) 160

Sales Volume Variance (4) = (3) – (5)

Static Budget (5) 140

$36,000

$ 5,600 F

$30,400a

$ 3,800 F

$ 26,600

680 3,600 600

40 F 720 U 360 F

720b 2,880c 960d

90 U 360 U 120 U

630 2,520 840

4,880 31,120 4,900 $26,220

320 U 5,280 F 0 $ 5,280 F

4,560 25,840 4,900 $20,940

570 U 3,230 F 0 $ 3,230 F

3,990 22,610 4,900 $17,710

a160 × ($26,600/140) b160 × ($630/140) c160 × ($2,520/140) d160 × ($840/140)

3. Actual sales price = $36,000 ÷ 160 = $225 Sales Price Variance = (Actual sales price – Budgeted sales price) × Actual number of offices cleaned: = ($225 – $190) × 160 = $5,600 Favourable Labour efficiency for experienced worker: Standard offices expected to be completed by experienced worker based on actual number of offices cleaned = (84 ÷ 140) × 160 = 96 offices Labour efficiency variance = Budgeted wage rate per office × (Actual offices cleaned – budgeted offices cleaned) = $30 × (120 – 96) = $720 Unfavourable Labour efficiency for less-experienced workers: Standard offices expected to be completed by less-experienced workers based on actual number of offices cleaned = (56 ÷ 140) × 160 = 64 offices Labour efficiency variance = Budgeted wage rate per office × (Actual offices cleaned – budgeted offices cleaned) = $15 × (40 – 64) = $360 Favourable

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Note that these are the same as the flexible budget variances calculated earlier for labour. Since there were no wage increases, the labour price variances are zero, and so the flexible budget variance and the efficiency variance for labour are the same. 4. In addition to understanding the variances computed above, Brown should attempt to keep track of the number of offices cleaned by each employee, as well as the number of hours actually spent on each office. In addition, Brown should look at the prices charged for cleaning, in relation to the hours spent on each job. It should also be considered whether the experienced worker should be asked to take less time per office, given her prior years at work and the fact that she is paid twice the wage rate of the lessexperienced employees.

7-35 (35 min.)

Variances in the service sector

1. Skilled ($20 × 3 hrs.) Unskilled ($10 × 2 hrs.) Cost per job Number of jobs Total budgeted cost

60 20 $ 80 × 600 units $ 48,000

2. Solution Exhibit presents the total price variance ($1,151 F), the total efficiency variance ($1,560 U), and the total flexible-budget variance ($409 U).  SOLUTION EXHIBIT Columnar Presentation of Direct Labour Price and Efficiency Variances for Clean Ride Enterprises

Skilled Unskilled

Actual Costs Incurred (Actual Input Quantity × Actual Price) (1) $39,117 9,292 $48,409

Flexible Budget (Budgeted Input Quantity Allowed for Actual Output × Budgeted Price) (3) 1,800 × $20 = $36,000 1,200 × $10 = 12,000 $48,000

Actual Input Quantity × Budgeted Price (2) 2,006 × $20 = $40,120 944 × $10 = 9,440 $49,560 $1,151 F Total price variance

$1,560 U Total efficiency variance

$409 U Total flexible-budget variance F = favourable effect on operating income; U = unfavourable effect on operating income

Chapter 7: Flexible Budgets, Variances, and Management Control: I

3. In a company where there is a mixture of workers, some at higher wages and others at lower, all working on the same projects, an unfavourable efficiency variance can be the result of which employees worked on the project, not just how many hours were spent. If higher paid workers worked more than their standard percentage of the time, an unfavourable efficiency variance will result. 4.

Skilled: Unskilled: Total

Actual Quantity of Input 2,006 hours 944 hours 2,950 hours

Actual Mix 68.0% 32.0% 100.0%

Budgeted Quantity of Input for Actual Output 3 hours × 600 units = 1,800 hours 2 hours × 600 units = 1,200 hours 3,000 hours

Budgeted Mix 60% 40% 100%

5. Solution Exhibit presents the total direct labour yield and mix variances for Clean Ride Enterprises.  SOLUTION EXHIBIT Columnar Presentation of Direct Labour Yield and Mix Variances for Clean Ride Enterprises

Actual Total Quantity of All Inputs Used × Actual Input Mix × Budgeted Price (1) Skilled: 2,950 × 0.68 × $20 = $40,120 Unskilled: 2,950 × 0.32 × $10 = 9,440 $49,560

Actual Total Quantity of All Inputs Used × Budgeted Input Mix × Budgeted Price (2) 2,950 × 0.60 × $20 = $35,400 2,950 × 0.40 × $10 = 11,800 $47,200

Flexible Budget: Budgeted Total Quantity of All Inputs Allowed for Actual Output × Budgeted Input Mix × Budgeted Price (3) 3,000 × 0.60 × $20 = 3,000 × 0.40 × $10 =

$2,360 U

$800 F

Total mix variance

Total yield variance $1,560 U

Total efficiency variance F = favourable effect on operating income; U = unfavourable effect on operating income.

$36,000 12,000 $48,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

6. While the efficiency variance was unfavourable, it was due to the mix of labour, not the total hours used. The unfavourable mix variance is the result of a higher than standard percentage of skilled labour (68% vs. 60%) used. The yield variance, which is a more accurate measure of hours used, is favourable because total hours (2,950) were actually lower than the standard for 600 detail jobs (3,000). The skilled labour workers were probably able to work more quickly than the unskilled. In light of the information regarding the vacancies in the unskilled positions, last month could be treated as an outlier (especially in terms of the mix of labour employed), and more normal variances will likely follow in future months. While it is recommended that variances be calculated monthly, no corrective action with the employees appears necessary.

7-36 (35 min.)

Direct manufacturing labour variances: price, efficiency, mix, and yield

1. Gabrielle ($25 × 3 hrs.) Joseph ($15 × 3 hrs.) Cost per cake Number of cakes Total budgeted cost

$ $ $

75 45 120 × 50 units 6,000

2. Solution Exhibit presents the total price variance ($0), the total efficiency variance ($25 F), and the total flexible-budget variance ($25 F). Total direct labour price variance can also be computed as: Direct labour Actual Budgeted  Actual quantity price variance =  price of input price of input × of input  for each input 

Gabrielle = ($25 – $25) × 140 = $0 Joseph = ($15 – $15) × 165 = 0 Total direct labour price variance $0 Total direct labour efficiency variance can also be computed as:  Direct labour efficiency variance = Actual quantity Budgeted quantity of input × Budgeted  of input allowed for actual output  for each input   price of input Gabrielle = (140 – 150) × $25.00 = $250 F Joseph = (165 – 150) × $15.00 = 225 U Total direct labour efficiency variance $25 F

Chapter 7: Flexible Budgets, Variances, and Management Control: I

 SOLUTION EXHIBIT Columnar Presentation of Direct Labour Price and Efficiency Variances for Elena Martinez Wedding Cakes Actual Costs Incurred (Actual Input Quantity × Actual Price) (1) 140 × $25 = $3,500 165 × $15 = 2,475 $5,975

Gabrielle Joseph

Actual Input Quantity × Budgeted Price (2) 140 × $25 = $3,500 165 × $15 = 2,475 $5,975 $0 Total price variance

Flexible Budget (Budgeted Input Quantity Allowed for Actual Output × Budgeted Price) (3) 150 × $25 = $3,750 150 × $15 = 2,250 $6,000

$25 F Total efficiency variance

$25 F Total flexible-budget variance F = favourable effect on operating income; U = unfavourable effect on operating income

3. Actual Quantity of Input 140 hours 165 hours 305 hours

Gabrielle Joseph Total

Actual Mix 45.9% 54.1% 100.0%

Budgeted Quantity of Input for Actual Output 3 hours × 50 units = 150 hours 3 hours × 50 units = 150 hours 300 hours

Budgeted Mix 50% 50% 100%

4. Solution Exhibit presents the total direct labour yield and mix variances for Elena Martinez Wedding Cakes. The total direct labour yield variance can also be computed as the sum of the direct labour yield variances for each input: Direct labour yield variance for each input

Actual total Budgeted total quantity quantity of – of all direct labour all direct inputs allowed for labour actual output inputs used

Budgeted direct labour input mix percentage

Gabrielle = (305 – 300) × 0.50 × $25 = 5 × 0.50 × $25 = Joseph = (305 – 300) × 0.50 × $15 = 5 × 0.50 × $15 = Total direct labour yield variance

Budgeted price of direct labour inputs

$ 62.50 U 37.50 U $ 100.00 U

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

The total direct labour mix variance can also be computed as the sum of the direct labour mix variances for each input:

Direct labour mix

  Actual total  Actual  Budgeted Budgeted   quantity of  direct   direct labour    price of all direct   input mix  direct labour labour input  mix    Gabrielle = (0.459 – 0.50) × 305 × $25 = – 0.041 × 305 × $25 = $312.63 F Joseph = (0.541 – 0.50) × 305 × $15 = 0.041 × 305 × $15 = 187.58 U Total direct labour mix variance $125.05 F round to $125 F

The sum of the direct labour mix variance and the direct labour yield variance equals the direct labour efficiency variance. The favourable mix variance arises from using more of the cheaper labour (and less of the costlier labour) than the budgeted mix. The yield variance indicates that the cakes required more total inputs (305 hours) than expected (300 hours) for the production of 50 guitars. Both variances are relatively small and probably within tolerable limits. It is likely that Joseph, who is less experienced, worked more slowly than Gabrielle, which caused the unfavourable yield variance. Elena Martinez should be careful that using more of the cheaper labour does not reduce the quality of the wedding cake or how customers perceive it.  SOLUTION EXHIBIT Columnar Presentation of Direct Labour Yield and Mix Variances for Elena Martinez Wedding Cakes

Actual Total Quantity of All Inputs Used × Actual Input Mix × Budgeted Price (1) Gabrielle 305 × 0.459 × $25 Joseph 305 × 0.541 × $15 rounded $5,975.00

= =

$3,499.88 2,475.08

Actual Total Quantity of All Inputs Used × Budgeted Input Mix × Budgeted Price (2)

Flexible Budget: Budgeted Total Quantity of All Inputs Allowed for Actual Output × Budgeted Input Mix × Budgeted Price (3)

305 × 0.50 × $25 = $3,812.50 305 × 0.50 × $15 = 2,287.50 $6,100.00

300 × 0.50 × $25 = $3,750 300 × 0.50 × $15 = 2,250 $6,000

$125 F

$100 U

Total mix variance

Total yield variance

$25 F Total efficiency variance F = favourable effect on operating income; U = unfavourable effect on operating income.

Chapter 7: Flexible Budgets, Variances, and Management Control: I

7-37 (30 min.)

Use of materials and manufacturing labour variances for benchmarking

1. Unit variable cost (dollars) and component percentages for each firm:

DM DL VOH Total

Firm A

Firm B

$10.75 37.6% 10.88 38.1% 6.94 24.3% $28.57 100.0%

$10.50 27.3% 14.00 36.3% 14.00 36.4% $38.50 100.0%

Firm C

Firm D

$11.22 44.0% 9.26 36.3% 5.04 19.7% $25.52 100.0%

$11.70 38.2% 10.68 34.9% 8.23 26.9% $30.61 100.0%

2. Variances and percentage over/under standard for each firm relative to the Industry Benchmark: Firm A Firm B Firm C Firm D % over % over % over % over Variance standard Variance standard Variance standard Variance standard

DM Price Variance DM Efficiency Variance DL Price Variance DL Efficiency Variance

$0.22 F

1.96%

$0.30 U

2.94%

—

$1.56 F

11.76%

—

$0.77 F

-6.98%

$0.26 U

2.33%

$2.30 U

20.93%

$1.50 U

16.00%

$1.50 U

12.00%

$1.14 U

14.00%

$1.93 U

22.00%

$0.63 U

7.14%

$3.75 U

42.86%

$0.63 F

7.14%

—

We illustrate these calculations for Firm A. The DM Price Variance is computed as: (Firm A Price – Benchmark Price) × Firm A Usage = ($5.00 - $5.10) × 2.15 oz. = $0.22 F The DM Efficiency Variance is computed as follows: (Firm A Usage – Benchmark Usage) × Benchmark Price = (2.15 oz. – 2.15 oz.) x $5.10 = $0

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

The DL Price Variance is computed as: (Firm A Rate – Benchmark Rate) × Firm A Hours = ($14.50 – $12.50) × 0.75 = $1.50 U The DL Efficiency Variance is computed as follows: (Firm A Usage – Benchmark Usage) × Benchmark Rate = (0.75 hrs. – 0.70 hrs.) × $12.50 = $0.63 U The % over standard is the percentage difference in prices relative to the Industry Benchmark. Again using the DM Price Variance calculation for Firm A, the % over standard is given by: (Firm A Price – Benchmark Price)/Benchmark Price = ($5.00 - $5.10)/$5.10 = 1.96% under standard. 3. To: Controller From: Junior Accountant Re: Benchmarking & productivity improvements Date: October Benchmarking advantages - we can see how productive we are relative to our competition and the industry benchmark - we can see the specific areas in which there may be opportunities for us to reduce costs Benchmarking disadvantages - some of our competitors are targeting the market for high-end and custom-made lenses. I'm not sure that looking at their costs helps with understanding ours better - we may focus too much on cost differentials and not enough on differentiating ourselves, maintaining our competitive advantages, and growing our margins Areas to discuss - we may want to find out whether we can get the same lower price for glass as Firm D - we may want to re-evaluate the training our employees receive given our level of unfavourable labour efficiency variance compared to the benchmark. - can we use Firm B’s materials efficiency and Firm C’s variable overhead consumption levels as our standards for the coming year? Copyright © 2022 Pearson Canada Inc. 7-36

Chapter 7: Flexible Budgets, Variances, and Management Control: I

- It is unclear why the trade association is still using $12.50 for the labour rate benchmark. Given the difficulty of hiring qualified workers, real wage rates are now substantially higher. We pay our workers $2 more per hour, and at least one of our competitors pays even higher wages than we do! Firm B does pay $0.50 less than we do per hour and that may be worth looking into.

7-38 (30 min.)

Direct-cost and selling price variances.

1. Computing unit selling prices and unit costs of inputs: Actual selling price = $3,626,700 ÷ 462,000 = $7.85 Budgeting selling price = $3,360,000 ÷ 420,000 = $8.00 = × = ($7.85/unit – $8.00/unit) = $69,300 U

× 462,000 units

2., 3., and 4. The actual and budgeted unit costs are: Direct materials Specialty polymer Connector pins Wi-Fi transreceiver Direct manuf. labour Setup Fabrication

Actual

Budgeted

$0.05 ($415,000 ÷ 8,300,000) 0.11 ($550,000 ÷ 5,000,000) 0.50 ($235,000 ÷ 470,000)

$0.05 0.10 0.50

24.00 ($182,000 ÷ 455,000 × 60) 31.00 ($446,400 ÷ 864,000 × 60)

24.00 30.00

The actual output achieved is 462,000 Mini SDs.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

5. The direct cost price and efficiency variances are: Actual Costs Incurred (Actual Input Qty. × Actual Price) (1)

Direct materials Specialty polymer $ 415,000 Connector pins 550,000 Wi-Fi transreceiver 235,000 $1,200,000 Direct manuf. labour costs Setup $182,000 Fabrication 446,400 $628,400 a

Price Variance (2) = (1) – (3)

Actual Input Qty. × Budgeted Price (3)

Flex. Budget (Budgeted Input Qty. Allowed for Efficiency Actual Output Variance × Budgeted Price) (4) = (3) – (5) (5)

0 $ 415,000 b 50,000 U 500,000 c 0 235,000 $50,000 U $1,150,000

$22,300 U 38,000 U 4,000 U $64,300 U

$ 392,700 g 462,000 h 231,000 $1,085,700

$ 2,800 F 30,000 F $32,800 F

$184,800 j 462,000 $646,800

$182,000 e 432,000 $614,000

0 14,400 U $ 14,400 U

$0.05 × 8,300,000 = $415,000 b $0.10 × 5,000,000 = $500,000 c $0.50 × 470,000 = $235,000 d $24.00/hr. × (455,000 min. ÷ 60 min./hr.) = $182,000 e $30.00/hr. × (864,000 min. ÷ 60 min./hr.) = $432,000

$0.05 × 17 × 462,000 = $392,700 $0.10 × 10 × 462,000 = $462,000 h $0.50 × 1 × 462,000 = $231,000 i $24.00 × (462,000  60) = $184,800 j $30.00 × (462,000  30) = $462,000 g

Comments on the variances include: 

Selling price variance. This may arise from a proactive decision to reduce price to expand market share or from a reaction to a price reduction by a competitor. It could also arise from unplanned price discounting by salespeople.



Material price variance. The $0.01 increase in the price per connector pin could arise from uncontrollable market factors or from poor contract negotiations by MicroDisk.



Material efficiency variance. For all three material inputs, usage is greater than budgeted. Possible reasons include lower quality inputs, use of lower quality workers (although this is not reflected in the labour price variances), and the setup and fabrication equipment not being maintained in a fully operational mode. The higher price paid for connector pins (and perhaps higher quality of pins) did not reduce the number of connector pins used to produce actual output.



Labour efficiency variance. There is a small favourable efficiency variance for setup labour and a larger one for fabrication, which could both result from workers eliminating nonvalue-added steps in production.



Labour price variance. There is an unfavourable price variance for fabrication as a result of the $1 higher wage per hour paid for that labour. The higher labour quality could also explain the significant efficiency variance for fabrication labour.

Chapter 7: Flexible Budgets, Variances, and Management Control: I

7-39 (25 min.) Price and efficiency variances, benchmarking. 1.

Direct materials Direct labour Variable overhead Budgeted variable cost

Providence Plant Prices and quantities Cost per lot 74.0 lbs @ $ 3.20 per lb $236.80 2.5 hrs @ $12.00 per hr 30.00 20.00 $286.80 Amherst Plant Prices and quantities 76.50 lbs @ $ 3.10 per lb 2.4 hrs @ $12.20 per hr

Beverage Mate Prices and quantities 70.00 lbs @ $ 2.90 per lb 2.4 hrs @ $10.50 per hr

Cost per lot $237.15 29.28 22.00 $288.43

Cost per lot $203.00 25.20 20.00 $248.20

2. Providence Plant

Lots Direct materials Direct labour

Actual Results (1) 5,000 $1,184,000 $ 150,000

Price Variance (2) = (1) – (3)

Actual Quantity × Budgeted Price (3)

Efficiency Variance (4) = (3) – (5)

$111,000 U $ 18,750 U

$1,073,000b $ 131,250c

$58,000 U $5,250 U

aUsing Beverage Mate’s prices and quantities as the standard:

Direct materials: (70 lbs./lot × 5,000 lots) × $2.90/lb. = $1,015,000 Direct labour: (2.4 hrs./lot × 5,000 lots) × $10.50/hr. = $126,000 b(74.0 lbs./lot × 5,000 lots) × $2.90 per lb. = $1,073,000 c(2.5 hours/lot × 5,000 lots) × $10.50/hr. = $131,250

Flexible Budgeta (5) 5,000 $1,015,000 $ 126,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Amherst Plant

Actual Results (1) Lots 5,000 Direct Materials $1,185,750 Direct Labour $ 146,400

Price Variance (2) = (1) – (3)

Actual Quantity × Budgeted Price (3)

Efficiency Variance (4) = (3) – (5)

$76,500 U $20,400 U

$1,109,250b $ 126,000c

$94,250 U $ 0F

Flexible Budgeta (5) 5,000 $1,015,000 $ 126,000

aUsing Beverage Mate’s prices and quantities as the standard:

Direct materials: (70 lbs./lot × 5,000 lots) × $2.90/lb. = $1,015,000 Direct labour: (2.4 hrs./lot × 5,000 lots) × $10.50/hr. = $126,000 b(76.5 lbs./lot × 5,000 lots) × $2.90 per lb. = $1,109,250 c(2.4 hours/lot × 5,000 lots) × $10.50/hr. = $126,000

3. Using an objective, external benchmark, like that of a competitor, will preempt the possibility of any one plant feeling that the other is being favoured. That this competitor, Beverage Mate, is successful will also put positive pressure on the two plants to improve (note that all variances are zero or unfavourable). Issues that Bryant should keep in mind include the following: 

Ensure that Beverage Mate is indeed the best and most relevant standard (for example, is there another competitor in the marketplace which should be considered?)



Ensure that the data is reliable



Ensure that Beverage Mate is similar enough to use as a standard (if Beverage Mate has a different business model, for example, it may be following a strategy of lowering costs that Nantucket may not want to emulate because Nantucket is trying to differentiate its products)



The difference in hourly wages is not likely something that Nantucket can easily remedy, as it is associated with the market wage rate for the location of its plants.

Chapter 7: Flexible Budgets, Variances, and Management Control: I

MINI-CASES

7-40 (30-40 min.) Procurement costs, variance analysis, governance. 1. Purchase rate variances can be computed for each country.





Purchase price  Actual price Budgeted price  Actual quantity variance of input of input of input Hergonia = ($15.60* – $14.00)  250,000 = $400,000 U *$3,900,000 ÷ 250,000 = $15.60 On a per-unit basis, there is a $12.43(a) payment to the shoe manufacturer and a $3.17(b) payment for “other costs.” (a)$3,108,000 ÷ 250,000

= $12.43 = $3.17

(b)$792,000 ÷ 250,000

Tanista = ($13.67* – $14.00)  900,000 = $297,000 F *$12,300,000 ÷ 900,000 = $13.67 On a per-unit basis, there is an $11.26(c) payment to the shoe manufacturer and a $2.40(d) payment for “other costs.” (c) $10,136,000  900,000 (d) $2,164,000(e)  900,000 (e) $12,300,000 – 10,136,000

= $11.26 = $2.40 = $2,164,000

2. Daley and Mullins face many ethical issues: (a) Reliability of cost information to be presented to the board of directors. There are minimal or questionable receipts for $792,000 in Hergonia and $827,000 in Tanista. (b) Potential existence of kickback payments in both Hergonia and Tanista. (c) Employment of young children (many of them under 15 years old). Should Daley and Mullins be forthright and present all their concerns on (a), (b), and (c)? Both Daley and Mullins face the dilemma that any discussion of (a), (b), or (c) will raise questions about their own behaviour at the time the acquisitions were made. Board members

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

may ask “When did you first know about (a), (b), and (c)?” and “If it is only recently, why did you not undertake examination of these issues at the time you supported the acquisitions?” 3. Mullins has very high standards of ethical conduct to meet. She should not make presentations to the board based on information she has strong doubts about. If she decides to make the presentation, all her concerns and caveats should be presented. She should require detailed documentation for all payments. No future payments should be made without adequate documentation. Investigation of kickback allegations should be made, however difficult that may be. Mullins should be able to show she made a good-faith effort to ensure kickback payments are not an ongoing practice in Hergonia or Tanista.

7-41 (30 min.) Rate and efficiency variances, problems in standard-setting, benchmarking. 1. Budgeted direct materials input per shirt = 600 rolls ÷ 6,000 shirts = 0.10 roll of cloth Budgeted direct manufacturing labour-hours per shirt = 1,500 hours ÷ 6,000 shirts = 0.25 hours Budgeted direct materials cost = $30,000 ÷ 600 = $50 per roll Budgeted direct manufacturing labour cost per hour = $27,000 ÷ 1,500 = $18 per hour Actual output achieved = 6,732 shirts Flexible Budget Actual Costs (Budgeted Input Incurred Qty. Allowed for (Actual Input Qty. Actual Input Qty. Actual Output × Actual Rate) × Budgeted Rate × Budgeted Rate) Direct (612 × $50) (6,732 × 0.10 × $50) Materials $30,294 $30,600 $33,660 $306 F Rate variance Direct Manufacturing Labour $27,693

$3,060 F Efficiency variance

(1,530 × $18) $27,540 $153 U Rate variance

(6,732 × 0.25 × $18) $30,294

$2,754 F Efficiency variance

2. Actions employees may have taken include: (a) Adding steps that are not necessary in working on a shirt. (b) Taking more time on each step than is necessary.

Chapter 7: Flexible Budgets, Variances, and Management Control: I

(c) Creating problem situations so that the budgeted amount of average downtime will be overstated. (d) Creating defects in shirts so that the budgeted amount of average rework will be overstated. Employees may take these actions for several possible reasons. (a) They may be paid on a piece-rate basis with incentives for production levels above budget. (b) They may want to create a relaxed work atmosphere, and a less demanding standard can reduce stress. (c) They have a “them vs. us” mentality rather than a partnership perspective. (d) They may want to gain all the benefits that ensue from superior performance (job security, wage rate increases) without putting in the extra effort required. This behaviour is unethical if it is deliberately designed to undermine the credibility of the standards used at New Fashions. 3. If Jorgenson does nothing about standard costs, his behaviour will violate a number of standards of ethical conduct for practitioners of management accounting. In particular, he would violate the (a) standards of competence, by not performing professional duties in accordance with relevant standards; (b) standards of integrity, by passively subverting the attainment of the organization’s objective to control costs; and (c) standards of credibility, by not communicating information fairly and not disclosing all relevant cost information. 4. Jorgenson should discuss the situation with Fenton and point out that the standards are lax and that this practice is unethical. If Fenton does not agree to change, Jorgenson should escalate the issue up the hierarchy in order to effect change. If organizational change is not forthcoming, Jorgenson should be prepared to resign rather than compromise his professional ethics. 5. Main pros of using Benchmarking Clearing House information to compute variances are: (a) Highlights to New Fashions in a direct way how it may or may not be cost-competitive. (b) Provides a “reality check” to many internal positions about efficiency or effectiveness. Main cons are: (a) New Fashions may not be comparable to companies in the database. (b) Cost data about other companies may not be reliable. (c) Cost of Benchmarking Clearing House reports. Copyright © 2022 Pearson Canada Inc. 7-43

CHAPTER 8 FLEXIBLE BUDGETS, VARIANCES, AND MANAGEMENT CONTROL: II MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

SHORT-ANSWER QUESTIONS 8-1

Effective planning of variable overhead costs involves:

1. Planning to undertake only those variable overhead activities that add value for customers using the product or service, and 2. Planning to use the drivers of costs in those activities in the most efficient way.

8-2

At the start of an accounting period, a larger percentage of fixed overhead costs are locked-in than is the case with variable overhead costs. When planning fixed overhead costs, a company must choose the appropriate level of capacity or investment that will benefit the company over a long time. This is a strategic decision.

8-3

The key differences are how direct costs are traced to a cost object and how indirect costs are allocated to a cost object: Direct costs Indirect costs

8-4 1. 2. 3. 4.

Actual Costing Actual prices × Actual inputs used Actual indirect rate × Actual inputs used

Standard Costing Standard prices × Standard inputs allowed for actual output Standard indirect cost-allocation rate × Standard quantity of cost-allocation base allowed for actual output

Steps in developing a budgeted variable-overhead cost rate: Choose the period to be used for the budget, Select the cost-allocation bases to use in allocating variable overhead costs to the output produced, Identify the variable overhead costs associated with each cost-allocation base, and Compute the rate per unit of each cost-allocation base used to allocate variable overhead costs to output produced.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

8-5  

Price inflation or deflation of individual items included in variable overhead. Usage of individual items included in variable overhead.

8-6    

Two factors affecting the rate variance for variable manufacturing overhead are:

Reasons for a $30,000 favourable variable-overhead efficiency variance:

Workers more skillful in using machines than budgeted. Production scheduler was able to schedule jobs better than budgeted, resulting in lower-thanbudgeted machine-hours. Machines operated with fewer slowdowns than budgeted. Machine time standards set with padding built in by machine-workers.

8-7

A direct materials efficiency variance indicates whether more or less direct materials were used than was budgeted for the actual output achieved. A variable manufacturing overhead efficiency variance indicates whether more or less of the chosen allocation base was used than was budgeted for the actual output achieved.

8-8 1. 2. 3. 4.

Steps in developing a budgeted fixed-overhead rate are

Choose the period to use for the budget, Select the cost-allocation base to use in allocating fixed overhead costs to output produced, Identify the fixed-overhead costs associated with each cost-allocation base, and Compute the rate per unit of each cost-allocation base used to allocate fixed overhead costs to output produced.

8-9

The relationship for fixed-manufacturing overhead variances is: Flexible-budget variance

Rate variance

Efficiency variance (never a variance)

There is never an efficiency variance for fixed overhead because managers cannot be more or less efficient in dealing with an amount that is fixed regardless of the output level. The result is that the flexible-budget variance amount is the same as the rate variance for fixedmanufacturing overhead.

8-10 For planning and control purposes, fixed overhead costs are a lump sum amount that is not controlled on a per-unit basis. In contrast, for inventory costing purposes, fixed overhead costs are allocated to products on a per-unit basis.

Chapter 8: Flexible Budgets, Variances, and Management Control: II

8-11 An important caveat is what change in selling price might have been necessary to attain the level of sales assumed in the denominator of the fixed manufacturing overhead rate. For example, the entry of a new low-price competitor may have reduced demand below the denominator level if the budgeted selling price was maintained. An unfavourable productionvolume variance may be small relative to the selling-price variance had prices been dropped to attain the denominator level of unit sales.

8-12 A strong case can be made for writing off an unfavourable production-volume variance to cost of goods sold. The alternative is prorating it among inventories and cost of goods sold, but this would “penalize” the units produced (and in inventory) for the cost of unused capacity, i.e., for the units not produced. But, if we take the view that the denominator level is a “soft” number —i.e., it is only an estimate, and it is never expected to be reached exactly, then it makes more sense to prorate the production volume variance—whether favourable or not—among the inventory stock and cost of goods sold. Prorating a favourable variance is also more conservative: it results in a lower operating income than if the favourable variance had all been written off to cost of goods sold. Finally, prorating also dampens the efficacy of any steps taken by company management to manage operating income through manipulation of the production volume variance. In sum, a production-volume variance need not always be written off to cost of goods sold.

8-13 The four variances are: 

Variable manufacturing overhead costs  rate variance  efficiency variance



Fixed manufacturing overhead costs  rate variance  production-volume variance

A four-variance analysis relies on variable and fixed components, rate variance, efficiency variance, and production volume variance, while a three-variance analysis relies on rate, efficiency, and production volume variances, a two-variance analysis relies on production volume and flexible-budget variances, and a one-variance analysis relies on one total variance where there is no further breakdown of variances.

8-14 Interdependencies among the variances could arise for the rate and efficiency variances. For example, if the chosen allocation base for the variable overhead efficiency variance is only one of several cost drivers, the variable overhead rate variance will include the effect of the other cost drivers. As a second example, interdependencies can be induced when there are misclassifications of costs as fixed when they are variable, and vice versa.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

EXERCISES 8-15 (10 min.)

Terminology.

1. Interpretation of variances strategically means management teams must place their internal performance relative to their competitors and to what their customers value. Decisions about capacity incur capacity costs of ownership and maintenance for the long term. 2. To the customer, however, the cost of unused capacity is a non-value-added cost for which they will not pay. 3. This cost arises because the quantity produced is less than the capacity available. The cost is fixed therefore the burden assigned to each actual unit produced is higher than it should be. This unfavourable outcome is a denominator-level variance. 4. It is also referred to as the production volume variance and is an underallocation of capacity costs that will persist until consumer demand, actual production and available capacity intersect. 5. But fixed costs also include contractual costs such as salaries and regulatory costs of taxes. These costs can change unexpectedly and will result in a fixed overhead rate variance. 6. Equipment also requires maintenance which, along with custodial and security costs are required and shared resources that benefit all outputs. When the actual measure of benefit provided exceeds the budget what arises is an unfavourable variable overhead efficiency variance. 7. When the actual cost per unit of benefit provided exceeds budget there arises an unfavourable variable overhead rate variance. Both are underallocations of variable overhead cost

Chapter 8: Flexible Budgets, Variances, and Management Control: II

8-16 (20 min.)

Variable manufacturing overhead, variance analysis.

1. Variable Manufacturing Overhead Variance Analysis for Young Clothing for June

Actual Costs Incurred (1) $53,298

Actual Input Qty. × Budgeted Rate (2) (4,536 × $12) $54,432

$1,134 F Rate variance

Flexible Budget: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (3) (4 × 1,080 × $12) $51,840

$2,592 U Efficiency variance

$1,458 U Flexible-budget variance

Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4)1 (4 × 1,080 × $12) $51,840

Never a variance Never a variance

2. Young had a favourable rate variance of $1,134 because the actual variable overhead rate was $11.75 per direct manufacturing labour-hour versus $12 budgeted. It had an unfavourable efficiency variance of $2,592 U because each suit averaged 4.2 labour-hours (4,536 hours ÷ 1,080 suits) versus 4.0 budgeted labour-hours.

1 Column 4 is an options’ component of the solution

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

8-17 (20 min.) 1 & 2.

Fixed manufacturing overhead variance analysis (continuation of 8-16). Budgeted fixed overhead = rate per unit of allocation base

= =

$62, 400 1, 040  4 $62, 400 4,160 $15 per hour

Fixed Manufacturing Overhead Variance Analysis for Young Clothing for June Flexible Budget: Same Budgeted Same Budgeted Allocated: Lump Sum Lump Sum Budgeted Input Qty. (as in Static Budget) (as in Static Budget) Allowed for Actual Actual Costs Regardless of Regardless of Output Incurred Output Level Output Level × Budgeted Rate (1) (2) (3) (4) (4 × 1,080 × $15) $63,916 $62,400 $62,400 $64,800 $1,516 U Rate variance

$2,400 F Never a variance

$1,516 U Flexible-budget variance

Production-volume variance $2,400 F Production-volume variance

The fixed manufacturing overhead rate variance and the fixed manufacturing flexible budget variance are the same––$1,516 U. Young spent $1,516 above the $62,400 budgeted amount for June. The production-volume variance is $2,400 F. This arises because Young utilized its capacity more intensively than budgeted (the actual production of 1,080 suits exceeds the budgeted 1,040 suits). This results in overallocated fixed manufacturing overhead of $2,400 (= 4 × 40 × $15). Young would want to understand the reasons for a favourable production-volume variance. Is the market growing? Is Young gaining market share? Will Young need to add capacity? 3. The total overallocated FMOH amounts to $884 F (= $1,516 U flexible-budget variance + $2,400 F production volume variance). Since this figure is a combination of two variances, there is a limited amount of inference that can be drawn from the variance. Given that both variances are relatively small when compared to the original budget ($62,400), management should probably not read too much into this variance.

Chapter 8: Flexible Budgets, Variances, and Management Control: II

8-18 (30 min.)

Fixed manufacturing overhead variance analysis.

1. Budgeted standard direct manufacturing labour used = 0.02 per baguette Budgeted output = 3,840,000 loaves Budgeted standard direct manufacturing labour-hours = 3,840,000 × 0.02 = 76,800 hours Budgeted fixed manufacturing overhead costs = 76,800 × $4.00 per hour = $307,200 Actual output = 3,360,000 loaves Allocated fixed manufacturing overhead = 3,360,000 × 0.02 × $4 = $268,800 Fixed Manufacturing Overhead Variance Analysis for the Lebanese Bakery for the year

Actual Costs Incurred (1)

Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (2)

Flexible Budget: Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (3)

$272,000

$307,200

$35,200 F Rate variance

$38,400 U Production-volume variance

Never a variance

$35,200 F Flexible-budget variance

Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) (3,360,000 × 0.02 × $4) $268,800

$38,400 U Production-volume variance

$3,200 U Underallocated fixed overhead (Total fixed overhead variance) 2. The fixed manufacturing overhead is underallocated by $3,200.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. The production-volume variance of $38,400 U captures the difference between the budgeted 3,840,0000 loaves and the lower actual 3,360,000 loaves produced—the fixed cost capacity not used. The rate variance of $35,200 favourable means that the actual aggregate of fixed costs ($272,000) is less than the budget amount ($307,200). For example, monthly leasing rates for bread-making machines may have increased above those in the budget for the year.

8-19 (30–40 min.) Manufacturing overhead, variance analysis. 1. The summary information is: G-Force Corporation (June) Outputs units (number of assembled units) Hours of assembly time Assembly hours per unit Variable mfg. overhead cost per hour of assembly time Variable mfg. overhead costs Fixed mfg. overhead costs Fixed mfg. overhead costs per hour of assembly time

Actual 216 411 1.90b $ 30.22d $12,420 $20,560 $ 50g

a200 units 

2 assembly hours per unit = 400 hours 216 units = 1.90 assembly hours per unit c216 units  2 assembly hours per unit = 432 hours d$12,420  411 assembly hours = $30.22 per assembly hour e432 assembly hours  $30 per assembly hour = $12,960 f400 assembly hours  $30 per assembly hour = $12,000 g$20,560  411 assembly hours = $50 per assembly hour h$19,200  400 assembly hours = $48 per assembly hour b411 hours 

Flexible Budget 216 432c 2.00 $ 30.00 $12,960e $19,200

Static Budget 200 400a 2.00 $ 30.00 $12,000f $ 19,200 $ 48h

Chapter 8: Flexible Budgets, Variances, and Management Control: II

Variable Manufacturing Overhead

Flexible Budget: Allocated: Budgeted Input Budgeted Input Actual Input Qty. × Actual Costs Qty. Allowed Budgeted Qty. Allowed Budgeted for Actual Output × Rate Incurred Budgeted Rate for Actual Output × Rate 411 $30.00 432 $30.00 432 $30.00    assy. per assy. per assy. hrs. hr. assy. hrs. hr. assy. hrs. per assy. hr. $12,420 $12,330 $12,960 $12,960 $90 U $630 F Rate variance Efficiency variance Never a variance $540 F Flexible-budget variance

Never a variance

$540 F Overallocated variable overhead

Fixed Manufacturing Overhead

Actual Costs Incurred

Static Budget Lump Sum Regardless of Output Level

$20,560

$19,200 $1,360 U Rate variance

Flexible Budget: Static Budget Lump Sum Regardless of Output Level

Never a variance

$1,360 U Flexible-budget variance

Budgeted Input Allocated: Allowed Budgeted for Actual Output  Rate 432  $48.00 assy. hrs. assy. hr. $19,200 $20,736 $1,536 F Production-volume variance $1,536 F Production-volume variance

$176 F Overallocated fixed overhead

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

The summary analysis is: Rate Variance Variable Manufacturing Overhead Fixed Manufacturing Overhead

Efficiency Variance

Production-Volume Variance

$630 F

Never a variance

$1,536 F

90 U

$1,360 U

2. Variable Manufacturing Costs and Variances a. Variable Manufacturing Overhead Control Accounts Payable Control and various other accounts To record actual variable manufacturing overhead costs incurred.

12,420

b. Work-in-Process Control Variable Manufacturing Overhead Allocated To record variable manufacturing overhead allocated.

12,960

c. Variable Manufacturing Overhead Allocated Variable Manufacturing Overhead Rate Variance Variable Manufacturing Overhead Control Variable Manufacturing Overhead Efficiency Variance To isolate variances for the accounting period.

12,960 90

12,420

12,960

12,420 630

d. Variable Manufacturing Overhead Efficiency Variance 630 Variable Manufacturing Overhead Rate Variance 90 Cost of Goods Sold 540 To write off variable manufacturing overhead variances to cost of goods sold.

Chapter 8: Flexible Budgets, Variances, and Management Control: II

Fixed Manufacturing Costs and Variances a. Fixed Manufacturing Overhead Control Salaries Payable, Acc. Depreciation, various other accounts To record actual fixed manufacturing overhead costs incurred.

20,560

b. Work-in-Process Control Fixed Manufacturing Overhead Allocated To record fixed manufacturing overhead allocated.

20,736

c. Fixed Manufacturing Overhead Allocated Fixed Manufacturing Overhead Rate Variance Fixed Manufacturing Overhead Production-Volume Variance Fixed Manufacturing Overhead Control To isolate variances for the accounting period.

20,736 1,360

20,560

20,736

d. Fixed Manufacturing Overhead Production-Volume Variance 1,536 Fixed Manufacturing Overhead Rate Variance Cost of Goods Sold To write off fixed manufacturing overhead variances to cost of goods sold.

1,536 20,560

1,360 176

3. Planning and control of variable manufacturing overhead costs has both a long-run and a short-run focus. It involves G-Force planning to undertake only value-added overhead activities (a long-run view) and then managing the cost drivers of those activities in the most efficient way (a short-run view). Planning and control of fixed manufacturing overhead costs at G-Force have primarily a long-run focus. It involves undertaking only value-added fixedoverhead activities for a budgeted level of output. G-Force makes most of the key decisions that determine the level of fixed-overhead costs at the start of the accounting period.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

8-20 (1015 min.) Four-variance analysis, fill in the blanks. 1. 2. 3. 4. 5.

Rate variance Efficiency variance Production-volume variance Flexible-budget variance Underallocated (overallocated) MOH

Variable MOH

Actual Costs Incurred (1) $35,000

Variable $900 U 200 U NEVER 1,100 U 1,100 U

Fixed $300 U NEVER 500 U 300 U 800 U

Flexible Budget: Budgeted Input Qty. Allowed for Actual Input Qty. Actual Output × Budgeted Rate × Budgeted Rate (2) (3) $34,100 $33,900

$900 U Rate variance

$200 U Efficiency variance

$1,100 U Flexible-budget variance

Never a variance

$1,100 U Underallocated variable overhead (Total variable overhead variance)

Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) $33,900

Chapter 8: Flexible Budgets, Variances, and Management Control: II

Fixed MOH

Actual Costs Incurred (1) $18,200

Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (2) $17,900

$300 U Rate variance

Flexible Budget: Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (3) $17,900

Never a variance

Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) $17,400

$500 U Production-volume variance

$300 U $500 U Production-volume variance Flexible-budget variance $800 U Underallocated fixed overhead (Total fixed overhead variance) An overview of the four overhead variances is: ProductionFour-Variance Rate Efficiency Volume Analysis Variance Variance Variance Variable Overhead $900 U $200 U Never a variance Fixed Overhead

$300 U

Never a variance

$500 U

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

8-21 (20–30 min.) Straightforward four-variance overhead analysis. 1. The budget for fixed manufacturing overhead is 4,000 units × 6 machine-hours × $15 machine-hours/unit = $360,000. An overview of the four-variance analysis is: Four-Variance Analysis Variable Manufacturing Overhead Fixed Manufacturing Overhead

Rate Variance

Efficiency Variance

ProductionVolume Variance

$17,800 U

$16,000 U

Never a Variance

$13,000 U

Never a Variance

$36,000 F

Solution Exhibit (below) has details of these variances. A detailed comparison of actual and flexible budgeted amounts is: Output units (auto parts) Allocation base (machine-hours) Allocation base per output unit Variable MOH Variable MOH per hour Fixed MOH Fixed MOH per hour

Actual 4,400 28,400 b 6.45 $245,000 d $8.63 $373,000 f $ 13.13

Flexible Budget 4,400 a 26,400 6.00 c $211,200 $ 8.00 e $360,000 –

a4,400 units × 6.00 machine-hours/unit = 26,400 machine-hours b28,400 ÷ 4,400 = 6.45 machine-hours per unit c4,400 units × 6.00 machine-hours per unit × $8.00 per machine-hour = $211,200 d$245,000 ÷ 28,400 = $8.63 e4,000 units × 6.00 machine-hours per unit × $15 per machine-hour = $360,000 f$373,000 ÷ 28,400 = $13.13

Chapter 8: Flexible Budgets, Variances, and Management Control: II

SOLUTION EXHIBIT

Actual Costs Incurred (1) Variable MOH

$245,000

Actual Input × Budgeted Rate (2) (28,400 × $8) $227,200

$17,800 U Rate variance

Flexible Budget: Budgeted Input Allowed for Actual Output × Budgeted Rate (3) (4,400 × 6 × $8) $211,200

$16,000 U Efficiency variance

Allocated: Budgeted Input Allowed for Actual Output × Budgeted Rate (4) (4,400 × 6 × $8) $211,200

Never a variance

$33,800 U Flexible-budget variance

Never a variance

$33,800 U Underallocated variable overhead (Total variable overhead variance)

Actual Costs Incurred (1) Fixed MOH

$373,000

Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (2) (4,000 × 6 × $15) $360,000

$13,000 U Rate variance

Flexible Budget: Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (3) (4,000 × 6 × $15) $360,000

Never a variance

$13,000 U Flexible-budget variance

Allocated: Budgeted Input Allowed for Actual Output × Budgeted Rate (4) (4,400 × 6 × $15) $396,000

$36,000 F Production-volume variance $36,000 F Production-volume variance

$23,000 F Overallocated fixed overhead (Total fixed overhead variance)

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Variable Manufacturing Overhead Control Accounts Payable Control and other accounts

245,000

Work-in-Process Control Variable Manufacturing Overhead Allocated

211,200

Variable Manufacturing Overhead Allocated Variable Manufacturing Overhead Rate Variance Variable Manufacturing Overhead Efficiency Variance Variable Manufacturing Overhead Control

211,200 17,800 16,000

Fixed Manufacturing Overhead Control Wages Payable Control, Accumulated Depreciation

373,000 Control, etc.

245,000 211,200

245,000

Work-in-Process Control Fixed Manufacturing Overhead Allocated

396,000

Fixed Manufacturing Overhead Allocated Fixed Manufacturing Overhead Rate Variance Fixed Manufacturing Overhead Production-Volume Variance Fixed Manufacturing Overhead Control

396,000 13,000

373,000 396,000

36,000 373,000

3. The control of variable manufacturing overhead requires the identification of the cost drivers for such items as energy, supplies, and repairs. Control often entails monitoring nonfinancial measures that affect each cost item, one by one. Examples are kilowatt-hours used, quantities of lubricants used, and repair parts and hours used. The most convincing way to discover why overhead performance did not agree with a budget is to investigate possible causes, line item by line item. Individual fixed manufacturing overhead items are not usually affected very much by day-today control. Instead, they are controlled periodically through planning decisions and budgeting procedures that may sometimes have horizons covering six months or a year (for example, management salaries) and sometimes covering many years (for example, long-term leases and depreciation on plant and equipment).

Chapter 8: Flexible Budgets, Variances, and Management Control: II

8-22 (3040 min.) Straightforward coverage of manufacturing overhead, standard cost system. 1. Solution Exhibit (below) shows the computations. Summary details are: Actual 49,200 15,960 0.324b $186,120

Output units Allocation base (machine-hours) Allocation base per output unit Variable MOH Variable MOH per hour Fixed MOH Fixed MOH per hour

$11.66 $481,200 e $ 30.15

Flexible Budget 49,200 a 14,760 0.30 c $212,544 $14.40 $468,000 –

a49,200 × 0.30 = 14,760

d$186,120 ÷ 15,960 = $11.66

b15,960 ÷ 49,200 = 0.324

e$481,200 ÷ 15,960 = $30.15

c14,760 × $14.40 = $212,544

An overview of the four-variance analysis is: Four-Variance Analysis Variable Manufacturing Overhead Fixed Manufacturing Overhead

Rate Variance

Efficiency Variance

ProductionVolume Variance

$43,704 F

$17,280 U

Never a variance

$13,200 U

Never a variance $25,200 U

2. Variable Manufacturing Overhead Control Accounts Payable Control and other accounts

186,120

Work-in-Process Control Variable Manufacturing Overhead Allocated

212,544

Variable Manufacturing Overhead Allocated Variable Manufacturing Overhead Efficiency Variance Variable Manufacturing Overhead Rate Variance Variable Manufacturing Overhead Control

212,544 17,280

Fixed Manufacturing Overhead Control Wages Payable Control, Accumulated Depreciation Control, etc.

481,200

186,120 212,544

43,704 186,120

481,200

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Work-in-Process Control Fixed Manufacturing Overhead Allocated

442,800

Fixed Manufacturing Overhead Allocated Fixed Manufacturing Overhead Rate Variance Fixed Manufacturing Overhead Production-Volume Variance Fixed Manufacturing Overhead Control

442,800 13,200

442,800

25,200 481,200

3. The control of variable manufacturing overhead requires the identification of the cost drivers for such items as energy, supplies, and repairs. Control often entails monitoring nonfinancial measures that affect each cost item, one by one. Examples are kilowatt-hours used, quantities of lubricants used, and repair parts and hours used. The most convincing way to discover why overhead performance did not agree with a budget is to investigate possible causes, line item by line item. Individual fixed manufacturing overhead items are not usually affected by day-to-day control. Instead, they are controlled periodically through planning decisions and budgeting procedures that may sometimes have horizons covering six months or a year (for example, management salaries) and sometimes covering many years (for example, long-term leases and depreciation on plant and equipment).

Chapter 8: Flexible Budgets, Variances, and Management Control: II

SOLUTION EXHIBIT

Actual Costs Incurred (1) Variable Manufacturing Overhead

$186,120

Actual Input × Budgeted Rate (2) (15,960 × $14.40) $229,824

$43,704 F Rate variance

Flexible Budget: Budgeted Input Allowed for Actual Output × Budgeted Rate (3) (14,760 × $14.40) $212,544

Allocated: Budgeted Input Allowed for Actual Output × Budgeted Rate (4) (14,760 × $14.40) $212,544

$17,280 U Efficiency variance Never a variance

$26,424 F Flexible-budget variance

Never a variance

$26,424 F Overallocated variable overhead (Total variable overhead variance)

Fixed Manufacturing Overhead

Actual Costs Incurred (1)

Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (2)

Flexible Budget: Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (3)

$481,200

$468,000

$13,200 U Rate variance

$25,200 U Production-volume variance

Never a variance

$13,200 U Flexible-budget variance

$25,200 U Production-volume variance

$38,400 U Underallocated fixed overhead (Total fixed overhead variance) =

Allocated: Budgeted Input Allowed for Actual Output × Budgeted Rate (4) (14,760 × $30) $442,800

$468,000 = $30 per machine-hour. 15,600 machine - hours

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

8-23 (20–25 min.) Overhead variances, service sector. 1. Meals on Wheels (May) Output units (number of deliveries) Hours per delivery Hours of delivery time Variable overhead costs per delivery hour Variable overhead (VOH) costs Fixed overhead costs Fixed overhead cost per hour

Actual Results 8,800 0.65a 5,720 $ 1.80c $10,296 $38,600

Flexible Budget 8,800 0.70 6,160 $ 1.50 $ 9,240 $35,000

Static Budget 10,000 0.70 7,000b $ 1.50 $ 10,500d $ 35,000 $ 5.00e

a5,720 hours 

8,800 deliveries = 0.65 hours per delivery Number of deliveries = 0.70  10,000 = 7,000 hours c$10,296 VOH costs  5,720 delivery hours = $1.80 per delivery hour dDelivery hours  VOH cost per delivery hour = 7,000  $1.50 = $10,500 eStatic budget delivery hours = 10,000 units  0.70 hours/unit = 7,000 hours; Fixed overhead rate = Fixed overhead costs  Static budget delivery hours = $35,000  7,000 hours = $5 per hour bHours per delivery 

VARIABLE OVERHEAD

Actual Costs Incurred $10,296

Actual Input Qty. × Budgeted Rate 5,720 hrs × $1.50 per hr. $8,580 $1,716 U Rate variance

Flexible Budget: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate 6,160 hrs × $1.50 per hr. $9,240

$660 F Efficiency variance FIXED OVERHEAD

Chapter 8: Flexible Budgets, Variances, and Management Control: II

Actual Costs Incurred

Flexible Budget: Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level

$38,600

$35,000 $3,600 U Rate variance

Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate 8,800 units  0.70 hrs./unit  $5/hr. 6,160 hrs.  $5/hr. $30,800

$4,200 U Production-volume variance

3. The rate variances for variable and fixed overhead are both unfavourable. This means that MOW had increases over budget in either or both the cost of individual items (such as telephone calls and gasoline) in the overhead cost pools, or the usage of these individual items per unit of the allocation base (delivery time). The favourable efficiency variance for variable overhead costs results from more efficient use of the cost allocation base––each delivery takes 0.65 hours versus a budgeted 0.70 hours. MOW can best manage its fixed overhead costs by long-term planning of capacity rather than day-to-day decisions. This involves planning to undertake only value-added fixed-overhead activities and then determining the appropriate level for those activities. Most fixed overhead costs are committed well before they are incurred. In contrast, for variable overhead, a mix of long-run planning and daily monitoring of the use of individual items is required to manage costs efficiently. MOW should plan to undertake only value-added variable-overhead activities (a long-run focus) and then manage the cost drivers of those activities in the most efficient way (a short-run focus). There is no production-volume variance for variable overhead costs. The unfavourable production-volume variance for fixed overhead costs arises because MOW has unused fixed overhead resources that it may seek to reduce in the long run.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

8-24 (15 min.)

Identifying favourable and unfavourable variances.

VOH Scenario Rate Variance Production output is Cannot be 5% more than determined: no budgeted, and actual information on fixed manufacturing actual versus overhead costs are 6% budgeted VOH more than budgeted rates Production output is 10% more than budgeted; actual machine hours are 5% less than budgeted

VOH Efficiency Variance Cannot be determined: no information on actual versus flexible-budget machine-hours

FOH Rate Variance Unfavourable: actual fixed costs are more than budgeted fixed costs

FOH Production-Volume Variance Favourable: output is more than budgeted causing FOH costs to be overallocated

Cannot be determined: no information on actual versus budgeted VOH rates

Favourable: actual Cannot be machine-hours less determined: no than flexible-budget information on machine-hours actual versus budgeted FOH costs

Favourable: output is more than budgeted causing FOH costs to be overallocated

Production output is Cannot be 8% less than budgeted determined: no information on actual versus budgeted VOH rates

Cannot be Cannot be determined: no determined: no information on information on actual machineactual versus hours versus budgeted FOH flexible-budget costs machine-hours Unfavourable: more Cannot be machine-hours used determined: no relative to flexible information on budget actual versus budgeted FOH costs

Unfavourable: output less than budgeted will cause FOH costs to be underallocated

Unfavourable: actual machinehours greater than flexible-budget machine-hours

Cannot be determined: no information on actual output relative to budgeted output

Actual machine hours are 15% greater than flexible-budget machine hours

Cannot be determined: no information on actual versus budgeted VOH rates

Relative to the flexible Unfavourable: budget, actual machine actual VOH rate hours are 10% greater greater than and actual variable budgeted VOH manufacturing rate overhead costs are 15% greater

Cannot be determined: no information on actual versus budgeted FOH costs

Cannot be determined: no information on flexible-budget machine-hours relative to static-budget machine-hours

Chapter 8: Flexible Budgets, Variances, and Management Control: II

8-25 (35 min.)

Flexible-budget variances, review of Chapters 7 and 8.

1. SOLUTION EXHIBIT Actual Costs Incurred: Actual Input Qty. × Actual Rate Direct (12,400  $11) Materials $136,400

Actual Input Qty. × Budgeted Price Purchases Usage (12,400  $10) (8,500  $10) $124,000 $85,000

$12,400 U

$2,000 F

a. Price variance Direct Manufacturing Labour

Variable Manufacturing Overhead

b. Efficiency variance

(29,200  $17) $496,400

$671,600

(29,000  1.2  $17) $591,600

$175,200 U

$95,200 F

c. Price variance

d. Efficiency variance

Actual Costs Incurred

Actual Input Qty.  Budgeted Rate

Flexible Budget: Budgeted Input Qty. Allowed for Actual Output  Budgeted Rate

$65,100

(8,500  $5) $42,500

(8,700  $5) $43,500

$22,600 U

$158,000

Allocated: (Budgeted Input Qty. Allowed for Actual Output  Budgeted Rate) (29,000  0.3  $5) $43,500

$1,000 F

e. Spending variance Fixed Manufacturing Overhead

Flexible Budget: Budgeted Input Qty. Allowed for Actual Output × Budgeted Price (29,000  0.3  $10) $87,000

f. Efficiency variance

$157,500*

$157,500

$500 U

Never a variance (29,000  0.3  $15) $130,500

$27,000 U

h. Spending variance

Never a variance

g. Production volume variance

*Denominator level (Annual) in kilograms of material: 420,000 x 0.3 = 126,000 kg

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. The direct materials price variance indicates that DDC paid more for brass than they had planned. If this is because they purchased a higher quality of brass, it may explain why they used less brass than expected (leading to a favourable material efficiency variance). In turn, since variable manufacturing overhead is assigned based on kilograms of materials used, this directly led to the favourable variable overhead efficiency variance. The purchase of a better quality of brass may also explain why it took less Labour time to produce the doorknobs than expected (the favourable direct Labour efficiency variance). Finally, the unfavourable direct Labour price variance could imply that the workers who were hired were more experienced than expected, which could also be related to the positive direct material and direct Labour efficiency variances.

PROBLEMS 8-26 (30 min.)

Comprehensive variance analysis.

1. Budgeted number of machine-hours planned can be calculated by multiplying the number of units planned (budgeted) by the number of machine-hours allocated per unit: 888 units  2 machine-hours per unit = 1,776 machine-hours. 2. Budgeted fixed MOH costs per machine-hour can be computed by dividing the flexible budget amount for fixed MOH (which is the same as the static budget) by the number of machine-hours planned (calculated in (a.)): $348,096 ÷ 1,776 machine-hours = $196 per machine-hour 3. Budgeted variable MOH costs per machine-hour are calculated as budgeted variable MOH costs divided by the budgeted number of machine-hours planned: $71,040 ÷ 1,776 machine-hours = $40 per machine-hour. 4. Budgeted number of machine-hours allowed for actual output achieved can be calculated by dividing the flexible-budget amount for variable MOH by budgeted variable MOH costs per machine-hour: $76,800 ÷ $40 per machine-hour = 1,920 machine-hours allowed 5. The actual number of output units is the budgeted number of machine-hours allowed for actual output achieved divided by the planned allocation rate of machine hours per unit: 1,920 machine-hours ÷ 2 machine-hours per unit = 960 units. 6. The actual number of machine-hours used per output unit is the actual number of machine hours used (given) divided by the actual number of units manufactured: 1,824 machine-hours ÷ 960 units = 1.9 machine-hours used per output unit.

Chapter 8: Flexible Budgets, Variances, and Management Control: II

8-27 (60 min.)

Journal entries (continuation of 8-26).

1. Key information underlying the computation of variances is:

1. Output units (food processors) 2. Machine-hours 3. Machine-hours per output unit

Actual Results 960 1,824 1.90

Flexible-Budget Amount 960 1,920 2.00

Static-Budget Amount 888 1,776 2.00

4. Variable MOH costs 5. Variable MOH costs per machinehour (Row 4 ÷ Row 2) 6. Variable MOH costs per unit (Row 4 ÷ Row 1)

$ 76,608

$ 76,800

$ 71,040

42.00

40.00

79.80

80.00

7. Fixed MOH costs 8. Fixed MOH costs per machinehour (Row 7 ÷ Row 2) 9. Fixed MOH costs per unit (7 ÷ 1)

$350,208

$348,096

$ 192.00 $ 364.80

$ 181.30 $ 362.60

$ 196.00 $ 392.00

Solution Exhibit shows the computation of the variances. Journal entries for variable MOH, year ended December 31: Variable MOH Control Accounts Payable Control and Other Accounts

76,608

Work-in-Process Control Variable MOH Allocated

76,800

Variable MOH Allocated Variable MOH Rate Variance Variable MOH Control Variable MOH Efficiency Variance

76,800 3,648

76,608 76,800

76,608 3,840

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Journal entries for fixed MOH, year ended December 31: Fixed MOH Control Wages Payable, Accumulated Depreciation, etc.

350,208

Work-in-Process Control Fixed MOH Allocated

376,320

Fixed MOH Allocated Fixed MOH Rate Variance Fixed MOH Control Fixed MOH Production-Volume Variance

376,320 2,112

350,208 376,320

350,208 28,224

2. Adjustment of COGS Variable MOH Efficiency Variance Fixed MOH Production-Volume Variance Variable MOH Rate Variance Fixed MOH Rate Variance Cost of Goods Sold

3,840 28,224 3,648 2,112 26,304

SOLUTION EXHIBIT Variable Manufacturing Overhead

Actual Costs Incurred (1) (1,824  $42) $76,608

Actual Input Qty. × Budgeted Rate (2) (1,824  $40) $72,960

$3,648 U Rate variance

Flexible Budget: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (3) (1,920  $40) $76,800

$3,840 F Efficiency variance

Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) (1,920  $40) $76,800

Never a variance

Chapter 8: Flexible Budgets, Variances, and Management Control: II

Fixed Manufacturing Overhead

Actual Costs Incurred (1)

Same Budgeted Lump Sum (as in Static Budget) Regardless Of Output Level (2)

Flexible Budget: Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (3)

$350,208

$348,096

$2,112U Rate variance

Never a variance

Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) (1,920 × $196) $376,320

$28,224 F Production-volume variance

8-28 (3040 min.) Graphs and overhead variances. 1. Fixed Manufacturing Overhead Costs Total Fixed Manuf. Overhead Costs

Graph for planning and control purpose Graph for inventory costing purpose ($18 per machine-hour)

$18,000,000

9,000,000

1,000,000 Machine-Hours

= = $18,000,000/ 1,000,000 machine hours = $18 per machine-hour

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. (a) Variable Manufacturing Overhead Variance Analysis for Fresh Inc. for 2022

Actual Costs Incurred (1) $9,025,000

Flexible Budget: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (3) (875,000  $9) $7,875,000

Actual Input Qty. × Budgeted Rate (2) (950,000  $9) $8,550,000

$475,000 U Rate variance

$675,000 U Efficiency variance

Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) (875,000  $9) $7,875,000

Never a variance

$1,150,000 U Flexible-budget variance

Never a variance

$1,150000 U Underallocated variable overhead (Total variable overhead variance) (b) Fixed Manufacturing Overhead Variance Analysis for Fresh Inc. for 2022

Actual Costs Incurred (1)

Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (2)

Flexible Budget: Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (3)

$18,050,000

$18,000,000

$50,000 U Rate variance

Never a variance

$50,000 U Flexible-budget variance

Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) (875,000 × $18) $15,750,000

$2,250,000 U* Production-volume variance $2,250,000 U* Production-volume variance

$2,300,000 U Underallocated fixed overhead (Total fixed overhead variance) *Alternative computation: 1,000,000 denominator hrs. – 875,000 budgeted hrs. allowed = 125,000 hrs.

125,000  $18 = $2,250,000 U

Chapter 8: Flexible Budgets, Variances, and Management Control: II

3. The underallocated manufacturing overhead was: variable, $1,150,000 and fixed, $2,300,000. The flexible-budget variance and underallocated overhead are always the same amount for variable manufacturing overhead, because the flexible-budget amount of variable manufacturing overhead and the allocated amount of variable manufacturing overhead coincide. In contrast, the budgeted and allocated amounts for fixed manufacturing overhead only coincide when the budgeted input of the allocation base for the actual output level achieved exactly equals the denominator level. 4. The choice of the denominator level will affect inventory costs. The new fixed manufacturing overhead rate would be $18,000,000 ÷ 750,000 = $24 per machine-hour. In turn, the allocated amount of fixed manufacturing overhead and the production-volume variance would change as seen below: Actual

Budget

$18,050,000

$18,000,000

$50,000 U Flexible-budget variance

Allocated 875,000 × $24 = $21,000,000

$3,000,000 F* Prodn. volume variance

$2,950,000 F Total fixed overhead variance *Alternative computation: (750,000 – 875,000) × $24 = $3,000,000 F

The major point of this requirement is that inventory costs (and, hence, income determination) can be heavily affected by the choice of the denominator level used for setting the fixed manufacturing overhead rate.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

8-29 (30 min.) 1.

Variable manufacturing overhead variance analysis.

Denominator level = (3,100,000 × 0.02 hours) = 62,000 hours

Actual Results 2,600,000 46,800 0.018 $617,760 $13.20 $0.238

1. Output units (baguettes) 2. Direct manufacturing Labour-hours 3. Labour-hours per output unit (2 1) 4. Variable manuf. overhead (MOH) costs 5. Variable MOH per Labour-hour (4 2) 6. Variable MOH per output unit (4 1) a2,600,000 baguettes 

Flexible Budget Amounts 2,600,000 52,000a 0.020 $520,000 $10 $0.200

0.02 hours per baguette = 52,000 hours

Variable Manufacturing Overhead Variance Analysis for Sourdough Bread Company for the year: Actual Costs Incurred Actual Input Qty. × Actual Rate (1) (46,800 × $13.20) $617,760

Actual Input Qty. × Budgeted Rate (2) (46,800 × $10) $468,000

$149,760 U Spending variance

Flexible Budget: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (3) (52,000 × $10) $520,000

$52,000 F Efficiency variance

$97,760 U Flexible-budget variance

Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) (52,000 × $10) $520,000

Never a variance Never a variance

3. Spending variance of $149,760 U. It is unfavourable because variable manufacturing overhead was 32% higher than planned. A possible explanation could be an increase in energy rates relative to the rate per standard Labour-hour assumed in the flexible budget. Efficiency variance of $52,000 F. It is favourable because the actual number of direct manufacturing Labour-hours required was lower than the number of hours in the flexible budget. Labour was more efficient in producing baguettes than management had anticipated in the budget. This could occur because of improved morale in the company, which could result from an increase in wages or an improvement in the compensation scheme. Flexible-budget variance of $97,760 U. It is unfavourable because the favourable efficiency variance was not sufficient to compensate for the large unfavourable spending variance.

Chapter 8: Flexible Budgets, Variances, and Management Control: II

8-30 (30 min.)

Fixed manufacturing overhead variance analysis (continuation of 8-29).

1. Budgeted standard direct manufacturing Labour used = 0.02 per baguette Budgeted output = 3,100,000 baguettes Budgeted standard direct manufacturing Labour-hours = 3,100,000 × 0.02 = 62,000 hours Budgeted fixed manufacturing overhead costs = 62,000 × $3.00 per hour = $186,000 Actual output = 2,600,000 baguettes Allocated fixed manufacturing overhead = 2,600,000 × 0.02 × $3 = $156,000 Fixed Manufacturing Overhead Variance Analysis for Sourdough Bread Company for the year:

Actual Costs Incurred (1)

Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (2)

Flexible Budget: Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (3)

$294,000

$186,000

$108,000 U Spending variance

Never a variance

$108,000 U Flexible-budget variance

Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) (2,600,000 × 0.02 × $3) $156,000

$30,000 U Production-volume variance $30,000 U Production-volume variance

$138,000 U Underallocated fixed overhead (Total fixed overhead variance) 2. The fixed manufacturing overhead is underallocated by $138,000. 3. The production-volume variance of $30,000 U captures the difference between the budgeted 3,100,0000 baguettes and the lower actual 2,600,000 baguettes produced—the fixed cost capacity not used. The spending variance of $108,000 unfavourable means that the actual aggregate spending on fixed costs ($294,000) exceeds the budgeted amount ($186,000). For example, monthly leasing rates for baguette-making machines may have increased above those in the budget for the year.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

8-31 (15 min.)

Identifying favourable and unfavourable variances.

Scenario Production output is 8% more than budgeted, and actual fixed manufacturing overhead costs are 7% less than budgeted Production output is 11% more than budgeted; actual machine-hours are 5% less than budgeted Production output is 15% less than budgeted

Actual machinehours are 18% greater than flexiblebudget machinehours

Relative to the flexible budget, actual machine-hours are 10% greater, and actual variable manufacturing overhead costs are 15% less

VOH Spending Variance Cannot be determined: no information on actual versus budgeted VOH rates

VOH Efficiency Variance Cannot be determined: no information on actual versus flexible-budget machine-hours

FOH Spending Variance Favourable: actual fixed costs are less than budgeted fixed costs

Cannot be determined: no information on actual versus budgeted VOH rates

Favourable: actual machinehours less than flexible-budget machine-hours

Cannot be determined: no information on actual versus budgeted VOH rates Cannot be determined: no information on actual versus budgeted VOH rates

Cannot be determined: no information on actual versus flexible-budget machine-hours Unfavourable: too many machine-hours used relative to flexible budget

Cannot be determined: no information on actual versus budgeted FOH costs Cannot be determined: no information on actual versus budgeted FOH costs Cannot be determined: no information on actual versus budgeted FOH costs

Favourable: actual VOH rate lower than budgeted VOH rate

Unfavourable: actual machinehours greater than flexible-budget machine-hours

Cannot be determined: no information on actual versus budgeted FOH costs

FOH ProductionVolume Variance Favourable: output is greater than budgeted causing FOH costs to be overallocated Favourable: output is more than budgeted, causing FOH costs to be overallocated Unfavourable: output less than budgeted will cause FOH costs to be underallocated Cannot be determined: no information on flexible-budget machine-hours relative to staticbudget machinehours Cannot be determined: no information on actual output relative to budgeted output

Chapter 8: Flexible Budgets, Variances, and Management Control: II

8-32 (20 min.)

Activity-based costing, batch-level variance analysis

1. Static budget number of crates = Budgeted pairs shipped ÷ Budgeted pairs per crate

= 240,000/12 = 20,000 crates 2. Flexible budget number of crates = Actual pairs shipped ÷ Budgeted pairs per crate

= 180,000/12 = 15,000 crates 3. Actual number of crates shipped = Actual pairs shipped ÷ Actual pairs per box

= 180,000/10 = 18,000 crates 4. Static budget number of hours = Static budget number of crates × Budgeted hours per box

= 20,000 × 1.2 = 24,000 hours Fixed overhead rate = Static budget fixed overhead ÷ Static budget number of hours

= 60,000/24,000 = $2.50 per hour 5. Variable Overhead Variance Analysis for Amir’s Fleet Feet Inc. for the year

Actual Variable Overhead (18,000 × 1 × $21) $378,000

Actual hours ×Budgeted rate (18,000 × 1 × $20) $360,000

$18,000 U Rate variance

Budgeted hours allowed for Actual output × Budgeted rate (15,000 × 1.2 × $20) $360,000

$0 Efficiency variance

6. Fixed Overhead Variance Analysis for Amir’s Fleet Feet Inc. for the year Actual Static Budget Fixed Overhead Fixed Overhead $55,000

$60,000 $5,000 F Rate variance

Budgeted hours allowed for Actual output × Budgeted Rate (15,000 × 1.2 ×$2.5) $45,000

$15,000 U Production volume variance

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

8-33 (30 min.)

Activity-based costing, batch-level variance analysis

1. Static budget number of setups = Budgeted books produced ÷ Budgeted books per setup = 200,000 ÷ 500 = 400 setups 2. Flexible budget number of setups = Actual books produced ÷ Budgeted books per setup = 216,000 ÷ 500 = 432 setups 3. Actual number of setups = Actual books produced ÷ Actual books per setup = 216,000/480 = 450 setups 4. Static budget number of hours = Static budget # of setups × Budgeted hours per setup = 400 × 6 = 2,400 hours Fixed overhead rate = Static budget fixed overhead ÷ Static budget number of hours = 72,000/2,400 = $30 per hour 5. Budgeted variable overhead cost of a setup = Budgeted variable cost per setup-hour × Budgeted number of setup-hours = $100 × 6 = $600. Budgeted total overhead cost of a setup = Budgeted variable overhead cost + Fixed overhead rate × Budgeted number of setup-hours = $600 + ($30 × 6) = $780. So, the charge of $700 covers the budgeted incremental (i.e., variable overhead) cost of a setup, but not the budgeted full cost.

Chapter 8: Flexible Budgets, Variances, and Management Control: II

6. Variable Setup Overhead Variance Analysis for Jo Nathan Publishing Company for the year Actual Variable Overhead (450 × 6.5 × $90) $263,250

Actual hours × Budgeted rate (450 × 6.5 × $100) $292,500

$29,250F Rate variance

Standard hours × Standard rate (432 × 6.0 × $100) $259,200

$33,300U Efficiency variance

7. Fixed Setup Overhead Variance Analysis for Jo Nathan Publishing Company for the year Actual Fixed Overhead

Static Budget Fixed Overhead

$79,000

$72,000 $7,000 U Rate variance

Standard hours × Budgeted Rate (432 × 6.0 × $30) $77,760

$5,760 F Production-volume variance

8. Rejecting an order may have implications for future orders (i.e., professors would be reluctant to order books from this publisher again). Jo Nathan should consider factors such as prior history with the customer and potential future sales. If a book is relatively new, Jo Nathan might consider running a full batch and holding the extra books in case of a second special order or just hold the extra books until next semester. If the special order comes at heavy volume times, Jo Nathan should look at the opportunity cost of filling it (i.e., accepting the order may interfere with or delay the printing of other books).

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

8-34 (35 min.) 1. and 2.

Production-volume variance analysis and sales volume variance.

Fixed Overhead Variance Analysis for Chart Hills Company for March Actual Fixed Overhead

Static Budget Fixed Overhead

$28,000

$28,500 $500 F Spending variance

Standard Hours × Budgeted Rate (4,200 × 3 × $1.90*) $23,940

$4,560 U Production-volume variance

* fixed overhead rate = (budgeted fixed overhead)/(budgeted DL hours at capacity) = $28,500/(5,000 × 3 hours) = $28,500/15,000 hours = $1.90/hour 3. An unfavourable production-volume variance measures the cost of unused capacity. Production at capacity would result in a production-volume variance of 0 since the fixed overhead rate is based upon expected hours at capacity production. However, the existence of an unfavourable volume variance does not necessarily imply that management is doing a poor job or incurring unnecessary costs. Two reasons can be identified. a. For most products, demand varies from month to month while commitment to the factors that determine capacity, e.g. size of workshop or supervisory staff, tends to remain relatively constant. If Chart Hills wants to meet demand in high demand months, it will have excess capacity in low demand months. In addition, forecasts of future demand contain uncertainty due to unknown future factors. Having some excess capacity would allow Chart Hills to produce enough to cover peak demand as well as slack to deal with unexpected demand surges in non-peak months. b. Basic economics provides a demand curve that shows a tradeoff between price charged and quantity demanded. Potentially, Chart Hills could have a lower net revenue if they produce at capacity and sell at a lower price than if they sell at a higher price at some level below capacity. In addition, the unfavourable production-volume variance may not represent a feasible cost savings associated with lower capacity. Even if Chart Hills could shift to lower fixed costs by lowering capacity, the fixed cost may behave as a step function. If so, fixed costs would decrease in fixed amounts associated with a range of production capacity, not a specific production volume. The production-volume variance would only accurately identify potential cost savings if the fixed cost function is continuous, not discrete.

Chapter 8: Flexible Budgets, Variances, and Management Control: II

4. The static-budget operating income for March is: Revenues $35 × 5,000 Variable costs $18 × 5,000 Fixed overhead costs Static-budget operating income

$175,000 90,000 28,500 $56,500

The flexible-budget operating income for March is: Revenues $35 × 4,200 Variable costs $18 × 4,200 Fixed overhead costs Flexible-budget operating income

$147,000 75,600 28,500 $42,900

The sales-volume variance represents the difference between the static-budget operating income and the flexible-budget operating income: Static-budget operating income Flexible-budget operating income Sales-volume variance

$56,500 42,900 $13,600 U

Equivalently, the sales-volume variance captures the fact that when Chart Hills sells 4,200 shirts instead of the budgeted 5,000, only the revenue and the variable costs are affected. Fixed costs remain unchanged. Therefore, the shortfall in profit is equal to the budgeted contribution margin per unit times the shortfall in output relative to budget. =

–

× = ($35 – $18) × 800 = $17 × 800 = $13,600 U

In contrast, we computed in requirement 2 that the production-volume variance was $4,560 U. This captures only the portion of the budgeted fixed overhead expected to be unabsorbed because of the 800-unit shortfall. To compare it to the sales-volume variance, consider the following: Budgeted selling price Budgeted variable cost per unit Budgeted fixed cost per unit ($28,500 ÷ 5,000) Budgeted cost per unit Budgeted profit per unit

$35.00 $18.00 5.70

Operating income based on budgeted profit per unit $11.30 per unit × 4,200 shirts

23.70 $11.30 $47,460

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

The $4,560 U production-volume variance explains the difference between operating income based on the budgeted profit per unit and the flexible-budget operating income: Operating income based on budgeted profit per unit Production-volume variance Flexible-budget operating income

$47,460 4,560 U $42,900

Since the sales-volume variance represents the difference between the static- and flexible-budget operating incomes, the difference between the sales-volume and production-volume variances, which is referred to as the operating-income volume variance is: Operating-income volume variance = Sales-volume variance – Production-volume variance = Static-budget operating income - Operating income based on budgeted profit per unit = $56,500 – $42,900 = $13,600 U. The operating-income volume variance explains the difference between the static-budget operating income and the budgeted operating income for the units actually sold. The staticbudget operating income is $56,500 and the budgeted operating income for 4,200 units would have been $47,460 ($11.30 operating income per unit × 4,200 units). The difference, $13,600 U, is the operating-income volume variance, i.e., the 800 unit drop in actual volume relative to budgeted volume would have caused an expected drop of $13,600 in operating income, at the budgeted operating income of $11.30 per unit. The operating-income volume variance assumes that $4,560 in fixed cost ($5.70 per unit × 800 units) would be saved if production and sales volumes decreased by 800 units.

Chapter 8: Flexible Budgets, Variances, and Management Control: II

8-35 (1525 min.) Flexible budgets, 4-variance analysis. 1.

= = 3,360,000/672,000 = 5 hours per unit Budgeted DLH allowed for May output Allocated total MOH

= 72,000 units  5 hrs./unit = 360,000 hrs. = 360,000  Total MOH rate per hour = 360,000  $0.99 = $356,400

2, 3, 4, 5. See Solution Exhibit Variable manuf. overhead rate per DLH = $0.30 + $0.20 = $0.50 Fixed manuf. overhead rate per DLH = $0.17 + $0.11 + $0.21 = $0.49 Fixed manuf. overhead budget for May = ($571,200 + $369,600 + $705,600) ÷ 12 = $1,646,400 ÷ 12 = $137,200 or, Fixed manuf. overhead budget for May = $47,600 + $30,800 + $58,800 = $137,200 Using the format of Exhibit 8-5 for variable manufacturing overhead and then fixed manufacturing overhead: Actual variable manuf. overhead: $84,000 + $117,000 = $201,000 Actual fixed manuf. overhead: $41,000 + $55,000 + $58,800 = $154,800 An overview of the 4-variance analysis using the block format of the text is: 4-Variance Analysis

Spending Variance

Efficiency Variance

ProductionVolume Variance

Variable Manufacturing Overhead

$40,500 U

$19,500 F

Never a variance

Fixed Manufacturing Overhead

$17,600 U

Never a variance

$39,200 F

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT Variable Manufacturing Overhead

Actual Costs Incurred (1) $201,000

Actual Input Qty. × Budgeted Rate (2) (321,000  $0.50) $160,500

$40,500 U Spending variance

Flexible Budget: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (3) (360,000  $0.50) $180,000

$19,500 F Efficiency variance

Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) (360,000  $0.50) $180,000

Never a variance

Fixed Manufacturing Overhead

Actual Costs Incurred (1)

Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (2)

Flexible Budget: Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (3)

$154,800

$137,200

$17,600 U Spending variance

Never a variance

Allocated: Budgeted Input Allowed for Actual Output × Budgeted Rate (4) (360,000  $0.49) $176,400

$39,200 F Production-volume variance

Chapter 8: Flexible Budgets, Variances, and Management Control: II

8-36 (3050 min.) Review of Chapters 7 and 8, three-variance analysis. 1. Total standard production costs are based on 7,800 units of output. Direct materials, 7,800  $15.00 7,800  3 kg  $5.00 (or 23,400 kg  $5.00) Direct manufacturing labour, 7,800  $75.00 7,800  5 hrs.  $15.00 (or 39,000 hrs.  $15.00) Manufacturing overhead: Variable, 7,800  $30.00 (or 39,000 hrs.  $6.00) Fixed, 7,800  $40.00 (or 39,000 hrs.  $8.00) Total The following is for later use: Fixed manufacturing overhead, a lump-sum budget

$ 117,000 585,000 234,000 312,000 $1,248,000 $320,000*

Budgeted fixed manufacturing overhead Denominator level Budget $8.00 = 40,000 hours Budget = 40,000 hours  $8.00 = $320000

*Fixed manufacturing overhead rate

2. Solution Exhibit presents a columnar presentation of the variances. An overview of the threevariance analysis using the block format of the text is: Three-Variance Analysis

Rate Variance

Efficiency Variance

Production Volume Variance

Total Manufacturing Overhead

$39,400 U

$6,600 U

$8,000 U

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Direct Materials

Flexible Budget: Actual Costs Budgeted Input Qty. Incurred: Actual Input Qty. Allowed for  Budgeted Price Actual Input Qty. Actual Output × Actual Rate Purchases Usage × Budgeted Price (25,000  $5.20) (25,000  $5.00) (23,100  $5.00) (23,400  $5.00) $130,000 $125,000 $115,500 $117,000 $5,000 U a. Rate variance

Direct Manuf. Labour

(40,100  $14.60) $585,460

$1,500 F b. Efficiency variance (40,100  $15.00) $601,500

$16,040 F c. Rate variance

Variable Manuf. Overhead

(39,000  $15.00) $585,000

$16,500 U d. Efficiency variance

Actual Costs Incurred

Actual Input Qty.  Budgeted Rate

Flexible Budget: Budgeted Input Qty. Allowed for Actual Output  Budgeted Rate

(not given)

(40,100  $6.00) $240,600

(39,000  $6.00) $234,000

$6,600 U Efficiency variance Fixed Manuf. Overhead

(not given)

$320,000

Total Manuf. Overhead

(given) $600,000

($240,600 + $320,000) $560,600

$39,400 U e. Rate variance

(39,000  $8.00) $312,000

$8,000 U* Prodn. volume variance

($234,000 + $320,000) $554,000

$6,600 U f. Efficiency variance

(39,000  $6.00) $234,000

Never a variance

$320,000

Never a variance

Allocated: (Budgeted Input Qty. Allowed for Actual Output  Budgeted Rate)

($234,000 + $312,000) $546,000

$8,000 U g. Prodn. volume variance

Chapter 8: Flexible Budgets, Variances, and Management Control: II

*Denominator level in hours

Production volume in standard hours allowed Production-volume variance

8-37 (20 min.)

40,000 39,000 1,000 hours × $8.00 = $8,000 U

Nonfinancial and non-manufacturing variances

1. Variance Analysis of Inspection Hours for Belle’s Treats for May Actual Hours For Inspections 210 hours

Actual Kilograms Inspected/Budgeted Kilograms per hour 200,000 kg/1,000 kg/hr 200 hours

10 hours U Efficiency variance

Standard KilogramsInspected for Actual Output /Budgeted Kilograms per hour (2,250,000 × 0.1)/1,000 kg/hr 225 hours

25 hours F Quantity variance

2. Variance Analysis of Kilograms Failing Inspection for Belle’s Treats for May Actual Kilograms Failing Inspections

3,500 kg

Actual Kilograms Inspected × Budgeted Inspection Failure Rate

(200,000 kg × 0.02) 4,000 kg

500 kg F Efficiency variance

Standard Kilograms Inspected for Actual Output × Budgeted Inspection Failure Rate

(2,250,000 × 0.1 × 0.02) 4,500 kg

500 kg F Quantity variance

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

8-38 (20 minutes) Nonfinancial variances 1. Variance Analysis of Inspection Hours for Kathy’s Kettle Potato Chips for May

Actual Hours For Inspections 120 hours

Actual Kilograms Inspected/Budgeted Kilograms per hour 22,300 kg/200 kg/hr 111.5 hours

8.5 hours U Efficiency Variance

Standard Kilograms Inspected for Actual Output /Budgeted Kilograms per hour (113,000 × 0.2) kg/(200 kg/hr) 113 hours

1.5 hours F Quantity Variance

2. Variance Analysis of Kilograms Failing Inspection for Kathy’s Kettle Potato Chips for May Actual Kilograms Actual Kilograms Failing Inspections 215 kg

Standard Kilograms Inspected Inspected × Budgeted for Actual Output × Budgeted Inspection Failure Rate Inspection Failure Rate (22,300 kg × 0.01) (113,000 × 0.2 × 0.01) 223 kg 226 kg

8 kg F Quality Variance

3 kg F Quantity Variance

Chapter 8: Flexible Budgets, Variances, and Management Control: II

8-39 (45 min.)

Overhead variances, governance.

1. a. Total budgeted overhead Budgeted variable overhead ($11 budgeted rate per machine-hour × 2,500,000 budgeted machine-hours) Budgeted fixed overhead

$31,250,000 27,500,000 $ 3,750,000

b. Budgeted cost per machine-hour Budgeted fixed OH rate 

$3,750,000 budgeted amount = $1.50 per machine-hour 2,500,000 budgeted machine-hours

c. Fixed overhead rate variance = Actual costs incurred – Budgeted amount. Because fixed overhead rate variance is unfavourable, the amount of actual costs is higher than the budgeted amount. Actual cost = $3,750,000 + $1,500,000 = $5,250,000 d. Production-volume variance = Budgeted fixed overhead – = $3,750,000 – ($1.50 per machine-hour × 2 machine-hours per unit* × 1,245,000 units) = $3,750,000 – $3,735,000= $15,000 U *Budgeted variable overhead per unit = $22

Budgeted variable overhead rate = $11 per machine-hour Therefore, budgeted machine hours allowed per unit = $22/$11 = 2 machine-hours

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Variable overhead rate variance:

 Actual variable Budgeted variable  Actual quantity overhead cost overhead cost  of variable overhead   cost-allocation base per unit of cost  per unit of   allocation base cost-allocation base  used for actual output    $25,200,000 budget amount   $11 per machine-hour  2, 400, 000 machine-hours 2,400,000 actual machine-hours  = ($10.50 – $11) × 2,400,000 = $1,200,000 F Variable overhead efficiency variance: Budgeted units of   Actual units of variable overhead variable overhead  Budgeted cost allocation variable cost-allocation base    overhead  allowed for  base used for  rate  actual output  actual output     = (2,400,000 – (2 × 1,245,000)) × $11 = (2,400,000 – 2,490,000) × $11 = $990,000 F

3. By manipulating, Remich has created a sizable unfavourable fixed overhead rate variance or, at least, has increased its magnitude. Angela Remich’s action is clearly unethical. Variances draw attention to the areas that need management attention. If the top management relies on Remich, due to her expertise, to interpret and explain the reasons for the unfavourable variance, it is likely that her report will be biased and misleading to the top management. The top management may erroneously conclude that Monroe is not able to manage his fixed overhead costs effectively. Another probable adverse outcome of Remich’s actions will be that Monroe will have even less confidence in the usefulness of accounting reports. This, of course, defeats the purpose of preparing the reports. In summary, Remich’s unethical actions will waste top management’s time and may lead to wrong decisions.

Chapter 8: Flexible Budgets, Variances, and Management Control: II

8-40 (30 min.)

Activity-based costing, batch-level variance analysis

1. Static budget number of setups = Budgeted shirts produced/ Budgeted shirts per setup = 125,000 ÷ 100 = 1,250 setups 2. Flexible budget number of setups = Actual shirts produced / Budgeted shirts per setup = 114,000 ÷ 100 = 1,140 setups 3. Actual number of setups = Actual shirts produced / Actual shirts per setup = 114,000/95 = 1,200 setups 4. Static budget number of hours = Static budget # of setups × Budgeted hours per setup = 1,250 × 5 = 6,250 hours Fixed overhead rate = Static budget fixed overhead / Static budget number of hours = $56,250/6,250 = $9 per hour 5. Budgeted direct variable cost of a setup = Budgeted variable cost per setup-hour × Budgeted number of setup-hours = $30 × 5 = $150. Budgeted total cost of a setup = Budgeted direct variable cost + (Fixed overhead rate × Budgeted number of setup-hours) = $150 + ($9 per hour × 5 hours) = $195. So, the charge of $175 covers the budgeted incremental (i.e., variable) cost of a setup, but not the budgeted full cost. 6. Direct Variable Variance Analysis for Saluki Company for the year Actual Variable Cost (1,200 × 5.2 × $32) $199,680

Actual hours × Budgeted rate (1,200 × 5.2 × $30) $187,200

$12,480 U Spending variance

Standard hours × Standard rate (1,140 × 5.0 × $30) $171,000

$16,200 U Efficiency variance

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

7. Fixed Setup Overhead Variance Analysis for Saluki Company for the year Actual Fixed Overhead $56,000

Static Budget Fixed Overhead $56,250

$250 F Spending variance

Standard hours × Budgeted Rate (1,140 × 5.0 × $9) $51,300

$4,950 U Production-volume variance

8. Rejecting an order may have implications for future orders (i.e., groups might be reluctant to order shirts from this supplier again). Saluki should consider factors such as prior history with the customer and potential future sales. If a shirt is relatively new, Saluki might consider running a full batch and holding the extra shirts in case of a second special order or just hold the extra shirts until next semester. If the special order comes at heavy volume times, Saluki should look at the opportunity cost of filling it, i.e., accepting the order may interfere with or delay the printing of other shirts.

Chapter 8: Flexible Budgets, Variances, and Management Control: II

8-41 (20 min.)

Activity-based costing, batch-level variance analysis

1. Static budget number of crates = Budgeted pairs shipped / Budgeted pairs per crate = 225,000/15 = 15,000 crates 2. Flexible budget number of crates = Actual pairs shipped / Budgeted pairs per crate = 180,000/15 = 12,000 crates 3. Actual number of crates shipped = Actual pairs shipped / Actual pairs per box rate = 180,000/10 = 18,000 crates 4. Static budget number of hours = Static budget number of crates × budgeted hours per box = 15,000 × 0.9 = 13,500 hours Fixed overhead rate = Static budget fixed overhead / static budget number of hours = $54,000/13,500 = $4.00 per hour 5. Variable Direct Variance Analysis for Audrina’s Fleet Feet, Inc. for the year Actual Variable Cost (18,000 × 1.1 × $16) $316,800

Actual hours × Budgeted rate (18,000 × 1.1 × $18) $356,400

$39,600 F Price variance

Budgeted hours allowed for Actual output × Budgeted rate (12,000 × 0.9 × $18) $194,400

$162,000 U Efficiency variance

6. Fixed Overhead Variance Analysis for Audrina’s Fleet Feet, Inc. for the year Actual Fixed Overhead

Static Budget Fixed Overhead

$56,500

$54,000 $2,500 U Spending variance

Budgeted hours allowed for Actual output × Budgeted Rate (12,000 × 0.9 × $4.0) $43,200

$10,800 U Production volume variance

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

8-42 (30 min.) Overhead variance, missing information. Known figures denoted by an * Case A:

Variable Manufacturing Overhead

Actual Costs Incurred

Actual Input Qty. × Budgeted Rate

Flexible Budget: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate

Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate

$10,511*

(4,570 × $2.20) $10,054

(4,700* × $2.20) $10,340*

$457 U* Spending variance Fixed Manufacturing Overhead

$27,000*

$286 F Efficiency variance Never a variance

(Lump sum) $23,375*

$3,625 U Spending variance Never a variance

(4,700* × $4.25) $19,975*

$3,400 U Production-volume variance

Budgeted FMOH rate = Standard fixed manufacturing overhead allocated ÷ Standard machine-hours allowed for actual output achieved = $19,975 ÷ 4,700 = $4.25 per machine-hour Denominator level in machine hours = Budgeted Fixed Overhead/Fixed OH standard rate = $23,375 / $4.25 = 5,500 machine hours Total budgeted manufacturing overhead = $10,340 + $23,375 = $33,715 Actual machine hours = 4,570 (calculated as: ($10,511 – $457 U spending variance)/$2.20)

Chapter 8: Flexible Budgets, Variances, and Management Control: II

Case B:

Variable Manufacturing Overhead

Actual Costs Incurred

Actual Input Qty. × Budgeted Rate

Flexible Budget: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate

Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate

$91,750

(44,400  $2.10*) (45,200  $2.10*) $93,240 $94,920

(45,200  $2.10*) $94,920

$1,490 F* $1,680 F* Spending variance Efficiency variance Never a variance Fixed Manufacturing Overhead

$132,900*

(Lump sum) $130,500*

$2,400 U Spending variance Never a variance

45,200 x $2.90 $131,080

$580 F* Production-volume variance

Budgeted FMOH rate = Budgeted fixed manufacturing overhead ÷ Denominator level in machine-hours = $130,500 ÷ 45,000 = $2.90 per machine-hour Standard machine-hours allowed for actual output = Fixed manufacturing overhead allocated / Budgeted FMOH rate = $131,080/$2.90 = 45,200 machine-hours Total budgeted manufacturing overhead = $94,920 + $130,500 = $225,420 Actual machine hours = 44,400 (calculated as: ($94,920 – $1,680 F efficiency variance)/$2.10)

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

8-43 (3040 min.) Graphs and overhead variances. 1. Variable Manufacturing Overhead Costs Total Variable Manuf. Overhead Costs $17,000,000

Graph for planning and control and inventory costing purposes at $10 per machine-hour

$8,500,000

1,000,000 Machine-Hours

Fixed Manufacturing Overhead Costs Total Fixed Manuf. Overhead Costs

Graph for planning and control purpose Graph for inventory costing purpose ($17 per machine-hour)

$17,000,000

$8,500,000

1,000,000 Machine-Hours

= = $17,000,000/ 1,000,000 machine hours = $17 per machine-hour

Chapter 8: Flexible Budgets, Variances, and Management Control: II

2. (a) Variable Manufacturing Overhead Variance Analysis for Best Around, Inc. for 2022

Actual Costs Incurred (1) $12,075,000

Flexible Budget: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (3) (1,125,000  $10) $11,250,000

Actual Input Qty. × Budgeted Rate (2) (1,200,000  $10) $12,000,000

$75,000 U Spending variance

$750,000 U Efficiency variance

Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) (1,125,000  $10) $11,250,000

Never a variance

$,825,000 U Flexible-budget variance

Never a variance

$825000 U Underallocated variable overhead (Total variable overhead variance) (b) Fixed Manufacturing Overhead Variance Analysis for Best Around, Inc. for 2022

Actual Costs Incurred (1)

Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (2)

Flexible Budget: Same Budgeted Lump Sum (as in Static Budget) Regardless of Output Level (3)

$17,100,000

$17,000,000

$100,000 U Spending variance

Never a variance

$100,000 U Flexible-budget variance

Allocated: Budgeted Input Qty. Allowed for Actual Output × Budgeted Rate (4) (1,125,000 × $17) $19,125,000

$2,125,000 F* Production-volume variance $2,125,000 F* Production-volume variance

$2,025,000 F Overallocated fixed overhead (Total fixed overhead variance) *Alternative computation: 1,125,000 budgeted hrs. allowed – 1,000,000 denominator hrs. = 125,000 hrs.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. The underallocated variable manufacturing overhead was $825,000 and overallocated fixed overhead was $2,025,000. The flexible-budget variance and underallocated overhead are always the same amount for variable manufacturing overhead, because the flexible-budget amount of variable manufacturing overhead and the allocated amount of variable manufacturing overhead coincide. In contrast, the budgeted and allocated amounts for fixed manufacturing overhead only coincide when the budgeted input of the allocation base for the actual output level achieved exactly equals the denominator level. 4. The choice of the denominator level will affect inventory costs. The new fixed manufacturing overhead rate would be $17,000,000 ÷ 1,700,000 = $10.00 per machine-hour. In turn, the allocated amount of fixed manufacturing overhead and the production-volume variance would change as seen below: Actual

Budget

$17,100,000

$17,000,000

Allocated 1,125,000 × $10.00 = $11,250,000

$100,000 U $5,750,000 U* Flexible-budget variance Prodn. volume variance $5,850,000 U Total fixed overhead variance *Alternate computation: (1,700,000 – 1,125,000) × $10.00 = $5,750,000 U

Chapter 8: Flexible Budgets, Variances, and Management Control: II

8-44 (40 minutes)

Overhead variances, ethics

1. Budget Fixed Overhead per Labour Hour = Budgeted Fixed Overhead / Standard Direct Labour Hours for Budgeted Production $1,800,000 / (1,200,000 × .5 DLH per unit) = $3 per DLH 2. Variable overhead variances: Actual Variable Overhead $2,700,000

Actual hours × Budgeted rate (760,000 × $3.50) $2,660,000

$40,000 U Spending variance

Budgeted input allowed for Actual output × Budgeted rate (1,500,000 × 0.5 × $3.50) $2,625,000

$35,000 U Efficiency variance

3. Fixed overhead variances: Actual Fixed Overhead

Static Budget Fixed Overhead

$1,850,000

$1,800,000

$50,000 U Spending variance

Budgeted input allowed for Actual output × Budgeted Rate (1,500,000 × 0.5 × $3) $2,250,000

$450,000 F Production-volume variance

4. Budget Fixed Overhead per Labour Hour = Budgeted Fixed Overhead / Standard Direct Labour Hours for Budgeted Production $1,800,000 / (1,500,000 × .5 DLH per unit) = $2.40 per DLH

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

5. Fixed overhead variances with realistic budget: Actual Fixed Overhead

Static Budget Fixed Overhead

$1,850,000

$1,800,000

$50,000 U Spending variance

Budgeted input allowed for Actual output × Budgeted Rate (1,500,000 × 0.5 × $2.40) $1,800,000

$ -0Production-volume variance

Fixed Manufacturing Overhead Variances:

Fixed Overhead Spending Variance Fixed Overhead Product-Volume Variance Total Fixed Overhead Variance

Manipulated Production 1,200,000 units $ 50,000 U $450,000 F $400,000 F

Realistic Expected Production 1,500,000 units $ 50,000 U $ -0$ 50,000 U

6. Tom Saban made it appear as though his friend, the plant manager, did better than the level at which he actually performed. The fixed overhead spending variance was unaffected by the manipulation of expected production since it relies on a comparison of the budgeted to actual cost realizations. However, the fixed overhead product-volume variance was affected by the manipulated budgeted units of production. By estimating an unrealistically small level of output, Tom Saban affected the budgeted rate for fixed overhead and thus the amount of fixed overhead allocated to production. The resulting overallocation led to a significantly positive production-volume variance for fixed overhead, as well as a favourable fixed overhead variance overall, even though there was no change to the real cost of the units produced. 7. Tom Saban’s behaviour is not ethical. He attempted to make his friend better off by manipulating budgets and overhead rates, rather than focusing on which cost system would provide the best measure of costs and of managerial performance.

Chapter 8: Flexible Budgets, Variances, and Management Control: II

MINI-CASE 8-45

(30 min.)

Standard setting, benchmarking, governance.

Solution Exhibit shows the summary results: 1. 1.

Favourable VOH efficiency = (Budgeted hours allowed – Actual hours)  $12 $2,400* = (1,800* – A) $12* $2,400 = $21,600 – $12A $12A = $19,200 A = 1,600

Budgeted total MOH = Budgeted fixed MOH + Budgeted variable MOH $27,000* = B.F. MOH + (1,800*  $12*) Budgeted fixed MOH = $5,400

Answer (2) + $1,080, or: Fixed MOH overhead allocated = Budgeted fixed MOH + Favourable production-volume variance = $5,400 + $1,080* = $6,480 Answer (3) ÷ 1,800 hours = Fixed MOH rate $6,480 ÷ 1,800* = $3.60

Favourable productionvolume variance

Budgeted Denominator    level  hours   allowed  hours  

$1,080* $1,080 –$5,400 D

= = = =

(1,800* – D) $3.6 $6,480 – $3.60D –$3.60D 1,500 hours

Budgeted Fixed MOH Rate

Alternatively,

Budgeted     fixed   MOH     rate   

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT

Variable Overhead

Actual Costs Incurred (Actual Input  Actual Rate)

Actual Input  Budgeted Rate

Flexible Budget: (Budgeted Input Allowed for Actual Output Achieved  Budgeted Rate)

(1,600  $13.50) $21,600

(1,600  $12*) $19,200

(1,800*  $12*) $21,600

$2,400 U*

Rate variance

Actual Costs Incurred Fixed Overhead

$2,400 F*

Efficiency variance

Same Lump Sum Regardless of Output Level

Allocated: (Budgeted Input Allowed for Actual Output Achieved  Budgeted Rate)

$5,400

($1,800*  $3.60) $6,480

$5,160 $240 F*

$1,080 F*

Rate variance

Efficiency variance (Never a variance)

Production-volume variance

*Given 2.

Padding of standard costs and standard amounts for billing operations can arise from: (a) Deliberately taking longer time to process the bills when standards are being set. (b) Deliberately not taking advantage of information technology in the standard-setting period and then exploiting that technology later on. (c) Creating problems in billing for which solutions have already been worked out and using those solutions only in the non-standard-setting period. (d) Not purchasing items in the most economic way during the standard-setting period. Reasons for padding include: (a) Individual performance evaluation—individuals who wish to look “good” for bonuses, promotion, etc. purposes. (b) Department performance evaluation—departments wish to retain autonomy, which is more likely with favourable variances. (c) Defying authority and control systems—some individuals have an inherent opposition to “standards” and “controls.”

Chapter 8: Flexible Budgets, Variances, and Management Control: II

Stone can operate at several levels: (a) Best practice observation—MEG’s report should be a catalyst to General’s examining what other hospitals in the survey are doing and then using this best practice internally. MEG may be hired to facilitate field visits to other more efficient hospitals. (b) Operations—make flowcharts of how billing occurs at General and eliminate all unnecessary steps. (c) Incentive systems—provide economic and other incentives to General employees to implement efficiency and effectiveness improvements. The emphasis here should be on accuracy and timeliness of billing as well as the cost of billing. (d) Corporate culture—Stone should emphasize that “padding” and the deliberate misrepresentation it entails are unacceptable. This could be done via in-house programs on ethics and culture or by making “examples” of those found deliberately undermining a culture of honesty and teamwork for General.

CHAPTER 9 INCOME EFFECTS OF DENOMINATOR LEVEL ON INVENTORY VALUATION MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

SHORT-ANSWER QUESTIONS 9-1

No. Differences in operating income between variable costing and absorption costing are due to accounting for fixed manufacturing costs. Under variable costing, only variable manufacturing costs are included as inventoriable costs. Under absorption costing, both variable and fixed manufacturing costs are included as inventoriable costs. Fixed marketing and distribution costs are not accounted for differently under variable costing and absorption costing.

9-2

The term direct costing is a misnomer for variable costing for two reasons:

a. Variable costing does not include all direct costs as inventoriable costs. Only variable direct manufacturing costs are included. Any fixed direct manufacturing costs, and any direct nonmanufacturing costs (either variable or fixed), are excluded from inventoriable costs. b. Variable costing includes as inventoriable costs not only direct manufacturing costs but also some indirect costs (variable indirect manufacturing costs).

9-3

No. The difference between absorption costing and variable costs is due to accounting for fixed manufacturing costs. As service or merchandising companies have no fixed manufacturing costs, these companies do not make choices between absorption costing and variable costing.

9-4

The main issue between variable costing and absorption costing is the proper timing of the release of fixed manufacturing costs as costs of the period: a. at the time of incurrence, or b. at the time the finished units to which the fixed overhead relates are sold. Variable costing uses (a) and absorption costing uses (b).

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

9-5

No. A company that makes a variable-cost/fixed-cost distinction is not forced to use any specific costing method. The Stassen Company example in Chapter 9 makes a variablecost/fixed-cost distinction. As illustrated, it can use variable costing, absorption costing, or throughput costing. A company that does not make a variable-cost/fixed-cost distinction cannot use variable costing or throughput costing. However, it is not forced to adopt absorption costing. For internal reporting, it could, for example, classify all costs as costs of the period in which they are incurred.

9-6

Variable costing does not view fixed costs as unimportant or irrelevant, but it maintains that the distinction between behaviours of different costs is crucial for certain decisions. The planning and management of fixed costs is critical, irrespective of what inventory costing method is used.

9-7

Under absorption costing, large reductions of inventory during the accounting period might combine with low production and a large production volume variance. This combination could result in lower operating income even if the unit sales level rises.

9-8

(a) The factors that affect the breakeven point under variable costing are: 1. Fixed (manufacturing and operating) costs. 2. Contribution margin per unit. (b) The factors that affect the breakeven point under absorption costing are: 1. Fixed (manufacturing and operating) costs. 2. Contribution margin per unit. 3. Production level in units in excess of breakeven sales in units. 4. Denominator level chosen to set the fixed manufacturing cost rate.

9-9

Examples of dysfunctional decisions managers may make to increase reported operating income include: a. Plant managers may switch production to those orders that absorb the highest amount of manufacturing overhead, irrespective of the demand by customers. b. Plant managers may accept a particular order to increase production even though another plant in the same company is better suited to handle that order. c. Plant managers may defer maintenance beyond the current period to free up more time for production.

9-10 Approaches used to reduce the negative aspects associated with using absorption costing include: a. Change the accounting system:  Adopt either variable or throughput costing, both of which reduce the incentives of managers to produce for inventory.  Adopt an inventory holding charge for managers who tie up funds in inventory. Copyright © 2022 Pearson Canada Inc. 9-2

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

b. Extend the time period used to evaluate performance. By evaluating performance over a longer time period (say, three to five years), the incentive to take short-run actions that reduce long-term income is lessened. c. Include nonfinancial as well as financial variables in the measures used to evaluate performance.

9-11 The downward demand spiral is the continuing reduction in demand for a company’s product that occurs when the prices of competitors’ products are not met and (as demand drops further), higher and higher unit costs result in more and more reluctance to meet competitors’ prices. Pricing decisions need to consider competitors and customers as well as costs.

9-12 No. It depends on how a company handles the production-volume variance in the end-ofperiod financial statements. For example, if the adjusted allocation-rate approach is used, each denominator-level capacity concept will give the same financial statement numbers at year-end.

9-13 The denominator-level concepts of theoretical and practical capacity emphasize what a plant can supply. The denominator-level concepts of normal utilization and master budget utilization emphasize what customers demand for products produced by a plant.

9-14 No. The costs of having too much capacity/too little capacity involve revenue opportunities potentially forgone as well as costs of money tied up in plant assets.

EXERCISES 9-15 (10 min.)

Terminology.

1. When the full costs of production are included, this is called absorption costing, but it is sometimes more appropriate to use either variable costing or to include only direct materials called throughput or supervariable costing. 2. The two types of demand capacity that can be used in the denominator to calculate a unitized fixed cost rate are long-term demand normal capacity or short-term demand called master budget capacity. 3. The only acceptable measure for CRA is master budget capacity, while the only ASPE/IFRS compliant measure to value inventory and COGS is normal capacity. 4. The two supply side measures that may be used in the denominator to calculate a unitized fixed-cost rate are long-term measures. The first is unrealistic and excludes any allowance for off-limits idle capacity. It is a 24/7/365 measure called theoretical capacity. The second includes allowance for scheduled maintenance but not for nonproductive idle capacity, It is called practical capacity.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

9-16 (30 min.)

Variable and absorption costing; explaining operating-income differences.

1. Key inputs for income statement computations are April 0 500 500 350 150

Beginning inventory Production Goods available for sale Units sold Ending inventory

May 150 400 550 520 30

The budgeted fixed cost per unit and budgeted total manufacturing cost per unit under absorption costing are (a) (b) (c)=(a)÷(b) (d) (e)=(c)+(d)

Budgeted fixed manufacturing costs Budgeted production Budgeted fixed manufacturing cost per unit Budgeted variable manufacturing cost per unit Budgeted total manufacturing cost per unit

April

May

$2,000,000 500 $4,000 $10,000 $14,000

(a) Variable costing April $9,100,000

Revenue Variable costs Beginning inventory Variable manufacturing costsb Cost of goods available for sale Deduct ending inventoryc Variable cost of goods sold d Variable operating costs Total variable costs Contribution margin Fixed costs Fixed manufacturing costs Fixed operating costs Total fixed costs Operating income a$26,000 × 350; $26,000 × 520 b$10,000 × 500; $10,000 × 400

$ 0 5,000,000 5,000,000 (1,500,000) 3,500,000 1,050,000

May $13,520,000 $1,500,000 4,000,000 5,500,000 (300,000) 5,200,000 1,560,000

4,550,000 4,550,000 2,000,000 600,000

6,760,000 6,760,000 2,000,000 600,000

2,600,000 $1,950,000 c$10,000 × 150; $10,000 × 30 d$3,000 × 350; $3,000 × 520

2,600,000 $4,160,000

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

(b) Absorption costing Revenuea Cost of goods sold Beginning inventory Variable manufacturing costsb Allocated fixed manufacturing costsc Cost of goods available for sale Deduct ending inventoryd Adjustment for prod.-vol. variancee Cost of goods sold Gross margin Operating costs Variable operating costsf Fixed operating costs Total operating costs Operating income

April $9,100,000 $ 0 5,000,000 2,000,000 7,000,000 (2,100,000) 0

May $13,520,000 $2,100,000 4,000,000 1,600,000 7,700,000 (420,000) 400,000 U

4,900,000 4,200,000 1,050,000 600,000

7,680,000 5,840,000 1,560,000 600,000

1,650,000 $2,550,000

2,160,000 $ 3,680,000

a$26,000 × 350; $26,000 × 520

d$14,000 × 150; $14,000 × 30

b$10,000 × 500; $10,000 × 400

e$2,000,000 – $2,000,000; $2,000,000 – $1,600,000

c$4,000 × 500; $4,000 × 400

f$3,000 × 350; $3,000 × 520

Absorption-costing Variable-costing Fixed manufacturing costs Fixed manufacturing costs =   operating income operating income in ending inventory in beginning inventory

April: $2,550,000 – $1,950,000 $600,000

= ($4,000 × 150) – ($0) = $600,000

May: $3,680,000 – $4,160,000 = ($4,000 × 30) – ($4,000 × 150) – $480,000 = $120,000 – $600,000 – $480,000 = – $480,000 The difference between absorption and variable costing is due solely to moving fixed manufacturing costs into inventories as inventories increase (as in April) and out of inventories as they decrease (as in May).

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

9-17 (20 min.)

Throughput costing (continuation of 9-16).

1. April Revenuea $9,100,000 Direct materials cost of goods sold Beginning inventory Direct materials in goods $ 0 b manufactured 3,350,000 Cost of goods available for sale 3,350,000 Deduct ending inventoryc (1,005,000) Total direct materials cost of goods sold 2,345,000 Throughput contribution 6,755,000 Other costs Manufacturing costs 3,650,000d Other operating costs 1,650,000f Total other costs 5,300,000 Operating income $1,455,000

May $13,520,000 $1,005,000 2,680,000 3,685,000 (201,000) 3,484,000 10,036,000 3,320,000e 2,160,000g

a$26,000 × 350; $26,000 × 520

e($3,300 × 400) + $2,000,000

b$6,700 × 500; $6,700 × 400

f($3,000 × 350) + $600,000

c$6,700 × 150; $6,700 × 30

g($3,000 × 520) + $600,000

5,480,000 $ 4,556,000

d($3,300 × 500) + $2,000,000

2. Operating income under: Absorption costing Variable costing Throughput costing

April $2,550,000 1,950,000 1,455,000

May $3,680,000 4,160,000 4,556,000

In April, throughput costing has the lowest operating income, whereas in May throughput costing has the highest operating income. Throughput costing puts greater emphasis on sales as the source of operating income than does either absorption or variable costing. 3. Throughput costing puts a penalty on production without a corresponding sale in the same period. Costs other than direct materials that are variable with respect to production are expensed in the period of incurrence, whereas under variable costing they would be capitalized. As a result, throughput costing provides less incentive to produce for inventory than either variable costing or absorption costing.

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

9-18 (40 min.)

Variable and absorption costing, explaining operating-income differences.

The following solution is based on budgeted monthly production of 1,000 units. 1. Key inputs for operating income statement computations are: January Beginning inventory Production Goods available for sale Units sold Ending inventory

0 1,000 1,000 700 300

February 300 800 1,100 800 300

March 300 1,250 1,550 1,500 50

The budgeted fixed manufacturing cost per unit and budgeted total manufacturing cost per unit under absorption costing are: (a) (b) (c)=(a)÷(b) (d) (e)=(c)+(d)

Budgeted fixed manufacturing costs Budgeted production Budgeted fixed manufacturing cost per unit Budgeted variable manufacturing cost per unit Budgeted total manufacturing cost per unit

January $400,000 1,000 $400 $900 $1,300

February $400,000 1,000 $400 $900 $1,300

March $400,000 1,000 $400 $900 $1,300

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

(a) Variable Costing Revenuea Variable costs Beginning inventoryb Variable manufacturing costsc Cost of goods available for sale Deduct ending inventoryd Variable cost of goods sold Variable operating costse Total variable costs

January $2,100,000 $ 0 900,000 900,000 (270,000) 630,000 420,000

Contribution margin Fixed costs Fixed manufacturing costs 400,000 Fixed operating costs 140,000 Total fixed costs Operating income a $3,000× 700; $3,000× 800; $3,000× 1,500 b $? × 0; $900 × 300; $900 × 300 c $900 × 1,000; $900 × 800; $900 × 1,250 d $900 × 300; $900 × 300; $900 × 50 e $600 × 700; $600 × 800; $600 × 1,500

February $2,400,000 $270,000 720,000 990,000 (270,000) 720,000 480,000

March $4,500,000 $ 270,000 1,125,000 1,395,000 (45,000) 1,350,000 900,000

1,050,000

1,200,000

1,050,000

1,200,000

2,250,000 2,250,000

540,000 $ 510,000

400,000 140,000

400,000 140,000 540,000 $ 660,000

540,000 $ 1,710,000

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

(b) Absorption Costing Revenuea Cost of goods sold Beginning inventoryb Variable manufacturing costsc Allocated fixed manufacturing costsd Cost of goods available for sale Deduct ending inventorye Adjustment for prod. vol. var.f Cost of goods sold Gross margin Operating costs Variable operating costsg Fixed operating costs Total operating costs Operating income

January $2,100,000

February $2,400,000

March $4,500,000

$ 0 900,000

$ 390,000 720,000

$ 390,000 1,125,000

400,000 1,300,000 (390,000) 0

320,000 1,430,000 (390,000) 80,000 U

500,000 2,015,000 (65,000) (100,000) F

910,000 1,190,000 420,000 140,000

1,120,000 1,280,000 480,000 140,000

560,000 $ 630,000

1,850,000 2,650,000 900,000 140,000

620,000 $ 660,000

1,040,000 $ 1,610,000

a$3,000× 700; $3,000 × 800; $3,000 × 1,500

b$?× 0; $1,300 × 300; $1,300 × 300

c$900 × 1,000; $900 × 800; $900 × 1,250

d$400 × 1,000; $400 × 800; $400 × 1,250

e$1,300 × 300; $1,300 × 300; $1,300 × 50

f$400,000 – $400,000; $400,000 – $320,000; $400,000 – $500,000

g$600 × 700; $600 × 800; $600 × 1,500

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Fixed manufacturing  Fixed manufacturing  Absorption-costing  Variable costing     costs in costs in 2.        operating income operating income     ending inventory  beginning inventory    

January:

$630,000 – $510,000 = ($400 × 300) – $0 $120,000 = $120,000

February:

$660,000 – $660,000 = ($400 × 300) – ($400 × 300) $0 = $0

March:

$1,610,000 – $1,710,000 = ($400 × 50) – ($400 × 300) – $100,000 = – $100,000

The difference between absorption and variable costing is due solely to moving fixed manufacturing costs into inventories as inventories increase (as in January) and out of inventories as they decrease (as in March).

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

9-19 (20–30 min.) Throughput costing (continuation of 9-18). 1. Revenuea

January $2,100,000 0

Direct material cost of goods sold Beginning inventoryb

Direct materials in goods manufacturedc Cost of goods available for sale Deduct ending inventoryd Total direct material cost of goods sold Throughput contribution Other costs Manufacturinge Operatingf Total other costs Operating income

500,000 500,000 (150,000)

February $2,400,000 $150,000

March $4,500,00 0 $ 150,000

400,000 550,000 (150,000)

625,000 775,000 (25,000)

350,000 1,750,000 800,000 560,000

400,000 2,000,000 720,000 620,000

1,360,000 $ 390,000

a$3,000 × 700; $3,000 × 800; $3,000 × 1,500

b$? × 0; $500 × 300; $500 × 300

c$500 × 1,000; $500 × 800; $500 × 1,250

d$500 × 300; $500 × 300; $500 ×50

e($400 × 1,000) + $400,000; ($400 × 800) + $400,000; ($400 × 1,250) + $400,000 f($600 × 700) + $140,000; ($600 × 800) + $140,000; ($600 × 1,500) + $140,000

750,000 3,750,000 900,000 1,040,000

1,340,000 $ 660,000

1,940,000 $1,810,00 0

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Operating income under: Variable costing Absorption costing Throughput costing

January $510,000 630,000 390,000

February $660,000 660,000 660,000

March $1,710,000 1,610,000 1,810,000

Throughput costing puts greater emphasis on sales as the source of operating income than does absorption or variable costing. 3. Throughput costing puts a penalty on producing without a corresponding sale in the same period. Costs other than direct materials that are variable with respect to production are expensed when incurred, whereas under variable costing they would be capitalized as an inventoriable cost.

9-20 (10 min.)

Absorption and variable costing.

The answers are 1(b) and 2(c). Computations: 1. Absorption Costing: Revenuea Cost of goods sold: Beginning inventory Variable manufacturing costsb Allocated fixed manufacturing costsc Cost of goods available for sale Deduct: Ending inventory Cost of goods sold Gross margin Operating costs: Variable operatingd Fixed operating Operating income

$8,550,000 $0 5,000,000 800,000 5,800,000 (290,000) 5,510,000 3,040,000 1,900,000 500,000

a$45 × 190,000 b$25 × 200,000 cFixed manufacturing rate = $800,000 ÷ 200,000 = $4 per output unit

Fixed manufacturing costs = $4 × 200,000 d$10 × 190,000

2,400,000 $ 640,000

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

2. Variable Costing: Revenuea Variable costs: Beginning inventory Variable manufacturing cost of goods soldb Cost of goods available for sale Deduct: Ending inventory Variable cost of goods sold Variable operating costsc Contribution margin Fixed costs: Fixed manufacturing costs Fixed operating costs Operating income

$8,550,000 $0 5,000,000 5,000,000 (250,000) 4,750,000 1,900,000 800,000 500,000

6,650,000 1,900,000 1,300,000 $ 600,000

a$45 × 190,000 b$25 × 200,000 c$10 × 190,000

9-21 (40 min)

Absorption versus variable costing.

1. The variable manufacturing cost per unit is $55 + $45 + $120 = $220. Variable-Costing Based Operating Income Statement Revenue (8,960 × $1,200 per unit) Variable costs Beginning inventory Variable manufacturing costs (10,000 units × $220 per unit) Cost of goods available for sale Deduct: Ending inventory (1,040a units × $220 per unit) Variable cost of goods sold Variable marketing costs (8,960 units × $75 per unit) Total variable costs Contribution margin Fixed costs Fixed manufacturing costs Fixed R&D Fixed marketing Total fixed costs Operating income

$10,752,00 0 $ 0 2,200,000 2,200,000 (228,800) 1,971,200 672,000 2,643,200 8,108,800 1,471,680 981,120 3,124,480

aBeginning Inventory 0 + Production 10,000 – Sales 8,960 = Ending Inventory 1,040 units

5,577,280 $2,531,520

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Absorption-Costing Based Operating Income Statement Revenue (8,960 units × $1,200 per unit) Cost of goods sold Beginning inventory Variable manufacturing costs (10,000 units × $220 per unit) Allocated fixed manufacturing costs (10,000 units × $165 per unit) Cost of goods available for sale Deduct ending inventory (1,040 units × ($220 + $165) per unit) Deduct favourable production volume variance Cost of goods sold Gross margin Operating costs Variable marketing costs (8,960 units × $75 per unit) Fixed R&D Fixed marketing Total operating costs Operating income

$10,752,000 $ 0 2,200,000 1,650,000 3,850,000 (400,400) (178,320)a F 3,271,280 7,480,720 672,000 981,120 3,124,480 4,777,600 $ 2,703,120

aPVV = Allocated $1,650,000 ($165 × 10,000) – Actual $1,471,680 = $178,320

3. The operating income under absorption costing is greater than the operating income under variable costing because during the year inventories increased by 1,040 units, and under absorption costing fixed overhead remained in the ending inventory, and resulted in a lower cost of goods sold (relative to variable costing). As shown below, the difference in the two operating incomes is exactly the same as the difference in the fixed manufacturing costs included in ending vs. beginning inventory (under absorption costing). Operating income under absorption costing Operating income under variable costing Difference in operating income under absorption vs. variable costing

$2,703,120 2,531,520 $ 171,600

Under absorption costing: Fixed mfg. costs in ending inventory (1,040 units × $165 per unit) Fixed mfg. costs in beginning inventory (0 units × $165 per unit) Change in fixed mfg. costs between ending and beginning inventory

$ 171,600 0 $ 171,600

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

4. Relative to the obvious alternative of using contribution margin (from variable costing), the absorption-costing-based gross margin has some pros and cons as a performance measure for Electron’s supervisors. It takes into account both variable costs and fixed costs—costs that the supervisors should be able to control in the long run—and therefore it is a more complete measure than contribution margin which ignores fixed costs (and may cause the supervisors to pay less attention to fixed costs). The downside of using absorption-costing-based gross margin is the supervisor’s temptation to use inventory levels to control the gross margin—in particular, to shore up a sagging gross margin by building up inventories. This can be offset by specifying, or limiting, the inventory buildup that can occur, charging the supervisor a carrying cost for holding inventory, and using nonfinancial performance measures such as the ratio of ending to beginning inventory.

9-22 (10 min.)

Capacity management, denominator-level capacity concepts.

1. a, b 2. a 3. d 4. c, d 5. c 6. d 7. a 8. b (or a) 9. b 10. c, d 11. a, b

9-23 (40 min) 1.

Variable versus absorption costing.

Operating Income Statement for the Zwatch Company, Variable Costing for the Year Ended December 31 Revenue: $22 × 345,400 $7,598,800 Variable costs Beginning inventory: $5.10 × 85,000 $ 433,500 Variable manufacturing costs: $5.10 × 294,900 1,503,990 Cost of goods available for sale 1,937,490 Deduct ending inventory: $5.10 × 34,500 (175,950) Variable cost of goods sold 1,761,540 Variable operating costs: $1.10 × 345,400 379,940 Adjustment for variances 0 Total variable costs 2,141,480 Contribution margin 5,457,320 Fixed costs Fixed manufacturing overhead costs 1,440,000 Fixed operating costs 1,440,000 Total fixed costs 2,880,000 Operating income $2,577,320

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Absorption Costing Data: Fixed manufacturing overhead allocation rate = Fixed manufacturing overhead/Denominator level machine-hours = $1,440,000 ÷ 6,000 = $240 per machine-hour Fixed manufacturing overhead allocation rate per unit = Fixed manufacturing overhead allocation rate/standard production rate = $240 ÷ 50 = $4.80 per unit Operating Income Statement for the Zwatch Company, Absorption Costing for the Year Ended December 31 Revenue: $22 × 345,400 $7,598,800 Cost of goods sold Beginning inventory ($5.10 + $4.80) × 85,000 $ 841,500 Variable manuf. costs: $5.10 × 294,900 1,503,990 Allocated fixed manuf. costs: $4.80 × 294,900 1,415,520 Cost of goods available for sale $3,761,010 Deduct ending inventory: ($5.10 + $4.80) × 34,500 (341,550) a Adjust for manuf. variances ($4.80 × 5,100) 24,480 U Cost of goods sold 3,443,940 Gross margin 4,154,860 Operating costs Variable operating costs: $1.10 × 345,400 $ 379,940 Fixed operating costs 1,440,000 Total operating costs 1,819,940 Operating income $2,334,920 aProduction volume variance = [(6,000 hours × 50) – 294,900] × $4.80

= (300,000 – 294,900) × $4.80 = $24,480 2. Zwatch’s operating margins as a percentage of revenue are Under variable costing: Revenue Operating income Operating income as percentage of revenues

$7,598,800 2,577,320 33.92%

Under absorption costing: Revenues Operating income Operating income as percentage of revenues

$7,598,800 2,334,920 30.73%

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

3. Operating income using variable costing is about 10% higher than operating income calculated using absorption costing. Variable costing operating income – Absorption costing operating income = $2,577,320 – $2,334,920 = $242,400 4. The factors the CFO should consider include (a) Effect on managerial behaviour. (b) Effect on external users of financial statements. I would recommend absorption costing because it considers all the manufacturing resources (whether variable or fixed) used to produce units of output. Absorption costing has many critics. However, the dysfunctional aspects associated with absorption costing can be reduced by   

Careful budgeting and inventory planning. Adding a capital charge to reduce the incentives to build up inventory. Monitoring nonfinancial performance measures.

PROBLEMS 9-24 (30 min.)

Variable and absorption costing and breakeven points.

1. Production

= Sales + Ending Inventory - Beginning Inventory = 400,000 + 0  20,000 = 380,000 basketballs.

Breakeven point in units (basketballs sold): a. Variable Costing: Q =

Q = Q =

Total Fixed costs  Target operating Income Contribution Margin Per Unit

$380, 000  $660, 000  $0 $12 $3 $4 $1, 040, 000 $5

Q = 208,000 units.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

b. Absorption costing: Fixed manufacturing cost rate = $380,000 ÷ 380,000 = $1 per unit  Fixed Manuf.  Breakeven Units  Total Fixed  Target         Cost OI Cost Rate Sales in Units Produced     Q = Contribution Margin Per Unit

Q =

$1, 040, 000  $0   $1Q 380, 000   $5

Q =

$1, 040, 000  Q 380, 000 $5

Q =

$660, 000  Q $5

4Q Q

= $660,000 = 165,000 basketballs.

2. If direct materials costs were $4 instead per basketball, the contribution margin would be lowered to $4. a. Variable Costing: Q =

$1, 040, 000  $120, 000 $4

$1,1160, 000 $4

= 290,000 basketballs b. Absorption Costing: Q =

$1, 040, 000  $120, 000   $1Q 380, 000   $4

4 Q = $780,000 + Q 3 Q = $780,000 Q = 260,000 basketballs

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

9-25 (35 min.)

Absorption costing and production volume variance—alternative capacity bases

1. Inventoriable cost per unit = Variable production cost + Fixed manufacturing overhead/Capacity

Capacity Type Theoretical Practical Normal Master Budget

Capacity Level 800,000 500,000 250,000 200,000

Fixed Mfg. Overhead $1,000,000 $1,000,000 $1,000,000 $1,000,000

Fixed Mfg. Overhead Rate $1.25 $2.00 $4.00 $5.00

Variable Production Cost $2.50 $2.50 $2.50 $2.50

Inventoriable Cost Per Unit $3.75 $4.50 $6.50 $7.50

2. ELF’s actual production level is 220,000 bulbs. We can compute the production-volume variance as: Budgeted Fixed MOH – (Fixed MOH Rate × Actual Production Level)

Capacity Type Theoretical Practical Normal Master Budget

Capacity Level 800,000 500,000 250,000 200,000

Fixed Mfg. Overhead $1,000,000 $1,000,000 $1,000,000 $1,000,000

Fixed Mfg. Overhead Rate $1.25 $2.00 $4.00 $5.00

Fixed Mfg. Overhead Rate × Actual Production $ 275,000 $ 440,000 $ 880,000 $1,100,000

Production Volume Variance $725,000 U $560,000 U $120,000 U $100,000 F

3. Operating income for ELF given production of 220,000 bulbs and sales of 200,000 bulbs @ $9 apiece: Revenue Less: Cost of goods sold a Production-volume variance Gross margin Variable selling b Fixed selling Operating income

Theoretical $1,800,000 750,000 725,000 U 325,000 50,000 250,000 $ 25,000

Practical Normal Master Budget $1,800,000 $1,800,000 $1,800,000 900,000 1,300,000 1,500,000 560,000 U 120,000 U (100,000)F 340,000 380,000 400,000 50,000 50,000 50,000 250,000 250,000 250,000 $ 40,000 $ 80,000 $ 100,000

a200,000 × 3.75, × 4.50, × 6.50, × 7.50 b200,000 × 0.25

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

9-26 (40 min.)

Variable costing versus absorption costing.

2022 Production = Sales + Ending Inventory – Beginning Inventory = 1,080,000 + 80,000 – 60,000 = 1,100,000 1. Absorption Costing: Garvis Company Income Statement For the Year Ended December 31, 2022 Revenues (1,080,000 × $10.00) Cost of goods sold: Beginning inventory (60,000 × $6.70a) Variable manufacturing costs (1,100,000 × $6.00) Allocated fixed manufacturing costs (1,100,000 × $0.70) Cost of goods available for sale Deduct ending inventory (80,000 × $6.70) Add adjustment for prod.-vol. variance (100,000b × $0.70) Cost of goods sold Gross margin Operating costs: Variable operating costs (1,080,000 × $2) Fixed operating costs Total operating costs Operating income

$10,800,000 $ 402,000 6,600,000 770,000 7,772,000 (536,000) 70,000 U 7,306,000 3,494,000 2,160,000 240,000 2,400,000 $ 1,094,000

a$6.00 + ($14.00 ÷ 20) = $6.00 + $0.70 = $6.70 b

[(20 units per mach. hr. × 60,000 mach. hrs.) – 1,100,000 units)] = 100,000 units unfavourable 2. Variable Costing: Garvis Company Income Statement For the Year Ended December 31, 2022 Revenues (1,080,000 × $10.00) Variable cost of goods sold: Beginning inventory (60,000 × $6.00) Variable manufacturing costs (1,100,000 × $6.00) Cost of goods available for sale Deduct ending inventory (80,000 × $6.00) Variable cost of goods sold Variable operating costs Contribution margin Fixed costs: Fixed manufacturing overhead costs Fixed operating costs Total fixed costs Operating income

$10,800,000 $

360,000 6,600,000 6,960,000 (480,000)

6,480,000 2,160,000 2,160,000 840,000 240,000 1,080,000 $ 1,080,000

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

3. The difference in operating income between the two costing methods is:

Absorption- Variable-   Fixed  Fixed  costing   costing manuf. costs manuf. costs  operating    in ending in beginning  operating     inventory  income   inventory  income    $1, 094, 000 $1, 080, 000   80, 000  $0.70 (60, 000  $0.70)    $14, 000  $56, 000 $42, 000 $14, 000  $14, 000 The absorption-costing operating income exceeds the variable costing figure by $14,000 because of the increase of $14,000 during 2022 of the amount of fixed manufacturing costs in ending inventory vis-a-vis beginning inventory. 4. Total fixed manufacturing costs

Actual and budget line $840,000 $770,000

Unfavorable production-volume variance

production} Favorable volume variance

{

55,000

Allocated line @ $7.00

60,000

Machine-hours

5. Absorption costing is more likely to lead to buildups of inventory than does variable costing. Absorption costing enables managers to increase reported operating income by building up inventory which reduces the amount of fixed manufacturing overhead included in the current period’s cost of goods sold. Ways to reduce this incentive include (a) Careful budgeting and inventory planning. (b) Change the accounting system to variable costing or throughput costing. (c) Incorporate a carrying charge for carrying inventory. (d) Use a longer time period to evaluate performance than a quarter or a year. (e) Include nonfinancial as well as financial measures when evaluating management performance.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

9-27 (20 min.)

Throughput costing (continuation of 9-26).

1. Throughput Costing: Garvis Company Income Statement For the Year Ended December 31, 2022

Revenues (1,080,000 × $10.00) Direct material cost of goods sold: Beginning inventory (60,000 × $4.50) Direct materials in goods manufactureda Cost of goods available for sale Deduct ending inventoryb Total direct material cost of goods sold Throughput margin Other costs Manufacturing costs Other operating costs Total other costs Operating income

$10,800,000 $ 270,000 4,950,000 5,220,000 (360,000) 4,860,000 5,940,000 2,490,000c 2,400,000d 4,890,000 $ 1,050,000

a1,100,000 × $4.50

c(1,100,000 × $1.50) + $840,000

d(1,080,000 × $2) + $240,000

80,000 × $4.50

2. Garvis Company - Reconciliation Variable Costing Throughput Costing Difference Reasons for differences: Variable Manufacturing Cost (other than materials) (1,080,000 × $1.50) Variable Operating Cost (1,080,000 × $2.00) Lower expensing of Variable Manufacturing Cost (other than materials) under Variable costing: 20,000 units increase in inventory during the year × $1.50 per unit

Contribution/Throughput Margin $2,160,000 $5,940,000 $3,780,000

Operating Income $1,080,000 $1,050,000 $ (30,000)

$1,620,000 $2,160,000 $ (30,000)

3. Yes, I do agree. Because fixed manufacturing costs are expensed in the period incurred under throughput costing, there is no opportunity for managers to affect operating income by manipulating production levels. When a significant majority of an item’s cost is direct materials, when direct labour is really more fixed than variable (you have staff for direct labour and you don’t stop paying them for varying levels of production) and when production levels vary significantly creating large variances for fixed costs, using throughput costing can provide a more stable per unit cost for a company’s product. It is important for managers of Garvis, and other companies, to have as stable a unit cost as possible for decision-making. Copyright © 2022 Pearson Canada Inc. 9-22

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

9-28 (45 min.)

Denominator-level choices, changes in inventory levels, effect on operating income.

Denominator level in units Budgeted fixed manuf. costs Budgeted fixed manuf. cost allocated per unit Production in units Allocated fixed manuf. costs (production in units × budgeted fixed manuf. cost allocated per unit) Production volume variance (Budgeted fixed manuf. costs – allocated fixed manuf. costs)a

Theoretical Practical Capacity Capacity 144,000 120,000 $1,440,000 $1,440,000 $ 10.00 $ 12.00 104,000 104,000

Normal Utilization Capacity 96,000 $1,440,000 $ 15.00 104,000

$1,040,000

$1,560,000

$1,248,000

$ 400,000 U $ 192,000 U $ 120,000 F

aPVV is unfavourable if budgeted fixed manuf. costs are greater than allocated fixed costs

Units sold Budgeted fixed mfg. cost allocated per unit Budgeted var. mfg. cost per unit Budgeted cost per unit of inventory or production

Theoretical Capacity 112,000 $ 10 $ 3 $ 13

Practical Capacity 112,000 $ 12 $ 3 $ 15

Normal Utilization Capacity 112,000 $ 15 $ 3 $ 18

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

ABSORPTION-COSTING BASED OPERATING INCOME STATEMENTS Revenue ($30 selling price per unit × units sold) $3,360,000 $3,360,000 $3,360,000 Cost of goods sold Beginning inventory (10,000 units × budgeted cost per unit of inventory) 130,000 150,000 180,000 Variable manufacturing costs (104,000 units × $3 per unit) 312,000 312,000 312,000 Allocated fixed manufacturing overhead (104,000 units × budgeted fixed mfg. cost allocated per unit) 1,040,000 1,248,000 1,560,000 Cost of goods available for sale 1,482,000 1,710,000 2,052,000 Deduct ending inventory (2,000b units × budgeted cost per unit of inventory) (26,000) (30,000) (36,000) Adjustment for production-volume variance 400,000 U 192,000 U (120,000) F Total cost of goods sold 1,856,000 1,872,000 1,896,000 Gross margin 1,504,000 1,488,000 1,464,000 Operating costs 400,000 400,000 400,000 Operating income $1,104,000 $1,088,000 $1,064,000 bEnding inventory = Beginning inventory + Production – Sales

= 10,000 + 104,000 – 112,000 = 2,000 units 2,000 × $13; 2,000 × $15; 2,000 × $18 3. Yates’s beginning inventory was 10,000 units; its ending inventory was 2,000 units. So, during the year, there was a drop of 8,000 units in inventory levels (matching the 8,000 more units sold than produced). The smaller the denominator level, the larger is the budgeted fixed cost allocated to each unit of production, and, when those units are sold (all the current production is sold, and then some), the larger is the cost of each unit sold, and the smaller is the operating income. Normal utilization capacity is the smallest capacity of the three, hence in this year, when production was less than sales, the absorption-costing based operating income is the smallest when normal capacity utilization is used as the denominator level.

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

4. Reconciliation Theoretical capacity operating income – Practical capacity operating income Decrease in inventory level during the year Fixed mfg cost allocated per unit under practical capacity – fixed mfg. cost allocated per unit under theoretical capacity ($12 – $10) Additional allocated fixed cost included in COGS under practical capacity = 8,000 units × $2 per unit =

$16,000 8,000 $2 $16,000

More fixed manufacturing costs are included in inventory under practical capacity, so, when inventory level decreases (as it did this year), more fixed manufacturing costs are included in COGS under practical capacity than under theoretical capacity, resulting in a lower operating income.

9-29 (40 min.)

Variable and absorption costing, sales, and operating-income changes.

1. Headsmart’s annual fixed manufacturing costs are $1,200,000. It allocates $24 of fixed manufacturing costs to each unit produced. Therefore, it must be using $1,200,000 ÷ $24 = 50,000 units (annually) as the denominator level to allocate fixed manufacturing costs to the units produced. We can see from Headsmart’s income statements that it disposes off any production volume variance against cost of goods sold. In 2021, 60,000 units were produced instead of the budgeted 50,000 units. This resulted in a favourable production volume variance of $240,000 F (= (60,000 – 50,000) units × $24 per unit), which, when written off against cost of goods sold, increased gross margin by that amount. The breakeven calculation, same for each year, is shown below: Calculation of breakeven volume Selling price ($2,100,000 ÷ 50,000; $2,100,000 ÷ 50,000; $2,520,000 ÷ 60,000) Variable cost per unit (all manufacturing) Contribution margin per unit Total fixed costs (fixed mfg. costs + fixed selling & admin. costs) Breakeven quantity = Total fixed costs ÷ contribution margin per unit

2020 $

2021 42 $ 14 28 $

2022 42 $ 14 28 $

42 14 28

$1,400,000 $1,400,000 $1,400,000 50,000

50,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. Variable Costing Sales (units) Revenue Variable cost of goods sold Beginning inventory $14 × 0; 0; 10,000 Variable manuf. costs $14 × 50,000; 60,000; 50,000 Deduct ending inventory $14 × 0; 10,000; 0 Variable cost of goods sold Contribution margin Fixed manufacturing costs Fixed selling and administrative expenses Operating income Explaining variable costing operating income Contribution margin ($28 contribution margin per unit × sales units) Total fixed costs Operating income

2020 2021 2022 50,000 50,000 60,000 $2,100,000 $2,100,000 $2,520,000 0 0 140,000 700,000 840,000 700,000 0 (140,000) 0 700,000 700,000 840,000 $1,400,000 $1,400,000 $1,680,000 $1,200,000 $1,200,000 $1,200,000 200,000 200,000 200,000 $ 0 $ 0 $ 280,000

$1,400,000 $1,400,000 $1,680,000 1,400,000 1,400,000 1,400,000 $ 0 $ 0 $ 280,000

4. Reconciliation of absorption/variable costing operating incomes (1) Absorption costing operating income (ACOI) (2) Variable costing operating income (VCOI) (3) Difference (ACOI – VCOI) (4) Fixed mfg. costs in ending inventory under absorption costing (ending inventory in units × $24 per unit) (5) Fixed mfg. costs in beginning inventory under absorption costing (beginning inventory in units × $24 per unit) (6) Difference = (4) – (5)

2020 $0 0 $0

2021 2022 $240,000 $ 40,000 0 280,000 $240,000 $(240,000)

$240,000 $

0 $0

0 240,000 $240,000 $(240,000)

In the table above, row (3) shows the difference between the operating income (OI) under absorption costing and the OI under variable costing, for each of the three years. In 2020, the difference is $0; in 2021, absorption costing income is greater by $240,000; and in 2022, it is less by $240,000. Row (6) above shows the difference between the fixed costs in ending inventory and the fixed costs in beginning inventory under absorption costing, which is $0 in 2020, $240,000 in 2021, and –$240,000 in 2022. Row (3) and row (6) explain and reconcile the OI differences between absorption costing and variable costing. Stuart Weil is surprised at the non-zero, positive net income (reported under absorption costing) in 2021, when sales were at the ‘breakeven volume’ of 50,000; further, he is concerned about the drop in operating income in 2022, when, in fact, sales increased to 60,000 units. In 2021, starting with zero inventories, 60,000 units were produced, while 50,000 were sold (i.e., at the end of the year, 10,000 units remained in inventory). These Copyright © 2022 Pearson Canada Inc. 9-26

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

10,000 units had each absorbed $24 of fixed costs (total of $240,000), which would remain as assets on Headsmart’s balance sheet until they were sold. Cost of goods sold, representing only the costs of the 50,000 units sold in 2021, was accordingly reduced by $240,000, the production volume variance, resulting in a positive OI even though sales were at breakeven levels. The following year, in 2022, production was 50,000 units, while sales were 60,000 units (i.e., all of the fixed costs that were included in 2021 ending inventory flowed through COGS in 2022). Contribution margin in 2022 was $1,680,000 (= 60,000 units × $28), but, in absorption costing, COGS also contains the allocated fixed manufacturing costs of the units sold, which were $1,440,000 (= 60,000 units × $24), resulting in an OI of $40,000 = 1,680,000 – $1,440,000 – $200,000 (fixed sales and admin.) Hence the drop in operating income under absorption costing, even though sales were greater than the computed breakeven volume: inventory levels decreased sufficiently in 2022 to cause 2022’s OI to be lower than 2021 OI. Note that beginning and ending with zero inventories during the 2020-2022 period, under both costing methods, Headsmart’s total OI was $280,000.

9-30 (25 min.)

Denominator-level problem.

1. Budgeted fixed manufacturing overhead costs rates: Denominator Level Capacity Concept Theoretical Practical

Budgeted Fixed Manufacturing Overhead per Period $ 4,000,000 4,000,000

Normal Master-budget

4,000,000 4,000,000

Budgeted Capacity Level 2,880 1,920 1,200 1,500

Budgeted Fixed Manufacturing Overhead Cost Rate $ 1,388.89 2,083.33 3,333.33 2,666.67

The rates are different because of varying denominator-level concepts. Theoretical and practical capacity levels are driven by supply-side concepts (i.e., “How much can I produce?”). Normal and master-budget capacity levels are driven by demand-side concepts (i.e., “How much can I sell?” or “How much should I produce?”). 2. The variances that arise from use of the theoretical or practical level concepts will signal that there is a divergence between the supply of capacity and the demand for capacity. This is useful input to managers. As a general rule, however, it is important not to place undue reliance on the production volume variance as a measure of the economic costs of unused capacity. 3. Under a cost-based pricing system, the choice of a master-budget level denominator will lead to high prices when demand is low (more fixed costs allocated to the individual product level), further eroding demand; conversely, it will lead to low prices when demand is high, forgoing profits. This has been referred to as the downward demand spiral—the continuing reduction in demand that occurs when the prices of competitors are not met and demand drops, resulting in even higher unit costs and even more reluctance to meet the prices of competitors. The positive aspects of the master-budget denominator level are that it is based Copyright © 2022 Pearson Canada Inc. 9-27

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

on demand for the product and indicates the price at which all costs per unit would be recovered to enable the company to make a profit. Master-budget denominator level is also a good benchmark against which to evaluate performance.

9-31 (30 min.)

Cost allocation, downward demand spiral.

Budgeted fixed costs Denominator level Budgeted fixed cost per meal Budgeted fixed costs ÷ Denominator level ($1,533,000 ÷ 1,022,000; $1,533,000 ÷ 1,460,000; $1,533,000 ÷ 876,000) Budgeted variable cost per meal Total budgeted cost per meal

2021 2022 Master Practical Master Budget Capacity Budget (1) (2) (3) $1,533,000 $1,533,000 $1,533,000 1,022,000 1,460,000 876,000

$ $

1.50 $ 5.50 7.00 $

1.05 $ 5.50 6.55 $

1.75 5.50 7.25

1. The 2021 budgeted fixed costs are $1,533,000. Deliman budgets for 1,022,000 meals in 2021, and this is used as the denominator level to calculate the fixed cost per meal. $1,533,000 ÷ 1,022,000 = $1.50 fixed cost per meal. (see column (1)). 2. In 2022, three retirement homes have dropped out of the purchasing group and the master budget is 876,000 meals. If this is used as the denominator level, fixed cost per meal = $1,533,000 ÷ 876,000 = $1.75 per meal, and the total budgeted cost per meal would be $7.25 (see column (3)). If the retirement homes have already been complaining about quality and cost and are allowed to purchase from outside, they will not accept this higher price. More retirement homes may begin to purchase meals from outside the system, leading to a downward demand spiral, possibly putting Deliman out of business. 3. The basic problem is that Deliman has excess capacity and the associated excess fixed costs. If Smith uses the practical capacity of 1,460,000 meals as the denominator level, the fixed cost per meal will be $1.05 (see column (2)), and the total budgeted cost per meal would be $6.55, probably a more acceptable price to the customers (it may even draw back the three retirement homes that have chosen to buy outside). This denominator level will also isolate the cost of unused capacity and not allocate it to the meals produced. To make the $6.55 price per meal profitable in the long run, Smith will have to find ways to either use the extra capacity or reduce Deliman’s practical capacity and the related fixed costs.

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

9-32 (30 min.)

Effects of differing production levels on absorption costing income: Metrics to minimize inventory buildups.

1. Revenues Cost of goods sold Production-volume variance Net cost of goods sold Gross Margin

50,000 books $8,000,000 5,750,000a 0b 5,750,000 $2,250,000

65,000 Books $8,000,000 5,750,000 (225,000)c 5,525,000 $2,475,000

aCost per unit = ($100 + $750,000/50,000 books sold)

70,000 Books $8,000,000 5,750,000 (300,000)d 5,450,000 $2,550,000

= $115 per book

CGS = $115  50,000 = $5,750,000 bvolume variance = Budgeted fixed cost – fixed overhead rate  production

$750,000 – ($15  50,000 books) = $0 cvolume variance = Budgeted fixed cost – fixed overhead rate  production

$750,000 – ($15  65,000 books) = - $225,000 dvolume variance = Budgeted fixed cost – fixed overhead rate  production

$750,000 – ($15  70,000 books) = - $300,000 2.

Beginning inventory + Production – Books sold Ending inventory  Cost per book Cost of Ending Inventory

50,000 Books 0 50,000 books 50,000 50,000 0 books × $115 $0

65,000 Books 0 65,000 books 65,000 50,000 15,000 books × $115 $1,725,000

70,000 Books 0 70,000 books 70,000 50,000 20,000 books × $115 $2,300,000

65,000 books $2,475,000 (172,500) $2,302,500

70,000 books $2,550,000 (230,000) $2,320,000

3a. 50,000 books Gross margin $2,250,000 Less 10%  Ending inventory 0 Adjusted gross margin $2,250,000

While adjusting for ending inventory does to some degree mitigate the increase in inventory associated with excess production, it may be difficult to mechanically compensate for all of the increased income. In addition, it does nothing to hold the manager responsible for the poor decisions from the organization’s standpoint. Copyright © 2022 Pearson Canada Inc. 9-29

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

A change of 20% is more likely to have a quelling effect on an unwanted inventory increase. 3b. 50,000 Books

65,000 Books

70,000 Books

15,000 books

20,000 books

50,000 ÷ 50,000 1.0

65,000 ÷ 50,000 1.3

70,000 ÷50,000 1.4

1) Inventory change: End inventory ─ begin inventory 2) Excess production (%) Production ÷ sales  

A ratio of ending inventory to beginning inventory, as suggested in the book, is not possible because beginning inventory was zero, so we substituted change in inventory level. At 70,000, we are producing 40% more books than we expect to sell. Look to frequency of new publications as one way to determine the practicality of doing so.

For these nonfinancial measures to be useful they must be incorporated into the reward function of the manager.

9-33 (40 min.)

Variable costing and absorption costing, the Z-Var Corporation.

This problem always generates active classroom discussion. 1. The treatment of fixed manufacturing overhead in absorption costing is affected primarily by what denominator level is selected as a base for allocating fixed manufacturing costs to units produced. In this case, is 30,000 tons per year, 60,000 tons, or some other denominator level the most appropriate base? We usually place the following possibilities on the board or overhead projector and then ask the students to indicate by vote how many used one denominator level versus another. Incidentally, discussion tends to move more clearly if variable-costing income statements are discussed first, because there is little disagreement as to computations under variable costing. a. Variable-Costing Income Statement: Revenues (and contribution margin) Fixed costs: Manufacturing costs Operating costs Operating income

2020 $2,700,000

2021 $2,700,000

Together $5,400,000

2,682,000 18,000

5,364,000 $ 36,000

$2,580,000 102,000 $

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

b. Absorption-Costing Income Statement: The ambiguity about the 30,000- or 60,000-unit denominator level is intentional. If you wish, the ambiguity may be avoided by giving the students a specific denominator level in advance. Alternative 1. Use 60,000 units as a denominator; fixed manufacturing overhead per unit is $2,580,000  60,000 = $43. 2020 2021 Together Revenues $2,700,000 $ 2,700,000 $5,400,000 Cost of goods sold Beginning inventory 0 1,290,000a — Allocated fixed manufacturing costs at $43 2,580,000 — 2,580,000 (60,000 × $43; 0 × $43) Deduct ending inventory — — (30,000 × $43; 0 × $43) (1,290,000) Adjustment for production-volume varianceb 0 2,580,000 U 2,580,000 U Cost of goods sold 1,290,000 3,870,000 5,160,000 Gross margin 1,410,000 (1,170,000) 240,000 Operating costs 102,000 102,000 204,000 Operating income $1,308,000 $(1,272,000) $ 36,000 aInventory carried forward from 2020 and sold in 2021 bFixed manufacturing costs – Allocated fixed manufacturing costs = $2,580,000 – $2,580,000;

$2,580,000 − 0 Alternative 2. Use 30,000 units as a denominator; fixed manufacturing overhead per unit is $2,580,000  30,000 = $86. Revenues Cost of goods sold Beginning inventory Allocated fixed manufacturing costs at $86 (60,000 × $86; 0 × $86) Deduct ending inventory (30,000 × $86; 0 × $86) Adjustment for production-volume varianceb Cost of goods sold Gross margin Operating costs Operating income

2020 $2,700,000

2021 $ 2,700,000

Together $5,400,000

0 5,160,000

2,580,000a —

— 5,160,000

— (2,580,000) (2,580,000) F 0 2,700,000 102,000 $2,598,000

—

2,580,000 U 0 5,160,000 5,160,000 (2,460,000) 240,000 102,000 204,000 $(2,562,000) $ 36,000

aInventory carried forward from 2020 and sold in 2021 bFixed manufacturing costs – Allocated fixed manufacturing costs = $2,580,000 – $5,160,000;

$2,580,000  0

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Note that operating income under variable costing follows sales and is not affected by inventory changes. Note also that students will understand the variable-costing presentation much more easily than the alternatives presented under absorption costing.

Breakeven point Fixed costs $2, 682, 000 2. under variable =  Contribution margin per ton $90 costing = 29,800 tons per year or 59,600 for two years. Most students will say that the breakeven point is 29,800 tons per year under both absorption costing and variable costing. The logical question to ask a student who answers 29,800 tons for variable costing is: “What operating income do you show for 2020 under absorption costing?” If a student answers $1,308,000 (alternative 1 above), or $2,598,000 (alternative 2 above), ask: “But you say your breakeven point is 29,800 tons. How can you show an operating income on sales of only 20 tons (above breakeven) sold during 2020?” The answer to the above dilemma lies in the fact that operating income is affected by both sales and production under absorption costing. For example, Z-Var currently records a huge loss under absorption costing in 2021. Given that sales are expected to be 30,000 tons, let us solve for the production level that will provide a breakeven level of zero operating income. Using the formula in the chapter, sales of 30,000 units, and a fixed manufacturing overhead rate of $43 (based on $2,580,000 ÷ 60,000 units denominator level): Let P = Production level

Breakeven sales = in units

 Fixed Manuf.  Breakeven Units  Total Fixed  Target         Cost OI Cost Rate Sales in Units Produced     Contribution Margin Per Unit

$2, 682, 000  $0  $43 30, 000 P  $90 $2,700,000 = $2,682,000 + $1,290,000 – $43P $43P = $1,272,000 P = 29,582 units (rounded up)

30,000 tons =

Proof: Gross margin, 30,000 × ($90 – $43) Production-volume variance, (60,000 – 29,582) × $43 Operating costs Operating income (not 0 due to rounding)

$1,410,000 $1,307,974 102,000

1,409,974 26

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

Now, if production is known to be 60,000 tons in 2020, let us solve for the breakeven unit sales level for that year. Again using the formula in the chapter and a fixed manufacturing overhead rate of $43: Let N = Breakeven sales in units

 Fixed Manuf.  Units  Total Fixed  Target    N     Cost OI Cost Rate  Produced    = Contribution Margin Per Unit

$2, 682, 000  $0  $43  N 60, 000 $90 $90N = $2,682,000 + $43N – $2,580,000 $47N = $102,000 N = 2,171 units (rounded up)

Proof: Gross margin, 2,171 × ($90 – $43) Production-volume variance Marketing and administrative costs Operating income (not 0 due to rounding)

$102,037 $ 0 102,000

102,000 37

We find it helpful to put the following comparisons on the board: Variable costing breakeven = f(sales) = 29,800 tons Absorption costing breakeven = f(sales and production) = f(30,000 and 29,582) = f(2,171 and 60,000) 3. Absorption costing inventory cost: Either $1,290,000 or $2,580,000 at the end of 2020 depending on the chosen denominator level, and zero at the end of 2021. Variable costing: Zero at all times. This is a major criticism of variable costing and focuses on the issue of the definition of an asset. 4. Operating income is affected by both production and sales under absorption costing. Hence, most managers would prefer absorption costing because their performance in any given reporting period, at least in the short run, is influenced by how much production is scheduled near the end of a period.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

9-34 Variable and absorption costing, and breakeven points. 1. Production = Sales + Ending inventory – Beginning inventory = 242,400 + 24,800 – 32,600 = 234,600 2. Breakeven point in cases: a. Variable Costing: Q

Total fixed costs  Target operating income Contribution margin per unit

Q

($4,504,320  $7,882,560)  $0 $112.80 ($19.20  $12.00  $7.20  $16.80  $2.40)

Q

$12,386,880 $55.20

Q  224, 400 cases

b. Absorption Costing:  Fixed Manuf. Breakeven Units  Total Fixed  Target         cost OI cost rate sales in units produced    Q Contribution Margin Per Unit

Q

$12,386,880   $19.20a (Q 234, 600)    $55.20

Q

$12,386,880  $19.20Q 4,504,320 $55.20

Q

$7,882,560  $19.20Q $55.20

55.20Q – 19.20Q = $7,882,560 36Q = $7,882,560 Q = 218,960 cases a$4,504,320 ÷ 234,600 cases = $19.20

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

3. If grape prices increase by 25%, the cost of grapes per case will increase from $19.20 to $24. This will decrease the unit contribution margin from $55.20 to $50.40. a. Variable Costing: $12,386,880 Q $50.40  245, 772 cases (rounded up) b. Absorption Costing: $7,882,560  $19.20Q Q= $50.40 $50.40Q = $7,882,560 + $19.20Q $31.20Q = $7,882,560 Q = 252,647 cases (rounded up) 4. Variable Costing: OI = ($242,400 – 224,400) ×CM = (18,000) × (Revenue – Variable costs) = (18,000) × ($55.20) = $993,600 Variable costing: $993,600 × 110% = $1,092,960 OI Variable costing: Required OI = $1,092,960 Breakeven = 245,772 cases (from question 3a.) 1) OI = $1,092,960 2) CM = $50.40 Total fixed costs  Target operating income Q Contribution margin per unit  (12,386,880  $1, 092,960)  50.40  267, 458 cases (rounded up) Absorption Costing: $12,386,880  $1, 092,960  $19.20 Q 234, 600 Q $50.40 31.20Q  8,975,520

Q  287, 677 (rounded)

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

9-35 (30–35 min.) Comparison of variable costing and absorption costing. 1. Since production volume variance is unfavourable, the budgeted fixed manufacturing overhead must be larger than the fixed manufacturing overhead allocated. =

–

$405,000

= $1,350,000 – Allocated

Allocated

= $945,000, which is 70% of $1,350,000

If 70% of the budgeted fixed costs were allocated, the plant must have been operating at 70% of denominator level in 2021. 2. The problem provides the beginning and ending inventory balances under both, variable and absorption costing. Under variable costing, all fixed costs are written off as period costs, i.e., they are not inventoried. Under absorption costing, inventories include variable and fixed costs. Therefore the difference between inventory under absorption costing and inventory under variable costing is the amount of fixed costs included in the inventory.

Inventories: December 31, 2020 December 31, 2021

Absorption Costing

Variable Costing

Fixed Manuf. Overhead in Inventory

$1,730,000 215,000

$1,345,000 45,000

$385,000 170,000

3. Note that the answer to (3) is independent of (1). The difference in operating income of $215,000 ($1,610,000 – $1,395,000) is explained by the release of $215,000 of fixed manufacturing costs when the inventories were decreased during 2021:

Inventories: December 31, 2020 December 31, 2021 Release of fixed manuf. costs

Absorption Costing

Variable Costing

$1,730,000 215,000

$1,345,000 45,000

Fixed Manuf. Overhead in Inventory $385,000 170,000 $215,000

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

The above schedule in this requirement is a formal presentation of the equation: = ($1,395,000 – $1,610,000) – $215,000

= =

($170,000 – $385,000) – $215,000

4. Under absorption costing, operating income is a function of both sales and production (i.e., change in inventory levels). During 2021, Gammaro experienced a severe decline in inventory levels: sales were probably higher than anticipated, production was probably lower than planned (at 70% of denominator level), resulting in much of the 2021 beginning inventory passing through cost of goods sold in 2021. This means that under absorption costing, large amounts of inventoried fixed costs have flowed through 2021 cost of goods sold, resulting in a smaller operating income than in 2020, despite an increase in sales volume.

9-36 (25 min.)

Denominator-level choices, changes in inventory levels, effect on operating income.

Theoretical Capacity 300,000 $3,000,000 $ 10.00 240,000

Practical Capacity 279,070 $3,000,000 $ 10.75 240,000

Normal Capacity Utilization 232,558 $3,000,000 $ 12.90 240,000

$2,400,000

$2,580,000

$3,096,000

$ 600,000 U

$ 420,000 U $

aPVV is unfavourable if budgeted fixed manuf. costs are greater than allocated fixed costs

96,000 F

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Units produced Budgeted fixed mfg. cost allocated per unit Budgeted var. mfg. cost per unit Budgeted cost per unit of inventory or production

Theoretical Capacity 240,000 $10.00 $10.00

Practical Capacity 240,000 $10.75 $10.00

Normal Capacity Utilization 240,000 $12.90 $10.00

$20.00

$20.75

$22.90

ABSORPTION-COSTING BASED INCOME STATEMENTS Revenues ($50 selling price per unit × units sold) $13,000,000 $13,000,000 Cost of goods sold Beginning inventory (40,000 units × budgeted cost per unit of inventory: $20.00; $20.75; $22.90) 800,000 830,000 Variable manufacturing costs (240,000 units × $10 per unit) 2,400,000 2,400,000 Allocated fixed manufacturing overhead (240,000 units × budgeted fixed mfg. cost allocated per unit: $10.00; $10.75; $12.90) 2,400,000 2,580,000 Cost of goods available for sale 5,600,000 5,810,000 b Deduct ending inventory (20,000 units × budgeted cost per unit of inventory: $20.00; $20.75; $22.90) (400,000) (415,000) Adjustment for production-volume variance² 600,000 U 420,000 U Total cost of goods sold 5,800,000 5,815,000 Gross margin 7,200,000 7,185,000 Operating costs 500,000 500,000 Operating income $6,700,000 $6,685,000

$13,000,000

916,000 2,400,000 3,096,000 6,412,000 (458,000) (96,000) F 5,858,000 7,142,000 500,000 $ 6,642,000

bEnding inventory = Beginning inventory + production – sales = 40,000 + 240,000 – 260,000 = 20,000 units

20,000 × $20.00; 20,000 × $20.75; 20,000 × $22.90

3. Magic Me’s beginning inventory was 40,000 units; its ending inventory was 20,000 units. So, during the year, there was a drop of 20,000 units in inventory levels (matching the 20,000 more units sold than produced). The smaller the denominator level, the larger is the budgeted fixed cost allocated to each unit of production, and, when those units are sold (all the current production is sold, and then some), the larger is the cost of each unit sold, and the smaller is the operating income. Normal capacity utilization is the smallest capacity of the three, hence in this year, when production was less than sales, the absorption-costing based operating income is the smallest when normal capacity utilization is used as the denominator level.

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

4. Reconciliation Theoretical Capacity Operating Income – Practical Capacity Operating Income Decrease in inventory level during the year

$15,000 20,000

Fixed mfg cost allocated per unit under practical capacity – fixed mfg. cost allocated per unit under theoretical capacity ($10.75 – $10.00) $0.75 Additional allocated fixed cost included in COGS under practical capacity = 20,000 units × $0.75 per unit =

$15,000

More fixed manufacturing costs are included in inventory under practical capacity, so, when the inventory level decreases (as it did this year), more fixed manufacturing costs are included in COGS under practical capacity than under theoretical capacity, resulting in a lower operating income.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

9-37 (25–30 min.) Alternative denominator-level capacity concepts, effect on operating income. 1. Denominator-Level Capacity Concept Theoretical capacity Practical capacity Normal capacity utilization Master-budget utilization (a) January-June 2021 (b) July-December 2021

Budgeted Fixed Manuf. Overhead per Period (1) $27,900,000 27,900,000 27,900,000

Days of Hours of Production Production per Period per Day (2) (3) 358 22 348 20 348 20

13,950,000 13,950,000

174 174

Barrels per Hour (4) 545 510 410

Budgeted Denominator Level (Barrels) (5) = (2) × (3) × (4) 4,292,420 3,549,600 2,853,600

Budgeted Fixed Manufacturing Overhead Rate per Barrel (6) = (1) ÷ (5) $ 6.50 7.86 9.78

315 505

1,096,200 1,757,400

12.73 7.94

20 20

The differences arise for several reasons: a. The theoretical and practical capacity concepts emphasize supply factors and are consequently higher, while normal capacity utilization and master-budget utilization emphasize demand factors. b. The two separate six-month rates for the master-budget utilization concept differ because of seasonal differences in budgeted production. 2. Using column (6) from above,

Denominator-Level Capacity Concept Theoretical capacity Practical capacity Normal capacity utilization

Budgeted Fixed Mfg. Overhead Rate per Barrel (6) $6.50 7.86 9.78

Per Barrel Budgeted Budgeted Variable Total Mfg Mfg. Cost Rate Cost Rate (8) = (7) (6) + (7) $30.20a $36.70 30.20 38.06 30.20 39.98

Fixed Mfg. Overhead Costs Allocated (9) = 2,670,000 × (6) $17,355,000 20,986,200 26,112,600

a$80,634,000 ÷ 2,670,000 barrels

Fixed Mfg. Overhead Variance (10) = $26,700,000 – (9) $9,345,000 U 5,713,800 U 587,400 U

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

Absorption-Costing Income Statement

Revenues (2,460,000 bbls. × $47 per bbl.) Cost of goods sold Beginning inventory Variable mfg. costs Fixed mfg. overhead costs allocated (2,670,000 units × $6.50; $7.86; $9.78 per unit) Cost of goods available for sale Deduct ending inventory (210,000 units × $36.70; $38.06; $39.98 per unit) Adjustment for variances (add: all unfavourable) Cost of goods sold Gross margin Other costs Operating income

Theoretical Capacity $115,620,000

Practical Capacity $115,620,000

Normal Capacity Utilization $115,620,000

0 80,634,000

17,355,000 97,989,000

20,986,200 101,620,200

26,112,600 106,746,600

(7,707,000) 9,345,000 U 99,627,000 15,993,000 0 $ 15,993,000

(7,992,600) 5,713,800 U 99,341,400 16,278,600 0 $ 16,278,600

(8,395,800) 587,400U 98,938,200 16,681,800 0 $ 16,681,800

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

9-38 (20 min.)

Cost allocation, responsibility accounting, ethics (continuation of 9-31).

1. (See solution to Exercise 9-31). If Deliman uses its master budget capacity utilization to allocate fixed costs in 2022, it would allocate 806,840 × $1.75 = $1,411,970. Budgeted fixed costs are $1,533,000. Therefore, the production volume variance = $1,533,000 – $1,411,970 = $121,030 U. An unfavourable production volume variance will reduce operating income by this amount. (Note: in this business, there are no inventories. All variances are written off to cost of goods sold). 2. Retirement homes are charged a budgeted variable cost rate and allocated budgeted fixed costs. By overestimating budgeted meal counts, the denominator-level is larger, hence the amount charged to individual retirement homes is lower. Consider 2022 where the budgeted fixed cost rate is computed as follows: $1,533,000/876,000 meals = $1.75 per meal If, in fact, the retirement home administrators had better estimated and revealed their true demand (say, 806,800 meals), the allocated fixed cost per meal would have been $1,533,000/806,800 meals = $1.90 per meal, 8.6% higher than the $1.75 per meal. Hence, by deliberately overstating budgeted meal count, retirement homes are able to reduce the price charged by Deliman for each meal. In this scheme, Deliman bears the downside risk of demand overestimates. 3. Evidence that could be collected include: (a) Budgeted meal-count estimates and actual meal-count figures each year for each retirement home controller. Over an extended time period, there should be a sizable number of both underestimates and overestimates. Controllers could be ranked on both their percentage of overestimation and the frequency of their overestimation. (b) Look at the underlying demand estimates by patients at individual retirement homes. Each retirement home controller has other factors (such as hiring of nurses) that give insight into their expectations of future meal-count demands. If these factors are inconsistent with the meal-count demand figures provided to the central food-catering facility, explanations should be sought. 4. (a) Highlight the importance of a corporate culture of honesty and openness. Deli One could institute a Code of Ethics that highlights the upside of individual retirement homes providing honest estimates of demand (and the penalties for those who do not). (b) Have individual retirement homes contract in advance for their budgeted meal count. Unused amounts would be charged to each retirement home at the end of the accounting period. This approach puts a penalty on retirement home administrators who overestimate demand. (c) Use an incentive scheme that has an explicit component for meal-count forecasting accuracy. Each meal-count “forecasting error” would reduce the bonus by $0.05. Thus, if a retirement home bids for 292,000 meals and actually uses 200,000 meals, its bonus would be reduced by $0.05 × (292,000 – 200,000) = $4,600. Copyright © 2022 Pearson Canada Inc. 9-42

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

9-39 (55 min.)

Variable and absorption costing and breakeven points

1a. Variable-Costing Based Operating Income Statement Revenues (800 cat trees × $300 per tree) Variable costs Beginning inventory Variable manufacturing costs (1,000 trees × $75 per tree) Cost of goods available for sale Deduct: Ending inventory (200 trees × $75 per tree) Variable cost of goods sold Variable shipping costs (800 trees × $25 per tree) Total variable costs Contribution margin Fixed costs Fixed manufacturing costs Fixed selling and administrative

$240,000 $

0 75,000 75,000 (15,000) 60,000 20,000 80,000 160,000 100,000 50,000

Total fixed costs Operating income

150,000 $ 10,000

1b. Absorption-Costing Based Operating Income Statement Revenues (800 cat trees × $300 per tree) Cost of goods sold Beginning inventory Variable manufacturing costs (1,000 trees × $75 per tree) Allocated fixed manufacturing costs (1,000 trees × $100* per tree) Cost of goods available for sale Deduct ending inventory (200 trees × ($75 + $100) per tree) Cost of goods sold Gross margin Operating costs Variable shipping costs (800 trees × $25 per tree) Fixed selling and administrative Total operating costs Operating income

$240,000 $ 0 75,000 100,000 175,000 (35,000) 140,000 100,000 20,000 50,000 70,000 $ 30,000

*Fixed manufacturing rate = Fixed manufacturing cost/production = $100,000/1000 trees = $100 per tree

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Breakeven point in units: a. Variable Costing: Total Fixed Costs  Target Operating Income QT = Contribution Margin Per Unit QT =

($100, 000  $50, 000)  $0 $300 ($75  $25)

QT =

$150, 000 $200

QT = 750 cat trees b. Absorption costing: Fixed manufacturing cost rate = $100,000 ÷ 1,000 = $100 per cat tree  Fixed Manuf.  Breakeven Units  Total Fixed  Target         Cost OI Cost Rate Sales in Units Produced     QT = Contribution Margin Per Unit QT =

QT =

$150, 000  $100 (QT 1, 000) $200 $150, 000  $100 QT $100, 000 $200

$200 QT  $100 QT = $150,000 – $100,000 $100 QT = $50,000 QT = 500 cat trees

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

3. Breakeven point in units: a. Variable Costing: QT =

Total Fixed Costs  Target Operating Income Contribution Margin Per Unit

QT =

($100,000  $50,000)  $0 $300 ($100  $25)

QT =

$150,000 $175

QT = 858 cat trees b. Absorption costing: Fixed manufacturing cost rate = $100,000 ÷ 1,000 = $100 per cat tree  Fixed Manuf.  Breakeven Units  Total Fixed  Target         Cost OI Cost Rate Sales in Units Produced     QT = Contribution Margin Per Unit

QT =

$150, 000  $100 (QT 1, 000) $175 $150, 000  $100 QT $100, 000 $175

$175 QT  $100 QT = $150,000 – $100,000 $75 QT = $50,000 QT = 667 cat trees

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4. Units needed to achieve target operating income: a. Variable Costing: QT =

Total Fixed Costs  Target Operating Income Contribution Margin Per Unit

QT =

($100, 000  $50, 000)  $10, 000 $300 ($75  $25)

QT =

$160, 000 $200

QT = 800 cat trees b. Absorption costing: Fixed manufacturing cost rate = $100,000 ÷ 1,000 = $100 per cat tree  Fixed Manuf.  Breakeven Units  Total Fixed  Target         Cost OI Cost Rate Sales in Units Produced     QT = Contribution Margin Per Unit

QT =

$150, 000  30, 000  $100 (QT 1, 000) $200 $180, 000  $100 QT $100, 00 $200

$200 QT  $100 QT = $180,000 – $100,000 $100 QT = $80,000 QT = 800 cat trees

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

COLLABORATIVE LEARNING CASES

9-40 (50 min.) Absorption, variable, and throughput costing 1. Variable Costing April $300,000

Revenuea Variable costs Beginning inventoryb Variable manufacturing costsc Cost of goods available for sale Deduct ending inventoryd Variable cost of goods sold Variable selling costse Total variable costs Contribution margin Fixed costs Fixed manufacturing costs Fixed administrative costs Total fixed costs Operating income

$ 0 77,500 77,500 0 77,500 7,500

May $300,000 $ 0 108,500 108,500 (31,000) 77,500 7,500

85,000 215,000

June $300,000 $ 31,000 46,500 77,500 0 77,500 7,500

85,000

85,000 215,000

215,000 105,000 35,000

105,000 35,000 140,000 $ 75,000

$6 × 50,000 ? × 0; $1.55 × 0; $1.55 × 20,000 c $1.55 × 50,000; $1.55 × 70,000; $1.55 × 30,000 d $1.55 × 0; $1.55 × 20,000; $1.55 × 0 e $.15 × 50,000 b

105,000 35,000 140,000 $ 75,000

140,000 $ 75,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Absorption Costing April $300,000

Revenuea Cost of goods sold Beginning inventoryb Variable manufacturing costsc Allocated fixed manufacturing costsd Cost of goods available for sale Deduct ending inventorye Adjustment for prod. vol. var.f Cost of goods sold Gross margin Operating costs Variable selling costsg Fixed administrative costs Total operating costs Operating income

$ 0 77,500 105,000 182,500 0 0

May

June $300,000

$ 0 108,500 105,000 213,500 (61,000) 0 182,500 117,500

7,500 35,000

$300,000 $ 61,000 46,500 105,000 212,500 0 0

152,500 147,500 7,500 35,000

42,500 $ 75,000

a$6 × 50,000 b$?× 0; $3.65× 0; $3.05 × 20,000 c$1.55 × 50,000; $1.55 × 70,000; $1.55 × 30,000 d($105,000/50,000)×50,000; ($105,000/70,000) ×70,000; (105,000/30,000)×30,000 e$3.65 × 0; $3.05 × 20,000; $5.05 × 0 f$105,000 – $105,000; $105,000 – $105,000; $105,000 – $105,000 g$.15 × 50,000

212,500 87,500 7,500 35,000

42,500 $105,000

42,500 $ 45,000

Chapter 9: Income Effects of Denominator Level on Inventory Valuation

3. Throughput costing April $300,000

Revenuea Direct material cost of goods sold Beginning inventoryb Direct materials in goods manufacturedc Cost of goods available for sale Deduct ending inventoryd Total direct material cost of goods sold Throughput contribution Other costs Manufacturinge Operatingf Total other costs Operating income

May $300,000 $

40,000 40,000 0

June $300,000

$ 16,000

56,000 56,000 (16,000)

24,000 40,000 0

40,000

260,000

142,500 42,500

157,500 42,500 185,000 $ 75,000

127,500 42,500 200,000 $ 60,000

170,000 $ 90,000

a$6 × 50,000 b$?× 0; $0.80× 0; $0.80 × 20,000 c$0.80 × 50,000; $0.80 × 70,000; $0.80 × 30,000 d$0.80 × 0; $0.80 × 20,000; $0.80 × 0 e($0.75 × 50,000) + $105,000; ($0.75× 70,000) + $105,000; ($0.75 × 30,000) + $105,000 f($0.15 × 50,000) + $35,000

4. The benefit of using throughput costing is that net income is reduced if managers produce more units than they can sell. By treating all costs, except direct material costs, as period costs, the income statement expenses not only the cost of goods sold but also the direct labour and variable overhead costs associated with units in ending inventory. So reported income is reduced by the cost of unnecessary production. For performance evaluation purposes, variable costing is superior to absorption costing because it prevents managers from increasing income by just increasing production. In the same way, throughput costing may be considered superior to variable costing because not only is management not rewarded for producing more than can be sold, they are penalized for excess production. In this example, income is highest when management produced less than demand and therefore reduced inventory that already existed.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

MINI-CASE 9-41 Capacity-level (denominator) choices. 1.

DenominatorLevel Capacity Theoretical capacity Practical capacity Normal capacity Master-budget capacity Jan–Jun 2021 Jul–Dec 2021

Budgeted Fixed Manufacturing Overhead Per Period ($) 50,000,000 50,000,000 50,000,000

Budgeted Denominator Level 5,256,000 3,500,000 2,800,000

Budgeted Fixed Manufacturing Overhead Cost Rate ($) 9.51 14.29 17.86

25,000,000 25,000,000

1,120,000 1,680,000

22.32 14.88

The differences arise for several reasons: a. The theoretical and practical capacity concepts emphasize supply factors, while normal capacity utilization and master-budget capacity utilization emphasize demand factors. b. The two separate six-month rates for the master-budget capacity utilization concept differ because of seasonal differences in budgeted production. 2. Theoretical capacity—based on the production of output at maximum efficiency for 100% of the time. Practical capacity—reduces theoretical capacity for unavoidable operating interruptions such as scheduled maintenance time, shutdowns for holidays and other days, and so on. For each of the three determinants of capacity in Sooke Ale’s plant, practical capacity is less than theoretical capacity: Capacity Type Theoretical Practical 3.

Barrels per Hour 600 500

Working Hrs./Day 24 20

Working Days/Year 365 350

Capacity 5,256,000 3,500,000

The smaller the denominator, the higher will be the amount of overhead costs capitalized for inventory units. Thus, if the plant manager wishes to be able to “adjust” plant operating income by building inventory, master-budget capacity utilization or possibly normal capacity utilization would be preferred.

Chapter 9: Income Effect of Denominator Level on Inventory Valuation

4. Inventoriable cost per unit = Variable production cost + Fixed manufacturing overhead/Capacity Capacity Type Theoretical Practical Normal

Capacity Level 5,256,000 3,500,000 2,800,000

Fixed Mfg. Overhead $50,000,000 $50,000,000 $50,000,000

Fixed Mfg. Overhead Rate $9.51 $14.29 $17.86

Variable Production Cost $51.40 $51.40 $51.40

Inventoriable Cost Per Unit $60.91 $65.69 $69.26

Sooke Ale’s actual production level is 2,600,000 barrels. We can compute the productionvolume variance as: Production Volume Variance = Budgeted fixed mfg. overhead – (Fixed mfg. overhead rate × Actual production level)

Capacity Type Theoretical Practical Normal

Capacity Level 5,256,000 3,500,000 2,800,000

Fixed Mfg. Overhead $50,000,000 $50,000,000 $50,000,000

Fixed Mfg. Overhead Rate $9.51 $14.29 $17.86

Fixed Mfg. Overhead Rate × Actual Production $ 24,726,000 $ 37,154,000 $ 46,436,000

Production Volume Variance $25,274,000 U $12,846,000 U $ 3,564,000 U

Operating Income for Sooke Ale given production of 2,600,000 barrels and sales of 2,400,000 barrels @ $82 apiece: Theoretical Revenue Less: Cost of goods sold a Production-volume variance Rate variance Gross margin Variable selling b Fixed selling Operating income

Practical

Normal

$196,800,000 $196,800,000 $196,800,000 146,184,000 157,656,000 166,224,000 25,274,000 U 12,846,000 U 3,564,000 U 1,241,600 F 1,241,600 F 1,241,600 F 24,100,400 25,056,400 25,770,400 0 0 0 0 0 0 $24,100,400 $25,056,400 $25,770,400

a2,400,000 × 60.91, × 65.69, × 69.26 bNone, internal transfer.

5. Based on the calculations above, theoretical would be preferred, as normal has a higher dollar-value level of inventory left thus increasing tax burden. 6. CRA requires consistency in use of method; master-budget capacity. Copyright © 2022 Pearson Canada Inc. 9-51

CHAPTER 10 ANALYSIS OF COST BEHAVIOUR MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

SHORT-ANSWER QUESTIONS 10-1

The two assumptions are

1. Changes in the level of a single direct input used or an activity (the cost driver) explain the changes in the related total costs. 2. Cost behaviour is estimated by a continuous, linear cost function within the relevant range. Within the relevant range, the graph of data pairs of total quantity used and total MOH cost can be joined and will form a straight line.

10-2

Three alternative linear cost functions are

1. Variable cost function––a cost function in which total costs change in proportion to the changes in the level of activity or resources consumed within the relevant range. 2. Fixed cost function––a cost function in which total costs do not change with changes in the level of activity, inputs consumed or outputs produced in the relevant range of production. 3. Mixed cost function––a cost function that has both variable and fixed costs accumulated from using many different types of resources. Total costs change but cannot be fully explained by changes in the level of a single activity or quantity of single direct input used.

10-3

The first step is to identify the dependent variable (Y) throughout some time period and then develop a correlation with one or more likely independent variables (X) throughout the same time period in preparation for developing a predictive model. Together the values form an (X, Y) pair of actual data points that have actually occurred. These are called time-series data.

10-4

No. High correlation merely indicates that changes in (X) correspond to changes in the (Y) data. It does not matter how high this correlation is; no inference can ever be made about a cause and effect relationship. Even a strong or high correlation can be a coincidence. The management team must consider how well the correlation reflects what actually happens in a production process. This is economic plausibility. Without any economic plausibility, any predictions of future cost (y) will be just a guess and therefore irrelevant to any management decision making. Should the management team mistakenly use just the results without thinking about their economic plausibility any predictions made will be unreliable.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

10-5

A discontinuous linear cost function will either have different slopes throughout the relevant range, or will be a series of horizontal lines with zero slope throughout the relevant range. Some types of analyses that can be done to improve cost control include the industrial engineering method, conference method, account analysis method, and quantitative analyses (high–low, ordinary least squares linear regression).

10-6 1. 2. 3. 4.

Four approaches to estimating a cost function are

Industrial engineering method. Conference method. Account analysis method. Quantitative analysis of current or past cost relationships.

10-7

The conference method estimates cost functions on the basis of analysis and opinions about costs and their drivers gathered from various departments of a company (purchasing, process engineering, manufacturing, employee relations, etc.). Advantages of the conference method include 1. The speed with which cost estimates can be developed. 2. The pooling of knowledge from experts across functional areas. 3. The improved credibility of the cost function to all personnel.

10-8

The cost driver (X) is the predictor variable and when using the high–low method you base the observations on the high and low values of (X). The cost pool is the outcome variable (Y). Based on economic plausibility, changes in the predictor variable are supposed to explain changes in the outcome variable, not the reverse.

10-9

The goal of an ordinary least squares (OLS) linear regression is to select the best cost driver from all the existing data available in a traditional costing system, which will most reliably predict the values of the MOH cost pool.

10-10 Three criteria important when choosing among alternative cost functions are 1. Economic plausibility. 2. Goodness of fit (the explanatory power measured as r2). 3. Confidence level (either 95% or 99%).

10-11 The goodness of fit is mathematically calculated as a straight line that minimizes the sum of the differences squared between the actual data points (X, Y) and the corresponding predicted data points on the linear regression line (X, y). The smaller this sum is, the higher will be the proportion of changes in y explained by corresponding changes in X. The proportion is reported by the coefficient of determination, measured by r2 in decimal form such as 0.32. This means that 32% of the changes in predicted y can be explained by corresponding actual, historical changes in X. All other things equal, the cost driver with the higher r2 will be the better choice.

Chapter 10: Analysis of Cost Behaviour

10-12 This is not true. Some of the predictor variables may report the effect of predictable changes in the business environment on the changes in the MOH cost pool. Examples include temperature, seasonal demand, foreign currency exchange rates, and inflation.

10-13 Frequently encountered problems when collecting cost data on variables included in a cost function are 1. The time period used to measure the outcome variable (MOH cost pool) is not properly matched with the time period used to measure the predictor variable (cost driver(s)). 2. Fixed costs are allocated as if they were variable. 3. Data are either not available for all observations or are not uniformly reliable. 4. Extreme values of either X or Y occur due to random events, unlikely to recur. 5. A homogeneous relationship between the individual cost items in the dependent variable cost pool and the cost driver(s) does not exist. 6. The relationship between the cost and the cost driver is not stationary over time. 7. Inflation has occurred in a dependent variable, a cost driver, or both.

10-14 Quality costs (including the opportunity cost of lost sales because of poor quality) can be as much as 10% to 20% of sales revenues of many organizations. Quality-improvement programs can result in substantial cost savings and higher revenues and market share from increased customer satisfaction.

10-15 Design quality refers to how closely the characteristics of a product or service meet the needs and wants of customers. Conformance quality refers to the performance of a product or service relative to its design and product specifications.

10-16 The following six line items are in the prevention costs category: design engineering; process engineering; supplier evaluations; preventive equipment maintenance; quality training; and testing of new materials.

10-17 An internal failure cost differs from an external failure cost on the basis of when the nonconforming product is detected. Internal failure costs are costs incurred on a defective product before a product is shipped to a customer, whereas external failure costs are costs incurred on a defective product after a product is shipped to a customer.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

EXERCISES 10-18 (10 min.)

Terminology.

1. A management team can use several methods of quantitative analysis to predict the value of a single overhead cost pool in a traditional costing system. The methods are: account analysis method, conference method, high–low method, industrial engineering method, and ordinary least squares (OLS). 2. There are different criteria to consider when choosing a method of analysis which are: affordability, understandability, data availability and quality, explanatory power, and economic plausibility. 3. The relationship between cost of unequally shared resources used in production, and their benefit to distinct types of cost objects must be economically plausible. The change in quantity of resources used must be a good measure of change in benefit. The relationship must be a linear cost function if OLS simple linear regression analysis is to be used. 4. Ideally, the OLS will be based on at least 25 data points observed and reported in the past as a time series. If insufficient data are available then the other methods of analysis will help the management team predict the value of the indirect cost pool. 5. When true, the orderly change in the quantity of resource used will explain a large proportion of the change in the indirect cost pool. This is called explanatory power. A high explanatory power indicates a high correlation between the change in the measure of benefit or the predictor variable, X, and the change in the predicted indirect cost pool or outcome variable, y. 6. You can observe this in the goodness of fit between the predicted (X, y) line and the actual data points (X, Y) from which the prediction was made. 7. The measure of goodness of fit is called r2. Other important statistics that assess the reliability of the predicted regression line are the t-Stat and P-value. 8. While the OLS is a very rigorous analysis and can predict future values at a specific confidence level, it is not appropriate for all situations.

10-19 (10 min.)

Estimating a cost function.

1. Slope coefficient = = $5,400 – $4,000 / 10,000 – 5,000 = $1,400 / 5,000 = $0.28 per machine-hour Constant = Total cost – (Slope coefficient  Quantity of cost driver) = $5,400 – ($0.28  10,000) = $2,600 = $4,000 – ($0.28  6,000) = $2,600 The cost function based on the two observations is Maintenance costs = $2,600 + $0.28  machine hour

Chapter 10: Analysis of Cost Behaviour

2. The cost function in requirement 1 is an estimate of how costs behave within the relevant range, not at cost levels outside the relevant range. If there are no months with zero machinehours represented in the maintenance account, data in that account cannot be used to estimate the fixed costs at the zero machine-hours level. Rather, the constant component of the cost function provides the best available starting point for a straight line that approximates how a cost behaves within the relevant range.

10-20 (20 min.) 1. 2. 3. 4. 5. 6. 7. 8. 9.

Discontinuous linear cost functions.

K B G J Note that A is incorrect because, although the cost per kilogram eventually equals a constant at $9.20, the total dollars of cost increases linearly from that point onward. I The total costs will be the same regardless of the volume level. L F This is a classic step-cost function. K C

10-21 (30 min.)

Account analysis method.

1. Manufacturing cost classification for 2021:

Account

Total Costs (1)

Direct materials Direct manufacturing labour Power Supervision labour Materials-handling labour Maintenance labour Depreciation Rent, property taxes, admin Total

$300,000 225,000 37,500 56,250 60,000 75,000 95,000 100,000 $948,750

% of Total Costs Variable That is Fixed Variable Costs Variable Costs Cost per Unit (3) = (1)  (2) (4) = (1) – (3) (5) = (3) ÷ 75,000 (2) 100% 100 100 20 50 40 0 0

$300,000 225,000 37,500 11,250 30,000 30,000 0 0 $633,750

Total manufacturing cost for 2021 = $948,750

0 0 0 45,000 30,000 45,000 95,000 100,000 $315,000

$4.00 3.00 0.50 0.15 0.40 0.40 0 0 $8.45

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Variable costs in 2022: Unit Variable Increase in Cost per Variable Variable Cost Unit for Percentage Cost per Unit 2021 Increase per Unit for 2022 (6) (7) (8) = (6)  (7) (9) = (6) + (8)

Total Variable Costs for 2022 (10) = (9)  80,000

$4.00 3.00 0.50 0.15 0.40 0.40 0 0 $8.45

$336,000 264,000 40,000 12,000 32,000 32,000 0 0 $716,000

Account Direct materials Direct manufacturing labour Power Supervision labour Materials-handling labour Maintenance labour Depreciation Rent, property taxes, admin. Total

5% 10 0 0 0 0 0 0

$0.20 0.30 0 0 0 0 0 0 $0.50

$4.20 3.30 0.50 0.15 0.40 0.40 0 0 $8.95

Fixed and total costs in 2022:

Account

Dollar Fixed Increase in Fixed Costs Variable Total Fixed Costs Costs Percentage for 2022 Costs for Costs (13) = for 2021 Increase (14) = 2022 (16) = (11)  (12) (11) + (13) (11) (12) (15) (14) + (15)

Direct materials $ 0 0% Direct manufacturing labour 00 Power 00 Supervision labour 45,000 0 Materials-handling labour 30,000 0 Maintenance labour 45,000 0 Depreciation 95,000 5 Rent, property taxes, admin. 100,000 7 Total $315,000

$ 0 0 0 0 0 0 4,750 7,000 $11,750

Total manufacturing costs for 2022 = $1,042,750 $948, 750 = $12.65 75, 000 $1, 042, 750 Total cost per unit, 2022 = = $13.03 80, 000

2. Total cost per unit, 2021 =

$ 0 0 0 45,000 30,000 45,000 99,750 107,000 $326,750

$336,000 $ 336,000 264,000 264,000 40,000 40,000 12,000 57,000 32,000 62,000 32,000 77,000 0 99,750 0 107,000 $716,000 $1,042,750

Chapter 10: Analysis of Cost Behaviour

3. Cost classification into variable and fixed costs is based on qualitative, rather than quantitative, analysis. How good the classifications are depends on the knowledge of individual managers who classify the costs. Gower may want to undertake quantitative analysis of costs, using regression analysis on time-series or cross-sectional data to better estimate the fixed and variable components of costs. Better knowledge of fixed and variable costs will help Gower to better price his products, to know when he is getting a positive contribution margin, and to better manage costs.

10-22 (30–40 min.) Linear cost approximation. 1. Slope coefficient (b) =

Difference in cost $529, 000 $400, 000  = $43.00 Difference in labour-hours 7, 000 4, 000

Constant (a) = $529,000 – ($43.00 × 7,000) = $228,000 Cost function = $228,000 + $43.00 × Professional labour-hours The linear cost function is plotted in Solution Exhibit 10-22. No, the constant component of the cost function does not represent the fixed overhead cost. The relevant range of professional labour-hours is from 3,000 to 8,000. The constant component provides the best available starting point for a straight line that approximates how a cost behaves within the 3,000 to 8,000 relevant range. 2. A comparison at various levels of professional labour-hours follows. The linear cost function is based on the formula of $228,000 per month plus $43.00 per professional labour-hour.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Total overhead cost behaviour: Professional labour-hours Actual total overhead costs Linear approximation Actual minus linear approximation

Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 3,000 4,000 5,000 6,000 7,000 8,000 $340,000 $400,000 $435,000 $477,000 $529,000 $587,000 357,000 400,000 443,000 486,000 529,000 572,000 $(17,000) $

0 $ (8,000) $ (9,000) $

0 $ 15,000

The data are shown in Solution Exhibit 10-22. The linear cost function overstates costs by $8,000 at the 5,000-hour level and understates costs by $15,000 at the 8,000-hour level. 3. Contribution before deducting incremental overhead Incremental overhead Contribution after incremental overhead

Based on Actual $38,000 35,000 $ 3,000

Based on Linear Cost Function $38,000 43,000 $ (5,000)

The total contribution margin actually forgone is $3,000.

SOLUTION EXHIBIT 10-22 Linear Cost Function Plot of Professional Labour-Hours on Total Overhead Costs

Total Overhead Costs

$700,000 600,000 500,000 400,000 300,000 200,000 100,000 0 0

1,000 2,000 3,000 4,000 5,000 6,000 7,000 Professional Labour-Hours Billed

8,000

9,000

Chapter 10: Analysis of Cost Behaviour

10-23 (20 min.)

Cost–volume–profit and regression analysis. Total manufacturing costs Number of bicycle frames $900,000   $30 per frame 30,000

Average cost of manufacturing 

1a.

This cost is greater than the $28.50 per frame that Ryan has quoted. 1b. Garvin cannot take the average manufacturing cost in 2023 of $30 per frame and multiply it by 36,000 bicycle frames to determine the total cost of manufacturing 36,000 bicycle frames. The reason is that some of the $900,000 (or equivalently the $30 cost per frame) are fixed costs and some are variable costs. Without distinguishing fixed from variable costs, Garvin cannot determine the cost of manufacturing 36,000 frames. For example, if all costs are fixed, the manufacturing costs of 36,000 frames will continue to be $900,000. If, however, all costs are variable, the cost of manufacturing 36,000 frames would be $30  36,000 = $1,080,000. If some costs are fixed and some are variable, the cost of manufacturing 36,000 frames will be somewhere between $900,000 and $1,080,000. Some students could argue that another reason for not being able to determine the cost of manufacturing 36,000 bicycle frames is that not all costs are output unit-level costs. If some costs are, for example, batch-level costs, more information would be needed on the number of batches in which the 36,000 bicycle frames would be produced, in order to determine the cost of manufacturing 36,000 bicycle frames. 2. Expected cost to make = $432,000 + $15  36,000 36,000 bicycle frames = $432,000 + $540,000 = $972,000 Purchasing bicycle frames from Ryan will cost $28.50  36,000 = $1,026,000. Hence, it will cost Garvin $1,026,000  $972,000 = $54,000 more to purchase the frames from Ryan rather than manufacture them in-house. 3. Garvin would need to consider several factors before being confident that the equation in requirement 2 accurately predicts the cost of manufacturing bicycle frames. a. Is the relationship between total manufacturing costs and quantity of bicycle frames economically plausible? For example, is the quantity of bicycles made the only cost driver or are there other cost-drivers (for example batch-level costs of setups, production orders, or material handling) that affect manufacturing costs? b. How good is the goodness of fit? That is, how well does the estimated line fit the data? c. Is the relationship between the number of bicycle frames produced and total manufacturing costs linear? d. Does the slope of the regression line indicate that a strong relationship exists between manufacturing costs and the number of bicycle frames produced?

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

e. Are there any data problems such as, for example, errors in measuring costs, trends in prices of materials, labour, or overheads that might affect variable or fixed costs over time, extreme values of observations, or a nonstationary relationship over time between total manufacturing costs and the quantity of bicycles produced? f. How is inflation expected to affect costs? g. Will Ryan supply high-quality bicycle frames on time?

10-24

(25 min.)

Regression analysis, service company.

1. Solution Exhibit 10-24 plots the relationship between labour-hours and overhead costs and shows the regression line. y = $43,563 + $14.66 X Economic plausibility. Labour-hours appears to be an economically plausible driver of overhead costs for the character company. Overhead costs such as scheduling, hiring and training of workers, and managing the workforce are largely incurred to support labour. Goodness of fit. The vertical differences between actual and predicted costs are extremely small, indicating a very good fit. The good fit indicates a strong relationship between the labour-hour cost driver and overhead costs. Slope of regression line. The regression line has a reasonably steep slope from left to right. Given the small scatter of the observations around the line, the positive slope indicates that, on average, overhead costs increase as labour-hours increase. 2. The regression analysis indicates that, within the relevant range of 1,200 to 2,200 labourhours, the variable cost per person for a birthday party equals: Balloons, cupcakes and punch Labour (0.25 hrs.  $20 per hour) Variable overhead (0.25 hrs.  $14.66 per labour-hour) Total variable cost per person

$ 7.00 5.00 3.67 $15.67

3. To earn a positive contribution margin, the minimum bid for a 20-child birthday party would be any amount greater than $313.40. This amount is calculated by multiplying the variable cost per child of $15.67 by the 20 children. At a price above the variable cost of $313.40, Linda Olson will be earning a contribution margin toward coverage of her fixed costs. Of course, Linda Olson will consider other factors in developing her bid including (a) an analysis of the competition––vigorous competition will limit Linda’s ability to obtain a higher price (b) a determination of whether or not her bid will set a precedent for lower prices––overall, the prices Linda Olson charges should generate enough contribution to cover fixed costs and earn a reasonable profit, and (c) a judgment of how representative past historical data (used in the regression analysis) is about future costs.

Chapter 10: Analysis of Cost Behaviour

SOLUTION EXHIBIT 10-24 Regression Line of Overhead Costs on Labour-Hours for Linda Olson’s Character Business

80,000

Overhead Costs

75,000 70,000

y = 14.6642x + 43563.4304 R2 = 0.9551

65,000 60,000 55,000 50,000 1,000

1,200

1,400

1,600

1,800

2,000

2,200

2,400

Labor-Hours

10-25

(20 min.)

Estimating a cost function, high-low method.

1. There is a positive relationship between the number of service reports (a cost driver) and the customer-service department costs. This relationship is economically plausible. 2. Highest observation of cost driver Lowest observation of cost driver Difference

Number of Service Reports 440 120 320

Customer-Service Department Costs $21,600 12,000 $ 9,600

Customer-service department costs = a + b (number of service reports)

$9, 600 = $30 per service report 320 Constant (a) = $21,600 – ($30 × 440) = $8,400 = $12,000 – ($30 × 120) = $8,400 Customer-service = $8,400 + $30 (number of service reports) department costs Slope coefficient (b) =

3. Other possible cost drivers of customer-service department costs are: a. Number of products replaced with a new product (and the dollar value of the new products charged to the customer-service department). b. Number of products repaired and the time and cost of repairs. Copyright © 2022 Pearson Canada Inc. 10-11

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 10-25 Plot of Number of Service Reports versus Customer-Service Dept. Costs for Camilla Products

Customer-Service Department Costs

$24,000 $22,000 $20,000 $18,000 $16,000 $14,000 $12,000 $10,000 100

150

200

250

300

350

400

450

500

Number of Service Reports

PROBLEMS 10-26 1.

(25 min.)

High-low, regression

May will pick the highest point of activity, 4,153 parts (March) at $17,653 of cost, and the lowest point of activity, 2,298 parts (August) at $10,233.

Highest observation of cost driver Lowest observation of cost driver Difference

Cost driver: Quantity Purchased 4,153 2,298 1,855

Cost $17,653 10,233 $ 7,420

Purchase costs = a + b × Quantity purchased Slope Coefficient = $7,420/1,855 = $4 per part Constant (a) = $17,653 − ($4 × 4,153) = $1,041 The equation May gets is: Purchase costs = $1,041 + ($4 × Quantity purchased)

Chapter 10: Analysis of Cost Behaviour

2. Using the equation above, the expected purchase costs for each month will be: Purchase Quantity Expected 3,340 parts 3,710 3,040

Month October November December

Expected Formula cost y = $1,041 + ($4 × 3,340) $14,401 y = $1,041 + ($4 × 3,710) 15,881 y = $1,041 + ($4 × 3,040) 13,201

3. Economic Plausibility: Clearly, the cost of purchasing a part is associated with the quantity purchased. Goodness of Fit: As seen in Solution Exhibit 10-26, the regression line fits the data well. The vertical distance between the regression line and observations is small. An r-squared value of close to 0.96 indicates that almost 98% of the change in cost can be explained by the change in quantity purchased. Significance of the Independent Variable: The relatively steep slope of the regression line suggests that the quantity purchased is correlated with purchasing cost for part #696. SOLUTION EXHIBIT 10-26 Clayton Manufacturing Purchase Costs for Part #696 $20,000

Cost of Purchase

$18,000

y = 3.5376x + 2582.5733 R2 = 0.9583

$16,000 $14,000 $12,000 $10,000 $8,000 2,000

2,500

3,000

3,500

4,000

4,500

Quantity Purchased

According to the regression, May’s original estimate of fixed cost is too low given all the data points. The original slope is too steep, but only by 46 cents. So, the variable rate is lower but the fixed cost is higher for the regression line than for the high-low cost equation.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

The regression is the more accurate estimate because it uses all available data (all nine data points) while the high-low method only relies on two data points and may therefore miss some important information contained in the other data. 4. Using the regression equation, the purchase costs for each month will be:

Month October November December

Purchase Quantity Expected 3,340 parts 3,710 3,040

Formula y = $2,582.60 + ($3.54 × 3,340) y = $2,582.60 + ($3.54 × 3,710) y = $2,582.60 + ($3.54 × 3,040)

Expected cost $14,406.20 15,716.00 13,344.20

Although the two equations are different in both fixed element and variable rate, within the relevant range they give similar expected costs. This implies that the high and low points of the data are a reasonable representation of the total set of points within the relevant range.

10-27

(25 min.)

High-low method.

1. Highest observation of cost driver Lowest observation of cost driver Difference Utility costs

Utility Costs

150,000 75,000 75,000

$270,000 150,000 $120,000

= a + b × Machine-hours

Slope coefficient (b) = Constant (a)

Machine-Hours

$120, 000 = $1.60 per machine-hour 75, 000

= $270,000 – ($1.60 × 150,000) = $270,000 – $240,000 = $30,000

Constant (a)

= $150,000 – ($1.60 × 75,000) = $150,000 – $120,000 = $30,000

Utility costs

= $30,000 + ($1.60 × Machine-hours)

Chapter 10: Analysis of Cost Behaviour

2. SOLUTION EXHIBIT 10-27 Plot and High-Low Line of Utility Costs as a Function of Machine-Hours

$280,000 $260,000 $240,000

Utility Costs

$220,000 $200,000 $180,000 $160,000 $140,000 $120,000 $100,000 60,000

80,000

100,000

120,000

140,000

160,000

Machine-Hours

Solution Exhibit 10-27 presents the high-low line. Economic plausibility. The cost function shows a positive economically plausible relationship between machine-hours and utility costs. There is a clear-cut engineering relationship of higher machine-hours and utility costs. Goodness of fit. The high-low line appears to “fit” the data well. The vertical differences between the actual and predicted costs appear to be quite small. Slope of high-low line. The slope of the line appears to be reasonably steep indicating that, on average, utility costs in a quarter vary with machine-hours used. 3. Using the cost function estimated in 1, predicted utility costs would be: $30,000 + ($1.60 × 125,000 hours) = $230,000. Mueller should budget $230,000 in quarter 9 because the relationship between machine-hours and utility costs in Solution Exhibit 10-27 is economically plausible, has an excellent goodness of fit, and indicates that an increase in machine-hours in a quarter causes utility costs to increase in the quarter.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

10-28

(15–20 min.)

Interpreting regression results, matching time periods.

1. Here is the regression data for monthly operating costs as a function of the total freight miles travelled by Sprit vehicles: SUMMARY OUTPUT Regression Statistics Multiple R 0.927299101 R Square 0.859883623 Adjusted R Square 0.845871986 Standard Error 132.0816002 Observations 12 ANOVA df Regression Residual Total

Intercept X Variable 1

1 10 11 Coefficients 445.76 0.26

SS MS 1070620.18 1070620.18 174455.49 17445.55 1245075.67 Standard Error 112.97 0.03

t Stat 3.95 7.83

Significance F F 61.37 0.00

P-value 0.00 0.00

Lower 95% 194.04 0.18

Upper 95% 697.48 0.33

Chapter 10: Analysis of Cost Behaviour

2. The chart below presents the data and the estimated regression line for the relationship between monthly operating costs and freight miles traveled by Spirit Freightways.

Economic plausibility

A positive relationship between freight miles traveled and monthly operating costs is economically plausible since increased levels of economic activity should lead to the consumption of greater amounts of labour, fuel and other operating expenses.

Goodness of fit

r2 = 86%, Adjusted r2 = 85% Standard error of regression = 132.08 Excellent fit; there is indisputable evidence of a linear relationship between the dependent and independent variables. The distances between the estimated line and the actual data points are small, other than at the highest level of activity recorded during the year.

Significance of Independent Variables

The t-value of 7.83 for freight miles traveled output units is significant at the 0.05 and 0.01 levels.

3. If Brown expects Spirit to generate an average of 3,600 miles each month next year, the best estimate of operating costs is given by: Monthly operating costs = $445.76 + ($0.26) × (3,600 miles) = $1,381.76. Annual operating costs = ($1,381.76) × 12 = $16,581.12. 4. Three variables, other than freight miles, that Brown might expect to be important cost drivers for Spirit’s operating costs are: input prices (fuel prices and wage rates), mix of agricultural output carried (weight, volume, value), and route mix and conditions (weather, flat versus mountainous terrain, short-haul versus long-haul carriage). Copyright © 2022 Pearson Canada Inc. 10-17

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

5. Here is the regression data for monthly maintenance costs as a function of the total freight miles travelled by Sprit vehicles: SUMMARY OUTPUT Regression Statistics Multiple R 0.87887319 R Square 0.77241808 Adjusted R Square 0.74965989 Standard Error 106.470794 Observations 12 ANOVA Regression Residual Total

Intercept X Variable 1

df 1 10 11

Significance F F 33.94 0.00

SS MS 384747.37 384747.37 113360.30 11336.03 498107.67

Coefficients 1170.57 −0.15

Standard Error 91.07 0.03

t Stat 12.85 −5.83

P-value 0.00 0.00

The data and regression estimate are provided in the chart below:

Lower 95% 967.66 −0.21

Upper 95% 1373.48 −0.09

Chapter 10: Analysis of Cost Behaviour

6. At first glance, the regression result in requirement 5 is surprising and economicallyimplausible. In the regression, the coefficient on freight miles traveled has a negative sign. This implies that the greater the number of freight miles (i.e., the more activity Spirit carries out), the smaller are the maintenance costs; specifically, it suggests that each extra freight mile reduces maintenance costs by $0.14 (recall that all data are in thousands). Clearly, this estimated relationship is not economically credible. However, one would think that freight miles should have some impact on fleet maintenance costs. The logic behind the estimated regression becomes clearer once one realizes that maintenance costs have a discretionary component to them, especially in terms of timing. Spirit’s peak months of work transporting agricultural products in western Canada occur in late spring and summer (the period from April through August). It is likely that Spirit is simply choosing to defer maintenance to those months when its vehicles are not in use, thereby creating a negative relationship between monthly activity and maintenance costs. The causality also goes the other way – if vehicles are in the shop for maintenance, they are clearly not on the road generating freight miles. A third reason is that vehicles might need to be serviced at greater frequency during the winter months because of the wear and tear that comes from driving on icy terrain and in poor weather conditions. Possible alternative specifications that would better capture the link between Spirit’s activity levels and the spending on maintenance are to estimate the relationship using annual data over a period of several years, to look at spending on corrective rather than preventive maintenance, or to look at the relation using lags (i.e., freight miles traveled in a period against the spending on maintenance done in a subsequent period in order to service the vehicles).

10-29

(30–40 min.)

Cost estimation, cumulative average-time learning curve.

1. Cost to produce the 2nd through the 7th troop deployment boats: Direct materials, 6 × $199,000 Direct manufacturing labour (DML), 61,8521 × $42 Variable manufacturing overhead, 61,852 × $26 Other manufacturing overhead, 20% of DML costs Total costs

$1,194,000 2,597,784 1,608,152 519,557 $5,919,493

1The direct manufacturing labour-hours to produce the second to seventh boats can be calculated

in several ways, given the assumption of a cumulative average-time learning curve of 90%:

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Use of table format: Cumulative Number of Units (X) (1) 1

90% Learning Curve Cumulative Average Time per Unit (y): Labour Hours (2) 14,700

13,230

3 4 5 6 7

12,439 11,907 11,509 11,195 10,936

Cumulative Total Time: Labour-Hours (3) = (1) × (2) 14,700

= (14,700 × 0.90)

26,460 37,317 47,628 57,545 67,170 76,552

= (13,230 × 0.90)

The direct labour-hours required to produce the second through the seventh boats is 76,552 – 14,700 = 61,852 hours. Use of formula: y = aXb where

a = 14,700, X = 7, and b = – 0.152004 y = 14,700  7– 0.152004 = 10,936 hours

The total direct labour-hours for 7 units is 10,936  7 = 76,552 hours Note: Some students will debate the exclusion of the $279,000 tooling cost. The question specifies that the tooling “cost was assigned to the first boat.” Although Pacific Boat may well seek to ensure its total revenue covers the $1,477,600 cost of the first boat, the concern in this question is only with the cost of producing six more PT109s. 2. Cost to produce the 2nd through the 7th boats assuming linear function for direct labour-hours and units produced: Direct materials, 6 × $199,000 Direct manufacturing labour (DML), 6 × 14,700 hrs. × $42 Variable manufacturing overhead, 6 × 14,700 hrs. × $26 Other manufacturing overhead, 20% of DML costs Total costs

$1,194,000 3,704,400 2,293,200 740,880 $7,932,480

The difference in predicted costs is: Predicted cost in requirement 2 (based on linear cost function) Predicted cost in requirement 1 (based on 90% learning curve) Difference in favour of learning curve cost function

$7,932,480 5,919,493 $2,012,987

Chapter 10: Analysis of Cost Behaviour

Note that the linear cost function assumption leads to a total cost that is almost 35% higher than the cost predicted by the learning curve model. Learning curve effects are most prevalent in large manufacturing industries such as airplanes and boats where costs can run into the millions or hundreds of millions of dollars, resulting in very large and monetarily significant differences between the two models. In the case of Pacific Boat, if it is in fact easier to produce additional boats as the firm gains experience, the learning curve model is the right one to use. The firm can better forecast its future costs and use that information to submit an appropriate cost bid to the Navy, as well as refine its pricing plans for other potential customers. 10-30 (20 min.) Costs of quality analysis. 1. Appraisal cost = Inspection cost = $5 × 200,000 car seats = $1,000,000 2. Internal failure cost = Rework cost = 5% × 200,000 × $1 = 10,000 × $1 = $10,000 3. Out of pocket external failure cost = Shipping cost + Repair cost = 1% × 200,000 × ($8 + $1) = 2,000 × $9 = $18,000 4. Opportunity cost of external failure = Lost future profits = (1% × 200,000) × $100 = 2,000 car seats × $100 = $200,000 5. Total cost of quality control = $1,000,000 + $10,000 + $18,000 + $200,000 = $1,228,000 6. Quality control costs under the alternative inspection technique: Appraisal cost = $3 × 200,000 = $600,000 Internal failure cost = 3.5% × 200,000 × $1 = $7,000 Out-of-pocket external failure cost = 2.5% × 200,000 × ($8 + $1) = 5,000 × $9 = $45,000 Opportunity cost of external failure = (2.5% × 200,000) × $100 = 5,000 car seats × $100 = $500,000 Total cost of quality control = $600,000 + $7,000 + $45,000 + $500,000 = $1,152,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

7. In addition to the lower costs under the alternative inspection plan, Safe Travel should consider a number of other factors: a. There could easily be serious reputation effects if the percentage of external failures increases by 250% (from 1% to 2.5%). This rise in external failures may lead to costs greater than $100 per failure due to lost profits. b. Higher external failure rates may increase the probability of lawsuits. c. Government intervention is a concern with the chances of government regulation increasing with the number of external failures.

10-31

(15 min.)

Cost of quality, ethical considerations (continuation of 10-30).

1. Cost of improving quality of plastic = $10 × 200,000 = $2,000,000 2. Total cost of lawsuits = 3 × $500,000 = $1,500,000 3. Although economically this may seem like a good decision, qualitative factors should be more important than quantitative factors when it comes to protecting customers from harm and injury. If a product can cause a customer serious harm and injury, an ethical and moral company should take steps to prevent that harm and injury. The company’s code of ethics should guide this decision. 4. In addition to ethical considerations, the company should consider the societal cost of this decision, reputation effects if word of these problems leaks out at a later date, and governmental intervention and regulation.

10-32

(25 min.)

Costs of quality, quality improvements.

1. Cell Design’s managers plan to increase spending on CAD design improvement improving machine calibrations to achieve product specifications. These are prevention activities. Cell Design’s managers plan to increase prevention costs to improve quality. This is consistent with much of the research on quality. Preventing defects from occurring in the first place generally gives the best cost to benefit gains from quality improvement. 2. Cost of making quality improvements = $150,000 + $137,500 = $287,500 Benefits of quality improvements: (1) 70% decrease in lost sales from customer returns = 70% × $787,500 = $551,250 Increase in contribution margin = Contribution margin % × Increase in sales = 40% × $551,250 = $220,500 (2) 60% decrease in customer replacement costs = 60% × $315,000 = $189,000 Total benefit = $220,500 + $189,000 = $409,500 The benefits of making the quality improvements exceed the costs by $ 122,000 ($409,500 – $287,500), so Cell Design should implement the changes to improve quality.

Chapter 10: Analysis of Cost Behaviour

3. The following table shows the actual costs of quality at Cell Design, as a percentage of total costs of quality, and as a percentage of revenues, before the change in the production process. Note that sales revenues = $10 × 1,050,000 units = $10,500,000.

Description (1) Prevention costs Appraisal costs Internal failure costs Rework Scrap Total internal failure costs External failure costs Customer replacements Lost contr. margin from customer returns1 Total external failure costs Total costs of quality

Amount (2) $ 210,000 100,000

Percentage of Total Costs of Quality (3) = (2) ÷ $1,381,000 15.2% 7.3%

Percentage of Revenues (4) = (2) ÷ $10,500,000 2.0% 1.0%

420,000 21,000 441,000

31.9%

4.2%

45.6% 100.0%

6.0% 13.2%

315,000 315,000 630,000 $1,381,000

1Lost contribution margin from customer returns = 40% × Lost sales from customer returns.

= 40% × $787,500 = $315,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

The following table shows the actual costs of quality at Cell Design, as a percentage of total costs of quality, and as a percentage of revenues, after the change in the production process. Note that as a result of these changes, lost sales from customer returns decrease by 70% × $787,500 = $551,250, so sales revenues increase by the same amount. Sales revenues in this case = $10,500,000 + $551,250 = $11,051,250

Description Amount (1) (2) 1 Prevention costs $ 497,500 Appraisal costs 100,000 Internal failure costs Rework 420,000 Scrap 21,000 Total internal failure costs 441,000 External failure costs Customer replacement costs2 126,000 3 Lost contr. margin from customer returns 94,500 Total external failure costs 220,500 Total costs of quality $1,259,000

Percentage of Total Costs of Quality (3) = (2) ÷ $1,259,000 39.5% 8.0%

Percentage of Revenues (4) = (2) ÷ $11,051,250 4.5% 0.9%

35.0%

4.0%

17.5% 100.0%

2.0% 11.4%

1Prevention costs = Existing prevention costs + CAD design improvement costs + Machine calibration costs

= $210,000 + $150,000 + $137,500 = $497,500 2Customer replacement costs = $315,000 × (1 – 0.60) = $126,000 3Lost contribution margin from customer returns = 40% × Lost sales from customer returns

= 40% × $787,500 × (1 – 0.70) = 40% × $236,250 = $94,500 As a result of implementing the changes in the production process, prevention costs, which are 15.2% of the total costs of quality and 2% of revenues, will become 39.5% of the total costs of quality and 4.5% of revenues. External failure costs, which are 45.6% of the total costs of quality and 6% of revenues, will become 17.5% of the total costs of quality and 2% of revenues. The changes also result in a decrease in the total costs of quality. The preceding calculations assume that overall sales revenues (other than the additional sales from fewer returns) will be unaffected by the change in the production process. But quality improvements could well result in an increase in sales, providing further benefit to Cell Design. Improvements in the production process could also decrease rework costs resulting in even more benefits from quality improvement. Better quality could also have other advantages such as making employees proud to work for Cell Design and increasing employee morale.

Chapter 10: Analysis of Cost Behaviour

10-33

(25 min.)

Quality improvement, relevant costs, and relevant revenues.

1. Relevant costs over the next year of changing to the new component = $70  18,000 copiers = $1,260,000 Relevant Benefits over the Next Year of Choosing the New Component Costs of quality items Savings in rework costs $79  14,000 rework hours Savings in customer-support costs $35  850 customer-support hours Savings in transportation costs for parts $350  225 fewer loads Savings in warranty repair costs $89  8,000 repair-hours

$1,106,000 29,750 78,750 712,000

Opportunity costs Contribution margin from increased sales

1,680,000

Cost savings and additional contribution margin

$3,606,500

Because the expected relevant benefits of $3,606,500 exceed the expected relevant costs of the new component of $1,260,000, SpeedPrint should introduce the new component. Note that the opportunity cost benefits in the form of higher contribution margin from increased sales is an important component for justifying the investment in the new component. 2. The incremental cost of the new component of $1,260,000 is less than the incremental savings in rework and repair costs of $1,926,500 ($1,106,000 + $29,750 + $78,750 + $712,000). Thus, it is beneficial for SpeedPrint to invest in the new component even without making any additional sales. 3. SpeedPrint should consider nonfinancial factors such as the reputation benefits of high quality that often cannot be quantified in terms of higher sales. Higher quality also improves the morale of employees working in the company and their care and commitment to improving processes.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

10-34 (20 min.) Quality improvement, relevant costs, relevant revenues. 1. Budgeted variable cost per attendee: Customer support and service personnel Food and drink Conference materials Incidental products and services Total budgeted variable cost per attendee Total budgeted variable cost ($246 × 50,000 attendees) Budgeted fixed costs: Building and facilities Management salaries Total budgeted fixed costs Total budgeted costs Budgeted operating income Budgeted revenues Budgeted revenue per conference attendee ($22,500,000 ÷ 50,000)

$ 120 42 18

$ 246 $12,300,000 $4,320,000 1,680,000 6,000,000 18,300,000 4,200,000 $22,500,000 $

450

The budgeted revenue per conference attendee is $450. 2. Quality improvements: additional menu items; additional incidental products and services; improved facilities. Budgeted variable cost per attendee: Customer support and service personnel ($66 + $4) Food and drink ($120 + $5) Conference materials ($42 + $0) Incidental products and services ($18 + $3) Total budgeted variable cost per attendee Budgeted revenues ($450 per attendee  70,000 attendees) Total budgeted variable costs ($258  70,000 attendees) Budgeted fixed costs: Building and facilities (4,320,000  1.50) Management salaries (1,680,000  1.50) Total budgeted fixed costs Total budgeted costs Budgeted operating income`

$ 125 42 21

$ 258 $31,500,000 18,060,000 $6,480,000 2,520,000 9,000,000 27,060,000 $ 4,440,000

The improvements above would increase operating income from $4,200,000 to $4,440,000. Moreover, improving the company’s meeting facilities could also lead to long-term growth.

Chapter 10: Analysis of Cost Behaviour

3. Using information from requirement 2, Revenues $31,500,000 Fixed costs $9,000,000 Denote total variable costs by $x $31,500,000 – $x – $9,000,000 = $4,200,000 $x = $31,500,000 – $9,000,000 – $4,200,000 = $18,300,000 Total variable costs = $18,300,000 Variable cost per conference attendee = $18,300,000 ÷ 70,000 = $261.43 At a variable cost per conference attendee of $261.43, Keswick would be indifferent between implementing and not implementing the proposed changes. 10-35

(25min.)

Waiting time.

1. 2

Average waiting time 

Annual average  Manufacturing      number of orders  time per order    Annual machine   Annual average  Manufacturing  2           number of orders  time per order     capacity  2

2, 000  4   2  [10, 000 [2, 000  4]] 32, 000   8 hours 2  [10, 000 8, 000] 2. To: Management of Kitty Wonderland Subject: Explanation of waiting times Even though Kitty Wonderland expects to utilize only 8,000 hours of the 10,000 hours of capacity available to it, queues can form for two reasons. (1) Kitty Wonderland expects to receive 2,000 orders, but it may receive fewer (say 1,800 orders) or more (say 2,200) orders. (2) Kitty Wonderland may receive orders while it is processing other orders. For example, Kitty Wonderland may receive three orders as soon as it starts processing an order. In this case, the first order would have to wait four hours till manufacturing of the current order is completed; the second order would have to wait another four hours till the first order is completed for a total of eight hours; the third order would have to wait yet another four hours till the second order is completed for a total of 12 hours. The denominator in the formula is a measure of the unused capacity, or cushion. As the unused capacity becomes smaller as a result of Kitty Wonderland receiving more orders, the chance that the machine is processing an earlier order when an order arrives becomes more likely, leading to greater delays.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Note that if the time it takes to process each order increases, the waiting times will also increase because the numerator in the formula will increase and the denominator will decrease. The manufacturing time per order appears as a squared term in the numerator. The squared term indicates the disproportionately large impact the manufacturing time has on the waiting time. As the manufacturing time lengthens, there is a much greater chance that the machine will be in use when an order arrives, leading to longer delays. At the same time, the cushion in the denominator decreases causing greater delays. 3. Management can take a number of actions to reduce wait times. a. Increase the annual capacity by purchasing another machine. This will, of course, increase costs. b. Work with customers to smooth the receipt of orders throughout the year or produce for inventory rather than only when an order is received. This will increase inventory holding costs. c. Work with process engineering to reduce manufacturing time. In each case, management would have to consider the benefits of reducing wait times against the costs. 4. If sales increase, the average wait time will increase because the cushion provided by unused capacity will become smaller and the chance that the machine is processing an earlier order when another order arrives becomes more likely, resulting in greater delays. 10-36

(30 min.)

Waiting time, service industry.

1. If SWU’s advisors expect to see 300 students each day and it takes an average of 12 minutes to advise each student, then the average time that a student will wait can be calculated using the following formula: 2  Annual average  Time taken to      of students per day  advise a student   Waiting time    Maximum amount    Average number  Time taken to  2           of students per day  advise a student   of time available   2 300  (12)  2  [10 advisors  10 hours  60 minutes [300  12]] 43, 000   9 minutes 2  [6, 000 3, 600]

Chapter 10: Analysis of Cost Behaviour

2. At 420 students seen a day, 2

Waiting time 

 Annual average  Time taken to      of students per day  advise a student 

  Maximum amount    Average amount  Time taken to  2           of students per day  advise a student   of time available   2 420  (12)  2  [10 advisors  10 hours  60 minutes [420  12]] 

60, 480  31.5 minutes 2  [6, 000 5, 040]

3. If the average time to advise a student is reduced to 10 minutes, then the average wait time would be 2

 Annual number  Time taken to      of students per day  advise a student 



  Maximum amount    Average amount  Time taken to  2           of students per day  advise a student   of time available   2 420  (10)  2  [10 advisors  10 hours  60 minutes [420  10]] 42, 000   11.67 minutes 2  [6, 000 4, 200]

10-37

(25 min.) Waiting time, cost considerations, and customer satisfaction (continued from 10-36).

1. a) If SWU hires two more advisors, then the average wait time will be 2



 Annual number  Time taken to      of students per day  advise a student    Maximum amount    Average amount  Time taken to  2         of time available   of students per day  advise a student    

420  (12)2  2  [12 advisors  10 hours  60 minutes [420  12]] 60, 480   14 minutes 2  [7, 200 5, 040]

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

If SWU has its current employees work six days a week and has them advise 350 students a day, then the average wait time will be 2



 Annual number  Time taken to      of students per day  advise a student 

  Maximum amount    Average amount  Time taken to  2           of students per day  advise a student   of time available   2 350  (12)  2  [10 advisors  10 hours  60 minutes [350  12]] (50, 400)   14 minutes 2  [6, 000 4, 200]

2. a) Cost if SWU hires two extra advisors for the registration period: Advisor salary cost = 12 advisors ×10 days × $100 = $12,000 b) Cost if SWU has its 10 advisors work six days a week for the registration period: Advisor salary cost = 10 advisors × 10 days × $100 + 10 advisors × 2 days × $150 = $13,000 Alternative (a) is less costly for SWU. 3. Hiring two extra advisors has the same waiting time and a lower cost than extending the workweek to six days during the registration period. However, the quality of the advising may not be as high. The temporary advisors may not be as familiar with the requirements of the university. They may also be unaware of how to work within the system (i.e., they may not be aware of alternatives that may be available to help students). Therefore, from a student satisfaction standpoint, it would be better to have the regular advisors work an extra day in the week and pay them overtime. This alternative will be more costly for SWU, but it is likely to result in better student advising.

Chapter 10: Analysis of Cost Behaviour

COLLABORATIVE LEARNING CASES 10-38 (20–30 min.) Cost estimation, incremental unit-time learning model. 1. Cost to produce the 2nd through the 7th boats: Direct materials, 6 × $199,000 Direct manufacturing labour (DML), 71,2171 × $42 Variable manufacturing overhead, 71,217 × $26 Other manufacturing overhead, 20% of DML costs Total costs

$1,194,000 2,991,114 1,851,642 598,223 $6,634,979

The direct labour hours to produce the second through the seventh boats can be calculated via a table format, given the assumption of an incremental unit-time learning curve of 90%: 1

90% Learning Curve Cumulative Number of Units (X) (1)

Individual Unit Time for Xth Unit (y)*: Labour Hours (2)

14,700

2 3 4 5 6 7

13,230 12,439 11,907 11,510 11,195 10,936

= (14,700 × 0.90) = (13,230 × 0.90)

Cumulative Total Time: LabourHours (3) 14,700 27,930 40,369 52,276 63,786 74,981 85,917

*Calculated as y = aXb where a = 14,700, b = – 0.152004, and X = 1, 2, 3,. . .7. The direct manufacturing labour-hours to produce the second through the seventh boat is 85,917 – 14,700 = 71,217 hours. 2. Difference in total costs to manufacture the second through the seventh boat under the incremental unit-time learning model and the cumulative average-time learning model is $6,634,979 (calculated in requirement 1 of this problem) – $5,919,493 (from requirement 1 of Problem 10-40) = $715,486, i.e., the total costs are higher for the incremental unit-time model.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

The incremental unit-time learning curve has a slower rate of decline in the time required to produce successive units than does the cumulative average-time learning curve (see Problem 10-40, requirement 1). Assuming the same 90% factor is used for both curves: Cumulative Number of Units 1 2 4 7

Estimated Cumulative Direct Manufacturing Labour-Hours Cumulative AverageIncremental Unit-Time Time Learning Model Learning Model 14,700 14,700 26,460 27,930 47,628 52,276 76,552 85,917

The reason is that, in the incremental unit-time learning model, as the number of units double, only the last unit produced has a cost of 90% of the initial cost. In the cumulative average-time learning model, doubling the number of units causes the average cost of all the units produced (not just the last unit) to be 90% of the initial cost. Pacific Boat should examine its own internal records on past jobs and seek information from engineers, plant managers, and workers when deciding which learning curve better describes the behaviour of direct manufacturing labour-hours on the production of the PT109 boats.

10-39 Evaluating alternative simple regression models, not-for-profit. 1a. Solution Exhibit 10-39A plots the relationship between number of academic programs and overhead costs. 1b. Solution Exhibit 10-39B plots the relationship between number of enrolled students and overhead costs. 2.

Solution Exhibit 10-39C compares the two simple regression models estimated by Hanks. Both regression models appear to perform well when estimating overhead costs. Cost function 1, using the number of academic programs as the independent variable, appears to perform slightly better than cost function 2, which uses number of enrolled students as the independent variable. Cost function 1 has a high r2 and goodness of fit, a high t-value, indicating a significant relationship between number of academic programs and overhead costs, and meets all the specification assumptions for ordinary least-squares regression. Cost function 2 has a lower r2 than cost function 1 and exhibits positive autocorrelation among the residuals as indicated by a low Durbin-Watson statistic.

The analysis indicates that overhead costs are related to the number of academic programs and the number of enrolled students. If Eastern has pressures to reduce and control overhead costs, it may need to look hard at closing down some of its academic programs and reducing its intake of students. Reducing the number of enrolled students may cut down on overhead costs, but it also cuts down on revenues (tuition payments), hurts the reputation of the school, and reduces its alumni base, which is a future source of funds. For these reasons, Eastern may prefer to downsize its academic programs, particularly those programs that attract few students. Of course, Eastern should continue to reduce costs by improving the efficiency of the delivery of its programs. Copyright © 2022 Pearson Canada Inc. 10-32

Chapter 10: Analysis of Cost Behaviour

SOLUTION EXHIBIT 10-39A Plot of Number of Academic Programs versus Overhead Costs (in thousands)

SOLUTION EXHIBIT 10-39B

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 10-39C Comparison of Alternative Cost Functions for Overhead Costs Estimated with Simple Regression for Eastern University Criterion

1. Economic plausibility

2. Goodness of fit

3. Significance of independent variable(s) 4. Specification analysis of estimation assumptions

Cost Function 1: Number of Academic Programs as Independent Variable A positive relationship between overhead costs and number of academic programs is economically plausible at Eastern University. r2 = 0.72, Adj. R2 = 0.693 Excellent goodness of fit

Cost Function 2: Number of Enrolled Students as Independent Variable A positive relationship between overhead costs and number of enrolled students is economically plausible at Eastern University. r2 = 0.55, Adj. R2 = 0.509 Good goodness of fit but not as good as for number of academic programs t-value of 5.08 is significant. t-value of 3.52 is significant. d.f. = 11, (critical = 2.20 at d.f. = 11, (critical = 2.20 at 95% C.L.) 95% C.L.) Plot of the data indicates that Plot of the data indicates that assumptions of linearity, assumptions of linearity, constant variance, constant variance, and independence of residuals, and normality of residuals hold, normality of residuals hold, but inferences drawn from but inferences drawn from only 12 observations are not only 12 observations are not reliable; the Durbin-Watson reliable; Durbin Watson statistic = 0.82 indicates that statistic = 2.07 indicates that independence of residuals independence of residuals does not hold. holds.

Chapter 10: Analysis of Cost Behaviour

4. Two issues that might suggest a result are unreliable are (1) a small sample size, ands (2) a high standard error. Depending on the nature of regressions, other acceptable answers could also include a skewed distribution favouring one-side of the distribution (either above or below the mean), auto-correlated answers, or a high degree of covariance.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

10-40 (25 min.) Interpreting regression results, matching time periods 1. Here is the summary output for the monthly regression of Sales Revenue on Online Advertising Expense: SUMMARY OUTPUT Regression Statistics Multiple R 0.15 R Square 0.02 Adjusted R Square -0.07 Standard Error 11837.30 Observations 12.00 ANOVA Regression Residual Total

Intercept X Variable 1

Significance SS MS F F 33972689.79 33972690 0.242451 0.633072 1401216525 1.4E+08 1435189215

df 1 10 11 Coefficients 51999.64 −0.98

Standard Error 7988.68 1.99

t Stat 6.51 −0.49

P-value 0.00 0.63

Lower 95% 34199.74 −5.41

Upper 95% 69799.54 3.45

2. SOLUTION EXHIBIT 10-40A presents the data plot for the initial analysis. The formula of Sales Revenue = $52,000 − (0.98 × Online advertising expense) indicates that there is a fixed amount of revenue each month of $52,000, which is reduced by 0.98 times that month’s online advertising expense. This relationship is not economically plausible, as advertising would not reduce revenue. The data points do not appear linear, and the r-square of 0.02 indicates a very weak goodness of fit (in fact, almost no fit at all).

Chapter 10: Analysis of Cost Behaviour

SOLUTION EXHIBIT 10-40 A Plot and Regression Line for Sales Revenue and Online Advertising Expense $70,000 $65,000 $60,000

Sales Revenue

$55,000 $50,000 $45,000

y = -0.9789x + 51999.6376 R2 = 0.0237

$40,000 $35,000 $30,000 $25,000

$7,000

$6,000

$5,000

$4,000

$3,000

$2,000

$1,000

$20,000

Online Advertising Expense

3. Here is the summary output for the regression of monthly Sales Revenue on the prior month’s Online Advertising Expense: SUMMARY OUTPUT Regression Statistics Multiple R 0.808588 R Square 0.653815 Adjusted R Square 0.61535 Standard Error 7393.922 Observations 11 ANOVA Regression Residual Total

Intercept X Variable 1

df 1 9 10

SS 9.29E+08 4.92E+08 1.42E+09

Coefficients 28361.37 5.381665

Standard Error 5428.687 1.305336

MS F 929262059 16.99763 54670085

t Stat 5.2243522 4.1228186

P-value 0.000546 0.002587

Significance F 0.002587

Lower 95% 16080.83 2.428789

Upper 95% 40641.91 8.33454

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. SOLUTION EXHIBIT 10-40B presents the data plot for the revised analysis. The formula of Sales Revenue = $28,361 + (5.38 × Online Advertising Expense) indicates that there is a fixed amount of revenue each month of $28,361, which increases by 5.38 times the prior month’s advertising expense in the online channel. This relationship is economically plausible. One would expect a positive correlation between advertising expense and (future) sales revenue. The slope coefficient of 5.38 has a t stat of 4.12 indicating that it is statistically significant at the 5% level. In the revised analysis, there is improved linearity in the data points, and the r-square of 0.65 indicates a much stronger goodness of fit. SOLUTION EXHIBIT 10-40B Plot and Regression Line for Sales Revenue and Previous Month Online Advertising 70,000 65,000

Sales Revenue

60,000 55,000

y = 5.3817x + 28361.3714 R2 = 0.6538

50,000 45,000 40,000 35,000 30,000 0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

Online Advertising Expense (Prior Month)

4. Nandita must be very careful about making conclusions regarding cause and effect. Even a strong goodness of fit does not prove a cause and effect relationship. The independent and dependent variables could both be caused by a third factor, or the correlation could be simply coincidental. However, there is enough of a correlation in the revised analysis for Nandita to make a meaningful presentation to the store’s owner. 10-41 (25 min) (40–50 min.)

Purchasing department cost drivers, activity-based costing, simple regression analysis.

Chapter 10: Analysis of Cost Behaviour

2. Both Regressions 2 and 3 are well-specified regression models. The slope coefficients on their respective independent variables are significantly different from zero. These results support the Kaliko Fabrics’ presentation in which the number of purchase orders and the number of suppliers were reported to be drivers of purchasing department costs. In designing an activity-based cost system, Perfect Fit should use number of purchase orders and number of suppliers as cost drivers of purchasing department costs. As the chapter appendix describes, Perfect Fit can either (a) estimate a multiple regression equation for purchasing department costs with number of purchase orders and number of suppliers as cost drivers, or (b) divide purchasing department costs into two separate cost pools, one for costs related to purchase orders and another for costs related to suppliers, and estimate a separate relationship for each cost pool. 3. Guidelines presented in the chapter could be used to gain additional evidence on cost drivers of purchasing department costs. 1. Use physical relationships or engineering relationships to establish cause-and-effect links. Hart could observe the purchasing department operations to gain insight into how costs are driven. 2. Use knowledge of operations. Hart could interview operating personnel in the purchasing department to obtain their insight on cost drivers. SOLUTION EXHIBIT 10-41A Regression Lines of Various Cost Drivers for Purchasing Dept. Costs for Perfect Fit

Purchasing Department Costs

$2,500,000 y = 0.0031x + 1041421.3662 R2 = 0.0798

$2,000,000 $1,500,000 $1,000,000 $500,000 $0 0

50,000,000

100,000,000

Dollar Value of Merchandise Purchased

150,000,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

y = 159.4842x + 722537.851 R2 = 0.4306

$2,000,000 $1,500,000 $1,000,000 $500,000 $0 0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

Number of Purchase Orders $2,500,000 Purchasing Department Costs

Purchasing Department Costs

$2,500,000

$2,000,000 y = 3815.6949x + 828814.2417 R2 = 0.3868 $1,500,000 $1,000,000 $500,000 $0 0

100

150

Number of Suppliers

200

250

8,000

Chapter 10: Analysis of Cost Behaviour

SOLUTION EXHIBIT 10-41B Comparison of Alternative Cost Functions for Purchasing Department Costs Estimated with Simple Regression for Perfect Fit

Criterion 1. Economic Plausibility

2. Goodness of fit

Regression 1 PDC = a + (b  MP$) Result presented at seminar by Kaliko Fabrics found little support for MP$ as a driver. Purchasing personnel at the Miami store believe MP$ is not a significant cost driver.

Regression 2 PDC = a + (b  # of POs) Economically plausible. The higher the number of purchase orders, the more tasks undertaken.

Regression 3 PDC = a + (b  # of Ss) Economically plausible. Increasing the number of suppliers increases the costs of certifying vendors and managing the Perfect Fit-supplier relationship.

r2 = 0.08. Poor goodness of fit.

r2 = 0.43. Reasonable goodness of fit.

r2 = 0.39. Reasonable goodness of fit.

3. Significance t-value on MP$ of of Independent 0.83 is insignificant. Variables

t-value on # of POs of 2.46 t-value on # of Ss of 2.25 is significant. is significant.

4. Specification Analysis A. Linearity within the relevant range

Appears questionable Appears reasonable. but no strong evidence against linearity.

Appears reasonable.

B. Constant variance of residuals

Appears questionable, Appears reasonable. but no strong evidence against constant variance.

Appears reasonable.

C. Independence of residuals

Durbin-Watson Statistic = 2.41 Assumption of independence is not rejected.

Durbin-Watson Statistic = 2.01 Assumption of independence is not rejected.

D. Normality of residuals

Data base too small to Data base too small to make reliable make reliable inferences. inferences.

Durbin-Watson Statistic = 1.97 Assumption of independence is not rejected.

Data base too small to make reliable inferences.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

10-42

(30–40 min.)

Purchasing department cost drivers, multiple regression analysis (continuation of 10-41).

The problem reports the exact t-values from the computer runs of the data. Because the coefficients and standard errors given in the problem are rounded to three decimal places, dividing the coefficient by the standard error may yield slightly different t-values. 1. Regression 4 is a well-specified regression model: Economic plausibility: Both independent variables are plausible and are supported by the findings of the Kaliko Fabrics study. Goodness of fit: The r2 of 0.64 indicates an excellent goodness of fit. Significance of independent variables: The t-value on # of POs is 2.19 while the t-value on # of Ss is 1.99. These t-values are either significant or border on significance. Specification analysis: Results are available to examine the independence of residuals assumption. The Durbin-Watson statistic of 1.91 indicates that the assumption of independence is not rejected. Regression 4 is consistent with the findings in Problem 10-41 that both the number of purchase orders and the number of suppliers are drivers of purchasing department costs. Regressions 2, 3, and 4 all satisfy the four criteria outlined in the text. Regression 4 has the best goodness of fit (0.64 for Regression 4 compared to 0.43 and 0.39 for Regressions 2 and 3, respectively). Most importantly, it is economically plausible that both the number of purchase orders and the number of suppliers drive purchasing department costs. We would recommend that Hart use Regression 4 over Regressions 2 and 3. 2. Regression 5 adds an additional independent variable (MP$) to the two independent variables in Regression 4. This additional variable (MP$) has a t-value of -0.01, implying its slope coefficient is insignificantly different from zero. The r2 in Regression 5 (0.64) is the same as that in Regression 4 (0.64), implying the addition of this third independent variable adds close to zero explanatory power. In summary, Regression 5 adds very little to Regression 4. We would recommend that Hart use Regression 4 over Regression 5. 3. Budgeted purchasing department costs for the Baltimore store next year are $484,522 + ($126.66  4,100) + ($2,903  110) = $1,323,158

Chapter 10: Analysis of Cost Behaviour

4. Multicollinearity is a frequently encountered problem in cost accounting; it does not arise in simple regression because there is only one independent variable in a simple regression. One consequence of multicollinearity is an increase in the standard errors of the coefficients of the individual variables. This frequently shows up in reduced t-values for the independent variables in the multiple regression relative to their t-values in the simple regression: t-value in Multiple Regression

t-value from Simple Regressions in Problem 10-41

Variables Regression 4: # of POs # of Ss

2.19 1.99

2.46 2.25

Regression 5: # of POs # of Ss MP$

1.99 1.79 −0.01

2.46 2.25 0.83

The decline in the t-values in the multiple regressions is consistent with some (but not very high) collinearity among the independent variables. Pairwise correlations between the independent variables are: Correlation # of POs and # of Ss # of POs and MP$ # of Ss and MP$

0.29 0.27 0.30

There is no evidence of difficulties due to multicollinearity in Regressions 4 and 5. 5. Decisions in which the regression results in Problems 10-41 and 10-42 could be useful are Cost management decisions: Perfect Fit could restructure relationships with the suppliers so that fewer separate purchase orders are made. Alternatively, it may aggressively reduce the number of existing suppliers. Purchasing policy decisions: Perfect Fit could set up an internal charge system for individual retail departments within each store. Separate charges to each department could be made for each purchase order and each new supplier added to the existing ones. These internal charges would signal to each department ways in which their own decisions affect the total costs of Perfect Fit. Accounting system design decisions: Perfect Fit may want to discontinue allocating purchasing department costs on the basis of the dollar value of merchandise purchased. Allocation bases that better capture cause-and-effect relations at Perfect Fit are the number of purchase orders and the number of suppliers.

CHAPTER 11 DECISION MAKING AND RELEVANT INFORMATION MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

SHORT-ANSWER QUESTIONS 11-1

The five steps in the decision process outlined in Exhibit 11-1 of the text are:

1. Identify the problem and uncertainties 2. Obtain information 3. Make predictions about the future 4. Make decisions by choosing among alternatives 5. Implement the decision, evaluate performance, and learn Examples of interdependencies include absenteeism/low employee morale and increased labour costs.

11-2

Relevant costs are expected future costs that differ among the alternative courses of action being considered. Historical costs are irrelevant because they are past costs and, therefore, cannot differ among alternative future courses of action.

11-3

Quantitative factors are outcomes that are measured in numerical terms. Some quantitative factors are financial––that is, they can easily be expressed in monetary terms. Direct materials are an example of a quantitative financial factor. Qualitative factors are outcomes that are difficult to measure accurately in numerical terms. An example is employee morale.

11-4

Two potential problems that should be avoided in relevant-cost analysis are

(i) Do not assume all variable costs are relevant and all fixed costs are irrelevant. (ii) Do not use unit-cost data directly. It can mislead decision makers because a. it may include irrelevant costs, and b. comparisons of unit costs computed at different output levels lead to erroneous conclusions

11-5

Opportunity cost is the contribution to income that is forgone (rejected) by not using a limited resource in its next-best alternative use.

11-6

No. Some variable costs may not differ among the alternatives under consideration and, hence, will be irrelevant. Some fixed costs may differ among the alternatives and, hence, will be relevant.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

11-7

No. Managers should aim to get the highest contribution margin per unit of the constraining (that is, scarce, limiting, or critical) factor. The constraining factor is what restricts or limits the production or sale of a given product (for example, availability of machine-hours).

11-8

No. When deciding on the quantity of inventory to buy, managers must consider both the purchase cost per unit and the opportunity cost of funds invested in the inventory. For example, the purchase cost per unit may be low when the quantity of inventory purchased is large, but the benefit of the lower cost may be more than offset by the high opportunity cost of the funds invested in acquiring and holding inventory.

11-9

No. For example, if the revenues that will be lost exceed the costs that will be saved, the branch or business segment should not be shut down. Shutting down will only increase the loss. Allocated costs are always irrelevant to the shut-down decision.

11-10 Cost written off as depreciation is irrelevant when it pertains to costs for equipment already purchased. But the purchase cost of new equipment to be acquired in the future that will later be written off as depreciation is relevant.

11-11 No. Managers tend to favour the alternative that makes their performance look best, so they focus on the measures used in the performance-evaluation model. If the performanceevaluation model does not emphasize maximizing operating income or minimizing costs, managers will most likely not choose the alternative that maximizes operating income or minimizes costs.

11-12 No. Relevant costs are defined as those expected future costs that differ among alternative courses of action being considered. Thus, future costs that do not differ among the alternatives are irrelevant to deciding which alternative to choose.

11-13 The four key steps in managing bottleneck resources are: Step 1: Step 2: Step 3: Step 4:

Recognize that the bottleneck operation determines throughput contribution. Search for and find the bottleneck. Keep the bottleneck busy and subordinate all non-bottleneck operations to the bottleneck operation. Increase bottleneck efficiency and capacity.

Chapter 11: Decision Making and Relevant Information

EXERCISES 11-14 (10 min.) Terminology. 1. A full absorption cost refers to all manufacturing costs including all MOH whereas full product costs refers to all period or non-manufacturing costs as well as all manufacturing costs to bring the product to point of sale. 2. The opportunity cost is the value lost because a different alternative was not chosen. 3. The incremental revenue and incremental cost are the unique inflows and outflows arising from a specific alternative, should it be chosen. 4. Similarly an outlay cost arises from implementation of a specific alternative. In comparison a differential cost is the savings or added costs that arise when comparing alternatives to the current state. 5. There are some costs that are always irrelevant and one category is sunk costs that have already been spent and cannot be recovered by making a different decision. 6. One way to select an alternative is to use an optimization technique called linear programming. Optimization under specific constraints on resources may target either cost minimization or profit maximization. The technical name to calculate what will be optimized is the objective function.

11-15

(20 min.)

Disposal of assets.

1. This is an unfortunate situation, yet the $88,000 costs are irrelevant regarding the decision to remachine or scrap. The only relevant factors are the future revenues and future costs. By ignoring the accumulated costs and deciding on the basis of expected future costs, operating income will be maximized (or losses minimized). The difference in favour of not remachining is $400:

Future revenues Deduct future costs Operating income

(a) Remachine $37,000 33,000 $ 4,000

Difference in favour of not remachining

(b) Scrap $4,400 — $4,400 $400

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. This too is an unfortunate situation. But the $110,000 original cost is irrelevant to this decision. The difference in favour of rebuilding is $7,700:

New truck Deduct current disposal price of existing truck Rebuild existing truck

(a) Replace $112,200

(b) Rebuild —

11,000 — $101,200

— $93,500 $93,500

Difference in favour of rebuilding

$7,700

Note here that the current disposal price of $11,000 is relevant, but the original cost (or book value, if the truck were not brand new) is irrelevant.

11-16

(10 min.)

Inventory decision, opportunity costs.

1. Unit cost, orders of 25,000 Unit cost, order of 300,000 (0.97  $10.00)

$10.00 $ 9.70

Alternatives under consideration: (a) Buy 300,000 units at start of year. (b) Buy 25,000 units at start of each month. Average investment in inventory: (a) (300,000  $9.70) ÷ 2 (b) (25,000  $10.00) ÷ 2 Difference in average investment

$1,455,000 125,000 $1,330,000

Opportunity cost of interest forgone from 300,000-unit purchase at start of year = $1,330,000  0.08 = $106,400 2. No. The $106,400 is an opportunity cost rather than an incremental or outlay cost. No actual transaction records the $106,400 as an entry in the accounting system.

Chapter 11: Decision Making and Relevant Information

3. The following table presents the two alternatives: Alternative A: Purchase 300,000 spark plugs at beginning of year (1) Annual purchase-order costs (1  $125; 12  $125) Annual purchase (incremental) costs (300,000  $9.70; 300,000  $10) Annual interest income that could be earned if investment in inventory were invested (opportunity cost) (8%  $1,455,000; 8%  $125,000) Relevant costs

Alternative B: Purchase 25,000 spark plugs at beginning of each month Difference (2) (3) = (1) – (2)

125 2,910,000

1,500 3,000,000

$(1,375) (90,000)

116,400 $ 3,026,525

10,000 $3,011,500

106,400 $15,025

Column (3) indicates that purchasing 25,000 spark plugs at the beginning of each month is preferred relative to purchasing 300,000 spark plugs at the beginning of the year because the opportunity cost of holding larger inventory exceeds the lower purchasing and ordering costs. If other incremental benefits of holding lower inventory such as lower insurance, materials handling, storage, obsolescence, and breakage costs were considered, the costs under Alternative A would have been higher, and Alternative B would be preferred even more.

11-17

(20 min.)

Relevant and irrelevant costs.

1. Relevant costs Variable costs Avoidable fixed costs Purchase price Unit relevant cost

Make

Buy

$180 20 ____ $200

$210 $210

Ewing Computers should reject HT’s offer. The $30 of fixed costs are irrelevant because they will be incurred regardless of this decision. When comparing relevant costs between the choices, HT’s offer price is higher than the cost to continue to produce.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Cash operating costs (4 years) Current disposal value of old machine Cost of new machine Total relevant costs

Keep $80,000 ______ $80,000

Replace $48,000 (2,500) 8,000 $53,500

Difference $32,000 2,500 (8,000) $26,500

AP Manufacturing should replace the old machine. The cost savings are far greater than the cost to purchase the new machine.

11-18

(10 min.)

The careening personal computer.

Considered alone, book value is irrelevant as a measure of loss when equipment is destroyed. The measure of the loss is replacement cost or some computation of the present value of future services lost because of equipment loss or damage. In the specific case described, the following observations may be apt: 1. A fully depreciated item probably is relatively old. Chances are that the loss from this equipment is less than the loss for a partially depreciated item because the replacement cost of an old item would be far less than that for a nearly new item. 2. The loss of an old item, assuming replacement is necessary, automatically accelerates the timing of replacement. Thus, if the old item were to be junked and replaced tomorrow, no economic loss would be evident. However, if the old item were supposed to last five more years, replacement is accelerated five years. The best practical measure of such a loss probably would be the cost of comparable used equipment that had five years of remaining useful life. The fact that the computer was fully depreciated also means the accounting reports will not be affected by the accident. If accounting reports are used to evaluate the office manager’s performance, the manager will prefer any accidents to be on fully depreciated units.

11-19

Keep or drop a business segment

Choice “c” is correct. Whether to keep or drop a segment will depend on whether the contribution margin of the segment in question exceeds avoidable fixed costs (relevant costs that wouldn’t exist if the segment did not exist). Unavoidable fixed costs will be incurred regardless of whether or not the segment is kept, so they are not factored into the decision. Choice “a” is incorrect. Fixed costs need to be broken out between avoidable and unavoidable in order to make the determination as to whether to keep or drop a segment. Lees Corp. would only drop the segment if the contribution margin of the segment is less than the avoidable fixed (relevant) cost. Choice “b” is incorrect. The contribution margin needs to be compared to avoidable fixed costs in order to determine whether to keep or drop a segment. Choice “d” is incorrect. Unavoidable fixed costs will be incurred regardless, so contribution margin of the segment needs to be compared to the avoidable fixed costs as the key elements to determine whether to keep or drop a segment.

Chapter 11: Decision Making and Relevant Information

11-20

Relevant costs

Choice “a” is correct. Sunk costs are not relevant since they were incurred in the past and cannot be recovered as a result of the company’s current decision. Variable costs are relevant as also any avoidable fixed costs associated with the decision. Opportunity cost is the cost of foregoing the next best alternative when making a decision. These costs are relevant since the company has alternative courses of action. Choice “b” is incorrect. Sunk costs are not relevant since they were incurred in the past and cannot be recovered as a result of the company’s current decision. Choice “c” is incorrect. Opportunity cost is the cost of foregoing the next best alternative when making a decision. These costs are relevant since the company has alternative courses of action. Choice “d” is incorrect. Sunk costs are not relevant since they were incurred in the past and cannot be recovered as a result of the company’s current decision. Variable costs are relevant as also any avoidable fixed costs associated with the decision.

11-21

(30 min.)

Dropping a product line, selling more tours

1. Baldwin should not drop the advanced tours, as follows: Lost revenues from advanced tours Avoidable operating costs from dropping advanced tours: Administrative salaries Guide wages Supplies Vehicle fuel Total avoidable costs Lost operating income from dropping advanced tours

$(1,320,000) 100,000 760,000 200,000 48,000 1,108,000 $ (212,000)

Note: Equipment depreciation, allocated corporate costs, and unavoidable administrative salaries are irrelevant to the decision. 2. Baldwin should drop the advanced tours, as follows: Revenues Operating costs: Administrative salaries Guide wages Supplies Vehicle fuel Total change in operating costs Operating income

Beginner $450,000

Advanced $1,320,000

0 130,000 50,000 30,000 210,000 $240,000

100,000 760,000 200,000 48,000 1,108,000 $ 212,000

Difference

$28,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. Baldwin should consider if it is possible to increase the number of advanced tours sold, or if it is possible to reduce the costs of those tours before dropping them. He could also investigate the possibility of increasing the price of the advanced tours if customers would tolerate it.

11-22

(25 min.)

Theory of constraints, throughput contribution, relevant costs.

1. Finishing is a bottleneck operation. Therefore, producing 1,150 more units will generate additional contribution (throughput) margin and operating income. Increase in contribution (throughput) margin ($75 – $35)  1,150 Incremental costs of the jigs and tools Increase in operating income investing in jigs and tools

$46,000 35,000 $11,000

Denver should invest in the modern jigs and tools because the benefit of higher contribution (throughput) margin of $46,000 exceeds the cost of $35,000. 2. The Machining Department has excess capacity and is not a bottleneck operation. Increasing its capacity further will not increase contribution (throughput) margin. There is, therefore, no benefit from spending $20,000 to increase the Machining Department’s capacity by 9,000 units. Denver should not implement the change to do setups faster. 3. Finishing is a bottleneck operation. Therefore, getting an outside contractor to produce 10,000 units will increase contribution (throughput) margin. Increase in contribution (throughput) margin ($75 – $35)  10,000 Incremental contracting costs $9  10,000 Increase in operating income by contracting 10,000 units of finishing

$400,000 90,000 $310,000

Denver should contract with an outside contractor to do 10,000units of finishing at $9 per unit because the benefit of higher throughput margin of $360,000 exceeds the cost of $90,000. The fact that the cost of $9 per unit is three times Denver’s finishing cost of $3 per unit is irrelevant. 4. Operating costs in the Machining Department of $600,000, or $6 per unit, are fixed costs. Denver will not save any of these costs by subcontracting machining of 5,000 units to Hammond Corporation. Total costs will be greater by $15,000 ($3 per unit  5,000 units) under the subcontracting alternative. Machining more filing cabinets will not increase contribution (throughput) margin, which is constrained by the finishing capacity. Denver should not accept Hammond’s offer. The fact that Hammond’s costs of machining per unit are half of what it costs Denver in-house is irrelevant.

Chapter 11: Decision Making and Relevant Information

5. The cost of 2,000 defective units in the Machining Operation is $35 per unit  2,000 units = $70,000. Because the Machining Operation has a capacity of 120,000 units, it can still produce and transfer 100,000 good units to the Finishing Operation. There is, therefore, no opportunity cost of producing defective units in the Machining Operation. 6. The cost of 2,000 defective units in the Finishing Operation is: Cost of direct materials used in the defective units $35 per unit  2,000 units $ 70,000 Opportunity cost, lost contribution (throughput) margin $40 per unit  2,000 units 80,000 Total cost of defective units in the Finishing Operation $150,000 Alternatively, the cost of 2,000 defective units in the Finishing Operation equals the revenues lost by selling 2,000 fewer units = $75 per unit  2,000 units = $150,000. The cost of the defective unit at a bottleneck operation is much higher than at a non-bottleneck operation because of the opportunity cost of lost contribution margin at the bottleneck operation.

11-23

(10 min.)

Sell or process further.

Xylon should not process the Aardyn further and turn it into Anardyn. The incremental costs of processing further are: The incremental revenues of processing further are: Revenues if processed further ($2.45 × 10,200) Revenues if sold at splitoff point Incremental revenues Net loss

$8,900 (given) $24,990 17,000

7,990 ($ 910)

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

11-24

(30 min.)

Special order, activity-based costing.

1. Direct materials cost per unit ($600,000  10,000 units) = $60 per unit Direct manufacturing labour cost per unit ($700,000  10,000 units) = $70 per unit Variable cost per batch = $1,500 per batch Reward One’s operating income under the alternatives of accepting/rejecting the special order are: Without OneWith OneTime Only Time Only Special Order Special Order 10,000 Units 12,000 Units Revenues Variable costs: Direct materials Direct manufacturing labour Batch manufacturing costs Fixed costs: Fixed manufacturing costs Fixed marketing costs Total costs Operating income 1$600,000 + ($60  2,000 units) 3$150,000 + ($1,500  25 batches)

Difference 2,000 Units

$2,500,000

$2,950,000

$450,000

600,000 700,000 150,000

720,000 2 840,000 3 187,500

120,000 140,000 37,500

250,000 400,000 2,100,000 $ 400,000

250,000 400,000 2,397,500 $ 552,500

–– –– 297,500 $152,500

2$700,000 + ($70  2,000 units)

Chapter 11: Decision Making and Relevant Information

Alternatively, we could calculate the incremental revenue and the incremental costs of the additional 2,000 units as follows: Incremental revenue $225  2,000 Incremental direct manufacturing costs Incremental direct manufacturing costs Incremental batch manufacturing costs Total incremental costs Total incremental operating income from accepting the special order

$ 60  2,000 units $ 70  2,000 units $1,500  25 batches

$450,000 120,000 140,000 37,500 297,500 $152,500

Reward One should accept the one-time-only special order if it has no long-term implications because accepting the order increases Reward One’s operating income by $152,500. If, however, accepting the special order would cause the regular customers to be dissatisfied or to demand lower prices, then Reward One will have to trade off the $152,500 gain from accepting the special order against the operating income it might lose from regular customers. 2. Reward One has a capacity of 11,000 windows. Therefore, if it accepts the special one-time order of 2,000 windows, it can sell only 9,000 windows instead of the 10,000 windows that it currently sells to existing customers. That is, by accepting the special order, Reward One must forgo sales of 1,000 windows to its regular customers. Alternatively, Reward One can reject the special order and continue to sell 10,000 windows to its regular customers. Reward One’ operating income from selling 9,000 windows to regular customers and 2,000 windows under one-time special order follow: Revenues (9,000  $250) + (2,000  $225) Direct materials (9,000  $60) + (2,000  $60) Direct manufacturing labour (9,000  $70) + (2,000  $70) 1 Batch manufacturing costs (90  $1,500) + (25  $1,500) Fixed manufacturing costs Fixed marketing costs Total costs Operating income

$2,700,000 660,000 770,000 172,500 250,000 400,000 2,252,500 $ 447,500

1Reward One makes regular windows in batch sizes of 100. To produce 9,000 windows

requires 90 (9,000 ÷ 100) batches. Accepting the special order will result in an increase in operating income of $47,500 ($447,500 – $400,000). The special order should, therefore, be accepted.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

A more direct approach would be to focus on the incremental effects––the benefits of accepting the special order of 2,000 units versus the costs of selling 1,000 fewer units to regular customers. Increase in operating income from the 2,000-unit special order equals $152,500 (requirement 1). The loss in operating income from selling 1,000 fewer units to regular customers equals: Lost revenue, $250  1,000 Savings in direct materials costs, $60  1,000 Savings in direct manufacturing labour costs, $70  1,000 Savings in batch manufacturing costs, $1,500  10 Operating income lost

$(250,000) 60,000 70,000 15,000 $(105,000)

Accepting the special order will result in an increase in operating income of $47,500 ($152,500 – $105,000). The special order should, therefore, be accepted. Reward One should consider the effect on its regular customers of accepting the special order. For example, would selling 1,000 fewer windows to its regular customers cause these customers to find new suppliers that might adversely impact Reward One’s business in the long run. 3. Reward One should not accept the special order. Increase in operating income by selling 2,000 units under the special order (requirement 1) Operating income lost from existing customers ($20  10,000) Net effect on operating income of accepting special order

$152,500 (200,000) $ (47,500)

The special order should, therefore, be rejected.

11-25

(30 min.)

Make versus buy, activity-based costing.

1. The expected manufacturing cost per unit of CMCBs in 2022 is as follows:

Direct materials, $170  10,000 Direct manufacturing labour, $45  10,000 Variable batch manufacturing costs, $1,500  80 Fixed manufacturing costs Avoidable fixed manufacturing costs Unavoidable fixed manufacturing costs Total manufacturing costs

Total Manufacturing Manufacturing Costs of CMCB Cost per Unit (1) (2) = (1) ÷ 10,000 $1,700,000 $170 450,000 45 120,000 12 320,000 800,000 $3,390,000

32 80 $339

Chapter 11: Decision Making and Relevant Information

2. The following table identifies the incremental costs in 2022 if Svenson (a) made CMCBs and (b) purchased CMCBs from Minton.

Incremental Items Cost of purchasing CMCBs from Minton Direct materials Direct manufacturing labour Variable batch manufacturing costs Avoidable fixed manufacturing costs Total incremental costs Difference in favour of making

Total Incremental Costs Make Buy $3,000,000 $1,700,000 450,000 120,000 320,000 $2,590,000 $3,000,000

Per-Unit Incremental Costs Make Buy $300 $170 45 12 32 $259 $300

$410,000

$41

Note that the opportunity cost of using capacity to make CMCBs is zero because Svenson would keep this capacity idle if it purchases CMCBs from Minton. Svenson should continue to manufacture the CMCBs internally because the incremental costs to manufacture are $259 per unit compared to the $300 per unit that Minton has quoted. Note that the unavoidable fixed manufacturing costs of $800,000 ($80 per unit) will continue to be incurred whether Svenson makes or buys CMCBs. These are not incremental costs under either the make or the buy alternative and, hence, are irrelevant. 3. Svenson should continue to make CMCBs. The simplest way to analyze this problem is to recognize that Svenson would prefer to keep any excess capacity idle rather than use it to make CB3s. Why? Because expected incremental future revenues from CB3s, $2,000,000, are less than expected incremental future costs, $2,150,000. If Svenson keeps its capacity idle, we know from requirement 2 that it should make CMCBs rather than buy them. An important point to note is that, because Svenson forgoes no contribution by not being able to make and sell CB3s, the opportunity cost of using its facilities to make CMCBs is zero. It is, therefore, not forgoing any profits by using the capacity to manufacture CMCBs. If it does not manufacture CMCBs, rather than lose money on CB3s, Svenson will keep capacity idle. A longer and more detailed approach is to use the total alternatives or opportunity cost analyses shown in Exhibit 11-7 of the chapter.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Choices for Svenson Make CMCBs Buy CMCBs and Do Not and Make Make CB3s CB3s, if Profitable

Relevant Items

TOTAL-ALTERNATIVES APPROACH TO MAKE-OR-BUY DECISIONS Total incremental costs of making/buying CMCBs (from requirement 2) Because incremental future costs exceed incremental future revenues from CB3s, Svenson will make zero CB3s even if it buys CMCBs from Minton Total relevant costs

$2,590,000

$3,000,000

0 $2,590,000

0 $3,000,000

Svenson will minimize manufacturing costs and maximize operating income by making CMCBs.

Chapter 11: Decision Making and Relevant Information

OPPORTUNITY-COST APPROACH TO MAKE-OR-BUY DECISIONS Total incremental costs of making/buying CMCBs (from requirement 2) Opportunity cost: profit contribution forgone because capacity will not be used to make CB3s Total relevant costs

$2,590,000

$3,000,000

0* $2,590,000

0 $3,000,000

*Opportunity cost is zero because Svenson does not give up anything by not making CB3s.

Svenson is best off leaving the capacity idle (rather than manufacturing and selling CB3s).

11-26

(25 min.)

Product mix, constrained resource.

1. Selling price Variable costs: Direct materials (DM) Labour and other costs Total variable costs Contribution margin Pounds of DM per unit Contribution margin per lb.

A130 $252

B324 $ 168

C587 $210

72 84 156 $ 96 ÷8 lbs. $ 12 per lb.

45 81 126 $ 42 ÷5 lbs. $8.40 per lb.

27 120 147 $ 63 ÷ 3 lbs. $ 21 per lb.

First, satisfy minimum requirements. Minimum units Times pounds per unit Pounds needed to produce min. units

A130 200 ×8 1,600

B324 200 ×5 1,000

C587 200 ×3 600

Total 3,200 lb.

The remaining 1,800 pounds (5,000 – 3,200) should be devoted to C587 because it has the highest contribution margin per pound of direct material. Because each unit of C587 requires 3 pounds of Brac, the remaining 1,800 pounds can be used to produce another 600 units of C587. The following combination yields the highest contribution margin given the 5,000 pounds constraint on availability of Brac. A130: 200 units B324: 200 units C587: 800 units (200 minimum + 600 extra)

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. The demand for Wechsler’s products exceeds the materials available. Assuming that fixed costs are covered by the original product mix, Wechsler would be willing to pay up to an additional $21 per pound (the contribution margin per pound of C587) for another 1,200 pounds of Brac. That is, Wechsler would be willing to pay $9 + $21 = $30 per pound of Brac for the pounds of Brac that will be used to produce C587.1 If sufficient demand does not exist for 400 units (1,200 pounds ÷ 3 pounds per unit) of C587, then the maximum price Wechsler would be willing to pay is an additional $12 per pound (the contribution margin per pound of A130) for the pounds of Wechsler that will be used to produce A130. In this case Wechsler would be willing to pay $9 + $12 = $21 pound. If all the 1,200 pounds of Brac are not used to satisfy the demand for C587 and A130, then the maximum price Wechsler would be willing to pay is an additional $8.40 per pound (the contribution margin per pound of B324) for the pounds of Brac that will be used to produce B324. Wechsler would be willing to pay $8.40 + $9 = $17.40 per pound of Brac. 1An alternative calculation focuses on column 3 for C587 of the table in requirement 1.

Selling price Variable labour and other costs (excluding direct materials) Contribution margin Divided by pounds of direct material per unit Direct material cost per pound that Wechsler can pay without contribution margin becoming negative

11-27

(20 min.)

$210 120 $ 90 ÷3 lbs. $ 30

Theory of constraints, throughput contribution, and relevant costs.

1. It will cost Washington $500 per unit to reduce manufacturing time. But manufacturing is not a bottleneck operation; installation is. Therefore, manufacturing more equipment will not increase sales and throughput margin. Washington Industries should not implement the new manufacturing method. 2. Increase in throughput margin, $25,000  35 units, Additional relevant costs of new direct materials, $2,000  285 units, Increase/(Decrease) in operating income

$875,000 570,000 $305,000

The additional incremental benefits from higher throughput margin exceed the incremental costs by $305,000, so Washington Industries should implement the new design. Alternatively, compare throughput margin under each alternative. With the modification, throughput margin is $23,000  285 units Current throughput margin is $25,000  250 Increase/(Decrease) in operating income

$6,555,000 6,250,000 $ 305,000

The throughput margin resulting from the proposed change in direct materials is greater than the current throughput margin. Therefore, Washington Industries should implement the new design. Copyright © 2022 Pearson Canada Inc. 11-16

Chapter 11: Decision Making and Relevant Information

3. Increase in throughput margin, $25,000  7 units Increase in relevant costs Increase in operating income

$ 175,000 145,000 $ 30,000

The additional throughput margin exceeds incremental costs by $30,000, so Washington Industries should implement the new installation technique. 4. Motivating installation workers to increase productivity is worthwhile because installation is a bottleneck operation, and any increase in productivity at the bottleneck will increase throughput margin. On the other hand, motivating workers in the manufacturing department to increase productivity is not worthwhile. Manufacturing is not a bottleneck operation, so any increase in output will result only in extra inventory of equipment. Washington Industries should encourage manufacturing to produce only as much equipment as the installation department needs, not to produce as much as it can. Under these circumstances, it would not be a good idea to evaluate and compensate equipment manufacturing workers on the basis of their productivity.

11-28

(10 min.)

Selection of most profitable product.

Only Model 9 should be produced. The key to this problem is the relationship of manufacturing overhead to each product. Note that it takes twice as long to produce Model 9; machine-hours for Model 9 are twice that for Model 14. Management should choose the product mix that maximizes operating income for a given production capacity (the scarce resource in this situation). In this case, despite the fact that model 9 requires twice the number of machine hours to produce each unit, its contribution margin per unit is so great that it still has a higher contribution margin per machine-hour. Model 14 will yield a $29 contribution to fixed costs per machine hour, and Model 9 will yield $40: Model 9 Selling price Variable cost per unit* ($23 + $16 + $18 + $13; $13 + $19 + $9 + $15) Contribution margin per unit Relative use of machine-hours per unit of product Contribution margin per machine hour

Model 14

$150.00

$85.00

70.00 $ 80.00 ÷ 2 $ 40.00

56.00 $29.00 ÷ 1 $29.00

*Variable cost per unit = Direct material cost per unit + Direct manufacturing labour cost per unit + Variable manufacturing cost per unit + Variable marketing cost per unit.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

PROBLEMS 11-29

(15 min.)

Multiple choice.

1. (b) Special order price per unit Variable manufacturing cost per unit Contribution margin per unit

$7.50 5.75 $1.75

Effect on operating income = $1.75  25,000 units = $43,750 increase 2. (b) Costs of purchases for Part No. 498, 10,000 units  $71 Total relevant costs of making part No. 498: Variable manufacturing costs, $3 + $40 + $10 $53 Fixed costs eliminated 11 Costs saved by not making $64 Multiply by 10,000 units, so total costs saved are $64  10,000 Extra costs of purchasing outside Minimum overall savings for Manchester Necessary relevant costs that would have to be saved in manufacturing Part No. 575

$710,000

640,000 70,000 45,000 $115,000

Before outsourcing to Remnant, Manchester must consider the consequence of increasing its dependence on Remnant. Manchester would want to be sure about the quality of Remnant’s product and the reliability of its delivery schedules over a long-run period. Manchester would also want Remnant to continuously reduce costs. To achieve all these goals, Manchester may want to build close partnerships and alliances with Remnant.

Chapter 11: Decision Making and Relevant Information

11-30 (20–25 min.)

Relevant costs, contribution margin, product emphasis.

1. Cola $18.80 14.20 $ 4.60

Selling price Deduct variable cost per case Contribution margin per case

Lemonade $20.00 16.10 $ 3.90

Punch $27.10 20.70 $ 6.40

Natural Orange Juice $39.20 30.20 $ 9.00

2. The argument fails to recognize that shelf space is the constraining factor. There are only 12 feet of front shelf space to be devoted to drinks. Sexton should aim to get the highest daily contribution margin per foot of front shelf space:

Contribution margin per case Sales (number of cases) per foot of shelf space per day Daily contribution per foot of front shelf space

Cola 4.60

Lemonade $ 3.90

Punch $ 6.40

Natural Orange Juice $ 9.00

 25

 24

 4

 5

$115.00

$93.60

$25.60

$45.00

3. The allocation that maximizes the daily contribution from soft drink sales is: Feet of Shelf Space Cola Lemonade Natural Orange Juice Punch

6 4 1 1

Daily Contribution per Foot of Total Contribution Front Shelf Space Margin per Day $115.00 $ 690.00 93.60 374.40 45.00 45.00 25.60 25.60 $1,135.00

The maximum of six feet of front shelf space will be devoted to Cola because it has the highest contribution margin per unit of the constraining factor. Four feet of front shelf space will be devoted to Lemonade, which has the second highest contribution margin per unit of the constraining factor. No more shelf space can be devoted to Lemonade since each of the remaining two products, Natural Orange Juice and Punch (that have the second lowest and lowest contribution margins per unit of the constraining factor) must each be given at least one foot of front shelf space.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

11-31

(30–40 min.)

Optimal product mix.

1. Let D represent the batches of Della’s Delight made and sold. Let B represent the batches of Bonny’s Bourbon made and sold. The contribution margin per batch of Della’s Delight is $300. The contribution margin per batch of Bonny’s Bourbon is $250. The LP formulation for the decision is: Maximize Subject to

$300D + $250 B 30D + 15B  660 (Mixing Department constraint) 15B  270 (Filling Department constraint) 10D + 15B  300 (Baking Department constraint)

2. Solution Exhibit presents a graphical summary of the relationships. The optimal corner is the point (18, 8) i.e., 18 batches of Della’s Delights and 8 batches of Bonny’s Bourbons.

Chapter 11: Decision Making and Relevant Information

SOLUTION EXHIBIT Graphic Solution to Find Optimal Mix, Della Simpson, Inc. Della Simpson Production Model 50

0, 44 45

B (batches of Bonny's Bourbons)

Mixing Dept. Constraint 40

Equal Contribution Margin Lines

Optimal Corner (18,8) 25

3, 18

Filling Dept. Constraint

0, 18

Feasible Region

Baking Dept. Constraint

22, 0

0 0

D (batches of Della's Delight)

We next calculate the optimal production mix using the trial-and-error method. The corner point where the Mixing Dept. and Baking Dept. constraints intersect can be calculated as (18, 8) by solving: 30D + 15B = 660 (1) Mixing Dept. constraint 10D + 15B = 300 (2) Baking Dept. constraint Subtracting (2) from (1), we have 20D = 360 or D = 18 Substituting in (2) (10  18) + 15B = 300 that is, 15B = 300  180 = 120 or B = 8

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

The corner point where the Filling and Baking Department constraints intersect can be calculated as (3,18) by substituting B = 18 (Filling Department constraint) into the Baking Department constraint: 10 D + (15 × 18) = 300 10 D = 300  270 = 30 D= 3 The feasible region, defined by five corner points, is shaded in Solution Exhibit 11-33. We next use the trial-and-error method to check the contribution margins at each of the five corner points of the area of feasible solutions. Trial 1 2 3 4 5

Corner (D,B) (0,0) (22,0) (18,8) (3,18) (0,18)

Total Contribution Margin ($300  0) + ($250  0) = $0 ($300  22) + ($250  0) = $6,600 ($300  18) + ($250  8) = $7,400 ($300  3) + ($250  18) = $5,400 ($300  0) + ($250  18) = $4,500

The optimal solution that maximizes contribution margin and operating income is 18 batches of Della’s Delights and 8 batches of Bonny’s Bourbons.

11-32

(30–40 min.)

Optimal product mix.

1. Let S represent the batches of Sarah’s Special made and sold. Let R represent the batches of Rose’s Ruby made and sold. The contribution margin per batch of Sarah’s Special is $600. The contribution margin per batch of Rose’s Ruby is $500. The LP formulation for the decision is: Maximize $600S + $500R Subject to 60S + 30R  1,320 (Mixing Department constraint) 30R  540 (Filling Department constraint) 20S + 30R  600 (Baking Department constraint)

Chapter 11: Decision Making and Relevant Information

2. Step 1 - In Excel, create the following table as per the instructions in Appendix 11B: Descriptions Contribution Margin Data and constraints: Mixing Mixing constraint Filling Filling constraint Baking Baking constraint Volume

S 600.00

R 500.00

60.00 0.00

20.00 0.00

30.00 0.00 30.00 0.00 30.00 0.00

Total CM

0.00

Total

Constraints

0.00

1,320.00

0.00

540.00

0.00

600.00

0.00

Note: Make sure you have built the appropriate formulas. For example, all the 0.00s are formulas. Step – 2 - Determine the optimal solution using Solver. Instructions on how to use Solver are in Appendix 11B. Descriptions Contribution Margin Data and constraints: Mixing Mixing constraint Filling Filling constraint Baking Baking constraint Volume Total CM

S 600.00

R 500.00

60.00 1,080.00

20.00 360.00 18.00

30.00 240.00 30.00 240.00 30.00 240.00 8.00

10,800.00

4,000.00

Total

Constraints

1,320.00

240.00

540.00

600.00

14,800.00

The optimal solution that maximizes contribution margin and operating income is 18 batches of Sarah’s Special and 8 batches of Rose’s Ruby.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

11-33

(20 min.)

Opportunity costs.

1. The opportunity cost to Wild Orchid of producing the 3,500 units of Stronglast is the contribution margin lost on the 3,500 units of Everlast that would have to be forgone, as computed below: Selling price Variable costs per unit: Direct materials Direct manufacturing labour Variable manufacturing overhead Variable marketing costs Contribution margin per unit

24 28

$10 2 8 4

Contribution margin for 3,500 units ($28  3,500 units)

$98,000

The opportunity cost is $98,000. Opportunity cost is the maximum contribution to operating income that is forgone (rejected) by not using a limited resource in its next-best alternative use. 2. Contribution margin from manufacturing 3,500 units of Stronglast and purchasing 3,500 units of Everlast from Chesapeake is $105,000, as follows: Manufacture Stronglast Selling price Variable costs per unit: Purchase costs Direct materials Direct manufacturing labour Variable manufacturing costs Variable marketing costs Variable costs per unit Contribution margin per unit Contribution margin from selling 3,500 units of Stronglast and 3,500 units of Everlast ($18  3,500 units; $12  3,500 units)

– 10 2 8 $

Purchase Everlast $

Total

2 22 18

$63,000

4 40 12

$42,000

$105,000

As calculated in requirement 1, Wild Orchid’s contribution margin from continuing to manufacture 3,500 units of Everlast is $98,000. Accepting the Apex Company and Chesapeake offer will benefit Wild Orchid by $7,000 ($105,000 – $98,000). Hence, Wild Orchid should accept the Apex Company and Chesapeake Corporation’s offers.

Chapter 11: Decision Making and Relevant Information

3. The minimum price would be any price greater than $22, the sum of the incremental costs of manufacturing and marketing Stronglast as computed in requirement 2. This follows because, if Wild Orchid has surplus capacity, the opportunity cost = $0. For the short-run decision of whether to accept Apex’s offer, fixed costs of Wild Orchid are irrelevant. Only the incremental costs need to be covered for it to be worthwhile for Wild Orchid to accept the Apex offer.

11-34

(20 min.)

Choosing customers.

If Newbury accepts the additional business from Kimberly, it would take an additional 800 machine-hours. If Newbury accepts all of Kimberly’s and Wallace’s business for February, it would require 4,000 machine-hours (2,400 hours for Wallace and 1,600 hours for Kimberly). Newbury has only 3,200 hours of machine capacity. It must, therefore, choose how much of the Wallace or Kimberly business to accept. To maximize operating income, Newbury should maximize contribution margin per unit of the constrained resource. (Fixed costs will remain unchanged at $125,000 regardless of the business Newbury chooses to accept in February and are, therefore, irrelevant.) The contribution margin per unit of the constrained resource for each customer in January is:

Contribution margin per machine-hour

Wallace Kimberly Corporation Corporation $110,400 $48, 000 = $46 = $60 2,400 800

Because the $160,000 of additional Kimberly business in February is identical to jobs done in January, it will also have a contribution margin of $60 per machine-hour, which is greater than the contribution margin of $46 per machine-hour from Wallace. To maximize operating income, Newbury should first allocate all the capacity needed to take the Kimberly Corporation business (1,600 machine-hours) and then allocate the remaining 1,600 (3,200 – 1,600) machine-hours to Wallace.

Contribution margin per machine-hour Machine-hours to be worked Contribution margin Fixed costs Operating income

Wallace Corporation $46  1,600 $73,600

Kimberly Corporation $60  1,600 $96,000

Total $169,600 125,000 $ 44,600

An alternative approach is to use the opportunity cost approach. The opportunity cost of giving up 800 machine-hours for the Wallace Corporation jobs is the contribution margin forgone of $46 per machine-hour  800 machine-hours equal to $36,800. The contribution margin gained from using the 800 machine-hours for the Kimberly Corporation business is the contribution margin per machine-hour of $60  800 machine-hours equal to $48,000.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

The net benefit is: Contribution margin from Kimberly Corporation business Less: Opportunity cost (of giving up Wallace Corporation business) Net benefit

$48,000 (36,800) $11,200

Although taking the Kimberly Corporation business over the Wallace Corporation business will maximize Newbury’s profits in the short run, Newbury’s managers must also consider the longrun effects of this decision. Will Kimberly Corporation continue to demand the same level of business going forward? Will turning down the Wallace business affect customer satisfaction? If Newbury turns down the Wallace business, will Wallace continue to place orders with Newbury or seek alternative suppliers? Newbury’s managers need to consider these long-run effects and then decide whether it should accept Kimberly’s business at the cost of Wallace’s. In other words, choosing customers is a strategic decision. If it sees long-run benefit in working with Wallace, Newbury’s managers must also look for ways to increase the profitability of the business it does with Wallace by increasing prices or reducing costs.

11-35 (30–40 min.) Reduce conflict. Make or buy, unknown level of volume. 1. The variable costs required to manufacture 150,000 starter assemblies are Direct materials Direct manufacturing labour Variable manufacturing overhead Total variable costs

$400,000 300,000 200,000 $900,000

The variable costs per unit are $900,000 ÷ 150,000 = $6.00 per unit. Let X = number of starter assemblies required in the next 12 months. The data can be presented in both “all data” and “relevant data” formats:

Variable manufacturing costs Fixed general manufacturing overhead Fixed overhead, avoidable Division 2 manager’s salary Division 3 manager’s salary Purchase cost, if bought from Tutwiler Electronics Total costs

All Data Relevant Data Alternative Alternative Alternative Alternative 1: 2: 1: 2: Buy Make Buy Make $ 6X – $ 6X – 300,000 $300,000 – – 200,000 – 200,000 – 80,000 100,000 80,000 $100,000 100,000 – 100,000 – – $680,000 + $ 6X

8X $400,000 + $ 8X

– $380,000 + $ 6X

8X $100,000 + $ 8X

Chapter 11: Decision Making and Relevant Information

The number of units at which the costs of make and buy are equivalent is All data analysis:

$680,000 + $6X = $400,000 + $8X 2X = 280,000 X = 140,000

or Relevant data analysis:

$380,000 + $6X = $100,000 + $8X 2X = 280,000 X = 140,000 Assuming cost minimization is the objective, then  If production is expected to be less than 140,000 units, it is preferable to buy units from Tutwiler.  If production is expected to exceed 140,000 units, it is preferable to manufacture internally (make) the units.  If production is expected to be 140,000 units, Denver should be indifferent between buying units from Tutwiler and manufacturing (making) the units internally. 2. The information on the storage cost, which is avoidable if self-manufacture is discontinued, is relevant; these storage charges represent current outlays that are avoidable if selfmanufacture is discontinued. Assume these $100,000 charges are represented as an opportunity cost of the make alternative. The costs of internal manufacture that incorporate this $100,000 opportunity cost are All data analysis: Relevant data analysis:

$780,000 + $6X $480,000 + $6X

Alternatively stated, we would add the following line to the table shown in requirement 1 causing the total costs line to change as follows: All Data Alternative 1: Alternative 2: Make Buy Outside storage charges Total costs

Relevant Data Alternative 1: Alternative 2: Make Buy

$100,000

$780,0001 + 6X

$400,000 + 8X

$480,0002 + 6X

$100,000 + 8X

1$780,000 = $680,000 + $100,000

2$480,000 = $380,000 + $100,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

The number of units at which the costs of make and buy are equivalent is All data analysis:

$780,000 + $6X = $400,000 + $8X 2X = 380,000 X = 190,000

Relevant data analysis:

$480,000 + $6X = $100,000 + $8X 2X = 380,000 X = 190,000

If production is expected to be less than 190,000, it is preferable to buy units from Tutwiler. If production is expected to exceed 190,000, it is preferable to manufacture the units internally.

11-36

(30 min.)

Equipment upgrade versus replacement.

1. Based on the analysis in the table below, TechMech will be better off by $180,000 over three years if it replaces the current equipment. Over 3 years Comparing Relevant Costs of Upgrade and Replace Alternatives Cash operating costs $140; $80 per desk × 6,000 desks per yr. × 3 yrs. Current disposal price One time capital costs, written off periodically as depreciation Total relevant costs

Upgrade (1)

Replace (2)

Difference in favour of Replace (3) = (1) – (2)

$2,520,000

$1,440,000 (600,000)

$1,080,000 600,000

2,700,000 $ 5,220,000

4,200,000 $5,040,000

(1,500,000) $ 180,000

Note that the book value of the current machine ($900,000) would either be written off as depreciation over three years under the upgrade option, or, all at once in the current year under the replace option. Its net effect would be the same in both alternatives: to increase costs by $900,000 over three years, hence it is irrelevant in this analysis. 2. Suppose the capital expenditure to replace the equipment is $X. From requirement 1, column (2), substituting for the one-time capital cost of replacement, the relevant cost of replacing is $1,440,000 – $600,000 + $X. From column (1), the relevant cost of upgrading is $5,220,000. We want to find X such that $1,440,000 – $600,000 + $X < $5,220,000 (i.e., TechMech will favour replacing). Solving the above inequality gives us X < $5,220,000 – $840,000 = $4,380,000. TechMech would prefer to replace, rather than upgrade, if the replacement cost of the new equipment does not exceed $4,380,000. Note that this result can also be obtained by taking the original replacement cost of $4,200,000 and adding to it the $180,000 difference in favour of replacement calculated in requirement 1.

Chapter 11: Decision Making and Relevant Information

3. Suppose the units produced and sold over 3 years equal y. Using data from requirement 1, column (1), the relevant cost of upgrade would be $140y + $2,700,000, and from column (2), the relevant cost of replacing the equipment would be $80y – $600,000 + $4,200,000. TechMech would want to upgrade if $140y + $2,700,000 < $80y – $600,000 + $4,200,000 $60y < $900,000 y < $900,000 ÷ $60 = 15,000 units or upgrade when y < 15,000 units (or 5,000 per year for 3 years) and replace when y > 15,000 units over 3 years. When production and sales volume is low (less than 5,000 per year), the higher operating costs under the upgrade option are more than offset by the savings in capital costs from upgrading. When production and sales volume is high, the higher capital costs of replacement are more than offset by the savings in operating costs in the replace option. 4. Operating income for the first year under the upgrade and replace alternatives are shown below:

Revenues (6,000 × $500) Cash operating costs $140; $80 per desk × 6,000 desks per year Depreciation ($900,000a + $2,700,000) ÷ 3; $4,200,000 ÷ 3 Loss on disposal of old equipment (0; $900,000 – $600,000) Total costs Operating income

Year 1 Upgrade Replace (1) (2) $3,000,000 $3,000,000 840,000 480,000 1,200,000 1,400,000 0 300,000 2,040,000 2,180,000 $ 960,000 $ 820,000

aThe book value of the current production equipment is

$1,500,000 × 3 ÷ 5 = $900,000; it has a remaining useful life of 3 years. First-year operating income is higher by $140,000 under the upgrade alternative, and Dan Doria, with his one-year horizon and operating income-based bonus, will choose the upgrade alternative, even though, as seen in requirement 1, the replace alternative is better in the long run for TechMech. This exercise illustrates the possible conflict between the decision model and the performance evaluation model.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

11-37

(30–40 min.) Product mix, special order.

1. A6 Selling price Variable manufacturing cost per unit Variable marketing cost per unit Total variable costs per unit Contribution margin per unit Contribution margin per hour of the constrained resource Total contribution margin from selling only A6 or only EX4 A6: $50/hr.  50,000 hrs.; EX4: $60/hr.  50,000 hrs. Less Lease costs of high-precision machine to produce and sell EX4 Net relevant benefit

180 110 20 130 50

EX4 $

280 190 60 250 30

$ $50 = $50 1

$ $30 = $60 0.5

$2,500,000

$3,000,000

0 $2,500,000

600,000 $2,400,000

Even though EX4 has the higher contribution margin per unit of the constrained resource, the fact that Gormley must incur additional costs of $600,000 to achieve this higher contribution margin means that Gormley is better off using its entire 50,000-hour capacity on the regular machine to produce and sell 50,000 units (50,000 hours  1 hour per unit) of A6. The additional contribution from selling EX4 rather than A6 is $500,000 ($3,000,000  $2,500,000), which is not enough to cover the additional costs of leasing the high-precision machine. Note that, because all other overhead costs are fixed and cannot be changed, they are irrelevant for the decision. Gormley produces 50,000 units of A6, which increases operating income by $2,500,000. 2. If capacity of the regular machines is increased by 15,000 machine-hours to 65,000 machinehours (50,000 originally + 15,000 new), the net relevant benefit from producing A6 and EX4 is as follows: A6 EX4 Total contribution margin from selling only A6 or only EX4 A6: $50  65,000; EX4: $60  65,000 Less Lease costs of high-precision machine that would be incurred if EX4 is produced and sold Less Cost of increasing capacity by 15,000 hours on regular machine Net relevant benefit

$3,250,000

$3,900,000 600,000

300,000 $2,950,000

300,000 $3,000,000

Chapter 11: Decision Making and Relevant Information

Investing in the additional capacity increases Gormley’s operating income by $500,000 ($3,000,000 calculated in requirement 2 minus $2,500,000 calculated in requirement 1), so Gormley should add 15,000 hours to the regular machine. With the extra capacity available to it, Gormley should use its entire capacity to produce EX4. Using all 65,000 hours of capacity to produce EX4 rather than to produce A6 generates additional contribution margin of $650,000 ($3,900,000  $3,250,000), which is more than the additional cost of $600,000 to lease the high-precision machine. Gormley should therefore produce and sell 130,000 units of EX4 (65,000 hours  0.5 hours per unit of EX4) and zero units of A6. 3. Selling price Variable manufacturing costs per unit Variable marketing costs per unit Total variable costs per unit Contribution margin per unit

EX4

$180 110 20 130 $ 50

$280 190 60 250 $ 30

$240 130 20 150 $ 90

$50 $30 $90 = $50; = $60; = $90 1 0.5 1 The first step is to compare the operating profits that Gormley could earn if it accepted the Clark Corporation offer for 20,000 units with the operating profits Gormley is currently earning. V2 has the highest contribution margin per hour on the regular machine and requires no additional investment such as leasing a high-precision machine. To produce the 20,000 units of V2 requested by Clark Corporation, Gormley would require 20,000 hours on the regular machine resulting in contribution margin of $90  20,000 = $1,800,000. Gormley now has 45,000 hours available on the regular machine to produce A6 or EX4.

Contribution margin per unit of the constrained resource

Total contribution margin from selling only A6 or only EX4 A6: $50  45,000; EX4: $60  45,000 Less Lease costs of high-precision machine to produce and sell EX4 Net relevant benefit

EX4

$2,250,000

$2,700,000

 $2,250,000

600,000 $2,100,000

Gormley should use all the 45,000 hours of available capacity to produce 45,000 units of A6. Thus, the product mix that maximizes operating income is 20,000 units of V2, 45,000 units of A6, and zero units of EX4. This optimal mix results in a contribution margin of $4,050,000 ($1,800,000 from V2 and $2,250,000 from A6). Relative to requirement 2, operating income increases by $1,050,000 ($4,050,000 minus $3,000,000 calculated in requirement 2). Hence, Gormley should accept the Clark Corporation business and supply 20,000 units of V2.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

11-38

(30 min.)

Relevant costs, opportunity costs.

1. Easyspread 2.0 has a higher relevant operating income than Easyspread 1.0. Based on this analysis, Easyspread 2.0 should be introduced immediately: Relevant revenues Relevant costs: Manuals, diskettes, compact discs Total relevant costs Relevant operating income

Easyspread 1.0 $165

Easyspread 2.0 $215

$ 0

$38 0 $165

38 $177

Reasons for other cost items being irrelevant are Easyspread 1.0  Manuals, diskettes—already incurred  Development costs—already incurred  Marketing and administrative—fixed costs of period Easyspread 2.0 • Development costs—already incurred • Marketing and administration—fixed costs of period Note that total marketing and administration costs will not change whether Easyspread 2.0 is introduced on July 1, 2021, or on October 1, 2021. 2. Other factors to be considered: a. Customer satisfaction. If 2.0 is significantly better than 1.0 for its customers, a customerdriven organization would immediately introduce it unless other factors offset this bias toward “do what is best for the customer.” b. Quality level of Easyspread 2.0. It is critical for new software products to be fully debugged. Easyspread 2.0 must be error-free. Consider an immediate release only if 2.0 passes all quality tests and can be supported fully by the salesforce. c. Importance of being perceived to be a market leader. Being first in the market with a new product can give Oregano Software a “first-mover advantage,” e.g., capturing an initial large share of the market that, in itself, causes future potential customers to lean toward purchasing Easyspread 2.0. Moreover, by introducing 2.0 earlier, Oregano can get quick feedback from users about ways to further refine the software while its competitors are still working on their own first versions. Moreover, by locking in early customers, Oregano may increase the likelihood of these customers also buying future upgrades of Easyspread 2.0. d. Morale of developers. These are key people at Oregano Software. Delaying introduction of a new product can hurt their morale, especially if a competitor then preempts Oregano from being viewed as a market leader.

Chapter 11: Decision Making and Relevant Information

11-39 (15–20 min.) Product Mix. Short-run pricing, capacity constraints. 1. Per pair of shorts: Fabric (3 yards × $12 per yard) Variable direct manufacturing labour Variable manufacturing overhead Fixed manufacturing cost allocated Total manufacturing cost

$36 10 4 9 $59

If Fashion Fabrics can get all the fabric it needs and has sufficient production capacity, then the minimum price it should charge per pair of shorts is the variable cost per pair of shorts = $36 + $10 + $4 = $50 per pair of shorts. 2. If the fabric is in short supply, then the fabric used for 2 shorts displaces 1 pant (6 yards of fabric per pant versus 3 yards of fabric per short). We calculate the contribution margin per pair of pants = Selling price – Variable costs = $142 − $100a = $42 aDirect materials, $72 + Variable direct manufacturing labour, $20 + Variable manufacturing

overhead, $8 Pants require 6 yards of fabric so the contribution margin per unit of the constrained resource is $42 ÷ 6 yards = $7 per yard The minimum price Fashion Fabrics should charge for a pair of shorts is the variable cost per pair of shorts plus the contribution margin from 3 yards of fabric, or, $50 + (3 × $7 per yard) = $71 per pair of shorts That is, if fabric is in short supply, Fashion Fabrics should not agree to produce any shorts unless the buyer is willing to pay at least $71 per pair of shorts. Another way to calculate the opportunity cost of producing a pair of shorts is to recognize that every time Fashion Fabrics uses fabric to produce a pair of shorts, it gives up the opportunity to produce 0.5 pants. So, Opportunity cost of a pair of shorts = 0.5 × Contribution margin from producing a pair of pants = 0.5 × $42 = $21. The minimum price Fashion Fabrics should charge for a pair of shorts is the variable cost per pair of shorts plus the opportunity cost of not producing 0.5 pants = $50 + $21 = $71.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

11-40

(20 min.)

Special order, short-run pricing

1. Revenues from special order ($21 × 10,000 bats) Variable manufacturing costs ($201 × 10,000 bats) Increase in operating income if Home Run order accepted

$210,000 (200,000) $ 10,000

1Direct

materials cost per unit + Direct manufacturing labour cost per unit + Variable manufacturing overhead cost per unit = $14 + $4 + $2 = $20 Diamond should accept Home Run’s special order because it increases operating income by $10,000. Because no variable selling costs will be incurred on this order, this cost is irrelevant. Similarly, fixed costs are irrelevant because they will be incurred regardless of the decision. 2a. Revenues from special order ($21 × 10,000 bats) Variable manufacturing costs ($20 × 10,000 bats) Contribution margin foregone ([$37 ─ $221] × 10,000 bats) Decrease in operating income if Home Run order accepted

$ 210,000 (200,000) (150,000) $(140,000)

1Direct materials cost per unit + Direct manufacturing labour cost per unit + Variable manufacturing

overhead cost per unit + Variable selling expense per unit = $14 + $4 + $2 + $2 = $22 Based strictly on financial considerations, Diamond should reject Home Run’s special order because it results in a $140,000 reduction in operating income. 2b. Diamond will be indifferent between the special order and continuing to sell to regular customers if the special order price is $35. At this price, Diamond recoups the variable manufacturing costs of $200,000 and the contribution margin given up from regular customers of $150,000 ([$200,000 + $150,000] ÷ 10,000 units = $35). That is, at the special order price of $35, Diamond recoups the variable cost per unit of $20 and the contribution margin per unit given up from regular customers of $15 per unit. An alternative approach is to recognize that Diamond needs to earn $140,000 more than the revenues of $210,000 in requirement 2a, so that the decrease in operating income of $140,000 becomes $0. Diamond will be indifferent between the special order and continuing to sell to regular customers if revenues from the special order = $210,000 + $140,000 = $350,000 or $35 per bat ($350,000  10,000 bats) Looked at a different way, Diamond needs to earn the full price of $37 less the $2 saved on variable selling costs. 2c. Diamond may be willing to accept a loss on this special order if the possibility of future long-term sales seem likely at a higher price. Moreover, Diamond should also consider the negative long-term effect on customer relationships of not selling to existing customers. Diamond cannot afford to sell bats to customers at the special order price for the long term because the $21 price is less than the full manufacturing cost of the product of $25. This means that in the long term, the contribution margin earned will not cover the fixed costs and result in a loss. Diamond will then be better off shutting down.

Chapter 11: Decision Making and Relevant Information

11-41 (60 min.) Linear programming. 1. Solver Worksheet Contribution Margin Hours Hours - S1 Hours - S2 Hours - S3 Shoes Jackets Volume Total CM

S1S

S1J

S2S

S2J

S3S

S3J

164.50 4.50 36.00

222.50 7.50 0.00

159.00 4.00

219.00 6.50

196.00 4.50

308.00 6.00

36.00

8.00 1,316

0.00 0

0.00

9.00 1,431

0.00 0

0.00

36.00

0.00 0

6.00 1,848

Total

Constraints

36.00 36.00 36.00 17.00 6.00

36.00 36.00 36.00 12.00 4.00

4,595

2. S1 – 8 pairs of shoes. The weekly contribution margin from S1 will equal $1,316. 3. The new value is $4,754; an increase of $159 from the original value of $4,595. One additional pair of shoes will be made by S2. Hint: Re-run your solver with the revised constraint adjustment to determine the new values. 4. The new value is $4,525; a decrease of $70 from the original value of $4,595. Two additional pairs of shoes will be made; however, 1.5 jackets will not be made by S3. Hint: Re-run your solver with the new condition added in to determine the new values. 5. Seamstress S3 labour cost for jackets (as a percentage of the selling price) is really low compared to seamstresses S1 and S2, creating a very high jacket cm. Details related to this data are below: Data:

S1S

S1J

S2S

S2J

S3S

S3J

Selling Price Variable Costs: Labour Sales Commission Material Contribution Margin

400.0

800.0

400.0

800.0

400.0

800.0

130.5 80.0 25.0 164.5

217.5 160.0 200.0 222.5

136.0 80.0 25.0 159.0

221.0 160.0 200.0 219.0

99.0 80.0 25.0 196.0

132.0 160.0 200.0 308.0

33%

27%

34%

28%

25%

17%

Labour cost per selling price

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

11-42 (60 min.)

Linear programming.

1. Max Objective Constraints: Direct labour - machining Direct labour - assembly Contract - S Contract - D Contract - T Customer - T Non-negativity

Selling Price Variable Costs: Direct labour Direct material Variable OH Contribution Margin (CM)

490S + 300D + 220T 3S + 2D + 1T <= 340 3S + 2D + 1T <= 320 S >= 15 D >= 45 T >= 80 T <= 150 S, D, T >= 0 S

1,100.00

775.00

450.00

240.00 320.00 50.00

160.00 250.00 65.00

80.00 75.00 75.00

490.00

300.00

220.00

Chapter 11: Decision Making and Relevant Information

2. S

490.00

300.00

220.00

CM Constraints: Labour - machining Labour - assembly Labour - machining Labour - assembly Product S Product D Product T Product T Volume Total CM

3.00 3.00 80.00 80.00

2.00 2.00 90.00 90.00

1.00 1.00 150.00 150.00

26.67 13,066.67

45.00 13,500.00

150.00 33,000.00

Total CM Fixed Costs Operating Income

59,566.67 (45,000.00) 14,566.67

Total

Constraints

Slack 320.00 320.00 26.67 45.00 150.00 150.00

340.00 320.00 15.00 45.00 80.00 150.00

59,566.67

3. No, unable to utilize. Why? Assembly labour maxed out. Need to reallocate labour to assembly department. 4. CM Labour hours CM/Labour hours

S 490.00 6.00 81.67

D 300.00 4.00 75.00

T 220.00 2.00 110.00

Priority

2nd

3rd

1st

0.00

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

COLLABORATIVE LEARNING CASES 11-43 (30 min.) Make versus buy, governance. 1. Direct materials per unit = $195,000 ÷ 30,000 = 6.50 Direct manufacturing labour per unit = $120,000 ÷ 30,000 = $4 Variable manufacturing overhead for 30,000 units = 40% of $225,000 = $90,000 Variable manufacturing overhead as a percentage of direct manufacturing labour = $90,000 ÷ $120,000 = 75% Fixed manufacturing overhead = 60% of $225,000 = $135,000 SOLUTION EXHIBIT A

Purchasing costs ($17.30/unit × 32,000 units) Direct materials ($6.50/unit × 30,000; 32,000 units) Direct manufacturing labour ($4/unit × 30,000; 32,000 units) Plant space rental (or penalty to terminate) Equipment leasing (or penalty to terminate) Variable overhead (75% of direct manufacturing labour) Fixed manufacturing overhead Total manufacturing or purchasing costs

Manuf. Costs for 30,000 Units (1)

Manuf. Costs for 32,000 Units with Porter Estimates (2)

$195,000 120,000 84,000 36,000 90,000 135,000 $660,000

$208,000 128,000 84,000 36,000 96,000 135,000 $687,000

Purchase Costs for 32,000 Units with Porter Estimates (3) $553,600 10,000 5,000 135,000 $703,600

On the basis of Porter’s estimates, Solution Exhibit A suggests that in 2023, the cost to purchase 32,000 units of MTR-2000 will be $703,600, which is greater than the estimated $687,000 costs to manufacture MTR-2000 in-house. Based solely on these financial results, the 32,000 units of MTR-2000 for 2023 should be manufactured in-house.

Chapter 11: Decision Making and Relevant Information

SOLUTION EXHIBIT B Manufacturing Costs for 32,000 Units w/ Hardt Estimates (4) Purchasing costs ($17.30/unit × 32,000 units) Direct materials ($208,000 × 1.08) Direct manufacturing labour ($128,000 × 1.05) Plant space rental (or penalty to terminate) Equipment leasing (or penalty to terminate) Variable overhead (75% of direct mfg. labour) Fixed manufacturing overhead Total manufacturing or purchasing costs

Purchase Costs for 32,000 Units w/ Hardt Estimates (5) $553,600

$224,640 134,400 84,000 36,000 100,800 135,000 $714,840

10,000 3,000 135,000 $701,600

Based solely on the financial results shown in Solution Exhibit B, Hardt’s estimates suggest that the 32,000 units of MTR-2000 should be purchased from Marley. The total cost from Marley would be $701,600, or $13,240 less than if the units were made by Paibec. 2. At least four other factors that Paibec Corporation should consider before agreeing to purchase MTR-2000 from Marley Company include the following:  In future years, Paibec will not incur the rental and lease contract termination costs on its annual contacts that it will incur in 2023. This will make the purchase option even more attractive, in a financial sense. But then, Marley’s own longevity, its ability to provide the required units of MTR-2000, and its demanded price should be considered, since terminating the contracts may make the make-versus-buy decision a long-term one for Paibec.  The quality of the Marley component should be equal to, or better than, the quality of the internally made component. Otherwise, the quality of the final product might be compromised and Paibec’s reputation affected.  Marley’s reliability as an on-time supplier is important, since late deliveries could hamper Paibec’s production schedule and delivery dates for the final product.  Layoffs may result if the component is outsourced to Marley. This could impact Paibec’s other employees and cause labour problems or affect the company’s position in the community. In addition, there may be labour termination costs, which have not been factored into the analysis.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. Referring to “Standards of Ethical Conduct for Management Accountants,” Lynn Hardt would consider the request of John Porter to be unethical for the following reasons: 1. Prepare complete and clear reports and recommendations after appropriate analysis of relevant and reliable information. Adjusting cost numbers violates the competence standard. 2. Refrain from either actively or passively subverting the attainment of the organization’s legitimate and ethical objectives. Paibec has a legitimate objective of trying to obtain the component at the lowest cost possible, regardless of whether it is manufactured internally or outsourced to Marley. 2. Communication of unfavourable as well as favourable information and professional judgments or opinions. Hardt needs to communicate the proper and accurate results of the analysis, regardless of whether or not it favours internal production. 3. Refrain from engaging in or supporting any activity that would discredit the profession. Falsifying the analysis would discredit Hardt and the profession. 4. Communicate of information fairly and objectively. Hardt needs to perform an objective make-versus-buy analysis and communicate the results fairly. 5. Disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations presented. Hardt needs to fully disclose the analysis and the expected cost increases. Hardt should indicate to Porter that the costs she has derived under the make alternative are correct. If Porter still insists on making the changes to lower the costs of making MTR-2000 internally, Hardt should raise the matter with Porter’s superior, after informing Porter of her plans. If, after taking all these steps, there is a continued pressure to understate the costs, Hardt should consider resigning from the company, rather than engage in unethical conduct.

Chapter 11: Decision Making and Relevant Information

11-44 (30–40 min.) Relevance, short-term. 1. Hernandez Corporation has already purchased the 10,000 kilograms of the special cement that it needs, so it will incur no incremental costs. Alternatively stated, the costs of materials are past (sunk) costs. If Hernandez obtained Contract No. 2 a month from now, it would cost $25,000 in substitute material (10,000 kilograms  $2.50 per kilogram). There is, therefore, a cost (lost benefit) of $25,000 by using the special cement on Contract No. 1 now. Alternatively, Hernandez could sell the special cement immediately for $16,000. The opportunity cost that Hernandez should use is the benefit it would get in the next-best alternative should it not use the cement in Contract No. 1. The greater of these two benefits is using the cement in Contract No. 2. The opportunity cost is $25,000. The relevant cost that Gomez should use when bidding on Contract No. 1 is: Incremental cost Plus opportunity cost Relevant cost

$ 0 25,000 $25,000

2. As in Question 1, the incremental costs of acquiring the special cement for use on Contract No. 1 are zero because Hernandez has already purchased the material. If Hernandez does not land Contract No. 2, the opportunity cost of using the special cement for Contract No. 1 is $15,000 (10,000 kilograms  $1.50 per kilogram), the amount Hernandez would get if it sold the special cement one month from now. Gomez assesses a probability of 0.7 that the special cement will be used on Contract No. 2 and a probability of 0.3 that the special cement will be sold. The expected benefit of holding the special cement and not using it on Contract No. 1 is: = (0.7  $25,000*) + (0.3  $15,000**) = $17,500 + $4,500 = $22,000 *relevant cost if special cement is used in Contract No. 2 (see requirement 1) **relevant cost if special cement is sold one month from now Alternatively, the special cement can be sold right away and fetch $16,000. The opportunity cost is the greater of these two benefits and hence equals $22,000. When bidding on the Contract, Gomez should use: Incremental cost Plus opportunity cost Relevant cost

$ 0 22,000 $22,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

In this case, the benefit of selling the cement now is $23,000, while the benefit of using the cement in Contract No. 2 is $25,000. The opportunity cost of using the cement in Contract No. 1 is the lesser of these two numbers, $23,000. Incremental cost Plus opportunity cost Relevant cost

Appendix 11B: Using Excel Solver - Problems Visit MyLab to download Excel solutions to the Solver Problems.

$ 0 23,000 $23,000

CHAPTER 12 DATA ANALYTIC THINKING AND PREDICTION MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

12-1

Management accountants can contribute in each step of the seven-step decision-making process for applying machine learning techniques in business situations. They use their substantive expertise to evaluate the costs and benefits of different data-science based decisions, for example, to allocate marketing and sales resources.

12-2

The seven-step decision-making process for applying machine learning techniques in business situations are (1) Gain a business understanding of the problem (2) Obtain and explore relevant data (3) Prepare the data (4) Build a model (5) Evaluate the model (6) Visualize and communicate insights and (7) Deploy the model.

12-3

Target leakage refers to data that are not available at the time of the analysis and should be excluded.

12-4

The decision tree is a technique for segmenting the target variable into different regions based on a set of rules. Decisions, for example whether to grant a customer a loan or not, are made depending on whether the loan characteristics fall into the make loan or reject loan region. These rules make the model easier to interpret than some other models.

12-5

Gini impurity is a way to measure the purity of a collection of observations in a set (or rectangle). If a set of observations is very mixed it is “impure” and the Gini impurity is high. As a set becomes more pure, that is, it contains more members of one class than another, the Gini impurity decreases.

12-6

Overfitting is a direct outcome of the flexibility and power of data science models. Overfitting occurs when a model adheres too closely to the specific details of a dataset such that, in addition to signal, it captures noise from random chance, making it less effective at accurately classifying observations from a new dataset. Overfitting limits a model’s ability to predict future outcomes.

12-7

Pruning is a technique in which the tree is not grown to its full size, but instead is only allowed to grow to a certain depth. It is helpful as a solution to the problem of overfitting.

12-8

Data scientists use cross-validation to compare predictions of different models on a new set of data for which actual outcomes are already known. Managers choose the model that predicts most accurately.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

A holdout set is data the model has not seen. Data scientists would be more confident of a model’s ability to predict, for example defaults, if the overall likelihood value in the holdout sample is similar to the overall likelihood value in the cross-validation set.

12-9

The likelihood value ranges between 0 and 1 with a value near 0 when the predicted probability is very far from the actual value and a value close to 1 when the predicted probability is close to the actual value. Data scientists use this approach to compare the performance of the models. Maximizing the likelihood value means that the across the entire sample, the chosen model gives predictions that are closest to the actual values.

12-10 Data scientists try to balance the bias-variance tradeoff. Building complex models reduces bias but also risks overfitting the model to noise or peculiarities in the training data. The predictions these models make on real data have high variance, that is, the predictions on different real-world data yield some good predictions and some bad ones. Decision scientists build less-complex models with some bias in them (they do not fit the training data very well) because these models make predictions with less variance (the model does reasonably well across different data sets). Pruning trees to various depths is one technique to balance the biasvariance tradeoff. The greater the depth of a tree, the lower the bias but the higher the variance of the model. Pruning introduces bias but it also reduces variance. At what point is the tradeoff optimal? It is difficult to determine this a priori. Data scientists and management accountants train different models and determine which model has a higher overall likelihood value and makes good business sense.

12-11 The Receiver-Operating-Characteristic (ROC) Curve is a useful and commonly used tool to evaluate a model. It plots the false positive rate (FP) on the x-axis and the true positive rate (TP) on the y-axis. Comparing these two rates provides insight into the tradeoffs associated with correctly identifying true positives (default loans for example) without capturing false positives (loans that repay but predicted as defaults). Generally, increasing the true positive rate also increases the false positive rate. Management accountants play a crucial role in determining the costs and benefits of identifying true positives in the presence of false positives.

12-12 A confusion matrix is a matrix that shows the predicted and actual classifications at a given threshold value. It identifies the true positives, false positives, true negatives and false negatives at a threshold value.

12-13 False positives (FP) are negatives incorrectly predicted as positives. For example, actual repay loans (negatives) incorrectly classified as default loans (positives). False negatives (FN) are positives incorrectly predicted as negatives. For example, actual default loans (positives) incorrectly classified as repay loans (negatives).

12-14 Management accountants use their insights and knowledge of the business to estimate the payoffs. Based on the payoff matrix results, management accountants identify the costs of true positives and false positives and true negatives and false negatives. This is crucial information in making decisions, such as, which loans to accept and which to reject.

Chapter 12: Data Analytic Thinking and Prediction

12-15 Management accountants work with managers to operationalize the data science model to make decisions. In doing so, they evaluate what elements need to be modified in light of the model inputs and how best to balance quantitative and qualitative assessments of the business situation.

12-16 Terminology 1. Data science refers to the use of data analytics to draw conclusions from data. Predictive modelling is a data science technique used to make predications based on past or current data. 2. The decision tree is a technique for segmenting the target variable into different regions based on a set of rules. Gini impurity is a way to measure the purity of a collection of observations in a rectangle (set). Two specific areas that management accountants address when refining a decision tree to better match the economics of business are overfitting and pruning. 3. A useful and commonly used tool to evaluate a model is the receiver operating characteristic (ROC) curve that plots the false positive rate (FP) on the x-axis and the true positive rate (TP) on the y-axis. 4. A confusion matrix is a matrix that shows the predicted and actual classifications at a given threshold value.

12-17 Gini impurity. 1. There are 8 data points in this sample: 3 default loans and 5 repay loans. The diagram on the left identifies the optimal cut. The diagram on the right shows two alternatives that do not reduce Gini Impurity as much as the optimal cut.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Optimal Cut: At credit score = 650, the Gini impurity calculations for R1 and R2 are:

R1:

2 0 0 2     0.0 2 2 2 2

1 5 5 1 10 R2 :      0.278 6 6 6 6 36 Gini impurity for R1/R2 = proportion of observations in R1  Gini impurity for R1  proportion of observations in R 2  Gini impurity for R 2

2 6 10 15  0    0.208 8 8 36 72 Suboptimal Cuts: At credit score = 715 or income = $50,000 the resulting R1/R2 distributions were (R1) 2 repayers and (R2) 3 defaulters and 3 repayers. The Gini impurity calculations for R1 and R2 are: 2 0 0 2 R1:     0.0 2 2 2 2 3 3 3 3 18 R2 :      0.5 6 6 6 6 36 Gini impurity for R1/R2 = proportion of observations in R1  Gini impurity for R1  proportion of observations in R 2  Gini impurity for R 2

2 6 1 6  0     0.375 8 8 2 16 3. Default loans significantly hurt profitability because Boehm and Sons lose interest income and also the money they have loaned. Traditionally, bank officers have evaluated lenders based on their characteristics, purpose of the loan and experience and made judgments about loan repayment. Their goal---to avoid making loans to borrowers who they believe will have trouble repaying. Machine learning has automated this process. Using decision trees, senior managers predict default loans, allowing Boehm and Sons to focus their investments on repay loans and thereby increase profitability.

Chapter 12: Data Analytic Thinking and Prediction

12-18 Gini impurity. 1. At credit score equals 650, the Gini impurity calculations for R1 and R2 are: 3 0 0 3 R1:     0.0 3 3 3 3 1 3 3 1 6 R 2 :      0.375 4 4 4 4 16 Gini impurity for R1/R2 = proportion of observations in R1  Gini impurity for R1  proportion of observations in R 2  Gini impurity for R 2

3 4  0.0   0.375  0.2143 7 7 At income equals $70,000, the Gini impurity calculations for R1 and R2 are:

4 1 1 4     0.32 5 5 5 5 0 2 2 0 R 2 :     0.0 2 2 2 2

R1:

Gini impurity for R1/R2 = proportion of observations in R1  Gini impurity for R1  proportion of observations in R 2  Gini impurity for R 2

5 2  0.32   0.0  0.2286 7 7 The two cuts have different Gini impurities, so Rech and her team are not correct that they are equivalent; the cut at credit score = 650 should be used as the first node of the decision tree. The intuition is that the credit score = 650 cut has more observations in the pure rectangle 3 (versus 2 observations in the pure rectangle when income = $70,000 is used to make the cut). 2. Gini impurity computations give Rech and her team insights about the value of the decision tree approach. Insignificant reductions in Gini impurity in the first few cuts, signal that decision trees will not be helpful in improving Donnelly Bank’s decision-making. Why? Because small reductions in Gini impurity mean that the algorithm is not able to separate default loans from repay loans---the decision tree model is not able to purify the sets (or rectangles) that determine default loans and repay loans. Significant reductions in Gini impurity mean that the cuts can help discriminate default loans from repay loans.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

12-19 Decision trees. 1. If Credit Score <= 680 & Income <= $68,500  DEFAULT If 715 < Credit Score <= 743  DEFAULT If Credit Score <= 680 & Income > $68,500  REPAY If 680 < Credit Score <= 715  REPAY If Credit Score > 743  REPAY 2. i. DEFAULT ii. REPAY iii. REPAY iv. DEFAULT 3. Brown is correct that something appears to be wrong with the model; in cut 4, loans with a higher credit score (greater than 715) are classified as default, and loans with a lower credit score (less than 715) are classified as repay. This may indicate that the model is overfitting the training data. In this example, Brown’s business understanding helps him appreciate the limits of the model. Although cut 4 may reduce the Gini impurity, it contradicts Brown’s business experience and his knowledge of the economics of the company. Brown would alert the data science team to these anomalies and suggest that they consider other more important variables such as debt-to-income ratio. The data science team might also propose that they prune the decision tree to avoid overfitting. The predictions this model will make on real data have high variance, that is, the predictions on different real-world data will yield some good predictions and some bad ones. Consequently, the model will perform poorly when applied to new data, even though it seems to fit the training data more closely. Decision scientists build less-complex models with some bias in them (they do not fit the training data very well) because these models make predictions with less variance (the model does reasonably well across different data sets). Pruning trees to various depths is a technique to balance the bias-variance tradeoff. The greater the depth of a tree, the lower the bias but the higher the variance of the model because of overfitting. Pruning introduces bias but it also reduces variance. The data scientists and management accountants train different models and determine the model that captures most of the signal without overfitting to the noise. The goal is to choose a model that will work very well in predicting loans that default without incorrectly classifying many loans that repay as defaulting loans.

12-20 Decision trees. 1. If Number of Lines <= 1.5  LEAVE If 1.5 < Number of Lines <= 3.5 & Months <= 21.5  LEAVE If 1.5 < Number of Lines <= 3.5 & Months > 21.5  STAY If Number of Lines > 3.5  STAY

Chapter 12: Data Analytic Thinking and Prediction

2. Observation (1) 1 2 3 4 5 6 7 8 9

Number of Lines (2) 2 2 1 4 3 3 5 1 3

Number of Months (3) 13 23 20 21 27 19 25 21 23

Actual Outcome (4) Leave Stay Stay Stay Stay Leave Stay Stay Stay

Model Prediction (Full Tree) (5) Leave Stay Leave Stay Stay Leave Stay Leave Stay

7/9 customers were correctly classified by the full tree. The model does reasonably well in predicting which customers will stay with TelMark and which customers will leave.

12-21 Decision trees and pruning. 1. Observation (1) 1 2 3 4 5 6 7 8 9

Number of Lines (2) 2 2 1 4 3 3 5 1 3

Number of Months (3) 13 23 20 21 27 19 25 21 23

Actual Outcome (4) Leave Stay Stay Stay Stay Leave Stay Stay Stay

Model Prediction (Pruned Tree) (5) Stay Stay Leave Stay Stay Stay Stay Leave Stay

5/9 customers were correctly classified by the pruned tree. The model does a poor job of identifying which customers will leave and which customers will stay.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Sylvia should use the full tree, as this model had a higher accuracy on the validation set. A careful student will note that the pruned tree does not use income at all when predicting churn. If the number of lines is 2 or more, the pruned tree model predicts the customer will stay. If a customer has only 1 line, the pruned tree model predicts the customer will leave. As a result, of pruning, this model has a high bias because it is omitting an important signal--customer income. 3. Sylvia can use the model to advise management how to manage customer relationships to reduce churn. For example, Sylvia could recommend that TelMark offer deals to customers with only one phone line to get them to purchase additional lines, which the decision tree suggests would make them less likely to leave. She could also recommend offering discounts on the first 2 years of customers’ plans so that they are more likely to stay beyond the 21.5 month threshold.

12-22 Maximum likelihood. 1.

Observation (1) 1 2 3 4 5 6

Actual Outcome (y) (2) 1 (fraud) 0 (clean) 0 (clean) 0 (clean) 0 (clean) 0 (clean)

Probability of Fraud (p) (3) 0.45 0.30 0.01 0.99 0.70 0.01

Likelihood Value py × (1−p)1−y (4) 0.45 0.70 0.99 0.01 0.30 0.99

2. Overall likelihood value = 0.45 * 0.70 * 0.99 * 0.01 * 0.30 * 0.99 = 0.0009 3. The overall likelihood value is very low. A low likelihood value indicates that the model’s prediction probabilities across all observations are not close to the actual prediction probabilities of fraudulent activities within customers’ accounts. Consequently, it would probably not be useful for decision-making. Consider, for example, customers 4 and 5. There is no fraudulent activity within these customers’ accounts. However, the model predicts high probabilities 0.99 and 0.70 that there is fraudulent activity in these customers’ accounts. Norse Credit will likely often intervene in preventing these customers from doing transactions because the company is suspicious that there is fraudulent activity in these accounts when in fact there is not. Equally problematically, in one account with fraudulent activity (customer 1), the model assesses a low probability (0.45) that there is fraudulent activity resulting in poor monitoring of this customer’s account and fraud-related losses. Both types of problems will likely result in customers leaving Norse Credit.

Chapter 12: Data Analytic Thinking and Prediction

Observation

Actual Outcome (y)

Probability of Fraud (p)

(1)

(2)

(3)

1 2 3 4 5 6

1 (fraud) 0 (clean) 0 (clean) 0 (clean) 0 (clean) 0 (clean)

0.99 0.20 0.33 0.01 0.01 0.01

Likelihood Value py × (1−p)1-y 0.99 0.80 0.67 0.99 0.99 0.99

Overall likelihood = 0.99 * 0.80 * 0.67 * 0.99 * 0.99 * 0.99 = 0.5149 The overall likelihood of the new model is significantly higher than the original model, so the new model has more prediction power. For all five customers where there is no fraudulent activity, the model predicts a probability of fraud less than or equal to 0.33. For customer 1 where there is fraud activity, the model predicts a probability of fraud of 0.99. Customers will be far more satisfied and feel more secure if Norse Credit protects fraudulent activity in their accounts and does not incorrectly stop non-fraudulent customer transactions.

12-23 Receiver-Operating-Characteristic (ROC) curve. 1. Because Curve 3 represents a model that allows for an increase in the true positive rate without a significant increase in the false positive rate, it is the curve (and model) that would be most useful for a management accountant. The management accountant can choose a cutoff value that yields a high true positive rate (greater than 0.80) while keeping the false positive rate small (below 0.10). In the example of identifying default loans, this cutoff would correctly identify over 80% of default loans while only incorrectly identifying a very small number of repay loans as default loans. The exact cutoff would depend on the payoff matrix but the ROC curve 3 suggests that the model is very useful for making business decisions. Model 2 and 3 would be less useful for business decisions because in identifying true positives, the decision maker must accept a large number of false positives. 2. The straight-line ROC curve 1 indicates that as the percentage of true positives identified by the model (default loans, for example) increases, the percentage of false positives increases at the same rate. The model is not discriminating enough in identifying true positives. In other words, it is equally likely that the model will classify an observation as a true positive as it will classify the observation as a false positive. This means that the straight-line ROC curve represents a model that performs as well as random guessing.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

12-24 Confusion matrices, payoff matrix, and choosing cut off values. 1. Confusion Matrix (0.70) Predicted NonBuyers Buyers Actual Buyers Actual NonBuyers

Confusion Matrix (0.30) Predicted Total

Buyers

Non-Buyers

Total

100

800

900

660

240

900

120

880

1,000

750

250

1,000

2. Payoff Matrix

Actual

Buyers NonBuyers

Predicted NonBuyers Buyers $200 $0 −$20

Total payoff at cutoff = 0.70: $200(20) − $20(100) + $0(80) + $0(800) = $2,000 Total payoff at cutoff = 0.30: $200(90) − $20(660) + $0(10) + $0(240) = $4,800 SunTV should use a cutoff of 0.30 because the total payoff is higher based on the validation set. Sun TV gains $14,000 ($200 × 70) from the 70 (90 − 20) additional customers by marketing aggressively. The more aggressive marketing campaign costs it $11,200 ($20 × 560) from marketing to 560 (660 − 100) additional customers. This results in an increase in profit of $2,800 ($14,000 − $11,200). 3. Before building such a model, SunTV should consider the potential side effects of marketing too aggressively. If the company’s marketing efforts irritate or offend interested customers, they may turn those customers away leading to lost sales. SunTV could use pilot studies to evaluate the side effects of different marketing strategies. If Sun could target customers more accurately, it may be able to offer better promotions to attract the smart TV customers. They could then spend their marketing dollars on the smart TV customer segment they want to attract rather than wasting marketing dollars on customers who are not interested in buying smart TVs.

Chapter 12: Data Analytic Thinking and Prediction

12-25 Model thresholds and payoff matrices. 1. Payoff Matrix

Actual

Low Quality Acceptable Quality

Predicted Low Acceptable Quality Quality $0.04 −$1.05 $0.04

$0.30

2. Total payoff at cutoff = 0.30: $0.04(130) − $1.05(20) + $0.04(230) + $0.30(620) = $179.40 Total payoff at cutoff = 0.50: $0.04(100) − $1.05(50) + $0.04(120) + $0.30(730) = $175.30 The data science team should use a cutoff of 0.30 because the total payoff is higher than when using a cutoff of 0.50. At this cutoff, however, Blanda Brothers is being very conservative. It is only supplying apples when the predicted probability of it being a lowquality apple is below 0.30. As a result, it is classifying 230 acceptable quality apples as being of low quality and selling them at a profit of $0.04 rather than at a profit of $0.30. Cindy Hansen should carefully evaluate the payoff matrix since small changes in these payoffs could change the cutoff. More importantly, Cindy should evaluate whether Blanda Brothers can improve the algorithm it is using to reduce the number of false positives and false negatives. She would then be able to better separate the low-quality apples from the acceptable quality apples and not sell so many acceptable quality apples as low quality apples to apple processors.

12-26 Model thresholds and payoff matrices (continuation of 12-25). 1. Payoff Matrix

Actual

Low Quality Acceptable Quality

Predicted Low Acceptable Quality Quality $0.04 −$0.75 $0.04

$0.30

Total payoff at cutoff = 0.30: $0.04(130) − $0.75(20) + $0.04(230) + $0.30(620) = $185.40 Total payoff at cutoff = 0.50: $0.04(100) − $0.75(50) + $0.04(120) + $0.30(730) = $190.30 Under the lower cost of $0.75 for supplying low quality apples as good quality apples to stores, the optimal model cutoff changes from 0.30 in the previous problem to 0.50. Blanda Brothers is willing to supply more apples and take more risk. It is now willing to supply apples when the predicted probability of it being a low-quality apple is below 0.50 rather than below 0.30 in Exercise 11-29. It now supplies 780 apples to stores rather than the Copyright © 2022 Pearson Canada Inc. 12-11

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

640 apples in Exercise 11-29. Of these 780 apples, 50 (as compared to 20 in Exercise 11-29) are poor quality apples and has a cost of $0.75 per apple. But it also supplies 730 (as compared to 620 good-quality apples in Exercise 11-29) with each apple netting a $0.30 profit. The lower cost (penalty) of supplying a low-quality apple to stores allows Blanda to be more aggressive. 2. As this problem illustrates, an understanding of the costs and benefits of each outcome is critical to determine which model cut off is optimal. It is vital for the management accountant to carefully understand the economics of the business and share this information with the data science team. Without this perspective, the data science team will likely choose a model cut off that does not correctly balance the payoffs for each outcome. At the same time, the management accountant needs to have a good understanding of the data science model to judge the level of false positives and false negatives at each cutoff value. This allows the management accountant to gauge the power of the model in making decisions. If the model is not very good, the management accountant needs to assess the risks of using it. For example, if Cindy has concerns that supplying poor-quality apples to stores risks negative long-run consequences, she may not want to be aggressive in marketing more apples to the stores if the model’s predictive power is not very good. However, if the risks of using the model are not very great, Cindy may be more comfortable being aggressive in her marketing even if the model has weak predictive power.

Problems 12-27 Thinking through the data. 1. In machine learning models, it is often better to obtain data that are more recent because conditions may have changed. Machine learning relies on the past being a good predictor of the future and more recent data often leads to better predictions. Collecting more data is, however, costly. James must exercise judgement in evaluating the costs and benefits of updating a data set. What should Keebler-Olson do with the older data? More data is always better provided it is still useful for making future predictions. James must evaluate whether the economic conditions in 2015 are similar to those in 2019. In this case, James believes they are so he suggests using the data from before 2015 through 2019 to build and validate the model. He cautions against using any data that may be available from before the global financial crisis that affected the economy from 2008 through 2010 because these conditions are not representative of what Keebler-Olson anticipates it will face in 2020. James might also propose that the data scientists run tests to check if the post-2015 data have similar characteristics to the pre-2015 data. 2. Information about the actual performance of a loan after making the loan will not be available to James when he is predicting whether a loan will default or repay in the future. James should only use information available at the time of making the loan such as credit score, income, debt-to-income ratio, size of loan, purpose of loan etc.. He should not include any information about repayments, loan restructuring, delayed repayments, hardship plans

Chapter 12: Data Analytic Thinking and Prediction

etc. in the model that occurs after the loan is made. This is an example of target leakage. It will make the model appear to explain the data very well when in fact, this is occurring because the model is using information about the actual performance of the loan over time.

12-28 Decision trees. 1. If Credit Score <= 675 and Income <= $70,000  DEFAULT If Credit Score > 675 and $55,000 < Income <= $60,000  DEFAULT If Credit Score <= 675 and Income > $70,000  REPAY If Credit Score > 675 and Income > $60,000  REPAY If Credit Score > 675 and Income <= $55,000  REPAY 2.

Observation (1) 1 2 3 4 5 6 7 8

Income (2) $85,000 $62,000 $72,000 $75,000 $71,000 $59,000 $48,000 $57,000

Credit Score (3) 710 650 660 640 680 705 690 685

Actual Outcome (4) (0) Repay (1) Default (0) Repay (0) Repay (0) Repay (0) Repay (1) Default (0) Repay

Model Prediction (Full Tree) (5) (0) Repay (1) Default (0) Repay (0) Repay (0) Repay (1) Default (0) Repay (1) Default

5/8 loans were correctly classified by the full tree. Predicting only 62.5% (5/8) correctly indicates that the model is not performing well. 3. James notices that at a depth of 3, loans with a higher income (greater than $55,000) are predicted to default and loans with a lower income (less than $55,000) are predicted to repay. James believes that this may be the result of the model overfitting to some peculiarities (errors or random occurrences) in the training sample. To address the issue of overfitting, James should propose pruning the tree at a depth of 3. Why? Because the predictions this model will make on real data will have high variance, that is, the predictions on different real-world data will yield some good predictions and some bad ones. Consequently, the model will perform poorly when applied to new data, even though it seems to fit the training data well. Less-complex models with some bias in them (they do not fit the training data very well) have lower variance in their predictions (the model does reasonably well across different data sets). Pruning trees is a technique to balance the bias-variance tradeoff. The greater the depth of a tree, the lower the bias but the higher the variance of the model because of overfitting. Pruning introduces bias but it also reduces variance. The goal is to identify a model that captures most of the signal without overfitting to the noise. Such a model will do a good job of predicting loans that default without incorrectly classifying too many loans that repay as defaulting loans. Copyright © 2022 Pearson Canada Inc. 12-13

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

12-29 Decision trees and pruning (continuation of 12-28). 1. Observation (1) 1 2 3 4 5 6 7 8

Income (2) $85,000 $62,000 $72,000 $75,000 $71,000 $59,000 $48,000 $57,000

Credit Score (3) 710 650 660 640 680 705 690 685

Actual Outcome (4) (0) Repay (1) Default (0) Repay (0) Repay (0) Repay (0) Repay (1) Default (0) Repay

Model Prediction (Pruned Tree) (5) (0) Repay (1) Default (0) Repay (0) Repay (0) Repay (0) Repay (0) Repay (0) Repay

7/8 loans were correctly classified by the pruned tree. 2. James should use the pruned tree because this model has a higher accuracy on the validation set. The pruned tree does much better than the full tree in predicting default and repay loans. Although pruning introduces bias compared to the full tree, there is less overfitting and consequently lower variance. 3. James would need to explain the bias-variance tradeoff to the president. Building complex models reduces bias but also risks overfitting the model to noise or peculiarities in the training data. The predictions these models make on real data have high variance, that is, the predictions on different real-world data yield some good predictions and some bad ones. Consequently, the model would perform poorly when applied to new data, even though it seems to fit the training data more closely. Decision scientists build less-complex models with some bias in them (they do not fit the training data very well) because these models make predictions with less variance (the model does reasonably well across different data sets). Pruning trees to various depths is one technique to balance the bias-variance tradeoff. The greater the depth of a tree, the lower the bias but the higher the variance of the model because of overfitting. Pruning introduces bias but it also reduces variance. At what point is the tradeoff optimal? It is difficult to determine this a priori. The data scientists and management accountants train different models and determine the model that captures most of the signal without overfitting to the noise. This model will work very well in predicting loans that will default without incorrectly classifying too many repay loans as default loans.

Chapter 12: Data Analytic Thinking and Prediction

12-30 Calculate likelihood values (continuation of 12-28 and 12-29). 1. For Full Tree

For Pruned Tree

Observation

Income

Credit Score

Actual Outcome (y)

Probability of Default (p)

Likelihood Value py × (1-p)1−y

Probability of Default (p)

Likelihood Value py × (1−p)1−y

(1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

1 2 3 4 5 6 7 8

$85,000 $62,000 $72,000 $75,000 $71,000 $59,000 $48,000 $57,000

710 650 660 640 680 705 690 685

(0) Repay (1) Default (0) Repay (0) Repay (0) Repay (0) Repay (1) Default (0) Repay

0.01 0.99 0.01 0.01 0.01 0.99 0.01 0.99

0.99 0.99 0.99 0.99 0.99 0.01 0.01 0.01

0.01 0.99 0.01 0.01 0.01 0.33 0.33 0.33

0.99 0.99 0.99 0.99 0.99 0.67 0.33 0.67

2. Overall likelihood value of full tree = 0.99 * 0.99 * 0.99 * 0.99 * 0.99 * 0.01 * 0.01 * 0.01 = 9.5099E-7 Overall likelihood value of pruned tree = 0.99 * 0.99 * 0.99 * 0.99 * 0.99 * 0.67 * 0.33 * 0.67 = 0.1409 The overall likelihood value for the pruned tree is good but the overall likelihood value for the full tree is very small. 3. James would be comfortable using the pruned tree model to make predictions but would not want to use the full tree model. This is consistent with the conclusion in Problem 12-29, requirement 2 when evaluating the tree based only on the proportion of correctly classified observations. The likelihood value of the pruned tree is larger because it makes better predictions for the last three observations (6, 7, 8) in the validation sample. The better predictions are because pruning reduces overfitting the model to special features of the training data that adds noise to the predictions.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

12-31 Payoff matrix and choosing cut off values (continuation of 12-28, 12-29, and 12-30). 1. Payoff Matrix Predicted Default Repay Actual Default Actual Repay

$14

−$60

$14

$48

2. Confusion Matrix (0.5) Predicted Default Repay Actual Default Actual Repay

Confusion Matrix (0.25) Predicted Default Repay

3. Total payoff at cutoff = 0.5: $14(1) − $60(1) + $14(0) + $48(6) = $242 Total payoff at cutoff = 0.25: $14(2) − $60(0) + $14(2) + $48(4) = $248 James should use a cutoff of 0.25 because it results in a higher total payoff on the validation set. This means that James classifies any loan with a probability of default greater than 0.25 as a default loan. Keebler-Olson only makes loans when the probability of default is less than 0.25. At this cutoff, however, Keebler-Olson is being very conservative. It classifies 2 repay loans as being default loans and invests in the alternative investment yielding $14 instead of earning $48 if it had made the loan. It does so because choosing this lower cutoff avoids the false negative of lending to loan 7, which defaults and costs KeeblerOlson $60. James should carefully evaluate the payoff matrix since small changes in these payoffs could change the cutoff. More importantly, James should evaluate whether Keebler-Olson can improve the algorithm it is using to reduce the number of false positives and false negatives. He would then be able to better separate the default loans from the repay loans and not forgo investing in repay loans that yield a high payoff.

12-32 Maximum likelihood. 1. Observation # Model Probability (p) Actual Outcome (y) Likelihood

1 2 3 4 5 6 7 0.99 0.01 0.33 0.20 0.01 0.33 0.33 1 0 1 0 0 0 0 0.99 0.99 0.33 0.80 0.99 0.67 0.67

Chapter 12: Data Analytic Thinking and Prediction

2. Overall likelihood = 0.99 * 0.99 * 0.33 * 0.80 * 0.99 * 0.67 * 0.67 = 0.1150 3. Turcotte’s prediction model takes into account various operating parameters of the machines used to make brake pads and details from inspecting the product to predict whether there are latent defects in the brake pads. The re-inspection machines then do more rigorous lighting and abrasion tests to check if the brake pads are defective. The overall likelihood value for this model is reasonably high. This indicates that the model does well in predicting those brake pads that are defective from those brake pads that are working. Consequently, it has the potential to improve decision-making at Turcotte. It will help Turcotte to not ship defective brake pads to customers and thereby improve customer satisfaction with the potential to gain future customer business. Sarah might also want to explore if reducing defective brake pads to the customer reduces customers’ costs as well, creating a win-win situation. Turcotte would also benefit from reducing re-inspection costs. Seeing the value of this prediction model, Sarah may want to encourage the data science team to improve the model itself, while also working to reduce the cost of reinspection. The next task would be develop a payoff matrix and choose a cutoff value for deciding whether to release a brake pad to Turcotte’s customers.

12-33 Payoff matrix and choosing cut off values (continuation of 12-32). 1. Payoff Matrix Predicted Defective Working Actual Defective Actual Working

$ 5

−$50

$17

$25

Actual Defective Actual Working

Confusion Matrix (0.50)

Confusion Matrix (0.30)

Predicted

Defective

Working

Defective

Working

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4. Total payoff at cutoff = 0.50: $5(1) − $50(1) + $17(0) + $25(5) = $80 Total payoff at cutoff = 0.30: $5(2) − $50(0) + $17(2) + $25(3) = $119 Sarah should use a cutoff of 0.30 because it results in a higher total payoff on the validation set. This means that Turcotte classifies any brake pads with a probability of being defective greater than 0.30 as a defective brake pad and re-inspects it. Turcotte is being very conservative. It only ships brake pads when the probability of being defective is less than 0.30. The benefit of the lower cutoff is that it avoids the false negative of shipping brake pad 3 as a working brake pad when it is defective, costing Turcotte $50. The cost of this conservatism is that 2 brake pads that are actually working well (brake pads 6 and 7) have to incur the cost of re-inspection. This is still worthwhile doing because the re-inspection costs of $8 are small relative to the loss from shipping a defective brake pad. Sarah should evaluate whether Turcotte Manufacturing can improve the algorithm it is using to reduce the number of false positives and false negatives. She would then be able to better separate the defective brake pads from the working brake pads and not incur unnecessary additional advanced re-inspection costs. 4. Let the net loss from shipping a defective brake pad to a customer be $X. The payoff at cutoff = 0.50: $5(1) - $X(1) + $17(0) + $25(5) The payoff at cutoff = 0.30 = $5(2) - $X(0) + $17(2) + $25(3) = $119 To find the point of indifference between these cutoff values we set these payoff to be the same. So $5(1) − $X(1) + $17(0) + $25(5) = $5(2) − $X(0) + $17(2) + $25(3) = $119 $130 – X = $119 X = $11 If the net loss from supplying a defective brake pad to a customer is less than $11, Turcotte Manufacturing would choose a cutoff of 0.50. For this to occur the cost of supplying a defective brake pad would need to decrease by nearly $40, an unlikely outcome. The sensitivity analysis indicates to Sarah that under the current manufacturing process, being more conservative is the correct strategy. The key insight is the ratio of re-inspection costs versus shipping a defective product. When re-inspection costs ($8) is low relative to the loss from shipping products ($50), Turcotte is better off being conservative.

12-34 Receiver-Operating-Characteristic (ROC) curve. 1. Predicted Probability of Household Having Kids Ranked from Highest to Lowest 0.95

Cumulative Number of Households With No Kids 0

Cumulative Number of Households With Kids 30

False Positive Rate (x-axis) 0

True Positive Rate (y-axis) 0.30

0.55 0.33 0.01

135 585 900

50 90 100

0.15 0.65 1.00

0.50 0.90 1.00

Chapter 12: Data Analytic Thinking and Prediction

This ROC curve reflects a significant improvement over the baseline 45-degree line. Ideally, ROC curves would move up along the y-axis indicating an increase in the true positive rate without a significant increase in the false positive rate. These ROC curves are most useful to the management accountant. The ROC curve here is not that good but it appears to be good enough for decision-making. The management accountant can choose a cutoff value that yields a high true positive rate (0.50, say) while keeping the false positive rate small (0.15). In this example, this cutoff would correctly identify over 50% of households with kids entering school for the first time while only incorrectly identifying a very small number of households with no such kids as households who have kids entering school for the first time. The exact cutoff would depend on the payoff matrix 3.

Confusion Matrix (0.50) Predicted Kids No Kids Actual Kids Actual No Kids

Confusion Matrix (0.25) Predicted Kids No Kids

135

765

585

315

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4. Payoff Matrix Predicted Actual Kids Actual No Kids

Kids

No Kids

$25

$10

−$2

Total payoff at cutoff = 0.50: $25(50) + $10(50) − $2(135) + $0(765) = $1,480 Total payoff at cutoff = 0.25: $25(90) + $10(10) − $2(585) + $0(315) = $1,180 Caitlin should use a cutoff of 0.50 because it results in a higher total payoff on the validation set. She only markets to those households that the model assesses a probability of having kids going to school for the first time of greater than 0.50. The benefit of the higher cutoff is that it avoids the false positive of sending marketing materials to too many households that do not have kids going to school for the first time. At this cutoff, Stapleton is being conservative and only seeking to attract 50 of the 100 households that have kids going to school for the first time. The cost of this conservatism is that she does not identify more households with kids going to school for the first time. This is still worthwhile doing because if she tries to attract more households with kids going to school for the first time, Stapleton will spend a lot more money marketing to several households that do not have kids going to school for the first time. Sarah should evaluate whether Stapleton can improve the algorithm it is using to reduce the number of false positives and false negatives. She would then be able to better separate households with kids going to school for the first time from households that do not have kids going to school for the first time and not incur unnecessary additional marketing costs. 5. Stapleton might be willing to lower the cutoff and market to more households if the cost of a false positive (-$2) is small relative to the benefit of identifying a true positive which in this example is $15 ($25 − $10). For example, if the gain from identifying a true positive were $25, Stapleton would be willing to accept a relatively high rate of false positives because the costs will be outweighed by the benefits of more true positives.

Chapter 12: Data Analytic Thinking and Prediction

12-35 Model thresholds and payoff matrices. 1. Confusion Matrix (0.40) Predicted Default Repay Actual Default Actual Repay

Confusion Matrix (0.55) Predicted Default Repay

Total

200

140

340

120

220

340

250

150

400

160

240

400

2. Payoff Matrix Predicted Actual Default Actual Repay

Default

Repay

$90

−$650

$90

$300

Total payoff at cutoff = 0.40: $90(50) − $650(10) + $90(200) + $300(140) = $58,000 Total payoff at cutoff = 0.55: $90(40) − $650(20) + $90(120) + $300(220) = $67,400 David should use a cutoff of 0.55 because it results in a higher total payoff on the validation set. At this cutoff, Spruce Bank is being aggressive and making loans whenever the cutoff probability of default is below 0.55 rather than making loans when the cutoff probability of default is below 0.40. It is willing to take this greater risk because it can make 80 (220 – 140) more loans that will repay even though it will make 10 (20 – 10) more loans that will default. David should evaluate whether Spruce Bank can improve the algorithm it is using to reduce the number of false positives and false negatives. He would then be able to better separate repay loans from default loans and not incur losses from loans that are predicted to repay but that actually default.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

12-36 Model thresholds and payoff matrices, sensitivity analysis (continuation of 12-35). 1. Worst case payoff at cutoff = 0.40: $90(50) − $750(10) + $90(200) + $300(140) = $57,000 Worst case payoff at cutoff = 0.55: $90(40) − $750(20) + $90(120) + $300(220) = $65,400 Best case payoff at cutoff = 0.40: $90(50) − $550(10) + $90(200) + $300(140) = $59,000 Best case payoff at cutoff = 0.55: $90(40) − $550(20) + $90(120) + $300(220) = $69,400 2. The analysis shows that under both the worst and best-case payoff scenarios, David should use a cutoff of 0.55 because it results in a higher total payoff on the validation set. These sensitivity analyses give David confidence that errors in estimating the loss on default loans does not affect his decision to be aggressive in lending decisions.

CHAPTER 13 PRICING DECISIONS: PROFITABILITY AND COST MANAGEMENT MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

SHORT-ANSWER QUESTIONS 13-1

The three major influences on pricing decisions are:

(a) Customers (b) Competitors (c) Costs

13-2

There are many circumstances when a company might price below full cost, but the key issue is capacity. When a company has idle capacity, pricing to cover outlay costs (normally variable costs but may include relevant fixed costs) will contribute to fixed cost coverage and will be considered by the firm. This could apply in decisions to accept or reject special orders, but could also apply to pricing of existing products. With idle capacity the company might consider pricing a new or struggling product below full cost to penetrate the market and gain market share. The company might also price below full cost to be in line with market-based pricing. It will then work to achieve cost reductions.

13-3

Two examples of pricing decisions with a short-run focus:

(a) Pricing for a one-time-only special order with no long-term implications. (b) Adjusting product mix and volume in a competitive market.

13-4

Activity-based costing helps managers in pricing decisions in two ways.

(a) It gives managers more accurate product-cost information for making pricing decisions. (b) It helps managers to manage costs during value engineering by identifying the cost impact of eliminating, reducing, or changing various activities.

13-5

Two alternative approaches for long-run pricing decisions are:

(a) Market-based pricing, an important form of which is target pricing. The market-based approach asks, “Given what our customers want and how our competitors will react to what we do, what price should we charge?”

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

(b) Cost-based pricing which asks, “What does it cost us to make this product, and hence what price should we charge that will recoup our costs and produce a desired profit?”

13-6

Product life cycle means different things to different stakeholders. To the seller it means a cradle to grave total cost of the product or service, which may include recycling, reclamation and reuse of product components. To the buyer it means all costs of ownership, operations, maintenance, and disposal of a product.

13-7

Collusive pricing is the practice among competitors of negotiating a price above the competitive price, at which all will sell their product or service. It is illegal because it lessens or unduly restrains competition. Predatory pricing arises when one manufacturer sells output at less than the total variable cost of the product repeatedly, with the intent of obstructing or eliminating competition. Both are illegal under the Competition Act of Canada.

13-8

Life-cycle budgeting is an estimate of the revenue and costs attributable to each product from its initial R&D to its final customer servicing and support.

13-9

No. It is important to distinguish between when costs are locked in (through design decisions) and when costs are incurred, because it is difficult to alter or reduce costs that have already been locked in.

13-10 Three benefits of using a product life-cycle reporting format are: 1. The full set of revenues and costs associated with each product becomes more visible. 2. Differences among products in the percentage of total costs committed at early stages in the life cycle are highlighted. 3. Interrelationships among business function cost categories are highlighted.

13-11 Cost-plus pricing methods vary depending on the bases used to calculate prices. Examples are (a) variable manufacturing costs, (b) manufacturing function costs, (c) variable product costs, and (d) full product costs. 13-12 Two examples where the difference in the incremental or outlay costs of two products or services is much smaller than the differences in their prices follow: 1. The difference in prices charged for a telephone call, hotel room, or car rental during busy versus slack periods is often much greater than the difference in costs to provide these services. 2. The difference in incremental or outlay costs for an airplane seat sold to a passenger travelling on business or a passenger travelling for pleasure is roughly the same. However, airline companies routinely charge business travellers—those who are likely to start and complete their travel during the same week excluding the weekend—a much higher price than pleasure travellers, who generally stay at their destinations over at least one weekend.

Chapter 13: Pricing Decisions: Profitability and Cost Management

EXERCISES 13-13 (10 min.)

Terminology.

1. Target pricing is a policy well suited to a highly competitive environment where many substitutes are available and may provide customers with the same valuable attributes at lower cost. 2. Target cost per unit is set after the price and target margin are determined. This target margin may be in percent or dollars at either the gross or operating margin level. 3. In a highly competitive environment, customer life-cycle pricing refers to the total cost of ownership of a product including purchase, operating costs, maintenance, and disposal. In comparison, life-cycle pricing refers to the total cost to the seller of the product from cradle to grave. 4. The invested capital refers in this chapter to total assets. The target return on investment is the target operating income divided by the invested capital. 5. Price discrimination is illegal because the manufacturer's intent is to obstruct or destroy competition. In contrast, peak load pricing is the practice of charging the highest rate to provide a service when demand for the service is highest. It is common practice and not illegal. 6. Value engineering is the evaluation by a top management team of any innovations and modifications to any business function that customers would value most highly. In comparison, value analysis is a process to retain both quality and all attributes that customers value while reducing costs.

13-14 (15 min.) Noncost factors. No. We would expect the incremental or outlay costs of providing telephone services to be no different in peak versus off-peak hours. Most costs of maintaining and operating the telephone network are fixed costs that are the same in peak and off-peak periods. In fact, the unit cost per telephone call is likely to be higher during off-peak hours when fewer calls are made. Yet the prices charged for telephone calls during peak periods are higher than the prices charged for offpeak evenings, nights, and weekends. Charging higher prices for peak period calls is an example of price discrimination. Price discrimination occurs because calls made between 8 a.m. and 6 p.m. are generally made by businesses who are relatively more price insensitive—they must make telephone calls to conduct their regular day-to-day business activities. Charging a higher price for peak-period calls maximizes the telephone company’s operating income. Charging higher prices during business hours is also an example of peak-load pricing. Because the number of telephone calls that can be put through at any one time is limited, the telephone company raises prices to levels that the market will bear when demand is high. It is interesting that the prices of telephone calls do not vary much with the distances over which the calls are placed. Technological advances such as fibre optic cables have made costly devices such as repeaters and amplifiers, that were formerly needed to ensure high-quality sound reproduction over long distances, unnecessary. The cost of laying cables has also decreased. The cost of a phone call does not vary much with distance. Copyright © 2022 Pearson Canada Inc. 13-3

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

13-15 (25 min.) Cost-plus, target pricing, working backward. 1. In the following table, work backward from operating income to calculate the selling price. Selling price Less: Variable cost per unit Unit contribution margin Number of units produced and sold Contribution margin Less: Fixed costs Operating income

9.36 (plug) 4.00 $ 5.36 × 500,000 units $2,680,000 2,500,000 $ 180,000

(a) Total sales revenue = $9.36 × 500,000 units = $4,680,000 (b) Selling price = $9.36 (from above) Alternatively, Operating income Add fixed costs Contribution margin Add variable costs ($4.00 × 500,000 units) Sales revenue Selling price 

$ 180,000 2,500,000 2,680,000 2,000,000 $4,680,000

Sales revenue $4, 680, 000   $9.36 Units sold 500, 000

Operating income $180, 000   8% Total investment in assets $2, 250, 000

(d) Markup % on full cost Total cost = ($4 × 500,000 units) + $2,500,000 = $4,500,000 $4,500, 000 Unit cost =  $9.00 500, 000 units Markup % = Or

$9.36 $9.00  4% $9.00

$4, 680, 000 $4,500, 000  4% $4,500, 000

Chapter 13: Pricing Decisions: Profitability and Cost Management

New fixed costs New variable costs New total costs New total sales (4% markup) New selling price Alternatively, New unit cost New selling price

=$2,500,000 – $225,000 = $2,275,000 = $4.00 – $0.30 = $3.70 = ($3.70 × 500,000 units) + $2,275,000 = $4,125,000 = $4,125,000 × 1.04 = $4,290,000 = $4,290,000 ÷ 500,000 units = $8.58 = $4,125,000 ÷ 500,000 units = $8.25 = $8.25 × 1.04 = $8.58

New units sold = 500,000 units × 95% = $475,000 units Budgeted Operating Income for the Year Ending December 31, 20xx Revenues ($8.58 × 475,000 units) Variable costs ($3.70 × 475,000 units) Contribution margin Fixed costs Operating income

$4,075,500 1,757,500 2,318,000 2,275,000 $ 43,000

4. The CEO has not considered customers in these pricing decisions. Will customers continue to want the product at these prices? What are competitors doing? The CEO should take a more market-based approach to pricing. The CEO should also think about the effect of cost cutting on employee participation and morale and whether the cuts are falling disproportionately on any specific value-chain function.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

13-16

(20 min.)

Cost-plus target return on investment pricing.

1. Target operating income = Target return on investment  Invested capital Target operating income (25% of $1,000,000) $250,000 Total fixed costs 358,000 Target contribution margin $608,000 Target contribution per room-night, ($608,000 ÷ 16,000) $ 38.00 Add variable costs per room-night 8 Price to be charged per room-night $ 46.00 Proof Total room revenue ($46.00 × 16,000 room-nights) Total costs: Variable costs ($8 × 16,000) Fixed costs Total costs Operating income

$736,000 $128,000 358,000 486,000 $250,000

The full cost of a room The full cost of a room Markup per room

= Variable cost per room + Fixed cost per room = $8 + ($358,000 ÷ 16,000) = $8 + $22.38 = $30.38 = Rental price per room – Full cost of a room = $46 – $30.38 = $15.62 Markup percentage as a fraction of full cost = $15.62 ÷ $30.38 = 51.4% 2. If price is reduced by 10%, the number of rooms Beck could rent would increase by 10%. The new price per room would be 90% of $46 $ 41.40 The number of rooms Beck expects to rent is 110% of 16,000 17,600 The contribution margin per room would be $41.40 − $8 $33.40 Contribution margin ($33.40 × 17,600) $587,840 Because the contribution margin of $587,840 at the reduced price of $41.40 is less than the contribution margin, Beck should not reduce the price of the rooms. Note that the fixed costs of $358,000 will be the same under both alternatives and hence, are irrelevant to the analysis.

Chapter 13: Pricing Decisions: Profitability and Cost Management

13-17

(15–20 min.)

Short-run pricing, capacity constraints.

1. Per kilogram of hard cheese: Milk (10 litres × $1.50 per litre) Direct manufacturing labour Variable manufacturing overhead Fixed manufacturing cost allocated Total manufacturing cost

$15 5 5 6 $31

If Manitoba Dairy can get all the Holstein milk it needs, and has sufficient production capacity, then, the minimum price per kilogram it should charge for the hard cheese is the variable cost per kilogram = $15 + $5 + $5 = $25 per kilogram. 2. If milk is in short supply, then each kilogram of hard cheese displaces 2.5 kilograms of soft cheese (10 litres of milk per kilogram of hard cheese versus 4 litres of milk per kilogram of soft cheese). Then, for the hard cheese, the minimum price Manitoba should charge is the variable cost per kilogram of hard cheese plus the contribution margin from 2.5 kilograms of soft cheese, or, $25 + (2.5 × $8 per kilogram) = $45 per kilogram That is, if milk is in short supply, Manitoba should not agree to produce any hard cheese unless the buyer is willing to pay at least $45 per kilogram.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

13-18

(20 min.)

Target costs, effect of product-design changes on product costs.

1. and 2. Manufacturing costs of HJ6 in 2021 and 2022 are as follows: 2021 Total (1) Direct materials, $1,400 × 5,000; $1,375 × 5,000 $7,000,000 Batch-level costs, $9,000 × 75; $8,500 × 80 675,000 Manuf. operations costs, $70 × 21,000; $65 × 21,000 1,470,000 Engineering change costs, $15,000 × 12; $14,000 × 10 180,000 Total $9,325,000

Per Unit (2) = (1) ÷ 5,000 $1,400 135

2022 Per Unit Total (4) = (3) (3) ÷ 5,000 $6,875,000 $1,375 680,000 136

294

1,365,000

273

36 $1,865

140,000 $9,060,000

28 $1,812

3. Target manufacturing cost Manufacturing cost   98% per unit of HJ6 in 2022 per unit in 2021  $1,865  0.98  $1,827.70

Actual manufacturing cost per unit of HJ6 in 2022 was $1,812. Hence, Medical Instruments did achieve its target manufacturing cost per unit of $1,827.70. A $265,000 cost reduction. 4. To reduce the manufacturing cost per unit in 2022, Medical Instruments reduced the cost per unit in three of the four cost categories—direct materials costs, manufacturing operations costs, and engineering change costs. Medical Instruments achieved these gains through value engineering activities that retained only those product features that customers wanted while eliminating non-value-added activities and costs.

Chapter 13: Pricing Decisions: Profitability and Cost Management

13-19

(25–30 min.) Value-added, non-value-added costs.

1. Category Value-added costs

Examples a. Materials and labour for regular repairs

Nonvalue-added costs

b. Rework costs c. Expediting costs caused by work delays g. Breakdown maintenance of equipment Total

Gray area

d. Materials handling costs $ 80,000 e. Materials procurement and inspection costs 45,000 f. Preventive maintenance of equipment 55,000 Total $ 180,000

$1,100,000 $

90,000 65,000 75,000 $ 230,000

Classifications of value-added, nonvalue-added, and gray area costs are often not clear-cut. Other classifications of some of the cost categories are also plausible. For example, some students may include materials handling, materials procurement, and inspection costs and preventive maintenance as value-added costs (costs that customers perceive as adding value and as being necessary for good repair service) rather than as in the gray area. Preventive maintenance, for instance, might be regarded as value-added because it helps prevent nonvalue-adding breakdown maintenance. 2. Total costs in the gray area are $180,000. Of this, we assume 60%, or $108,000, are valueadded and 40%, or $72,000, are nonvalue-added. Total value-added costs: $1,100,000 + $108,000 Total nonvalue-added costs: $230,000 + $72,000 Total costs

$1,208,000 302,000 $1,510,000

Nonvalue-added costs are $302,000 ÷ $1,510,000 = 20% of total costs. Value-added costs are $1,208,000 ÷ $1,510,000 = 80% of total costs.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. Program (a) Quality improvement programs to  reduce rework costs by 40% (0.40  $90,000)  reduce expediting costs by 40%  (0.40  $65,000)  reduce materials and labour costs by 5% (0.05  $1,100,000) Total effect (b) Working with suppliers to  reduce materials procurement and inspection costs by 20% (0.20  $45,000)  reduce materials handling costs by 30% (0.30  $80,000) Total effect Transferring 60% of gray area costs (0.60  $33,000 = $19,800) as value-added and 40% (0.40  $33,000 = $13,200) as nonvalue-added Effect on value-added and nonvalue-added costs (c) Maintenance programs to  increase preventive maintenance costs by 70% (0.70  $55,000)  decrease breakdown maintenance costs by 50% (0.50  $75,000) Total effect Transferring 60% of gray area costs (0.60  $38,500 = $23,100) as value-added and 40% (0.40  $38,500 = $15,400) as nonvalue-added Effect on value-added and nonvalue-added costs Total effect of all programs Value-added and nonvalue-added costs calculated in requirement 2 Expected value-added and nonvalue-added costs after implementing these programs

Effect on Costs Classified as Value-Added NonvalueGray Added Area –$ 36,000 – –$ –$

26,000

55,000 55,000 –$ 62,000

–$ 9,000 – 24,000 – 33,000 –$ –$

19,800 –$ 13,200 19,800 –$ 13,200

+ 33,000 $ 0

+$38,500 –$ 37,500 – 37,500

+ 38,500

+$ +$

23,100 + 15,400 23,100 –$ 22,100

– 38,500 $ 0

–$

51,700 –$ 97,300 1,208,000

302,000

$1,156,300

$204,700

If these programs had been implemented, total costs would have decreased from $1,510,000 (requirement 2) to $1,156,300 + $204,700 = $1,361,000, and the percentage of nonvalue-added costs would decrease from 20% (requirement 2) to $204,700 ÷ $1,316,000 = 15%. These are significant improvements in Magill’s performance. Some students might question whether Magill should implement program (c) because the costs of preventive maintenance of $38,500 exceeds the cost of breakdown maintenance of $37,500. The instructor may want to point out that if all costs of breakdown maintenance (loss of reputation, disruption of schedules etc.) are fully accounted for (which they are probably not), Magill may wish to not do preventive maintenance reducing costs by another $1,000. This may also cause students to debate why preventive maintenance is in the gray area of costs. It is value added only when the preventive maintenance activity reduces breakdown maintenance costs. Copyright © 2022 Pearson Canada Inc. 13-10

Chapter 13: Pricing Decisions: Profitability and Cost Management

13-20

Life-cycle product costing.

1. Variable cost per unit = Production cost per unit + Marketing and distribution cost per unit = $30 + $10 = $40 Total fixed costs over life of Yew = $7,200,000 + $1,700,000 + $21,000,000 + 6,200,000 + $2,400,000 = $38,500,000 Break Even Point in Units = $38,500,000/($80 - $40) = 962,500 units 2a. Revenue ($80 × 1,600,000 units) Variable costs ($40 × 1,600,000 units) Fixed costs Operating income

$128,000,000 64,000,000 38,500,000 $ 25,500,000

Revenue Year 2 ($95 × 1,000,000 units) Years 3 & 4 ($80 × 300,000 units) Total revenue Variable costs ($40 × 1,300,000 units) Fixed costs Operating income

$ 95,000,000 24,000,000 119,000,000 52,000,000 38,500,000 $ 28,500,000

2b.

Over the product’s life-cycle, Option B results in an overall higher operating income of $3,000,000. 3. Before selecting its pricing strategy, Digital Arts’s managers should evaluate whether the same pricing policy will be adopted globally. Different markets may need different pricing. For example, special taxes on imports may mean higher prices in foreign markets. Digital Arts’s pricing strategy must be sensitive to changing customer preferences and reactions of competitors.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

13-21

(25–30 min.)

Target prices, target costs, activity-based costing.

1. Snappy’s operating income in 2020 is as follows:

Revenues ($4  250,000) Purchase cost of tiles ($3  250,000) Ordering costs ($50  500) Receiving and storage ($30  4,000) Shipping ($40  1,500) Total costs Operating income

Total for 250,000 Tiles (1) $1,000,000 750,000 25,000 120,000 60,000 955,000 $ 45,000

Per Unit (2) = (1) ÷ 250,000 $4.00 3.00 0.10 0.48 0.24 3.82 $0.18

2. Price to retailers in 2021 is 95% of 2020 price = 0.95  $4 = $3.80; cost per tile in 2021 is 96% of 2020 cost = 0.96  $3 = $2.88. Snappy’s operating income in 2021 is as follows:

Revenues ($3.80  250,000) Purchase cost of tiles ($2.88  250,000) Ordering costs ($50  500) Receiving and storage ($30  4,000) Shipping ($40  1,500) Total costs Operating income

Total for 250,000 Tiles (1) $950,000 720,000 25,000 120,000 60,000 925,000 $ 25,000

Per Unit (2) = (1) ÷ 250,000 $3.80 2.88 0.10 0.48 0.24 3.70 $0.10

3. Snappy’s operating income in 2021, if it makes changes in ordering and material handling, will be as follows:

Revenues ($3.80  250,000) Purchase cost of tiles ($2.88  250,000) Ordering costs ($25  200) Receiving and storage ($28  3,125) Shipping ($40  1,500) Total costs Operating income

Total for 250,000 Tiles (1) $950,000 720,000 5,000 87,500 60,000 872,500 $ 77,500

Per Unit (2) = (1) ÷ 250,000 $3.80 2.88 0.02 0.35 0.24 3.49 $0.31

Through better cost management, Snappy will be able to achieve its target operating income of $0.30 per tile despite the fact that its revenue per tile has decreased by $0.20 ($4.00 – $3.80), while its purchase cost per tile has decreased by only $0.12 ($3.00 – $2.88).

Chapter 13: Pricing Decisions: Profitability and Cost Management

13-22

(30 min.)

Target service costs, value engineering, activity-based costing.

1. Weekly Revenue: 55,000 patrons  $35 per patron Desired profit margin: $1,925,000  35% Targeted weekly cost Targeted cost per patron; $1,251,250 ÷ 55,000 Weekly costs: Ticket sales and verification $3.35 per patron × 55,000 patrons Operating attractions: $90.00 × 11,340 runs Litter patrol: $20 × 1,750 Total weekly costs Cost per patron: $1,239,850 ÷ 55,000 Operating profit: ($1,925,000 – $1,239,850)

$1,925,000 673,750 $1,251,250 $22.75 $184,250 1,020,600 35,000 $1,239,850 $22.54 $ 685,150

Lagoon does achieve its target profit of 35% of revenues. 2. Weekly Revenue: 55,000 patrons  $33 per patron Weekly costs Ticket sales and verification $3a per patron × 55,000 patrons Operating attractions: 10,340b runs  $90 Litter patrol: 1,400c  $20 + $250 Total weekly costs Operating profit

$1,815,000 165,000 930,600 28,250 1,123,850 $ 691,150

a$3.35 − $0.35 = $3 b11,340 – 1,000 = 10,340 runs c1,750 hours × 80% = 1,400 hours

This profit is slightly greater than Lagoon’s current profitability. Yes, the changes and improvements will allow Lagoon to achieve the target operating income in dollars calculated in requirement 1 ($691,150 versus $673,750). It will also achieve its desired profit margin of 35% ($691,150 ÷ $1,815,000 = 38.08%). 3. The challenges that Lagoon might encounter in achieving the target cost are mostly employee related. If the employees resist the changes, or struggle with the implementation of the improvements, the target cost will be in danger of not being met. Lagoon might counter these struggles by training employees to implement these changes successfully and by adapting its incentive program to reward the desired improvements.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4. Building on the calculations in #2, above, we note that operating profits are $691,150 based on 10,340 runs at a cost of $90 per run. The incremental cost of the carbon tax is $3 per run, resulting to an increase in operating costs of $3 × 10,340 runs (11,340 runs less the planned 1,000 run reduction) which equals $31,020 dollars. Thus, operations will still be profitable, but will be reduced to $660,130 ($691,150 − $31,020).

13-23

(2530 min.)

Target operating income, value-added costs, service company.

1. The classification of total costs for the year into value-added, nonvalue-added, or in the gray area in between follows: Value Gray NonvalueTotal Added Area added (4) = (1) (2) (3) (1)+(2)+(3) Doing calculations and preparing drawings 77% × $390,000 $300,300 $300,300 Checking calculations and drawings 3% × $390,000 $11,700 11,700 Correcting errors found in drawings 8% × $390,000 31,200 31,200 Making changes in response to client requests 5% × $390,000 19,500 19,500 Correcting errors to meet government building code, 7% × $390,000 27,300 27,300 Total professional labour costs 319,800 11,700 58,500 390,000 Administrative and support costs at 44% ($171,600 ÷ $390,000) of professional labour costs 140,712 5,148 25,740 171,600 Travel 15,000 — 15,000 Total $475,512 $16,848 $84,240 $576,600 Doing calculations and responding to client requests for changes are value-added costs because customers perceive these costs as necessary for the service of preparing architectural drawings. Costs incurred on correcting errors in drawings and making changes because they were inconsistent with building codes are nonvalue-added costs. Customers do not perceive these costs as necessary and would be unwilling to pay for them. Calvert should seek to eliminate these costs by making sure that all associates are well-informed regarding building code requirements and by training associates to improve the quality of their drawings. Checking calculations and drawings is in the gray area (some, but not all, checking may be needed). There is room for disagreement on these classifications. For example, checking calculations may be regarded as value added.

Chapter 13: Pricing Decisions: Profitability and Cost Management

2. The consequences of classifying a non-value-added cost as a value-added cost is that managers may hesitate to reduce these costs thinking that if they eliminate these costs it would reduce the value or utility (usefulness) customers experience from using the product or service. But if these costs are really non-value-added costs, mangers should try to reduce these costs because these costs support activities that customers do not value. For these reasons, managers who are unsure if a cost is value-added or nonvalue-added, often classify costs as nonvalue-added. The nonvalue-added classification focuses organization attention on reducing these costs. The risk with this approach is that an organization may cut some costs that are value-adding, leading to poor customer experiences. Distinguishing value-added from nonvalue-added costs is valuable but also requires the exercise of careful judgment. 3. Reduction in professional labour-hours by a. Correcting errors in drawings (8% × 7,500) b. Correcting errors to conform to building code (7% × 7,500) Total Cost savings in professional labour costs (1,125 hours × $52) Cost savings in variable administrative and support costs (44% × $58,500) Total cost savings Current operating income Add cost savings from eliminating errors Operating income if errors eliminated

600 hours 525 hours 1,125 hours $ 58,500 25,740 $ 84,240 $124,650 84,240 $208,890

4. Currently 85% × 7,500 hours = 6,375 hours are billed to clients generating revenues of $701,250. The remaining 15% of professional labour-hours (15% × 7,500 = 1,125 hours) is lost in making corrections. Calvert bills clients at the rate of $701,250 ÷ 6,375 = $110 per professional labour-hour. If the 1,125 professional labour-hours currently not being billed to clients were billed to clients, Calvert’s revenues would increase by 1,125 hours × $110 = $123,750 from $701,250 to $825,000 ($701,250 + $123,750). Costs remain unchanged Professional labour costs Administrative and support (44% × $390,000) Travel Total costs Calvert’s operating income would be Revenues Total costs Operating income

$390,000 171,600 15,000 $576,600 $825,000 576,600 $248,400

Operating income would increase by $123,750 ($248,400 – $124,650) or 99.3% ($123,750 ÷ $124,650). Eliminating 15% of nonvalue-added costs results in a doubling of operating income if the resources saved could be used to generate revenues. For this reason, organizations place great emphasis on reducing and eliminating nonvalue-added costs.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

13-24

(25 min.)

Cost-plus, target return on investment pricing.

1. Target operating income = Return on capital in dollars = $10,000,000 × 12% = $1,200,000 2. Revenues* Variable costs [($3.00 + $2.00) × 400,000 cases Contribution margin Fixed costs ($400,000 + $700,000 + $500,000) Operating income (from requirement 1) *solve backwards for revenues

$4,800,000 2,000,000 2,800,000 1,600,000 $1,200,000

$4,800, 000  $12 per case. 400, 000 cases Markup % on full cost Full cost = $2,000,000 + $1,600,000 = $3,600,000 Unit cost = $3,600,000 ÷ 400,000 cases = $9.00 per case

Selling price =

Markup % on full cost =

$12 $9 = 33.33% $9

3. Budgeted Operating Income For the year ending December 31, 20xx Revenues ($13 × 360,000 cases*) $4,680,000 Variable costs ($5 × 360,000 cases) 1,800,000 Contribution margin 2,880,000 Fixed costs 1,600,000 Operating income $1,280,000 *New units = 400,000 cases × 90% = 360,000 cases Return on investment =

$1, 280, 000  12.8% $10, 000, 000

Yes, increasing the selling price is a good idea because operating income increases without increasing invested capital, which results in a higher return on investment. The new return on investment exceeds the 12% target return on investment.

Chapter 13: Pricing Decisions: Profitability and Cost Management

PROBLEMS 13-25

(20 min.)

Cost-plus, time and materials, ethics.

1. As shown in the table below, if Anderson were to quote on both options, he will tell Lee that she will have to pay $481 to get the air conditioning system repaired and $450 to get it replaced. COST Repair option (5 hrs. × $30 per hr.; $140) Replace option (2 hrs. × $30 per hr.; $240)

Labour Materials Total Cost $150 $140 $290 60 240 300

PRICE (90% markup on labour cost; 40% markup on materials) Repair option ($150 × 1.9; $140 × 1.4) Replace option ($60 × 1.9; $240 × 1.4)

Labour Materials Total Price $285 $196 $481 114 336 450

2. If the repair and replace options are equally effective, Lee will choose to get the air conditioning system replaced for $450 (rather than spend $481 on repairing it). 3. C&S Mechanical will earn a greater contribution toward overhead in the repair option ($191 = $481 – $290) than in the replace option ($150 = $450 – $300). Therefore, Anderson will recommend the repair option to Lee, which is not the one she would prefer. Recognizing this conflict, Anderson may even present only the repair option to Brooke Lee. Of course, he runs the risk of Lee walking away and thinking of other options (at which point, he could present the replace option as a compromise). The problem is that Anderson has superior information about the repairs needed but his incentives may cause him to not reveal his information and instead use it to his advantage. It is only the seller’s desire to build a reputation, to have a long-term relationship with the customer, and to have the customer recommend the seller to other potential buyers of the service, that encourages an honest discussion of the options. The ethical course of action would be to honestly present both options to Lee and have her choose. To have their employees act ethically, organizations do not reward employees on the basis of the profits earned on various jobs. They also develop codes of conduct and core values and beliefs that specify appropriate and inappropriate behaviours.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

13-26

(25 min.)

Cost-plus, target pricing, working backward.

1. In the following table, work backward from operating income to calculate the selling price Operating income Add fixed costs Contribution margin Add variable costs ($2.50 × 500,000 units) a) Sales revenue

$ 225,000 3,250,000 3,475,000 1,250,000 $4,725,000

b) $4,725,000 / 500,000 units = $9.45 c) Rate of return on investment =

Operating income $225,000  = 9% Total investment in assets 2,500, 000

d) Markup % on full cost Total cost = ($2.50 × 500,000 units) + $3,250,000 = $4,500,000 Unit cost = $4,500,000 / 500,000 = $9.00 Markup % = ($9.45 – $9.00) / $9.00 = 5.0% 2. New fixed costs = $3,250,000 ─ $250,000 = $3,000,000 New variable costs = $2.50 ─ $0.50 = $2 New total costs = ($2 × 500,000 units) + $3,000,000 = $4,000,000 New total sales (5% markup) = $4,000,000 × 1.05 = $4,200,000 New selling price = $4,200,000 ÷ 500,000 units = $8.40 Alternatively, New unit cost = $4,000,000 ÷ 500,000 units = $8 New selling price = $8 × 1.05 = $8.40 3. New units sold = $500,000 × 90% = $450,000 units Budgeted Operating Income For the year ending December 31 Revenue ($8.40 × 450,000 units) Variable costs ($2.00 × 450,000 units) Contribution margin Fixed costs Operating income (loss)

$3,780,000 900,000 2,880,000 3,000,000 $ (120,000)

Chapter 13: Pricing Decisions: Profitability and Cost Management

13-27 (30 min.) Value engineering, target pricing, and target costs. 1. Product design and licensing Direct materials Direct manufacturing labour ($4 × 400,000 units) Variable manufacturing overhead Fixed manufacturing overhead Fixed marketing Total cost Cost per unit ($13,200,000 ÷ 400,000) Target cost per unit ($45 × 0.70)

$ 1,700,000 4,000,000 1,600,000 400,000 2,500,000 3,000,000 $13,200,000 $ 33.00 $ 31.50

The original cost estimate of $13,200,000 does not meet the company’s requirements. Value engineering will be needed to reduce the cost per unit to the target cost. Westerly Cosmetic’s operating income is estimated to be $4,800,000 ($45 × 400,000 – $13,200,000). Its costs are expected to be 73.33% ($13,200,000 ÷ $18,000,000) of revenues whereas the target costs are 70% of revenues or $12,600,000 (70% × $18,000,000). 2. Total cost Less: Reduction in material costs ($4,000,000 × 25%) Increase in design costs Add: Total costs of redesigned cream Revised cost per unit ($12,500,000 ÷ 400,000 units) Target cost per unit ($45 × 0.70)

$13,200,000 (1,000,000) 300,000 $12,500,000 $ 31.25 $ 31.50

The design change allows the cream to meet its goal of target costs less than 70% of revenue and target operating income greater than 30% of revenue.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. Total cost Less: Decrease in fixed manufacturing costs Less: Decrease in variable direct manufacturing costs ($1 × 400,000 units) Total costs of redesigned cream Revised cost per unit ($12,550,000 ÷ 400,000 units) Target cost per unit ($45 × 0.70)

$13,200,000 (250,000) (400,000) $12,550,000 $ 31.375 $ 31.50

Yes, this proposal does allow the company to meet its goal of target costs less than 70% of revenue and target operating income greater than 30% of revenue. 4. The company must take into account many considerations, when deciding between the preceding requirements 2 and 3. Both options meet the target costing objectives, and generate roughly similar levels of operating income. The alternative in requirement 2 will result in operating income of ($45 × 400,000) – $12,500,000 = $5,500,000. The alternative in requirement 3 will provide a slightly lower income of ($45 × 400,000) – $12,550,000 = $5,450,000. In the long run, however, there are other considerations that are important to consider if the company chooses the alternative in requirement 2 by using the chemical equivalent of the nectar obtained from the plant in South America. For example, will the nectar become more expensive in future periods? If so, could the product be reengineered at a later time or are the materials locked-in with the design for the full product life cycle. If the company chemically engineers the material, will this tarnish the quality of the product or more importantly, the company’s brand image? How might this affect the price in future periods and/or the sales of other products within the company? The answers to these questions will drive the company’s decision to consider the alternative of replacing the nectar with a chemical equivalent. Some students might point out that Westerly Cosmetics could implement both the alternatives presented in requirements 2 and 3. They could reduce the cost of direct materials by using the chemical equivalent (assuming there are no other negative effects of making this change as discussed in the previous paragraph) and reduce fixed manufacturing costs by $250,000 and variable direct manufacturing costs by $1 per unit. Assuming there are no negative effects on quality of the product from reducing fixed manufacturing and direct manufacturing labour costs, this would be a preferred alternative.

Chapter 13: Pricing Decisions: Profitability and Cost Management

13-28 1.

(30 min.)

Relevant-cost approach to pricing decisions.

Revenue (1,000 crates at $100 per crate) Variable costs: Manufacturing Marketing Total variable costs Contribution margin Fixed costs: Manufacturing Marketing Total fixed costs Operating income

$100,000 $40,000 14,000 54,000 46,000 $20,000 16,000 36,000 $ 10,000

Normal markup percentage: $46,000 ÷ $54,000 = 85.19% of total variable costs. 2. Only the manufacturing-cost category is relevant to considering this special order; no additional marketing costs will be incurred. The relevant manufacturing costs for the 200crate special order are: Variable manufacturing cost per unit $40  200 crates Special packaging Relevant manufacturing costs

$ 8,000 4,000 $12,000

Any price above $60 per crate ($12,000 ÷ 200) will make a positive contribution to operating income. Therefore, based on financial considerations, Stardom should not accept the 200crate special order at $55 per crate that will generate a loss. The reasoning based on a comparison of $55 per crate price with the $60 per crate absorption cost ignores monthly cost–volume–profit relationships. The relevant range for the fixed manufacturing costs is from 500 to 1,500 crates per month; the special order will increase production from 1,000 to 1,200 crates per month. Furthermore, the special order requires no incremental marketing costs. 3. Stardom should consider whether a strictly short-run focus is appropriate, as a price based on variable cost plus a small contribution margin is not sustainable. If the new customer wants the contract to extend over a longer time frame (or to form a long-term relationship), Stardom should negotiate a higher price.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

13-29

(25 min.)

Cost-plus and market-based pricing.

1. Georgia Temps’ full cost per hour of supplying contract labour is Variable costs Fixed costs ($168,000 ÷ 84,000 hours) Full cost per hour

$13 2 $15

Price per hour at full cost plus 20% = $15  1.20 = $18 per hour. 2. Contribution margins for different prices and demand realizations are as follows:

Price per Hour (1) $16 17 18 19 20

Variable Cost per Hour (2) $13 13 13 13 13

Contribution Margin per Hour (3) = (1) – (2) $3 4 5 6 7

Demand in Hours (4) 124,000 104,000 84,000 74,000 61,000

Total Contribution (5) = (3) × (4) $372,000 416,000 420,000 444,000 427,000

Fixed costs will remain the same regardless of the demand realizations. Fixed costs are, therefore, irrelevant because they do not differ among the alternatives. The table above indicates that Georgia Temps can maximize contribution margin ($444,000) and operating income by charging a price of $19 per hour. 3. The cost-plus approach to pricing in requirement 1 does not explicitly consider the effect of prices on demand. The approach in requirement 2 models the interaction between price and demand and determines the optimal level of profitability using concepts of relevant costs. The two different approaches lead to two different prices in requirements 1 and 2. As the chapter describes, pricing decisions should consider both demand or market considerations and supply or cost factors. The approach in requirement 2 is the more balanced approach. In most cases, of course, managers use the cost-plus method of requirement 1 as only a starting point. They then modify the cost-plus price on the basis of market considerations— anticipated customer reaction to alternative price levels and the prices charged by competitors for similar products.

Chapter 13: Pricing Decisions: Profitability and Cost Management

13-30 (35 min.)

Pricing of a special order.

1. Fane Industries has a maximum capacity of 350,000 units. The production flow is as follows: Beginning inventory 5,000 Maximum production 350,000 Goods available 355,000 Special order needs 50,000 Available for regular customers 305,000 Required for regular customers 325,000 Lost sales 20,000 Less recovery of lost sales in future months (30%) 6,000 Total lost sales 14,000 Sales to regular customers earn a contribution margin of $23 compared to the $9 contribution margin earned on the special order: Regular Sales Special Order Selling price $70.00 $52.00 Variable manufacturing costs $35.00 $35.00 Variable selling costs $12.00 $8.00 Contribution margin $23.00 $9.00 If the special order is accepted: The company will lose: 14,000 units @ CM of $23/unit or $322,000 And the company will gain: 50,000 units @ CM of $9/unit or $450,000 The order should be accepted for a net benefit of $128,000 (= $450,000 – $322,000). 2. The minimum price that should be accepted is based on incremental outlay cost plus the opportunity cost: The outlay cost is $35 + $8 = $43 The opportunity cost in total is $322,000 (from above) This cost expressed on a per unit basis is $322,000/50,000 = $6.44 The minimum price for the order is $43.00 + $6.44 = $49.44 Proof: Total CM on special order with selling price of $49.44 = ($49.44 – $35.00 – $8.00) * 50,000 = $322,000 3. Factors to consider in pricing special orders:  What will be the response of existing customers?  What will be the response of the competition?  What impact is there on employees and production (maintenance schedules)?  Will this customer order in the future?  How accurate is the estimate of the recovery of lost sales? Copyright © 2022 Pearson Canada Inc. 13-23

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

13-31

(25–30 min.)

Life-cycle costing.

1. Projected Life Cycle Income Statement Revenue [$500 × (16,000 + 4,800)] Variable costs: Production [$225 × (16,000 + 4,800)] Distribution [($20 × 16,000) + ($22 × 4,800)] Contribution margin Fixed costs: Design costs Production ($9,000 × 48 mos.) Marketing [($3,000 × 32 mos.) + ($1,000 × 16 mos.)] Distribution [($2,000 × 32 mos.) + ($1,000 × 16 mos.)] Life cycle operating income Average profit per desk =

$10,400,000 4,680,000 425,600 5,294,400 700,000 432,000 112,000 80,000 $ 3,970,400

$3,970, 400  $190.88 (16, 000  4,800)

2. Projected Life Cycle Income Statement Revenue ($400 × 16,000) Variable costs: Production ($225 × 16,000) Distribution ($20 × 16,000) Contribution margin Fixed costs: Design costs Production ($9,000 × 32 mos.) Marketing ($3,000 × 32 mos.) Distribution ($2,000 × 32 mos.) Life cycle operating income

$6,400,000 3,600,000 320,000 2,480,000 700,000 288,000 96,000 64,000 $1,332,000

The new desk design is still profitable even if FFM drops the product after only 32 months of production. However, the operating income per unit falls to only $83.25 ($1,332,000/16,000 desks) per desk.

Chapter 13: Pricing Decisions: Profitability and Cost Management

3. Life cycle operating income (requirement 2) Additional fixed production costs ($9,000 × 16 mos.) Revised life cycle operating income

$1,332,000 144,000 $1,188,000

No, the answer does not change even if FFM continues to incur the fixed production costs for the full 48 months. The revised operating income for the new executive desk becomes $1,188,000, which translates  $1,188, 000  into $74.25  operating income per desk.  16, 000 desks 

13-32

(30 min.)

Airline pricing, considerations other than cost in pricing.

1. If the fare is $500, a. Snowbound Air would expect to have 200 business and 100 pleasure travellers. b. Variable costs per passenger would be $80. c. Contribution margin per passenger = $500 – $80 = $420. If the fare is $2,000, a. Snowbound Air would expect to have 190 business and 20 pleasure travellers. b. Variable costs per passenger would be $180. c. Contribution margin per passenger = $2,000 – $180 = $1,820. Contribution margin from business travellers at prices of $500 and $2,000, respectively, follow: At a price of $500: $420 × 200 passengers = $ 84,000 At a price of $2,000: $1,820 × 190 passengers = $345,800 Snowbound Air would maximize contribution margin and operating income by charging business travellers a fare of $2,000. Contribution margin from pleasure travellers at prices of $500 and $2,000, respectively, follow: At a price of $500: $420 × 100 passengers = $42,000 At a price of $2,000: $1,820 × 20 passengers = $36,400 Snowbound Air would maximize contribution margin and operating income by charging pleasure travellers a fare of $500. Snowbound Air would maximize contribution margin and operating income by a price differentiation strategy, where business travellers are charged $2,000 and pleasure travellers $500. In deciding between the alternative prices, all other costs such as fuel costs, allocated annual lease costs, allocated ground services costs, and allocated flight crew salaries are irrelevant. Why? Because these costs will not change whatever price Snowbound Air chooses to charge.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. The elasticity of demand of the two classes of passengers drives the different demands of the travellers. Business travellers are relatively price insensitive because they must get to their destination during the week (exclusive of weekends) and their fares are paid by their companies. A 300% increase in fares from $500 to $2,000 will deter only 5% of the business passengers from flying with Snowbound Air. In contrast, a similar fare increase will lead to an 80% drop in pleasure travellers who are paying for their own travels, unlike business travellers, and who may have alternative vacation plans they could pursue instead. 3. Since business travellers often want to return within the same week, while pleasure travellers often stay over weekends, a requirement that a Saturday night stay is needed to qualify for the $500 discount fare would discriminate between the passenger categories. This price discrimination is legal because airlines are service companies rather than manufacturing companies and because these practices do not, nor are they intended to, destroy competition.

13-33

(20 min.)

Ethics and pricing.

1. The $600 spent on the basketball tickets is a sunk (past) cost and is, therefore, irrelevant to the bid decision. Insight will incur the $600 cost whether it bids, loses the bid, or wins the bid. 2. If the target price is $156,000 and the markup is 20% of full cost, the target full cost is $130,000 ($156,000 ÷ 1.20). The difference in full cost is $8,000 ($138,000 − $130,000). Therefore, the target cost of furniture and artwork is $62,000 ($70,000 − $8,000). There are four model homes in the job, so the target cost of furniture and artwork per home equals $15,500 ($62,000 ÷ 4) versus the $17,500 ($70,000 ÷ 4) currently being planned to be spent on each home. 3. It was unethical for Doogan to use the basketball tickets to get the tip out of the developer. Knowing about Doogan’s action and suggesting a way to use it is unethical on the part of Groom. In assessing the situation, ethical considerations an accountant should consider are: 1. Accountants have a responsibility to avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict. Using unethically gathered information to compromise a sealed bid arrangement is clearly a violation of this standard. Both Doogan’s and Groom’s behaviour could be viewed as unethical. 2. Accountants are required to fairly and objectively communicate all relevant information should be disclosed. From a management accountant’s standpoint, revising a bid based on this kind of information violates both of these precepts. Doogan and Groom should leave the bid as it was originally produced, without using the unethically obtained inside information. The company should clarify its policy on business entertainment.

Chapter 13: Pricing Decisions: Profitability and Cost Management

COLLABORATIVE LEARNING CASE 13-34 (40–50 min.) Target prices, target costs, value engineering. 1. Activity-based allocation of overhead costs: Tvez

Units of Cost Drivers (3)

Cost Allocation (4) = (3)  Rate/Hour

 (100a  15hrs)

$ 45,000

 (125b  18hrs)

$ 67,500

 (50,000  2.5hrs)

300,000 200,000

 (25,000  5 hrs)

300,000 280,000

Units of Cost Drivers (1) Machine setup costs: $30/setup hr. Testing costs: $2.40/testing hr. Engineering costs Total ABC overhead allocation

Premia Cost Allocation (2) = (1)  Rate/Hour

$545,000

$647,500

a50,000 units/500 units per batch = 100 batches b25,000 units/200 units per batch = 125 batches

Activity-based full-product costs of Tvez and Premia are as follows: Tvez $1,020,000 360,000 180,000 45,000 300,000 200,000 $2,105,000 50,000 $42.10

Direct materials costs Direct manufacturing labour costs Direct machine costs Machine setup costs Testing costs Engineering costs Total manufacturing and full product costs Number of units Full product cost per unit

Premia $ 720,000 240,000 120,000 67,500 300,000 280,000 $1,727,500 25,000 $69.10

Selling price Full product cost Full product cost = ($52.50 – $42.10)/$42.10 = 24.7%

2. Markup on full product cost per unit of Tvez =

3. The target price for New Tvez is $48.00. Suppose the target cost per unit of New Tvez is $X. Then $X(1.27) = $48.00 = $48.00/1.27 = $37.80

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4. Activity-based costs of New Tvez are as follows: Direct materials ($20.40 – $2.50)  50,000 units Direct manufacturing labour ($7.20 – $0.70)  50,000 units Direct machining* (fixed) Machine setup costs (7 hours  100 setups  $30 per setup hour) Testing costs (2.5 hours – 0.5 hours)  50,000  $2.40 Engineering costs (same as for Tvez) Manufacturing and full product costs Number of units Manufacturing and full product costs per unit

$ 895,000 325,000 180,000 21,000 240,000 200,000 $1,861,000 50,000 $ 37.22

*Machining costs are long-run fixed costs and so will not change even though it requires 20 fewer minutes to make each unit of New Tvez. The New Tvez design will reduce the manufacturing costs per unit by $4.88 ($42.10 – $37.22). The $37.22 cost is less than the target cost of $40.00 5.

$37.22 × 1.27= $47.27

6. Avery should charge the target price of $48.00 to maintain its market of 50,000 units. If it uses the cost-plus price of $52.50, Avery risks losing some of its market share for New Tvez. Avery should strive to further reduce costs and achieve its target cost, either by changing the design to reduce cost drivers more, or by reducing the costs per unit of the cost driver.

CHAPTER 14 STRATEGY, THE BALANCED SCORECARD, AND PROFITABILITY ANALYSIS MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

SHORT-ANSWER QUESTIONS 14-1

Strategy specifies how an organization matches its own capabilities with the opportunities in the marketplace to accomplish its objectives.

14-2

The five key forces to consider in industry analysis are: (a) competitors, (b) potential entrants into the market, (c) equivalent products, (d) bargaining power of customers, and (e) bargaining power of input suppliers.

14-3

Two generic strategies are (1) value leadership (product differentiation), an organization’s ability to offer products or services perceived by its customers to be superior and unique relative to the products or services of its competitors, and (2) cost leadership, an organization’s ability to achieve lower costs relative to competitors through productivity and efficiency improvements, elimination of waste, and tight cost control.

14-4

A customer preference map describes how different competitors perform across various product attributes desired by customers, such as price, quality, customer service, and product features.

14-5

Reengineering is the fundamental rethinking and redesign of business processes to achieve improvements in critical measures of performance such as cost, quality, service, speed, and customer satisfaction.

14-6

The four key perspectives in the balanced scorecard are: (1) Financial perspective, which evaluates the profitability of the strategy, (2) Customer perspective, which identifies the targeted customer and market segments and measures the company’s success in these segments, (3) Internal business process perspective, which focuses on internal operations that further both the customer perspective by creating value for customers and the financial perspective by increasing shareholder value, and (4) Learning and growth perspective, which identifies the capabilities the organization must excel at to achieve superior internal processes that create value for customers and shareholders.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

14-7

A strategy map represents more detailed and specific cause-and-effect relationships across various scorecard measures. It describes specific links across the measures.

14-8

A good balanced scorecard design has several features:

1. It tells the story of a company’s strategy by articulating a sequence of cause-and-effect relationships. 2. It helps to communicate the strategy to all members of the organization by translating the strategy into a coherent and linked set of understandable and measurable operational targets. 3. It places strong emphasis on financial objectives and measures in for-profit companies. Nonfinancial measures are regarded as part of a program to achieve future financial performance. 4. It limits the number of measures to only those that are critical to the implementation of strategy. 5. It highlights suboptimal tradeoffs that managers may make when they fail to consider operational and financial measures together.

14-9

Pitfalls to avoid when implementing a balanced scorecard are:

1. Don’t assume the cause-and-effect linkages are precise; they are merely hypotheses. An organization must gather evidence of these linkages over time. 2. Don’t seek improvements across all of the measures all of the time. 3. Don’t use only objective measures in the balanced scorecard. 4. Don’t fail to consider both costs and benefits of different initiatives before including these initiatives in the balanced scorecard. 5. Don’t ignore nonfinancial measures when evaluating managers and employees. 6. Don’t use too many measures.

14-10 Three key components in doing a strategic analysis of operating income are: 1. The growth component, which measures the change in operating income attributable solely to the change in quantity of output sold from one year to the next. 2. The price-recovery component, which measures the change in operating income attributable solely to changes in the prices of inputs and outputs from one year to the next. 3. The productivity component, which measures the change in costs attributable to a change in the quantity and mix of inputs used in the current year relative to the quantity and mix of inputs that would have been used in the previous year to produce current year output.

14-11 A stakeholder might not have a financial interest in what the corporation accomplishes. A shareholder has a financial interest.

14-12 Engineered costs result from a cause-and-effect relationship between the cost driver, output, and (direct or indirect) resources used to produce that output. Discretionary costs arise from periodic (usually annual) decisions regarding the maximum amount to be incurred. There is no measurable cause-and-effect relationship between output and resources used.

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

14-13 Downsizing (also called rightsizing) is an integrated approach configuring processes, products, and people to match costs to the activities that need to be performed for operating effectively and efficiently in the present and future. Downsizing is an attempt to eliminate unused capacity.

14-14 No. Total factor productivity (TFP) and partial productivity measures work best together because the strengths of one offset weaknesses in the other. TFP measures are comprehensive, consider all inputs together, and explicitly consider economic substitution among inputs. Physical partial productivity measures are easier to calculate and understand and, as in the case of labour productivity, relate directly to employees’ tasks. Partial productivity measures are also easier to compare across different plants and different time periods.

EXERCISES 14-15 (10 min.)

Terminology.

1. Any management team must understand how it creates value for its customers and decide how to accomplish this goal better than all its competitors. This is a decision about strategy. For exciting new products and products with no substitutes, consumers are willing to pay a premium price. 2. Focusing on inventing and commercializing products with unique attributes is a value leadership (or product differentiation) strategy. 3. For most mass-produced products sold by many competitors, consumers readily find substitutes. Cost leadership is the alternative strategy that improves profitability and ROI through economies of scale and economies of scope. 4. Usually this means the management team will work on increasing the quantity of output using the same capacity. The fixed cost per unit produced will decrease and, if price is fixed, then profit will increase. Often cost leadership (or reduction) is achieved by reengineering the production process. Growth can also be achieved by producing similar but not identical products and this is organic revenue growth that provides economies of scope. 5. Competitive advantage is identified by a resource or set of resources available to a company that enable it to execute its business activities more profitably than other competitors. Management teams must align the choice of strategy with the competitive advantage to implement a strategy well. The resources that provide competitive advantage are called key success factors (KSF) 6. To obtain feedback on how successful the implementation of strategy is, a balanced scorecard (BSC) is often used. The BSC is the foundation of more technologically intensive enterprise risk management (ERM) systems. 7. The BSC and ERM require refined cost reporting systems. The BSC measures success from four perspectives: customer perspective, internal process perspective, learning/growth, and of course financial perspective The BSC approach provides a more detailed basis upon which to evaluate the success of implementation of strategy.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

14-16 (15 min.)

Balanced scorecard.

1. La Flamme’s 2021 strategy is a cost leadership strategy. La Flamme plans to grow by producing high-quality boxes at a low cost delivered to customers in a timely manner. La Flamme’s boxes are not differentiated, and there are many other manufacturers who produce similar boxes. To succeed, La Flamme must produce high-quality boxes at lower costs relative to competitors through productivity and efficiency improvements. 2. Solution Exhibit 14-16A shows the customer preference map for corrugated boxes for La Flamme and Portage on price, timeliness, quality, and design. SOLUTION EXHIBIT 14-16A Customer Preference Map for Corrugated Boxes

3. Measures that we would expect to see on a La Flamme’s balanced scorecard for 2021 are Financial Perspective (1) Operating income from productivity gain, (2) operating income from growth, (3) cost reductions in key areas. These measures evaluate whether La Flamme has successfully reduced costs and generated growth through cost leadership.

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

Customer Perspective (1) Market share in corrugated boxes market, (2) new customers, (3) customer satisfaction index. The logic is that improvements in these customer measures are leading indicators of whether La Flamme’s cost leadership strategy is succeeding with its customers and helping it to achieve superior financial performance. Internal Business Process Perspective (1) Productivity, (2) order delivery time, (3) on-time delivery, (4) number of major process improvements. Improvements in these measures are key drivers of achieving cost leadership and are expected to lead to more satisfied customers and in turn to superior financial performance. Learning and Growth Perspective (1) Percentage of employees trained in process and quality management, (2) employee satisfaction. Improvements in these measures aim to improve La Flamme’s ability to achieve cost leadership and have a cause-and-effect relationship with improvements in internal business processes, which in turn lead to customer satisfaction and financial performance. Solution Exhibit 14-16B presents the strategy for La Flamme for 2021.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 14-16B Strategy Map for La Flamme for 2021

Operating income from productivity gain

FINANCIAL PERSPECTIVE

Cost reduction in key areas

CUSTOMER PERSEPCTIVE

Customer satisfaction

Number of new customers

Productivity

Quality

INTERNALBUSINESSPROCESS PERSEPCTIVE

LEARNING-ANDGROWTH PERSEPCTIVE

14-17 (20 min.)

On-time delivery

Employeesatisfaction ratings

Operating income from growth

Market share in corrugated boxes market

Number of major improvements in manufacturing process

Percentage of employees trained in process and quality management

Analysis of growth, price-recovery, and productivity components.

1. La Flamme’s operating income gain is consistent with the cost leadership strategy identified in requirement 1 of Exercise 14-16. The increase in operating income in 2022 was driven by the $180,000 gain in productivity. La Flamme took advantage of its productivity gain to reduce the prices of its boxes and to fuel growth. It increased market share by growing even though the total market size was unchanged. 2. The productivity component measures the change in costs attributable to a change in the quantity and mix of inputs used in a year relative to the quantity and mix of inputs that would have been used in a previous year to produce the current year output. It measures the amount by which operating income increases and costs decrease through the productive use of input quantities. When comparing productivities across years, the productivity calculations use current year input prices in all calculations. Hence, the productivity component is unaffected by input price changes. The productivity component represents savings in both variable costs and fixed costs. With respect to variable costs, such as direct materials, productivity improvements immediately translate into cost savings. In the case of fixed costs, such as fixed manufacturing conversion costs, productivity gains result only if management takes actions to reduce unused capacity. For example, reengineering manufacturing processes will Copyright © 2022 Pearson Canada Inc. 14-6

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

decrease the capacity needed to produce a given level of output, but it will lead to a productivity gain only if management reduces the unused capacity by, say, selling off the excess capacity.

14-18 (15 min.)

Strategy, balanced scorecard.

1. Grey Corporation follows a value leadership (product differentiation) strategy in 2022. Grey’s D4H machine is distinct from its competitors and generally regarded as superior to competitors’ products. To succeed, Grey must continue to differentiate its product and charge a premium price. 2. Balanced scorecard measures for 2022 follow: Financial Perspective (1) Increase in operating income from charging higher margins, (2) price premium earned on products. These measures indicate whether Grey has been able to charge premium prices and achieve operating income increases through value leadership. Customer Perspective (1) Market share in high-end special-purpose textile machines, (2) customer satisfaction, (3) new customers. Grey’s strategy should result in improvements in these customer measures that help evaluate whether Grey’s value leadership strategy is succeeding with its customers. These measures are leading indicators of superior financial performance. Internal Business Process Perspective (1) Manufacturing quality, (2) new product features added, (3) order delivery time. Improvements in these measures are expected to result in more distinctive products delivered to its customers and in turn superior financial performance. Learning and Growth Perspective (1) Development time for designing new machines, (2) improvements in manufacturing processes, (3) employee education and skill levels, (4) employee satisfaction. Improvements in these measures are likely to improve Grey’s capabilities to produce distinctive products that have a cause-and-effect relationship with improvements in internal business processes, which in turn lead to customer satisfaction and financial performance.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

14-19 (30 min.)

Strategic analysis of operating income. Refer to the information in Exercise 14-18.

1. Operating income for each year is as follows: 2021 $8,000,000

2022 $8,820,000

Revenue ($40,000  200; $42,000  210) Costs Direct materials costs ($8  300,000; $8.50  310,000) 2,400,000 2,635,000 Manufacturing conversion costs ($8,000  250; 8,100  250) 2,000,000 2,025,000 Selling & customer service costs ($10,000  100; $9,900  95) 1,000,000 940,500 Design costs ($100,000  12; $101,000  12) 1,200,000 1,212,000 Total costs 6,600,000 6,812,500 Operating income $1,400,000 $2,007,500 Change in operating income $607,500 F 2. The Growth Component Revenue Actual units Actual units of  effect of   of output  output sold in  Selling price  in 2021 growth  2021 sold in 2022      (210 200)  $40, 000  $400, 000 F Cost effect of Units required to Actual units of    Input price in growth for  produce 2022  inputs used to output in 2021 produce 2021 output  2021 variable costs     Actual units of capacity in 2021   if adequate to produce 2022    output in 2021   Price per unit Cost effect of OR Actual units of   growth for fixed     of capacity in If 2021 capacity is inadequate to capacity in 2021  costs 2021  produce 2022 output in 2021,     units of capacity required to   produce 2022 output in 2021   

Direct materials costs that would be required in 2022 to produce 210 units instead of the 200 units produced in 2021, assuming the 2021 input–output relationship continued into 300,000 2022, equal 315,000 kilograms (  210). Manufacturing conversion costs and 200 selling and customer-service costs will not change since adequate capacity exists in 2021 to support year 2022 output and customers. R&D costs are discretionary costs and would not change in 2021 if Grey had to produce and sell the higher 2022 volume in 2022.

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

The cost effects of growth component are: Direct materials costs (315,000  300,000)  $8 = $120,000 U Manufacturing conversion costs (250  250)  $8,000 = 0 Selling & customer-service costs (100  100)  $10,000 = 0 Design costs (12-12)  $100,000 = 0 Cost effect of growth $120,000 U In summary, the net increase in operating income as a result of the growth component equals: Revenue effect of growth $400,000 F Cost effect of growth 120,000 U Change in operating income due to growth $280,000 F The Price-Recovery Component

Revenue Actual units effect of  Selling price Selling price in     of output sold price 2021  in 2022  in 2022 recovery  ($42, 000 $40, 000)  210  $420, 000 F Cost effect of Units of input price recovery Input price in Input price in  required to produce    2022 output in for variable 2021  2022  costs 2021 Actual units of capacity in 2021 if adequate to produce 2022 output in 2021 Cost effect of Price per unit Price per unit  OR price recovery  of capacity in of capacity in    If 2021 capacity is inadequate to for fixed costs  2022 2021  produce 2022 output in 2021, units of capacity required to produce 2022 output in 2021 Direct materials costs ($8.50  $8)  315,000 = $157,500 U Manufacturing conversion costs ($8,100  $8,000)  250 = 25,000 U Selling & customer-service costs ($9,900  $10,000)  100 = 10,000 F Design costs ($101,000  $100,000)  12 = 12,000 U Cost effect of price-recovery $184,500 U

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

In summary, the net increase in operating income as a result of the price-recovery component equals: Revenue effect of price-recovery Cost effect of price-recovery Change in operating income due to price-recovery

$420,000 F 184,500 U $235,500 F

The Productivity Component

Actual units of Units of input  Cost effect of  input used to required to  Input price in productivity for     produce 2022 produce 2022  2022  variable costs   output output in 2021   Actual units of capacity in 2021    if adequate to produce 2022    output in 2021  Price per unit Cost effect of Actual units of OR   of capacity in productivity for   capacity in  If 2021 capacity is inadequate  fixed costs 2022 2022  to produce 2022 output in 2021,    units of capacity required to    produce 2022 output in 2021    The productivity component of cost changes are: Direct materials costs (310,000  315,000) Manufacturing conversion costs (250  250) Selling & customer-service costs (95  100) Design costs (12  12) Change in operating income due to productivity

 $8.50  $8,100  $9,900  $101,000

= = = =

$42,500 F 0 49,500 F 0 $92,000 F

The change in operating income between 2021 and 2022 can be analyzed as follows: Revenue and Revenue and Cost Effect Income Income Cost Effects Cost Effects of of Statement Statement of Growth Price-Recovery Productivity Amounts Amounts Component Component Component in 2022 in 2021 in 2022 in 2022 in 2022 (5) = (1) + (2) + (1) (2) (3) (4) (3) + (4)  Revenues $8,000,000 $400,000 F $420,000 F $8,820,000 Costs 6,600,000 120,000 U 184,500 U $92,000 F 6,812,500 Operating income $1,400,000 $280,000 F $235,500 F $92,000 F $2,007,500 $607,500 F Change in operating income

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

3. The analysis of operating income indicates that a significant amount of the increase in operating income resulted from Grey’s value leadership strategy. The company was able to continue to charge a premium price while growing sales. Grey was also able to earn additional operating income by improving its productivity.

14-20

(20 min.)

Analysis of growth, price-recovery, and productivity components. Continuation of Exercise 14-19.

Effect of the industry market-size factor on operating income Of the 10-unit increase in sales from 200 to 210 units, 3% or 6 (= 3%  200) units are due to growth in market size, and 4 (= 10 – 6) units are due to an increase in market share. The change in Grey’s operating income from the industry market-size factor rather than from specific strategic actions is: 6 $280,000 (the growth component in Exercise 14-19)  $168,000 F 10 Effect of value leadership (product differentiation) on operating income The change in operating income due to: Increase in the selling price of D4H (revenue effect of price recovery) $420,000 F Increase in price of inputs (cost effect of price recovery) 184,500 U Growth in market share due to value leadership 4 $280,000 (the growth component in Exercise 14-19)  112,000 F 10 Change in operating income due to value leadership $347,500 F Effect of cost leadership on operating income The change in operating income from cost leadership is: Productivity component

$ 92,000 F

The change in operating income between 2021 and 2022 can be summarized as follows: Change due to industry market-size Change due to value leadership Change due to cost leadership Change in operating income

$168,000 F $347,500 F 92,000 F $607,500 F

Grey has been successful in implementing its value leadership strategy. More than 57% (= $347,500  $607,500) of the increase in operating income during 2022 was due to value leadership, i.e., the distinctiveness of its machines. It was able to raise the prices of its machines faster than the costs of its inputs and still grow market share. Grey’s operating income increase in 2022 was also helped by a growth in the overall market and some productivity improvements.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

14-21 (15 min.)

Identifying and managing unused capacity.

1. The amount and cost of unused capacity at the beginning of year 2022 based on year 2022 production follows:

Manufacturing, 250 – 210; (250 – 210)  $8,100 Selling and customer service, 95 – 80; (95 – 80)  $9,900 Design

Amount of Unused Capacity 40 15 Discretionary cost, so cannot determine unused capacity*

Cost of Unused Capacity $324,000 148,500 Discretionary cost so cannot be calculated*

*The absence of a cause-and-effect relationship makes identifying unused capacity for discretionary costs difficult. Management cannot determine the R&D resources used for the actual output produced to compare R&D capacity against. 2. Grey can reduce manufacturing capacity from 250 units to 220 (= 250  30) units. Grey will save 30  $8,100 = $243,000. This is the maximum amount of costs Grey can save in 2022. It cannot reduce capacity further (by another 30 units to 190 units) because it would then not have enough capacity to manufacture 210 units in 2022 (units that contribute significantly to operating income). 3. Grey may choose not to downsize because it projects sales increases that would lead to a greater demand for and utilization of capacity. Grey may have also decided not to downsize because downsizing requires a significant reduction in capacity. For example, Grey may have chosen to downsize some more manufacturing capacity if it could do so in increments of, say, 10 rather than 30 units. Also, Grey may be focused on value leadership, which is key to its strategy, rather than on cost reduction. Not reducing significant capacity also helps to boost and maintain employee morale.

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

14-22 (20–30 min.)

Balanced scorecard.

Perspectives  Financial

Strategic Objectives  Increase shareholder value  Increase profit generated by each salesperson

Performance Measures  Earnings per share  Net income  Return on assets  Return on sales  Return on equity  Product cost per unit  Customer cost per unit  Profit per salesperson  Number of new customers  Percentage of customers retained  Customer profitability

 Customer

 Acquire new customers  Retain customers  Develop profitable customers

 Internal Business Process

 Improve manufacturing quality  Introduce new products  Minimize invoice error rate  Increase on-time delivery by suppliers  Increase proprietary products  Increase information system capabilities

 Percentage of defective product units  Percentage of error-free invoices  Percentage of on-time deliveries by suppliers  Number of patents  Percentage of processes with real-time feedback

 Learning and Growth

 Enhance employee skills

 Average job-related training hours per employee  Employee turnover rate

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

14-23 (15 min.)

Strategy, balanced scorecard, service company.

1. Haller Corporation’s strategy in 2022 is cost leadership. Haller’s consulting services for implementing sales management software are not distinct from its competitors’. The market for these services is very competitive. To succeed, Haller must deliver quality service at low cost. Improving productivity while maintaining quality is key. 2. Balanced scorecard measures for 2022 follow: Financial Perspective (1) Increase operating income from productivity gains and growth, (2) increase revenue per employee, (3) reduce costs in key areas, for example, software implementation and overhead costs. These measures indicate whether Haller has been able to reduce costs and achieve operating income increases through cost leadership. Customer Perspective (1) Market share, (2) new customers, (3) customer responsiveness, (4) customer satisfaction. Haller’s strategy should result in improvements in these customer measures that help evaluate whether Haller’s cost leadership strategy is succeeding with its customers. These measures are leading indicators of superior financial performance. Internal Business Process Perspective (1) Time to complete customer jobs, (2) time lost due to errors, (3) quality of job (is system running smoothly after job is completed?) Improvements in these measures are key drivers of achieving cost leadership and are expected to lead to more satisfied customers, lower costs, and superior financial performance. Learning and Growth Perspective (1) Time required to analyze and design implementation steps, (2) time taken to perform key steps implementing the software, (3) skill levels of employees, (4) hours of employee training, (5) employee satisfaction and motivation. Improvements in these measures are likely to improve Haller’s ability to achieve cost leadership and have a cause-and-effect relationship with improvements in internal business processes, customer satisfaction, and financial performance.

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

14-24 (30 min.)

Strategic analysis of operating income. Refer to the information in Exercise 14-23.

1. Operating income for each year is as follows: Revenue ($50,000  60; $48,200  70) Costs Software implementation labour costs ($60  30,000; $63  32,000) Software implementation support costs ($4,000  90; $4,100  90) Software development costs ($125,000  3; $130,000  3) Total costs Operating income Change in operating income

2021 $3,000,000

2022 $3,374,000

1,800,000

2,016,000

360,000

369,000

375,000 390,000 2,535,000 2,775,000 $ 465,000 $ 599,000 $134,000 F

2. The Growth Component Revenue Actual units Actual units  Selling price effect of   of output  of output    in 2021 growth  sold in 2022 sold in 2021  (70 60)  $50, 000  $500, 000 F Cost effect of Units required to inputs used to  Input price in growth for   produce 2022 produce 2021  2021   variable costs output output in 2021  Actual units of capacity in 2021   if adequate to produce 2022    output in 2021   Price per unit Cost effect of OR Actual units of   growth for fixed     of capacity in If 2021 capacity is inadequate to capacity in 2021  costs 2021  produce 2022 output in 2021,     units of capacity required to   produce 2022 output in 2021   

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Software implementation labour costs that would be required in 2022 to produce 70 units instead of the 60 units produced in 2021, assuming the 2021 input–output relationship 30, 000 continued into 2022, equal 35,000 (=  70) labour-hours. Software 60 implementation support costs would not change since adequate capacity exists in 2021 to support year 2022 output and customers. Software development costs are discretionary costs not directly related to output and, hence, would not change in 2021 even if Haller had to produce and sell the higher year 2022 output in 2021. The cost effects of growth component are Software implementation labour costs (35,000 – 30,000)  $60 = $300,000 U Software implementation support costs (90 – 90)  $4,000 = 0 Software development costs (3 – 3)  $125,000 = 0 Cost effect of growth $300,000 U In summary, the net increase in operating income as a result of the growth component equals: Revenue effect of growth Cost effect of growth Change in operating income due to growth

$500,000 F 300,000 U $200,000 F

The Price-Recovery Component

Revenue Actual units effect of  Selling price Selling price in     of output sold price 2021  in 2022  in 2022 recovery  ($48, 200 $50, 000)  70  $126, 000 U Cost effect of Units of input price recovery Input price in Input price in  required to produce    2022 output in for variable 2021  2022  costs 2021 Actual units of capacity in 2021 if adequate to produce 2022 output in 2021 Cost effect of Price per unit Price per unit  OR price recovery  of capacity in of capacity in    If 2021 capacity is inadequate to for fixed costs  2022 2021  produce 2022 output in 2021, units of capacity required to produce 2022 output in 2021

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

Software implementation labour costs ($63 – $60)  35,000 Software implementation support costs ($4,100 – $4,000)  90 Software development costs ($130,000 – $125,000)  3 Cost effect of price recovery

= = =

$105,000 U 9,000 U 15,000 U $129,000 U

In summary, the net decrease in operating income as a result of the price-recovery component equals: Revenue effect of price-recovery $126,000 U Cost effect of price-recovery 129,000 U Change in operating income due to price recovery $255,000 U The Productivity Component

Actual units of Units of input  Cost effect of  input used to required to  Input price in productivity for     produce 2022 produce 2022 2022  variable costs   output  output in 2021  Actual units of capacity in 2021    if adequate to produce 2022    output in 2021   Price per unit Cost effect of Actual units of OR   of capacity in productivity for   capacity in  If 2021 capacity is inadequate  fixed costs 2022 2022   to produce 2022 output in 2021,   units of capacity required to    produce 2022 output in 2021   

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

The productivity component of cost changes are: Software implementation labour costs (32,000 – 35,000)  $63 Software implementation support costs (90 – 90)  $4,100 Software development costs (3 – 3)  $130,000 Change in operating income due to productivity

= $189,000 F = 0 = 0U $189,000 F

The change in operating income between 2021 and 2022 can be analyzed as follows:

Revenue

Income Statement Amounts in 2021 (1) $3,000,000

Revenue and Cost Effects of Growth Component in 2022 (2) $500,000 F

Revenue and Income Cost Effects of Cost Effect of Statement Price-Recovery Productivity Amounts Component Component in 2022 in 2022 in 2022 (5) = (3) (4) (1) + (2) + (3) + (4) $126,000 U $3,374,000 

Costs

2,535,000

300,000 U

129,000 U

$189,000 F

2,775,000

Operating income

$ 465,000

$200,000 F

$255,000 U

$189,000 F

$ 599,000

$134,000 F Change in operating income

3. The analysis of operating income indicates that a significant amount of the increase in operating income resulted from Haller’s productivity improvements in 2022. The company had to reduce selling prices while labour costs were increasing but it was able to increase operating income by improving its productivity. The productivity gains also allowed Haller to be competitive and grow the business. The unfavourable price recovery component indicates that Haller could not pass on increases in labour-related wages via price increases to its customers, very likely because its product was not differentiated from competitors’ offerings.

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

14-25 (25 min.)

Analysis of growth, price-recovery, and productivity components. Continuation of Exercise 14-24.

Effect of industry-market-size factor on operating income Of the 10-unit increase in sales from 60 to 70 units, 5% or 3 units (= 5%  60) are due to growth in market size, and 7 (= 10  3) units are due to an increase in market share. The change in Haller’s operating income from the industry market-size factor rather than from specific strategic actions is: 3 $200,000 (the growth component in Exercise 14-24)  $ 60,000 F 10 Effect of value leadership (product differentiation) on operating income Of the $1,800 decrease in selling price, 1% or $500 (= 1%  $50,000) is due to a general decline in prices, and the remaining decrease of $1,300 (= $1,800  $500) is due to a strategic decision by Haller’s management to implement its cost leadership strategy of lowering prices to stimulate demand. The change in operating income due to a decline in selling price (other than the strategic reduction in price included in the cost leadership component) $500  70 units $ 35,000 U Increase in prices of inputs (cost effect of price recovery) 129,000 U Change in operating income due to value leadership $164,000 U Effect of cost leadership on operating income Productivity component $189,000 F Effect of strategic decision to reduce selling price, $1,300  70 91,000 U Growth in market share due to productivity improvement and strategic decision to reduce selling price 7 $200,000 (the growth component in Exercise 14-24)  140,000 F 10 Change in operating income due to cost leadership $238,000 F The change in operating income between 2021 and 2022 can then be summarized as Change due to industry-market-size Change due to value leadership Change due to cost leadership Change in operating income

$ 60,000 F 164,000 U 238,000 F $134,000 F

Haller has been very successful in implementing its cost leadership strategy. Due to a lack of value leadership, Haller was unable to pass along increases in labour costs by increasing the selling price—in fact, the selling price declined by $1,800 per work unit. However, Haller was able to take advantage of its productivity gains to reduce price, gain market share, and increase operating income.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

14-26 (20 min.)

Identifying and managing unused capacity.

1. The amount and cost of unused capacity at the beginning of year 2022 based on work performed in year 2022 follows: Amount of Cost of Unused Unused Capacity Capacity Software implementation support, 90  70; (90  70)  $4,100 20 $82,000 Software development Discretionary Discretionary cost, so cannot cost, so cannot determine be calculated* unused capacity* *The absence of a cause-and-effect relationship makes identifying unused capacity for discretionary costs difficult. Management cannot determine the software development resources used for the actual output produced to compare against software development capacity. 2. Haller can reduce software implementation support capacity from 90 units to 70 (= 90  20) units. Haller will save 20  $4,100 = $82,000. This is the maximum amount of costs Haller can save by downsizing in 2022. It cannot reduce capacity further (by another 5 units to 65 units) because it would then not have enough capacity to perform 70 units of work in 2022 (work that contributes significantly to operating income). 3. Haller may choose not to downsize because it projects sales increases that would lead to greater demand for and utilization of capacity. Haller may have also decided not to downsize because downsizing requires significant reduction in capacity. Not reducing significant capacity by laying employees off boosts employee morale and keeps employees more motivated and productive.

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

14-27 (45 min.)

Growth, price-recovery, and productivity components.

1. Lakeside follows a value leadership (product differentiation strategy). Lakeside

2021 Results

# of T-Shirts purchased Cost of T-Shirts Total Design Cost Design Cost /T Shirt T-Shirt Costs Total Admin Costs Total Costs # T Shirts Sold Selling Price

210,000 $ 7 210,000 $

1 $1,680,000 $1,200,000 $2,880,000

208,500 $ 28 $5,838,000

Net Revenue

$2,958,000

Net Revenue (pretax) suggest an EBIT net profit margin of 51%. Such broad margins suggest a value proposition. A pricing proposition would see a smaller margin. 2. Possible key elements of Lakeside’s balanced scorecard, given its value leadership strategy: Financial Perspective (1) Increase in operating income from charging higher margins, (2) price premium earned on products. These measures will indicate whether Lakeside has been able to charge premium prices and achieve operating income increases through value leadership. Customer Perspective (1) Market share in distinctive, name-brand T-shirts, (2) customer satisfaction, (3) new customers, (4) number of mentions of Lakeside’s T-shirts in the leading fashion magazines Lakeside’s strategy should result in improvements in these customer measures that help evaluate whether Lakeside’s value leadership strategy is succeeding with its customers. These measures are, in turn, leading indicators of superior financial performance. Internal Business Process Perspective (1) Quality of silk-screening (number of colours, use of glitter, durability of the design), (2) frequency of new designs, (3) time between concept and delivery of design Improvements in these measures are expected to result in more distinctive and trendsetting designs delivered to its customers and, in turn, superior financial performance. Copyright © 2022 Pearson Canada Inc. 14-21

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Learning and Growth Perspective (1) Ability to attract and retain talented designers (2) improvements in silk-screening processes, (3) continuous education and skill levels of marketing and sales staff, (4) employee satisfaction. Improvements in these measures are expected to improve Lakeside’s capabilities to produce distinctive designs that have a cause-and-effect relationship with improvements in internal business processes, which in turn lead to customer satisfaction and financial performance.

14-28 Strategic analysis of operating income. Continuation of Exercise 14-27. 1. Operating Income Statement Revenue ($28 × 208,500; $29 × 239,200) Costs T-shirts purchased ($7 × 210,000; $7.75 × 240,000) Administrative costs Design costs Total costs Operating income Change in operating income

2021 2022 $5,838,000 $6,936,800 1,470,000 1,860,000 1,200,000 1,225,000 210,000 220,000 2,880,000 3,305,000 $2,958,000 $3,631,800 $673,800 F

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

2. The Growth Component Revenue Actual units Actual units of  Selling price effect of   of output  output sold in    in 2021 growth  sold in 2022 2021   (239, 200 208,500)´$28  $859, 600 F Actual units of   Cost effect of Units required to inputs used to  Input price in growth for   produce 2022   produce 2021  2021  variable costs output in 2021  output   Actual units of capacity in 2021   if adequate to produce 2022    output in 2021   Price per unit Cost effect of OR Actual units of   growth for fixed     of capacity in If 2021 capacity is inadequate to capacity in 2021  costs 2021  produce 2022 output in 2021,     units of capacity required to   produce 2022 output in 2021   

Direct Materials units = 239,200/208,500  210,000 = 240,921 Administration and design capacity are adequate to support the output in 2022. The cost effects of growth component are Direct materials costs (240,921  210,000)  $7 Administrative costs (5,000 – 5,000)  $240 Design costs (5 – 5)  $42,000 Cost effect of growth

= = =

$216,447 U 0 0 $216,447 U

In summary, the net increase in operating income as a result of the growth component equals: Revenue effect of growth $859,600 F Cost effect of growth 216,447 U Change in operating income due to growth $ 643,153 F

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

The Price-Recovery Component

Revenue Actual units effect of  Selling price Selling price in     of output sold price 2021  in 2022  in 2022 recovery  ($29 $28)  239, 200  $239, 200 F Cost effect of Units of input price recovery Input price in Input price in  required to produce    2022 output in for variable 2021  2022  costs 2021 Actual units of capacity in 2021 if adequate to produce 2022 output in 2021 Cost effect of Price per unit Price per unit  OR price recovery  of capacity in of capacity in    If 2021 capacity is inadequate to for fixed costs  2022 2021  produce 2022 output in 2021, units of capacity required to produce 2022 output in 2021 Direct materials costs ($7.75  $7)  240,921 = $180,691 U Administrative costs ($245  $240)  5,000 = 25,000 U Design costs ($44,000  $42,000)  5 = 10,000 U Total cost effect of price-recovery component $215,691 U In summary, the net increase in operating income as a result of the price-recovery component equals: Revenue effect of price-recovery $239,200 F Cost effect of price-recovery 215,691 U Change in operating income due to price-recovery $23,509 F

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

The Productivity Component

Actual units of Units of input  Cost effect of  input used to required to  Input price in productivity for     produce 2022 produce 2022  2022 variable costs   output  output in 2021  Actual units of capacity in 2021    if adequate to produce 2022    output in 2021  Price per unit Cost effect of Actual units of OR   of capacity in productivity for   capacity in  If 2021 capacity is inadequate  fixed costs 2022 2022  to produce 2022 output in 2021,    units of capacity required to    produce 2022 output in 2021    The productivity component of cost changes are Direct materials costs (240,000  240,921)  Administrative costs (5,000  5,000)  Design costs (5  5)  Change in operating income due to productivity

$7.75 $245 $44,000

= = =

$ 7,138 F 0 0 $7,138 F

The change in operating income between 2021 and 2022 can be analyzed as follows: Income Revenue and Statement Cost Effects of Cost Effect of Amounts Price-Recovery Productivity in 2022 in 2022 in 2022 (5) = (3) (4) (1) + (2) + (3) + (4)  $239,200 F $6,936,800

Revenue

Income Statement Amounts in 2021 (1) $5,838,000

Revenue and Cost Effects of Growth in 2022 (2) $859,600 F

Costs

2,880,000

216,447 U

215,691 U

$7,138 F

3,305,000

Operating income

$2,958,000

$643,153 F

$23,509 F

$7,138 F

$3,631,800

$673,800 F Change in operating income

3. The analysis of operating income indicates that growth, price-recovery, and productivity all resulted in favourable changes in operating income in 2022. The company was able to continue to charge a premium price while growing sales.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

PROBLEMS 14-29 (30 min.)

Balanced scorecard, non-profit, governance.

1. ANIPAL is a non-profit organization dedicated to the rescue and protection of domestic animals. It operates several animal shelters in the Sunset Heights area (including animal adoption services), rescues injured or abused domestic animals, and educates volunteers, pet owners, and potential pet owners on animal guardianship. It offers a variety of programs and therefore scorecard measures should reflect the various programs. Applying balanced scorecard concepts to this organization is different from applying balanced scorecards to traditional profit organizations, not only because of the absence of profit, but also because the “customers” of the organization may be defined as the animals, as well as members of society. Strategic objectives may include: i. Improve the level of service or care to animals in custody ii. Increase the animal adoption rate iii. Reduce the number of animals requiring services iv. Increase the number of volunteers v. Improve transparency and visibility of financial reporting vi. Improve accountability for donations vii. Increase the number of workshops in the community viii. Improve financial position ix. Improve the visibility of the organization x. Increase funds raised The following lists potential measures to be included on the scorecard. A scorecard would likely focus on two to four measures within each perspective. Financial Perspective (1) Increase funding from donations or sponsorship as measured by dollars raised, (2) number of donors, (3) number of new donors, (4) average donation (in dollars), (5) operating costs by program. If ANIPAL raises restricted donations, then it may want to track operating costs of the restricted fund relative to restricted funds raised. The measures directly relate to strategic objectives v, vi, viii and x and indirectly relate to i. Learning and Growth Perspective (1) Hours of employee training, or percentage of employees trained, (2) employee satisfaction and motivation (as measured by survey), (3) hours of volunteer training, or percentage of volunteers trained, (4) number (or hours) of workshops provided, (5) number of hits on the organization’s website.

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

Volunteer measures are important since ANIPAL requires volunteers to deliver its programs. These measures relate directly to strategic objectives i and iv. Customer Perspective “Customers” may include the animals serviced or the general public. (1) Number of workshops provided, (2) number of animals rescued, (3) number of lost animals found, (4) number or percentage of animals adopted, (5) size (square metres) of recreation area for animals in care, (6) adoption rate These measures directly relate to strategic objectives i, ii, iii, vii. Internal Business Process Perspective (1) Response time, (2) capacity measures (number or percentage of cages occupied), (3) number of animals in care, (4) average time to adoption. These measures directly relate to strategic objectives i, ii, and viii. 2. Corporate governance issues. Students with knowledge of not-for-profit accounting can address restricted funds and encumbrance issues. The general issues in this case are:  Organization’s inability to respond to board of directors’ request for information  Accountability to donors  Failure to operate with a balanced budget To address these issues, ANIPAL must ensure it has an information system that records donations, including any donations that are earmarked for specific purposes. It must also improve its accounting system to track direct costs of individual programs. It may wish to consider allocating common costs to programs if a cause-andeffect relationship can be established. Reporting and review of results must be made on an ongoing basis (such as weekly or monthly). The organization must be aware of its available funds and its service levels. If funding is running out, it must have mechanisms in place to review its various services and service levels and prioritize the services it can provide. Alternatively, it may trigger a need for additional fundraising or sponsorship activities.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

14-30 (25–30 min.) Strategic analysis of operating income. 1. Operating income for each year is as follows: Revenue ($44  5,000; $50  6,250) Less: Sales returns ($44  500; $50  225) Net revenue Costs Direct materials costs ($10  2,500; $10  3,125) Conversion costs Selling & customer service costs Advertising costs Total costs Operating income Change in operating income

2021 $220,000 22,000 198,000

2022 $312,500 11,250 301,250

25,000 31,250 128,000 184,000 4,000 4,180 20,000 24,000 177,000 243,430 $ 21,000 $ 57,820 $36,820 F

2. The Growth Component Revenue Actual units Actual units of  Selling price effect of   of output  output sold in    in 2021 growth  sold in 2022 2021   (6, 025 4,500)  $44  $67,100 F Actual units of   Cost effect of Units required to inputs used to  Input price in growth for   produce 2022   produce 2021  2021 variable costs  output in 2021   output   Actual units of capacity in 2021   if adequate to produce 2022    output in 2021   Price per unit Cost effect of OR Actual units of   growth for fixed     of capacity in If 2021 capacity is inadequate to capacity in 2021  costs 2021  produce 2022 output in 2021,     units of capacity required to   produce 2022 output in 2021   

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

Direct materials costs that would be required in 2022 to produce 6,025 units instead of the 4,500 units produced in 2021 assuming the 2022 input–output relationship continued into 2021, equal 2,500  6,025 3,347.22 kilograms ( ). Conversion costs and selling and customer-service costs 4,500 will not change since adequate capacity exists in 2021 to support year 2022 output and customers. Advertising costs are discretionary costs and would not change in 2021 if Dransfield had to produce and sell the higher 2022 volume in 2021. The cost effects of growth component are: (3,347  2,500)  (8,000  8,000)  (60  60)  (1-1) 

Direct materials costs Conversion costs Selling & cust.-serv. costs Advertising costs

$ 10 = $ 16 = $ 66.67 = $20,000 =

Cost effect of growth

$8,470 U 0 0 0 $8,470 U

In summary, the net increase in operating income as a result of the growth component equals: Revenue effect of growth Cost effect of growth Change in operating income due to growth

$67,100 F 8,470 U $58,630 F

The Price-Recovery Component

Revenue Actual units effect of  Selling price Selling price in     of output sold price 2021  in 2022  in 2022 recovery  ($50 $44)  6, 025  $36,150 F Cost effect of Units of input price recovery Input price in Input price in  required to produce    2022 output in for variable 2021  2022  costs 2021 Actual units of capacity in 2021 if adequate to produce 2022 output in 2021 Cost effect of Price per unit Price per unit  OR price recovery  of capacity in of capacity in    If 2021 capacity is inadequate to for fixed costs  2022 2021  produce 2022 output in 2021, units of capacity required to produce 2022 output in 2021

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Direct materials costs Conversion costs Selling & customer-service costs Advertising costs Cost effect of price-recovery

($10  $10)  ($23  $16)  ($69.67  $66.67)  ($24,000  $20,000) 

3,347 = 8,000 = 60 = 1 =

$ 0 56,000 U 180 U 4,000 U $60,180 U

In summary, the net increase in operating income as a result of the price-recovery component equals: Revenue effect of price-recovery $36,150 F Cost effect of price-recovery 60,180 U Change in operating income due to price-recovery $24,030 U The Productivity Component

Actual units of Units of input  Cost effect of  input used to required to  Input price in productivity for     produce 2022 produce 2022  2022 variable costs   output  output in 2021   Actual units of capacity in 2021    if adequate to produce 2022    output in 2021  Price per unit Cost effect of Actual units of OR   of capacity in productivity for   capacity in  If 2021 capacity is inadequate  fixed costs 2022 2022  to produce 2022 output in 2021,    units of capacity required to    produce 2022 output in 2021    The productivity component of cost changes are Direct materials costs (3,125  3,347) Conversion costs (8,000  8,000) Selling & customer-service costs (60  60) Advertising costs (1  1) Change in operating income due to productivity

 $10  $23  $69.67  $24,000

= = = =

$2,220 F 0 0 0 $2,220 F

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

The change in operating income between 2021 and 2022 can be analyzed as follows:

Revenue

Income Statement Amounts in 2021 (1) $198,000

Revenue and Cost Effects of Growth Component in 2022 (2) $67,100 F

Revenue and Income Cost Effects of Cost Effect of Statement Price-Recovery Productivity Amounts Component Component in 2022 in 2022 in 2022 (5) = (3) (4) (1) + (2) + (3) + (4)  $36,150 F $301,250

Costs

177,000

8,470 U

60,180 U

$2,220 F

243,430

Operating income

$ 21,000

$58,630 F

$24,030 U

$2,220 F

$ 57,820

$36,820 F Change in operating income

3. The analysis of operating income indicates that a significant amount of the increase in operating income resulted from Dransfield’s cost leadership strategy. The company was able to improve quality and grow sales. The price recovery component indicates that selling prices increased in line with the market but Dransfield’s costs increased even faster, particularly the price of conversion cost capacity, as Dransfield focused on improving quality. The benefit of this improved quality came in the form of higher sales that more than offset the spending on quality.

14-31 (20 min.)

Analysis of growth, price-recovery, and productivity components.

Effect of the industry-market-size factor on operating income Of the 1,525 increase in sales from 4,500 to 6,025 units, 8% or 360 (= 8%  4,500) units are due to growth in market size, and 1,165 (= 1,525  360) units are due to an increase in market share. The change in Dransfield’s operating income from the industry-market size factor rather than from specific strategic actions is: 360 $58,630 (the growth component in Exercise 14-30)  $13,841 F 1,525 Effect of value leadership (product differentiation) on operating income The change in operating income due to: Increase in the selling price of ZP98 (revenue effect of price recovery) $36,150 F Increase in price of inputs (cost effect of price recovery) 60,180 U Change in operating income due to value leadership $24,030 U Effect of cost leadership on operating income The change in operating income from cost leadership is: Productivity component Growth in market share due to cost leadership $58,630 (the growth component in Exercise 14-30) 

$ 2,220 F

1,165 1,525

Change in operating income due to cost leadership

44,789 F $47,009 F

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

$13,841 F 24,030 U 47,009 F $36,820 F

A thoughtful student might argue that the $24,030 U price-recovery variance could also be thought of as part of the productivity variance. Why? Because a large component of this cost is from conversion costs incurred to improve quality which is more closely associated with productivity and process improvement rather than product development and value leadership. Under this assumption, the change in operating income between 2021 and 2022 can be summarized as follows: Change due to market industry size Change due to value leadership Change due to cost leadership ($47,009 ─ $24,030) Change in operating income

$13,841 F 0 22,979 F $36,820 F

Dransfield has been successful in implementing its cost leadership strategy. The increase in operating income during 2022 was due to quality improvements and sales growth. Dransfield’s operating income increase in 2022 was also helped by a growth in the overall market size.

14-32 (20 min.)

Identifying and managing unused capacity.

1. The amount and cost of unused capacity at the beginning of the year for 2022 production follows: Amount of Cost of Unused Unused Capacity Capacity Manufacturing, 8,000  6,250; (8,000 – 6,250)  $23 1,750 $40,250 0 Selling and customer service, 60 – 60; (60– 60)  $4,180 $ 0 Advertising Discretionary cost, Discretionary so cannot determine cost, so cannot unused capacity* be calculated* *The absence of a cause-and-effect relationship makes identifying unused capacity for discretionary costs difficult. Management cannot determine the advertising resources used for the actual output produced to compare advertising capacity against. 2. Reasons for Downsizing: 1. Currently Dransfield only operates at 78% of capacity (6,250 units ÷ 8,000 units). Downsizing will allow the company to match resources available with resources consumed and eliminate management time and effort in managing unused capacity.

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

2. Downsizing should lead to cost savings and increased efficiency that result in higher operating income. Reasons against Downsizing: 1. Downsizing may require layoffs, which can hurt employee morale and loyalty. 2. Dransfield may want to maintain some unused capacity for future growth. 3a. Misclassification of the cost will not affect overall operating income because the cost will still be included in the calculation of operating income, only as advertising instead of sales and customer service. For financial accounting purposes, it will still be part of selling and administration (period) costs. 3b. This cost will not affect the growth component since the growth component is calculated using cost data from 2021. Misclassification of the cost will have no effect on the sales and customer service component of the cost effect of price recovery because adequate capacity exists in 2021 to produce 2022 output. It will increase the advertising component of the cost effect of price recovery. Misclassification of this cost will increase the productivity component because the capacity amount for selling and customer-service cost will be understated. There will be no effect on advertising because advertising capacity has not changed. The net effect of this misclassification is to decrease the price-recovery component by increasing the cost effect of price-recovery for advertising and to increase the productivity component by an equal amount by understating the selling and customer-service capacity. 3c. The misclassification will make the performance of the ZP98 manager look better than it is because selling and customer-service costs that the manager is evaluated on will appear lower. The higher advertising cost does not affect the manager’s performance evaluation because advertising costs are excluded from the manager’s performance evaluation measure. The manager’s cost classification actions are unethical because the sole purpose of the misclassification of customer-service costs as advertising costs is to make the manager’s performance look better than it is. Like many other corporations, Dransfield’s code of conduct, values and culture need to clearly proscribe such behaviour.

14-33 (20 min.)

Balanced scorecard.

1. Caltex’s strategy is to focus on “service-oriented customers” who are willing to pay a higher price for services. Even though gasoline is largely a commodity product, Caltex wants to differentiate itself through the service it provides at its retailing stations. Does the scorecard represent Caltex’s strategy? By and large it does. The focus of the scorecard is on measures of process improvement, quality, market share, and financial success from value leadership and charging higher prices for customer service. There are some deficiencies that the subsequent assignment questions raise but, abstracting from these concerns for the moment, the scorecard does focus on implementing a value leadership strategy. Having concluded that the scorecard has been reasonably well designed, how has Caltex performed relative to its strategy for the year? It appears from the scorecard that Caltex was successful in implementing its strategy for the year. It achieved all targets in the Copyright © 2022 Pearson Canada Inc. 14-33

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

financial, internal business, and learning and growth perspectives. The only target it missed was the market share target in the customer perspective. At this stage, students may raise some questions about whether this is a good scorecard measure. Requirement 3 gets at this issue in more detail. The bottom line is that measuring “market share in the overall gasoline market” rather than in the “service-oriented customer” market segment is not a good scorecard measure, so not achieving this target may not be as big an issue as it may seem at first. 2. Yes, Caltex should include some measure of employee satisfaction and employee training in the learning and growth perspective. Caltex’s differentiation strategy and ability to charge a premium price is based on customer service. The key to good, fast, and friendly customer service is well trained and satisfied employees. Untrained and dissatisfied employees will have poor interactions with customers and cause the strategy to fail. Hence, training and employee satisfaction are very important to Caltex for implementing its strategy. These measures are leading indicators of whether Caltex will be able to successfully implement its strategy and should be measured on the balanced scorecard. 3. Caltex’s strategy is to focus on the 60% of gasoline consumers who are service-oriented, not on the 40% price-shopper segment. To evaluate if it has been successful in implementing its strategy, Caltex needs to measure its market share in its targeted market segment, “serviceoriented customer,” not its market share in the overall market. Given Caltex’s strategy, it should not be concerned if its market share in the price-shopper segment declines. In fact, charging premium prices will probably cause its market share in this segment to decline. Caltex should replace “market share in overall gasoline market” with “market share in the service-oriented customer segment” in its balanced scorecard customer measure. Caltex may also want to consider putting a customer satisfaction measure on the scorecard. This measure should capture an overall evaluation of customer reactions to the facility, the convenience store, employee interactions, and quick turnaround. The customer satisfaction measure would serve as a leading indicator of market share in the service-oriented customer segment. 4. Although there is a cause-and-effect link between internal business process measures and customer measures on the current scorecard, Caltex should add more measures to tighten this linkage. In particular, the current scorecard measures focus exclusively on refinery operations and not on gas station operations. Caltex should add measures of gas station performance such as cleanliness of the facility, turnaround time at the gas pumps, the shopping experience at the convenience store, and the service provided by employees. Many companies do random audits of their facilities to evaluate how well their branches and retail outlets are performing. These measures would serve as leading indicators of customer satisfaction and market share in Caltex’s targeted segments. 5. Caltex is correct in not measuring changes in operating income from productivity improvements on its scorecard under the financial perspective. Caltex’s strategy is to grow by charging premium prices for customer service. The scorecard measures focus on Caltex’s success in implementing this strategy. Productivity gains in themselves are not critical to Caltex’s strategy and therefore, should not be measured on the scorecard.

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

14-34

(20–25 min.) Balanced scorecard and strategy.

1. Solution Exhibit 14-34A shows the customer preference map for DVD players for Scott Company and Nomad Manufacturing on price, playback features, and quality. SOLUTION EXHIBIT 14-34A Customer Preference Map for DVD Players Nomad Manufacturing



Price

Product Attributes

Scott Company

Playback Features



Quality



Poor

5 Very good

Attribute Rating

2. Scott currently follows a cost leadership strategy, which is reflected in its lower price compared to Nomad Manufacturing. The Orlicon DVD player is similar to products offered by competitors. 3. Solution Exhibit 14-34B presents Scott’s strategy map explaining cause-and-effect relationships in its balanced scorecard.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 14-34B Strategy Map for Scott Company

In the learning and growth perspective, Scott measures the percentage of employees trained in quality management and the percentage of manufacturing processes with real-time feedback. These objectives improve manufacturing processes, which has strong ties to improving productivity and quality in the internal-business process perspective. Moreover, improving quality and productivity are distinctive objectives. Improvements in these measures increase customer satisfaction (as a strong tie) and market shares, which in turn increase revenues and operating income. To see if the increases in operating income are coming from productivity improvements, Scott measures the changes in operating income specifically attributable to productivity and quality improvements. The strategy map suggests that Scott has a very good implementation plan to successfully implement its strategies.

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

4. To achieve its goals, Scott could include the following measures under each perspective of the balanced scorecard related to its strategy map: Financial Perspective

Operating income from productivity and quality improvement Operating income from growth Revenue growth

Customer Perspective

Market share Number of additional customers Customer-satisfaction ratings

Internal-BusinessProcess Perspective

Percentage of defective products sold Number of major improvements in manufacturing process

Learning-and-Growth Perspective

Employee-satisfaction ratings Percentage of employees trained in quality management Percentage of line workers empowered to manage processes Percentage of manufacturing processes with real-time feedback

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

14-35 (20 min.)

Partial productivity measurement.

1. Guble Company’s partial productivity ratios in 2022 are as follows: Direct Quantity of output produced in 2022 2, 650, 000 1.59 wallets materials    partial per metre Metres of direct materials used in 2022 1, 669,500 productivity Conversion 0.95 wallets Quantity of output produced in 2022 2, 650, 000 costs partial    per unit of Units of manuf . capacity in 2022 2,800, 000 productivity capacity

To compare partial productivities in 2022 with partial productivities in 2021, we first calculate the inputs that would have been used in 2021 to produce year 2022’s 2,650,000 units of output assuming the year 2021 relationship between inputs and outputs. Direct materials

= 1,875,000 metres  2,650,000/2,500,000 = 1,875,000 metres  1.06 = 1,987,500 metres

Manufacturing capacity = 3,000,000 units of capacity, because manufacturing capacity is fixed, and adequate capacity existed in 2021 to produce year 2022 output. Partial productivity calculations for 2021 based on year 2022 output (to make the partial productivities comparable across the two years): Direct Quantity of output produced in 2022 2, 650, 000 1.33 units per materials    partial Metres of direct materials that would have been 1,987,500 metre productivity used in 2021 to produce year 2022 output Conversion 0.883 units Quantity of output produced in 2022 2, 650, 000 costs partial    per unit of Units of manuf. capacity that would have been used 3, 000, 000 productivity capacity in 2021 to produce year 2022 output The calculations indicate that Guble improved the partial productivity of direct materials and conversion costs between 2021 and 2022 via efficiency improvements and by reducing unused manufacturing capacity.

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

2. Guble Company management can use the partial productivity measures to set targets for the next year. Partial productivity measures can easily be compared over multiple periods. For example, they may specify bonus payments if partial productivity of direct materials increases to 1.75 units of output per metre and if partial productivity of conversion costs improves to 1 unit of output per unit of capacity. A major advantage of partial productivity measures is that they focus on a single input; hence, they are simple to calculate and easy to understand at the operations level. Managers and operators can also examine these numbers to understand the reasons underlying productivity changes from one period to the next— better training of workers, lower labour turnover, better incentives, or improved methods. Management can then implement and sustain these factors in the future.

14-36 (25 min.)

Total factor productivity (continuation of Exercise 14-35).

1. Quantity of output produced in 2022 Total factor productivity for  2022 using 2022 prices Costs of inputs used in 2022 based on 2022 prices 2,650,000 (1,669,500  $4) + (8, 680, 000) 2, 650, 000 2,650,000   $6, 678, 000  $8,680,00 $15,358,000 

 0.1725 units of output per dollar of input

2. By itself, the 2022 TFP of 0.1725 units per dollar of input is not particularly helpful. We need something to compare the 2022 TFP against. We use, as a benchmark, TFP calculated using the inputs that Guble would have used in 2021 to produce 2,650,000 units of output calculated in requirement 1 at 2022 prices. Using the current year’s (2022) prices in both calculations controls for input price differences and focuses the analysis on the adjustments the manager made in the quantities of inputs in response to changes in prices.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Cost of capacity in 2022 $8, 680, 000   $3.10 per unit of capacity Capacity in 2022 2,800, 000 units Quantity of output produced in 2022 Benchmark TFP  Costs of inputs that would have been used in 2021 to produce 2022 output at year 2022 input prices

2022 price of capacity 

2,650,000 (1,987,500  $4) + (3,000,000  $3.10) 2,650,000  $7,950,000 + $9,300,000 2,650,000  $17,250,000  0.1536 units of output per dollar of input Using year 2022 prices, total factor productivity increased 12.3% [= (0.1725  0.1536)  0.1536] from 2021 to 2022. 

3. Total factor productivity increased because Guble produced more output per dollar of input in 2022 relative to 2021, measured in both years using 2022 prices. The change in partial productivity of direct materials and conversion costs tells us that Guble used less materials and capacity in 2022 relative to output, than in 2021. A major advantage of TFP over partial productivity measures is that TFP combines the productivity of all inputs and so measures gains from using fewer physical inputs and substitution among inputs. Partial productivities cannot be combined to indicate the overall effect on cost as a result of these individual improvements. The TFP measure allows managers to evaluate the change in overall productivity by simultaneously combining all inputs to measure gains from using fewer physical inputs as well as substitution among inputs.

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

COLLABORATIVE LEARNING CASES 14-37 (35 min.) Strategic analysis of operating income. 1. Halsey is following a value leadership (product differentiation) strategy. Halsey offers a wide selection of clothes and excellent customer service. Halsey’s strategy is to distinguish itself from its competitors and to charge a premium price. 2. Operating income for each year is as follows: 2021 $2,400,000

2022 $2,360,000

Revenue ($60  40,000; $59  40,000) Costs Costs of goods sold ($40  40,000; $41  40,000) 1,600,000 1,640,000 Selling & customer service costs ($7  51,000); $6.90  43,000) 357,000 296,700 Purchasing & admin. costs ($250  980; $240  850) 245,000 204,000 Total costs 2,202,000 2,140,700 Operating income $ 198,000 $ 219,300 Change in operating income $21,300 F 3. The Growth Component Revenue Actual units Actual units of  Selling price effect of   of output  output sold in    in 2021 growth sold in 2022 2021   (40, 000 40, 000)  $60  $0 Actual units of   Cost effect of Units required to inputs used to  Input price in growth for   produce 2022   produce 2021  2021 variable costs  output in 2021   output   Actual units of capacity in 2021   if adequate to produce 2022    output in 2021   Price per unit Cost effect of OR Actual units of   growth for fixed     of capacity in If 2021 capacity is inadequate to capacity in 2021  costs 2021  produce 2022 output in 2021,     units of capacity required to   produce 2022 output in 2021   

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Pieces of clothing that would be required to be purchased in 2022 would be the same as that required in 2021 because output is the same between 2021 and 2022. Purchasing and administrative costs and selling and customer-service costs will not change since adequate capacity exists in 2021 to support year 2022 output and customers. The cost effects of growth component are: Costs of goods sold Selling & customer-service costs Purch. & admin. costs Cost effect of growth

(40,000  40,000) (51,000  51,000) (980  980)

  

$40 = $0 $7 = 0 $250 = 0 $0

In summary, the net effect on operating income as a result of the growth component equals: Revenue effect of growth Cost effect of growth Change in operating income due to growth

$0 0 $0

The Price-Recovery Component

Revenue Actual units effect of  Selling price Selling price in     of output sold price 2021  in 2022  in 2022 recovery  ($59 $60)  40, 000  $40, 000 U Cost effect of Units of input price recovery Input price in Input price in  required to produce    2022 output in for variable 2021  2022  costs 2021 Actual units of capacity in 2021 if adequate to produce 2022 output in 2021 Cost effect of Price per unit Price per unit  OR price recovery  of capacity in of capacity in    If 2021 capacity is inadequate to for fixed costs  2022 2021  produce 2022 output in 2021, units of capacity required to produce 2022 output in 2021

Costs of goods sold Selling & cust.-serv. costs Purchas. & admin. costs Cost effect of price-recovery

($41  $40)  40,000 ($6.90  $7)  51,000 ($240  $250)  980

= = =

$40,000 U 5,100 F 9,800 F $25,100 U

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

In summary, the net decrease in operating income as a result of the price-recovery component equals: Revenue effect of price-recovery Cost effect of price-recovery Change in operating income due to price-recovery

$40,000 U 25,100 U $65,100 U

The Productivity Component

Actual units of Units of input  Cost effect of  input used to required to  Input price in productivity for     produce 2022 produce 2022  2022 variable costs   output  output in 2021   Actual units of capacity in 2021    if adequate to produce 2022    output in 2021  Price per unit Cost effect of Actual units of OR   of capacity in productivity for   capacity in  If 2021 capacity is inadequate  fixed costs 2022 2022  to produce 2022 output in 2021,    units of capacity required to    produce 2022 output in 2021    The productivity component of cost changes are: Costs of goods sold (40,000  40,000)  $41 Selling & customer-service costs (43,000  51,000)  $6.90 Purchasing & admin. costs (850  980)  $240 Change in operating income due to productivity

= = =

0 $55,200 F 31,200 F $86,400 F

The change in operating income between 2021 and 2022 can be analyzed as follows:

Revenue

Income Statement Amounts in 2021 (1) $2,400,000

Revenue and Revenue and Income Cost Effects Cost Effects of Cost Effect of Statement of Growth Price-Recovery Productivity Amounts Component Component Component in 2022 in 2022 in 2022 in 2022 (5) = (2) (3) (4) (1) + (2) + (3) + (4) $0 $40,000 U $2,360,000

Costs

2,202,000

25,100 U

$ 86,400 F

2,140,700

Operating income $ 198,000

$65,100 U

$ 86,400 F

$ 219,300

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4. The analysis of operating income indicates that a significant amount of the increase in operating income resulted from productivity gains rather than value leadership. The company was unable to charge a premium price for its clothes. Thus, the strategic analysis of operating income indicates that Halsey has not been successful at implementing its premium price, value leadership strategy, despite the fact that operating income increased by more than 10% between 2021 and 2022. Halsey could not pass on increases in purchase costs to its customers via higher prices. Halsey must either reconsider its value leadership strategy or focus managers on increasing margins and growing market share by offering better product variety and superb customer service.

14-38 (20–30 min.)

Balanced scorecard, sustainability. Note to instructors: this question is intended to be open-ended. 1. Nost Vineyards has a stated objective to be the number one distributor of its product lines within Canada. It has also identified quality, efficiency, and innovation as key factors in its success. While there are many possible balanced scorecards that could be created, it is important that students’ answers reflect these key factors. It is also important to note that Nost distributes its products to retailers. It operates in a B2B environment; however, the retailers are not the company’s ultimate customers. Therefore while it is important to create distributor relationships, the company cannot overlook the final customer. Strategic objectives may include: i. Improve manufacturing quality (quality). ii. Improve yields and manufacturing processes (efficiency). iii. Introduce new products (innovation). iv. Be number one in Canada. Financial Perspective (1) Increase operating income from productivity gains and growth, (2) revenues per distributor. [primary strategic objective iv] Customer Perspective (1) Market share, (2) customer satisfaction, (3) Number and/or percentage of retailers carrying Nost’s products. [strategic objectives iv, i, and iii] Further to the comments above, it is important for Nost to evaluate its success with distributors as well as with the final consumer.

Chapter 14: Strategy, the Balanced Scorecard, and Profitability Analysis

Internal Business Process Perspective (1) Yields (fruit inputs to final product outputs), (2) percentage of good units, (3) process time. [strategic objective ii] Improvements in these measures are key drivers of achieving cost leadership and are expected to lead to more satisfied customers, lower costs, and superior financial performance. Learning and Growth Perspective (1) Hours of employee training, or percentage of employees trained, (2) employee satisfaction and motivation (as measured by survey), (3) number of new products introduced to the market [all strategic objectives emphasized]. Employee measures are important since Nost has identified problems in managing turnover. Employees are important for efficiency and for innovation. 2. Sustainability Measures This question was left intentionally vague regarding whether or not Nost grows the grapes or merely processes the grapes into wine. If Nost is also a grower, then a whole host of sustainability measures become important. Nost must consider the sustainability of the land, and look at crop rotations, soil nutrients, etc. Also the issues of insect control and the use of pesticides and their impact are important from a sustainability perspective. However, if we assume that Nost processes the grapes, then a key measure would be a waste/input ratio. The Dow Jones Sustainability Index is another consideration. 3. Employee turnover issues can be addressed through training at both the individual and management levels and through improved communication. Staff need to be trained not only for current positions, but also for future growth and advancement. Supervisory or management staff need to clarify the links between performance and reward (particularly non-monetary rewards such as recognition and opportunities for advancement). (Most students studying cost accounting at this level have had an introductory course in organizational behaviour. The human resources aspect of this question allows students to integrate their knowledge of motivational theory with management/cost accounting. Students could refer to expectations theory and concepts of leadership, including leadership styles and roles (e.g. task versus consideration).) If employees can see a future in the organization, they may be more inclined to stay with the organization, particularly when it offers competitive wages. In addition to employee and supervisory training, the company could implement additional communication mechanisms, such as employee suggestion boxes. It could introduce measures designed to enhance organizational culture, such as employee events (casual Fridays, Tuesday lunch-time speakers, etc.). From a sustainability perspective, some of these events could be tied to external events or causes (e.g., a corporate team participating in the Terry Fox Run for the Cure, or in a Bike Tour for MS (multiple sclerosis)). Many such initiatives have minimal costs and would have long-run benefits through the reduction of employee turnover related costs.

CHAPTER 15 PERIOD COST APPLICATION MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

SHORT-ANSWER QUESTIONS 15-1

Disagree. Cost accounting data plays a key role in many management planning and control decisions. The division president will be able to make better operating and strategy decisions by being involved in key decisions about cost pools and cost allocation bases.

15-2

The dual-rate method provides information to division managers about cost behaviour. Knowing how fixed costs and variable costs behave differently is useful in decision making.

15-3 1. 2. 3. 4.

The four purposes of cost allocation are:

To provide information for economic decisions. To motivate managers and employees. To justify costs or compute reimbursement internally or externally. To measure income and assets for meeting external reporting and legal regulatory obligations.

15-4

Criteria used to justify cost allocation decisions include:

1. Cause and effect. 2. Benefits received. 3. Fairness or equity. 4. Ability to bear. Either the cause-and-effect criterion or the benefits received criterion is the dominant one when the purpose of the allocation is related to the economic decision purpose or the motivation purpose.

15-5

The first consideration is to select the method that best reflects the economic facts of production. The second is affordability. The management team’s decisions will always improve with higher quality information but the cost of obtaining that information may be too high relative to the benefit received.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

15-6

Cost–benefit considerations can affect costing choices in several ways:

(a) Classifying some immaterial costs as indirect when they could, at high cost, be traced to products, services, or customers as direct costs. (b) Using a small number of indirect cost pools when, at high cost, an increased number of indirect cost pools would provide more homogeneous cost pools. (c) Using allocation bases that are readily available (or can be collected at low cost) when, at high cost, more appropriate cost allocation bases could be developed.

15-7

Three decisions managers face when designing the cost allocation component of an accounting system are: i. Which cost items should be included in the indirect cost pools? ii. How many indirect cost pools should be used? iii. Which allocation base should be used for each indirect cost pool?

15-8

Examples of bases used to allocate corporate cost pools to operating divisions are:

Corporate Cost Pools Corporate executive department Treasury department Legal department Marketing department Payroll department Human resources department

Possible Allocation Bases Sales; assets employed; operating income Sales; assets employed; estimated time or usage Estimated time or usage; sales; assets employed Sales; number of sales personnel Number of employees; payroll dollars Number of employees; payroll dollars; number of new hires

15-9

The use of budgeted indirect cost allocation rates rather than actual indirect rates has several attractive features to the manager of a user department: a. The user knows the costs in advance and can factor them into ongoing operating choices, b. The cost allocated to a particular user department does not depend on the amount of resources used by other user departments, and c. Inefficiencies at the department providing the service do not affect the costs allocated to the user department.

15-10 Disagree. Allocating costs on “the basis of estimated long-run use by user department managers” means department managers can lower their cost allocations by deliberately underestimating their long-run use.

Chapter 15: Period Cost Application

15-11 The three methods differ in how they recognize reciprocal services among support departments: a. The direct allocation method ignores any services rendered by one support department to another; it allocates each support department’s total costs directly to the operating departments. Strengths of the direct allocation method are that it is simple to calculate, easy to understand, inexpensive to implement, and does not require support departments to be ranked. Weaknesses are that it may not accurately reflect the economic reality of value being added by support division activities, it fails to recognize level of activity between support divisions, and it may result in large cost/value distortions. b. The step-down allocation method allows for partial recognition of support rendered by support departments to other support departments. Strengths of the step-down allocation method are that it is simpler than the reciprocal method, recognizes some of the activity between support divisions, may be viewed as “fairer” than the direct method, and if one division provides a majority of the interdivisional support, there is minimal distortion of cost (compared to the direct method). Weaknesses include that it is not as economically plausible as the reciprocal method, more complex than the direct method, and requires support divisions to be ranked. c. The reciprocal allocation method allocates costs by explicitly recognizing the mutual services rendered among support departments. Strengths of the reciprocal method are that it is conceptually the best method, it reflects economic reality of support divisions, and does not require them to be ranked. Weaknesses are that it is difficult for non-accountants to understand, complex to calculate, and most expensive.

15-12 The reciprocal method is theoretically the most defensible method because it explicitly recognizes the mutual services rendered among all departments, irrespective of whether those departments are operating or support departments.

15-13 The incremental common cost allocation method first allocates the common costs to the primary user; the incremental party is allocated the incremental component of the common cost arising because there are two users and not just the primary user. The stand-alone common cost allocation method allocates the common cost on the basis of each user’s percentage of the total of the individual stand-alone costs.

15-14 One key method to avoid disputes is to clearly define the basis for support cost allocation.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

EXERCISES 15-15 (10 min.) Terminology. 1. Target pricing is a policy well suited to a highly competitive environment where the corporation is a price taker because customers set the price. 2. Depending on the proportion of fixed costs in the pool, the management team must choose between a dual-rate or a single-rate cost pool. 3. Cost leadership is an appropriate policy and the reciprocal method most accurately reflects cost flows from support divisions back and forth among one another and to core operating divisions. To implement the reciprocal method, the support cost pools must be arithmetically adjusted to create artificial cost pools, which are then the basis for all cost allocation. 4. The sequential method is an improvement over the direct method of applying support costs, but only reports the flow of support departments to one another in one direction. The support divisions are first ranked on some basis from highest to lowest flow of either costs or resources then step down from the largest to smallest support division. Then the adjusted support cost pools are allocated to core operating divisions. 5. A common cost arises when two or more users share benefits from consuming a corporate resource. 6. There are two ways to recognize proportional cost and benefit. The stand-alone cost allocation method defines each cost object as if it were the only output. The incremental cost allocation method ranks those who share in benefits from incurring the total common cost pool from high to low. The highest ranked is the primary party who bears most of the total shared cost. The remaining incremental parties share the difference of the total common cost pool minus the costs allocated to the primary party. Disputes over the primary party often arise.

15-16 (15–20 min.)

Criteria of cost allocation decisions.

1. Direct costs = $3.20 Indirect costs = $10.62– $3.20 = $7.42 Overhead rate = $7.42 ÷ $3.20 = 231.9% 2. The answers here are less than clear-cut in some cases. Overhead Cost Item Processing of paperwork for purchase Supplies room management fee Operating room and patient room handling charge Administrative hospital costs Research-related recoupment Malpractice insurance costs Costing of treating uninsured patients Profit component

Allocation Criteria Cause and effect Benefits received Cause and effect Benefits received Ability to bear Ability to bear or benefits received Ability to bear None. This is not a cost.

Chapter 15: Period Cost Application

3. Note: In the United States’ for-profit health-care system, individuals purchase their own insurance for medical procedures or pay privately in the same way that Canadians pay for dental care. Assuming that Meltzer’s insurance company is responsible for paying the $4,800 bill, Meltzer probably can only express outrage at the amount of the bill. The point of this question is to note that even if Meltzer objects strongly to one or more overhead items, it is his insurance company that likely has the greater incentive to challenge the bill. Individual patients have very little power in the medical arena. In contrast, insurance companies have considerable power and may decide that certain costs are not reimbursable—for example, the costs of treating uninsured patients.

15-17 (20 min.)

Single-rate versus dual-rate methods, support department.

Bases available (kilowatt hours): Loretta Practical capacity 13,000 Expected monthly usage 10,000

Bently 21,000 9,000

Melboum 14,000 10,000

Eastmoreland 32,000 11,000

Total 80,000 40,000

1a. Single-rate method based on practical capacity: Total costs in pool = $8,000 + $12,000 = $20,000 Practical capacity = 80,000 kilowatt hours Allocation rate = $20,000 ÷ 80,000 = $0.25 per hour of capacity Practical capacity in hours Costs allocated at $0.25 per hour

Loretta Bently 13,000 21,000 $3,250 $5,250

Melboum 14,000 $3,500

Eastmoreland Total 32,000 80,000 $8,000 $20,000

1b. Single-rate method based on expected monthly usage: Total costs in pool = $8,000 + $12,000 = $20,000 Expected usage = 40,000 kilowatt hours Allocation rate = $20,000 ÷ 40,000 = $0.50 per hour of expected usage Expected monthly usage in hours Costs allocated at $0.50 per hour

Loretta 10,000 $5,000

Bently 9,000 $4,500

Melboum 10,000 $5,000

Eastmoreland Total 11,000 40,000 $5,500 $20,000

2. Variable-Cost Pool: Total costs in pool = $8,000 Expected usage = 40,000 kilowatt hours Allocation rate = $8,000 ÷ 40,000 = $0.20 per hour of expected usage Fixed-Cost Pool: Total costs in pool = $12,000 Practical capacity = 80,000 kilowatt hours Allocation rate = $12,000 ÷ 80,000 = $0.15 per hour of capacity

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Loretta Variable-cost pool $0.20 × 10,000; 9,000; 10,000, 11,000 Fixed-cost pool $0.15 × 13,000; 21,000; 14,000, 32,000 Total

Bently

Melboum

Eastmoreland

Total

$2,000

$1,800

$2,000

$2,200

$ 8,000

1,950 $3,950

3,150 $4,950

2,100 $4,100

4,800 $7,000

12,000 $20,000

The dual-rate method permits a more refined allocation of the power department costs; it permits the use of different allocation bases for different cost pools. The fixed costs result from decisions most likely associated with the scale of the facility, or the practical capacity level. The variable costs result from decisions most likely associated with monthly usage.

15-18

(20–25 min.)

Single-rate method, budgeted versus actual costs and quantities.

Budgeted indirect costs = $120,000/60 trips = $2,000 per round-trip Budgeted trips Indirect costs allocated to dark chocolate division = $2,000 per round-trip × 35 budgeted round trips = $70,000 Indirect costs allocated to milk chocolate division = $2,000 per round-trip × 25 budgeted round trips = $50,000

1a. Budgeted rate =

1b. Budgeted rate = $2,000 per round-trip Indirect costs allocated to dark chocolate division = $2,000 per round-trip × 30 actual round trips = $60,000 Indirect costs allocated to milk chocolate division = $2,00 per round-trip × 25 actual round trips = $50,000 Actual indirect costs = $112,750/ 55 trips = $2,050 per round-trip Actual trips Indirect costs allocated to dark chocolate division = $2,050 per round-trip × 30 actual round trips = $61,500 Indirect costs allocated to milk chocolate division = $2,050 per round-trip × 25 actual round trips = $51,250

1c. Actual rate =

Chapter 15: Period Cost Application

2. When budgeted rates/budgeted quantities are used, the dark chocolate division and milk chocolate division know at the start of the year that they will be charged a total of $70,000 and $50,000 respectively for transportation. In effect, the fleet resource becomes a fixed cost for each division. Then, each may be motivated to over-use the trucking fleet, knowing that their transportation costs will not change. When budgeted rates/actual quantities are used, the dark chocolate division and milk chocolate division know at the start of the year that they will be charged a rate of $2,000 per round trip (i.e., they know the price per unit of this resource). This enables them to make operating decisions knowing the rate they will have to pay for transportation. Each can still control its total transportation costs by minimizing the number of round trips it uses. Assuming that the budgeted rate was based on honest estimates of their annual usage, this method will also provide an estimate of the excess trucking capacity (the portion of fleet costs not charged to either division). In contrast, when actual costs/actual quantities are used, the two divisions must wait until year-end to know their transportation charges. The use of actual costs/actual quantities makes the costs allocated to one division a function of the actual demand of other users. In the year, the actual usage was 55 trips, which is 5 trips below the 60 trips budgeted. The dark chocolate division used only 30 out of the 35 trips it had budgeted. The milk chocolate division used 20 of the 20 trips it budgeted. When costs are allocated based on actual costs and actual quantities, the same fixed costs are spread over fewer trips, resulting in a higher rate than if the dark chocolate division had used its budgeted 35 trips. As a result, the milk chocolate division bears a proportionately higher share of the fixed costs. Using actual costs/actual rates also means that any efficiencies or inefficiencies of the trucking fleet get passed along to the user divisions. In general, this will have the effect of making the truck fleet less careful about its costs, although in the year, it appears to have managed its costs well, leading to a slightly higher actual cost per round trip relative to the budgeted cost per round trip. For the reasons stated above, of the three single-rate methods suggested in this problem, the budgeted rate and actual quantity may be the best to use. (The management of Chocolat Inc. would have to ensure that the managers of the dark chocolate division and milk chocolate division do not systematically overestimate their budgeted use of the fleet division in an effort to drive down the budgeted rate).

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

15-19

(20 min.)

Dual-rate method, budgeted versus actual costs, and practical capacity versus actual quantities (continuation of Exercise 15-18).

1. Charges with dual rate method. Variable indirect cost rate = $1,100 per trip Fixed indirect cost rate = $54,000 budgeted costs/ 60 round trips budgeted = $900 per trip Dark chocolate division Variable indirect costs, $1,100 × 30 $33,000 Fixed indirect costs, $900 × 35 31,500 $64,500 Milk chocolate division Variable indirect costs, $1,100 × 25 $27,500 Fixed indirect costs, $900 × 25 22,500 $50,000 2. The dual rate changes how the fixed indirect cost component is treated. By using budgeted trips made, the milk chocolate division is unaffected by changes from its own budgeted usage or that of other divisions. When budgeted rates and actual trips are used for allocation (see requirement 1a. of Problem 15-18), the milk chocolate division is assigned the same $50,000 for fixed costs as under the dual-rate method because it made the same number of trips as budgeted. As such, the milk chocolate division is not made to appear disproportionately more expensive than the dark chocolate division simply because the latter did not make the number of trips it budgeted at the start of the year.

Chapter 15: Period Cost Application

15-20

(30 min.)

Support-department cost allocation; direct and step-down methods.

1. a. Direct method costs Alloc. of AS costs (40/75, 35/75) Alloc. of IS costs (30/90, 60/90) b. Step-down (AS first) costs Alloc. of AS costs (0.25, 0.40, 0.35) Alloc. of IS costs (30/90, 60/90)

AS IS $600,000 $2,400,000

GOVT

CORP

(600,000)

$ 320,000

$ 280,000

(2,400,000) $ 0 $ 0 $600,000 $2,400,000

800,000 $1,120,000

1,600,000 $1,880,000

(600,000)

150,000

$ 240,000

$ 210,000

(2,550,000) 0 $ 0

850,000 $1,090,000

1,700,000 $1,910,000

240,000 (2,400,000)

$ 720,000

$1,440,000

(840,000) $ 0 $

448,000 $1,168,000

392,000 $1,832,000

GOVT $1,120,000 1,090,000 1,168,000

CORP $1,880,000 1,910,000 1,832,000

$ c. Step-down (IS first) costs Alloc. of IS costs (0.10, 0.30, 0.60) Alloc. of AS costs (40/75, 35/75)

$600,000 $2,400,000

2. Direct method Step-down (AS first) Step-down (IS first)

The direct method ignores any services to other support departments. The step-down method partially recognizes services to other support departments. The information systems support group (with total budget of $2,400,000) provides 10% of its services to the AS group. The AS support group (with total budget of $600,000) provides 25% of its services to the information systems support group. When the AS group is allocated first, a total of $2,550,000 is then assigned out from the IS group. Given CORP’s disproportionate (2:1) usage of the services of IS, this method then results in the highest overall allocation of costs to CORP. By contrast, GOVT’s usage of the AS group exceeds that of CORP (by a ratio of 8:7), and so GOVT is assigned relatively more in support costs when AS costs are assigned second, after they have already been incremented by the AS share of IS costs as well.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. Three criteria that could determine the sequence in the step-down method are as follows: a. Allocate support departments on a ranking of the percentage of their total services provided to other support departments. 1. Administrative Services 2. Information Systems

25% 10%

b. Allocate support departments on a ranking of the total dollar amount in the support departments. 1. Information Systems $2,400,000 2. Administrative Services $ 600,000 c. Allocate support departments on a ranking of the dollar amounts of service provided to other support departments 1. Information Systems (0.10  $2,400,000) = $240,000 2. Administrative Services (0.25  $600,000) = $150,000 The approach in (a) above typically better approximates the theoretically preferred reciprocal method. It results in a higher percentage of support-department costs provided to other support departments being incorporated into the step-down process than does (b) or (c), above.

15-21

(50 min.)

Support-department cost allocation, reciprocal method (continuation of 15-20).

1a.

Costs Alloc. of AS costs (0.25, 0.40, 0.35) Alloc. of IS costs (0.10, 0.30, 0.60)

Support Departments AS IS $600,000 $2,400,000

Operating Departments Govt. Corp.

(861,538)

215,385

$ 344,615

$ 301,538

261,538 0

(2,615,385) $ 0

784,616 $1,129,231

1,569,231 $1,870,769

Chapter 15: Period Cost Application

Reciprocal Method Computation AS = $600,000 + 0.10 IS IS = $2,400,000 + 0.25AS IS = $2,400,000 + 0.25 ($600,000 + 0.10 IS) = $2,400,000 + $150,000 + 0.025 IS 0.975IS = $2,550,000 IS = $2,550,000 ÷ 0.975 = $2,615,385 AS = $600,000 + 0.10 ($2,615,385) = $600,000 + $261,538 = $861,538 1b.

Costs 1st Allocation of AS (0.25, 0.40, 0.35) 1st Allocation of IS (0.10, 0.30, 0.60) 2nd Allocation of AS (0.25, 0.40, 0.35) 2nd Allocation of IS (0.10, 0.30, 0.60) 3rd Allocation of AS (0.25, 0.40, 0.35) 3rd Allocation of IS (0.10, 0.30, 0.60) 4th Allocation of AS (0.25, 0.40, 0.35) 4th Allocation of IS (0.10, 0.30, 0.60) 5th Allocation of AS (0.25, 0.40, 0.35) 5th Allocation of IS (0.10, 0.30, 0.60) Total allocation

Support Departments AS IS $600,000 $2,400,000

Operating Departments Govt. Corp.

(600,000)

150,000 2,550,000

$ 240,000

$ 210,000

255,000

(2,550,000)

765,000

1,530,000

(255,000)

63,750

102,000

89,250

6,375

(63,750)

19,125

38,250

(6,375)

1,594

2,550

2,231

160

(1,594)

478

956

(160)

(40)

(4)

0 $1,129,231

1 $1,870,769

0 0

(1) 0

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. a. b. c. d.

Direct Step-Down (AS first) Step-Down (IS first) Reciprocal

Govt. Consulting $1,120,000 1,090,000 1,168,000 1,129,231

Corp. Consulting $1,880,000 1,910,000 1,832,000 1,870,769

The four methods differ in the level of support department cost allocation across support departments. The level of reciprocal service by support departments is material. Administrative Services supplies 25% of its services to Information Systems. Information Systems supplies 10% of its services to Administrative Services. The Information Department has a budget of $2,400,000 that is 400% higher than Administrative Services. The reciprocal method recognizes all the interactions and is thus the most accurate. This is especially clear from looking at the repeated iterations calculations.

Chapter 15: Period Cost Application

15-22

(45 min.)

Allocating costs of support departments; step-down and direct methods.

1. Step-down method: (1) Building & grounds at $0.10/sq.m. ($10,000 ÷ 100,000) (2) Personnel at $6/employee ($1,200 ÷ 200) (3) General plant administration at $1/labour-hour ($27,000 ÷ 27,000) (4) Cafeteria at $20/employee ($3,100 ÷ 155) (5) Storeroom at $1.50/requisition ($4,500 ÷ 3,000) (6) Costs allocated to operating depts. (7) Divide (6) by dir. manuf. labour-hrs. (8) Overhead rate per direct manuf. labour-hour 2. Direct method: (1) Building & grounds, 30,000/80,000; 50,000/80,000 (2) Personnel, 50/150; 100/150 (3) General plant administration, 8,000/25,000; 17,000/25,000 (4) Cafeteria, 50/150; 100/150 (5) Storeroom: 2,000/3,000; 1,000/3,000 (6) Costs allocated to operating depts. (7) Divide (6) by direct manufacturing labour-hours (8) Overhead rate per direct manufacturing labour-hour

Building & Grounds $ 10,000 $(10,000)

Personnel $ 1,000 200 $(1,200)

General Plant Admin. $ 26,090 700 210 $(27,000)

$ 10,000

$ 1,000

$ 26,090

Cafeteria Operating Loss $ 1,640

Storeroom $ 2,670

Machining $34,700

Assembly $ 48,900

400

700

3,000

5,000

300

600

1,000

8,000

17,000

$(3,100)

100

1,000

2,000

$(4,500)

3,000 $50,000 ÷ 5,000

1,500 $ 75,000 ÷15,000

$ 1,640

$ 2,670

(10,000) (1,000) (26,090) (1,640) (2,670)

$34,700

$ 48,900

3,750 333

6,250 667

8,349 547

17,741 1,093

1,780 $49,459

890 $ 75,541

÷ 5,000 $ 9.892

÷15,000 $ 5.036

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. Comparison of Methods: Step-down method:

Job 88: Job 89:

Direct method:

Job 88: Job 89:

18 × $10 2×$5 3 × $10 17 × $ 5 18 × $9.892 2 × $5.036 3 × $9.892 17 × $5.036

$180 10 $ 30 85 $178.06 10.07 $ 29.68 85.61

$190.00 115.00 $188.13 115.29

4. The manager of the machining department would prefer the direct method. The direct method results in a lower amount of support departments’ costs being allocated to the machining department than the step-down method. This is clear from a comparison of the overhead rate, per direct manufacturing labour-hour, for the machining department under the two methods.

Chapter 15: Period Cost Application

15-23

Fixed cost allocation

1. i) Allocation using actual usage. Restaurant A B C Total

Actual Usage 1,500 1,400 1,300 4,200

Percentage of Total Usage 0.357 0.333 0.310

Allocation % × 10,000 $ 3,570 3,330 3,100 $10,000

ii) Allocation using planned usage. Restaurant A B C Total

Planned Usage 1,600 1,300 1,100 4,000

Percentage of Total Planned Usage 0.400 0.325 0.275

Allocation % × 10,000 $ 4,000 3,250 2,750 $10,000

iii) Allocation using practical capacity. Restaurant A B C Total

Practical Capacity 2,000 1,500 1,500 5,000

Percentage of Total Practical Capacity 0.400 0.300 0.300

Allocation % × 10,000 $ 4,000 3,000 3,000 $10,000

2. If the practical capacity refers to the number of parking spots that are reserved for each of the restaurants, then it would appear to be the most appropriate basis for allocating the $10,000 common cost. This ratio is a stable benchmark and does not fluctuate based on variations in either the actual or planned monthly usage of spots for each of the restaurants, which is an issue with each of the other two methods. Moreover, the practical capacity taken by each restaurant presumably reflects the restaurant’s expectation of the long-run usage of the parking facility by its patrons. The cost of any unused capacity then highlights the extent to which these expectations are not met, and might lead to the restaurant settling for a smaller parking facility in the future. Of course, if it is ever the case that the expected or actual usage for any restaurant exceeds the practical capacity that it has “booked,” it would need to suitably compensate the other restaurants for the portion of their parking capacity it has appropriated.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

15-24

(40 min.)

Direct and step-down allocation.

Costs incurred Alloc. of HR costs (42/70, 28/70) Alloc. of info. syst. costs (1,920/3,520, 1,600/3,520)

Support Divisions HR Info. Systems $82,700 $234,400 (82,700) _ ____ $ 0

( 234,400) $ 0

Operating Divisions Corporate Consumer Sales Sales $ 998,270 $ 489,860 49,620

33,080

127,855 1,175,745

106,545 $629,485

Total $1,805,230

_________ $1,805,230

2. Rank on percentage of services rendered to other support divisions. Step 1: HR provides 23.077% of its services to information systems: 21 21 = = 23.077% 42  28  21 91 This 23.077% of $82,700 HR division costs is $19,085. Step 2: Information systems provides 8.333% of its services to HR: 320 320 = = 8.333% 1,920  1, 600  320 3,840 This 8.333% of $234,400 information systems division costs is $19,533. Support Divisions Costs incurred Alloc. of HR costs (21/91, 42/91, 28/91) Alloc. of info. syst. costs (1,920/3,520, 1,600/3,520)

Operating Divisions Corporate Consumer Sales Sales $ 998,270 $489,860

HR $82,700

Info. Systems $234,400

(82,700) $ 0

19,085 253,485

38,169

25,446

( 253,485)

138,265

115,220

$1,174,704

$630,526

Total $1,805,230

$1,805,230

3. An alternative ranking is based on the dollar amount of services rendered to other support divisions. Using numbers from requirement 2, this approach would use the following sequence: Step 1: Allocate information systems first ($19533 provided to HR). Step 2: Allocate HR second ($19,085 provided to information systems). Copyright © 2022 Pearson Canada Inc. 15-16

Chapter 15: Period Cost Application

15-25

(30 min.)

Reciprocal cost allocation (continuation of 15-24).

1. The reciprocal allocation method explicitly includes the mutual services provided among all support divisions. Interdepartmental relationships are fully incorporated into the support division cost allocations. 2.

HR = $82,700 + 0.08333IS IS = $234,400 + 0.23077HR HR = $82,700 + [0.08333($234,400 + 0.23077HR)] = $82,700 + [$19,532.55 + 0.01923HR] 0.98077HR = $102,232.55 HR = $102,232.55  0.98077 = $104,237.04 IS = $234,400 + (0.23077  $104,237.04) = $258,455

Costs incurred Alloc. of HR costs (21/91, 42/91, 28/91) Alloc. of info. syst. costs (320/3,840, 1,920/3,840, 1,600/3,840)

Support Div. Info. HR Systems $82,700 $234,400

Operating Division Corporate Consumer Sales Sales $ 998,270 $489,860

(104,238 )

24,055

48,110

21,538 $ 0

(258,455) $ 0

Total $1,805,230

32,073

129,227 107,690 $1,175,607 $629,623

$1,805,230

3. The reciprocal method is more accurate than the direct and step-down methods when there are reciprocal relationships among support divisions. A summary of the alternatives is: Direct method Step-down method (HR first) Reciprocal method

Corporate Sales $1,175,745 1,174,704 1,175,607

Consumer Sales $629,485 630,526 629,623

The reciprocal method is the preferred method, although for September, the numbers do not appear materially different across the alternatives.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

PROBLEMS 15-26 (20 min.)

Single-rate, dual-rate, and practical capacity allocation.

Budgeted number of gifts wrapped = 6,750 Budgeted fixed costs = $6,750 Fixed cost per gift based on budgeted volume = $6,750 ÷ 6,750 = Average budgeted variable cost per gift = Total cost per gift wrapped

$1.00 0.50 $1.50

1a. Allocation based on budgeted usage of gift-wrapping services: Women’s face wash (2,475 × $1.50) Men’s face wash (825 × $1.50) Fragrances (1,800 × $1.50) Body wash (450 × $1.50) Hair products (1,200 × $1.50) Total

$ 3,712.50 1,237.50 2,700.00 675.00 1,800.00 $10,125.00

1b. Allocation based on actual usage of gift-wrapping services: Women’s face wash (2,100 × $1.50) Men’s face wash (750 × $1.50) Fragrances (1,575 × $1.50) Body wash (525 × $1.50) Hair products (1,050 × $1.50) Total 1c. Practical gift-wrapping capacity = 7,500 Budgeted fixed costs = $6,750 Fixed cost per gift based on practical capacity = $6,750 ÷ 7,500 = Average budgeted variable cost per gift = Total cost per gift wrapped Allocation based on actual usage of gift-wrapping services: Women’s face wash (2,100 × $1.40) $2,940 Men’s face wash (750 × $1.40) 1,050 Fragrances (1,575 × $1.40) 2,205 Body wash (525 × $1.40) 735 Hair products (1,050 × $1.40) 1,470 Total $8,400

$3,150.00 1,125.00 2,362.50 787.50 1,575.00 $9,000.00

$0.90 0.50 $1.40

Chapter 15: Period Cost Application

Budgeted fixed costs Practical capacity = $6,750 ÷ 7,500 gifts = $0.90 per gift Fixed costs allocated on budgeted usage.

2. Budgeted rate for fixed costs =

Rate for variable costs = $0.50 per item Variable costs based on actual usage. Allocation: Department Women’s face wash Men’s face wash Fragrances Body wash Hair products Total

Variable Costs Fixed Costs 2,100 × $0.50 =$1,050.00 2,475 × $0.90 = $2,227.50 750 × $0.50 = 375.00 825 × $0.90 = 742.50 1,575 × $0.50 = 787.50 1,800 × $0.90 = 1,620.00 525 × $0.50 = 262.50 450 × $0.90 = 405.00 1,050 × $0.50 = 525.00 1,200 × $0.90 = 1,080.00 $3,000.00 $6,075.00

Total $3,277.50 1,117.50 2,407.50 667.50 1,605.00 $9,075.00

3. The dual-rate method has two major advantages over the single-rate method: a. Fixed costs and variable costs can be allocated differently—fixed costs based on rates calculated using practical capacity and budgeted usage and variable costs based on budgeted rates and actual usage. b. Fixed costs are allocated proportionately to the departments causing the incurrence of those costs based on the capacity of each department. c. The costs allocated to a department are not affected by the usage by other departments. Note: If capacity costs are the result of a long-term decision by top management, it may be desirable to allocate to each department the cost of capacity used based on actual usage. The users are then not allocated the costs of unused capacity.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

15-27 (15 min.)

Allocating costs to divisions.

1. Allocations based on square metres.

1. Square metres 2. % square metres (130,000; 90,000; 80,000; 100,000 ÷ 400,000) 3. Allocated HQ cost (Row 2 × $14,255,000)

Segment margin Less: Headquarters costs Division margin Division margin ÷ Revenue

Refrigerator 130,000

Stove 90,000

Dishwasher 80,000

Microwave Oven 100,000

32.5%

22.5%

20%

25%

100%

$4,632,875

$3,207,375

$2,851,000

$3,563,750

$14,255,000

Total 400,000

Microwave Refrigerator Stove Dishwasher Oven Total $5,200,000 $8,400,000 $5,300,000 $3,560,000 $22,460,000 4,632,875 3,207,375 2,851,000 3,563,750 14,255,000 $ 567,125 $5,192,625 $2,449,000 $ (3,750) $ 8,205,000 5.2% 27.6% 21.3% (0.06)% 17.1%

Allocations based on segment margin. 1. Segment margin 2. % segment margin $5,200,000; $8,400,000; $5,300,000; $3,560,000 ÷ $22,460,000 3. Allocated headquarters cost (Row 2 × $14,255,000)

Refrigerator

Stove

Dishwasher

Microwave Oven

Total

$5,200,000

$8,400,000

$5,300,000

$3,560,000

$22,460,000

23.15% $3,300,033

37.40% $5,331,370

23.60% $3,364,180

15.85% $2,259,417

100% $14,255,000

Refrigerator

Stove

Dishwasher

Microwave Oven

Total

Segment margin

$5,200,000

$8,400,000

$5,300,000

$3,560,000

$22,460,000

Less: Headquarters costs

3,300,033

5,331,370

3,364,180

2,259,417

14,255,000

Division margin

$1,899,967

$3,068,630

$1,935,820

$1,300,583

$ 8,205,000

Division margin ÷ Revenue

17.4%

16.3%

16.8%

19.2%

17.1%

2. I prefer the allocation based on segment margins because a cause-and-effect relationship may exist between headquarters costs and division segment margin—headquarters staff are likely to spend more time on divisions that have more revenue and segment margins. Segment margins can also be justified on the ability-to-bear principle—divisions with higher margins can bear more of the headquarters costs. The physical size of the divisions probably has no cause-andeffect relationship with headquarters costs. 3. None of the divisions should be dropped, since all four have positive segment margins before considering the headquarters’ cost allocation. As seen by these two options, the allocation of headquarters costs is arbitrary and should not serve as the basis for closing a division. Copyright © 2022 Pearson Canada Inc. 15-20

Chapter 15: Period Cost Application

15-28

(40–60 min.) Support-department cost allocations; single-department cost pools; direct, step-down, and reciprocal methods.

All the following computations are in dollars. 1. Direct method: A B Total

To X To Y 1,000/1,600  $420,000 = $262,500 600/1,600  $420,000 = $157,500 250/1,000  $180,000 = 45,000 750/1,000  $180,000 = 135,000 $307,500 $292,500

Step-down method, allocating A first: A Costs to be allocated $420,000 Allocate A: (400; 1,000; 600 ÷ 2,000) (420,000) Allocate B: (250; 750 ÷ 1,000) — Total $ 0

B $180,000 84,000 (264,000) $ 0

X — $210,000 66,000 $276,000

Y — $126,000 198,000 $324,000

B X $180,000 — (180,000) $ 18,000 — 330,000 $ 0 $ 348,000

Y — $ 54,000 198,000 $252,000

Step-down method, allocating B first: A Costs to be allocated $420,000 Allocate B: (1500; 250; 750 ÷ 2,500) 108,000 Allocate A: (1,000; 600 ÷ 1,600) (528,000) Total $ 0

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Note that these methods produce significantly different results, so the choice of method may frequently make a difference in the budgeted department overhead rates. Reciprocal method: Stage 1: Let A = B = (1) A = (2) B =

total costs of materials-handling department total costs of power-generating department $420,000 + 0.6 B $180,000 + 0.2 A

Stage 2: Substituting in (1):

Substituting in (2):

A A 0.88 A A

= = = =

$420,000 + 0.6 ($180,000 + 0.2 A) $420,000 + $108,000 + 0.12 A $528,000 $600,000

B = $180,000 + 0.2 ($600,000) B = $300,000

Stage 3:

Original amounts Allocation of A Allocation of B Totals accounted for

A $420,000 (600,000) 180,000 (60%) $ 0

B $180,000 120,000 (20%) (300,000) $ 0

X — $300,000 (50%) 30,000 (10%) $330,000

Y — $180,000 (30%) 90,000 (30%) $270,000

Chapter 15: Period Cost Application

SOLUTION EXHIBIT 15-28 Reciprocal Method of Allocating Support Department Costs for Martinez Company Using Repeated Iterations. Support Departments A B Budgeted manufacturing overhead costs before any interdepartmental cost allocations 1st Allocation of Dept. A (2/10, 5/10, 3/10)a 1st Allocation of Dept. B (6/10, 1/10, 3/10)b 2nd Allocation of Dept. A (2/10, 5/10, 3/10)a 2nd Allocation of Dept. B: (6/10, 1/10, 3/10)b 3rd Allocation of Dept. A: (2/10, 5/10, 3/10)a 3rd Allocation of Dept. B: (6/10, 1/10, 3/10)b 4th Allocation of Dept. A (2/10, 5/10, 3/10)a 4th Allocation of Dept. B (6/10, 1/10, 3/10)b 5th Allocation of Dept. A (2/10, 5/10, 3/10)a 5th Allocation of Dept. B (6/10, 1/10, 3/10)b 6th Allocation of Dept. A (2/10, 5/10, 3/10)a 6th Allocation of Dept. B (6/10, 1/10, 3/10)b 7th Allocation of Dept. A (2/10, 5/10, 3/10)a Total budgeted manufacturing overhead of operating departments

Operating Departments X Y

$420,000

$180,000

(420,000)

84,000 264,000

$210,000

$126,000

158,400

(264,000)

26,400

79,200

(158,400)

31,680

79,200

47,520

19,008

(31,680)

3,168

9,504

(19,008)

3,802

9,504

5,702

2,282

(3,802)

380

1,140

(2,282)

456

1,140

686

274

(456)

136

(274)

136

(56)

(34)

(6)

(4)

$330,000

$270,000

Total accounts allocated and reallocated (the numbers in parentheses in first two columns) Dept A; Materials Handling: $420,000 + $158,400 + $19,008 + $2,282 + $274 + $34 + $4 = $600,000 Dept B; Power Generation: $264,000 + $31,680 + $3,802 + $456 + $56 + $6 = $300,000 aBase is (400 + 1,000 +600) or 2,000 labour-hours; 400 ÷ 2,000 = 2/10, 1,000 ÷ 2,000 = 5/10,

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Comparison of methods: Method of Allocation Direct method Step-down: A first Step-down: B first Reciprocal method

X $307,500 276,000 348,000 330,000

Y $292,500 324,000 252,000 270,000

2. It appears that the cost of power is $72 per kilowatt-hour ($180,000 ÷ 2,500 Kwh) plus the material handling costs. But Martinez should make the decision after considering the effects of the interdependencies and the fixed costs. Note that the power needs would be less (students frequently miss this) if they were purchased from the outside: Outside Power Units Needed Needed X 250 Y 750 A (1,500 units minus 20% of 1,500 units, because there is no need to service the nonexistent power department) 1,200 Total units 2,200 Total costs, 2,200  $80 = $176,000 In contrast, the total costs that would be saved by not producing the power inside would depend on the effects of the decision on various costs:

Variable indirect labour and indirect material costs Supervision in power department Materials handling, 20% of $300,000* Probable minimum cost savings Possible additional savings: a. Can any supervision in materials handling be saved because of overseeing less volume? Minimum savings is probably zero; the maximum is probably 20% of $90,000 or $18,000. b. Is any depreciation a truly variable, wear-and-tear type of cost? Total savings by not producing 2,500 units of power

Avoidable Costs of 2,500 Units of Power Produced Inside $ 30,000 50,000 60,000 $140,000 ?

? ________ $140,000 + ?

*Materials handling costs are higher because the power department uses 20% of materials handling. Therefore, materials-handling costs will decrease by 20%. In the short run (at least until a capital investment in equipment is necessary), the data suggest continuing to produce internally because the costs eliminated would probably be less than the comparable purchase costs. Copyright © 2022 Pearson Canada Inc. 15-24

Chapter 15: Period Cost Application

15-29

(25 min.)

Common costs.

1. Stand-alone cost-allocation method. Tate Inc.

$26, 000  $36, 000 = $23,400 ($26, 000  $14, 000)

Booth Inc.

$14, 000  $36, 000 = $12,600 ($26, 000  $14, 000)

$36,000 2. With Tate Inc. as the primary party: Party Tate Booth Total

Costs Allocated $26,000 10,000 ($36,000 – $26,000) $36,000

Cumulative Costs Allocated $26,000 $36,000

With Booth Inc. as the primary party: Party Booth Tate Total

Costs Allocated $14,000 22,000 ($36,000 – $14,000) $36,000

Cumulative Costs Allocated $14,000 $36,000

3. To use the Shapley value method, consider each party as first the primary party and then the incremental party. Compute the average of the two to determine the allocation. Tate Inc.: Allocation as the primary party Allocation as the incremental party Total Allocation ($48,000 ÷ 2)

$26,000 22,000 $48,000 $24,000

Booth Inc.: Allocation as the primary party Allocation as the incremental party Total Allocation ($24,000 ÷ 2)

$14,000 10,000 $24,000 $12,000

Using this approach, Tate Inc. is allocated $24,000, and Booth, Inc. is allocated $12,000 of the total costs of $36,000.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4. The results of the four cost-allocation methods are shown below. Tate Inc. $23,400 26,000 22,000 24,000

Stand-alone method Incremental (Tate primary) Incremental (Booth primary) Shapley value

Booth Inc. $12,600 10,000 14,000 12,000

The allocations are very sensitive to the method used. With the incremental costallocation method, Tate Inc. and Booth Inc. would probably have disputes over who is the primary party because the primary party gets allocated all of the primary party’s costs. The stand-alone method is simple and fair because it allocates the common cost of the cutting machine in proportion to the individual costs of leasing the machine. The Shapley values are also fair. They result in allocations that are similar to those of the stand-alone method. Either of the methods can be chosen. Given its simplicity, the stand-alone method is likely more acceptable.

15-30 (40–60 min.) Support-department cost allocations: single-department cost pools; direct, step-down, and reciprocal methods. 1. a. Allocate the total Support Department costs to the production departments under the Direct Allocation Method: Clothing $21,000

Departmental Costs From: Information Technology (10,080/18,000) × $5,200 ( 7,920/18,000) × $5,200

Shoes $15,000

2,912 2,288

Human Resources (440/616) × $2,800 (176/616) × $2,800

2,000 .

800

Total Departmental Costs

$25,912

$18,088

Total Costs to account for: $44,000

Chapter 15: Period Cost Application

b. Allocate the Support Department Costs to the Production Department under the Stepdown (Sequential) Allocation Method IT first sequentially: To: IT $5,200

Departmental Costs From: Information Technology ( 6,000/24,000) × $5,200 (10,080/24,000) × $5,200 ( 7,920/24,000) × $5,200 Human Resources (440/616) × $4,100 (176/616) × $4,100 Total Departmental Costs

HR $2,800

Clothing $21,000

Shoes $15,000

(5,200) 1,300 2,184 1,716 (4,100) 2,929 . $

$26,113

1,171 $17,887

Total Costs to account for: $44,000 c. Allocate the Support Department Costs to the Production Department under the Stepdown (Sequential) Allocation Method HR first sequentially: To: Departmental Costs

HR $2,800

From: Human Resources (184/800) × $2,800 (440/800) × $2,800 (176/800) × $2,800

IT $5,200

Clothing $21,000

Shoes $15,000

(2,800) 644 1,540 $ 616

Information Technology (10,080/18,000) × $5,844 ( 7,920/18,000) × $5,844 Total Departmental Costs $

(5,844) 3,273 . 0

$25,813

Total Costs to account for: $44,000

$2,571 $18,187

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

d. Allocate the Support Department Costs to the Production Department under the Reciprocal Allocation Method: i. Assign reciprocal equations to the support departments. Note that IT uses 184/800 or 0.23 of HR department resources (allocation based on number of employees) and HR uses 6,000/24,000 of IT department resources (allocation based on number of IT hours). IT = ($5,200 + 0.23 HR) HR = ($2,800 + 0.25 IT) ii. Solve the equation to complete the reciprocal costs of the support departments IT = $5,200 + 0.23 HR IT = $5,200 + 0.23($2,800 + 0.25 IT) IT = $5,200 + $644 + 0.0575 IT 0.9425 IT = $5,844 IT = $6,200 HR = $2,800 + 0.25 IT HR = $2,800 + 0.25($6,200) HR = $2,800 + $1,550 HR = $4,350 iii. Allocate Reciprocal costs to departments (all numbers rounded to nearest dollar) Departmental Costs Information Technology ( 6,000/24,000) × $6,200 (10,080/24,000) × $6,200 ( 7,920/24,000) × $6,200 Human Resources (184/800) × $4,350 (440/800) × $4,350 (176/800) × $4,350 Total Departmental Costs

IT $ 5,200

HR $ 2,800

Clothing $21,000

Shoes $15,000

$(6,200) 1,550 2,604 $2,046 $(4,350) $1,000 2,393 . $

957

$25,997

$18,003

Costs allocated to the Clothing Department equal $4,997 ($2,604 + $2,393). Costs allocated to the Shoes Department equal $3,003 ($2,046 + $957). Total Costs to account for is $44,000. Solution Exhibit 15-30 shows the allocation of the IT and HR Department costs to the Clothing Department ($4,997) and to the Shoes Department ($3,003) using repeated iterations.

Chapter 15: Period Cost Application

SOLUTION EXHIBIT 15-30 Reciprocal Method of Allocating Support Department Costs for Sportz, Inc. Using Repeated Iterations. Support Departments IT HR Budgeted manufacturing overhead costs before any interdepartmental cost allocations 1st Allocation of IT Dept. (0.25, 0.42, 0.33)a 1st Allocation of HR Dept. (0.23, 0.55, 0.22)b 2nd Allocation of IT Dept. (0.25, 0.42, 0.33)a 2nd Allocation of HR Dept. (0.23, 0.55, 0.22)b 3rd Allocation of IT Dept. (0.25, 0.42, 0.33)a 3rd Allocation of HR Dept. (0.23, 0.55, 0.22)b 4th Allocation of IT Dept. (0.25, 0.42, 0.33)a 4th Allocation of HR Dept. (0.25, 0.42, 0.33)a Total budgeted manufacturing overhead of operating departments

Operating Departments Clothing Shoes

$5,200

$2,800

(5,200)

1,300 4,100

$2,184

$1,716

943

(4,100)

2,255

902

(943)

236

396

311

(236)

130

(54)

(13)

(3)

(1)

$4,997

$3,003

Total accounts allocated and reallocated (the numbers in parentheses in first two columns) IT Dept.: $5,200 + $943 + +$54 + $3 = $6,200 HR Dept.: $4,100 + $236 + $13 + 1 = $4,350 aBase is (6,000 + 10,080 + 7,920) or 24,000 IT-hours; 6,000 ÷ 24,000 = 0.25, 10,080 ÷ 24,000 =

0.42, 7,920 ÷ 24,000 = 0.33. bBase is (184 + 440 + 176) or 800 employees; 184 ÷ 800 = 0.23, 440 ÷ 800 = 0.55, 176 ÷ 800 =

0.22.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. If Sportz decides to outsource its Information Technology needs, the company has to pay $97.50 per hour for the 24,000 hours of IT services it needs, for a total outlay of $2,340,000. In return, Sportz saves 30% of the IT department’s fixed costs ($4,000,000 × 0.30 = $1,200,000). The issue then is how much it saves in variable costs. The key is to recognize that Sportz saves more than the $1,200,000 of variable costs assigned to IT because of the interlinks between the IT and HR groups. To quantify this, we have to calculate the reciprocated cost of the IT department using the variable costs alone. IT = $1,200,000 + 0.23 HR HR = $ 800,000 + 0.25 IT IT = $1,200,000 + 0.23($800,000 + 0.25 IT) IT = $1,384,000 + 0.0575 IT 0.9425 IT = $1,384,000 IT = $1,468,435 Sportz’s total savings therefore amount to $1,200,000 + $1,468,435 = $2,668,435, which exceeds the direct outsourcing payment of $2,340,000. Therefore, on financial grounds alone, Sportz should outsource its Information Technology services. Beyond the financial perspective, Sportz should decide how important it is to the company to have control over its own IT support. It may be critical, especially with information technology, that the knowledge and expertise be maintained within the firm so critical decisions do not depend on a third party. It may also be critical for security purposes to maintain IT support internally so that company information is kept confidential. In addition, by maintaining IT support in-house, the response time to production departments and other support departments will likely be greater than if the services are outsourced. It is also possible that the quality of the service would be higher as well. Finally, Sportz should consider the internal repercussions of dismissing a large portion of its workforce. This could create morale issues for the company’s remaining workers.

Chapter 15: Period Cost Application

15-31 (20–25 mins.) Stand-alone revenue allocation. 1. Allocation using individual selling price per unit. Computer Hardware Component PC tower Monitor Color laser printer Total

Individual Selling Price per Unit $1,150 250 600 $2,000

Percentage of Total Price 0.575 0.125 0.30

Allocation % × $1,500 $ 862.50 187.50 450.00 $1,500.00

Percentage of Cost per Unit Total Cost $375 0.46875 200 0.25 225 0.28125 $800

Allocation % × $1,500 $ 703.12 375.00 421.88 $1,500.00

2. Allocation using cost per unit Computer Hardware Component PC tower Monitor Color laser printer Total

3. Allocation using number of individual units of product sold per bundle Computer Hardware Component PC tower Monitor Color laser printer Total

Individual Units of Product Sold per Bundle 1 1 1 3

Percentage of Total Price 0.333 0.333 0.333

Allocation % × $1,500 $ 500 500 500 $1,500

4. Sharing on the basis of revenue makes the most sense. Using this method each division takes a uniform percentage decrease in the revenue received regardless of the cost of the division’s individual products. For example: Individual Computer Price per Hardware Unit Component (a) PC tower $1,150 Monitor $ 250 Color laser printer $ 600 Total $2,000

Allocated Revenue per Unit (b) $ 862.50 $ 187.50 $ 450.00 $1,500.00

Decrease in Price (c) = (a) – (b) ($287.50) ($ 62.50) ($150.00) ($500.00)

Percentage Decrease in Price by Product (d) = (c) ÷ (a) –25% –25% –25%

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Furthermore, the cost-based method might actually discourage cost efficiencies. Increasing the cost per unit of product relative to other products would give the division a greater share of the overall revenue. Last, under the physical unit allocation method, the motivation of the divisional managers to produce for the bundled purchase would likely change significantly. The PC Tower Division would see the largest decrease in revenue and the Monitor Division would see the largest increase in revenue. The PC Tower Division would have much less incentive to produce for the bundled purchase, if the divisional revenue were cut from $1,140 to $500 dollars per unit. The Monitor Division would be highly motivated to produce for the bundled purchase, as the sales revenue per unit would go from $260 to $500. This method is also not the most reasonable because the relative price of $500 for each component is not representative of the amount individual price customers are willing to pay for each of the components independently.

15-32 Cost allocation to divisions. 1. Segment margin Allocated headquarters costs ($5,100,000 ÷ 3) Operating income

Bread $6,400,000

Cake $1,300,000

Doughnuts $6,150,000

Total $13,850,000

1,700,000 $4,700,000

1,700,000 $ (400,000)

1,700,000 $4,450,000

5,100,000 $ 8,750,000

2. $1,300,000

Doughnuts $6,150,00 0

Total $13,850,00 0

950,000

237,500

712,500

1,900,000

754,600

162,400

483,000

1,400,000

600,000

240,000

360,000

1,200,000

200,000

Total

2,504,600

839,900

Operating income

$3,895,400

$ 460,100

Segment margin Allocated headquarters costs, Human resources1 (50%; 12.5%; 37.5% × $1,900,000) Accounting department2 (53.9%; 11.6%; 34.5% × $1,400,000) Rent and depreciation3 (50%; 20%; 30% × $1,200,000)

1 3

 

Other   $600, 000 

Bread

Cake

$6,400,000

200,000 1,755,500 $4,394,50 0

600,000 5,100,000 $ 8,750,000

1HR costs: 400 ÷ 800 = 50%; 100 ÷ 800 = 12.5%; 300 ÷ 800 = 37.5% 2Accounting:

$20,900,000 ÷ $38,800,000 = 53.9%; $4,500,000 ÷ $38,800,000 = 11.6%; $13,400,000 ÷ $38,800,000 = 34.5% 3Rent and depreciation: 10,000 ÷ 20,000 = 50%; 4,000 ÷ 20,000 = 20%; 6,000 ÷ 20,000 = 30%

Chapter 15: Period Cost Application

A cause-and-effect relationship may exist between human resources costs and the number of employees at each division. Rent and depreciation costs may be related to square metres, except that very expensive machines may require few square metres, which is inconsistent with this choice of allocation base. The accounting department costs are probably related to the revenue earned by each division—higher revenue means more transactions and more accounting. Other overhead costs are allocated arbitrarily. 3. The manager suggesting the new allocation bases probably works in the cake division. Under the old scheme, the cake division shows an operating loss after allocating headquarters costs because it is smaller, yet was charged an equal amount (one-third) of headquarters costs. The new allocation scheme shows an operating profit in the cake division, even after allocating headquarters costs. The ABC method is a better way to allocate headquarters costs because it uses cost allocation bases that, by and large, represent cause-and-effect relationships between various categories of headquarters costs and the demands that different divisions place on these costs.

15-33 (20–25 min.) Revenue allocation, bundled products. 1.a. The stand-alone revenues (using unit selling prices) of the three components of the $800 package are: Lodging $375 × 2 = $750 Recreation $150 × 2 = 300 Food $100 × 2 = 200 $1,250 Lodging

$750  $1, 000  0.60  $1, 000  $600 $1, 250

Spa

$300  $1, 000  0.24  $1, 000  $240 $1, 250

Food

$200  $1, 000  0.16  $1, 000  $160 $1, 250

Total Allocated

$1,000

b. Product Spa Lodging Food

Revenue Allocated $ 300 700 ($1,000 – $300) 0 $1,000

Cumulative Revenue Allocated $ 300 $1,000 $1,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

The pros of the stand-alone-revenue-allocation method include the following: a. Each item in the bundle receives a positive weight, which means the resulting allocations are more likely to be accepted by all parties than a method allocating zero revenues to one or more products. b. It uses market-based evidence (unit selling prices) to decide the revenue allocations— unit prices are one indicator of benefits received. c. It is simple to implement. The cons of the stand-alone revenue-allocation method include the following: a. It ignores the relative importance of the individual components in attracting consumers to purchase the bundle. b. It ignores the opportunity cost of the individual components in the bundle. The spa operates at 100% capacity. A getaway participant who does not use the spa option will not displace anyone. Thus, under the stand-alone method, the spa may be paid twice— once from the non-getaway person who does use the spa and second from an allocation of the $1,000 package amount for the getaway person who does not use the spa (either did not want to use the spa or failed to show). c. The weight can be artificially inflated by individual product managers setting “high” list unit prices and then being willing to frequently discount these prices. The use of actual unit prices or actual revenues per product in the stand-alone formula will reduce this problem. d. The weights may change frequently if unit prices are constantly changing. This is not so much a criticism as a reflection that the marketplace may be highly competitive. The pros of the incremental method include the following: a. It has the potential to reflect that some products in the bundle are more highly valued than others. Not all products in the bundle have a similar “write-down” from unit list prices. Ensuring this “potential pro” becomes an “actual pro” requires that the choice of the primary product be guided by reliable evidence on consumer preferences. This is not an easy task. b. Once the sequence is chosen, it is straightforward to implement. The cons of the incremental method include the following: a. Obtaining the rankings can be highly contentious and place managers in a “no-win” acrimonious debate. The revenue allocations can be sensitive to the chosen rankings. b. Some products will have zero revenues assigned to them. Consider the Food division. It would incur the costs for the two dinners but receive no revenue.

Chapter 15: Period Cost Application

3. Under the Shapley value method the revenue allocated represents an average of the revenue that would have been received if each product or service were ranked as both the primary party and the incremental party a. Product Primary party Incremental party

Lodging Food

Product Primary party Incremental party

Revenue Received under Incremental Method $750 50 ($800 – $750) $800 Revenue Received under Incremental Method

Food Lodging

$200 600 ($800 – $200) $800 Revenue allocation under the Shapley value method, based on the data from the incremental rankings above is: Average Lodging ($750 + $600) ÷2 $675 Average Food Total Revenue Dollars Allocated

($200 + $50) ÷ 2

125 $800

b. Assuming that lodging is three times as likely to be sold as food, the revenue allocated under the weighted Shapley value method, using data from the incremental rankings above would be: Average Lodging ($750 × 3 + $600 × 1) ÷ 4 $712.50 Average Food Total Revenue Dollars Allocated

($200 × 1 + $ 50 × 3) ÷ 4

87.50 $800.00

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

15-34 (20 min.) Support-department cost allocations; direct, step-down, and reciprocal methods. 1

a. Allocate the total Support Department costs to the operating departments under the Direct Allocation Method: Eastern Department $650,000

Departmental Overhead Costs From: Engineering ($50,000/$140,000) × $300,000 ($90,000/$140,000) × $300,000

Western Department $ 920,000

107,143 192,857

Information Technology (1,500/2,550) × $250,000 (1,050/2,550) × $250,000

147,059 _______

102,941

Total Departmental Overhead Costs $904,202

$1,215,798

Total Costs to account for: $2,120,000 b. Allocate the Support Department Costs to the Operating Departments under the Stepdown (Sequential) Allocation Method with Engineering first sequentially: To: Departmental Overhead Costs From: Engineering 30% × $300,000 25% × $300,000 45% × $300,000 Information Technology (1,500/2,550) × $340,000 (1,050/2,550) × $340,000 Total Departmental Costs

Engineering $ 300,000

Eastern Department $650,000

IT $250,000

Western Department $ 920,000

$(300,000) 90,000 75,000 135,000 (340,000) . $

. $

Total Costs to account for: $2,120,000

200,000 . $925,000

140,000 $1,195,000

Chapter 15: Period Cost Application

c. Allocate the Support Department Costs to the Operating Departments under the Stepdown (Sequential) Allocation Method IT first sequentially: To: IT $250,000

Departmental Costs From: Information Technology 15% × $250,000 50% × $250,000 35% × $250,000

Engineering $300,000

Eastern Department $650,000

Western Department $ 920,000

(250,000) 37,500 125,000 87,500

Engineering ($50,000/$140,000) × $337,500 ($90,000/$140,000) × $337,500 Total Departmental Costs

(337,500) 120,536 . $

$895,536

216,964 $1,224,464

Total Costs to account for: $2,120,000 d. Allocate the Support Department Costs to the Operating Departments under the Reciprocal Allocation Method: Assign reciprocal equations to the support departments: Engineering (E) and Information Technology (IT) E = $300,000 + 0.15 IT IT = $250,000 + 0.30 E Solve the equation to complete the reciprocal costs of the support departments E = $300,000 + 0.15 IT E = $300,000 + 0.15 ($250,000 + 0.30 E) E = $300,000 + $37,500 + 0.045 E 0.955 E = $337,500 E = $353,403 IT = $250,000 + 0.30 E IT = $250,000 + 0.30 ($353,403) IT = $250,000 + $106,021 IT = $356,021

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Allocate Reciprocal costs to departments (all numbers rounded to nearest dollar)

Departmental Costs Engineering 30% × $353,403 25% × $353,403 45% × $353,403

Engineering $300,000

Eastern Department $650,000

IT $250,000

Western Department $ 920,000

(353,403) 106,021 88,351 159,031

Information Technology 15% × $356,021 50% × $356,021 35% × $356,021 Total Departmental Costs $

(356,021) 53,403 . 0

. $

178,011 . $916,362

124,607 $1,203,638

Costs allocated to the Eastern Department equal $266,362 ($88,351 + $178,011). Costs allocated to the Western Department equal $283,638 ($159,031 + $124,607). Total Support Department Costs to account for $550,000 (Engineering, $300,000 + Information Technology, $250,000). Solution Exhibit 15-34 shows the allocation of the IT and HR Department costs to the Eastern Department and to the Western Department using repeated iterations. 2. Summary of cost allocation resulting from the four methods in part 1:

Direct method Step-down method (Engineering primary) Step-down method (IT primary) Reciprocal method

Eastern Department $904,202 $925,000 $895,536 $916,362

Western Department $1,215,798 $1,195,000 $1,224,464 $1,203,638

Although the reciprocal method produces the most accurate support department cost allocation, it is also the most complicated. The step-down method with Engineering being the primary department produces similar results. That is due to the fact that 30% of Engineering services are provided to the IT department, another support department, while only 15% of IT services are provided to Engineering. Therefore, the step-down method with Engineering as the primary department would be an acceptable substitute for the reciprocal method.

Chapter 15: Period Cost Application

SOLUTION EXHIBIT 15-34 Reciprocal Method of Allocating Support Department Costs for Ballantine Tours Using Repeated Iterations. Support Departments Engineering IT Budgeted manufacturing overhead costs before any interdepartmental cost allocations 1st Allocation of Engg. Dept. (30%, 25%, 45%)a 1st Allocation of IT Dept. (15%, 50%, 35%)b 2nd Allocation of Engg. Dept. (30%, 25%, 45%)a 2nd Allocation of IT Dept. (15%, 50%, 35%)b 3rd Allocation of Engg. Dept. (30%, 25%, 45%)a 3rd Allocation of IT Dept. (15%, 50%, 35%)b 4th Allocation of Engg. Dept. (30%, 25%, 45%)a 4th Allocation of IT Dept. (15%, 50%, 35%)b 5th Allocation of Engg. Dept. (30%, 25%, 45%)a 5th Allocation of IT. Dept. (15%, 50%, 35%)a Total budgeted manufacturing overhead of operating departments

Operating Departments Eastern Western

$300,000

$250,000

$650,000

$ 920,000

(300,000)

90,000 340,000

75,000

135,000

51,000

(340,000)

170,000

119,000

(51,000)

15,300

12,750

22,950

2,295

(15,300)

7,650

5,355

(2,295)

688

574

1,033

103

(688)

344

241

(103)

(31)

(5)

(2)

$916,362

$1,203,638

Total accounts allocated and reallocated (the numbers in parentheses in first two columns) Engg. Dept.: $300,000 + $51,000 + $2,295 + $103 + $5 = $353,403 IT Dept.: $340,000 + $15,300 + $688 + $31 + $2 = $356,021 aBase is ($60,000 + $50,000 + $90,000) or $200,000; $60,000 ÷ $200,000 = 30%, $50,000 ÷

$200,000 = 25%, $90,000 ÷ $200,000 = 45%. bBase is (450 + 1,500 + 1,050) or 3,000 IT service-hours; 450 ÷ 3,000 = 15%, 1,500 ÷ 3,000 =

50%, 1,050 ÷ 3,000 = 35%.

CHAPTER 16 COST ALLOCATION: JOINT PRODUCTS AND BYPRODUCTS MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

SHORT-ANSWER QUESTIONS 16-1

Exhibit 16-2 presents examples from four different general industries. These include: Industry Separable Products at the Splitoff Point Agriculture:  Lamb • Lamb cuts, tripe, hides, bones, fat Extractive:  Petroleum • Crude oil, natural gas, raw LPG

Student answers may vary.

16-2

A joint cost is a cost of a production process that yields multiple products simultaneously. A separable cost is a cost incurred beyond the splitoff point that is assignable to each of the specific products identified at the splitoff point.

16-3

The distinction between a joint product and a byproduct is based on relative sales value. A joint product is a product that has a relatively high sales value. A byproduct is a product that has low sales value compared to the sales value of the joint (or main) products.

16-4

A product is any output that has a positive sales value (or an output that enables an organization to avoid incurring costs). In some joint cost settings, outputs can occur that do not have a positive sales value. The offshore processing of hydrocarbons yields water that is recycled back into the ocean while yielding oil and gas. The processing of mineral ore to yield gold and silver also yields dirt as an output, which is recycled back into the ground.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

16-5

The chapter lists the following seven reasons for allocating joint costs:

1. Inventory cost and cost-of-goods-sold computations for external financial statements and reports for income tax authorities. 2. Inventory cost and cost-of-goods-sold computations for internal financial reporting. 3. Cost reimbursement under contracts when only a portion of a business’s products or services is sold or delivered to a single customer. 4. Customer profitability analysis where individual customers purchase varying combinations of joint products or byproducts as well as other products of the company. 5. Insurance settlement computations. 6. Rate regulation when one or more of the jointly produced products or services are subject to price regulation. 7. Contract litigation in which costs of joint products are key inputs.

16-6

The joint production process yields individual products that are either sold this period or held as inventory to be sold in subsequent periods. Hence the joint costs need to be allocated over total production rather than just what was sold this period.

16-7

This situation can occur when a production process yields separable outputs at the splitoff point that do not have selling prices available until further processing. The result is that selling prices are not available at the splitoff point to use the sales value at splitoff method. Examples include processing in integrated pulp and paper companies and in petro-chemical operations.

16-8

Both methods use market selling-price data in allocating joint costs, but they differ in which sales-price data they use. The sales value at splitoff method allocates joint costs on the basis of each product’s relative sales value at the splitoff point. The estimated net realizable value method allocates joint costs on the basis of the relative estimated net realizable value (expected final sales value in the ordinary course of business minus the expected separable costs of production and marketing).

16-9

Limitations of the physical measure method of joint cost allocation include:

a. The physical weights used for allocating joint costs may have no relationship to the revenueproducing power of the individual products. b. The joint products may not have a common physical denominator—for example, one may be a liquid while another a solid with no readily available conversion factor.

16-10 The estimated NRV method can be simplified by assuming (a) a standard set of postsplitoff point processing steps and (b) a standard set of selling prices. The use of (a) and (b) achieves the same benefits that the use of standard costs does in costing systems.

Chapter 16: Cost Allocation: Joint Products and Byproducts

16-11 The constant gross-margin percentage NRV method takes account of the post-splitoff point “profit” contribution earned on individual products, in addition to the joint costs, when making cost assignments to joint products.

16-12 No. Management teams should select the method that best reflects the economic facts of the production process. Teams also need to do a careful cost/benefit analysis to ensure the method they select is affordable for the benefits received. When a product is an inherent result of a joint process, the decision to process further should not be influenced by either the size of the total joint costs or the portion of the joint costs assigned to particular products. Joint costs are irrelevant for these decisions. The only relevant items for these decisions are the incremental revenue and the incremental costs beyond the splitoff point.

16-13 No. The only relevant items are incremental revenues and incremental costs when making decisions about selling products at the splitoff point or processing them further. Separable costs are not always identical to incremental costs. Separable costs are costs incurred beyond the splitoff point that are assignable to individual products. Some separable costs may not be incremental costs in a specific setting (e.g., allocated manufacturing overhead that includes amortization).

16-14 Two methods to account for byproducts are: a. Production method—recognizes byproducts in the financial statements at the time production is completed. b. Sales method—delays recognition of byproducts until the time of sale.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

EXERCISES 16-15 (10 min.) Terminology. 1. Companies provide value-added to their customers through the sale of their products. 2. A product is any output or service that can be sold for a price that recovers the total costs to bring the product to the customer plus some reasonable profit. Some product processes yield a main product with the highest sales price, a byproduct that requires little if any further processing but is sold for a far lower price, and scrap, which is usually unused direct materials recovered and sold for almost nothing. 3. Two or more products sold at a high price are called joint products. The costs of producing more than one product can be common or joint costs plus separable costs to complete each product. 4. The splitoff point determines what pool comprises the joint costs that must be allocated on a reasonable basis. 5. The allocation methods are physical measure, sales value at splitoff, net realizable value, and constant gross margin percentage. The task of the management team is to select the method of joint cost allocation that best represents what actually happened in the physical production process.

16-16 (20–30 min.) Joint cost allocation, insurance settlement. 1. a. Sales value at splitoff method:

Breasts Wings Thighs Bones Feathers

Wholesale Kilograms Selling Price Sales of per Value Product Kilogram at Splitoff 105 $0.65 $68.25 25 0.25 6.25 40 0.40 16.00 70 0.10 7.00 5 0.05 0.25 245 $97.75

Weighting: Sales Value at Splitoff 0.698 0.064 0.164 0.072 0.003 1.000

Costs of Destroyed Product Breasts: $0.399 per kilogram  60 kilograms Wings: $0.153 per kilogram  20 kilograms

Joint Costs Allocated $41.89 3.84 9.82 4.30 0.15 $60.00

= $23.94 = 3.06 $27.00

Allocated Costs per Kilogram 0.399 0.153 0.246 0.061 0.031

Chapter 16: Cost Allocation: Joint Products and Byproducts

b. Physical measure method:

Breasts Wings Thighs Bones Feathers

Kilograms of Product 105 25 40 70 5 245

Weighting: Physical Measures 0.429 0.102 0.163 0.286 0.020 1.000

Joint Costs Allocated $25.71 6.12 9.80 17.15 1.22 $60.00

Allocated Costs per Kilogram $0.245 0.245 0.245 0.245 0.245

Costs of Destroyed Product Breast: $0.245 per kilogram  60 kilograms = $14.70 Wings: $0.245 per kilogram  20 kilograms = 4.90 $19.60 Note: Although not required, it is useful to highlight the individual product profitability figures:

Sales Product Value Breasts $68.25 Wings 6.25 Thighs 16.00 Bones 7.00 Feathers 0.25 2.

Sales Value at Splitoff Method Joint Costs Gross Allocated Income $41.89 $26.36 3.84 2.41 9.82 6.18 4.30 2.70 0.15 0.10

Physical Measures Method Joint Costs Gross Allocated Income $25.71 $42.54 6.12 0.13 9.80 6.20 17.15 (10.15) 1.22 (0.97)

The sales-value at split off method captures the benefits-received criterion of cost allocation and is the preferred method. The costs of processing a chicken are allocated to products in proportion to the ability to contribute revenue. Quality Chicken’s decision to process chicken is heavily influenced by the revenues from breasts and thighs. The bones provide relatively few benefits to Quality Chicken despite their high physical volume. The physical measures method shows profits on breasts and thighs and losses on bones and feathers. Given that Quality Chicken has to jointly process all the chicken products, it is counterintuitive to single out individual products that are being processed simultaneously as making losses while the overall operations make a profit. Quality Chicken is processing chicken mainly for breasts and thighs and not for wings, bones, and feathers, while the physical measure method allocates a disproportionate amount of costs to wings, bones, and feathers.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

16-17 (10 min.)

Joint products and byproducts (continuation of Exercise 16-16).

1. Ending inventory: Breasts Wings Thighs Bones Feathers

20 5 10 10 5

    

$0.3990 0.1535 0.2455 0.0614 0.0307

= $ 7.98 = 0.77 = 2.46 = 0.61 = 0.15 $11.97

2. Joint Products Breasts Thighs

Net Realizable Values of Byproducts: Wings $ 6.25 Bones 7.00 Feathers 0.25 $13.50

Byproducts Wings Bones Feathers

Joint costs to be allocated: Joint costs – Net realizable values of byproducts = $60 – $13.50 = $46.50 Kilogra ms of

Wholesale Selling Price per Kilogram

Product Breast Thighs

105 40

Ending inventory: Breasts 20  $0.3588 Thighs 10  0.2208

$0.65 0.40

Sales Value at Splitoff

Weighting: Sales Value at Splitoff

Joint Costs Allocated

$68.25 16.00 $84.25

68.25 ÷ 84.25 16.00 ÷ 84.25

$37.67 8.83 $46.50

Allocated Costs Per

Kilogram $0.3588 0.2208

$7.1751 2.2077 $9.3828

3. Treating all products as joint products does not require judgments as to whether a product is a joint product or a byproduct. Joint costs are allocated in a consistent manner to all products for the purpose of costing and inventory valuation. In contrast, the approach in requirement 2 lowers the joint cost by the amount of byproduct net realizable values and results in inventory values being shown for only two of the five products, the ones (perhaps arbitrarily) designated as being joint products.

Chapter 16: Cost Allocation: Joint Products and Byproducts

16-18 (40 min.)

Irrelevance of joint costs.

A diagram of the situation is in Solution Exhibit 16-18. 1. Physical measure of total production (litres) Weighting Joint costs allocated, M, 0.25  $144,000; T, 0.75  $144,000

Methanol

Turpentine

Total

10,000

30,000

40,000

10, 000  0.25 40, 000

30, 000  0.75 40, 000

$36,000

$108,000

$144,000

Methanol

Turpentine

Total

$63,000

$126,000

$189,000

9,000

18,000

27,000

$54,000

$108,000

$162,000

$54, 000 1  162, 000 3

$108, 000 2  162, 000 3

2. Final sales value of total production, M, 10,000  $6.30; T, 30,000  $4.20 Deduct separable costs to complete and sell, M, 10,000  $0.90; T, 30,000  $0.60 Net realizable value at splitoff point Weighting

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Joint costs allocated, M, 1/3  $144,000; T, 2/3  $144,000

$48,000

$96,000

$144,000

Methanol $63,000

Turpentine $126,000

Total $189,000

36,000 9,000 45,000 $18,000

108,000 18,000 126,000 $ 0

144,000 27,000 171,000 $ 18,000

Methanol $63,000

Turpentine $126,000

Total $189,000

48,000 9,000 57,000 $ 6,000

96,000 18,000 114,000 $ 12,000

144,000 27,000 171,000 $ 18,000

Lab Ethanol

Turpentine

Total

$180,000

$126,000

$306,000

72,000 $108,000

18,000 $ 108,000

90,000 $216,000

3. a. Physical-measure (litres) method: Revenues Cost of goods sold: Joint costs (25%; 75% × $144,000) Separable costs Total costs Gross margin

b. Estimated net realizable value method: Revenues Cost of goods sold: Joint costs Separable costs Total costs Gross margin 4. Final sales value of total production, Lab ethanol, 10,000  $18.00; T, 30,000  $4.20 Deduct separable costs to complete and sell, Lab ethanol, 10,000  $3.60* + (0.20  $180,000); T, 30,000  $0.60 Net realizable value at splitoff point

$108, 000  0.50 $216, 000

Weighting Joint costs allocated, Lab ethanol, 0.5  $144,000; T, 0.5  $144,000

$ 72,000

$108, 000  0.50 $216, 000

$ 72,000

* $2.70 + $0.90

$144,000

Chapter 16: Cost Allocation: Joint Products and Byproducts

An incremental approach demonstrates that the company should use the new process: Incremental revenue, ($18.00 – $6.30)  10,000 Incremental costs: Added processing, $2.70  10,000 Taxes, (0.20  $18.00)  10,000 Incremental operating income from further processing Proof:

Total sales of both products Joint costs Separable costs Cost of goods sold New gross margin Old gross margin Difference in gross margin

SOLUTION EXHIBIT 16-18

$117,000 $27,000 36,000

63,000 $ 54,000 $306,000 144,000 90,000 234,000 72,000 18,000 $ 54,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

16-19 (20 min.)

Joint cost allocation: sell immediately or process further.

1. a. Sales value at splitoff method: Cookies/ Soymeal Sales value of total production at splitoff, 500 lbs × $1; 100 gallons × $4 Weighting, $500; $400 ÷ $900 Joint costs allocated, 0.556; 0.444  $500

$500 0.556 $278

Soyola/ Soy Oil

Total

$400 0.444

$900

$222

$500

b. Net realizable value method: Cookies Final sales value of total production, 600 lbs × $2; 400 qts × $1.25 Deduct separable costs Net realizable value

$1,200 300 $ 900

Soyola $500 200 $300

Total $1,700 500 $1,200

Weighting, $900; $300 ÷ $1,200 Joint costs allocated, 0.75; 0.25  $500

0.75

0.25

$ 375

$125

$ 500

2. Revenue if sold at splitoff Process further NRV Profit (Loss) from processing further

Cookies/Soy Meal $500a 900c $400

Soyola/Soy Oil $ 400b 300d $(100)

a500 lbs × $1 = $500 b100 gal × $4 = $400 c600 lbs × $2 – $300 = $900 d400 qts × $1.25 – $200 = $300

The company should process the soy meal into cookies because it increases profit by $400 (= $900 – $500). However, they should sell the soy oil as is, without processing it into the form of Soyola, because profit will be $100 (= $400 – $300) higher if they do. Since the total joint cost is the same under both allocation methods, it is not a relevant cost to the decision to sell at splitoff or process further.

Chapter 16: Cost Allocation: Joint Products and Byproducts

16-20 (10 min.)

Net realizable value method.

A diagram of the situation is in Solution Exhibit 16-20. Final sales value of total production, 12,500  $50; 6,250  $25 Deduct separable costs Net realizable value at splitoff point Weighting, $250,000; $62,500 ÷ $312,500 Joint costs allocated, 0.8; 0.2  $325,000

Corn Syrup

Corn Starch

$625,000 375,000 $250,000 0.8 $260,000

$156,250 93,750 $ 62,500 0.2 $ 65,000

Total $781,250 468,750 $312,500 $325,000

SOLUTION EXHIBIT 16-20 Separable Costs

Joint Costs

Processing $375,000

Corn Syrup: 12,500 cases at $50 per case

Processing $93,750

Corn Starch: 6,250 cases at $25 per case

Processing $325,000

Splitoff Point

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

16-21 (30 min.)

Joint cost allocation, sales value, physical measure, NRV methods.

1. a. PANEL A: Allocation of Joint Costs Using Sales Value at Splitoff Method Sales value of total production at splitoff point (10,000 tons × $10 per ton; 20,000 × $15 per ton) Weighting ($100,000; $300,000 ÷ $400,000) Joint costs allocated (0.25; 0.75 × $240,000) PANEL B: Product-Line Income Statement for June Revenues (12,000 tons × $18 per ton; 24,000 × $25 per ton) Deduct joint costs allocated (from Panel A) Deduct separable costs Gross margin Gross margin percentage

Special B/ Beef Ramen

Special S/ Shrimp Ramen

$100,000 0.25 $ 60,000

$300,000 0.75 $180,000

$400,000

Special B

Special S

Total

$216,000 60,000 48,000 $108,000 50%

$600,000 180,000 168,000 $252,000 42%

$816,000 240,000 216,000 $360,000 44%

Special B/ Beef Ramen 10,000 33% $79,200

Special S/ Shrimp Ramen 20,000 67% $160,800

Total 30,000 $240,000

Special B

Special S

Total

$216,000 79,200 4 8,000 $ 88,800 41%

$600,000 160,800 168,000 $271,200 45%

$816,000 240,000 216,000 $360,000 44%

Total

$240,000

1. b. PANEL A: Allocation of Joint Costs Using Physical-Measure Method Physical measure of total production (tons) Weighting (10,000 tons; 20,000 tons ÷ 30,000 tons) Joint costs allocated (0.33 × $240,000; 0.67 × $240,000) PANEL B: Product-Line Income Statement for June Revenues (12,000 tons × $18 per ton; 24,000 × $25 per ton) Deduct joint costs allocated (from Panel A) Deduct separable costs Gross margin Gross margin percentage

Chapter 16: Cost Allocation: Joint Products and Byproducts

1. c. PANEL A: Allocation of Joint Costs Using Net Realizable Value Method Final sales value of total production during accounting period (12,000 tons × $18 per ton; 24,000 tons × $25 per ton) Deduct separable costs Net realizable value at splitoff point Weighting ($168,000; $432,000 ÷ $600,000) Joint costs allocated (0.28; 0.72 × $240,000) PANEL B: Product-Line Income Statement for June Revenues (12,000 tons × $18 per ton; 24,000 tons × $25 per ton) Deduct joint costs allocated (from Panel A) Deduct separable costs Gross margin Gross margin percentage

Special B

Special S

Total

$216,000 48,000 $168,000 28% $ 67,200

$600,000 168,000 $432,000 72% $172,800

$816,000 216,000 $600,000

Special B

Special S

Total

$216,000 67,200 48,000 $100,800 46.7%

$600,000 172,800 168,000 $259,200 43.2%

$816,000 240,000 216,000 $360,000 44.1%

$240,000

2. Sherrie Dong probably performed the analysis shown below to arrive at the net loss of $2,228 from marketing the stock: PANEL A: Allocation of Joint Costs Using Sales Value at Splitoff Sales value of total production at splitoff point (10,000 tons × $10 per ton; 20,000 × $15 per ton; 4,000 × $5 per ton) Weighting ($100,000; $300,000; $20,000 ÷ $420,000) Joint costs allocated (0.238095; 0.714286; 0.047619 × $240,000) PANEL B: Product-Line Income Statement for June Revenues (12,000 tons × $18 per ton; 24,000 × $25 per ton; 4,000 × $5 per ton) Separable processing costs Joint costs allocated (from Panel A) Gross margin Deduct marketing costs Operating income

Special B/ Beef Ramen

Special S/ Shrimp Ramen

Stock

Total

$ 100,000

$ 300,000

$ 20,000

$420,000

23.8095%

71.4286%

4.7619%

100%

57,143

$ 171,429

$ 11,428

$240,000

Special B

Special S

Stock

Total

$216,000 48,000 57,143 $110,857

$600,000 168,000 171,429 $260,571

$20,000 0 11,428 8,572 10,800 $ (2,228)

$836,000 216,000 240,000 380,000 10,800 $369,200

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

In this (misleading) analysis, the $240,000 of joint costs are reallocated between Special B, Special S, and the stock. Irrespective of the method of allocation, this analysis is wrong. Joint costs are always irrelevant in a process-further decision. Only incremental costs and revenues past the splitoff point are relevant. In this case, the correct analysis is much simpler: the incremental revenues from selling the stock are $20,000, and the incremental costs are the marketing costs of $10,800. So, Instant Foods should sell the stock—this will increase its operating income by $9,200 (= $20,000 – $10,800).

16-22 (30 min.)

Joint cost allocation, process further.

Joint Costs = $1800

ICR8 (Non-Saleable)

Processing $175

Crude Oil 150 bbls × $18 / bbl = $2700

ING4 (Non-Saleable)

Processing $105

NGL 50 bbls × $15 / bbl = $750

XGE3 (Non-Saleable)

Processing $210

Gas 800 eqvt bbls × $1.30 / eqvt bbl = $1040

Splitoff Point

1a. Physical Measure Method: 1. Physical measure of total prodn. 2. Weighting (150; 50; 800 ÷ 1,000) 3. Joint costs allocated (weights  $1,800)

Crude Oil 150 0.15 $270

NGL 50 0.05 $90

Gas 800 0.80 $1,440

Total 1,000 1.00 $1,800

Crude Oil $ 2,700 175 $ 2,525 0.63125 $1,136.25

NGL $ 750 105 $ 645 0.16125 $ 290.25

Gas $ 1,040 210 $ 830 0.20750 $ 373.50

Total $4,490 490 $4,000

1b. NRV Method 1. 2. 3. 4. 5.

Final sales value of total production Deduct separable costs NRV at splitoff Weighting (2,525; 645; 830 ÷ 4,000) Joint costs allocated (weights  $1,800)

$1,800

Chapter 16: Cost Allocation: Joint Products and Byproducts

2. The operating income amounts for each product using each method is: a. Physical Measure Method Revenues Cost of goods sold Joint costs Separable costs Total cost of goods sold Gross margin

Crude Oil $2,700

NGL $750

Gas $1,040

Total $4,490

270 175 445 $2,255

90 105 195 $555

1,440 210 1,650 $ (610)

1,800 490 2,290 $2,200

Crude Oil $2,700.00

NGL $750.00

Gas $1,040.00

Total $4,490.00

1,136.25 175.00 1,311.25 $1,388.75

290.25 105.00 395.25 $354.75

373.50 210.00 583.50 $ 456.50

1,800.00 490.00 2,290.00 $2,200.00

b. NRV Method Revenues Cost of goods sold Joint costs Separable costs Total cost of goods sold Gross margin

3. Neither method should be used for product emphasis decisions. It is inappropriate to use joint cost-allocated data to make decisions regarding dropping individual products, or pushing individual products, as they are joint by definition. Product-emphasis decisions should be made based on relevant revenues and relevant costs. Each method can lead to product emphasis decisions that do not lead to maximization of operating income. 4. Since crude oil is the only product subject to taxation, it is clearly in Sinclair’s best interest to use the NRV method since it leads to a lower profit for crude oil and, consequently, a smaller tax burden. A letter to the taxation authorities could stress the conceptual superiority of the NRV method. Chapter 16 argues that, using a benefits-received cost allocation criterion, market-based joint cost allocation methods are preferable to physical-measure methods. A meaningful common denominator (revenues) is available when the sales value at splitoff point method or NRV method is used. The physical-measures method requires nonhomogeneous products (liquids and gases) to be converted to a common denominator.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

16-23 (40 min.)

Alternative methods of joint cost allocation, ending inventories.

Total production for the year was: X Y Z

Sold 120 340 475

Ending Inventories 180 60 25

Total Production 300 400 500

A diagram of the situation is in Solution Exhibit 16-23. 1. a. Net realizable value (NRV) method: Final sales value of total production, 300  $1,500; 400  $1,000; 500  $700 Deduct separable costs Net realizable value at splitoff point Weighting, $450; $400; $150 ÷ $1,000 Joint costs allocated, 0.45, 0.40, 0.15  $400,000

Total

$450,000 –– $450,000

$400,000 –– $400,000

$350,000 200,000 $150,000

$1,200,000 200,000 $1,000,000

0.45

0.40

0.15

$180,000

$160,000

$ 60,000

X 180 300 60%

Y 60 400 15%

Z 25 500 5%

Total

$180,000

$340,000

$332,500

$852,500

180,000 –– 180,000

160,000 –– 160,000

60,000 200,000 260,000

400,000 200,000 600,000

108,000 72,000 $108,000

24,000 136,000 $204,000

13,000 247,000 $ 85,500

145,000 455,000 $397,500

60%

25.71%

$ 400,000

Ending Inventory Percentages: Ending inventory Total production Ending inventory percentage Income Statement Revenues, 120  $1,500; 340  $1,000; 475  $700 Cost of goods sold: Joint costs allocated Separable costs Production costs Deduct ending inventory, 60%; 15%; 5% of production costs Cost of goods sold Gross margin Gross-margin percentage

Chapter 16: Cost Allocation: Joint Products and Byproducts

b. Constant gross-margin percentage NRV method: Step 1: Final sales value of prodn., (300  $1,500) + (400  $1,000) + (500  $700) Deduct joint and separable costs, $400,000 + $200,000 Gross margin Gross-margin percentage, $600,000 ÷ $1,200,000

$1,200,000 600,000 $ 600,000 50%

Step 2: Final sales value of total production, 300  $1,500; 400  $1,000; 500  $700 Deduct gross margin, using overall gross-margin percentage of sales, 50% Total production costs Step 3: Deduct separable costs Joint costs allocated

Total

$450,000

$400,000

$350,000

$1,200,000

225,000 225,000

200,000 200,000

175,000 175,000

600,000 600,000

$225,000

$200,000

200,000 200,000 $ (25,000) $ 400,000

The negative joint cost allocation to Product Z illustrates one “unusual” feature of the constant gross-margin percentage NRV method: some products may receive negative cost allocations so that all individual products have the same gross-margin percentage. Income Statement Revenues, 120  $1,500; 340  $1,000; 475  $700 Cost of goods sold: Joint costs allocated Separable costs Production costs Deduct ending inventory, 60%; 15%; 5% of production costs Cost of goods sold Gross margin Gross-margin percentage

Total

$180,000

$340,000

$332,500

$852,500

225,000 — 225,000

200,000 — 200,000

(25,000) 200,000 175,000

400,000 200,000 600,000

135,000 90,000 $ 90,000 50%

30,000 170,000 $170,000 50%

8,750 166,250 $166,250 50%

173,750 426,250 $426,250 50%

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Summary X

Total

$108,000 72,000

$ 24,000 136,000

$ 13,000 247,000

$145,000 455,000 $600,000

$135,000 90,000

$ 30,000 170,000

$ 8,750 166,250

$173,750 426,250 $600,000

60% 50%

25.71% 50.00%

a. NRV method: Inventories on balance sheet Cost of goods sold on income statement b. Constant gross-margin percentage NRV method Inventories on balance sheet Cost of goods sold on income statement 2. Gross-margin percentages: NRV method Constant gross-margin percentage NRV SOLUTION EXHIBIT 16-23

Chapter 16: Cost Allocation: Joint Products and Byproducts

16-24 (40 min.)

Process further or sell, byproduct.

1. The analysis shown below indicates that it would be more profitable for Newcastle Mining Company to continue to sell bulk raw coal without further processing. This analysis ignores any value related to coal fines. It also assumes that the costs of loading and shipping the bulk raw coal on river barges will be the same whether Newcastle sells the bulk raw coal directly or processes it further. Incremental sales revenues: Sales revenue after further processing (9,400,000a tons  $36) Sales revenue from bulk raw coal (10,000,000 tons  $29) Incremental sales revenue

$338,400,000 290,000,000 48,400,000

Incremental costs: Direct labour Supervisory personnel Heavy equipment costs ($25,000  12 months) Sizing and cleaning (10,000,000 tons  $3.50) Outbound rail freight (9,400,000 tons  60 tons)  $240 per car Incremental costs Incremental gain (loss)

800,000 200,000 300,000 35,000,000 37,600,000 73,900,000 $(25,500,000)

a10,000,000 tons  (1– 0.06)

2. The cost of producing the raw coal is irrelevant to the decision to process further or not. As we see from requirement 1, the cost of producing raw coal does not enter any of the calculations related to either the incremental revenues or the incremental costs of further processing. The answer would the same as in requirement 1: do not process further.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. The analysis shown below indicates that the potential revenue from the coal fines byproduct would result in additional revenue, ranging between $4,950,000 and $9,900,000, depending on the market price of the fines. Coal fines

= = =

75% of 6% of raw bulk tonnage 0.75  (10,000,000  0.06) 450,000 tons

Potential incremental income from preparing and selling the coal fines: Minimum Maximum Incremental income per ton $11 (= $15 – $4) $22 (= $24 – $2) (Market price – Incremental costs) $4,950,000 $9,900,000 Incremental income ($11; $22  450,000) The incremental loss from sizing and cleaning the raw coal is $25,500,000, as calculated in requirement 1. Analysis indicates that relative to selling bulk raw coal, the effect of further processing and selling coal fines is negative at the minimum incremental gain ($4,950,000 – $25,500,000 = –$20,550,000) and at the maximum incremental gain ($9,900,000 – $25,500,000 = $15,600,000). NMC will not benefit from further processing and selling the coal fines. Note that other than the financial implications, some factors that should be considered in evaluating a sell-or-process-further decision include:     

Stability of the current customer market for raw coal and how it compares to the market for sized and cleaned coal. Storage space needed for the coal fines until they are sold and the handling costs of coal fines. Reliability of cost (e.g., rail freight rates) and revenue estimates, and the risk of depending on these estimates. Timing of the revenue stream from coal fines and impact on the need for liquidity. Possible environmental problems, i.e., dumping of waste and smoke from unprocessed coal.

Chapter 16: Cost Allocation: Joint Products and Byproducts

16-25 (30 min.)

Accounting for a main product and a byproduct. Production Method

Revenues Main product Byproduct Total revenues Cost of goods sold Total manufacturing costs Deduct value of byproduct production Net manufacturing costs Deduct main product inventory Cost of goods sold Gross margin

a32,000  $20.00

Sales Method

$640,000a — 640,000

$640,000 28,000d 668,000

480,000 40,000b 440,000 88,000c 352,000 $288,000

480,000 0 480,000 96,000e 384,000 $284,000

d5,600  $5.00

b8,000  $5.00 c(8,000/40,000) × $440,000 = $88,000

e(8,000/40,000) × $480,000 = $96,000

2. Production Method $88,000 12,000a

Main Product Byproduct aEnding inventory shown at unrealized selling price.

BI + Production – Sales = EI 0 + 8,000 – 5,600 = 2,400 kilograms Ending inventory = 2,400 kilograms  $5 per kilogram = $12,000

Sales Method $96,000 0

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

16-26 (35–45 min.) Joint costs and byproducts. 1. Computing byproduct deduction to joint costs:

A B Totals

Revenues from C, 16,000  $6 Deduct: Gross margin, 10% of revenues Marketing costs, 20% of revenues Peanut Butter Department separable costs Net realizable value (less gross margin) of C

$ 96,000

Joint costs Deduct byproduct contribution Net joint costs to be allocated

$180,000 55,200 $124,800

Quantity 12,000 65,000

Unit Sales Price $12 3

Joint Costs Allocation $ 46,800 78,000 $124,800 Unit cost for C: or

Deduct Final Separable Sales Processing Value Cost $144,000 $27,000 195,000 –– $339,000 $27,000 Add Separable Processing Costs $27,000 –– $27,000

9,600 19,200 12,000 $ 55,200

Net Realizable Allocation of Value at $124,800 Splitoff Weighting Joint Costs $117,000 37.5% $ 46,800 195,000 62.5% 78,000 $312,000 $124,800

Total Costs $ 73,800 78,000 $151,800

Units 12,000 65,000 77,000

Unit Cost $6.15 1.20

($55,200 ÷ 16,000) + ($12,000 ÷ 16,000) = $3.45 + $0.75 = $4.20, $6.00 – (10%  $6) – (20%  $6) = $6.00 – $0.60 – $1.20 = $4.20.

Chapter 16: Cost Allocation: Joint Products and Byproducts

2. If all three products are treated as joint products:

A B C Totals

Quantity 12,000 65,000 16,000

A B C Totals

Unit Sales Price $12 3 6

Final Sales Value $144,000 195,000 96,000 $435,000

Deduct Separable Processing Cost $27,000 ─ 31,200 $58,200

Add Separable Processing Costs $27,000 –– 12,000 $39,000

Joint Costs Allocation $ 55,892 93,153 30,955 $180,000

Net Realizable Value at Splitoff $117,000 195,000 64,800 $376,800

Total Costs $ 82,892 93,153 42,955 $219,000

Allocation of $180,000 Joint Costs $ 55,892 93,153 30,955 $180,000

Weighting 117 ÷ 376.8 195 ÷ 376.8 64.8 ÷ 376.8

Units 12,000 65,000 16,000 93,000

Unit Cost $6.91 1.43 2.68

Call the attention of students to the different unit “costs” resulting from the two assumptions about the relative importance of Product C. The point is that costs of individual products depend heavily on which assumptions are made and which accounting methods and techniques are used.

16-27 (30 min)

Joint cost allocation, process further or sell.

1. Part 1 A

Sales Value and Split Off Monthly

Sales

Output

Price

Value

Allocation Weight

Studs

75,000

$ 600,000

46.15%

461,539

Decorative

5,000

$ 300,000

23.08%

230,769

Posts

20,000

$ 400,000

30.77%

307,692

Total

100,000

$1,300,000

$1,000,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Physical Measure Monthly Output

Weight

Allocation

Studs

75,000

75.0%

750,000

Decorative

5,000

5.0%

50,000

Posts

20,000

20.0%

200,000

Total

100,000

$1,000,000

NRV

Monthly

Full Process

Output

Sale Price

Sales Value Weight

Allocation

Studs

75,000

$ 600,000

44.44%

444,444

Decorative

4,500

100

$ 350,000

25.93%

259,259

Posts

20,000

$ 400,000

29.63%

296,296

Total

99,500

$1,350,000

$1,000,000

Chapter 16: Cost Allocation: Joint Products and Byproducts

2. Presented below is an analysis for Lanigan, Inc., comparing the processing of decorative pieces further versus selling the rough-cut product immediately at split-off: Part 2 Analysis of selling Decorative pieces fully processed or sold at split-off

Monthly Output

5,000

Spoilage

500

Net Output

4,500

Final Value

$100 per unit

$450,000

LESS: Value at Split-off

$300,000

Incremental Value

$150,000

LESS: Further processing Costs

$100,000

Profit(Loss) from further processing

$ 50,000

3. Assuming Lanigan announces that in six months it will sell the rough-cut product at split-off due to increasing competitive pressure, behavior that may be demonstrated by the skilled labor in the planning-and-sizing process include the following:   

Lower quality Reduced motivation and morale Job insecurity, leading to nonproductive employee time looking for jobs elsewhere.

Management actions that could improve this behavior include the following: 

 

Improve communication by giving the workers a more comprehensive explanation as to the reason for the change (and in particular the analysis in requirement 2 above) so they can better understand the situation and bring out a plan for future operation of the rest of the plant. The company can offer incentive bonuses to maintain quality and production and align rewards with goals and also share some of the savings from not processing the unfinished decorative pieces. The company could provide job relocation and internal job transfers.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

PROBLEMS 16-28 (40 min.)

Alternative methods of joint-cost allocation, product-mix decisions.

A diagram of the situation is in Solution Exhibit 16-28. 1. Computation of joint-cost allocation proportions: a.

Sales Value of Total Production at Splitoff A $150,000 B 125,000 C 90,000 D 135,000 $500,000

Weighting 150.0 ÷ 500 = 0.30 125.0 ÷ 500 = 0.25 90.0 ÷ 500 = 0.18 135.0÷ 500 = 0.27 1.00

Allocation of $210,000 Joint Costs $ 63,000 52,500 37,800 56,700 $210,000

Weighting 550 ÷ 1,000 = 0.55 200 ÷ 1,000 = 0.20 150 ÷ 1,000 = 0.15 100 ÷ 1,000 = 0.10 1.00

Allocation of $210,000 Joint Costs $115,500 42,000 31,500 21,000 $210,000

b. Physical Measure of Total Production A 550,000 gallons B 200,000 gallons C 150,000 gallons D 100,000 gallons 1,000,000 gallons c. Final Sales Value of Total Production Super A $750,000 Super B 300,000 C 90,000 Super D 150,000

Net Realizable Separable Value at Costs Splitoff $480,000 $270,000 120,000 180,000 – 90,000 90,000 60,000 $600,000

Weighting 270 ÷ 600 = 0.45 180 ÷ 600= 0.30 90 ÷ 600 = 0.15 60 ÷ 600 = 0.10 1.00

Allocation of $210,000 Joint Costs $ 94,500 63,000 31,500 21,000 $210,000

Chapter 16: Cost Allocation: Joint Products and Byproducts

Computation of gross-margin percentages: a. Sales value at splitoff method: Super A Super B Revenues $750,000 $300,000 Joint costs 63,000 52,500 Separable costs 480,000 120,000 Total cost of goods sold 543,000 172,500 Gross margin $207,000 $127,500 Gross-margin percentage 27.6% 42.5% b. Physical-measure method: Super A Super B Revenues $750,000 $300,000 Joint costs Separable costs Total cost of goods sold Gross margin Gross-margin percentage

115,500 480,000 595,500 $154,500 20.6%

42,000 120,000 162,000 $138,000 46.0%

c. Net realizable value method: Super A Super B Revenues $750,000 $300,000 Joint costs 94,500 63,000 Separable costs 480,000 120,000 Total cost of goods sold 574,500 183,000 Gross margin $175,500 $117,000 Gross-margin percentage 23.4% 39.0%

C $90,000 37,800 0 37,800 $52,200 58.0%

C $90,000

Super D Total $150,000 $1,290,000 56,700 210,000 90,000 690,000 146,700 900,000 $ 3,300 $ 390,000 2.2% 30.2%

0 31,500 $58,500 65%

Super D Total $150,000 $1,290,00 0 21,000 210,000 90,000 690,000 111,000 900,000 $39,000 $ 390,000 26% 30.2%

C $90,000 31,500 0 31,500 $58,500 65.0%

Super D Total $150,000 $1,290,000 21,000 210,000 90,000 690,000 111,000 900,000 $ 39,000 $ 390,000 26.0% 30.2%

31,500

Summary of gross-margin percentages: Joint-Cost Allocation Method Sales value at splitoff Physical measure Net realizable value

Super A 27.6% 20.6% 23.4%

Super B C 42.5% 58.0% 46.0% 65.0% 39.0% 65.0%

Super D 2.2% 26.0% 26.0%

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Further Processing of A into Super A: Incremental revenue, $750,000 – $150,000 Incremental costs Incremental operating income from further processing

$ 600,000 480,000 $ 120,000

Further processing of B into Super B: Incremental revenue, $300,000 – $125,000 Incremental costs Incremental operating income from further processing

$ 175,000 120,000 $ 55,000

Further Processing of D into Super D: Incremental revenue, $150,000 – $135,000 Incremental costs Incremental operating loss from further processing

$ 15,000 90,000 $ (75,000)

Chicago Oil Company is making the right decision by processing A and B further. However, the company will increase its operating income by $75,000 if it sells D at the splitoff point rather than refining it into Super D. SOLUTION EXHIBIT 16-28 Revenues at Splitoff and Separable Costs

Joint Costs

A, 550000 gallons Revenue = $150000 B, 200000 gallons Revenue = $125000 Processing $210000

Processing $480000

Super A $750000

Processing $120000

Super B $300000

Processing $90000

Super D $150000

C, 150000 gallons Revenue = $90000 D, 100000 gallons Revenue = $135000

Splitoff Point

Chapter 16: Cost Allocation: Joint Products and Byproducts

16-29 Alternative methods of joint cost allocation, product-mix decisions. 1. Computation of joint-cost allocation proportions: a.

Sales Value of Total Production at Splitoff A $ 50,000 B 30,000 C 50,000 D 70,000 $200,000

Weighting 50.0 ÷ 200 = 0.25 30.0 ÷ 200 = 0.15 50.0 ÷ 200 = 0.25 70.0 ÷ 200 = 0.35 1.00

Allocation of $100,000 Joint Costs $ 25,000 15,000 25,000 35,000 $100,000

Physical Measure of Total Production A 300,000 litres B 100,000 litres C 50,000 litres D 50,000 litres 500,000 litres

Weighting 300 ÷ 500 = 0.60 100 ÷ 500 = 0.20 50 ÷ 500 = 0.10 50 ÷ 500 = 0.10 1.00

Allocation of $100,000 Joint Costs $ 60,000 20,000 10,000 10,000 $100,000

c. Final Sales Value of Total Production Super A $300,000 Super B 100,000 C 50,000 Super D 120,000

Net Realizable Separable Value at Costs Splitoff $200,000 $100,000 80,000 20,000 – 50,000 90,000 30,000 $200,000

Weighting 100 ÷ 200 = 0.50 20 ÷ 200 = 0.10 50 ÷ 200 = 0.25 30 ÷ 200 = 0.15 1.00

Allocation of $100,000 Joint Costs $ 50,000 10,000 25,000 15,000 $100,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Computation of gross-margin percentages: a. Sales value at splitoff method: Super A Super B Revenues $300,000 $100,000 Joint costs 25,000 15,000 Separable costs 200,000 80,000 Total cost of goods sold 225,000 95,000 Gross margin $ 75,000 $ 5,000 Gross-margin percentage 25.0% 5.0%

C $50,000 25,000 0 25,000 $25,000 50.0%

Super D Total $120,000 $570,000 35,000 100,000 90,000 370,000 125,000 470,000 $ (5,000) $100,000 (4.2)% 17.5%

b. Physical-measure method: Super A Super B Revenues $300,000 $100,000 Joint costs 60,000 20,000 Separable costs 200,000 80,000 Total cost of goods sold 260,000 100,000 Gross margin $ 40,000 $ 0 Gross-margin percentage 13.3% 0.0%

C Super D Total $50,000 $120,000 $570,000 10,000 10,000 100,000 0 90,000 370,000 10,000 100,000 470,000 $40,000 $20,000 $100,000 80.0% 16.7% 17.5%

c. Net realizable value method: Super A Super B Revenues $300,000 $100,000 Joint costs 50,000 10,000 Separable costs 200,000 80,000 Total cost of goods sold 250,000 90,000 Gross margin $ 50,000 $ 10,000

C $50,000 25,000 0 25,000 $ 25,000

Super D $120,000 15,000 90,000 105,000 $15,000

Total $570,000 100,000 370,000 470,000 $100,000

10.0%

50.0%

12.5%

17.5%

Super B 5.0% 0% 10.0%

C 50.0% 80.0% 50.0%

Super D (4.2)% 16.7% 12.5%

Gross-margin percentage

16.7%

Summary of gross-margin percentages: Joint-Cost Allocation Method Sales value at splitoff Physical measure Net realizable value

Super A 25.0% 13.3% 16.7%

2. Further Processing of A into Super A: Incremental revenue, $30,000 – $50,000 Incremental costs Incremental operating income from further processing

$250,000 200,000 $ 50,000

Chapter 16: Cost Allocation: Joint Products and Byproducts

Further processing of B into Super B: Incremental revenue, $100,000 – $30,000 Incremental costs Incremental operating income from further processing

$ 70,000 80,000 $ (10,000)

Further Processing of D into Super D: Incremental revenue, $120,000 – $70,000 Incremental costs Incremental operating loss from further processing

$ 50,000 90,000 $ (40,000)

Operating income can be increased by $50,000 if Product B and D are sold at their splitoff point rather than processing them further into Super B and Super D.

16-30 (25 min.)

Methods of joint-cost allocation, ending inventory.

1. Net realizable value of human product: (2,500 gallons × $600) – $130,000 = $1,370,000 Net realizable value of veterinarian product: 500 gallons × ($450 – $20) = $215,000 Joint costs: $50,000 + $155,000 = $205,000 Joint costs charged to human product:

1,370, 000  $205, 000 = $177,192 1,585, 000

Joint costs charged to veterinarian product:

215, 000  $205, 000 = $27,808 1,585, 000

2. Separable costs, $130,000; 500 × $20 Joint costs (from above) Total costs

Human Product

Vet Product

Total

$130,000 177,192 $307,192

$10,000 27,808 $37,808

$140,000 205,000 $345,000 3,000

Units produced (gallons) Cost per gallon $307,192 ÷ 2,500; $37,808 ÷ 500

2,500

500

$ 122.88

$ 75.62

Units in ending inventory (gallons)

500

200

700

61,440

$15,124

$ 76,564

Cost of ending inventory $122.88 × 500; $75.62 × 200

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. Final gross margin: NRV (Human) + NRV (Vet) – Joint costs = $1,370,000 + $215,000 – $205,000 = $1,380,000 Final sales revenues: (2,500 × $600) + (500 × $450) = $1,725,000 Final gross margin percentage (1,380,000/1,725,000) = 80% By applying this constant gross margin percentage of 80% to both products, we can identify the amount of joint costs allocated to each product, as shown below. Constant gross-margin percentage NRV method Final sales value of production 2,500 × $600; $450 × 500 Gross Margin (80%) Total costs Separable costs Joint costs

Human Product

Vet Product

Total

$1,500,000 1,200,000 $ 300,000 130,000 $ 170,000

$225,000 180,000 $ 45,000 10,000 $ 35,000

$1,725,000 1,380,000 $ 345,000 140,000 $ 205,000

4. In March, Garden Labs sold 2,000 gallons for human use for a sales revenue of: 2,000 × $600 = $1,200,000 Under the constant gross-margin percentage NRV method, each product is provided a gross margin of 80%. Therefore, the gross margin for the sale of human product in March is: $1,200,000 × 80% = $960,000 5. Revenue from accepting the offer: Cost of modification (300 pints × $35): Net Inflow: Add: Cost saving from not having to dispose of toxic byproduct Total benefit from offer:

$7,000 10,500 ($3,500) 6,000 $2,500

Garden Labs should therefore accept the offer because its net income will increase by $2,500 as a result.

Chapter 16: Cost Allocation: Joint Products and Byproducts

16-31 (25 min.) Accounting for a byproduct. 1.

Byproduct recognized at time of production: Joint cost = $1,500 Joint cost to be charged to main product = Joint Cost – NRV of Byproduct = $1,500 – (50 kg × $1.20) = $1,440 Inventoriable cost of main product = $1,440 / 500 = $2.88 per container Inventoriable cost of byproduct = NRV = $1.20 per kilogram

Gross Margin Calculation under Production Method Revenues Main product: Water (600/2 containers × $8) Byproduct: Sea Salt Cost of goods sold Main product: Water (300 containers × $2.88) Gross margin Gross-margin percentage ($1,536 ÷ $2,400)

$2,400 0 2,400 864 $1,536 64.00%

Inventoriable costs (end of period): Main product: Water (200 containers × $2.88) = $576 Byproduct: Sea Salt (10 kilograms × $1.20) = $12 2.

Byproduct recognized at time of sale: Joint cost to be charged to main product = Total joint cost = $1,500 Inventoriable cost of main product = $1500 / 500 = $3.00 per container Inventoriable cost of byproduct = $0 Gross Margin Calculation under Sales Method Revenues Main product: Water (600/2 containers × $8) Byproduct: Sea Salt (40 kilograms × $1.20) Cost of goods sold Main product: Water (300 containers × $3.00) Gross margin Gross-margin percentage ($1,548 ÷ $2,448)

$2,400 48 2,448 900 $1,548 63.2%

Inventoriable costs (end of period): Main product: Water (200 containers × $3.00) = $600 Byproduct: Sea Salt (10 kilograms × $0) = $0 3. The production method recognizes the byproduct cost as inventory in the period it is produced. This method sets the cost of the byproduct inventory equal to its net realizable value. When the byproduct is sold, inventory is reduced without being expensed through the income statement. The sales method associates all of the production cost with the main product. Under this method, the byproduct has no inventoriable cost and is recognized only when it is sold. Copyright © 2022 Pearson Canada Inc. 16-33

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

16-32 (40–60 min.) Comparison of alternative joint-cost allocation methods, furtherprocessing decision, chocolate products. Joint Costs $70,000

Separable Costs

ChocolatePowder Liquor Base

Cocoa Beans

Processing $46,035

Chocolate Powder

Processing

Milk-Chocolate Liquor Base

Milk Chocolate

Processing $55,085

SPLITOFF POINT

1a. Sales value at splitoff method:

Sales value of total production at splitoff, 46  20  $21; 46  60  $28 Weighting, $19,320; $77,280 ÷ $96,600 Joint costs allocated, 0.20; 0.80  $70,000 Production cost per pound [$14,000 + $46,035] ÷ 31,280; [$56,000 + $55,085] ÷ 50,600

ChocolatePowder/ Liquor Base

MilkChocolate/ Liquor Base

Total

$19,320 0.20

$77,280 0.80

$96,600 1.00

$14,000

$56,000

$70,000

1.92

2.20

Chapter 16: Cost Allocation: Joint Products and Byproducts

1b. Physical-measure method: Physical measure of total production (27,600 ÷ 600)  20; 60 Weighting, 920; 2,760 ÷ 3,680 Joint costs allocated, 0.25; 0.75  $70,000 Production cost per pound [$17,500 + $46,035] ÷ 31,280; [$52,500 + $55,085] ÷ 50,600

920 gallons 0.25

2,760 gallons 0.75

$17,500 $

$52,500

3,680 gallons 1.00 $70,000

2.03 $ 2.13

1c. Net realizable value method: Chocolate Powder Final sales value of total production, 31,280 × $8; 50,600 × $9 $250,240 Deduct separable costs 46,035 Net realizable value at splitoff point $204,205 Weighting, $204,205; $400,315 ÷ $604,520 0.3378 Joint costs allocated, 0.3378; 0.6622  $70,000 $ 23,646 Production cost per pound [$23,646 + $46,035] ÷ 31,280; $ 2.23 [$46,354 + $55,085] ÷ 50,600

Milk Chocolate

Total

$455,400 55,085 $400,315 0.6622

$705,640 101,120 $604,520 1.0000

$ 46,354

$ 70,000

2.00

1d. Constant gross-margin percentage NRV method: Step 1: Final sales value of total production, (31,280 × $8; 50,600 × $9) Deduct joint and separable costs, ($70,000 + $46,035 + $55,085) Gross margin Gross-margin percentage ($534,520 ÷ $705,640)

$705,640 171,120 $534,520 75.75%

Step 2: Final sales value of total production, 31,280 × $8; 50,600 × $9 Deduct gross margin, using overall grossmargin percentage of sales (75.7497%) Total production costs

Chocolate Powder

Milk Chocolate

$250,240

$455,400

$705,640

189,556 60,684

344,964 110,436

534,520 171,120

Total

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Step 3: Deduct separable costs Joint costs allocated

46,035 $14,649

Production cost per pound [$14,649 + $46,035] ÷ 31,280; [$55,351 + $55,085] ÷ 50,600

2. a.

Revenues (6,800 × $8; 14,400 × $9) Cost of goods sold Joint costs Separable costs Production costs Deduct ending inventory (24,480 × $1.92; 36,200 × $2.20) Cost of goods sold Gross margin Gross-margin percentage

101,120 $ 70,000

1.94 $

2.18

Chocolate Powder $54,400

Milk Chocolate $129,600

Total $184,000

14,000 46,035 60,035

56,000 55,085 111,085

70,000 101,120 171,120

47,002 13,033 $41,367

79,640 31,445 $ 98,155

126,642 44,478 $139,522

76.04%

Revenues Cost of goods sold Joint costs Separable costs Production costs Deduct ending inventory (24,480 × $2.03; 36,200 × $2.13) Cost of goods sold Gross margin Gross-margin percentage

55,085 $ 55,351

75.74%

$54,400

$129,600

$184,000

17,500 46,035 63,535

52,500 55,085 107,585

70,000 101,120 171,120

49,694 13,841 $40,559

77,106 30,479 $ 99,121

126,800 44,320 $139,680

74.56%

76.48%

Chapter 16: Cost Allocation: Joint Products and Byproducts

Revenues Cost of goods sold Joint costs Separable costs Production costs Deduct ending inventory (24,480 × $2.23; 36,200 × $2.00) Cost of goods sold Gross margin

$54,400

$129,600

$184,000

23,646 46,035 69,681

46,354 55,085 101,439

70,000 101,120 171,120

54,590 15,091 $39,309

72,400 29,039 $100,561

126,990 44,130 $139,870

Gross-margin percentage

72.26%

77.59%

Revenues Cost of goods sold Joint costs Separable costs Production costs Deduct ending inventory (24,480 × $1.94; 36,200 × $2.18) Cost of goods sold Gross margin

$54,400

$129,600

$184,000

14,649 46,035 60,684

55,351 55,085 110,436

70,000 101,120 171,120

47,491 13,193 $41,207

78,916 31,520 $ 98,080

126,407 44,713 $139,287

Gross-margin percentage

75.75%

75.68%

3. Further processing of chocolate-powder liquor base into chocolate powder: Incremental revenue, 31,280 × $8 – $19,320 ($21 × 920) $230,920 Incremental costs 46,035 Incremental operating income from further processing $184,885 Further processing of milk-chocolate liquor base into milk chocolate: Incremental revenue, 50,600 × $9 – $77,280 ($28 × 2,760) Incremental costs Incremental operating income from further processing

$378,120 55,085 $323,035

Chocolate Factory should continue to process milk-chocolate liquor base into milk chocolate, and chocolate-powder liquor base into chocolate powder.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

16-33 (40 min.)

Joint-cost allocation.

1. Joint Costs $136,800

Separable Costs

Bread Flour Flour Sifting

Baking Flour

Processing $1.00 per cup of baking flour

Super-Fine Baking Flour

SPLITOFF POINT

Physical-measure method: Physical measure of total production (12,000 inputs × 3; 9) Weighting, 36,000; 108,000 ÷ 144,000 Joint costs allocated, 0.25; 0.75 × $136,800

Baking Flour

Bread Flour

Total

36,000 cups 0.25

108,000 cups 0.75

144,000 cups

$34,200

$102,600

$136,800

Chapter 16: Cost Allocation: Joint Products and Byproducts

b. Sales value at splitoff method: Baking Flour

Bread Flour

Total

$129,600 0.20

$518,400 0.80

$648,000

$27,360

$109,440

$136,800

Sales value of total production at splitoff, 12,000 inputs × (3 × $3.60); (9 × $4.80) Weighting, $129,600; $518,400 ÷ $648,000 Joint costs allocated, 0.20; 0.80  $136,800 c. Net realizable value method:

Super-Fine Baking Flour Final sales value of total production, (36,000 ÷ 2) × $9.60; 108,000 $172,800 cups  $4.80 Deduct separable costs 36,000 Net realizable value $136,800 Weighting, $136,800; $518,400 ÷ 0.209 $655,200 Joint costs allocated, 0.209; 0.791  $136,800 $ 28,591

Bread Flour

Total

$518,400

$691,200

0 $518,400 0.791

36,000 $655,200

$108,209

$136,800

d. Constant gross-margin percentage NRV method: Step 1: Final sales value of total production (see 1c.) Deduct joint and separable costs ($136,800 + $36,000) Gross margin Gross-margin percentage ($518,400 ÷ $691,200)

$691,200 172,800 $518,400 75.0%

Step 2:

Final sales value of total production Deduct gross margin, using overall gross-margin percentage of sales (75.0%) Total production costs Step 3: Deduct separable costs Joint costs allocated

Super-Fine Bread Flour Total Baking Flour $172,800 $518,400 $691,200 129,600 43,200

388,800 129,600

518,400 172,800

36,000 $ 7,200

0 $129,600

36,000 $136,800

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Advantages and disadvantages: - Physical-Measure Advantage: Low information needs. Only knowledge of joint cost and physical distribution is needed. Disadvantage: Allocation is unrelated to the revenue-generating ability of products. - Sales Value at Splitoff Advantage: Considers market value of products as basis for allocating joint cost. Relative sales value serves as a proxy for relative benefit received by each product from the joint cost. Disadvantage: Uses selling price at the time of splitoff even if product is not sold by the firm in that form. Selling price may not exist for product at splitoff. - Net Realizable Value Advantages: Allocates joint costs using ultimate net value of each product; applicable when the option to process further exists Disadvantages: High information needs; Makes assumptions about expected outcomes of future processing decisions - Constant Gross-Margin percentage method Advantage: Since it is necessary to produce all joint products, they all look equally profitable. Disadvantages: High information needs. All products are not necessarily equally profitable; method may lead to negative cost allocations so that unprofitable products are subsidized by profitable ones. 3. When selling prices for all products exist at splitoff, the sales value at split off method is the preferred technique. It is a relatively simple technique that depends on a common basis for cost allocation – revenues. It is better than the physical method because it considers the relative market values of the products generated by the joint cost when seeking to allocate it (which is a surrogate for the benefits received by each product from the joint cost). Further, the sales value at splitoff method has advantages over the NRV method and the constant gross margin percentage method because it does not penalize managers by charging more for developing profitable products using the output at splitoff, and it requires no assumptions about future processing activities and selling prices.

Chapter 16: Cost Allocation: Joint Products and Byproducts

16-34 (20 min.)

Joint-cost allocation with a byproduct.

1. Sales value at splitoff method: Byproduct recognized at time of production method Table Covers 30,000a 25,000 5,000

Products manufactured Products sold Ending inventory

Package Filler (lbs) 6,000c 5,000 1,000

Chair Covers 90,000b 80,000 10,000

a0.25 table covers per 1 lb of bottles × 120,000 lbs of bottles = 30,000 table covers b0.75 chair covers per 1 lb of bottles × 120,000 lbs of bottles = 90,000 chair covers c0.05 lbs of package filler per 1 lb of bottles × 120,000 lbs of bottles = 6,000 lbs of package

filler Joint cost to be charged to joint products = Joint Cost – NRV of Byproduct = $600,000 – (6,000 lbs x 1 per lb) = $600,000 – $6,000 = $594,000 Table Covers

Chair Covers

Total

$360,000 1/3 $198,000

$720,000 2/3 $396,000

$1,080,000

Table Covers $ 300,000

Chair Covers $640,000

Total $940,000

$198,000 (33,000)d $165,000 $135,000

$396,000 (44,000)e $352,000 $288,000

$594,000 (77,000) $517,000 $423,000

Sales value of covers at splitoff, 30,000 × $12; 90,000 × $8 Weighting, $360,000; $720,000 ÷ $1,080,000 Joint costs allocated, 1/3; 2/3 × $594,000

Revenues, 25,000 × $12; 80,000 × $8 Cost of goods sold: Joint costs allocated, 1/3; 2/3 × $594,000 Less: Ending inventory Cost of goods sold Gross margin

$ 594,000

d5,000 × ($198,000/30,000) = $33,000 e10,000 × ($396,000/90,000) = $44,000

The ending inventory of package filler is reported at its estimated market value of $1,000 (1,000 lbs × $1).

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Sales value at splitoff method: Byproduct recognized at time of sale method Joint cost to be charged to joint products = Joint Cost = $600,000

Sales value of covers at splitoff, 30,000 × $12; 90,000 × $8 Weighting, $360,000; $720,000 ÷ $1,080,000 Joint costs allocated, 1/3; 2/3 × $600,000

Revenues, 25,000 × $12; 80,000 × $8; 5,000 × $1 Cost of goods sold: Joint costs allocated, 1/3; 2/3 × $600,000 Less: Ending inventory Cost of goods sold Gross margin

Table Covers

Chair Covers

Total

$360,000 1/3 $200,000

$720,000 2/3 $400,000

$1,080,000 $ 600,000

Table Covers

Chair Covers

Package Filler (lbs)

Total

$300,000

$640,000

$5,000

$945,000

$200,000

$400,000

$600,000

(33,333)f $166,667 $133,333

(44,444)g $355,556 $284,444

(77,777) $522,223 $422,777

$5,000

f5,000 × ($200,000/30,000) = $33,333 g

10,000 × ($400,000/90,000) = $44,444

3. The production method of accounting for the byproduct is only appropriate if SRC is positive they can sell the byproduct at the expected selling price. Moreover, SRC should view the byproduct’s contribution to the firm as material enough to find it worthwhile to record and track any inventory that may arise. The sales method is appropriate if either the disposition of the byproduct is unsure or the selling price is unknown, or if the amounts involved are so negligible as to make it economically infeasible for SRC to keep track of byproduct inventories. The gross margin for package fillers is less than 2% of the total company gross margin. SRC should probably use the sales method based on the negligible monetary value associated with the byproduct.

Chapter 16: Cost Allocation: Joint Products and Byproducts

16-35 (15 min.) Byproduct-costing journal entries. 1. Byproduct—production method journal entries i) At time of production: Work-in-process Inventory Accounts Payable, etc.

600,000 600,000

For Byproduct Finished Goods Inv – Package Filler Work-in-process Inventory

6,000

For Joint Products Finished Goods Inv – Table Covers Finished Goods Inv – Chair Covers Work-in-process Inventory

198,000 396,000

6,000

594,000

ii) At time of sale: For Byproduct Cash or A/R Finished Goods Inv – Package Filler For Joint Products Cash or A/R Sales Revenue – Table Covers Sales Revenue – Chair Covers Cost of Goods Sold – Table Covers Cost of Goods Sold – Chair Covers Finished Goods Inv – Table Covers Finished Goods Inv – Chair Covers

5,000 5,000 940,000 300,000 640,000 165,000 352,000

165,000 352,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Byproduct—sales method journal entries i) At time of production: Work-in-process Inventory Accounts Payable, etc.

600,000 600,000

For Byproduct No entry For Joint Products Finished Goods Inv – Table Covers Finished Goods Inv – Chair Covers Work-in-process Inventory

200,000 400,000 600,000

ii) At time of sale: For Byproduct Cash or A/R Sales Revenue – Package Filler For Joint Products Cash or A/R Sales Revenue – Table Covers Sales Revenue – Chair Covers Cost of Goods Sold – Table Covers Cost of Goods Sold – Chair Covers Finished Goods Inv – Table Covers Finished Goods Inv – Chair Covers

5,000 5,000 940,000 300,000 640,000 166,667 355,556

166,667 355,556

Chapter 16: Cost Allocation: Joint Products and Byproducts

16-36 (30 min.) Joint-cost allocation, process further or sell. 1.

Joint costs

Separable Costs Amber Further Processing

Processing

AT/Cobalt

$2,200,000

Bronze

Splitoff Point

Deduct separable costs Net realizable value at splitoff point

Amber $892,500 — $892,500

Bronze $990,000 _____ — $990,000

AT/Cobalt Total $6,000,000 $7,882,500 2,200,000 2,200,000 $3,800,000 $5,682,500

Weightingb Joint costs allocatedc

0.157 $847,800

0.174 $939,600

0.669 $3,612,600

Final sales value of total productiona

a$3.50 × 255,000; $2 × 495,000; $8 × 750,000 b$892,500; $990,000; $3,800,000 ÷ $5,682,500 c$5,400,000 × 0.157; 0.174; 0.669

1.000 $5,400,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Further processing Amber Incremental revenue ($5.50 × 227,500) – ($3.50 × 255,000) Incremental processing cost Incremental operating income/(loss)

$ 358,750 750,000 $ (391,250)

Further processing Bronze Incremental revenue ($4.00 × (495,000 × 1.15)) – ($2 × 495,000) Incremental processing cost Incremental operating income

$1,287,000 1,000,000 $ 287,000

Further processing Cobalt Incremental revenue ($8.00 × 750,000) – ($2.40 × 750,000) Less Incremental processing cost Incremental operating income/(loss)

$4,200,000 2,200,000 $2,000,000

Current Policy NRV (from requirement 1): Sell Amber at splitoff Sell Bronze at splitoff Process Cobalt further Joint costs Operating income Preferred Options Sell Amber at splitoff Process Bronze further ($990,000 + $287,000 incremental optg. inc.) Continue to Process Cobalt further Joint costs Operating income

$ 892,500 990,000 3,800,000 5,682,500 5,400,000 $ 282,500 $

892,500

1,277,000 3,800,000 5,969,500 5,400,000 $ 569,500

Arnold is $287,000 better off by changing its policy regarding Bronze – it should process it further beyond the splitoff point.

Chapter 16: Cost Allocation: Joint Products and Byproducts

16-37 (60 min.) Methods of joint-cost allocation, comprehensive. 1. Joint costs for Kardash include $440,000 in direct materials, $220,000 in direct labour, and $110,000 in overhead costs, for a total of $770,000. 2. At splitoff, the relative weights of the two perfumes are 7,000 ounces of Seduction and 49,000 ounces of Romance (in the form of residue) respectively. Accordingly, the allocation of joint costs under the physical measure method would be in the ratio of 1:7, or as follows: 1  Seduction:   $770, 000  $96, 250 8  7  Romance:   $770, 000  $673, 750. 8 

3. The relative sales values of production at splitoff are as follows: Seduction: 7,000 × $56 per ounce = $ 392,000 Romance: 49,000 × $24 per ounce = $1,176,000 The ratio of the sales values is 392:1176, or 1:3. Accordingly, the joint costs are allocated as: 1  Seduction:   $770, 000  $192,500 4  3  Romance:   $770, 000  $577,500. 4  4. Estimated net realizable value per ounce of Seduction perfume: Selling price per unit: (−) Unit packaging cost: $137,500/5,000 = Estimated NRV per ounce:

$109.50 27.50 $ 82.00

Estimated net realizable value per ounce of Romance perfume: Selling price per unit: (−) Unit packaging cost: $196,000/28,000 = (−) Unit processing cost in B: $112,000/28,000 = Estimated NRV per ounce:

$31.50 7.00 4.00 $20.50

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

5. The estimated net realizable values of the two perfumes are as follows: Seduction: 7,000 × $82 per ounce = $ 574,000 Romance: 49,000 × $20.50 per ounce = $1,004,500 The ratio of the ENRVs is 574,000:1,004,500, or 4:7. Accordingly, the joint costs are allocated as: 4  Seduction:   $770, 000  $280,500 11   7  Romance:   $770, 000  $490, 000. 11   6. The gross margin for Kardash Cosmetics as a whole is the sum of the expected net realizable values from Seduction and Perfume, less the joint costs incurred. From the calculations in requirement 5, this is given by: ENRV of Seduction ($574,000) + ENRV of Romance ($1,004,500) – Joint Costs ($770,000) = $808,500. The final sales value of the total production is: Seduction (7,000 × $109.50) + Romance (49,000 × $31.50) = $2,310,000. The gross margin percentage for the firm as a whole is therefore: $808,500 = 35%. $2,310, 000 7. The joint cost allocations to Seduction and Romance under the constant gross-margin percentage NRV method are given as follows: Final sales value of production 7,000 × $109.50; 49,000 × $31.50 Gross Margin (35%) Total costs Separable costs 7,000 × $27.50; 49,000 × $11 Joint costs

Seduction

Romance

Total

$766,500 268,275 $498,225

$1,543,500 540,225 $1,003,275

$2,310,000 808,500 $1,501,500

192,500 $305,725

539,000 $ 464,275

731,500 $ 770,000

8. No. Selling the residue earns Kardash $24 per ounce. Selling Romance perfume yields (from the calculations in requirement 4) $20.50 per ounce, which is lower. The manager of Kardash Cosmetics could earn an extra $3.50 per ounce by selling residue rather than Romance.

Chapter 16: Cost Allocation: Joint Products and Byproducts

COLLABORATIVE LEARNING CASES 16-38 Usefulness of joint cost allocation. 1. Two reasons are relevant. The first is that the OPOs are being reimbursed on a contracted basis that specifies allowable costs, some of which are allocated. Some proportion of the allocated costs are joint costs. The OPOs can only justify claiming those costs which are identified using the contracted joint costing method. The second is litigation—the government will use the courts if necessary to recover the lost $47 million from the OPOs. The standardization of joint costing methods and the specification of the allowable joint costs will enable each party to defend its actions. 2. The splitoff point is the event beyond which costs become separately identifiable. If a donor had chosen to donate both a kidney and part of a liver, then the incision by the surgeon would be the splitoff point. Costs incurred for procedures subsequent to the incision (e.g., disposable supplies, labour, fees for the organ removal, storage, transportation etc.) for the kidney donation service would be split off from those incurred for the liver donation service. 3. Different surgical techniques, preservatives, and processes are required for each organ recovered. The use of the operating room and the anaesthetic would be joint costs as well as any antibiotic medications to prevent post-surgical infection and the hospital days in recovery. 4. Joint cost allocation is relevant information when decision-makers are assessing the rates at which hospitals and surgeons will be reimbursed for the recovery process. The governments do not want to pay twice for the same activities and joint cost allocation is a technique to ensure this does not happen.

16-39 (60 min.) 1. a.

Joint cost allocation.

The Net Realizable Value Method allocates joint costs on the basis of the relative net realizable value (final sales value minus the separable costs of production and marketing). Joint costs would be allocated as follows: Deluxe Standard

Final sales value of total production Deduct separable costs Net realizable value at splitoff point Weighting ($23,500; $7,500 ÷ $31,000) Joint costs allocated (0.7581; 0.2419 × $24,000) Total production costs ($18,194 + $1,500; $5,806 + $1,000) Production costs per unit ($19,694; $6,806 ÷ 500 units)

Module $25,000 1,500 $23,500 0.7581 $18,194

Module $ 8,500 1,000 $ 7,500 0.2419 $ 5,806

Total $33,500 2,500 $31,000

$19,694

$ 6,806

$26,500

$ 39.39

$ 13.61

$24,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

b. The constant gross-margin percentage NRV method allocates joint costs in such a way that the overall gross-margin percentage is identical for all individual products as follows: Step 1 Final sales value of total production: (Deluxe, $25,000; Standard, $8,500) Deduct joint and separable costs (Joint, $24,000 + Separable Deluxe, $1,500 + Separable Standard, $1,000) Gross margin Gross-margin percentage ($7,000 ÷ $33,500)

$ 33,500 26,500 $ 7,000 20.8955%

Step 2

Final sales value of total production Deduct gross margin using overall gross margin percentage (20.8955%) Total production costs

Deluxe

Standard

Module $25,000

Module $ 8,500

Total $33,500

5,224 19,776

1,776 6,724

7,000 26,500

1,500 $18,276

1,000 $5,724

2,500 $24,000

$ 39.55

$13.45

Step 3 Deduct separable costs Joint costs allocated Production costs per unit ($19,776; $6,724 ÷ 500 units) c.

The physical measure method allocates joint costs on the basis of the relative proportions of total production at the splitoff point, using a common physical measure such as the number of bits produced for each type of module. Allocation on the basis of the number of bits produced for each type of module follows:

Physical measure of total production (bits) Weighting (500,000; 250,000 ÷ 750,000) Joint costs allocated (0.6667; 0.3333 × $24,000) Total production costs ($16,000 + $1,500; $8,000 + $1,000) Production costs per unit ($17,500; $9,000 ÷ 500 units)

Deluxe Module/ Chips

Standard Module/ Chips

500,000 0.6667 $16,000

250,000 0.3333 $ 8,000

750,000

$17,500

$ 9,000

$26,500

$ 35.00

$ 18.00

Total

$24,000

Chapter 16: Cost Allocation: Joint Products and Byproducts

Each of the methods for allocating joint costs has weaknesses. Because the costs are joint in nature, managers cannot use the cause-and-effect criterion in making this choice. Managers cannot be sure what causes the joint costs attributable to individual products. The net realizable value (NRV) method (or sales value at splitoff method) is widely used when selling price data are available. The NRV method provides a meaningful common denominator to compute the weighting factors. It allocates costs on the ability-to-pay principle. It is probably preferred to the constant gross-margin percentage method which also uses sales values to allocate costs to products. That’s because the constant gross-margin percentage method makes the further tenuous assumption that all products have the same ratio of cost to sales value. The physical measure method bears little relationship to the revenue-producing power of the individual products. Several physical measures could be used, such as the number of chips and the number of good bits. In each case, the physical measure only relates to one aspect of the chip that contributes to its value. The value of the module as determined by the marketplace is a function of multiple physical features. Another key question is whether the physical measure chosen portrays the amount of joint resources used by each product. It is possible that the resources required by each type of module depend on the number of good bits produced during chip manufacturing. But this cause-and-effect relationship is hard to establish. MMC should use the NRV method. But the choice of method should have no effect on their current control and measurement systems. 2. The correct approach in deciding whether to process further and make DRAM modules from the standard modules is to compare the incremental revenue with the incremental costs: Incremental revenue from making DRAMs ($26 × 400) – ($17 × 500) Incremental costs of DRAMs, further processing Incremental operating income from converting standard modules into DRAMs

$1,900 1,600 $ 300

A total income computation of each alternative follows: Alternative 1: Sell Deluxe and Standard Total revenues ($25,000 + $8,500) $33,500 Total costs 26,500 Operating income $ 7,000

Alternative 2: Sell Deluxe and DRAM ($25,000 + $10,400) $35,400 ($26,500 + $1,600) 28,100 $ 7,300

Difference $1,900 1,600 $ 300

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

It is profitable to extend processing and to incur additional costs on the standard module to convert it into a DRAM module as long as the incremental revenue exceeds incremental costs. The amount of joint costs incurred up to splitoff ($24,000)—and how these joint costs are allocated to each of the products—are irrelevant to the decision of whether to process further and make DRAM modules. That’s because the joint costs of $24,000 remain the same whether or not further processing is done on the standard modules. Joint cost allocations using the physical measure method (on the basis of the number of bits) may mislead FCC, if FCC uses unit-cost data to guide the choice between selling standard modules versus selling DRAM modules. In requirement 2, allocating joint costs on the basis of the number of good bits yielded a cost of $16,000 for the Deluxe modules and $8,000 for the Standard modules. A product-line income statement for selling Deluxe modules and DRAM modules would appear as follows:

Revenues Cost of goods sold Joint costs allocated Separable costs Total cost of goods sold Gross margin

Deluxe Module $25,000 16,000 1,500 17,500 $ 7,500

DRAM Module $10,400 8,000 2,600* 10,600 $ (200)

*Separable costs of $1,000 to manufacture the Standard module and further separable costs of $1,600 to manufacture the DRAM module. This product-line income statement would erroneously imply that FCC would suffer a loss by selling DRAM modules, and as a result, it would suggest that FFC should not process further to make and sell DRAM modules. This occurs because of the way the joint costs are allocated to the two products. As mentioned earlier, the joint cost allocation is irrelevant to the decision. On the basis of the incremental revenues and incremental costs, FFC should process the Standard modules into DRAM modules.

CHAPTER 17 REVENUE AND CUSTOMER PROFITABILITY ANALYSIS MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

SHORT-ANSWER QUESTIONS 17-1

Companies increasingly are selling packages of products or services for a single price. Revenue allocation is required when managers in charge of developing or marketing individual products in a bundle are evaluated using product-specific revenue.

17-2

The stand-alone revenue-allocation method uses product-specific information on the products in the bundle as weights for allocating the bundled revenue to the individual products. The incremental revenue allocation method ranks individual products in a bundle according to criteria determined by management—such as the product in the bundle with the most sales—and then uses this ranking to allocate bundled revenue to the individual products. The first-ranked product is the primary product in the bundle. The second-ranked product is the first incremental product, the third-ranked product is the second incremental product, and so on.

17-3

Managers typically will argue that their individual product is the prime reason why consumers buy a bundle of products. Evidence on this argument could come from the sales of the products when sold as individual products. Other pieces of evidence include surveys of users of each product and surveys of people who purchase the bundle of products.

17-4

A dispute over allocation of revenue of a bundled product could be resolved by (a) having an agreement that outlines the preferred method in the case of a dispute, or (b) having a third party (such as the company president or an independent arbitrator) make a decision.

17-5

Using the levels approach introduced in Chapter 7, the sales-volume variance is a Level 2 variance. By sequencing through Level 3 (sales-mix and sales-quantity variances) and then Level 4 (market-size and market-share variances), managers can gain insight into the causes of a specific sales-volume variance caused by changes in the mix and quantity of the products sold as well as changes in market size and market share.

17-6

The total sales-mix variance arises from differences in the budgeted contribution margin of the actual and budgeted sales mix. The composite unit concept enables the effect of individual product changes to be summarized in a single intuitive number by using weights based on the mix of individual units in the actual and budgeted mix of products sold.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

17-7

A favourable sales-quantity variance arises because the actual units of all products sold exceed the budgeted units of all products sold.

17-8

The sales-quantity variance can be decomposed into (a) a market-size variance (because the actual total market size in units is different from the budgeted market size in units), and (b) a market share variance (because the actual market share of a company is different from the budgeted market share of a company). Both variances use the budgeted average contribution margin per unit.

17-9

Some companies believe that reliable information on total market size is not available and therefore they choose not to compute market-size and market-share variances.

17-10 Customer profitability analysis highlights to managers how individual customers differentially contribute to total profitability. It helps managers to see whether customers who contribute sizably to total profitability are receiving a comparable level of attention from the organization.

17-11 No. Government-funded social services receive revenue based on revenue allocation methods. One example is the social welfare programs provided from casino revenue by the First Nations to its own people.

17-12 No. A customer-profitability profile highlights differences in the current period's profitability across customers. Dropping customers should be the last resort. An unprofitable customer in one period may be highly profitable in subsequent future periods. Moreover, costs assigned to individual customers need not be purely variable with respect to short-run elimination of sales to those customers. Thus, when customers are dropped, costs assigned to those customers may not disappear in the short run.

17-13 Five categories in a customer cost hierarchy are identified in the chapter. The examples given relate to the Spring Distribution Company used in the chapter:   



Customer output-unit-level costs—costs of activities to sell each unit (case) to a customer. An example is product-handling costs of each case sold. Customer batch-level costs—costs of activities that are related to a group of units (cases) sold to a customer. Examples are costs incurred to process orders or to make deliveries. Customer-sustaining costs—costs of activities to support individual customers, regardless of the number of units or batches of product delivered to the customer. Examples are costs of visits to customers or costs of displays at customer sites. Distribution-channel costs—costs of activities related to a particular distribution channel rather than to each unit of product, each batch of product, or specific customers. An example is the salary of the manager of Spring’s retail distribution channel. Facility/corporate-sustaining costs—costs of activities that cannot be traced to individual customers or distribution channels. Examples are top management and general administration costs. Copyright © 2022 Pearson Canada Inc. 17-2

Chapter 17: Revenue and Customer Profitability Analysis

17-14

Companies that separately record (a) the list price and (b) the discount have sufficient information to subsequently examine the level of discounting by each individual customer and by each individual salesperson.

EXERCISES 17-15

(10–15 min.)

Terminology.

1. To satisfy their customers' value proposition and benefit from economies of scale, companies often create customized product bundles from individual products. This is also called a composite unit. 2. The decision the management team needs to make is how to allocate the bundled revenue to each component of the bundle. There are two methods: standalone and incremental revenue allocation. 3. In combination with ABC systems, the management team can examine detailed variance reports of sales-mix, sales-quantity, market-share and market-size variance. This informs the team how well they are implementing their strategy. 4. The team can also use the customer as cost object in an ABC system and conduct a customer profitability analysis to determine whether to drop or add customers, stores, or branches to improve profit.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

17-16 (15 min.) Cost allocation and decision making. 1. Allocations based on revenues. 1. Revenues 2. % revenues ($23,400,000; $25,500,000; $18,600,000; $16,500,000 ÷ $84,000,000) 3. Allocated headquarter cost (Row 2 × $16,800,000)

Segment margin Less: Headquarter costs Division margin

Acme $23,400,000

27.86%

Stark $18,600,000

30.36%

22.14%

Brothers $16,500,000

19.64%

Total $84,000,000

100%

$ 4,680,480

$ 5,100,480

$ 3,719,520

$ 3,299,520

$16,800,000

Acme $ 7,500,000 4,680,480 $ 2,819,520

Dune $13,200,000 5,100,480 $ 8,099,520

Stark $ 5,700,000 3,719,520 $ 1,980,480

Brothers $2,700,000 3,299,520 $ (599,520)

Total $29,100,000 16,800,000 $12,300,000

Dune $12,300,000

Stark $12,900,000

Brothers $13,800,000

Total $54,900,000

25.14%

100%

$ 3,948,000

$ 4,223,520

$16,800,000

Stark $5,700,000 3,948,000 $1,752,000

Brothers $ 2,700,000 4,223,520 $(1,523,520)

Total $29,100,000 16,800,000 $12,300,000

Stark $5,700,000

Brothers $2,700,000

Total $29,100,000

Allocations based on direct costs. Acme 1. Direct Costs $15,900,000 2. % direct costs $15,900,000; $12,300,000; $12,900,000; $13,800,000 ÷ $54,900,000 28.96% 3. Allocated headquarter cost (Row 2 × $16,800,000) $ 4,865,280

Segment margin Less: Headquarter costs Division margin

Dune $25,500,000

Acme $7,500,000 4,865,280 $2,634,720

22.40% $ 3,763,200 Dune $13,200,000 3,763,200 $ 9,436,800

Allocations based on segment margin. Acme Dune 1. Segment Margins $7,500,000 $13,200,000 2. % segment margins $7,500,000; $13,200,000; $5,700,000; $2,700,000 ÷ $29,100,000 25.77% 45.36% 3.Allocated headquarter cost (Row 2 × $16,800,000) $4,329,360 $7,620,480

23.50%

19.59% $3,291,120

9.28% $1,559,040

100% $16,800,000

Chapter 17: Revenue and Customer Profitability Analysis

Segment margin

Acme $7,500,000

Dune $13,200,000

Stark $5,700,000

Brothers $2,700,000

Total $29,100,000

Less: Headquarter costs Division margin

4,329,360 $3,170,640

7,620,480 $5,579,520

3,291,120 $2,408,880

1,559,040 $1,140,960

16,800,000 $12,300,000

Stark 4,500

Brothers 1,500

Total 24,000

18.75%

6.25%

100%

$3,150,000

$1,050,000

$16,800,000

Stark $5,700,000 3,150,000 $2,550,000

Brothers $2,700,000 1,050,000 $1,650,000

Allocations based on number of employees. Acme Dune 1. Number of Employees 6,000 12,000 2. % Number of employees 6,000; 12,000; 4,500; 1,500 ÷ 24,000 25.00% 50.00% 3. Allocated headquarter cost (Row 2 × $16,800,000) $4,200,000 $8,400,000

Segment margin Less: Headquarter costs Division margin

Acme $7,500,000 4,200,000 $3,300,000

Dune $13,200,000 8,400,000 $ 4,800,000

Total $29,100,000 16,800,000 $12,300,000

2. The Brothers Division manager will prefer to use the number of employees as the allocation base because it results in the highest operating margin for the division. 3. The Acme Division and the Stark Division receive roughly the same percentage allocation of headquarter costs regardless of the allocation base used (Acme range = 25%–29%; Stark range = 18.75%–23.5%). However, the Dune Division and the Brothers Division vary widely (Dune range = 22.4%–50%; Brothers range = 6.25%–25.1%). All four methods are reasonable options, but none clearly meets the cause-and-effect criterion for selecting the allocation base. If larger divisions tend to consume more of headquarters’ resources, then using division revenues or number of employees seem to be the best choices. Without compelling reason to change, Reidland should stay with the division revenues as the allocation base. Another alternative is to use segment margin as the allocation base on the grounds that this best captures the ability of different divisions to bear corporate overhead costs. 4. If Reidland elects to use direct costs as the allocation base, the Brothers Division will appear to have a $1,523,520 operating loss. Even so, the Brothers Division generates a $2,700,000 segment margin before allocating the cost of the corporate headquarters. As seen in the analysis in requirement 1, different allocation bases yield different operating incomes for the Brothers Division, with the direct cost allocation base being the lowest. The Brothers Division should not be closed because (1) the choice of allocation base is not based on a cause-and-effect relation (i.e., it is arbitrary), and (2) the division earns positive segment margin, which contributes to covering the cost of the corporate headquarters. The Brothers Division should only be closed if closing it will save more than $1,523,520 in corporate headquarter costs—a highly unlikely scenario.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

17-17

(20 min.)

Revenue allocation.

1. a. Stand-alone method for the BegM + RCC package DVD BegM RCC

Separate Revenue $ 60 40 $100

Joint Percentage Revenue $60 ÷ $100 = 0.6 $90 $40 ÷ $100 = 0.4 90

Allocation $54 36 $90

1. b. Incremental method i) BegM RCC

Allocated Revenue (BegM first) $60 30

Revenue Remaining To Allocate $30 ($90 − $60)

RCC BegM

Allocated Revenue (RCC first) $40 50

Revenue Remaining To Allocate $50 ($90 − $40)

ii)

1. c. Shapley method (assuming each DVD is demanded in equal proportion) i) BegM ii) RCC

($60 + $50) ÷ 2 = $55 ($30 + $40) ÷ 2 = $35

2. a. Stand-alone method for the ConM + RCC package DVD ConM RCC

Separate Revenue $50 40 $90

Joint Percentage Revenue $50 ÷ $90=0.556 $72 $40 ÷ $90=0.444 72

Allocation $40 32 $72

Chapter 17: Revenue and Customer Profitability Analysis

b. Incremental method i) ConM RCC

Allocated Revenue Revenue Remaining (ConM first) To Allocate $50 $22 ($72 − $50) 22

RCC ConM

Allocated Revenue Revenue Remaining (RCC first) To Allocate $40 $32 ($72 − $40) 32

ii)

c. Shapley method. (assuming each DVD is demanded in equal proportion) i) BegM ii) RCC

(50 + 32) ÷ 2 = 41 (22 + 40) ÷ 2 = 31

3. For each DVD package, the stand-alone method and the Shapley method give approximately the same allocation to each DVD. These methods are fair if the demands for the DVDs are approximately equal. The stand-alone method might be slightly preferable here since it is simpler and easier to explain. The incremental method would be appropriate if one DVD has a higher level of demand than the other DVD. In this situation, the dominant DVD would be sold anyway so it should receive its stand-alone revenue, and the other DVD should receive the remainder.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

17-18 (30 min.)

Variance analysis, working backward.

1. and 2. Solution Exhibit 17- presents the sales-volume, sales-quantity, and sales-mix variances for the Plain and Chic wine glasses and in total for Guangzhou Corporation in June. The steps to fill in the numbers in Solution Exhibit 17-follow: Step 1 Consider the static budget column (Column 3): Static budget total contribution margin $5,600 Budgeted units of all glasses to be sold 2,000 Budgeted contribution margin per unit of Plain $2 Budgeted contribution margin per unit of Chic $6 Suppose that the budgeted sales-mix percentage of Plain is y. Then the budgeted salesmix percentage of Chic is (1 – y). Therefore, (2,000y  $2) + (2,000  (1 – y)  $6) $4000y + $12,000 – $12,000y $8,000y y 1–y

= $5,600 = $5,600 = $6,400 = 0.8 or 80% = 20%

Guangzhou’s budgeted sales mix is 80% of Plain and 20% of Chic. We can then fill in all the numbers in Column 3. Step 2 Next, consider Column 2 of Solution Exhibit 17-. The total is $4,200 (the static budget total contribution margin of $5,600 – the total sales-quantity variance of $1,400 U which was given in the problem). We need to find the actual units sold of all glasses, which we denote by q. From Column 2, we know that (q  0.8  $2) + (q  0.2  $6) $1.6q + $1.2q $2.8q q

= $4,200 = $4,200 = $4,200 = 1,500 units

So, the total quantity of all glasses sold is 1,500 units. This computation allows us to fill in all the numbers in Column 2.

Chapter 17: Revenue and Customer Profitability Analysis

Step 3 Next, consider Column 1 of Solution Exhibit 17-. We know actual units sold of all glasses (1,500 units), the actual sales-mix percentage (given in the problem information as Plain, 60%; Chic, 40%), and the budgeted unit contribution margin of each product (Plain, $2; Chic, $6). We can therefore determine all the numbers in Column 1. Solution Exhibit 17-displays the following sales-quantity, sales-mix, and sales-volume variances: Sales-Volume Variance Plain $1,400 U Chic 1,200 F All Glasses $ 200 U Sales-Mix Variances Plain $ 600 U Chic 1,800 F All Glasses $1,200 F

Sales-Quantity Variances Plain $ 800 U Chic 600 U All Glasses $1,400 U

3. Guangzhou Corporation shows an unfavourable sales-quantity variance because it sold fewer wine glasses in total than was budgeted. This unfavourable sales-quantity variance is partially offset by a favourable sales-mix variance because the actual mix of wine glasses sold has shifted in favour of the higher contribution margin Chic wine glasses. The problem illustrates how failure to achieve the budgeted market penetration can have negative effects on operating income.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 17Columnar Presentation of Sales-Volume, Sales-Quantity, and Sales-Mix Variances for Guangzhou Corporation Flexible Budget: Actual Units of All Glasses Sold  Actual Sales Mix  Budgeted Contribution Margin per Unit

Actual Units of All Glasses Sold  Budgeted Sales Mix  Budgeted Contribution Margin per Unit

Static Budget: Budgeted Units of All Glasses Sold  Budgeted Sales Mix  Budgeted Contribution Margin per Unit

Panel A: Plain

(1,500  0.6)  $2 (1,500  0.8)  $2 (2,000  0.8)  $2 900  $2 1,200  $2 1,600  $2 $1,800 $2,400 $3,200 $600 U $800 U Sales-mix variance Sales-quantity variance $1,400 U Sales-volume variance

Panel B: Chic

(1,500  0.4)  $6 (1,500  0.2)  $6 (2,000  0.2)  $6 600  $6 300  $6 400  $6 $3,600 $1,800 $2,400 $1,800 F $600 U Sales-mix variance Sales-quantity variance $1,200 F Sales-volume variance

Panel C: All Glasses

$5,400

$4,200 $5,600 $1,200 F $1,400 U Total sales-mix variance Total sales-quantity variance $200 U Total sales-volume variance

F = favourable effect on operating income; U = unfavourable effect on operating income.

Chapter 17: Revenue and Customer Profitability Analysis

17-19 (60 min.) Variance analysis, multiple products. 1.

Kola Lima Oranga Total

Budget for 2022 Selling Price (1) $6.00 4.00 7.00

Actual for 2022 Variable Selling Price (1) Kola $6.20 Lima 4.25 Oranga 6.80 Total

Variable Cost per Unit (2) $4.00 2.80 4.50

Contrib. Margin Units per Unit Sold (3) = (1) – (2) (4) $2.00 400,000 1.20 600,000 2.50 1,500,000 2,500,000

Sales Mix (5) 16% 24 60 100%

Contribution Margin (6) = (3) × (4) $ 800,000 720,000 3,750,000 $5,270,000

Contrib. Cost Margin Units per Unit per Unit Sold (2) (3) = (1) – (2) (4) $4.50 $1.70 480,000 2.75 1.50 900,000 4.60 2.20 1,620,000 3,000,000

Sales Mix (5) 16% 30 54 100%

Contribution Margin (6) = (3) × (4) $ 816,000 1,350,000 3,564,000 $5,730,000

Solution Exhibit 17-presents the sales-volume, sales-quantity, and sales-mix variances for each product and in total for 2022.

Budgeted Budgeted   Actual Sales-volume  quantity of quantity of   contribution margin variance units sold per unit units sold    Kola Lima Oranga Total

= (480,000 – 400,000) × $2.00 = = (900,000 – 600,000) × $1.20 = = (1,620,000 – 1,500,000) × $2.50 =

$160,000 F 360,000 F 300,000 F $820,000 F

Budgeted Budgeted Actual units Budgeted units  Sales-quantity  of all products of all products   sales-mix  contribution margin variance   percentage per unit sold sold  

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Kola Lima Oranga Total

= (3,000,000 – 2,500,000) × 0.16 × $2.00 = (3,000,000 – 2,500,000) × 0.24 × $1.20 = (3,000,000 – 2,500,000) × 0.60 × $2.50

Actual units Actual Sales-mix = of all products × sales-mix variance sold percentage Kola Lima Oranga Total

= = =

$ 160,000 F 144,000 F 750,000 F $1,054,000 F

Budgeted Budgeted – sales-mix × contrib. margin percentage per unit

3,000,000 × (0.16 – 0.16) × $2.00 3,000,000 × (0.30 – 0.24) × $1.20 3,000,000 × (0.54 – 0.60) × $2.50

= = =

$ 0 216,000 F 450,000 U $234,000 U

2. The breakdown of the favourable sales-volume variance of $820,000 shows that the biggest contributor is the 500,000 unit increase in sales resulting in a favourable sales-quantity variance of $1,054,000. There is a partially offsetting unfavourable sales-mix variance of $234,000 in contribution margin.

Chapter 17: Revenue and Customer Profitability Analysis

SOLUTION EXHIBIT 17Sales-Mix and Sales-Quantity Variance Analysis of The PopStop for 2022 Flexible Budget: Actual Units of All Products Sold  Actual Sales Mix  Budgeted Contribution Margin Per Unit Kola Lima Oranga

3,000,000  0.16  $2 = $ 960,000 3,000,000  0.30  $1.20 = 1,080,000 3,000,000  0.54  $2.50 = 4,050,000 $6,090,000

Actual Units of All Products Sold  Budgeted Sales Mix  Budgeted Contribution Margin Per Unit

Static Budget: Budgeted Units of All Products Sold  Budgeted Sales Mix  Budgeted Contribution Margin Per Unit

3,000,000  0.16  $2 = $ 960,000 3,000,000  0.24  $1.20 = 864,000 3,000,000  0.60  $2.50 = 4,500,000 $6,324,000 $234,000 U Sales-mix variance $820,000 F Sales-volume variance

F = favourable effect on operating income; U= unfavourable effect on operating income

2,500,000  0.16  $2 = $ 800,000 2,500,000  0.24  $1.20 = 720,000 2,500,000  0.60  $2.50 = 3,750,000 $5,270,000 $1,054,000 F Sales-quantity variance

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

17-20 (30–40 min.) 1.

Variance analysis, multiple products.

Sales-volume  Actual sales Budgeted sales  Budgeted contribution    variance quantity in units quality in units  margin per ticket

Lower-tier tickets Upper-tier tickets All tickets

= (3,300 – 4,500)  $20 = $24,000 U = (7,700 – 5,500)  $ 7 = 15,400 F $ 8,600 U

(4,500  $20)  (5,500  $7) Budgeted average  contribution margin per unit 10, 000 $90, 000  $38, 000 $128, 000  10, 000 10, 000  $12.85 per unit (seat sold)



Sales-mix percentages: Lower-tier

Upper-tier

Budgeted 4,500 = 0.45 10, 000

Actual 3,300 = 0.30 11, 000

5,500 7, 700 = 0.55 = 0.70 10, 000 11, 000

Solution Exhibit presents the sales-volume, sales-quantity, and sales-mix variances for lower-tier tickets, upper-tier tickets, and in total for Chicago Tigers in the year. The sales-quantity variances can also be computed as:

Budgeted Actual units Budgeted units  Budgeted Sales-quantity    of all tickets  of all tickets  sales-mix  cont. margin variance   sold  sold  percentage per ticket The sales-quantity variances are: Lower-tier tickets = (11,000 – 10,000) × 0.45 × $20 = $ 9,000 F Upper-tier tickets = (11,000 – 10,000) × 0.55 × $ 7 = 3,850 F All tickets $12,850 F

Chapter 17: Revenue and Customer Profitability Analysis

The sales-mix variance can also be computed as:

Actual units  Actual Budgeted  Budgeted Sales-quantity  of all tickets  sales-mix sales-mix  contribution margin variance   sold per ticket percentage percentage  The sales-mix variances are Lower-tier tickets = 11,000 × (0.30 – 0.45) × $20 Upper-tier tickets = 11,000 × (0.70 – 0.55) × $ 7 All tickets

= $33,000 U = 11,550 F $21,450 U

3. The Chicago Tigers average attendance increased by 10% per game relative to the budget. But the sales of the higher contribution margin lower-tier seats (budgeted contribution margin of $20 per seat) decreased sharply by 26.67% [(3,300 – 4,500) ÷ 4,500]. The higher overall attendance was the result of much higher sales of the Upper Tier seats (actual of 7,700 seats versus a budget of 5,500 seats). However the contribution margin from these seats was only $7 per ticket. The net result: the actual contribution margin was $8,600 below the budgeted contribution margin.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT Columnar Presentation of Sales-Volume, Sales-Quantity and Sales-Mix Variances for Chicago Tigers Flexible Budget: Actual Units of All Products Sold × Actual Sales Mix × Budgeted Contribution Margin per Unit (1) Panel A: Lower-tier

Panel B: Upper-tier

Panel C: All Tickets (Sum of Lowertier and Uppertier Tickets)

Actual Units of All Products Sold × Budgeted Sales Mix × Budgeted Contribution Margin per Unit (2)

Static Budget: Budgeted Units of All Products Sold × Budgeted Sales Mix × Budgeted Contribution Margin per Unit (3)

$21,450 U Total sales-mix variance

$12,850 F Total sales-quantity variance

(11,000 × 0.30 ) × $20 (11,000 × 0.45 ) × $20 (10,000 × 0.45 ) × $20 3,300 × $20 4,950 × $20 4,500 × $20 $66,000 $99,000 $90,000 $33,000 U $9,000 F Sales-mix variance Sales-quantity variance $24,000 U Sales-volume variance (11,000 × 0.70 ) × $7 (11,000 × 0.55 ) × $7 (10,000 × 0.55 ) × $7 7,700 × $7 6,050 × $7 5,500 × $7 $53,900 $42,350 $38,500 $11,550 F $3,850 F Sales-mix variance Sales-quantity variance $15,400 F Sales-volume variance e f g $119,900 $141,350 $128,500 $8,600 U Total sales-volume variance

F = favourable effect on operating income; U = unfavourable effect on operating income. Actual Sales Mix: Budgeted Sales Mix: a b Lower-tier = 3,300 ÷ 11,000 = 30% Lower-tier = 4,500 ÷ 10,000 = 45% c d Upper-tier = 7,700 ÷ 11,000 = 70% Upper-tier = 5,500 ÷ 10,000 = 55% e f $66,000 + $53,900 = $119,900 $99,000 + $42,350 = $141,350 g $90,000 + $38,500 = $128,500

Chapter 17: Revenue and Customer Profitability Analysis

17-21 (2025 min.)

Customer profitability, distribution.

1. The activity-based costing for each customer is:

1. 2. 3. 4. 5.

Order processing, $40 × 13; $40 × 10 Line-item ordering, $3 × (13 × 9; 10 × 18) Store deliveries, $50 × 7; $50 ×10 Carton deliveries, $1 × (7 × 22; 10 × 20) Shelf-stocking, $16 × (7 × 0; 10 × 0.5) Operating costs

Charlesville Pharmacy

Chapelville Pharmacy

$ 520

$ 400

351

540

350

500

154

200

0 $1,375

80 $1,720

Charlesville Pharmacy

Chapelville Pharmacy

$16,800

$18,000

14,700 2,100 1,375 $ 725

16,500 1,500 1,720 $ (220)

The operating income of each customer is:

Revenue $2,400 × 7; $1,800 × 10 Cost of goods sold, $2,100 × 7; $1,650 × 10 Gross margin Operating costs Operating income

Chapelville Pharmacy has a lower gross margin percentage than Charlesville (8.33% vs. 12.50%) and consumes more resources to obtain this lower margin. 2. Ways Generic could use this information include: a. Pay increased attention to the top 20% of the customers. This could entail asking them for ways to improve service. Alternatively, you may want to highlight to your own personnel the importance of these customers (e.g., it could entail stressing to delivery people the importance of never missing delivery dates for these customers). b. Work out ways internally at Generic to reduce the rate per cost driver (e.g., reduce the cost per order by having better order placement linkages with customers). This cost reduction by Generic will improve the profitability of all customers.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

c. Work with customers so that their behaviour reduces the total “system-wide” costs. At a minimum, this approach could entail having customers make fewer orders and fewer line items. This latter point is controversial with students; the rationale is that a reduction in the number of line items (diversity of products) carried by mom-and-pop stores may reduce the diversity of products Generic carries. There are several options here:  

Simple verbal persuasion by showing customers cost drivers at Generic. Explicitly pricing out activities like cartons delivered and shelf-stocking so that customers pay for the costs they cause.  Restricting options available to certain customers (e.g., customers with low revenue could be restricted to one free delivery per week). An even more extreme example is working with customers so that deliveries are easier to make and shelf-stocking can be done faster. d. Offer salespeople bonuses based on the operating income of each customer rather than the gross margin of each customer. Some students will argue that the bottom 40% of the customers should be dropped. This action should be only a last resort after all other avenues have been explored. Moreover, an unprofitable customer today may well be a profitable customer tomorrow, and it is myopic to focus on only a 1-month customer-profitability analysis to classify a customer as unprofitable.

Chapter 17: Revenue and Customer Profitability Analysis

PROBLEMS 17-22 (25 min.)

Customer profitability.

1. Customer 03 04

Customer-level costs Customer orders ($42 × 3; 10; 1; 8; 17; 5) $126 Customer fittings ($30 × 1; 6; 0; 0; 4; 0) 30 Rush order costs ($90 × 0; 2; 1; 2; 3; 0) 0 Return visits for repair ($40 × 0; 0; 0; 0; 0; 1) 0 Total customer-level costs $156

$ 420 180 180 0 $ 780

$ 42 0 90 0 $132

Revenue Cost of product Gross profit Customer-level costs Customer-level operating income

$4,500 2,700 1,800 780 $1,020

$280 168 112 132 $ (20)

$850 510 340 156 $184

$ 336 0 180 0 $ 516

$ 714 120 270 0 $1,104

$210 0 0 40 $250

$2,200 1,320 880 516 $ 364

$5,500 3,300 2,200 1,104 $1,096

$650 390 260 250 $ 10

The table indicates there are profitable and unprofitable customers. The ranking of customers from most to least profitable is:

Customer Number 05 02 04 01 06 03

CustomerLevel Operating Income (1) $1,096 1,020 364 184 10 (20) $2,654

Customer Revenue (2) $ 5,500 4,500 2,200 850 650 280 $13,980

Customer-Level Operating Income Divided by Revenue (3) = (1) ÷ (2) 19.9% 22.7% 16.5% 21.6% 1.5% –7.1%

Cumulative CustomerLevel Operating Income (4) $1,096 $2,116 $2,480 $2,664 $2,674 $2,654

Cumulative Customer-Level Operating Income as a % of Total Customer Income (5) = (4) ÷ $2,654 41.3% 79.7% 93.4% 100.4% 100.8% 100.0%

2. Customer 03 is unprofitable and, of the rest, customer 06 has the lowest operating income and operating income as a percentage of revenue. Customer 3 is unprofitable because it has very low revenues and requires a rush order. Customer 6 has a low operating income percentage because of many hours spent on customer orders and the cost of repair and refitting during a return visit.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Bracelet Delights could make these customers more profitable by charging more for rush orders and increasing the selling price, or requiring a minimum total revenue for free post-sales service. Whatever decision it takes, Bracelet Delights must also consider the effect the decision might have on sales.

17-23 (60 min.) Customer profitability and ethics. 1. Order taking Product handling Delivery Expedited delivery Restocking Visits to customers Sales commissions

– Customer batch-level – Customer output-unit-level – Customer batch-level – Customer batch-level – Customer batch-level – Customer sustaining-level – Customer batch-level

2. Customer-level operating income based on expected cost of orders: Customers Revenues $30 × 225; 520; 295; 110; 390; 1,050 Less: Returns $30 ×15; 40; 0; 0; 35; 40 Net Revenues $30 ×210; 480; 295; 110; 355; 1,010 Cost of goods sold $18 × 210; 480; 295; 110; 355; 1,010 Gross margin Customer-level operating costs: Order taking $15 ×10; 20; 9; 12; 24; 36 Product handling $1 × 225; 520; 295; 110; 390; 1,050 Delivery $1.20 × 360; 580; 350; 220; 790; 850 Expedited delivery $175 × 0; 8; 0; 0; 3; 4 Restocking $50 ×3; 2; 0; 0; 1; 5 Visits to customers Sales commissions $10× 10; 20; 9; 12; 24; 36 Total customer-level operating costs Customer-level operating income

$6,750

$15,600

$8,850

$3,300

$11,700

$31,500

450

1,200

1,050

1,200

6,300

14,400

8,850

3,300

10,650

30,300

3,780 2,520

8,640 5,760

5,310 3,540

1,980 1,320

6,390 4,260

18,180 12,120

150

300

135

180

360

540

225

520

295

110

390

1,050

432

696

420

264

948

1,020

1,400

525

700

150

100

250

125

100 1,182 $1,338

200 3,341 $ 2,419

90 1,065 $2,475

120 799 $ 521

240 2,638 $ 1,622

360 4,045 $ 8,075

Chapter 17: Revenue and Customer Profitability Analysis

3. Customer level operating income based on actual order costs: Customers Revenues $30 × 225; 520; 295; 110; 390; 1,050 Less: Returns $30 ×15; 40; 0; 0; 35; 40 Net Revenues $30 ×210; 480; 295; 110; 355; 1,010 Cost of goods sold $18 × 210; 480; 295; 110; 355; 1,010 Gross margin Customer-level operating costs: Order taking $8 ×10; $15 × 20; $8 × 9; $8 × 12; $8 × 24; $8 × 36 Product handling $1 × 225; 520; 295; 110; 390; 1,050 Delivery $1.20 × 360; 580; 350; 220; 790; 850 Expedited delivery $175 × 0; 8; 0; 0; 3; 4 Restocking $50 ×3; 2; 0; 0; 1; 5 Visits to customers Sales commissions $10× 10; 20; 9; 12; 24; 36 Total customer-level operating costs Customer-level operating income

$6,750

$15,600

$8,850

$3,300

$11,700

$31,500

450

1,200

1,050

1,200

6,300

14,400

8,850

3,300

10,650

30,300

3,780 2,520

8,640 5,760

5,310 3,540

1,980 1,320

6,390 4,260

18,180 12,120

300

192

288

225

520

295

110

390

1,050

432

696

420

264

948

1,020

1,400

525

700

150

100

250

125

100 1,112 $1,408

200 3,341 $ 2,419

90 1,002 $2,538

120 715 $ 605

240 2,470 $ 1,790

360 3,793 $ 8,327

Comparing the answers in requirements 2 and 3, it appears that operating income is higher than expected, so the management of KC Corporation would be very pleased with the performance of the salespeople for reducing order costs. Except for DC, all of the customers are more profitable than originally reported.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4. Customer-level operating income based on actual orders and adjusted commissions Customers Revenues $30 × 225; 520; 295; 110; 390; 1,050 Less: Returns $30 ×15; 40; 0; 0; 35; 40 Net Revenues $30 ×210; 480; 295; 110; 355; 1,010 Cost of goods sold $18 × 210; 480; 295; 110; 355; 1,010 Gross margin Customer-level operating costs: Order taking $15 ×5; 20; 4; 6; 9; 18 Product handling $1 × 225; 520; 295; 110; 390; 1,050 Delivery $1.20 × 360; 580; 350; 220; 790; 850 Expedited delivery $175 × 0; 8; 0; 0; 3; 4 Restocking $50 ×3; 2; 0; 0; 1; 5 Visits to customers Sales commissions $10× 5; 20; 4; 6; 9; 18 Total customer-level operating costs Customer-level operating income

$6,750

$15,600

$8,850

$3,300

$11,700

$31,500

450

1,200

1,050

1,200

6,300

14,400

8,850

3,300

10,650

30,300

3,780 2,520

8,640 5,760

5,310 3,540

1,980 1,320

6,390 4,260

18,180 12,120

300

135

270

225

520

295

110

390

1,050

432

696

420

264

948

1,020

1,400

525

700

150

100

250

125

50 1,057 $1,463

200 3,341 $ 2,419

40 940 $2,600

60 649 $ 671

90 2,263 $ 1,997

180 3,595 $ 8,525

5. The behaviour of the salespeople is costing KC Corporation $588 in profit (the difference between the incomes in requirements 3 and 4.) Although management thinks the salespeople are saving money based on the budgeted order costs, in reality they are costing the firm money by increasing the costs of orders ($1,028 in requirement 3 versus $930 in requirement 4) and at the same time increasing their sales commissions ($1,110 in requirement 3 versus $620 in requirement 4). This is not ethical. KC Corporation needs to change the structure of the sales commission, possibly linking commissions to the overall units sold rather than on number of orders. Some students might argue that the amount is not material, but in matters of ethics be wary of the slippery slope. Most organizations do not stand for any deviation from ethical principles, regardless of the amount involved. Students can engage in an interesting debate around this point.

Chapter 17: Revenue and Customer Profitability Analysis

17-24

(60 min.)

Variance analysis, sales-mix, and sales-quantity variances.

1. Actual Contribution Margins

Product SlatePro Slate SlateLite

Actual Selling Price $349 285 102

Actual Variable Cost per Unit $178 92 73

Actual Contribution Margin per Unit $171 193 29

Actual Actual Sales Volume in Contribution Units Dollars 11,000 $ 1,881,000 44,000 8,492,000 55,000 1,595,000 110,000 $11,968,000

Actual Contribution Percent 16% 71% 13% 100%

The actual average contribution margin per unit is $108.80 (= $11,968,000  110,000 units). Budgeted Contribution Margins

Product SlatePro Slate SlateLite

Budgeted Budgeted Variable Selling Cost per Price Unit $379 $182 269 98 149 65

Budgeted Contribution Margin per Unit $197 171 84

Budgeted Sales Volume in Units 12,500 37,500 50,000 100,000

Budgeted Contribution Dollars $ 2,462,500 6,412,500 4,200,000 $13,075,000

Budgeted Contribution Percent 19% 49% 32% 100%

The budgeted average contribution margin per unit is $130.75 (= $13,075,000  100,000 units). 2. Actual Sales Mix

Product Slate Pro Slate SlateLite

Actual Sales Volume in Units 11,000 44,000 55,000 110,000

Actual Sales Mix 10.0% (11,000 ÷ 110,000) 40.0% (44,000 ÷ 110,000) 50.0% (55,000 ÷ 110,000) 100.0%

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Budgeted Sales Mix

Product SlatePro Slate SlateLite

Budgeted Sales Volume Budgeted in Units Sales Mix 12,500 12.5% (12,500 ÷ 100,000) 37,500 37.5% (37,500 ÷ 100,000) 50,000 50.0% (50,000 ÷ 100,000) 100,000 100.0%

3. Sales-volume variance:

Budgeted Budgeted   Actual   contribution margin quantity of  quantity of = × units sold  per unit units sold   SlatePro (11,000  12,500) Slate (44,000  37,500) SlateLite (55,000  50,000) Total sales-volume variance

× × ×

$197 $171 $ 84

295,500 U 1,111,500 F 420,000 F $1,236,000 F

Sales-mix variance: Actual units Budgeted  Budgeted Actual of all = × sales mix  sales mix × contrib. margin products sold  per unit percentage percentage    SlatePro = 110,000 × (0.10 Slate = 110,000 × (0.40 SlateLite = 110,000 × (0.50 Total sales-mix variance

 0.125) × $197  0.375) × $171  0.50) × $ 84

$541,750 U 470,250 F 0F $ 71,500 U

Sales-quantity variance: Budgeted Budgeted units  Budgeted Actual units × sales mix × contrib. margin of all =  of all  products sold products sold  percentage per unit   SlatePro (110,000  100,000) × 0.125 × $197 Slate (110,000  100,000) × 0.375 × $171 SlateLite (110,000  100,000) × 0.500 × $ 84 Total sales-quantity variance

$ 246,250 F 641,250 F 420,000 F $1,307,500 F

Solution Exhibit presents the sales-volume variance, the sales-mix variance, and the salesquantity variance for SlatePro, Slate, and SlateLite and in total for the third quarter 2022.

Chapter 17: Revenue and Customer Profitability Analysis

SOLUTION EXHIBIT Sales-Mix and Sales-Quantity Variance Analysis of Blank Slate for the Third Quarter 2022. Flexible Budget: Actual Units of All Products Sold  Actual Sales Mix  Budgeted Contribution Margin Per Unit SlatePro Slate SlateLite

Actual Units of All Products Sold  Budgeted Sales Mix  Budgeted Contribution Margin Per Unit

Static Budget: Budgeted Units of All Products Sold  Budgeted Sales Mix  Budgeted Contribution Margin Per Unit

110,000  0.10  $197 =$ 2,167,000 110,000  0.125  $197 =$ 2,708,750 110,000  0.40  $171 = 7,524,000 110,000  0.375  $171 = 7,053,750 110,000  0.50  $ 84 = 4,620,000 110,000  0.50  $ 84 = 4,620,000 $14,311,000 $14,382,500

100,000  0.125  $197 =$ 2,462,500 100,000  0.375  $171 = 6,412,500 100,000  0.50  $ 84 = 4,200,000 $13,075,000

$71,500 U

$1,307,500 F

Sales-mix variance

Sales-quantity variance $1,236,000 F

Sales-volume variance

F = favourable effect on operating income; U= unfavourable effect on operating income 4. The following factors help us understand the differences between actual and budgeted amounts: 

  

 

The difference in actual versus budgeted contribution margins was $1,107,000 unfavourable ($11,968,000  $13,075,000). However, the contribution margin from the Slate exceeded budget by $2,079,500 (= $8,492,000  $6,412,500) while the contributions from the SlatePro and the SlateLite were lower than expected and offset this gain. This is attributable to lower unit sales in the case of SlatePro and lower contribution margins in the case of SlateLite. In percentage terms, the Slate accounted for 71% of actual contribution margin versus a planned 49% contribution margin. However, the SlatePro accounted for 16% versus planned 19% and the SlateLite accounted for only 13% versus a planned 32%. In unit terms (rather than in contribution terms), the SlateLite accounted for 50% of the sales mix as planned. However, the SlatePro accounted for only 10% versus a budgeted 12.5% and the Slate accounted for 40% versus a planned 37.5%. Variance analysis for the SlatePro shows an unfavourable sales-mix variance outweighing a favourable sales-quantity variance and producing an unfavourable salesvolume variance. The drop in sales-mix share was far larger than the gain from an overall greater quantity sold. The Slate gained both from an increase in share of the sales mix as well as from the increase in the overall number of units sold. The SlateLite maintained sales-mix share at 50%––as a result, the sales-mix variance is zero. However, SlateLite sales gained from the overall increase in units sold.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition



Overall, there was a favourable total sales-volume variance. However, the large drop in SlateLite’s contribution margin per unit combined with a decrease in the actual number of SlatePro units sold as well as a drop in the actual contribution margin per unit below budget, led to the total contribution margin being much lower than budgeted.

Other factors could be discussed here––for example, it seems that the SlateLite did not achieve much success with a three digit price point––selling price was budgeted at $149 but dropped to $102. At the same time, variable costs increased. This could have been due to a marketing push that did not succeed.

17-25

(20 min.)

Market-share and market-size variances (continuation of 17-24).

1. Worldwide Blank Slate’s Info. Market share

Actual 500,000 110,000 22%

Budgeted 400,000 100,000 25%

Average contribution margin per unit: Actual = $108.80 ($11,968,000  110,000) Budgeted = $130.75 ($13,075,000  100,000)

Budgeted Actual Actual Budgeted  Market-share contribution margin  market size  market  market  variance   per composite unit in units share  share for budgeted mix  500, 000  (0.22 0.25)  $130.75  500, 000  ( 0.03)  $130.75  $1,961, 250 U Budgeted Budgeted  Budgeted  Actual Market-size  contribution margin  market size market size  market  variance per composite unit   in units  share  in units for budgeted mix  (500, 000 400, 000)  0.25  $130.75  00, 000  0.25  $130.75  $3, 268, 750 F Solution Exhibit 17-presents the market-share variance, the market-size variance, and the sales-quantity variance for the third quarter 2022.

Chapter 17: Revenue and Customer Profitability Analysis

SOLUTION EXHIBIT 17Market-Share and Market-Size Variance Analysis of Blank Slate for the Third Quarter 2022.

Actual Market Size  Actual Market Share  Budgeted Average Contribution Margin Per Unit 500,000  0.22a  $130.75b $14,382,500

Static Actual Market Size  Budgeted Market Share  Budgeted Average Contribution Margin Per Unit 500,000  0.25c  $130.75 b $16,343,750

Budget: Budgeted Market Size  Budgeted Market Share  Budgeted Average Contribution Margin Per Unit 400,000  0.25c  $130.75b $13,075,000

$1,961,250 U

$3,268,750 F

Market-share variance

Market-size variance

$1,307,500 F Sales-quantity variance

F = favourable effect on operating income; U = unfavourable effect on operating income aActual market share: 110,000 units ÷ 500,000 units = 0.22, or 22% bBudgeted average contribution margin per unit $13,075,000 ÷ 100,000 units = $130.75 per unit cBudgeted market share: 100,000 units ÷ 400,000 units = 0.25, or 25%

2. While the market share declined (from 25% to 22%), the overall increase in the total market size meant a favourable sales-quantity variance: Sales-Quantity Variance $1,307,500 F

Market-Share Variance $1,961,250 U

Market Size Variance $3,268,750 F

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. The required actual market size is the budgeted market size, i.e., 400,000 units. This can easily be seen by setting up the following equation: Budgeted Budgeted  Budgeted  Actual Market-size  contribution margin  market size market size  market  variance per composite unit   in units  share  in units for budgeted mix  (M 400, 000)  0.25  $130.75

When M = 400,000, the market-size variance is $0. Actual Market-Share Calculation Again, the answer is the budgeted market share, 25%. By definition, this will hold irrespective of the actual market size. This can be seen by setting up the appropriate equation: Budgeted Actual Actual Budgeted  Market-share contribution margin  market size  market  market  variance   per composite unit in units share  share for budgeted mix  Actual market size  (M 25%)  $130.75 When M  25%, the market-share variance is $0.

17-26 (40 min.)

Variance analysis, multiple products.

1, 2, and 3. Solution Exhibit 17-presents the sales-volume, sales-quantity, and sales-mix variances for each type of cookie and in total for Momma’s Pan Inc., in August. The sales-volume variances can also be computed as Sales-volume = Actual quantity Budgeted quantity × Budgeted contribution margin per kilogram of kilogram sold of kilogram sold variance





The sales-volume variances are Chocolate chip = (57,600 – 45,000)  $2.00 Oatmeal raisin = (18,000 – 25,000)  $2.30 Coconut = (9,600 – 10,000)  $2.60 White chocolate = (13,200 – 5,000)  $3.00 Macadamia nut = (21,600 – 15,000)  $3.10 All cookies

= $25,200 F = 16,100 U = 1,040 U = 24,600 F = 20,460 F $53,120 F

The sales-quantity variance can also be computed as Budgeted Actual kilogram Budgeted kilogram  Budgeted Sales-volume =   of all cookies  of all cookies  sales-mix  contribution variance   percentage margin per kilogram sold sold   Copyright © 2022 Pearson Canada Inc. 17-28

Chapter 17: Revenue and Customer Profitability Analysis

The sales-quantity variances are Chocolate chip = (120,000 – 100,000)  0.45  $2.00 Oatmeal raisin = (120,000 – 100,000)  0.25  $2.30 Coconut = (120,000 – 100,000)  0.10  $2.60 White chocolate = (120,000 – 100,000)  0.05  $3.00 Macadamia nut = (120,000 – 100,000)  0.15  $3.10 All cookies

= $18,000 F = 11,500 F = 5,200 F = 3,000 F = 9,300 F $47,000 F

The sales-mix variance can also be computed as:

Budgeted kilogram Sales-quantity = Actual sales- Budgeted sales-  Actual contribution of all cookies  mix percentage mix percentage variance margin per kilogram sold





The sales-mix variances are: Chocolate chip = (0.48 – 0.45)  120,000  $2.00 = $ 7,200 F Oatmeal raisin = (0.15 – 0.25)  120,000  $2.30 = 27,600 U Coconut = (0.08 – 0.10)  120,000  $2.60 = 6,240 U White chocolate = (0.11 – 0.05)  120,000  $3.00 = 21,600 F Macadamia nut = (0.18 – 0.15)  120,000  $3.10 = 11,160 F All cookies $ 6,120 F A summary of the variances is: Sales-Volume Variance Chocolate chip $25,200 F Oatmeal raisin 16,100 U Coconut 1,040 U White chocolate 24,600 F Macadamia nut 20,460 F All cookies $53,120 F

Sales-Mix Variance Chocolate chip $ 7,200 F Oatmeal raisin 27,600 U Coconut 6,240 U White chocolate 21,600 F Macadamia nut 11,160 F All cookies $ 6,120 F

Sales-Quantity Variance Chocolate chip $18,000 F Oatmeal raisin 11,500 F Coconut 5,200 F White chocolate 3,000 F Macadamia nut 9,300 F All cookies $47,000 F

4. Momma’s Pan shows a favourable sales-quantity variance because it sold more cookies in total than was budgeted. Together with the higher quantities, Momma’s also sold more of the high-contribution margin white chocolate and macadamia nut cookies relative to the budgeted mix––as a result, Momma’s also showed a favourable total sales-mix variance.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 17Columnar Presentation of Sales-Volume, Sales-Quantity, and Sales-Mix Variances for Momma’s Pan Inc. Flexible Budget: Static Budget: Actual Kilograms of Actual Kilograms of Budgeted Kilograms of All Cookies Sold All Cookies Sold All Cookies Sold × Actual Sales Mix × Budgeted Sales Mix × Budgeted Sales Mix × Budgeted × Budgeted × Budgeted Contribution Margin Contribution Margin Contribution Margin per Kilogram per Kilogram per Kilogram (1) (2) (3) a b b Panel A: (120,000 × 0.48 ) × $2 (120,000 × 0.45 ) × $2 (100,000 × 0.45 ) × $2 Chocolate Chip 57,600 × $2 54,000 × $2 45,000 × $2 $115,200

$108,000

$90,000

$7,200 F Sales-mix variance

$18,000 F Sales-quantity variance $25,200 F Sales-volume variance

Panel B: Oatmeal Raisin

(120,000 × 0.15 ) × $2.30 18,000 × $2.30 $41,400

(120,000 × 0.25 ) × $2.30 30,000 × $2.30 $69,000

$27,600 U Sales-mix variance

(100,000 × 0.25 ) × $2.30 25,000 × $2.30 $57,500

$11,500 F Sales-quantity variance

$16,100 U Sales-volume variance

Chapter 17: Revenue and Customer Profitability Analysis

Panel C: Coconut

(120,000 × 0.08 ) × $2.60 9,600 × $2.60 $24,960

(120,000 × 0.10 ) × $2.60 12,000 × $2.60 $31,200

$6,240 U Sales-mix variance

(100,000 × 0.10 ) × $2.60 10,000 × $2.60 $26,000

$5,200 F Sales-quantity variance

$1,040 U Sales-volume variance

F = favourable effect on operating income; U = unfavourable effect on operating income. Actual Sales Mix: a Chocolate Chip = 57,600 ÷ 120,000 = 48% c Oatmeal Raisin = 18,000 ÷ 120,000 = 15% e Coconut = 9,600 ÷ 120,000 = 8%

Panel D: White Chocolate

Budgeted Sales Mix: b Chocolate Chip = 45,000 ÷ 100,000= 45% d Oatmeal Raisin = 25,000 ÷ 100,000= 25% f Coconut = 10,000 ÷ 100,000= 10%

Flexible Budget: Actual Kilograms of All Cookies Sold × Actual Sales Mix × Budgeted Contribution Margin per Kilogram (1)

Actual Kilograms of All Cookies Sold × Budgeted Sales Mix × Budgeted Contribution Margin per Kilogram (2)

Static Budget: Budgeted Kilograms of All Cookies Sold × Budgeted Sales Mix × Budgeted Contribution Margin per Kilogram (3)

(120,000 × 0.11g) × $3.00 13,200 × $3.00 $39,600

(120,000 × 0.05h) × $3.00 6,000 × $3.00 $18,000

(100,000 × 0.05h) × $3.00 5,000 × $3.00 $15,000

$21,600 F $3,000 F Sales-mix variance Sales-quantity variance $24,600 F Sales-volume variance

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Panel E: Macadamia Nut

(120,000 × 0.18 ) × $3.10 21,600 × $3.10 $66,960

(120,000 × 0.15 ) × $3.10 18,000 × $3.10 $55,800

(100,000 × 0.15 ) × $3.10 15,000 × $3.10 $46,500

$9,300 F $11,160 F Sales-quantity variance Sales-mix variance $20,460 F Sales-volume variance Panel F: All Cookies

$288,120l

$282,000

$6,120 F Total sales-mix variance

$235,000

$47,000 F Total sales-quantity variance

$53,120 F Total sales-volume variance F = favourable effect on operating income; U = unfavourable effect on operating income. Actual Sales Mix: g White Chocolate= 13,200 ÷ 120,000 = 11% j Macadamia Nut = 21,600 ÷ 120,000 = 18% l $115,200 + $41,400 + $24,960 + $39,600 + $66,960 = $288,120

Budgeted Sales Mix: h White Chocolate= 5,000 ÷ 100,000 = 5% k Macadamia Nut = 15,000 ÷ 100,000 =15% m $108,000 + $69,000 + $31,200 + $18,000 + $55,800 = $282,000 n $90,000 + $57,500 + $26,000 + $15,000 + $46,500 = $235,000

Chapter 17: Revenue and Customer Profitability Analysis

17-27

(30 min.)

Cost-hierarchy income statement and allocation of corporate costs to customers.

1. Revenue Customer-level costs Customer-level operating income Corporate costs Operating income

Eastern $4,000,000 2,920,000 $1,080,000

Midwest $2,600,000 1,768,000 $ 832,000

South $1,800,000 1,674,000 $ 126,000

Total $8,400,000 6,362,000 $2,038,000 750,000 $1,288,000

Eastern $4,000,000 2,920,000 1,080,000 357,143 $ 722,857

Midwest $2,600,000 1,768,000 832,000 232,143 $ 599,857

South $1,800,000 1,674,000 126,000 160,714 $ (34,714)

Total $8,400,000 6,362,000 2,038,000 750,000 $1,288,000

2. Revenue Customer-level costs Customer-level operating income Corp costs allocated on revenues1 Regional operating income

1$750,000 × ($4,000,000 ÷ $8,400,000; $2,600,000 ÷ $8,400,000; $1,800,000 ÷ $8,400,000)

The customer-level operating income of all three regions is positive although the operating income of the Southern region is low in relation to the other regions in dollars and as a percentage of revenue. This is because the Southern region has had several hurricanes and The Insurance Company has paid out large sums to homeowners in the Southern region. If corporate level costs are allocated to the three regions, the Southern region will report a loss. The Insurance Company is earning relatively consistent operating income as a percentage of revenue from the Eastern and Midwest regions. 3. After allocating corporate costs, the Southern region shows a loss. Should The Insurance Company discontinue doing business within that region? First the current costs are past costs and so are irrelevant for making any decision. Now let us assume that the customer-level operating income for the South Region is expected to look similar to the past year’s costs in the future. The Insurance Company should only close down the South Region if the corporate costs saved by dropping the region are more than the $126,000 of customer-level operating that the South Region generates. The allocated costs are irrelevant. The key question is whether The Insurance Company will save more than the $126,000 of customer-level operating income it is currently making by keeping the Southern region open. Allocating corporate costs gives the misleading impression that potential cost savings from dropping a region are greater than the likely amount. A cost-hierarchy-based income statement does not allocate corporate costs to regions but instead subtracts these amounts as lump-sum amounts from total customer-level operating income.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Insurance companies also provide a service. Since the probability of hurricanes is greater in the Southern region, The Insurance Company should charge higher premiums in this region to cover the higher risk of loss. The Insurance Company could use historical data, such as actuarial tables in life insurance policies, to determine the probability of hurricanes and compute the cost. This cost would be reflected in the rates while still providing customers with insurance coverage protecting their property. Without insurance on one’s home, usually the largest asset of most individuals, the loss of an uninsured home would be catastrophic. Insurance companies can compute the higher probability of such occurrences and factor these into the cost of insuring homes and thus spread the cost over a large region, similar to all insurance coverage and costs. 4. Advantages of allocating corporate costs One important advantage of allocating corporate costs to the regions is that the full costs of supporting the sales of products to customers are included when determining customer-level profitability. In the long run, customers (and products) must be profitable on a full-cost basis, if the company is to be profitable. Another advantage of allocating all costs to customers (regions) is to encourage long-run prices to be set to cover the cost of all resources used to produce and sell products to customers. Fullcost allocation reduces the temptation of companies to cut prices to simply cover partial (or variable) costs. Allocating all costs motivates managers and salespersons servicing individual customer accounts to examine how corporate costs are planned and controlled. These managers and salespersons want to understand whether these costs are providing them benefits in line with their costs. Are the corporate costs supporting better distribution of products to customers? Are the marketing activities increasing the demand for products by customers? Disadvantages of allocating corporate costs Managers sometimes prefer not to allocate corporate costs to customers because changes in customer behaviour will have no effect on these costs. For example, only decisions pertaining to the company as a whole will influence these costs. Another disadvantage of allocating corporate costs is that salespeople responsible for managing individual customer accounts would lose motivation if sales bonuses were adversely affected as a result of allocating to customers costs over which they had minimal influence. This is the controllability principle. Even if the salesperson benefited from the corporate costs, he or she would not be responsible for how much of these costs to use or what they would cost. Corporate administration costs may have a very weak cause-and-effect relationship with regional revenues which is the basis used to allocate corporate costs to customers. Allocating corporate costs will then serve little useful purpose for decision making, performance evaluation, or motivation.

Chapter 17: Revenue and Customer Profitability Analysis

A final disadvantage is the cost of designing and implementing complex cost-allocation systems as well as helping managers understand the system. These costs must be weighed against the benefits of better pricing and cost-control decisions, which are sometimes difficult to measure. However, as the costs of collecting and processing information decrease, companies are more easily able to justify more-complex cost allocations.

17-28 (40 min.)

Customer profitability and ABC hierarchy.

1. Gold Program Revenue 2,673  20  ($200  0.90) 2,673  30  ($200  0.80) 2,673  10  ($200  0.70) Total revenue Variable costs Hotel variable costs, 2,673  60  $65 Wine costs 2,673  50  $5 2,673  10  $20 Restaurant costs 2,673  20  $10 2,673  30  $15 2,673  10  $20 Total variable costs Contribution margin Silver Program Revenue 9,174  20  ($200  0.90) 9,174  15  ($200  0.80) Total revenue Variable costs Hotel variable costs, 9,174  35  $65 Wine costs, 9,174  35  $5 Restaurant costs 9,174  20  $10 9,174  15  $15 Total variable costs Contribution margin

$ 9,622,800 12,830,400 3,742,200 26,195,400 10,424,700 668,250 534,600 534,600 1,202,850 534,600 13,899,600 $ 12,295,800

$ 33,026,400 22,017,600 55,044,000 20,870,850 1,605,450 1,834,800 2,064,150 26,375,250 $ 28,668,750

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Bronze Program Revenue, 88,330  10  ($200  0.90) Variable costs Hotel variable costs, 88,330  10  $65 Wine costs 88,330  10  $5 Restaurant costs 88,330  10  $10 Total variable costs Contribution margin

$158,994,000 57,414,500 4,416,500 8,833,000 70,664,000 $88,330,000

No Program Revenue, 240,900  1  $200 Variable costs, 240,900  1  $65 Contribution margin Loyalty Program Gold Silver Bronze No program Total

Total Revenue $ 26,195,400 55,044,000 158,994,000 48,180,000 $288,413,400

Variable Costs $ 13,899,600 26,375,250 70,664,000 15,658,500 $126,597,350

$48,180,000 15,658,500 $32,521,500 Contribution Margin $ 12,295,800 28,668,750 88,330,000 32,521,500 $161,816,050

Contrib. Margin/ Total Revenue 46.94% 52.08 55.56 67.50

The no-program group of customers has the highest contribution margin per revenue dollar. However, it comprises only 16.71% (= $48,180,000 ÷ $288,413,000) of total revenue. The gold program has the lowest contribution margin per revenue dollar. However, it is misleading to evaluate each program in isolation. A key aim of loyalty programs is to promote a high frequency of return business. The contribution margin to total revenue ratio of each program in isolation does not address this issue. 2. Revenue Variable costs Contribution margin Fixed costs Operating income

$288,413,400 126,597,350 161,816,050 140,580,000 $ 21,236,050

Chapter 17: Revenue and Customer Profitability Analysis

3. Number of room nights Gold, 2,673  60 Silver, 9,174  35 Bronze, 88,330  10 No program, 240,900  1

Average room rate per night:

160,380 321,090 883,300 240,900 1,605,670 $288, 413, 400  $179.62 1, 605, 670

Average variable cost per night:

$126,597,350  $78.84 1, 605, 670

4. Sherriton Hotels has fixed costs of $140,580,000. A key challenge is to attract a high number of repeat business customers. Loyalty programs aim to have customers return to Sherriton multiple times. Their aim is increasing the revenue beyond what they would be without the program. It is to be expected that the higher the level of nights stayed, the greater the inducements necessary to keep attracting the customer to return. However, given the low level of variable costs to room rates, there is a considerable cushion available for Sherriton to offer high inducements for frequent stayers. Sherriton could adopt a net present value analysis of customers who are in the different loyalty clubs. It would be informative for Sherriton to have information on how much of each customer’s total lodging industry expenditures it captures. It may well want to give higher levels of inducements to frequent stayers if the current program attracts only, say, 30% of each of its frequent customers’ total business in cities where it has lodging properties available.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

17-29

(30 min.)

Customer profitability, customer-cost hierarchy.

All amounts in thousands of U.S. dollars Wholesale Retail North America South America Big Sam World

Revenue at list prices Price discounts Revenue (at actual prices) Cost of goods sold Gross margin

Wholesaler $450,000 30,000 420,000 325,000 95,000

Wholesaler $580,000 40,000 540,000 455,000 85,000

Stereo $130,000 7,000 123,000 118,000 5,000

Customer-level operating costs Delivery 450 650 200 Order processing 800 1,000 200 Sales visit 5,600 5,500 2,300 Total cust.-level optg. costs 6,850 7,150 2,700 Customer-level operating income $88,150 $77,850 $2,300

Market $100,000 500 99,500 90,000 9,500 125 130 1,350 1,605 $7,895

2. Customer Distribution Channels (All amounts in thousands of dollars) Wholesale Customers Retail Customers

Revenue (at actual prices) Customer-level costs Customer-level operating income Distribution-channel costs Distribution-channellevel operating income Corporate-sustaining costs Operating income

Total $1,182,500 1,006,305

Total $960,000 794,000

176,195 45,000

166,000 38,000

131,195 65,000 $ 66,195

$128,000

North America Wholesaler $420,000 331,850

South America Wholesaler $540,000 462,150

$ 88,150

$ 77,850

Total $222,500 212,305 10,195 7,000 $ 3,195

Big Sam Stereo $123,000 120,700

World Market $99,500 91,605

$ 2,300

$ 7,895

Chapter 17: Revenue and Customer Profitability Analysis

3. If corporate costs are allocated to the channels, the retail channel will show an operating loss of $10,805,000 (= $3,195,000 – $14,000,000), and the wholesale channel will show an operating profit of $77,000,000 (= $98,000,000 – $51,000,000). The overall operating profit, of course, is still $66,195,000, as in requirement 2. There is, however, no cause-and-effect or benefits-received relationship between corporate costs and any allocation base (i.e., the allocation of $51,000,000 to the wholesale channel and of $14,000,000 to the retail channel is arbitrary and not useful for decision-making). Therefore, the management of Ramish Electronics should not base any performance evaluations or investment/disinvestment decisions on these channel-level operating income numbers. They may want to take corporate costs into account, however, when making pricing decisions.

17-30

(30 min.)

Cost-hierarchy income statement and allocation of corporate, division, and channel costs to customers

Revenue Customer-level costs Customer-level operating income Distribution costs: Marketing costs1 Administration costs2 Allocated distribution costs Distribution-channel operating income after allocating distribution costs Allocated corporate costs Fully allocated distribution channel operating income Distribution-channel operating income as a percentage of revenue

Distribution Channel A $850,000 628,000 222,000

Distribution Channel B $910,000 532,400 377,600

Total $1,760,000 1,160,400 599,600

125,568 108,239 233,807

134,432 91,761 226,193

260,000 200,000 460,000

(11,807) 45,000

151,407 55,000

139,600 100,000

$(56,807)

$ 96,407

(1.4)%

16.6%

7.9%

39,600

1$260,000 × ($850,000 ÷ $1,760,000; $910,000 ÷ $1,760,000) 2$200,000 × ($628,000 ÷ $1,160,400; $532,400 ÷ $1,160,400)

2. Vocal Speakers should not close down any distribution channel just based on these cost numbers. Distribution Channel A shows a loss, but the key question is whether it will be able to save more than $222,000 of marketing and administration costs if the company was to close down this channel. The actual costs of $233,807 allocated to Distribution Channel A is irrelevant. We know that Vocal Speakers will not save any corporate costs so these costs are irrelevant to the decision. Allocating marketing and administration costs to the distribution channels gives the misleading impression that potential cost savings from closing down a channel are greater than the likely amount. Of course, the overall profitability of Vocal Speakers at the distribution-channel level is low (7.9%), so Vocal Speakers should carefully examine all its costs to see where it might be able to achieve cost savings. Copyright © 2022 Pearson Canada Inc. 17-39

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. I would allocate corporate costs to distribution channels. One important advantage of doing so is that the full costs of supporting the sales of products to customers in a distribution channel are included when determining customer-level profitability. In the long run, distribution channels must be profitable on a full-cost basis if the company is to be profitable. Another advantage of allocating corporate costs to distribution channels is to encourage distribution-channel managers to set long-run prices to cover the costs of all resources used to produce and sell products to customers. Full-cost allocation reduces the temptation for companies to cut prices to simply cover partial (or variable) costs. Allocating corporate costs will motivate managers of the distribution channels to examine how corporate costs are planned and controlled. The distribution-channel managers will want to understand whether these costs are providing them benefits in line with their costs. For example, are corporate costs supporting better distribution of products to customers? At the same time, I would make managers of the distribution channels aware that the bonuses of salespeople responsible for managing individual customer accounts would not be affected as a result of allocating corporate costs to distribution channels because salespersons have minimal influence over these corporate costs. This is the controllability principle. Even if the salesperson benefits from the corporate costs, he or she has no say in (“is not responsible for”) how much of these costs to use or the amount of these costs. Corporate costs have a very weak cause-and-effect relationship with distribution-channel costs. For many decisions, corporate cost allocations will not be useful as already discussed in requirement 2 and in the previous paragraph. It is important for distribution-channel managers to understand the purposes for which corporate cost allocations are useful and the purposes for which it is not. This is in keeping with the idea of “different costs for different purposes.” A final issue to consider is the cost of designing and implementing complex costallocation systems and explaining these systems to managers. However, as the costs of collecting and processing information decrease, senior managers are more easily able to justify morecomplex cost allocations.

Chapter 17: Revenue and Customer Profitability Analysis

17-31 (40 min.)

Customer profitability and governance

1. Customer-level operating income based on expected cost of orders: Customers Revenue at list price $40 × 200; 540; 300; 100; 400; 1,000 Price discounts PRU: 5% × $21,600; Pmart: 5% × $40,000 Revenue (actual price) Cost of good sold $30 × 200; 540; 300; 100; 400; 1,000 Gross margin Customer-level operating costs: Order taking $28 × 4; 12; 6; 4; 16; 20 Product handling $1 × 200; 540; 300; 100; 400; 1,000 Delivery $1 × 80; 120; 72; 28; 304; 100 Expedited delivery $300 × 0; 4; 0; 0; 1; 3 Sales commissions $20 × 4; 12; 6; 4; 16; 20) Total customer-level operating costs Customer-level operating income

IHP

PRU

$8,000

$21,600 $12,000

Pmart

$4,000 $16,000

$40,000

1,080

2,000

8,000

20,520

12,000

4,000

16,000

38,000

6,000 2,000

16,200 4,320

9,000 3,000

3,000 1,000

12,000 4,000

30,000 8,000

112

336

168

112

448

560

200

540

300

100

400

1,000

120

304

100

1,200

300

900

80 320 320 1,772 $ 680 $ 2,228

400 2,960 $ 5,040

80 472 $1,528

240 120 2,436 660 $ 1,884 $ 2,340

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Customer level operating income based on actual order costs: Customer Revenue at list price $40 × 200; 540; 300; 100; 400; 1,000 Price discounts PRU: 5% × $21,600; Pmart: 5% × $40,000 Revenue (actual price) Cost of good sold $30 × 200; 540; 300; 100; 400; 1,000 Gross margin Customer-level operating costs: Order taking $12 × 4; $28 × 12; $12 × 6; $12 × 4; $12 × 16; $12 × 20 Product handling $1 × 200; 540; 300; 100; 400; 1,000 Delivery $1 × 80; 120; 72; 28; 304; 100 Expedited delivery $300 × 0; 4; 0; 0; 1; 3 Sales commissions $20 × 4; 12; 6; 4; 16; 20 Total customer-level operating costs Customer-level operating income

IHP

PRU

Pmart

$8,000

$21,600 $12,000

$4,000 $16,000

$40,000

0 8,000

1,080 20,520

0 12,000

0 4,000

0 16,000

2,000 38,000

6,000 2,000

16,200 4,320

9,000 3,000

3,000 1,000

12,000 4,000

30,000 8,000

336

192

240

200

540

300

100

400

1,000

120

304

100

1,200

300

900

80 408 $1,592

240 2,436 $ 1,884

120 564 $ 2,436

80 320 256 1,516 $ 744 $ 2,484

400 2,640 $ 5,360

Comparing the answers in requirements 1 and 2, it appears that operating income is higher than expected, so the management of Pilt Corporation would be very pleased with the performance of the salespeople for reducing order costs. Except for PRU, all of the customers are more profitable than originally reported.

Chapter 17: Revenue and Customer Profitability Analysis

3. Customer-level operating Customer Revenue at list price $40 × 200; 540; 300; 100; 400; 1,000 Price discounts PRU: 5% × $21,600; Pmart: 5% × $40,000 Revenue (actual price) Cost of good sold $30 × 200; 540; 300; 100; 400; 1,000 Gross margin Customer-level operating costs: Order taking $28 × 2; 12; 2; 2; 4; 10 Product handling $1 × 200; 540; 300; 100; 400; 1,000 Delivery $1 × 80; 120; 72; 28; 304; 100 Expedited delivery $300 × 0; 4; 0; 0; 1; 3 Sales commissions $20 × 2; 12; 2; 2; 4; 10 Total customer-level operating costs Customer-level operating income

IHP

PRU

Pmart

$8,000

$21,600

$12,000

$4,000

$16,000

$40,000

0 8,000

1,080 20,520

0 12,000

0 4,000

0 16,000

2,000 38,000

6,000 2,000

16,200 4,320

9,000 3,000

3,000 1,000

12,000 4,000

30,000 8,000

336

112

280

200

540

300

100

400

1,000

120

304

100

1,200

300

900

40 376 $1,624

240 2,436 $ 1,884

40 468 $ 2,532

40 224 $ 776

80 1,196 $ 2,804

200 2,480 $ 5,520

4. The behaviour of the salespeople is costing Pilt Corporation $640 in profit (the difference between the incomes in requirements 2 and 3). Although management thinks the salespeople are saving money based on the budgeted order costs, in reality they are costing the firm money by increasing the costs of orders ($936 in requirement 2 versus $896 in requirement 3) and at the same time increasing their sales commissions ($1,240 in requirement 2 versus $640 in requirement 3). This is not ethical. Pilt Corporation needs to change the structure of the sales commission, possibly linking commissions to the overall units sold rather than to number of orders. They could also base commissions on total revenue, which will discourage salespeople from offering discounts unless they are needed to close the sale. A negative consequence of greater reluctance to offer discounts is that salespeople will not seek larger orders but instead focus on smaller orders that do not require discounts to be offered. This behaviour will, in turn, increase order-taking costs.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

17-32 (30 min.) Cost allocation to divisions. 1. Segment margin Allocated headquarter costs ($5,100,000 ÷ 3) Operating income

Bread $6,400,000

Cake $1,300,000

Doughnuts $6,150,000

Total $13,850,000

1,700,000 $4,700,000

1,700,000 $ (400,000)

1,700,000 $4,450,000

5,100,000 $ 8,750,000

Bread $6,400,000

Cake $1,300,000

Doughnuts $6,150,000

Total $13,850,000

950,000

237,500

712,500

1,900,000

754,600

162,400

483,000

1,400,000

600,000

240,000

360,000

1,200,000

200,000

600,000

2,504,600 $3,895,400

839,900 $ 460,100

1,755,500 $4,394,500

5,100,000 $ 8,750,000

2. Segment margin Allocated headquarter costs, Human resources1 (50%; 12.5%; 37.5% × $1,900,000) Accounting department2 (53.9%; 11.6%; 34.5% × $1,400,000) Rent and depreciation3 (50%; 20%; 30% × $1,200,000) 1  Other   $600, 000  3  Total Operating income

1Total number of employees= 400+100+ 300=800;

HR costs allocation %age: 400 ÷ 800 = 50%; 100 ÷ 800 = 12.5%; 300 ÷ 800 = 37.5% 2Total revenues=$20,900,000 + $4,500,000 + $13,400,000 = $38,800,000;

Accounting costs allocation %age: $20,900,000 ÷ $38,800,000 = 53.9%; $4,500,000 ÷ $38,800,000 = 11.6%; $13,400,000 ÷ $38,800,000 = 34.5% 3 Total square feet of space = 10,000 + 4,000 + 6,000 = 20,000 Rent and depreciation costs allocation %age: 10,000 ÷ 20,000 = 50%; 4,000 ÷ 20,000 = 20%; 6,000 ÷ 20,000 = 30% A cause-and-effect relationship may exist between Human Resources costs and the number of employees at each division. Rent and depreciation costs may be related to square feet, except that very expensive machines may require little square footage, which is inconsistent with this choice of allocation base. The Accounting Department costs are probably related to the revenues earned by each division—higher revenues mean more transactions and more accounting. Other overhead costs are allocated arbitrarily.

Chapter 17: Revenue and Customer Profitability Analysis

3. The manager who suggested the new allocation bases probably works in the Cake Division. Under the old scheme, the Cake Division shows an operating loss after allocating headquarter costs because it is smaller, yet was charged an equal amount (a third) of headquarter costs. The new allocation scheme shows an operating profit in the Cake Division, even after allocating headquarter costs. The ABC method is a better way to allocate headquarter costs because it uses cost allocation bases that, by and large, represent cause-and-effect relationships between various categories of headquarter costs and the demands that different divisions place on these costs.

17-33 (40 min.)

Allocation of corporate costs to divisions.

1. The purposes for allocating central corporate costs to each division include the following (students may pick and discuss any two): a. To provide information for economic decisions. Allocations can signal to division managers that decisions to expand (contract) activities will likely require increases (decreases) in corporate costs that should be considered in the initial decision about expansion (contraction). When top management is allocating resources to divisions, analysis of relative division profitability should consider differential use of corporate services by divisions. Some allocation schemes can encourage the use of central services that would otherwise be underutilized. A common rationale related to this purpose is to remind profit center managers that central corporate costs exist and that division earnings must be adequate to cover some share of those costs. b. Motivation. Allocations create incentives for division managers to control costs; for example, by reducing the number of employees at a division, a manager will save direct labour costs as well as central personnel and payroll costs allocated on the basis of number of employees. Allocation also creates incentives for division managers to monitor the effectiveness and efficiency with which central corporate costs are spent. c. Income measurement for external parties. Sweet and Salty may include allocations of central corporate costs in its external line-of-business reporting in order to communicate the full costs of a line-of-business.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Revenues Percentage of revenues $870,000; $975,000; $654,000; $501,000  $3,000,000

Candy $870,000

Nuts $975,000

Crackers $654,000

Cookies $501,000

Total $3,000,000

29.0%

32.5%

21.8%

16.7%

100%

Candy $870,000 330,800 539,200

Nuts $975,000 378,000 597,000

Crackers $654,000 658,000 (4,000)

Cookies $501,000 314,000 187,000

Total $3,000,000 1,680,800 1,319,200

390,000 $207,000

261,600 $(265,600)

200,400 $ (13,400)

1,200,000 $ 119,200

Revenues Operating costs Operating income Corp. costs allocated on revenues (% of revs  $1,200,000) 348,000 Division operating income $191,200

3. First, calculate the share of each allocation base for each of the four corporate cost pools: Candy $1,800,00 0

Identifiable assets (1) Percentage of total identifiable assets $1.8M; $2.88M; $1.44M; $1.08M  $7.2M

25%

Nuts

Crackers

Total

$2,880,000

$1,440,000

$1,080,000

$7,200,000

40%

20%

15%

100%

Division revenues (2) Percentage of total division revenues $870,000; $975,000; $654,000; $501,000  $3,000,000

$870,000

$975,000

$654,000

$501,000

$3,000,000

29.0%

32.5%

21.8%

16.7%

100%

Positive operating income (3) Percentage of total positive operating income $539,200; $597,000; 0; $187,000  1,323,200

$539,200

$597,000

NONE

$187,000

$1,323,200

40.75%

45.12%

14.13%

100%

Number of employees (4) Percentage of total employees 3,600; 6,600; 2,700; 2,100  15,000

3,600

2,100

15,000

14%

100%

24%

6,600

2,700

44%

18%

Using these allocation percentages and the allocation bases suggested by Carpenter, we can allocate the $1,200,000 of corporate costs as shown below. Note that the costs in Cost Pool 2 total $530,000 ($200,000 + $160,000 + $170,000).

Revenues Operating Costs Operating Income Cost Pool 1 Allocation (1)  Cost Pool 2 Allocation (2)  Cost Pool 3 Allocation (3)  Cost Pool 4 Allocation (4) 

$380,000 $530,000 $150,000 $140,000

Candy $870,000 330,800 539,200 95,000 153,700 61,125 33,600

Nuts $975,000 378,000 597,000 152,000 172,250 67,680 61,600

Crackers $ 654,000 658,000 (4,000) 76,000 115,540 0 25,200

Cookies $501,000 314,000 187,000 57,000 88,510 21,195 19,600

Total $3,000,000 1,680,800 1,319,200 380,000 530,000 150,000 140,000

Chapter 17: Revenue and Customer Profitability Analysis

Division Income

$195,775

$143,470

$(220,740)

695

$ 119,200

4. The table below compares the reported income of each division under the original revenuebased allocation scheme and the new four-pool-based allocation scheme. The Nuts division seems 30.7% less profitable than before ($143,470  $207,000 = 69.3%) and will likely resist the new allocation, but each of the other divisions seem more profitable (or less loss-making) than before, and they will probably welcome it. In this setting, corporate costs are large [about 41.5% ($1,200,000 ÷ ($1,200,000 + $1,680,800) of total operating costs], and division incomes are sensitive to the corporate cost allocation method. Operating Income (before corp. cost allocation) Division income under revenue-based allocation of corporate costs Division income under four-cost-pool allocation of corporate costs

Candy

Nuts

Crackers

Total

$539,200

$597,000

(4,000)

$187,000

$1,319,200

$191,200

$207,000

$(265,600)

$ (13,400)

$ 119,200

$195,775

$143,470

$(220,740)

$ 119,200

695

Strengths of Carpenter’s proposal relative to existing single-cost pool method: a. Better able to capture cause-and-effect relationships. Interest on debt is more likely caused by the financing of assets than by revenues. Personnel and payroll costs are more likely caused by the number of employees than by revenues. b. Relatively simple. No extra information need be collected beyond what is already available. (Some students will list the extra costs of Carpenter’s proposal as a weakness.) Weaknesses of Carpenter’s proposal relative to existing single-cost pool method: a. May promote dysfunctional decision making. May encourage division managers to lease or rent assets rather than to purchase assets, even where it is economical for Sweet and Salty Snack Company to purchase them. This off-balance sheet financing will reduce the “identifiable assets” of the division and thus will reduce the interest on debt costs allocated to the division. (Sweet and Salty could counteract this problem by incorporating leased and rented assets in the “identifiable assets” base.) Note: Some students criticized Carpenter’s proposal despite agreeing that it is preferable to the existing single-cost-pool method. These criticisms include: a, The proposal may give rise to disputes over the definition and valuation of “identifiable assets.” b. The use of actual rather than budgeted amounts in the allocation bases creates interdependencies between divisions. Moreover, use of actual amounts means that division managers do not know cost allocation consequences of their decisions until the end of each reporting period. c. A separate allocation of fixed and variable costs would result in more refined cost allocations.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

d. It is questionable that 100% of central corporate costs should be allocated. Many students argue that public affairs should not be allocated to any division, based on the notion that division managers may not control many of the individual expenditures in this cost pool.

Chapter 17: Revenue and Customer Profitability Analysis

17-34 (50–60 min.)

Revenue allocation for bundled products.

1. a) Stand-alone revenue: Fraîche ($110  20,000) Désarmer ($88  37,500) Innocence ($275  20,000)

$2,200,000 3,300,000 5,500,000

The weights for Fraîche + Désarmer suite: Fraîche:

$2,200,000  $165  $66 $2,200,000 + $3,300,000

Désarmer:

$3,300,000  $165  $99 $2,200,000 + $3,300,000

The weights for Fraîche + Innocence suite: Fraîche:

$2,200,000  $308  $88 $2,200,000 + $5,500,000

Innocence:

$5,500,000  $308  $220 $2,200,000 + $5,500,000

b) Fraîche + Désarmer suite:

Product Désarmer Fraîche Total revenue allocated

Revenue Allocated $ 88 77 $165

Revenue Remaining to be Allocated $77 ($165 – $88) 0

Revenue Allocated $275 33 $308

Revenue Remaining to be Allocated $33 ($308 – $275) 0

Fraîche + Innocence suite:

Product Innocence Fraîche Total revenue allocated

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Each product will be considered as a primary product and first incremental product. An average revenue is the final revenue allocation to the product. This approach is illustrated below. Fraîche + Désarmer suite: Fraîche Allocation as the primary product Allocation as the incremental product ($165 – $88) Total Allocation ($187 ÷ 2) Désarmer Allocation as the primary product Allocation as the incremental product ($165 – $110) Total Allocation ($143 + 2)

10 77 $ 187 $93.50 $

88 55 $ 143 $71.50

According to this approach, Fraîche’s revenue allocation is $93.50 and Désarmer’s revenue allocation is $71.50 out of the total suite revenue of $165. Fraîche + Innocence suite: Fraîche Allocation as the primary product Allocation as the incremental product ($308 – $275) Total Allocation ($143 ÷ 2)

110 33 $ 143 $ 71.50

Allocation as the primary product Allocation as the incremental product ($308 – $110) Total Allocation ($473 ÷ 2)

Innocence 275 198 $ 473 $236.50

Fraîche is allocated $71.50 revenue and Innocence is allocated $236.50 revenue out of the total suite revenue of $308. An alternative approach is to take into account both the price and the units sold, that is, total revenue from each product when calculating the weights. On a stand-alone basis, the price of Fraîche plus Désarmer is $110 + $88 = $198. On a stand-alone basis, the revenue is Fraîche Désarmer Total

$2,200,000 3,300,000 $5,500,000

Chapter 17: Revenue and Customer Profitability Analysis

So Fraîche accounts for 40% (= $2,200,000 ÷ $5,500,000) and Désarmer 60% (= $3,300,000 ÷ 5,500,000) of total revenue from Fraîche and Désarmer. Applying these percentages to the total stand-alone price of $198, we get revenueweighted prices of $198  40% = $79.20 for Fraîche and $198  60% = $118.80 for Désarmer. Using these revenue-weighted prices and considering each product as the primary product and then the incremental product: Fraîche and Désarmer suite: Fraîche Allocation as the primary product Allocation as the incremental product ($165 – $118.80) Total Allocation ($125.40 ÷ 2) Désarmer Allocation as the primary product Allocation as the incremental product ($165 – $79.20) Total Allocation ($204.60 ÷ 2)

$ 79.20 46.20 $125.40 $ 62.70 $118.80 85.80 $204.60 $102.30

On a stand-alone basis, the price of Fraîche + Innocence is $110 + $275 = $385. On a stand-alone basis, the revenue is Fraîche $2,200,000 Innocence 5,500,000 Total $7,700,000 So Fraîche accounts for 2/7 (= $2,200,000 ÷ $7,700,000) and Innocence 5/7 (= $5,500,000 ÷ $7,700,000) of total revenue from Fraîche and Innocence. Applying these percentages to the total stand-alone price of $385, we get revenueweighted prices of $385  28.6% = $110 for Fraîche and $385  71.4% = $275 for Innocence. Using these revenue-weighted prices and considering each product as the primary product and then the incremental product: Fraîche and Innocence suite: Fraîche Allocation as the primary product Allocation as the incremental product ($308 – $275) Total Allocation ($143 ÷ 2) Innocence Allocation as the primary product Allocation as the incremental product ($308 – $110) Total Allocation ($473 ÷ 2)

110 33 $ 143 $ 71.50 $ 275 $ 198 $ 473 $236.50

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

A summary of the price allocations for the bundled products under different methods follows.

Fraîche Désarmer Total Fraîche Innocence Total

Stand-alone Revenue Allocation (1) $ 66 99 $165 $ 88 220 $308

Incremental With Fraîche Primary (2) $110 55 $165 $110 198 $308

Incremental With Désarmer/ Innocence Primary (3) $ 77 88 $165 $ 33 275 $308

Shapley Value Based on Price (4) $ 93.50 71.50 $ 165.00 $ 71.50 236.50 $ 308.00

Shapley Value Based on RevenueWeighted Price (5) $ 62.70 102.30 $ 165.00 $ 71.50 236.50 $ 308.00

Note that the Shapley value calculations based on price and revenue-weighted prices are the same for Fraîche and Innocence because the same number of units of each of these products is sold (20,000 units). In general, the Shapley value calculations based on revenue-weighted prices gives the fairest allocation of prices to each product in the bundle because it considers not only the prices of each product sold but also the units. Thus, if one of the products in the bundle sells very few units, it gets very little revenue allocated to it even if it sells for a high price. The table above also indicates that the stand-alone revenue allocation method closely approximates the Shapley value calculations based on revenue-weighted prices. Note that columns 2 and 4 in the above table allocate more revenue with Fraîche-Désarmer bundle to Fraîche because Fraîche sells for a higher price ($110 versus $88). But the allocations in these columns ignore the important fact that Fraîche sells far fewer units than Désarmer (20,000 versus 37,500).

Chapter 17: Revenue and Customer Profitability Analysis

17-35

(25–30 min.) Closing and opening stores.

1. Solution Exhibit 17-, Column 1, presents the relevant loss in revenue and the relevant savings in costs from closing the Surrey store. Lopez is correct that Your Market’s operating income would increase by $7,000 if it closed down the Surrey store. Closing down the Surrey store results in a loss of revenue of $860,000 but cost savings of $867,000 (from cost of goods sold, rent, labour, utilities, and corporate costs). Note that by closing down the Surrey store, Your Market will save none of the equipment-related costs because this is a past cost. Also note that the relevant corporate overhead costs are the actual corporate overhead costs of $44,000 that YM expects to save by closing the Surrey store. The corporate overhead of $30,000 allocated to the Surrey store is irrelevant to the analysis. 2. Solution Exhibit 17-, Column 2, presents the relevant revenue and relevant costs of opening another store like the Surrey store. Lopez is correct that opening such a store would increase Your Market’s operating income by $11,000. Incremental revenue of $860,000 exceeds the incremental costs of $849,000 (from higher cost of goods sold, rent, labour, utilities, and some additional corporate costs). Note that the cost of equipment written off as depreciation is relevant because it is an expected future cost that YM will incur only if it opens the new store. Also note that the relevant corporate overhead costs are the $4,000 of actual corporate overhead costs that YM expects to incur as a result of opening the new store. YM may, in fact, allocate more than $4,000 of corporate overhead to the new store but this allocation is irrelevant to the analysis. The key reason that YM’s operating income increases either if it closes down the Surrey store or if it opens another store like it is the behaviour of corporate overhead costs. By closing down the Surrey store, YM can significantly reduce corporate overhead costs presumably by reducing the corporate staff that oversees the Surrey operation. On the other hand, adding another store like Surrey does not increase actual corporate costs by much, presumably because the existing corporate staff will be able to oversee the new store as well.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 17Relevant-Revenue and Relevant-Cost Analysis of Closing Surrey Store and Opening Another Store Like It.

Revenue Cost of goods sold Lease rent Labour costs Depreciation of equipment Utilities (electricity, heating) Corporate overhead costs Total costs Effect on operating income (loss)

Incremental Revenue and Savings in Costs from Closing Surrey Store (1) $(860,000) 660,000 75,000 42,000 0 46,000 44,000 867,000 $ 7,000

(Loss in Revenue) (Incremental Costs) of Opening New Store Like Surrey Store (2) $ 860,000 (660,000) (75,000) (42,000) (22,000) (46,000) (4,000) (849,000) $ 11,000

Chapter 17: Revenue and Customer Profitability Analysis

17-36 (30 min.) Customer profitability in a manufacturing firm. 1. Calculation of customer profitability by customer: Customer A

$604,800

$201,600

$134,400

$492,800

$907,200

60,480 544,320

20,160 181,440

0 134,400

49,280 443,520

45,360 861,840

513,000 31,320

171,000 10,440

114,000 20,400

418,000 25,520

769,500 92,340

2,880

5,760

18,000

7,200

6,480

8,100

2,700

1,800

6,600

12,150

1,120

3,920

560

4,480

Revenues at list price $112 × 5,400; 1,800; 1,200; 4,400; 8,100 Price discount 10% × $604,800; 10% × $201,600; 0; 10% × $492,800; 10% × (8,100 × 50%) × $112 Revenues (actual price) Cost of goods sold $95 × 5,400; 1,800; 1,200; 4,400; 8,100 Gross margin Customer-level costs: Order taking $360 × 8; 16; 50; 20; 18 Product handling $15 × 540; 180; 120; 440; 810 Rush order processing $560 × 2; 7; 1; 0; 8 Exchange and repair $50 × 18; 70; 13; 50; 200

900

3,500

650

2,500

10,000

Total customer-level costs

13,000

15,880

21,010

16,300

33,110

Customer-level operating income

$ 18,320

$ (5,440)

9,220

$ 59,230

(610) $

Customer ranking

Customer-Level Operating Customer Income Code (1)

Customer Revenue (2)

Customer-Level Operating Cumulative Income Customer-Level Divided by Revenue Operating Income (3) = (1) ÷ (2) (4)

Cumulative Customer-Level Operating Income as a % of Total Customer-Level Operating Income (5) = (4) ÷ $80,810

$59,230

$ 861,840

6.87%

$59,230

73.38%

18,320

544,320

3.37%

$77,550

96.07%

9,220

443,520

2.08%

$86,770

107.50%

(610)

134,400

−0.45%

$86,160

106.74%

−3.00%

$80,720

100.00%

(5,440)

181,440

Total

$80,720

$2,165,520

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Customer B and Customer C are Mississippi’s unprofitable customers. All other customers are profitable. If Customer B were not being given price discounts, B would be profitable. The salesperson is giving discounts on orders, even though the size of the order is small (the average order size is about 112 (1,800 ÷16) units). It is costing Mississippi money to process many small orders as opposed to a few large orders. To turn Customer B into a profitable customer, Mississippi needs to encourage Customer B to place fewer, larger orders and offer a price discount only if Customer B changes behaviour, rather than as a reward for repeat business. Customer B has many rush orders in proportion to total number of orders. Mississippi should work with Customer B to find a production schedule that would meet its needs without having to rush the order. Mississippi should also work with Customer B to reduce the number of units exchanged/repaired. Customer E also has many rush orders and large number of units exchanged/repaired that are costly to Mississippi. Mississippi should work with Customer E to align its production schedule to Customer E’s needs and reduce the number of units exchanged/repaired. Customer C has a slightly negative operating income (close to breakeven) and a small (negative) operating income as a percentage of revenues. Customer C places a large number of small orders (average order size is 24 (1,200 ÷ 50) units and gets no price discounts. Mississippi could work with Customer C to reduce the number of orders by encouraging Customer C to take price discounts on large orders. The exchange and repair rate for customers with rush orders is higher than for other customers. Mississippi should explore whether rushing an order reduces attention to quality. Either reducing the number of rush orders (which would also save Mississippi money) or working toward increasing the quality of rush orders would help to reduce these costs. The three most profitable customers (E, A, and D) generate 107% of the customer-level operating income. These customers are valued customers and should receive the highest level of customer service.

Chapter 17: Revenue and Customer Profitability Analysis

17-37 (30 min.)

Customer profitability, distribution.

1. a

Revenues at list prices b Discount Revenues (at actual prices) c Cost of goods sold Gross margin Customer-level operating costs d Order taking e Customer visits f Deliveries g Product handling h Expedited runs Total Customer-level operating income

1 $47,580 0 47,580 36,600 10,980

2 $176,280 5,424 170,856 135,600 35,256

900 225 504 2,196 0 3,825 $ 7,155

1,620 375 336 8,136 0 10,467 $ 24,789

Customer 3 4 $1,157,000 $811,200 75,650 6,240 1,081,350 804,960 890,000 624,000 191,350 180,960 3,150 900 1,560 53,400

1,440 300 450 37,440

0 59,010 $ 132,340

0 39,630 $141,330

5 $50,700 4,095 46,605 39,000 7,605 3,150 900 4,725 2,340 750 11,865 $ (4,260)

a$26  1,830; 6,780; 44,500; 31,200; 1,950 b($26 – $26)  1,830; ($26 – $25.20)  6,780; ($26 – $24.30)  44,500; ($26 – $25.80)  31,200; ($26 – $23.90)  1,950 c$20  1,830; 6,780; 44,500; 31,200; 1,950 d$90  10; 18; 35; 16; 35 e$75  3; 5; 12; 4; 12 f$3  (12  14); (28  4); (65  8); (25  6); (35  45) g$1.20  1,830; 6,780; 44,500; 31,200; 1,950 h$250  0; 0; 0; 0; 3 Customer 4 is the most profitable customer, despite having only 70% (31,200  44,500) of the unit volume of Customer 3. A major explanation is that Customer 3 receives a $1.70 discount per case, while Customer 4 receives only a $0.20 discount per case. Customer 5 is unprofitable, while the smaller Customer 1 is profitable. Customer 5 receives a $2.10 discount per case, makes more frequent orders, requires more customer visits, and requires more delivery miles and expedited deliveries than does Customer 1.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Separate reporting of both the list selling price and the actual selling price enables Green Paper Delivery to examine which customers receive different discounts and how salespeople may differ in the discounts they grant. The following table shows the discounts given after ranking customers on the basis of the total volume of products sold. Customer Number/Sales Volume 3 (44,500 cases) 4 (31,200 cases) 2 (6,780 cases) 5 (1,950 cases) 1 (1,830 cases)

Discount per case $1.70 $0.20 $0.80 $2.10 $0.00

The reasons for the $2.10 discount for Customer 5 with a sales volume of only 1,950 cases and the $0.80 discount for Customer 2 with only 6,780 cases should be explored. 3. Dropping customers should be the last resort taken by Green Paper Delivery. Factors to consider include the following: a. What is the expected future profitability of each customer? Are the currently unprofitable (5) or low-profit (1) customers likely to be highly profitable in the future? b. Are there externalities from having some customers, even if they are unprofitable in the short run? For example, some customers have a marquee-value that is “in effect” advertising that benefits the business. c. What costs are avoidable if one or more customers are dropped? d. Can the relationship with the “problem” customers be restructured so that there is a “winwin” situation? For example, could Customer 5 get by with fewer deliveries per month?

COLLABORATIVE LEARNING CASE 17-38

Relevance of variance analyses.

1. The yield trend analysis over eight years is an example of a linear regression (Chapter 10). If you input the data on weather (the predictor variable) and yield (the outcome variable) into Excel’s regression function you would be able to determine how much of the change in yield is explained by changes in the weather. A good r2 would probably be in excess of 50% and knowing this would help you decide if you would purchase at the spring price. If the regression result is above 50% then you know roughly how to model future yield under different assumptions about weather. You are, of course, most interested in what the yield is likely to be given what you expect the local weather conditions to be in the Okanagan Valley. You know the cost of unused capacity and this is your opportunity cost. If the strike price with the Okanagan producer is lower than the opportunity cost and the expected yield will fill your unused capacity, you would be willing to contract. If, however, your assumptions about the weather in the Okanagan lead to a yield that will not fill your unused capacity, you will be unlikely to contract at the specified strike price.

Chapter 17: Revenue and Customer Profitability Analysis

2. Knowing the probable yield this year from both your leased harvest and the purchased grapes will help you estimate your productive efficiency and effectiveness. Even the most efficient producer, however, must sell the output to generate a profit. If your estimate of normal (longterm demand) capacity is too high relative to your practical capacity, you will lose market share to your competitors, and to retain share you will need to make a decision about whether or not you can remain competitive without increasing your capacity. On the other hand, if your practical capacity is too high relative to normal capacity, you may not generate sufficient revenue in the short run to realize the longer term profit when this gap closes. Understanding the market size, expected rate of growth, and your market share is important and relevant to your long-term profitability. Understanding what causes unfavourable variances, especially in market share, will help you and your management team direct attention to discovering what causes the variance and changing activities to control the causes if possible.

CHAPTER 18 PROCESS COSTING MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

SHORT-ANSWER QUESTIONS 18-1 Industries using process costing in their manufacturing area include chemical processing, oil refining, pharmaceuticals, plastics, brick and tile manufacturing, semiconductor chips, beverages, and breakfast cereals.

18-2 Process costing systems separate costs into cost categories according to the timing of when costs are introduced into the process. Often, only two cost classifications—direct materials and conversion costs—are necessary. Direct materials are frequently added at one point in time, often the start or the end of the process, and all conversion costs are added at about the same time, but in a pattern different from direct materials costs.

18-3 Equivalent units is a derived amount of output units that takes the quantity of each input (factor of production) in units completed or in incomplete units in work in process, and converts the quantity of input into the amount of completed output units that could be made with that quantity of input. Each equivalent unit comprises the physical quantities of direct materials or conversion costs inputs necessary to produce output of one fully completed unit. Equivalent unit measures are necessary since all physical units are not completed to the same extent at the same time.

18-4 Two conditions under which computing equivalent units will make a material difference are when significant amounts of work in process exist, and when labour and conversion costs are input throughout the process.

18-5 The weighted-average process-costing method calculates the equivalent-unit cost of all the work done to date (regardless of the accounting period in which it was done), assigns this cost to equivalent units completed and transferred out of the process, and to equivalent units in ending work-in-process inventory.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

18-6 FIFO computations are distinctive because they assign the cost of the previous accounting period’s equivalent units in beginning work-in-process inventory to the first units completed and transferred out of the process, and they assign the cost of equivalent units worked on during the current period first to complete beginning inventory, next to start and complete new units, and finally to units in ending work-in-process inventory. In contrast, the weightedaverage method costs units completed and transferred out and in ending work in process at the same average cost.

18-7 The journal entries in process costing are basically similar to those made in job-costing systems. The main difference is that, in process costing, there is often more than one work-inprocess account––one for each process.

18-8 Standard-cost procedures are particularly appropriate to process-costing systems where there are various combinations of materials and operations used to make a wide variety of similar products, as in the textiles, paints, and ceramics industries. Standard-cost procedures also avoid the intricacies involved in detailed tracking with weighted-average or FIFO methods when there are frequent price variations over time.

18-9 There are two reasons why the accountant should distinguish between transferred-in costs and additional direct materials costs for a particular department: (a) All direct materials may not be added at the beginning of the department process. (b) The control methods and responsibilities may be different for transferred-in items and materials added in the department.

18-10 No. Transferred-in costs or previous department costs are costs incurred in a previous department that have been charged to a subsequent department. These costs may be costs incurred in that previous department during this accounting period or a preceding accounting period.

18-11 Materials are only one cost item. Other items (often included in a conversion costs pool) include labour, energy, and maintenance. If the costs of these items vary over time, this variability can cause a difference in cost of goods sold and inventory amounts when the weighted-average or FIFO methods are used. A second factor is the amount of inventory on hand at the beginning or end of an accounting period. The smaller the amount of production held in beginning or ending inventory relative to the total number of units transferred out, the smaller the effect on operating income, cost of goods sold, or inventory amounts from the use of weighted-average or FIFO methods.

Chapter 18: Process Costing

EXERCISES 18-12 (10 min.) Terminology. 1. In process costing, the cost object is the entire production process. The method is used for mass-produced items that are identical. That is why a weighted average can be used to calculate the ratio of work in process to finished goods. A common denominator must be found because a physical unit 100% converted has cost more to produce than one that is only 50% converted and remains in work-in-process inventory. The benefits of the conversion process are unequally shared between the items in each type of inventory. The average conversion rate is calculated using a denominator called an equivalent unit (EU). 2. Three methods assign conversion costs to finished goods and work in process. The choice of method should be made by the management team such that the method is economically plausible. The method reflects the facts of the economic outcome of the production process in a specified time period. The three methods are first-in, first-out (FIFO) method, the weighted-average process-costing method, and the standard costing method.

18-13 (25 min.) Equivalent units, zero beginning inventory. 1. Direct materials cost per unit ($900,000 ÷ 12,000) Conversion cost per unit ($957,600 ÷ 12,000) Assembly department cost per unit

$ 75.00 79.80 $154.80

2a. Solution Exhibit 18-13A calculates the equivalent units of direct materials and conversion costs in the assembly department of A&A Inc. in February. Solution Exhibit 18-13B computes equivalent unit costs. 2b. Direct materials cost per unit $ 75 Conversion cost per unit 91.20 Assembly department cost per unit $166.20 3. The difference in the assembly department cost per unit calculated in requirements 1 and 2 arises because the costs incurred in January and February are the same but fewer equivalent units of work are done in February relative to January. In January, all 12,000 units introduced are fully completed, resulting in 12,000 equivalent units of work done with respect to direct materials and conversion costs. In February, of the 12,000 units introduced, 12,000 equivalent units of work is done with respect to direct materials but only 10,500 equivalent units of work is done with respect to conversion costs. The assembly department cost per unit is, therefore, higher.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 18-13A Steps 1 and 2: Summarize Output in Physical Units and Compute Output in Equivalent Units; Assembly Department of A&A Inc. for February. (Step 1) Physical Units

Flow of Production Work in process, beginning (given) Started during current period (given) To account for Completed and transferred out during current period Work in process, ending* (given) 3,000  100%; 3,000  50% Accounted for Work done in current period

(Step 2) Equivalent Units Direct Conversion Materials Costs

0 12,000 12,000 9,000 3,000

9,000

3,000

1,500

12,000

10,500

12,000

*Degree of completion in this department: direct materials, 100%; conversion costs, 50%. SOLUTION EXHIBIT 18-13B Compute Cost per Equivalent Unit, Assembly Department of A&A Inc. for February.

(Step 3) Costs added during February Divide by equivalent units of work done in current period (Solution Exhibit 18-l3A) Cost per equivalent unit

Total Production Direct Costs Materials $1,857,600 $900,000

 12,000 $ 75

Conversion Costs $957,600  10,500 $ 91.20

Chapter 18: Process Costing

18-14 (20 min.) Journal entries. 1. Work in Process––Assembly Accounts Payable To record $900,000 of direct materials purchased and used in production during February

900,000

2. Work in Process––Assembly Various accounts To record $957,600 of conversion costs for February; examples include energy, manufacturing supplies, all manufacturing labour, and plant depreciation

957,600

3. Work in Process––Testing Work in Process––Assembly To record 9,000 units completed and transferred from assembly to testing during February at $166.2  9,000 units = $1,495,800

900,000

957,600

1,495,800 1,495,800

Postings to the Work in Process––Assembly account follow. Work in Process –– Assembly Department Beginning inventory, Feb. 1 03. Transferred out to 1. Direct materials 900,000 Work in Process––Testing 2. Conversion costs 957,600 Ending inventory, Feb. 28 361,800

1,495,800

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

18-15 (25 min.) Zero beginning inventory, materials introduced in middle of process. 1. Solution Exhibit 18-15A shows equivalent units of work done in the current period of Chemical P, 50,000; Chemical Q, 35,000; conversion costs, 45,000. 2. Solution Exhibit 18-15B summarizes the total mixing department costs for July, calculates cost per equivalent unit of work done in the current period for Chemical P, Chemical Q, and conversion costs, and assigns these costs to units completed (and transferred out) and to units in ending work in process. 3. Since there is no BI WIP, there is no difference in the EU calculations between the weightedaverage method and the FIFO method. SOLUTION EXHIBIT 18-15A Steps 1 and 2: Summarize Output in Physical Units and Compute Output in Equivalent Units; Mixing Department of Roary Chemicals for July. (Step 1) Flow of Production Work in process, beginning (given) Started during current period (given) To account for Completed and transferred out during current period Work in process, ending* (given) 15,000  100%; 15,000  0%; 15,000  66 2/3% Accounted for Work done in current period only

Physical Units 0 50,000 50,000 35,000 15,000

(Step 2) Equivalent Units Chemical P

Chemical Q

Conversion Costs

35,000

15,000

10,000

50,000

35,000

45,000

50,000

*Degree of completion in this department: Chemical P, 100%; Chemical Q, 0%; conversion costs, 66 2/3%.

Chapter 18: Process Costing

SOLUTION EXHIBIT 18-15B Steps 3, 4, and 5: Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed and to Units in Ending Work in Process; Mixing Department of Roary Chemicals for July.

(Step 3) Costs added during July Total costs to account for

Total Production Costs Chemical P Chemical Q $455,000 $250,000 $70,000 $455,000 $250,000 $70,000

(Step 4) Costs added in current period Divide by equivalent units of work done in current period (Solution Exhibit 18-l5A) Cost per equivalent unit (Step 5) Assignment of costs: Completed and transferred out (35,000 units) Work in process, ending (15,000 units) Total costs accounted for

Conversion Costs $135,000 $135,000

$250,000

$70,000

$135,000

 50,000 $ 5

35,000 $ 2

 45,000 $ 3

$350,000

(35,000*  $5) + (35,000*  $2) + (35,000*  $3)

105,000 $455,000

(15,000†  $5) + (0†  $2) + (10,000†  $3) $250,000 + $70,000 + $135,000

*Equivalent units completed and transferred out from Solution Exhibit 18-15A, Step 2. †Equivalent units in ending work in process from Solution Exhibit 18-15A, Step 2.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

18-16 (25 min.) Weighted-average method, assigning costs. 1. & 2. Solution Exhibit 18-16A shows equivalent units of work done to date for Bio Doc Corporation for direct materials and conversion costs. Solution Exhibit 18-16B summarizes total costs to account for, calculates the cost per equivalent unit of work done to date for direct materials and conversion costs, and assigns these costs to units completed and transferred out and to units in ending work-in-process inventory. SOLUTION EXHIBIT 18-16A Steps 1 and 2: Summarize Output in Physical Units and Compute Output in Equivalent Units; Weighted-Average Method of Process Costing, Bio Doc Corporation for July.

Flow of Production Work in process, beginning (given) Started during current period (given) To account for Completed and transferred out during current period Work in process, ending* (given) 20,000  100%; 20,000  50% Accounted for Work done to date

(Step 1) Physical Units 12,500 50,000 62,500 42,500 20,000

(Step 2) Equivalent Units Direct Conversion Materials Costs

42,500

20,000

10,000

62,500

52,500

62,500

*Degree of completion: direct materials, 100%; conversion costs, 50%.

Chapter 18: Process Costing

SOLUTION EXHIBIT 18-16B Steps 3, 4, and 5: Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed and to Units in Ending Work in Process; Weighted-Average Method of Process Costing, Bio Doc Corporation for July.

(Step 3) Work in process, beginning (given) Costs added in current period (given) Total costs to account for

Total Production Costs $162,500 788,750 $951,250

(Step 4) Costs incurred to date Divide by equivalent units of work done to date (Solution Exhibit 18-16A) Cost per equivalent unit of work done to date (Step 5) Assignment of costs: Completed and transferred out (42,500 units) Work in process, ending (20,000 units) Total costs accounted for

$718,250 233,000 $951,250

*Equivalent units completed and transferred out (given). †Equivalent units in ending work in process (given).

Direct Materials $ 75,000 325,000 $400,000

Conversion Costs $ 87,500 463,750 $551,250

$400,000

$551,250

 62,500 $ 6.40

 52,500 $ 10.50

(42,500*  $6.40) + (42,500*  $10.50) (20,000†  $6.40) + (10,000†  $10.50) $400,000 + $551,250

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

18-17 (30 min.) FIFO method, assigning costs. Refer to the information in Exercise 18-16. 1. & 2. Solution Exhibit 18-17A calculates the equivalent units of work done in the current period. Solution Exhibit 18-17B summarizes total costs to account for, calculates the cost per equivalent unit of work done in the current period for direct materials and conversion costs, and assigns these costs to units completed and transferred out and to units in ending work-in-process inventory. SOLUTION EXHIBIT 18-17A Steps 1 and 2: Summarize Output in Physical Units and Compute Output in Equivalent Units; FIFO Method of Process Costing, Bio Doc Corporation for July.

Flow of Production Work in process, beginning (given) Started during current period (given) To account for Completed and transferred out during current period: From beginning work in process§ 12,500  (100%  100%); 12,500  (100% – 70%) Started and completed 30,000 × 100%, 30,000 × 100% Work in process, ending* (given) 20,000 × 100%; 20,000 × 50% Accounted for Work done in current period only

(Step 1) Physical Units 12,500 50,000 62,500

(Step 2) Equivalent Units Direct Conversion Materials Costs (work done before current period)

12,500 0

3,750

30,000

20,000

10,000

50,000

43,750

30,000† 20,000 62,500

§Degree of completion in this department: direct materials, 100%; conversion costs, 70%. †42,500 physical units completed and transferred out minus 12,500 physical units completed and

transferred out from beginning work-in-process inventory. *Degree of completion in this department: direct materials, 100%; conversion costs, 50%.

Chapter 18: Process Costing

SOLUTION EXHIBIT 18-17B Steps 3, 4, and 5: Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed and to Units in Ending Work in Process; FIFO Method of Process Costing, Bio Doc Corporation for July.

(Step 3) Work in process, beginning (given) Costs added in current period (given)

Total Production Costs $162,500 788,750

Direct Materials $ 75,000 325,000

Conversion Costs $ 87,500 463,750

Total costs to account for

$951,250

$400,000

$551,250

$325,000

$463,750

Divide by equivalent units of work done in current period (Solution Exhibit 18-17A)

 50,000

 43,750

Cost per equivalent unit of work done in current period

(Step 4) Costs added in current period

(Step 5) Assignment of costs: Completed and transferred out (42,500 units): Work in process, beginning (12,500 units) Cost added to beginning work in process in current period Total from beginning inventory Started and completed (30,000 units) Total costs of units completed and transferred out Work in process, ending (20,000 units) Total costs accounted for

$162,500 39,750 202,250 513,000 715,250 236,000 $951,250

6.50

$75,000 + $87,500 * (0  $6.50) + (3,750*  $10.60) (30,000†  $6.50) + (30,000†  $10.60) (20,000#  $6.50) + (10,000#  $10.60) $400,000 + $551,250

*Equivalent units used to complete beginning work in process from Solution Exhibit 18-17A, Step 2. †Equivalent units started and completed from Solution Exhibit 18-17A, Step 2. #Equivalent units in ending work in process from Solution Exhibit 18-17A, Step 2.

10.60

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

18-18 (30 min.) Standard-costing method, assigning costs. Refer to the information in Exercise 18-16. 1. The calculations of equivalent units for direct materials and conversion costs are identical to the calculations of equivalent units under the FIFO method. Solution Exhibit 18-17A shows the equivalent unit calculations for standard costing and computes the equivalent units of work done in July. Solution Exhibit 18-18 uses the standard costs (direct materials, $6.60; conversion costs, $10.40) to summarize total costs to account for, and to assign these costs to units completed and transferred out and to units in ending work-in-process inventory. 2. Solution Exhibit 18-18 shows the direct materials and conversion costs variances for Direct materials $5,000 F Conversion costs $8,750 U SOLUTION EXHIBIT 18-18 Steps 3, 4, and 5: Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed and to Units in Ending Work in Process; Standard Costing Method of Process Costing, Bio Doc Corporation for July.

(Step 3) Work in process, beginning (given) Costs added in current period at standard costs Total costs to account for

Total Production Direct Conversion Costs Materials Costs $ 173,500 (12,500  $6.60) + (8,750  $10.40) 785,000 (50,000  $6.60) + (43,750  $10.40) $958,500 $412,500 + $546,000

(Step 4) Standard cost per equivalent unit (given) (Step 5) Assignment of costs at standard costs: Completed and transferred out (42,500 units): Work in process, beginning (12,500 units) $173,500 Costs added to beg. work in process in current period 39,000 Total from beginning inventory 212,500 Started and completed (30,000 units) 510,000 Total costs of units transferred out 722,500 Work in process, ending (20,000 units) 236,000 Total costs accounted for $958,500 Summary of variances for current performance: Costs added in current period at standard costs (see Step 3 above) Actual costs incurred (given) Variance

$ 6.60

(12,500  $6.60) + (8,750  $10.40) (0*  $6.60) + (3,750*  $10.40) (30,000†  $6.60) + (30,000†  $10.40) (20,000#  $6.60) + (10,000#  $10.40) $412,500 + $546,000 $330,000 325,000 $ 5,000 F

*Equivalent units to complete beginning work in process from Solution Exhibit 18-17A, Step 2. †Equivalent units started and completed from Solution Exhibit 18-17A, Step 2. #Equivalent units in ending work in process from Solution Exhibit 18-17A, Step 2.

$ 10.40

$455,000 463,750 $ 8,750 U

Chapter 18: Process Costing

18-19 (15 min.) Weighted-average method, equivalent units and unit costs. Under the weighted-average method, equivalent units are calculated as the equivalent units of work done to date. Solution Exhibit 18-19 shows equivalent units of work done to date for the satellite assembly division for direct materials and conversion costs. SOLUTION EXHIBIT 18-19 Steps 1 and 2: Summarize Output in Physical Units and Compute Equivalent Units Weighted-Average Method of Process Costing, Satellite Assembly Division for May. (Step 1) (Step 2) Physical Equivalent Units Units Direct Conversion Flow of Production (given) Materials Costs Work in process beginning 8 Started during current period 55 To account for 63 Completed and transferred out during current period 51 51.0 51.0 Work in process, ending* (12  60%; 12  30%) 12 7.2 3.6 Accounted for 63 ____ Work done to date 58.2 54.6 *Degree of completion in this department: direct materials, 60%; conversion costs, 30%. Costs per equivalent unit: $5, 426,960  $35, 420, 000 $40,846,960 DM   58.2 58.2

 $701,837.80 / equivalent unit

CV 

$1, 001, 440  $15,312, 000 $16,313, 440  54.6 54.6  $298, 780.95 / equivalent unit

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

18-20 (20 min.) Weighted-average method, assigning costs. (continuation of Exercise 18-19). Solution Exhibit 18-20 calculates cost per equivalent unit of work done to date in the assembly division, summarizes total costs to account for, and assigns costs to units completed and to units in ending work-in-process inventory. SOLUTION EXHIBIT 18-20 Steps 3, 4, and 5: Compute Equivalent Unit Costs, Summarize Total Costs to Account for, and Assign Costs to Units Completed and to Units in Ending Work in Process Weighted-Average Method of Process Costing, Satellite Assembly Division for May.

(Step 3) Work in process, beginning (given) Costs added in current period (given) Costs incurred to date Divide by equivalent units of work done to date (Solution Exhibit 18-19) Cost per equivalent unit of work done to date (Step 4) Total costs to account for (Step 5) Assignment of costs: Completed and transferred out (51 units) Work in process, ending (12 units) Direct materials Conversion costs Total work in process Total costs accounted for

Total Production Costs $ 6,428,400 50,732,000

Direct Materials $ 5,426,960 35,420,000 $40,846,960 ÷

58.20

$701,837.80

Conversion Costs $ 1,001,440 15,312,000 $16,313,440 ÷

54.60

$298,780.95

$57,160,400 $51,031,556 5,053,232 1,075,612 6,128,844 $57,160,400

(51* $701,837.80) + (51* $298,780.95) 7.2†  $701,837.80 3.6†  $298,780.95

*Equivalent units completed and transferred out from Solution Exhibit 18-19, Step 2. †Equivalent units in work in process, ending from Solution Exhibit 18-19 Step 2.

Chapter 18: Process Costing

18-21 (15 min.) FIFO method, equivalent units and unit costs. Refer to the information in Exercise 18-19. 1. Under the FIFO method, equivalent units are calculated as the equivalent units of work done in the current period only. Solution Exhibit 18-21 shows equivalent units of work done in May in the assembly division for direct materials and conversion costs. SOLUTION EXHIBIT 18-21 Steps 1 and 2: Summarize Output in Physical Units and Compute Equivalent Units FIFO Method of Process Costing, Satellite Assembly Division of for May.

Flow of Production Work in process, beginning (given) Started during current period (given) To account for (work done before current period) Completed and transferred out during current period: From beginning work in process§ 8  (100% – 90%); 8  (100% – 40%) Started and completed 43  100%, 43  100% Work in process, ending* (given) 12  60%; 12  30% Accounted for Work done in current period only

(Step 2) (Step 1) Equivalent Units Physical Direct Conversion Units Materials Costs 8 (work done before current period) 55 63

8 0.8

4.8

43.0

7.2

3.6

51.0

51.4

43† 12 63

§Degree of completion in this department: direct materials, 90%; conversion costs, 40%. †51 physical units completed and transferred out minus 8 physical units completed and transferred

out from beginning work-in-process inventory. *Degree of completion in this department: direct materials, 60%; conversion costs, 30%. 2.

Direct material costs, added May Equivalent units Cost per equivalent unit Conversion costs, May Equivalent units Cost per equivalent units

$35,420,000 51 $694,510 $15,312,000 51.4 $297,899

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

18-22 (20 min.) FIFO method, assigning costs (continuation of Exercise 18-21). Solution Exhibit 18-22 calculates cost per equivalent unit of work done in May in the assembly division, summarizes total costs to account for, and assigns costs to units completed, and to units in ending work-in-process inventory. SOLUTION EXHIBIT 18-22 Steps 3, 4, and 5: Compute Equivalent Unit Costs, Summarize Total Costs to Account For, and Assign Costs to Units Completed and to Units in Ending Work in Process FIFO Method of Process Costing, Satellite Assembly Division for May. Total Production Costs

Direct Materials

Conversion Costs

Work in process, beginning ($5,426,960 + $1,001,440) $ 6,428,400 (costs of work done before current period) (Step 3) Costs added in current period (given) 50,732,000 $35,420,000 $15,312,000 Divide by equivalent units of work done in current period (Solution Exhibit 18-21) ÷ 51 ÷ 51.4 Cost per equivalent unit of work done in current period __________ $ 694,510 $ 297,899 (Step 4) Total costs to account for $57,160,400 (Step 5) Assignment of costs: Completed and transferred out (51 units): Work in process, beginning (8 units) $ 6,428,400 Direct materials added in current period 555,608 0.8*  $694,510 Conversion costs added in current period 1,429,915 4.8  $297,899 Total from beginning inventory 8,413,923 Started and completed (43 units) 42,673,587 (43†$694,510) + 43†$297,899) Total costs of units completed & transf. out 51,087,510 Work in process, ending (12 units) Direct materials 5,000,472 7.2#  $694,510 Conversion costs 1,072,436 3.6#  $297,899 Total work in process, ending 6,072,908 Total costs accounted for $57,160,400 [rounded down] *Equivalent units used to complete beginning work in process from Solution Exhibit 18-21, Step 2. †Equivalent units started and completed from Solution Exhibit 18-21, Step 2. #Equivalent units in work in process, ending from Solution Exhibit 18-21, Step 2.

Chapter 18: Process Costing

18-23 (30–35 min.) Standard-costing with beginning and ending work in process. 1. Solution Exhibit 18-23A computes the equivalent units of work done in November by Lawrence Company for direct materials and conversion costs. 2. and 3. Solution Exhibit 18-23B summarizes total costs of the Lawrence Company for August 31, and, using the standard cost per equivalent unit for direct materials and conversion costs, assigns these costs to units completed and transferred out and to units in ending work in process. The exhibit also summarizes the cost variances for direct materials and conversion costs for August. SOLUTION EXHIBIT 18-23A Summarize the Flow of Physical Units and Compute Output in Equivalent Units; Standard Costing Method of Process Costing, Lawrence Company for the month ended August 31.

Flow of Production Work in process, beginning (given) Started during current period (given) To account for Completed and transferred out during current period: From beginning work in process§ 15,000  (100%  100%); 15,000  (100% – 30%) Started and completed 80,000 × 100%, 80,000 × 100% Work in process, ending* (given) 20,000 × 100%; 20,000 × 80% Accounted for Equivalent units of work done in current period §Degree of completion in this department:

(Step 2) (Step 1) Equivalent Units Physical Direct Conversion Units Materials Costs (work done before current period) 15,000 100,000 115,000 15,000 0

10,500

80,000

20,000 _______ 100,000

16,000 _______ 106,500

80,000† 20,000 _______ 115,000

direct materials, 100%; conversion costs, 30%.

†95,000 physical units completed and transferred out minus 15,000 physical units completed and

transferred out from beginning work-in-process inventory. *Degree of completion in this department: direct materials, 100%; conversion costs, 80%.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 18-23B Summarize the Total Costs to Account For, Compute the Cost per Equivalent Unit, and Assign Costs to the Units Completed and Units in Ending Work-in-Process Inventory; Standard-Costing Method of Process Costing, Lawrence Company for the month ended August 31.

(Step 3) Work in process, beginning (given) Costs added in current period at standard costs Total costs to account for (Step 4) Standard cost per equivalent unit (given) (Step 5) Assignment of costs at standard costs: Completed and transferred out (95,000 units): Work in process, beginning (15,000 units) Costs added to beg. work in process in current period Total from beginning inventory Started and completed (80,000 units) Total costs of units transferred out Work in process, ending (20,000 units) Total costs accounted for

Total Production Costs $ 141,375 1,879,625 $2,021,000

Direct Materials $ 86,250

(100,000  5.75) + (106,500  $12.25) $661,250 + $1,359,750 $

$ 141,375 128,625 270,000 1,440,000 1,710,000 311,000 $ 2,021,000

Conversion Costs $ 55,125

5.75

$86,250 (0*  $5.75)

+ $ 55,125 + (10,500*  $12.25)

(80,000†  $5.75) +

(80,000†  $12.25)

(20,000#  $5.75) + (16,000#  $12.25) $661,250 + $1,359,750

Summary of variances for current performance: Costs added in current period at standard costs (see Step 3 above) Actual costs incurred (given) Variance

$575,000 569,000 $ 6,000 F

$1,304,625 1,307,240 $ 2,615 U

*Equivalent units to complete beginning work in process from Solution Exhibit 18-23A, Step 2. †Equivalent units started and completed from Solution Exhibit 18-23A, Step 2. #Equivalent units in ending work in process from Solution Exhibit 18-23A, Step 2.

4. Direct Materials Direct Materials Control Accounts Payable Control

569,000

Work in Process Direct Materials Variance Direct Materials Control

575,000

569,000 6,000 569,000

Conversion Costs Conversion Costs Control Various Accounts (e.g., Acc Dep – Factory, Wages Pay)

12.25

1,307,240 1,307,240

Work in Process Conversion Costs Allocated

1,304,625

Conversion Costs Allocated

1,304,625

Chapter 18: Process Costing

Conversion Costs Variance Conversion Costs Control

2,615 1,307,240

18-24 (35–40 min.) Transferred-in costs, weighted-average method. 1., 2., & 3. Solution Exhibit 18-24A calculates the equivalent units of work done to date. Solution Exhibit 18-24B summarizes total costs to account for, calculates the cost per equivalent unit of work done to date for transferred-in costs, direct materials, and conversion costs, and assigns these costs to units completed and transferred out and to units in ending work-in-process inventory. SOLUTION EXHIBIT 18-24A Steps 1 and 2: Summarize Output in Physical Units and Compute Output in Equivalent Units Weighted-Average Method of Process Costing; Finishing Department of Asaya Clothing for June. (Step 1) Flow of Production Work in process, beginning (given) Transferred in during current period (given) To account for Completed and transferred out during current period Work in process, ending* (given) 60  100%; 60  0%; 60  75% Accounted for Work done to date

Physical Units 75 135 210 150 60

(Step 2) Equivalent Units TransferredDirect Conversion in Costs Materials Costs

150

210

150

195

210

*Degree of completion in this department: transferred-in costs, 100%; direct materials, 0%; conversion costs, 75%.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 18-24B Steps 3, 4, and 5: Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed and to Units in Ending Work in Process; Weighted-Average Method of Process Costing, Finishing Department of Asaya Clothing for June. Total Production Costs $105,000 258,000 $363,000

(Step 3) Work in process, beginning (given) Costs added in current period (given) Total costs to account for

Transferred-in Costs $ 75,000 142,500 $ 217,500

Direct Materials $ 0 37,500 $37,500

Conversion Costs $ 30,000 78,000 $108,000

$ 217,500

$37,500

$108,000

÷ 210 $1,035.71

÷ 150 $ 250

÷ 195 $ 553.85

(Step 4) Costs incurred to date Divide by equivalent units of work done to date (Solution Exhibit 18-24A) Cost per equivalent unit of work done to date (Step 5) Assignment of costs: Completed and transferred out (150 units) Work in process, ending (60 units): Total costs accounted for

$275,934 87,066 $363,000

(150 a  $1,035.71) + (150 a  $250) + (150a  $553.85)

(60b  $1,035.71) + (0b  $250) + (45b  $553.85) $ 217,500 + $ 37,500 + $108,000

aEquivalent units completed and transferred out from Sol. Exhibit 18-24, step 2. bEquivalent units in ending work in process from Sol. Exhibit 18-24A, step 2.

Chapter 18: Process Costing

18-25 (35–40 min.) Transferred-in costs, FIFO method. Solution Exhibit 18-25A calculates the equivalent units of work done in the current period (for transferred-in costs, direct-materials, and conversion costs) to complete beginning work-in-process inventory, to start and complete new units, and to produce ending work in process. Solution Exhibit 18-25B summarizes total costs to account for, calculates the cost per equivalent unit of work done in the current period for transferred-in costs, direct materials, and conversion costs, and assigns these costs to units completed and transferred out and to units in ending work-in-process inventory. SOLUTION EXHIBIT 18-25A Steps 1 and 2: Summarize Output in Physical Units and Compute Output in Equivalent Units FIFO Method of Process Costing; Finishing Department of Asaya Clothing for June. (Step 1)

Flow of Production Work in process, beginning (given) Transferred-in during current period (given) To account for Completed and transferred out during current period: From beginning work in processa [75 × (100% – 100%); 75 × (100% – 0%); 75 × (100% – 60%)] Started and completed (75 × 100%; 75 × 100%; 75 × 100%) Work in process, endingc (given) (60 × 100%; 60 × 0%; 60 × 75%) Accounted for Work done in current period only

(Step 2) Equivalent Units Physical Transferred-in Direct Conversion Units Costs Materials Costs 75 (work done before current period) 135 210 75 0

60 ___ 135

0 ___ 150

45 ___ 150

75b 60 ___ 210

aDegree of completion in this department: Transferred-in costs, 100%; direct materials, 0%; conversion costs, 60%. b150 physical units completed and transferred out minus 75 physical units completed and transferred out from beginning

work-in-process inventory. cDegree of completion in this department: transferred-in costs, 100%; direct materials, 0%; conversion costs, 75%.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 18-25B Steps 3, 4, and 5: Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed and to Units in Ending Work in Process; FIFO Method of Process Costing, Finishing Department of Asaya Clothing for June. Total Production Transferred-in Costs Costs Direct Materials Conversion Costs (Step 3) Work in process, beginning (given) $ 90,000 $ 60,000 $ 0 $ 30,000 Costs added in current period (given) 246,300 130,800 37,500 78,000 Total costs to account for $336,300 $190,800 $37,500 $ 108,000 (Step 4) Costs added in current period $130,800 $37,500 $ 78,000 Divide by equivalent units of work done in current period (Solution Exhibit 18-25A) ÷ 135 ÷ 150 ÷ 150 Cost per equivalent unit of work done in current period $ 968.89 $ 250 $ 520 (Step 5) Assignment of costs: Completed and transferred out (150 units) Work in process, beginning (75 units) $ 90,000 $ 60,000 $ 0 $ 30,000 Costs added to beginning work in process in current (0a  $968.89) + (75a  $250) + (30 a  $520) period 34,350 Total from beginning inventory 124,350 (75b  $968.89) + (75b  $250) + (75b  $520) Started and completed (75 units) 130,417 Total costs of units completed and transferred out 254,767 (60c  $968.89) + (0c  $250) + (45c  $520) Work in process, ending (60 units): 81,533 Total costs accounted for $336,300 $190,800 + $ 37,500 + $ 108,000 aEquivalent units used to complete beginning work in process from Solution Exhibit 18-25A, step 2. bEquivalent units started and completed from Solution Exhibit 18-25A, step 2. cEquivalent units in ending work in process from Solution Exhibit 18-25A, step 2.

Chapter 18: Process Costing

18-26 (15 min.) Weighted-average method, equivalent units. Under the weighted-average method, equivalent units are calculated as the equivalent units of work done to date. Solution Exhibit 18-26 shows equivalent units of work done to date for the assembly division of Fenton Watches, Inc., for direct materials and conversion costs. SOLUTION EXHIBIT 18-26 Steps 1 and 2: Summarize Output in Physical Units and Compute Output in Equivalent Units; WeightedAverage Method of Process Costing, Assembly Division of Fenton Watches, Inc., for May.

Flow of Production Work in process beginning (given) Started during current period (given) To account for Completed and transferred out during current period Work in process, ending* (120  60%; 120  30%) Accounted for Work done to date *

(Step 1) Physical Units 80 500 580 460 120 580

(Step 2) Equivalent Units Direct Conversion Materials Costs

460 72 ___ 532

Degree of completion in this department: direct materials, 50%; conversion costs, 30%.

460 36 ___ 496

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

18-27 (20 min.) Weighted-average method, assigning costs (continuation of Exercise 18-26). Solution Exhibit 18-27 summarizes total costs to account for, calculates cost per equivalent unit of work done to date in the assembly division of Fenton Watches Inc., and assigns costs to units completed and to units in ending work-in-process inventory. SOLUTION EXHIBIT 18-27 Steps 3, 4, and 5: Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed and to Units in Ending Work in Process; WeightedAverage Method of Process Costing, Assembly Division of Fenton Watches Inc., for May.

(Step 3)

Work in process, beginning (given) Costs added in current period (given) Total costs to account for

(Step 4)

Costs incurred to date Divide by equivalent units of work done to date (Solution Exhibit 18-26) Cost per equivalent unit of work done to date

(Step 5)

Assignment of costs: Completed and transferred out (460 units) Work in process, ending (120 units) Total costs accounted for

Total Production Costs $ 584,400 4,612,000 $5,196,400

Direct Materials $ 493,360 3,220,000 $3,713,360

Conversion Costs $ 91,040 1,392,000 $1,483,040

$3,713,360

$1,483,040

 532 $ 6,980 $4,586,200 610,200

 496 2,990

(460*  $6,980) + (460*  $2,990) (72†  $6,980) + (36†  $2,990) $3,713,360 + $ 1,483,040

$5,196,40 0 *Equivalent units completed and transferred out from Solution Exhibit 18-26, Step 2. † Equivalent units in work in process, ending from Solution Exhibit 18-26, Step 2.

Chapter 18: Process Costing

18-28 (15 min.) FIFO method, equivalent units. Refer to the information in Exercise 18-26. Under the FIFO method, equivalent units are calculated as the equivalent units of work done in the current period only. Solution Exhibit 18-28 shows equivalent units of work done in May in the assembly division of Fenton Watches Inc., for direct materials and conversion costs. SOLUTION EXHIBIT 18-28 Steps 1 and 2: Summarize Output in Physical Units and Compute Output in Equivalent Units; FIFO Method of Process Costing, Assembly Division of Fenton Watches Inc., for May.

Flow of Production Work in process, beginning (given) Started during current period (given) To account for Completed and transferred out during current period: From beginning work in process§ 80 × (100%  90%); 80 × (100%  50%) Started and completed 380 × 100%, 380 × 100% Work in process, ending* (given) 120 × 60%; 120 × 30% Accounted for Work done in current period only

(Step 1) Physical Units 80 500 580

(Step 2) Equivalent Units Direct Conversion Materials Costs (work done before current period)

80 8

380

460

456

380† 120 580

§Degree of completion in this department: direct materials, 90%; conversion costs, 50%. †460

physical units completed and transferred out minus 80 physical units completed and transferred out from beginning work-in-process inventory. *Degree of completion in this department: direct materials, 60%; conversion costs, 30%.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

18-29 (20 min.) FIFO method, assigning costs (continuation of Exercise 18-28). Solution Exhibit 18-29 summarizes total costs to account for, calculates cost per equivalent unit of work done in May in the assembly division of Fenton Watches Inc., and assigns total costs to units completed and to units in ending work-in-process inventory. SOLUTION EXHIBIT 18-29 Steps 3, 4, and 5: Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed and to Units in Ending Work in Process; FIFO Method of Process Costing, Assembly Division of Fenton Watches Inc., for May. Total Production Costs $ 584,400 4,612,000 $5,196,400

(Step 3) Work in process, beginning (given) Costs added in current period (given) Total costs to account for (Step 4) Costs added in current period Divide by equivalent units of work done in current period (Solution Exhibit 18-28) Cost per equiv. unit of work done in current period (Step 5) Assignment of costs: Completed and transferred out (460 units): Work in process, beginning (80 units) $ 584,400 Costs added to beginning work in process in current period 178,105 Total from beginning inventory 762,505 Started and completed (380 units) 3,820,000 Total costs of units completed and transferred out 4,582,505 Work in process, ending (120 units) 613,895 Total costs accounted for $5,196,400

Direct Materials $ 493,360 3,220,000 $3,713,360 $3,220,000  460

Conversion Costs $ 91,040 1,392,000 $1,483,040 $1,392,000  456

$ 7,000.00

$ 3,052.63

$493,360 +

$91,040

(8*  $7,000) + (40*  $3,052.63) (380† $7,000)+(380†$3,052.63) (72#  $7,000) + (36# $3,052.63) $3,713,360 + $1,483,040

*Equivalent units used to complete beginning work in process from Solution Exhibit 18-28, Step 2. †Equivalent units started and completed from Solution Exhibit 18-28, Step 2. #Equivalent units in work in process, ending from Solution Exhibit 18-28, Step 2.

Chapter 18: Process Costing

PROBLEMS 18-30 (25 min.) Weighted-average method. 1. Solution Exhibit 18-30A shows equivalent units of work done to date of: Direct materials Conversion costs

570 equivalent units 468 equivalent units

Note that direct materials are added when the Assembly Department process is 10% complete. Both the beginning and ending work in process are more than 10% complete and hence are 100% complete with respect to direct materials. Solution Exhibit 18-30B summarizes the total Assembly Department costs for April, calculates cost per equivalent unit of work done to date for direct materials and conversion costs, and assigns these costs to units completed (and transferred out), and to units in ending work in process using the weighted-average method. SOLUTION EXHIBIT 18-30A Summarize the Flow of Physical Units and Compute Output in Equivalent Units; Weighted-Average Method of Process Costing, Assembly Department of McKnight Handcraft for April. (Step 1) Flow of Production Work in process, beginning (given) Started during current period (given) To account for Completed and transferred out during current period Work in process, ending* (given) 120 × 100%; 120 × 15% Accounted for Equivalent units of work done to date

Physical Units 60 510 570

(Step 2) Equivalent Units Direct Conversion Materials Costs

450 120

450

120

570

468

570

*Degree of completion in this department: direct materials, 100%; conversion costs, 15%.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 18-30B Summarize the Total Costs to Account For, Compute the Cost per Equivalent Unit, and Assign Costs to the Units Completed and Units in Ending Work-in-Process Inventory; Weighted-Average Method of Process Costing, Assembly Department of McKnight Handcraft for April.

(Step 3) Work in process, beginning (given) Costs added in current period (given) Total costs to account for

Total Production Costs

Direct Materials

Conversion Costs

$ 1,686 29,394 $31,080

$ 1,530 17,850 $19,380

$19,380

$11,700

 $

(Step 4) Costs incurred to date Divide by equivalent units of work done to date (Solution Exhibit 18-30A) Cost per equivalent unit of work done to date (Step 5) Assignment of costs: Completed and transferred out (450 units) Work in process, ending (120 units) Total costs accounted for

$26,550 4,530 $31,080

570 34

156 11,544 $11,700

468 25

(450*  $34) + (450*  $25) (120†  $34) + (18†  $25) $19,380 + $11,700

*Equivalent units completed and transferred out from Solution Exhibit 18-30A, Step 2. †Equivalent units in ending work in process from Solution Exhibit 18-30A, Step 2.

2. To show better performance, a department supervisor might report a higher degree of completion resulting in understated cost per equivalent unit and overstated operating income. If performance for the period is very good, the department supervisor may be tempted to report a lower degree of completion reducing income in the current period. This has the effect of reducing the costs carried in ending inventory and the costs carried to the following year in beginning inventory. In other words, estimates of degree of completion can help to smooth earnings from one period to the next. To guard against the possibility of bias, managers should ask supervisors specific questions about the process they followed to prepare estimates. Top management should always emphasize obtaining the correct answer, regardless of how it affects reported performance. This emphasis drives ethical actions throughout the organization.

Chapter 18: Process Costing

18-31 (20 min.) FIFO method (continuation of 18-30). 1. & 2. The equivalent units of work done in April in the Assembly Department for direct materials and conversion costs are shown in Solution Exhibit 18-31A. Solution Exhibit 18-31B summarizes the total Assembly Department costs for April, calculates the cost per equivalent unit of work done in April in the Assembly Department for direct materials and conversion costs, and assigns these costs to units completed (and transferred out) and to units in ending work in process under the FIFO method. The equivalent units of work done in beginning inventory is: direct materials, 60  100% = 60; and conversion costs 60 × 40% = 24. The cost per equivalent unit of beginning inventory and of work done in the current period are:

Direct materials Conversion costs

Beginning Inventory $25.50 ($1,530  60) $ 6.50 ($156  24)

Work Done in Current Period (Calculated Under FIFO Method) $35 $26

The following table summarizes the costs assigned to units completed and those still in process under the weighted-average and FIFO process-costing methods for our example.

Cost of units completed and transferred out Work in process, ending Total costs accounted for

Weighted Average FIFO (Solution (Solution Exhibit 18-30B) Exhibit 18-31B) Difference $26,550 $26,412 + $138 4,530 4,668 – $138 $31,080 $31,080

The FIFO ending inventory is higher than the weighted-average ending inventory by $138. This is because FIFO assumes that all the lower-cost prior-period units in work in process are the first to be completed and transferred out while ending work in process consists of only the higher-cost current-period units. The weighted-average method, however, smooths out cost per equivalent unit by assuming that more of the higher-cost units are completed and transferred out, while some lower-cost units in beginning work in process are placed in ending work in process. Hence, in this case, the weighted-average method results in a higher cost of units completed and transferred out and a lower ending work-in-process inventory relative to the FIFO method. Given the relatively small difference in the income numbers generated by the two methods, McKnight’s managers would likely be indifferent between the two methods. If the differences are expected to be larger in future years, the managers should act in the firm’s method and choose the method that will lower McKnight’s operating income and taxes. They may have an incentive, however, to use the alternate method in order to obtain higher levels of income-based compensation or if there are debt covenants that would be violated by showing lower income. One advantage of the FIFO method worth considering is that it provides better information for managing the business because it keeps separate the costs of the current period from costs incurred in previous periods. Copyright © 2022 Pearson Canada Inc. 18-29

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 18-31A Summarize the Flow of Physical Units and Compute Output in Equivalent Units; FIFO Method of Process Costing, Assembly Department of McKnight Handcraft for April.

Flow of Production Work in process, beginning (given) Started during current period (given) To account for Completed and transferred out during current period: From beginning work in process§ 60 × (100%  100%); 60 × (100%  40%) Started and completed 390 × 100%; 390 × 100% Work in process, ending* (given) 120 × 100%; 120 × 15% Accounted for Equivalent units of work done in current period

(Step 2) (Step 1) Equivalent Units Physical Direct Conversion Units Materials Costs 60 (work done before current 510 period) 570 60 0

390

120

510

444

390† 120 570

§Degree of completion in this department: direct materials, 100%; conversion costs, 40%. †450

physical units completed and transferred out minus 60 physical units completed and transferred out from beginning work-in-process inventory. *Degree of completion in this department: direct materials, 100%; conversion costs, 15%.

Chapter 18: Process Costing

SOLUTION EXHIBIT 18-31B Summarize the Total Costs to Account For, Compute the Cost per Equivalent Unit, and Assign Costs to the Units Completed and Units in Ending Work-in-Process Inventory; FIFO Method of Process Costing, Assembly Department of McKnight Handcraft for April. Total Production Costs $ 1,686 29,394 $31,080

(Step 3) Work in process, beginning (given) Costs added in current period (given) Total costs to account for (Step 4) Costs added in current period Divide by equivalent units of work done in current period (Exhibit 18-31A) Cost per equivalent unit of work done in current period (Step 5) Assignment of costs: Completed and transferred out (455 units): Work in process, beginning (95 units) $ 1,686 Costs added to begin. work in process in current period 936 Total from beginning inventory 2,622 Started and completed (360 units) 23,790 Total costs of units completed & tsfd. out 26,412 Work in process, ending (130 units) 4,668 Total costs accounted for $31,080

Direct Materials $ 1,530 17,850 $19,380 $17,850

Conversion Costs $ 156 11,544 $11,700 $11,544



510



444

$1,530

$156

(0*  $35)

(36*  $26)

(390†  $35)

(390†  $26)

(120#  $35) $19,380

+ +

(18#  $26) $ 11,700

*Equivalent units used to complete beginning work in process from Solution Exhibit 18-32A, Step 2. †Equivalent units started and completed from Solution Exhibit 18-32A, Step 2. #Equivalent units in ending work in process from Solution Exhibit 18-32A, Step 2.

18-32 (30–35 min.) Standard costing, journal entries. 1. Solution Exhibit 18-32A computes the equivalent units of work done in May by the Warner Company for direct materials and conversion costs. 2. & 3. Solution Exhibit 18-32B summarizes total costs of the Warner Company for May 31, and using the standard cost per equivalent unit for direct materials and conversion costs, assigns these costs to units completed and transferred out and to units in ending work in process. The exhibit also summarizes the cost variances for direct materials and conversion costs for May.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 18-32A Summarize the Flow of Physical Units and Compute Output in Equivalent Units; Standard Costing Method of Process Costing, Warner Company for the Month Ended May 31.

Flow of Production Work in process, beginning (given) Started during current period (given) To account for Completed and transferred out during current period: From beginning work in process§ 22,000  (100%  100%); 22,000 × (100% – 60%) Started and completed 65,000 × 100%, 65,000 × 100% Work in process, ending* (given) 30,000 × 100%; 30,000 × 75% Accounted for Equivalent units of work done in current period §Degree of completion in this department:

(Step 2) (Step 1) Equivalent Units Physical Direct Conversion Units Materials Costs (work done before current period) 22,000 95,000 117,000 22,000 0

8,800

65,000

30,000 ______ 95,000

22,500 ______ 96,300

65,000† 30,000 _______ 117,000

direct materials, 100%; conversion costs, 60%.

†87,000 physical units completed and transferred out minus 22,000 physical units completed and

transferred out from beginning work-in-process inventory. *Degree of completion in this department: direct materials, 100%; conversion costs, 75%.

Chapter 18: Process Costing

SOLUTION EXHIBIT 18-32B Summarize the Total Costs to Account for, Compute the Cost per Equivalent Unit, and Assign Costs to the Units Completed and Units in Ending Work-in-Process Inventory; Standard-Costing Method of Process Costing, the Warner Company for the Month Ended May 31.

(Step 3) Work in process, beginning (given) Costs added in current period at standard costs Total costs to account for (Step 4) Standard cost per equivalent unit (given) (Step 5) Assignment of costs at standard costs: Completed and transferred out (87,000 units): Work in process, beginning (22,000 units) Costs added to beg. work in process in current period Total from beginning inventory

Total Production Direct Conversion Costs Materials Costs $ 81,400 $ 48,400 + $ 33,000 449,750 (95,000  $2.20) + (96,300  $2.50) $531,150 $257,400 + $273,750 $

2.20

$ 81,400

$48,400

22,000

(0*  $2.20)

+ (8,800*  $2.50)

$48,400

$ 103,400

Started and completed (65,000 units) 305,500 Total costs of units transferred out 408,900 Work in process, ending (30,000 units) 122,250 Total costs accounted for $531,150 Summary of variances for current performance: Costs added in current period at standard costs (see Step 3 above) Actual costs incurred (given) Variance

(65,000†  $2.20) +

$ 33,000

$55,000 (65,000†  $2.50)

(30,000#  $2.20) + (22,500#  $2.50) $257,400 + $273,750 $209,000 207,500 $ 1,500 F

$240,750 238,000 $ 2,750 F

*Equivalent units to complete beginning work in process from Solution Exhibit 18-32A, Step 2. †Equivalent units started and completed from Solution Exhibit 18-32A, Step 2. #Equivalent units in ending work in process from Solution Exhibit 18-32A, Step 2.

2.50

Direct Materials Direct Materials Control ` Accounts Payable Control Work in Process Direct Materials Variance Direct Materials Control Conversion Costs Conversion Costs Control Various Accounts (e.g., Acc Dep – Factory, Wages Pay)

207,500 207,500 209,000 1,500 207,500 238,000 238,000

Work in Process Conversion Costs Allocated

240,750

Conversion Costs Allocated Conversion Costs Variance Conversion Costs Control

240,750

240,750 2,750 238,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

18-33 43 (20 min.) Transferred-in costs, weighted-average method. 1. Solution Exhibit 18-33A computes the equivalent units of work done to date in the Stitching Department for transferred-in costs, direct materials, and conversion costs. Solution Exhibit 18-33B summarizes total Stitching Department costs for March, calculates the cost per equivalent unit of work done to date in the Stitching Department for transferred-in costs, direct materials, and conversion costs, and assigns these costs to units completed and transferred out and to units in ending work in process using the weightedaverage method. 2. Journal entries: a. Work in Process–– Stitching Department Work in Process––Cutting Department Cost of goods completed and transferred out during March from the Cutting Department to the Stitching Department b. Finished Goods Work in Process–– Stitching Department Cost of goods completed and transferred out during March from the Stitching Department to Finished Goods inventory

154,560 154,560

268,320 268,320

SOLUTION EXHIBIT 18-33A Summarize the Flow of Physical Units and Compute Output in Equivalent Units; Weighted-Average Method of Process Costing, Stitching Department of Spelling Sports for March. (Step 1)

(Step 2) Equivalent Units Physical Transferred- Direct Conversion Flow of Production Units in Costs Materials Costs Work in process, beginning (given) 17,500 Transferred-in during current period (given) 56,000 To account for 73,500 Completed and transferred out during current period: 52,000 52,000 52,000 52,000 a Work in process, ending (given) 21,500 (21,500 × 100%; 21,500 × 0%; 21,500 × 20%) 21,500 0 4,300 Accounted for 73,500 Equivalent units of work done to date 73,500 52,000 56,300 aDegree of completion in this department: transferred-in costs, 100%; direct materials, 0%;

conversion costs, 20%.

Chapter 18: Process Costing

SOLUTION EXHIBIT 18-33B Summarize the Total Costs to Account For, Compute the Cost per Equivalent Unit, and Assign Costs to the Units Completed and Units in Ending Work-in-Process Inventory; Weighted-Average Method of Process Costing, Stitching Department of Spelling Sports for March. Total Production Costs $ 63,020 271,950 $334,970

(Step 3)

Work in process, beginning (given) Costs added in current period (given) Total costs to account for

(Step 4)

Costs incurred to date Divide by equivalent units of work done to date (Solution Exhibit 18-33A) Cost per equivalent unit of work done to date

(Step 5)

Assignment of costs: Completed and transferred out (52,000 units) Work in process, ending (21,500 units): Total costs accounted for

$268,320 66,650 $334,970

Transferred-in Costs $ 45,360 154,560 $199,920

Direct Materials $ 0 28,080 $28,080

Conversion Costs $ 17,660 89,310 $106,970

$199,920

$28,080

$106,970

÷ 73,500 $ 2.72

÷ 52,000 $ 0.54

÷ 56,300 $ 1.90

(52,000a × $2.72) + (52,000a × $0.54) + (52,000a × $1.90) (21,500b × $2.72) + (0b × $0.54) + (4,300b × 1.90)

$199,920

aEquivalent units completed and transferred out from Sol. Exhibit 18-33A, step 2. bEquivalent units in ending work in process from Sol. Exhibit 18-33A, step 2.

+ $28,080

$106,970

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

18-34 (30 min.) Transferred-in costs, FIFO method (continuation of 18-33). 1. Solution Exhibit 18-34A calculates the equivalent units of work done in March in the Stitching Department for transferred-in costs, direct materials, and conversion costs. Solution Exhibit 18-34B summarizes total Stitching Department costs for March, calculates the cost per equivalent unit of work done in March in the Stitching Department for transferred-in costs, direct materials, and conversion costs, and assigns these costs to units completed and transferred out and to units in ending work in process using the FIFO method. Journal entries: a. Work in Process–– Stitching Department Work in Process––Cutting Department Cost of goods completed and transferred out during March from the Cutting Department to the Stitching Department. b. Finished Goods Work in Process–– Stitching Department Cost of goods completed and transferred out during March from the Stitching Department to Finished Goods inventory.

154,560 154,560

267,245 267,245

2. The equivalent units of work done in beginning inventory is: Transferred-in costs, 17,500  100% = 17,500; direct materials, 0; and conversion costs, 17,500  60% = 10,500. The cost per equivalent unit of beginning inventory and of work done in the current period are:

Transferred-in costs Direct materials Conversion costs

Beginning Inventory $2.59 ($45,360  17,500) — $1.68 ($17,660  10,500)

Work Done in Current Period $2.76 $0.54 $1.95

The following table summarizes the costs assigned to units completed and those still in process under the weighted-average and FIFO process-costing methods for the Stitching Department.

Cost of units completed and transferred out Work in process, ending Total costs accounted for

Weighted Average FIFO (Solution (Solution Exhibit 18-33B) Exhibit 18-34B) Difference $268,320 $267,245 + $1,075 66,650 67,725 – $1,075 $334,970 $334,970

Chapter 18: Process Costing

The FIFO ending inventory is higher than the weighted-average ending inventory by $1,075. This is because FIFO assumes that all the lower-cost prior-period units in work in process (resulting from the lower transferred-in costs in beginning inventory) are the first to be completed and transferred out while ending work in process consists of only the higher-cost current-period units. On the other hand, the weighted-average method smooths out cost per equivalent unit by assuming that more of the higher-cost units are completed and transferred out, while some of the lower-cost units in beginning work in process are placed in ending work in process. Hence, in this case, the weighted-average method results in a higher cost of units completed and transferred out and a lower ending work-in-process inventory relative to FIFO. Note that the difference in cost of units completed and transferred out (–$1,075) exactly offsets the difference in ending work-in-process inventory (+$1,075). This is because the costs were the same, except that the FIFO and weighted-average methods result in different values being assigned to units transferred out and those costs remaining in ending work in process. SOLUTION EXHIBIT 18-34A Summarize the Flow of Physical Units and Compute Output in Equivalent Units; FIFO Method of Process Costing, Stitching Department of Spelling Sports for March. (Step 1)

(Step 2) Equivalent Units

Physical Transferred-in Direct Conversion Flow of Production Units Costs Materials Costs Work in process, beginning (given) 17,500 (work done before current period) Transferred-in during current period (given) 56,000 To account for 73,500 Completed and transferred out during current period: From beginning work in processa 17,500 [17,500 × (100% – 100%); 17,500 × (100% – 0%); 17,500 × (100% – 60%)] 0 17,500 7,000 Started and completed 34,500b (34,500 × 100%; 34,500 × 100%; 34,500 × 100%) 34,500 34,500 34,500 Work in process, endingc (given) 21,500 (21,500 × 100%; 21,500 × 0%; 21,500 × 20%) ____ 21,500 0 4,300 Accounted for 73,500 ____ ____ ____ Equivalent units of work done in current period 56,000 52,000 45,800 aDegree

of completion in this department: Transferred-in costs, 100%; direct materials, 0%; conversion costs, 60%. b52,000 physical units completed and transferred out minus 17,500 physical units completed and transferred out from beginning work-in-process inventory. cDegree of completion in this department: transferred-in costs, 100%; direct materials, 0%; conversion costs, 20%.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 18-34B Summarize the Total Costs to Account For, Compute the Cost per Equivalent Unit, and Assign Costs to the Units Completed and Units in Ending Work-in-Process Inventory; FIFO Method of Process Costing, Stitching Department of Spelling Sports for March. Total Production Costs Transferred-in Costs $ 63,020 $ 45,360 271,950 154,560 $334,970 $199,920

(Step 3) Work in process, beginning (given) Costs added in current period (given) Total costs to account for (Step 4) Costs added in current period Divide by equivalent units of work done in current period (Sol. Exhibit 18-34A) Cost per equivalent unit of work done in current period (Step 5) Assignment of costs: Completed and transferred out (56,000 units) Work in process, beginning (17,500 units) Costs added to beginning work in process in current period Total from beginning inventory Started and completed (34,500 units) Total costs of units completed and transferred out Work in process, ending (21,500 units): Total costs accounted for

$ 63,020 23,100 86,120 181,125 267,245 67,725 $334,970

cEquivalent units in ending work in process from Solution Exhibit 18-34A, step 2.

Conversion Costs $ 17,660 89,310 $106,970

$154,560

$28,080

$ 89,310

÷ 56,000 $ 2.76

÷ 52,000 $ 0.54

÷ 45,800 $ 1.95

$45,360 (0a × $2.76)

+ $0 + $17,660 + (17,500a × $0.54) + (7,000a × $1.95)

(34,500b × $2.76) + (34,500b × $0.54) + (34,500b × $1.95) (21,500c × $2.76) + $199,920 +

aEquivalent units used to complete beginning work in process from Solution Exhibit 18-34A, step 2. bEquivalent units started and completed from Solution Exhibit 18-34A, step 2.

Direct Materials $ 0 28,080 $28,080

(0c × $0.54) $28,080

+ (4,300c × $1.95) + $106,970

Chapter 18: Process Costing

18-35 (25 min.) Weighted-average method. Solution Exhibit 18-35A shows equivalent units of work done to date of: Direct materials Conversion costs

625 equivalent units 525 equivalent units

Note that direct materials are added when the assembly department process is 10% complete. Both the beginning and ending work in process are more than 10% complete and hence are 100% complete with respect to direct materials. Solution Exhibit 18-35B summarizes the total assembly department costs for April, calculates cost per equivalent unit of work done to date for direct materials and conversion costs, and assigns these costs to units completed (and transferred out), and to units in ending work in process using the weighted-average method. SOLUTION EXHIBIT 18-35A Steps 1 and 2: Summarize Output in Physical Units and Compute Output in Equivalent Units; Weighted-Average Method of Process Costing, Assembly Department of Porter Handcraft for April (Step 1) Flow of Production Work in process, beginning (given) Started during current period (given) To account for Completed and transferred out during current period Work in process, ending* (given) 125  100%; 125  20% Accounted for Work done to date

Physical Units 75 550 625

(Step 2) Equivalent Units Direct Conversion Materials Costs

500 125

625

500 25 ___

625

525

*Degree of completion in this department: direct materials, 100%; conversion costs, 20%.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 18-35B Steps 3, 4, and 5: Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed and to Units in Ending Work in Process; WeightedAverage Method of Process Costing, Assembly Department of Porter, April

(Step 3) Work in process, beginning (given) Costs added in current period (given) Total costs to account for

Total Production Direct Costs Materials $ 1,910 $ 1,775 28,490 17,600 $30,400 $19,375

(Step 4) Costs incurred to date Divide by equivalent units of work done to date (Solution Exhibit 18-36A) Cost per equivalent unit of work done to date (Step 5) Assignment of costs: Completed and transferred out (500 units) Work in process, ending (125 units) Total costs accounted for

$19,375  625 31

$ $26,000 4,400 $30,400

Conversion Costs $ 135 10,890 $11,025 $11,025

(500*  $31) + (500*  $21) (125†  $31) + (25†  $21) $19,375 + $11,025

*Equivalent units completed and transferred out from Solution Exhibit 18-35A, Step 2. †Equivalent units in ending work in process from Solution Exhibit 18-35A, Step 2.

 525 21

Chapter 18: Process Costing

18-36 (5–10 min.) Journal entries (continuation of 18-35). 1. Work in Process––Assembly Department Accounts Payable To record direct materials purchased and used in production during April

17,600

2. Work in Process––Assembly Department Various Accounts To record assembly department conversion costs for April 3. Work in Process––Finishing Department Work in Process––Assembly Department To record cost of goods completed and transferred out in April from the assembly department to the finishing department

10,890

17,600

10,890 26,000

Work in Process –– Assembly Department Beginning inventory, April 1 1,9103. Transferred out to 1. Direct materials 17,600 Work in Process––Finishing 2. Conversion costs 10,890 Ending inventory, April 30 4,400

26,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

18-37 (20 min.) FIFO method (continuation of 18-35). The equivalent units of work done in April in the assembly department for direct materials and conversion costs are shown in Solution Exhibit 18-37A. Solution Exhibit 18-37B summarizes the total assembly department costs for April, calculates the cost per equivalent unit of work done in April in the assembly department for direct materials and conversion costs, and assigns these costs to units completed (and transferred out) and to units in ending work in process under the FIFO method. The equivalent units of work done in beginning inventory is: direct materials, 75  100% = 75; and conversion costs 75  40% = 30. The cost per equivalent unit of beginning inventory and of work done in the current period are:

Direct materials Conversion costs

Beginning Inventory $23.67 ($1,775  75) $4.50 ($135  30)

Work Done in Current Period (Calculated Under FIFO Method) $32 $22

The following table summarizes the costs assigned to units completed and those still in process under the weighted-average and FIFO process-costing methods for our example.

Cost of units completed and transferred out Work in process, ending Total costs accounted for

Weighted Average FIFO (Solution (Solution Exhibit 18-35B) Exhibit 18-37B) Difference $26,000 $25,850 –$150 4,400 4,550 +$150 $30,400 $30,400

The FIFO ending inventory is higher than the weighted-average ending inventory by $150. This is because FIFO assumes that all the lower-cost prior-period units in work in process are the first to be completed and transferred out, while ending work in process consists of only the higher-cost current-period units. The weighted-average method, however, smooths out cost per equivalent unit by assuming that more of the higher-cost units are completed and transferred out, while some of the lower-cost units in beginning work in process are placed in ending work in process. Hence, in this case, the weighted-average method results in a higher cost of units completed and transferred out and a lower ending work-in-process inventory relative to the FIFO method.

Chapter 18: Process Costing

SOLUTION EXHIBIT 18-37A Steps 1 and 2: Summarize Output in Physical Units and Compute Output in Equivalent Units; FIFO Method of Process Costing, Assembly Department of Porter Handcraft for April

Flow of Production Work in process, beginning (given) Started during current period (given) To account for Completed and transferred out during current period: From beginning work in process§ 75 × (100%  100%); 75 × (100%  40%) Started and completed 425 × 100%; 425 × 100% Work in process, ending* (given) 125 × 100%; 125 × 20% Accounted for Work done in current period only

(Step 2) (Step 1) Equivalent Units Physical Direct Conversion Units Materials Costs 75 (work done before current 550 period) 625 75 0

425

125

550

495

425† 125 625

§Degree of completion in this department: direct materials, 100%; conversion costs, 40%. †500

physical units completed and transferred out minus 75 physical units completed and transferred out from beginning work-in-process inventory. *Degree of completion in this department: direct materials, 100%; conversion costs, 20%.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 18-37B Steps 3, 4, and 5: Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed and to Units in Ending Work in Process; FIFO Method of Process Costing, Assembly Department of Porter Handcraft for April Total Production Costs $ 1,910 28,490 $30,400

(Step 3) Work in process, beginning (given) Costs added in current period (given) Total costs to account for (Step 4) Costs added in current period Divide by equivalent units of work done in current period (Exhibit 1837A) Cost per equivalent unit of work done in current period (Step 5) Assignment of costs: Completed and transferred out (500 units): Work in process, beginning (75 units) $ 1,910 Costs added to begin work in process in current period 990 Total from beginning inventory 2,900 Started and completed (425 units) 22,950 Total costs of units completed & transferred out 25,850 Work in process, ending (125 units) 4,550 Total costs accounted for $30,400

Direct Materials $ 1,775 17,600 $19,375 $17,600

Conversion Costs $ 135 10,890 $11,025 $10,890  495

 550 $

$1,775

$135

(0*  $32)

+ (45*  $22)

(425†  $32) + (425†  $22) (125#  $32) $19,375

+ (25#  $22) + $11,025

*Equivalent units used to complete beginning work in process from Solution Exhibit 18-37A, Step 2. †Equivalent units started and completed from Solution Exhibit 18-37A, Step 2. #Equivalent units in ending work in process from Solution Exhibit 18-37A, Step 2.

Chapter 18: Process Costing

18-38 (30 min.) Transferred-in costs, weighted average method. 1. Solution Exhibit 18-38A computes the equivalent units of work done to date in the binding department for transferred-in costs, direct materials, and conversion costs. Solution Exhibit 18-38B summarizes total binding department costs for April, calculates the cost per equivalent unit of work done to date in the binding department for transferred-in costs, direct materials, and conversion costs, and assigns these costs to units completed and transferred out and to units in ending work in process using the weightedaverage method. 2. Journal entries: a. Work in Process––Binding Department Work in Process––Printing Department Cost of goods completed and transferred out during April from the printing department to the binding department b. Finished Goods Work in Process––Binding Department Cost of goods completed and transferred out during April from the binding department to finished goods inventory

144,000 144,000

249,012 249,012

SOLUTION EXHIBIT 18-38A Steps 1 and 2: Summarize Output in Physical Units and Compute Output in Equivalent Units; Weighted-Average Method of Process Costing, Binding Department of Choice Books Inc. for April. (Step 1)

(Step 2) Equivalent Units Physical Transferred-in Direct Conversion Flow of Production Units Costs Materials Costs Work in process, beginning (given) 900 Transferred-in during current period (given) 2,700 To account for 3,600 Completed and transferred out during current period: 3,000 3,000 3,000 3,000 a Work in process, ending (given) 600 (600 × 100%; 600 × 0%; 600 × 60%) 600 0 360 Accounted for 3,600 Work done to date 3,600 3,000 3,360 aDegree of completion in this department: transferred-in costs, 100%; direct materials, 0%;

conversion costs, 60%.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 18-38B Steps 3, 4, and 5: Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed and to Units in Ending Work in Process; Weighted-Average Method of Process Costing, Binding Department of Choice Books Inc. for April. Total Production Costs $ 47,775 239,700 $287,475

(Step 3)

Work in process, beginning (given) Costs added in current period (given) Total costs to account for

(Step 4)

Costs incurred to date Divide by equivalent units of work done to date (Solution Exhibit 18-38A) Cost per equivalent unit of work done to date

(Step 5)

Assignment of costs: Completed and transferred out (3,000 units) Work in process, ending (600 units): Total costs accounted for

$249,012 38,463 $287,475

Transferred-in Costs $ 32,775 144,000 $176,775

Direct Materials $ 0 26,700 $26,700

Conversion Costs $15,000 69,000 $84,000

$176,775

$26,700

$84,000

÷ 3,600 $ 49.104

÷ 3,000 $ 8.90

÷ 3,360 $ 25

(3,000a × $49.104) + (3,000a × $8.90) + (3,000a × $25) (600b × $49.104) + (0b × $8.90) + (360b × $25) $176,775 + $ 26,700 + $84,000

aEquivalent units completed and transferred out from Sol. Exhibit 18-38A, step 2. bEquivalent units in ending work in process from Sol. Exhibit 18-38A, step 2.

Chapter 18: Process Costing

18-39 (30 min.) Transferred-in costs, weighted-average method 18-181. Transferred-in costs are 100% complete, and direct materials are 0% complete in both beginning and ending work-in-process inventory. The reason is that transferred-in costs are always 100% complete as soon as they are transferred in from the Assembly Department to the Testing Department. Direct materials in beginning or ending work in process for the Testing Department are 0% complete because direct materials are added only when the testing process is 90% complete and the units in beginning and ending work in process are only 65% and 45% complete, respectively. 2. Solution Exhibit 18-39A computes the equivalent units of work done to date in the Testing Department for transferred-in costs, direct materials, and conversion costs. 3. Solution Exhibit 18-39B summarizes total Testing Department costs for October, calculates the cost per equivalent unit of work done to date in the Testing Department for transferred-in costs, direct materials, and conversion costs, and assigns these costs to units completed and transferred out and to units in ending work in process using the weighted-average method. 4.

Journal entries: a. Work in Process––Testing Department Work in Process––Assembly Department Cost of goods completed and transferred out during October from the Assembly Department to the Testing Department b. Finished Goods Work in Process––Testing Department Cost of goods completed and transferred out during October from the Testing Department to Finished Goods inventory

8,094,000 8,094,000

26,373,000 26,373,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 18-39A Summarize the Flow of Physical Units and Compute Output in Equivalent Units; Weighted-Average Method of Process Costing, Testing Department of Hoffman Company for October. (Step 1) Physical Flow of Production Units Work in process, beginning (given) 5,500 Transferred in during current period (given) 26,000 To account for 31,500 Completed and transferred out during current period 29,800 Work in process, ending* (given) 1,700 1,700  100%; 1,700  0%; 1,700  45% Accounted for 31,500 Equivalent units of work done to date

(Step 2) Equivalent Units Transferred-in Direct Conversion Costs Materials Costs

29,800

1,700

765

31,500

29,800

30,565

*Degree of completion in this department: transferred-in costs, 100%; direct materials, 0%; conversion costs, 60%.

Chapter 18: Process Costing

SOLUTION EXHIBIT 18-39B Summarize the Total Costs to Account For, Compute the Cost per Equivalent Unit, and Assign Costs to the Units Completed and Units in Ending Work-in-Process Inventory; Weighted-Average Method of Process Costing, Testing Department of Hoffman Company for October. Total Production Costs $ 3,430,790 23,667,260 $27,098,050

(Step 3) Work in process, beginning (given) Costs added in current period (given) Total costs to account for (Step 4) Costs incurred to date Divide by equivalent units of work done to date (Solution Exhibit 18-39A) Equivalent unit costs of work done to date (Step 5) Assignment of costs: Completed and transferred out (29,800 units) Work in process, ending (1,700 units) Total costs accounted for

$26,373,000 725,050 $27,098,050

Transferred -in Costs $ 2,931,000 8,094,000 $11,025,000

Direct Materials $ 0 10,877,000 $10,877,000

Conversion Costs $ 499,790 4,696,260 $5,196,050

$11,025,000

$10,877,000

$5,196,050

 $

 30,565 $ 170

31,500 350

29,800 365

(29,800*  $350) + (29,800*  $365) (1,700†  $350) + (0†  $365) $ 11,025,000 + $ 10,877,000

*Equivalent units completed and transferred out from Solution Exhibit 18-39A, Step 2. †Equivalent units in ending work in process from Solution Exhibit 18-39A, Step 2.

+ (29,800*  $170) + (765†  $170) + $ 5,196,050

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

18-40 (30 min.) Transferred-in costs, FIFO method (continuation of 18-39). 1. As explained in Problem 18-39, requirement 1, transferred-in costs are 100% complete and direct materials are 0% complete in both beginning and ending work-in-process inventory. 2. The equivalent units of work done in October in the Testing Department for transferred-in costs, direct materials, and conversion costs are calculated in Solution Exhibit 18-40A. 3. Solution Exhibit 18-40B summarizes total Testing Department costs for October, calculates the cost per equivalent unit of work done in October in the Testing Department for transferred-in costs, direct materials, and conversion costs, and assigns these costs to units completed and transferred out and to units in ending work in process using the FIFO method. 4. Journal entries: a. Work in Process––Testing Department Work in Process––Assembly Department Cost of goods completed and transferred out during October from the Assembly Dept. to the Testing Dept. b. Finished Goods Work in Process––Testing Department Cost of goods completed and transferred out during October from the Testing Department to Finished Goods inventory.

9,048,000 9,048,000

27,275,340 27,275,340

Chapter 18: Process Costing

SOLUTION EXHIBIT 18-40A Summarize the Flow of Physical Units and Compute Output in Equivalent Units; FIFO Method of Process Costing, Testing Department of Hoffman Company for October.

Flow of Production Work in process, beginning (given) Transferred-in during current period (given) To account for Completed and transferred out during current period: From beginning work in process§ 5,500 × (100%  100%); 5,500 × (100%  0%); 5,500 × (100%  65%) Started and completed 24,300 × 100%; 24,300 × 100%; 24,300 × 100% Work in process, ending* (given) 1,700 × 100%; 1,700 × 0%; 1,700 × 45% Accounted for Equivalent units of work done in current period

(Step 2) (Step 1) Equivalent Units Physical TransferredDirect Conversion Units in Costs Materials Costs 5,500 (work done before current period) 26,000 31,500 5,500 0

5,500

1,925

24,300

1,700

0 ______ 29,800

______

24,300† 1,700 ______ 31,500

26,000

§Degree of completion in this department:

765 26,990

Transferred-in costs, 100%; direct materials, 0%; conversion costs, 65%. †29,800 physical units completed and transferred out minus 5,500 physical units completed and transferred out from beginning work-in-process inventory. *Degree of completion in this department: transferred-in costs, 100%; direct materials, 0%; conversion costs, 45%.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 18-40B Summarize the Total Costs to Account For, Compute the Cost per Equivalent Unit, and Assign Costs to the Units Completed and Units in Ending Work-in-Process Inventory; FIFO Method of Process Costing, Testing Department of Hoffman Company for October. Total Production Costs $ 3,378,790 24,621,260 $28,000,050

(Step 3) Work in process, beginning (given) Costs added in current period (given) Total costs to account for (Step 4) Costs added in current period Divide by equivalent units of work done in current period (Solution Exhibit 18-40A) Cost per equiv. unit of work done in current period (Step 5) Assignment of costs: Completed and transferred out (29,800 units): Work in process, beginning (5,500 units) Costs added to beg. work in process in current period Total from beginning inventory Started and completed (24,300 units) Total costs of units completed & transferred out Work in process, ending (1,700 units) Total costs accounted for

Transferred-in Costs $ 2,879,000 9,048,000 $ 11,927,000

Direct Materials $ 0 10,877,000 $10,877,000

Conversion Costs $ 499,790 4,696,260 $5,196,050

$10,877,000

$4,696,260

 $

9,048,000 

$ 3,378,790 2,342,450 5,721,240 21,554,100 27,275,340 724,710 $28,000,050

26,000 348.00

29,800 365.00

26,990 174.00

$2,879,000 (0*  $348)

+ $0 + (5,500*  $365)

+ +

(24,300†  $348)

+ (24,300†  $365)

+ (24,300†  $174)

(1,700#  $348) $11,927,000

+ +

*Equivalent units used to complete beginning work in process from Solution Exhibit 18-40A, Step 2. †Equivalent units started and completed from Solution Exhibit 18-40A, Step 2. #Equivalent units in ending work in process from Solution Exhibit 18-40A, Step 2.

(0#  $365) $10,877,000

+ +

$499,790 (1,925*  $174)

(765#  $174) $5,196,050

Chapter 18: Process Costing

COLLABORATIVE LEARNING CASES 18-41 (20–25 min.) Equivalent-unit computations, benchmarking, governance. 1. The reported monthly cost per equivalent unit of either direct materials or conversion costs is lower when the plant manager overestimates the percentage of completion of ending work in process; the overestimate increases the denominator and thus decreases the cost per equivalent whole unit. By reporting a lower cost per equivalent unit, the plant manager increases the likelihood of being in the top three ranked plants for the benchmarking comparisons. A plant manager can manipulate the monthly estimate of percentage of completion by understating the number of steps yet to be undertaken before a suit becomes a finished good. 2. There are several options available: a. Major shows the letters to the line executive to whom the plant managers report in a hardline way (say, the corporate manager of manufacturing). This approach is appropriate if the letters allege it is the plant managers who are manipulating the percentage of completion estimates. b. Major herself shows the letters to the plant managers. This approach runs the danger of the plant managers ignoring or reacting negatively to someone to whom they do not report in a line-mode questioning their behaviour. Much will depend here on how Major raises the issue. Unsigned letters need not have much credibility unless they contain specific details. c. Major discusses the letters with the appropriate plant controllers without including the plant manager in the discussion. While the plant controller has responsibility for preparing the accounting reports from the plant, the plant controller in most cases reports hard-line to the plant manager. If this reporting relationship exists, Major may create a conflict of interest situation for the plant controller. Only if the plant controller reports hard-line to the corporate controller and dotted-line to the plant manager should Major show the letters to the plant controller without simultaneously showing them to the plant manager. 3. The plant controller’s ethical responsibilities to Major and to Leisure Suits should be the same. These include:  The plant controller is expected to have the competence to make equivalent unit computations. This competence does not always extend to making estimates of the percentage of completion of a product. In Leisure Suits’ case, however, the products are probably easy to understand and observe. Hence, a plant controller could obtain reasonably reliable evidence on percentage of completion at a specific plant.  The plant controller should not allow the possibility of the division being written up favourably in the company newsletter to influence the way equivalent unit costs are computed.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4. Major could seek evidence on possible manipulations as follows: a. Have plant controllers report detailed breakdowns on the stages of production and then conduct end-of-month audits to verify the actual stages completed for ending work in process. b. Examine trends over time in ending work in process. Divisions that report low amounts of ending work in process relative to total production are not likely to be able to greatly affect equivalent cost amounts by manipulating percentage of completion estimates. Divisions that show sizable quantities of total production in ending work in process are more likely to be able to manipulate equivalent cost computations by manipulating percentage of completion estimates.

18-42 (25–30 min.) Operation costing 1. To obtain the overhead rates, divide the budgeted cost of each operation by the pairs of shoes that are expected to go through that operation.

Operation 1 Operation 2 Operation 3 Operation 4 Operation 5 Operation 6

Budgeted Conversion Cost $145,125 58,050 4,275 67,725 13,500 2,025

Budgeted Pairs of Shoes 32,250 32,250 2,250 32,250 30,000 2,250

Conversion Cost per Pair of Shoes $4.50 1.80 1.90 2.10 0.45 0.90

Shoe type: Quantity: Direct materials Operation 1 Operation 2 Operation 3 Operation 4 Operation 5 Operation 6 Total

Work Order 10399 Basic 1,000 $13,000 4,500 1,800 0 2,100 450 0 $21,850

Work Order 10400 Elaborate 150 $4,200 675 270 285 315 0 135 $5,880

The direct materials costs per unit vary based on the type of shoe ($390,000 ÷ 30,000 = $13 for the basic, and $63,000 ÷ 2,250 = $28 for the elaborate). Conversion costs are charged using the rates computed in requirement 1, taking into account the specific operations that each type of shoe actually goes through. Copyright © 2022 Pearson Canada Inc. 18-54

Chapter 18: Process Costing

Work order 10399 (basic shoes):

Work order 10400 (elaborate shoes):

Total cost $21,850 Divided by number of pairs of shoes: ÷ 1,000 Cost per pair of plain shoes: $ 21.85

Total cost: $5,880 Divided by number of pairs of shoes: ÷ 150 Cost per pair of fancy shoes: $39.20

CHAPTER 19 SPOILAGE, REWORK, AND SCRAP MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

SHORT-ANSWER QUESTIONS 19-1 Managers have found that improved quality and intolerance for high spoilage have lowered overall costs and increased sales.

19-2 Spoilage—units of production that do not meet the standards required by customers for good units and that are discarded or sold at reduced prices. Reworked units—units of production that do not meet the specifications required by customers but which are subsequently repaired and sold as good finished units. Scrap—residual material that results from manufacturing a product. It has low total sales value compared to the total sales value of the product.

19-3 Normal spoilage is spoilage inherent in a particular production process that arises even under efficient operating conditions. Management decides the spoilage rate it considers normal depending on the production process.

19-4 Abnormal spoilage is spoilage that is not inherent in a particular production process and would not arise under efficient operating conditions. Costs of abnormal spoilage are “lost costs,” measures of inefficiency that should be written off directly as losses in the current accounting period.

19-5 Management effort can affect the spoilage rate. Many companies are relentlessly reducing their rates of normal spoilage, spurred on by competitors who, likewise, are continuously reducing costs.

19-6 Normal spoilage typically is expressed as a percentage of good units passing the inspection point. Given actual spoiled units, we infer abnormal spoilage as follows: Abnormal spoilage = Actual spoilage – Normal spoilage.

19-7 Accounting for spoiled goods deals with cost assignment, rather than with cost incurrence, because the existence of spoiled goods does not involve any additional cost beyond the amount already incurred.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

19-8 Yes. Normal spoilage rates should be computed from the good output or from the normal input, not the total input. Normal spoilage is a given percentage of a certain output base. This base should never include abnormal spoilage, which is included in total input. Abnormal spoilage does not vary in direct proportion to units produced, and to include it would cause the normal spoilage count to fluctuate irregularly and not vary in direct proportion to the output base.

19-9 Yes, the point of inspection is the key to the assignment of spoilage costs. Normal spoilage costs do not attach solely to units transferred out. Thus, if units in ending work in process have passed inspection, they should have normal spoilage costs added to them.

19-10 No. If abnormal spoilage is detected at a different point in the production cycle than normal spoilage, then unit costs would differ. If, however normal and abnormal spoilage are detected at the same point in the production cycle, their unit costs would be the same.

19-11 No. Spoilage may be considered a normal characteristic of a given production cycle. The costs of normal spoilage caused by a random malfunction of a machine would be charged as a part of the manufacturing overhead allocated to all jobs. Normal spoilage attributable to a specific job is charged to that job.

19-12 No. Unless there are special reasons for charging normal rework to jobs that contained the bad units, the costs of extra materials, labour, and so on are usually charged to manufacturing overhead and allocated to all jobs.

19-13 Yes. Abnormal rework is a loss just like abnormal spoilage. By charging it to manufacturing overhead, the abnormal rework costs are spread over other jobs and also included in inventory to the extent a job is not complete. Abnormal rework is rework over and above what is expected during a period, and is recognized as a loss for that period.

19-14 A company is justified in inventorying scrap when its estimated net realizable value is significant and the time between storing it and selling or reusing it is quite long.

Chapter 19: Spoilage, Rework, and Scrap

EXERCISES 19-15 (10 min.) Terminology. 1. There is no perfect machine, nor is there a perfect manufacturing process. That is why each process has at least one inspection point to assess the output quality and send the units back for rework and ultimately prepare for sale, or scrap them. Costs of reworked units are nonvalue added for the customer who will therefore, not pay for them. The company bears this cost. 2. The difference between abnormal spoilage and normal spoilage is in accounting for the costs. Normal spoilage is predictable but unavoidable; therefore ASPE/IFRS allows this cost in cost of goods manufactured. Abnormal spoilage is avoidable but unpredictable and ASPE/IFRS requires this cost to be expensed. These costs did not produce an asset from which future revenue will be recovered and therefore are not part of cost of goods manufactured.

19-16 (5–10 min.)

Normal and abnormal spoilage in units.

1. Total spoiled units Normal spoilage in units, 5%  132,000 Abnormal spoilage in units 2. Abnormal spoilage, 5,400  $20 Normal spoilage, 6,600  $20 Potential savings, 12,000  $20

12,000 6,600 5,400 $108,000 132,000 $240,000

Regardless of the targeted normal spoilage, abnormal spoilage is non-recurring and avoidable. The targeted normal spoilage rate is subject to change. Many companies have reduced their spoilage to almost zero, which would realize all potential savings. Of course, zero spoilage usually means higher-quality products, more customer satisfaction, more employee satisfaction, and various beneficial effects on nonmanufacturing (for example, purchasing) costs of direct materials.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

19-17 (20 min.)

Weighted-average method, spoilage, equivalent units.

Solution Exhibit 19-17 calculates equivalent units of work done to date for direct materials and conversion costs. SOLUTION EXHIBIT 19-17 Summarize Output in Physical Units and Compute Output in Equivalent Units; Weighted-Average Method of Process Costing with Spoilage, Grey Manufacturing Company for November.

Flow of Production Work in process, beginning (given) Started during current period To account for Good units completed and transferred out during current period: Normal spoilage* 100  100%; 100  100% Abnormal spoilage† 50  100%; 50  100% Work in process, ending‡ (given) 2,000  100%; 2,000  30% Accounted for Work done to date

(Step 1) Physical Units

(Step 2) Equivalent Units Direct Conversion Materials Costs

1,000 10,150a 11,150 9,000 100

9,000

100

2,000

600

11,150

9,750

50 2,000 11,150

aFrom below, 11,150 total units are accounted for. Therefore, units started during current period

must be = 11,150 – 1,000 = 10,150. *Degree of completion of normal spoilage in this department: direct materials, 100%; conversion

costs, 100%. of completion of abnormal spoilage in this department: direct materials, 100%; conversion costs, 100%. ‡Degree of completion in this department: direct materials, 100%; conversion costs, 30%. †Degree

Chapter 19: Spoilage, Rework, and Scrap

19-18 (2025 min.) Weighted-average method, assigning costs (continuation of Exercise 19-17). Solution Exhibit 19-18 summarizes total costs to account for, calculates the costs per equivalent unit for direct materials and conversion costs, and assigns total costs to units completed and transferred out (including normal spoilage), to abnormal spoilage, and to units in ending work in process. SOLUTION EXHIBIT 19-18 Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed, to Spoiled Units, and to Units in Ending Work in Process; WeightedAverage Method of Process Costing, Grey Manufacturing Company, November.

(Step 3)

Work in process, beginning (given) Costs added in current period (given) Total costs to account for

(Step 4)

Costs incurred to date Divided by equivalent units of work done to date Cost per equivalent unit

Assignment of costs Good units completed and transferred out (9,000 units) Costs before adding normal spoilage Normal spoilage (100 units) (A) Total cost of good units completed & transf. out (B) Abnormal spoilage (50 units) (C) Work in process, ending (2,000 units) (A)+(B)+(C) Total costs accounted for

Total Production Direct Costs Materials $ 2,533 $ 1,423 39,930 12,180 $42,463 $13,603

(Step 5)

Conversion Costs $ 1,110 27,750 $28,860

$13,603 11,150

$28,860  9,750

1.22

2.96

$37,620 418 38,038

(9,000#  $1.22) + (9,000#  $2.96) (100#  $1.22) + (100#  $2.96)

209 4,216 $42,463

(50#  $1.22) + (50#  $2.96) (2,000#  $1.22) + (600#  $2.96) $13,603 + $28,860

#Equivalent

units of direct materials and conversion costs calculated in Step 2 in Solution Exhibit 19-17.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

19-19 (15 min.)

FIFO method, spoilage, equivalent units. Refer to information in Exercise 19-17.

Solution Exhibit 19-19 calculates equivalent units of work done in the current period for direct materials and conversion costs. SOLUTION EXHIBIT 19-19 Summarize Output in Physical Units and Compute Output in Equivalent Units; First-in, First-out (FIFO) Method of Process Costing with Spoilage, Grey Manufacturing Company for November.

Flow of Production Work in process, beginning (given) Started during current period To account for Good units completed and transferred out during current period: From beginning work in process|| 1,000  (100% 100%); 1,000  (100%  50%) Started and completed 8,000  100%; 8,000  100% Normal spoilage* 100  100%; 100  100% Abnormal spoilage† 50  100%; 50  100% Work in process, ending‡ 2,000  100%; 2,000  30% Accounted for Work done in current period only

(Step 1) Physical Units 1,000 10,150a 11,150

(Step 2) Equivalent Units Direct Conversion Materials Costs

1,000 0

500

8,000

100

2,000

600

10,150

9,250

8,000# 100 50 2,000 11,150

aFrom below, 11,150 total units are accounted for. Therefore, units started during current period

must be 11,150 – 1,000 = 10,150. ||Degree of completion in this department: direct materials, 100%; conversion costs, 50%. #9,000 physical units completed and transferred out minus 1,000 physical units completed and transferred out from beginning work-in-process inventory. *Degree of completion of normal spoilage in this department: direct materials, 100%; conversion costs, 100%. †Degree of completion of abnormal spoilage in this department: direct materials, 100%; conversion costs, 100%. ‡Degree of completion in this department: direct materials, 100%; conversion costs, 30%.

Chapter 19: Spoilage, Rework, and Scrap

19-20 (2025 min.) FIFO method, assigning costs (continuation of Exercise 19-19). Solution Exhibit 19-20 summarizes total costs to account for, calculates the costs per equivalent unit for direct materials and conversion costs, and assigns total costs to units completed and transferred out (including normal spoilage), to abnormal spoilage, and to units in ending work in process. SOLUTION EXHIBIT 19-20 Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed, to Spoiled Units, and to Units in Ending Work in Process; FIFO Method of Process Costing, Grey Manufacturing Company, November.

(Step 3) Work in process, beginning (given) Costs added in current period (given) Total costs to account for

Total Production Direct Costs Materials $ 2,533 $ 1,423 39,930 12,180 $42,463 $13,603

(Step 4) Costs added in current period Divided by equivalent units of work done in current period Cost per equivalent unit (Step 5) Assignment of costs: Good units completed and transferred out (9,000 units) Work in process, beginning (1,000 units) Costs added to beg. work in process in current period Total from beginning inventory before normal spoilage Started and completed before normal spoilage (8,000 units) Normal spoilage (100 units) (A) Total costs of good units completed and transferred out (B) Abnormal spoilage (50 units) (C) Work in process, ending (2,000 units) (A)+(B)+(C) Total costs accounted for

$12,180 10,150 $ 1.20

$ 2,533 1,500

$1,423 + (0a  $1.20) +

Conversion Costs $ 1,110 27,750 $28,860 $27,750  9,250 $ 3

$1,110 (500a  $3)

4,033 33,600

(8,000a  $1.20) + (8,000a$3)

420 38,053

(100a  $1.20) +

210 4,200 $42,463

(50a  $1.20) + (50a  $3) (2,000a  $1.20) + (600a  $3) $13,603 + $28,860

aEquivalent

(100a  $3)

units of direct materials and conversion costs calculated in Step 2 in Solution Exhibit 19-19.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

19-21 (35 min.)

Weighted-average method, spoilage.

1. Solution Exhibit 19-21A calculates equivalent units of work done in the current period for direct materials and conversion costs. SOLUTION EXHIBIT 19-21A Summarize Output in Physical Units and Compute Output in Equivalent Units; Weighted-Average Method of Process Costing with Spoilage, Winding River Company for August.

Flow of Production Work in process, beginning (given) Started during current period (given) To account for Good units completed and tsfd. out during current period: Normal spoilagea (900 × 100%; 900 × 100%) Abnormal spoilageb (300 × 100%; 300 × 100%) Work in process, endingc (given) (1,800 × 100%; 1,800 × 75%) Accounted for Work done to date

(Step 2) (Step 1) Equivalent Units Physical Direct Conversion Units Materials Costs 2,000 10,000 12,000 9,000 9,000 9,000 900 900 900 300 300 300 1,800 _____ 1,800 1,350 12,000 _____ ______ 12,000 11,550

aNormal spoilage is 10% of good units transferred out: 10% × 9,000 = 900 units. Degree of

completion of normal spoilage in this department: direct materials, 100%; conversion costs, 100%. bTotal spoilage = Beg. units + Units started – Good units transferred out – Ending units = 2,000 + 10,000 – 9,000 – 1,800 = 1,200; Abnormal spoilage = Total spoilage – Normal spoilage = 1,200 – 900 = 300 units. Degree of completion of abnormal spoilage in this department: direct materials, 100%; conversion costs, 100%. cDegree of completion in this department: direct materials, 100%; conversion costs, 75%. 2. Solution Exhibit 19-21B summarizes total costs to account for, calculates the costs per equivalent unit for direct materials and conversion costs, and assigns total costs to units completed and transferred out (including normal spoilage), to abnormal spoilage, and to units in ending work in process, using the weighted-average method.

Chapter 19: Spoilage, Rework, and Scrap

SOLUTION EXHIBIT 19-21B Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed, to Spoiled Units, and to Units in Ending Work in Process; WeightedAverage Method of Process Costing, Winding River Company, August.

(Step 3)

(Step 4)

Work in process, beginning (given) Costs added in current period (given)

Total Production Costs $ 28,600 174,300

Direct Materials $17,700 81,300

Conversion Costs $ 10,900 93,000

Total costs to account for

$202,900

$99,000

$103,900

$99,000 ÷12,000 $ 8.250

$103,900 ÷11,550 $ 8.9957

Costs incurred to date Divide by equivalent units of work done to date Cost per equivalent unit

(Step 5)

Assignment of costs Good units completed and transferred out (9,000 units) Costs before adding normal spoilage Normal spoilage (900 units) Total costs of good units completed and (A) transferred out (B) Abnormal spoilage (300 units) (C) Work in process, ending (1,800 units): (A) + (B) + (C) Total costs accounted for

$155,211 15,521

(9,000d$8.25) + (9,000 d$8.9957) (900d  $8.25) + (900d  $8.9957)

170,732 (300d  $8.25) + (300d  $8.9957) 5,174 26,994 (1,800d  $8.25) + (1,350d  $8.9957) $202,900 $99,000 + $103,900

dEquivalent units of direct materials and conversion costs calculated in step 2 of Solution

Exhibit 19-21A.

19-22 (10 min.)

Standard-costing method, spoilage, and journal entries.

Spoilage represents the amount of resources that go into the process, but do not result in finished product. A simple way to account for spoilage in process costing is to calculate the amount of direct material that was spoiled. The journal entry to record the spoilage incurred in Aaron’s production process is: Manufacturing overhead control (normal spoilage) Work-in-process inventory (cost of spoiled sheet metal)

500 500

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

19-23 (15 min.)

Recognition of loss from spoilage.

1. The unit cost of making the 20,000 globes is: $800,000 ÷ 20,000 units = $40 per unit 2. The total cost of the 750 spoiled units is: $40 × 750 units = $30,000 3. The increase in the per-unit cost of goods sold as a result of the normal spoilage is: $30,000 ÷ 19,250 good units = $1.56 (rounded) Unit cost of goods sold for units remaining after the spoilage = $40 + $1.56 = $41.56. (Or $800,000 ÷ 19,250 = $41.56) 4. The $30,000 cost for the 750 spoiled units is taken out of manufacturing costs and expensed in the period of the spoilage. The journal entry to record the abnormal spoilage incurred is: Loss from abnormal spoilage Work-in-process control

30,000 30,000

19-24 (25 min.) Weighted-average method, spoilage. 1. Solution Exhibit 19-24, Panel A, calculates the equivalent units of work done to date for each cost category in September. 2. Solution Exhibit 19-24, Panel B, summarizes total costs to account for, calculates the costs per equivalent unit for each cost category, and assigns total costs to units completed (including normal spoilage), to abnormal spoilage, and to units in ending work in process using the weighted-average method.

Chapter 19: Spoilage, Rework, and Scrap

SOLUTION EXHIBIT 19-24 Weighted-Average Method of Process Costing with Spoilage; Chipcity, September. PANEL A: Steps 1 and 2—Summarize Output in Physical Units and Compute Output in Equivalent Units (Step 2) (Step 1) Equivalent Units Physical Direct Conversion Flow of Production Units Materials Costs Work in process, beginning (given) 600 Started during current period (given) 2,550 To account for 3,150 Good units completed and transferred out during current period: 2,100 2,100 2,100 Normal spoilage* 315 315 315 315  100%; 315  100% 285 Abnormal spoilage† 285 285 285  100%; 285  100% ‡ 450 Work in process, ending (given) 450 180 450  100%; 450  40% 3,150 Accounted for 3,150 2,880 Work done to date *Normal spoilage is 15% of good units transferred out: 15% × 2,100 = 315 units. Degree of

completion of normal spoilage in this department: direct materials, 100%; conversion costs, 100%. †Total spoilage = 600 + 2,550 – 2,100 – 450 = 600 units; Abnormal spoilage = Total spoilage  Normal spoilage = 600  315 = 285 units. Degree of completion of abnormal spoilage in this department: direct materials, 100%; conversion costs, 100%. ‡Degree of completion in this department: direct materials, 100%; conversion costs, 40%.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 19-24 PANEL B: Steps 3, 4, and 5—Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed, to Spoiled Units, and to Units in Ending Work in Process

(Step 3)

Work in process, beginning (given) Costs added in current period (given) Total costs to account for

(Step 4)

Costs incurred to date Divided by equivalent units of work done to date Cost per equivalent unit

Assignment of costs Good units completed and transferred out (2,100 units) Costs before adding normal spoilage Normal spoilage (315 units) (A) Total cost of good units completed and transferred out (B) Abnormal spoilage (285 units) (C) Work-in-process, ending (450 units) (A) + (B) + (C) Total costs accounted for

Total Production Costs $111,300 797,400 $908,700

Direct Materials $ 96,000 567,000 $663,000 $663,000  3,150 $210.476

Conversion Costs $ 15,300 230,400 $245,700 $245,700  2,880 $85.3125

(Step 5)

$621,156 93,173

(2,100#$210.476) + (2,100#$85.3125) (315#  $210.476) + (315#  $85.3125)

714,329 84,300 110,071 $908,700

(285#  $210.476) + (285#  $85.3125) (450#  $210.476) + (180#  $85.3125) $663,000 $245,700

#Equivalent units of direct materials and conversion costs calculated in Step 2 in Panel A.

19-25 (25 min.) FIFO method, spoilage. Refer to the information in Exercise 19-24. 1. Solution Exhibit 19-25, Panel A, calculates the equivalent units of work done in the current period for each cost category in September. 2. Solution Exhibit 19-25, Panel B, summarizes the total chip department costs for September, calculates the costs per equivalent unit for each cost category, and assigns total costs to units completed and transferred out (including normal spoilage), to abnormal spoilage, and to units in ending work in process under the FIFO method.

Chapter 19: Spoilage, Rework, and Scrap

SOLUTION EXHIBIT 19-25 First-in, First-out (FIFO) Method of Process Costing with Spoilage; Chipcity, September. PANEL A: Steps 1 and 2—Summarize Output in Physical Units and Compute Output in Equivalent Units

Flow of Production Work in process, beginning (given) Started during current period (given) To account for Good units completed and transferred out during current period: From beginning work in process|| 600  (100%  100%); 600  (100%  30%) Started and completed 1,500  100%; 1,500  100% Normal spoilage* 315  100%; 315  100% Abnormal spoilage† 285  100%; 285  100% Work in process, ending‡ 450  100%; 450  40% Accounted for Work done in current period only

(Step 1) Physical Units 600 2,550 3,150

(Step 2) Equivalent Units Direct Conversion Materials Costs

600 0

420

1,500

315

285

450

180

2,550

2,700

1,500# 315 285 450 3,150

||Degree of completion in this department: direct materials, 100%; conversion costs, 30%. #2,100 physical units completed and transferred out minus 600 physical units completed and

transferred out from beginning work in process inventory. *Normal spoilage is 15% of good units transferred out: 15%  2,100 = 315 units. Degree of

completion of normal spoilage in this department: direct materials, 100%; conversion costs, 100%. †Abnormal spoilage = Actual spoilage  Normal spoilage = 600  315 = 285 units. Degree of completion of abnormal spoilage in this department: direct materials, 100%; conversion costs, 100%. ‡Degree of completion in this department: direct materials, 100%; conversion costs, 40%.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 19-25 PANEL B: Steps 3, 4 and 5—Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed, to Spoiled Units, and to Units in Ending Work in Process

(Step 3)

Work in process, beginning (given) Costs added in current period (given) Total costs to account for

(Step 4)

Costs added in current period Divided by equivalent units of work done in current period Cost per equivalent unit

(Step 5)

Assignment of costs: Good units completed and transferred out (2,100 units) Work in process, beginning (600 units) Costs added to beg. work in process in current period Total from beginning inventory before normal spoilage Started and completed before normal spoilage (1,500 units) Normal spoilage (315 units) Total costs of good units completed and transferred out Abnormal spoilage (285 units) Work in process, ending (450 units)

(A) (B) (C)

(A) + (B) + (C)

Total costs accounted for

Total Production Costs $111,30 0 797,400 $908,70 0

$111,300 35,840

Direct Materials $ 96,000 567,000 $663,000

Conversion Costs $ 15,300 230,400 $245,700

$567,000  2,550 $222.353

$230,400  2,700 $ 85.333

$96,000 + $15,300 (0§  $222.353) + (420§  $85.333)

147,140 461,529 96,921 705,590

(1,500§  $222.353)+(1,500§$85.333) (315§  $222.353) + (315§ $85.333)

87,691 115,419 $908,700

(285§  $222.353) + (285§ $85.333) (450§  $222.353) + (180§  $85.333) $663,000 + $245,700

§Equivalent units of direct materials and conversion costs calculated in Step 2 in Panel A.

19-26 (30 min.) Standard-costing method, spoilage. 1. Solution Exhibit 19-25, Panel A, shows the computation of the equivalent units of work done in September for direct materials (2,550 units) and conversion costs (2,700 units). (This computation is the same for FIFO and standard-costing.) 2. The direct materials cost per equivalent unit of beginning work in process and of work done in September is the standard cost of $200 given in the problem. The conversion cost per equivalent unit of beginning work in process and of work done in September is the standard cost of $75 given in the problem. Solution Exhibit 19-26 summarizes the total costs to account for, and assigns these costs to units completed (including normal spoilage), to abnormal spoilage, and to units in ending work in process using the standard costing method.

Chapter 19: Spoilage, Rework, and Scrap

SOLUTION EXHIBIT 19-26 Standard Costing Method of Process Costing with Spoilage; Chipcity, September. Steps 3, 4, and 5—Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed, to Spoiled Units, and to Units in Ending Work in Process Total Production Costs (Step 3) Work in process, beginning* Costs added in current period at standard prices Costs to account for

$133,500 712,500 $846,000

(Step 4) Standard costs per equivalent unit (given)

275

Direct Materials

Conversion Costs

(600  $200) (2,550  $200) $630,000

(180  $75) (2,700  $75) $216,000

$ 200

(Step 5) Assignment of costs at standard costs: Good units completed and transferred out (2,100 units) BI WIP (600 units)* Costs added to BI WIP in current period Total from BI WIP before normal spoilage

(A) (B) (C)

$133,500 31,500 165,000

Started and completed before normal spoilage 412,500 (1,500 units) Normal spoilage (315 units) 86,625 Total costs of good units completed and transferred out 664,125 Abnormal spoilage (285 units) 78,375 Work in process, ending (450 units) 103,500

(A) + (B) + (C)

Total costs accounted for

$846,000

(600  $200) + (0§  $200) +

(180  $75) (420§  $75)

(1,500§  $200) + (1,500§  $75) (315§  $200) +

(315§  $75)

(285§  $200) + (450§  $200) +

(285§  $75) (180§  $75)

$630,000 +

$216,000

*Work in process, beginning has 600 equivalent units (600 physical units  100%) of direct

materials and 180 equivalent units (600 physical units  30%) of conversion costs. §Equivalent units of direct materials and conversion costs calculated in Step 2 in Solution Exhibit 19-25, Panel A.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

19-27 (20–30 min.) Spoilage and job costing. 1. Cash Loss from Abnormal Spoilage Work-in-Process Control Loss = ($6.00  200) – $200 = $1,000

200 1,000 1,200

Remaining cases cost = $6.00 per case. The cost of these cases is unaffected by the loss from abnormal spoilage. 2. a. Cash Work-in-Process Control

400 400

The cost of the remaining good cases = [($6.00  2,500) – $400] = $14,600 The unit cost of a good case now becomes $14,600  2,300 = $6.3478 b. Cash Manufacturing Department Overhead Control Work-in-Process Control

400 800 1,200

The unit cost of a good case remains at $6.00. c. The unit costs in 2a and 2b are different because in 2a the normal spoilage cost is charged as a cost of the job which has exacting job specifications. In 2b however, normal spoilage is due to the production process, not the particular attributes of this specific job. These costs are, therefore, charged as part of manufacturing overhead and the manufacturing overhead cost of $1 per case already includes a provision for normal spoilage. 3. a. Work-in-Process Control Materials Control, Wages Payable Control, Manufacturing Overhead Allocated

200 200

The cost of the good cases = [($6.00  2,500) + $200] = $15,200 The unit cost of a good case is $15,200  2,500 = $6.08 b. Manufacturing Department Overhead Control Materials Control, Wages Payable Control, Manufacturing Overhead Allocated

200 200

The unit cost of a good case = $6.00 per case c. The unit costs in 3a and 3b are different because in 3a the normal rework cost is charged as a cost of the job that has exacting job specifications. In 3b however, normal rework is due to the production process, not the particular attributes of this specific job. These costs are, therefore, charged as part of manufacturing overhead and the manufacturing overhead cost of $1 per case already includes a provision for this normal rework.

Chapter 19: Spoilage, Rework, and Scrap

19-28 (15 min.) Reworked units, costs of rework. 1. The two alternative approaches to account for the materials costs of reworked units are: a. To charge the costs of rework to the current period as a separate expense item as abnormal rework. This approach would highlight to Heyer Appliances the costs of the supplier problem. b. To charge the costs of the rework to manufacturing overhead as normal rework. 2. The $125 circulation motor cost is the cost of the actual circulation motors included in the dishwashers. The $110 circulation motors from the first supplier were eventually never used in any dishwashers, and that supplier is now bankrupt. The units have now been disposed of at zero disposal value. 3. The total costs of rework due to the defective circulation motors include the following: a. the labour and other conversion costs spent on substituting the new circulation motors; b. the costs of any extra negotiations to obtain the replacement circulation motors; c. any higher price the existing supplier may have charged to do a rush order for the replacement circulation motors; and d. ordering costs for the replacement circulation motors.

19-29 (25 min.) Scrap, job-order costing. 1. Journal entry to record scrap generated by a specific job and accounted for at the time scrap is sold is: Cash or Accounts Receivable Work-in-Process Control To recognize asset from sale of scrap. A memo posting is also made to the specific job record.

490 490

2. Scrap common to various jobs and accounted for at the time of its sale can be accounted for in two ways: a. Regard scrap sales as a separate line item of revenue (the method generally used when the dollar amount of scrap is immaterial): Cash or Accounts Receivable Sale of Scrap To recognize revenue from sale of scrap.

4,000 4,000

b. Regard scrap sales as offsets against manufacturing overhead (the method generally used when the dollar amount of scrap is material): Cash or Accounts Receivable Manufacturing Department Overhead Control To record cash raised from sale of scrap.

4,000 4,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. Journal entry to record scrap common to various jobs at the time scrap is returned to storeroom: Materials Control 4,000 Manufacturing Department Overhead Control 4,000 To record value of scrap returned to storeroom. When the scrap is reused as direct material on a subsequent job, the journal entry is: Work-in-Process Control 4,000 Materials Control 4,000 To record reuse of scrap on a job. Explanations of journal entries are provided here but are not required.

PROBLEMS 19-30 (30 min.) Weighted-average method, spoilage. Solution Exhibit 19-30 summarizes total costs to account for, calculates the equivalent units of work done to date for each cost category, and assigns total costs to units completed (including normal spoilage), to abnormal spoilage, and to units in ending work in process using the weighted-average method.

Chapter 19: Spoilage, Rework, and Scrap

SOLUTION EXHIBIT 19-30 Weighted-Average Method of Process Costing with Spoilage; Cleaning Department of the White Crab Company for May. PANEL A: Steps 1 and 2—Summarize Output in Physical Units and Compute Output in Equivalent Units

Flow of Production Work in process, beginning (given) Started during current period (given) To account for Good units completed and transferred out during current period: Normal spoilage* 1,850  100%; 1,850  100% Abnormal spoilage† 650  100%; 650 100% Work in process, ending‡ (given) 4,000  100%; 4,000  25% Accounted for Work done to date

(Step 1) Physical Units 2,500 22,500 25,000

(Step 2) Equivalent Units Direct Conversion Materials Costs

18,500

1,850

650

4,000

1,000

25,000

22,000

*Normal spoilage is 10% of good units transferred out: 10% × 18,500 = 1,850 units. Degree of

completion of normal spoilage in this department: direct materials, 100%; conversion costs, 100%. †Total spoilage = 2,500 + 22,500 – 18,500 – 4,000 = 2,500 units; Abnormal spoilage = 2,500 – 1,850 = 650 units. Degree of completion of abnormal spoilage in this department: direct materials, 100%; conversion costs, 100%. ‡Degree of completion in this department: direct materials, 100%; conversion costs, 25%.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 19-30 PANEL B: Steps 3, 4, and 5—Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed, to Spoiled Units, and to Units in Ending Work in Process Total Production Direct Conversion Costs Materials Costs (Step 3) Work in process, beginning (given) $ 4,500 $ 2,500 $ 2,000 Costs added in current period (given) 42,500 22,500 20,000 Total costs to account for $47,000 $25,000 $22,000 (Step 4)

Costs incurred to date Divided by equivalent units of work done to date Cost per equivalent unit

Assignment of costs Good units completed and transferred out (18,500 units) Costs before adding normal spoilage Normal spoilage (1,850 units) (A) Total costs of good units completed and transferred out (B) Abnormal spoilage (650 units) (C) Work in process, ending (4,000 units) (A) + (B) + (C) Total costs accounted for

$25,000 25,000 $ 1

$22,000 22,000 $ 1

(Step 5)

$37,000 3,700

(18,500#  $1) (1,850#  $1) +

(18,500#  $1) (1,850#  $1)

40,700 1,300 5,000 $47,000

(650#  $1) + (4,000#  $1) + $25,000 +

(650#  $1) (1,000#  $1) $22,000

#Equivalent units of direct materials and conversion costs calculated in Step 2 in Panel A above.

19-31

(25 min.) FIFO method, spoilage. Refer to the information in Problem 19-30.

For the cleaning department, Solution Exhibit 19-31 summarizes the total costs for May, calculates the equivalent units of work done in the current period for direct materials and conversion costs, and assigns total costs to units completed and transferred out (including normal spoilage), to abnormal spoilage, and to units in ending work in process under the FIFO method.

Chapter 19: Spoilage, Rework, and Scrap

SOLUTION EXHIBIT 19-31 First-in, First-out (FIFO) Method of Process Costing with Spoilage; Cleaning Department of the White Crab Company for May. PANEL A: Steps 1 and 2—Summarize Output in Physical Units and Compute Output in Equivalent Units (Step 2) (Step 1) Equivalent Units Physical Direct Conversion Flow of Production Units Materials Costs Work in process, beginning (given) 2,500 Started during current period (given) 22,500 To account for 25,000 Good units completed and transferred out during current period: From beginning work in process|| 2,500 2,500  (100% 100%); 2,500  (100%  80%) 0 500 Started and completed 16,000# 16,000  100%; 16,000  100% 16,000 16,000 Normal spoilage* 1,850 1,850  100%; 1,850%  100% 1,850 1,850 Abnormal spoilage† 650 650  100%; 650  100% 650 650 Work in process, ending‡ 4,000 4,000  100%; 4,000  25% 4,000 1,000 Accounted for 25,000 Work done in current period only 22,500 20,000 ||Degree of completion in this department: direct materials, 100%; conversion costs, 80%. #18,500 physical units completed and transferred out minus 2,500 physical units completed and

transferred out from beginning work-in-process inventory. *Normal spoilage is 10% of good units transferred out: 10%  18,500 = 1,850 units. Degree of

completion of normal spoilage in this department: direct materials, 100%; conversion costs, 100%. †Total spoilage = 2,500 + 22,500 – 18,500 – 4,000 = 2,500 units Abnormal spoilage = 2,500 – 1,850 = 650 units. Degree of completion of abnormal spoilage in this department: direct materials, 100%; conversion costs, 100%. ‡Degree of completion in this department: direct materials, 100%; conversion costs, 25%.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 19-31 PANEL B: Steps 3, 4, and 5—Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed, to Spoiled Units, and to Units in Ending Work in Process

(Step 3)

Work in process, beginning (given) Costs added in current period (given) Total costs to account for

(Step 4)

Costs added in current period Divided by equivalent units of work done in current period Cost per equivalent unit

Total Production Costs $ 4,500 42,500 $47,000

Assignment of costs: Good units completed and transferred out (18,500 units) Work in process, beginning (2,500 units) $ 4,500 Costs added to beg. work in process in current period 500 Total from beginning inventory before normal spoilage Started and completed before normal spoilage (16,000 5,000 units) Normal spoilage (1,850 units) (A) Total costs of good units completed and transferred out 32,000 (B) Abnormal spoilage (650 units) 3,700 (C) Work in process, ending (4,000 units) 40,700 (A) + (B) + (C) Total costs accounted for 1,300 5,000 $47,000

Direct Materials $ 2,500 22,500 $25,000

Conversion Costs $ 2,000 20,000 $22,000

$22,500 22,500 $ 1

$20,000 20,000 $ 1

$2,500 + (0§  $1) +

$2,000 (500§  $1)

(Step 5)

(16,000§  $1) + (16,000§  $1) (1,850§  $1) + (1,850§  $1) (650§  $1) + (650§  $1) (4,000§  $1) + (1,000§  $1) $25,000 + $22,000

§Equivalent units of direct materials and conversion costs calculated in Step 2 in Panel A.

19-32 (35 min.) Weighted-average method, Packaging department (continuation of Problem 19-30). For the packaging department, Solution Exhibit 19-32 summarizes total costs to account for, calculates the equivalent units of work done to date for each cost category, and assigns costs to units completed (including normal spoilage), to abnormal spoilage, and to units in ending work in process using the weighted-average method.

Chapter 19: Spoilage, Rework, and Scrap

SOLUTION EXHIBIT 19-32 Weighted-Average Method of Process Costing with Spoilage; Packaging Department of the White Crab Company for May. PANEL A: Steps 1 and 2—Summarize Output in Physical Units and Compute Output in Equivalent Units (Step 2) (Step 1) Equivalent Units Physical TransferredDirect Conversion Flow of Production Units in Costs Materials Costs Work in process, beginning (given) 7,500 Started during current period (given) 18,500 To account for 26,000 Good units completed and transferred out during current period: 15,000 15,000 15,000 15,000 Normal spoilage* 750 750  100%; 750  100%; 750  100% 750 750 750 Abnormal spoilage† 250 250  100%; 250 100%, 250  100% 250 250 250 Work in process, ending‡ (given) 10,000 10,000 100%; 10,0000%; 10,00025% 10,000 0 2,500 Accounted for 26,000 ______ Work done to date 26,000 16,000 18,500 *Normal spoilage is 5% of good units transferred out: 5%  15,000 = 750 units. Degree of

completion of normal spoilage in this department: transferred-in costs, 100%; direct materials, 100%; conversion costs, 100%. †Total spoilage =7,500 + 18,500 – 15,000 – 10,000 = 1,000 units. Abnormal spoilage = 1,000 – 750 = 250 units. Degree of completion of abnormal spoilage in this department: transferred-in costs, 100%; direct materials, 100%; conversion costs, 100%. ‡Degree of completion in this department: transferred-in costs, 100%; direct materials, 0%; conversion costs, 25%.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 19-32 PANEL B: Steps 3, 4, and 5—Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed, to Spoiled Units, and to Units in Ending Work in Process Total Production TransferredCosts in costs (Step 3)

Work in process, beginning (given) Costs added in current period (given) Total costs to account for

(Step 4)

Costs incurred to date Divided by equivalent units of work done to date Cost per equivalent unit

$22,250 54,675 $76,925

Assignment of costs Good units completed and transferred out (15,000 units) Costs before adding normal spoilage $49,284 Normal spoilage (750 units) 2,464 (A) Total cost of good units completed and transferred out 51,748 (B) Abnormal spoilage (250 units) 821 (C) Work in process, ending (10,000 units) 24,356 (A) + (B) + (C) Total costs accounted for $76,925

Direct Materials

Conversion Costs

$16,125 40,700* $56,825

0 1,600 $1,600

$ 6,125 12,375 $18,500

56,825 26,000 $2.1856

1,600  16,000 $ 0.10

18,500 18,500 $ 1

(Step 5)

15,000#  ($2.1856 + $0.10 + $1) 750#  ($2.1856 + $0.10 + $1) 250#  ($2.1856 + $0.10 + $1) (10,000#  $2.1856) + (0#  $0.10) + (2,500#  $1) $56,825 +

$1,600

$18,500

*Total costs of good units completed and transferred out in Panel B (Step 5) of Solution Exhibit 19-30. #Equivalent units of direct materials and conversion costs calculated in Step 2 in Panel A above.

19-33 (25 min.) FIFO method, packaging department (continuation of 19-31). Solution Exhibit 19-33 summarizes the total packaging department costs for May, shows the equivalent units of work done in the packaging department in the current period for transferredin costs, direct materials, and conversion costs, and assigns total costs to units completed and transferred out (including normal spoilage), to abnormal spoilage, and to units in ending workin-process under the FIFO method.

Chapter 19: Spoilage, Rework, and Scrap

SOLUTION EXHIBIT 19-33 First-in, First-out (FIFO) Method of Process Costing with Spoilage; Packaging Department of the White Crab Company for May. PANEL A: Steps 1 and 2—Summarize Output in Physical Units and Compute Output in Equivalent Units (Step 2) (Step 1) Equivalent Units Physical Transferred Direct Conversion Flow of Production Units in Costs Materials Costs Work in process, beginning (given) 7,500 Started during current period (given) 18,500 To account for 26,000 Good units completed and transferred out during current period: From beginning work in process|| 7,500 7,500  (100%  100%); 7,500  (100%  0%); 7,500  (100%  80%) 0 7,500 1,500 Started and completed 7,500  100%; 7,500  100%; 7,500  7,500# 100% 7,500 7,500 7,500 Normal spoilage* 750  100%; 750%  100%; 750  100% 750 Abnormal spoilage† 750 750 750 250 250  100%; 250  100%; 250  100% 250 250 250 Work in process, ending‡ 10,000  100%; 10,000  0%; 10,000  25% 10,000 10,000 0 2,500 Accounted for 26,000 Work done in current period only 18,500 16,000 12,500 ||Degree of completion in this department: transferred-in costs, 100%; direct materials, 0%;

conversion costs, 80%. #15,000 physical units completed and transferred out minus 7,500 physical units completed and transferred out from beginning work-in-process inventory. *Normal spoilage is 5% of good units transferred out: 5%  15,000 = 750 units. Degree of completion of normal spoilage in this department: transferred-in costs, 100%; direct materials, 100%; conversion costs, 100%. †Total spoilage = 7,500 + 18,500 – 15,000 – 10,000 = 1,000 units. Abnormal spoilage = 1,000 – 750 = 250 units. Degree of completion of abnormal spoilage in this department: transferred-in costs, 100%; direct materials, 100%; conversion costs, 100%. ‡Degree of completion in this department: transferred-in costs, 100%; direct materials, 0%; conversion costs, 25%.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 19-33 PANEL B: Steps 3, 4, and 5—Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed, to Spoiled Units, and to Units in Ending Work in Process Total Production Costs (Step 3)

(Step 4)

Work in process, beginning (given) Costs added in current period (given) Total costs to account for

Transferredin Costs

$22,250 54,675 $76,925

$16,125 40,700* $56,825

Costs added in current period Divided by equivalent units of work done in current period Cost per equivalent unit

Assignment of costs: Good units completed and transferred out (15,000 units) Work in process, beginning (7,500 units) $22,250 Costs added to beg. work in process in current period 2,235 Total from beginning inventory before normal spoilage 24,485 Started and completed before normal spoilage (7,500 units) 24,675 Normal spoilage (750 units) 2,467 (A) Total costs of good units completed and transferred out 51,627 (B) Abnormal spoilage (250 units) 823 (C) Work in process, ending (10,000 units) 24,475 (A) + (B) + (C) Total costs accounted for $76,925

Direct Materials

Conversion Costs

$40,700 18,500 $ 2.20

0 1,600 $1,600

$ 6,125 12,375 $18,500

$1,600 ÷ 16,000 $ 0.10

$12,375 12,500 $ 0.99

(Step 5)

$16,125

$6,125

(0  $2.20) + (7,500§  0.10) + (1,500§  $0.99)

7,500§  ($2.20 + $0.10 + $0.99) 750§  ($2.20 + $0.10 + $0.99) 250§  ($2.20 + $0.10 + $0.99) (10,000§  $2.20) + (0§  $0.10) + (2,500§  $0.99) $56,825 + $1,600 + $18,500

*Total costs of good units completed and transferred out in Step 5 Panel B of Solution Exhibit 19-31. §Equivalent units of direct materials and conversion costs calculated in Step 2 in Panel A.

Chapter 19: Spoilage, Rework, and Scrap

19-34 (15 min.) Spoilage in job costing 1. Normal spoilage rate = Units of normal spoilage ÷ Total good units completed = 6 ÷ 40 = 15%. 2. a) Journal entry for spoilage related to a specific job: Materials Control (spoiled goods at current disposal value) 6 × $235 Work-in-Process Control (Job #10)

1,410 1,410

Note: The costs incurred on the bad units (6 × $1,100) are already part of the balance in WIP. The cost of the 40 good units is (40 × 1,100) + (6 × $865) = $49,190 b) Journal entry for spoilage common to all jobs: Materials Control (spoiled goods at current disposal value) 6 × $235 Manufacturing Overhead Control (normal spoilage) Work-in-Process Control (Job #10)

1,410 5,190 6,600

Note: In developing the predetermined O/H rate, the budgeted manufacturing overhead would include expected normal spoilage costs. c) Journal entry for abnormal spoilage: Materials Control (spoiled goods at current disposal value) 6 × $235 Loss from Abnormal Spoilage 6 × $865 Work-in-Process Control (Job #10)

1,410 5,190 6,600

Note: If the spoilage is abnormal, the net loss is highlighted and always charged to an abnormal loss account.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

19-35 (25 min.) Weighted-average method, spoilage 1. PHYSICAL FLOW Beginning WIP Started into production To account for Completed & transferred out Normal spoilage (15%)* Abnormal spoilage* Ending WIP Accounted for Work done to date (1)

Physical UNITS 400 1,700 2,100 1,400 210 190 300 2,100

Equivalent units MATERIALS CONVERSION

1,400 210 190 300 (100%)

1,400 210 190 120 (40%)

2,100

1,920

*Normal spoilage is 15% of good units produced or 1,400 × 15% = 210. The number of units of

abnormal spoilage is equal to 2,100 total units to account for – 1,400 good units – 210 normal spoilage – 300 in ending WIP = 190. Note that spoilage is identified at the end of the process and units are complete as to both materials and conversion costs. 2. COST RECONCILIATION Beginning WIP Added this period Costs to account for Cost of work done to date (2) Cost per equivalent unit (2)/(1) 3. Cost assignment Completed & transferred out** Normal spoilage** Total cost of good units Abnormal spoilage** Ending WIP** Costs accounted for

$ 89,040 637,920 $726,960

$ 496,925 74,539 571,464 67,440 88,056 $726,960

$ 76,800 453,600

$ 12,240 184,320

$530,400 $252.571

$196,560 $102.375

$353,600 53,040

$143,325 21,499

47,989 75,771 $530,400

19,451 12,285 $196,560

Cost of goods completed and transferred out, normal spoilage, abnormal spoilage, and ending work-in-process inventory are equal to the appropriate equivalent unit amount for each item multiplied by the cost per equivalent unit for that item. For example: 1,400 × $102.375 = $143,325. Note that we add across the individual item costs to determine the total cost of each line in the table. **

Chapter 19: Spoilage, Rework, and Scrap

19-36 (25 min.) FIFO method. Refer to information in Problem 19-35. Physical PHYSICAL FLOW UNITS Beginning WIP 400 Started into production 1,700 To account for 2,100 Current period only Completion of beginning WIP 400 Started and completed 1,000 Normal spoilage* 210 * Abnormal spoilage 190 Ending WIP 300 Accounted for 2,100 Work done in current period (1)

Equivalent units MATERIALS CONVERSION 400 (100%) 120 (30%)

0 1,000 210 190 300 (100%)

280 (70%) 1,000 210 190 120 (40%)

1,700

1,800

*Normal spoilage is 15% of good units produced or 1,400 × 15% = 210. The number of units of

abnormal spoilage is equal to 2,100 total units to account for – 1,400 good units completed – 210 normal spoilage – 300 in ending WIP = 190. Note that spoilage is identified at the end of the process and units are complete as to both materials and conversion costs. COST RECONCILIATION Beginning WIP** Added this period (2) Costs to account for Cost per equivalent unit this period (2)/(1)

Materials $ 89,040 637,920 $726,960

Conversion Costs

$453,600

$184,320

$266.824

$ 102.40

76,800 0 266,824 56,033

12,240 28,672 102,400 21,504

50,696 80,047 $530,400

19,456 12,288 $196,560

**$76,800 + $12,240 = $89,040

Cost assignment Beginning WIP $ 89,040 Completion of beginning WIP*** 28,672 *** Started and completed 369,224 Normal spoilage*** 77,537 Total cost of good units 564,473 Abnormal spoilage*** 70,152 *** Ending WIP 92,335 Costs accounted for $726,960

Costs to complete beginning WIP, started and completed, normal spoilage, abnormal spoilage, and ending work-in-process inventory are equal to the appropriate equivalent unit amount for each item multiplied by the cost per equivalent unit for that item. For example: 280 × $102.40 = $28,672. Note that we add across the individual item costs to determine the total cost of each line in the table. ***

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

19-37 (30 min.) Standard-costing method, spoilage. Refer to the information in Problem 19-35. PHYSICAL FLOW Beginning WIP Started into production To account for Current period only Completion of beginning WIP Started and completed Normal spoilage* Abnormal spoilage* Ending WIP Accounted for Work done in current period (1)

Physical UNITS 400 1,700 2,100 400 1,000 210 190 300 2,100

Equivalent units MATERIALS CONVERSION

0 1,000 210 190 300 (100%)

280 (70%) 1,000 210 190 120 (40%)

1,700

1,800

*Normal

spoilage is 15% of good units produced or 1,400 × 15% = 210. The number of units of abnormal spoilage is equal to 2,100 total units to account for – 1,400 good units – 210 normal spoilage – 300 in ending WIP = 190. Note that spoilage is identified at the end of the process and units are complete as to both materials and conversion costs. Cost per equivalent unit (given) COST RECONCILIATION Beginning WIP* Added this period*

$109,920 591,000

Costs to account for

$700,920

$ 246

$ 96

$ 98,400 $418,200

$ 11,520 $172,800

$ 98,400 0 246,000 51,660

$ 11,520 26,880 96,000 20,160

At standard cost

Cost assignment Beginning WIP $109,920 Completion of beginning WIP** 26,880 Started and completed** 342,000 Normal spoilage** 71,820 Total cost of good units 550,620 Abnormal spoilage**

64,980

46,740

18,240

Ending WIP** Costs accounted for

85,320 $700,920

73,800 $516,600

11,520 $184,320

**Cost of goods completed and transferred out, normal spoilage, abnormal spoilage, and ending

work-in-process inventory are equal to the appropriate equivalent unit amount for each item multiplied by the cost per equivalent unit for that item. For example: 1,000 × $246 = $246,000. Note that we add across the individual item costs to determine the total cost of each line in the table.

Chapter 19: Spoilage, Rework, and Scrap

19-38 (2025 min.) Physical units, inspection at various stages of completion.

Work in process, beginning (20%)* Started during March To account for Good units completed and transferred out Normal spoilage Abnormal spoilage (10,000 – normal spoilage) Work in process, ending (70%)* Accounted for

Inspection at 15% 14,000 120,000 134,000 113,000a

Inspection at 40% 14,000 120,000 134,000 113,000a

Inspection at 100% 14,000 120,000 134,000 113,000a

6,600b 3,400

7,440c 2,560

6,780d 3,220

11,000 134,000

*Degree of completion for conversion costs of the forging process at the dates of the work-in-

process inventories a14,000 beginning inventory +120,000 –10,000 spoiled – 11,000 ending inventory = 113,000. b6%  (120,000 units started – 10,000 units spoiled) = 6%  110,000 = 6,600; beginning work-

in-process inventory is excluded because it was already 20% complete at March 1 and past the inspection point. c6%  (134,000 units – 10,000 ) = 6%  124,000 = 7,440, because all units passed the 40% completion inspection point in March. d6%  113,000 = 6,780, because 113,000 units are fully completed and inspected during March.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

19-39 (2535 min.) Weighted-average method, inspection at 80% completion. The computation and allocation of spoilage is the most difficult part of this problem. The units in the ending inventory have passed inspection. Therefore, of the 100,000 units to account for (12,500 beginning + 87,500 started), 12,500 must have been spoiled in August [100,000 – (62,500 completed + 25,000 ending inventory)]. Normal spoilage is 8,750 [0.10  (62,500 + 25,000)]. The 3,750 remainder is abnormal spoilage (12,500 – 8,750). Solution Exhibit 19-39, Panel A, calculates the equivalent units of work done for each cost category. We comment on several points in this calculation:   

Ending work in process includes an element of normal spoilage since all the ending WIP has passed the point of inspection––inspection occurs when production is 80% complete, while the units in ending WIP are 95% complete. Spoilage includes no direct materials units because spoiled units are detected and removed from the finishing activity when inspection occurs at the time production is 80% complete. Direct materials are added only later when production is 90% complete. Direct materials units are included for ending work in process, which is 95% complete, but not for beginning work in process, which is 25% complete. The reason is that direct materials are added when production is 90% complete. The ending work in process, therefore, contains direct materials units; the beginning work in process does not.

Solution Exhibit 19-39, Panel B, summarizes total costs to account for, computes the costs per equivalent unit for each cost category, and assigns costs to units completed (including normal spoilage), to abnormal spoilage, and to units in ending work in process using the weighted-average method. The cost of ending work in process includes the assignment of normal spoilage costs since these units have passed the point of inspection. The costs assigned to each cost category are as follows: Cost of good units completed and transferred out (including normal spoilage costs on good units) Abnormal spoilage Cost of ending work in process (including normal spoilage costs on ending work in process) Total costs assigned and accounted for

$2,346,687 84,638 917,675 $3,349,000

Chapter 19: Spoilage, Rework, and Scrap

SOLUTION EXHIBIT 19-39 Weighted-Average Method of Process Costing with Spoilage; Finishing Department of the Ottawa Manufacturing Company for August. PANEL A: Steps 1 and 2—Summarize Output in Physical Units and Compute Output in Equivalent Units (Step 2) (Step 1) Equivalent Units Physical Transferred Direct Conversion Flow of Production Units Materials Costs in Costs Work in process, beginning (given) 12,500 Started during current period (given) 87,500 To account for 100,000 Good units completed and transferred out during current period: 62,500 62,500 62,500 62,500 Normal spoilage on good units* 6,250 6,250 0 5,000 6,250  100%; 6,250  0%; 6,250  80% ‡ 25,000 Work in process, ending (given) 25,000 25,000 23,750 25,000  100%; 25,000  100%; 25,000  95% 2,500 Normal spoilage on ending WIP** 2,500 0 2,000 2,500  100%; 2,500  0%; 2,500  80% † 3,750 Abnormal spoilage 3,750 0 3,000 3,750  100%; 3,750  0%; 3,750  80% 100,000 Accounted for 100,000 87,500 96,250 Work done to date *Normal spoilage is 10% of good units that pass inspection: 10% × 62,500 = 6,250 units. Degree

of completion of normal spoilage in this department: transferred-in costs, 100%; direct materials, 0%; conversion costs, 80%. ‡Degree of completion in this department: transferred-in costs, 100%; direct materials, 100%; conversion costs, 95%. **Normal spoilage is 10% of the good units in ending WIP that have passed the inspection point, 10%  25,000 = 2,500 units. Degree of completion of normal spoilage in this department: transferred-in costs, 100%; direct materials, 0%; conversion costs, 80%. †Abnormal spoilage = Actual spoilage  Normal spoilage = 12,500  8,750 = 3,750 units. Degree of completion of abnormal spoilage in this department: transferred-in costs, 100%; direct materials, 0%; conversion costs, 80%.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 19-39 PANEL B: Steps 3, 4, and 5—Summarize Total Costs to Account For, Compute Cost per Equivalent Unit, and Assign Total Costs to Units Completed, to Spoiled Units, and to Units in Ending Work in Process

(Step 3)

Work in process, beginning (given) Costs added in current period (given) Total costs to account for

(Step 4)

Costs incurred to date Divided by equivalent units of work done to date Cost per equivalent unit

(Step 5)

Total Production Costs

Transferredin Costs

$ 156,125 3,192,875 $3,349,000

$103,625 809,375 $913,000

$  819,000 $819,000

$ 52,500 1,564,500 $1,617,000

$913,000 100,000

$819,000  87,500

$1,617,000  96,250

Assignment of costs Good units completed and transferred out (62,500 units) Costs before adding normal spoilage $2,205,625 141,063 Normal spoilage (6,250 units) (A) Total costs of good units completed and 2,346,687 transferred out 84,638 (B) Abnormal spoilage (3,750 units) Work in process, ending (25,000 units) 861,250 WIP ending, before normal spoilage Normal spoilage on ending WIP 56,425 (C) Total costs of ending WIP 917,675 (A)+(B)+(C) Total costs accounted for $3,349,000

9.13

Direct Materials

9.36

Conversion Costs

16.80

62,500#  ($9.13 + $9.36 + $16.80) (6,250#  $9.13) + (0#  $9.36) + (5,000#  $16.80) (3,750#  $9.13) + (0#  $9.36) + (3,000#  $16.80) (25,000#$9.13) + (25,000#  $9.36) + (23,750#  $16.80) (2,500#  $9.13) + (0#  $9.36) + (2,000#  $16.80) $913,000 +

$819,000 +

$1,617,000

#Equivalent units of transferred-in costs, direct materials, and conversion costs calculated in Step

2 in Panel A.

Chapter 19: Spoilage, Rework, and Scrap

19-40 (15 min.) Spoilage in job costing 1. Normal spoilage rate = Units of normal spoilage ÷ Total good units completed = 5 ÷ 40 = 12.5%. 2. a) Journal entry for spoilage related to a specific job: Materials Control (spoiled goods at current disposal value) 5 × $200 Work-in-Process Control (Job #10)

1,000 1,000

Note: The costs incurred on the bad units (5 × $1,000) are already part of the balance in WIP. The cost of the 40 good units is (40 × 1,000) + (5 × $800) = $44,000 b) Journal entry for spoilage common to all jobs: Materials Control (spoiled goods at current disposal value) 5 × $200 Manufacturing Overhead Control (normal spoilage) Work-in-Process Control (Job #10)

1,000 4,000 5,000

Note: In developing the predetermined O/H rate, the budgeted manufacturing overhead would include expected normal spoilage costs. c) Journal entry for abnormal spoilage: Materials Control (spoiled goods at current disposal value) 5 × $200 Loss from Abnormal Spoilage 5 × $800 Work-in-Process Control (job #10)

1,000 4,000 5,000

Note: If the spoilage is abnormal, the net loss is highlighted and always charged to an abnormal loss account.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

19-41 (10 min.) Rework in job costing, journal entry. a) Journal entry for rework related to a specific job: Work-in-Process Control (Job #10) Various Accounts (To charge rework costs to the job)

1,800 1,800

b) Journal entry for rework common to all jobs: Manufacturing Overhead Control (rework costs) Various Accounts

1,800

c) Journal entry for abnormal rework: Loss from Abnormal Rework Various Accounts

1,800

19-42 (10 min.) Scrap at time of sale or at time of production, journal entries. a) Journal entry for recognizing immaterial scrap at time of sale: Cash or Accounts Receivable 300 Scrap Revenues 300 (To record other revenue sale of scrap) b) Journal entry for recognizing material scrap related to a specific job at time of sale: Cash or Accounts Receivable 300 Work-in-Process Control (Job #10) 300 c) Journal entry for recognizing material scrap common to all jobs at time of sale: Cash or Accounts Receivable 300 Manufacturing Overhead Control 300 d) Journal entry for recognizing material scrap as inventory at time of production and recording at net realizable value: Materials Control 300 Work-in-Process Control (Job #10) 300 Cash or Accounts Receivable Materials Control (When later sold)

300 300

Chapter 19: Spoilage, Rework, and Scrap

19-43 (30 min.) Job costing, rework. 1.

Work-in-Process Control (CS1 chips) ($110  80) Materials Control ($60  80) Wages Payable ($12  80) Manufacturing Overhead Allocated ($38  80) Total costs assigned to 80 spoiled units of CS1 chips before considering rework costs.

8,800

Manufacturing Department Overhead Control (rework) Materials Control ($12  50) Wages Payable ($9  50) Manufacturing Overhead Allocated ($15  50) Normal rework on 50 units, but not attributable specifically to the CS1 chip batches or jobs.

1,800

Loss from Abnormal Rework ($36  30) Materials Control ($12  30) Wages Payable ($9  30) Manufacturing Overhead Allocated ($15  30) Total costs of abnormal rework on 30 units (Abnormal rework = Actual rework – Normal rework = 80 – 50 = 30 units) of CS1 chips.

1,080

Work-in-Process Control (CS1 chips) Work-in-Process Control (CS2 chips) Manufacturing Department Overhead Allocated (rework) (Allocating manufacturing department rework costs to CS1 and CS2 in the proportion 1,000:500 since each chip requires the same number of machine-hours.)

1,200 600

4,800 960 3,040

600 450 750

360 270 450

1,800

Total rework costs for CS1 chips in August are as follows: Normal rework costs allocated to CS1 Abnormal rework costs for CS1 Total rework costs

$1,200 1,080 $2,280

We emphasize two points: a. Only $1,200 of the normal rework costs are allocated to CS1 even though the normal rework costs of the 50 CS1 chips reworked equal $1,800. The reason is that the normal rework costs are not specifically attributable to CS1. For example, the machines happened to malfunction when CS1 was being made, but the rework was not caused by the specific requirements of CS1. If it were, then all $1,800 would be charged to CS1.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

b. Abnormal rework costs of $1,080 are linked to CS1 in the management control system even though for financial reporting purposes the abnormal rework costs are written off to the income statement.

19-44 (40 min.) Job costing, classifying spoilage, ethics. 1. Analysis of the 6,000 units rejected by Flextron Company for Job No. M102 yields the following breakdown between normal and abnormal spoilage. Units 2,500 3,500 6,000

Normal spoilage* Abnormal spoilage (6,000 – 2,500) Total units rejected *Normal spoilage = 0.02 of normal input When output equals 122,500 units, Normal input = 122,500 ÷ (1– 0.02) = 125,000 units Normal spoilage = 125,000  0.02 = 2,500 units

2. The journal entries required to properly account for Job No. M102 are presented below and use an average cost per unit of $27 ($3,469,500 ÷ 128,500). 1

Accounts Receivable or Cash 2 Abnormal loss 3 WIP Control To account for 6,000 units rejected.

24,000 80,500 104,500

Finished Good Control 3,365,000 WIP Control 3,365,000 To transfer 128,500 units to finished goods inventory (costs incurred on job and debited to WIP Control, $3,469,500, minus $104,500 credited to WIP control). 1 2

Units sold: 6,000 units at $4 each. Loss from abnormal spoilage: 3,500 units at $27 Cost recovery (3,500  $4) WIP control: 3,500 abnormal spoilage units at $27 2,500 normal spoilage units at $4

$ 94,500 (14,000) $ 80,500 $ 94,500 10,000 $104,500

Chapter 19: Spoilage, Rework, and Scrap

3a. If all spoilage were considered normal, the journal entries to account for Job No. M102 would be as follows: Accounts Receivable or Cash 24,000 WIP Control 24,000 To account for 6,000 units of normal spoilage, credited to WIP Control at $24,000 (6,000 units  $4). Finished Goods Control 3,445,500 WIP Control 3,445,500 To transfer 128,500 units to finished-goods inventory (costs incurred on job and debited to WIP Control, $3,469,500, minus $24,000 credited to WIP Control). By considering all spoilage as normal, Flextron will show no abnormal loss of $80,500 (see requirement 2) but instead will add $80,500 to the finished-goods inventory [$3,445,500 (in requirement 3a) minus $3,365,000 (in requirement 2)]. As a result, showing all spoilage as normal will increase Flextron’s operating income by $80,500. 3b. Incorrect reporting of spoilage as normal instead of abnormal with the goal of increasing operating income is unethical. In assessing the situation, the management accountant should consider the following: Competence Spoilage should be accounted for using relevant and reliable information. Accounting for spoilage incorrectly to make the company’s operating performance look better than it is violates competence standards. It is unethical for Chadwick to suggest that Suarez change abnormal spoilage to normal spoilage in order to make operating performance look good. Integrity The management accountant has a responsibility to avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict. Chadwick’s motivation for wanting Suarez to revise the quality figures could well have been motivated by Chadwick’s desire to please senior management. This action could be viewed as violating the responsibility for integrity. The Standards of Ethical Conduct require the management accountant to communicate favourable as well as unfavourable information. In this regard, both Chadwick’s and Suarez’s behaviour (if Suarez agrees to modify the spoilage classification) could be viewed as unethical. Objectivity The management accountant's standards of ethical conduct require that information should be fairly and objectively communicated and that all relevant information should be disclosed. From a management accountant's standpoint, showing abnormal spoilage as normal spoilage to make operating performance look good would violate the standard of objectivity. For the various reasons cited above, we should take the position that Chadwick’s and Suarez's behaviour (if Suarez goes along with Chadwick’s wishes) is unethical. Suarez should indicate to Chadwick that the classification of normal and abnormal spoilage established by Flextron Company is, indeed, appropriate. If Chadwick still insists on modifying the spoilage classification for this job to report higher operating income figures, Suarez should raise the matter with one of Chadwick’s superiors. If, after taking all these steps there is continued pressure to overstate operating income, Suarez should consider resigning from the company rather than engaging in unethical behaviour.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

19-45 (2025 min.) Physical units, inspection at various stages of completion.

Work in process, beginning (20%)* Started during March To account for Good units completed and transferred out Normal spoilage Abnormal spoilage (12,000 – normal spoilage) Work in process, ending (70%)* Accounted for

Inspection at 15% 16,000 129,000 145,000 a 120,000 b

Inspection at 40% 16,000 129,000 145,000 a 120,000 c

Inspection at 100% 16,000 129,000 145,000 a 120,000 d

8,190 3,810

9,310 2,690

8,400 3,600

13,000 145,000

*Degree of completion for conversion costs of the forging process at the dates of the work-in-

process inventories a16,000 beginning inventory +129,000 –12,000 spoiled – 13,000 ending inventory = 120,000. b7%  (129,000 units started – 12,000 units spoiled) = 7%  117,000 = 8,190; beginning workin-process inventory is excluded because it was already 20% complete at March 1 and past the inspection point. c7%  (145,000 units – 12,000 ) = 7%  133,000 = 9,310, because all units passed the 40% completion inspection point in March. d7%  120,000 = 8,400, because 120,000 units are fully completed and inspected during March.

19-46 (30 min.) Job costing, scrap. 1. Materials Control Materials-Related Manufacturing Overhead Control (To record scrap common to all jobs at the time it is returned to the storeroom)

$8,400

2. Cash or Accounts Receivable Materials Control (To record sale of scrap from the storeroom)

$8,400

Chapter 19: Spoilage, Rework, and Scrap

3. A summary of the manufacturing costs for HM3 and JB4 before considering the value of scrap are as follows: HM3 JB4 Total Costs Cost Cost per Total per Total Unit Costs Unit Costs (1) (2) = (1)  20,000 (3) (4) = (3)  10,000(5) = (2) + (4) $12.00 $240,000 $18.00 $180,000 $420,000 3.60 72,000 4.80 48,000 120,000

Direct materials Direct manufacturing labour Materials-related manufacturing overhead (20% of direct materials)2.40 Other manufacturing overhead (200% of direct manufacturing labour) 7.20 Total $25.20

48,000

3.60

36,000

84,000

144,000 9.60 $504,000 $36.00

96,000 $360,000

240,000 $864,000

The value of scrap generated during March of $8,400 will reduce materials-related manufacturing overhead costs by $8,400 from $84,000 to $75,600. Materials-related manufacturing overhead will then be allocated at 18% of direct materials costs ($75,600 ÷ $420,000 = 0.18). The revised manufacturing cost per unit would then be: HM3 JB4 Total Costs Cost Cost per Total per Total Unit Costs Unit Costs (1) (2)=(1)  20,000 (3) (4)=(3)  10,000 (5)=(2)+(4) $12.00 $240,000 $18.00 $180,000 $420,000 3.60 72,000 4.80 48,000 120,000

Direct materials Direct manufacturing labour Materials-related manufacturing overhead (18% of direct materials) 2.16 Other manufacturing overhead (200% of direct manufacturing labour) 7.20 Total $24.96

43,200

3.24

32,400

75,600

144,000 $499,200

9.60 $35.64

96,000 $356,400

240,000 $855,600

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

COLLABORATIVE LEARNING CASE 19-47 (35 min.) FIFO method, spoilage, working backward. 1. Equivalent units of work done in the current period can be calculated using Step 2 as follows:

Costs added in January Divided by costs per equivalent unit of work done in January Equivalent units of work done in January

Direct Materials $1,776,000

Conversion Costs $1,130,400

$24 74,000

$14.40 78,500

2. Solution Exhibit 19-47, Panel A, shows the equivalent units of work done (a) to complete beginning work-in-process inventory, (b) to start and complete new units, (c) for normal spoilage, (d) for abnormal spoilage and (e) work in process inventory. 3. The physical units of ending work in process can be calculated by taking total physical units to account for, 84,000 (beginning work in process, 10,000 plus units started 74,000) and subtracting good units completed and transferred out, 61,000; normal spoilage, 6,710; and abnormal spoilage, 1,290, to obtain 15,000 physical units in ending work in process. The percentage of completion of ending work in process for each cost category can then be calculated as follows: Direct Conversion Materials Costs Equivalent units of ending work in process (requirement 2) 15,000 12,000 Divided by physical units of ending work in process ÷15,000 ÷15,000 Percentage of completion of ending work in process 100% 80% 4. Solution Exhibit 19-47, Panel B summarizes total costs to account for, and assigns these costs to units completed and transferred out (including normal spoilage), to abnormal spoilage, and to units in ending work in process.

Chapter 19: Spoilage, Rework, and Scrap

SOLUTION EXHIBIT 19-47 First-in, First-out (FIFO) Method of Process Costing with Spoilage Cooking Department of Deli Inc. for January PANEL A: Steps 1 and 2—Summarize Output in Physical Units and Compute Equivalent Units

Flow of Production Work in process, beginning (given) Started during current period (given) To account for Good units completed and transferred out during current period: From beginning work in process* 10,000  (100% – 100%); 10,000  (100% – 25%) Started and completed 51,000  100%; 51,000  100% Normal spoilage** 6,710  100%; 6,710%  100% Abnormal spoilage† 1,290  100%; 1,290  100% Work in process, ending‡ 15,000  100%; 15,000  80% Accounted for Work done in current period only

(Step 1) Physical Units 10,000 74,000 84,000

(Step 2) Equivalent Units Direct Conversion Materials Costs

10,000 0

7,500

51,000

6,710

1,290

15,000

12,000

74,000

78,500

51,000# 6,710 1,290 15,000 84,000

*Degree of completion in this department: direct materials, 100%; conversion costs, 25%.

#61,000 physical units completed and transferred out minus 10,000 physical units completed and transferred out from beginning work-in-process inventory. **Normal spoilage is 11% of good units transferred out: 11%  61,000 = 6,710 units. Degree of completion of normal spoilage in this department: direct materials, 100%; conversion costs, 100%. †Abnormal spoilage = Actual spoilage – Normal spoilage = 8,000 – 6,710 = 1,290 units. Degree of completion of abnormal spoilage in this department: direct materials, 100%; conversion costs, 100%. ‡Degree of completion in this department: direct materials, 100%; conversion costs, 80%.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

PANEL B: Steps 3, 4, and 5—Compute Equivalent Unit Costs, Summarize Total Costs to Account For, and Assign Costs to Units Completed, to Spoilage Units, and to Units in Ending Work in Process

Work in process, beginning (given: $264,000 + $36,000) Costs added in current period (given) Divided by equivalent units of work done in current period Equivalent unit costs of work done in current period (Step 4) Total costs to account for (Step 5) Assignment of costs: Good units completed and transferred out (61,000 units) Work in process, beginning (10,000 units) Direct materials added in current period Conversion costs added in current period Total from beginning inventory before normal spoilage Started and completed before normal spoilage (51,000 units) Normal spoilage (6,710 units) (A) Total cost of good units transferred out (B) Abnormal spoilage (1,290 units) Work in process, ending (15,000 units) Direct materials Conversion costs (C) Total work in process, ending (A)+(B)+(C) Total costs accounted for

Total Production Costs

Direct Materials

Conversion Costs

$ 300,000 2,906,400

$1,776,000

$1,130,400

÷ 74,000 $ 24

÷ $

(Step 3)

78,500 14.40

$3,206,400

$ 300,000 0 108,000

7,500§  $14.40

408,000 1,958,400 257,664 2,216,064 49,536

(51,000§  $24) + (51,000§  $14.40) (6,710§  $24) + (6,710§  $14.40)

360,000 172,800 532,800 $3,206,400

(15,000§  $24)

(1,290§  $24) + (1,290  $14.40) (12,000§  $14.40)

§Equivalent units of direct materials and conversion costs calculated in Step 2 in Panel A.

CHAPTER 20 INVENTORY COST MANAGEMENT STRATEGIES MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

SHORT-ANSWER QUESTIONS 20-1 Cost of goods sold (in retail organizations) or direct materials costs (in organizations with a manufacturing function) as a percentage of sales frequently exceeds net income as a percentage of sales by many orders of magnitude. For example, for Kroger grocery stores, cost of goods sold to sales is 73.7%, and net income to sales is 0.6%. Thus, a 10% reduction in the ratio of cost of goods sold to sales (73.7 to 66.3%) without any other changes can result in a 1233% increase in net income to sales (0.6% to 8.0%).

20-2 Five cost categories important in managing goods for sale in a retail organization are: 1. 2. 3. 4. 5.

Purchasing costs Ordering costs Carrying costs Stockout costs Quality costs

20-3 Five assumptions made when using the simplest version of the EOQ model are: 1. 2. 3. 4. 5.

The same quantity is ordered at each reorder point. Demand, ordering costs, carrying costs, and the purchase-order lead time are certain. Purchasing cost per unit is unaffected by the quantity ordered. No stockouts occur. Costs of quality are considered only to the extent that these costs affect ordering costs or carrying costs.

20-4 Costs included in the carrying costs of inventory are incremental costs for such items as insurance, rent, obsolescence, spoilage, and breakage plus the opportunity cost of capital (or required return on investment).

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

20-5 Examples of opportunity costs relevant to the EOQ decision model but typically not recorded in accounting systems are the following: 1. The return forgone by investing capital in inventory; 2. Lost contribution margin on existing sales when a stockout occurs; and 3. Lost contribution margin on potential future sales that will not be made to disgruntled customers.

20-6 The steps in computing the costs of a prediction error when using the EOQ decision model are: Step 1: Step 2: Step 3:

Compute the monetary outcome from the best action that could be taken, given the actual amount of the cost input. Compute the monetary outcome from the best action based on the incorrect amount of the predicted cost input. Compute the difference between the monetary outcomes from Steps 1 and 2.

20-7 Goal congruence issues arise when there is an inconsistency between the EOQ decision model and the model used for evaluating the performance of the person implementing the model. For example, if opportunity costs are ignored in performance evaluation, the manager may be induced to purchase in a quantity larger than the EOQ model indicates is optimal.

20-8 Just-in-time (JIT) purchasing is the purchase of materials (or goods) so that they are delivered just as needed for production (or sales). Benefits include lower inventory holdings (reduced warehouse space required and less money tied up in inventory) and less risk of inventory obsolescence and spoilage.

20-9 Factors causing reductions in the cost to place purchase orders of materials are:   

Companies are establishing long-run purchasing agreements that define price and quality terms over an extended period. Companies are using electronic links, such as the Internet, to place purchase orders. Companies are increasing the use of purchase-order cards.

20-10 Supply-chain analysis describes the flow of goods, services, and information from the initial sources of materials and services to the delivery of products to consumers, regardless of whether those activities occur in the same organization or in other organizations. Sharing of information across companies enables a reduction in inventory levels at all stages, fewer stockouts at the retail level, reduced manufacture of product not subsequently demanded by retailers, and a reduction in expedited manufacturing orders.

Chapter 20: Inventory Cost Management Strategies

20-11 Obstacles to companies adopting a supply-chain approach include:    

Communication obstacles—the unwillingness of some parties to share information. Trust obstacles—the concern that all parties will not meet their agreed-upon commitments. Information system obstacles—problems due to the information systems of different parties not being technologically compatible. Limited resources—problems due to the people and financial resources given to support a supply-chain initiative not being adequate.

20-12 Just-in-time (JIT) production is a “demand-pull” manufacturing system that has the following features:     

Organize production in manufacturing cells. Hire and retain workers who are multi-skilled. Aggressively pursue total quality management (TQM) to eliminate defects. Place emphasis on reducing both setup time and manufacturing lead time. Carefully select suppliers who are capable of delivering quality materials in a timely manner.

20-13 Traditional normal and standard costing systems use sequential tracking, in which journal entries are recorded in the same order as actual purchases and progress in production, typically at four different trigger points in the process. Backflush costing omits recording some of the journal entries relating to the cycle from purchase of direct materials to sale of finished goods (i.e. it has fewer trigger points at which journal entries are made). When journal entries for one or more stages in the cycle are omitted, the journal entries for a subsequent stage use normal or standard costs to work backward to “flush out” the costs in the cycle for which journal entries were not made.

20-14 Versions of backflush costing differ in the number and placement of trigger points at which journal entries are made in the accounting system: Number of Journal Entry Location in Cycle Where Trigger Points Journal Entries Made Version 1 3 Stage A. Purchase of direct materials Stage C. Completion of good finished units of product Stage D. Sale of finished goods Version 2 2 Stage A. Purchase of direct materials Stage D. Sale of finished goods Version 3 2 Stage C. Completion of good finished units of product Stage D. Sale of finished goods

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

EXERCISES 20-15 (10 min.) Terminology. 1. Supply-chain strategy decisions determine inventory management activities. 2. Managing inventory involves the identification of three relevant costs: purchasing costs, ordering costs, and carrying costs. 3. One strategy of just-in-time (JIT) purchasing will match to a production decision of just-in-time (JIT) production or lean production. This JIT purchasing strategy will minimize purchasing costs of inventory and reduce or eliminate both shrinkage costs and carrying costs but may increase ordering costs. 4. The goal of the management team is to minimize the overall combination of costs associated with inventory management. Any inventory management model requires careful analysis to identify the reorder point, the economic order quantity, and the trigger points. 5. The management team requires high-quality information in a database of the type found in enterprise resource planning (ERP) systems. ERP systems are demand-pull systems. Implementing a good demand-pull system requires a highly coordinated information flow that supports lean production. 6. Lean production (JIT) can eliminate inventory and therefore backflush costing is appropriate. With no WIP or materials inventories, the need for sequential or synchronous tracking of costs of production through the inventories is no longer necessary. Instead trigger points are identified such as materials purchase and completion of good finished units of product. Costs transfer at only these two trigger points from the Direct Materials to the Finished Goods inventory.

20-16 (20 min.)

EOQ for retailer.

1. D = 20,000, P = $200, C = $8 2 DP 2  20, 000  $200 EOQ    1, 000 jerseys C 8 2. Number of orders per year =

D = 20,000 / 1,000 = 20 orders EOQ

D 20, 000 = = 54.79 jerseys per day Number of working days 365 Purchase lead time = 7 days Reorder point = 54.79  7 = 383.53  384 jerseys

each 3. Demand working day

Chapter 20: Inventory Cost Management Strategies

20-17 (20 min.)

EOQ, effect of parameter changes.

1. D = 20,000, P = $30, C = $8 2 DP 2  20, 000  $30 EOQ   = 387.3 jerseys  388 jerseys C 8 The sizable reduction in ordering cost (from $200 to $30 per purchase order) has reduced the EOQ. 2. The AT proposal has both an upside and a downside. The upside is potentially higher sales. FB customers may purchase more online than if they have to physically visit a store. FB would also have lower administrative costs and lower inventory holding costs with the proposal. The downside is that AT could capture FB’s customers. Repeat customers to the AT website need not be classified as FB customers. FB would have to establish enforceable rules to make sure it captures ongoing revenue from customers it directs to the AP website. There is insufficient information to determine whether FB should accept AT’s proposal. Much depends on whether FB views AT as a credible, “honest” partner.

20-18 (15 min.) EOQ for a retailer. 1. D = 20,000, P = $160, C = 20%  $10 = $2 2  20, 000  $160 2 DP EOQ = = = 1,789 metres $2.00 C 2. Number of orders per year:

D = 20,000 / 1,789 = ~ 12 orders (rounded) EOQ

D Number of working days = 20, 000 250 = 80 metres per day = 400 metres per week Purchasing lead time = 2 weeks Reorder point = 400 metres per week  2 weeks = 800 metres

3. Demand each working day =

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

20-19 (20 min.) EOQ for manufacturer. 1. Relevant carrying costs per part per year: Required annual return on investment 15%  $60 = Relevant insurance, materials handling, breakage, etc. costs per year Relevant carrying costs per part per year

$ 9 6 $15

With D = 18,000; P = $150; C = $15, EOQ for manufacturer is: 2 DP 2  18, 000  $150  = 600 units C $15

D  Total relevant 2. ordering costs =  Q  P     18,000   =  $150   600  = $4,500 where Q = 600 units, the EOQ.

3. At the EOQ, total relevant ordering costs and total relevant carrying costs will be exactly equal. Therefore, total relevant carrying costs at the EOQ = $4,500 (from requirement 2). We can also confirm this with direct calculation: Q  Total relevant carrying costs    C  2  600     $15  2   $4,500 where Q = 600 units, the EOQ. 4. Purchase order lead time is half a month. Monthly demand is 18,000 units ÷ 12 months = 1,500 units per month. Demand in half a month is 12  1,500 units or 750 units. Lakeland should reorder when the inventory of rotor blades falls to 750 units.

Chapter 20: Inventory Cost Management Strategies

20-20 (20 min.)

Sensitivity of EOQ to changes in relevant ordering and carrying costs.

1. A straightforward approach to the requirement is to construct the following table for EOQ at relevant carrying and ordering costs. Annual demand is 11,000 units. The formula for the EOQ model is: EOQ =

2DC C

where D = demand in units for a specified period of time P = relevant ordering costs per purchase order C = relevant carrying costs of one unit in stock for the time period Option #1: D = 11,000, P = 325, C = 11 Option #2: D = 11,000, P = 225, C = 11 Option #3: D = 11,000, P = 325, C = 16 Option #4: D = 11,000, P = 225, C = 16 Option #5: D = 11,000, P = 325, C = 21 Option #6: D = 11,000, P = 225, C = 21

EOQ = 806 EOQ = 671 EOQ = 668 EOQ = 556 EOQ = 584 EOQ = 486

2. For a given demand level, as relevant carrying costs increase, EOQ becomes smaller. For a given demand level, as relevant order costs increase, EOQ increases.

20-21 (15 min.) Inventory management and the balanced scorecard. 1. The incremental increase in operating profits from employee cross-training (ignoring the cost of the training) is: Increased revenue from higher customer satisfaction ($5,000,000 × 2% × 5) Reduced inventory-related costs Incremental increase in operating profits (ignoring training costs)

$500,000 100,000 $600,000

2. At a cost of $600,000, DSC will be indifferent between current expenditures and increasing employee cross-training by 5%. Consequently, the most DSC would be willing to pay for this cross-training is the $600,000 benefit received. 3. Besides increasing short-term operating profits, additional employee cross-training can improve employee satisfaction because their jobs can have more variety, potentially leading to unanticipated productivity improvements and lower employee turnover. Multi-skilled employees can also understand the production process better and can suggest potential improvements. Each of these may lead to additional cost reductions.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

20-22 (20 min.) JIT production, relevant benefits, relevant costs. 1. Solution Exhibit 20-22 presents the annual net benefit of $630,000 to Colonial Hardware Company of implementing a JIT production system. 2. Other nonfinancial and qualitative factors that Colonial should consider in deciding whether it should implement a JIT system include: a. The possibility of developing and implementing a detailed system for integrating the sequential operations of the manufacturing process. Direct materials must arrive when needed for each subassembly so that the production process functions smoothly. b. The ability to design products that use standardized parts and reduce manufacturing time. c. The ease of obtaining reliable vendors who can deliver quality direct materials on time with minimum lead time. d. Willingness of suppliers to deliver smaller and more frequent orders. e. The confidence of being able to deliver quality products on time. Failure to do so would result in customer dissatisfaction. f. The skill levels of workers to perform multiple tasks such as minor repairs, maintenance, quality testing and inspection. 3. Personal observation by production line workers and managers is more effective in JIT plants than in traditional plants. A JIT plant’s production process layout is streamlined. Operations are not obscured by piles of inventory or rework. As a result, such plants are easier to evaluate by personal observation than are cluttered plants where the flow of production is not logically laid out. Besides personal observation, nonfinancial performance measures are the dominant methods of control. Nonfinancial performance measures provide most timely and easy to understand measures of plant performance. Examples of nonfinancial performance measures of time, inventory, and quality include the following:    

Manufacturing lead time Units produced per hour Machine setup time ÷ manufacturing time Number of defective units ÷ number of units completed

Chapter 20: Inventory Cost Management Strategies

In addition to personal observation and nonfinancial performance measures, financial performance measures are also used. Examples of financial performance measures include the following:  Cost of rework  Ordering costs  Stockout costs  Inventory turnover (cost of goods sold  average inventory) The success of a JIT system depends on the speed of information flows from customers to manufacturers to suppliers. The Enterprise Resource Planning (ERP) system has a single database and gives lower-level managers, workers, customers, and suppliers access to operating information. This benefit, accompanied by tight coordination across business functions, enables the ERP system to rapidly transmit information in response to changes in supply and demand so that manufacturing and distribution plans may be revised accordingly. SOLUTION EXHIBIT 20-22 Annual Relevant Costs of Current Production System and JIT Production System for Colonial Hardware Company

Relevant Items Annual tooling costs Required return on investment: 15% per year  $2,000,000 of average inventory per year 15% per year  $400,000a of average inventory per year Insurance, space, materials handling, and setup costs Rework costs Incremental revenues from higher selling prices Total net incremental costs

Relevant Costs under Current Production System

–

Relevant Costs under JIT Production System $200,000

$ 300,000 600,000 400,000 $1,300,000

Annual difference in favour of JIT production a$2,000,000  (1 – 80%) = $400,000 b

$600,000  (1 – 0.25) = $450,000 $400,000  (1 – 0.30) = $280,000 d $8 × 40,000 units = $320,000 c

60,000 450,000b 280,000c (320,000)d $670,000 $630,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

20-23 (30 min.) Backflush costing and JIT production. 1. (a) Purchases of direct materials

Inventory: Materials and In-Process Control Accounts Payable Control

(b) Incur conversion costs (c) Completion of finished goods

2,754,000 2,754,00 0

Conversion Costs Control Various Accounts

723,600

Finished Goods Controla Inventory: Materials and In-Process Control

3,484,000

723,600

2,733,60 0 750,400

Conversion Costs Allocated (d) Sale of finished goods

Cost of Goods Soldb Finished Goods Control

3,432,000 3,432,00 0

a26,800 × ($102 + $28) = $3,484,000 b26,400 × ($102 + $28) = $3,432,000

2. Inventory: Materials and In-Process Control (a) 2,754,000

Finished Goods Control

Cost of Goods Sold

(d) 3,432,000

Bal. 52,000

Bal. 20,400

Direct Materials Conversion Costs Allocated (c) 750,400

Conversion Costs

Conversion Costs Control (b) 723,600

Chapter 20: Inventory Cost Management Strategies

3. Under an ideal JIT production system, there could be zero inventories at the end of each day. Entry (c) would be $3,432,000 finished goods production, not $3,484,000. Also, there would be no inventory of direct materials instead of $2,754,000 – $2,733,600 = $20,400.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

20-24 (20 min.) Backflush costing, two trigger points, materials purchase and sale. 1. (a) Purchases of direct materials (b) Incur conversion costs

Inventory Control Accounts Payable Control

2,754,000

Conversion Costs Control Various Accounts

723,600

2,754,000 723,600

No entry

(d) Sale of finished goods

Cost of Goods Sold Inventory Control Conversion Costs Allocated

3,432,000

Conversion Costs Allocated Costs of Goods Sold Conversion Costs Control

739,200

(e) Underallocated or overallocated conversion costs

2,692,800 739,200 15,600 723,600

2. Inventory Control

Direct Materials

(a) 2,754,000

(d) 2,692,800

Cost of Goods Sold (d) 3,432,000

Bal. 61,200

Conversion Costs Allocated (e) 739,200 (d) 739,200

Conversion Costs

Conversion Costs Control (b) 723,600

(e) 723,600

(e) 15,600

Chapter 20: Inventory Cost Management Strategies

20-25 (20 min.) Backflush costing, two trigger points, completion of production and sale. 1. (a) Purchases of direct materials (b) Incur conversion costs

No Entry Conversion Costs Control Various Accounts

(d) Sale of finished goods (e) Underallocated or Overallocated conversion Costs

723,600 723,600

Finished Goods Control 3,484,000 Accounts Payable Control Conversion Costs Allocated

2,733,600 750,400

Cost of Goods Sold Finished Goods Control

3,432,000 3,432,000

Conversion Costs Allocated Costs of Goods Sold Conversion Costs Control

750,400 26,800 723,600

Direct Materials



Conversion Costs



Finished Goods Control (c) 3,484,000

(d) 3,432,000

Cost of Goods Sold (d) 3,432,000

Bal. 52,000

Conversion Costs Allocated (e) 750,400 (c) 750,400

Conversion Costs Control (b) 723,600

(e) 723,600

(e) 26,800

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

PROBLEMS 20-26 (30 min.)

Effect of different order quantities on ordering costs and carrying costs, EOQ.

1. Demand (units) (D) Cost per purchase order (P) Annual carrying cost per package (C) Order quantity per purchase order (units) (Q) Number of purchase orders per year (D  Q) Annual ordering costs (D  Q)  P Annual carrying costs (QC  2) Total relevant costs of ordering and carrying inventory

1 234,000 $ 81.00 $ 11.70 900 260.00 $21,060 $ 5,265

2 234,000 $ 81.00 $ 11.70 1,500 156.00 $12,636 $ 8,775

Scenario 3 234,000 $ 81.00 $ 11.70 1,800 130.00 $10,530 $10,530

$26,325

$21,411

$21,060

4 234,000 $ 81.00 $ 11.70 2,100 111.43 $ 9,026 $12,285

5 234,000 $ 81.00 $ 11.70 2,700 86.67 $ 7,020 $15,795

$21,311

$22,815

The economic order quantity is 1,800 packages. It is the order quantity at which carrying costs equal ordering costs and total relevant ordering and carrying costs are minimized. We can also confirm this from direct calculation. Using D = 234,000; P = $81 and C = $11.70 2  234,000  $81 EOQ = = 1,800 packages $11.70 It is interesting to note that Koala Blue faces a situation where total relevant ordering and carrying costs do not vary significantly when order quantity ranges from 1,500 packages to 2,700 packages. 2. When the ordering cost per purchase order is reduced to $49: 2  234, 000  $49 EOQ = = 1,400 packages $11.70 The EOQ drops from 1,800 packages to 1,400 packages when Koala Blue’s ordering cost per purchase order decreases from $81 to $49. D  234, 000   $49 = $8,190 And the new relevant costs of ordering inventory =   P  =   Q   1, 400 1,400   Q  and the new relevant costs or carrying inventory =   C  =   $11.70 = $8,190 2  2  The total new costs of ordering and carrying inventory = $8,190  2 = $16,380

Chapter 20: Inventory Cost Management Strategies

3. As summarized below, the new Mona Lisa web-based ordering system, by lowering the EOQ to 1,400 packages, will lower the carrying and ordering costs by $4,680. Koala Blue will spend $2,000 to train its purchasing assistants on the new system. Overall, Koala Blue will still save $2,680 in the first year alone. Total relevant costs at EOQ (from Requirement 2) Annual cost benefit over old system ($21,060 – $16,380) Training costs Net benefit in first year alone

$16,380 $ 4,680 2,000 $ 2,680

20-27 (30 min.) EOQ, uncertainty, safety stock, reorder point. 1. EOQ = ((2DP)/C) = ((2 × 114,000 × 180)/3.60) = 3,376 pairs of shoes 2. Weekly demand = Monthly demand ÷ 4 = 9,500 ÷ 4 = 2,375 pairs of shoes per week Purchasing lead time = 1 week Reorder point = 2,375 pairs of shoes per week × 1 week = 2,375 pairs of shoes 3. Safety stock = 10% × 9,500 = 950 pairs of shoes Reorder point and quantity = Weekly demand + Safety stock = 2,375 + 950 = 3,325 pairs of shoes 4. Safety stock cost = 950 shoes × $3.60 = $3,420

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

20-28 (25 min.) MRP and ERP. 1. Under an MRP system: Annual cost of producing and carrying J-Pods in inventory = Variable production cost + Setup cost + Carrying cost = $50 × 48,000 + ($50,000 × 12 months) + [$20 × (4,000 ÷ 2)] = $2,400,000 + 600,000 + 40,000 = $3,040,000 2. Using an EOQ model to determine batch size:

EOQ 

2 DP 2  48, 000  $50, 000  C $20

= 15,492 J-Pods per batch Production of 48,000 per year divided by a batch size of 15,492 would imply J-Pods would produce 3.1 batches per year; rounding this up to the nearest whole number yields 4 batches per year. Annual cost of producing and carrying J-Pods in inventory = Variable production cost + Setup cost + Carrying cost = $50 × 48,000 + ($50,000 × 4) + [$20 × (15,492 ÷ 2)] = $2,400,000 + 200,000 + 154,920 = $2,754,920 3. Under a JIT system Annual cost of producing and carrying J-Pods in inventory = Variable production cost + Setup cost + Carrying cost = $50 × 48,000 + ($5,000 × 96 a) + [$20 × (500 ÷ 2)] = $2,400,000 + 480,000 + 5,000 = $2,885,000 aproduction of 48,000 per year divided by a batch size of 500 would imply 96 setups per

year. 4. The EOQ system resulted in the lowest costs, despite the fact that carrying costs were lower for the JIT model. However, the EOQ model, in this case, limits production to only once every four months. This would not allow managers to react quickly to changing market demand or economic conditions. The JIT model provides management with much more flexibility. JIT systems might also lead managers to improve processes, reduce costs and increase quality.

Chapter 20: Inventory Cost Management Strategies

20-29 (30 min.) Effect of management evaluation criteria on EOQ model. 2 DP 2  600, 000  $1, 200  C $75  4,382 computers

1. EOQ 

2. Number of orders per year =

D 600, 000 = = 137 orders EOQ 4,382

 600, 000 Total relevant D     P    $1, 200  $164,309 ordering costs Q    4,382 Total relevant Q  4,382    C    $75  $164,325 carrying costs  2  2 

Relevant total costs = $164,309 + $164,325 = $328,634

2 DP 2  600, 000  $1, 200  C $45  5, 657 computers

EOQ 

 600, 000 Total relevant D     P    $1, 200  $127, 276 ordering costs Q    5, 657 Total relevant Q  5, 657     C    $75  $212,138 carrying costs 2  2 

Relevant total costs = $127,276 + $212,138 = $339,414 4. Because managers will choose to order 5,657 computers instead of 4,382, the cost to the company will be $10,780 ($339,414 – $328,634) higher than it would be if managers were evaluated based upon all carrying costs. The EOQ quantity and relevant total costs are higher if the company ignores holding costs when evaluating managers, but only by about 3.28% ($10,780 ÷ $328,634). The square root in the EOQ model reduces the sensitivity of the ordering decision to errors in parameter estimates. Computer Depot probably does not include the opportunity costs of carrying inventory because it is not tracked by the financial accounting system. The company could change the evaluation model to include a cost of investment in inventory. Even though this would involve an additional calculation, it would encourage managers to make optimal decisions, more congruent with the goal of reducing total inventory costs.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

20-30 (30 min.) EOQ, uncertainty, safety stock, reorder point. 1. EOQ 

2 DP 2  10, 400  $100  C $13

EOQ = 400 steering wheels 2. Average weekly demand = 10,400 ÷ 52 weeks = 200 steering wheels per week Purchasing lead time = 1.5 weeks Reorder point at each plant = 200 steering wheels × 1.5 weeks = 300 steering wheels 3. Solution Exhibit 20-30 presents the safety stock computations for a given assembly plant when the reorder point excluding safety stock is 300 steering wheels. The exhibit shows that annual relevant total stockout and carrying costs are the lowest ($2,470) when a safety stock of 100 steering wheels is maintained. Therefore, a given assembly plant should hold a safety stock of 100 steering wheels. As a result, Reorder point with safety stock = 300 steering wheels + 100 steering wheels = 400 steering wheels. Reorder quantity is unaffected by the holding of safety stock and remains the same as calculated in requirement 1. Reorder quantity = 400 steering wheels A given assembly plant should order 400 steering wheels each time its inventory falls to 400 steering wheels.

Chapter 20: Inventory Cost Management Strategies

SOLUTION EXHIBIT 20-30 Computation of Safety Stock for the assembly plant when Reorder Point is 300 Units Demand Levels Resulting in Stockouts (2)

Stockout in Unitsa (3) = (2) – 300 – (1)

Probability of Stockouts (4)

Relevant Stockout Costsb (5) = (3) × $9

Number of Orders per Yearc (6)

Expected Stockout Costsd (7) = (4) × (5) × (6)

Relevant Carrying Costse (8) = (1) × $13

Relevant Total Costs (9) = (7) + (8)

400 500

100 200

0.20 0.05

$ 900 $1,800

26 26

100 200

500 --

100 --

0.05 --

$ 900 --

26 --

$4,680 2,340 $7,020 $1,170 $ 0f

$ 0 $1,300 $2,600

$7,020 $2,470 $2,600

Safety Stock Level in Units (1)

aDemand level resulting in stockouts – Inventory available during lead time (excluding safety

stock), 300 units – Safety stock. bStockout in units × Relevant stockout costs of $9.00 per unit. cAnnual demand, 10,400 ÷ 400 EOQ = 26 orders per year. dProbability of stockout × Relevant stockout costs × Number of orders per year. eSafety stock × Annual relevant carrying costs of $13 per unit (assumes that safety stock is on hand at all times and that there is no overstocking caused by decreases in expected usage). fAt a safety stock level of 200 units, no stockout will occur and, hence, expected stockout costs = $0.

20-31 (30 min.) JIT purchasing, relevant benefits, relevant costs. 1. Solution Exhibit 20-31 presents the $37,500 cash savings that would result if CH Holling Corporation (CHH) adopted the just-in-time inventory system in 2022. 2. Conditions that should exist in order for a company to successfully adopt just-in-time purchasing include the following:  

  

Top management must be committed and provide the necessary leadership support to ensure a companywide, coordinated effort. A detailed system for integrating the sequential operations of the manufacturing process needs to be developed and implemented. Direct materials must arrive when needed for each subassembly so that the production process functions smoothly. Accurate sales forecasts must be available for effective finished goods planning and production scheduling. Products should be designed to maximize use of standardized parts to reduce manufacturing time and costs. Reliable vendors who can deliver quality direct materials on time with minimum lead time must be obtained.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT 20-31 Annual Relevant Costs of Current Purchasing Policy and JIT Purchasing Policy for CHH Relevant Costs under Current Purchasing Policy Required return on investment 20% per year  $600,000 of average inventory per year 20% per year  $0 inventory per year Annual insurance and property tax costs Warehouse rent Overtime costs No overtime Overtime premium Stockout costs No stockouts $6.50b contribution margin per unit  20,000 units Total incremental costs Difference in favour of JIT purchasing a$(13,500) = Warehouse rental revenue, [(75% 

Relevant Costs under JIT Purchasing Policy

$120,000 $ 14,000 60,000

0 0 (13,500)a

0 40,000 0 130,000 $194,000 $156,500 $37,500

12,000)  $1.50].

bCalculation of unit contribution margin

Selling price ($10,800,000 ÷ 900,000 units) Variable costs per unit: Variable manufacturing cost per unit ($4,050,000 ÷ 900,000 units) Variable marketing and distribution cost per unit ($900,000 ÷ 900,000 units) Total variable costs per unit Contribution margin per unit

$12.00 $4.50 1.00 5.50 $ 6.50

Note that the incremental costs of $40,000 in overtime premiums to make the additional 15,000 units are less than the contribution margin from losing these sales equal to $97,500 (= $6.50  15,000). CHH would rather incur overtime than lose 15,000 units of sales.

Chapter 20: Inventory Cost Management Strategies

20-32 (25 min.) Supply-chain effects on total relevant inventory costs. 1. The relevant costs of purchasing from Maji and Induk are: Cost Category

Maji

Purchase costs 10,000 boards × $93 per board 10,000 boards × $90 per board Ordering costs 50 orders × $10 per order 50 orders × $8 per order Inspection costs 10,000 boards × 5% × $5 per board 10,000 boards × 25% × $5 per board Required annual return on investment 100 boards × $93 per board × 10% 100 boards × $90 per board × 10% Stockout costs 100 boards × $5 per board 300 boards × $8 per board Return costs 50 boards × $20 per board 500 boards × $20 per board Other carrying costs 100 boards × $2.50 per board per year 100 boards × $2.50 per board per year Total Cost

Induk

$930,000 900,000 500 400 2,500 12,500 930 900 500 2,400 1,000 10,000 250 ________ $935,680

250 $926,450

2. While Induk will save Cow Spot $9,230 (= $935,680 − $926,450), Cow Spot may still choose to use Maji for the following reasons: a. The savings are less than 1% of the total cost of the motherboards. b. With ten times the number of returns, Induk will probably have a negative effect on Cow Spot’s reputation. c. With Induk’s higher stockouts, Cow Spot’s reputation for availability and on time delivery will be affected. d. The increased number of inspections may necessitate the hiring of additional personnel and the need for additional factory space and equipment.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

20-33 (20 min.) Backflush costing and JIT production. 1. (a) Purchases of direct materials

(b) Incur conversion costs (c) Completion of finished goods

(d) Sale of finished goods

Inventory: Materials and In-Process Control Accounts Payable Control

550000

Conversion Costs Control Various Accounts

440000

Finished Goods Controla Inventory: Materials & In-Process Control Conversion Costs Allocated

945000

Cost of Goods Soldb Finished Goods Control

900000

550000 440000 525000 420000 900000

a21000 × $45 ($25 + $20) = $945000 b20000 × $45 = $900000

2. Direct Materials

Inventory Materials and In-Process Control ( a ) 5 50 ,00 0 (c ) 5 25 ,00 0 B al . 2 5,0 00

Conversion Costs

Finished Goods Control (c )

9 45 ,0 00 (d)

Ba l. 4 5, 00 0

Conversion Costs Allocated (c ) 4 20 ,0 00 Conversion Costs Control (b) 4 40 ,0 00

9 00 ,00 0

Cost of Goods Sold (d)

9 00 ,00 0

Chapter 20: Inventory Cost Management Strategies

20-34 (20 min.) Backflush, two trigger points, materials purchase and sale. 1. (a) Purchases of direct materials

Inventory Control Accounts Payable Control

550,000 550,000

(b) Incur conversion costs

Conversion Costs Control 440,000 Various Accounts (such as Accounts Payable Control and Wages Payable Control) 440,000

No entry

(d) Sale of finished goods

Cost of Goods Sold Inventory Control Conversion Costs Allocated

900,000

Conversion Costs Allocated Cost of Goods Sold Conversion Costs Control

400,000 40,000

(e) Underallocated or overallocated conversion costs

500,000 400,000

440,000

2. Inventory Control Direct Materials

(a) 550000

(d) 500000

Cost of Goods Sold (d) 900000

Bal.50000

Conversion Costs Allocated (e) 400000

(d) 400000

Conversion Costs

(e) 40000 Conversion Costs Control (b) 440000

(e) 440000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

20-35 (20 min.) Backflush, two trigger points, completion of production and sale. 1. (a) Purchase of direct materials

No entry

(b) Incur conversion costs

Conversion Costs Control 440,000 Various Accounts (such as Accounts Payable Control and Wages Payable Control) 440,000

Finished Goods Control Accounts Payable Control Conversion Costs Allocated

945,000

(d) Sale of finished goods

Cost of Goods Sold Finished Goods Control

900,000

Conversion Costs Allocated Cost of Goods Sold Conversion Costs Control

420,000 20,000

(e) Underallocated or overallocated conversion costs

525,000 420,000 900,000

440,000

2. Finished Goods Control Dir ect M ate ri al s

Cost of Goods Sold (d ) 9 00 ,0 00

Bal. 45,000

C onver sion Costs Al l oca ted (e ) 4 20 ,0 00 (c) 4 20 ,0 00 Conv ersi on Costs

(e ) 20 ,0 00 Con ver si on C osts Control (b) 4 40 ,0 00 (e ) 4 40 ,0 00

Chapter 20: Inventory Cost Management Strategies

20-36 (20 min.) Lean accounting. 1. The cost object in lean accounting is the value stream, not the individual product. FSD has identified two distinct value streams: mechanical devices and electronic devices. All direct costs are traced to the value streams. However, not all plant-level overhead costs are allocated to the value streams when computing operating income. Value streams are only charged for the percentage of space they actually use, only 85% of the $120,000 occupancy costs are charged to the two value streams. The remaining 15%, or $18,000, is not used to compute value stream profits, nor are other plant-level overhead costs. 2. Operating income under lean accounting are the following (in thousands of dollars):

Sales ($700 + $500; $900 + $450) Costs Direct material purchased ($190 + $125; $250 + $90) Direct manufacturing labour ($150 + $75; $200 + $60) Equipment costs ($90 + $125; $200 + $100) Product-line overhead ($110 + $60; $125 + $50) Occupancy costs ($120 × 40%) ($120 × 45%) Value stream operating income

Mechanical Devices $1,200

Electronic Devices $1,350

315

340

225

260

215

300

170

175

48 $ 227

54 $ 221

In addition to the differences discussed in requirement 1, LT’s lean accounting system treats all direct materials costs as expenses in the period they are purchased. The following factors explain the differences between traditional operating income and lean accounting income for the two value streams:

Traditional operating income ($100 + $105; $45 + $140) Additional cost of direct materials ($315 − $300; $340 − $325) Decrease in allocated plant-level overhead ($85 − $48; $105 − $54) Value stream operating income

Mechanical Devices

Electronic Devices

$205

$185

(15)

37 $227

51 $221

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

20-37 (20–30 min.) EOQ conflicts. 2DP C

1. EOQ =

D = 2,000; P = $48; C = $4.80 + (10%  $60) = $10.80 2(2,000)$48  133.333 tires 133 tires $10.80

EOQ =

DP QC  where Q can be any quantity, including the EOQ Q 2

TRC =

2,000  48 133.3  $10.80   $720  $720  $1,440. 133.3 2

If students used an EOQ of 133 tires (order quantities rounded to the nearest whole number), TRC =

2,000  $48 133  $10.80   $721.80  $718.20  $1,440.00. 133 2

Sum of annual relevant ordering and carrying costs equal $1,440. 2.

The prediction error affects C, which is now: C = $4.80+ (10%  $36) = $8.40 D = 2,000, P = $48, C = $8.40 2(2,000)$48  151.186 tires  151 tires $8.40 The cost of the prediction error can be calculated using a three-step procedure:

EOQ =

Step 1: Compute the monetary outcome from the best action that could have been taken, given the actual amount of the cost input. TRC = = =

DP QC  Q 2

2,000  $48 151.186  $8.40  151.186 2 $634.98 + $634.98 = $1,269.96

Chapter 20: Inventory Cost Management Strategies

Step 2: Compute the monetary outcome from the best action based on the incorrect amount of the predicted cost input. TRC =

DP QC  Q 2

2,000  $48 133.333  $8.40  133.333 2 = $720 + $560.00 = $1,280 =

Step 3: Compute the difference between the monetary outcomes from Step 1 and Step 2: Monetary Outcome Step 1 $1,269.96 Step 2 1,280.00 Difference $ (10.04) The cost of the prediction error is $10.04. Note: The $24 prediction error for the purchase price of the heavy-duty tires is irrelevant in computing purchase costs under the two alternatives because the same purchase costs will be incurred whatever the order size. Some students may prefer to round off the EOQs to 133 tires and 151 tires respectively. The calculations under each step in this case follow: Step 1: TRC =

2,000  $48 151  8.40   $635.76  $634.20  $1,269.96 151 2

Step 2: TRC =

2,000  $48 133  $8.40   $721.80  $558.60  $1,280.40 133 2

Step 3: Difference = $1,269.96 – $1,280.40 = $10.44

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

20-38 (20–25 min.) Backflush costing. 1. (a) Purchases of raw materials

Inventory: Raw and In-Process Control Accounts Payable Control

$6,360,000

(b) Incur conversion costs

Conversion Costs Control Various Accounts

$3,696,000

Finished Goods Control $9,840,0001) Inventory: Raw and In-Process Control $6,240,0002) Conversion Costs allocated 3,600,0003)

(d) Sale of finished goods

Cost of Goods Sold Finished Goods Control

1)200,000 units × ($31.20 + $18) 2)200,000 units × $31.20 3)200,000 units × $18 4)192,000 units × ($31.20 + $18)

= = = =

$9,840,000 $6,240,000 $3,600,000 $9,446,400

$6,360,000

$3,696,000

$9,446,4004) $9,446,4004)

Chapter 20: Inventory Cost Management Strategies

20-39 (25 min.) Supplier evaluation and relevant costs of qualify and timely deliveries. Solution Exhibit 20-39 presents the $1,702 annual relevant costs difference in favour of purchasing from Quality Sports. Copeland should buy the footballs from Quality Sports. SOLUTION EXHIBIT 20-39 Annual Relevant Costs of Purchasing from Big Red and Quality Sports

Relevant Item Purchasing costs $60 per unit  12,000 units per year $61.20 per unit  12,000 units per year Inspection costs $0.02 per unit  12,000 units No inspection necessary Opportunity carrying costs, required return on investment, 15% per year  $60 cost per unit  100 units of average inventory per year; 15% per year  $61.20 cost per unit  100 units of average inventory per year Other carrying costs (insurance, material handling, and so on) $4 per unit  100 units of average inventory per year $4.50 per unit  100 units of average inventory per year Stockout costs $24 per unit  350 units per year $12 per unit  60 units per year Customer returns costs $30 per unit  300 units $30 per unit  25 units Total annual relevant costs Annual difference in favour of Quality Sports

Relevant Costs of Purchasing From Big Red Quality Sports $720,000 $734,400 240 0

900 918

400 450 8,400 720 9,000 $738,940

750 $737,238 $1,702

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

20-40 (20 min.) Backflush costing and JIT production. 1. (a) Record purchases of direct materials (b) Record conversion costs incurred

Materials and In-Process Inventory Control Accounts Payable Control Conversion Costs Control Various Accounts (such as Wages Payable Control) Finished Goods Controla Materials and In-Process Inventory Controla Conversion Costs Allocateda Cost of Goods Soldb Finished Goods Control

(d) Record cost of finished goods sold

500,000 500,000 425,000 425,000 700,000 400,000 300,000 665,000 665,000

a20,000 × ($20 + $15) = $700,000; 20,000 × $20 = $400,000; 20,000 × $15 = $300,000 b19,000 × ($20 + $15) = $665,000

2. Materials and In-Process Inventory Control

Direct Materials

(a)

500,000

(c)

400,000

Bal. 100,000

Finished Goods Control (c) 700,000

(d) 665,000

Bal. 35,000

Conversion Costs Allocated (c)

300,000

Conversion Costs Conversion Costs Control (b)

425,000

Cost of Goods Sold (d) 665,000

Chapter 20: Inventory Cost Management Strategies

20-41 (20–30 min.) Purchase order size for retailer, EOQ, JITpurchasing. 1. EOQ =

2DP C

(a) D = 7,200; P = $36; C = $1.20 EOQ =

2(7,200) ($36)  432,000  657.3 cases ~ 658 cases $1.20

(b) D = 7,200; P = $36; C = $1.80 EOQ =

2(7,200) ($36)  288,000  536.7 cases  537 cases $1.80

2(7,200) ($6)  48,000  219.1 cases  220 cases $1.80

2. A just-in-time purchasing policy involves the purchase of goods such that their delivery immediately precedes their demand. Given the purchase order sizes calculated in requirement 1, the number of purchase orders placed each month is (D ÷ EOQ): D 7,200 (a) = 11 orders per month or  1 every 2.7 days  EOQ 658 D 7,200 (b) = 14 orders per month or  1 every 2.15 days  EOQ 537 D 7,200 (c) = 33 orders per month or  1.1 every day  EOQ 220 An increase in C and a decrease in P led to increases in the optimal frequency of orders. The 24-Hour Mart has increased the frequency of delivery from every third day (1a: P = $36; C = $1.20) to a delivery every day (1c: P = $6; C = $1.80). There is a reduction of 219 cases in the average inventory level: (658 – 220) ÷ 2 = 219.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

COLLABORATIVE LEARNING CASE 20-42 (35–40 min.) Backflushing. 1. Glendale has successfully implemented JIT in its production operations and, as a result, minimized work-in-process inventory. However, it still has a fair amount of raw material and finished goods inventory. Glendale should, therefore, adopt a backflush costing system with two trigger points, as follows: a. Direct materials purchases charged to Inventory: Materials and In-Process Control. b. Completion of finished goods recorded as Finished Goods Control. The backflush approach described closely approximates the costs computed using sequential tracking. There is no work in process so there is no need for a Work in Process inventory account. Further, by maintaining a Materials and In-Process Inventory Control and Finished Goods Control account, Glendale can keep track of and control the inventories of direct materials and finished goods in its plant. 2. a. Glendale should adopt a backflush costing system with trigger points at completion of finished goods and at the sale of finished goods. This would approximate the sequential tracking approach since the question assumes Glendale has no direct materials or work-inprocess inventories. There is, therefore, no need for these inventory accounts. b. A backflush costing system with two trigger points—when purchases of direct materials are made (debited to Inventory Control), and when Finished Goods are sold—would approximate sequential tracking, since the question assumes Glendale has no work-inprocess or finished goods inventories. c. A backflush costing system with a single trigger point when finished goods are sold would approximate sequential tracking, since the question assumes Glendale has no direct material, work-in-process, or finished goods inventories. This is a further simplification of the examples in the text. The principle here is that backflushing of costs should be triggered at the finished goods inventory stage if Glendale plans to hold finished goods inventory. If Glendale plans to hold no finished goods inventory, backflushing can be postponed until the finished goods are sold. In other words, the trigger points for backflushing relate to the points where inventory is being accumulated. As a result, backflushing matches the sequential tracking approach and also maintains a record for the monitoring and control of the inventory.

Chapter 20: Inventory Cost Management Strategies

3. Some comments follow: a. The backflush system is a standard costing system, not an actual costing system. b. If standard costing is used, an up-to-date, realistic set of standard costs is always desirable––as long as the set meets the cost–benefit test of updating. c. The operating environments of “the present JIT era” have induced many companies toward more simplicity (backflush) and to abandon the typical standard costing system (sequential tracking). d. Backflush is probably closer to being a periodic system than a perpetual system. However, a periodic system may be cost-effective, particularly where physical inventories are relatively low or stable. e. The textbook points out that, to be attractive, backflush costing should generate the same financial measurements as sequential tracking––and at a lower accounting cost. f. The choice of a product costing system is highly contextual. Its characteristics should be heavily affected by its costs, the preferences of operating managers, and the underlying operating processes. Sweeping generalizations about any cost accounting system or technique are unjustified.

CHAPTER 21 CAPITAL BUDGETING: METHODS OF INVESTMENT ANALYSIS MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

21-1 No. Capital budgeting focuses on an individual investment project throughout its life, recognizing the time value of money. The life of a project is often longer than a year. Accrual accounting focuses on a particular accounting period, often a year, with an emphasis on income determination.

21-2 The six parts in the capital budgeting decision process are: 1. An identification stage to distinguish the types of capital expenditure projects that will accomplish strategic goals for the organization. 2. A stage to establish assumptions that are common for exploring several potential capital expenditure investments that will achieve organization objectives. 3. An information-acquisition stage to consider the predicted costs and consequences of alternative capital investments through an analysis of the present value of future cash inflows and outflows and relevant qualitative factors. 4. A selection stage to decide on the projects to execute, timing of implementation, and performance criteria. 5. A financing stage to obtain project financing. 6. An implementation and control stage to put the projects in motion and monitor their performance throughout the investment life.

21-3 In essence, the discounted cash-flow method calculates the expected cash inflows and outflows of a project as if they occurred at a single point in time so that they can be aggregated (added, subtracted, etc.) in an appropriate way. This enables comparison with cash flows from other projects that might occur over different time periods.

21-4 No. Only quantitative outcomes are formally analyzed in capital budgeting decisions. Many effects of capital budgeting decisions, however, are difficult to quantify in financial terms. These nonfinancial or qualitative factors (for example, the number of accidents in a manufacturing plant or employee morale) are important to consider in making capital budgeting decisions.

21-5 Sensitivity analysis can be incorporated into DCF analysis by examining how the DCF of each project changes with changes in the inputs used. These could include changes in revenue assumptions, cost assumptions, tax rate assumptions, and discount rates.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

21-6 The payback method measures the time it will take to recoup, in the form of expected future net cash inflows, the net initial investment in a project. The payback method is simple and easy to understand. It is a handy method when screening many proposals and particularly when predicted cash flows in later years are highly uncertain. The main weaknesses of the payback method are its neglect of the time value of money and of the cash flows after the payback period.

21-7 The accrual accounting rate of return (AARR) method divides an accrual accounting measure of average annual income of a project by an accrual accounting measure of investment. The strengths of the accrual accounting rate of return method are that it is simple, easy to understand, and considers profitability. Its weaknesses are that it ignores the time value of money and does not consider the cash flows for a project.

21-8 No. The discounted cash-flow techniques implicitly consider depreciation in rate of return computations; the compound interest tables automatically allow for recovery of investment. The net initial investment of an asset is usually regarded as a lump-sum outflow at time zero. Where taxes are included in the DCF analysis, depreciation costs are included in the computation of the taxable income number that is used to compute the tax payment cash flow.

21-9 A point of agreement is that an exclusive attachment to the mechanisms of any single method examining only quantitative data is likely to result in overlooking important aspects of a decision. Two points of disagreement are (1) DCF can incorporate those strategic considerations that can be expressed in financial terms, and (2) “Practical considerations of strategy” not expressed in financial terms can be incorporated into decisions after DCF analysis.

21-10 No. If managers are evaluated on the accrual accounting rate of return, they may not use the NPV method for capital budgeting decisions. Instead, managers will choose investments that maximize the accrual accounting rate of return.

21-11 All overhead costs are not relevant in NPV analysis. Overhead costs are relevant only if the capital investment results in a change in total overhead cash flows. Overhead costs are not relevant if total overhead cash flows remain the same but the overhead allocated to the particular capital investment changes.

21-12 Capital investment projects typically have five major categories of cash flows: 1. Initial investment in machine and working capital: outflows made for purchasing plant, equipment, and machines that occur in the early periods of the project’s life and include cash outflows for transporting and installing the item. Investments in plant, equipment, machines and sales promotions for product lines are invariably accompanied by incremental investments in working capital. These investments take the form of current assets, such as receivables and inventories, minus current liabilities, such as accounts payable. Working capital investments are similar to machine investments. In each case, available cash is tied up. 2. Cash flow from current disposal of the old machine: any cash received from disposal of the old machine is a relevant cash inflow. Copyright © 2022 Pearson Canada Inc. 21-2

Chapter 21: Capital Budgeting: Methods of Investment Analysis

3. Recurring operating cash flows: these inflows may result from producing and selling additional goods or services or from operating cost savings. 4. Cash flow from terminal disposal of machine and recovery of working capital: the disposal of the investment at the date of termination of a project generally increases cash inflow in the year of disposal. The initial investment in working capital is usually fully recouped when the project is terminated. At that time, inventories and receivables necessary to support the project are no longer needed. 5. Income tax impacts on cash flows: to be discussed in Chapter 22.

21-13 Four critical success factors that managers focus on when controlling job projects are (a) scope, (b) quality, (c) time schedule, and (d) costs.

21-14 The Division Y manager should consider why the Division X project was accepted and the Division Y project rejected by the president. Possible explanations are: a. The president considers qualitative factors not incorporated into the IRR computation and this leads to the acceptance of the X project and rejection of the Y project. b. The president believes that Division Y has a history of overstating cash inflows and understating cash outflows. c. The president has a preference for the manager of Division X over the manager of Division Y—this is a corporate politics issue. Factor (a) means qualitative factors should be emphasized more in proposals. Factor (b) means Division Y needs to document whether its past projections have been relatively accurate. Factor (c) means the manager of Division Y has to play the corporate politics game better.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

EXERCISES 21-15 (10 min.) Terminology. 1. The goal of capital budgeting is to provide capacity in a planned and orderly manner that will match the predicted demand growth of the company and achieve a targeted rate of return (ROR) on these investments. The determination of the ROR links closely to the operating income or profit on sales. That is why investments affect the statement of financial position, the statement of comprehensive income, and the statement of cash flows. 2. Capital budgeting requires a careful analysis of the amount and timing of cash outflows and cash inflows. There are four methods from which a management team can choose: net present value (NPV), internal rate of return (IRR), payback method, and accrual accounting rate of return (AARR) (or return on investment (ROI)). The first two methods require the calculation of discounted cash flow. 3. The NPV method requires that the management team determine what its required rate of return (RRR) must be (also called the discount rate, hurdle rate, or opportunity cost of capital). This discount rate is the return the team could expect from investing in a different project of similar risk. In contrast the IRR (sometimes called the time-adjusted rate of return is fully determined by cash inflow and outflow. It is the rate at which the discounted net cash flow is zero. 4. The payback method is based on nominal, not discounted, cash flow. It is simply the total investment divided by cash inflow to determine the time it takes to recover the cost of the investment. 5. The accrual accounting rate of return (AARR) is calculated by dividing the increase in an accrual, expected average operating income, by the cost of the initial investment.

21-16 Exercises in compound interest, no income taxes. The general approach to these exercises centres on a key question: Which of the four basic tables in Appendix A should be used? No computations should be made until this basic question has been answered with confidence. 1. From Table 1. The $50,000 is the present value P of your winnings. Their future value S in 5 years will be: S = P (1 + r )n The conversion factor, (1 + r)n, is on line 5 of Table 1. Substituting at 6%: S = 50,000(1.338) = $66,900 Substituting at 12%: S = 50,000(1.762) = $88,100

Chapter 21: Capital Budgeting: Methods of Investment Analysis

2. From Table 2. The $249,600 is a future value. You want the present value of that amount. P = S / (1 + r)n. The conversion factor, 1 / (1 + r)n, is on line 12 of Table 2. Substituting, P = $249,600(0.497) = $124,051.20 3. From Table 3. The $249,600 is a future value. You are seeking the uniform amount (annuity) to set aside annually. Note that $1 invested each year for 12 years at 6% has a future value of $16.870 after 12 years, from line 12 of Table 3.

S n = Annual deposit (F) $249,600 = Annual deposit (16.870) Annual deposit =

$249, 600  $14, 795.45 16.870

4. From Table 3. You need to find the future value of an annuity of $4,800 per year. Note that $1 invested each year for 8 years at 4% has a future value of $9.214 after 8 years.

S n = $4,800 F, where F is the conversion factor S n = $4,800(9.214) = $44,227.20 5. From Table 4. When you reach age 65, you will get $400,000, a present value at that time. You need to find the annuity that will exactly exhaust the invested principal in 7 years. To pay yourself $1 each year for 7 years when the interest rate is 6% requires you to have $5.582 today, from line 7 of Table 4. Pn = Annual withdrawal (F) $400,000 = Annual withdrawal (5.582) $400, 000 Annual withdrawal =  $71, 658.90 5.582 6. From Table 4. You need to find the present value of an annuity for 6 years. At 4%: Pn = Annual withdrawal (F) Pn = $48,000 (5.242) Pn = $251,616 At 6%: Pn = $48,000 (4.917) Pn = $236,016, a much lower figure

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

7. Plan B is preferable. The NPV of plan B exceeds that of plan A by $857 ($3,040 – $2,183): Even though plans A and B have the same total cash inflows over the five years, plan B is preferred because it has greater cash inflows occurring earlier.

Year 0 1 2 3 4 5

PV Factor At 6% 1.000 0.943 0.890 0.840 0.792 0.747

Cash Inflows $(18,000) 2,000 3,000 4,000 7,000 9,000

Plan A PV of Cash Inflows $(18,000) 1,886 2,670 3,360 5,544 6,723 $ 2,183

Plan B Cash Inflows $(18,000) 3,000 5,000 9,000 5,000 3,000

PV of Cash Inflows $(18,000) 2,829 4,450 7,560 3,960 2,241 $ 3,040

21-17 (22–25 min.) Capital budget methods, no income taxes. 1a. The table for the present value of annuities (Appendix A, Table 4) shows: 5 periods at 12% = 3.605 Net present value = $60,000 (3.605) – $180,000 = $216,300 – $180,000 = $36,300 1b.

Payback period = $180,000 ÷ $60,000 = 3 years

1c.

Internal rate of return: $180,000 = Present value of annuity of $60,000 at R% for 5 years, or what factor (F) in the table of present values of an annuity (Appendix A, Table 4) will satisfy the following equation. $180,000 = $60,000F 180,000 ÷ $60,000 F=3 On the 5-year line in the table for the present value of annuities (Appendix A, Table 4), find the column closest to 3.000; it is between a rate of return of 18% and 20%. Interpolation is necessary: 18% IRR rate 20% Difference

Present Value Factors 3.127 3.127 –– 3.000 2.991 –– 0.136 0.127

Chapter 21: Capital Budgeting: Methods of Investment Analysis

1d. Accrual accounting rate of return based on net initial investment: Net initial investment = $180,000 Estimated useful life = 5 years Annual straight-line depreciation = $180,000 ÷ 5 = $36,000 Accrual accounting Increase in expected average annual operating income  rate of return Net initial investment  (60, 000 36, 000) /180, 000  24, 000 /180, 000  13.3%

Note how the accrual accounting rate of return, whichever way calculated, can produce results that differ markedly from the internal rate of return. 2.

Other than the NPV, rate of return, and the payback period on the new computer system, factors that Lethbridge should consider are:    

Issues related to financing the project, and the availability of capital to pay for the system. The effect of the system on employee morale, particularly those displaced by the system. Salesperson expertise and real-time help from experienced employees is key to the success of a hardware store. The benefits of the new system for customers (faster checkout, fewer errors). The upheaval of installing a new computer system. Its useful life is estimated to be five years. This means that Lethbridge could face this upheaval again in five years. Also ensure that the costs of training and other “hidden” start-up costs are included in the estimated $160,000 cost of the new computer system.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

21-18 (25 min.) Capital budgeting methods, no income taxes. The table for the present value of annuities (Appendix A, Table 4) shows: 10 periods at 14% = 5.216 1a. Net present value = $28,000 (5.216) – $110,000 = $146,048 – $110,000 = $36,048 b. Payback period

$110, 000 = 3.93 years $28, 000

c. For a $110,000 initial outflow, the project generates $28,000 in cash flows at the end of each of years one through ten. Using either a calculator or Excel, the internal rate of return for this stream of cash flows is found to be 21.96%. d. Accrual accounting rate of return based on net initial investment: Net initial investment = $110,000 Estimated useful life = 10 years Annual straight-line depreciation = $110,000 ÷ 10 = $11,000 $28, 000 $11, 000 Accrual accounting rate of return = $110, 000 $17, 000 = = 15.45% $110, 000 e. Accrual accounting rate of return based on average investment: Average investment = ($110,000 + $0) / 2 = $55,000 Accrual accounting rate of return =

$28, 000 $11, 000 = 30.91%. $55, 000

2. Factors City Hospital should consider include: a. Quantitative financial aspects. b. Qualitative factors, such as the benefits to its customers of a better eye-testing machine and the employee-morale advantages of having up-to-date equipment. c. Financing factors, such as the availability of cash to purchase the new equipment.

Chapter 21: Capital Budgeting: Methods of Investment Analysis

21-19 (20 min.) New equipment purchase. 1. The cash inflow per year is $31,250. a. Solution Exhibit 21-19a shows the NPV computation. NPV= $32,656 An alternative approach: Present value of 5-year annuity of $31,250 at 12% $31,250  3.605 $ 112,656 Present value of cash outlays, $80,000  1.000 80,000 Net present value $ 32,656 EXHIBIT 21-19a Total Present Value

Present Value Discount Factors At 12% 0

1a. Initial equipment investment $(80,000) 1.000 1b. Initial working capital investment 0 1.000 2a. Annual cash flow from operations (excl. depr.) Year 1 27,906 0.893 Year 2 24,906 0.797 Year 3 22,250 0.712 Year 4 19,875 0.636 Year 5 17,719 0.567 3 a. Terminal disposal of equipment 0 0.567 3 b. Recovery of working capital 0 0.567 Net present value if new equipment is purchased $ 32,656

Sketch of Relevant Cash Flows 2 3 4

$(80,000) $

0 $31,250 $31,250 $31,250

b. Payback = $80,000 ÷ $31,250 = 2.56 years c. Let F = Present value factor for an annuity of $1 for 5 years in Appendix A, Table 4 F = $80,000 ÷ $31,250 = 2.56 The internal rate of return can be calculated by interpolation:

26% IRR 28% Difference

Present Value Factors for Annuity of $1 for 5 years 2.635 2.635 2.560  2.532  0.103 0.075

$31,250 $31,250 $

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Both the net present value and internal rate of return methods use the discounted cash flow approach in which all expected future cash inflows and outflows of a project are measured as if they occurred at a single point in time. The net present value approach computes the surplus generated by the project in today’s dollars, while the internal rate of return attempts to measure its effective return on investment earned by the project. The payback method, by contrast, considers nominal cash flows (without discounting) and measures the time at which the project’s expected future cash inflows recoup the net initial investment in a project. The payback method thus ignores the profitability of the project’s entire stream of future cash flows. 3. The adjustment in discount rate made by the controller in headquarters will only change the net present value, while IRR and payback period will remain the same. Present value of 5-year annuity of $31,250 at 20% $31,250  2.991 Present value of cash outlays, $80,000  1.000 Net present value

$ 93,469 80,000 $ 13,469

The project will be approved by Innovation Inc. because its NPV is positive at a 20% required rate of return. The same conclusion can be achieved if the required rate of return (20%) is compared with the internal rate of return of the project (27.46%)

Chapter 21: Capital Budgeting: Methods of Investment Analysis

21-20 (30 min.) Payback methods, even and uneven cash flows. Payback problem:

1. Annual revenue Annual costs Fixed Variable Net annual cash inflow

$140,000 $80,000 7,000

87,000 $ 53,000

Payback period = Investment / Net cash inflows = $159,000 / $53,000 = 3 years Discounted Payback Period with even cash flows: Cash Year Revenues 0 1 $140,000 2 $140,000 3 $140,000 4 $140,000 5 $140,000 6 $140,000 7 $140,000 8 $140,000 9 $140,000

Fixed Costs $80,000 $80,000 $80,000 $80,000 $80,000 $80,000 $80,000 $80,000 $80,000

Net Disc Discounted Cumulative Variable Cash Factor Cash Disc. Cash Unrecovered Costs Inflows (10%) Savings Savings Investment $159,000 $7,000 $53,000 .909 $110,823 $48,177 $ 48,177 $7,000 $53,000 .826 $ 67,045 $43,778 $ 91,955 $7,000 $53,000 .751 $ 27,242 $39,803 $131,758 $7,000 $53,000 .683 $ 0 $36,199 $167,957 $7,000 $53,000 .621 $32,913 $7,000 $53,000 .564 $29,892 $7,000 $53,000 .513 $27,189 $7,000 $53,000 .467 $24,751 $7,000 $53,000 .424 $22,472

In year 4, $27,242/$36,199 = .75 Discounted Payback Period = 3.75 years

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Revenue (1) $ 90,000 120,000 125,000 85,000 150,000 210,000 130,000 140,000 190,000

Year 1 2 3 4 5 6 7 8 9

Cash Fixed Costs (2) $80,000 80,000 80,000 80,000 80,000 80,000 80,000 80,000 80,000

Cash Variable Costs (3) $ 4,500 6,000 6,250 4,250 7,500 10,500 6,500 7,000 9,500

Net Cash Inflows (4) = (1) − (2) − (3) $ 5,500 34,000 38,750 750 62,500 119,500 43,500 53,000 100,500

Cumulative Amounts $ 5,500 39,500 78,250 79,000 141,500 261,000 304,500 357,500 458,000

The cumulative amount exceeds the initial $159,000 investment for the first time at the end of year 6. So, payback happens in year 6. Using linear interpolation, a more precise measure is that payback happens at: 5 years + ($159,000 - $141,500)/$119,500=5.15 years Discounted Payback Period with uneven cash flows:

Year 0 1 2 3 4 5 6 7 8 9

Cash Revenues

Fixed Costs

Variabl e Costs

$ 90,000 120,000 125,000 85,000 150,000 210,000 130,000 140,000 190,000

$80,000 $ 4,500 80,000 6,000 80,000 6,250 80,000 4,250 80,000 7,500 80,000 10,500 80,000 6,500 80,000 7,000 80,000 9,500

Net Cash Inflows $

5,500 34,000 38,750 750 62,500 119,500 43,500 53,000 100,500

Disc Factor (10%)

Discounte d Cash Savings

Cumulative Disc. Cash Savings

.909 .826 .751 .683 .621 .564 .513 .467 .424

$ 5,000 28,084 29,101 512 38,813 67,398 22,316 24,751 42,612

$ 5,000 33,084 62,185 62,697 101,510 168,908 191,224 215,975 258,587

Discounted payback period = 5 years + $57,490/$67,398 = 5.85 years

Unrecovered Investment $159,000 154,000 125,916 96,815 96,303 57,490 0

Chapter 21: Capital Budgeting: Methods of Investment Analysis

21-21 (30 min.) Comparison of projects, no income taxes. 1. Total Present Value Plan I $ (375,000) (3,526,725) $(3,901,725)

Present Value Discount Factors at 12%

Year 0

1.000 0.797

$ (375,000)

Plan II $(1,500,000) (1,339,500) (1,195,500) $(4,035,000)

1.000 0.893 0.797

$(1,500,000)

Plan III $ (150,000) (1,339,500) (1,195,500) (1,068,000) $(3,753,000)

1.000 0.893 0.797 0.712

$ (150,000)

$(4,425,000)

$(1,500,000) $(1,500,000)

$(1,500,000) $(1,500,000) $(1,500,000)

2. Plan III has the lowest net present value cost. Plan III is the preferred one on financial criteria. 3. Factors to consider, in addition to NPV, are: a. Financial factors including:  Competing demands for cash.  Availability of financing for project. b. Nonfinancial factors including:  Risk of building contractor not remaining solvent. Plan II exposes the company most if the contractor becomes bankrupt before completion because it requires more of the cash to be paid earlier.  Ability to have leverage over the contractor if quality problems arise or delays in construction occur. Plans I and III give the company more negotiation strength by being able to withhold sizable payment amounts if, say, quality problems arise in Year 1.  Investment alternatives available. If the company has capital constraints, the new building project will have to compete with other projects for the limited capital available.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

21-22 (30 min.) Payback and NPV methods, no income taxes. 1a. Payback measures the time it will take to recoup, in the form of expected future cash flows, the net initial investment in a project. Payback emphasizes the early recovery of cash as a key aspect of project ranking. Some managers argue that this emphasis on early recovery of cash is appropriate if there is a high level of uncertainty about future cash flows. Projects with shorter paybacks give the organization more flexibility because funds for other projects become available sooner. Strengths  Easy to understand  One way to capture uncertainty about expected cash flows in later years of a project (although sensitivity analysis is a more systematic way) Weaknesses  Fails to incorporate the time value of money  Does not consider a project’s cash flows after the payback period 1b. Project A Outflow, $3,000,000 Inflow, $1,000,000 (Year 1) + $1,000,000 (Year 2) + $1,000,000 (Year 3) + $1,000,000 (Year 4) Payback = 3 years

Chapter 21: Capital Budgeting: Methods of Investment Analysis

Project B Outflow, $1,500,000 Inflow, $400,000 (Year 1) + $900,000 (Year 2) + $800,000 (Year 3) Payback = 2 years +

($1,500, 000 $400, 000 $900, 000) = 2.25 years $800, 000

Project C Outflow, $4,000,000 Inflow, $2,000,000 (Year 1) + $2,000,000 (Year 2) + $200,000 (Year 3) + $100,000 (Year 4) Payback = 2 years 1. Project C 2. Project B 3. Project A

Payback Period 2 years 2.25 years 3 years

If payback period is the deciding factor, Andrews will choose Project C (payback period = 2 years; investment = $4,000,000) and Project B (payback period = 2.25 years; investment = $1,500,000), for a total capital investment of $5,500,000. Assuming that each of the projects is an all-or-nothing investment, Andrews will have $500,000 left over in the capital budget, not enough to make the $3,000,000 investment in Project A. 2. Solution Exhibit 21- shows the following ranking: 1. Project B 2. Project A 3. Project C

NPV $ 207,800 $ 169,000 $(311,500)

3. Using NPV rankings, Projects B and A, which require a total investment of $3,000,000 + $1,500,000 = $4,500,000, which is less than the $6,000,000 capital budget, should be funded. This does not match the rankings based on payback period because Projects B and A have substantial cash flows after the payback period, cash flows that the payback period ignores. Nonfinancial qualitative factors should also be considered. For example, are there differential worker safety issues across the projects? Are there differences in the extent of learning that can benefit other projects? Are there differences in the customer relationships established with different projects that can benefit Andrews Construction in future projects?

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT Total Present Value

PROJECT A Net initial invest. Annual cash inflow

Net present value PROJECT B Net initial invest. Annual cash inflow Net present value PROJECT C Net initial invest. Annual cash inflow

Net present value

Present Value Discount Factors at 10%

$(3,000,000)

1.000

909,000 826,000 751,000 683,000 $ 169,000

0.909 0.826 0.751 0.683

$(1,500,000)

1.000

363,600 743,400 600,800 $ 207,800

0.909 0.826 0.751

$(4,000,000)

1.000

1,818,000 1,652,000 150,200 68,300 $ (311,500)

0.909 0.826 0.751 0.683

Sketch of Relevant Cash Flows 0

$(3,000,000) $1,000,000 $1,000,000 $1,000,000 $1,000,000 $(1,500,000) $ 400,000 $ 900,000 $ 800,000 $(4,000,000) $2,000,000 $2,000,000 $ 200,000 $ 100,000

Chapter 21: Capital Budgeting: Methods of Investment Analysis

21-23 (60 min.) Equipment replacement, no income taxes. 1. Cash flows for modernizing alternative: Year (1) Jan. 1, 2021 Dec. 31, 2021 Dec. 31, 2022 Dec. 31, 2023 Dec. 31, 2024 Dec. 31, 2025 Dec. 31, 2026 Dec. 31, 2027

Net Cash Units Sold Contributions (2) (3) = (2) × $16,500a –– 615 680 745 810 875 940 1,005

–– $10,147,500 11,220,000 12,292,500 13,365000 14,437,500 15,510000 16,582,500

Initial Investments (4)

Sale of Equip. at Termination (5)

$(35,300,000)

––

$7500000

a$95000 – $78,500 = $16,500 cash contribution per prototype.

Cash flows for replacement alternative: Net Cash Year Units Sold Contributions (1) (2) (3) = (2) × $29,000b Jan. 1, 2021 Dec. 31, 2021 Dec. 31, 2022 Dec. 31, 2023 Dec. 31, 2024 Dec. 31, 2025 Dec. 31, 2026 Dec. 31, 2027

–– 615 680 745 810 875 940 1,005

–– $17,835,000 19,720,000 21,605,000 23,490000 25,375000 27,260000 29,145,000

Initial Investments (4)

Sale of Equip. (5)

$(66,300,000)

$ 4,200,000

b$95000 – $66000 = $29000 cash contribution per prototype.

$16000000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Payback period calculations for modernizing alternative: Year (1)

Cash Inflow (2)

Cumulative Cash Inflow (3)

Jan. 1, 2021 Dec. 31, 2021 Dec. 31, 2022 Dec. 31, 2023 Dec. 31, 2024

–– $10,147,500 11,220000 12,292,500 13,365,000

–– $10,147,500 21,367500 33,660000 47,025,000

Net Initial Investment Unrecovered at End of Year (4) $35,300,000 25,152500 13,932500 1,640000 0

Payback = 3 + ($1,640,000 ÷ $13,365,000) = 3.12 years Payback period calculations for replace alternative: Year (1)

Cash Inflow (2)

Cumulative Cash Inflow (3)

Jan. 1, 2021 Dec. 31, 2021 Dec. 31, 2022 Dec. 31, 2023 Dec. 31, 2024

–– $17,835000 19,720000 21,605000 23,490000

–– $17,835000 37,555000 59,160000 82,650,000

Payback = 3 + ($2,940,000 ÷ $23,490,000) = 3.13 years

Net Initial Investment Unrecovered at End of Year (4) $62,100,000 44,265000 24,545000 2,940000 0

Chapter 21: Capital Budgeting: Methods of Investment Analysis

3. Modernizing alternative: Present Value Discount Factors Year At 14% Jan. 1, 2021 1.000 Dec. 31, 2021 0.877 Dec. 31, 2022 0.769 Dec. 31, 2023 0.675 Dec. 31, 2024 0.592 Dec. 31, 2025 0.519 Dec. 31, 2026 0.456 Dec. 31, 2027 0.400 Total

Net Cash Flow $(35,300000) 10,147,500 11,220000 12,292,500 13,365,000 14,437,500 15,510000 24,082,500

Present Value $(35,300,000) 8,899,358 8,628,180 8,297,438 7,912,080 7,493,063 7,072,560 9,633,000 $22,635,679

Net Cash Flow $(62,100000) 17,835,000 19,720000 21,605,000 23,490,000 25,375,000 27,260000 45,145,000

Present Value $(62,100,000) 15,641,295 15,164,680 14,583,375 13,906,080 13,169,625 12,430,560 18,058,000 $ 40,853,615

Replace Alternative: Present Value Discount Factors Year At 14% Jan. 1, 2021 1.000 Dec. 31, 2021 0.877 Dec. 31, 2022 0.769 Dec. 31, 2023 0.675 Dec. 31, 2024 0.592 Dec. 31, 2025 0.519 Dec. 31, 2026 0.456 Dec. 31, 2027 0.400 Total

4. Using the payback period, the modernize alternative is preferred, albeit by a very slight margin, to the replace alternative. On the other hand, the replace alternative has a significantly higher NPV than the modernize alternative and so should be preferred. Of course, the NPV amounts are based on best estimates of cash flows going out into the future. Dublin Chips should examine the sensitivity of the NPV amounts to variations in the estimates. Nonfinancial qualitative factors should also be considered. These could include the quality of the prototypes produced by the modernize and replace alternatives. These alternatives may differ in capacity and their ability to meet surges in demand beyond the estimated amounts. The alternatives may also differ in how workers increase their shop floorcapabilities. Such differences could provide labour force externalities that can be the source of future benefits to Dublin Chips.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

21-24 (22–30 min.)

DCF, accrual accounting rate of return, working capital, evaluation of performance, no income taxes.

1. Present value of annuity of savings in cash operating costs ($31,250 per year for 8 years at 14%): $31,250  4.639 Present value of $37,500 terminal disposal price of machine at end of year 8: $37,500  0.351 Present value of $10,000 recovery of working capital at end of year 8: $10,000  0.351 Gross present value Deduct net initial investment: Centrifuge machine, initial investment Additional working capital investment Net present value 2. Use a trial-and-error approach. First, try a 16% discount rate: $31,250  4.344 ($37,500 + $10,000)  0.305 Gross present value Deduct net initial investment Net present value

$135,750 14,488 150,238 (147,500) $ 2,738

Second, try an 18% discount rate: $31,250  4.078 ($37,500 + $10,000)  .266 Gross present value Deduct net initial investment Net present value

$127,438 12,635 140,073 (147,500) $ (7,427)

By interpolation:

 $2, 738  Internal rate of return = 16% +  × 2% $2, 738  $7, 427  = 16% + (0.2693  2%) = 16.54%

$144,969 13,163 3,510 161,642 $137,500 10,000

147,500 $ 14,142

Chapter 21: Capital Budgeting: Methods of Investment Analysis

3. Accrual accounting rate of return based on net initial investment: Net initial investment = $137,500 + $10,000 = $147,500 Annual depreciation ($137,500 – $37,500) ÷ 8 years = $12,500 Accrual accounting rate of return

$31,250 $12,500 = 12.71%. $147,500

4. If your decision is based on the DCF model, the purchase would be made because the net present value is positive, and the 16.54% internal rate of return exceeds the 14% required rate of return. However, you may believe that your performance may actually be measured using accrual accounting. This approach would show a 12.71% return on the initial investment, which is below the required rate. Your reluctance to make a “buy” decision would be quite natural unless you are assured of reasonable consistency between the decision model and the performance evaluation method.

21-25 (20 min.) DCF, sensitivity analysis, no income taxes. 1. Revenues, $100 × 2,000,000 Variable cash costs, $50 × 2,000,000 Cash contribution margin Fixed cash costs Cash inflow from operations Net present value: Cash inflow from operations: $82,000,000 × 2.798 Cash outflow for initial investment Net present value 2a. 20% reduction in selling prices: Revenues, $80 × 2,000,000 Variable cash costs, $50 × 2,000,000 Cash contribution margin Fixed cash costs Cash inflow from operation Net present value: Cash inflow from operations: $42,000,000 × 2.798 Cash outflow for initial investment Net present value

$200,000,000 100,000,000 100,000,000 18,000,000 $ 82,000,000 $229,436,000 (100,000,000) $129,436,000 $160,000,000 100,000,000 60,000,000 18,000,000 $ 42,000,000 $117,516,000 (100,000,000) $ 17,516,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

b. 20% increase in the variable cost per unit: Revenues, $100 × 2,000,000 Variable cash costs, $60 × 2,000,000 Cash contribution margin Fixed cash costs Cash inflow from operations Net present value: Cash inflow from operations: $62,000,000 × 2.798 Cash outflow for initial investment Net present value

$200,000,000 120,000,000 80,000,000 18,000,000 $ 62,000,000 $173,476,000 (100,000,000) $ 73,476,000

3. Sensitivity analysis enables management to see those assumptions for which input variations have sizable impact on NPV. Extra resources could be devoted to getting more informed estimates of those inputs with the greatest impact on NPV, in this case the potential reduction in selling prices. Sensitivity analysis also enables management to have contingency plans in place if the assumptions underlying the analysis are not met.

21-26 (22–30 min.) DCF, accrual accounting rate of return, working capital, evaluation of performance, no income taxes. 1. Present value of annuity of savings in cash operating costs ($22,250 per year for 8 years at 12%): $22,250 × 4.968 Present value of $22,500 terminal disposal price of machine at end of year 8: $22,500 × 0.404 Present value of $10,000 recovery of working capital at end of year 8: $10,000 × 0.404 Gross present value Deduct net initial investment: Rendering machine, initial investment Additional working capital investment Net present value

$110,538 9,090 4,040 123,668 102,500 10,000 112,500 $ 11,168

Chapter 21: Capital Budgeting: Methods of Investment Analysis

2. The sequence of cash flows from the project is: For a $102,500 initial outflow, the project now generates $22,250 in cash flows at the end of each of years 1 through 7 and $54,750 (= $22,500 + $22,250 + $10,000) at the end of year 8. Using either a calculator or Excel, the internal rate of return for this stream of cash flows is found to be 17.10%. 3. Accrual accounting rate of return based on net initial investment: Net initial investment = $102,500 + $10,000 = $112,500 Annual depreciation ($102,500 – $22,500) ÷ 8 years = $10,000 Accrual accounting rate of return

= 10.89%.

4. Accrual accounting rate of return based on average investment: Net terminal cash flow = $22,500 terminal disposal price + $10,000 working capital recovery = $32,500 Average investment = ($112,500 + $32,500) / 2 = $72,500 Accrual accounting rate of return = 16.90%. 5. If your decision is based on the DCF model, the purchase would be made because the net present value is positive, and the 17.10% internal rate of return exceeds the 12% required rate of return. However, you may believe that your performance may actually be measured using accrual accounting. This approach would show a 10.89% return on the initial investment, which is below the required rate. Your reluctance to make a “buy” decision would be quite natural unless you are assured of reasonable consistency between the decision model and the performance evaluation method.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

21-27 (30–35 min.) NPV and AARR, goal-congruence issues. 1. Annual cash flow from operations Income tax payments (30%) Annual after-tax cash flow from operations (excl. deprn.)

$130,000 39,000 $ 91,000

Depreciation: $495,000 ÷ 9 = $55,000 per year Income-tax cash savings from depreciation deduction: $55,000 × 0.30 = $16,500 per year The present value of an annuity of $1 per year for 9 years discounted at 14% = 4.946. So, present value of annual cash flows = ($91,000 + $16,500) × 4.946 = $531,695 Net initial investment = $(495,000) + $(5,000) = $(500,000) Present value of working capital recovery = $5,000 × 0.308 = $1,540 Net present value of project = $(500,000) + $531,695 + $1,540 = $33,235 2. Accrual accounting rate of return (AARR): The accrual accounting rate of return takes the annual accrual net income after tax and divides by the initial investment to get a return. Incremental net operating income excluding depreciation Less: Depreciation expense ($495,000 ÷ 9) Income before tax Income tax expense (at 30%) Net income per period

$130,000 55,000 75,000 22,500 $ 52,500

AARR = $52,500 ÷ $500,000 = 10.50%. 3. Liam will not accept the project if he is being evaluated on the basis of accrual accounting rate of return, because the project does not meet the 14% threshold above which Liam earns a bonus. Liam should accept the project if he wants to act in the firm’s best interest because the NPV is positive, implying that, based on the cash flows generated, the project exceeds the firm’s required 14% rate of return. Thus, Liam will turn down an acceptable long-run project to avoid a poor evaluation based on the measure used to evaluate his performance. To remedy this, the firm could evaluate Liam instead on a project-by-project basis, by looking at how well he achieves the cash flows forecasted when he chose to accept the project.

Chapter 21: Capital Budgeting: Methods of Investment Analysis

21-28 (40 min.) Customer value. 1. Annual Increases* 2020 2021 2022 2023 6% $ 567,000 $ 601,020 $ 637,081 $ 675,306

Square Cash Revenues Cash Expenses Net Cash Flows

364,800 383,040 402,192 422,302 $ 202,200 $ 217,980 $ 234,889 $ 253,004

Annual Increases* 2020 2021 2022 2023 5.5% $3,510,000 $3,703,050 $3,906,718 $4,121,587

Cloudburst Cash Revenues Cash Expenses Net Cash Flows

4.5%

3,060,000 3,197,700 3,341,597 3,491,968 $ 450,000 $ 505,350 $ 565,121 $ 629,619

*Given in the problem.

2. Square Year 2021 2022 2023

PV Factor for 12% 0.893 0.797 0.712

Net Cash Flows $217,980 234,889 253,004

Present Value $194,656 187,207 180,139 $562,002

Cloudburst Net Cash Flows $505,350 565,121 629,619

Based on NPV at 12%, Cloudburst is the more valuable customer.

Present Value $ 451,278 450,401 448,289 $1,349,968

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. Assuming a 10% discount on the revenues for Cloudburst calculated in requirement 1, we have Cloudburst Cash Revenues*

Annual Increases 2020 5.5% $3,510,000

Cash Expenses Net Cash Flows

4.5%

3,060,000 $ 450,000

2021 $3,332,745

2022 $3,516,046

2023 $3,709,428

3,197,700 $ 135,045

3,341,597 $ 174,449

3,491,968 $ 217,460

*Cloudburst’s revenue from requirement 1 reduced by 10% each year from 2021 onwards.

Net present value if revenues are reduced by 10% each year relative to original estimates: Cloudburst Year 2021 2022 2023

PV Factor for 12% 0.893 0.797 0.712

Net Cash Flows $135,045 174,449 217,460

Present Value $120,595 139,036 154,832 $414,463

The 10% discount and reduced subsequent annual revenue reduces the NPV from $1,349,968 to $414,463. The NPV is still positive and so Ortel should continue to sell to Cloudburst Constructors. However, this is almost a 70% drop in NPV from Cloudburst, and it makes Square now the more profitable customer. Ortel should consider whether the price discount demanded by Cloudburst needs to be met in its entirety to keep the account. The implication of meeting the full demand is that the account is minimally profitable. A serious concern is whether Square will also demand comparable price discounts if Cloudburst’s demands are met. This could result in large reductions in the NPVs of all of Ortel’s customers. Ortel should also consider the reliability of the growth estimates used in computing the NPVs. Are the predicted differences in revenue growth rates based on reliable information? Many revenue growth estimates by salespeople turn out to be overestimates or occur over a longer time period than initially predicted.

Chapter 21: Capital Budgeting: Methods of Investment Analysis

21-29 Estimated cash flows, tax minimization, calculated depreciation 1. Initial investment Recurring after-tax operating savings* Tax shield from CCA** Proceeds from disposal of machine Tax shield lost from disposal*** NPV

Present Value (222,000)

Cash Flow Factor 1

Discounted Cash Flows (222,000)

14,950

3.170

47,392

49,445

10,000

0.683

6,830

(2,333)

0.683

(1,594) (119,927)

*23,000 × (1-0.35) **(222,000 × 0.35) × (0.20/(0.20 + 0.10)) × ((2 + 0.10)/(2(1 + 0.10))) ***(−10,000 × 0.35) × (0.2/(0.20 + 0.10)) 2. The company should not purchase the machine as NPV is negative. The future cash flows (expected benefits as a result of the investment) are not enough to offset the cost of the new machine.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

21-30 Internal rate of return in capital budgeting. 1) Year 1 2 3 4

CCA 2,220 3,996 3,196.80 2,557.44

a) b) c) d)

Total Shield (CCA × 0.35) X 777 1,399 1,119 895

Cumulative Cash Flows Y 14,950 14,950 14,950 14,950

Cash Flows Z=X+Y 15,727 16,349 16,069 15,845

Cash Flows 15,727 32,076 48,145 63,990

a)0.20 × (1/2) × 22,200 b)0.20 × (22,200 − 2,220) c)0.20 × (22,200 – (2,220 + 3,996)) d)0.20 × (22,200 – (2,220 + 3,996 + 3,196.80)) Cumulative cash flows = 23,000 × (1 – 0.35) Payback period = 1 + ((22,200 – 15,727)/16,349) Payback period 1.40 2) The NPV method uses a discounted cash flow approach to calculate the present value of all future expected cash flow. The payback method only considers cash flows up to the time that the project makes back the original invest amount. In situations where the economies are instable, for example on a global stage, payback period is an appropriate method in decisionmakers are extremely concerned with making back their investment quickly. Generally speaking the more unstable the environment the shortest the acceptable payback period.

Chapter 21: Capital Budgeting: Methods of Investment Analysis

21-31 Capital budgeting and NPV. 1) *($150,000 × 0.4) × (0.25/(0.25 + 0.15) × ((2 + 0.15)/2(1 + 0.15))) **Calculation below: After tax cash inflow (Expected cash flow × PV Discount factors Year (A) 1-tax rate) at 15% 1 53,400.00 0.870

Total PV 46,458.00

2) Yes, NPV>0 therefore the investment is profitable.

Initial Investment in machine Tax shield from CCA* Recurring cash flows from machine** Proceeds from disposal of equipment Lost tax shield due to disposal*** NPV

Present Value (150,000.00 ) 35,054.35

Cash Flow Factor 1 1

11,000.00

0.658

7,238.00

(2,750.00)

0.658

(1,809.50) 18,093.25

*($150,000x0.4) × (0.25/(0.25 + 0.15) × ((2 + 0.15)/2(1 + 0.15))) **Calculation below Year After tax cash PV (A) inflow discount (Expected cash factors flow × 1-tax at rate) 15% 1 2 3

53,400.00 54,600.00 60,600.00

0.870 0.756 0.658

Total

Discounted Cash Flows (150,000.00) 35,054.35 127,610.40

Total PV

46,458.00 41,277.60 39,874.80 127,610.40

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

21-32 Capital budgeting, NPV, and economic factors. 1. Real rate of return = [(1 + nominal rate)/(1 + inflation rate)] − 1 0.147058824 2.

Initial Investment in machine Tax shield from CCA* Recurring cash flows from machine** Proceeds from disposal of equipment Lost tax shield due to disposal*** NPV

Present Value (150,000.00) 35,356.13

Cash Flow Factor 1 1

11,000.00 (2,770.08)

0.658 0.658

Discounted Cash Flows (150,000.00) 35,356.13 128,204.06 7,238.00 (1,822.71) 18,975.48

*($150,000 × 0.4) × (0.25/(0.25 + 0.147058824) × ((2 + 0.147058824)/(2(1 + 0.147058824)))) **Calculation below

After tax cash inflow (Expected cash flow × 1-tax rate) (X) 1 53,400.00 2 54,600.00 3 60,600.00

Year (A)

Total

***(−11,000 × 0.4) × (0.25/(0.25 + 0.1471)

Total PV (X/((1 + 0.147058824)^year) 46,553.85 41,497.44 40,152.77 128,204.06

Chapter 21: Capital Budgeting: Methods of Investment Analysis

21-33 Capital budgeting and NPV, and IRR. 1. Present value of annuity of savings in cash operating costs ($23,000 per year for 15 years at 12%) Factor (12% rate at 15 years) 23,000 × 6.81086

6.810860 156,649.78

Present value of terminal disposal price ($10,000 at end of year 15) Factor (12% rate at 15 years) 10,000 × 0.183

0.183 1,830.00

Present value of $5,000 recovery of working capital at end of year 15 Factor (12% rate at 15 years) 5,000 × 0.183 Gross Present Value Initial Investment Additional working capital investment NPV

0.183 915.00 159,394.78 120,000.00 5,000.00 34,394.78

2. Method 1: Trial and error to determine the discount rate that produces an NPV of $0. If two answers are very close to zero (one above and one below$0) you can use interpolation to approximate the internal rate of return. Method 2: Financial calculators or Excel can be used to determine the discount rate when NPV = O 3. Because the NPV is positive we know that the IRR will be greater than 12% 4. Accrual accounting rate of return = (savings per year − annual depreciation)/ net initial investment Annual depreciation (120,000 − 10,000)/15 = 7,333.33 AARR

13%

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

21-34 (25–30 min.) DCF, accrual accounting rate of return, working capital, evaluation of performance, no income taxes. 1. Present value of annuity of savings in cash operating costs ($24,900 per year for 6 years at 12%): $24,900  4.111 Present value of $9,000 terminal disposal price of machine at end of year 6: $9,000  0.507 Present value of $4,000 recovery of working capital at end of year 6: $4,000  0.507 Gross present value Deduct net initial investment: Centrifuge machine, initial investment Additional working capital investment Net present value

$102,364 4,563 2,028 108,955 $94,000 4,000

98,000 $ 10,955

2. The sequence of cash flows from the project is: For a $98,000 initial outflow, the project generates $24,900 in cash flows at the end of each of years one through five and $37,900 (= $24,900 + $9,000 + $4,000) at the end of year 6. Using either a calculator or Excel, the internal rate of return for this stream of cash flows is found to be 15.66%. 3. Accrual accounting rate of return based on net initial investment: Net initial investment = $94,000 + $4,000 = $98,000 Annual depreciation ($94,000 – $9,000) ÷ 6 years = $14,166.67 Accrual accounting rate of return =

$24,900 $14,166.67 = 10.95%. $98,000

4. Accrual accounting rate of return based on average investment: Net terminal cash flow

= $9,000 terminal disposal price + $4,000 working capital recovery = $13,000

Average investment

= ($98,000 + $13,000) / 2 = $55,500

Accrual accounting rate of return =

$24,900 $14,166.67 = 19.34%. $55,500

Chapter 21: Capital Budgeting: Methods of Investment Analysis

5. If your decision is based on the DCF model, the purchase would be made because the net present value is positive, and the 15.66% internal rate of return exceeds the 12% required rate of return. However, you may believe that your performance may actually be measured using accrual accounting. This approach would show a 10.95% return on the initial investment, which is below the required rate. Your reluctance to make a “buy” decision would be quite natural unless you are assured of reasonable consistency between the decision model and the performance evaluation method.

21-35 (30 min.) Comparison of projects, no income taxes. 1. Total Present Value Plan I $ (175,000) (3,614,300) $(3,789,300)

Present Value Discount Factors at 14%

Year 0

1.000 0.769

$ (175,000)

Plan II $(1,625,000) (1,425,125) (1,249,625) $(4,299,750)

1.000 0.877 0.769

$(1,625,000)

Plan III $ (325,000) (1,315,500) (1,153,500) (1,012,500) $(3,806,500)

1.000 0.877 0.769 0.675

$ (325,000)

$(4,700,000)

$(1,625,000) $(1,625,000)

$(1,500,000) $(1,500,000) $(1,500,000)

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Plan I has the lowest net present value cost, and is therefore preferable on financial criteria. 3. Factors to consider, in addition to NPV, are: a. Financial factors including:  Competing demands for cash.  Availability of financing for project. b. Nonfinancial factors including:  Risk of building contractor not remaining solvent. Plan II exposes New Pharm most if the contractor becomes bankrupt before completion because it requires more of the cash to be paid earlier.  Ability to have leverage over the contractor if quality problems arise or delays in construction occur. Plans I and III give New Pharm more negotiation strength by being able to withhold sizable payment amounts if, say, quality problems arise in Year 1.  Investment alternatives available. If New Pharm has capital constraints, the new building project will have to compete with other projects for the limited capital available.

Chapter 21: Capital Budgeting: Methods of Investment Analysis

21-36 (25 min.) Capital budgeting with uneven cash flows, no income taxes. 1. Present value of savings in cash operating costs: $25,000 × 0.847 22,000 × 0.718 21,000 × 0.609 20,000 × 0.516 Present value of savings in cash operating costs Net initial investment Net present value

$ 21,175 15,796 12,789 10,320 60,080 (65,000) $ (4,920)

2. Payback period: Year 0 1 2 3

Cash Savings – $25,000 22,000 21,000

Payback period = 2 years +

Cumulative Cash Savings – $25,000 47,000 68,000

Initial Investment Yet to Be Recovered at End of Year $65,000 40,000 18,000 -

$18,000 = 2.86 years $21,000

3. Discounted Payback Period

Period 0 1 2 3 4

Cash Savings

Disc Factor (18%)

Discounted Cash Savings

$25,000 $22,000 $21,000 $20,000

.847 .718 .609 .516

$21,175 $15,796 $12,789 $10,320

Cumulative Discounted. Unrecovered Cash Savings Investment −$65,000 $21,175 −$43,825 $36,971 −$28,029 $49,760 −$15,240 $60,080 −$ 4,920

At a 18% rate of return, this project does not save enough to make it worthwhile using the discounted payback method.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4. From requirement 1, the net present value is negative with a 18% required rate of return. Therefore, the internal rate of return must be less than 18%.

Year (1) 1 2 3 4

Cash Savings (2) $25,000 22,000 21,000 20,000

P.V. Factor at 14% (3) 0.877 0.769 0.675 0.592

P.V. at 14% (4) = (2) × (3) $ 21,925 16,918 14,175 11,840 $ 64,858

P.V. Factor at 12% (5) 0.893 0.797 0.712 0.636

P.V. at 12% (6) = (2) × (5) $22,325 17,534 14,952 12,720 $67,531

P.V. Factor at 10% (7) 0.909 0.826 0.751 0.683

Net present value at 14% = $64,858 – $65,000 = $(142) Net present value at 12% = $67,531 – $65,000 = $2,531

 2,531  Internal rate of return = 12% +  × (2%) 2,531  142  = 12% + (0.947) × (2%) = 13.89% 5. Accrual accounting rate of return based on net initial investment: Average annual savings in cash operating costs =

$88, 000 = $22,000 4 years

Annual straight-line depreciation =

$65, 000 = $16,250 4 years

Accrual accounting rate of return =

$22,000 $16,250 $65,000

$5,750 = 8.85% $65,000

P.V. at 10% (8) = (2) × (7) $22,725 18,172 15,771 13,660 $70,328

Chapter 21: Capital Budgeting: Methods of Investment Analysis

21-37 (40 min.) New equipment purchase, income taxes. 1. a. Solution NPV computation. NPV = $ 6,923 Present-Value

Initial machine investment Recurring after-tax operating savings* Tax shield from CCA** Proceeds from disposal of machine Tax shield lost from terminal value*** Net present value

Relevant Cash Flows $(95,000) 21,600 22,478 -

Discount Factors at 12% 1.000 3.037 1.000 0.636 0.636

Total Present Value $(95,000) 65,599 22,478 $ (6,923)

*36,000  (1 – 0.4) = $21,600 **($95,000  0.4)  (0.20/(0.20 + 0.12))  ((2 + 0.12)/(2(1 + 0.12))) = $22,478 ***no lost tax shield as no salvage value

b. Payback TaxOperating Year 1 2 3 4

CCA $9,500a) 17,100b) 13,680c) 10,944 d)

Total Cumulative Shield Cash (CCA @ 0.40) Flows $3,800 $21,600 6,840 21,600 5,472 21,600 4,378 21,600

Cash Flows $25,400 28,440 27,072 25,978

Payback period = 3 + (($95,000 – $80,912)/$25,978) = 3.54 years a)0.20  1/2  95,000 = 9,500 b)0.20  (95,000 – 9,500) = 17,100 c)0.20  (95,000 – (9,500 + 17,100)) = 13,680 d)0.20  (95,000 – (9,500 + 17,100 + 13,680)) = 10,944

Cash Flows $ 25,400 53,840 80,912 106,890

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

c. Part (a) calculates the NPV as $(6,923) using 12%. Therefore, the IRR, the discount rate at which the NPV of the cash flows is zero, must be less than 12%. Using trial and error, use the tables to calculate the NPV for 8% IRR:

Initial machine investment Recurring after-tax operating savings* Tax shield from CCA** Proceeds from disposal of machine Tax shield lost from terminal value*** Net present value

Relevant Cash Flows $(95,000) 21,600 26,138 -

Discount Factors at 8% 1.000 3.312 1.000 0.592 0.592

Total Present Value $(95,000) 71,539 26,138 $ 2,677

*36,000  (1 – 0.4) = $21,600 **($95,000  0.4)  (0.20/(0.20 + 0.08))  ((2 + 0.08)/(2(1 + 0.08))) = $26,138 ***no lost tax shield as no salvage value

12%, NPV = $(6,923) 8%, NPV = $ 2,677 Therefore, the IRR is between 8% and 12%. 2. Both the net present value and internal rate of return methods use a discounted cash flow approach in which all expected future cash inflows and cash outflows of a project are measured as if they occurred at a single point in time. The payback method considers only cash flows up to the time when the expected future cash inflows recoup the net initial investment in a project. The payback method ignores profitability and the time value of money. However, the payback method is becoming increasingly important in the global economy. When the local environment in an international location is unstable and therefore highly risky for a potential investment, a company would likely pay close attention to the payback period for making its investment decision. In general, the more unstable the environment, the shorter the payback period desired.

Chapter 21: Capital Budgeting: Methods of Investment Analysis

21-38 (20–25 min.) Capital budgeting methods, no income taxes. 1a. The table for the present value of annuities (Appendix A, Table 4) shows: $1 for 10 periods at 6% = 7.36 Net present value = $15,000 (7.36) – $80,000 = $110,400 – $80,000 = $30,400 1b. Payback period 1c

Discounted Payback Period

Period 0 1 2 3 4 5 6 7

= $80,000 ÷ $15,000 = 5.33 years

Cash Savings

Discount Factor (6%)

$15,000 $15,000 $15,000 $15,000 $15,000 $15,000 $15,000

0.943 0.890 0.840 0.792 0.747 0.705 0.665

Cumulative Discounted Discounted Cash Savings Cash Savings $14,145 $13,350 $12,600 $11,880 $11,205 $10,575 $ 9,975

$14,145 $27,495 $40,095 $51,975 $63,180 $73,755 $83,730

Unrecovered Investment −$80,000 ($65,855) ($52,505) ($39,905) ($28,025) ($16,820) ($ 6,245)

$6,245/$9,975 = .6261 Discounted Payback period = 6.63 years 1d. Internal rate of return: $80,000 = Present value of annuity of $15,000 at R% for 10 years, or what factor (F) in the table of present values of an annuity (Appendix A, Table 4) will satisfy the following equation. $80,000 = $15,000F F = 80,000/15,000= 5.333 On the 10-year line in the table for the present value of annuities (Appendix A, Table 4), find the column closest to 5.333; it is between a rate of return of 12% and 14%.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Interpolation is necessary: 12% IRR rate 14% Difference

Present Value Factors 5.650 5.650 – 5.333 5.216 –– 0.434 0.317

Internal rate of return = 12% + (0.317/0.434) * (2%) = 12% + .730 (2%) = 13.46% 1e. Accrual accounting rate of return based on net initial investment: Net initial investment = $80,000 Estimated useful life = 10 years Annual straight-line depreciation = $80,000 ÷ 10 = $8,000 Accrual accounting rate of return = Increase in expected average annual operating income Net initial investment

= ($15,000 – $8,000) / $80,000 = $7,000 / $80,000 = 8.75% Note how the accrual accounting rate of return can produce results that differ markedly from the internal rate of return. 2.

Other than the NPV, rate of return and the payback period on the new computer system, factors that Yummy should consider are:  Issues related to the financing the project, and the availability of capital to pay for the system.  The benefits of the machine for customers (more customers, more variety of products, faster production time, special orders).  Ensure that the costs of training and other “hidden” start-up costs are included in the estimated $80,000 cost of the new machine.  Verify that the technology of the machine will last for the estimated 10 years.

Chapter 21: Capital Budgeting: Methods of Investment Analysis

21-39 (20 min.) DCF, sensitivity analysis, no income taxes. 1.

Revenues, $25 × 1,000,000 $25,000,000 Variable cash costs, $10 × 1,000,000 10,000,000 Cash contribution margin 15,000,000 Fixed cash costs 5,000,000 Cash inflow from operations $10,000,000 Net present value: Cash inflow from operations: $10,000,000 × 3.433 Cash outflow for initial investment Net present value

$34,330,000 (30,000,000) $ 4,330,000

2a. 5% reduction in selling prices: Revenues, $23.75 × 1,000,000 $23,750,000 Variable cash costs, $10 × 1,000,000 10,000,000 Cash contribution margin 13,750,000 Fixed cash costs 5,000,000 Cash inflow from operations $ 8,750,000 Net present value: Cash inflow from operations: $8,750,000 × 3.433 Cash outflow for initial investment Net present value

$ 30,038,750 (30,000,000) $ 38,750

b. 5% increase in the variable cost per unit: Revenues, $25 × 1,000,000 $ 25,000,000 Variable cash costs, $10.50 × 1,000,000 10,500,000 Cash contribution margin 14,500,000 Fixed cash costs 5,000,000 Cash inflow from operations $ 9,500,000 Net present value: Cash inflow from operations: $9,500,000 × 3.433 $ 32,613,500 Cash outflow for initial investment (30,000,000) Net present value $ 2,613,500 3.

Sensitivity analysis enables management to see those assumptions for which input variations have sizable impact on NPV. Extra resources could be devoted to getting more informed estimates of those inputs with the greatest impact on NPV. Sensitivity analysis also enables management to have contingency plans in place if assumptions are not met. For example, if a 5% reduction in selling price is viewed as occurring with 0.40 probability, management may wish to line up bank loan facilities.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

21-40 (45 min.) NPV, IRR and sensitivity analysis. 1. Net present value of project: Period 0 Cash inflows Cash outflows Net cash flows

$(42,000) $(42,000)

Periods 1 - 10 $23,000 (16,000)

Annual net cash inflows Present value factor for annuity, 10 periods, 6% Present value of net cash inflows Initial investment Net present value

$ 7,000 × 7.36 $51,520 (42,000) $ 9,520

To find IRR, first divide the initial investment by the net annual cash inflow: $42,000 ÷ $7,000 = 6.0. The 6.0 represents the present value factor for a ten-period project with the given cash flows, so look in Table 4, Appendix A, for the present value of an annuity in arrears to find the factor closest to 6.0 along the ten period row. You should find that it is between 10% and 12%. The internal rate of return can be calculated by interpolation:

10% IRR 12% Difference

Present Value Factors for Annuity of $1 for 10 years 6.145 6.145 6.000  5.650 − 0.495 0.145

0.145  Internal rate of return = 10% +  (2%) = 10.6%. 0.495  Note: You can use a calculator or excel to find the IRR, and you will get an answer of approximately 10.56%.

2. If revenues are 10% higher, the new net present value will be: Period 0 Periods 1 - 10 $25,300 Cash inflows (16,000) Cash outflows $(42,000) $ 9,300 Net cash inflows $(42,000) Annual net cash inflows Present value factor for annuity, 10 periods, 6% Present value of net cash inflows Initial investment Net present value Copyright © 2022 Pearson Canada Inc. 21-42

$ 9,300 × 7.36 $68,448 (42,000) $26,448

Chapter 21: Capital Budgeting: Methods of Investment Analysis

And the IRR will be: $42,000 ÷ $9,300 = present value factor of 4.516, yielding a return of 17.87% via interpolation (see below), or using a calculator, a return of 17.86%.

16% IRR 18% Difference

Present Value Factors for Annuity of $1 for 10 years 4.833 4.833 4.516  4.494  0.339 0.317

0.317  (2%) = 17.87%. 0.339 

Internal rate of return = 16% + 

If revenues are 10% lower, the new net present value will be: Period 0 Periods 1 – 10 $20,700 Cash inflows (16,000) Cash outflows $(42,000) $ 4,700 Net cash inflows $(42,000) Annual net cash inflows Present value factor for annuity, 10 periods, 6% Present value of net cash inflows Initial investment Net present value

$ 4,700 × 7.36 $ 34,592 (42,000) $ (7,408)

And the IRR will be: $42,000 ÷ $4,700 = present value factor of 8.936, yielding a return of 2.11% using interpolation (see calculations below) or, using a calculator, a return of 2.099%.

2% IRR 4% Difference

Present Value Factors for Annuity of $1 for 10 years 8.983 8.983 8.936  8.111  0.872 0.047

0.047  Internal rate of return = 2% +  (2%) = 2.11%. 0.872 

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. If both revenues and costs are higher, the new net present value will be: Period 0 Periods 1 –10 $25,300 Cash inflows (17,120) Cash outflows $(42,000) $ 8,180 Net cash inflows $(42,000) Annual net cash inflows Present value factor for annuity, 10 periods, 6% Present value of net cash inflows Initial investment Net present value

$ 8,180 × 7.36 $60,205 (42,000) $18,205

And the IRR will be: $42,000 ÷ $8,180 = present value factor of 5.134, yielding a return of 14.43% via interpolation, or using a calculator, a return of 14.406%.

14% IRR 16% Difference

Present Value Factors for Annuity of $1 for 10 years 5.216 5.216 5.134  4.833  0.383 0.082

0.082  Internal rate of return = 14% +  (2%) = 14.43%. 0.383 

If both revenues and costs are lower, the new net present value will be: Period 0 Periods 1 - 10 $20,700 Cash inflows (14,400) Cash outflows $(42,000) $ 6,300 Net cash inflows $(42,000) Annual net cash inflows Present value factor for annuity, 10 periods, 6% Present value of net cash inflows Initial investment Net present value

$ 6,300 × 7.36 $46,368 (42,000) $ 4,368

Chapter 21: Capital Budgeting: Methods of Investment Analysis

To compute the IRR, note that the present value factor is $42,000 ÷ $6,300 = present value factor of 6.667, yielding a return of 8.15% from interpolation or, using a calculator, a return of 8.144%.

8% IRR 10% Difference

Present Value Factors for Annuity of $1 for 10 years 6.710 6.710 6.667  6.145  0.565 0.043

0.043  Internal rate of return = 8% +  (2%) = 8.15%. 0.565 

4. To find the NPV with a different rate of return, use the same cash flows but with a different discount rate, this time for ten periods at 8%. Annual net cash inflows Present value factor for annuity, 10 periods, 8% Present value of net cash inflows Initial investment Net present value

$ 7,000 × 6.71 $46,970 (42,000) $ 4,970

The NPV is positive, so they should accept this project. Of course, this result is to be expected since in requirement 1, the IRR was determined to be 10.6%. Therefore, for any discount rate less than 10.6%, the NPV of the stream of cash flows will be positive.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

21-41 (30 min.)

Relevance and DCF.

1. Relevant operating cash outflows and operating cash savings each year if Part No. 789 is outsourced:

Operating cash outflows for purchasing Part No. 789 Relevant operating cash savings from outsourcing Part No. 789: Direct materials Direct manufacturing labour Variable overhead Product and process engineering Rent Total relevant operating cash savings Net relevant operating cash outflows if Part No. 789 is purchased from Gabriella

Year 1 $(60,000)

Years 2-5 $(60,000)

26,400 13,200 8,400 — 1,200 49,200

26,400 13,200 8,400 4,800 1,200 54,000

$(10,800) ($ 6,000)

NPV of cash inflows and outflows if Part No. 789 is purchased from outside (in thousands):

End of Year

Total Present Value

Present Value of $1 Discounted at 12%

1. Disposal price of machine $18.000

1.000

2. Recurring operating cash flows

0.893 0.797 0.712 0.636 0.567

Net present value

$ (9.644) (4.782) (4.272) (3.816) (3.402) $ (7.916)

$18 $(10.80) $(6) $(6) $(6) $(6)

The decision to purchase Part No. 789 from Gabriella has a negative NPV of $7,916. Dannich should continue to make Part No. 789 in-house based on quantitative, financial considerations. Note the following: (a) Equipment amortization is a noncash cost and hence irrelevant for the NPV analysis. (b) Product and process engineering is irrelevant for the first year, since $4,800 in costs will be incurred in the first year whether Part No. 789 is outsourced or manufactured in-house. But product and process engineering is relevant from year 2 to year 5. These cash costs will be saved if Dannich decides to outsource Part No. 789. (c) The allocated rent costs of $2,400 are irrelevant for NPV analysis, but the $1,200 rent saved for outside storage if Dannich outsources Part No. 789 is a relevant cash saving under the “outsourcing” alternative. (d) Allocation of general plant overhead costs of $6,000 is irrelevant since these costs will not change in total whether Part No. 789 is outsourced or manufactured in-house.

Chapter 21: Capital Budgeting: Methods of Investment Analysis

2. Sensitivity analysis with respect to the quantity of Part No. 789 required seems desirable.  If demand for Part No. 789 decreases, Gabriella is willing to supply a lower quantity at the same price of $60 per part. If Dannich continued to manufacture Part No. 789, the costs it would incur may not decrease quite as fast with lower quantities of production because of fixed costs. Furthermore, the net cash outflows of outsourcing calculated in requirement 1 will be smaller if lower quantities of Part No. 789 are demanded. For example, if only 900 units per year are required, the net relevant cash outflows if Part No. 789 is purchased from Gabriella will be less by $6,000 in years 2 through 5. Note that cash inflow from selling the machine is still $18,000. This would make outsourcing Part No. 789 more attractive.  If, on the other hand, Dannich’s demand for Part No. 789 increases, Dannich will continue to prefer manufacturing the part in-house. 3. Other nonfinancial and qualitative factors that Lin should consider before making a decision are: (a) Whether Gabriella will deliver Part No. 789 according to the agreed-upon delivery schedule. (b) Whether Gabriella will produce Part No. 789 according to the desired quality standards. (c) Whether Gabriella will be in a position to accommodate modifications in Part No. 789 if Dannich’s requirements change. (d) Whether Gabriella will continue in business for the next five years and continue to make Part No. 789 based on Dannich’s demands.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4. Compute the effects of relevant items on operating income under the alternatives of outsourcing versus making Part No. 789 in-house. Increase (Decrease) in Dannich’s Operating Income (in thousands) Cost of Making Part No. 789 in-house Direct materials Direct manufacturing labour Variable manufacturing overhead Amortization on machine Relevant costs for operating income calculations if Part No. 789 is manufactured in-house Cost of outsourcing Part No. 789 Purchase costs of Part No. 789 Savings in rent Loss on sale of machinea Relevant costs to consider for operating income computations if Part No. 789 is outsourced aProceeds from sale of machine

Deduct book value of machine ($72,000 – $12,000) Loss on sale of machine

$26,400 13,200 8,400 12,000 $60,000 $60,000 (1,200) 42,000 $100,800 $18,000 60,000 $42,000

Lin will maximize reported operating income by manufacturing Part No. 789 in-house (relevant costs of $60,000 by manufacturing in-house versus $100,800 by outsourcing). In this case, there is no conflict between the conclusions Lin will reach based on NPV and on operating income analysis. Note the following: (a) Machine amortization is relevant for operating income computations. This cost will only be incurred if Dannich continues to manufacture Part No. 789. (b) Product and process engineering costs, allocated rent, and allocated general plant overhead costs are irrelevant because these costs will continue to be incurred in total whether Part No. 789 is outsourced or manufactured in-house. The savings in rent of $1,200 will only occur if Part No. 789 is outsourced. These savings are relevant and are therefore included in the calculation of operating income under the “outsource Part No. 789” alternative.

Chapter 21: Capital Budgeting: Methods of Investment Analysis

21-42 (40 min.) NPV and customer profitability, no income taxes. 1. Homebuilders Revenues (5%)* COGS (4%)* Op. Costs (4%)* Total costs Cash flow from operations

2020 $54,000 26,400 12,000 38,400

2021 $56,700 27,456 12,480 39,936

2022 $59,535 28,554 12,979 41,533

2023 $62,512 29,696 13,498 43,194

2024 $65,637 30,884 14,038 44,922

2025 $68,919 32,120 14,600 46,720

$15,600

$16,764

$18,002

$19,318

$20,715

$22,199

$390,000 216,000 90,000 306,000

$448,500 224,640 93,600 318,240

$515,775 233,626 97,344 330,970

$593,141 242,971 101,238 344,209

$682,112 252,689 105,287 357,976

$784,429 262,797 109,499 372,296

$ 84,000

$130,260

$184,805

$248,932

$324,136

$412,133

$1,032,000 $1,114,560 660,000 686,400 282,000 293,280 942,000 979,680

$1,203,725 713,856 305,011 1,018,867

$1,300,023 742,410 317,212 1,059,622

$1,404,025 772,107 329,900 1,102,007

$1,516,346 802,991 343,096 1,146,087

$ 184,858

$ 240,401

$ 302,018

$ 370,259

Kitchen Revenues (15%)* COGS (4%)* Op. Costs (4%)* Total costs Cash flow from operations Subdivision Revenues (8%)* COGS (4%)* Op. Costs (4%)* Total costs Cash flow from operations

90,000 $ 134,880

*Annual increases given in question. 2.

Year 2021 2022 2023 2024 2025

Homebuilders Cash Flow P.V. Factor from Present for 10% Operations Value 0.909 $16,764 $15,238 0.826 18,002 14,870 0.751 19,318 14,508 0.683 20,715 14,148 0.621 22,199 13,786 $72,550

Kitchen Cash Flow from Present Operations Value $130,260 $118,406 184,805 152,649 248,932 186,948 324,136 221,385 412,133 255,935 $935,323

Customer NPVs over next 5 years (2021 to 2025): Homebuilders $ 72,550 Kitchen Constructors 935,323 Subdivision Erectors 892,049

Subdivision Cash Flow from Present Operations Value $134,880 $122,606 184,858 152,693 240,401 180,541 302,018 206,278 370,259 229,931 $892,049

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. Assume the 20% discount occurred in 2021.

Revenues (5%) Total costs (4%) Cash flow from operations

2020 $390,000 306,000

2021 $312,000a 318,240

2022 $327,600b 330,970

2023 $343,980b 344,208

2024 $361,179b 357,976

2025 $379,238b 372,296

$ 84,000

$ (6,240)

$ (3,370)

$ 3,203

$ 6,942

(228)

a20% price discount b5% annual increase

Net present value: Year 2021 2022 2023 2024 2025

PV Factor at 10% 0.909 0.826 0.751 0.683 0.621

Cash Flow from Operations $(6,240) (3,370) (228) 3,203 6,942

Present Value $(5,672) (2,784) (171) 2,188 4,311 $(2,128)

4. The 20% discount and reduced subsequent annual revenue reduces the NPV from $935,323 to ($2,128). This is a drop of $937,451 in NPV. The year ended is 2020; therefore, 2021 is the startup and the first 5% increase in revenue will occur in 2022 (after the 20% discount). In year 1 (2021), 100% of revenue will be obtained; in year 2 (2022) 105% of revenue, and so on. Christen should consider whether the price discount demanded by Kitchen needs to be met in full to keep the account. The implication of meeting the full demand is that the account is minimally profitable at best. An equally serious concern is whether Christen’s other two customers will demand comparable price discounts if Kitchen’s full demands are met. The consequence would be very large reductions in the NPVs of all its customers. Christen should also consider the reliability of the growth estimates used in computing the NPVs. Are the predicted differences in revenue growth rates based on reliable information? Many revenue growth estimates by salespeople turn out to be overestimates or occur over a longer time period than initially predicted.

Chapter 21: Capital Budgeting: Methods of Investment Analysis

21-43 (30 min.)

Payback, even and uneven cash flows.

1. Annual revenue $140,000 Annual costs Fixed $96,000 Variable 14,000 110,000 Net annual cash inflow $ 30,000 Payback period = Investment  net cash inflows = $189,000 ÷ $30,000 = 6.30 years 2. Year 1 2 3 4 5 6 7 8 9

Revenue (1) $ 90,000 115,000 130,000 155,000 170,000 180,000 140,000 125,000 80,000

Cash Fixed Costs (2) $96,000 96,000 96,000 96,000 96,000 96,000 96,000 96,000 96,000

Cash Variable Costs (3) $ 9,000 11,500 13,000 15,500 17,000 18,000 14,000 12,500 8,000

Net Cash Inflows (4) = (1) − (2) − (3) $(15,000) 7,500 21,000 43,500 57,000 66,000 30,000 16,500 (24,000)

Cumulative Amounts $(15,000) (7,500) 13,500 57,000 114,000 180,000 210,000 226,500 202,500

The cumulative amount exceeds the initial $189,000 investment for the first time at approximately the mid-way point between year 6 and 7. So, payback happens in year 7. Using linear interpolation, a more precise measure is that payback happens at: 6 years +

$189,000 $180,000  6.3 years. $30,000

21-44 (30–35 min.) NPV and AARR, goal-congruence issues. 1. Annual cash flow from operations $100,000 Depreciation: $320,000 ÷ 6 = $53,333 per year, but this is irrelevant because it has no impact on cash flows beyond moment 0.

Initial investment Initial working capital investment Cash flow from operations (exl. deprcn.) Times discount factor at 16% Present value Net present value

0 $(320,000)

Time Period 2 3

(5,000) × 1.000 $(325,000) $ 45,450

6 5,000

$100,000 × 0.862 $ 86,200

$100,000 $100,000 $100,000 $100,000 $105,000 × 0.743 × 0.641 × 0.552 × 0.476 × 0.410 $ 74,300 $ 64,100 $ 55,200 $ 47,600 $ 43,050

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Alternative solution using the annuity tables: PV Factor at i+16%, n+6 Net present value: Present value of annuity of equal annual after-tax cash flows from operations Net initial investment Net present value

Net Cash Inflow

Total Present Value

3.685 × $100,000 per year + (5,000 × .410) = $370,550 (325,000) $ 45,550

Note: There is a difference of $100 between the two solutions due to rounding in the tables.

2. Accrual accounting rate of return (AARR): The accrual accounting rate of return takes the annual accrual net income and divides by the initial investment to get a return. Incremental net operating income excluding depreciation Less: depreciation expense ($320,000 ÷ 6) Income before tax

$100,000 53,333 46,667

AARR = $46,667 ÷ $325,000 = 14.36%. Note to faculty: Over time, varying approaches to the calculation of accounting rate of return have been employed (Brief and Larson, 1992). In an effort to ensure students receive a rich exposure to accounting rate of return as an analytical tool, more than one approach to the calculation has been highlighted in the text. The intent of this approach is to ensure students understand the principle of using AARR, and can adapt to multiple organizations and circumstances of available data. Brief, R. P., & Lawson, R. A. (1992). The role of the accounting rate of return in financial statement analysis. Accounting Review, 67(2): 411–426. 3. Nate will not accept the project if he is being evaluated on the basis of accrual accounting rate of return, because the project does not meet the 16% threshold above which Nate earns a bonus. However, Nate should accept the project if he wants to act in the firm’s best interest because the NPV is positive, implying that, based on the cash flows generated, the project exceeds the firm’s required 16% rate of return. Thus, Nate will turn down an acceptable longrun project to avoid a poor evaluation based on the measure used to evaluate his performance. To remedy this, the firm could evaluate Nate instead on a project-by-project basis by looking at how well he achieves the cash flows forecasted when he chose to accept the project.

Chapter 21: Capital Budgeting: Methods of Investment Analysis

21-45 (40–45 min.) Recognizing cash flows for capital investment projects, NPV. 1. Net initial investment Initial equipment investment Initial working-capital investment Net initial investment Cash flow from operations Annual after-tax cash flow from operations (excl. deprn. effects) Cash revenues Material cash costs 1  Direct labour cash costs   $3, 600, 000  4  Increase in cash overhead costs Annual cash flow from operations with new equipment Deduct income-tax payments (0.30 × $730,000) Annual after-tax cash flow from operations

$(5,000,000) (45,000) $(5,045,000)

$3,750,000 (1,700,000) (900,000) (420,000) (730,000) (219,000)

Income-tax cash savings from annual depreciation deductions (0.30×$460,000)1 Total cash flow from operations (after-tax) Cash flow from terminal disposal of investment Cash flow from terminal disposal of machine (net of tax of $0) Cash flow from terminal disposal of working capital (net of tax of $0) After-tax cash flow from terminal disposal of investment 1

Depreciation deductions =

511,000

138,000 649,000

400,000

45,000 445,000

$5,000,000 $400, 000  $460, 000 10

Cash flows not relevant to the capital budgeting problem - The revenues and investment in the furniture parts division are not relevant to the project - The costs of the furniture parts division are not relevant except as the basis for estimation of labour costs for the project - The CFO salary is irrelevant since it is not affected by the project 2. These three amounts can be combined to determine the NPV at a 12% discount rate: Present value of net initial investment, $(5,045,000) × 1.000 Present value of 10-year annuity of annual after-tax cash flow from operations ($649,000 × 5.650) Present value of after-tax cash flow from terminal disposal of investment ($445,000 × 0.322) Net present value

$(5,045,000) 3,666,850 143,290 $(1,234,860)

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Since the net present value is negative, this is clearly not a good investment for a firm that requires a 12% rate of return. Met-All should not expand into bicycle parts. However, if the tax shield from the purchase of the new equipment, and the corresponding loss of a shield on disposal is recognized, the NPV would change. Calculation of Tax Shield:

n C r T d

Project Years Initial Cost Discount Tax Rate CCA Salvage Value

PV tax shield on CCA 

$937,500 0.9464 $887,277

10 $5,000,000 12% 30% 20% $ 400,000

CdT 1  0.5r SdT 1    d r 1 r d  r (1  r )n

−

$ 863,129

$75,000 0.3220 $24,148

This would change the NPV, accounting for the tax shield to: Operational NPV (without accounting for a tax shield) Present value of Purchase accounting for Salvage Net NPV

$(1,234,860) $ 863,129 ($ 371,731)

The calculation including the tax shield remains a negative NPV, so the investment remains a poor choice for a firm that requires a 12% rate of return. Met-All should not expand into bicycle parts.

Chapter 21: Capital Budgeting: Methods of Investment Analysis

21-46 (35 min.)

Recognizing cash flows for capital investment projects.

1. Partitioning relevant cash flows into categories: (1) Net initial investment cash flows:  The $98,000 cost of the new Flab-Buster 3000.  The disposal value of the old machine, $5,000, is a cash inflow. (2) Cash flow savings from operations:  The 30% savings in utilities cost per year of $4,320 (30% × $1,200 per month × 12 months) results in cash inflow from operations of $4,320.  The savings of half the maintenance costs per year of $5,000 (50% × $10,000) results in a cash inflow from operations of $5,000. (3) Cash flows from terminal disposal of investment:  The $10,000 salvage value of Flab-Buster 3000 minus the $0 salvage value of the old Fit-O-Matic is a terminal cash flow at the end of Year 10. (4) Data not relevant to the capital budgeting decision:  The $10 charge for customers, since it would not change whether or not Ludmilla got the new machine.  The $78,000 cost of the machine Ludmilla does not intend to buy.  The $50,000 original cost, nor the $46,000 in accumulated depreciation of the Fit-OMatic machine.  The annual depreciation. 2. Net present value of the investment: Net initial investment: Initial investment in Flab-Buster 3000 Current disposal value of Fit-O-Matic Net initial investment Annual cash flow from operations: Savings in utilities costs Savings in maintenance costs Annual cash flow from operations Cash flow from terminal disposal of machines

$(98,000) 5,000 $(93,000) $ 4,320 5,000 $ 9,320 $ 10,000

These three amounts can be combined to determine the NPV at an 8% discount rate. Present value of net initial investment, $(93,000) × 1.000 PV of 10-year annuity of cash flow from operations $9,320 × 6.710 PV of cash flow from terminal disposal of machines $10,000 × 0.463 Net present value

$(93,000) 62,537 4,630 $(25,833)

At the required rate of return of 8%, the net present value of the investment in the Flab-Buster 3000 is substantially negative. Ludmilla should therefore not make the investment.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

21-47 (25 min.)

Defensive and offensive strategies in capital budgeting.

1. Project: Increase capacity to serve new markets Initial investment $600,000 + $50,000

Project: Upgrade customer service Initial investment $345,000 + $150,000

Years 1 to 9 Cash inflow Present value 5.328

Years 1 to 4 Cash inflow Present value 3.037

$400,000 $2,131,200

Year 10 Working capital Disposal value Cash inflow Present value 0.322

$50,000 $60,000 $400,000 $164,220

Net present value

$1,645,420

$80,000 + $40,000 $364,440

Year 5 Working capital Cash inflow

$150,000 $80,000 + $40,000

Present value 0.567

$153,090 $22,530

2. Deciding based only on NPV, Kleinburg should immediately execute the project proposed by the production manager. 3. Capital investment decisions that are strategic in nature require managers to consider a broad range of factors that may be difficult to estimate. The proposal of the production manager is a typical offensive strategy in capital budgeting, while the sales and marketing manager proposal is a defensive strategy in capital budgeting. A defensive strategy does not necessarily have to yield a positive NPV; sometimes it is acceptable that it breaks even while maintaining the company at a competitive level with the rest of the players in the industry. In this problem, the bakery can do both projects but not at the same time, so when prioritizing, managers must evaluate their position in the industry and see if their direct competitors have the same technology for flexible planning of routes or not, because if everybody but Kleinburg has the technology, then the sales and marketing manager project must be done first; otherwise, it can wait until next year.

Chapter 21: Capital Budgeting: Methods of Investment Analysis

COLLABOURATIVE LEARNING CASE 21-48 (45 min.) Net present value, internal rate of return, sensitivity analysis. 1. Given the annual operating cash outflows of $160,000 and the payment of 10% of revenues (10% × $260,000 = $26,000), the net cash inflows for each period are as follows: Period 0 Cash inflows Cash outflows Net cash inflows

1–12 $260,000 (186,000) $ 74,000

$(500,000) $(500,000)

The NPV of the investment is: Annual net cash inflows Present value factor for annuity, 12 periods, 8% Present value of net cash inflows Initial investment Net present value

$ 74,000 × 7.536 $557,664 (500,000) $ 57,664

And the IRR will be: $500,000 ÷ $74,000 = present value factor of 6.76, yielding a return just over 10% from the table, or using a calculator, a return of 10.17%. 2. For revenues of $240,000, the cash flows and NPV computation are given below. Period 0 Cash inflows Cash outflows Net cash inflows

$(500,000) $(500,000)

Annual net cash inflows Present value factor for annuity, 12 periods, 8% Present value of net cash inflows Initial investment Net present value

1–12 $240,000 (184,000) $ 56,000 $ 56,000 × 7.536 $422,016 (500,000) $ (77,984)

And the IRR will be: $500,000 ÷ $56,000 = present value factor of 8.93, yielding a return between 4% and 6% from the table, or using a calculator, a return of 4.87%.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

For revenues of $220,000: Period 0 Cash inflows Cash outflows Net cash inflows

1–12 $220,000 (182,000) $ 38,000

$(500,000) $(500,000)

Annual net cash inflows Present value factor for annuity, 12 periods, 8% Present value of net cash inflows Initial investment Net present value

$ 38,000 × 7.536 $ 286,368 (500,000) $(213,632)

And the IRR will be: $500,000 ÷ $38,000 = present value factor of 13.16, yielding a return of less than 2% from the table or −1.35% using a calculator. 3. For revenues of $240,000, lower costs of $150,000, and payments of only 6% of revenues equal to $14,400: Period 0 Cash inflows Cash outflows Net cash inflows

$(500,000) $(500,000)

Annual net cash inflows Present value factor for annuity, 12 periods, 8% Present value of net cash inflows Initial investment Net present value

1–12 $240,000 (164,400) $ 75,600 $ 75,600 × 7.536 $569,722 (500,000) $ 69,722

And the IRR will be: 500,000 ÷ 75,600 = present value factor of 6.61, yielding a return between 10% and 12% from the table, or using a calculator, a return of 10.61%.

Chapter 21: Capital Budgeting: Methods of Investment Analysis

For revenues of $220,000, lower costs of $150,000, and payments of only 6% of revenues equal to 13,200: Period 0 1–12 Cash inflows $220,000 Cash outflows $(500,000) (163,200) Net cash inflows $(500,000) $ 56,800 Annual net cash inflows Present value factor for annuity, 12 periods, 8% Present value of net cash inflows Initial investment Net present value

$ 56,800 × 7.536 $ 428,045 (500,000) $ (71,955)

And the IRR will be: 500,000 ÷ 56,800 = present value factor of 8.80, yielding a return between 4% and 6% from the table, or using a calculator, a return of 5.12%. 4. Under the scenario of higher costs, Francesca will only be well off making the investment if she can reach the sales revenue goal of $260,000. Otherwise she will earn less than her desired return of 8%. In fact, her return at the lower revenue scenarios will be below 6%, her cost of capital (see the IRR calculations). If Francesca is able to lower the operating costs to $150,000 and pay out a smaller share of her revenues, the project will be profitable unless she only reaches the revenue level of $220,000; in that case, she will fall short not only of her desired return, but also her cost of capital of 6%. In summary, unless Francesca is either fairly certain to reach the $260,000 revenue level or fairly certain to lower her costs, it is advised that she not make the investment. It is not necessary to redo the NPV with different interest rates if you already calculated the IRR, since the IRR will not change with changes in desired rate of return. All you need to do is compare the IRR of the project to different desired returns if you are changing the required rate of return and not the cash flows themselves.

CHAPTER 22 TRANSFER PRICING AND MULTINATIONAL MANAGEMENT CONTROL SYSTEMS MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

SHORT-ANSWER QUESTIONS 22-1 A management control system is a means of gathering and using information to aid and coordinate the planning and control decisions throughout an organization and to guide the behaviour of its managers and employees. The goal of the system is to improve the collective decisions within an organization.

22-2 To be effective, management control systems should be (a) closely aligned to an organization's strategies and goals, (b) designed to support the organizational responsibilities of individual managers, and (c) able to motivate managers and employees to put in effort to attain selected goals desired by top management.

22-3 Motivation combines goal congruence and effort. Motivation is the desire to attain a selected goal specified by top management (the goal-congruence aspect) combined with the resulting pursuit of that goal (the effort aspect).

22-4 The chapter cites five benefits of decentralization: 1. 2. 3. 4. 5.

Creates greater responsiveness to local needs Leads to gains from faster decision making Increases motivation of subunit managers Assists management development and learning Sharpens the focus of subunit managers

The chapter cites four costs of decentralization: 1. 2. 3. 4.

Leads to suboptimal decision making Focuses managers’ attention on the subunit rather than the company as a whole Increases costs of gathering information Results in duplication of activities

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

22-5 No. Organizations typically compare the benefits and costs of decentralization on a function-by-function basis. For example, companies with highly decentralized operating divisions frequently have centralized income tax strategies.

22-6 No. A transfer price is the price one subunit of an organization charges for a product or service supplied to another subunit of the same organization. The two segments can be cost centres, profit centres, or investment centres. For example, the allocation of service department costs to production departments that are set up as either cost centres or investment centres is an example of transfer pricing.

22-7 The three general methods for determining transfer prices are: 1. Market-based transfer prices 2. Cost-based transfer prices 3. Negotiated transfer prices

22-8 Transfer prices should have the following properties. They should 1. 2. 3. 4.

promote goal congruence, be useful for evaluating subunit performance, motivate management effort, and preserve a high level of subunit autonomy in decision making.

22-9 No, the chapter illustration demonstrates how division operating incomes differ dramatically under the variable costs, full costs, and market price methods of transfer pricing.

22-10 Transferring products or services at market prices generally leads to optimal decisions when (a) the market for the intermediate product market is perfectly competitive, (b) interdependencies of subunits are minimal, and (c) there are no additional costs or benefits to the company as a whole from buying or selling in the external market instead of transacting internally.

22-11 One potential limitation of full-cost-based transfer prices is that they can lead to suboptimal decisions for the company as a whole. An example of a conflict between divisional action and overall company profitability resulting from an inappropriate transfer-pricing policy is buying products or services outside the company when it is beneficial to overall company profitability to source them internally. This situation often arises where full-cost-based transfer prices are used. This situation can make the fixed costs of the supplying division appear to be variable costs of the purchasing division. Another limitation is that the supplying division may not have sufficient incentives to control costs if the full-cost-based transfer price uses actual costs rather than standard costs. The purchasing division sources externally if market prices are lower than full costs. From the viewpoint of the company as a whole, the purchasing division should source from outside only if market prices are less than variable costs of production, not full costs of production.

Chapter 22: Transfer Pricing and Multinational Management Control Systems

22-12 Reasons why a dual-pricing approach to transfer pricing is not widely used in practice include: 1. In this approach, the manager of the supplying division uses a cost-based method to record revenues and does not have sufficient incentives to control costs. 2. This approach does not provide clear signals to division managers about the level of decentralization top management wants. 3. This approach tends to insulate managers from the frictions of the marketplace because costs, not market prices, affect the revenues of the supplying division. 4. It leads to problems in computing the taxable income of subunits located in different tax jurisdictions.

22-13 Yes. The general transfer-pricing guideline specifies that the minimum transfer price equals the incremental cost per unit incurred up to the point of transfer plus the opportunity cost per unit to the supplying division. When the supplying division has idle capacity, its opportunity cost per unit is zero; when the supplying division has no idle capacity, its opportunity cost per unit is positive. Hence, the minimum transfer price will vary depending on whether the supplying division has idle capacity or not.

22-14 Alternative transfer-pricing methods can result in sizable differences in the reported operating income of divisions in different income tax jurisdictions. If these jurisdictions have different tax rates or deductions, the net income of the company as a whole can be affected by the choice of the transfer-pricing method.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

EXERCISES 22-15 (10 min.) Terminology. 1. The CRA constrains global transfer-pricing choices, and provincial tax authorities constrain the interprovincial transfer-pricing choice of management teams. A wise team will undertake an advance transfer price arrangement (APA) to avoid future tax liabilities. 2. There are two interprovincial transfer-price alternatives when no market-based price exists. The alternatives are either cost-based, which is a cost plus approach, or negotiated transfer prices that fall between a market and cost-plus price. 3. Of course a cost-plus price may be either full absorption or variable cost-based, and in the transfer the same company may use dual pricing. The transferring division charges at a cost-based price while the receiving division pays at a market-based price. The difference is billed to a common corporate account rather than to the divisions. This method reduces goal-congruence problems between transferring divisions. 4. There are three multinational corporate transfer-price alternatives. The respective tax authorities scrutinize these related-party transactions very carefully to ensure their jurisdictions receive the appropriate tax payments from each party in the transfer. The alternatives are the comparable uncontrolled price (CUP), resale price (RPM), costplus method (CPM), profit split method (PSM), and transactional net margin method (TNMM). In addition to negotiating APA with governments, corporations also minimize taxes by establishing legitimate subsidiaries in tax havens that share information with other governments.

22-16 (15 min.) Evaluating management control systems, balanced scorecard. 1. Correct answers may include any of the following:    

Financial perspective—stock price, net income, return on investment, cash flow from operations, cost per visitor, gross margin percentage in retail venues Customer perspective—percentage of repeat visitors, customer satisfaction, ratings by travel organizations, cleanliness ratings Internal-business-process perspective—wait time and number of riders per hour for popular rides, accident-free days, downtime for repairs Learning-and-growth perspective—employee satisfaction, return employees, training hours, absenteeism

2. Each manager would be concerned with management controls related specifically to their level of responsibility. Within the financial perspective, for example, the souvenir shop manager might be concerned with controlling gross margin percentage or inventory turnover, the theme park manager might be concerned with gate proceeds or cash flow from operations, and the CEO might be concerned with stock price or earnings per share. Within the customer perspective, the souvenir shop manager might be concerned with sales per

Chapter 22: Transfer Pricing and Multinational Management Control Systems

customer, the theme park manager might be concerned with percentage of repeat visitors, and the CEO might be concerned with travel organization ratings across the entire group of parks.

22-17 (25 min.) Cost centres, profit centres, decentralization, transfer prices. 1. The Glass Department sends its product to the Wood and Metal Departments for finishing. The Glass Department does not negotiate internal prices. The Glass, Wood, and Metal Departments are cost centres because they are only evaluated on output and cost control (cost variances). 2. The three departments are centralized because upper management dictates their production schedules. 3. A centralized department can be a profit centre. Centralization relates to the degree of autonomy that a department has for decision making. This concept is independent of the type of responsibility centre used to evaluate performance (for example the Glass Department could be a profit centre if upper management chooses a transfer price for the glass transferred from the Glass to the Wood and Metal Departments). A department may be organized as a profit centre, but it will be centralized if it has little freedom in making decisions. 4. a. With these changes, Fenster will be moving toward a more decentralized environment because each department will have more local decision-making authority, such as the ability to set its own production schedule, buy and sell products in the external market, and negotiate transfer prices. These changes also make all three departments profit centres (rather than cost centres) because the managers of each department are responsible for both costs and revenues. b. I would recommend that upper management evaluate the three departments as profit centres because profits would be a good indicator of the performance of each department.

22-18 (35 min.) Multinational transfer pricing, effect of alternative transfer-pricing methods, global income tax minimization. 1. This is a three-country, three-division transfer-pricing problem with three alternative transfer-pricing methods. Summary data in Canadian dollars are: China division Variable costs: Fixed costs: South Korea division Variable costs: Fixed costs: Canada division Variable costs: Fixed costs:

1,000 yuan ÷ 8 yuan per $ = $125 per subunit 1,800 yuan ÷ 8 yuan per $ = $225 per subunit 360,000 won ÷ 1,200 won per $ = $300 per unit 480,000 won ÷ 1,200 won per $ = $400 per unit = $100 per unit = $200 per unit

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Market prices for private-label sale alternatives: China division: 3,600 yuan ÷ 8 yuan per $ South Korea division: 1,560,000 won ÷ 1,200 won per $ The transfer prices under each method are: a. Market price  

China to South Korea South Korea to Canada

= $450 per subunit = $1,300 per unit

b. 200% of full costs  

China to South Korea 2.0  ($125 + $225) South Korea to Canada 2.0  ($700 + $300 + $400)

= $700 per subunit = $2,800 per unit

c. 300% of variable costs  

China to South Korea 3.0  $125 South Korea to Canada 3.0  ($375 + $300)

= $375 per subunit = $2,025 per unit

= $450 per subunit = $1,300 per unit

Chapter 22: Transfer Pricing and Multinational Management Control Systems

Method A Internal Transfers at Market Price 1.

China division Division revenue per unit Cost per unit: Division variable cost per unit Division fixed cost per unit Total division cost per unit Division operating income per unit Income tax at 20% Division net income per unit 2South Korea division Division revenue per unit Cost per unit: Transferred-in cost per unit Division variable cost per unit Division fixed cost per unit Total division cost per unit Division operating income per unit Income tax at 20% Division net income per unit

Canada division Division revenue per unit Cost per unit: Transferred-in cost per unit Division variable cost per unit Division fixed cost per unit Total division cost per unit Division operating income per unit Income tax at 30% Division net income per unit

Method B Internal Transfers at 200% of Full Cost

Method C Internal Transfers at 300% of Variable Cost

$ 450

$ 700

$ 375

125 225 350 100 20 $ 80

125 225 350 350 70 $ 280

125 225 350 25 5 $ 20

$1,300

$2,800

$2,025

450 300 400 1,150 150 30 $ 120

700 300 400 1,400 1,400 280 $1,120

375 300 400 1,075 950 190 $ 760

$3,200

1,300 100 200 1,600 1,600 480 $1,120

2,800 100 200 3,100 100 30 $ 70

2,025 100 200 2,325 875 262.5 $612.5

2. Division net income: Market Price China division South Korea division Canada division User Friendly Computer Inc.

$ 80 120 1,120 $1,320

200% of Full Cost $ 280 1,120 70 $1,470

300% of Variable Cos $ 20.00 760.00 612.50 $1,392.50

User Friendly will maximize its net income by using 200% of full costs as the transfer-price. This is because Method B sources the largest proportion of income in Korea, the country with the lowest income tax rate.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

22-19 (30 min.) Transfer-pricing methods, goal-congruence. 1. Alternative 1: Sell as raw lumber for $220 per 100 board feet: Revenue Variable costs Contribution margin

220 105 $115 per 100 board feet

Alternative 2: Sell as finished lumber for $305 per 100 board feet: Revenue Variable costs: Raw lumber Finished lumber Contribution margin

305 $105 130

235 $ 70 per 100 board feet

British Columbia Lumber will maximize its total contribution margin by selling lumber in its raw form. An alternative approach is to examine the incremental revenues and incremental costs in the finished lumber division: Incremental revenues, $305 – $220 Incremental costs Incremental loss

$ 85 130 $(45) per 100 board feet

2. Transfer price at 120% of variable costs: = $105 + ($105  0.20) = $126 per 100 board feet Sell as Raw Lumber Raw lumber division Division revenue Division variable costs Division operating income

$220 105 $115

Finished lumber division Division revenue Transferred-in costs Division variable costs Division operating income

Sell as Finished Lumber $126 105 $ 21 $305 126 130 $ 49

The raw lumber division will maximize reported division operating income by selling raw lumber, which is the action preferred by the company as a whole. The finished lumber division will maximize division operating income by selling finished lumber, which is contrary to the action preferred by the company as a whole. Copyright © 2022 Pearson Canada Inc. 22-8

Chapter 22: Transfer Pricing and Multinational Management Control Systems

3. Transfer price at market price = $220 per 100 board feet. Sell as Raw Lumber Raw lumber division Division revenue Division variable costs Division operating income

Sell as Finished Lumber

$220 105 $115

Finished lumber division Division revenue Transferred-in costs Division variable costs Division operating income

$305 220 130 $ (45)

Since the raw lumber division will be indifferent between selling the lumber in raw or finished form, it would be willing to maximize division operating income by selling raw lumber, which is the action preferred by the company as a whole. The finished lumber division will maximize division operating income by not further processing raw lumber and this is preferred by the company as a whole. Thus, transfer at market price will result in division actions that are also in the best interest of the company as a whole.

22-20 (30 minutes) Multinational transfer pricing, effect of alternative transfer-pricing methods. 1) Division A 100,000 230,000 330,000

Total variable costs Total Fixed costs

Revenue ($7 × 300,000 units) Transferred-in costs ($5 × 300,000 units) Variable Costs (0.30 × 300,000 units) Fixed Costs (0.5 × 300,000 units) Division Operating Income

Division B 90,000 150,000 240,000

Division B 2,100,000 (1,500,000) (90,000) (150,000) 360,000

2) Revenue ($5 × 300,000 units) Variable Costs (0.33333 × 300,000 units)

Division A 1,500,000 (100,000)

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Fixed Costs (0.77777 × 300,000 units) Division Operating Income

(230,000) 1,170,000

3) Answers may vary. For example, reliability (do not have to rely on an outside supplier), ability to work closely with supplier on company-wide objectives, protect market share and company knowledge/competitive advantage (i.e. how they manufacture bottles, details of beverage, etc.)

22-21 (30 minutes) Multinational transfer pricing, effect of alternative transfer-pricing methods. 1) Division A Total variable costs Total Fixed costs

Division B

100,000 230,000 330,000

Revenues ($7 × 300,000 units) Transferred-in costs* Variable Costs (0.30 × 300,000 units) Fixed Costs (0.5 × 300,000 units) Division Operating Income

90,000 150,000 240,000

Division B 2,100,000 (346,500) (*330,000 * 1.05) (90,000) (150,000) 1,513,500

2) Revenues Variable Costs (0.33333 × 300,000 units) Fixed Costs (0.77777 × 300,000 units) Division Operating Income

Division A 346,500 (100,000) (230,000) 16,500

3) The manager of Division A will vote for market value transfer-pricing to achieve a higher bonus. 4) The 105% of manufacturing cost transfer price is much lower than the $5 per bottle transfer price under the market value method. Division B could see a boost in morale due to higher operating income or less emphasis on minimizing costs and improving revenues as the division would look better due to the change of transfer-price method. The opposite might happen with Division A (i.e. lower morale, more emphasis on cost cutting which could lead to lower quality). Division A may so decide to split and sell to an outside market. Measures should be taken to spread the income/profits between divisions so they work towards common goals instead of competing with each other and operating as separate profit centres. Copyright © 2022 Pearson Canada Inc. 22-10

Chapter 22: Transfer Pricing and Multinational Management Control Systems

22-22 (30 min.) Effect of alternative transfer-pricing methods on division operating income.

1. Mining Division Revenues: $90, $661  200,000 units Costs: Division variable costs: $522  200,000 units Division fixed costs: $83  200,000 units Total division costs Division operating income Metals Division Revenues: $150  200,000 units Costs: Transferred-in costs: $90, $66  200,000 units Division variable costs: $364  200,000 units Division fixed costs: $155  200,000 units Total division costs Division operating income

Method A Internal Transfers at Market Prices

Method B Internal Transfers at 110% of Full Costs

$18,000,000

$13,200,000

10,400,000

1,600,000 12,000,000 $ 6,000,000

1,600,000 12,000,000 $ 1,200,000

$30,000,000

18,000,000

13,200,000

7,200,000

3,000,000 28,200,000 $ 1,800,000

3,000,000 23,400,000 $ 6,600,000

$66 = Full manufacturing cost per unit in the Mining Division, $60  110% Variable cost per unit in Mining Division = Direct materials + Direct manufacturing labour + 75% of manufacturing overhead = $12 + $16 + (75%  $32) = $52 3 Fixed cost per unit = 25% of manufacturing overhead = 25% $32 = $8 4 Variable cost per unit in Metals Division = Direct materials + Direct manufacturing labour + 40% of manufacturing overhead = $6 + $20 + (40%  $25) = $36 5 Fixed cost per unit in Metals Division = 60% of manufacturing overhead = 60%  $25 = $15 2

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Bonus paid to division managers at 1% of division operating income will be as follows:

Mining Division manager’s bonus (1%  $6,000,000; 1%  $1,200,000) Metals Division manager’s bonus (1%  $1,800,000; 1% $6,600,000)

Method A Internal Transfers at Market Prices

Method B Internal Transfers at 110% of Full Costs

$60,000

$ 12,000

18,000

66,000

The Mining Division manager will prefer Method A (transfer at market prices) because this method gives him $60,000 of bonus rather than $12,000 under Method B (transfers at 110% of full costs). The Metals Division manager will prefer Method B because this method provides $66,000 of bonus rather than $18,000 under Method A. 3. Brian Jones, the manager of the Mining Division, will appeal to the existence of a competitive market to price transfers at market prices. Using market prices for transfers in these conditions leads to goal congruence. Division managers acting in their own best interests make decisions that are also in the best interests of the company as a whole. Jones will further argue that setting transfer prices based on cost will cause him to pay no attention to controlling costs because all costs incurred will be recovered from the Metals Division at 110% of full costs.

22-23 (30 min.) Transfer pricing, general guideline, goal congruence. 1. Using the general guideline presented in the chapter, the minimum price at which the airbag division would sell airbags to the tivo division is $90, the incremental costs. The airbag division has idle capacity (it is currently working at 80% of capacity). Therefore, its opportunity cost is zero—the airbag division does not forgo any external sales and as a result, does not forgo any contribution margin from internal transfers. Transferring airbags at incremental cost achieves goal congruence. 2. Transferring products internally at incremental cost has the following properties: a. Achieves goal congruence—Yes, as described in requirement 1 above. b. Useful for evaluating division performance—No, because this transfer price does not cover or exceed full costs. By transferring at incremental costs and not covering fixed costs, the airbag division will show a loss. This loss, the result of the incremental costbased transfer price, is not a good measure of the economic performance of the subunit. c. Motivating management effort—Yes, if based on budgeted costs (actual costs can then be compared to budgeted costs). If, however, transfers are based on actual costs, airbag division management has little incentive to control costs. d. Preserves division autonomy—No. Because it is rule-based, the airbag division has no say in the setting of the transfer price.

Chapter 22: Transfer Pricing and Multinational Management Control Systems

3. If the two divisions were to negotiate a transfer price, the range of possible transfer prices will be between $90 and $125 per unit. The airbag division has excess capacity that it can use to supply airbags to the tivo division. The airbag division will be willing to supply the airbags only if the transfer price equals or exceeds $90, its incremental costs of manufacturing the airbags. The tivo division will be willing to buy airbags from the airbag division only if the price does not exceed $125 per airbag, the price at which the tivo division can buy airbags in the market from external suppliers. Within the price range of $90 to $125, each division will be willing to transact with the other and maximize overall income of Quest Motors. The exact transfer price between $90 and $125 will depend on the bargaining strengths of the two divisions. The negotiated transfer price has the following properties. a. Achieves goal congruence—Yes, as described above. b. Useful for evaluating division performance—Yes, because the transfer price is the result of direct negotiations between the two divisions. Of course, the transfer prices will be affected by the bargaining strengths of the two divisions. c. Motivating management effort—Yes, because once negotiated, the transfer price is independent of actual costs of the airbag division. Airbag division management has every incentive to manage efficiently to improve profits. d. Preserves subunit autonomy—Yes, because the transfer price is based on direct negotiations between the two divisions and is not specified by headquarters on the basis of some rule (such as airbag division’s incremental costs). 4. Neither method is perfect, but negotiated transfer pricing (requirement 3) has more favourable properties than the cost-based transfer pricing (requirement 2). Both transferpricing methods achieve goal congruence, but negotiated transfer pricing facilitates the evaluation of division performance, motivates management effort, and preserves division autonomy, whereas the transfer price based on incremental costs does not achieve these objectives.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

22-24 (35 min.) Multinational transfer pricing, effect of alternative transfer-pricing methods, global income tax minimization. 1. This is a three-country, three-division transfer-pricing problem with three alternative transfer-pricing methods. Summary data in U.S. dollars are as follows: China Plant Variable costs: 900 Yuan ÷ 9 Yuan per $ = $100 per subunit Fixed costs: 1,980 Yuan ÷ 9 Yuan per $ = $220 per subunit South Korea Plant Variable costs: 350,000 Won ÷ 1,000 Won per $ = $350 per unit Fixed costs: 470,000 Won ÷ 1,000 Won per $ = $470 per unit U.S. Plant Variable costs: = $125 per unit Fixed costs: = $325 per unit Market prices for private-label sale alternatives: China Plant: 4,500 Yuan ÷ 9 Yuan per $ = $500 per subunit South Korea Plant: 1,340,000 Won ÷ 1,000 Won per $ = $1,340 per unit The transfer prices under each method are: a. Market price  China to South Korea = $500 per subunit  South Korea to U.S. Plant = $1,340 per unit b. 200% of full costs  China to South Korea 2.0  ($100 + $220) = $640 per subunit  South Korea to U.S. Plant 2.0  ($640 + $350 + $470) = $2,920 per unit c. 350% of variable costs  China to South Korea 3.5  $100 = $350 per subunit  South Korea to U.S. Plant 3.5  ($350 + $350) = $2,450 per unit

Chapter 22: Transfer Pricing and Multinational Management Control Systems

1. China Division Division revenue per unit Cost per unit: Division variable cost per unit Division fixed cost per unit Total division cost per unit Division operating income per unit Income tax at 40% Division net income per unit 2. South Korea Division Division revenue per unit Cost per unit: Transferred-in cost per unit Division variable cost per unit Division fixed cost per unit Total division cost per unit Division operating income per unit Income tax at 20% Division net income per unit 3. United States Division Division revenue per unit Cost per unit: Transferred-in cost per unit Division variable cost per unit Division fixed cost per unit Total division cost per unit Division operating income per unit Income tax at 30% Division net income per unit

Method A Internal Transfers at Market Price

Method B Internal Transfers at 200% of Full Costs

Method C Internal Transfers at 350% of Variable Costs

$ 500

$ 640

$ 350

100 220 320 180 72 $ 08

100 220 320 320 128 $ 192

100 220 320 30 12 $ 18

$1,340

$2,920

$2,450

500 350 470 1,320 20 4 $ 16

640 350 470 1,460 1,460 292 $1,168

350 350 470 1,170 1,280 256 $1,024

$3,800

1,340 125 325 1,790 2,010 603 $1,407

2,920 125 325 3,370 430 129 $ 301

2,450 125 325 2,900 900 270 $ 630

2. Division net income: Market Price China Division South Korea Division U.S. Division Tech Friendly Computer, Inc.

$ 108 16 1,407 $1,531

200% of Full Costs $ 192 1,168 301 $1,661

350% of Variable Costs $ 18 1,024 630 $1,672

Tech Friendly will maximize its net income by using the third method, 350% of variable costs, as the transfer price. This is because this method sources relatively little income in China, the country with the highest income tax rate. Copyright © 2022 Pearson Canada Inc. 22-15

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

22-25 (25 min.) Multinational transfer pricing, global tax minimization. 1. Solution Exhibit 22-26 shows the after-tax operating incomes earned by the U.S. and German divisions from transferring 100,000 broadband routers using (a) full manufacturing cost per unit, and (b) market price of comparable imports as transfer prices. 2. There are many ways to proceed, but the first thing to note is that the transfer price that minimizes the total of company import duties and income taxes will be either the full manufacturing cost or the market price of comparable imports. Consider what happens every time the transfer price is increased by $1 over, say, the full manufacturing cost of $400. This results in the following change for each unit: a. an increase in U.S. taxes of 35%  $1 $0.35 b. an increase in import duties paid in Germany, 15%  $1 0.15 c. a decrease in German taxes of 40%  $1.15 (the $1 increase in transfer price + $0.15 paid by way of import duty) (0.46) Net effect is an increase in import duty and tax payments of: $0.04 To verify this solution, note that if the transfer price changes from $400 to $475, the net effect is an increase in import duty and tax payments of ($475 – $400) × $0.04 = $3 per unit. Across 100,000 units, this implies a decrease in total profits of (100,000) × $3 = $300,000, which corresponds exactly to the $300,000 difference in total after-tax operating incomes documented in Solution Exhibit 22-26. Therefore, Questron Company will minimize import duties and income taxes by setting the transfer price at its minimum level of $400, the full manufacturing cost.

Chapter 22: Transfer Pricing and Multinational Management Control Systems

SOLUTION EXHIBIT 22-25 Division Incomes of U.S. and German Divisions from Transferring 100,000 broadband routers Method A Internal Transfers at Full Manufacturing Cost U.S. Division Revenues: $400, $475  100,000 units Costs: Full manufacturing cost: $400  100,000 units Division operating income Division income taxes at 35% Division after-tax operating income German Division Revenues: $575  100,000 units Costs: Transferred-in costs: $400  100,000, $475  100,000 units Import duties at 15% of transferred-in price $60  100,000, $71.25  100,000 units Total division costs Division operating income Division income taxes at 40% Division after-tax operating income Sum of divisional after-tax operating incomes

Method B Internal Transfers at Market Price

$40,000,000

$47,500,000

40,000,000 0 0

40,000,000 7,500,000 2,625,000 $ 4,875,000

$57,500,000

40,000,000

47,500,000

6,000,000 46,000,000 11,500,000 4,600,000 $ 6,900,000

7,125,000 54,625,000 2,875,000 1,150,000 $ 1,725,000

$ 6,900,000

$ 6,600,000

0 $

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

22-26 (20 min.) Transfer-pricing dispute. 1. Company as a whole will not benefit if Division C purchases from external suppliers: Purchase costs paid to external suppliers, 2,000 units  $135 Deduct: Savings in variable costs by reducing Division A output, 2,000 units  $120 Net cost (benefit) to company as a whole as a result of purchasing from external suppliers

$270,000 240,000 $ 30,000

Any transfer price between $120 and $135 per unit will achieve goal congruence. Division managers acting in their own best interests will take actions that are in the best interests of the company as a whole. 2. Company as a whole will benefit if Division C purchases from external suppliers: Purchase costs paid to external suppliers, 2,000 units  $135 Deduct: Savings in variable costs, 2,000 units  $120 $240,000 Savings due to A’s equipment and facilities assigned to other operations 18,000 Net cost (benefit) to company as a whole as a result of purchasing from external suppliers

$270,000

258,000 $ 12,000

Division C should purchase from internal suppliers. 3. Company as a whole will benefit if Division C purchases from external suppliers: Purchase costs paid to external suppliers, 2,000 units  $115 $ 230,000 Deduct: Savings in variable costs by reducing Division A output, 2,000 units  $120 240,000 Net cost (benefit) to company as a whole as a result of purchasing from external suppliers $ (10,000) The three requirements are summarized below (in thousands): Purchase costs paid to external suppliers Relevant costs if purchased from Division A: Incremental (outlay) costs if purchased from Division A Opportunity costs if purchased from Division A Total relevant costs if purchased from Division A Operating income advantage (disadvantage) to company as a result of purchasing from Division A

(1) $135

(2) $135

(3) $115

120 – 120

120 18 138

120 – 120

$ 15

$ (3)

$ (5)

Goal congruence would be achieved if the transfer price is set equal to the total relevant costs of purchasing from Division A.

Chapter 22: Transfer Pricing and Multinational Management Control Systems

22-27 (15 min.) Transfer-pricing problem (continuation of 22-26). The company as a whole would benefit in this situation if Division C purchased from external suppliers. The $30,000 disadvantage to the company as a whole as a result of purchasing from external suppliers would be more than offset by the $60,000 contribution margin of Division A’s sale of 2,000 units to other customers: Purchase costs paid to external suppliers, 2,000 units × $135 Deduct variable cost savings, 2,000 units × $120 Net cost to the company as a result of purchasing from external suppliers

$270,000 240,000 $ 30,000

Division A’s sales to other customers, 2,000 units × $155 Deduct: Variable manufacturing costs, $120 × 2,000 units Variable marketing costs, $5 × 2,000 units Total variable costs Contribution margin from selling units to other customers

$310,000 $240,000 10,000 250,000 $ 60,000

22-28 (20 min.) General guideline, transfer pricing. 1. The minimum transfer price that the SD would demand from the AD is the net price it could obtain from selling its screens on the outside market: $120 minus $5 marketing and distribution cost per screen, or $115 per screen. The SD is operating at capacity. The incremental cost of manufacturing each screen is $80. Therefore, the opportunity cost of selling a screen to the AD is the contribution margin the SD would forgo by transferring the screen internally instead of selling it on the outside market. Contribution margin per screen = $115 – $80 = $35 Using the general guideline, Incremental cost per Opportunity cost per Minimum transfer screen inccurred up to screen to the = + price per screen the point of transfer selling division = $80 + $35 = $115 2. The maximum transfer price the AD manager would be willing to offer SD is its own total cost for purchasing from outside, $120 plus $3 per screen, or $123 per screen. 3a. If the SD has excess capacity (relative to what the outside market can absorb), the minimum transfer price using the general guideline is: for the first 2,000 units (or 20% of output), $80 per screen because opportunity cost is zero; for the remaining 8,000 units (or 80% of output), $115 per screen because opportunity cost is $35 per screen.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3b. From the point of view of Clover’s management, all of the SD’s output should be transferred to the AD. This would avoid the $3 per screen variable purchasing cost that is incurred by the AD when it purchases screens from the outside market and it would also save the $5 marketing and distribution cost the SD would incur to sell each screen to the outside market. 3c. If the managers of the AD and the SD could negotiate the transfer price, they would settle on a price between $115 per screen (the minimum transfer price the SD will accept) and $123 per screen (the maximum transfer price the AD would be willing to pay). From requirements 1 and 2, we see that any price in this range would be acceptable to both divisions for all of the SD’s output, and would also be optimal from Clover’s point of view. The exact transfer price between $115 and $123 will depend on the bargaining strengths of the two divisions. Of course, Clover’s management could also mandate a particular transfer price between $115 and $123 per screen.

22-29 (20–30 min.) Pertinent transfer price. This problem explores the “general transfer-pricing guideline” discussed in the chapter. 1. No, transfers should not be made to Division B if there is no unused capacity in Division A. An incremental (outlay) cost approach shows a positive contribution for the company as a whole: Selling price of final product Incremental cost per unit in Division A Incremental cost per unit in Division B Contribution margin per unit

$330 $120 150

270 $ 60

However, if there is no excess capacity in Division A, any transfer will result in diverting products from the market for the intermediate product. Sales in this market result in a greater contribution for the company as a whole. Division B should not assemble the bicycle since the incremental revenue Europa can earn, $130 per unit (= $330 from selling the final product – $200 from selling the intermediate product) is less than the incremental cost of $150 to assemble the bicycle in Division B. Alternatively, Europa’s contribution margin from selling the intermediate product exceeds Europa’s contribution margin from selling the final product: Selling price of intermediate product $200 Incremental (outlay) cost per unit in Division A 120 Contribution margin per unit $ 80 Using the general guideline described in the chapter, Additional incremental cost  Opportunity cost  minimum   per unit to the    per unit incurred up transfer price    supplying division   to the point of transfer    $120  ($200 $120)  $200, which is the market price

Chapter 22: Transfer Pricing and Multinational Management Control Systems

The market price is the transfer price that leads to the correct decision; that is, do not transfer to Division B unless there are extenuating circumstances for continuing to market the final product. Therefore, Division B must either drop the product or reduce the incremental costs of assembly from $150 per bicycle to less than $130 (selling price, $330 – transfer price, $200). 2. If (a) A has excess capacity, (b) there is intermediate external demand for only 800 units at $200, and (c) the $200 price is to be maintained, then the opportunity costs per unit to the supplying division are $0. The general guideline indicates a minimum transfer price of: $120 + $0 = $120, which is the incremental or outlay costs for the first 200 units. B would buy 200 units from A at a transfer price of $120 because B can earn a contribution of $60 per unit [$330 – ($120 + $150)]. In fact, B would be willing to buy units from A at any price up to $150 per unit because any transfers at a price of up to $150 will still yield B a positive contribution margin. Note, however, that if B wants more than 200 units, the minimum transfer price will be $200 as computed in requirement 1 because A will incur an opportunity cost in the form of lost contribution of $80 (market price, $200 – outlay costs of $120) for every unit above 200 units that are transferred to B. The following schedule summarizes the transfer prices for units transferred from A to B: Units Transfer Price 0–200 $120–$150 200–1,000 $200 For an exploration of this situation when imperfect markets exist, see the next problem. 3. Division B would show zero contribution, but the company as a whole would generate a contribution of $60 per unit on the 200 units transferred. Any price between $120 and $150 would induce the transfer that would be desirable for the company as a whole. A motivational problem may arise regarding how to split the $60 contribution between Division A and B. Unless the price is below $150, B would have little incentive to buy. Note: The transfer price that may appear optimal in an economic analysis may, in fact, be totally unacceptable from the viewpoints of (1) preserving autonomy of the managers, and (2) evaluating the performance of the divisions as economic units. For instance, consider the simplest case discussed previously, where there is idle capacity and the $200 intermediate price is to be maintained. To direct that A should sell to B at A’s variable cost of $120 may be desirable from the viewpoint of B and the company as a whole. However, the autonomy (independence) of the manager of A is eroded. Division A will earn nothing, although it could argue that it is contributing to the earning of income on the final product. If the manager of A wants a portion of the total company contribution of $60 per unit, the question is: How is an appropriate amount determined? This is a difficult question in practice. The price can be negotiated upward to somewhere between $120 and $150 so that some “equitable” split is achieved. A dual transfer-pricing scheme has also been suggested, whereby the supplier gets credit for the full intermediate market price and the buyer is charged with only variable or incremental costs. In any event, when there is heavy interdependence between divisions, such as in this case, some system of subsidies may be needed to deal with the three problems of goal congruence, management effort, and subunit autonomy. Of course,

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

where heavy subsidies are needed, a question can be raised as to whether the existing degree of decentralization is optimal.

22-30 (30–40 min.) Pricing in imperfect markets (continuation of 22-29). (By James Patell) 1. Company Viewpoint a: Sell 1,000 units outside at $195 per unit b: Sell 800 units outside at $200 per unit, transfer 200 Price $195 Transfer price $200 Variable cost per unit 120 Variable cost per unit 120 Contribution $ 75  1,000 = $75,000 Contribution $ 80  800 = $64,000 Total contribution given up if transfer occurs* = $75,000 – $64,000 = $11,000 On a per-unit basis, the relevant costs are:

Incremental cost per unit incurred up to + Opportunity cost per unit = Transfer price to Division A the point of transfer $120 +

$11,000 = $175 200

By formula, costs are:

Increment cost per unit   Lost opportunity to Gain when 1st 800 units      incurred up to point +  sell 200 units at $195 per unit, –  sell at $200 per unit        to transfer for contribution of $75 per unit  instead of $195 per unit     = $120 +

200  $75 ($200 $195)  800 – 200 200

= $120 + $75 – $20 = $175 *Contribution of $30 per unit by B is not given up if transfer occurs, so it is not relevant here.

Chapter 22: Transfer Pricing and Multinational Management Control Systems

2a. At most, Division A can sell only 900 units and can produce 1,000. Therefore, at least 100 units should be transferred at a transfer price no less than $120. The question is whether or not a second 100 units should be transferred: Company Viewpoint a: Sell 900 units outside at $195 per unit b: Sell 800 units outside at $200 per unit, transfer 100 Transfer price $195 Transfer price $200 Variable cost per unit 120 Variable cost per unit 120 Contribution $ 75  900 = $67,500 Contribution $ 80  800 = $64,000 Total contribution forgone if transfer of 100 units occurs = $67,500 – $64,000 = $3,500 (or $35 per unit)

Incremental cost per unit Opportunity cost per unit + = Transfer price incurred up to point of transfer to Division A $120

$35

= $155

2b. By formula:

Incremental cost per unit   Lost opportunity to Gain when 1st 800 units      incurred up to point +  sell 100 units at $195 per unit, –  sell at $200 per unit        of transfer for contribution of $75 per unit  instead of $195 per unit    

100  $75 [($200 $195)  800] – 100 100 = $120 + $75 – $40 = $155 =

$120 +

Transfer Price Schedule (minimum acceptable transfer price): Units 0–100 101–200 201–1,000

Transfer Price $120 $155 $195

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

PROBLEMS 22-31 (30–35 min.) Effect of alternative transfer-pricing methods on division operating income. 1. Kilograms of cranberries harvested Litres of juice processed (1,900 L per 1,000 kg) Revenue (344,736 L  $0.55263/L) Costs Harvesting Division Variable costs (181,440 kg  $0.2205/kg) Fixed costs (181,440 kg  $0.5511/kg) Total harvesting division costs Processing Division Variable costs (344,736 L  $0.05263/L) Fixed costs (344,736 L  $0.1053/L) Total processing division costs Total costs Operating income

181,440 344,736 $190,511 $ 40,008 99,992 140,000 $ 18,143 36,301 54,444 194,444 ($ 3,933)

2. 200% of Full Costs Transfer price per kilogram (($0.2205 + $0.5511)  2; $1.3228) 1. Harvesting Division Revenue (181,440 kg  $1.5432; $1.3228) Costs Division variable costs (181,440 kg  $0.2205/kg) Division fixed costs (181,440 kg  $0.5511/kg) Total division costs Division operating income Harvesting division manager's bonus (5% of operating income) 2. Processing Division Revenue (344,736 L  $0.55263/L) Costs Transferred-in costs Division variable costs (344,736 L  $0.05263/L) Division fixed costs (344,736 L  $0.1053/L) Total division costs Division operating income Processing division manager’s bonus (5% of operating income)

Market Price

1.5432

$1.3228

$ 279,998

$ 240,009

40,008 99,992 140,000 $ 139,998 $ 7,000

40,008 99,992 140,000 $ 100,009 $ 5,000

$ 190,511

279,998 18,143 36,301 334,442 $(143,931) $ 0

240,009 18,143 36,301 294,453 $(103,942) $ 0

Chapter 22: Transfer Pricing and Multinational Management Control Systems

3. Bonus paid to division managers at 5% of division operating income is computed above and summarized below: Internal Transfers Internal Transfers at 200% of Full Costs at Market Prices Harvesting division manager’s bonus (5% × $139,998; 5% × $100,009) $7,000 $5,000 Processing division manager’s bonus (5% × $0; 5% × $0)

The harvesting division manager will prefer to transfer at 200% of full costs because this method gives a higher bonus. The processing division manager will be indifferent since neither transfer cost results in positive operating income but would likely prefer the market price since it results in a lower operating loss. Crango may resolve or reduce transfer pricing conflicts by:  Basing division managers’ bonuses on overall Crango profits in addition to division operating income. This will motivate each manager to consider what is best for Crango overall and not be concerned with the transfer price alone.  Letting the two divisions negotiate the transfer price between themselves. However, this may result in constant re-negotiation between the two managers each accounting period.  Using dual transfer prices However, a cost-based transfer price will not motivate cost control by the harvesting division manager. It will also insulate that division from the discipline of market prices.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

22-32 (25 min.) Goal-congruence problems with cost-plus transfer-pricing methods, dual-pricing system (continuation of 22-31). 1. Two examples of goal congruence problems that arise if a transfer price of 200% of full costs is mandated and Borges’ decentralization policy is adopted are: a. The processing division manager will prefer to buy cranberries from an external supplier at $1.3228 per kilogram, incurring some extra purchasing costs and lowering Crango’s overall operating income. Crango will incur costs of $1.3228 per kilogram and save variable costs of only $0.2205 per kilogram. b. The harvesting division manager is forced to sell to an outside purchaser (because the processing division prefers to purchase from an external supplier) when it is better for Crango Products to process internally. 2. Transfer into buying division at market price Harvesting division to processing division = $1.3228 per kilogram of cranberries Transfer out of selling division at 200% of full costs Harvesting division to processing division = 2.0 × ($0.2205 + $0.5511) = $1.5432 per kilogram of cranberries As calculated in requirement 2 of 22-31 and also shown below, under the dual transferpricing policy, the harvesting division will earn an operating income of $139,998 and the processing division will earn an operating income of $(103,942). 200% of Full Costs Harvesting Division Revenue (181,440 kg  $1.5432/kg) Costs Division variable costs (181,440 kg  $0.2205/kg) Division fixed costs (181,440 kg  $0.5511/kg) Total division costs Division operating income Processing Division Revenues (344,736 L  $0.55263/L) Costs Transferred in costs Division variable costs (344,736 L  $0.05263/L) Division fixed costs (344,736 L  $0.1053/L) Total division costs Division operating income

Market Price

$279,998 40,008 99,992 140,000 $139,998 $190,511 240,009 18,143 36,301 294,453 (103,942)

Chapter 22: Transfer Pricing and Multinational Management Control Systems

3. Under the dual transfer pricing policy, Division Operating Income Harvesting division Processing division Crango Products

$139,998 (103,942) $ 36,056

The overall company operating income from harvesting and processing 181,440 kilograms of cranberries is ($3,933) (see Problem 22-31, requirement 1). A dual transfer-pricing method entails using different transfer prices for transfers into the buying division and transfers out of the supplying division. As a result, the sum of division operating incomes does not equal the total company operating income. 4. Problems which may arise if Crango Products uses the dual transfer-pricing system include: a. It may reduce the incentives of the supplying division to control costs since every $1 of cost of the supplying division is transferred out to the buying division at $2.00. b. A dual transfer-pricing system does not provide clear signals to the individual divisions about the level of decentralization top management seeks. c. It insulates the harvesting division manager from the frictions and the discipline of the marketplace because costs, not market prices, affect the revenue of the supplying division.

22-33 (40 min.) Multinational transfer pricing, global tax minimization. This is a two-country two-division transfer-pricing problem with two alternative transfer-pricing methods. Summary data in U.S. dollars are: North Italy Mining Division Variable costs: 72 EURO ÷ 0.8 = $ 90 per ton of raw potash Fixed costs: 112 EURO ÷ 0.8 = $140 per ton of raw potash Market price: 296 EURO ÷ 0.8 = $370 per ton of raw potash U.S. Processing Division Variable costs = $ 48 per ton of fertilizer Fixed costs = $ 120 per ton of fertilizer Market price = $1,150 per ton of fertilizer 1. The transfer prices are: a. 150% of full costs Mining Division to Processing Division = 1.5 × ($90 + $140) = $345 per ton of raw potash b. Market price Mining Division to Processing Division = $370 per ton of raw potash

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

150% of Full Cost North Italy Mining Division Division revenues, $345, $370  12,000 Costs Division variable costs, $90  12,000 Division fixed costs, $140  12,000 Total division costs Division operating income U.S. Processing Division Division revenues, $1,150  6,000 Costs Transferred-in costs, $345, $370  12,000 Division variable cost, $48  6,000 Division fixed costs, $120  6,000 Total division costs Division operating income 2.

Market Price

$4,140,000

$4,440,000

1,080,000 1,680,000 2,760,000 $1,380,000

1,080,000 1,680,000 2,760,000 $1,680,000

$6,900,000

4,140,000 288,000 720,000 5,148,000 $1,752,000

4,440,000 288,000 720,000 5,448,000 $1,452,000

150% of Full Cost

Market Price

North Italy Mining Division Division operating income Income tax at 30% Division after-tax operating income

$1,380,000 414,000 $ 966,000

$1,680,000 504,000 $1,176,000

U.S. Processing Division Division operating income Income tax at 35% Division after-tax operating income

$1,752,000 613,200 $1,138,800

$1,452,000 508,200 $ 943,800

150% of Full Cost

Market Price

$ 966,000

$1,176,000

1,138,800

943,800

$2,104,800

$2,119,800

3. North Italy Mining Division: After-tax operating income U.S. Processing Division: After-tax operating income Supergrow: After-tax operating income

The North Italy Mining Division manager will prefer the higher transfer price of market price, and the U.S. Processing Division manager will prefer the lower transfer price equal to 150% of full cost. Supergrow will maximize companywide net income by using the market price-based transfer-pricing method. This method sources more of the total income in Italy, the country with the lower income tax rate.

Chapter 22: Transfer Pricing and Multinational Management Control Systems

4. Factors that executives consider important in transfer pricing decisions include the following: a. Performance evaluation b. Management motivation c. Pricing and product emphasis d. External market recognition Factors specifically related to multinational transfer pricing include the following: a. Overall income of the company b. Income or dividend repatriation restrictions c. Competitive position of subsidiaries in their respective markets

22-34 (20–30 min.) Pertinent transfer price, perfect and imperfect markets. This problem explores the “general transfer-pricing guideline” discussed in the chapter. 1. No, transfers should not be made to Division B if there is no unused capacity in Division A. An incremental (outlay) cost approach shows a positive contribution for the company as a whole: Selling price of final product Incremental cost per unit in Division A Incremental cost per unit in Division B Contribution margin per unit

$ 360 $ 90 120

210 $ 150

$ 275 90 $ 185

Using the general guideline described in the chapter, Additional incremental cost  Opportunity cost  Minimum   per unit to the    per unit incurred up transfer price    supplying division   to the point of transfer    $90  ($275 $90)  $275, which is the market price

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Transfer Price $ 90–$240 $ 275

For an exploration of this situation when imperfect markets exist, see the next problem. 3. Division B would show zero contribution, but the company as a whole would generate a contribution of $150 per unit on the 300 units transferred. Any price between $90 and $240 would induce the transfer that would be desirable for the company as a whole. A motivational problem may arise regarding how to split the $150 contribution between Division A and B. Unless the price is below $240, B would have little incentive to buy. Note: The transfer price that may appear optimal in an economic analysis may, in fact, be totally unacceptable from the viewpoints of (1) preserving autonomy of the managers, and (2) evaluating the performance of the divisions as economic units. For instance, consider the simplest case discussed previously, where there is idle capacity and the $275 intermediate price is to be maintained. To direct that A should sell to B at A’s variable cost of $90 may be desirable from the viewpoint of B and the company as a whole. However, the autonomy (independence) of the manager of A is eroded. Division A will earn nothing, although it could argue that it is contributing to the earning of income on the final product.

Chapter 22: Transfer Pricing and Multinational Management Control Systems

If the manager of A wants a portion of the total company contribution of $150 per unit, the question is: How is an appropriate amount determined? This is a difficult question in practice. The price can be negotiated upward to somewhere between $90 and $240 so that some “equitable” split is achieved. A dual transfer-pricing scheme has also been suggested, whereby the supplier gets credit for the full intermediate market price and the buyer is charged with only variable or incremental costs. In any event, when there is heavy interdependence between divisions, such as in this case, some system of subsidies may be needed to deal with the three problems of goal congruence, management effort, and subunit autonomy. Of course, where heavy subsidies are needed, a question can be raised as to whether the existing degree of decentralization is optimal. Potential contribution from external intermediate sale is 1,200  ($270 – $90) Contribution through keeping price at $275 is 900  $185. Forgone contribution by transferring 300 units

$216,000 166,500 $ 49,500

Opportunity cost per unit to the supplying division by transferring internally:

$49,500 = $165 300 Transfer price = $90 + $165 = $255 An alternative approach to obtaining the same answer is to recognize that the incremental or outlay cost is the same for all 1,200 units in question. Therefore, the total revenue desired by A would be the same for selling outside or inside. Let X equal the transfer price at which Division A is indifferent between selling all units outside versus transferring 300 units inside. 1,200  $270 X

= (900  $275) + 300X = $255

The $255 price will lead to the correct decision. Division B will not buy from Division A because its total costs of $255 + $120 will exceed its prospective selling price of $360. Division A will then sell 1,200 units at $270 to the outside; Division A and the company will have a contribution margin of $216,000. Otherwise, if 900 units were sold at $275 and 300 units were transferred to Division B, the company would have a contribution of $166,500 plus $45,000 (300 units of final product  $150), or $211,500.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

A comparison might be drawn regarding the computation of the appropriate transfer prices between the preceding problem and this problem:

Opportunity cost  Additional incremental cost   Minimum     per unit incurred up  per unit to  transfer price     to the point of transfer   Division A  Perfect markets: = $90 + (Selling price – Outlay costs per unit) = $90 + ($275 – $90) = $275 Imperfect markets: = $90 +

Margincal revenues Outlay costs Number of units transferred

$76,500a $27,000b = $255 300 aMarginal revenues of Division A from selling 300 units outside rather than transferring to Division B = ($270  1,200) – ($275  900) = $324,000 – $247,500 = $76,500. bIncremental (outlay) costs incurred by Division A to produce 300 units = $90  300 = $27,000. = $90 +

Therefore, selling price ($270) and marginal revenues per unit ($255 = $76,500 ÷ 300) are not the same. The following discussion is optional. These points should be explored only if there is sufficient class time. Some students may erroneously say that the “new” market price of $270 is the appropriate transfer price. They may claim that the general guideline says that the transfer price should be $90 + ($270 – $90) = $270, the market price. This conclusion assumes a perfect market. However, in this case, there are imperfections in the intermediate market. That is, the market price is not a good approximation of alternative revenue. If a division’s sales are heavy enough to reduce market prices, marginal revenue will be less than market price. It is true that either $270 or $255 will lead to the correct decision by B in this case. But suppose that B’s variable costs were $90 instead of $120. Then B would buy at a transfer price of $255 (but not at a price of $270, because then B would earn no contribution per unit [$360 – ($270 + $90)]. Note that if B’s variable costs were $90, transfers would be desirable: Division A contribution is: [900  ($275 – $90)] + [300  ($255 – $90)] Division B contribution is: 300  [$360 – ($255 + $90)] Total contribution

$216,000 4,500 $220,500

Chapter 22: Transfer Pricing and Multinational Management Control Systems

Or the same facts can be analyzed for the company as a whole: Sales of intermediate product, 900  ($275 – $90) Sales of final products, 300  [360 – ($90 + $90)] Total contribution

= $166,500 =

54,000 $220,500

If the transfer price were $275, B would not accept the transfer and would not earn any contribution. As shown above, Division A and the company as a whole will earn a total contribution of $216,000 instead of $220,500. ALTERNATIVE PRESENTATION (by James Patell) Company Viewpoint a: Sell 1,200 units outside at $270 per unit

Price $ 270 Variable cost per unit 90 Contribution $ 180  1,200 = $216,000

b: Sell 900 units outside at $275 per unit, transfer 300 Price $ 275 Variable cost per unit 90 Contribution $ 185  900 = $166,500

Total contribution given up if transfer occurs = $216,000 – $166,500 = $49,500 On a per-unit basis, the relevant costs are:

Incremental cost per unit Opportunity cost per unit incurred up to + = Transfer price to Division A the point of transfer $90

$49,500 = $255 300

By formula, costs are:

Increment cost per unit    incurred up to point + [lost opportunity to sell 300 units at $270 per unit, for contribution   to transfer   of $185 per unit] – [gain when 1st 900 units sell at $275 per unit instead of $270 per unit] = $90 +

300  $180 ($275 $270)  900 – 300 300

= $90 + $180 – $15 = $255

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

22-35 (20 min.) Transfer pricing, goal congruence, ethics. 1. The transfer price is 110% of the full cost per unit: 1.10 × [($0.075 × 100) + $6.35 + $2.15] = $17.60 Because $17.00 is below the transfer price of $17.60, the manufacturing division manager would choose to purchase the 2,000 rolls from Ecofree. 2. The purchase is not in the best interest of Sustainable Industries because, if produced internally, the additional 2,000 rolls would only cost the company $27,700 ($13.85 of variable cost per unit × 2,000 rolls). Because there is available capacity, fixed costs would be unaffected. If purchased from Ecofree, the paper would cost $34,000. The cause of this goal incongruence is two-fold: setting a transfer price based on full cost treats fixed costs as variable, and setting the price above full cost (in this case 110%) artificially inflates the cost to the purchasing division. 3. $17.00 is not a valid market price because it could not be replicated on future orders. $18.50 is a more appropriate market price. The manufacturing manager was not acting ethically in this situation because he or she was withholding pertinent information from both upper management and the recycling division manager and was even promoting a position known to be false. If the transfer price had been changed to $17.00, it would not have affected the company overall, but profit incentive rewards would have been shifted away from the recycling division manager and to the manufacturing manager.

Chapter 22: Transfer Pricing and Multinational Management Control Systems

22-36 (30–35 min.) Transfer pricing, perfect and imperfect markets. SOLUTION EXHIBIT A22Pounds of Ranbax Processed in S Total Net Revenues ($) from Sale of Syntex Incremental net revenues from processing next 1,000 pounds of Ranbax in S Incremental net revenues per pound from processing next 1,000 pounds of Ranbax in S

1,000 $ 500

2,000 $ 850

3,000 $1,100

4,000 $1,200

$ 500

$ 350

$ 250

$ 100

$ 0.50

$ 0.35

$ 0.25

$ 0.10

SOLUTION EXHIBIT B22Pounds of Ranbax Processed in T Total Net Revenues ($) from Sale of Termix Incremental net revenues from processing next 1,000 pounds of Ranbax in T Incremental net revenues per pound from processing next 1,000 pounds of Ranbax in T

1,000

2,000

3,000

4,000

5,000

6,000

$600

$1,200

$1,800

$2,100

$2,250

$2,350

$600

$ 600

$ 300

$ 150

$ 100

$0.60

$ 0.60

$ 0.30

$ 0.15

$ 0.10

1. The variable cost per pound of Ranbax is $0.18. From the last row of Solution Exhibit A22-, it is evident that for the first 3,000 pounds of Ranbax processed in S, the incremental net revenue per pound exceeds $0.18. However, the next 1,000 pounds following that generate only $0.10 per pound when converted to Syntex, which is below the variable cost of $0.18. Similarly, from the last row of Solution Exhibit B22-, it is in Letang’s interest to transfer 4,000 pounds of Ranbax to T to be processed into Termix. Letang should therefore produce 7,000 pounds of Ranbax overall and send 3,000 pounds to S and 4,000 pounds to T. 2. Division R will produce and ship Ranbax of any quantity up to its capacity of 10,000 pounds provided it gets a price not lower than its variable cost of $0.18 per pound. From Solution Exhibit A22-, Division S will be motivated to acquire exactly 3,000 pounds of Ranbax if the transfer price lies between $0.10 and $0.25 per pound. From Solution Exhibit B22-, Division T will be motivated to acquire exactly 4,000 pounds of Ranbax if the transfer price lies between $0.15 and $0.30 per pound. The set of transfer prices that will induce all three divisions to implement the plan found to be optimal in requirement 1 is given by the intersection of these three ranges. In other words, the transfer price must lie between $0.18 and $0.25 per pound of Ranbax.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. If R can sell any quantity of Ranbax in a competitive market for $0.33 per pound, Letang will choose to have Ranbax processed further into Syntex or Termix only to the extent the incremental net revenue per pound exceeds $0.33. From Solution Exhibits A22- and B22-, Letang would therefore like to process 2,000 pounds of Ranbax into Syntex and 3,000 pounds of Ranbax into Termix. Because the variable cost of producing Ranbax is $0.18 less than the market price of $0.33, Letang will now choose to have Division R operate at capacity. The final 5,000 pounds of Ranbax will then be sold in the external market. 4. The presence of a competitive external market with a price higher than $0.18 implies that Division R will operate at capacity. Further, R must receive a transfer price of at least $0.33 per pound in order to transfer any units internally. From Solution Exhibit A22-, Division S will be motivated to acquire exactly 2,000 pounds of Ranbax if the transfer price lies between $0.25 and $0.35 per pound. From Solution Exhibit B22-, Division T will be motivated to acquire exactly 3,000 pounds of Ranbax if the transfer price lies between $0.30 and $0.60 per pound. The set of transfer prices that will induce all three divisions to implement the plan found to be optimal in Requirement 3 is given by the intersection of these three ranges. This implies that the transfer price must lie between $0.33 and $0.35 per pound of Ranbax. Of course, if the market is truly competitive, in the sense that Divisions S and T can also purchase Ranbax externally for $0.33 per pound, then there is a unique optimal transfer price, given by the market price of $0.33 per pound!

22-37 (25 min.) Transfer pricing, goal congruence. 1. For each unit sold, Hauser receives a selling price of $32 and must incur a variable cost of $12 and a transfer price of $8 for the infrared LED from Croydon. Accordingly, Hauser’s incremental profits from each of the possible additional levels of monthly promotional expenses are as follows: $ 80,000: (10,000 units) × ($32 – $12 – $8) – $ 80,000 = $40,000 $120,000: (15,000 units) × ($32 – $12 – $8) – $120,000 = $60,000 $160,000: (18,000 units) × ($32 – $12 – $8) – $160,000 = $56,000 It is in Hauser’s interest therefore to spend $120,000 on promotional expenses, thereby boosting profits by $60,000. 2. For each additional unit, Croydon receives a transfer price of $8 while incurring a variable cost of $4.80 for the infrared LED. Given this positive margin, and because Croydon does not have to internalize the promotional expense, it is in that division’s best interest to have as high a level of output as possible. Therefore, Croydon’s manager would like Hauser to spend the highest amount, $160,000, on additional promotional expenses, to generate additional volume of 18,000 units.

Chapter 22: Transfer Pricing and Multinational Management Control Systems

3. From the company’s standpoint, the transfer price across the divisions is not relevant. What matters are the external selling price of $32 and the variable costs of $4.80 and $12 for the two divisions. The company’s incremental profits from each of the possible additional levels of monthly promotional expenses are as follows: $ 80,000: (10,000 units) × ($32 – $12 – $4.80) – $ 80,000 = $ 72,000 $120,000: (15,000 units) × ($32 – $12 – $4.80) – $120,000 = $108,000 $160,000: (18,000 units) × ($32 – $12 – $4.80) – $160,000 = $113,600 The company would also like Hauser to spend the maximum amount, $160,000, on additional monthly promotional expenses. 4. Note that the Croydon division and the company as a whole would like Hauser to spend $160,000, while Hauser itself benefits from spending just $120,000. To induce Hauser to increase promotional spending, it is clear that the transfer price for the infrared LED has to be lowered below $8. Letting the price be p, we can identify the values of p for which Hauser would prefer spending $160,000 to $120,000. Using the calculations in requirement 1, this requires: (18,000 units) × ($32 – $12 – p) – $160,000 ≥ (15,000 units) × ($32 – $12 – p) – $120,000 or (3,000 units) × ($20 – p) ≥ $40,000 or p ≤ $6.67 Similarly, for Hauser to prefer spending $160,000 to $80,000, p must satisfy: (18,000 units) × ($32 – $12 – p) – $160,000 ≥ (10,000 units) × ($32 – $12 – p) – $80,000 or (8,000 units) × ($20 – p) ≥ $80,000 or p ≤ $10 The maximum price that induces Hauser to act in the best interest of the firm is therefore $6.67. For any transfer price between $0 and $6.67, Hauser will invest $160,000 in additional monthly promotional expenses, and we have goal congruence.

22-38 (30–40 min.) International transfer pricing, taxes, goal congruence. 1. The minimum transfer price would be $64 to cover the variable production ($56 per unit) and shipping ($8 per unit) costs because Pollux would want, at a minimum, zero contribution margin. The opportunity cost is $0 because there are no external customers for IP-2014. The maximum transfer price would be the $77 market price that Castor would have to pay to acquire a product similar to IP-2014 from the external market in the United States. 2. To minimize income taxes, Gemini should use a transfer price of $64. Canada has a higher tax rate so goods coming from Canada should have the lowest transfer price. Pollux would not like a transfer price of $64 because it would report no operating income from the transfer. Castor would like a transfer price of $64 because it is lower than the outside market price of $77.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3a. It is easiest to see the solution to this problem if we assume a selling price for the product that Castor manufactures, for example, $120. (The actual selling price you choose is irrelevant.) Pollux’s after-tax income on each unit from accepting the special order is as follows: Revenue per unit $62.00 Variable cost per unit 56.00 Contribution margin per unit 6.00 Income taxes (0.40 × $6) 2.40 Increase in division income per unit after tax $ 3.60 Castor’s after-tax income on each unit if Pollux accepts the special order and Castor buys the substitute product for IP-2014 in the United States for $77 per unit is as follows: Revenue per unit $120.00 Variable cost per unit 77.00 Contribution margin per unit 43.00 Income taxes (0.30 × $43) 12.90 Increase in division income per unit after tax $ 30.10 Gemini’s total net income on each unit from Pollux accepting the special order is therefore $3.60 + $30.10 = $33.70. If Pollux rejects the special order and instead transfers the units internally to Castor at $64 per unit, Pollux’s after-tax income would be as follows: Revenue per unit $64 Variable cost per unit 64 Contribution margin per unit 0 Income taxes 0 Increase in division income per unit after tax $ 0 Castor’s after-tax income on each unit is as follows: Revenue per unit Variable cost per unit Contribution margin per unit Income taxes (0.30 × $56) Increase in division income per unit after tax

$120.00 64.00 56.00 16.80 $ 39.20

Gemini’s total net income on each unit as a result of Pollux rejecting the special order and transferring units of IP-2014 to Castor at $64 per unit is therefore $39.20 per unit. As this is higher than $33.70, accepting the special order does not maximize after-tax operating income. After-tax operating income is maximized by rejecting the special order.

Chapter 22: Transfer Pricing and Multinational Management Control Systems

3b. Castor will not want Pollux to accept the special order. It is more costly to buy from the external market than from Pollux. 3c. Pollux will want to accept the special order because Pollux’s income per unit after-tax increases by $3.60 per unit by accepting the special order rather than transferring IP-2014 to Castor at $64 per unit and earning $0 operating income. 3d. Gemini should set the transfer price at $70 per unit. This will result in each division taking actions in its own best interest that are also in the best interest of Gemini as a whole acting as a decentralized organization. The opportunity cost of transferring IP-2014 internally is $6 ($62 ─ $56) per unit for the first 8,000 units and $0 per unit thereafter. Using the general guideline, Incremental cost per Opportunity cost per Minimum transfer = unit inccurred up to + unit to the price the point of transfer selling subunit So, minimum transfer price

= $64 + $6 = $70 per unit for the first 8,000 units $64 + $0 = $64 per unit for the next 7,000 units

Gemini should use these minimum transfer prices because they are also (reasonably) taxefficient. At a transfer price of $70 per unit for the first 8,000 units, Pollux is indifferent between accepting the special order or transferring internally. Pollux earns $6 per unit if it accepts the special order. It also earns $6 per unit if it transfers IP-2014 to Castor ($70 − $64 variable cost per unit). Castor will prefer to “buy” IP-2014 from Pollux because the transfer price of $70 is less than the $77 price it would pay to buy a product similar to IP-2014 in the United States.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

The increase in Gemini’s income will be as follows: From Pollux: Revenue per unit Variable cost per unit Contribution margin per unit Income taxes (0.40 × $6) Increase in division income per unit after tax

$70.00 64.00 6.00 2.40 $ 3.60

From Castor: Revenue per unit Transfer price per unit Contribution margin per unit Income taxes (0.30 × $50) Increase in division income per unit after tax

$120.00 70.00 50.00 15.00 $ 35.00

Increase in Gemini’s income = $3.60 + $35.00 = $38.60 This net income is greater than the $33.70 net income that Gemini would earn if Pollux accepted the special order. It is less than the $39.20 that Gemini would earn if Pollux had transferred IP-2014 at $64 per unit. Of course, if the transfer price is set at $64 per unit, Pollux would accept the special order, which would lead to a lower net income of $33.70. If Gemini wants to get the benefits of decentralization, it must be willing to suffer the consequences of higher taxes that Pollux would have to pay. Note that Gemini would not want to set the transfer price any higher than $70, the minimum transfer price that would induce Pollux to transfer internally to Castor. Why? Because setting the transfer price any higher would result in exactly the same action (transferring IP-2014 internally) but at a higher cost because of the higher taxes that Pollux would have to pay in Canada. Consider for example a transfer price of $75 per unit. The increase in Gemini’s income will be as follows: From Pollux: Revenue per unit Variable cost per unit Contribution margin per unit Income taxes (0.4 × $11) Increase in division income per unit after tax

$75.00 64.00 11.00 4.40 $ 6.60

From Castor: Revenue per unit Transfer price per unit Contribution margin per unit Income taxes (0.30 × $45) Increase in division income per unit after tax

$120.00 75.00 45.00 13.50 $ 31.50

Increase in Gemini’s income is $6.60 + $31.50 = $38.10, which is less than the $38.60 Gemini earns if the transfer price is set at $70 per unit. A transfer price of $70 is the most tax-efficient transfer price consistent with Gemini operating as a decentralized organization. Note also that the transfer price cannot be set above $77 per unit because then Castor would buy a product similar to IP-2014 in the United States rather than from Pollux. Copyright © 2022 Pearson Canada Inc. 22-40

Chapter 22: Transfer Pricing and Multinational Management Control Systems

COLLABORATIVE LEARNING CASES 22-39 (30 min.) Transfer pricing, goal-congruence. 1. See column (1) of Solution Exhibit. The net cost of the in-house option is $230,000. 2. See columns (2a) and (2b) of Solution Exhibit. As the calculations show, if Johnson Corporation offers a price of $38 per laser mechanism, Evans Corporation should purchase the laser mechanisms from Johnson; this will result in an incremental net cost of $210,000 (column 2a). If Johnson Corporation offers a price of $45 per laser mechanism, Evans Corporation should manufacture the laser mechanisms in-house; this will result in an incremental net cost of $280,000 (column 2b). Comparing columns (1) and (2a), at a price of $38 per laser mechanism from Johnson, the net cost of $210,000 is less than the net cost of $230,000 to Evans Corporation if it made the laser mechanism in-house. So, Evans Corporation should outsource to Johnson. Comparing columns (1) and (2b), at a price of $45 per laser mechanism from Johnson, the net cost of $280,000 is greater than the net cost of $230,000 to Evans Corporation if it made the laser mechanisms in-house. Therefore, Evans Corporation should reject Johnson’s offer. Now consider column (2x) of Solution Exhibit. It shows that at a price of $40 per laser mechanism from Johnson, the net cost is exactly $230,000, the same as the net cost to Evans Corporation of manufacturing in-house (column 1). Thus, for prices between $38 and $40, Evans will prefer to purchase from Johnson. For prices greater than $40 (and up to $45), Evans will prefer to manufacture in-house.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

SOLUTION EXHIBIT Buy 10,000 laser Buy 10,000 Buy 10,000 mechanisms laser laser from mechanisms Transfer mechanisms Johnson at from Johnson 10,000 laser from Johnson $40. Sell at $45. Sell mechanisms to at $38. Sell 12,000 laser 12,000 laser assembly. Sell 12,000 laser mechanisms mechanisms in 2,000 in outside mechanisms in in outside outside market at $35 outside market market at market at $35 each at $35 each $35 each each (1) (2a) (2x) (2b) Incremental cost of laser division supplying 10,000 laser mechanisms to assembly division $25  10,000; 0; 0; 0

$(250,000)

Incremental costs of buying 10,000 laser mechanisms from Johnson $0; $38  10,000; $40  10,000; $45  10,000

(300,000)

Revenue from selling laser mechanisms in outside market $35  2,000; 12,000; 12,000; 12,000

70,000

420,000

Incremental costs of manufacturing laser mechanisms for sale in outside market $25  2,000; 12,000; 12,000; 12,000

(50,000)

(300,000)

Revenue from supplying lenses to Johnson $20  0; 10,000; 10,000; 10,000

200,000

Incremental costs of supplying lenses to Johnson $15  0; 10,000; 10,000; 10,000

(150,000)

$(230,000)

$(210,000)

$(230,000)

$(280,000)

Net costs

Chapter 22: Transfer Pricing and Multinational Management Control Systems

3. The laser division can manufacture at most 12,000 laser mechanisms and it is currently operating at capacity. The incremental costs of manufacturing a laser mechanism are $25 per unit. The opportunity cost of manufacturing laser mechanisms for the assembly division is (1) the contribution margin of $10 (selling price, $35 minus incremental costs $25) that the laser division would forgo by not selling laser mechanisms in the outside market plus (2) the contribution margin of $5 (selling price, $20 minus incremental costs, $15) that the laser division would forgo by not being able to sell the lens to external suppliers of laser mechanisms such as Johnson (recall that the laser division can produce as many lenses as demanded by external suppliers, but their demand will fall if the laser division supplies the assembly division with laser mechanisms). Thus, the total opportunity cost to the laser division of supplying laser mechanisms to assembly is $10 + $5 = $15 per unit. Using the general guideline, Incremental cost per Opportunity cost per Minimum transfer  laser mechanism up to the  Laser mechanism to the price per laser mechanism point of transfer selling division  $25  $15  $40

Thus, the minimum transfer price that the laser division will accept for each laser mechanism is $40. Note that at a price of $40, Evans is indifferent between manufacturing laser mechanisms in-house or purchasing them from an external supplier. 4a. The transfer price is set to $40 + $1 = $41 and Johnson is offering the laser mechanisms for $40.50 each. Now, for an outside price per laser mechanisms below $41, the assembly division would prefer to purchase from outside; above it, the assembly division would prefer to purchase from the laser division. So, the assembly division will buy from Johnson at $40.50 each and the laser division will be forced to sell its output on the outside market. 4b. But for Evans, as seen from requirements 1 and 2, an outside price of $40.50, which is greater than the $40 cut-off price, makes in-house manufacture the optimal choice. So, a mandated transfer price of $41 causes the division managers to make choices that are suboptimal for Evans. 4c. When selling prices are uncertain, the transfer price should be set at the minimum acceptable transfer price. It is only if the price charged by the external supplier falls below $40 that Evans Corporation as a whole is better off purchasing from the outside market. Setting the transfer price at $40 per unit achieves goal congruence. The laser division will be willing to sell to the assembly division, and the assembly division will be willing to buy in-house and this would be optimal for Evans, too.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

22-40 (40–50 min.) Goal-congruence, taxes, different market conditions. 1. New Frame: Sales price Less: Direct materials Direct manufacturing labour Variable manufacturing overhead Contribution margin from new frame

450 100 48 30 272

If order for the new frame is accepted, TECA earns a contribution margin of $272  2,000 units.

$544,000

However, frames division will only be in a position to supply 2,000 units to assembly and assembly will have to purchase 1,200 frames from outside. The incremental cost of buying frames from outside is $240 (proof below)  1,200.

288,000

Savings in purchase costs by making frames in-house Manufacturing costs: Direct materials Direct manufacturing labour Variable manufacturing overhead Total costs of manufacturing Net savings in costs by making existing frame in house Net benefit from accepting order

$480 $150 60 30 $240 $240 $256,000

TECA should: (a) make 2,000 units of the new frames in the frames division, (b) make 2,000 units of the existing frames for the assembly division, and (c) have the assembly division purchase 1,200 frames that it requires from the outside market. 2. The options facing the frames division manager are (a) to sell 2,000 units of the special order frames and make 2,000 units for the assembly division or (b) to make 3,200 units for the assembly division. The contribution margin per unit from accepting the special order is $272 per unit. Let the transfer price be $X. Then we want to find X such that

Chapter 22: Transfer Pricing and Multinational Management Control Systems

$272  2,000 + ($X – $240) 2,000 = ($X – $240) 3,200 ($X – $240) (3,200 – 2,000) = $544,000 $X – $240 = $544,000 / 1,200 $X - $240 = $453.33 X = $693.33 For transfer prices below $693.33, the frames division gets more by selling 2,000 units outside and transferring 2,000 units to assembly division. It will not transfer more than 2,000 units to assembly even though the transfer price is greater than the variable costs of manufacturing the existing frames, $240 plus the contribution margin per unit from accepting the special order of $272 equal to $512. Why? Because by transferring an additional 1,200 units it will have to give up $544,000 ($272  2,000) of contribution margin by not accepting the special order. The frames division manager would be willing to transfer the remaining 2,000 units for which it has capacity to the assembly division, provided the transfer price covers the frames division’s variable costs. So the range of transfer price that will induce the frames division manager to implement the optimal solution in requirement 1 is: $240 ≤ TP < $693.33 The assembly division manager would be willing to buy from the frames division so long as the transfer price is less than or equal to the price at which the assembly division can buy the frames on the outside market. TP ≤ $480 It will not buy the frames from the frames division if TP > $480. The range of TP that will result in both managers favouring the optimal actions in requirement 1 are TPs that satisfy the respective constraints described above. $240 ≤ TP ≤ $480 for the first 2,000 units $480 < TP < $693.33 for any additional units This transfer pricing scheme will induce both managers to transfer 2,000 units between the frames and assembly divisions but no more. 3. a. The full manufacturing costs of the frames transferred to the assembly division are: Direct materials Direct manufacturing labour Variable manufacturing overheads Fixed manufacturing overhead: $724,000 / 2 = $362,000 And $362,000 / 2,000 frames since the frames transferred to the assembly division use up half the frames division’s capacity Total manufacturing cost Copyright © 2022 Pearson Canada Inc. 22-45

$150 60 30

181 $421

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

b. A transfer price of $421 is in the optimal range identified in requirement 2 and so will achieve the optimal actions of selling 2,000 frames under the outside offer and transferring 2,000 frames to the assembly division as identified in requirement 1. (If we also want the assembly division manager to not ask for any additional frames beyond 2,000 units, the transfer price for any additional frames would have to be set such that $480 < TP < $693.33.) If the transfer price is set at $421, the assembly division manager will want more frames but the frames division manager will not have any incentive to transfer anything more than 2,000 units, preferring to supply 2,000 units for the special order. c. One advantage of full-cost transfer pricing is that it is useful for the firm’s long-run pricing decisions. One disadvantage of full-cost transfer pricing is that costs that are fixed for the corporation as a whole look like variable costs from the viewpoint of the assembly division manager. This is because by choosing not to have a unit transferred from the frames division, the assembly division manager would appear to save both the variable and fixed costs of the frames. This could lead to suboptimal decisions. 4. a. To minimize taxes, TECA should transfer the frames at the market price of $480. The frames division would pay no taxes on any income that it would report. By setting the transfer price as high as possible, the assembly division would minimize the income it would report and hence the taxes it would pay. b. Yes, as in part 3b, the transfer price of $480 is also within the range identified in requirement 2 and so will achieve the outcome desired in requirement 1 (sell 2,000 frames under the outside offer and transfer 2,000 frames to the assembly division). 5. Recommend that TECA use a transfer price of $480 for transferring frames from the frames division to the assembly division. This transfer price minimizes tax payments for TECA as a whole and also achieves goal congruence. That is, at a transfer price of $480 for all frames transferred from the frames division to the assembly division, both divisions will be content with the following arrangement: (a) The frames division will make 2,000 frames for outside customers and 2,000 frames for the assembly division. (b) The assembly division will take 2,000 frames from the frames division and the remaining frames from the outside market. Of course the assembly division manager would like to negotiate a price lower than $480 (but greater than $240) for the 2,000 frames from the frames division, but this would increase TECA’s tax payments. At a transfer price of $480, it would still be alright to evaluate each division’s performance on the basis of division operating income because the transfer price of $480 approximates the market prices for the frames transferred from the frames division to the assembly division. Market-based transfer prices give top management a reasonably good picture of the contributions of the individual divisions to overall companywide profitability.

CHAPTER 23 MULTINATIONAL PERFORMANCE MEASUREMENT AND COMPENSATION MyLab Accounting Make the grade with MyLab Accounting: Select end-of-chapter questions can be found on MyLab Accounting. You can practise them as often as you want, and most feature step-by-step guided instructions to help you find the right answer.

SHORT-ANSWER QUESTIONS 23-1 Examples of financial and nonfinancial measures of performance are: Financial: Nonfinancial:

ROI, residual income, economic value added, and return on sales. Customer perspective: market share, customer satisfaction. Internal-business-processes perspective: manufacturing lead time, yield, on-time performance, number of new product launches, and number of new patents filed. Learning-and-growth perspective: employee satisfaction, informationsystem availability.

23-2 The six steps in designing an accounting-based performance measure are: 1. 2. 3. 4. 5. 6.

Choose performance measures that align with top management’s financial goals Choose the time horizon of each performance measure in Step 1 Choose a definition of the components in each performance measure in Step 1 Choose a measurement alternative for each performance measure in Step 1 Choose a target level of performance Choose the timing of feedback

23-3 The DuPont method highlights that ROI is increased by any action that increases return on sales or investment turnover. ROI increases with 1. increases in revenues, 2. decreases in costs, or 3. decreases in investments, while holding the other two factors constant.

23-4 Yes. Residual income (RI) is not identical to return on investment (ROI). ROI is a percentage with investment as the denominator of the computation. RI is an absolute monetary amount which includes an imputed interest charge based on investment.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

23-5 Economic value added (EVA) is a specific type of residual income measure that is calculated as follows:



Economic value = After-tax – Weighted-average  Total assets minus added (EVA) operating income cost of capital current liabilities



23-6 Definitions of investment used in practice when computing ROI are 1. 2. 3. 4.

Total assets available Total assets employed Total assets employed minus current liabilities Shareholders’ equity

23-7 Current cost is the cost of purchasing an asset today identical to the one currently held if an identical asset can currently be purchased; it is the cost of purchasing an asset that provides services like the one currently held if an identical asset cannot be purchased. Historical-costbased measures of ROI compute the asset base as the original purchase cost of an asset minus any accumulated depreciation. Some commentators argue that current cost is oriented to current prices, while historical cost is past-oriented.

23-8 Special problems arise when evaluating the performance of divisions in multinational companies because a. The economic, legal, political, social, and cultural environments differ significantly across countries. b. Governments in some countries may impose controls and limit selling prices of products. c. Availability of materials and skilled labour, as well as costs of materials, labour, and infrastructure may differ significantly across countries. d. Divisions operating in different countries keep score of their performance in different currencies.

23-9 In some cases, the subunit’s performance may not be a good indicator of a manager’s performance. For example, companies often put the most skillful division manager in charge of the weakest division in an attempt to improve the performance of the weak division. Such an effort may yield results in years, not months. The division may continue to perform poorly with respect to other divisions of the company. But it would be a mistake to conclude from the poor performance of the division that the manager is performing poorly. A second example of the distinction between the performance of the manager and the performance of the subunit is the use of historical cost-based ROIs to evaluate the manager even though historical cost-based ROIs may be unsatisfactory for evaluating the economic returns earned by the organization subunit. Historical cost-based ROI can be used to evaluate a manager by comparing actual results to budgeted historical cost-based ROIs.

Chapter 23: Multinational Performance Measurement and Compensation

23-10 Moral hazard describes situations in which an employee prefers to exert less effort (or to report distorted information) compared with the effort (or accurate information) desired by the owner because the employee’s effort (or validity of the reported information) cannot be accurately monitored and enforced.

23-11 Rewarding managers on the basis of their performance measures only, such as ROI, subjects them to uncontrollable risk because managers’ performance measures are also affected by random factors over which they have no control. A manager may put in a great deal of effort but her performance measure may not reflect this effort if it is negatively affected by various random factors. Thus, when managers are compensated on the basis of performance measures, they will need to be compensated for taking on extra risk. Therefore, when performance-based incentives are used, they are generally more costly to the owner. The motivation for having some salary and some performance-based bonus in compensation arrangements is to balance the benefits of incentives against the extra costs of imposing uncontrollable risk on the manager.

23-12 Benchmarking or relative performance evaluation is the process of evaluating a manager’s performance against the performance of other similar operations. The ideal benchmark is another operation that is affected by the same noncontrollable factors that affect the manager’s performance. Benchmarking cancels the effects of the common noncontrollable factors and provides better information about the manager’s performance.

23-13 When employees have to perform multiple tasks as part of their jobs, incentive problems can arise when one task is easy to monitor and measure while the other task is more difficult to evaluate. Employers want employees to intelligently allocate time and effort among various tasks. If, however, employees are rewarded on the basis of the task that is more easily measured, they will tend to focus their efforts on that task and ignore the others.

23-14 Diagnostic systems monitor critical performance factors—such as ROI, RI, EVA, ROS, customer satisfaction, and employee satisfaction—that help managers monitor progress toward attaining the company’s strategic goals. Boundary systems describe standards of behaviour and codes of conduct expected of all employees, especially actions that are off-limits. Ethical behaviour on the part of managers is paramount. Belief systems articulate the mission, purpose, and core values of a company. They describe the accepted norms and patterns of behaviour expected of all managers and employees with respect to each other, shareholders, customers, and communities. Interactive control systems are formal information systems that managers use to focus organization attention and learning on key strategic issues. Interactive control systems track strategic uncertainties that businesses face. Measuring and rewarding managers for achieving critical performance variables is an important driver of corporate performance. But these diagnostic control systems must be counterbalanced by the other levers of control—boundary systems, belief systems, and interactive control systems—to ensure that proper business ethics, inspirational values, and attention to future threats and opportunities are not sacrificed to achieve business results. An excessive focus on diagnostic control systems and critical performance variables can cause an organization to ignore emerging threats and opportunities—changes in technology, customer preferences, regulations, and industry competition that can undercut a business.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

EXERCISES 23-15 (10 min.) Terminology. 1. Governance, or the management stewardship of assets management does not own, according to laws and regulations is more closely scrutinized than before. Legal reform in the United States now mandates a shareholder vote on any executive compensation packages, referred to as a say on pay. 2. While we are very familiar with executive bonus, a new clawback of previous compensation, or a malus, is becoming a feature of compensation. 3. One important performance measure that could determine a bonus or malus is the accounting return on investment (ROI), calculated by dividing the net income by the investment made. Another measure is the ROR, also called the imputed cost of investment, which represents a return forgone from tying up cash in existing investments. A third measure is the economic value added (EVA), which is calculated by subtracting the total assets minus current liabilities multiplied by the weightedaverage cost of capital (WACC) from the after-tax operating income. 4. But executive performance is not the only factor or even the most important factor affecting corporate profitability, excellent governance, and corporate social responsibility. Good management control systems will separate the effects of good luck from good management on performance. Additional considerations when designing a good management control system include boundary systems, belief systems, intrinsic motivation, and interactivity.

Chapter 23: Multinational Performance Measurement and Compensation

23-16 (30 min.) ROI, comparisons of three companies. 1. The separate components highlight several features of return on investment not revealed by a single calculation: a. The importance of investment turnover as a key to income is stressed. b. The importance of revenues is explicitly recognized. c. The important components are expressed as ratios or percentages instead of dollar figures. This form of expression often enhances comparability of different divisions, businesses, and time periods. d. The breakdown stresses the possibility of trading off investment turnover for income as a percentage of revenues so as to increase the average ROI at a given level of output. 2. (Filled-in blanks are in boldface.) Revenue Income Investment Income as a % of revenue Investment turnover Return on investment

A $1,000,000 $ 100,000 $ 500,000 10% 2.0 20%

Companies in Same Industry B C $ 500,000 $10,000,000 $ 50,000 $ 50,000 $5,000,000 $ 5,000,000 10% 0.5% 0.1 2.0 1% 1%

Income and investment alone shed little light on comparative performances because of disparities in size between Company A and the other two companies. Thus, it is impossible to say whether B’s low return on investment in comparison with A’s is attributable to its larger investment or to its lower income. Furthermore, the fact that Companies B and C have identical income and investment may suggest that the same conditions underlie the low ROI, but this conclusion is erroneous. B has higher margins but a lower investment turnover. C has very small margins (1/20th of B) but turns over investment 20 times faster. Introducing revenues to measure level of operations helps to disclose specific areas for more intensive investigation. Company B does as well as Company A in terms of income margin, for both companies earn 10% on revenues. But Company B has a much lower turnover of investment than does Company A. Whereas a dollar of investment in Company A supports two dollars in revenues each period, a dollar investment in Company B supports only ten cents in revenues each period. This suggests that the analyst should look carefully at Company B’s investment. Is the company keeping an inventory larger than necessary for its revenue level? Are receivables being collected promptly? Or did Company A acquire its fixed assets at a price level that was much lower than that at which Company B purchased its plant? “On the other hand, C’s investment turnover is as high as A’s, but C’s income as a percentage of revenue is much lower. Why? Are its operations inefficient, are its material costs too high, or does its location entail high transportation costs?” “Analysis of ROI raises questions such as the foregoing. When answers are obtained, basic reasons for differences between rates of return may be discovered. For example, in Company B’s case, it is apparent that the emphasis will have to be on increasing turnover by reducing investment or increasing revenues. Clearly, B cannot appreciably increase its ROI simply by increasing its income as a percent of revenue. In contrast, Company C’s management should concentrate on increasing the percent of income on revenue.” Copyright © 2022 Pearson Canada Inc. 23-5

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

23-17 (30 min.) Analysis of return on invested assets, comparison of two divisions, DuPont method. 1. Operating Income  Operating Revenues

Operating Revenues  Total Assets

Operating Income  Total Assets

Operating Income

Operating Revenues

Total Assets

Test Preparation Division 2020

$680

4.1

35.4%

840

10%

4.2

42%

2022 Language Arts Department 2020

1,160

$1920 $840  42% = $2,000 $10,545  5 = $2,109

8.5%

2021

$7,960 $840  10% = $8,400 $1,160  11% = $10,545

11%

55%

2021 2022 Learning World Inc. 2020 2021 2022

$620 $3,000  22%= $660 $2,340  25% = $585

$2,360

$1,280

26.3%

1.8

48.4%

3,000 $2,340  2 = $4,680

1,800

22%

1.7

36.7%

2,340

12.5%

25%

$1,300 $840 + $660 = $1,500 $1,160 + $585 = $1,745

$10,320 $8,400 + $3,000 = $11,400 $10,545 + $4,680 = $15,225

$3,200 $2,000 + $1,800 = $3,800 $2,109 + $2,340 = $4,449

12.6%

3.2

40.6%

13.2%

39.5%

11.5%

3.4

39.2%

2. Based on revenues, Test Preparation is about twice as big as Language Arts. The Language Arts Department earns higher margins (operating income as a percent of operating revenues); the Test Preparation Division turns over its assets at more than twice the rate of the Language Arts Department (operating revenues as a multiple of total assets). The net result is that the ROI of the two divisions was similar (in the 30–50% range). But whereas the ROI of the Test Preparation Division has been increasing from 2020 to 2022, the ROI of the Language Arts Department has been falling. Overall, this has resulted in Learning World showing stable ROI over the past three years.

Chapter 23: Multinational Performance Measurement and Compensation

23-18 (10–15 min.) ROI and RI. 1. Operating income = (Contribution margin per unit  140,000 units) – Fixed costs = ($700 – $400)  140,000 – $32,000,000 = $10,000,000 ROI =

Operating income = $10,000,000 ÷ $50,000,000 = 20% Investment

2. Operating income = ROI × Investment [No. of pairs sold (Selling price – Var. cost per unit)] – Fixed costs = ROI Investment Let $X = minimum selling price per unit to achieve a 25% ROI 140,000 ($X – $400) – $32,000,000 = 25% ($50,000,000) $140,000X = $12,500,000 + $56,000,000 + $32,000,000 X = $718 3. Let $X = minimum selling price per unit to achieve a 15% rate of return 140,000 ($X – $400) – $32,000,000 = 15% ($50,000,000) $140,000X = $7,500,000 + $56,000,000 + $32,000,000 X = $682

23-19 (20 min.) ROI and RI with manufacturing costs. 1. The operating income is: Sales revenue ($17,000 × 11,500) Less: Direct materials ($8,200 × 11,500) Setup ($1,700 × 5,800) Production ($445 × 181,000) Gross margin Selling and administration Operating income

$195,500,000 $94,300,000 9,860,000 80,545,000

184,705,000 $ 10,795,000 8,200,000 $ 2,595,000

Average invested capital is ($15,500,000 + $15,900,000) ÷ 2 = $15,700,000 ROI = $2,595,000/$15,700,000 = 16.5% 2. Residual income = Operating income − (14% × Invested capital) = $2,595,000 − (14% × $15,700,000) = $2,595,000 − $2,198,000 = $397,000

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

23-20 (25 min.) Goal incongruence and ROI. 1. McCall would be better off if the machine is replaced. Its cost of capital is 4%, and the IRR of the investment is 10%, indicating that this is a positive net present value project. 2. The ROIs for the first five years are as follows:

Operating income1 End of year net assets Average net assets ROI

Year 1 $3,000 45,000 47,5002 6.32%

Year 2 $3,000 40,000 42,500 7.06%

Year 3 $3,000 35,000 37,500 8.00%

Year 4 $3,000 30,000 32,500 9.23%

Year 5 $3,000 25,000 27,500 10.91%

1Income is cash savings of $8,000 less $5,000 annual depreciation expense. 2($50,000 + $45,000) ÷ 2 = $47,500

The manager would not want to replace the machine before retiring because the division is currently earning a ROI of 10%, and replacement of the machine will lower the ROI every year until the fifth year, when the manager is long gone. 3. McCall could use long-term rather than short-term ROI, or use ROI and some other longterm measures to evaluate the Patio Furniture division to create goal congruence. Evaluating the managers on residual income rather than ROI would also achieve goal congruence. For example, replacing the machine increases residual income in Year 1. Residual income = Operating income − (4% × Average net assets) = $3,000 − (4% × 47,500) = $3,000 − $1,900 = $1,100

Chapter 23: Multinational Performance Measurement and Compensation

23-21 (25 min.) ROI, RI, EVA. 1. The required division ROIs using total assets as a measure of investment is shown in the row labeled (1) in Solution Exhibit 23SOLUTION EXHIBIT 23-

(1) (2) (3)

Total assets Current liabilities Operating income Required rate of return Total assets – current liabilities ROI (based on total assets) ($2,475,000  $33,000,000; $2,565,000  $28,500,000) RI (based on total assets – current liabilities) ($2,475,000 – (12%  $26,400,000); $2,565,000 – (12%  $20,100,000)) RI (based on total assets) ($2,475,000 – (12%  $33,000,000); $2,565,000 – (12%  $28,500,000))

New Car Division $33,000,000 $ 6,600,000 $ 2,475,000 12% $26,400,000

Performance Parts Division $28,500,000 $ 8,400,000 $ 2,565,000 12% $20,100,000

7.5%

9.0%

693,000)

$ 153,000

($ 1,485,000)

($ 855,000)

2. The required division RIs using total assets minus current liabilities as a measure of investment is shown in the row labeled (2) in the table above. 3. The row labeled (3) in the table above shows division RIs using assets as a measure of investment. Even with this new measure that is insensitive to the level of short-term debt, the New Car Division has a relatively worse RI than the Performance Parts Division. Both RIs are negative, indicating that the divisions are not earning the 12% required rate of return on their assets. 4. After-tax cost of debt financing = (1– 0.4) × 10% = 6% After-tax cost of equity financing = 15%

($18,000,000  6%) + ($12,000,000  15%) Weighted average = 9.6% = cost of capital $18,000,000 + $12,000,000 Operating income after tax 0.6 × operating income before tax (0.6 × $2,475,000; 0.6 × $2,565,000) Required return for EVA 9.6% × Investment (9.6% × $26,400,000; 9.6% × $20,100,000) EVA (Optg. inc. after tax – reqd. return)

$ 1,485,000

$1,539,000

2,534,400 $(1,049,400)

1,929,600 $ (390,600)

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

5. Both the residual income and the EVA calculations indicate that the Performance Parts Division is performing nominally better than the New Car Division. The Performance Parts Division has a higher residual income. The negative EVA for both divisions indicates that, on an after-tax basis, the divisions are destroying value––the after-tax economic returns from them are less than the required returns.

23-22 (25–30 min.) ROI, RI, measurement of assets. The method for computing profitability preferred by each manager follows: Manager of

Method Chosen

Radnor Easttown Marion

RI based on net book value RI based on gross book value ROI based on either gross or net book value

Supporting Calculations: ROI Calculations

Radnor Easttown Marion

Operating Income Gross Book Value $142,050 ÷ $1,200,000 = 11.84% (3) $137,550 ÷ $1,140,000 = 12.07% (2) $ 92,100 ÷ $ 750,000 = 12.28% (1)

Division

RI Calculations 1 Operating Income – 10% Gross BV Operating Income – 10% Net BV

Radnor Easttown Marion

$142,050 – $120,000 = $22,050 (2) $137,550 – $114,000 = $23,550 (1) $ 92,100 – $ 75,000 = $17,100 (3)

Division

Operating Income Net Book Value * $142,050 ÷ $555,000 = 25.59% (3) $137,550 ÷ $525,000 = 26.20% (2) $ 92,100 ÷ $330,000 = 27.91% (1)

$142,050 – $55,500 = $86,550 (1) $137,550 – $52,500 = $85,050 (2) $ 92,100 – $33,000 = $59,100 (3)

1Net book value is gross book value minus accumulated depreciation.

The biggest weakness of ROI is the tendency to reject projects that will lower historical ROI even though the prospective ROI exceeds the required ROI. RI achieves goal congruence because subunits will make investments as long as they earn a rate in excess of the required return for investments. The biggest weakness of RI is that it favours larger divisions in ranking performance. The greater the amount of the investment (the size of the division), the more likely that larger divisions will be favoured assuming that income grows proportionately. The strength of ROI is that it is a ratio and so does not favour larger divisions. In general, though, achieving goal congruence is very important. Therefore, the RI measure is often preferred to ROI.

Chapter 23: Multinational Performance Measurement and Compensation

23-23 (20 min.) Multinational performance measurement, ROI, RI. 1a. Canadian Division’s ROI in 2023 =

Operating income Operating income = = 15% $8,000,000 Total assets

Hence, operating income = 15%  $8,000,000 = $1,200,000. 1b. Norwegian Division’s ROI in 2023 (based on kroner) = 2.

8,100,000 kroner = 15.43% 52,500,000 kroner

Convert total assets into dollars using the December 31, 2022, exchange rate, the rate prevailing when the assets were acquired (6 kroner = $1): 52,500,000 kroner = $8,750,000 6 kroner per dollar

Convert operating income into dollars at the average exchange rate prevailing during 2023 when operating income was earned (6.5 kroner = $1):

8,100,000 kroner = $1,246,154 6.5 kroner per dollar $1,246,154 Comparable ROI for Norwegian Division = = 14.24% $8,750,000 The Norwegian Division’s ROI based on kroner is helped by the inflation that occurs in Norway in 2023 (that caused the Norwegian krone to weaken against the dollar from 6 kroner = $1 on Dec. 31, 2022, to 7 kroner = $1 on Dec. 31, 2023). Inflation boosts the division’s operating income. Since the assets are acquired at the start of the year 2023, the asset values are not increased by the inflation that occurs during the year. The net effect of inflation on ROI calculated in kroner is to use an inflated value for the numerator relative to the denominator. Adjusting for inflationary and currency differences negates the effects of any differences in inflation rates between the two countries on the calculation of ROI. After these adjustments, the Canadian Division earned a higher ROI than the Norwegian Division. 3.

Canadian Division’s RI in 2023 = $1,200,000  (12%  $8,000,000) = $1,200,000  $960,000 = $240,000 Norwegian Division’s RI in 2023 (in CAD) is calculated as: $1,246,154  (12%  $8,750,000) = 1,246,154  $1,050,000 = $196,154. The Canadian Division’s RI also exceeds the Norwegian Division’s RI in 2023 by $43,846.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

23-24 (20 min.) ROI, RI, EVA, and performance evaluation. 1. ROI and residual income: Operating income after tax Net assets ROI ($800,000 ÷ $3,200,000; $1,800,000 ÷ $7,500,000) RI ($800,000 − 11% × 3,200,000; $1,800,000 − 11% × $7,500,000)

Clothing $ 800,000 $3,200,000

Cosmetics $ 1,800,000 $ 7,500,000

25.00% $ 448,000

24.00% $

975,000

The choice of measure used to evaluate performance will determine which division gets the bonus. If Lucy uses ROI, then the Clothing Division will get the bonus. However, the Cosmetics Division has much larger absolute and residual income. If Lucy evaluates performance based on residual income, then the Cosmetics Division will get the bonus. The advantages of ROI are that it is easy to calculate and easy to understand. It combines revenue, cost, and investment into a single number, so that managers can clearly see what can be changed to increase returns. But ROI has limitations. Managers who are evaluated based on ROI have incentives to reject investments with ROIs below their divisions’ current average ROI, even when the investments have positive net present values. Residual income has the advantage of goal congruence because any investment that earns more than the required capital charge increases RI and, thereby, increases the managers’ performance evaluations. The measure is not subject to the “cutoff” problems that occur when managers compare a new investment’s ROI to the average ROI being earned on existing investments. However, RI is not as easy to measure because it requires the company to determine the amount of capital and the cost of capital for each business unit. 2. Adjusted operating income Net assets less current liabilities Revised ROI ($938,000 ÷ $2,680,000; $1,147,200 ÷ $7,170,000) EVA ($938,000 − 11% × $2,680,000; $1,147,200 − 11% × $7,170,000)

Clothing $ 938,000 $2,680,000 35.00% $ 643,200

Cosmetics $1,147,200 $7,170,000 16.00% $ 358,500

Clothing Division will get the bonus because both EVA and ROI (using EVA’s definition of operating income and assets) are higher than those of the Cosmetics Division. 3. Because this is a manufacturing firm, there are a variety of nonfinancial performance measures such as market share, customer satisfaction, defect rates, and response times that can be used to ensure that managers do not increase short-term operating income, residual income, or EVA at the expense of performance categories that are long-term drivers of company value.

Chapter 23: Multinational Performance Measurement and Compensation

23-25 (20–30 min.) Risk sharing, incentives, benchmarking, multiple tasks. 1. An evaluation of the three proposals to compensate Marks, the general manager of the Dexter Division follows: a. Paying Marks a flat salary will not subject Marks to any risk, but it will provide no incentives for Marks to undertake extra physical and mental effort. b. Rewarding Marks only on the basis of Dexter Division’s ROI would motivate Marks to put in extra effort to increase ROI because Marks’s rewards would increase with increases in ROI. But compensating Marks solely on the basis of ROI subjects Marks to excessive risk because the division’s ROI depends not only on Marks’s effort but also on other random factors over which Marks has no control. For example, Marks may put in a great deal of effort, but, despite this effort, the division’s ROI may be low because of adverse factors (such as high interest rates or a recession) which Marks cannot control. To compensate Marks for taking on uncontrollable risk, AMCO must pay him additional amounts within the structure of the ROI-based arrangement. Thus, compensating Marks only on the basis of performance-based incentives will cost AMCO more money, on average, than paying Marks a flat salary. The key question is whether the benefits of motivating additional effort justify the higher costs of performance-based rewards. Furthermore, the objective of maximizing ROI may induce Marks to reject projects that, from the viewpoint of the organization as a whole, should be accepted. This would occur for projects that would reduce Marks’s overall ROI but that would earn a return greater than the required rate of return for that project. c. The motivation for having some salary and some performance-based bonus in compensation arrangements is to balance the benefits of incentives against the extra costs of imposing uncontrollable risk on the manager. 2. Marks’s complaint does not appear to be valid. The senior management of AMCO is proposing to benchmark Marks’s performance using a relative performance evaluation (RPE) system. RPE controls for common uncontrollable factors that similarly affect the performance of managers operating in the same environments (for example, the same industry). If business conditions for car battery manufacturers are good, all businesses manufacturing car batteries will probably perform well. A superior indicator of Marks’s performance is how well Marks performed relative to his peers. The goal is to filter out the common noise to get a better understanding of Marks’s performance. Marks’s complaint will be valid only if there are significant differences in investments, assets, and the business environment in which AMCO and Tiara operate. Given the information in the problem, this does not appear to be the case. Of course, using RPE does not eliminate the problem with the ROI measure itself. To keep ROI high, Marks will still prefer to reject projects whose ROI is greater than the required rate of return but lower than the current ROI.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

3. Superior performance measures change significantly with the manager’s performance and not very much with changes in factors that are beyond the manager’s control. If Marks has no authority for making capital investment decisions, then ROI is not a good measure of Marks’s performance––it varies with the actions taken by others rather than the actions taken by Marks. AMCO may wish to evaluate Marks on the basis of operating income rather than ROI. ROI, however, may be a good measure to evaluate Dexter’s economic viability. Senior management at AMCO could use ROI to evaluate if the Dexter Division’s income provides a reasonable return on investment, regardless of who has authority for making capital investment decisions. That is, ROI may be an inappropriate measure of Marks’s performance but a reasonable measure of the economic viability of the Dexter Division. If, for whatever reasons—bad capital investments, weak economic conditions, etc.—the Division shows poor economic performance as computed by ROI, AMCO management may decide to shut down the division even though they may simultaneously conclude that Marks performed well. 4. There are three main concerns with Marks’s plans. First, creating very strong sales incentives imposes excessive risk on the sales force because a salesperson’s performance is affected not only by his or her own effort, but also by random factors (such as a recession in the industry) that are beyond the salesperson’s control. If salespersons are risk averse, the firm will have to compensate them for bearing this extra uncontrollable risk. Second, compensating salespersons only on the basis of sales creates strong incentives to sell but may result in lower levels of customer service and sales support (this was the story at Sears auto repair shops where a change in the contractual terms of mechanics to “produce” more repairs caused unobservable quality to be negatively affected). Where employees perform multiple tasks, it may be important to “blunt” incentives on those aspects of the job that can be measured well (for example, sales) to try and achieve a better balance of the two tasks (for example, sales and customer service and support). In addition, the division should try to better monitor customer service and customer satisfaction through surveys, or through quantifying the amount of repeat business. Finally, setting compensation on the basis of number of units sold, rather than the revenue generated, may result in excess discounting by salespersons whose goal is to increase volume without attention to the impact on brand perception or the division’s income from prices that are too low.

Chapter 23: Multinational Performance Measurement and Compensation

23-26 (20 min.) Executive compensation, balanced scorecard. The percentage changes in net income and customer satisfaction in the three business units between 2022 and 2023 are as follows:

Percentage change in net income ($3,912,000 − $3,600,000) ÷ $3,600,000; ($3,940,000 − $3,800,000) ÷ $3,800,000; ($3,499,000 − $3,550,000) ÷ $3,550,000 Percentage change in customer satisfaction (75.48 − 73) ÷ 73; (75.9 − 68) ÷ 68; (78.88 − 67) ÷ 67

Retail Banking

Business Banking

Credit Cards

8.67%

3.68%

(1.44%)

3.40%

11.62%

17.73%

1. The bonus formula indicates that the executives of the three units will receive the following 2023 bonuses as a percent of salary: Retail Banking: 8.67% + 3.40% = 12.07% of salary Business Banking: 3.68% + 11.62% = 15.30% of salary Credit Cards: 0% + 17.73% = 17.73% of salary 2. The results show an inverse relation between changes in net income and changes in customer satisfaction. When changes in net income are higher, changes in customer satisfaction are lower and vice versa. Some units may be over-investing in customer satisfaction initiatives, causing overall financial performance to decline. However, increases in customer satisfaction are not likely to pay off as immediately as increases in net income, which suggests that some units may be making investments in customer satisfaction to increase long-term financial performance, even though these investments cause short-term net income to decline. The company needs to examine whether one or both of these explanations is true. 3. The board of directors can set targets for changes in both net income and customer satisfaction. This would allow the company to take differences in the units, their competitive environments, and their customers into account when assessing performance. Target setting would also allow the company to reward managers when desirable investments in one dimension lead to short-term declines in the other. In addition, the board can improve the bonus plan by determining the relative importance of short-term changes in net income and customer satisfaction. Currently, a 1% change in either measure receives the same weight in the bonus formula, and declines have no effect on bonus payouts. However, a 1% increase in one measure may be more valuable than a 1% increase in the other, and declines in either measure may have a bigger effect on long-term value than increases. The payment formula can be modified by putting appropriate (and different) weights on each of these factors.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

23-27 (30 min.) Multinational firms, differing risk, comparison of profit, ROI, and RI. 1. Comparisons of after-tax operating income using translated values: Canada Operating revenues ($23,362,940; 6,250,000 eu × $1.50; 5,718,750 NZD × $0.60) Operating expenses ($18,520,000; 4,200,000 eu × $1.50; 4,250,000 NZD × $0.60) Operating income Income tax at 40%; 35%; 25% After-tax operating income

Germany

$23,362,940 $9,375,000 $3,431,250 18,520,000 4,842,940 1,937,176

6,300,000 3,075,000 1,076,250

2,550,000 881,250 220,313

$ 2,905,764 $1,998,750 $ 660,937

In terms of after-tax operating income, the Canadian division is doing best, with Germany second. The New Zealand division is far behind the other two in terms of operating income. 2. Comparison of ROI for each division. 1. After-tax operating income 2. Long-term assets ($24,214,700; 11,897,321 eu × $1.40; 7,343,744 NZD × $0.75) 3. ROI (Row 1 ÷ Row 2)

Canada $ 2,905,764

Germany $ 1,998,750

NZ $ 660,937

$24,214,700 12%

$16,656,250 12%

$5,507,808 12%

Because of differences in the value of assets employed in each division, they have identical returns on investment despite the differences in after-tax operating income. 3. After-tax operating income Long-term assets Cost of capital (given) Imputed cost of assets (cost of capital times long-term assets Residual income (After-tax operating income less imputed cost of assets)

Canada Germany $ 2,905,764 $ 1,998,750 $24,214,700 $16,656,250 6.5% 10%

NZ $ 660,937 $5,507,808 13%

$ 1,573,956

$ 1,665,625

$ 716,015

$ 1,331,808

333,125

(55,078)

Chapter 23: Multinational Performance Measurement and Compensation

In contrast to the same ROIs found in each division, the Canadian division is performing the best on the basis of residual income as its return substantially exceeds its cost of capital of 6.5%. Germany has a small positive residual income, while New Zealand’s residual income is negative. These differences are due to differences in the cost of capital across countries. Both Germany and New Zealand achieved the same 12% ROI, but the required rate of return in Germany was just 10%, while that in New Zealand was much higher, at 13%. 4. Comparison of ROI using pre-tax operating income: 1. Operating income (from requirement 1) 2. Long-term assets 3. ROI (Row 1 ÷ Row 2)

Canada

Germany

$ 4,842,940 $24,214,700 20.00%

$ 3,075,000 $16,656,250 18.46%

$ 881,250 $5,507,808 16.00%

The divisional ranking on the basis of pre-tax ROI is identical to that based on residual income. Note that the ROI computed using pre-tax operating income is much higher than the 12% ROI for all divisions using after-tax income. The differences arise from the different tax rates imposed on each division. The divisions should be compared on after-tax dollars because selling prices and costs in each country reflect different expectations regarding income taxes. For instance, selling prices are likely to be higher in the Canadian division, which has the highest tax rate.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

23-28 (20 min.)

Multinational performance measurement, ROI, RI.

1a. U.S. Division’s ROI in 2023 =

Operating income Operating income = = 13.75% $8,000,000 Total assets

Hence, operating income = 13.75%  $8,000,000 = $1,100,000. 1b. Norwegian Division’s ROI in 2023 (based on kroners) = 2.

7,560,000 kroners = 14% 54,000,000 kroners

Convert total assets into dollars using the December 31, 2022 exchange rate, the rate prevailing when the assets were acquired (6 kroners = $1):

54,000,000 kroners = $9,000,000 6 kroner per dollar Convert operating income into dollars at the average exchange rate prevailing during 2023 when operating income was earned (7 kroners = $1):

7,560,000 kroners = $1,080,000 7 kroners per dollar $1,080,000 Comparable ROI for Norwegian Division = = 12% $9,000,000 The Norwegian Division’s ROI based on kroners is helped by the inflation that occurred in Norway in 2023 (that caused the Norwegian kroner to weaken against the dollar from 6 kroners = $1 on 12-31-2022 to 8 kroners = $1 on 12-31-2023). Inflation boosts the division’s operating income. Because the assets were acquired at the start of the year 2023, the asset values are not increased by the inflation that occurs during the year. The net effect of inflation on ROI calculated in kroners is to use an inflated value for the numerator relative to the denominator. Adjusting for inflationary and currency differences negates the effects of any differences in inflation rates between the two countries on the calculation of ROI. After these adjustments, the U.S. Division earned a higher ROI (13.75%) than the Norwegian Division (12%). 3.

U.S. Division’s RI in 2023 = $1,100,000  (13%  $8,000,000) = $1,100,000  $1,040,000 = $60,000 Norwegian Division’s RI in 2023 (in U.S. dollars) is calculated as: $1,080,000  (13%  $9,000,000) = $1,080,000  $1,170,000 = $(90,000). The U.S. Division’s RI also exceeds the Norwegian Division’s RI in 2023 by $150,000.

Chapter 23: Multinational Performance Measurement and Compensation

PROBLEMS 23-29 (30–40 min.) ROI, RI, DuPont method, investment decisions, balanced scorecard. 1. 2022 Print Internet

ROI = Revenue Operating Income Operating Income × = Total Assets Revenues Total Assets  0.939 ($19,320 $20,580) 0.239 ($4,620 ÷ $19,320) 0.224 ($4,620  $20,580) 2.133 ($26,880  $12,600) 0.025 ($ 672 ÷ $26,880) 0.053 ($ 672  $12,600)

The Print Division has a relatively high ROI because of its high income margin relative to Internet. The Internet Division has a low ROI despite a high investment turnover because of its very low income margin. 2. Although the proposed investment is small, relative to the total assets invested, it earns less than the 2022 return on investment (0.224) (All dollar numbers in millions): 2022 ROI (before proposal) =

$4,620 $20,580

= 0.224

Investment proposal ROI

$120 $800

= 0.150

2022 ROI (with proposal)

$4,620  $120 = 0.222 $20,580  $800

Given the existing bonus plan, any proposal that reduces the ROI is unattractive. 3a. Residual income for 2022 (before proposal, in millions): Operating Income

Imputed Interest Charge

Division Residual Income

Print $4,620 – $3,087 (0.15 × $20,580) = $1,533 Internet 672 – 1,890 (0.15 × $12,600) = (1,218) 3b. Residual income for proposal (in millions): Operating Income $120

–

Imputed Interest Charge

Residual Income

$120 (0.15 × $800) =

Investing in the fast-speed printing press will have no effect on the Print Division’s residual income. As a result, if Mays is evaluated using a residual income measure, Mays would be indifferent to adopting the printing press proposal.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

4. As discussed in requirement 3b, Turner could consider using RI. The use of RI motivates managers to accept any project that makes a positive contribution to net income after the cost of the invested capital is taken into account. Making such investments will have a positive effect on Green News Group’s customers. Turner may also want to consider nonfinancial measures such as newspaper subscription levels, internet audience size, repeat purchase patterns, and market share. These measures will require managers to invest in areas that have favourable long-run effects on Green News Group’s customers.

23-30 (20–30 min.) Division manager’s compensation (continuation of 23-29). 1

Consider each of the three proposals that Turner is considering: a. Compensate managers on the basis of division RI. The benefit of this arrangement is that managers would be motivated to put in extra effort to increase RI because managers’ rewards would increase with increases in RI. But compensating managers largely on the basis of RI subjects the managers to excessive risk, because each division’s RI depends not only on the manager’s effort but also on random factors over which the manager has no control. A manager may put in a great deal of effort, but the division’s RI may be low because of adverse factors (high interest, recession) that the manager cannot control. To compensate managers for taking on uncontrollable risk, Turner must pay them additional amounts within the structure of the RI-based arrangement. Thus, using mainly performance-based incentives will cost Turner more money, on average, than paying a flat salary. The key question is whether the benefits of motivating additional effort justify the higher costs of performance-based rewards. The motivation for having some salary and some performance-based bonus in compensation arrangements is to balance the benefits of incentives against the extra costs of imposing uncontrollable risk on the manager. Finally, rewarding a manager only on the basis of division RI will induce managers to maximize the division’s RI even if taking such actions are not in the best interests of the company as a whole. b. Compensate managers on the basis of companywide RI. Rewarding managers on the basis of companywide RI will motivate managers to take actions that are in the best interests of the company rather than actions that maximize a division’s RI. A negative feature of this arrangement is that each division manager’s compensation will now depend not only on the performance of that division manager but also on the performance of the other division managers. For example, the compensation of Mays, the manager of the Print Division, will depend on how well the manager of Internet performs, even though Mays himself may have little influence over the performance of these divisions. Therefore, compensating managers on the basis of companywide RI will impose extra risk on each division manager, and will raise the cost of compensating them, on average.

Chapter 23: Multinational Performance Measurement and Compensation

c. Compensate managers using the other division’s RI as a benchmark. The benefit of benchmarking or relative performance evaluation is to cancel out the effects of common noncontrollable factors that affect a performance measure. Taking out the effects of these factors provides better information about a manager’s performance. What is critical, however, for benchmarking and relative performance evaluation to be effective is that similar noncontrollable factors affect each division. It is not clear that the same noncontrollable factors that affect the performance of the Print Division (cost of newsprint paper, for example) also affect the performance of the Internet division. If the noncontrollable factors are not the same, then comparing the RI of one division to the RI of the other division will not provide useful information for relative performance evaluation. A second factor for Turner to consider is the impact that benchmarking and relative performance evaluation will have on the incentives for the division managers of the Print and Internet Divisions to cooperate with one another. Benchmarking one division against another means that a division manager will look good by improving his or her own performance, or by making the performance of the other division manager look bad. 2. Using measures like RI and ROI—diagnostic levers of control—can cause managers to cut corners and take other actions that boost short-run performance but harm the company in the long run. Turner can guard against such problems by introducing and upholding strong boundary and belief systems of control within the company. Strict codes of conduct should govern what employees cannot do. Turner should also foster a culture where employees have a deep belief in the value of the company’s journalistic mission. 3. Another potential problem of an excessive focus on diagnostic measures is a myopic disregard for emerging threats and opportunities. Interactive control systems, based on debate and discussion and regular review of strategic uncertainties and the competitive landscape can help overcome this problem. Turner should not only ask for regular reports on ROI, RI, etc., he should meet regularly with division managers, discuss 5- and 10-year strategic plans, and obtain their field-based inputs. Such regular dialogues will help surface emerging threats and opportunities, and the action plans that need to be taken in response.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

23-31 (20 min.) Residual income and EVA; timing issues. 1. RI = Operating income – (WACC × Assets) = $690,000 – (0.05 × $5,900,000) = $690,000 – $295,000 = $395,000 2. EVA = Adjusted operating income – (WACC × (Total assets – Current liabilities)) Operating income is adjusted as follows: Operating income Add back this period’s advertising expense Less amortized advertising (1/4 of year’s expense) Adjusted operating income

$ 690,000 120,000 (30,000) $ 780,000

Assets are adjusted as follows: Total assets Plus capitalized, unamortized advertising Adjusted total assets

$5,900,000 90,000 $5,990,000

EVA = $780,000 – (0.05 × ($5,990,000 − $750,000)) = $780,000 − $262,000 = $518,000 3. The differences between the RI and EVA results are due to two factors in this problem: the definition of capital and the treatment of advertising. EVA subtracts current liabilities from total assets when computing capital. Because some types of current liabilities represent sources of “free” short-term funds (e.g., holding off payments to suppliers), they reduce the assets needed to produce income. If short-term liabilities represent a source of funds, EVA more accurately reflects the assets that the company employed to achieve its operating income. Under traditional accounting rules, advertising is a period expense, and the costs and benefits of advertising are not matched if advertising affects revenues over multiple years. Consequently, EVA does a better job matching revenues and costs when the effects of advertising persist over multiple periods and solves the goal incongruence problem that sometimes arises with the RI measures.

Chapter 23: Multinational Performance Measurement and Compensation

23-32 (40–50 min.) ROI performance measures based on historical cost and current cost. 1. ROI using historical cost measures: Passion Fruit Kiwi Fruit Mango Fruit

$ 480,000 ÷ $ 965,000 = 49.74% $ 575,000 ÷ $2,175,000 = 26.44% $1,210,000 ÷ $3,890,000 = 31.11%

The Passion Fruit Division appears to be considerably more efficient than the Kiwi Fruit and Mango Fruit Divisions. 2. The gross book values (i.e., the original costs of the plants) under historical cost are calculated as the useful life of each plant (12 years)  the annual depreciation: Passion Fruit Kiwi Fruit Mango Fruit

12  $270,000 = $3,240,000 12  $175,000 = $2,100,000 12  $290,000 = $3,480,000

Step 1: Restate long-term assets from gross book value at historical cost to gross book value at current cost as of the end of 2023: (Gross book value of long-term assets at historical cost)  (Construction cost index in 2023 ÷ Construction cost index in year of construction). Passion Fruit Kiwi Fruit Mango Fruit

$3,240,000  (200 ÷ 100) = $6,480,000 $2,100,000  (200 ÷ 120) = $3,500,000 $3,480,000  (200 ÷ 185) = $3,762,162

Step 2: Derive net book value of long-term assets at current cost as of the end of 2023. (Estimated useful life of each plant is 12 years.) (Gross book value of long-term assets at current cost at the end of 2023)  (Estimated remaining useful life ÷ Estimated total useful life) Passion Fruit Kiwi Fruit Mango Fruit

$6,480,000  ( 2 ÷ 12) = $1,080,000 $3,500,000  ( 9 ÷ 12) = $2,625,000 $3,762,162  (11 ÷ 12) = $3,448,649

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Step 3: Compute current cost of total assets at the end of 2023. (Assume current assets of each plant are expressed in 2023 dollars.) (Net book value of long-term assets at current cost at the end of 2023 [Step 2]) + (Current assets at the end of 2023 [given]) Passion Fruit Kiwi Fruit Mango Fruit

$1,080,000 + $425,000 = $1,505,000 $2,625,000 + $600,000 = $3,225,000 $3,448,649 + $700,000 = $4,148,649

Step 4: Compute current-cost depreciation expense in 2023 dollars. Gross book value of long-term assets at current cost at the end of 2023 (from Step 1) ÷ 12 Passion Fruit Kiwi Fruit Mango Fruit

$6,480,000 ÷ 12 = $540,000 $3,500,000 ÷ 12 = $291,667 $3,762,162 ÷ 12 = $313,514

Step 5: Compute 2023 operating income using 2023 current-cost depreciation expense. (Historical-cost operating income – [Current-cost depreciation expense in 2023 dollars (Step 4) – Historical-cost depreciation expense]) Passion Fruit Kiwi Fruit Mango Fruit

$ 480,000 – ($540,000 – $270,000) = $ 210,000 $ 575,000 – ($291,667 – $175,000) = $ 458,333 $1,210,000 – ($313,514 – $290,000) = $1,186,486

Step 6: Compute ROI using current-cost estimates for long-term assets and depreciation expense (Step 5 ÷ Step 3). Passion Fruit Kiwi Fruit Mango Fruit

Passion Fruit Kiwi Fruit Mango Fruit

$ 210,000 ÷ $1,505,000 = 13.95% $ 458,333 ÷ $3,225,000 = 14.21% $1,186,486 ÷ $4,148,649 = 28.60% ROI: Historical Cost 49.74% 26.44 31.11

ROI: Current Cost 13.95% 14.21 28.60

Use of current cost results in the Mango Fruit Division appearing to be the most efficient. The Passion Fruit ROI is reduced substantially when the 10-year-old plant is restated for the doubling of construction costs during the ten year period. 3. Use of current costs increases the comparability of ROI measures across divisions’ operating plants built at different construction cost price levels. Use of current cost also will increase the willingness of managers, evaluated on the basis of ROI, to move between divisions with assets purchased many years ago and divisions with assets purchased in recent years.

Chapter 23: Multinational Performance Measurement and Compensation

23-33 (40–50 min.) Evaluate accrual measures. 1. ROI using historical cost measures: Calistoga

$156, 000 $408, 000

38.24%

Alpine Springs

$264, 000 $1, 380, 000

19.13%

Rocky Mountains

$456, 000 $1, 944, 000

23.46%

The Calistoga Division appears to be considerably more efficient than the Alpine Springs and Rocky Mountain Divisions. 2. The gross book values (i.e., the original costs of the plants) under historical cost are calculated as the useful life of each plant (12)  the annual depreciation: Calistoga Alpine Springs Rocky Mountains

: 12  $ 84,000 = $1,008,000 : 12  $120,000 = $1,440,000 : 12  $144,000 = $1,728,000

Step 1: Restate long-term assets from gross book value at historical cost to gross book value at current cost as of the end of 2022. Calistoga: Alpine Springs: Rocky Mountain:

$1,008,000  (150 ÷ 100) = $1,512,000 $1,440,000  (150 ÷ 135) = $1,600,000 $1,728,000  (150 ÷ 140) = $1,851,429

Step 2: Derive net book value of long-term assets at current cost as of the end of 2022. (Assume estimated useful life of each plant is 12 years.) Calistoga: Alpine Springs: Rocky Mountains:

$1,512,000  (2 ÷ 12) = $ 252,000 $1,600,000  (9 ÷ 12) = $1,200,000 $1,851,429  (11 ÷ 12) = $1,697,143

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

Step 3: Compute current cost of total assets at the end of 2022. (Assume current assets of each plant are expressed in 2022 dollars.) Calistoga: Alpine Springs: Rocky Mountains:

$240,000 + $ 252,000 = $ 492,000 $300,000 + $1,200,000 = $1,500,000 $360,000 + $1,697,143 = $2,057,143

Step 4: Compute current-cost depreciation expense in 2022 dollars. Gross book value of long-term assets at current cost at the end of 2022 (from Step 1)  (1 ÷ 12) Calistoga: Alpine Springs: Rocky Mountains:

$1,512,000  (1 ÷ 12) = $126,000 $1,600,000  (1 ÷ 12) = $133,333 $1,851,429  (1 ÷ 12) = $154,286

Step 5: Compute 2022 operating income using 2022 current-cost depreciation. Calistoga: Alpine Springs: Rocky Mountains:

$156,000 – ($126,800 – $ 84,000) = $114,000 $264,000 – ($133,333 – $120,000) = $250,667 $456,000 – ($154,286 – $144,000) = $445,714

Step 6: Compute ROI using current-cost estimates for long-term assets and depreciation. Calistoga: Alpine Springs: Rocky Mountains:

$ 114,000 ÷ $ 492,000 = 23.17% $250,667 ÷ $1,500,000 = 16.71% $445,714 ÷ $2,057,143 = 21.67%

Calistoga Alpine Springs Rocky Mountains

ROI: Historical Cost 38.24% 19.13 23.46

ROI: Current Cost 23.17 % 16.71 21.67

Use of current cost results in the Rocky Mountains Division appearing to be the most efficient. The Calistoga ROI is reduced substantially when the ten-year-old plant is restated for the 70% increase in construction costs over the 2012 to 2022 period. 3. Use of current costs increases the comparability of ROI measures across divisions operating plants built at different construction cost price levels. Use of current cost also will increase the willingness of managers, evaluated on the basis of ROI, to move from divisions with assets purchased many years ago to divisions with assets purchased in recent years.

Chapter 23: Multinational Performance Measurement and Compensation

23-34 (30 min.) Financial and nonfinancial performance measures, goal congruence. 1. Operating income is a good summary measure of short-term financial performance. By itself, however, it does not indicate whether operating income in the short run was earned by taking actions that would lead to long-run competitive advantage. For example, Precision’s divisions might be able to increase short-run operating income by producing more product while ignoring quality or rework. Mendez, however, would like to see division managers increase operating income without sacrificing quality. The new performance measures take a balanced scorecard approach by evaluating and rewarding managers on the basis of direct measures (such as rework costs, on-time delivery performance, and sales returns). This motivates managers to take actions that Mendez believes will increase operating income now and in the future. The nonoperating income measures serve as surrogate measures of future profitability. 2. The semiannual installments and total bonus for the Central Division are calculated as follows: Central Division Bonus Calculation For Year Ended December 31, 2022 January 1, 2022 to June 30, 2022 Profitability (0.02  $346,500) Rework (0.02  $346,500) – $8,625 On-time delivery No bonus—under 96% Sales returns [(0.015  $3,150,000) – $63,000]  50% Semiannual installment Semiannual bonus awarded

July 1, 2022 to December 31, 2022 Profitability (0.02  $330,000) Rework (0.02  $330,000) – $8,250 On-time delivery 96% to 98% Sales returns [(0.015  $3,300,000) – $52,500]  50% Semiannual installment Semiannual bonus awarded Total bonus awarded for the year

6,930 (1,695)

(7,875) $ (2,640) $ 0

$ 6,600 (1,650) 1,500 (1,500) $ 4,950 $ 4,950 $ 4,950

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

The semiannual installments and total bonus for the Western Division are calculated as follows: Western Division Bonus Calculation For Year Ended December 31, 2022 January 1, 2022 to June 30, 2022 Profitability (0.02  $256,500) Rework (0.02  $256,500) – $4,500 On-time delivery Over 98% Sales returns [(0.015  $2,137,500) – $33,560]  50% Semiannual bonus installment Semiannual bonus awarded July 1, 2022 to December 31, 2022 (0.02  $304,500) (0.02  $304,500) – $6,000 No bonus—under 96% [(0.015  $2,175,000) – $31,875] which is greater than zero, yielding a bonus Semiannual bonus installment Semiannual bonus awarded Total bonus awarded for the year Profitability Rework On-time delivery Sales returns

$5,130 0a 4,000 (749) $8,381 $8,381 $ 6,090 0a 0 2,500b $ 8,590 $ 8,590 $16,971

aThe amount is zero because there is no adjustment if rework costs

are less than or equal to 2% of operating income. bThe amount is $2,500 because sales returns are less than or equal to 1.5% of sales’. 3. The manager of the Central Division is likely to be frustrated by the new plan, as the division bonus has fallen by more than $15,000 compared to the bonus of the previous year. However, the new performance measures have begun to have the desired effect––both on-time deliveries and sales returns improved in the second half of the year, while rework costs were also moderately lower. If the division continues to improve at the same rate, the bonus could approximate or exceed what it was under the old plan. The manager of the Western Division should be at least as satisfied with the new plan as with the old plan, as the bonus is higher. Sales returns decreased slightly, to under the 1.5% benchmark. However, on-time deliveries declined considerably in the second half of the year and rework costs increased. Unless the manager institutes better controls, the bonus situation may not be as favourable in the future. This could motivate the manager to improve in the future, but currently at least, the manager has been able to maintain his bonus without showing improvement in all of the areas targeted by Mendez. Pedro Mendez’s revised bonus plan for the Central Division fostered the following improvements in the second half of the year despite an increase in sales:  An increase of 1.9 percentage points in on-time deliveries  A $375 reduction in rework costs  A $10,500 reduction in sales returns Copyright © 2022 Pearson Canada Inc. 23-28

Chapter 23: Multinational Performance Measurement and Compensation

However, operating income as a percent of sales has decreased (11% to 10%). The Western Division’s bonus has remained approximately the same as a result of the following effects:    

An increase of 2.0 percentage points in operating income as a percent of sales (12% to 14%). A decrease of 3.6 percentage points in on-time deliveries. A $1,500 increase in rework costs. A $1,685 decrease in sales returns.

This would suggest that revisions to the bonus plan are needed. Possible changes include the following:    

Increase the weights put on on-time deliveries, rework costs, and sales returns in the performance measures while decreasing the weight put on operating income. Create a reward structure for rework costs that are below 2% of operating income that would encourage managers to drive costs lower. Review the whole year in total. The bonus plan should carry forward the negative amounts for one six-month period into the next six-month period incorporating the entire year when calculating a bonus; and Develop benchmarks and then give rewards for improvements over prior periods and encouraging continuous improvement.

23-35 (40–50 min.) ROI, measurement alternatives for performance measures. 1. ROI = Operating income ÷ Net book value of total assets St. Louis ROI = $1,446,000 ÷ ($9,000,000 – $6,600,000 + 1,999,600) = $1,446,000 ÷ $4,399,600 = 32.87% Memphis ROI = $1,008,000 ÷ ($7,500,000 – $3,500,000 + 1,536,400) = $1,008,000 ÷ $5,536,400 = 18.21% New Orleans ROI = $932,000 ÷ ($8,100,000 – $2,160,000 + 1,649,200) = $932,000 ÷ $7,589,200 = 12.28%

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Step 1:

St. Louis Memphis New Orleans

Gross book value of long-term assets at historical cost $9,000,000 $7,500,000 $8,100,000

Construction cost index in 2022

× × ×

(122 (122 (122

Construction cost index in year of construction

Gross book value of long-term assets at current cost at end of 2022

÷ ÷ ÷

100) 110) 118)

= = =

$10,980,000 $ 8,318,182 $ 8,374,576

Net book value of long-term assets at current cost at end of 2022

= = =

$2,928,000 $4,436,364 $6,141,356

Step 2: Gross book value of long-term assets at historical cost St. Louis Memphis New Orleans

$10,980,000 $ 8,318,182 $ 8,374,576

Estimated remaining useful life

× × ×

( 4 ( 8 (11

÷ ÷ ÷

Long-term assets (from Step 2, above)

+ + +

$2,928,000 $4,436,364 $6,141,356

= = =

Estimated useful life 15) 15) 15)

Step 3: Current assets at end of 2022 St. Louis Memphis New Orleans

$1,999,600 $1,536,400 $1,649,200

Current cost of total assets at end of 2022 $4,927,600 $5,972,764 $7,790,556

Step 4:

St. Louis Memphis New Orleans

Gross book value of long-term assets at current cost at end of 2022

$10,980,000 $ 8,318,182 $ 8,374,576

÷ ÷ ÷

Estimated total useful life

15 15 15

= = =

Current-cost depreciation expense in 2022 dollars $732,000 $554,545 $558,305

Step 5: Historical-cost operating income St. Louis Memphis New Orleans

$1,446,000 $1,008,000 $ 932,000

–

Current-cost depreciation expense in 2022 dollars

– – –

($732,000 ($554,545 ($558,305

–

Historicalcost depreciation expense

Operating income for 2022 using current-cost depreciation expense in 2022 dollars

– – –

$600,000) $500,000) $540,000)

= = =

$1,314,000 $ 953,454 $ 913,695

Chapter 23: Multinational Performance Measurement and Compensation

Step 6:

St. Louis Memphis New Orleans

Operating income for 2022 using current-cost depreciation expense in 2022 dollars

Current cost of total assets at end of 2022

$1,314,000 $953,454 $913,695

÷ ÷ ÷

$4,927,600 $5,972,764 $7,790,556

= = =

ROI using current-cost estimate 26.67% 15.96% 11.73%

3. Adjusting assets to recognize current costs negates differences in the investment base caused solely by differences in construction-price levels. Compared with historical-cost ROI, current cost ROI better measures the current economic returns from the investment. Because the St. Louis assets are older, there is a more significant difference between historical cost and current cost.

23-36 (25 min.) Historical-cost and current-cost ROI measures. 1. Major Mackenzie and Keele

Jane and Rutherford ROI 

ROI 

Operating Income

28, 000

Historical cost of investment

50, 000

Operating Income

28, 000

Current cost of investment

120, 000

= 56%

= 23.33%

33, 000 100, 000 33, 000 135, 000

Weston and Langstaff = 33%

= 24.44%

15, 000 30, 000 15, 000 80, 000

2. Using investments at historical cost as the denominator, the location of Jane and Rutherford has the highest ROI and the location of Major Mackenzie and Keele the lowest. Using investment at current cost as the denominator, Major Mackenzie and Keele has the highest ROI and Weston and Langstaff the lowest. The choice of an appropriate measure depends on how Corners Ltd. judges the performance of its convenience stores. If Corners uses a single benchmark (say, 20%) in judging the performance of each store, the current cost measure will promote comparability among stores that were bought at different times or in areas with different real estate markets. Historical cost will give rise to differences in ROI among convenience stores that are unrelated to differences in operating efficiency. For example, in times of rising prices, the oldest store (Jane and Rutherford) will have a lower historical cost investment level than the newest store (Major Mackenzie and Keele) for comparable amounts of square metres of store space in comparable locations. The current cost differences of the investment in the Jane and Rutherford store and Major Mackenzie and Keele store, for example, are much smaller than the differences in historical costs, due largely to the different time periods in which the two stores were built. A drawback of current cost is that current cost estimates are difficult to obtain. Copyright © 2022 Pearson Canada Inc. 23-31

= 50%

= 18.75%

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

If Corners Ltd. tailors the performance benchmark for each convenience store in its budgeting process, then the choice of a specific investment measure is less contentious. For example, if historical cost is used, the budgeted ROI benchmark for the Major Mackenzie and Keele store could be, say, 30%, whereas the budgeted ROI benchmark for the other two stores could be, say, 50%. Another benefit of tailoring the budget to each manager is that more incentives are provided to managers who are put in charge of poorly performing stores or stores in highly competitive markets.

23-37 (25 min.) ROI, RI, decision making. 1. Annual income = 300,000 × ($80 – $48) – $4,000,000 = $5,600,000 Capital charge = 20% × $16,000,000 = $3,200,000 Residual income = $5,600,000 - $3,200,000 = $2,400,000 2. Additional income = 100,000 × ($60 – $48) - $850,000 = $350,000 Additional capital charge = 20% × $2,000,000 = $400,000 Additional residual income = $350,000 – $400,000 = ($50,000) Munger’s residual income would decrease by $50,000 if the order were accepted. 3. If Munger accepts the order, its performance measures would look as follows: Annual income = 300,000 × ($80 – $44 – $5.25) – $3,800,000 = $5,425,000 Capital charge = 20% × $15,240,000 = $3,048,000 Residual income = $5,425,000 – $3,048,000 = $2,377,000 Relative to the status quo residual income of $2,400,000 (see requirement 1), accepting this offer lowers Munger’s residual income by $23,000. Munger will therefore decide to make the component in-house rather than buy it externally. 4. The minimum selling price, p, is one at which Munger is indifferent to taking on the deal, in the sense that it yields $0 in residual income. The residual income from the deal is given by $0 = 15,000 × (p – $54) – (20% × $1,500,000) $0 = 15,000p – $810,000 – $300,000 $1,110,000 = 15,000p p = $74 Setting this to equal zero reveals that the minimum selling price is p = $74.

Chapter 23: Multinational Performance Measurement and Compensation

5a. At a price of $82, the residual income from the special tempered steel drills is 15,000 × ($82 – $54) – (20% × $1,500,000) = $120,000 The loss in residual income from the lost sales of 6,000 original cordless drills is 6,000 × ($80 – $48) = $192,000. Overall, Munger’s residual income is reduced by $72,000 ($192,000 – $120,000) as a result of the transaction related to the special tempered steel drills. 5b. For each original drill that Munger does not sell, it loses a residual income (or, equivalently, contribution margin) of $32 per unit ($80 – $48). From requirement 5a, the residual income from the new tempered steel drills is $120,000. Therefore, the drop in unit sales of the regular drill that would leave Munger indifferent to the offer is

$120, 000  3,750 regular drills. $32

23-38 (15 min.) Ethics, levers of control. 1. If Stuart Brown “turns a blind eye” toward what he has just observed at the Dallas distribution centre, he will be violating the competence, integrity, and objectivity standards for management accountants. Competence  Perform professional duties in accordance with technical standards. Integrity 

Abstain from engaging in or supporting any activity that would discredit the profession.

Credibility  

Communicate information fairly and objectively. Disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, analyses, or recommendations.

Brown should: a. Follow established company policies to bring the issue to the attention of Best management through regular channels; then, if necessary, b. Discuss the problem with the immediate superior who is not involved in the overstatement of material yield. c. Clarify relevant ethical issues with an objective advisor, preferably a professional person outside Best. d. If all the above channels fail to lead to a correction in the organization, he may have to resign and become a “whistle-blower” to bring Best to justice. Copyright © 2022 Pearson Canada Inc. 23-33

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

2. Best is clearly emphasizing profit, driving managers to find ways to keep profits strong and increasing. This is a diagnostic measure, and over-emphasis on diagnostic measures can cause employees to do whatever is necessary—including unethical actions—to keep the measures in the acceptable range, not attract negative senior management attention and possibly improve compensation and job reviews. To avoid problems like this in the future, Best needs to establish some strong boundary systems and codes of conduct. There should be a clear message from upper management that unethical behaviour will not be tolerated. Best management needs to pay close attention to inspecting inventory for quality when the year-end inventory count is conducted. They should also investigate unusual changes, such as the increase in the Dallas centre yield. Best needs to articulate a belief system of core values. The goal is to inspire managers and employees to do their best, exercise greater responsibility, take pride in their work, and do things the right away.

23-39 (45 minutes)

RI, EVA, measurement alternatives, goal congruence.

1. Spa Key West Phoenix Carmel

Operating Income $1,220,000 1,190,000 1,295,000

– – – –

Required Rate of Return (11% (11% (11%

× Investment × 6,155,000) × 6,312,000) × 7,435,000)

Residual Income = $542,950 = 495,680 = 477,150

The residual income from the new saunas would be: $22,000 operating income – ($225,000 investment ×11% required rate) = ($2,750) Because the RI of the project is negative, the rate of return on the project is less than the required rate of 11%, and the Key West manager would reject the project. Other managers would also reject the project because they all face a required rate of return of 11%. 2. Refresh Resorts may want to use EVA instead of RI because EVA explicitly takes into consideration both the weighted-average cost of capital and the effect of income taxes. EVA also uses long-term assets and working capital in its calculation as opposed to the use of total assets in the RI calculation. When performance is evaluated using EVA, managers must either earn more after-tax operating income with the same capital, use less capital to earn the same after-tax operating income, or invest capital in high-return projects. EVA is considered a stricter standard by which to gauge performance. 3. WACC =

8%  (1 35%)  $15,300,000  (14%  $7,650,000) $1,866,600   8.13% $15,300,000  $7,650,000 $22,950,000

Chapter 23: Multinational Performance Measurement and Compensation

4. EVA = After-tax operating income – [WACC × (Total assets – current liabilities)] Using net book value of assets: Key West EVA = ($1,220,000 × 65%) – [8.13% × ($6,155,000 – $330,000)] = $793,000 – $ 473,573 = $ 319,427 Phoenix EVA

= ($1,190,000 × 65%) – [8.13% × ($6,312,000 – $265,000)] = $773,500 – $ 491,621 = $281,879

Carmel EVA

= ($1,295,000 × 65%) – [8.13% × ($7,435,000 – $84,000)] = $841,750 – $597,636 = $244,114

Using gross book value of assets: Key West EVA = ($1,220,000 × 65%) – [8.13% × ($8,355,000a – $330,000)] = $793,000 – $652,432 = $140,568 Phoenix EVA

= ($1,190,000 × 65%) – [8.13% × ($7,822,000a – $265,000)] = $773,500 – $614,384 = $159,116

Carmel EVA

= ($1,295,000 × 65%) – [8.13% × ($7,655,000a – $84,000)] = $841,750 – $615,522 = $226,228

aTotal assets + Accumulated depreciation

Using net book value of assets, Key West, the oldest spa, shows the highest EVA, and Carmel shows the lowest. This is understandable, as the Key West assets have been more fully depreciated. This technique, however, can lead management to make false assumptions about the earning power of the Key West spa. Using the gross book value method, Carmel shows the highest EVA, while Key West shows the lowest. This method unmasks the decline in earning power of older spa assets. 5. If Refresh Resorts chooses to use gross book value of assets in its EVA calculation, it may achieve greater goal congruence, as spa managers will be less reluctant otherwise to invest in newer assets that will produce higher future revenue. If a company measures assets using net book value, a manager will reject replacing older, fully depreciated, less profitable assets with newer ones because the initial effect will be lower EVA, even though the replacement may have positive long-term effects for the company.

Instructor’s Solutions Manual for Cost Accounting, Ninth Canadian Edition

COLLABORATIVE LEARNING CASES 23-40 (30 min.) ROI, RI, division manager’s compensation, nonfinancial measures. Operating Income = $3,000,000 / $20,000,000 = 15% Sales Operating Income ROI = = $3,000,000 / $15,000,000 = 20% Total Assets

1. ROS =



2. a. ROI = 22% =

Operating Income = X / $15,000,000 Total Assets

 Hence operating income = 22%  15,000,000 = $3,300,000 Operating income = Revenue – Costs, therefore: Costs = $20,000,000 – $3,300,000 = $16,700,000  Currently, Costs = $20,000,000 – $3,000,000 = $17,000,000 Costs need to be reduced by $300,000 ($17,000,000 – $16,700,000) b. ROI = 22% =

Operating Income = $3,000,000 / X Total Assets

Hence X = $3,000,000 ÷ 22% = $13,636,364 Mandarin would need to decrease total assets in 2023 by $1,363,636 ($15,000,000 – $13,636,364).  3. RI = Income – (Required rate of return  Investment) = $3,000,000 – (0.18  $15,000,000) = $300,000 4. Mandarin wants RI to increase by 30%  $300,000 = $90,000. That is, Mandarin wants RI in 2023 to be $300,000 + $90,000 = $390,000. If Mandarin cuts costs by $30,000 its operating income will increase to $3,000,000 + $30,000 = $3,030,000. RI = $390,000 = $3,030,000 – (0.18  Assets) $2,640,000 = 0.18  Assets Assets = $2,640,000 ÷ 0.18 = $14,666,667 Mandarin would need to decrease total assets by $333,333 (= $15,000,000 – $14,666,667). 5. Key Products could use ROS to some degree. That way there is less focus on cutting costs and reduction in assets and more emphasis on actual revenues and how they translate into operating income. Key Products may also want to consider nonfinancial measures such as customer satisfaction and market share, quality, yield, and on-time performance as well as monitor employee satisfaction and the development of employee skills.

Chapter 23: Multinational Performance Measurement and Compensation

23-41 (40–50 min.) ROI, RI, division manager’s compensation, nonfinancial measures (CGA adapted). The first issue is: Was focusing on quality the right decision for GA? Evidence from both sales and the quality-cost report support the decision taken by management to focus on quality. External failure costs dropped from 8.2% of sales in 2020 to 1.15% of sales in 2022. Given that external failures are those captured by the customer, this percentage has a direct effect on product reputation. That sales had stopped plummeting and remained relatively stable for two years would indicate that the emphasis on quality to the customer was paying off. Still, product reputation is a valuable but fragile commodity. Given the level of competition, the question of whether GA responded in time remains to be answered. The second issue is to evaluate the compensation system and the transfer pricing policy. Why do all three divisions have to be profit centres? It seems that electronic circuits can be a cost centre and transfer at standard full cost might be the ideal. Why use RI with the required rate of return as the lowest ROI? It seems that electronic circuits is in a different business with a different margin ratio than the other 2 divisions. Why is the performance in quality being compared if electronic circuits cannot have ‘external failures’ according to company’s policies?

2022

Electronic circuits 20% 500,000 – 250,000 $50,000

Coffee makers 10% 0 $0

ROI RI 50% of bonus pool: financial performance Quality effort (level of Minimum Maximum appraisal and prevention) Quality costs as % of sales Low Very high 50% of bonus pool: quality 5% – 0% = 5% of net 2% –1.2% = 0.8% performance profit of net profit Quality performance bonus 5% of net profit = 0.8% of net profit $25,000 = $5,600 Total bonus $75,000 $5,600

Battery-powered small tools 11% 660,000 – 600,000 $12,000 Maximum Very high 3.2% – 2.4% = 0.8% of net profit 0.8% of net profit = $5,280 $17,280