Managerial Accounting The Cornerstone of Business Decision Making 8th Ed Mowen

Managerial Accounting The Cornerstone of Business Decision Making, 8e Maryanne Mowen, Don Hansen, Dan Heitger (Solutions Manual, All Chapters. 100% Original Verified, A+ Grade) All Chapters Download Link At The End of This File.

INTRODUCTION TO MANAGERIAL ACCOUNTING DISCUSSION QUESTIONS

1. Managerial accounting provides accounting information for internal users in a firm. Specifically, managerial accounting identifies, collects, measures, classifies, and reports financial and nonfinancial information that is useful to internal users in planning, controlling, and decision making. Managerial accounting also has no mandatory rules, emphasizes the future, and is multidisciplinary. 2. The three broad objectives of managerial accounting are to provide information for planning, controlling, and decision making. 3. The users of managerial accounting information are generally managers and other employees of a firm. Managerial accounting information is typically not provided to outsiders but may be in selected cases. For example, a bank may require budgeting information for the next few years before agreeing to grant a loan. 4. A managerial accounting system typically provides both financial and nonfinancial information. For example, financial information on cost of production is tracked. Other information, such as the number of warranty returns, may also be tracked by the management information system. 5. Controlling involves comparing the expected performance with the actual performance to see what differences, if any, exist. 6. Planning occurs first. Planning requires setting objectives and identifying the means of achieving those objectives. Then, the results of the plan are compared with the plan, which is called controlling. Clearly, it is also feedback, in that any impediments or unexpected occurrences are noted. This feedback is then used to develop the plan for the next period. 7. Managerial accounting is internally focused, does not follow mandatory rules, keeps track of both financial and nonfinancial information, emphasizes the future, and relies on a broad range of disciplines. Financial accounting, on the other hand, is externally focused, follows externally imposed rules (such as GAAP), has a historical orientation, and provides information about the company as a whole. 8. Managerial accountants have had to broaden their focus beyond simple financial reporting to include the gathering of information on all types of costs and of the value of the product or service to customers. These broader costs are used in planning and decision making. 9. Customer value is the difference between what a customer receives and what the customer gives up when buying a product or service. The focus on customer value forces management accounting to look at many types of costs, not simply manufacturing cost. These may include the price of the good or service, maintenance costs, search costs, learning costs, and disposal costs. 10.

The value chain is the set of activities required to design, develop, produce, market, and deliver products and services to customers. It is important because it helps the company to understand its role in serving customers and to develop strategic competence.

11.

Today’s managerial accountant must understand many functions of the business, from manufacturing to marketing to distribution to customer service, in order to provide appropriate information for managing the value chain. Increased international trade means the managerial accountant must be familiar with not only business practices and laws in his or her own country but also in the countries with which the company trades.

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12.

Enterprise risk management (ERM) refers to the formal process of identifying the factors or threats, both internal and external to the organization, that might prevent the organization from achieving its strategic objectives. The managerial accountant plays an increasingly important role in ERM by providing financial and nonfinancial measures of these threats and communicating them to high-level executives (e.g., chief risk officer, chief financial officer, board of directors) in the organization who manage these factors.

13.

Line positions are those that have direct responsibility for the basic objectives of an organization. These typically include producing and selling a product. Staff positions are supportive in nature (e.g., human resources, maintenance) and have only indirect responsibility for an organization’s basic objectives.

14.

Yes, the controller should be a member of top management. This is because the controller, as the chief accountant for the firm, has a wealth of information needed by top management in determining the strategic direction of the firm.

15.

Ethical behavior involves choosing actions that are right, proper, and just. Yes, it is possible to teach aspects of ethical behavior in a managerial accounting classroom. Students need to see examples of right and wrong behavior in business. These examples help them to recognize ethical dilemmas later on the job.

16.

One major theme or executive pressure common to many of the recent accounting scandals is a focus on the short term, rather than the long term. For example, WorldCom wrongly decided to increase current period net income by inappropriately decreasing current period expenses (by recording more of the expenditures as an asset that would be expensed in small amounts each period rather than all at once in the current period). Often, the high-level executives that perpetrate such financial fraud are rewarded by incentives that overweight current period net income performance relative to long-term net income performance. Another major theme common to many of the accounting and banking frauds is a lack of sufficient transparency, or clarity, in the types and timing of the information that is reported to parties outside of the organization. Some business experts also would argue that a third common theme underlying many of these scandals was the lack of sufficient oversight (i.e., watchdog mentality) by the perpetrating organization’s auditors, board of directors, or both.

17.

The three forms of certification discussed are the Certified Management Accountant, the Certified Public Accountant, and the Certified Internal Auditor. While all three are appropriate to the accountant within the company, only the CMA exam is interdisciplinary and covers the broad range of subjects faced by the managerial accountant.

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MULTIPLE-CHOICE QUESTIONS 1-1.

1-2.

1-3.

1-4.

1-5.

1-6.

1-7.

1-8.

1-9.

1-10.

1-11.

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EXERCISES E 1-12 a.

Decision making

Controlling

Planning

Decision making

Planning

Decision making

E 1-13 a.

Managerial accounting oriented

Financial accounting oriented

Managerial accounting oriented

Financial accounting oriented

Managerial accounting oriented

E 1-14 1. The total product is the product and its features (processing speed, disk drives, software packages, and so on), the service, the operating and maintenance requirements, and the delivery speed. 2. One company is emphasizing low costs, and the other is attempting to differentiate its PC by offering faster delivery and higher-quality service. 3. The Confiar’s service component and its delivery time appear to be better than Drantex’s. Thus, the realization of these features appears to outweigh the additional sacrifice (the additional operating and maintenance cost) associated with the Confiar PC. The implications for management accounting are straightforward. The management accounting information system should collect and report information about customer realization and sacrifice. Much of this information is external to the firm but clearly needed by management. 4. Better quality and shorter delivery time increase the value of what the customer receives, while lowering the price decreases the amount paid. In total, customer value has increased, and presumably, this should make the Drantex PC much more competitive. This example illustrates how quality, time, and costs are essential competitive weapons. It also illustrates how critical it is for the management accounting system to collect and report data concerning these three dimensions.

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E 1-15 Joan Dennison is staff. She is in a support role—she prepares reports and helps explain and interpret them. Her role is to help the line managers more effectively carry out their responsibilities. Steven Swasey is a line manager. He has direct responsibility for producing a garden hose. Clearly, one of the basic objectives for the existence of a manufacturing firm is to make a product. Thus, Steven has direct responsibility for a basic objective and holds a line position.

E 1-16 No, it is not ethical for Steve to demand a kickback from Dave. Dave should not agree to this unethical proposal. This brief situation actually happened to Dave, a friend of one of the authors. The author advised Dave not to accept the deal. Dave then checked with his lawyer who bluntly told him the deal was illegal. Dave did not accept. In addition to rejecting Steve’s unethical offer, Dave might consider reporting the unethical offer to relevant key stakeholders, such as Steve’s superiors in the university’s Athletic Department, university’s Office of the Provost, or president. Hopefully, university administrators would be interested in learning of one (or more) of its employees damaging the integrity of its bidding process with key business partners such as Dave’s printing shop. If Dave were a management accountant, he should consider the IMA's Statement of Ethical Professional Practice and what it says about avoiding and reporting such unethical behavior (e.g., see the first standard under Integrity and the second under Credibility).

E 1-17 A manager has a responsibility to the company as well as society. If the manager lays off the employees, he or she ignores both of these responsibilities. In effect, the manager would be pursuing self-interest at the expense of the company and the salespeople. While pursuit of self-interest is not necessarily unethical, it can be if it harms others. In this case, the manager’s action could result in lower profits for the company because sales may decrease and unnecessary training costs will be incurred when the positions are refilled the following year. Similarly, it is unjust to penalize productive employees simply to earn a bonus. The right choice is to retain the three salespeople. In ethical terms, the manager is not behaving with integrity. The reward system, in part, encouraged this behavior. Apparently, the manager is paid a bonus if profits exceed 10% of planned profits. By basing rewards on a measure such as short-run profits, the company has given the manager an incentive to manipulate earnings in the short run. One way of manipulating annual earnings is to reduce or defer discretionary expenditures. This type of behavior can be discouraged by proper matching of expenses with revenues and by expanding the performance measures to include long-run factors like market share, productivity, and personnel development. The accounting system 1-5

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can also be used to track trends (e.g., training costs over time). Moreover, managers can be required to provide extensive justification for significant changes in discretionary expenses.

E 1-18 1. By the time most students graduate from high school, they have not had much exposure to business. Therefore, they do not have full knowledge of acceptable behavior for the business environment. Students may not know that certain practices are unethical because they may not be familiar with the behavioral norms associated with these practices. Once students begin to learn business practices, they begin to see what ethical dilemmas can arise in a business context. Then they are able to apply the moral training they have had to deal with the situations. Furthermore, evidence exists that ethical reasoning can be changed for the better. Thus, instruction in ethics can be a vital part of a student’s education. 2. Sacrificing self-interest is a choice that each person must make. Others may be influenced by those individuals who behave ethically. Individuals committed to ethical behavior produce societies committed to ethical behavior. 3. While this sounds noble, many would disagree that managers are first seeking to serve others and accept personal financial rewards as a by-product of a good job. Pursuit of self-interest and personal financial well-being is not necessarily unethical. It is only when this pursuit is done at the expense of the collective good that the behavior becomes questionable. 4. It is often true that unethical firms and individuals suffer financially. In the long run, some evidence suggests that ethical behavior does pay. It is doubtful, however, that every unethical firm or individual is wiped out financially. Too many notable exceptions to this statement exist (e.g., the selling of drugs by organized crime). 5. While some unethical behavior might be highly visible, many discoveries of unethical behavior reveal that the unethical behavior spanned long time periods, often multiple years. For example, the fake account scandal at Wells Fargo was publicly announced in 2016, but had been building internally for several years. This scandal eventually revealed that over 5,000 Wells Fargo employees were fired for opening millions of customer accounts without customer knowledge or consent. The scandal cost Wells Fargo—an historic and long respected banking giant in the United States—billions of dollars in fines, regulatory fees, legal and risk management expenses, stock price valuation decreases, and reputational damage. Therefore, some evidence exists that suggests that unethical behavior is not usually highly visible and, thus, not quickly detected or, ultimately corrected.

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E 1-19 The employees should not follow the suggestion of their boss to purchase more shares in anticipation of a buyout. This is insider trading and is illegal. Insider trading is prohibited by many corporate codes of ethics. Even when it is not explicitly prohibited by the corporate code of ethics, it is still wrong and illegal.

E 1-20 Answers will vary.

E 1-21 1. Answers will vary. However, some companies discuss various environmental issues, such as rising sea levels, greenhouse gas emissions, or pollution (e.g., of water, air, soil, landfills, etc.) as having important ethical consequences to their key stakeholders (customers, employees, community members near their facilities, etc.). Other companies discuss various social issues, such as worker safety, child labor, and human rights as having important ethical consequences to their key stakeholders (employees and suppliers). Finally, yet other companies discuss various governance issues, such as company performance measures and employee compensation, as having important ethical consequences to their key stakeholders (executives and other employees) as the actions that are measured and rewarded (as part of governance’s compensation oversight) typically reflect the items of greatest interest to the company. Of course, successes (or failures) in identifying and managing the ethical consequences of any environmental, social, or governance ultimately have materially significant impacts on company shareholders. 2. Again answers will vary. However, companies are generally increasing use of data analytics (e.g., descriptive, diagnostic, predictive, or prescriptive approaches) in various ways to capture and analyze data regarding their environmental, social, or governance performance. In addition, companies often utilize various static and dynamic data visualization techniques (e.g., dashboards, charts) to communicate their ESG performance to key stakeholders within their ESG reports. Finally, Chapter 2 discusses data analytics (including Exhibit 2.2) in more detail.

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BASIC MANAGERIAL ACCOUNTING CONCEPTS DISCUSSION QUESTIONS

Cost is the amount of cash or cash equivalent sacrificed for goods and/or services that are expected to bring a current or future benefit to the organization. An expense is an expired cost; the benefit has been used up.

Accumulating costs is the way that costs are measured and recorded. Assigning costs is linking costs to some cost object. For example, a company accumulates or tracks costs by entering them into the general ledger accounts. Direct materials would be entered into the materials account; direct labor would be entered into the direct labor account. Then, these costs are assigned to units of product.

A cost object is something for which you want to know the cost. For example, a cost object may be the human resources department of a company. The costs related to that cost object might include salaries of employees of that department, telephone costs for that department, and depreciation on office equipment. Another example is a customer group of a company. Atlantic City and Las Vegas casinos routinely treat heavy gamblers to free rooms, food, and drink. The casino owners know the benefits yielded by these high rollers and need to know the costs of keeping them happy, such as the opportunity cost of lost revenue from the rooms, the cost of the food, and so on.

A direct cost is one that can be traced to the cost object, typically by physical observation. An indirect cost cannot be traced easily and accurately to the cost object. The same cost can be direct for one purpose and indirect for another. For example, the salaries paid to purchasing department employees in a factory are a direct cost to the purchasing department but an indirect cost (overhead) to units of product.

Allocation means that an indirect cost is assigned to a cost object using a reasonable and convenient method. Since no causal relationship exists, allocating indirect costs is based on convenience or some assumed linkage.

The practice of data analytics is used widely within many management accounting environments. Therefore, answers to this question will vary. Overall, a data analytics perspective helps management accountants decide what to measure and why to measure it. Management accountants then use the answers to these important questions to decide how to quantify these measures and where to assemble (i.e., existing data), collect (i.e., using an existing or new information system), or purchase (i.e., from outside the company) the necessary data. Management accountants next use the resulting data and decide which specific data analytic technique to use in their decision scenario. A sample of data analytic examples within management accounting environments includes (some of which will be specifically studied in future chapters): • sentiment analysis to discover customer loyalty patterns • regression analysis to find significant cost drivers • high-low to separate variable and fixed cost components • pivot tables • budget forecasts of product and period costs • profit and loss projections for proposed or existing product and service lines 2-1

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Furthermore, these data analytic techniques usually fall within one of four general types (as described in Exhibit 2.2): • descriptive • diagnostic • predictive • prescriptive In every situation, the management accountant should be careful to match the appropriate use of data analytics to the particular decision and business environment of interest. 7.

A product is tangible in that you can see, feel, and take it with you. Examples of products include a tube of toothpaste, a car, or an orange. A service is a task or an activity performed for a customer. For example, the dental hygienist who cleans your teeth provides a service.

Manufacturing overhead includes all product costs other than direct materials and direct labor. It is because the remaining manufacturing (product) costs are gathered into one category that overhead is often thought of as a “catchall.”

Direct materials purchases are first entered into the materials inventory. They may or may not be used during the month. Only when the materials are withdrawn from inventory for use in production are they known as “direct materials.”

10. Prime cost is the sum of direct materials and direct labor. Conversion cost is the sum of direct labor and overhead. Total product cost consists of direct materials, direct labor, and overhead. This is not equal to the sum of prime cost and conversion cost because then direct labor would be double counted. 11. A period cost is one that is expensed immediately, rather than being inventoried like a product cost. 12. Selling cost is the cost of selling and delivering products and services. Examples include free samples, advertising, sponsorship of sporting events, commissions on sales, and the depreciation on delivery trucks (such as Coca-Cola or Pepsi trucks). 13. The cost of goods manufactured is the sum of direct materials, direct labor, and overhead used in producing the units completed during the current period and transferred to finished goods inventory. 14. The cost of goods manufactured is the cost of direct materials, direct labor, and overhead for the units produced (completed) during a time period. The cost of goods sold is the cost of direct materials, direct labor, and overhead for the units sold during a time period. The number of units produced is not necessarily equal to the number of units sold during a period. For example, a company may produce 1,000 pairs of jeans in a month but sell only 900 pairs. 15. The income statement for a manufacturing firm includes the cost of goods sold, which is the sum of direct materials, direct labor, and manufacturing overhead. The income statement for a service firm contains no cost of goods sold because there is no product to purchase or to manufacture and, thus, there is no inventory account to expense as cost of goods sold. In addition, because there is no cost of goods sold on the income statement of a service firm, there is no gross margin, unlike a manufacturing firm. 16. The percentage column on the income statement gives some insight into the relative spending on the various expense categories. These percentages can then be compared with those of other firms in the same industry to see if the company’s spending appears to be in line or out of line with the experiences of others. These percentages can also be compared to prior periods of the company for variance analysis. 2-2 © 2023 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Basic Managerial Accounting Concepts

MULTIPLE-CHOICE QUESTIONS 2-1.

2-2.

2-3.

Conversion Cost per Unit = $6 + $19 = $25

2-4.

Sales = $75 × 2,000 units = $150,000 Production Cost per Unit = $15 + $6 + $19 = $40 Cost of Goods Sold = $40 × 2,000 = $80,000 Gross Margin = $150,000 – $80,000 = $70,000

2-5.

2-6.

2-7.

2-8.

2-9.

2-10.

2-11.

2-12.

2-13.

Diagnostic

2-14.

Total Prime Cost = $50,000 + $20,000 = $70,000

Prime Cost per Unit = $8.65 + $1.10 = $9.75

Prime Cost per Unit = $70,000/10,000 units = $7.00 2-15.

Total Conversion Cost = $20,000 + $130,000 = $150,000 Conversion Cost per Unit = $150,000/10,000 units = $15.00

2-16.

Cost of Goods Sold = $50,000 + $20,000 + $130,000 = $200,000 Cost of Goods Sold per Unit = $200,000/10,000 units = $20.00

2-17. b

Sales = $31 × 10,000 = $310,000 Gross Margin = $310,000 – $200,000 = $110,000 Gross Margin per Unit = $110,000/10,000 units = $11.00

2-18. c

Period Expense = $40,000 + $36,000 = $76,000

2-19. a

Operating Income = $310,000 – $200,000 – $76,000 = $34,000

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BRIEF EXERCISES: SET A BE 2-20 1. Direct materials…………………………………………………… Direct labor………………………………………………………… Manufacturing overhead………………………………………… Total product cost……………………………………………… 2.

Per-Unit Product Cost =

$120,000 500 units

$ 32,000 28,000 60,000 $120,000

= $240

Therefore, one hockey stick costs $240 to produce. BE 2-21 1. Direct materials…………………………………………………… Direct labor………………………………………………………… Total prime cost………………………………………………… 2.

Per-Unit Prime Cost =

$60,000 500 units

Direct labor………………………………………………………… Manufacturing overhead………………………………………… Total conversion cost……………………………………………

Per-Unit Conversion Cost =

$88,000 500 units

$32,000 28,000 $60,000

= $120 $28,000 60,000 $88,000

= $176

BE 2-22 Materials inventory, June 1…………………………………………………………… Purchases………………………………………………………………………………… Materials inventory, June 30…………………………………………………………… Direct materials used in production…………………………………………………

$ 48,000 132,000 (45,000) $135,000

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BE 2-23 1. Direct materials*……………………………………………………………… Direct labor……………………………………………………………………… Manufacturing overhead……………………………………………………… Total manufacturing cost for June………………………………………… Work in process, June 1………………………………………………… Work in process, June 30………………………………………………… Cost of goods manufactured…………………………………………………

$135,000 113,000 187,000 $435,000 65,000 (63,000) $437,000

* Direct Materials = $48,000 + $132,000 – $45,000 = $135,000 [This was calculated in Brief Exercise 2-22.]

Per-Unit Cost of Goods Manufactured =

$437,000 1,900 units

= $230

BE 2-24 1.

Slapshot Company Cost of Goods Sold Statement For the Month of June Cost of goods manufactured………………………………….…………… $437,000 80,000 Finished goods inventory, June 1…………………………………….…… (84,000) Finished goods inventory, June 30…………………………………….…… Cost of goods sold…………………………………………………………… $433,000

Number of units sold: Finished goods inventory, June 1…………………………………….…… Units finished during June………………………………………….……… Finished goods inventory, June 30…………………………………….…… Units sold during June……………………………………………….………

350 1,900 (370) 1,880

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BE 2-25 Slapshot Company Income Statement For the Month of June $752,000 433,000 $319,000

Sales revenue (1,880 × $400)………………………………………… Cost of goods sold ……………………………………..…………… Gross margin………………………………...…………………… Less: Selling expense: Commissions (0.10 × $752,000)…………………………… Fixed selling expense ………………….…………………… Administrative expense …………………………...…………… Operating income…………………………………..…………

$75,200 65,000

140,200 53,800 $125,000

BE 2-26 Slapshot Company Income Statement For the Month of June Sales revenue (1,880 × $400)………………………… Cost of goods sold …………………………………… Gross margin………………………………………

$752,000 433,000 $319,000

Percent* 100.0 57.6 42.4

Less: Selling expense: Variable commissions (0.10 × $752,000)…… $75,200 65,000 Fixed selling expense………………………… Administrative expense…………………………… Operating income……………………………...

140,200 53,800 $125,000

18.6 7.2 16.6

* Steps in calculating the percentages (the percentages are rounded): 1. Sales Revenue Percent = $752,000/$752,000 = 1.00, or 100% (sales revenue is always 100% of sales revenue) 2. Cost of Goods Sold Percent = $433,000/$752,000 = 0.576, or 57.6% 3. Gross Margin Percent = $319,000/$752,000 = 0.424, or 42.4% 4. Selling Expense Percent = $140,200/$752,000 = 0.186, or 18.6% 5. Administrative Expense Percent = $53,800/$752,000 = 0.072, or 7.2% 6. Operating Income Percent = $125,000/$752,000 = 0.166, or 16.6%

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Basic Managerial Accounting Concepts

BE 2-27 1.

Allstar Exposure Income Statement For the Past Month Sales revenues………………………………………………… Less operating expenses: Sales commissions……………………………………… Technology………………………………………………… Research and development……………………………… Selling expenses…………………………………………… Administrative expenses ………………………………… Operating income…………………………………………

$410,000 $ 50,000 75,000 200,000 10,000 35,000

370,000 $ 40,000

Allstar has no cost of goods sold line item because the company is a service provider, rather than a manufacturer. Therefore, as a service provider, Allstar has no inventory costs (raw materials, work in process, or finished goods) to flow through to cost of goods sold when it recognizes its sales revenue. Instead, all of the costs it incurs in providing advertising services appear as operating expenses on the income statement.

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BRIEF EXERCISES: SET B BE 2-28 $500,000 1. Direct materials…………………………………………………… 100,000 Direct labor………………………………………………………… 400,000 Manufacturing overhead………………………………………… Total product cost……………………………………………… $1,000,000 2.

Per-Unit Product Cost =

$1,000,000 = $20 50,000 units

Therefore, one flask costs $20 to produce. BE 2-29 1. Direct materials…………………………………………………… Direct labor………………………………………………………… Total prime cost………………………………………………… 2.

Per-Unit Prime Cost =

Per-Unit Conversion Cost =

$500,000 100,000 $600,000

$600,000 = $12 50,000 units $100,000 400,000 $500,000

$500,000 = $10 50,000 units

BE 2-30 Materials inventory, March 1…………………………………………………………… $ 50,000 Purchases…………………………………………………………………………………… 2,000,000 (60,000) Materials inventory, March 31…………………………………………………………… Direct materials used in production…………………………………………………… $1,990,000

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BE 2-31 1. Direct materials*………………………………………………………………… $1,990,000 425,000 Direct labor……………………………………………………………………… 1,600,000 Manufacturing overhead……………………………………………………… Total manufacturing cost for March………………………………………… $4,015,000 90,000 Work in process, March 1………………………………………………… (75,000) Work in process, March 31………………………………………………… Cost of goods manufactured………………………………………………… $4,030,000 * Direct Materials = $50,000 + $2,000,000 – $60,000 = $1,990,000 [This was calculated in Brief Exercise 2-30.]

Per-Unit Cost of Goods Manufactured =

= $20.15 $4,030,000 200,000 units

BE 2-32 1.

Clear Water Drinking Company Cost of Goods Sold Statement For the Month of March Cost of goods manufactured………………………………….……………… $4,030,000 100,000 Finished goods inventory, March 1…………………………………….…… Finished goods inventory, March 31…………………………………….… (85,000) Cost of goods sold……………………………………………………………… $4,045,000

Number of units sold: Finished goods inventory, March 1…………………………………….…… Units finished during March………………………………………….……… Finished goods inventory, March 31…………………………………….… Units sold during March……………………………………………….………

11,000 200,000 (10,000) 201,000

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BE 2-33 Clear Water Drinking Company Income Statement For the Month of March Sales revenue (201,000 × $50)………………………………………….……… Cost of goods sold ……………………………………..………………………… Gross margin………………………………...…………………………………

$10,050,000 4,045,000 $6,005,000

Less: Selling expense: Variable commissions (0.05 × $10,050,000)………………………… Fixed selling expense ………………….………………………………… Administrative expense …………………………...………………….…… Operating income…………………………………..……………………

$502,500 1,510,000

2,012,500 2,116,000 $ 1,876,500

BE 2-34 Clear Water Drinking Company Income Statement For the Month of March Sales revenue (201,000 × $50)………………………………… Cost of goods sold ……………………………………………… Gross margin…………………………………………………

$10,050,000 4,045,000 $6,005,000

Percent* 100.0 40.2 59.8

Less: Selling expense: Variable commissions (0.05 × $10,050,000)………… $502,500 Fixed selling expense…………………………………… 1,510,000 Administrative expense…………………………………… Operating income……………………………...…………

2,012,500 2,116,000 $ 1,876,500

20.0 21.1 18.7

* Steps in calculating the percentages (the percentages are rounded): 1.Sales Revenue Percent = $10,050,000/$10,050,000 = 1.00, or 100% (sales revenue is always 100% of sales revenue) 2.Cost of Goods Sold Percent = $4,045,000/$10,050,000 = 0.402, or 40.2% 3.Gross Margin Percent = $6,005,000/$10,050,000 = 0.598, or 59.8% 4.Selling Expense Percent = $2,012,500/$10,050,000 = 0.200, or 20.0% 5.Administrative Expense Percent = $2,116,000/$10,050,000 = 0.211, or 21.1% 6.Operating Income Percent = $1,876,500/$10,050,000 = 0.187, or 18.7%

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Basic Managerial Accounting Concepts

BE 2-35 1.

Healing Hands Massage Hut Income Statement For the Past Month Sales revenues………………………………………………… Less operating expenses: Technology………………………………………………… Wages expense…………………………………………… Rent expense……………………………………………… Selling (advertising) expenses………………………… Administrative expenses ………………………………… Operating income…………………………………………

$200,000 $ 10,000 100,000 15,000 5,000 20,000

150,000 $ 50,000

Healing Hands has no cost of goods sold line item because the company is a service provider (i.e., of massage therapy activities), rather than a manufacturer. Therefore, as a service provider, Healing Hands has no inventory costs (raw materials, work in process, or finished goods) to flow through to cost of goods sold when it recognizes its sales revenue. Instead, all of the costs it incurs in providing massage and other beauty services appear as operating expenses on the income statement.

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CHAPTER 2

Basic Managerial Accounting Concepts

EXERCISES E 2-36 1.

Cost

Salaries

Commissions

Derek………………………………………………………… Lawanna……………………………………………………… Total………………………………………………………

$25,000 30,000 $55,000

$6,000 1,500 $7,500

All of Derek’s time is spent selling, so all of his salary cost is selling cost. Lawanna spends two-thirds of her time selling, so $20,000 ($30,000 × 2/3) of her salary is selling cost. The remainder is administrative cost. All commissions are selling costs.

Cost

Selling Costs

Administrative Costs

Derek’s salary……………………………………………… Lawanna’s salary…………………………………………… Derek’s commissions……………………………………… Lawanna’s commissions………………………………… Total………………………………………………………

$25,000 20,000 6,000 1,500 $52,500

— $10,000 — — $10,000

E 2-37 1. The two products that Holmes sells are playhouses and the installation of playhouses. The playhouse itself is a product, and the installation is a service. 2.

Holmes could assign the costs to production and to installation, but if the installation is a minor part of its business, it probably does not go to the trouble.

The opportunity cost of the installation process is the loss of the playhouses that could have been built by the two workers who were pulled off the production line.

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E 2-38 a. Salary of cell supervisor—Direct b.

Power to heat and cool the plant in which the cell is located—Indirect

Materials used to produce the motors—Direct

Maintenance for the cell’s equipment—Indirect

Labor used to produce motors—Direct

Cafeteria that services the plant’s employees—Indirect

Depreciation on the plant—Indirect

Depreciation on equipment used to produce the motors—Direct

Ordering costs for materials used in production—Indirect

Engineering support—Indirect

Cost of maintaining the plant and grounds—Indirect

Cost of the plant’s personnel office—Indirect

Property tax on the plant and land—Indirect

E 2-39 1. Direct materials—Product cost Direct labor—Product cost Manufacturing overhead—Product cost Selling expense—Period cost 2.

Direct materials………………………………………………………………… Direct labor……………………………………………………………………… Manufacturing overhead……………………………………………………… Total product cost…………………………………………………………

Unit Product Cost =

$12,000 4,000 units

$ 7,000 3,000 2,000 $12,000

= $3.00

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Basic Managerial Accounting Concepts

E 2-40 1. Costs

Product Cost Direct Direct Manufact. Materials Labor Overhead

Direct materials………………… $216,000 Factory rent……………………… Direct labor……………………… Factory utilities………………… Supervision in the factory…… Indirect labor in the factory………………………… Depreciation on factory equipment……………………… Sales commissions…………… Sales salaries…………………… Advertising……………………… Depreciation on the headquarters building……… Salary of the corporate receptionist…………………… Other administrative costs…… Salary of the factory receptionist…………………… Totals………………………… $216,000

Period Cost Selling Administrative Expense Expense

$ 24,000 $120,000 6,300 50,000 30,000 9,000 $ 27,000 65,000 37,000 $ 10,000 30,000 175,000

$120,000

28,000 $147,300

$129,000

Direct materials…………………………………………………………………… Direct labor………………………………………………………………………… Manufacturing overhead………………………………………………………… Total product cost………………………………………………………………

Total Period Cost =

Unit Product Cost =

$215,000

$216,000 120,000 147,300 $483,300

$129,000 + $215,000 = $344,000 $483,300 30,000 units

= $16.11

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E 2-40 (Continued) 5. The product and period costs could be used in any of the four data analytic types across a variety of different decision contexts. For example: • In a descriptive data analytic context, a trend analysis of how product costs and period costs have been changing over time would provide insights into Valentina’s financial performance (i.e., “What is happening?”). These insights could help the accountants better understand the various sections of the company’s income statement (e.g., product costs affect cost of goods sold, which affects gross margin; while period costs affect later expenses in the income statement). These insights also could be useful in deciphering profit and loss statements for specific product or service lines. • In a diagnostic data analytic context, an examination of each element of prime costs (i.e., direct materials and direct labor) would provide insights into why product costs have increased or decreased over time (i.e., “Why it is happening?”). A similar examination of period costs might be helpful in providing insights into the causes of period cost changes, starting with selling versus administrative costs and analyzing further as needed. • In a predictive data analytics context, an estimation (or prediction) model that forecasts the amount of product costs (and period costs) at different anticipated production levels (or other pertinent decision criteria) would provide insights into how profits are likely to vary across such production levels (“What is likely to happen?”). • In a prescriptive data analytics context, a process analysis that reveals a particular laboratory technique for testing new prototype designs will lead to the lowest period costs over the life of the new product (i.e., What do I need to do?”). Such insights would provide decision guidance regarding how to maximize profits. Note: As students develop an understanding of cost behaviors (in Chapter 3), they will be able to more fully consider the above data analytic product and period cost outcomes on both a total and a per-unit cost basis.

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Basic Managerial Accounting Concepts

E 2-41 Direct Materials

Costs

Jars……………………………………………………… Sugar…………………………………………………… Fruit…………………………………………………… Pectin…………………………………………………… Boxes…………………………………………………… Depreciation on the factory building……………… Cooking equipment operators’ wages…………… Filling equipment operators’ wages……………… Packers’ wages……………………………………… Janitors’ wages……………………………………… Receptionist’s wages………………………………… Telephone……………………………………………… Utilities………………………………………………… Rental of Santa Claus suit………………………… Supervisory labor salaries………………………… Insurance on factory building……………………… Depreciation on factory equipment……………… Oil to lubricate filling equipment…………………

Direct Labor

Manufact. Overhead

X X X X X X X X X X X X X X X X X X

E 2-42 $400,000 1. Direct materials…………………………………………………… 80,000 Direct labor………………………………………………………… 320,000 Manufacturing overhead………………………………………… Total product cost……………………………………………… $800,000 2.

Product Cost per Unit = =

Total Product Cost Number of Units $800,000 4,000 units

= $200.00

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Basic Managerial Accounting Concepts

E 2-43 1. Direct materials…………………………………………………………………… Direct labor………………………………………………………………………… Total prime cost…………………………………………………………………… 2.

Prime Cost per Unit

$400,000 80,000 $480,000

Total Prime Cost Number of Units

$480,000 4,000 units = $120.00 =

Direct labor………………………………………………………………………… Manufacturing overhead………………………………………………………… Total conversion cost…………………………………………………………

Conversion Cost per Unit = =

$ 80,000 320,000 $400,000

Total Conversion Cost Number of Units $400,000 4,000 units

= $100.00 E 2-44 1. Materials inventory, June 1……………………………………………………… Materials purchases in June…………………………………………………… Materials inventory, June 30…………………………………………………… Direct materials used in June……………………………………………… 2.

$ 3,700 15,500 (1,600) $17,600

As shown in the exercise, the cost of direct materials purchased in June is $15,500. Also, as calculated in response to Requirement 1, the cost of direct materials used in production in June is $17,600. Therefore, in this case, the cost of direct materials used is greater than the cost of direct materials purchased, which means that—for whatever reason—Hannah Banana Bakers decided to let its ending inventory (of $1,600) drop below its beginning inventory (of $3,700). The difference in beginning and ending inventories ($3,700 – $1,600 = $2,100) accounts for the difference between the cost of direct materials purchased and the cost of direct materials used in production (also $2,100; or $17,600 – $15,500). Hannah might have elected to let its ending materials inventory drop in order to save cash for purchases other than buying materials inventory. Also, it might have elected to do so to reduce its materials inventory holding costs (e.g., inspection, handling, insurance, etc.). Furthermore, Hannah might have reduced its ending materials inventory because it foresaw that demand in July would be lower than in June and did not want to be left holding additional inventory at the end of July. Alternately, Hannah might have experienced stronger than expected sales in June and used more direct materials in production than it had anticipated when purchasing materials. Regardless of the reason, it is helpful for students to understand the relationship between the cost of materials purchased versus the cost of materials used in production in a given period. 2-17

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E 2-45 1. Finished goods inventory, January 1………………………………… Units completed during the year……………………………………… Finished goods inventory, December 31……………………………… Units sold……………………………………………………………… 2.

Units sold…………………………………………………………………… × Unit cost………………………………………………………………… Cost of goods sold……………………………………………………

E 2-46 1. Materials inventory, September 1………………………………………… Materials purchases in September………………………………………… Materials inventory, September 30………………………………………… Direct materials used in September……………………………………

6,800 94,000 (7,200) 93,600 93,600 $ 2,200 $205,920,000

$ 120,000 200,000 (130,000) $ 190,000

Direct materials……………………………………………………………… Direct labor…………………………………………………………………… Manufacturing overhead…………………………………………………… Total manufacturing cost………………………………………………

$190,000 120,000 325,000 $635,000

Total manufacturing cost…………………………………………………… Add: Work in process, September 1……………………………………… Less: Work in process, September 30…………………………………… Cost of goods manufactured……………………………………………

$635,000 80,000 (90,000) $625,000

Students are instructed to use a spreadsheet software tool, such as Excel, to help them set up and solve the exercise’s requirements. For requirement 4, the spreadsheet needs to be adjusted to accommodate the two cost changes. Most students should be able to simply type in the new increased total direct labor cost and new decreased total overhead costs and easily observe the resulting new cost of goods manufactured. However, requirement 4’s sensitivity analysis requires more time and effort for students who instead elect to write out and solve these requirements by hand. Therefore, even for a relatively simple exercise, this requirement illustrates the time and effort savings of utilizing technology in setting up and solving formulas as typically required in management accounting data analytic settings. As shown in detail below, total direct labor increases by 25% from $120,000 to $150,000 and total overhead decreases by 20% from $325,000 to $260,000. As a result, the new cost of goods manufactured decreases by $35,000 from a total of $625,000 to a total of $590,000.

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Basic Managerial Accounting Concepts

E 2-46 (Continued) Materials inventory, September 1………………………………………… Materials purchases in September……………………………………… Materials inventory, September 30………………………………………. Direct materials used in September…………………………………

$120,000 200,000 (130,000) $190,000

Direct materials………………………………………….……………………. Direct labor………………………………………….…………………………. Manufacturing overhead………………………………………….……….. Total manufacturing cost………………………………………….……

$190,000 150,000* 260,000** $600,000

Total manufacturing cost………………………………………….………… Add: Work in process, September 1……………………………………… Less: Work in process, September 30…………………………………… Cost of goods manufactured…………………………………………..

$600,000 80,000 (90,000) $590,000

* $120,000 x 1.25 ** $325,000 x 0.8 E 2-47 Cost of goods manufactured*…………………………………………………… Finished goods, September 1…………………………………………………… Finished goods, September 30………………………………………………… Cost of goods sold……………………………………………………………

$625,000 70,000 (65,000) $630,000

* See solution to requirement 3 of Exercise 2-46. E 2-48 Direct materials…………………………………………………………………… Direct labor………………………………………………………………………… Manufacturing overhead………………………………………………………… Cost of goods sold……………………………………………………………

$180,000 505,000 110,000 $795,000

Note: Because there were no beginning or ending work-in-process or finished goods inventories, there is no difference here between cost of goods sold and cost of goods manufactured, so no interim calculations for them are necessary.

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Basic Managerial Accounting Concepts

E 2-49 1. Sales Revenue

= Number of Units Sold × Selling Price = 280,000 units × $12 = $3,360,000 Jasper Company Income Statement For the Last Year

Sales revenue……………………………………………………………… Cost of goods sold*………………………………………………………… Gross profit………………………………………………………………… Less: Selling expense………………………………………………………… Administrative expense……………………………………………… Operating income…………………………………………………………

$3,360,000 795,000 $2,565,000 437,000 854,000 $1,274,000

* Calculated in E2-48 Direct materials………………………………… Direct labor……………………………………… Manufacturing overhead……………………… Cost of goods sold…………………………

$180,000 505,000 110,000 $795,000

E 2-50 Jasper Company Income Statement For the Last Year

Sales & Expenses

Percent of Sales

Sales revenue………………………………………… Cost of goods sold*………………………………… Gross profit……………………………………………

$3,360,000 795,000 $2,565,000

100.0 a 23.7 b 76.3 c

Less: Selling expense…………………………………… Administrative expense………………………… Operating income……………………………………

437,000 854,000 $1,274,000

13.0 d 25.4 e 37.9 f

* See solution to Exercise 2-49, Requirement 2. a b c d e f

Sales revenue: $3,360,000/$3,360,000 = 1.00, or 100% Cost of goods sold: $795,000/$3,360,000 = 0.237, or 23.7% Gross profit: $2,565,000/$3,360,000 = 0.763, or 76.3% Selling expense: $437,000/$3,360,000 = 0.130, or 13.0% Administrative expense: $854,000/$3,360,000 = 0.254, or 25.4% Operating income: $1,274,000/$3,360,000 = 0.379, or 37.9% 2-20

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E 2-50 (Continued) 2. The income statement showing each account as a percentage of sales helps focus managerial attention on those expenses that are relatively high. For Jasper, it appears as though administrative expense is twice as large as selling expense. Perhaps management could explain ways to reduce certain administrative expenses, such as research and development or fees incurred for general counsel (e.g., size of Jasper’s legal staff). E 2-51 a (Direct Materials Used in Production) = Beginning Inventory Direct Materials + Purchases – Ending Inventory Direct Materials a

= $10,000 + $45,000 – $15,000 = $40,000

To find b, one can rearrange the Cost of Goods Manufactured equation to solve for Direct Labor Used in Production (i.e., the unknown, or b): b (Direct Labor Used in Production) = Cost of Goods Manufactured – Direct Materials Used in Production – Manufacturing Overhead Costs Used in Production – Beginning WIP Inventory + Ending WIP Inventory b = COGM – $40,000 (from a) – $80,000 – $17,000 + $14,000 Thus, in order to find b, we first need to calculate Cost of Goods Manufactured as follows: Cost of Goods Manufactured = Cost of Goods Sold – Beginning Finished Goods Inventory + Ending Finished Goods Inventory COGM

= $169,000 – $8,000 + $7,000 = $168,000

Finally, inserting Cost of Goods Manufactured into the earlier equation: b

= $168,000 – $40,000 – $80,000 – $17,000 + $14,000 = $45,000

c (Direct Materials Beginning Inventory for Year 2) = Direct Materials Ending Inventory for Year 1 = $15,000 d (Direct Materials Purchases for Year 2) = Direct Materials Used in Production – Direct Materials Beginning Inventory + Direct Materials Ending Inventory d

= $50,000 – $15,000 + $17,000 = $52,000

e (Cost of Goods Sold for Year 2) = Beginning Finished Goods Inventory + Cost of Goods Manufactured – Ending Finished Goods Inventory e = $7,000 + COGM – $11,000; therefore, we must first calculate COGM to be able to calculate COGS.

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Basic Managerial Accounting Concepts

E 2-51 (Continued) So, COGM = Direct Materials Used in Production + Direct Labor Used in Production + MOH Costs Used in Production + Beginning WIP Inventory – Ending WIP Inventory COGM = $50,000 + $53,000 + $76,000 + $14,000 – $19,000 = $174,000 Therefore, e

= $7,000 + $174,000 – $11,000 = $170,000

CHAPTER 2

Basic Managerial Accounting Concepts

PROBLEMS P 2-52 1. Cost

Direct Materials

Hamburger meat…………………………… Buns, lettuce, pickles, and onions……… Frozen potato strips……………………… Wrappers, bags, and condiment packages………………………………… Other ingredients………………………… Part-time employees’ wages…………… John Peterson’s salary…………………… Utilities……………………………………… Rent………………………………………… Depreciation, cooking equipment and fixtures……………………………… Advertising………………………………… Janitor’s wages…………………………… Janitorial supplies………………………… Accounting fees…………………………… Taxes………………………………………… Totals……………………………………

Direct Labor

Manufact. Overhead

Selling and Administrative

$4,500 800 1,250 600 660 $7,250 $3,000 $1,500 1,800 600 500 520 150

$7,810

$7,250

$4,570

1,500 4,250 $9,250

Explanation of Classification Direct materials include all the food items that go into a burger bag, as well as the condiment packages and the wrappers and bags themselves. These materials go “out the door” in the final product. “Other ingredients” might include the oil to fry the potato strips and grease the frying surface for the hamburgers and the salt for the fries. They are direct materials but could also be classified as overhead because of cost and convenience. Direct labor consists of the part-time employees who cook food and fill orders. Manufacturing overhead consists of all indirect costs associated with the production process. These are the utilities, rent for the building, depreciation on the equipment and register, and cost of janitorial fees and supplies. Selling and administrative expense includes John Peterson’s salary, advertising, accounting fees, and taxes.

CHAPTER 2

Basic Managerial Accounting Concepts

P 2-52 (Continued) 2.

Pop’s Drive-Thru Burger Heaven Income Statement For the Month of December Sales ($3.50 × 10,000)………………………………………………… Less cost of goods sold: Direct materials…………………………………………………… $7,810 7,250 Direct labor………………………………………………………… Manufacturing overhead………………………………………… 4,570 Gross margin…………………………………………………………… Less: Selling and administrative expense………………………… Net income…………………………………………………………

$35,000

19,630 $15,370 9,250 $ 6,120

Elena’s simplifying assumptions were: (1) all part-time employees are production workers, (2) John Peterson’s salary is for selling and administrative functions, (3) all building-related expense as well as depreciation on cooking equipment and fixtures are for production, and (4) all taxes are administrative expense. These make it easy to classify 100% of each expense as product cost or selling and administrative cost. The result is that she does not have to perform studies of the time spent by each employee on producing versus selling burger bags. In addition, it is likely that John Peterson pitches in to help fry burgers or assemble burger bags when things get hectic. Of course, during those times, he is engaged in production—not selling or administration. The cost of determining just exactly how many minutes of each employee’s day is spent in production versus selling is probably not worth it. (Remember, accountants charge by the number of hours spent—the more time Elena spends separating costs into categories, the higher her fees.) For this small business, there is little problem with misclassifying Pop’s expenses. Pop’s Drive-Thru Burger Heaven is not a publicly traded company, and its income statements do not have to conform to GAAP. Outside use of the statements is confined to government taxing authorities and a bank (if a loan or line of credit is necessary). Elena’s accounting works well for those purposes. In addition, and perhaps more importantly, the analysis of Pop’s results is not likely to change dramatically based on these assumptions and therefore, the decisions that Pop’s makes based on these statements would not be affected.

CHAPTER 2

P 2-53 1. Cost per Page for Black Ink =

Basic Managerial Accounting Concepts

$25.50 = $0.03 850 pages

Total Owed to Harry by Mary = $0.03 × 500 pages = $15 Total Owed to Harry by Natalie = $0.03 × 1,000 pages = $30 2.

Cost per Sheet for Paper =

$2.50 = $0.005 500 sheets

Total Cost for Mary = 500 pages × ($0.03 + $0.005) = $17.50 Total Cost for Natalie = 1,000 pages × ($0.03 + $0.005) = $35 3.

Cost per Page for Color Ink =

$31 = $0.10 310 pages

Number of Black Ink Pages for Natalie = 1,000 × 0.80 = 800 Number of Color Ink Pages for Natalie = 1,000 × 0.20 = 200 Total Owed to Harry by Natalie = ($0.03 × 800 pages) + ($0.10 × 200) = $44 Total Cost to Natalie = [($0.03 + $0.005) × 800 pages] + [($0.10 + $0.005) × 200 pages] = $49 P 2-54 1. Direct Materials = $40,000 + $64,000 – $19,800 = $84,200 2.

Direct materials used………………………………………………………… Direct labor……………………………………………………………………… Manufacturing overhead……………………………………………………… Total manufacturing cost for July……………………………………… Work in process, July 1……………………………………………………… Work in process, July 31……………………………………………………… Cost of goods manufactured………………………………………………

$ 84,200 43,500 108,750 $236,450 21,000 (32,500) $224,950

Cost of goods manufactured………………………………………………… Finished goods inventory, July 1…………………………………………… Finished goods inventory, July 31………………………………………… Cost of goods sold…………………………………………………………

$224,950 23,200 (22,100) $226,050

CHAPTER 2

Basic Managerial Accounting Concepts

P 2-55 1. Direct materials……………………………… Direct labor…………………………………… Manufacturing overhead…………………… Unit product cost…………………………

$18 12 16 $46

Total Product Cost = $46 × 200,000 units = $9,200,000 2.

Laworld Inc. Income Statement For Last Year Sales revenue ($60 × 200,000)…………………………………………… Cost of goods sold………………………………………………………… Gross margin……………………………………………………………… Less: Commissions ($2 × 200,000)………………………………………… Fixed selling expense………………………………………………… Administrative expense……………………………………………… Operating income…………………………………………………………

$12,000,000 9,200,000 $ 2,800,000 $

400,000 100,000 300,000 $ 2,000,000

No, we do not need to prepare a statement of cost of goods manufactured because there were no beginning or ending inventories of work in process. As a result, total manufacturing cost is equal to the cost of goods manufactured. 3.

The 10,000 tents in beginning finished goods inventory have a cost of $40, and that is lower than the year’s unit product cost of $46. The FIFO assumption says that beginning inventory is sold before current year production. Therefore, the cost of goods sold will be lower than it would be if there were no beginning inventory. This can be seen in the following statement of cost of goods sold. Cost of goods manufactured ($46 × 200,000)………………………… Beginning finished goods inventory ($40 × 10,000)………………… Ending finished goods inventory ($46 × 10,000)…………………… Cost of goods sold……………………………………………………

$9,200,000 400,000 (460,000) $9,140,000

CHAPTER 2

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P 2-55 (Continued) Laworld Inc. Revised Income Statement For Last Year Sales revenue ($60 × 200,000)…………………………………………… Cost of goods sold………………………………………………………… Gross margin………………………………………………………………… Less: Commissions ($2 × 200,000)………………………………………… Fixed selling expense………………………………………………… Administrative expense………………………………………………… Operating income……………………………………………………………

$12,000,000 9,140,000 $ 2,860,000 $

400,000 100,000 300,000 $ 2,060,000

P 2-56 1. Direct Materials = $3,475 + $15,000 – $9,500 = $8,975 Hayward Company Statement of Cost of Goods Manufactured For the Month of May Direct materials used…………………………………… Direct labor………………………………………………… Manufacturing overhead: Factory supplies……………………………………… Factory insurance…………………………………… Factory supervision…………………………………… Material handling……………………………………… Total manufacturing cost for May……………………… Work in process, May 1………………………………… Work in process, May 31………………………………… Cost of goods manufactured……………………… 2.

$ 8,975 10,500 $ 675 350 2,225 3,750

7,000 $ 26,475 12,500 (14,250) $ 24,725

Hayward Company Statement of Cost of Goods Sold For the Month of May Cost of goods manufactured…………………………………………… Finished goods inventory, May 1………………………………………… Finished goods inventory, May 31……………………………………… Cost of goods sold………………………………………………………

$24,725 6,685 (4,250) $27,160

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Basic Managerial Accounting Concepts

P 2-57 1. c. These costs include direct materials, direct labor, and manufacturing overhead. The total of these three types of costs equals product cost. 2. a. If Linda returns to school, she will need to quit her job. The lost salary is the opportunity cost of returning to school. 3. b. If Randy were engaged in manufacturing a product, his salary would be a product cost. Instead, the product has been manufactured. It is in the finished goods warehouse waiting to be sold. This is a period cost. 4. j.

Jamie is working at company headquarters, and her salary is part of administrative cost.

5. i.

All factory costs other than direct materials and direct labor are, by definition, overhead.

6. d. The design engineer is estimating the total number of labor hours required to complete the manufacturing of a product. This total will be used to compute direct labor cost. 7. h. This is direct materials cost. 8. g. The sum of direct materials and direct labor is, by definition, prime cost. 9. f. The cost of converting direct materials into finished product is the sum of direct labor and manufacturing overhead. This is conversion cost. 10. e. The depreciation on the delivery trucks is part of selling cost, the cost of selling and delivering product.

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Basic Managerial Accounting Concepts

P 2-58 1. Before COGM can be calculated, Direct Materials Used in Production must first be calculated as: Direct Materials Used in Production = Beginning Direct Materials Inventory + Direct Materials Purchases – Ending Direct Materials Inventory = $20,000 + $40,000 – $10,000 = $50,000 Now, COGM = Direct Materials Used in Production + Direct Labor Costs Used in Production + Manufacturing Overhead Costs Used in Production + Beginning WIP Inventory – Ending WIP Inventory = $50,000 + $800,000 + $100,000 + $60,000 – $100,000 = $910,000 2.

COGS = Beginning Finished Goods Inventory + COGM – Ending Finished Goods Inventory = $300,000 + $910,000 – $280,000 = $930,000

CHAPTER 2

Basic Managerial Accounting Concepts

P 2-58 (Continued) Berry Company Income Statement For Last Year

Sales ($2,100 × 700)…………………………………………………………… $1,470,000 930,000 Cost of goods sold…………………………………...……………………… $ 540,000 Gross margin……………………………………………………………… Less: 60,000 Selling expense…………………………………………..………………… 150,000 Administrative expense…………………………………………….…… Operating income…………………………………………...………… $ 330,000 4.

The dominant cost is direct labor cost of $800,000. Direct labor is the dominant cost because Berry’s core business is creating building plans, which is a laborintensive process requiring expensive, well-trained architects. The materials used to create building plans are relatively inexpensive.

P 2-59 1.

W. W. Phillips Company Statement of Cost of Goods Manufactured For Last Year $300,000 200,000

Direct materials*…………………………………………… Direct labor…………………………………………………… Manufacturing overhead: Indirect labor…………………………………………… Rent, factory building………………………………… Depreciation, factory equipment…………………… Utilities, factory………………………………………… Total cost of product……………………………………… Beginning work in process……………………………… Ending work in process…………………………………… Cost of goods manufactured…………………………

$40,000 42,000 60,000 11,900

153,900 $653,900 13,040 (14,940) $652,000

* Beg. Inventory + Purchases – Ending Inventory = Direct Materials Used Direct Materials Used = $46,800 + $320,000 – $66,800 = $300,000

CHAPTER 2

P 2-59 (Continued) 2. Average Cost of One Unit of Product = 3.

$652,000 4,000

Basic Managerial Accounting Concepts

= $163

W. W. Phillips Company Income Statement For Last Year Sales ($400 × 3,800*)……………………………….………… Cost of goods sold**…………………………………………… Gross margin…………………………………………………… Less: Selling expense: Sales supervisor’s salary……………………………… Commissions…………………………………………… General administration expense………………………… Operating income………………………………………

$1,520,000 617,900 $ 902,100

$ 90,000 180,000

270,000 300,000 $ 332,100

* Units Sold = 4,000 + 500 – 700 = 3,800 ** Cost of Goods Sold = $652,000 + $80,000 – $114,100 = $617,900 P 2-60 1. The Internet payment of $40 is an expense that would appear on the income statement. This is because the Internet services are used up each month—Luisa cannot “save” any unused Internet time for the next month. 2. The opportunity cost is the $100 that Luisa would have made if she had been able to accept the movie role. It is an opportunity cost because it is the cost of the next best alternative to dog walking. 3. The price is $250 per month per dog. (Note: The price is charged by Luisa to her clients; it is not her cost.) Total Revenue for a Month = $250 × 12 dogs = $3,000

CHAPTER 2

Basic Managerial Accounting Concepts

P 2-61 1. Direct materials: Magazine (5,000 × $0.40)…………………………………… Brochure (10,000 × $0.08)……………………………………

$2,000 800

$2,800

Direct labor: Magazine (5,000/20 × $10)…………………………………… Brochure (10,000/100 × $10)…………………………………

$2,500 1,000

3,500

Manufacturing overhead: Rent……………………………………………………………. Depreciation ($40,000/20,000 × 350*)……………………… Setups…………………………………………………………… Insurance……………………………………………………… Power…………………………………………………………… Cost of goods manufactured……………………………………

$1,400 700 600 140 350

3,190 $9,490

* Production is 20 units per printing hour for magazines and 100 units per printing hour for brochures, yielding monthly machine hours of 350 [(5,000/20) + (10,000/100)]. This is also monthly labor hours as machine labor only operates the presses.

Direct materials…………………………………………………… Direct labor………………………………………………………… Total prime costs………………………………………………

$2,800 3,500 $6,300

Magazine: Direct materials……………………………………………… Direct labor…………………………………………………… Total prime costs…………………………………………

$2,000 2,500 $4,500

Brochure: Direct materials……………………………………………… Direct labor…………………………………………………… Total prime costs…………………………………………

$ 800 1,000 $1,800

Total monthly conversion cost: Direct labor…………………………………………………… Manufacturing overhead…………………………………… Total…………………………………………………………

$3,500 3,190 $6,690

Magazine: Direct labor…………………………………………………… Manufacturing overhead: Power ($1 × 250)…………………………………………… Depreciation ($2 × 250)…………………………………… Setups (2/3 × $600)………………………………………… Rent and insurance ($4.40 × 250 DLH)*……………… Total ……………………………………………………

$2,500 $ 250 500 400 1,100

2,250 $4,750

CHAPTER 2

Basic Managerial Accounting Concepts

P 2-61 (Continued) Brochures: Direct labor………………………………………………… Manufacturing overhead: Power ($1 × 100)……………………………………… Depreciation ($2 × 100)……………………………… Setups (1/3 × $600)…………………………………… Rent and insurance ($4.40 × 100 DLH)*…………… Total …………………………………………………

$1,000 $100 200 200 440

940 $1,940

* Rent and insurance cannot be traced to each product so the costs are assigned using direct labor hours: $1,540/350 DLH = $4.40 per direct labor hour. The other overhead costs are traced according to their usage. Depreciation and power are assigned by using machine hours (250 for magazines and 100 for brochures); $350/350 = $1.00 per machine hour for power and $40,000/20,000 = $2.00 per machine hour for depreciation. Setups are assigned according to the time required. Since magazines use twice as much time, they receive twice the cost: Letting X = the proportion of setup time used for brochures, 2X + X = 1 implies a cost assignment ratio of 2/3 for magazines and 1/3 for brochures.

Sales [(5,000 × $1.80) + (10,000 × $0.45)]………………… Less cost of goods sold……………………………………… Gross margin…………………………………………………… Less operating expenses: Selling ……………………………………………………… Administrative …………………………………………… Operating income………………………………………………

$13,500 9,490 $ 4,010 $ 500 ** 1,500 ***

2,000 $ 2,010

** Distribution of goods is a selling expense. *** A case could be made for assigning part of her salary to production. However, since she is responsible for coordinating and managing all business functions, an administrative classification is more convincing.

CHAPTER 2

Basic Managerial Accounting Concepts

P 2-62 1. The costs of the tent sales are accounted for as selling expense. The tent sales are designed to sell outdated or remanufactured products. They are not the main reason that Kicker is in business. In fact, an important objective is simply to increase awareness of the Kicker brand. As a result, these related costs are selling expense. 2.

Revenue…………………………………………………………………… Cost of goods sold……………………………………………………… Tent sale expense……………………………………………………… Tent sale loss…………………………………………………………

$ 20,000 (7,000) (14,300) $ (1,300)

A couple of actions could be taken. First, it could look for a more appropriate venue. The outer parking lot of a shopping center, or even a large grocery store, would enable Kicker employees to easily load purchased product into customer cars. Second, the disc jockey could be dispensed with; instead, music could be played from CDs over the audio system in the truck. Third, Kicker could spend a year or so raising brand awareness in the Austin market before attempting another tent sale.

CHAPTER 2

Basic Managerial Accounting Concepts

CASES Case 2-63 1. Production (DL) Machine operators (DL) Other direct labor (OH) Supervisory salaries (DM) Pipe (OH) Tires and fuel (OH) Depreciation, equipment (OH) Salaries of mechanics 2.

Selling

Administrative

Sales salaries Advertising

Utilities Rent CPA fees Adm. salaries

Traceable costs using equipment hours: Machine operators…………………………… $ 218,000 Other direct labor…………………………… 265,700 Pipe……………………………………………… 1,401,340 418,600 Tires and fuel………………………………… 198,000 Depreciation, equipment…………………… 50,000 Salaries of mechanics……………………… Total………………………………………… $2,551,640 Machine operators, tires and fuel, and depreciation are all directly caused by equipment usage, which is measured by equipment hours. One can also argue that the amount of mechanic time required is also a function of equipment hours and so the salaries of mechanics can be assigned using equipment hours. Pipe and other direct labor can be assigned using equipment hours because their usage should be highly correlated with equipment hours. That is, equipment hours increase because there is more pipe being laid. As hours increase, so does the pipe usage. A similar argument can be made for other direct labor. Actually, it is not necessary to use equipment hours to assign pipe or other direct labor because these two costs are directly traceable to jobs. Traceable Cost per Equipment Hour = =

$2,551,640 18,200 hours $140.20 per hour

CHAPTER 2

Basic Managerial Accounting Concepts

Case 2-64 1. Leroy should politely and firmly decline the offer. The offer includes an implicit request to use confidential information to help Jean win the bid. Use of such information for personal advantage is wrong. Leroy has a professional and personal obligation to his current employer. This obligation must take precedence over the opportunity for personal financial gain. Corporate codes of conduct emphasize honesty and integrity. Leroy has a responsibility to act on behalf of his company, and clearly, disclosing confidential information acquired in the course of his work to a competitor would be prohibited. In addition, codes of corporate conduct also require employees to avoid conflicts of interest and to refuse any gift, favor, or hospitality that would influence employee actions inappropriately. 2.

If Leroy agrees to review the bid, he will likely use his knowledge of his current employer’s position to help Jean win the bid. In fact, agreement to help probably would reflect a desire for the bonus and new job with the associated salary increase. Helping would likely ensure that Jean would win the bid. Leroy was concerned about the political fallout and subsequent investigation revealing his involvement—especially if he sent up a red flag by switching to his friend’s firm. An investigation may reveal the up-front bonus and increase the suspicion about Leroy’s involvement. There is a real possibility that Leroy could be implicated. Whether this would lead to any legal difficulties is another issue. At the very least, some tarnishing of his professional reputation and personal character is possible. Some risk to Leroy exists. The amount of risk, though, should not be a factor in Leroy’s decision. What is right should be the central issue, not the likelihood of getting caught.

COST BEHAVIOR AND FORECASTING DISCUSSION QUESTIONS

Knowledge of cost behavior allows a manager to assess changes in costs that result from changes in activity. This allows a manager to examine the effects of choices that change activity. For example, if excess capacity exists, bids that at least cover variable costs may be totally appropriate. Knowing what costs are variable and what costs are fixed can help a manager make better bids and, ultimately, better business decisions.

A driver is a factor that causes or leads to a change in a cost or activity; it is an output measure. The driver for general machine maintenance cost in a factory could be machine hours. The driver for raw materials used is the number of units produced.

The cost formula for monthly shipping cost is: Monthly Shipping Cost = $3,560 + $6.70 × Packages Shipped The independent variable is packages shipped. The dependent variable is monthly shipping cost. The fixed cost per month is $3,560. The variable rate is $6.70.

Some account categories are primarily fixed or variable. Even if the cost is mixed, either the fixed component or the variable component is relatively small. As a result, assigning all of the cost to either a fixed or variable category is unlikely to result in large errors. For example, depreciation on property, plant, and equipment is largely fixed. The cost of telephone expense for the sales office, if it consisted primarily of long-distance calls, could be seen as largely variable (variable with respect to the number of customers).

Committed fixed costs are those incurred for the acquisition of long-term activity capacity and are not subject to change in the short run. Annual resource expenditure is independent of actual usage. For example, the cost of a factory building is a committed fixed cost. Discretionary fixed costs are those incurred for the acquisition of short-term activity capacity, the levels of which can be altered quickly. In the short run, resource expenditure is also independent of actual activity usage. Salaries of engineers are an example of such an expenditure.

The concept of relevant range is important in dealing with step costs because if the relevant range is contained completely within one step, the cost behaves as a fixed cost. However, if the relevant range spans two or more steps, the accountant must be aware of the cost increase as output goes up within the relevant range.

Mixed costs are usually reported in total in the accounting records. How much of the cost is fixed and how much is variable is unknown and must be estimated.

The cost formula for a strictly fixed cost has only a fixed cost amount. There is no variable rate and no independent variable. For the depreciation example, the cost formula looks like this: Depreciation per Year = $15,000

The cost formula for a strictly variable cost has only the variable rate and independent variable. There is no fixed component. For the electrical power example, the cost formula looks like this: Electrical Power = $1.15 × Machine Hours

3-1

CHAPTER 3

Cost Behavior and Forecasting

10. A scattergraph allows a visual portrayal of the relationship between cost and activity. It reveals to the investigator whether a relationship may exist and, if so, whether a linear function can be used to approximate the relationship. 11. As discussed in the text, data visualization as a data analytic technique provides useful insights into numerous important management accounting analysis inputs, including cost behavior patterns. For example, the plots produced using the scattergraph method can help accountants better understand whether there is a relationship between the cost driver independent variable and the total cost dependent variable. If there is a relationship, the visualization can shed light into whether the relationship is linear or nonlinear in nature, which has consequences for how subsequent cost analyses move forward (e.g., which statistical techniques are best suited for linear vs. nonlinear relationships). Furthermore, visualizations can help accountants identify the presence of outliers that should be included, excluded, or examined in more detail before moving forward with the cost forecast or other analyses. For some users, data visualizations, such as scattergraph plots, make spotting such important cost behavior patterns much easier than when the underlying data points are viewed simply in a table. Finally, for instructors and students with sophisticated data analytic backgrounds, this discussion question also can incorporate the use of real-time performance dashboards and specific software tools such as Tableau. 12. Managers can use their knowledge of the cost relationships to estimate the fixed and variable components. A scattergraph can be used as an aid in this process. From a scattergraph, a manager can select two points that best represent the relationship. These two points can then be used to derive a linear cost formula. The high-low method tells the manager which two points to select to compute the linear cost formula. The selection of the two points is not left to judgment. 13. Because the scattergraph method is not restricted to the high and low points, it is possible to select two points that better represent the relationship between activity and costs, producing a better estimate of fixed and variable costs. The main advantage of the high-low method is that it removes subjectivity from the choice process. The same line will be produced by two different people. 14. Assuming that the scattergraph reveals that a linear cost function is suitable, then the method of least squares selects a line that best fits the data points. The method also provides a measure of goodness of fit so that the strength of the relationship between cost and activity can be assessed. 15. The best-fitting line is the one that is “closest” to the data points. This is usually measured by the line that has the smallest sum of squared deviations from the individual data points. 16. The only difference between absorption costing and variable costing is the way in which fixed overhead costs are assigned. Under variable costing, fixed overhead is a period cost; under absorption costing, it is a product cost. 17. Absorption-costing income is greater because some of the period's fixed overhead is placed in inventory and not recognized as part of cost of goods sold on the absorption-costing income statement. 18. The coefficient of determination is the percentage of total variability in costs explained by activity. As such, it is a measure of goodness of fit, the strength of the relationship between cost and activity.

3-2

CHAPTER 3

MULTIPLE-CHOICE QUESTIONS 3-1.

3-2.

3-3.

3-4.

3-5.

3-6.

3-7.

3-8.

3-9.

3-10.

3-11.

3-12.

3-13.

3-14.

3-15.

3-16.

Total Cost = $235,000 + ($75 × 8,000) = $835,000

3-3

Cost Behavior and Forecasting

CHAPTER 3

Cost Behavior and Forecasting

BRIEF EXERCISES: SET A BE 3-17 1.

The cost formula takes the following form: Total Cost = Fixed Cost + (Variable Rate × Number of Flash Drives) The monthly fixed cost is the $15,000 cost of equipment depreciation, as it does not vary according to the number of flash drives manufactured. The variable costs are materials and manufacturing overhead, as both do vary with the number of flash drives produced. Cost of materials per flash drive is: 10,000 ounces/5,000 flash drives = 2 ounces per flash drive Given that, the material cost per drive = $3 × 2 ounces per drive = $6.00 per drive. Cost of manufacturing overhead per flash drive is: $22,500/5,000 flash drives = $4.50 per drive Therefore, the variable rate per flash drive is $6.00 + $4.50 = $10.50 The cost formula is: Total Cost of Flash Drives = $15,000 + ($10.50 × Number of Flash Drives)

Expected fixed cost for next month is $15,000. Expected variable cost for next month is: $10.50 × 6,000 flash drives = $63,000 Expected total manufacturing cost for next month is: $15,000 + $63,000 = $78,000

3-4

CHAPTER 3

Cost Behavior and Forecasting

BE 3-18 Step 1: Find the high and low points: The high number of employee hours is in March, and the low number of employee hours is in August. Step 2: Calculate the variable rate: Variable Rate

High Cost – Low Cost High Employee Hours – Low Employee Hours

= ($9,899 – $7,531)/(630 – 310) = $2,368/320 = $7.40 per employee hour Step 3: Calculate the fixed cost: Fixed Cost = Total Cost – (Variable Rate × Employee Hours) Let’s choose the low point with total cost of $7,531 and employee hours of 310. Fixed Cost = $7,531 – ($7.40 × 310) = $7,531 – $2,294 = $5,237 (Hint : Check your work by computing fixed cost using the high point.) Step 4: Construct a cost formula: If the variable rate is $7.40 per employee hour and fixed cost is $5,237 per month, then the formula for total monthly labor cost is: Total Labor Cost = $5,237 + ($7.40 × Employee Hours)

BE 3-19 1.

Total Variable Labor Cost

= Variable Rate × Employee Hours = $7.40* × 675 hours = $4,995

Total Labor Cost

= Fixed Cost + (Variable Rate × Employee Hours) = $5,237* + ($7.40 × 675) = $5,237 + $4,995 = $10,232

* Refer to the solution for Brief Exercise 3-18 for detailed explanation of the computations for variable cost per unit ($7.40) and total fixed cost ($5,237).

3-5

CHAPTER 3

Cost Behavior and Forecasting

BE 3-20 1.

Total Variable Labor Cost

= Variable Rate × Employee Hours = $7.40* × 4,000 hours = $29,600

Note: Remember that the cost formula is for the month, but we are being asked to budge labor cost for the year. So, we will need to multiply the fixed cost for the month by 12 (the number of months in a year). Total Fixed Labor Cost

= Fixed Cost × 12 Months in a Year = $5,237* × 12 = $62,844

Total Labor Cost

= (12 × $5,237) + ($7.40 × 4,000) = $62,844 + $29,600 = $92,444

* Refer to the solution for Brief Exercise 3-18 for detailed explanation of the computations for variable cost per unit ($7.40) and total monthly fixed cost ($5,237).

BE 3-21 1.

The fixed cost and the variable rate are given directly by regression. Fixed Cost

= $4,517

Variable Rate

= $8.20

The cost formula is: Total Labor Cost

= $4,517 + ($8.20 × Employee Hours)

Budgeted Labor Cost = $4,517 + ($8.20 × 675) = $10,052

3-6

CHAPTER 3

BE 3-22 1. Units Ending Inventory

Cost Behavior and Forecasting

= Units Beginning Inventory + Units Produced – Units Sold = 300 + 15,000 – 12,700 = 2,600 units $ 20 60 12 30 $122

Direct materials………………………… Direct labor……………………………… Variable overhead……………………… Fixed overhead………………………… Unit product cost………………………

Value of Ending Inventory = 2,600 units × $122 = $317,200

BE 3-23 1. Units Ending Inventory

= Units Beginning Inventory + Units Produced – Units Sold = 300 + 15,000 – 12,700 = 2,600 units $20 60 12 $92

Direct materials………………………… Direct labor……………………………… Variable overhead……………………… Unit product cost………………………

Value of Ending Inventory = 2,600 units × $92 = $239,200

BE 3-24 1. Direct materials………………………… Direct labor……………………………… Variable overhead……………………… Fixed overhead………………………… Unit product cost………………………

$ 9 6 4 5 $24

Total Cost of Goods Sold = $24 × 9,300 units = $223,200

3-7

CHAPTER 3

Cost Behavior and Forecasting

BE 3-24 (Continued) 2.

Osterman Company Income Statement under Absorption Costing For the Most Recent Year Sales ($47 × 9,300)………………………………………………………………… Less: Cost of goods sold………………………………………………………… Gross margin…………………………………………………………..………… Less: Selling and administrative expense………………………….………… Operating income……………………………………………………………………

$437,100 223,200 $213,900 138,000 $ 75,900

BE 3-25 1. Direct materials……………………………………………………………………… Direct labor…………………………………………………………………………… Variable overhead…………………………………………………………………… Unit product cost……………………………………………………………………

$ 9 6 4 $19

Total Cost of Goods Sold = $19 × 9,300 units = $176,700 2.

Osterman Company Income Statement under Variable Costing For the Most Recent Year Sales ($47 × 9,300)………………………….……………………… Less: Variable costs…………………………………………...… Contribution margin…………………………………………… Less fixed expense: Fixed overhead ($5 × 10,000) ……………………………… $ 50,000 138,000 Fixed selling and administrative expenses……………… Operating income…………………………………………………

3-8

$437,100 176,700 $260,400

188,000 $ 72,400

CHAPTER 3

Cost Behavior and Forecasting

BRIEF EXERCISES: SET B BE 3-26 1.

The cost formula takes the following form: Total Cost = Fixed Cost + (Variable Rate × Number of SUVs) The monthly fixed cost is the $25,000,000 cost of machinery and warehouse depreciation, as it does not vary according to the number of SUVs manufactured. The variable costs are materials and manufacturing overhead, as both do vary with the number of SUVs produced. Cost of materials per SUV is: 37,500,000 pounds/75,000 SUVs = 500 pounds per SUV Given that, the material cost per SUV = $1.20 × 500 pounds per SUV = $600.00 per SUV. Cost of manufacturing overhead per SUV is: $750,000,000/75,000 SUVs = $10,000.00 per SUV Therefore, the variable rate per SUV is $600.00 + $10,000.00 = $10,600.00. The cost formula is: Total Cost of SUVs = $25,000,000 + ($10,600.00 × Number of SUVs)

Expected fixed cost for next month is $25,000,000. Expected variable cost for next month is: $10,600.00 × 60,000 SUVs = $636,000,000 Expected total manufacturing cost for next month is: $25,000,000 + $636,000,000 = $661,000,000

3-9

CHAPTER 3

Cost Behavior and Forecasting

BE 3-27 Step 1: Find the high and low points: The high number of deliveries is in November and the low number of deliveries is in May. Step 2: Calculate the variable rate: Variable Rate

High Cost – Low Cost High Number of Deliveries – Low Number of Deliveries

= ($65,450 – $53,450)/(8,525 – 5,400) = $12,000/3,125 = $3.84 per delivery Step 3: Calculate the fixed cost: Fixed Cost = Total Cost – (Variable Rate × Number of Deliveries) Let’s choose the low point with total cost of $53,450 and number of deliveries of 5,400. Fixed Cost = $53,450 – ($3.84 × 5,400) = $53,450 – $20,736 = $32,714 (Hint : Check your work by computing fixed cost using the high point.) Step 4: Construct a cost formula: If the variable rate is $3.84 per delivery and fixed cost is $32,714 per month, then the formula for total monthly delivery cost is: Total Delivery Cost = $32,714 + ($3.84 × Number of Deliveries)

BE 3-28 1.

Total Variable Delivery Cost

= Variable Rate × Number of Deliveries = $3.84* × 9,000 deliveries = $34,560

Total Delivery Cost

= Fixed Cost + (Variable Rate × Number of Deliveries) = $32,714* + ($3.84 × 9,000) = $32,714 + $34,560 = $67,274

* Refer to the solution for Brief Exercise 3-27 for detailed explanation of the computations for variable cost per unit ($3.84) and total fixed cost ($32,714).

3-10

CHAPTER 3

Cost Behavior and Forecasting

BE 3-29 1.

Total Variable Delivery Cost

= Variable Rate × Number of Deliveries = $3.84* × 9,000 deliveries = $34,560

There’s a trick here; the cost formula is for the month, but we are being asked to budget total delivery cost for the year. So, we will need to multiply the fixed cost for the month by 12 (the number of months in a year). Total Fixed Delivery Cost

= Fixed Cost × 12 Months in a Year = $32,714* × 12 = $392,568

Total Delivery Cost

= (12 × $32,714) + ($3.84 × 9,000) = $392,568 + $34,560 = $427,128

* Refer to the solution for Brief Exercise 3-27 for detailed explanation of the computations for variable cost per unit ($3.84) and total monthly fixed cost ($32,714).

BE 3-30 1.

The fixed cost and the variable rate are given directly by regression. Fixed Cost

= $36,588

Variable Rate

= $3.35

The cost formula is: Total Delivery Cost

= $36,588 + ($3.35 × Number of Deliveries)

Budgeted Delivery Cost

= $36,588 + ($3.35 × 9,000) = $66,738

3-11

CHAPTER 3

Cost Behavior and Forecasting

BE 3-31 1.

Units Ending Inventory

= Units Beginning Inventory + Units Produced – Units Sold = 3,000 + 20,000 – 18,000 = 5,000 units

Direct materials………………………… Direct labor……………………………… Variable overhead……………………… Fixed overhead…………………………… Unit product cost…………………………

$ 20 40 10 50 $120

Value of Ending Inventory = 5,000 units × $120 = $600,000

BE 3-32 1.

Units Ending Inventory

= Units Beginning Inventory + Units Produced – Units Sold = 3,000 + 20,000 – 18,000 = 5,000 units

Direct materials………………………… Direct labor……………………………… Variable overhead……………………… Unit product cost…………………………

$20 40 10 $70

Value of Ending Inventory = 5,000 units × $70 = $350,000

BE 3-33 1.

$12 7 5 8 $32

Total Cost of Goods Sold = $32 × 8,800 units = $281,600

3-12

CHAPTER 3

Cost Behavior and Forecasting

BE 3-33 (Continued) 2.

Beyta Company Income Statement under Absorption Costing For the Most Recent Year Sales ($60 × 8,800)……………………………………………………………… Less: Cost of goods sold……………………………………………………… Gross margin…………………………………………………………..…… Less: Selling and administrative expense………………………….……… Operating income………………………………………………………………

BE 3-34 1. Direct materials…………………………………… Direct labor………………………………………… Variable overhead………………………………… Unit product cost…………………………………

$528,000 281,600 $246,400 138,000 $108,400

$12 7 5 $24

Total Cost of Goods Sold = $24 × 8,800 units = $211,200 2.

Beyta Company Income Statement under Variable Costing For the Most Recent Year Sales ($60 × 8,800)………………………….………………… Less: Variable costs………………………………………….. Contribution margin………………………………………… Less fixed expense: Fixed overhead ($8 × 10,000)……………………………… $ 80,000 138,000 Fixed selling and administrative expenses…………… Operating income………………………………………………

3-13

$528,000 211,200 $316,800

218,000 $ 98,800

CHAPTER 3

Cost Behavior and Forecasting

EXERCISES E 3-35 a.

Power to operate a drill (to drill holes in the wooden frames of the futons)— Variable cost

Cloth to cover the futon mattress—Variable cost

Salary of the factory receptionist—Fixed cost

Cost of food and decorations for the annual Fourth of July party for all factory employees—Fixed cost

Fuel for a forklift used to move materials in a factory—Variable cost

Depreciation on the factory—Fixed cost

Depreciation on a forklift used to move partially completed goods—Fixed cost

Wages paid to workers who assemble the futon frame—Variable cost

Wages paid to workers who maintain the factory equipment—Fixed cost

Cloth rags used to wipe the excess stain off the wooden frames—Variable cost

E 3-36 1.

Truck Depreciation

Depreciation Cost

$250,000 $200,000 $150,000 $100,000 $50,000 $0 0

Cubic Yards of Concrete (in thousands)

3-14

100

CHAPTER 3

Cost Behavior and Forecasting

E 3-36 (Continued) 2.

Cost (in thousands)

Raw Materials Cost $2,500 $2,000 $1,500 $1,000 $500 $0 0

100

Cubic Yards of Concrete (in thousands)

Truck depreciation: Fixed cost Raw materials cost: Variable cost

Truck depreciation is a fixed cost (with respect to the driver “cubic yards of cement”). Therefore, it cannot be managed by altering the number of cubic yards of cement, within the relevant range of course. Instead, the cost of truck depreciation could be reduced (or increased) by changing the depreciation method that is used to allocate the cost to each accounting period. Also, a more long-term approach to managing the total annual cost of truck depreciation would involve decisions to sell some trucks (make the fleet smaller), replace certain trucks (keep the fleet the same size), or buy additional trucks (make the fleet larger). In addition, the company could manage the depreciation cost by arranging to rent (rather than purchase) additional trucks (and thus only show a rent expense rather than a depreciation expense on its books) or obtain on-site mixing equipment for large jobs (and thus not be responsible for providing the trucks).

Raw materials is a variable cost (with respect to the driver “cubic yards of cement”). Therefore, total raw materials cost likely is best reduced (or managed) either by using fewer cubic yards of cement per job (i.e., more efficient use of cement) or by paying less to purchase or manufacture each cubic yard of cement (i.e., more efficient purchasing or manufacturing of cement). Also, a more long-term approach to reducing raw materials cost would be to discover different, cheaper materials that can be used in the business that yield the same quality of output as the existing materials.

E 3-37 Cost Category Technician salaries Laboratory facility Laboratory equipment Chemicals and other supplies

Variable Cost

Discretionary Fixed Cost X

Committed Fixed Cost X X

X 3-15

CHAPTER 3

Cost Behavior and Forecasting

E 3-38 1.

Total Maintenance Cost = $1,750,000 + ($125.00 × 50,000) = $8,000,000

Total Fixed Maintenance Cost = $1,750,000

Total Variable Maintenance Cost = $125.00 × 50,000 = $6,250,000

Total Maintenance Cost per Unit

= [$1,750,000 + ($125.00 × 50,000)]/50,000 units = $8,000,000/50,000 units = $160.00

Fixed Maintenance Cost per Unit = $1,750,000/50,000 units = $35.00

Variable Maintenance Cost per Unit = $125.00

Alisha management could identify (via research or conversations with its operations personnel or employees at other similar organizations) additional drivers of maintenance costs besides the total number of medical stents manufactured. For example, different types of medical stents might require different types of raw materials, different amounts of machine time, or different types of machines. Any or all of these potential additional factors might drive, or affect, the total amount of maintenance costs incurred by Alisha’s manufacturing facility. If so, their inclusion in Alisha’s cost formula likely would improve its ability to understand historical maintenance costs and predict future maintenance costs.

E 3-39 1.

Total Maintenance Cost = $1,750,000 + ($125.00 × 25,000) = $4,875,000

Total Fixed Maintenance Cost = $1,750,000

Total Variable Maintenance Cost = $125.00 × 25,000 = $3,125,000

Total Maintenance Cost per Unit

= [$1,750,000 + ($125.00 × 25,000)]/25,000 units = $4,875,000/25,000 units = $195.00

Fixed Maintenance Cost per Unit = $1,750,000/25,000 units = $70.00

Variable Maintenance Cost per Unit = $125.00

The maintenance cost per unit in Exercise 3-39 is higher ($195) than in Exercise 3-38 ($160) because Alisha incurs fixed costs of $1,750,000 to produce its stents. Assuming 25,000 and 50,000 stents are within the relevant range, Alisha’s fixed costs do not vary with the number of stents it produces. Therefore, even though its production volume declines by 50% (from 50,000 units down to 25,000 units), its total fixed costs remain at $1,750,000 and are spread out over a smaller number of units. As a result, Alisha’s maintenance costs per unit increase when its output volume decreases. It is important to 3-16

CHAPTER 3

Cost Behavior and Forecasting

E 3-39 (Continued) realize that the opposite result occurs when output volume increases (i.e., total cost per unit decreases as volume increases because fixed costs are spread out over a greater number of units, again assuming the same relevant range). Finally, Alisha’s management can consider maintenance costs per unit in certain decisions, but it must remember that unit costs at one output level cannot be used to estimate total costs at other output levels (again because unit costs differ across different volumes). E 3-40 1. Cost of Direct Labor

Direct Labor Cost $350,000 $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $0 0

1,000

2,000

3,000

4,000

5,000

Number of Units

The direct labor cost in the machining department is a step cost (with narrow steps). 2. Cost of Supervision

Supervision Cost $150,000 $100,000 $50,000 $0 0

1,000

2,000

3,000

4,000

5,000

Number of Units

The cost of supervision for the machining department is a step cost (with wide steps). 3.

Direct Labor Cost Increase = $144,000 – $108,000 = $36,000 Supervision Increase = $80,000 – $40,000 = $40,000

E 3-41 1. K 2. H 3. A 4. J 5. I 6. E 7. L 3-17

CHAPTER 3

Cost Behavior and Forecasting

E 3-42 1. A.

The cost depicted in the curve in graph A is zero up to a certain level of output (i.e., up to three squares on the output range horizontal axis). Once a certain level of output is reached (i.e., beyond the three squares), the cost becomes VARIABLE in nature. However, after yet another level of output is reached (i.e., about five squares), the variable cost per unit (or rate) decreases.

The cost depicted in the curve in graph B is a VARIABLE cost. However, the variable cost per unit (or rate) decreases at certain set intervals (e.g., just before the second square and again after the fifth square). Note: This cost curve is not a semi-variable cost because the rate of change does not change at every single unit of output, but instead only changes after particular levels of output are reached (i.e., at certain intervals).

The cost depicted in the curve in graph C is zero up to a certain level of output (i.e., up to three squares). Once a certain level of output is reached (i.e., at three squares), the cost becomes a VARIABLE cost. Finally, after yet another level of output is reached (i.e., about five squares along the horizontal axis), the cost becomes a FIXED cost in nature (i.e., the variable component ceases).

The cost depicted in the curve in graph D begins as a FIXED cost. Once a certain level of output is reached (i.e., five squares along the ouput range horizontal axis), the cost becomes MIXED in nature (i.e., a variable component is added onto the existing fixed component). Finally, after another level of output is reached (i.e., at eight squares), the cost remains mixed but the variable cost per unit (or rate) increases.

The cost depicted in the curve in graph E is a VARIABLE cost. However, the variable cost per unit (or rate) increases at certain set intervals (e.g., just after the fourth square and again after the seventh square). Note: This cost curve is not a semi-variable cost because the rate of change does not change at every single unit of output, but instead only changes after particular levels of output are reached (i.e., at certain intervals).

The cost depicted in the curve in graph F is a MIXED cost. However, the rate of change (for the variable component) increases at certain set intervals (e.g., just after the fourth square and again after the seventh square).

G. The cost depicted in the curve in graph G begins as a SEMI-VARIABLE cost that in total increases at a decreasing rate. However, once a certain level of output is reached (i.e., at eight squares along the output range horizontal axis), the cost becomes a FIXED cost. H.

The cost depicted in the curve in graph H is a STEP FUNCTION cost.

The cost depicted in the curve in graph I is a SEMI-VARIABLE cost that in total increases at a decreasing rate.

The cost depicted in the curve in graph J is a VARIABLE cost.

The cost depicted in the curve in graph K is a FIXED cost.

The cost depicted in the curve in graph L is a SEMI-VARIABLE cost that in total increases at an increasing rate. 3-18

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Cost Behavior and Forecasting

E 3-42 (Continued) 2. A graphical depiction of written cost behavior descriptions represents an example of data visualization because it provides the decision maker with a visual or pictorial format for viewing the data. This data visualization improves the decision maker’s ability to recognize the shape or type of the given cost behavior. For example, while recognizing a fixed cost in a table of data or a written description might not be very challenging for most decision makers, recognizing most other cost behavior patterns is quite difficult unless displayed visually such as in a graph. Furthermore, detecting less common but important cost behavior patterns, such as step costs or semi-variable costs, is particularly challenging when they are only described verbally and not shown visually in a graph. As explained in the text, decision makers can make consequential errors in forecasting costs (an example of predictive data analytics) when they fail to detect that a particular cost behaves in such a manner that it increases at an increasing rate (i.e., a semi-variable) or will step up to higher levels of total cost at certain intervals as the cost driver (e.g., units produced) increases. E 3-43 1.

Cost

Cost of Giving Opening Shows $8,000 $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $0 0

Number of Opening Shows

This is a strictly variable cost. 2.

Cost

Cost of Running Gallery $100,000 $80,000 $60,000 $40,000 $20,000 $0 0

Number of Opening Shows

This is a fixed cost. 3-19

CHAPTER 3

Cost Behavior and Forecasting

E 3-43 (Continued) 3. Ben's Total Costs $88,000 $87,000

Total Cost

$86,000 $85,000 $84,000 $83,000 $82,000 $81,000 $80,000 $79,000 0

Number of Opening Shows

This is a mixed cost.

E 3-44 1. Total Cost = $80,000 + ($500 × Number of Opening Shows) 2.

Total Cost = $80,000 + ($500 × 12) = $86,000 Total Cost = $80,000 + ($500 × 14) = $87,000

3-20

CHAPTER 3

Cost Behavior and Forecasting

E 3-45 1. The high point is March with 1,700 appointments. The low point is August with 1,200 appointments. Given that Sophia's Spa is located in a college town, it makes sense that the busiest month occurs during peak spring break season (March) when students likely have less access to natural sunlight and warm temperatures as compared to summer months. 2.

Variable Rate

= ($39,000 – $33,000)/(1,700 – 1,200) = $6,000/500 appointments = $12 per tanning appointment

Using the high point: Fixed Cost = $39,000 – ($12 × 1,700) = $18,600 OR Using the low point: Fixed Cost = $33,000 – ($12 × 1,200) = $18,600 3.

Total Tanning Service Cost = $18,600 + ($12 × Number of Appointments)

Total Predicted Cost for September = $18,600 + ($12 × 1,650) = $38,400 Total Fixed Cost for September = $18,600 Total Predicted Variable Cost for September = $12 × 1,650 = $19,800

Total Predicted Cost for September (2,100 appointments) = $18,600 + ($12 × 2,100) = $43,800 This question should trigger students to consider the critically important issue of relevant range. While the $43,800 total cost prediction is not much greater than the $38,400 prediction from Requirement 4, Sophia should be concerned that the number of tanning appointments of 2,100 in this calculation is greater than the highest number of tanning appointments (1,700) contained in the 8 months of data upon which the high-low method constructed the cost function. In other words, 2,100 tanning appointments might be outside of Sophia’s current relevant range as 2,100 appointments is 400 (or almost 24%) appointments beyond the 1,700 high point during the previous 8 months. As a result, Sophia should examine whether or not 2,100 monthly tanning appointments is within the current relevant range of tanning appointment capacity. If Sophia’s Spa cannot accommodate the provision of 2,100 tanning appointments in a month, then additional variable costs per unit (e.g., paying a higher hourly rate for overtime to accommodate the additional hours) and/or additional fixed costs (e.g., leasing more spray tanning equipment or space) would need to be incurred. Any such cost increases would need to be factored into generating an accurate prediction of total cost for 2,100 total tanning appointments in September.

3-21

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Cost Behavior and Forecasting

E 3-45 (Continued) 6. Using the high-low method means that Sophia's estimate of the cost formula (and therefore the cost behavior patterns) is based on only two data points and ignores all of the other data. She should investigate to be sure that neither the high nor the low data point are outliers that would distort the cost formula results. Also, Sophia might be wise to calculate the cost formula 6 to 12 months later after a longer time period has elapsed since starting the tanning business. More time, and data, would help her judge whether the high and low points are outliers or are representative of the typical cost behavior patterns in her new tanning business. E 3-46

Yes, it appears that there is a linear relationship between tanning cost and number of appointments.

E 3-47 1. Total Cost of Tanning Services = $17,844 + ($12.78 × Number of Appointments) 2.

Total Predicted Cost for September = $17,844 + ($12.78 × 1,550) = $37,653

3-22

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Cost Behavior and Forecasting

E 3-48 1. Airplane depreciation: Variable Rate = ($18,000,000 – $18,000,000)/(44,000 – 28,000) = $0 Fixed Cost = $18,000,000 – ($0 × 44,000) = $18,000,000 2.

Total Cost of Airplane Depreciation = $18,000,000 Airplane depreciation is a strictly fixed cost.

Fuel: Variable Rate = ($445,896,000 – $283,752,000)/(44,000 – 28,000) = $10,134 Fixed Cost = $445,896,000 – ($10,134 × 44,000) = $0

Total Cost of Fuel = $10,134 × (Number of Airplane Flight Hours) Fuel is a strictly variable cost.

Airplane maintenance: Variable Rate = ($15,792,000 – $11,504,000)/(44,000 – 28,000) = $268 Fixed Cost = $15,792,000 – ($268 × 44,000) = $4,000,000

Total cost of airplane maintenance: $4,000,000 + ($268 × Number of Airplane Flight Hours) Airplane maintenance is a mixed cost.

Total cost of each resource at 36,000 machine hours: Total Cost of Airplane Depreciation

= $18,000,000

Total Cost of Fuel = $10,134 × 36,000

= $364,824,000

Total Cost of Airplane Maintenance

= $4,000,000 + ($268 × 36,000) = $13,648,000

3-23

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Cost Behavior and Forecasting

E 3-49 1. Total Annual Cost of Airplane Depreciation

= 12 × $18,000,000 = $216,000,000 Total Annual Cost of Fuel = $10,134 × (Annual Number of Airplane Flight Hours) Total Annual Cost of Airplane Maintenance = (12 × $4,000,000) + ($268 × Number of Airplane Flight Hours) $48,000,000 + ($268 x Number of Airplane Flight Hours) Note: Fixed and variable costs, based on monthly data, are computed in Exercise 3-48.

Total Annual Cost of Airplane Depreciation

= 12 × $18,000,000 = $216,000,000 = $4,864,320,000

Total Annual Cost of Fuel = $10,134 × 480,000 Total Annual Cost of Airplane Maintenance: (12 × $4,000,000) + ($268 × 480,000) = $176,640,000 $48,000,000 + ($268 x 480,000) E 3-50 1. Answers will vary. However, whenever regression is used as a diagnostic data analytic tool, the intent is to answer the question, “Why is it happening? ”. Thus, Woody could use regression to identify statistically significant drivers (i.e., independent variables) of costs that are important to Fixit Company. In so doing, he could better explain why Fixit’s costs increase or decrease as the level of the cost drivers increase or decrease. Similarly, Woody could use regression to identify statistically significant drivers of sales revenue. In so doing, Fixit’s sales team could better understand why certain promotional activities or home improvement services are associated with increases or decreases in Fixit’s total revenue. 2. Again, answers will vary. However, whenever regression is used as a predictive data analytic tool, the intent is to answer the question, “ What is likely to happen ?”. Thus, Woody then could use regression to forecast (or predict) Fixit’s future costs using the statistically significant cost drivers and knowledge of how many cost driver units (e.g., pounds of construction materials, number of sub-contractor labor hours, gallons of work truck fuel, etc.) were expected to be consumed on a particular client job. Similarly, Woody also could use regression to forecast Fixit’s future sales revenues using the statistically significant revenue drivers and knowledge of how many revenue driver units (e.g., how many of each job type were expected to be performed, how many advertisements were run, etc.). E 3-51 1. Total Cost of Receiving = $147,400 + ($210 × Number of Parts Inspected) 2.

Independent variable—number of parts inspected Dependent variable—total cost of receiving Variable rate—$210 per part inspected Fixed cost per month—$147,400

Total Cost of Receiving

= $147,400 + ($210 × 6,800) = $1,575,400 3-24

CHAPTER 3

Cost Behavior and Forecasting

E 3-52 1. Total Annual Cost of Receiving: = (12 × $147,400) + ($210 × Number of Parts Inspected in a Year) = $1,768,800 + ($210 × Number of Parts Inspected in a Year) Note: Fixed and variable costs, based on monthly data, are computed in Exercise 3-51. 2.

Total Annual Cost of Receiving

= $1,768,800 + ($210 × 70,000) = $16,468,800

E 3-53 1. Overhead cost……………… Dependent variable

$150,000……………………

Fixed cost (intercept)

$52……………………………

Variable rate (slope)

Direct labor hours…………

Independent variable

Next Month’s Budgeted Overhead Cost

= $150,000 + ($52 × 8,000) = $566,000

Next Quarter’s Budgeted Overhead Cost

= (3 × $150,000) + ($52 × 23,000) = $450,000 + $1,196,000 = $1,646,000

Next Year’s Budgeted Overhead Cost

= (12 × $150,000) + ($52 × 99,000) = $1,800,000 + $5,148,000 = $6,948,000

3-25

CHAPTER 3

Cost Behavior and Forecasting

E 3-54 1.

Unit Direct Materials Cost = $80,000/20,000 units = $4.00 Unit Direct Labor Cost = $101,400/20,000 units = $5.07 Unit Variable Overhead Cost = $15,600/20,000 units = $0.78 Unit Fixed Overhead Cost = $54,600/20,000 units = $2.73

Unit direct materials cost………………………………………………… Unit direct labor cost……………………………………………………… Unit variable overhead cost……………………………………………… Unit fixed overhead cost…………………………………………………… Absorption cost per unit………………………………………………

Ending Inventory in Units = 20,000 – 18,900 = 1,100 units

Absorption-Costing Ending Inventory = $12.58 × 1,100 units = $13,838

$ 4.00 5.07 0.78 2.73 $12.58

E 3-55 1. Unit direct materials cost ($123,000/50,000 units)…………………… Unit direct labor cost ($93,000/50,000 units)…………………………… Unit variable overhead cost ($65,000/50,000 units)…………………… Variable-costing cost per unit………………………………………… 2.

Variable-Costing Ending Inventory = $5.62 × (50,000 – 47,300) = $15,174

3-26

$2.46 1.86 1.30 $5.62

CHAPTER 3

Cost Behavior and Forecasting

E 3-56 1. Unit direct materials cost……………………… $ 9.95 Unit direct labor cost…………………………… 2.75 Unit variable overhead cost…………………… 1.65 2.50 Unit fixed overhead cost………………………… Absorption cost per unit…………………… $16.85 2.

Unit direct materials cost……………………… $ 9.95 Unit direct labor cost…………………………… 2.75 Unit variable overhead cost…………………… 1.65 Variable cost per unit………………………… $14.35

Absorption-costing income: Sales ($32 × 28,700)…………………………………………… Less: Cost of goods sold ($16.85 × 28,700)……………… Gross margin……………………………………..………… Less: Variable selling expense ($2 × 28,700)………………… Fixed selling expense……………………………………… Fixed administrative expense………………….………… Operating income………………………………………………

$918,400 483,595 $434,805 $ 57,400 65,500 231,000

353,900 $ 80,905

Variable-costing income: Sales ($32 × 28,700)…………………………………………… Less variable expenses: Cost of goods sold ($14.35 × 28,700)…………………… Selling expense ($2.00 × 28,700)……..………………… Contribution margin……………………………….………… Less fixed expenses: Fixed overhead ($2.50 × 30,000)………...…...………… Selling and administrative expenses………..………… Operating income…………………………………..…………

3-27

$918,400 $411,845 57,400

$ 75,000 296,500

469,245 $449,155

371,500 $ 77,655

CHAPTER 3

Cost Behavior and Forecasting

E 3-57 1. SUMMARY OUTPUT Regression Statistics Multiple R

0.95657699

R Square

0.915039537

Adjusted R Square

0.90087946

Standard Error

27.97952866

Observations

ANOVA df

Regression

50588.87585

Residual

4697.124145

782.8540242

Total

55286

Coefficients

Standard Error

t Stat

Significance F

64.62108425

0.000198083

P-value

Lower 95%

Upper 95%

Lower 95.0%

Upper

Intercept

4315.593336

158.0347739

27.30787174

1.59382E-07

3928.896176 4702.290497

3928.896176

4702

DL hours

1.846241957

0.229668533

8.038724044

0.000198083

1.284263303

2.4

2.40822061

Overhead Cost = $4,316 + ($1.85 × Number of Direct Labor Hours)

The R² is 0.915, or 91.5%. In other words, 91.5% of the variation in the overhead costs from month to month can be explained by the variability in the number of direct labor hours. Another factor (or factors) accounts for 8.5% of the variability in monthly overhead cost. Thus, direct labor hours is a good predictor of overhead cost. Another factor (or factors) accounts for the remaining 8.5% of overhead cost.

Overhead Cost = $4,316 + ($1.85 × 700) = $5,611

3-28

CHA

E 3-58 1. SUMMARY OUTPUT Regression Statistics Multiple R

0.917226463

R Square

0.841304384

Adjusted R Square

0.825434822

Standard Error

164.5461114

Observations

ANOVA df

Regression

1435368.689

Residual

270754.2279

27075.42279

Total

1706122.917

Coefficients

Standard Error

Significance F

53.01371284

2.6597E-05

t Stat

P-value

Lower 95%

Upper 95%

Lower 95.0%

Intercept

942.1029802

88.16653478

10.68549402

8.62887E-07

745.6556994

1138.550261

745.6556994

Deliveries

1.78781384

0.245543354

7.28105163

2.6597E-05

1.240709154

2.334918525

1.240709154

Delivery Cost = $942 + ($1.79 × Number of Deliveries)

The R² is 0.841, or 84.1%. In other words, 84.1% of the variation in the monthly cost of delivery from month to mo can be explained by the variability in the number of deliveries. Another factor (or factors) accounts for just unde of the variability in monthly delivery cost. This means that the number of deliveries is a fairly good predictor of t cost.

Delivery Cost = $942 + ($1.79 × 300) = $1,479

3-29

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Cost Behavior and Forecasting

E 3-58 (Continued) 5.

Remember that the original predicted total cost = $942 + ($1.79 × Number of Deliveries) = $942 + ($1.79 × 300) = $1,479 Therefore, the highest (or maximum) total cost would be: = ($942 × 1.2) + ($1.79 × 1.20 × 300) = $1,775 The lowest (or minimum) total cost would be: = ($942 × 0.80) + ($1.79 × 0.80 × 300) = $1,183 Therefore, the range in total costs is calculated by taking the highest total cost and subtracting the lowest total cost: = $1,775 − $1,183 = $592 range It is worthy to note that this range in total cost appears likely to be material in that it represents a deviation of 40% ($592/$1,479) from the regression’s original point estimate calculated in Requirement 2. There are multiple ways that students can alter their spreadsheet to incorporate the 20% change in both cost components. One way to incorporate this 20% information is to multiply the original point estimate (calculated in Requirement 2) by 1.2 to obtain the highest (or maximum) total cost estimate of $1,775. The original point estimate can then be multiplied by 0.80 to obtain the lowest (or minimum) total cost estimate of $1,183.

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Cost Behavior and Forecasting

PROBLEMS P 3-59 1.

Mixed cost

Variable cost

Step cost with narrow steps

Fixed cost

Variable cost (assumes counter help can be called in or sent back home as the need arises)

Step cost

Mixed cost

While the contract stays the same ($150 per month plus $15 per hour of technical time), the company’s need for computer technical help is so stable that the same number of hours are required each month. Now, the cost is essentially fixed.

The company drives the vehicles on identical trips each month. Thus, the mileage and type of trip (highway vs. in town) never vary. Now, the cost is essentially fixed.

If beer is purchased in advance each day, in barrels to be tapped at night, and the leftover beer is poured down the drain at the close of business each day, the cost would be a step cost.

The college may use so much paper that it considers the cost of maintaining the printers and copiers as essentially variable.

Suppose that the dental office is located in a large shopping mall that charges rent based on the level of sales. Rent would be variable.

If the law office expanded and an additional, temporary receptionist was hired on days with a heavy volume of appointments, the cost would be mixed.

If the individuals working behind the counter are assured that their complete shift would be worked once they arrive, the cost would be a step cost (assumes more counter help could be called in if demand rose).

If the hygienists were paid based on number of patients seen, the cost would be variable.

If a company decided that the fixed amount of $15 per month was very small relative to the total electrical bill (e.g., $500 per month), then the cost could be viewed as variable.

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Cost Behavior and Forecasting

P 3-60 a.

This must be the high-low method because she has only two data points (one for each year).

This is the method of least squares done on a personal computer. While it is possible to use a personal computer to do the other methods, it is unlikely that Francis would have gone to all the trouble of entering 60 months of data simply to use the high-low method.

Ron is making a scattergraph.

In all probability, Lois is using the high-low method. She can do this quickly and get some rough results in time for her meeting.

P 3-61 a. b. c. d. e. f. g. h. i. j.

Variable cost Committed fixed cost Discretionary fixed cost Discretionary fixed cost Discretionary fixed cost Variable cost Variable cost Discretionary fixed cost Discretionary fixed cost Variable cost

3-32

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Cost Behavior and Forecasting

P 3-62 1. Based on a visual inspection of the data table alone, it is very difficult, if not impossible, to accurately assess whether the relationship between the cost driver (i.e., independent variable of receiving orders) and the total cost (i.e., dependent variable of receiving cost) is linear or nonlinear. 2.

Scattergraph of Receiving Activity $35,000

Receiving Cost

$30,000 $25,000 $20,000 $15,000 $10,000 $5,000 $0 0

500

1,000

1,500

2,000

Number of Receiving Orders

Based on examination of the scattergraph, the relationship appears to be reasonably linear. This assessment likely is considerably easier (and more accurate) based upon looking at the scattergraph plot than the table of data. 3.

Using the high-low method: Variable Receiving Cost = ($27,000 – $15,000)/(1,700 – 700) = $12 Fixed Receiving Cost = $15,000 – ($12 × 700) = $6,600 Predicted cost for 1,450 receiving orders: Receiving Cost = $6,600 + ($12 × 1,450) = $24,000

Receiving Cost for the Quarter

= (3 × $6,600) + ($12 × 4,650) = $19,800 + $55,800 = $75,600

Receiving Cost for the Year

= (12 × $6,600) + ($12 × 18,000)

= $79,200 + $216,000 = $295,200 As with the assessment of linearity (see requirement 1), identifying outliers simply by looking at a table of data is very difficult for most individuals. However, the scattergraph plot—a simple yet effective data visualization technique—allows most individuals to more easily identify trends in data and, as a result, also identify any data point(s) that represent significant deviations from such trends. For example, the scattergraph plot is 3-33

CHAPTER 3

Cost Behavior and Forecasting

P 3-62 (Continued) likely to suggest to many students that Month 2 (700 Receiving Orders, 15,000 Receiving Cost) is an outlier as perhaps the cost is too high or the number of orders is too low to fit what otherwise appears to be a consistent linear pattern in the plotted data. P 3-63 1. Yes, the relationship appears to be reasonably linear. Compared to the scattergraph using all 10 months of data (i.e., requirements of P 3-62), the scattergraph using only 9 months of data appears more clearly to be linear in nature (although both scattergraphs appear to depict a linear relationship). The following scattergraph shows a plot of the 9 months of data (i.e., Month 2 outlier excluded) along with the associated high-low cost function line.

Using the high-low method: Variable Receiving Cost = ($27,000 − $16,000)/(1,700 − 900) = $13.75 Fixed Receiving Cost = $16,000 − ($13.75 × 900) = $3,625 Removing the outlier data point results in considerable differences in the variable and fixed cost components: Using All 10 Months

Using Only 9 Months

Change

Per-unit variable cost:

$12.00

$13.75

$1.75 (or 15%)

Total fixed cost:

$6,600

$3,625

$2,975 (or 45%)

As shown in the above chart, the per-unit variable receiving cost increases by $1.75 from $12 to $13.75 (or an increase of about 15%) and the total fixed receiving cost decreases by $2,975 from $6,600 to $3,625 (or a decrease of about 45%). 3-34

CHAPTER 3

Cost Behavior and Forecasting

P 3-63 (Continued) It is also interesting to note that a regression analysis (method of least squares) based on only the remaining 9 months of data shows a similar directional pattern of change in the two cost components. Specifically, the regression output estimates variable receiving cost to be $16.42 (vs. $15.15 using all 10 months of data) and fixed cost to be $1,419 (vs. $3,212 using all 10 months of data). The R2 is .791 with only 9 months of data (vs. .848 with all 10 months of data). P 3-64 displays the regression output referenced in this paragraph based on using all 10 months of data. 3. 4.

Predicted cost for 1,450 receiving orders: Receiving Cost = $3,625 + ($13.75 × 1,450) = $23,562.50 The following scattergraph shows a plot of all 10 months of data along with the associated high-low cost function line.

$6,600 + (12 x # of Receiving Orders) The following scattergraph shows a plot of the 9 months of data (i.e., Month 2 outlier excluded) along with the associated high-low cost function line.

$3,625 + ($13.75 x Receiving orders) 3-35

CHAPTER 3

Cost Behavior and Forecasting

P 3-63 (Continued) 4. Removing the outlier (i.e., Month 2, which also represents the low data point in the 10 months of data) should increase the slope (i.e., become steeper) of the line (estimated cost function). Also, in steepening the slope, the y-axis intercept should decrease (i.e., the line should cross the y-axis at a lower location on the vertical axis). Taken together, removing this outlier data point should increase the variable cost per unit (or slope of the line) and decrease the total fixed cost (or y-axis intercept). As shown in an earlier chart (for Requirement 2) of the variable and fixed costs calculated based on the 9 months of data, the new estimates of per-unit variable receiving cost and total fixed receiving cost reflect this reasoning. Specifically, as the solution to requirement 2 noted, the variable cost per unit increased from $12.00 to $13.75 (the relatively steeper line shown in the 9-month plot) and total monthly fixed receiving cost decreased from $6,600 to $3,625 (the lower y-axis intercept shown in the 9-month plot). 5.

This problem provides students with practice in using data visualization (e.g., scattergraph plots) to detect important aspects within a data set, including the linearity (or nonlinearity) of the relationship in question and the presence (or absence) of outliers. Furthermore, this problem provides students with practice in using a common management accounting data analytic technique (i.e., cost forecasting using the high-low method) to estimate the financial consequences of these data aspects, such as calculating the changes in variable and fixed cost that result from dropping an identified outlier data point. Finally, using the high-low method to estimate costs (such as for a given number of expected receiving orders) represents an example of predictive data

analytics.

3-36

CHAPTER 3

P 3-64 1.

Receiving Cost = $3,212 + ($15.15 × Number of Receiving Orders)

Receiving Cost = $3,212 + ($15.15 × 1,450) = $25,180

Receiving Cost for the Quarter

= (3 × $3,212) + ($15.15 × 4,650) = $9,636 + $70,448* = $80,084

* Rounded

Receiving Cost for the Year

= (12 × $3,212) + ($15.15 × 18,000) = $38,544 + $272,700 = $311,244

P 3-65 1.

Salaries: Senior accountant—fixed Office assistant—fixed Internet and software subscriptions—mixed Consulting by senior partner—variable Depreciation (equipment)—fixed Supplies—mixed Administration—fixed Rent (offices)—fixed Utilities—mixed

3-37

Cost Behavior and Forecasting

CHAPTER 3

Cost Behavior and Forecasting

P 3-65 (Continued) 2.

Internet and software subscriptions: Variable Rate = ($850 – $700)/(150 – 120) = $5 Fixed Amount = $850 – ($5 × 150) = $100 Supplies: Variable Rate = ($1,100 – $905)/(150 – 120) = $6.50 Fixed Amount = $1,100 – ($6.50 × 150) = $125 Utilities: Variable Rate = ($365 – $332)/(150 – 120) = $1.10 Fixed Amount = $365 – ($1.10 × 150) = $200

Salaries: Senior accountant…………………………………… Office assistant………………………………………… Internet and software subscriptions…………………… Consulting by senior partner…………………………… Depreciation (equipment)……………………………… Supplies…………………………………………………… Administration…………………………………………… Rent (offices)……………………………………………… Utilities……………………………………………………… Total cost………………………………………………

Unit Fixed

Variable Cost

$2,500 1,200 100 — 2,400 125 500 2,000 200 $9,025

— — $ 5.00 10.00 — 6.50 — — 1.10 $22.60

Total Clinic Cost = $9,025 + ($22.60 × Professional Hours) For 140 professional hours: Clinic Cost = $9,025 + ($22.60 × 140) = $12,189 Charge per Hour = $12,189/140 = $87.06 Fixed Charge per Hour = $9,025/140 = $64.46 Variable Charge per Hour = $22.60 4.

For 170 professional hours: Charge per Hour = ($9,025/170) + $22.60 = $75.69 The charge drops because the fixed costs are spread over more professional hours.

3-38

CHAPTER 3

Cost Behavior and Forecasting

P 3-66 1.

Committed resource charges: monthly fee, activation fee, cancellation fee (if triggered by contract cancellation prior to 1 year) Flexible resource charges: all additional charges for airtime, long distance, and roaming.

Plan 1: Minutes Available 60 minutes

= =

Minutes Used 45 minutes

+ +

Unused Minutes 15 minutes

Plan 2: Minutes Available 120 minutes

= =

Minutes Used 45 minutes

+ +

Unused Minutes 75 minutes

Plan 1 is more cost-effective. Jana will have some unused capacity (on average, 15 minutes a month), and the overall cost will be lower by $10 per month. 3.

Plan 1:* Minutes Available 60 minutes

= =

Minutes Used 90 minutes

+ +

Unused Minutes 30 minutes

Minutes Available 60 minutes

= =

Minutes Used 60 minutes

+ +

Unused Minutes 0 minutes

Additional Minutes = 30 minutes * There are a number of ways to illustrate the use of minutes with Plan 1. Here are two possibilities. The problem, of course, is that all included monthly minutes are used and Jana must purchase additional minutes.

Plan 2: Minutes Available 120 minutes

= =

Minutes Used 90 minutes

+ +

Unused Minutes 30 minutes

Plan 2 is now more cost-effective, as the monthly cost is $30. Under Plan 1, Jana will pay $20 plus $30 (30 minutes × $1.00) per month. (The $1.00 additional charge includes the airtime and regional roaming charge.) 4.

Results of students’ analyses will vary.

3-39

CHAPTER 3

Cost Behavior and Forecasting

P 3-67 1.

Variable costs—salary of the two paralegals times the percentage of time spent in processing uncontested claims; salary of the accountant times the percentage of time spent in this activity; cost of claims forms, checks, envelopes, and postage. Fixed costs—salaries of the two paralegals times the percentage of time spent in handling contested claims; depreciation on office equipment used in claims processing activity.

The independent variable is number of claims; the dependent variable is cost of claims processing.

The low point is March with $31,260 cost and 4,900 claims; the high point is June with $44,895 cost and 7,930 claims. Variable Rate

= ($44,895 – $31,260)/(7,930 – 4,900) = $13,635/3,030 claims = $4.50 per claim

Using the high point: Fixed Cost = $44,895 – ($4.50 × 7,930) = $9,210 Total Cost of Claims Processing = $9,210 + ($4.50 × Claims) 4.

Cost of Outsourcing = $4.60 × 75,600

= $347,760

Cost of Processing In-House

= (12 × $9,210) + ($4.50 × 75,600) = $110,520 + $340,200 = $450,720

Tiffany should outsource the claims processing for a savings of $102,960 ($450,720 – $347,760).

3-40

CHAPTER 3

Cost Behavior and Forecasting

P 3-68 1.

The state unemployment insurance premiums and the average cost per injury are fixed with respect to the number of speakers sold. The state unemployment insurance premiums are variable (to an extent) with respect to the number of injury claims. That is, over a certain base premium, the premium increases as the number of injuries increases. The average cost per injury is variable with respect to the number of serious versus nonserious injuries incurred. However, Kicker’s experience was that serious injuries could be reduced through education and changes in dangerous practices. The number of speakers sold was not relevant.

Yes, the safety program paid for itself. There was a $50,000 reduction in annual cost of state unemployment insurance premiums and a $22,000 reduction in the total cost of injuries per year [$22,500 ($1,500 × 15) – $500 ($50 × 10)]. This is a monetary reduction of $72,000 per year versus the $60,000 salary of the safety director. In addition, the number of workdays lost went from 30 to 0, and the number of serious injuries went from 4 to 0. While these reductions were not quantified (outside the average injury cost), they are important and are considered a benefit of the safety program.

3-41

CHAPTER 3

Cost Behavior and Forecasting

P 3-69 1.

Direct materials……………………….………………… Direct labor……………………….……………………… Variable overhead……………………….……………… Fixed overhead ($180,000/200,000 units)…………… Total……………………….……………………………

$2.85 1.92 1.60 0.90 $7.27

Per-unit inventory cost on the balance sheet is $7.27. Units in Ending Inventory

= 8,200 units + 200,000 units – 204,300 units = 3,900 units

Total Ending Inventory 2.

= $7.27 × 3,900 units = $28,353

Absorption-costing income: Sales (204,300 units × $9)…….………….……………….………….… Less: Cost of goods sold (204,300 units × $7.27)………………… Gross margin……………………………………………...………… Less: Selling and administrative expenses……………………….… Operating income…………………………………….………………

Direct materials……………………….………………… Direct labor……………………….……………………… Variable overhead……………………….……………… Total……………………….……………………………

$1,838,700 1,485,261 $ 353,439 279,870 $ 73,569

$2.85 1.92 1.60 $6.37

Per-unit inventory cost under variable costing equals $6.37. This differs from the per-unit inventory cost in Requirement 1 because the balance sheet is for external use and reflects absorption costing. Variable costing does not include per-unit fixed overhead. Also, the difference between the number of units produced versus sold, multiplied by the fixed overhead per unit, equals the difference in operating income between absorption and variable costing income statements. 4.

Variable-costing income: Sales (204,300 units × $9)…….………….……………….………….… $1,838,700 Less variable expenses: Variable cost of goods sold (204,300 units × $6.37)…………… 1,301,391 Variable selling and administrative (204,300 units × $0.90)… 183,870 Contribution margin………………………………………………...…… $ 353,439 Less fixed expenses: 180,000 Fixed overhead…………………………………………….………… 96,000 Fixed selling and administrative…………………………………… Operating income…………………...………………………...………… $ 77,439

3-42

CHAPTER 3

Cost Behavior and Forecasting

P 3-69 (Continued) 5. Absorption-costing income: Sales (196,700 units × $9)……………………………...……………… Less: Cost of goods sold (196,700 units × $7.27)………………… Gross margin………………………………………...…………………… Less: Selling and administrative expenses……………………………… Operating income…………………………………………………………… Variable-costing income: Sales (196,700 units × $9)……………………………...……………… Less variable expenses: Variable cost of goods sold (196,700 units × $6.37)……………… Variable selling and administrative (196,700 units × $0.90)……… Contribution margin………………………………….……………………… Less fixed expenses: Fixed overhead…………………………………………………………… Fixed selling and administrative………………………………….…… Operating income…………………………………..…………………………

3-43

$1,770,300 1,430,009 $ 340,291 273,030 $ 67,261

$1,770,300 1,252,979 177,030 $ 340,291 180,000 96,000 $ 64,291

CHAPTER 3

Cost Behavior and Forecasting

P 3-70 1.

Results of regressions: 10 Months’ Data

12 Months’ Data

3,212 15.15 0.85

3,820 15.10 0.75

Intercept…………………… Slope………………………… R²…………………………… 2.

Scattergraph of Receiving Activity—12 Months' Data

Receiving Cost

$35,000 $30,000 $25,000 $20,000 $15,000 $10,000 $5,000 $0 0

500

1,000

1,500

2,000

Number of Receiving Orders

The regression run on the 11 months of data from “typical” months appears to be better than the one for all 12 months. R² is higher for the regression without the outlier (85.88% vs. 74.51%), and the scattergraph gives Theodore confidence that the data without the outlier describe a relatively linear relationship. Since the storm damage is not expected to recur, Month 11 can safely be dropped from a regression meant to help predict future receiving cost. The point for the 11th month (1,200 receiving orders and $28,000 total receiving cost) appears to be an outlier. Since the cost was so much higher in this month due to an event that is not expected to happen again, this data point could easily be dropped. Then, data from the 11 remaining months could be used to develop a cost formula for receiving cost.

3-44

CHA

P 3-70 (Continued) 3.

Results for the method of least squares after dropping Month 11. SUMMARY OUTPUT Regression Statistics Multiple R

0.926737002

R Square

0.85884147

Adjusted R Square

0.843157189

Standard Error

2051.780599

Observations

ANOVA df

Regression

230520858.3

Residual

37888232.62

4209803.625

Total

268409090.9

Coefficients

Standard Error

Significance F

54.75810248

4.10397E-05

t Stat

P-value

Lower 95%

Upper 95%

Lower 95.0%

Intercept

3168.559746

2565.261709

1.235179917

0.248035426

–2634.465393

8971.584884

–2634.465393

Receiving Orders

15.17946388

2.051314444

7.399871788

4.10397E-05

10.53906823

19.81985953

10.53906823

Receiving Cost = $3,169 + ($15.18 × Number of Receiving Orders) Predicted Receiving Cost for a Month = $3,169 + ($15.18 × 1,450) = $25,180

3-45

CHAPTER 3

Cost Behavior and Forecasting

P 3-71 1.

Scattergraph of Power Cost $45,000

Cost of Power

$40,000 $35,000 $30,000 $25,000 $20,000 $15,000 $10,000 $5,000 $0 0

10,000

20,000

30,000

40,000

Number of Machine Hours

The overall relationship looks reasonably linear—although the data point for the first quarter may be an outlier. 2.

Using the high-low method: Variable Power Cost

= ($42,500 – $29,000)/(30,000 – 18,000) = $1.125

Fixed Power Cost

= $42,500 – ($1.125 × 30,000) = $8,750

Total Power Cost

= $8,750 + ($1.125 × Number of Machine Hours)

3-46

CHAPTER 3

P 3-71 (Continued) 3.

Output of regression program: SUMMARY OUTPUT Regression Statistics Multiple R

0.893359672

R Square

0.798091504

Adjusted R Square

0.764440088

Standard Error

2673.924883

Observations

ANOVA df

Regression

169569504.3

169569504.3 23.71643159

Residual

42899245.69

7149874.282

Total

212468750

Coefficients

Standard Error

Intercept

6899.784483

5910.387735

Machine Hours

1.209051724

0.248267693

t Stat

P-value

Significance F 0.002794513

Lower 95%

Upper 95%

Lower 95.0%

Upper 95.0%

1.167399635 0.287338538

–7562.413284

21361.98225

–7562.413284

21361.982

4.869951909 0.002794513

0.601562566

1.816540883

0.601562566

1.8165408

Total Power Cost = $6,900 + ($1.209 × Number of Machine Hours)

R² is 0.798, which when rounded to two decimal places is .80, or 80.0%. This is not bad; however, 20% of the variance in the dependent variable (power cost) is not explained by the independent variable (machine hour

CHAPTER 3

Cost Behavior and Forecasting

P 3-71 (Continued) 4.

The output of a regression program after Quarter 1 (20,000, $26,000) has been dropped. SUMMARY OUTPUT Regression Statistics Multiple R

0.9578835

R Square

0.9175408

Adjusted R Square

0.90104896

Standard Error

1367.28482

Observations

ANOVA df

Regression

104009803.9

Residual

9347338.936

1869467.787

Total

113357142.9

Coefficients

Standard Error

Intercept

12407.563

Machine Hours

1.00980392

F 55.63605034

Significance F 0.000683462

t Stat

P-value

Lower 95%

Upper 95%

Lower 95.0%

3289.994132

3.771302479

0.013005506

3950.363873

20864.76218

3950.363873

0.135381371

7.458957725

0.000683462

0.661795029

1.357812814

0.661795029

Total Power Cost = $12,408 + ($1.01 × Number of Machine Hours)

This regression looks better in terms of R². The R² for this regression is 0.917, which when rounded to two dec 0.92, or 92%. By dropping the outlier, the explanatory power of machine hours is much improved. However, the should first carefully examine Quarter 1 to see what the reason was for the lower than expected power cost. If is that something occurred that is not expected to reoccur, then the point can be dropped. If the reason is one expected to reoccur, then that needs to be factored into the controller’s judgment about power costs.

3-48

CHAPTER 3

Cost Behavior and Forecasting

P 3-72 1.

The scattergraph provides evidence for a linear relationship, but the observation for 300 moves may be an outlier. Cost of Moving Materials $16,000 $14,000

Cost

$12,000 $10,000 $8,000 $6,000 $4,000 $2,000 $0 0

500

Number of Moves

High (800, $14,560); Low (100, $3,000) Variable Rate

= ($14,560 – $3,000)/(800 – 100) = $11,560/700 moves = $16.514 *

* Variable rate rounded to three decimal places. Fixed Rate Cost = $3,000 – ($16.514 × 100) = $3,000 – $1,651.40 = $1,349 ** ** Total fixed cost rounded to the nearest dollar.

Total Cost

= $1,349 + ($16.514 × Number of Moves) = $1,349 + ($16.514 × 550) = $10,432 ***

*** Total cost rounded to the nearest dollar.

3-49

1,000

CHAPTER 3

Cost Behavior and Forecasting

P 3-72 (Continued) 3.

Output of the regression routine calculated by a spreadsheet: SUMMARY OUTPUT Regression Statistics Multiple R

0.96785846

R Square

0.936749999

Adjusted R Square

0.926208332

Standard Error

1266.703399

Observations

ANOVA df

Regression

Residual Total

142581862.5

9627225

1604537.5

152209087.5

Coefficients

Standard Error

t Stat

Significance F

88.86165795

P-value

8.10236E-05

Lower 95%

Upper 95%

Lower 95.0%

Intercept

497.5

987.0073364

0.504048938

0.63219637

–1917.619944

2912.619944

–1917.619944

Number of Moves

18.425

1.954565778

9.426646167

8.10236E-05

13.64234984

23.20765016

13.64234984

Rounding the coefficients: Variable Rate = $18.43 per move Fixed Rate

= $498

Total Cost

= $498 + ($18.43 × Number of Moves) = $498 + ($18.43 × 550) = $10,635

R² = 0.94 (rounded) This says that 94% of the variability in the cost of moving materials is explained by the number of moves.

3-50

CHAPTER 3

Cost Behavior and Forecasting

P 3-72 (Continued) 4.

Normally, we would prefer the least squares method since the data appear to be linear. However, the third observation may be an outlier. If the third observation (300 moves and $3,400 of cost) is dropped, the R² rises to 99%. The new cost formula would be: Total Cost = $1,411 + ($17.28 × Number of Moves) The higher fixed cost is much more in keeping with what we observed with the scattergraph in Requirement 1.

3-51

CHAPTER 3

Cost Behavior and Forecasting

CASES Case 3-73 1. The order should cover the variable costs described in the cost formulas. These variable costs represent flexible resources. Materials ($94 × 20,000)……………………………………………………… Labor ($16 × 20,000)…………………………………………………………… Variable overhead ($80 × 20,000)…………………………………………… Variable selling ($7 × 20,000)………………………………………………… Total additional resource spending……………………………….……… Divided by units produced…………………………………….…………… Total unit variable cost……………………………...……………………

$1,880,000 320,000 1,600,000 140,000 $3,940,000 20,000 $ 197

Garner should accept the order because it would cover total variable costs and increase income by $15 per unit ($212 – $197) for a total increase of $300,000. 2.

The coefficients of determination indicate the reliability of the cost formulas. Of the four formulas, overhead activity may be a problem. A coefficient of determination of 0.56 means that only about 56% of the variability of overhead cost is explained by direct labor hours. This should have a bearing on the answer to Requirement 1 because if the percentage is low, there are activity drivers other than direct labor hours that are affecting variability in overhead cost. What these drivers are and how resource spending would change need to be known before a sound decision can be made.

Resource spending attributable to order: Materials ($94 × 20,000)…………………………………………….………… Labor ($16 × 20,000)…….………………………...………….…..…………… Variable overhead: ($85 × 20,000)……………….……………………………….……...……… ($5,000 × 12)…………………………….…...……………………………… ($300 × 600)……………………………..……………………..…………… Variable selling ($7 × 20,000)…………………………………….…...……… Total additional resource spending………………………………………… Divided by units produced…………………………………………...……… Total unit variable cost………………………………………..…………

$1,880,000 320,000 1,700,000 60,000 180,000 140,000 $4,280,000 20,000 $ 214

The order would not be accepted now because it does not cover the variable activity costs. Each unit would lose $2 ($214 – $212).

3-52

CHAPTER 3

Cost Behavior and Forecasting

Case 3-73 (Continued) It would also be useful to know the step-cost functions for any activities that have resources acquired in advance of usage on a short-term basis. It is possible that there may not be enough unused activity capacity to handle the special order, and resource spending may also be affected by a need (which, in this case, would be unexpected) to expand activity capacity. Case 3-74 1. Carl’s behavior is definitely unethical. He is stealing confidential information from Kilborn and using it for unethical advantages. Kilborn would not approve of Carl's actions and would have a potential lawsuit against him for theft of information. 2.

Assuming that the data were acquired illicitly, Bill’s instincts were on target. To hire Carl in implicit exchange for the confidential information would be a violation of integrity. As soon as Carl joined Brindon’s staff, Kilborn could have legal standing to include the Thomas Electronics Division in any suit against Carl. Not only are Carl’s actions in violation of Kilborn’s code of conduct, but they should also be against the Thomas Electronics Division's code of conduct. Finally, Bill should remember that Carl is basically a disloyal employee. If he is willing to act against the best interests of his former employer, he will certainly be willing to act against the best interests of his current and future employers.

3-53

JOB-ORDER COSTING AND OVERHEAD APPLICATION DISCUSSION QUESTIONS

Job-order costing accumulates costs by jobs, and process costing accumulates costs by processes. Job-order costing is suitable for operations that produce custom-made products that receive different doses of manufacturing costs. Process costing, on the other hand, is suitable for operations that produce homogeneous products that receive equal amounts of manufacturing costs in each process.

Job-order costing is appropriate for many service firms. The key factor is that differing amounts of resources must be used for different jobs. Examples of service firms that use job-order costing are law firms, accounting firms, dental offices, automobile repair shops, and architectural firms. The key point is that the costs of each job are unique to the job and must be tracked by job.

Normal costing defines product cost as the sum of actual direct materials, actual direct labor, and applied overhead. The difference between actual costing and normal costing lies in the treatment of overhead. Actual costing uses actual overhead; normal costing uses applied overhead.

Actual overhead rates are rarely used because managers cannot wait until the end of the year to obtain product costs. Information on product costs is needed as the year unfolds for planning, control, and decision making.

Overhead is assigned to production using the predetermined rate. The predetermined overhead rate is equal to estimated overhead divided by estimated activity level. The predetermined overhead rate is multiplied by the actual activity level or the cost driver on which the rate is based.

Underapplied overhead means that the applied overhead is less than the actual overhead. As a result, the unadjusted cost of goods is too small (because too little overhead has been applied). So, Cost of Goods Sold will increase by the amount of underapplied overhead.

Overapplied overhead means that the applied overhead is more than the actual overhead. As a result, the unadjusted cost of goods is too large (because too much overhead has been applied). So, Cost of Goods Sold will decrease by the amount of overapplied overhead.

Unless all your jobs (lawns) are the same size and require the same services, you will need to use a job-order costing system. At a minimum, you will need job-order cost sheets for each customer. You will need labor time tickets to record the amount of time spent on each job, both to cost the job and to pay the individual doing the work. A materials requisition form may be needed if fertilizer or weed control products are used (alternatively, it may be possible to just list the amount of product used directly on the job-order cost sheet). The more complicated your business becomes (e.g., mowing, trimming, fertilizing, trimming shrubbery, planting shrubs and trees), the more source documents will be needed to keep track of time, materials, and use of capital equipment (e.g., trimmers, brush hogs). Basically, as the business grows, the need for more formal accounting and source documentation grows. All source documents can be used descriptively so that you can see the actual amount of resources used by each job. The job-order cost sheets can be used predictively to help bid on similar jobs in the future.

4-1

CHAPTER 4 Job-Order Costing and Overhead Application

Multiple overhead rates often produce a more accurate assignment of overhead costs to jobs. This can be true if the departments through which products pass have different amounts of overhead and if the various products spend differing amounts of time in the departments. For example, a company may have two departments, but some products only go through one department. It would be more accurate to assign less overhead cost to the products using only one department. This can be easily accomplished using departmental overhead rates.

10. Materials requisition forms serve as the source document for posting materials usage and costs to individual jobs. Time tickets serve a similar function for labor. Predetermined overhead rates are used to assign overhead costs to individual jobs. 11. Because the overhead rate is based on direct labor cost, the amount of overhead applied will increase. As a result, the total cost of each job will go up. 12. The overhead variance is the difference between applied overhead and actual overhead. Typically, that variance is relatively small, and it is closed to Cost of Goods Sold. If overhead is underapplied, the variance is added to Cost of Goods Sold. If overhead is overapplied, the variance is subtracted from Cost of Goods Sold. 13. The cost of a job is often strongly related to the price charged. Logically enough, the higher the cost of the job, the higher the price charged to the customer. This relationship makes sense not only to the business but also to the customer. By comparing the cost of the individual job with the price charged, the firm can determine the profit attributable to each job. Then, the firm can decide whether the profit is sufficient to continue offering the product or service under the current terms. Many times, the price is actually based on the cost and determined by a particular mark-up percentage. 14. Because advertising expense is a period expense, it has no effect on overhead—either applied or actual. Therefore, changes in advertising expense cannot affect manufacturing cost or cost of goods sold. 15. A departmental overhead rate application can be easily converted to a plantwide rate. First, the estimated overhead for all departments is totaled, and a single plantwide driver is chosen. The plantwide overhead rate is simply the estimated plantwide overhead divided by the plantwide driver. When overhead is applied, the predetermined plantwide rate is multiplied by the actual amount of driver used in the factory. 16. Producing departments work directly on the products and services being made, whereas support departments provide indirect support to the producing departments. 17. Without any allocation of support department costs, users may view services as a free good and consume more of the service than is optimal. Allocating support department costs would encourage managers to use the service until such time as the cost of the service is equal to the benefit.

4-2

CHAPTER 4 Job-Order Costing and Overhead Application

18. The identification and use of causal factors ensures that support department costs are accurately assigned to users. This increases the legitimacy of the control function and enhances product-costing accuracy. 19. a.

Number of employees, number of meals

Square footage

Pounds of laundry

Orders processed, weight, number of units received

Maintenance hours worked

Number of employees

Number of transactions processed

20. The direct method allocates the direct costs of each support department directly to the producing departments. No consideration is given to the fact that other support departments may use support services. The sequential method allocates support department costs sequentially. First, the costs of the support department providing the greatest service to all user departments, including other support departments, are allocated. Next, the costs of the second greatest provider of services are allocated to all user departments, excluding any department(s) that has already allocated costs. This continues until all support department costs have been allocated. The principal difference in the two methods is the fact that the sequential method considers some interactions among support departments and the direct method ignores interactions.

4-3

CHAPTER 4 Job-Order Costing and Overhead Application

MULTIPLE-CHOICE QUESTIONS 4-1.

4-2.

4-3.

4-4.

4-5.

4-6.

4-7.

4-8.

4-9.

4-10.

4-11.

4-12.

4-13.

4-14.

d Direct materials……………………………………… Direct labor…………………………………………… Applied overhead ($5 × 500 DLH)………………… Total job cost……………………………………… ÷ Number of units………………………………… Unit cost…………………………………………………

4-4

$17,500 10,000 2,500 $30,000 1,000 $ 30

CHAPTER 4 Job-Order Costing and Overhead Application

4-15.

4-16.

4-17.

4-18.

4-19.

4-20.

4-21.

4-22.

4-5

CHAPTER 4 Job-Order Costing and Overhead Application

BRIEF EXERCISES: SET A BE 4-23 1. Predetermined Overhead Rate

Estimated Overhead Estimated Direct Labor Cost

= $416,000/$520,000 = 0.80, or 80% of direct labor cost 2.

Overhead Applied to December Production = 0.80 × $43,700 = $34,960

BE 4-24 1. Applied Overhead

= Overhead Rate × Actual Direct Labor Cost = 0.80 × $532,000 = $425,600

Actual overhead………………………………………………… Applied overhead……………………………………………… Overhead variance…………………………………………… 2.

Unadjusted cost of goods sold……………………………… Less: Overapplied overhead………………………………… Adjusted cost of goods sold…………………………………

BE 4-25 1. Cutting Department Overhead Rate

$423,600 425,600 $ 2,000 overapplied $1,890,000 (2,000) $1,888,000

= $240,000/150,000 mhrs = $1.60 per machine hour

Sewing Department Overhead Rate

= $350,000/100,000 DLH = $3.50 per direct labor hour

Overhead Applied to Cutting in June

= $1.60 × 13,640 = $21,824

Overhead Applied to Sewing in June

= $3.50 × 8,600 = $30,100

3. Actual overhead…………… Less: Applied overhead…………………… Overhead variance…………

Cutting Department

Sewing Department

$20,610

$35,750

21,824 $ 1,214 overapplied

30,100 $ 5,650 underapplied

4-6

CHAPTER 4 Job-Order Costing and Overhead Application

BE 4-26 1. Predetermined Plantwide Overhead Rate

= $590,000/131,200 DLH = $4.50 per direct labor hour*

* Rounded

Overhead Applied in June

Overhead Variance

= $4.50 × 11,400 = $51,300 = Applied Overhead – Actual Overhead = $51,300 – $56,360 = $5,060 underapplied

BE 4-27 1. Since the predetermined overhead rate is not given, it must be calculated from beginning work in process using either Job 44 or Job 45. Using Job 44, Predetermined Overhead Rate

Applied Overhead Direct Labor Cost

= $780/$1,200 = 0.650 or 65.0% (The predetermined overhead rate using Job 45 is identical, $1,950/$3,000 = 0.650.) 2. Beginning balance, June 1……… Direct materials…………………… Direct labor………………………… Applied overhead………………… Total, June 30……………………… 3.

Job 44

Job 45

Job 46

Job 47

$ 7,080 2,500 800 520 $10,900

$ 6,450 7,110 6,400 4,160 $24,120

0 1,800 900 585 $3,285

0 1,700 560 364 $2,624

By the end of June, Jobs 44, 45, and 47 have been transferred out of Work in Process. Thus, the ending balance in Work in Process consists of Job 46. $3,285

Work in Process, June 30……………

While three jobs (44, 45, and 47) were transferred out of Work in Process and into Finished Goods during June, only two jobs remain (Jobs 44 and 47). Finished Goods, June 1……………… Job 44…………………………………… Job 47…………………………………… Finished Goods, June 30…………… 4.

0 10,900 2,624 $13,524

One job, Job 45, was sold during June. Cost of goods sold……………………

$24,120

4-7

CHAPTER 4 Job-Order Costing and Overhead Application

BE 4-28 1. Allocation ratios for S1 based on number of employees: Cutting = 63/(63 + 147) = 0.30 Sewing = 147/(63 + 147) = 0.70 Allocation ratios for S2 based on number of maintenance hours: Cutting = 16,000/(16,000 + 4,000) = 0.80 Sewing = 4,000/(16,000 + 4,000) = 0.20

Allocate:

Support Departments S1 S2

Producing Departments Cutting Sewing

Direct costs…………………… S1…………………………… S2…………………………… Total……………………………

$ 180,000 (180,000) — $ 0

$122,000 54,000 120,000 $296,000

$ 150,000 — (150,000) $ 0

$ 90,500 126,000 30,000 $246,500

BE 4-29 1. Allocation ratios for S1 based on number of employees: S2 = 30/(30 + 63 + 147) = 0.1250 Cutting = 63/(30 + 63 + 147) = 0.2625 Sewing = 147/(30 + 63 + 147) = 0.6125 Allocation ratios for S2 based on number of maintenance hours: Cutting = 16,000/(16,000 + 4,000) = 0.8000 Sewing = 4,000/(16,000 + 4,000) = 0.2000 2. Allocate:

Support Departments S1 S2

Producing Departments Cutting Sewing

Direct costs……………………

$ 180,000

$ 150,000

$122,000

$ 90,500

S1…………………………… S2…………………………… Total……………………………

(180,000) — $ 0

22,500 (172,500) $ 0

47,250 138,000 $307,250

110,250 34,500 $235,250

4-8

CHAPTER 4 Job-Order Costing and Overhead Application

BRIEF EXERCISES: SET B BE 4-30 1. Predetermined Overhead Rate

Estimated Overhead Estimated Direct Labor Cost

= $720,000/$900,000 = 0.80, or 80% of direct labor cost 2.

Overhead Applied to September Production = 0.80 × $53,400 = $42,720

BE 4-31 1. Applied Overhead

= Overhead Rate × Actual Direct Labor Cost = 0.80 × $918,000 = $734,400

Actual overhead…………………………………………… $731,000 734,400 Applied overhead………………………………………… Overhead variance……………………………………… $ 3,400 overapplied 2.

Unadjusted cost of goods sold………………………… $1,970,000 3,400 Less: Overapplied overhead…………………………… Adjusted cost of goods sold…………………………… $1,966,600

BE 4-32 1. Firing Department Overhead Rate

= $405,000/90,000 kiln hours = $4.50 per kiln hour

Polishing Department Overhead Rate

= $110,000/100,000 DLH = $1.10 per direct labor hour

Overhead Applied to Firing in July

= $4.50 × 7,400 = $33,300

Overhead Applied to Polishing in July

= $1.10 × 8,600 = $9,460

Firing Department

Polishing Department

Actual overhead……… $34,000 Less: Applied overhead……………… 33,300 Overhead variance…… $ 700 underapplied

4-9

$9,370

9,460 90 overapplied

CHAPTER 4 Job-Order Costing and Overhead Application

BE 4-33 1. Predetermined Plantwide Overhead Rate

= $515,000/128,750 DLH = $4.00 per direct labor hour

2. 3.

Overhead Applied in July = $4.00 × 10,950 = $43,800 Overhead Variance = Applied Overhead – Actual Overhead = $43,800 – $43,370 = $430 overapplied

BE 4-34 1. Since the predetermined overhead rate is not given, it must be calculated from BWIP amounts using either Job 86 or Job 87. Using Job 86, Predetermined Overhead Rate

Applied Overhead Direct Labor Cost

= $3,000/2,500 = 1.200 or 120.0% (The plantwide overhead rate is identical for all jobs.) 2. Beginning balance, March 1… Direct materials……………… Direct labor…………………… Applied overhead……………… Total, March 31………………… 3.

Job 86

Job 87

Job 88

Job 89

$ 10,600 2,700 800 960 $15,060

$ 15,120 8,200 6,000 7,200 $36,520

0 4,400 900 1,080 $6,380

0 8,900 4,500 5,400 $18,800

By the end of March, Jobs 86, 87, and 89 have been transferred out of Work in Process. Thus, the ending balance in Work in Process consists of Job 88. Work in Process, March 31………

$6,380

While three jobs (86, 87, and 89) were transferred out of Work in Process and into Finished Goods during March, only Job 89 remains. Finished Goods, March 1……… 18,800 Job 89……………………………… Finished Goods, March 31……… $18,800 4.

Jobs 86 and 87 were sold during March. Cost of goods sold = $15,060 + $36,520 = $51,580

4-10

CHAPTER 4 Job-Order Costing and Overhead Application

BE 4-35 1. Allocation ratios for S1 based on square footage: Assembly = 1,875/(1,875 + 625) = 0.75 Painting = 625/(1,875 + 625) = 0.25 Allocation ratios for S2 based on number of machine hours: Assembly = 3,200/(3,200 + 12,800) = 0.20 Painting = 12,800/(3,200 + 12,800) = 0.80

Allocate:

Support Departments S1 S2

Producing Departments Assembly Painting

Direct costs…………………… S1…………………………… S2…………………………… Total……………………………

$ 200,000 (200,000) — $ 0

$115,000 150,000 28,000 $293,000

$ 140,000 — (140,000) $ 0

$ 96,000 50,000 112,000 $258,000

BE 4-36 1. Allocation ratios for S1 based on square footage: S2 = 500/(500 + 1,875 + 625) = 0.1667 Assembly = 1,875/(500 + 1,875 + 625) = 0.6250 Painting = 625/(500 + 1,875 + 625) = 0.2083 Allocation ratios for S2 based on number of machine hours: Assembly = 3,200/(3,200 + 12,800) = 0.2000 Painting = 12,800/(3,200 + 12,800) = 0.8000 2. Allocate:

Support Departments S1 S2

Producing Departments Assembly Painting

Direct costs…………………… S1…………………………… S2…………………………… Total……………………………

$ 200,000 (200,000) — $ 0

$115,000 125,000 34,668 $274,668

4-11

$ 140,000 33,340 (173,340) $ 0

$ 96,000 41,660 138,672 $276,332

CHAPTER 4 Job-Order Costing and Overhead Application

EXERCISES E 4-37 a. Hospital services—job-order b. Custom cabinet making—job-order c. Toy manufacturing—process d. Soft-drink bottling—process e. Airplane manufacturing (e.g., 767s)—job-order f. Personal computer assembly—process g. Furniture making—process h. Custom furniture making—job-order i. Dental services—job-order j. Paper manufacturing—process k. Nut and bolt manufacturing—process l. Auto repair—job order m. Architectural services—job-order n. Landscape design services—job-order o. Flashlight manufacturing—process E 4-38 The following are examples; answers may vary. a.

Auto manufacturing—a shop that builds autos from scratch (the way Rolls Royce used to build cars, or a car that can be built from kits) would use job-order costing. Large automobile manufacturers use process costing. (While the customer may think the car is being built to order when selecting among options, actually the manufacturer waits until enough of the same orders are received to build a run of virtually identical cars.)

Dental services—basic dental services use job-order costing, but denturists (who make only dentures) can use process costing. (It is important to recognize that while the dentures themselves are uniquely shaped to fit each patient, the costs involved do not differ from patient to patient.)

Auto repair—a general automobile repair shop uses job-order costing. However, a shop devoted to only one type of service or repair (e.g., oil change) can use process costing yet price the cost of the number of quarts of oil used for each customer.

Costume making—a small tailor shop would use job-order costing. However, a large costume manufacturer that sews a certain number of costume designs would use process costing.

4-12

CHAPTER 4 Job-Order Costing and Overhead Application

E 4-39 1. Predetermined Overhead Rate

= $522,900/83,000 DLH = $6.30 per direct labor hour

Applied Overhead

= $6.30 × 7,600 DLH = $47,880

E 4-40 1. Predetermined Overhead Rate

= $834,000/60,000 DLH = $13.90 per direct labor hour

Applied Overhead

= $13.90 × 5,150 DLH = $71,585

Applied Overhead

= $13.90 × 58,000 DLH = $806,200

Actual overhead…………………………… Applied overhead………………………… Overapplied overhead…………………… 4.

$805,000 806,200 $ 1,200

Adjusted Cost of Goods Sold = $2,840,000 – $1,200 = $2,838,800

E 4-41 1. Assembly Department Overhead Rate

= $338,000/130,000 DLH = $2.60 per direct labor hour

Testing Department Overhead Rate

= $630,000/120,000 mhrs = $5.25 per machine hour

Assembly Department Applied Overhead = $2.60 × 11,700 = $30,420 Testing Department Applied Overhead = $5.25 × 10,900 = $57,225

3. Actual overhead…………………………… Applied overhead………………………… Overhead variance……………………

Assembly Department

Testing Department

$29,850 30,420 $ (570)

$58,000 57,225 $ 775

Assembly department has overapplied overhead of $570. Testing department has underapplied overhead of $775.

4-13

CHAPTER 4 Job-Order Costing and Overhead Application

E 4-42 1. Ending Balance = Beginning Balance + Prime Costs + Applied Overhead $2,120 = $1,200 + $800 + Applied Overhead Applied Overhead = $2,120 – $1,200 – $800 = $120 2.

Direct Materials = 4 × Direct Labor Prime Cost = Direct Materials + Direct Labor $800 = (4 × Direct Labor) + Direct Labor Direct Labor = $800/5 = $160 Direct Materials = 4 × Direct Labor = 4($160) = $640

Applied Overhead = Direct Labor × Overhead Rate $120 = $160 × Overhead Rate Overhead Rate = $120/$160 = 0.75, or 75%

E 4-43 1. Materials requisition form 2. Time ticket 3. Mileage log 4. Job-order cost sheet E 4-44 1. Job 93 Direct Labor Hours = $2,160/$18 = 120 DLH Job 94 Direct Labor Hours = $5,400/$18 = 300 DLH Job 95 Direct Labor Hours = $2,610/$18 = 145 DLH Job 96 Direct Labor Hours = $900/$18 = 50 DLH 2.

August applied overhead for: Job 93 = 120 DLH × $8 = $960 Job 94 = 300 DLH × $8 = $2,400 Job 95 = 145 DLH × $8 = $1,160 Job 96 = 50 DLH × $8 = $400

3. Beginning balance……… Direct materials………… Direct labor……………… Applied overhead……… Total…………………… 4.

Job 93

Job 94

Job 95

$ 8,750 950 2,160 960 $12,820

$ 7,300 4,500 5,400 2,400 $19,600

Work in Process, August 31, consists of unfinished jobs: Job 94……………………… Job 95……………………… Job 96……………………… Total……………………

$19,600 7,070 2,600 $29,270 4-14

0 3,300 2,610 1,160 $7,070

Job 96 $

0 1,300 900 400 $2,600

CHAPTER 4 Job-Order Costing and Overhead Application

E 4-44 (Continued) 5. Price of Job 93 = $12,820 + (0.40 × $12,820) = $12,820 × 1.40 = $17,948 6.

Jagjit could treat the acquisition and use of the bulldozer as a separate department and create a departmental overhead rate for it based on the hours used. That is, the overhead rate would be the total budgeted cost of the bulldozer (depreciation, fuel, maintenance, and so on) divided by the anticipated annual hours of use. In this way, only the jobs requiring the use of the heavier equipment would be charged for it.

E 4-45 1.

Beginning balance…………… Direct materials……………… Direct labor……………………

Applied overhead in October for:

Job 877

Job 878

$12,350 9,200 11,200

$ 0 10,400 9,100

Job 879 $

0 3,700 2,200

Job 877 = $11,200 × 0.70 = $7,840 Job 878 = $9,100 × 0.70 = $6,370 Job 879 = $2,200 × 0.70 = $1,540 Job 880 = $1,600 × 0.70 = $1,120 3.

Work in Process, October 31: Job 878*……………………………………………………………… Job 879**……………………………………………………………… Job 880***…………………………………………………………… Total………………………………………………………………

$25,870 7,440 4,720 $38,030

* $10,400 + $9,100 + $6,370 = $25,870 ** $3,700 + $2,200 + $1,540 = $7,440 *** $2,000 + $1,600 + $1,120 = $4,720 4.

Cost of Job 877 = $12,350 + $9,200 + $11,200 + $7,840 = $40,590 Price of Job 877 = $40,590 + (0.60 × $40,590) = $64,944

E 4-46 1. Balance in Work in Process (all incomplete jobs): Job 303……………………………………………………………… Job 306……………………………………………………………… Job 308……………………………………………………………… Job 309……………………………………………………………… Job 310……………………………………………………………… Total……………………………………………………………… 4-15

$ 780 350 620 1,200 515 $3,465

Job 880 $

0 2,000 1,600

CHAPTER 4 Job-Order Costing and Overhead Application

E 4-46 (Continued) 2. Balance in Finished Goods (all jobs completed but not sold): Beginning balance (Job 300)………………………………… Job 301…………………………………………………………… Job 304…………………………………………………………… Job 305…………………………………………………………… Total…………………………………………………………… 3.

Cost of Goods Sold

= Job 302 + Job 307 = $1,240 + $710 = $1,950

E 4-47 1. Balance, July 1………………………………… Direct materials……………………………… Direct labor…………………………………… Applied overhead…………………………… Total………………………………………… 2.

Work in Process, July 31 = Job 87 = $29,750

Finished Goods:

Job 86

Job 87

Job 88

$15,310 4,450 16,000 5,000 $40,760

$ 4,250 10,300 12,200 3,000 $29,750

Beginning balance……………………………………………… Job 88 (transferred in)………………………………………… Job 82 (sold)…………………………………………………… Ending balance, July 31…………………………………… 4.

Cost of Goods Sold

Sales [$66,360 + (0.20 × $66,360)]…………………………… Cost of goods sold………………………………………….… Gross margin………………………………………………… Less: Variable marketing expenses (0.04 × $79,632)………… Fixed marketing expenses……………………………… Administrative expenses………………………………… Operating income………………………………………………

$ 300 1,600 2,300 4,150 $8,350

0 13,150 24,000 10,000 $47,150

$ 49,000 47,150 (25,600) $ 70,550

= Job 82 + Job 86 = $25,600 + $40,760 = $66,360 $79,632 66,360 $13,272 $3,185 1,275 3,900

The increased overhead rate will increase Work in Process to $30,350, Finished Goods to $72,550, and Cost of Goods Sold to $67,360. The new operating income is $5,064.

4-16

8,360 $ 4,912

CHAPTER 4 Job-Order Costing and Overhead Application

E 4-48 Job 213: 1.

Number of Units

Total Manufacturing Cost Unit Cost

= $855/$8.55 = 100 units 2.

Total Sales Revenue

= Price per Unit × Number of Units = $12 × 100 units = $1,200

Direct Labor Hours, Department 1

Overhead Applied, Department 1 Overhead Rate, Department 1

= $90/$6 = 15 DLH

Direct Labor Cost, Department 1

= 15 direct labor hours × $10 = $150

Overhead Applied, Department 2

= 25 machine hours × $8 = $200

Job 214: 1.

Price per Unit

Total Sales Revenue Number of Units

= $4,375/350 units = $12.50 2.

Direct Labor Hours, Department 1

= Direct Labor Cost, Department 1 Direct Labor Rate = $700/$10 = 70 DLH = Direct Labor Hours, Department 1 × $6

Overhead Applied, Department 1

= 70 DLH × $6 = $420 3.

Materials Used in Production

= Total Manufacturing Cost – Direct Labor Cost, Department 1 – Direct Labor Cost, Department 2 – Overhead Applied, Department 1 – Overhead Applied, Department 2 = $3,073 – $700 – $100 – $420 – $400 = $1,453 4-17

CHAPTER 4 Job-Order Costing and Overhead Application

E 4-48 (Continued) 4. Unit Cost =

Total Manufacturing Cost Number of Units

= $3,073/350 units = $8.78 Job 217: 1.

Machine Hours, Department 2

Overhead Applied, Department 2 Overhead Rate

= $160/$8 = 20 mhrs 2.

Total Manufacturing Cost

= Unit Cost × Number of Units = $9.87 × 400 units = $3,948

Direct Labor Cost, Department 2

= Total Manufacturing Cost – Materials Used in Production – Direct Labor Cost, Department 1 – Overhead Applied, Department 1 – Overhead Applied, Department 2 = $3,948 – $488 – $2,000 – $1,200 – $160 = $100

Job 225: 1.

Number of Units

Total Sales Revenue Price per Unit

= $1,150/$5 = 230 units 2.

Unit Cost

Total Manufacturing Cost Number of Units

= $575/230 units = $2.50 3.

Machine Hours, Department 2

Overhead Applied, Department 2 Overhead Rate

= $0/$8 = 0 mhrs

4-18

CHAPTER 4 Job-Order Costing and Overhead Application

E 4-49 1. Direct materials……………………………..……………………… Direct labor: Department A………………………………………...………… Department B……………………………...…………………… Overhead ($10 × 570 DLH)………...…………………………… Total manufacturing costs…………………………………… 2.

Unit Cost = $27,960/1,000 units = $27.96

Direct materials…………………………………………………… Direct labor: Department A…………………………………...……………… Department B…………………………………...……………… Overhead: Department A ($3 × 450)……………………………………… Department B ($7 × 800)……………………………………… Total manufacturing costs………………………………………

$12,000 $8,100 2,160

10,260 5,700 $27,960

$12,000 $8,100 2,160

10,260 1,350 5,600 $29,210

Unit Cost = $29,210/1,000 units = $29.21

The departmental method is more descriptive of the resources used by Job 9-601. This job uses more of the machine-hour intensive resources of Department B which are not captured using the plantwide overhead rate.

E 4-50 1. Balance, April 1 Direct materials Direct labor Applied overhead Total cost 2.

Job 39 $ 5,400 700 500 600 $7,200

Ending Balance in Work in Process Cost of Goods Sold for April

Job 40 $3,100 560 600 720 $4,980

Job 41 $2,850 375 490 588 $4,303

Job 42 $ 0 3,500 2,500 3,000 $9,000

Job 43 $ 0 3,500 3,000 3,600 $10,100

= Job 39 + Job 42 = $7,200 + $9,000 = $16,200

= Job 40 + Job 41 + Job 43 = $4,980 + $4,303 + $10,100 = $19,383

Duweynie Company Income Statement For the Month Ended April 30 Sales [$19,383 + (0.40 × $19,383)]……..………..……….………………….…… Cost of goods sold……………….…………………………..…….……………… Gross margin…………………….…………………………..…….…………… Less: Selling and administrative expenses………….………………………… Operating income………………….…………………………..…….…………

4-19

$27,136 19,383 $ 7,753 3,600 $ 4,153

CHAPTER 4 Job-Order Costing and Overhead Application

E 4-51 1. Date a.

Journal Account & Explanation Raw Materials Accounts Payable

Debit 29,670

Credit 29,670

Work in Process Raw Materials

24,500

Work in Process Wages Payable

32,400

Overhead Control Various Payables

17,880

Work in Process Overhead Control

8,640

24,500

32,400

17,880

8,640

Total Direct Labor Hours = $32,400/$18 = 1,800 DLH Applied Overhead = 1,800 DLH × $4.80 = $8,640

Finished Goods Work in Process (jobs 58 and 59)

50,020

Cost of Goods Sold Finished Goods (jobs 57 and 58)

53,040

Accounts Receivable Sales Revenue ($53,040 x 1.40)

74,256

50,020

53,040

74,256 Job 58

Job 59

Job 60

Direct materials…………………………...…… Direct labor……………………………………. Applied overhead……………………………… Total cost……………………………………

$ 9,200 14,400 3,840 $27,440

$ 8,900 10,800 2,880 $22,580

$ 6,400 7,200 1,920 $15,520

Raw Materials: Beginning balance…………………………… Purchases……………………………………... Direct materials………………………………. Ending balance……………………………

$ 2,300 29,670 (24,500) $ 7,470

4-20

CHAPTER 4 Job-Order Costing and Overhead Application

E 4-51 (Continued) 4. Work in Process: Beginning balance…………………………………………… Direct materials………………………………………………… Direct labor……………………………………………………… Applied overhead……………………………………………… Jobs completed: Job 58………………………………………………………… Job 59……………………………………………..………… Ending balance (Job 60)……………………………………… 5.

$27,440 22,580

Finished Goods: Beginning balance…………………………………………… Jobs transferred in: Job 58……………………………………………….……… Job 59………………………………………………………. Jobs sold: Job 57………………………………………………………… Job 58……………………………………………….……… Ending balance (Job 59)………………………………………

0 24,500 32,400 8,640

(50,020) $ 15,520

$ 25,600 $27,440 22,580 $25,600 27,440

50,020

(53,040) $ 22,580

E 4-52 1. Allocation ratios for Power based on number of machine hours: Battery = 3,000/(3,000 + 1,000) = 0.7500 Small Motors = 1,000/(3,000 + 1,000) = 0.2500 Allocation ratios for General Factory based on square footage: Battery = 4,000/(4,000 + 12,000) = 0.2500 Small Motors = 12,000/(4,000 + 12,000) = 0.7500 2.

Direct overhead costs…… Allocate: Power…………………… General Factory……… Total………………………… 3.

Support Departments General Power Factory

Operating Divisions Small Battery Motors

$ 220,000

$ 430,000

$176,000

$ 105,000

(220,000) — $ 0

— (430,000) $ 0

165,000 107,500 $448,500

55,000 322,500 $482,500

Battery Overhead Rate = $448,500/18,000 DLH = $24.92 Small Motors Overhead Rate = $482,500/60,000 DLH = $8.04

4-21

CHAPTER 4 Job-Order Costing and Overhead Application

E 4-53 1. Allocation ratios for General Factory based on square footage: Power = 5,000/(5,000 + 4,000 + 12,000) = 0.2381 Battery = 4,000/(5,000 + 4,000 + 12,000) = 0.1905 Small Motors = 12,000/(5,000 + 4,000 + 12,000) = 0.5714 Allocation ratios for Power based on number of machine hours: Battery = 3,000/(3,000 + 1,000) = 0.7500 Small Motors = 1,000/(3,000 + 1,000) = 0.2500 2.

Direct costs………………… Allocate: General Factory………… Power……………………… Total………………………… 3.

Support Departments General Power Factory

Operating Divisions Small Battery Motors

$ 220,000

$ 430,000

$176,000

$ 105,000

102,383 (322,383) $ 0

(430,000) — $ 0

81,915 241,787 $499,702

245,702 80,596 $431,298

Battery Overhead Rate = $499,702/18,000 DLH = $27.76 Small Motors Overhead Rate = $431,298/60,000 DLH = $7.19

4-22

CHAPTER 4 Job-Order Costing and Overhead Application

PROBLEMS P 4-54 1. Overhead Rate = $823,000/100,000 DLH = $8.23 per DLH Job 741

Job 742

Job 743

Job 744

Job 745

Balance, July 1……… $ 29,870 25,500 Direct materials……… Direct labor………… 61,300 31,274 Applied overhead…… Total cost………… $147,944

$ 55,210 39,800 48,500 23,867 $167,377

$27,880 14,450 28,700 18,106 $89,136

3. Ending Balance in Work in Process

0 13,600 24,500 16,460 $54,560

0 8,420 21,300 9,053 $38,773

= Job 744 + Job 745 = $54,560 + $38,773 = $93,333

Ending Balance in Finished Goods (Job 743) = 0 + $89,136 = $89,136 4. Cost of Goods Sold = Job 741 + Job 742 = $147,944 + $167,377 = $315,321 P 4-55 1. Cost of Alban job: Professional time (85 hours × $120)……………………………… $10,200 255 Mileage (510 miles @ $0.50)………………………………………… 120 Photographs…………………………………………………………… Total………………………………………………………………… $10,575 2. Overhead is included in the rate for professional time. This is easier for professionals than to calculate a separate overhead rate and charge it to clients. In effect, Spade Millhone charges a conversion cost rate, not a labor rate, to its clients.

4-23

CHAPTER 4 Job-Order Costing and Overhead Application

P 4-55 (Continued) 3. Answers may vary. The following is one example. Rex Spade Mileage Log Date

Client

Beginning Mileage

Ending Mileage

7/8

Alban

56,780

56,815

Ofc. to claimant #1, to Dr. Phony, to claimant #2, to ofc.

7/9

Alban

56,815

56,903

Ofc. to claimant #3, to claimant #4, to ofc.

7/10

Alban

56,903

57,078

Ofc. to witness #3, to client, to ofc.

175

7/11

Alban

57,078

57,290

Ofc. to claimant #2, to claimant #4, to ofc.

212

Destination

Total Miles

Note: Separate mileage logs are kept by Rex Spade and Victoria Millhone. Then, relevant amounts are transferred to cost sheets (or folders) for each client.

4-24

CHAPTER 4 Job-Order Costing and Overhead Application

P 4-56 1. Overhead Rate = $374/$440 = 0.8500 times direct labor cost (This rate was calculated using information from the Carter job; however, the Pelham and Tillson jobs would give the same answer.) 2. Beginning WIP……… Direct materials……… Direct labor………… Applied overhead…… Total………………

Carter

Pelham

Tillson

Jasper

$1,024 600 300 255 $2,179

$1,910 550 200 170 $2,830

$3,621 770 240 204 $4,835

Dashell

0 2,310 2,100 1,785 $6,195

0 190 240 204 $634

Note: This is just one way of setting up the job-order cost sheets. You might prefer to keep the details on the materials, labor, and overhead in beginning inventory costs. 3.

Since the Tillson and Jasper jobs were completed, the others must still be in process. Therefore, the ending balance in Work in Process is the sum of the costs of the Carter, Pelham, and Dashell jobs. Carter………………………………… Pelham……………………………… Dashell……………………………… Ending work in process………

$2,179 2,830 634 $5,643

Cost of Goods Sold = Tillson Job + Jasper Job = $4,835 + $6,195 = $11,030 4.

Pavlovich Prosthetics Company Income Statement For the Month Ended January 31 Sales (1.30 × $11,030)……………………………………………………………… Cost of goods sold………………………………………………………………… Gross margin…………………………………………………………………… Marketing and administrative expenses………………………………………… Operating income………………………………………………………………

4-25

$14,339 11,030 $ 3,309 2,635 $ 674

CHAPTER 4 Job-Order Costing and Overhead Application

P 4-57 1. OH Rate = $108,000/18,000 mhrs = $6.00 per machine hour 2.

Department A: $75,000/10,000 mhrs = $7.500 per machine hour Department B: $33,000/8,000 mhrs = $4.125 per machine hour

Job 73

Job 74

Plantwide: 70 mhrs × $6.00 = $420

Departmental: 20 mhrs × $7.500……… 50 mhrs × $4.125………

Departmental: 50 mhrs × $7.500………… 20 mhrs × $4.125…………

$150.00 206.25 $356.25

$375.00 82.50 $457.50

Department A appears to be more overhead intensive, so jobs spending more time in Department A ought to receive more overhead. Thus, departmental rates provide more accuracy. 4.

Plantwide rate: $135,000/18,000 mhrs = $7.50 Department A: $75,000/10,000 = $7.50 Department B: $60,000/8,000 mhrs = $7.50 Job 73

Job 74

Plantwide: 70 mhrs × $7.50 = $525

Departmental: 20 mhrs × $7.50………… 50 mhrs × $7.50…………

Departmental: 50 mhrs × $7.50…………… 20 mhrs × $7.50……………

$150.00 375.00 $525.00

$375.00 150.00 $525.00

Assuming that machine hours is a good cost driver, the departmental rates reveal that overhead consumption is the same in each department. In this case, there is no need for departmental rates, and a plantwide rate is sufficient.

4-26

CHAPTER 4 Job-Order Costing and Overhead Application

P 4-58 1. Overhead Rate = $432,000/8,000 mhrs = $54.00 per machine hour

Direct materials…………………………………………… Direct labor……………………………………………….… Overhead ($54.00 × 200 machine hours)……………… Total manufacturing cost……………………………… Plus 35% markup…………………………………………… Bid price………………………………………………… 2.

Job 1

Job 2

$ 6,725 1,800 10,800 $19,325 6,764 $26,089

$ 9,340 3,100 10,800 $23,240 8,134 $31,374

Welding Overhead Rate = $220,000/5,000 mhrs = $44.00 per machine hour Assembly Overhead Rate = $62,000/10,000 dlhrs = $6.20 direct labor hour Finishing Overhead Rate = $150,000/2,000 mhrs = $75.00 per machine hour

Direct materials………………………………………...…… Direct labor………………………………………………… Overhead: Welding ($44.00 × 50); ($44.00 × 50)………………… Assembly ($6.20 × 60); ($6.20 × 20)………………… Finishing ($75.00 × 90); ($75.00 × 125)……………… Total manufacturing cost………………………………… Plus 35% markup…………………………………………… Bid price………………………………………….……… 3.

Job 1

Job 2

$ 6,725 1,800

$ 9,340 3,100

2,200 372 6,750 $17,847 6,246 $24,093

2,200 124 9,375 $24,139 8,449 $32,588

The departmental rates give a more accurate picture of the actual cost. The plantwide rate overcosts job 1 and undercosts job 2.

4-27

CHAPTER 4 Job-Order Costing and Overhead Application

P 4-59 1. Materials……………………………………………….…………… Direct labor ($12 × 10 hours; $12 × 20 hours)……………… Applied overhead: 0.20 × ($50 + $120)…………………………………………... 0.20 × ($75 + $240)…………………………………………... Total……………………………………...………………………… 2.

Jan’s Job

Ed’s Job

$ 50 120

$ 75 240

34 $204

63 $378

Since Jan’s job is more like the jobs Steve is used to doing, her costs are likely to be more accurate. Clearly, Steve is unsure just how to cost Ed’s job. If he expects to get more use from the tools he buys for Ed’s job, then he can absorb them into his overhead rate. If not, perhaps they should be added to the cost of Ed’s job as a part of materials.

P 4-60 1. Job 64: Direct materials…………………………………………….……… Direct labor…………………………………………….…………… Overhead ($11 × 410 DLH)……………………………………… Total cost…………………………………………….…………

$ 3,560 6,720 4,510 $14,790

Unit Cost = $14,790/50 units = $295.80 2.

Ending Work in Process

3. Date

= Cost of Job 65 = $785 + $9,328 + ($11 × 583 DLH) = $16,526

Journal Account & Explanation Finished Goods Work in Process

Debit 14,790

Credit 14,790

Cost of Goods Sold Finished Goods

14,790

Accounts Receivable Sales Revenue (1.75 × $14,790) = $25,883

25,883

14,790

4-28

25,883

CHAPTER 4 Job-Order Costing and Overhead Application

P 4-61 1. Date a.

Journal Account & Explanation Raw Materials Accounts Payable

4,800

Work in Process [$14 × (65 DLH + 90 DLH)] Wages Payable

2,170

4,800

Date f.

2,170

Work in Process ($6.20 × 155 DLH) Overhead Control

961

Overhead Control Cash

973

Direct materials……………… Direct labor…………………… Applied overhead…………… Total…………………………

Credit 4,610

Work in Process Raw Materials

961

973

Job 518

Debit 4,610

Job 519 $3,170 910 403 $4,483

Direct materials……………… Direct labor…………………… Applied overhead…………… Total…………………………

Journal Account & Explanation Finished Goods Work in Process

Debit 4,483

$1,630 1,260 558 $3,448 Credit 4,483

Cost of Goods Sold Finished Goods

2,770

Accounts Receivable Sales ($2,770 × 1.25)

3,463

2,770

3,463

4-29

CHAPTER 4 Job-Order Costing and Overhead Application

P 4-61 (Continued) 3.

Nelson Company Schedule of Cost of Goods Manufactured For the Month Ended April 30

Direct materials: Beginning raw materials inventory…………… Purchases of raw materials…………………… Total raw materials available………………… Ending raw materials…………………………… Raw materials used……………………………… Direct labor…………………………………..……… Overhead……………………………………………… Less: Underapplied overhead………………… Overhead applied………………………………… Current manufacturing costs……………………… Add: Beginning work in process………………… Total manufacturing costs…………………… Less: Ending work in process…………………… Cost of goods manufactured…………………

$1,025 4,610 $5,635 835 $4,800 2,170 $ 973 12 961 $7,931 0 $7,931 3,448 $4,483

P 4-62 1. Applied Overhead = Direct Labor Cost × Overhead Rate $140,000 = $80,000 × Overhead Rate Overhead Rate = ($140,000/$80,000) = 1.75, or 175% of Direct Labor Cost 2.

Applied overhead………………………………..…………………… Actual overhead………………………………..……………………… Overapplied overhead………………………………..……………

$140,000 138,500 $ 1,500

Direct materials………………………………………………………… Direct labor……………………………………………………………… Overhead applied………………………………………………...……

$ 40,000 80,000 140,000 $260,000 17,000 (32,000) $245,000

Add: Beginning work in process…………………………………… Less: Ending work in process……………………………………… Cost of goods manufactured……………………………...………

4-30

CHAPTER 4 Job-Order Costing and Overhead Application

P 4-62 (Continued) Journal 4. Date Account & Explanation Overhead Control Cost of Goods Sold

Debit 1,500

Credit 1,500

Adjusted Cost of Goods Sold: $210,000 (1,500) $208,500 5.

Direct labor (1,000 × $10)…………………...………………………………… Overhead applied (1.75 × 10,000)…………………………………………… Direct materials ($32,000 – $10,000 – $17,500)……..……………………… Ending work in process…………………………………...………………

$10,000 17,500 4,500 $32,000

P 4-63 1. Overhead Rate = $129,600/13,500 DLH = $9.60 per direct labor hour 2.

Direct materials………………………………………………………...………… Direct labor……………………………………….……………………………… Applied overhead*………………………………………...…………………… Total cost of Job K456……………………………………….………………

$ 2,750 5,355 3,024 $11,129

* $9.60 × ($5,355/$17) = $3,024 3. Date

Journal Account & Explanation Overhead Control Lease Payable Accumulated Depreciation Wages Payable Utilities Payable Other Payables Work in Process ($9.60 × 18,100 DLH) Overhead Control

Debit 172,500

6,800 19,340 90,400 14,560 41,400 173,760 173,760

Actual overhead……………………………………………… Applied overhead……………………………………..……… Overapplied overhead……………………………………

$172,500 173,760 $ 1,260

Normal cost of goods sold………………………………… Less: Overapplied overhead………………………………… Adjusted cost of goods sold……………………………

$635,600 (1,260) $634,340

4-31

Credit

CHAPTER 4 Job-Order Costing and Overhead Application

P 4-64 1. Date a.

Debit 42,630

27,000

Work in Process Wages Payable

26,320

Overhead Control Cash

19,950

Work in Process [($780+$1,100) × $10] Overhead Control

18,800

Beginning balance, work in process…………………… Direct materials……………………………………………… Direct labor ($14 × 780 DLH)……………………………… Overhead applied ($10 × 780 DLH)……………………… Total…………………………………………………………

$10,000 12,500 10,920 7,800 $41,220

Credit 42,630

Work in Process Raw Materials

Journal Account & Explanation Raw Materials Accounts Payable

27,000

26,320

19,950

18,800

Job 703:

Job 704: Direct materials……………………………………………… Direct labor ($14 × 1,100 DLH)…………………………… Overhead applied ($10 × 1,100 DLH)……………………… Total…………………………………………………………

4-32

$14,500 15,400 11,000 $40,900

CHAPTER 4 Job-Order Costing and Overhead Application

P 4-64 (Continued) 3. Date f.

Journal Account & Explanation Finished Goods Work in Process

6,240

Accounts Receivable (Job 700) Sales ($6,240 × 1.30)

8,112

6,240

Raw Materials: $ 6,070 42,630 (27,000) $ 21,700

Work in Process: Beginning balance………………………… Add: Materials requisitioned………… Direct labor………………………… Overhead applied………………… Less: Jobs completed…………………… Ending balance…………………………

$ 10,000 27,000 26,320 18,800 (41,220) $ 40,900

Finished Goods: Beginning balance………………………… Add: Jobs completed…………………… Less: Jobs sold…………………………… Ending balance…………………………

4-33

Credit 41,220

Cost of Goods Sold Finished Goods (Job 700)

Beginning balance………………………… Add: Purchases………………………… Less: Materials requisitioned………… Ending balance………………………… b.

Debit 41,220

$ 6,240 41,220 (6,240) $41,220

8,112

CHAPTER 4 Job-Order Costing and Overhead Application

P 4-65 1. Direct method: Proportion of: Number of samples*…………………… Transactions processed**………………

Laboratory 0.6000 0.6500

Pathology 0.4000 0.3500

$345,000

$456,000

*70,200/117,000 = 0.60; 46,800/117,000 = 0.40 **24,700/38,000 = 0.65; 13,300/38,000 = 0.35

Direct costs…………………………………… Delivery: (0.6000 × $240,000)……………………… (0.4000 × $240,000)……………………… Accounting: (0.65 × $270,000)………………………… (0.35 × $270,000)………………………… Total…………………………………………… 2. Transactions……………… Number of samples……… Direct costs………………… Accounting: (0.0500 × $270,000)…… (0.6175 × $270,000)…… (0.3325 × $270,000)…… Delivery: (0.6000 × $253,500)…… (0.4000 × $253,500)…… Total………………………… P 4-66 1. a.

144,000 96,000 175,500 $664,500

94,500 $646,500

Delivery

Accounting

Laboratory

Pathology

0.0500 — $ 240,000

— — $ 270,000

0.6175 0.6000 $345,000

0.3325 0.4000 $456,000

13,500

(13,500) (166,725) (89,775)

166,725

(152,100) (101,400) $ 0

89,775 152,100

$663,825

Direct method: Machine hours*………………………… Kilowatt-hours**…………………………

Drilling

Assembly

0.8000 0.1000

0.2000 0.9000

*30,000/37,000 = 0.80; 7,500/37,500 = 0.20 **36,000/360,000 = 0.10; 324,000/360,000 = 0.90

Maintenance: (0.80 × $320,000)…………………… (0.20 × $320,000)…………………… Power: (0.10 × $400,000)…………………… (0.90 × $400,000)…………………… Overhead costs………………………… Total…………………………………… 4-34

$256,000 $ 64,000 40,000 163,000 $459,000

360,000 90,000 $514,000

101,400 $647,175

CHAPTER 4 Job-Order Costing and Overhead Application

P 4-66 (Continued) Drilling: $459,000/30,000 mhrs = $15.30 per machine hour Assembly: $514,000/40,000 DLH = $12.85 per direct labor hour Prime costs………………………………………………… Drilling ($15.30 × 2 mhrs)………………………………… Assembly ($12.85 × 50 DLH)…………………………… Total cost……………………………………………… Markup (15%)……………………………………………… Bid price…………………………………………………

$1,817.00 30.60 642.50 $2,490.10 373.52 $2,863.62

b. Sequential method: Allocate Power first, then Maintenance Maintenance

Power

Drilling

Assembly

Machine hours……… Kilowatt-hours………

— 0.10

— —

0.80 0.09

0.20 0.81

Overhead costs………

$ 320,000

$ 400,000

$163,000

$ 90,000

40,000

(40,000) (36,000) (324,000)

36,000

—

288,000

Power: (0.10 × $400,000)… (0.09 × $400,000)… (0.81 × $400,000)… Maintenance: (0.80 × $360,000)… (0.20 × $360,000)… Total……………………

(288,000) (72,000) $ 0

324,000

$487,000

72,000 $486,000

Drilling: $487,000/30,000 mhrs = $16.23 per machine hour Assembly: $486,000/40,000 DLH = $12.15 per direct labor hour Prime costs………………………………………………… Drilling ($16.23 × 2 mhrs)………………………………… Assembly ($12.15 × 50 DLH)…………………………… Total cost……………………………………………… Markup (15%)……………………………………………… Bid price…………………………………………………

$1,817.00 32.46 607.50 $2,456.96 368.54 $2,825.50

2. The sequential method is the more accurate because it considers some of the support department interactions.

4-35

CHAPTER 4 Job-Order Costing and Overhead Application

CASES Case 4-67 1. Mrs. Lucky won’t like being charged more for one job when the same number and type of announcements were produced in each job. 2.

May: Actual Rate = $20,000/500 hours = $40 per hour Overhead assigned: $40 × 5 hours = $200 June and July: Actual Rate = $20,000/250 hours = $80 per hour Overhead assigned: $80 × 5 hours = $400

Predetermined Rate = $240,000/(500 hours × 12) = $40 per hour Cost and price of each job: Direct materials……………………… Direct labor…………………………… Overhead (5 hours × $40)…………… Total cost………………………… Plus 25% markup…………………… Price…………………………………

$250.00 25.00 200.00 $475.00 118.75 $593.75

Using a predetermined rate will avoid the nonuniform production revealed in the first two requirements and result in a more accurate application of overhead and fairer costing of the summer jobs.

4-36

CHAPTER 4 Job-Order Costing and Overhead Application

Case 4-68 1. The solution Doug proposes is not ethical. Although maintaining the current plantwide rate is probably not illegal, its continuation has one purpose: to extract extra profits from government business. Doug knows the plantwide rate is not accurately assigning overhead costs to the various jobs and is willing to alter the assignments on an “unofficial basis” for purposes of bidding on private-sector jobs. Fundamentally, ethical behavior is concerned with choosing right over wrong. To knowingly overcharge the government for future business certainly seems wrong. To continue overpricing knowing the new overhead rates would more than make up for any lost profits from the government sector (through more competitive bidding in the private sector) is a clear indication of greed. While managers have an obligation to maximize profits, this obligation must be within ethical boundaries. 2.

Tonya should first determine whether or not Gunderson has a corporate code of conduct. She can pursue the avenues suggested by the code. For example, if Tonya cannot persuade Doug to refrain from implementing his scheme, she could present her objections to Doug’s immediate supervisor. If a resolution cannot be realized at this level, then Tonya should go to the next higher management level. If no resolution is possible after appealing to all higher levels, then resignation may be the only remaining option.

4-37

ACTIVITY-BASED COSTING AND MANAGEMENT DISCUSSION QUESTIONS

For plantwide rates, overhead is first collected in a plantwide pool, using direct tracing. Next, an overhead rate is computed and used to assign overhead to products.

First stage: Overhead is assigned to production department pools using direct tracing, driver tracing, and allocation. Second stage: Individual departmental rates are used to assign overhead to products as they pass through the departments.

Nonunit-level overhead activities are those overhead activities that are not highly correlated with production volume measures. Examples include setups, materials handling, and inspection. Nonunit-based cost drivers are causal factors—factors that explain the consumption of nonunit-level overhead. Examples include setup hours, number of moves, and hours of inspection.

Product diversity is present whenever products have different consumption ratios for different overhead activities.

An overhead consumption ratio measures the proportion of an overhead activity consumed by a product.

Activity-based product costing is an overhead costing approach that first assigns costs to activities and then to cost objects. The assignment is made possible through the identification of activities, their costs, and the use of cost drivers.

An activity dictionary is a list of activities accompanied by information that describes each activity (called attributes).

Costs are assigned using direct tracing and resource drivers.

Activity-based customer costing can identify what it is costing to service different customers. Once known, a firm can then devise a strategy to increase its profitability by focusing more on profitable customers, converting unprofitable customers to profitable ones where possible, and “firing” customers that cannot be made profitable.

10. Activity-based supplier costing traces all supplier-caused activity costs to suppliers. Often, many costs are overlooked by traditional costing. By assigning all costs that are caused by suppliers, a company may find that its low-cost supplier does not correspond to the one that has the lowest purchase price. 11. Driver analysis is concerned with identifying the root causes of activity costs. Knowing the root causes of activity costs is the key to improvement and innovation and also informs a processvalue analysis. Once a manager understands why costs are being incurred, efforts can be taken to focus on cost reduction. 12. Value-added activities are necessary activities. Activities are necessary if they are mandated or if they are not mandated and satisfy three conditions: (1) they cause a change of state, (2) the change of state is not achievable by preceding activities, and (3) they enable other activities to be performed. Value-added costs are costs caused by activities that are necessary and efficiently executed.

5-1

CHAPTER 5

Activity-Based Costing and Management

13. Nonvalue-added activities are unnecessary activities or activities that are necessary but inefficient and improvable. An example is moving goods. Nonvalue-added costs are those costs caused by nonvalue-added activities. An example is the cost of materials handling. 14. (1) Activity elimination—the identification and elimination of activities that fail to add value. (2) Activity selection—the process of choosing among different sets of activities caused by competing strategies. (3) Activity reduction—the process of decreasing the time and resources required by an activity. (4) Activity sharing—increasing the efficiency of necessary activities using economies of scale. 15. Cycle time is the length of time required to produce one unit of product; velocity is the number of units that can be produced in a given period of time. 16. The data analytic type is prescriptive because the value-added ABC unit cost is the unit cost that should exist in the absence of all waste and inefficiency.

MULTIPLE-CHOICE QUESTIONS 5-1.

5-2.

5-3.

500/1000; 500/1000

5-4.

Setup hours are twice as much for Laser, consuming more overhead

5-5.

5-6.

5-7.

5-8.

$40,000 × 0.25 = $10,000

5-9.

$80,000/40,000 moves = $2 per move Number of moves is the best driver

5-10.

5-11.

5-12.

5-13.

5-14.

5-15.

5-16.

5-17.

5-18.

(10 hours/60 units) × 60 minutes in 1 hours = 10 minutes

5-19.

60 units/10 hours = 6 units per hour

5-20.

e c

5-21.

$1,200,000/1,500,000 pounds = 0.80 per pound shipped Order of 10,000 pounds × 0.80 = $8,000 for shipping

Purchasing is a value-added activity

The $15 is certainly descriptive; the analysis that classifies activities and allows the calculation of the value-added and nonvalue-added unit costs is diagnostic; finally, the $5.00 and $10.00 are costs that should happen and, are therefore, prescriptive . 5-2

CHAPTER 5

Activity-Based Costing and Management

BRIEF EXERCISES: SET A BE 5-22 1. Activity Driver

Vaquero

Cutting hours Assembly hours Inspection hours Rework hours a b c d

Vaquera a

0.43 0.38 b 0.28 c d 0.25

0.57 0.62 b 0.72 c d 0.75

4,000/9,400; 5,400/9,400 2,850/7,500; 4,650/7,500 945/3,375; 2,430/3,375 150/600; 450/600

There is evidence of product diversity, but it is not strong. The consumption ratios vary from 0.25 to 0.43, revealing that the vaquero boots vary in their consumption of the activities. However, the range is narrow, and so the diversity is not great.

BE 5-23 Cutting: Assembling: Inspecting: Reworking:

$225,600/9,400 = $24 per Cutting hour $300,000/7,500 = $40 per Assembling hour $67,500/3,375 = $20 per Inspecting hour $45,000/600 = $75 per Reworking hour

BE 5-24 Activity

Classic

Processing transactions: $0.20 × 12,000……………..……………… $0.20 × 7,200……………..………………… Preparing statements: $0.95 × 12,000……………..……………… $0.95 × 7,200……………..………………… Answering questions: $4.00 × 24,000……………..……………… $4.00 × 36,000……………..……………… Providing ATMs: $1.50 × 48,000……………..……………… $1.50 × 14,400……………..……………… Total cost…………………………………… Unit cost…………………………………….. 5-3

Gold

2,400 $

1,440

11,400 6,840 96,000 144,000 72,000 $181,800 7,500 ÷ $ 24.24

21,600 $173,880 ÷ 30,000 $ 5.80

CHAPTER 5

Activity-Based Costing and Management

BE 5-25 Activity

Cost Assignment

Comparing source documents Resolving discrepancies Processing payment

0.25 × $500,000 = $125,000 0.60 × $500,000 = $300,000 0.15 × $500,000 = $75,000

BE 5-26 Order Filling Rate = ($1,455,127 + $970,085)/3,636 orders = $667 per order Selling Call Rate = ($719,820 + $479,880)/900 orders = $1,333 per sales call Large Retailer

Cost assignment: Ordering $667 × 36……………………….…………… $667 × 3,600……………………….……… Sales calls $1,333 × 18……………………….………… $1,333 × 882……………………….……… Total

5-4

Smaller Retailers

$24,012 $2,401,200 23,994 $48,006

1,175,706 $3,576,906

CHAPTER 5

BE 5-27 Test Rate

Activity-Based Costing and Management

= $1,200,000/2,000* failed tests = $600 per failed test

Reorder Rate = $300,000/100** reorders = $3,000 per reorder * (1,200 + 780 + 10 + 10) ** (60 + 40) Using these rates and the activity data, the total purchasing cost per unit of each component is computed as follows: Alpha Electronics 125X 30Y Purchase cost: $10 × 120,000……………… $26 × 60,000……………… $12 × 15,000……………… $28 × 15,000……………… Testing components: $600 × 1,200……………… $600 × 780………………… $600 × 10………………… $600 × 10………………… Reordering components: $3,000 × 60………………… $3,000 × 40………………… $3,000 × 0………………… $3,000 × 0………………… Total ÷ Units Unit cost

La Paz Company 125X 30Y

$1,200,000 $1,560,000 $180,000 $420,000 720,000 468,000 6,000 6,000 180,000 120,000 0 $2,100,000 120,000 $ 17.50

$2,148,000 60,000 $ 35.80

$186,000 15,000 $ 12.40

0 $426,000 15,000 $ 28.40

BE 5-28 Retesting: Nonvalue-Added Cost = $720,000. Retesting is a nonvalue-added activity, and its value-added standard is therefore 0. All cost is waste. Welding: $1,350,000/67,500 welding hours = $20 per welding hour Nonvalue-Added Cost = (AQ – SQ)$20 = (67,500 – 54,000) × $20 = $270,000 BE 5-29 Velocity = 144,000 units/36,000 hours = 4 units per hour Cycle Time = 36,000 hours/144,000 units = 0.25 hour (15 minutes) Notice that cycle time is the inverse of velocity. 5-5

CHAPTER 5

Activity-Based Costing and Management

BRIEF EXERCISES: SET B BE 5-30 1. Activity Driver

Casual

Formal

Cutting hours

0.40

0.60

Sewing hours

0.30

0.70

Inspection hours

0.33

0.67

Rework hours

0.40

0.60

a b c d

30,000/75,000; 45,000/75,000 7,500/25,000; 17,500/25,000 5,000/15,000; 10,000/15,000 1,000/2,500; 1,500/2,500

2. There is evidence of product diversity, but it is not strong. The consumption ratios vary from 0.30 to 0.40, for casual blouses, revealing that the casual blouses vary in their consumption of the activities. However, the range is narrow, and so the diversity is not great. The range is also narrow for formal blouses.

BE 5-31 Cutting: Sewing: Inspecting: Reworking:

$150,000/75,000 = $2 per Cutting hour $375,000/25,000 = $15 per Sewing hour $90,000/15,000 = $6 per Inspecting hour $20,000/2,500 = $8 per Reworking hour

BE 5-32 Activity

Silver

Processing transactions: $0.25 × 30,000……………..……………… $0.25 × 18,000……………..……………… Preparing statements: $0.80 × 30,000……………..……………… $0.80 × 18,000……………..……………… Answering questions: $1.80 × 60,000……………..……………… $1.80 × 90,000……………..……………… Providing ATMs: $2.00 × 120,000……………..…………… $2.00 × 36,000……………..……………… Total cost……………………………………………… Unit cost………………………………………...……

5-6

Premium

7,500 $

4,500

24,000 14,400 108,000 162,000 240,000 $379,500 ÷ 18,750 $ 20.24

72,000 $252,900 ÷ 75,000 $ 3.37

CHAPTER 5

BE 5-33 Activity Unloading goods Counting goods Inspecting goods

Activity-Based Costing and Management

Cost Assignment 0.35 × $480,000 = $168,000 0.25 × $480,000 = $120,000 0.40 × $480,000 = $192,000

BE 5-34 Order Filling Rate = ($1,939,200 + $448,400)/4,560 orders = $524 per order Selling Call Rate = ($960,000 + $240,000)/2,472 orders = $485 per sales call Cost assignment: Ordering $524 × 60……………………….……………….… $524 × 4,500……………………….……………… Sales calls $485 × 24……………………….……………….… $485 × 2,448……………………….……………… Total

5-7

Large Retailer

Smaller Retailers

$31,440 $ 2,358,000 11,640 $43,080

1,187,200 $3,545,280

CHAPTER 5

Activity-Based Costing and Management

BE 5-35 Test Rate

= $4,500,000/7,500* failed tests = $600 per failed test

Reorder Rate = $1,125,000/375** reorders = $3,000 per reorder (4,500 + 2,925 + 39 + 36) (225 + 150)

Using these rates and the activity data, the total purchasing cost per unit of each component is computed as follows: Otavalo Manufacturing #625 Purchase cost: $30 × 450,000…………… $78 × 225,000…………… $36 × 56,250……………… $84 × 56,250……………… Testing components: $600 × 4,500……………… $600 × 2,925……………… $600 × 39………………… $600 × 36………………… Reordering components: $3,000 × 225……………… $3,000 × 150……………… $3,000 × 0………………… $3,000 × 0………………… Total ÷ Units Unit cost

#827

Piura Company #625

#827

$13,500,000 $17,550,000 $2,025,000 $4,725,000 2,700,000 1,755,000 23,400 21,600 675,000 450,000 0 $16,875,000 450,000 $ 37.50

$19,755,000 225,000 $ 87.80

$2,048,400 56,250 $ 36.42

0 $4,746,600 56,250 $ 84.38

BE 5-36 Reworking: Nonvalue-Added Cost = $740,000. Reworking is a nonvalue-added activity, and its value-added standard is therefore 0. All cost is waste. Purchasing: $900,000/45,000 purchasing hours = $20 per purchasing hour Nonvalue-Added Cost = (AQ – SQ)$20 = (45,000 – 24,000) × $20 = $420,000

BE 5-37 Velocity = 40,000 units/8,000 hours = 5 units per hour Cycle Time = 8,000 hours/40,000 units = 0.20 hour (12 minutes) Notice that cycle time is the inverse of velocity.

5-8

CHAPTER 5

Activity-Based Costing and Management

EXERCISES E 5-38 1.

Scented Cards Inspection hours………………………… Setup hours……………………………… Machine hours…………………………… Number of moves………………………

a b c d

0.65 b 0.70 c 0.25 0.80 d

Regular Cards a

0.35 b 0.30 c 0.75 d 0.20

1,300/2,000; 700/2,000 630/900; 270/900 1,440/5,760; 4,320/5,760 4,320/5,400; 1,080/5,400

The consumption ratios vary significantly from driver to driver, ranging from 0.25 to 0.80 for Scented and 0.20 to 0.75 for the Regular cards. Thus, there seems to be significant product diversity. If machine hours are used as the only driver, Scented cards will receive 25% of the overhead, and Regular cards would receive 75% of the overhead. Yet, the Scented cards consume well over 65% of the non-machinerelated overhead. Thus, the Scented cards are undercosted, and the Regular cards are overcosted. This inaccuracy can adversely affect many decisions, including pricing, keep or drop, and cost-volume-profit.

Rates: Inspecting products: $45,000/2,000 inspection hours = $22.50 per inspection hour Setting up equipment: $42,750/900 setup hours = $47.50 per setup hour Machining: $46,080/5,760 machine hours = $8.00 per machine hour Moving materials: $24,300/5,400 moves = $4.50 per move Note: The denominator is the total driver amount (sum of the demand of the two products).

Rate =

Cost Hours

Inspection Hours =

Cost Rate

= $50,000/$25 = 2,000 inspection hours

5-9

CHAPTER 5

Activity-Based Costing and Management

E 5-39 1. Molding Activity Overhead Cost = $675,000 × 0.80 = $540,000 Activity Rate (molding)

Molding Activity Costs Pounds of Plastic Molded

= $540,000/3,000,000 pounds = $0.18 per pound molded 2. Decal Application Overhead Cost = $675,000 × 0.20 = $135,000 Activity Rate (application)

Decal Application Activity Costs Number of Decals Applied

= $135,000/375,000 decals = $0.36 per decal applied

E 5-40 1. a. Activity Rate

Setup Costs Total Setup Hours

= $864,000/16,000 setup hours = $54 per setup hour b. Activity Rate

Other Overhead Costs Total Oven Hours

= $2,880,000/19,200 oven hours = $150 per oven hour 2. Total overhead costs assigned to Fudge (ABC rates): = (Setup Rate × Fudge Setup Hours) + (Oven Hour Rate × Fudge Oven Hours) = ($54 × 12,800) + ($150 × 3,200) = $1,171,200 3. Unit overhead assigned to Fudge: =

Total Overhead Assigned to Fudge Number of Fudge Batches

= $1,171,200/16,000 batches = $73.20 4. Plantwide overhead rate based on oven hours: =

Total Overhead Costs Total Oven Hours

= $3,744,000/19,200 oven hours = $195 per oven hour 5. Total overhead costs assigned to Fudge (plantwide rate): = Plantwide Rate × Number of Oven Hours Used by Fudge = $195 × 3,200 = $624,000

5-10

CHAPTER 5

Activity-Based Costing and Management

E 5-40 (Continued) 6. The difference in overhead assignment to Fudge between the two systems is due to their different treatment of setup costs (i.e., both systems use oven hours to assign “other overhead” costs). The total overhead assigned to Fudge under the ABC system is much higher ($1,171,200) than under the nonABC system ($624,000) because the ABC system recognizes that Fudge consumes 80% of the setup hours (12,800/16,000) and, therefore, assigns 80% of the setup costs to Fudge. The nonABC system assigns all overhead costs (including setup costs) using oven hours, which results in Fudge being assigned only 16.67% (3,200/19,200 oven hours) of the setup costs, rather than 80% (12,800/16,000 setup hours). This difference—80% versus 16.67%—results in the $547,200 ($1,171,200 – $624,000) difference in setup costs assigned to Fudge under the two cost systems as shown in the following breakdown: (0.80 – 0.1667) × Total Setup Costs of $864,000 = 0.6333 × $864,000 = $547,200* * Rounded E 5-41 1. Treating patients:

Normal

$4.00 × 6,400………………………..……………….…… $4.00 × 8,000………………………..……………….…… Providing hygienic care: $5.00 × 4,800………………………..……………….…… $5.00 × 17,600………………………..……………….… Responding to requests: $2.00 × 32,000………………………..……………….… $2.00 × 80,000………………………..……………….… Monitoring patients: $3.00 × 6,000………………………..……………….…… $3.00 × 72,000………………………..……………….… Cost assigned………………………………………..……… 2. Nursing cost per patient day: $131,600/8,000 patient days…………………………… $496,000/6,400 patient days…………………………… 3. From Requirement 1, Total Nursing Cost Thus, using patient days (8,000 + 6,400): Nursing Cost per Patient Day

Intensive

$ 25,600 $ 32,000 24,000 88,000 64,000 160,000 18,000 $131,600

216,000 $496,000

Normal

Intensive

$16.45 $77.50 = $131,600 + $496,000 = $627,600 = $627,600/14,400 = $43.58

Both regular and intensive care patients would receive a charge of $43.58 per patient day for nursing services. However, this is manifestly unfair because intensive care patients clearly place much greater demands on nursing services than regular surgical patients. The ABC approach captures this difference as demonstrated in Requirements 1 and 2. 5-11

CHAPTER 5

Activity-Based Costing and Management

E 5-41 (Continued) 4. Requirement 1's calculation is descriptive in nature as it simply describes what is happening. The same is true for Requirement 2. Requirement 3, however, uses both the descriptive and the diagnostic analytic types. The calculation of the single patient day cost used for both patient categories is descriptive (it attempts to tell what is happening, albeit not so accurately), but the comparison and analysis that follows is diagnostic in nature. It explains why the single rate approach is defective by comparing the ABC approach with the single-rate approach. 5. a. Treating patients:

Normal

Intensive

$4.40 × 6,400………………………..……………….…… $4.40 × 8,000………………………..……………….…… Providing hygienic care: $5.50 × 4,800………………………..……………….…… $5.50 × 17,600………………………..……………….… Responding to requests: $2.20 × 32,000………………………..……………….… $2.20 × 80,000………………………..……………….… Monitoring patients: $3.30 × 6,000………………………..……………….…… $3.30 × 72,000………………………..……………….… Cost assigned………………………………………..………

$144,760

237,600 $545,600

Nursing cost per patient day:

Normal

Intensive

$144,760/8,000 patient days…………………………… $545,600/6,400 patient days……………………………

$ 28,160 $ 35,200 26,400 96,800 70,400 176,000 19,800

$18.10 $85.25

The calculation provides the costs that are expected for the coming year, and thus, what will likely be. Thus, the data analytic type is predictive. b. Using Excel with established equations would require only that the activity rates be updated. The calculations would then be automatically produced. Otherwise, all the calculations would need to be repeated manually, consuming more time and resources and with a greater chance of errors being made. Examples of equations needed would be the rate × activity quantity, the sum of all activity costs assigned, and the total activity cost for each patient category divided by the patient days for each patient category.

5-12

CHAPTER 5

E 5-42 1. Resource

Unloading

Equipment……………………………………… Fuel……………………………………………… Operating……………………………………… Labor*…………………………………………… Total…………………………………………

$15,000 3,600 1,500 60,000 $80,100

Activity-Based Costing and Management

Counting — — — $37,500 $37,500

Inspecting $ 1,200 — 750 52,500 $54,450

*(0.40 × $150,000; 0.25 × $150,000; 0.35 × $150,000)

Direct tracing and driver tracing are used. When the resource is used only by one activity, then direct tracing is possible. When the activities are shared, as in the case of labor, then resource drivers must be used.

E 5-43 1.

JIT a

Sales (in units) …………………………………………………

525,000

Sales ……………………………………………………………

$78,750,000

Allocationc………………………………………………………

$2,625,000

b c

NonJIT

Sales (in units) = Average Order Size × Sales Orders; JIT = 750 × 700 = 525,000; NonJIT = 7,500 × 70 = 525,000 525,000 units × $150 = $78,750,000 $5,250,000 × 0.50 = $2,625,000

Activity rates: Ordering Rate Selling Rate Service Rate

= $3,080,000/770 sales orders = $4,000 per sales order = $1,120,000/140 sales calls = $8,000 per sales call = $1,050,000/525 sales calls = $2,000 per sales call JIT

Ordering costs: $4,000 × 700……….…………….………………………….… $4,000 × 70……….…………….………………………….… Selling costs: $8,000 × 70……….…………….………………………….… $8,000 × 70……….…………….………………………….… Service costs: $2,000 × 350……….…………….………………………….… $2,000 × 175……….…………….………………………….… Total…….…………….………………………….…………

5-13

NonJIT

$2,800,000 $ 280,000 560,000 560,000 700,000 $4,060,000

350,000 $1,190,000

CHAPTER 5

Activity-Based Costing and Management

E 5-43 (Continued) For the nonJIT distributors, the customer costs amount to $2,625,000/70 = $37,500 per order under the original allocation. Using activity assignments, this drops to $1,190,000/70 = $17,000 per order, a difference of $20,500 per order. For an order of 7,500 units, the order price can be decreased by $2.73 per unit without affecting customer profitability. Overall profitability will decrease, however, unless the price for orders is increased to JIT distributors. 3.

It sounds like the JIT buyers are switching their inventory carrying costs to Stillwater Designs without any significant benefit to Stillwater Designs. Stillwater Designs needs to increase prices to reflect the additional demands on customersupport activities. Furthermore, additional price increases may be needed to reflect the increased number of setups, purchases, and so on, that are likely occurring inside the plant. Stillwater Designs should also immediately initiate discussions with its JIT customers to begin negotiations for achieving some of the benefits that a JIT supplier should have, such as long-term contracts. The benefits of long-term contracting may offset most or all of the increased costs from the additional demands made on other activities. Although the focus is on Stillwater Design customers, as an independent consultant I would suggest that similar outcomes for their suppliers would be good. Stillwater would benefit from suppliers using JIT manufacturing and working with them to establish a JIT delivery arrangement as well.

E 5-44 1. Supplier cost: First, calculate the activity rates for assigning costs to suppliers: Inspecting components: $480,000/4,000 sampling hours = $120 per sampling hour Reworking products: $6,084,000/6,000 rework hours = $1,014 per rework hour Warranty work: $9,600,000/16,000 warranty hours = $600 per warranty hour Next, calculate the cost per component by supplier: Manzer Inc. Purchase cost: $89 × 800,000……………………… $86 × 3,200,000……………………… Inspecting components: $120 × 80…………………………… $120 × 3,920…………………………

5-14

Buckner Company

$71,200,000 $275,200,000 9,600 470,400

CHAPTER 5

Activity-Based Costing and Management

E 5-44 (Continued) Manzer Inc. Reworking products: $1,014 × 360…..….………….….…………………...… $ 365,040 $1,014 × 5,640…..….………….….…………………. Warranty work: 480,000 $600 × 800…..….………….….…………………...…. $600 × 15,200…..….………….….………………….. $72,054,640 Total supplier cost……………………………………… ÷ Units supplied…………………………………………… 800,000 90.07 Unit cost…………………………………………………… $ 2.

Buckner Company

5,718,960

9,120,000 $290,509,360 3,200,000 $ 90.78

Using warranty hours, the rate is $4,000,000/16,000 = $250 per warranty hour. The cost assigned to each component would be: Bucker Manzer Inc. Lost sales: Company $250 × 800…..….………….….…………………...…. $250 × 15,200…..….………….….………………….. Total……………………………………………….. ÷ Units supplied…………………………………………… Increase in unit cost…………………………………

$200,000 $200,000 800,000 $ 0.25

$3,800,000 $3,800,000 3,200,000 $ 1.19

As with product costing, accurate assignment of costs to the cost object is essential for well-grounded decision-making. Suppliers can cause a firm to perform costly activities such as inspection, rework, and warranty work. The total cost of a component is thus more than its purchase price. As this example shows, the component with the higher price is actually less expensive because it causes less demand on internal costly activities. Thus, the company would likely decrease the purchases of one supplier in favor of the other. It also might attempt to work with the one supplier which is causing significant demands on internal activities to see if the quality of its component can be increased. Not only does this analysis assist with vendor-related decisions, but it highlights the reason for the loss of sales and development of a poor reputation by its customers, giving the company a sound basis for change. The analysis also provides a "talking point" when Bowman reaches out to its customers acknowledging a problem that now has a solution.

Supplier cost: First, calculate the activity rates for assigning costs to suppliers: Inspecting components: $130,000/1,300 sampling hours = $100 per sampling hours Reworking products: $2,850,000/2,850 rework hours = $1,000 per rework hours Warranty work: $3,500,000/7,000 warranty hours = $500 per warranty hours

5-15

CHAPTER 5

Activity-Based Costing and Management

E 5-44 (Continued) Next, calculate the cost per component by supplier: Manzer Inc. Purchase cost: $89 × 3,200,000……………..……………… $86 × 800,000……………..……………… Inspecting components: $100 × 320……………..…………………… $100 × 980……………..…………………… Reworking products: $1,000 × 1,440……………..……………… $1,000 × 1,410……………..……………… Warranty work: $500 × 3,200……………..………………… $500 × 3,800……………..………………… Total supplier cost………………………… ÷ Unit supplied Unit cost……………………………………..

Buckner Company

$284,800,000 $68,800,000 32,000 98,000 $ 1,440,000 $ 1,410,000 1,600,000 $287,872,000 3,200,000 $ 89.96

1,900,000 $72,208,000 800,000 $ 90.26

Using warranty hours, the rate is $2,100,000/7,000 = $300 per warranty hour. The cost assigned to each component would be: Lost sales:

Manzer Inc.

$300 × 3,200……………..………………… $300 × 3,800……………..………………… Total …………………………………………… ÷ Units supplied Increase in unit cost……………………

5-16

Bucker Company

$ 960,000 $ 960,000 3,200,000 $ 0.30

$ 1,140,000 $ 1,140,000 800,000 $ 1.43

CHAPTER 5

Activity-Based Costing and Management

E 5-44 (Continued) The critical equations that would appear in Excel to produce the answers of Requirements 1 and 4 are given in the boxes to the right of the answers. Note that there is an equation for each of the activity rates (activity costs divided by the sum of the activity driver demands). There are also equations for calculating the activities of purchasing, inspecting, reworking, and warranty work (unit price or cost times the activity quantity for each supplier). For Requirement 2, the lost sales activity rate and cost application equations are added. The shaded boxes show the cells where the new data can be inserted to produce new results. The unshaded boxes have embedded equations to use data previously calculated or inserted. For example, the 7,000 value for calculating the lost sales activity rate of $300 is simply the sum of the cells containing the warranty hours (3,200 + 3,800). Note that the summation equation to obtain the 7,000 value would be embedded in this cell. Changing from the old policy results to the new policy results is easily achieved by simply inserting the new data in the shaded boxes. It is fast, accurate, and efficient. Data analytics makes it easier to generate useful information. 5.

The total savings of the Requirement 4 purchasing policy compared to the current policy are $4,384,000 ($366,544,000 − $362,180,000). The total costs for the old policy and the new policy are the sum of the total supplier costs for each supplier before considering lost sales plus the total supplier costs for each supplier for the lost sales. This suggests that an equation that produces the total purchasing cost would be helpful. The calculations of Requirement 4 are predicting what the costs are likely to be for the new policy, and, thus the analytic type is predictive.

5-17

CHAPTER 5

Activity-Based Costing and Management

E 5-45 Case a b c d e f 1 2 3 4 5 6

Nonvalue-Added Cost 1 $9 per unit 2 $300 per setup 3 $120 per product 4 $400,000 per year 5 $250 per unit 6 $900,000 per year

(0.50 × $12) – (0.25 × $8) + [(8 – 7.5) × $10] = $9 (8 – 2) × $50 = $300 (6 – 0) × $20 = $120 $320,000 + (16,000 × $5) = $400,000 (6.5 – 6) × $500 = $250 As given

E 5-46 Case

Root Cause

a b c d e f

Process design Product design Plant layout Multiple* Suppliers Product design

* For example, process design, product design, and quality approach or philosophy E 5-47 Case

Cost Reduction

a b c d e f

Activity selection Activity reduction Activity elimination Activity elimination Activity selection Activity sharing

E 5-48 1. Velocity = 80,000/20,000 = 4 units per hour 2.

Cycle Time = 20,000/80,000 = 1/4 hour per unit = 15 minutes per unit

Cycle Time = 10 minutes = 10/60 = 1/6 hr. Velocity = 1/Cycle Time = 1 ÷ 1/6 = 6 units per hour Units Produced/Production Hours = Velocity Units Produced = Velocity × Production Hours = 6 units per hour × 20,000 production hours = 120,000 units 5-18

CHAPTER 5

Activity-Based Costing and Management

E 5-49 1. Yes. Because direct materials and direct labor are directly traceable to each product, their cost assignment should be accurate. 2.

The consumption ratios for each activity (using machine hours and setup hours as the activity drivers) are as follows:

Machining………………… Setups……………………… 3.

Elegant

Fina

0.10 0.50

0.90 0.50

(500/5,000 and 4,500/5,000) (100/200 and 100/200)

Elegant: $1.75* × $9,000/3,000 = $5.25 per briefcase Fina: $1.75* × $3,000/3,000 = $1.75 per briefcase * Overhead Rate = $21,000/$12,000 = $1.75 per direct labor dollar (or 175% of direct labor cost)

More machine and setup costs are assigned to Elegant than Fina. This is clearly a distortion because the production of Fina is automated and uses the machine resources much more than the handcrafted Elegant. In fact, the consumption ratios for machining are 0.1 and 0.9 (using machine hours as the measure of usage). Thus, Fina uses 9 times the machining resources that Elegant does. Setup costs are similarly distorted. The products use an equal number of setup hours. Yet, if direct labor dollars are used, then the Elegant briefcase receives three times more machining costs than the Fina briefcase. 4.

Products tend to make different demands on overhead activities, and this should be reflected in overhead cost assignments. Usually, this means the use of both unit- and nonunit-level activity drivers. In this example, there is a unit-level activity (machining) and a nonunit-level activity (setting up equipment). Machine rate: $18,000/5,000 = $3.60 per machine hour Setup rate: $3,000/200 = $15 per setup hour Costs assigned to each product: Machining: $3.60 × 500…………………………………………… $3.60 × 4,500…………………………………………… Setups: $15 × 100…………………………………………… Total……………………………………………….……… ÷ Units………………………………………………… Unit overhead cost………………………………..

5-19

Elegant

Fina

$1,800 $16,200 1,500 $3,300 3,000 $ 1.10

1,500 $17,700 3,000 $ 5.90

CHAPTER 5

Activity-Based Costing and Management

E 5-50 1. Total overhead: Activity driver:

$152,000 ($80,000 + $24,000 + $18,000 + $30,000) Machine hours (20,000 + 20,000 = 40,000)

Rate = $152,000/40,000 = $3.80 per machine hour Overhead assignment: Infantry: Special forces: 2.

$3.80 × 20,000 = $76,000 $3.80 × 20,000 = $76,000

Consumption ratios: Product

Machine Hours

Setups

Receiving Orders

Packing Orders

Infantry……………………… Special forces………………

0.50 0.50

0.75 0.25

0.90 0.10

0.67 0.33

Activity rates: Machining:

$80,000/40,000 machine hours = $2.00 per machine hour

Setups:

$24,000/400 setups = $60.00 per setup

Receiving:

$18,000/1,000 receiving orders = $18.00 per receiving order

Packing:

$30,000/2,400 packing orders = $12.50 per packing order

Overhead assignment:

Infantry

Machining: $2.00 × 20,000…………...………...…….…………...… $2.00 × 20,000…………...………...…….…………...… Setups: $60.00 × 300…………...………...…….…………...…… $60.00 × 100…………...………...…….…………...…… Receiving: $18.00 × 900…………...………...…….…………...…… $18.00 × 100…………...………...…….…………...…… Packing: $12.50 × 1,600…………...………...…….…………...… $12.50 × 800…………...………...…….…………...…… Total……...………...…….…………...…….…………...… 5.

Special Forces

$40,000 $40,000 18,000 6,000 16,200 1,800 20,000 $94,200

10,000 $57,800

Using only machine hours undercosts the infantry product and overcosts the special forces product. The consumption ratios reveal this before the actual calculations are made.

5-20

CHAPTER 5

Activity-Based Costing and Management

E 5-51 Activity Dictionary: Activity Name

Activity Description

Activity Driver

Providing nursing care*

Satisfying patient needs

Nursing hours

Supervising nurses

Coordinating nursing activities Providing meals to patients Cleaning and delivering clothes and bedding Therapy treatments directed by physician

Number of nurses

Using equipment to monitor patient conditions

Monitoring hours

Feeding patients Laundering bedding and clothes Providing physical therapy Monitoring patients

Number of meals Pounds of laundry Hours of therapy

*One or more of the individual tasks described for the activity, Providing Nursing Care," such as answering questions, changing bandages, and changing clothes might rise to the level of an activity if they are a large component and differ markedly for different groups of patients. How far to drill down for activity identification is always a difficult question and is a product of experience and judgment.

E 5-52 1.

Activity rates: Setups = $2,000,000/500 setups Machining = $80,000,000/400,000 machine hours Engineering = $6,000,000/150,000 engineering hours Packing = $100,000/500,000 packing orders

Calculation of unit product costs:

= $4,000 per setup = $200 per machine hour = $40 per engineering hour = $0.20 per packing order

Deluxe

Setups: $4,000 × 300…………...………...…….…… $4,000 × 200…………...………...…….…… Machining: $200 × 100,000…………...………...……. $200 × 300,000…………...………...……. Engineering: $40 × 50,000…………...………...…….…… $40 × 100,000…………...………...…….… Packing: $0.20 × 100,000…………...………...…… $0.20 × 400,000…………...……………… Total overhead……………………………… ÷ Units………………………………………… Overhead per unit…………………………… Prime cost per unit………………………… Unit cost…………………………………… * Rounded 5-21

Regular

$ 1,200,000 $

800,000

20,000,000 60,000,000 2,000,000 4,000,000 20,000 $23,220,000 100,000 $ 232 * 529 $ 761

80,000 $64,880,000 800,000 $ 81 * 483 $ 564

CHAPTER 5

Activity-Based Costing and Management

E 5-53 1. First, receiving is viewed as a value-added activity because the efficient level of the activity is nonzero. Second, receiving enables other activities to be performed. Third, there is a change of state—from a state of no materials received to a state of materials received. Fourth, the receiving state should not have been achieved by a prior activity. Fifth, it is a necessary activity— one essential for the firm to remain in business. Possible reasons for exceeding the value-added standard: suboptimal inventory management policies, reorders due to bad parts being delivered by suppliers, extra orders due to rework requirements, and additional orders because the wrong types and quantities of materials were ordered. 2.

Activity Rate = $630,000/72,000 orders = $8.75 per order Value-Added Costs = $8.75 × 36,000 = $315,000 Nonvalue-Added Costs = $8.75 × 36,000 = $315,000 The practical capacity is currently 72,000 orders; but, 36,000 orders are unnecessary.

5-22

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Activity-Based Costing and Management

PROBLEMS P 5-54 1. Cost before addition of duffel bags: $60,000*/100,000 = $0.60 per unit *$120,000/2 (costs doubled with the addition of new product)

The assignment is accurate because all costs belong to one product. 2.

Activity-based cost assignment: Stage 1: Activity Rate = $120,000/80,000 transactions = $1.50 per transaction Stage 2: Overhead applied: Backpacks: $1.50 × 40,000* = $60,000 Duffel bags: $1.50 × 40,000 = $60,000 *80,000 transactions/2 = 40,000 (number of transactions had doubled)

Unit cost: Backpacks: $60,000/100,000 units = $0.60 per unit Duffel bags: $60,000/25,000 units = $2.40 per unit 3.

Product cost assignment: Overhead rates: Patterns: $30,000/15,000 direct labor hours = $2.00 per direct labor hour Finishing: $90,000/30,000 direct labor hours = $3.00 per direct labor hour Unit cost computation: Backpacks Patterns: $2.00 × 0.10…………………………………… $0.20 $2.00 × 0.20…………………………………… Finishing: $3.00 × 0.20…………………………………… 0.60 $3.00 × 0.40…………………………………… Total per unit………………………………………… $0.80

5-23

Duffel Bags

$0.40

1.20 $1.60

CHAPTER 5

Activity-Based Costing and Management

P 5-54 (Continued) 4. This problem allows us to see what the accounting cost per unit should be by providing the ability to calculate the cost with and without the duffel bags. With this perspective, it becomes easy to see the benefits of the activity-based approach over those of the functional-based approach. The activity-based approach provides the same cost per unit as the singleproduct setting. The functional-based approach used transactions to allocate accounting costs to each producing department, and this allocation probably reflects quite well the consumption of accounting costs by each producing department. The problem is the second-stage allocation. Direct labor hours do not capture the consumption pattern of the individual products as they pass through the departments. The distortion occurs, not in using transactions to assign accounting costs to departments, but in using direct labor hours to assign these costs to the two products. In a single-product environment, ABC offers no improvement in productcosting accuracy. However, even in a single-product environment, it may be possible to increase the accuracy of cost assignments to other cost objects such as customers.

5-24

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Activity-Based Costing and Management

P 5-55 1. Plantwide Rate = $990,000/440,000 DLHs = $2.25 per DLH Overhead cost per unit: Model A: ($2.25 × 140,000)/10,000 units = $31.50 Model B: ($2.25 × 300,000)/100,000 units = $6.75 2.

Activity rates: Activity

Driver

Activity Rate

Setups Inspections Machining Maintenance

Production runs Inspection hours Machine hours Maintenance hours

$270,000/100 runs = $2,700 per run $210,000/2,000 hours = $105 per hour $240,000/220,000 hours = $1.09 per hour $270,000/100,000 hours = $2.70 per hour

Overhead assignment: Setups: $2,700 × 40…...………...………………. $2,700 × 60…...………...………………. Inspections: $105 × 800…...………...……………….. $105 × 1,200…...………...……………… Machining: $1.09 × 20,000…...………...…………… $1.09 × 200,000…...………...…………… Maintenance: $2.70 × 10,000…...………...…………… $2.70 × 90,000…...………...…………… Total overhead…………………………… ÷ Units produced…………………….…… Overhead per unit……………………… 3.

Model A

Model B

$108,000 $162,000 84,000 126,000 21,800 218,000 27,000 $240,800 10,000 $ 24.08

243,000 $749,000 100,000 $ 7.49

Departmental rates: Overhead cost per unit: Model A: ($3.50 × 10,000 machine hours) + ($0.90 × 130,000 direct labor hours) /10,000 units = $15.20 Model B: ($3.50 × 170,000 machine hours) + ($0.90 × 270,000 direct labor hours) /100,000 units = $8.38

Product

ABC Cost

Department Cost

Plantwide Cost

Difference

(1)

(2)

(3)

(1)–(2)

(1)–(3)

$24.08

$15.20

$31.50

$8.88

–$7.42

7.49

8.38

6.75

– 0.89

0.74

5-25

CHAPTER 5

Activity-Based Costing and Management

P 5-55 (Continued) A common justification is to use machine hours for machine-intensive departments and labor-hours for labor-intensive departments. Using activity-based costs as the standard, we can say the department rates decreased the accuracy of the overhead cost assignment for both products and were less accurate than the plantwide rates. The departmental rates cost Product A well below the ABC method while the plantwide rate costs Product A well above the ABC method (with the difference being somewhat greater than departmental rates). The departmental rates are not dramatically more wrong then the plantwide rate; however, they are wrong in a different direction. P 5-56 1. Labor and gasoline are driver tracing. Labor (0.75 × $120,000)…………………… Gasoline ($3 × 6,000 moves)…………… Depreciation (0.75 × $16,000)…………… Total cost……………………………… 2. Plantwide Rate

$ 90,000 Time = Resource Driver 18,000 Moves = Resource Driver 12,000 Time = Resource Driver $120,000

= $600,000/20,000 direct labor hours = $30 per DLH

Unit cost: Prime costs Overhead: $30 × 10,000 direct labor hours/40,000 units $30 × 10,000 direct labor hours/20,000 units

Basic $80.00

Deluxe $160

7.50 $87.50

15 $175

3. Activity rates: $114,000/4,000 = $28.50 per maintenance hour Maintenance: Engineering: $120,000/6,000 = $20 per engineering hour Materials handling: $120,000/6,000 = $20 per move Setting up: $96,000/80 = $1,200 per setup $60,000/300 = $200 per requisition Purchasing: $40,000/750 = $53.33 per order processed Receiving: Paying suppliers: $30,000/750 = $40 per invoice processed Providing space: $20,000/10,000 = $2 per machine hour Unit cost: Basic Deluxe $3,200,000 Prime costs ($80 × 40,000; $160 × 20,000)……………… $3,200,000 Overhead: Maintenance: $28.50 × 1,000……….…………….…………………. 28,500 $28.50 × 3,000……….…………….…………………. 85,500 Engineering: $20.00 × 1,500……….…………….…………………. 30,000 $20.00 × 4,500……….…………….…………………. 90,000 Materials handling: $20.00 × 1,200……….…………….…………………. 24,000 $20.00 × 4,800……….…………….…………………. 96,000 5-26

CHAPTER 5

P 5-56 (Continued) Setting up: $1,200 × 16……….…………….………………… $1,200 × 64……….…………….………………… Purchasing: $200 × 100……….…………….………………… $200 × 200……….…………….………………… Receiving: $53.33 × 250……….…………….……………… $53.33 × 500……….…………….……………… Paying suppliers: $40 × 250……….…………….………………….… $40 × 500……….…………….………………….… Providing space: $2 × 5,000……….…………….…………………. $2 × 5,000……….…………….…………………. Total………………………….…………….………… ÷ Units produced………….…………….………… Unit cost (ABC)…………….…………….………… Unit cost (traditional)……….…………….………

Activity-Based Costing and Management

19,200 76,800 20,000 40,000 13,333 * 26,665 10,000 20,000 10,000 $3,355,033 40,000 $ 83.88 $ 87.50

10,000 $3,644,965 20,000 $ 182.25 $ 175.00

The ABC costs are more accurate (better tracing—closer representation of actual resource consumption). This shows that the basic model was overcosted and the deluxe model undercosted when the plantwide overhead rate was used. 4.

Consumption ratios for each activity:

Basic

Deluxe

Maintenance (1,000/4,000; 3,000/4,000)……… Engineering (1,500/6,000; 4,500/6,000)………… Materials handling (1,200/6,000; 4,800/6,000)… Setups (16/80; 64/80)……………………….…… Purchasing (100/300; 200/300)………………… Receiving (250/750; 500/750)…………………… Paying suppliers (250/750; 500/750)………….… Providing space (5,000/10,000; 5,000/10,000)…

0.25 0.25 0.20 0.20 0.33 0.33 0.33 0.50

0.75 0.75 0.80 0.80 0.67 0.67 0.67 0.50

When products consume activities in the same proportion, the activities with the same proportions can be combined into one pool. This is so because the pooled costs will be assigned in the same proportion as the individual activity costs. Using these consumption ratios as a guide, we create four pools, reducing the number of rates from 8 to 4. * Rounded

5-27

CHAPTER 5

Activity-Based Costing and Management

P 5-56 (Continued) Pool 1: Maintenance……………………………………………… Engineering……………………………………………… Total…………………………………………………… ÷ Maintenance hours…………………………………… Pool rate………………………………………………

$114,000 120,000 $234,000 4,000 $ 58.50

Note: Engineering hours could also be used as a driver. The activities are grouped together because they have the same consumption ratios: (0.25, 0.75). Pool 2: Materials handling……………………………………… Setting up………………………………………………… Total…………………………………………………… ÷ Number of moves…………………………………… Pool rate………………………………………………

$120,000 96,000 $216,000 6,000 $ 36

Note: Materials handling and setups have the same consumption ratios: (0.20, 0.80). The number of setups could also be used as the pool driver. Pool 3: Purchasing……………………………………………… Receiving………………………………………………… Paying suppliers………………………………………… Total…………………………………………………… ÷ Orders processed…………………………………… Pool rate………………………………………………

$ 60,000 40,000 30,000 $130,000 750 $ 173.33

Note: The three activities are all product-level activities and have the same consumption ratios: (0.33, 0.67). Pool 4: Providing space………………………………………… ÷ Machine hours………………………………………… Pool rate……………………………………………… Note: This is the only facility-level activity.

5-28

$20,000 10,000 $ 2

CHAPTER 5

Activity-Based Costing and Management

P 5-57 1. The cost of supervision is computed as follows: Salary of supervisor (direct)…………………………………… Salary of secretary (direct)…………………………………… Other costs (direct)……………………………………………… Assistants (3 × 0.75 × $60,000)……………………………… Total……………………………………………………………

$ 80,000 35,000 170,000 135,000 $420,000

The total cost of care is $2,700,000 plus a $70,000 share of the cost of supervision (25/150 × $420,000). Thus, the cost per patient day is computed as follows: $2,770,000/10,000 = $277 per patient day (The total cost of care divided by patient days.) Notice that every maternity patient—regardless of type—would pay the daily rate of $277. 2.

First, the cost of the secondary activity (supervision) must be assigned to the primary activities (various nursing care activities) that consume it (the driver is the number of nurses): Maternity nursing care assignment: 25/150 × $420,000 = $70,000 Thus, the total cost of nursing care is $1,200,000 + $70,000 = $1,270,000. Next, calculate the activity rates for the two primary activities: Occupancy and feeding: $1,500,000/10,000 = $150.00 per day Nursing care: $1,270,000/50,000 = $25.40 per nursing hour Finally, the cost per patient day type can be computed:

a b c

Patient

Daily Rate

Normal…………………………………… Cesarean………………………………… Complications…………………………

$213.50 b $308.75 $658.00 c

($150 × 7,000) + ($25.40 × 17,500)/7,000 ($150 × 2,000) + ($25.40 × 12,500)/2,000 ($150 × 1,000) + ($25.40 × 20,000)/1,000

This example illustrates that activity-based costing can produce significant product-costing improvements in service organizations that experience product diversity.

5-29

CHAPTER 5

Activity-Based Costing and Management

P 5-57 (Continued) 3. The laundry department cost would increase the total cost of the maternity department by $115,200 (240,000/1,250,000 × $600,000). This would increase the cost per patient day by $11.52 ($115,200/10,000). The activity approach would need more detailed information—specifically, the amount of pounds of laundry caused by each patient type. The activity approach will increase the accuracy of the cost assignment if patient types produce a disproportionate share of laundry. For example, if patients with complications produce 40% of the pounds with only 10% of the patient days, then the $11.52 charge per day is not a fair assignment.

5-30

CHAPTER 5

Activity-Based Costing and Management

P 5-58 1. Cost per Account = $8,547,000/105,000 accounts = $81.40 Average Fee per Month = $81.40/12 months = $6.78 2.

Activity rates: Opening and closing accounts: $420,000/42,000 accounts = $10 per account Issuing monthly statements: $630,000/1,260,000 statements = $0.50 per statement Processing transactions: $4,305,000/43,050,000 transactions = $0.10 per transaction Customer inquiries: $840,000/4,200,000 minutes = $0.20 per minute Providing ATM services: $2,352,000/3,360,000 transactions = $0.70 per transaction Costs assigned:

Low

Opening and closing: $10 × 31,500………………………… $10 × 6,300………………………… $10 × 4,200………………………… Issuing monthly statements: $0.50 × 945,000…………………… $0.50 × 210,000…………………… $0.50 × 105,000…………………… Processing transactions: $0.10 × 37,800,000………………… $0.10 × 4,200,000………………… $0.10 × 1,050,000………………… Customer inquiries: $0.20 × 2,100,000………………… $0.20 × 1,260,000………………… $0.20 × 840,000…………………… Providing ATM services: $0.70 × 2,835,000………………… $0.70 × 420,000…………………… $0.70 × 105,000…………………… Total cost……………………………… Number of accounts………………… Cost per account…………………

Medium

High

$ 315,000 $ 63,000 $ 42,000 472,500 105,000 52,500 3,780,000 420,000 105,000 420,000 252,000 168,000 1,984,500 294,000 $6,972,000 79,800 $ 87.37

5-31

$1,134,000 16,800 $ 67.50

73,500 $441,000 8,400 $ 52.50

CHAPTER 5

Activity-Based Costing and Management

P 5-58 (Continued) 3.

Average profit per account: $90.00 – $81.40 = $8.60 ABC profit measure: Low-balance customers………………… $80.00 – $87.37 = $(7.37) Medium-balance customers……………… $100.00 – $67.50 = $32.50 High-balance customers………………… $165.00 – $52.50 = $112.50

First, calculate the profits from loans, credit cards, and other products by customer category (using ABC data). Next, compare 50% of the cross-sales profits from low-balance customers with the total loss from the low-balance checking accounts. If the cross-sales profits are greater than the loss, the president’s argument has merit.

P 5-59 1. GAAP mandates that all nonmanufacturing costs be expensed during the period in which they are incurred. GAAP is the most likely cause of the practice. The limitations of GAAP-produced information for cost management should be emphasized. The total product consists of all benefits, both tangible and intangible that a customer receives. One of the benefits is the order-filling service provided by Grundvig. Thus, it can be argued that these costs should be product costs and not assigning them to products undercosts all products. From the information given, there are more small orders than large (100,000 orders average 600 units); thus, these small orders consume more of the order-filling resources. They should, therefore, receive more of the order-filling costs.

5-32

CHAPTER 5

Activity-Based Costing and Management

P 5-59 (Continued) 2. The average order-filling cost per unit produced is computed as follows: $9,000,000/180,000,000* units = $0.05 per unit * (600 × 100,000) + (1,000 × 60,000) + (1,500 × 40,000) = 180,000,000 Thus, order-filling costs are about 6% to 10% of the selling price, clearly not a trivial amount. Furthermore, the per-unit cost for individual product families can be computed using the number of orders as the activity driver: Activity Rate = $9,000,000/200,000 orders = $45 per order The per-unit ordering cost for each product family can now be calculated: Category I: Category II: Category III:

$45/600 = $0.08 per unit $45/1,000 = $0.05 per unit $45/1,500 = $0.03 per unit

Category I, which has the smallest batches, is the most undercosted of the three categories. Furthermore, the unit ordering cost is quite high relative to Category I’s selling price (10% to 16% of the selling price). This suggests that something should be done to reduce the order-filling costs. 3.

With the pricing incentive feature, the average order size has been increased to 2,000 units for all three product families. The number of orders now processed can be calculated as follows: Orders = [(600 × 100,000) + (1,000 × 60,000) + (1,500 × 40,000)]/2,000 = 90,000 Reduction in Orders = 200,000 – 90,000 = 110,000 Steps That Can Be Reduced = 110,000/2,000 = 55 Reduction in resource spending: Step-fixed costs: Variable activity costs:

$50,000 × 55 = $20 × 110,000 =

5-33

$2,750,000 2,200,000 $4,950,000

CHAPTER 5

Activity-Based Costing and Management

P 5-59 (Continued) Customers were placing smaller and more frequent orders than necessary. They were receiving a benefit without being charged for it. By charging for the benefit and allowing customers to decide whether the benefit is worth the cost of providing it, Grundvig was able to reduce its costs (potentially by shifting the cost of the service to the customers). The customers, however, apparently did not feel that the benefit was worth paying for and so increased order size. By increasing order size, the number of orders decreased, decreasing the demand for the order-filling activity, allowing Grundvig to reduce its order-filling costs. Other benefits may also be realized. The order size affects activities such as scheduling, setups, and materials handling. Larger orders should also decrease the demand for these activities, and costs can be reduced even more. Competitive advantage is created by providing the same customer value for less cost or better value for the same or less cost. By reducing the cost, Grundvig can increase customer value by providing a lower price (decreasing customer sacrifice) or by providing some extra product features without increasing the price (increasing customer realization, holding customer sacrifice constant). This is made possible by the decreased cost of producing and selling the bolts. It may also be of value to note that we are discussing airplane bolt packages that are priced at $0.50 to $0.80 each. For Category I, that means the range of difference in inventory impact on the customer is $700 – $1,120 [$0.50 × (2,000 – 600) to $0.80 × (2,000 – 600)]. This is certainly manageable when they are placing so many orders. It is likely the customers will also realize some savings by placing fewer orders as the bolts are small, and the carrying cost should not be significant relative to ordering and receiving costs.

5-34

CHAPTER 5

Activity-Based Costing and Management

P 5-60 1. Supplier cost: First, calculate the activity rates for assigning costs to suppliers: Replacing engines: $1,200,000/3,000 engines = $400 per engine Expediting orders: $1,500,000/300 late shipments = $5,000 per late shipment Repairing engines: $2,700,000/3,750 engines = $720 per engine Next, calculate the cost per engine by supplier: Supplier cost: Watson Purchase cost: $1,850 × 27,000………………………….… $2,000 × 6,000………………………….…… Replacing engines: $400 × 2,970………………………….……… $400 × 30………………………….………… Expediting orders: $5,000 × 297………………………………... $5,000 × 3………..…………………………… Repairing engines: $720 × 3,660……………………………...… $720 × 90………………………………..…… Total supplier cost…………………………… ÷ Units supplied……………………….……… Unit cost……………...……………………

Johnson

$49,950,000 $12,000,000 1,188,000 12,000 1,485,000 15,000 2,635,200 $55,258,200 27,000 $ 2,046.60

64,800 $12,091,800 6,000 $ 2,015.30

The Johnson engine costs less when the full supplier effects are considered. This is a better assessment of cost because it considers the costs that are caused by the supplier due to poor quality, poor reliability, and poor delivery performance. 2.

In the short run, buy 30,000 from Johnson and 3,000 from Watson. In the long run, one possibility is to encourage Watson to increase its quality and maintain purchases from both sources (lowers source risk by having two suppliers).

5-35

CHAPTER 5

Activity-Based Costing and Management

P 5-61 1. Activity-based management is a system-wide, integrated approach that focuses management’s attention on activities. It involves two dimensions: a cost dimension and a process dimension. Key elements in activity management are identifying activities, assessing their value, and retaining only value-adding activities. The consultant identified the activities but did not formally classify the activities as value-added or nonvalue-added. Nor did the consultant offer any suggestions for increasing efficiency—at least not formally. The consultant apparently had tentatively identified potential savings through eliminating nonvalue-added activities. Management must still decide how to reduce, eliminate, share, and select activities to achieve cost reductions. 2.

Setting up equipment……………………………… Materials handling………………………………… Inspecting products……………………………… Handling customer complaints………………… Filling warranties…………………………………… Storing goods……………………………………… Expediting goods…………………………………… Total………………………………………………

5-36

$125,000 180,000 122,000 100,000 170,000 80,000 75,000 $852,000

CHAPTER 5

P 5-61 (Continued) Units produced and sold………………………………… Potential unit cost reduction………………………………

Activity-Based Costing and Management

120,000 * $7.10 **

* $1,920,000/$16 (Total Cost/Unit Cost) ** $852,000/120,000 = $7.10 The consultant’s estimate of cost reduction was on target. Per-unit costs can be reduced by at least $7, and further reductions may be possible if improvements in value-added activities are possible. We have identified $7.10 per unit of potential cost reduction. We don't know for sure that costs can actually be reduced that much, and, if they can, what the cost of doing that would be. For example, eliminating materials handling generally involves a change in layout, which costs money (additional fixed cost and depreciation). Setups are often the result of design changes or improvements to the circuit boards, and if they go to automation, that involves reprogramming the machine rather than simply telling the worker to make a change. They are currently making $2 per unit profit. If they can get a cost reduction of at least $4 per unit, they can maintain current sales and profit levels at a $14 price. Any additional cost savings contribute to profit. If they can achieve at least a $5.33 cost savings, they can maintain their current total profit at the increased volume.*** Any savings over those amounts is more profit than they are making currently. ***At the new price of $12, sales would be 180,000 units, producing revenue of $2,160,000. A profit of $240,000 means cost would be $1,920,000 or $10.67 per unit ($1,920,000/180,000.) Current cost is $16; thus savings of $5.33 ($16 – $10.67) would be needed.

Unit cost to maintain sales Unit cost to expand sales Current cost Cost reduction to maintain Cost reduction to expand

Total potential reduction:

= $14 – $4 = $10 = $12 – $4 = $8 = $16 = $16 – $10 = $6 = $16 – $8 = $8

$ 852,000 (from Requirement 2) 150,000 (by automating) $1,002,000 120,000 $ 8.35

÷ Units………………………………… Unit savings…………………………

Costs can be reduced by at least $7, enabling the company to maintain current market share. Further, if all the nonvalue-added costs are eliminated, then the cost reduction needed to increase market share is also possible. See also the discussion of profitability provided in Requirement 2. Activity selection is the form of activity management used here.

5-37

CHAPTER 5

Activity-Based Costing and Management

P 5-61 (Continued) 5. Current: $ 2,160,000 (1,920,000) $ 240,000

Sales………………………………………… Costs………………………………………… Income…………………………………… $14 price:

($18 × 120,000 units)

(assumes that current market share is maintained):

Sales………………………………………… Costs………………………………………… Income……………………………………

$1,680,000 (918,000) $ 762,000

($14 × 120,000 units) ($7.65 *× 120,000 units)

$ 2,160,000 (1,377,000) $ 783,000

($12 × 180,000 units) ($7.65 *× 180,000 units)

$12 price: Sales………………………………………… Costs………………………………………… Income…………………………………… * $16.00 – $8.35 = $7.65 The $12 price produces the greatest benefit but it produces a lot of pressure on the company to maintain that low cost. P 5-62 1. Nonvalue-added usage and costs, 20X1: VAQ**

AQ* Materials……… 600,000 * Engineering…… 48,000 **

Nonvalue Usage AQ – VAQ

Nonvalue Cost (AQ – VAQ)SP

120,000 20,160

$ 600,000 604,800 $1,204,800

480,000 *** 27,840 ****

* 1.25 × 6 × 80,000 = 600,000 ** (4 × 6,000) + (10 × 2,400) = 48,000 (AQ for engineering represents the actual practical capacity acquired.)

*** 6 × 80,000 = 480,000 **** (0.58 × 24,000) + (0.58 × 24,000) = 27,840 Note: VAQ = Value-Added Quantity; SP = Price of Activity Quantity; SP for materials is $5; SP for engineering is $30 (24 × $60,000)/48,000. 2. Expected values for the coming year (20X2): Materials: EQ = 480,000 + 0.60(120,000) = 552,000 pounds Engineering: EQ = 27,840 + 0.60(20,160) = 39,936 engineering hours

AQ Materials……… 584,800 Engineering…… 35,400

Excess Nonvalue Usage AQ – EQ

EQ* 552,000 39,936

32,800 (4,536)

Excess Nonvalue Cost (AQ – EQ)SP $164,000 U 136,080 F

* For engineering, the expected value is a measure of how much resource usage is needed (this year), and so progress is measured by comparing with actual usage, not activity availability. 5-38

CHAPTER 5

Activity-Based Costing and Management

P 5-62 (Continued) The company failed to meet the materials standard but beat the engineering standard. The engineering outcome is of particular interest. The actual usage of the engineering resource is 35,400 hours, and activity availability is 48,000. Thus, the company has created 12,600 hours of unused engineering capacity. Each engineer brings a capacity of 2,000 hours. Since engineers come in whole units, the company now has six too many! Thus, to realize the savings for the engineering activity, the company must decide how to best use these available resources. One possibility is to simply lay off six engineers, thereby increasing total profits by the salaries saved ($360,000). Other possibilities include reassignment to activities that have insufficient resources (assuming they could use engineers, e.g., perhaps new product development could use six engineers). The critical point is that resource usage reductions must be converted into reductions in resource spending, or the efforts have been in vain. P 5-63 1. Theoretical Velocity = 126,000/16,800 hours = 7.5 telescopes per hour Theoretical Cycle Time = 60/7.5 telescopes = 8 minutes per telescope 2.

Actual Velocity = 104,160/16,800 hours = 6.20 telescopes per hour Actual Cycle Time = 60/6.20 telescopes = 9.68 minutes

Budgeted Conversion Costs

= $10,500,000/(16,800 × 60) = $10.42 per minute

Theoretical Conversion Costs per Telescope = $10.42 × 8 = $83.36 Actual Conversion Costs per Telescope = $10.42 × 9.68 = $100.87 Yes. By reducing cycle time, the cost per unit can be reduced. The potential reduction is as follows: $100.87 – $83.36 = $17.51 per telescope

5-39

CHAPTER 5

Activity-Based Costing and Management

CASES Case 5-64 1. Shipping and warehousing costs are currently assigned using tons of paper produced, a unit-based measure. Many of these costs, however, are not driven by quantity produced. Many products have special handling and shipping requirements involving extra costs. These costs should not be assigned to those products that are shipped directly to customers. 2.

The new method proposes assigning the costs of shipping and warehousing separately for the low-volume products. To do so requires three cost assignments: receiving, shipping, and carrying. The cost drivers for each cost are tons processed, items shipped, and tons sold. Pool rate, receiving costs: Receiving Cost Tons Processed

= $1,100,000/56,000 tons = $19.64 per ton processed

Pool rate, shipping costs: Shipping Cost per Shipping Item

= $2,300,000/190,000 shipping items = $12.11 per shipping item

Pool rate, carrying cost (an opportunity cost): Carrying Cost per Year (LLHC)

= 25 × $1,665 × 0.16 = $6,660

Carrying Cost per Ton Sold

= $6,660/10 = $666

Shipping and warehousing cost per ton sold: Receiving………………………………… Shipping ($12.11 × 7)…………………… Carrying…………………………………… Total………………………………………

5-40

$ 19.64 84.77 666.00 $770.41

CHAPTER 5

Activity-Based Costing and Management

Case 5-64 (Continued) 3. Profit analysis: Revised profit per ton (LLHC): Selling price………………………………………………………………… Less manufacturing cost………………………………………………… Gross profit………………………………………………………………… Less shipping and warehousing………………………………………… Loss……………………………………………………………………………

$2,400.00 1,665.00 $ 735.00 770.41 $ (35.41)

Original profit per ton: Selling price………………………………………………………………… Less manufacturing cost………………………………………………… Gross profit………………………………………………………………… Less shipping and warehousing………………………………………… Profit…………………………………………………………………………

$2,400.00 1,665.00 $ 735.00 30.00 $ 705.00

The revised profit, reflecting a more accurate assignment of shipping and warehousing costs, presents a much different picture of LLHC. The product is, in reality, losing money for the company. Its earlier apparent profitability was attributable to a subsidy being received from the high-volume products (by spreading the special shipping and handling costs over all products, using tons produced as the cost driver). The same effect is also true for the other low-volume products. Essentially, the system is understating the handling costs for low-volume products and overstating the cost for high-volume products. 4.

The decision to drop some high-volume products and emphasize low-volume products could clearly be erroneous. As LLHC has demonstrated, its apparent profitability is attributable to distorted cost assignments. A significant change in the image of LLHC was achieved by simply improving the accuracy of shipping and handling costs. Further improvements in accuracy in the overhead assignments may cause the view of LLHC to deteriorate even more. Conversely, the profitability of high-volume products may improve significantly with increased costing accuracy. This example underscores the importance of having accurate and reliable accounting information. The accounting system must bear the responsibility of providing reliable information.

Ryan’s strategy changed because his information concerning the individual products changed. Apparently, the accounting system was undercosting the low-volume products and overcosting the high-volume products. Once better information was available, Ryan was able to respond better to competitive conditions.

5-41

CHAPTER 5

Activity-Based Costing and Management

Case 5-65 1. Disagree. Chuck is expressing an uninformed opinion. He has not spent the effort to find out exactly what activity-based management and costing are attempting to do; therefore, he has no real ability to offer any constructive criticism of the possible benefits of these two approaches. 2. and 3. At first glance, it may seem strange to even ask if Chuck’s behavior is unethical. After all, what is unethical about expressing an opinion, albeit uninformed? While offering uninformed opinions or recommendations may be of little consequence in many settings, a serious issue arises when a person’s expertise is relied upon by others to make decisions or take actions that could be wrong or harmful to themselves or their organizations. This very well may be the case for Chuck’s setting, and his behavior may be labeled professionally unethical. Chuck’s lack of knowledge about activity-based systems is a signal of his failure to maintain his professional competence. Standard I-1 of the IMA Statement of Ethical Professional Practice indicates that management accountants have a responsibility to continually develop their knowledge and skills. Failure to do so is unethical.

5-42

PROCESS COSTING DISCUSSION QUESTIONS

Process costing collects costs by process (department) for a given period of time. Unit costs are computed by dividing these costs by the department’s output measured for the same period of time. Job-order costing collects costs by job. Unit costs are computed by dividing the job’s costs by the units produced in the job. Process costing is typically used for industries where units are homogeneous and mass-produced. Job-order costing is used for industries that produce heterogeneous products (often custom-made).

In sequential processing, products pass through a series of processes, one after another (i.e., in a given sequence). In parallel processing, products pass through two or more different sequences at the same time, merging eventually at the final process.

The cost flows for process-costing and job-order costing systems are essentially the same. Process costing requires a work-in-process account for each process/producing department. Costs flow from one work-in-process account to another until the final process is reached.

The work-in-process account of the receiving department is debited, and the work-in-process account of the transferring department is credited. The finished goods account is debited, and the work-in-process account of the final department is credited upon completion of the product.

Service firms generally do not have work-in-process inventories, and so equivalent units of production are not needed. An important factor in process costing for services is determining just what constitutes a unit of output.

Firms adopting JIT reduce inventories to very low levels. As a result, work-in-process inventories are close to zero, and equivalent units of production need not be calculated. In essence, unit cost is total cost for the period divided by output.

(1) How output is measured, (2) How cost is measured, and (3) How to measure output and cost for a process when manufacturing inputs are not consumed uniformly.

Equivalent units are the number of whole units that could have been produced, given the amount of materials, labor, and overhead used. Equivalent units are the measure of a period’s output, a necessary input for the computation of unit costs in a process-costing system.

In calculating this period’s unit cost, the weighted average combines the work and costs in beginning inventory with current-period costs and work to calculate this period’s unit cost. The FIFO method excludes any costs and output carried over from the prior period’s unit cost computation; hence, only current work and costs are used to calculate this period's unit cost.

10. If the per-unit cost of the prior period is the same as the per-unit cost of the current period, there will be no difference between the results of the weighted average and FIFO methods. Additionally, if no beginning work-in-process inventory exists, both the FIFO and weighted average methods give the same results.

6-1

CHAPTER 6

Process Costing

11. The first step is the preparation of a physcial flow schedule. This schedule identifies the physical units that must be accounted for and provides an accounting for these units. The second step is the equivalent unit schedule. This schedule computes the equivalent whole output for the period. The schedule’s computations rely on information from the physical flow schedule. The third step is computation of the unit cost. To compute the unit cost, the manufacturing costs of the period for the process are divided by the period’s output. The output is obtained from the equivalent unit schedule. The fourth step uses the unit cost to value goods transferred out and those remaining in work in process. The final step checks to see if the costs assigned in Step 4 equal the total costs to account for. 12. A production report summarizes the activities and costs associated with a process for a given period. It shows the physical flow, the equivalent units, the unit cost, and the values of ending work in process and goods transferred out. The report serves the same function as a job-order cost sheet in a job-order costing system. 13. Separate equivalent units must be calculated for each category of materials and for conversion costs. 14. Transferred-in units represent partially completed units and are clearly a material for the receiving department. To complete the product (or further process it), additional materials and conversion costs are added by the receiving department. Transferred in costs are the costs associated with the transferred-in units which represent the partially completed units from the prior department. 15. The weighted average method uses the same unit cost for all goods transferred out. The FIFO method divides goods transferred out into two categories: units started and completed and units from beginning work in process. The period’s unit cost is used to value goods started and completed. The cost of goods transferred out from beginning work in process is obtained by (1) assigning them all costs carried over from the prior period and (2) using the current period’s unit cost to value the equivalent units completed this period.

6-2

If The link does not work with a click, then copy the complete Download link and paste link in internet explorer/ﬁrefox/google chrome and get all ﬁles download successfully.

CHAPTER 6

Process Costing

MULTIPLE-CHOICE QUESTIONS 6-1.

6-2.

6-3.

6-4.

6-5.

6-6.

0 + 2,300 units + (500 units × 0.4) = 2,500 units

6-7.

$46,000/[0 + 2,300 units + (500 units × 0.4)] = $18.40

6-8.

$18.40 × 2,300 units transferred = $42,320 (see M.C. 6-7 for calculation of $18.40)

6-9.

$18.40 × (500 units × 0.40) = $3,680 (see M.C. 6-7 for calculation of $18.40)

6-10.

(describes what is happening)

6-11.

100,000 units transferred + (25,000 units × 0.40) = 110,000 units

6-12.

100,000 units transferred + (25,000 units × 0.80) = 120,000 units

6-13.

($112,500 + $450,000)/125,000 units = $4.50 per unit 100,000 units transferred × $4.50 = $450,000

6-14.

($100,000 + $550,000)/100,000 units = $6.50

6-15.

(25,000 × 0.20) + 80,000 + (25,000 × 0.60) = 100,000 units

6-16.

(25,000 × 0.80) + 80,000 + (25,000 × 0.80) = 120,000 units

6-17.

$720,000/120,000 units = $6.00

6-18.

$450,000/125,000 EU = $3.60 per unit 100,000 units transferred × $3.60 per unit = $360,000

6-19.

6-20.

6-21.

6-3

CHAPTER 6

Process Costing

BRIEF EXERCISES: SET A BE 6-22

Mixing

Cooking

Packaging

$ 825,000 120,000 225,000 — $1,170,000

$ 379,500 75,000 82,500 1,170,000 $1,707,000

$ 330,000 180,000 332,500 1,707,000 $2,549,500

Description Work in Process—Cooking Work in Process—Mixing

Debit 1,170,000

Credit

Work in Process—Packaging Work in Process—Cooking

1,707,000

Finished Goods Work in Process—Packaging

2,549,500

Direct materials……………………… Direct labor………………………...…… Applied overhead……………………… Transferred-in cost…………………… Total cost………………………...…

Journal Date

1,170,000

1,707,000

2,549,500

BE 6-23 Units completed…………………………………...…………… EWIP (0.40 × 16,800)…………………….…...……………… Output……………………………………………...…………

Equivalent Units 112,000 6,720 118,720

BE 6-24 1. Equivalent Units Units completed…………………………………...……… 315,000 EWIP (0.60 × 112,500)…………………….…...………… 67,500 Output……………………………………………...…… 382,500

Unit Cost = $2,295,000/382,500………………..………

$6.00

Cost of goods tranferred out ($6 × 315,000)….……… Cost of EWIP ($6 × 67,500)…………….………………

$1,890,000 405,000

6-4

CHAPTER 6

BE 6-25 1. Units completed……………………………………………………………… EWIP (0.40 × 225,000)……………………………………………………… Output for January……………………………………………….………… 2.

Unit Cost = $1,215,000/810,000……………….....………………………

Cost of goods tranferred out ($1.50 × 720,000)………………………… EWIP ($1.50 × 90,000)………………………………………………………

Process Costing

Equivalent Units 720,000 90,000 810,000 $1.50 $1,080,000 135,000

BE 6-26 Physical flow schedule: Units in BWIP (80% complete)……………………… Units started…………………………………………… Total units to account for………………………… Units completed and transferred out: Units started and completed………………………… Units completed from BWIP………………………… Units in EWIP (60% complete)……………………… Total units accounted for…………………………

160,000 720,000 880,000 600,000 160,000

760,000 120,000 880,000

BE 6-27 Manzer Inc. Cutting Department Production Report For the Month of October Weighted Average Method UNIT INFORMATION Physical flow: Units to account for: Units accounted for: Units completed……………… Units in beginning WIP………… 4,000 Units in ending WIP………… Units started………………………31,200 Total units acct'd. for…… Total units to acct. for……… 35,200

27,200 8,000 35,200

Equivalent units: Units completed…………………………………...……………………………… Units in ending work in process (0.60 × 8,000)…………………………...… Total equivalent units………………………………………...………………

27,200 4,800 32,000

6-5

CHAPTER 6

Process Costing

BE 6-27 (Continued) COST INFORMATION Costs to account for: Beginning work in process…………………………………………………… Incurred during October………………………………………………………… Total costs to account for……………………………………………………

$ 32,000 608,000 $640,000

Cost per equivalent unit……………………………………………………………

$20.00

Costs accounted for: Transferred Out Goods transferred out ($20.00 × 27,200)………………………… Goods in ending WIP ($20.00 × 4,800)………………………… Total costs accounted for………………

Ending Work in Process

Total

$544,000

—

$544,000

— $544,000

$96,000 $96,000

96,000 $640,000

Materials 65,200

Conversion 65,200

12,000 77,200

7,200 72,400

BE 6-28 1. Units completed…………………………………...…………… Add: Units in ending WIP × Fraction complete (12,000 × 1; 12,000 × 0.60)…… Equivalent units of output……………………………..……

2. Unit materials cost [($40,980 + $125,000)/77,200]……………………………… Unit conversion cost [($28,920 + $210,000)/72,400]…………………………… Total unit cost………………………………………………...……………………

3. Cost transferred out (65,200 × $5.45)…………………………………………… Cost of ending WIP: Materials (12,000 × $2.15)……………………………………………………… Conversion (7,200 × $3.30)……………………………………………………… Total ending WIP cost………………………………………………………

6-6

$2.15 3.30 $5.45

$355,340 $ 25,800 23,760 $ 49,560

CHAPTER 6

BE 6-29 1. Physical flow schedule: Units in beginning work in process…………………………… Units started during the period………………………………… Total units to account for…………………………………… Units completed and transferred out: Units started and completed…………………………………… 192,500 Units completed from beginning work in process………… 70,000 Units in ending work in process……………………………… Total units accounted for……………………………………

Process Costing

70,000 240,000 310,000

262,500 47,500 310,000

2. Units completed…………………………………..………………… Units in EWIP………………………………………...……………… Equivalent units (transferred-in materials)…………………

262,500 47,500 310,000

3. Unit Transferred-In Cost = ($283,000 + $957,000)/310,000……

$4.00

BE 6-30 Equivalent Units 1. Units started and completed…………………………………………………… 570,000 24,000 Units in BWIP (0.20 × 120,000)…………………………………………………… Units in EWIP (0.75 × 80,000)…………………………………………………… 60,000 654,000 Total……………………………………………………………………………… 2. Unit Cost = $1,471,500/654,000…………………………………………………

$2.25

3. Cost of units transferred out: BWIP costs…………………………………...………………………………… $ 120,000 54,000 To finish BWIP ($2.25 × 24,000)……………………………………………… Started and completed ($2.25 × 570,000)……………………………....… 1,282,500 Total……………………………………………….………………………… $1,456,500 EWIP ($2.25 × 60,000)….….……………………………….………………………

6-7

$135,000

CHAPTER 6

Process Costing

BE 6-31 Aztec Inc. Mixing Department Production Report For the Month of July (FIFO Method) UNIT INFORMATION Physical flow: Units to account for: Units in beginning WIP……… 120,000 Units started…………………… 650,000

Units accounted for: Units started and completed…… From beginning WIP…………… Units in ending WIP……………… Total units acct'd. for…………

570,000 120,000 80,000 770,000

Equivalent units: Started and completed………………………………………………..……………… To complete beginning WIP (120,000 × 0.20)……………………………………… Units in ending WIP (80,000 × 0.75)………………………………………………… Total equivalent units……………………………………………………...………

570,000 24,000 60,000 654,000

Total units to acct. for…… 770,000

COST INFORMATION Costs to account for: Costs in beginning WIP……………………………………………………………… $ 120,000 Costs added by department…………………………………...……………………… 1,471,500 Total costs to account for……………………………………...………………… $1,591,500 Cost per Equivalent Unit = $1,471,500/654,000………………………………………

$2.25

Costs accounted for: Transferred out: Units started and completed (570,000 × $2.25)……………………………… $1,282,500 Units in beginning work in process: From prior period………………………………………………………….……… 120,000 54,000 From current period (24,000 × $2.25)…………………………………………… Total cost transferred out………………………………………….……………… $1,456,500 Goods in ending work in process (60,000 × $2.25)………………………………… 135,000 Total costs accounted for……………………………………..……………………… $1,591,500

6-8

CHAPTER 6

Process Costing

BRIEF EXERCISES: SET B BE 6-32 1.

Direct materials………………………...……… Direct labor………………………...…………… Applied overhead………………………...…… Transferred-in cost…………………………… Total cost………………………...……………

2. Date

Mixing

Cooking

Packaging

$600,500 90,000 117,000 — $807,500

$ 285,500 50,000 65,000 807,500 $1,208,000

$ 250,000 120,000 156,000 1,208,000 $1,734,000

Debit 807,500

Credit

Journal Description Work in Process—Cooking Work in Process—Mixing

807,500

Work in Process—Packaging Work in Process—Cooking

1,208,000

Finished Goods Work in Process—Packaging

1,734,000

1,208,000

1,734,000

BE 6-33 Equivalent Units Units completed…………………………………...…………………… 147,000 EWIP (0.30 × 22,050)…………………….…...………………………. 6,615 Output……………………………………………...………………… 153,615

BE 6-34 1. Equivalent Units Units completed…………………………………...……………… 285,000 EWIP (0.70 × 64,050)…………………….…...…………………… 44,835 Output……………………………………………...…………… 329,835

Unit Cost = $2,638,680/329,835………………..…………………

$8.00

Cost of goods tranferred out ($8 × 285,000)….……………… Cost of EWIP ($8 × 44,835)…………….………………………..

$2,280,000 358,680

6-9

CHAPTER 6

Process Costing

BE 6-35 1.

Equivalent Units Units completed………………………………………………………………………… 1,080,000 135,000 EWIP (0.40 × 337,500)…………………………………………………………………… Output for July……………………………………………….…………………………… 1,215,000

2. Unit Cost = $1,822,500/1,215,000……………….....……………………………………

$1.50

3. Cost of goods tranferred out ($1.50 × 1,080,000)…………………………………… $1,620,000 EWIP ($1.50 × 135,000)………………………………………………………………… 202,500

BE 6-36 Physical flow schedule: Units in BWIP (60% complete)……………………………...…… Units started………………………………………………………… Total units to account for……………………………………… Units completed and transferred out: Units started and completed……………………………………… Units completed from BWIP……………………………………… Units in EWIP (80% complete)…………………………………… Total units accounted for………………………………………

96,000 368,000 464,000 296,000 96,000

392,000 72,000 464,000

BE 6-37 Aoyagi Inc. Molding Department Production Report For the Month of June Weighted Average Method UNIT INFORMATION Physical flow: Units to account for: Units in beginning WIP……… Units started…………………… Total units to acct. for……

Units accounted for: 37,500 Units completed……………… 292,500 Units in ending WIP………… Total units acct'd for……… 330,000

255,000 75,000 330,000

Equivalent units: Units completed…………………………………...………………………………... Units in ending work in process (0.60 × 75,000)…………………………...…… Total equivalent units………………………………………...…………………

255,000 45,000 300,000

6-10

CHAPTER 6

Process Costing

BE 6-37 (Continued) COST INFORMATION Costs to account for: Beginning work in process………………………………………………… Incurred during June………………………………………………………… Total costs to account for…………………………………………………

$ 450,000 8,550,000 $9,000,000

Cost per equivalent unit…………………………………………………………

$30.00

Costs accounted for: Transferred Out

Ending Work in Process

Goods transferred out ($30.00 × 255,000)……………………… $7,650,000 Goods in ending WIP ($30.00 × 45,000)……………………… — Total costs accounted for……………… $7,650,000 BE 6-38 1. Units completed…………………………………...………… Add: Units in ending WIP × Fraction complete (2,400 × 1; 2,400 × 0.60)…… Equivalent units of output……………………………..…… 2. Unit materials cost [($16,000 + $50,000)/15,440]……… Unit conversion cost [($12,000 + $84,000)/14,480]…… Total unit cost……………………………………………

Total

—

$7,650,000

$1,350,000 $1,350,000

1,350,000 $9,000,000

Materials 13,040

Conversion 13,040

2,400 15,440

1,440 14,480 $ 4.27 * 6.63 * $10.90

*Rounded

3. Cost transferred out (13,040 × $10.90)…………………… Cost of ending WIP: Materials (2,400 × $4.27)………………………………… Conversion (1,440 × $6.63)……………………………… Total ending WIP cost……………………………… *Rounded

6-11

$142,136 $ 10,248 9,547 * $ 19,795

CHAPTER 6

Process Costing

BE 6-39 1. Physical flow schedule: Units in beginning work in process……………………………… Units started during the period…………………………………… Total units to account for……………………………………… Units completed and transferred out: Units started and completed……………………………………… Units completed from beginning work in process…………… Units in ending work in process………………………………… Total units accounted for………………………………………

30,000 120,000 150,000 110,000 30,000

140,000 10,000 150,000

2. Units completed…………………………………..…………………… Units in EWIP………………………………………...………………… Equivalent units (transferred-in materials)……………………

140,000 10,000 150,000

3. Unit Transferred-In Cost = ($63,000 + $237,000)/150,000…………

$2.00

BE 6-40 Equivalent Units 1. Units started and completed (34,500 – 6,000)…………………………………… 28,500 1,800 Units in BWIP (0.30 × 6,000)………………………………………………………… Units in EWIP (0.60 × 4,000)………………………………………………………… 2,400 32,700 Total…………………………………………………………………………………… 2. Unit Cost = $130,800/32,700…………………………………………………………

$4.00

3. Cost of units transferred out: BWIP costs…………………………………...……………………………………… To finish BWIP ($4 × 1,800)……………………………………………………… Started and completed ($4 × 28,500)……………………………....…………… Total……………………………………………….………………………………

$ 16,380 7,200 114,000 $137,580

EWIP ($4.00 × 2,400)….….……………………………….……………………………

$9,600

6-12

CHAPTER 6

Process Costing

BE 6-41 Saludable Inc. Drying Department Production Report For the Month of November (FIFO Method) UNIT INFORMATION Physical flow: Units to account for: Units in beginning WIP………… Units started………………………

Units accounted for: Units started and completed… From beginning WIP…………… Units in ending WIP…………… 38,500 Total units acct'd for………

28,500 6,000 4,000 38,500

Equivalent units: Started and completed………………………………………………..………………… To complete beginning WIP (6,000 × 0.30)………………………………………… Units in ending WIP (4,000 × 0.60)…………………………………………………… Total equivalent units……………………………………………………...………

28,500 1,800 2,400 32,700

Total units to acct. for………

6,000 32,500

COST INFORMATION Costs to account for: Costs in beginning WIP………………………………………………………………… $ 16,380 Costs added by department…………………………………...……………………… 130,800 Total costs to account for……………………………………...…………………… $147,180 Cost per Equivalent Unit = $130,800/32,700…………………………………………...

$4.00

Costs accounted for: Transferred out: Units started and completed (28,500 × $4.00)…………………………………… $114,000 Units in beginning work in process: From prior period………………………………………………………….………… 16,380 From current period (1,800 × $4.00)……………………………………………… 7,200 Total cost transferred out………………………………………….…………… $137,580 Goods in ending work in process (2,400 × $4.00)……………………………………… 9,600 $147,180 Total costs accounted for……………………………………..………………………

6-13

CHAPTER 6

Process Costing

EXERCISES E 6-42 1. Direct materials………… Direct labor……………… Applied overhead……… Transferred-in cost: From Molding………… From Grinding……… Total cost………………… 2.

Molding Department

Grinding Department

Finishing Department

$286,400 27,600 35,000

$ 30,400 67,200 272,000

$ 29,400 68,400 57,000

349,000 $349,000

$718,600

718,600 $873,400

Unit Cost = $873,400/18,000……….….…………………………………………………

$48.52

E 6-43 1. Date a.

c. 2.

Journal Description Work in Process—Grinding Work in Process—Molding

Debit 128,000

Credit 128,000

Work in Process—Finishing Work in Process—Grinding

232,000

Finished Goods Work in Process—Finishing

272,000

232,000

272,000

The journal entries for the job-order and process-costing systems are generally the same. There is one key difference. For process costing, each department has its own WIP account. As goods are completed in one department, they are transferred with their costs to the next department.

E 6-44 1.

Equivalent Units 21,600 21,600 units completed………………………………………………………………… (2,250 units × 0.60)………………………………………………………………… 1,350 December output……………………………………………………………………… 22,950

Unit Cost per Unit = $82,620/22,950……...…………………………………………

$3.60

Cost of Goods Transferred Out = $3.60 × 21,600….………………………………

$77,760

EWIP = $3.60 × 1,350………...…….…………..………………………………………

$4,860

6-14

CHAPTER 6

Process Costing

23,000 units completed……………………………………………………………… (2,750 units × 0.50)………………………………………………………………… December output………………………………………………………………………

Equivalent Units 23,000 1,375 24,375

Unit Cost per Unit = $78,000/24,375……...…………………………………………

$3.20

E 6-44 (Continued) 5.

Some possible reasons for the difference between the actual unit cost of $3.60 and the expected unit cost of $3.20: 1. Started fewer units than forecast (24,850 started versus expected start of 25,750), producing a lower output than expected (22,950 vs. expected output of 24,375). 2. Production costs were higher than expected ($82,620 vs. $78,000) which could be attributable to such things as unexpected waste of materials, labor inefficiency, and unexpected machine downtime and repair. 3. Lower output and higher costs produce a higher per unit cost. 4. Forecast error. The data analytic type is diagnostic as it is attempting to use the data to explain why the unit costs are different.

6-15

CHAPTER 6

Process Costing

E 6-45 Units completed……………………………………………………………………… Units in ending work in process × Fraction complete: (144,000 × 0.75)……………………………………………………………………… Equivalent units of output………………………...………………………………

756,000 108,000 864,000

E 6-46 1.

Unit Cost = $174,000/75,000 = $2.32 per unit

Cost of ending work in process ($2.32 × 21,600)……………………...………… Cost of goods tranferred out ($2.32 × 53,400)……………………...……………

Cassien is using the weighted average method for calculating unit costs. Thus, the unit cost for June will be a mixture of May and June costs. May costs will not reflect the cost savings and so the June unit cost will be higher than expected. Using FIFO for June would better reflect the effect of the cost reductions and overcome the problem.

$50,112 $123,888

E 6-47 1.

Unit Cost = $1,100,000/220,000……………………………………………………

$5.00

Cost of units transferred out (196,000 × $5.00)………………………………… Cost of ending WIP (24,000 × $5.00)…………………………………………… Total costs accounted for…………………..…………………………………

$ 980,000 120,000 $1,100,000

The weighted average method is simpler to use than FIFO, but it does not reflect the unit cost as well if costs are changing significantly from one period to the next. FIFO calculates the unit cost using only costs of the current period and output of the current period. Weighted average rolls back and picks up the costs and output in BWIP and counts them as if they belong to the current period. These costs and output of two periods are mixed. For Byford, the unit cost under weighted average is $5.00 (see solution to Requirement 1). The unit cost for units in BWIP is $3.06 ($107,000/35,000). This suggests a significant difference in the unit cost of the prior period from the unit cost of the current period. If this type of cost fluctuation is typical, Byford should switch to FIFO.

E 6-48 1. Units to account for: Units in beginning work in process……………………………… Units started during the period…………………………………… Total units to account for……………………...………………… Units completed and transferred out: Units started and completed*………………...…………………… 73,800 Units completed from beginning work in process…………… 91,500 Units in ending work in process………………….………………… Total units accounted for………………...……………………… *99,000 – 25,200 = 73,800 6-16

91,500 99,000 190,500

165,300 25,200 190,500

CHAPTER 6

E 6-48 (Continued) 2. Units to account for: Units in beginning work in process……………………………… Units started during the period…………………………………… Total units to account for……………………...…………………

190,500 99,000 289,500

Units completed and transferred out: Units started and completed………………...…………………… 73,800 Units completed from beginning work in process…………… 190,500 Units in ending work in process………………….………………… Total units accounted for………………...……………………… P4 N7 N8 P8 P10

264,300 25,200 289,500

=Sum(P2:P3) =Sum(P3-P9) =P2 =Sum(N7:N8) =Sum(P8:P9)

P4 =Sum(P2:P3) N7 =Sum(P8-N8) N8 =P2 P8 =Sum(P10-P9) P10 =P4 Physical flow schedule for June: Units to account for: Units in beginning work in process……………………………… Units started during the period…………………………………… Total units to account for……………………...………………… Units completed and transferred out: Units started and completed………………...…………………… Units completed from beginning work in process…………… Units in ending work in process………………….………………… Total units accounted for………………...……………………… Physical flow schedule for July: Units to account for: Units in beginning work in process……………………………… Units started during the period…………………………………… Total units to account for……………………...………………… Units completed and transferred out: Units started and completed………………...…………………… Units completed from beginning work in process…………… Units in ending work in process………………….………………… Total units accounted for………………...………………………

Process Costing

25,200 104,800 130,000 74,800 25,200

100,000 30,000 130,000

30,000 93,750 123,750 65,500 30,000

95,500 28,250 123,750

P3 =Sum(N7,P9) P4 =Sum(P2:P3) N7 =Sum(P8-N8) N8 =P2 P10 =Sum(P8:P9) The data analytic type for Requirement 1 is descriptive as the calculations are historical and describe what is happening. The data analytic type for Requirement 3 is predictive as the calculations indicate what will likely happen. 6-17

CHAPTER 6

Process Costing

E 6-49 Units to account for: Units in beginning WIP………………………………………………………………… Units started……………………………………………………………………………… Total units……………………………………………………………………………… Units accounted for: Completed from BWIP…………………………………………………………………… Started and completed*………………………………………………………………… Units in ending WIP……………………………………………………………………… Total units………………………………………………………………………………

25,000 142,500 167,500 25,000 107,500 35,000 167,500

142,500 – 35,000

E 6-50 Cochabamba Cooking Department Production Report For the Month of April (Weighted Average Method) UNIT INFORMATION Physical flow: Units to account for: Units in beginning WIP………… Units started……………………… Total units to acct. for………

Units accounted for: 50,000 Units completed……………… 100,000 Units in ending WIP…………… 150,000 Total units acct'd for………

125,000 25,000 150,000

Equivalent units: Units completed…………………………………………………………………………… Units in ending work in process (0.20 × 25,000)…………………………………… Total equivalent units…………………………………………………………………

125,000 5,000 130,000

COST INFORMATION Costs to account for: Costs in beginning WIP………………………………………………………………… $ 234,000 786,500 Costs added by department…………………………………………………………… Total costs to account for…………………………………………………………… $ 1,020,500 Cost per equivalent unit……………………………………………………………………

6-18

$7.85

CHAPTER 6

Process Costing

E 6-50 (Continued) Costs accounted for: Transferred Out

Ending Work in Process

Total

Goods transferred out ($7.85 × 125,000)…..…………

$981,250

—

Goods in ending WIP ($7.85 × 5,000)…..……………

—

$39,250

39,250

Total costs accounted for…..

$981,250

$39,250

$1,020,500

Materials

Conversion

Units completed……………………..……………… Add: Units in ending WIP × Fraction complete* (20,000 × 0.60)…..……

60,000

20,000

12,000

Equivalent units of output……………..……………

80,000

72,000

981,250

E 6-51

*60% completion is related to conversion.

E 6-52 1. Unit materials cost [($147,000 + $1,053,000)/240,000]………………………… Unit conversion cost [($7,875 + $236,205)/216,000]…………………………… Total unit cost……………………………………………………………………… 2.

$5.00 1.13 $6.13

Cost transferred out (180,000 × $6.13)…………………………………….….……

$1,103,400

Cost of ending WIP: Materials (60,000 × $5.00)……………………………………….….…………… Conversion (36,000 × $1.13)…………………………………………………… Total ending WIP cost……………………………………………………..………

$ 300,000 40,680 $ 340,680

E 6-53 1. Units to account for: Units in beginning WIP…… Units started*……………… Total units to acct. for…

Units accounted for: 56,000 Units transferred out……… 154,000 Units in ending WIP………… 210,000 Total units acct'd for……

6-19

168,000 42,000 210,000

CHAPTER 6

Process Costing

E 6-53 (Continued) * Calculation: Units transferred out……………..………………………………………………………… Units in ending WIP……………..………………………………………………………… Less: Units in beginning WIP…..………………………………………………………… Units transferred in………………..……………………………………………………

168,000 42,000 (56,000) 154,000

Transferred-In

Materials

Conversion

168,000 42,000 210,000

168,000 25,200 193,200

Units transferred out……………… Units in ending WIP………………… Equivalent units…………………

E 6-54 1.

Unit transferred-in cost [($2,100 + $30,900)/75,000]……..…………… Unit materials cost [($1,500 + $22,500)/75,000]……..………………… Unit conversion cost [($3,000 + $45,300)/69,000]……..………………

$0.44 0.32 0.70

Total unit cost…..……………..……………………………………………

$1.46

E 6-55 Units started and completed……..……………………………………… Units in BWIP × Fraction to be completed (15,000 × 0.60)……..…… Units in EWIP × Fraction complete (8,000 × 0.75)……..……………… Equivalent units of output…………………………………..……………

27,000 9,000 6,000 42,000

E 6-56 1.

Unit Cost = $14,000/7,840……………………………………….…………

$1.79 *

Cost of ending work in process ($1.79 × 2,400)……………..…………

$ 4,296

Cost of goods transferred out: From BWIP: Prior-period costs…………………………………………..…………… Completion costs ($1.79 × 840)…..…………………………………… Started and completed ($1.79 × 4,600)………..…………………… Total………..…………………………………………………………

$ 1,120 1,504 * 8,234 $10,858

* Rounded

6-20

CHAPTER 6

Process Costing

PROBLEMS P 6-57 1. Mixing department: a.

Units Transferred to Tableting

= Total Units* – Ending WIP = 420,000 – 36,000 = 384,000

*Total Units = Beginning WIP + Units Started = 0 + 420,000

Units completed………………………………………………….……………… Add: Units in ending work in process: 36,000 × 0.50…………………… Equivalent units of output…………..…………………………………………

384,000 18,000 402,000

Tableting department: Units Transferred Out = Total Units* – Ending WIP = 408,000 – 12,000 = 396,000 *Total Units = Beginning WIP + Units Transferred In = 24,000 + 384,000 = 408,000

The solution is to convert the transferred-in units to the same unit of measure as the output for the tableting department. Each bottle has eight ounces of transferredin material. Thus, 384,000 ounces become 48,000 bottles. Using this converted measure, the revised solution would be as follows: Units Transferred Out = Total Units* – Ending WIP = 51,000 – 1,500 = 49,500 *Total Units = Beginning WIP + Units Transferred In = 3,000 + 48,000 = 51,000

P 6-58 1. Units to account for: Units in beginning work in process………..…………………… Units started during the period……………..…………………… Total units to account for…………………..………………… Units accounted for: Units completed and transferred out: Started and completed……………………..………………… From beginning work in process…………..……………… Units in ending work in process…………..…………………… Total units accounted for…………………..…………………

6-21

60,000 120,000 180,000

90,000 60,000

150,000 30,000 180,000

CHAPTER 6

Process Costing

P 6-58 (Continued) 2.

Cabinets

Units completed……………………………… Units in EWIP………………………………… Equivalent units……………………………

Components

Conversion

150,000 30,000 180,000

150,000 6,000 * 156,000

Cabinets

Components

Conversion

Total

Beginning WIP……………… Incurred during April……… Total costs to acct. for…

$1,200,000 2,400,000 $3,600,000

$12,600,000 25,200,000 $37,800,000

$ 5,400,000 8,640,000 $14,040,000

$19,200,000 36,240,000 $55,440,000

Equivalent units……………

180,000

156,000

Cost per equivalent unit……

$20

$210

$90

*0.20 × 30,000

3. Costs to account for:

4. Costs Transferred Out Cost of Ending WIP

$320

= 150,000 × $320 = $48,000,000 = (30,000 × $20) + (30,000 × $210) + (6,000 × $90) = $7,440,000

5. Costs to account for: Beginning work in process………..…………………………………………… $19,200,000 Incurred during April………………..…………………………………………… 36,240,000 Total costs to account for………..………………………………………… $55,440,000 Costs accounted for: Goods transferred out……………..…………………………………………… $48,000,000 Goods in ending work in process……..……………………………………… 7,440,000 Total costs accounted for……………..…………………………………… $55,440,000

6-22

CHAPTER 6

Process Costing

P 6-59 1.

Stillwater Designs Assembly Department Production Report For the Month of April (Weighted Average Method) Unit Information Physical flow: Units to account for: Units in beginning WIP…… Units started………………… Total units to acct. for……

60,000 120,000 180,000

Equivalent units: Units completed……………………………… Units in EWIP…………………………………… Equivalent units……………………………

Units accounted for: Units completed…………… Units in ending WIP………… Total units acct’d. for……

150,000 30,000 180,000

Cabinets

Components

Conversion

150,000 30,000 180,000

150,000 6,000 * 156,000

Costs to account for:

Cabinets

Components

Conversion

Total

Beginning WIP……………… Incurred during April……… Total costs to acct. for…

$1,200,000 2,400,000 $3,600,000

$12,600,000 25,200,000 $37,800,000

$ 5,400,000 8,640,000 $14,040,000

$19,200,000 36,240,000 $55,440,000

Equivalent units………………

180,000

156,000

Cost per equivalent unit……

$20

$210

$90

Transferred Out

Ending Work in Process

Costs accounted for:

Goods transferred out ($320 × 150,000)……………………………… $48,000,000 Goods in ending WIP Cabinets ($20 × 30,000)…………………… Components ($210 × 30,000)…………… — Conversion ($90 × 6,000)………………… Total costs accounted for…………… $48,000,000 *0.20 × 30,000

6-23

$320 Total

—

$48,000,000

$ 600,000 6,300,000 540,000 $7,440,000

600,000 6,300,000 540,000 $55,440,000

CHAPTER 6

Process Costing

P 6-59 (Continued) 2.

Although the answers may vary, some essential elements should be mentioned in the report. The job cost sheet summarizes the manufacturing activity for a job, whereas the production report summarizes the manufacturing activity in a process department for a period of time. Both reports provide unit cost information, although the production report only provides the unit cost for a given process. Only the last process provides the total cost per unit. A similar observation can be made about the detail concerning materials and conversion costs. The job cost sheet acts as a subsidiary work-in-process account. The production report also provides the cost of ending work in process for each process. The sum of these amounts will give the total work in process—so the production report serves a similar information function. Thus, the purpose and content of the reports are very similar.

P 6-60 1.

Units to account for: Units in beginning work in process (60% complete)………….. Units started during the period………………..…………………… Total units to account for……………………..…………………

60,000 180,000 240,000

Units accounted for: Units completed and transferred out: Started and completed……………………..…………………… 120,000 From beginning work in process………..……………………… 60,000 Units in ending work in process (60% complete)…………..…… Total units accounted for………………………….…..…………

180,000 60,000 240,000

Units completed…………………………………………..……………… Add: Units in EWIP × Fraction complete (60,000 × 0.60)…..……………………………………………………… Equivalent units of output………………………………..……………… Unit Cost [($216,000 + $907,200)/216,000] = $5.20

6-24

180,000 36,000 216,000

CHAPTER 6

P 6-60 (Continued) 4. First, calculate the cost per unit for the equivalent units in beginning inventory (0.60 × 60,000 = 36,000 equivalent units in BWIP) = Prior-Period Unit Cost = $216,000/36,000……………………………………………

Process Costing

36,000 $6.00

Next, calculate the current-period (FIFO) cost per unit: FIFO Equivalent Units for Materials = Weighted Average Equivalent Units – Prior-Period Equivalent Units = 216,000 – 36,000 = 180,000 FIFO Unit Cost = $907,200/180,000 = $5.04 The weighted average unit cost = (36,000/216,000)$6 + (180,000/216,000)$5.04 = $5.20

P 6-61 Tapyt Inc. Throw Rug Department Production Report For the Month of August (Weighted Average Method) UNIT INFORMATION Physical flow: Units to account for: Units accounted for: 60,000 Units completed……………… Units in beginning WIP……… Units in ending WIP………… Units started…………………… 180,000 Total units acct’d. for…… Total units to acct. for…… 240,000

180,000 60,000 240,000

Equivalent units: Units completed……………… 180,000 Units in ending WIP…………… 36,000 Total equivalent units…… 216,000 COST INFORMATION Costs to account for: Costs in beginning WIP…………………………..………………………………… $ 216,000 907,200 Costs added by department………………………..……………………………… Total costs to account for…………………………..………………………… $1,123,200 Cost per equivalent unit…………………………..……………………………………

6-25

$5.20

CHAPTER 6

Process Costing

P 6-61 (Continued) Costs accounted for: Goods transferred out ($5.20 × 180,000)………………

Transferred Out

Ending Work in Process

$936,000

Total $ 936,000

Goods in ending WIP: Conversion ($5.20 × 36,000)…… Total costs accounted for…… $936,000

P 6-62 1. Units to account for: Units in beginning WIP……… Units started*………………… Total……………………………

15,000 35,000 50,000

$187,200 $187,200

Units accounted for: Transferred out……… Units in ending WIP… Total…………………

187,200 $1,123,200

45,000 5,000 50,000

*50,000 – 15,000 = 35,000

Equivalent Units Transferred out………………………………………..…………………………… Ending WIP (5,000 × 0.25)…………..……………………………………………… Total………………………………………………………………..………………

45,000 1,250 46,250

Unit cost [($1,656 + $26,094)/46,250]……..………………………………………

$0.60

Cost transferred out (45,000 × $0.60)………………...……..…………………… Cost of ending WIP (1,250 × $0.60)………………………………………………

$27,000 $750

To assign costs to spoiled units, they should appear as an item in the equivalent units schedule: Equivalent Units Transferred out…………………………………………………..………………… Spoiled units…………………………………………………………..…………… Ending WIP (5,000 × 0.25)…………..……………………………………………… Total………………………………………………………………………..………

6-26

42,500 2,500 1,250 46,250

CHAPTER 6

Process Costing

P 6-62 (Continued) The cost per equivalent unit is the same calculated without spoilage. Spoilage Cost = 2,500 × $0.60 = $1,500 If the spoilage cost is abnormal, then it will not be assigned to production. A common approach is to treat the $1,500 as a loss for the period. If the spoilage is normal, then it would be added to the cost of goods transferred out.

P 6-63 Millie Company Assembly Department Production Report For the Month of June (Weighted Average Method) UNIT INFORMATION Units to account for: Units in beginning WIP……… Units started…………………… Total units to acct. for……

Units accounted for: Units completed……………… Units in ending WIP………… Total units acct’d. for ……

70,000 10,000 80,000

Equivalent units: Units completed………………………………………………………………………… Units in ending WIP (10,000 × 0.70)………………………………………………… Total equivalent units………………………………………………………………

70,000 7,000 77,000

24,000 56,000 80,000

COST INFORMATION Costs to account for: Costs in beginning WIP………………………..……………………………………… $285,520 Costs added by department…………………..……………………………………… 638,480 Total costs to account for………………………………………………………… $924,000 Cost per equivalent unit ($924,000/77,000)……..………………………………………

$12.00

Costs accounted for: Goods transferred out (70,000 × $12.00)………..………………………………… $840,000 84,000 Ending WIP (7,000 × $12.00)……..…………………………………………………… Total costs accounted for……………………………………..………………… $924,000

6-27

CHAPTER 6

Process Costing

P 6-64 Millie Company Assembly Department Production Report For the Month of June (FIFO Method) UNIT INFORMATION Units to account for: Units in beginning WIP…….. Units started……..……………

Units accounted for: Started and completed…… From beginning WIP……… From ending WIP…………… Total units acct’d for……

24,000 56,000

46,000 24,000 10,000 80,000

Total units to acct. for……

80,000

Equivalent units: Started and completed……………………………………………………………… To complete beginning WIP (24,000 × 0.40)……………………………………… Units in ending WIP (10,000 × 0.70)……………………………………………… Total equivalent units……………………………………………………………

46,000 9,600 7,000 62,600

COST INFORMATION Costs to account for: Costs in beginning WIP…………………………..………………………………… $285,520 638,480 Costs added by department……………………..………………………………… Total costs to account for……………………..………………………………… $924,000 Cost per equivalent unit ($638,480/62,600)……………………………………..…… $10.1994 Costs accounted for: Transferred out: Units started and completed (46,000 × $10.1994)…………………………… $469,172 Units in beginning WIP: 285,520 From prior period………………………………………..…………………… 97,914 From current period (9,600 × $10.1994)…………………..……………… Total cost transferred out………………………………………………… $852,606 71,396 Goods in ending work in process (7,000 × $10.1994)………………………… Total costs accounted for……………………………………………………… $924,002 * * Rounded

6-28

CHAPTER 6

Process Costing

P 6-65 1.

Physical flow schedule: Units to account for: Units in BWIP……… Units started……… Total units………

Units accounted for: Units completed………… From EWIP……………… Total units……………

480,000 50,000 530,000

Units completed………………………………..……………………………… Units in ending WIP (50,000 × 0.40)…..…………………………………..… Total equivalent units…………..…………………………………………

480,000 20,000 500,000

30,000 500,000 530,000

Equivalent unit schedule:

Unit cost computation: Costs in BWIP………………..……………………………………………………… Costs added……………..…………………………………………………………… Total costs……………..…………………………………………………………

$ 270,000 11,342,500 $11,612,500

Unit Cost = $11,612,500/500,000…...……..………………………………………

$23.225

Ending work in process (20,000 × $23.225)…………………………………… Goods transferred out (480,000 × $23.225)……..…..…………………………

$464,500 $11,148,000

Cost reconciliation: Costs to account for: Beginning WIP…..……… August costs…..……… Total to acct. for…..…

$ 270,000 11,342,500 $11,612,500

Costs accounted for: Transferred out…..…… Ending WIP…..………… Total to acct. for…..…

Equivalent unit schedule:

Paraffin

Units completed………………..………………………………… Units in ending WIP……………………..……………………… Total equivalent units……………………..…………………

480,000 20,000 500,000

$11,148,000 464,500 $11,612,500 Pigment 480,000 20,000 500,000

Unit cost computation:

Paraffin

Pigment

Costs in BWIP……………………...…..………………………… Costs added……………………………..………………………… Total costs………….……..……………………………………

$ 120,000 3,250,000 $3,370,000

$ 100,000 2,550,000 $2,650,000

Unit paraffin cost = $3,370,000/500,000….……………..……………………… Unit pigment cost = $2,650,000/500,000………….…..…………………………

6-29

$6.74 $5.30

CHAPTER 6

Process Costing

P 6-66 1.

Department A a.

Physical flow schedule: Units in beginning WIP…………..………………… Units started in November…………..…………… Total units to account for………..……………

5,000 25,000 30,000

Units completed and transferred out: Units completed………..…………………………… Units in ending WIP……………..………………… Total units accounted for……………..…………

28,000 2,000 30,000

Equivalent unit calculation: Units completed……………..………………………………………… Add: Equivalent units in ending WIP (2,000 × 0.80)………..…… Total equivalent units……………………………………..……… Costs charged to the department:

Materials

Beginning WIP…………..……………… Incurred during November…………..… Total costs…………..…………………

$10,000 57,800 $67,800

Conversion $

6,900 95,220 $102,120

28,000 1,600 29,600 Total $ 16,900 153,020 $169,920

Unit cost calculation: Unit cost = $169,920/29,600………….…..……………………………

$5.7405

d. and e. Cost reconciliation: Costs to account for: Beginning WIP…………………………..……………………………… Costs incurred…………………………………..……………………… Total costs to account for………………..………………………

$ 16,900 153,020 $169,920

Total costs accounted for: Goods transferred out (28,000 × $5.7405)……..…..……………… Costs in ending WIP (1,600 × $5.7405)…………..………………… Total costs accounted for*…………………..……………………

$160,734* 9,185 * $169,919 *

* Rounded 2. Date

Journal Description Work in Process—Department A Raw Materials

Debit 57,800

57,800

Work in Process—Department A Conversion Costs—Department A

95,220

Work in Process—Department B Work in Process—Department A

160,734

6-30

Credit

95,220

160,734

CHAPTER 6

Process Costing

P 6-66 (Continued) Answers may vary, but could (or should) include: Using a conversion cost control account is more commonly used because direct labor is becoming a small percentage of total manufacturing costs. Automation is one cause; changing the nature of direct labor as in JIT is another cause. In manufacturing cells, direct labor also performs many so-called traditional overhead activities such as maintenance and inspection—thus, taking on the nature of “conversion labor.”

P 6-67 1. Department A a.

Physical flow schedule: Units in beginning WIP……………..…………………… Units started in November………..…………………… Total units to account for…………..………………

5,000 25,000 30,000

Units completed and transferred out: Started and completed…..……………………………… From beginning WIP………………..…………………… Units in ending WIP………………..…………………… Total units accounted for…………..………………

23,000 5,000 2,000 30,000

Equivalent unit calculation: Units started and completed……..……………………………………… Equivalent units in beginning WIP [(1 – 0.40) × 5,000]……………… Equivalent units in ending WIP (2,000 × 0.80)………………………… Total equivalent units…………………..………………………………

23,000 3,000 1,600 27,600

Costs charged to the department:

Total

Materials

Beginning WIP…..…………………………… $10,000 57,800 Incurred during November…..…………… Total costs…..…………………………… $67,800

Conversion $

6,900 95,220 $102,120

Unit cost calculation: Unit Cost = $153,020/27,600……………..……………………………………

6-31

$ 16,900 153,020 $169,920 $5.544

CHAPTER 6

Process Costing

P 6-67 (Continued) d. and e. Cost reconciliation: Costs of unit started and completed (23,000 × $5.544)……………….

$127,512

Costs of unit in beginning WIP: Prior period costs………………..……………………………………… Current cost to finish units (3,000 × $5.544)………….………..…… Total cost of units transferred out……..…………………………… Costs in ending WIP (1,600 × $5.544)……………………………………. Total costs accounted for*…………..…………………………………

16,900 16,632 $161,044 8,870 $169,914 *

Costs to account for: Beginning WIP………………………..…………………………………… Costs incurred………………………..…………………………………… Total costs to account for……………..……………………………

$ 16,900 153,020 $169,920

* Difference due to rounding. 2. Date

Journal Description Work in Process—Department A Raw Materials

Debit 57,800

Credit 57,800

Work in Process—Department A Conversion Costs—Department A

95,220

Work in Process—Department B Work in Process—Department A

161,044

95,220

161,044

Because conversion costs are not broken into labor and overhead components, a control account for conversion costs is used. Some firms are now combining overhead and direct labor costs into one category. This practice is developing because direct labor is becoming a small percentage of total manufacturing costs.

6-32

CHAPTER 6

Process Costing

P 6-68 1.

Benson Pharmaceuticals Mixing Department Production Report For the Month of March (Weighted Average Method) UNIT INFORMATION Units to account for: Units in beginning WIP……………………………………………………… Units started…………………………………………………………………… Total units to account for………………………………………………… Units accounted for: Units completed…………………………………………… Units in ending WIP ……………………………………… Total units accounted for………………………………

10 150 160

Physical Flow

Equivalent Units

140 20 160

140 10 150

COST INFORMATION Costs to account for: Beginning WIP……………………………… Incurred during March……………………… Total costs to account for………………

Materials

Conversion*

Total

$ 252 3,636 $3,888

$ 846 13,854 $14,700

$ 1,098 17,490 $18,588

Equivalent units…………………………………………………………………… Cost per equivalent unit…………………………………………………………

150 $123.92

* Conversion is labor plus overhead (200% of labor): BWIP: $282 + ($282 × 2.00) = $846 March: $4,618 + ($4,618 × 2.00) = $13,854

Costs accounted for: Goods transferred out (140 × $123.92)…………………………… Ending WIP (10 × $123.92)………………… Total costs accounted for……………… * Rounded

6-33

Transferred Out

Ending Work in Process

$17,349 *

— $1,239 * $1,239

$17,349

Total $17,349 1,239 $18,588

CHAPTER 6

Process Costing

P 6-68 (Continued) 2.

Benson Pharmaceuticals Encapsulating Department Production Report For the Month of March (Weighted Average Method) UNIT INFORMATION Units to account for: Units in beginning WIP…………………………………………………………… Units started………………………………………………………………………… Total units to account for ……………………………………………………

4,000 210,000 214,000

Equivalent Units Units accounted for: Units completed………………… Units in ending WIP…………… Total units accounted for……

Physical Flow

Trans. In

Materials

Conversion

208,000 6,000 214,000

208,000 2,400 210,400 *

* 6,000 × 0.40 COST INFORMATION Costs to account for:

Trans. In

Materials

Conversion **

Total

Beginning WIP…………………… Incurred during March………… Total costs to account for…

$ 140 17,349 $17,489

$ 32 1,573 $1,605

$ 50 4,860 $4,910

$ 222 23,782 $24,004

Equivalent units…………………

214,000

210,400

Cost per equivalent unit…………

$0.0817

$0.0075

$0.0233

$0.1125

Transferred Out

Ending Work in Process

Total

** BWIP: $20 + ($20 × 1.50) = $50 March: $1,944 + ($1,944 × 1.50) = $4,860

Costs accounted for:

Goods transferred out (208,000 × $0.1125)……………………………… $23,400 Ending WIP transferred in (6,000 × $0.0817)………………………………… Materials (6,000 × $0.0075)……………………… Conversion (2,400 × $0.0233)…………………… Total costs accounted for…………………… $23,400 * Rounded *** Difference due to rounding.

6-34

$23,400 $490* 45 56 $591*

490 45 56 $23,991 ***

CHAPTER 6

Process Costing

P 6-68 (Continued) 3.

Weighted average is easier to use than FIFO because it does not require separate tracking for units in BWIP. FIFO requires that prior-period work and costs be accounted for separately. The weighted average method commingles prior-period work and costs with current-period work and costs, thus making the computations much easier. The weighted average method will produce essentially the same results as the FIFO method if the cost of inputs remains relatively unchanged from one period to the next. If there are significant changes in costs, then the unit cost of the two periods can be significantly different. Of course, if BWIP is very small, then the difference in using weighted average as opposed to FIFO will be immaterial.

6-35

CHAPTER 6

Process Costing

P 6-69 1.

Benson Pharmaceuticals Mixing Department Production Report For the Month of March (FIFO Method) UNIT INFORMATION Units to account for: Units in beginning WIP……………… Units started…………………………… Total units to account for…………

10 150 160 Physical Flow

Units accounted for:

Units started and completed………… 130 10 Units in BWIP (to complete)………… Units in EWIP…………………………… 20 Total units accounted for………… 160

Equivalent Units 130 6* 10 ** 146

* 10 × 0.60 = 6 ** 20 × 0.50 = 10 COST INFORMATION Costs to account for:

Materials

Beginning WIP…………………………… Incurred during March…………………… Total costs to account for………………

$ 252 3,636 $3,888

Conversion ***

Total

$ 846 13,854 $14,700

$ 1,098 17,490 $18,588

Equivalent units………………………………………………………………… Cost per equivalent unit ($17,490 / 146)………………………………………

146 $119.7945

*** BWIP: $282 + ($282 × 2.00) = $846 March: $4,618 + ($4,618 × 2.00) = $13,854

Transferred Out

Costs accounted for: Units started and completed (130 × $119.7945)………………………… Units in beginning WIP: From prior period……………………… From current period (6 × $119.7945)……………………… Ending work in process (10 × $119.7945)……………………… Total costs accounted for……… *Rounded

6-36

Ending Work in Process

Total

$15,573*

—

$15,573

1,098

—

1,098

719*

—

719

$17,390

$1,198 $1,198

1,198 $18,588

CHAPTER 6

Process Costing

P 6-69 (Continued) 2.

Benson Pharmaceuticals Encapsulating Department Production Report For the Month of March (FIFO Method) UNIT INFORMATION Units to account for: Units in beginning WIP…………… Units started………………………… Total units to account for……

4,000 210,000 214,000 Equivalent Units

Units accounted for:

Physical Flow

Trans. In

Materials

Conversion

Units started and completed………… Units in BWIP (to complete)………… Units in EWIP…………………………… Total units accounted for…………

204,000 4,000 6,000 214,000

204,000 — 6,000 210,000

204,000 2,000 2,400 208,400

Total

COST INFORMATION Trans. In

Materials

Conversion

$ 140 Beginning WIP………………………… 17,390 Incurred during March………………… Total costs to account for………… $17,530

$ 32 1,573 $1,605

$ 50 * 4,860 ** $4,910

$ 222 23,823 $24,045

Equivalent units……………………… Cost per equivalent unit***……………

210,000 $0.0075

208,400 $0.0233

$0.1136

Costs to account for:

210,000 $0.0828

* BWIP: $20 + ($20 × 1.50) = $50 ** March: $1,944 + ($1,944 × 1.50) = $4,860 *** The numbers are rounded and the unit costs are calculated using only costs for March because FIFO is being used.

Transferred Out

Ending Work in Process

Units started and completed (204,000 × $0.1136)…………………… $23,174 Units in BWIP from prior period 222 47 Current period (2,000 × $0.0233)……

— — —

$23,174 222 47

$497 45 56 $598

497 45 56 $24,041

Costs accounted for:

Ending WIP: Transferred In (6,000 × $0.0828)… Materials (6,000 × $0.0075)……… Conversion (2,400 × $0.0233)…… Total costs accounted for*……

— — — $23,443

*Difference due to rounding. 6-37

Total

CHAPTER 6

Process Costing

CASES Case 6-70 1.

Unit cost computation: Physical flow schedule: Units, beginning work in process…………………………………………… Units started…………………………………………………………………… Total units to account for…………………………………………………

0 2,800 2,800

Units completed and transferred out: Started and completed………………………………………………………… From beginning work in process…………………………………………… Units, ending work in process……………………………………………… Total units accounted for…………………………………………………

2,500 0 300 2,800

Costs charged to the department:

Direct Materials

Conversion Cost

Total

Costs in BWIP………………………………… Costs added by department………………… Total costs…………………………………

$ 0 114,000 $114,000

$ 0 82,201 $82,201 *

$ 0 196,201 $196,201

Direct Materials

Conversion Cost

2,500 300 2,800

2,500 240 2,740

* $45,667 + (0.80 × $45,667) Equivalent units calculation: Units completed………………………………………………… Equivalent units in ending work in process………………… Total equivalent units………………………………………

Unit cost calculation: Unit Cost = Unit Direct Materials Cost + Unit Conversion Costs Direct material cost**………………………………………………………… Unit conversion cost…………………………………………………………… Total unit cost………………………………………………………………

$40.71 30.00 $70.71

** Rounded 2.

Since conversion activity is the same for both bows, only the materials cost will differ. Thus, the unit materials cost is computed and then added to the unit conversion cost obtained in Requirement 1. Econo Model Physical flow schedule: Units, beginning work in process…………………………………………… Units started…………………………………………………………………… Total units to account for…………………………………………………

6-38

0 1,600 1,600

CHAPTER 6

Process Costing

Case 6-70 (Continued) Units completed and transferred out: Started and completed…………………..……………………………………… From beginning work in process………..……………………………………… Units, ending work in process…………..……………………………………… Total units accounted for………………..…………………………………… Direct materials cost charged to the department: Costs in beginning work in process……..………………………………………… Costs added by department………………..……………………………………… Total costs…………………………………..……………………………………… Equivalent units calculation:

1,500 0 100 1,600 Direct Materials $ 0 30,000 $30,000 Direct Materials

Units completed……………………………..………………………………………… Add: Equivalent units in ending work in process…………..………………… Total equivalent units…………………………………………..…………………

1,500 100 1,600

Unit cost calculation: Unit Cost = Unit Direct Materials Cost + Unit Conversion Costs Direct material cost per unit………………………………..……………………… Unit conversion cost…………………………………………..……………………… Total unit cost………………………………………………..……………………

$18.75 30.00 $48.75

Deluxe Model Physical flow schedule: Units, beginning work in process…………………………..………………… Units started…………………………………………………..…………………… Total units to account for…………………………………..…………………

0 1,200 1,200

Units completed and transferred out: Started and completed……………………………………..…………………… From beginning work in process…………………………..…………………… Units, ending work in process……………………………..…………………… Total units accounted for…………………………………..…………………

1,000 0 200 1,200

Direct materials cost charged to the department: Costs in beginning work in process……………………..………………………… Costs added by department……………………………..………………………… Total costs…………………………………………………..………………………

6-39

Direct Materials $ 0 84,000 $84,000

CHAPTER 6

Process Costing

Case 6-70 (Continued) Equivalent units calculation:

Direct Materials

Units completed………..…………………………………………………………… Add: Equivalent units in ending work in process………..…………………… Total equivalent units……………………………………..……………………

1,000 200 1,200

Unit cost calculation:

Unit Cost = Unit Direct Materials Cost + Unit Conversion Costs Direct material cost per unit …………………………………..……………………… Unit conversion cost…………………………………………..……………………… Total unit cost…………………………………………………..……………………

$ 70 30 $100

Unit cost for Econo model……………………………..……………………………… Unit cost for Deluxe model…………………………..………………………………… Blended unit cost (from Requirement 1)……………………………..………………

$ 48.75 100.00 $ 70.71

Using pure process costing understates the cost of the Deluxe model and overstates the cost of the Econo model.The error is large, so Karen seems to be justified in her belief that a pure process-costing relationship is not appropriate. Process costing could be used for all departments other than the pattern department. The pattern procedures can be used for conversion costs, but the cost of direct materials should be tracked by batch. 4.

The profitability of the Econo line was being understated by nearly $22, while that of the Deluxe line was overstated by over $29 producing an erroneous $51 difference in profitability under the current process-costing system. This easily could be enough difference to make the marketing manager’s request for additional advertising dollars a sound one. It is quite possible that Aaron was wrong in not granting the request— wrong because he was using the wrong cost information. This example illustrates the importance of an accurate costing system.

6-40

CHAPTER 6

Process Costing

Case 6-71 1.

Physical flow schedule: Units, beginning work in process……………………………………………… Units started (transferred in)…………………..………………………………… Total units to account for……………………..……………………………

10,000 51,000 61,000

Units completed and transferred out: Started and completed………………………..………………………………… From beginning work in process……………..………………………………… Units, ending work in process………………..………………………………… Total units accounted for………………………..……………………………

40,000 10,000 11,000 61,000

Costs: Costs incurred by the gating department: Direct materials (0.23 × $378,000)…………………………………………… Direct labor (0.35 × $530,300)………………………………………………… Overhead (0.35 × $643,518)…………………………………………………… Total costs added……………………………………………….…………

$ 86,940 185,605 225,231 $497,776

*Assumes that overhead is used in the same proportion as direct labor

Direct Materials

Conversion Costs

40,000 11,000 51,000

40,000 4,000 6,600 50,600

Unit Cost = Unit Direct Materials Cost + Unit Conversion Costs Direct material cost per unit……………………………………..………………… Unit conversion cost*……………………………………………..………………… Total unit cost……………………………………………………..………………

$1.70 8.12 * $9.82

Equivalent units calculation: Units started and completed……………………………………… Units completed from beginning work in process…………… Add: Equivalent units in ending work in process…………… Total equivalent units……………………………………….…… Unit cost calculation:

*Rounded

Value of ending work in process: Direct materials (11,000 × $1.70)…..…………..……………………………… Conversion costs (6,600 × $8.12)…..…………..……………………………… Total cost of units in ending work in process………………..……………

$18,700 53,592 $72,292

Assumptions: Overhead is used at the same rate as direct labor. The FIFO method is used because the costs associated with the beginning work in process are not known. Only the manufacturing costs added this period (20X1) are known. Since the FIFO method requires only current output and current costs to calculate the unit cost, it is the method that should be used. Once a cost per equivalent unit is known, the ending work in process can be valued.

6-41

CHAPTER 6

Process Costing

Case 6-71 (Continued) 2. Units, beginning work in process…………………..……………………………… Units started (transferred in)………………………………………………………… Total units to account for…………………………………………………………

8,000 50,000 58,000

Units completed and transferred out: Started and completed…………………………………………………………… From beginning work in process………………………………………………… Units, ending work in process…………………………………………………… Total units accounted for………………………………………………………

42,000 8,000 8,000 58,000

Equivalent units calculation: Units started and completed…..…………………… Units to complete, beginning work in process…..………………………………… Add: Equivalent units in ending work in process…..………………………… Total equivalent units…..……………………………

Direct Materials

Conversion Costs

Transferred In

42,000

6,400

8,000 50,000

2,400 50,800

8,000 50,000

Costs: Transferred-in cost (50,000 × $9.82)*…………………………… Costs incurred by shell creating: Direct materials ($378,000 × 0.47)…………………………… $177,660 79,545 Direct labor ($530,300 × 0.15)………………………………… 96,528 ** Overhead ($643,518 × 0.15)…………………………………… Total conversion cost……………………………………… Total costs………………………………………………...…………

$491,000

353,733 $844,733

* Assumes that all units transferred out, including those finished from beginning work in process, have a cost of $9.82 per unit. In essence, this assumes that the unit cost of this period equals the unit cost of the prior period.

** Rounded Unit Cost = Unit Direct Materials Cost + Unit Conversion Costs + Unit Tranferred-In Cost Unit direct materials cost* (177,660 / 50,000)……………………………………… Unit conversion costs* [(79,545 + 96,528) / 50,800] ……………………………… Unit transferred-in cost………………………………………………………………… Units, ending work in process:* Direct materials (8,000 × $3.55)…………………………………………………… Conversion costs (2,400 × $3.47)………………………………………………… Transferred in (8,000 × $9.82)…………………………………………………… Total cost of ending work in process……………………………………… *Rounded

6-42

$ 3.55 3.47 9.82 $16.84 $ 28,400 8,328 78,560 $115,288

CHAPTER 6

Process Costing

Case 6-71 (Continued) In addition to the same assumptions made for the first department, we had to assume that the unit cost of all units transferred out was equal to the FIFO method unit cost. This assumption holds if the cost of producing last period did not change for this period. Even if the cost did change, the error is not likely to be large. For purposes of estimating the value of ending work in process, the assumption is quite workable.

Case 6-72 1. Gary’s proposal requires Donna to falsify the equivalent unit calculation so that income and assets can be inflated and reported incorrectly. Falsification of the production report would be a violation of at least two major ethical standards: integrity and credibility. If Donna agrees to the proposal, she would be taking action that would discredit her profession. In addition, Donna has an ethical obligation to communicate information fairly and objectively, disclosing all information that would be needed for the loan officer to fairly assess the merits of the company’s request for a loan. Clearly, Donna should not agree to falsify the production report. 2.

Donna has an obligation to report Gary to a superior only if an actual ethical problem exists. If Gary decides that the course of action he is suggesting is not really in his or the company’s best interests, then no ethical problem exists and no action by Donna is needed.

If Gary insists on his idea of falsification of the division’s reports, Donna should attempt to resolve the conflict by appealing to Gary’s immediate supervisor (and on up, if necessary and with the immediate supervisor’s knowledge, assuming he or she is not involved) until a satisfactory resolution is achieved. If no satisfactory resolution is possible, then Donna should consult her own attorney as to legal obligations and rights concerning the ethical conflict. She may also clarify the ethical issues by initiating a confidential discussion with an IMA Ethics Counselor.

In this situation, the ethical dilemma is complicated by two factors: Donna’s age and a low likelihood of resolution by appealing to higher-level authorities. Donna’s age may make it more difficult to find alternative employment (at least at the same level and pay), and it may mean possible forfeiture of retirement benefits. Seeking help from an expert in ethics and consulting a lawyer are certainly good recommendations. Donna has the option of fighting back, and at her age (with retirement benefits at stake), a good offense may be her best defense.

6-43

COST-VOLUME-PROFIT ANALYSIS DISCUSSION QUESTIONS

1. CVP analysis allows managers to focus on selling prices, volume, costs, profits, and sales mix. Many different “what-if” questions can be asked to assess the effect of changes in key variables on profits. 2. The units sold approach defines sales volume in terms of units of product and gives answers in these same terms. The unit contribution margin is needed to solve for the break-even units. The sales revenue approach defines sales volume in terms of revenues and provides answers in these same terms. The overall contribution margin ratio can be used to solve for the break-even sales dollars. 3. Break-even point is the level of sales activity where total revenues equal total costs or where zero profits are earned. 4. At the break-even point, all fixed costs are covered. Above the break-even point, only variable costs need to be covered. Thus, contribution margin per unit is profit per unit, provided that the unit selling price is greater than the unit variable cost (which it must be for break-even to be achieved). 5. Variable Cost Ratio = Unit Variable Cost/Price Contribution Margin Ratio = Contribution Margin/Sales Contribution Margin Ratio = 1 – Variable Cost Ratio 6. No. The increase in contribution is $9,000 (0.30 × $30,000), and the increase in advertising expense is $10,000. If the contribution margin ratio is 0.4, then the increased contribution margin is $12,000 (0.40 × $30,000). This is $2,000 above the increased advertising expense, so the increased advertising would be a good decision. 7. Sales mix is the relative combination of products being sold by a firm. For example, a sales mix of 3:2 means that three units of one product are sold for every two units of another product. 8. Packages of products, based on the expected sales mix, are defined as a single product. Selling price and cost information for this package can then be used to carry out CVP analysis. 9. This statement is wrong; break-even analysis can be easily adjusted to focus on targeted profit. 10. The basic break-even equation is adjusted for targeted profit by adding the desired targeted profit to total fixed cost in the numerator. The denominator remains the contribution margin per unit. 11. A change in sales mix will change the contribution margin of the package (defined by the sales mix), and thus will change the units needed to break even (assuming the different products in the mix have different contribution margins).

CHAPTER 7 Cost-Volume-Profit Analysis

12. Margin of safety is the sales activity in excess of that needed to break even. The higher the margin of safety, the lower the risk. 13. Operating leverage is the use of fixed costs to extract higher percentage changes in profits as sales activity changes. It is achieved by increasing fixed costs while lowering variable costs. Therefore, increased leverage implies increased risk, and vice versa. 14. Sensitivity analysis is a “what-if” technique that examines the impact of changes in underlying assumptions on an answer. A company can input data on selling prices, variable costs, fixed costs, and sales mix and set up formulas to calculate break-even points and expected profits. Then, the data can be varied as desired to see what impact changes have on the expected profit. 15. A declining margin of safety means that sales are moving closer to the break-even point. Profit is going down, and the possibility of loss is greater. Managers should analyze the reasons for the decreasing margin of safety and look for ways to increase revenue and/or decrease costs.

MULTIPLE-CHOICE QUESTIONS 7-1.

7-2.

7-3.

7-4.

7-5.

7-6.

7-7.

7-8.

7-9.

Break-Even Units = $7,200/($12 – $3) = 800

7-10.

Variable Cost Ratio = $3/$12 = 0.25, or 25% Contribution Margin Ratio = ($12 – $3)/$12 = 0.75, or 75%

7-11.

7-12.

7-13.

Units to Be Sold = ($15,000 + $3,600)/($8 – $6) = 9,300

CHAPTER 7 Cost-Volume-Profit Analysis

BRIEF EXERCISES: SET A BE 7-14 1. Variable Cost per Unit

= Direct Materials + Direct Labor + Variable Factory Overhead + Variable Selling Expense = $30 + $8 + $4 + $3 = $45

Total Fixed Expense

= $20,000 + $29,500 = $49,500

Head-First Company Contribution Margin Income Statement For the Coming Year

Sales ($75 × 5,000 helmets)…………………………… Total variable cost ($45 × 5,000 helmets)………… Total contribution margin………………………… Total fixed cost………………………....……………… Operating income ………………...………………

Total $375,000 225,000 $150,000 49,500 $100,500

Per Unit $75.00 45.00 $30.00

BE 7-15 1.

Break-Even Units

Total Fixed Cost Unit Contribution Margin

= $49,500/($75 – $45) = 1,650 helmets 2.

Head-First Company Contribution Margin Income Statement At Break-Even Point Sales ($75 × 1,650 helmets)……………….…….………….…….…… Total variable cost ($45 × 1,650 helmets)……………….…….……… Total contribution margin………………………………………….. Total fixed cost……………………………………………………...…… Operating income…………………………………………………...…

Total $123,750 74,250 $ 49,500 49,500 $ 0

CHAPTER 7 Cost-Volume-Profit Analysis

BE 7-16 1. Variable Cost Ratio

Variable Cost per Unit Price

= $45/$75 = 0.60, or 60% 2. Contribution Margin Ratio

Price – Variable Cost per Unit Price

Contribution Margin per Unit Price

= ($75 – $45)/$75 = 0.40, or 40% Head-First Company Contribution Margin Income Statement For the Coming Year

Sales ($75 × 5,000 helmets)……………………………… Total variable cost ($45 × 5,000 helmets)……………… Total contribution margin……………………………… Total fixed cost…………………...………………………… Operating income ………………………………………

BE 7-17 1. Break-Even Sales Dollars

$375,000 225,000 $150,000 49,500 $100,500

Percent of Sales 100% 60% 40%

Total Fixed Cost Contribution Margin Ratio

= $49,500/0.40 = $123,750 2.

Head-First Company Contribution Margin Income Statement At Break-Even Point Total Sales…………………………………………………………………………… $123,750 Total variable cost ($123,750 × 0.60)……………………….……………… 74,250 Total contribution margin……………………………………………… $ 49,500 Total fixed cost………………………………………………………………. 49,500 Operating income………………………………………………………… $ 0

CHAPTER 7 Cost-Volume-Profit Analysis

BE 7-18 1.

Break-Even Units

Total Fixed Cost + Target Income Unit Contribution Margin

= ($49,500 + $81,900)/($75 – $45) = 4,380 helmets 2.

Head-First Company Contribution Margin Income Statement At 4,380 Helmets Sold Total Sales ($75 × 4,380 helmets)……………………………………………… $328,500 197,100 Total variable cost ($45 × 4,380 helmets)……………………………… Total contribution margin……………………………………………… $131,400 49,500 Total fixed cost……….……………………………………………………… Operating income…………………...………………………………… $ 81,900

BE 7-19 1.

Sales for Target Income

Total Fixed Cost + Target Income Contribution Margin Ratio

= ($49,500 + $81,900)/0.40 = $328,500 2.

Head-First Company Contribution Margin Income Statement At 4,380 Helmets Sold Total Sales…………………………………………………………………………… $328,500 197,100 Total variable cost ($328,500 × 0.60)…………………………………… Total contribution margin……………………………………………… $131,400 49,500 Total fixed cost…………………………………………………..….……… Operating income……………..………………………………………… $ 81,900

CHAPTER 7 Cost-Volume-Profit Analysis

BE 7-20 1. Any package with 5 bicycle helmets for every 2 motorcycle helmets is fine. For example, 5:2, or 10:4, or 30:12. Throughout the rest of this exercise, we will use 5:2.

Product

Price

Bicycle helmet Motorcycle helmet Package total

$ 75.00 220.00

2. Break-Even Packages

Unit Unit Variable Contribution Sales – Cost = Margin × Mix =

$ 45.00 140.00

$30.00 80.00

5 2

Package Unit Contribution Margin

$150.00 160.00 $310.00

Total Fixed Cost Package Contribution Margin

= $58,900/$310 = 190 packages Break-Even Bicycle Helmets

= Number of Packages × Sales Mix Amount = 190 × 5 = 950

Break-Even Motorcycle Helmets = Number of Packages × Sales Mix Amount = 190 × 2 = 380 3.

Head-First Company Contribution Margin Income Statement At Break-Even Point Sales [($75 × 950) + ($220 × 380)]…………………………………………… Total variable cost [($45 × 950) + ($140 × 380)]…………………………… Total contribution margin………………………………………………… Total fixed cost…..……………………………………………………………… Operating income……………………………………………………………

Total $154,850 95,950 $ 58,900 58,900 $ 0

CHAPTER 7 Cost-Volume-Profit Analysis

BE 7-21 1.

Contribution Margin Ratio

Sales – Total Variable Cost Sales

= ($570,000 – $388,000)/$570,000 = 0.3193* Break-Even Sales Dollars

Total Fixed Cost Contribution Margin Ratio

= $58,900/0.3193 = $184,466 * * Rounded

Head-First Company Contribution Margin Income Statement At Break-Even Sales Dollars Sales……………………………………………...…………………………… Total variable cost ($184,466 × 0.6807)………………………………… Total contribution margin……………………………….…………… Total fixed cost…………………………………………………….………. Operating income………………………………………..………………

BE 7-22 1. Margin of Safety in Units

Total $184,466 125,566 $ 58,900 58,900 $ 0

= Budgeted Units – Break-Even Units = 5,000 – 1,650 = 3,350

Margin of Safety in Sales Revenue

= Budgeted Sales – Break-Even Sales = $375,000 – $123,750 = $251,250

CHAPTER 7 Cost-Volume-Profit Analysis

BE 7-23 Total Contribution Margin Operating Income

Degree of Operating Leverage =

= $150,000/$100,500 = 1.5* *Rounded

BE 7-24 1. Percent Change in Operating Income

= DOL × Percent Change in Sales = 1.5 × 10% = 15%

Expected Operating Income

= Original Income + (Percent Change × Original Income) = $100,500 + (0.15 × $100,500) = $115,575

CHAPTER 7 Cost-Volume-Profit Analysis

BRIEF EXERCISES: SET B BE 7-25 1. Variable Cost per Unit

= Direct Materials + Direct Labor + Variable Factory Overhead + Variable Selling Expense = $12 + $4 + $2 + $3 = $21

2. Total Fixed Expense 3.

= $30,000 + $48,000 = $78,000 Chillmax Company Contribution Margin Income Statement For the Coming Year

Sales ($60 × 3,500 pairs)………………………………...…… Total variable cost ($21 × 3,500 pairs)…………………...… Total contribution margin………………………………… Total fixed cost………………………....……………………… Operating income ………………...………………………

Total $210,000 73,500 $136,500 78,000 $ 58,500

Per Unit $60.00 21.00 $39.00

BE 7-26 1. Break-Even Units

Total Fixed Cost Unit Contribution Margin

= $78,000/($60 – $21) = 2,000 pairs 2.

Chillmax Company Contribution Margin Income Statement At Break-Even Point Sales ($60 × 2,000 pairs)……………….…….………….…….……………… Total variable cost ($21 × 2,000 pairs)……………….…….………….……. Total contribution margin…………………………………………...……… Total fixed cost……………………………………………………...…………… Operating income…………………………………………………...………

Total $120,000 42,000 $ 78,000 78,000 $ 0

CHAPTER 7 Cost-Volume-Profit Analysis

BE 7-27 1.

Variable Cost Ratio

Variable Cost per Unit Price

= = $21/$60

= 0.35, or 35% 2.

Contribution Margin Ratio

Price – Variable Cost per Unit Price

Contribution Margin per Unit Price

= ($60 – $21)/$60 = 0.65, or 65% 3.

Chillmax Company Contribution Margin Income Statement For the Coming Year

Sales ($60 × 3,500 pairs)………………………………………… Total variable cost ($21 × 3,500 pairs)………………………… Total contribution margin…………………………………… Total fixed cost…………………...……………………………… Operating income ……………………………………………

BE 7-28 1. Break-Even Sales Dollars

$210,000 73,500 $136,500 78,000 $ 58,500

Percent of Sales 100% 35% 65%

Total Fixed Cost Contribution Margin Ratio

= $78,000/0.65 = $120,000 2.

Chillmax Company Contribution Margin Income Statement At Break-Even Point Sales………………………………………………………………………………...… Total variable cost ($120,000 × 0.35)……………………….…………………… Total contribution margin…………………………………………………… Total fixed cost……………………………………………………………….…… Operating income………………………………………………………………

Total $120,000 42,000 $ 78,000 78,000 $ 0

CHAPTER 7 Cost-Volume-Profit Analysis

BE 7-29 1. Break-Even Units

Total Fixed Cost + Target Income Unit Contribution Margin

= ($78,000 + $97,500)/($60 – $21) = 4,500 pairs of shoes Chillmax Company Contribution Margin Income Statement At 4,500 Pairs of Shoes Sold

Sales ($60 × 4,500 pairs)…………………………………………………………… Total variable cost ($21 × 4,500 pairs)…………………………………………… Total contribution margin……………………………………………………… Total fixed cost……….……………………………………………………………… Operating income…………………...……………………………………………

Total $270,000 94,500 $175,500 78,000 $ 97,500

BE 7-30 1. Sales for Target Income

Total Fixed Cost + Target Income Contribution Margin Ratio

= ($78,000 + $97,500)/0.65 = $270,000 2.

Chillmax Company Contribution Margin Income Statement At 4,500 Pairs of Shoes Sold Total Sales…………………………………………………………………………………… $270,000 Total variable cost ($270,000 × 0.35)……………………………………………… 94,500 Total contribution margin……………………………………………………… $175,500 78,000 Total fixed cost…………………………………………………..….………………… Operating income……………..…………………………………………………… $ 97,500

CHAPTER 7 Cost-Volume-Profit Analysis

BE 7-31 1. Any package with 4 pairs of shoes for every 1 carryall is fine. For example, 4:1, or 8:2, or 24:6. Throughout the rest of this exercise, we will use 4:1.

Product

Price

Shoes Carryall Package total

$60.00 36.00

2. Break-Even Packages

–

Unit Unit Variable Contribution Sales Cost = Margin × Mix =

$21.00 9.00

$39.00 27.00

4 1

Package Unit Contribution Margin

$156.00 27.00 $183.00

Total Fixed Cost Package Contribution Margin

= $91,500/$183 = 500 packages Break-Even Pairs of Shoes

= Number of Packages × Sales Mix Amount = 500 × 4 = 2,000

Break-Even Carryalls

= Number of Packages × Sales Mix Amount = 500 × 1 = 500

Chillmax Company Contribution Margin Income Statement At Break-Even Point Sales [($60 × 2,000) + ($36 × 500)]………………………………………… Total variable cost [($21 × 2,000) + ($9 × 500)]…………………………… Total contribution margin……………………………………………… Total fixed cost…..…………………………………………………………… Operating income…………………………………………………………

Total $138,000 46,500 $ 91,500 91,500 $ 0

CHAPTER 7 Cost-Volume-Profit Analysis

BE 7-32 1. Contribution Margin Ratio

Sales – Total Variable Cost Sales

= ($210,000 – $81,375)/$210,000 = 0.6125 Break-Even Sales Dollars

Total Fixed Cost Contribution Margin Ratio

= $91,500/0.6125 = $149,388 * Rounded

Chillmax Company Contribution Margin Income Statement At Break-Even Sales Dollars Sales……………………………………………...……………………………. Total variable cost ($149,388 × 0.3875)…………………………………… Total contribution margin……………………………….……………… Total fixed cost…………………………………………………….……….… Operating income………………………………………..…………………

BE 7-33 1. Margin of Safety in Units

Total $149,388 57,888 $ 91,500 91,500 $ 0

= Budgeted Units – Break-Even Units = 3,500 – 2,000 = 1,500

2. Margin of Safety in Sales Revenue

= Budgeted Sales – Break-Even Sales = (3,500 × $60) – (2,000 × $60) = $210,000 – $120,000 = $90,000

CHAPTER 7 Cost-Volume-Profit Analysis

BE 7-34 Degree of Operating Leverage

Total Contribution Margin Operating Income

= [3,500 × ($60 – $21)]/$58,500 = $136,500/$58,500 = 2.3* *Rounded

BE 7-35 1. Percent Change in Operating Income

= DOL × Percent Change in Sales = 2.3 × 10% = 23%

Expected Operating Income

= Original Income + (Percent Change × Original Income) = $58,500 + (0.23 × $58,500) = $71,955

CHAPTER 7 Cost-Volume-Profit Analysis

EXERCISES E 7-36 1. Direct materials…………………………………….……………….……… Direct labor………………………………………….……………….……… Variable factory overhead………………………….……………….…… Variable selling and administrative expense………………………… Unit variable cost………………………...……………………………….… Unit Contribution Margin

$ 4.98 2.58 1.00 2.00 $10.56

= Price – Unit Variable Cost = $24.00 – $10.56 = $13.44

Contribution Margin Ratio

= $13.44/$24.00 = 0.56, or 56%

Variable Cost Ratio

= $10.56/$24.00 = 0.44, or 44%

Break-Even Units

= ($30,000 + $11,664)/($24.00 – $10.56) = 3,100

Sales ($24 × 3,100)……..……………….……………………….………… Variable cost ($10.56 × 3,100)……..…………………….……………… Total contribution margin…………………………………….……… Fixed cost ($30,000 + $11,664).………………….……………….……… Operating income…………………....……………….…………………

$74,400 32,736 $41,664 41,664 $ 0

E 7-37 1. At break-even: Total Fixed Cost = Total Contribution Margin = $349,600 Contribution Margin per Unit = Total Contribution Margin/Break-Even Units = $349,600/115,000 = $3.04 Contribution Margin per Unit = Price – Variable Cost per Unit $3.04 = Price – $4.56 Price = $3.04 + $4.56 = $7.60 2.

Operating Income = (Price × Quantity) – (Variable Cost per Unit × Quantity) – Fixed Cost $166,000 = ($120 × 15,600) – (Variable Cost per Unit × 15,600) – $458,000 $166,000 = $1,872,000 – (Variable Cost per Unit × 15,600) – $458,000 Variable Cost per Unit × 15,600 = $1,248,000 Variable Cost per Unit = $1,248,000/15,600 = $80 Contribution Margin Ratio = Unit Contribution Margin/Unit Selling Price = ($120 – $80)/$120 = 0.3333 7-15

CHAPTER 7 Cost-Volume-Profit Analysis

E 7-37 (Continued) 3. Total Contribution Margin = Actual Revenue × Contribution Margin Ratio = $235,000 × 0.25 = $58,750 Total Fixed Cost = Total Contribution Margin – Operating Income = $58,750 – $22,500 = $36,250 4.

Break-Even Units = Total Fixed Cost/(Price – Variable Cost per Unit) 23,600 = $103,840/[Price – (0.56 × Price)] Price – (0.56 × Price) = $103,840/23,600 Price (1.00 – 0.56) = $4.40 Price = $4.40/(1.00 – 0.56) Price = $4.40/0.44 = $10.00 OR $103,840/0.44 = $236,000 $236,600/23,600 = $10.00 Variable Cost per Unit = Price × Variable Cost Ratio = $10.00 × 0.56 = $5.60 Contribution Margin per Unit = Price – Variable Cost per Unit = $10.00 – $5.60 = $4.40

CHAPTER 7 Cost-Volume-Profit Analysis

E 7-38 1. Contribution Margin Ratio 2.

Variable Cost Ratio

Contribution Margin Sales = $65,320/$92,000 = 0.71, or 71%

= $26,680/$92,000 = 0.29, or 29%

OR Variable Cost Ratio

= 1 – Contribution Margin Ratio = 1.00 – 0.71 = 0.29

Break-Even Sales Revenue

Total Fixed Cost Contribution Margin Ratio

= $42,600/0.71 = $60,000 4.

To increase operating income without increasing sales revenue, Jeong would have to find a way to decrease variable cost (thus decreasing the variable cost ratio and increasing the contribution margin ratio), decrease fixed cost, or do a combination of both.

E 7-39 1. Sales ($16.00 × 18,300)………………..………………………..…… Variable cost ($13.70 × 18,300)…………………....………………… Total contribution margin……………………………………….. Fixed cost…………………………………………………………...…. Operating income………………………….……………...…..…… 2.

Break-Even Units = $34,500/($16.00 – $13.70) = 15,000

Units to Earn Target Income

$292,800 250,710 $ 42,090 34,500 $ 7,590

= ($34,500 + $13,800)/($16.00 – $13.70) = 21,000

E 7-40 1. Break-Even Units

= ($111,425 + $48,350)/($3.45 – $2.35) = $159,775/$1.10 = 145,250

Unit variable cost includes all variable costs on a unit basis: Direct materials…………………………………………………….…… Direct labor………………………………………………………….…… Variable factory overhead…………………………………………… Variable selling expense……………………………………………… Unit variable cost………………………………………………………

$0.67 0.86 0.63 0.19 $2.35

CHAPTER 7 Cost-Volume-Profit Analysis

E 7-40 (Continued) Unit variable manufacturing cost includes the variable costs of production on a unit basis: Direct materials…………………………………………………………… Direct labor…………………..……………………………………………… Variable factory overhead………………………………………………… Unit variable manufacturing cost………………………………………

$0.67 0.86 0.63 $2.16

Unit variable cost is used in CVP because it includes all variable costs, not just manufacturing costs. 3.

Units to earn $14,300

= ($111,425 + $48,350 + $14,300)/($3.45 – $2.35) = 158,250

Sales revenue to earn $14,300 = 158,250 × $3.45 = $545,963* *Rounded

Break-Even Units = ($111,425 + $48,350)/($3.45 – $2.29) = 137,737* Units for target income

= ($111,425 + $48,350 + $14,300)/($3.45 – $2.29) = 150,065*

*Rounded

Break-Even Units = ($111,425 + $50,000)/($3.45 – $2.35) = 146,750 Units for target income = ($111,425 + $50,000 + $14,300)/($3.45 – $2.35) = 159,750

E 7-41 1. Break-Even Units = ($245,650 + $237,950)/($8.10 – $5.50) = 186,000 2.

Expected sales in units……………………………………………..…… Break-even units………………………………………………………..… Margin of safety (in units)……………………………………………..…

225,000 (186,000) 39,000

Expected sales revenue ($8.10 × 225,000)…………………………… Break-even sales revenue*……………………………………………… Margin of safety (in dollars)………………………………………………

$1,822,500 1,506,600 $ 315,900

*Break-Even Revenue = Price × Break-Even Units = $8.10 × 186,000 units

If the price decreases, then the risk facing the company will go up. The price decrease means that the contribution margin per unit will decrease and the break-even units will increase. The increase in the break-even units will lead to a decrease in the margin of safety, as Ciganda, then, would be operating closer to the break-even point.

CHAPTER 7 Cost-Volume-Profit Analysis

E 7-42 Laertes

Ophelia

Fortinbras

Sales Total variable cost Total contribution margin Total fixed cost Operating income (loss)

$15,000 5,000 $10,000 9,500 * $ 500

$15,600 * 11,700 $ 3,900 4,000 $ (100) *

$16,250* 9,750 $ 6,500* 6,136* $ 364

$10,600 5,300 * $ 5,300 * 4,452 $ 848

Units sold Price per unit Variable cost per unit Contribution margin per unit Contribution margin ratio Break-even units

3,000 * $5.00 $1.67 * $3.33 * 67%* 2,853 *

1,300 $12.00* $9.00 $3.00 25%* 1,333*

125 $130.00 $78.00* $52.00*

1,000 $10.60 * $5.30 * $5.30 * 50%* 840 *

40% 118*

Claudius

*Designates calculated amount.

(Note: Calculated break-even units that include a fractional amount have been rounded to the nearest whole unit.) Laertes Total fixed cost = $10,000 – $500 = $9,500 Units sold = $15,000/$5.00 = 3,000 Variable cost per unit = $5,000/3,000 = $1.67 (rounded) Contribution margin per unit = $5.00 – $1.67 = $3.33 Contribution margin ratio = $10,000/$15,000 = 0.67, or 67% (rounded) Break-even units = $9,500/$3.33 = 2,853 (rounded) Ophelia Sales = $11,700 + $3,900 = $15,600 Operating loss = $3,900 – $4,000 = ($100) Price per unit = $15,600/1,300 = $12.00 Contribution margin ratio = $3,900/$15,600 = 0.25, or 25% Break-even units = $4,000/$3.00 = 1,333 (rounded)

CHAPTER 7 Cost-Volume-Profit Analysis

E 7-42 (Continued) Fortinbras Sales = 125 × $130.00 = $16,250 Total contribution margin = $16,250 – $9,750 = $6,500 Total fixed cost = $6,500 – $364 = $6,136 Variable cost per unit = $9,750/125 = $78.00 Contribution margin per unit = $6,500/125 = $52.00 Break-even units = $6,136/$52.00 = 118 Claudius Total contribution margin = $4,452 + $848 = $5,300 Total variable cost = $10,600 – $5,300 = $5,300 Price per unit = $10,600/1,000 = $10.60 Variable cost per unit = $5,300/1,000 = $5.30 Contribution margin per unit = $10.60 – $5.30 = $5.30 Contribution margin ratio = 5,300/$10,600 = $0.50, or 50% Break-even units = $4,452/$5.30 = 840

E 7-43 1. Variable Cost Ratio

= $302,950/$415,000 = 0.73, or 73%

Contribution Margin Ratio = $112,050/$415,000 = 0.27, or 27% 2. Because all fixed costs are covered at break-even, the contribution margin portion of any revenue above break-even contributes directly to operating income. Sales × Contribution Margin Ratio = Increased Operating Income $30,000 × 0.27 = $8,100 Therefore, operating income will be $8,100 higher. 3. Break-Even Sales Revenue = $64,800/0.27 = $240,000 Sales……………………………………………………………………………… Variable cost ($240,000 × 0.73)…..……………..….……………………… Contribution margin……………………………………………………… Fixed cost……………..………………………………………………………… Operating income………………………………………………………… 4. Expected sales………………………………………………………………… Break-even sales…………………………………….………………………… Margin of safety………………………..…………………………………… 5. Sales revenue………………..………………………………………………… Break-even sales……………………...……………………………………… Margin of safety………………..……………………………………………

$240,000 175,200 $ 64,800 64,800 $ 0 $415,000 240,000 $175,000 $380,000 240,000 $140,000

CHAPTER 7 Cost-Volume-Profit Analysis

E 7-44 1. Sales mix is 2:1 (twice as many vinyl mitts are sold as leather mitts). 2. Product

Price –

Vinyl mitts Leather mitts Total

$ 10 16

Variable Cost = $ 6 10

$ 4 6

Sales Mix

2 1

Total CM $8 6 $14

Break-Even Packages = $93,500/$14 = 6,678.5714 Break-Even Vinyl Mitts = 6,678.5714 × 2 = 13,357 Break-Even Leather Mitts = 6,678.5714 × 1 = 6,679

E 7-45 1. Sales mix is 4:2:1. 2. Product Vinyl mitts Leather mitts Autographed mitts Total

Variable Cost = Price –

$ 10 16 20

$ 4 6 8

$ 6 10 12

Sales × Mix 4 2 1

Total CM $16 12 8 $36

Break-Even Packages = $111,300/$36 = 3,091.6667 Break-Even Vinyl Mitts = 4 × 3,091.6667 = 12,367 Break-Even Leather Mitts = 2 × 3,091.6667 = 6,183 Break-Even Autographed Mitts = 1 × 3,091.6667 = 3,092 Andrews Sporting Goods Inc. Income Statement For the Coming Year

Sales……………………………………………………………………………… Total variable cost……………………………………………………………… Contribution margin………………………………………………………… Total fixed cost………………………………………………………………… Operating income……………………………………………………………

$552,000 336,000 $216,000 111,300 $ 104,700

Contribution Margin Ratio = $216,000/$552,000 = 0.3913*, or 39.13% Break-Even Sales Revenue = $111,300/0.3913 = $284,436* *Rounded

Margin of Safety = $552,000 – $284,436 = $267,564

CHAPTER 7 Cost-Volume-Profit Analysis

E 7-46 1. Sales mix is 4:10:1 (four times as many portable grills will be sold as smokers, and 10 times as many stationary grills will be sold as smokers). 2. Product

Price

Portable Stationary Smoker Total

$ 90 200 250

–

Variable Cost =

$ 45 130 140

$ 45 70 110

Sales Mix

4 10 1

Total CM $180 700 110 $990

Break-Even Packages = $2,128,500/$990 = 2,150 Break-Even Portable Grills = 4 × 2,150 = 8,600 Break-Even Stationary Grills = 10 × 2,150 = 21,500 Break-Even Smokers = 1 × 2,150 = 2,150 Texas-Q Company Income Statement For the Coming Year

Sales………………………………………………………………………… Total variable cost………………………………………………………… Contribution margin…………………………………………………… Total fixed cost……………………………………………………………… Operating income………………………………………………………

$13,050,000 8,100,000 $ 4,950,000 2,128,500 $ 2,821,500

Contribution Margin Ratio = $4,950,000/$13,050,000 = 0.3793, or 37.93%* Break-Even Revenue = $2,128,500/0.3793 = $5,611,653* *Rounded

Margin of Safety = $13,050,000 – $5,611,653 = $7,438,347

CHAPTER 7 Cost-Volume-Profit Analysis

E 7-47 1. $35,000 $30,000 $25,000 $20,000

Total Cost

$15,000 $10,000 $5,000

Total Revenue $0 0

500

1,000

1,500

2,000

2,500

3,000

3,500

Units Sold

Break-Even Point = 2,500 units; the plus-marked line is total revenue, and the heavy solid line is total cost. 2.

Fixed cost increases by $5,000:

$40,000 $35,000 $30,000 $25,000 $20,000 $15,000 $10,000 $5,000 $0 0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

Units Sold

CHAPTER 7 Cost-Volume-Profit Analysis

E 7-47 (Continued) 2. b. Unit variable cost increases to $7: $50,000

$40,000

$30,000

$20,000

$10,000

$0 0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2,500

3,000

3,500

4,000

Units Sold

Break-Even Point = 3,333 units 2.

Unit selling price increases to $12:

$60,000

$50,000

$40,000

$30,000

$20,000

$10,000

$0 0

500

1,000

1,500

2,000

Units Sold

Break-Even Point = 1,667 units

CHAPTER 7 Cost-Volume-Profit Analysis

E 7-47 (Continued) 2. d. Both fixed cost and unit variable cost increase:

Break-Even Point = 5,000 units

E 7-48 1. Unit Contribution Margin = $791,700/54,600 = $14.50 Break-Even Units = $801,850/$14.50 = 55,300 2.

Operating Income = 10,000 × $14.50 = $145,000

Contribution Margin Ratio = $14.50/$34.00 = 0.4265, or 42.65% Break-Even Sales Revenue = $801,850/0.4265 = $1,880,070 Profit = ($200,000 × 0.4265) – $10,150 = $75,150

CHAPTER 7 Cost-Volume-Profit Analysis

E 7-49 1. Break-Even Sales Dollars = $733,320/0.45* = $1,629,600 *Contribution Margin Ratio = $828,000/$1,840,000 = 0.45, or 45%

Margin of Safety = $1,840,000 – $1,629,600 = $210,400

Degree of Operating Leverage

Contribution Margin Operating Income

= $828,000/$94,680 = 8.75* 4.

Percent Change in Operating Income = 8.75 × 0.20 = 1.75 New Operating Income = $94,680 + (1.75 × $94,680) = $260,370 *Rounded

E 7-50 1. Product Vases Figurines Total

Price

–

Variable Cost

$30 42

$40 70

Sales × Mix =

Total CM

$10 28

2 1

$20 28 $48

Sales × Mix =

Total CM

$10 28

3 2

$30 56 $86

Break-Even Packages = $30,000/$48 = 625 Break-Even Vases = 2 × 625 = 1,250 Break-Even Figurines = 1 × 625 = 625 2.

The new sales mix is 3 vases to 2 figurines. Product

Price

Vases Figurines Total

$40 70

–

Variable Cost

$30 42

Break-Even Packages = $35,260/$86 = 410 Break-Even Vases = 3 × 410 = 1,230 Break-Even Figurines = 2 × 410 = 820

CHAPTER 7 Cost-Volume-Profit Analysis

E 7-51 1. a.

Variable Cost per Unit = $8,190,000/450,000 = $18.20

Contribution Margin per Unit = $3,510,000/450,000 = $7.80

Contribution Margin Ratio = $3,510,000/$11,700,000 = 0.30, or 30%

Break-Even Units = $2,254,200/$7.80 = 289,000 units

Break-Even Sales Dollars = $2,254,200/0.30 = $7,514,000

OR Break-Even Sales Dollars = 289,000 × $26* = $7,514,000 *Price = ($11,700,000/$450,000) = $26

Units for Target Income = ($2,254,200 + $296,400)/$7.80 = 327,000 units

Additional Operating Income = $50,000 × 0.30 = $15,000

Margin of Safety in Units = 450,000 – 289,000 = 161,000 units Margin of Safety in Sales Dollars = $11,700,000 – $7,514,000 = $4,186,000

Degree of Operating Leverage = $3,510,000/$1,255,800 = 2.8* *Rounded

New Operating Income = $1,255,800 + [(2.8 × 0.10) × $1,255,800] = $1,607,424

CHAPTER 7 Cost-Volume-Profit Analysis

PROBLEMS P 7-52 1.

Break-Even Units

Fixed Cost Unit Contribution Margin

= $380,400/($24 – $18) = $380,400/$6 = 63,400 units 2.

Units for Target Profit

= ($380,400 + $240,000)/($24 – $18) = $620,400/$6 = 103,400 units

Contribution Margin Ratio = $6/$24 = 0.25 With additional sales of $160,000, the additional profit would be 0.25 × $160,000 = $40,000.

Current Units = $2,040,000/$24 = 85,000 Margin of Safety in Units = 85,000 – 63,400 = 21,600

P 7-53 1.

Break-Even Units

Fixed Cost Price – Variable Cost per Unit

= $197,600/($13.50 – $9.85) = 54,137* 2.

Break-Even Units

= ($197,600 – $23,500)/($13.50 – $9.85) = 47,699*

The reduction in fixed cost reduces the break-even point because less contribution margin is needed to cover the new, lower fixed costs. Operating income goes up, and the margin of safety also goes up. *Rounded

CHAPTER 7 Cost-Volume-Profit Analysis

P 7-54 1. Unit Contribution Margin

= $6,090,000/203,000 = $30

Break-Even Point in Units

= $4,945,500/$30 = 164,850

Contribution Margin Ratio

= $30/$70 = 0.4286*

Break-Even Sales Revenue

= $4,945,500/0.4286* = $11,538,731

*Rounded

Increased contribution margin ($1,000,000 × 0.4286*)………………. Less: Increased advertising expense………………………….………… Increased operating income………………………………….……...…

$428,600 250,000 $178,600

*$30/$70 = 0.4286 (rounded)

$1,500,000 × 0.4286 = $642,900

Margin of Safety

Degree of Operating Leverage = $6,090,000/$1,144,500 = 5.32

= $14,210,000 – $11,538,731 = $2,671,269

0.08 × 5.32 = 42.56% (increase in operating income)

CHAPTER 7 Cost-Volume-Profit Analysis

P 7-55 1. Sales mix: Basic:

$3,000,000/$30 = 100,000 units

Aero:

$2,400,000/$60 = 40,000 units

Product

Price

Basic sleds Aerosleds Package

$30 60

–

Variable Cost* =

Contribution Sales Margin × Mix = $20 35

$10 25

5 2

Total CM $100 70 $170

*Basic Sled Variable Cost: $1,000,000/100,000 = $10 Aerosled Variable Cost: $1,000,000/40,000 = $25

Break-Even Packages = ($1,428,000 + $198,900)/$170 = 9,570 Break-Even Basic Sleds = 9,570 × 5 = 47,850 Break-Even Aerosleds = 9,570 × 2 = 19,140 2.

New mix: Product

Price

Basic sleds Aerosleds Package

$30 60

–

Variable Cost* =

Contribution Sales Margin × Mix = $20 35

$10 25

5 3

Total CM $100 105 $205

Break-Even Packages = ($1,428,000 + $198,900)/$205 = 7,936* Break-Even Basic Sleds = 7,936 × 5 = 39,680 Break-Even Aerosleds = 7,936 × 3 = 23,808 *Rounded to the nearest whole package.

Increase in contribution margin for aerosleds (12,000 × $35)……… $ 420,000 (100,000) Decrease in contribution margin for basic sleds (5,000 × $20)…… Increase in total contribution margin………………………………… $ 320,000 195,000 Less: Additional fixed cost……………………………………………… Increase in income………………………...…………………………… $ 125,000 Basu would gain $125,000 by increasing advertising for the aerosleds. This is a good strategy.

CHAPTER 7 Cost-Volume-Profit Analysis

P 7-56 1. Break-Even Units = $64,200/($5.60 – $3.92) = 38,214* *Rounded

Margin of Safety in Units = 70,000 – 38,214 = 31,786 2.

Sales revenue ($5.60 × 70,000)……………………..…...…………..…. Total variable cost ($3.92 × 70,000)……………….…………….……… Total contribution margin……………………….…………………… Total fixed cost……………………………………………………………… Operating income……………….………………………………………

Units for Target Profit

$392,000 274,400 $ 117,600 64,200 $ 53,400

= ($64,200 + $62,000)/($5.60 – $3.92) = 75,119 *

*Rounded

Operating Income = Sales – (Variable Cost Ratio × Sales) – Fixed Cost 0.10 Sales = Sales – (0.70 × Sales) – $64,200 0.10 Sales = 0.30 Sales – $64,200 $64,200 = (0.30 Sales – 0.10 Sales) $64,200 = 0.20 Sales Sales = $321,000

P 7-57 1. Contribution Margin Ratio = $294,592/$460,300 = 0.64, or 64% 2.

Break-Even Sales Revenue = $150,000/0.64 = $234,375

$460,300 × 1.15 = $165,708 × 1.15 =

$529,345 190,564 * $338,781

*Rounded

Contribution Margin Ratio = $338,781/$529,345 = 0.64 The contribution margin ratio remains at 0.64. 4.

Additional variable expense: $460,300 × 0.04 = $18,412 New Contribution Margin = $294,592 – $18,412 = 276,180 New Contribution Margin Ratio = $276,180/$460,300 = 0.60 Break-Even Sales Revenue = $150,000/0.60 = $250,000 The effect is to increase the break-even sales revenue.

Projected contribution margin*………………………………………… Present contribution margin………………….………………………… Increase in contribution margin/profit…………………………………

$324,180 294,592 $ 29,588

*($460,300 + $80,000) × 0.60 = $324,180

CHAPTER 7 Cost-Volume-Profit Analysis

P 7-57 (Continued) Operating leverage will decrease because the increase in variable cost (the sales commission) causes a decrease in the contribution margin. Elgart should pay the commission because profit would increase by $29,588.

P 7-58 1. Break-Even Sales Revenue

= Fixed Cost/Contribution Margin Ratio = $150,000/($200,000/$600,000) = $450,000

Of total sales revenue, 60% is produced by floor lamps and 40% by desk lamps. Floor lamps = (0.60 × $600,000)/$30 = 12,000 units Desk lamps = (0.40 × $600,000)/$20 = 12,000 units Thus, the sales mix is 1:1. Product

Price

Floor lamps Desk lamps Package

$30 20

Number of Packages

–

Variable Cost

Contribution Margin

$20.00 13.333*

$10.00 6.667

Sales Mix =

Total CM

1 1

$10.00 6.667 $16.667

Fixed Cost Contribution Margin

= $150,000/$16.667 = 9,000 * Floor lamps:

1 × 9,000 = 9,000

Desk lamps:

1 × 9,000 = 9,000

*Rounded

3. Operating Leverage

Contribution Margin Operating Income

= $200,000/$50,000 = 4.0 Percentage Increase in Profits = 4.0 × 40% = 160%

CHAPTER 7 Cost-Volume-Profit Analysis

P 7-59 1. CM CM ratio

Door Handles $12 – $9 = $3 $3/$12 = 0.25

Trim Kits $8 – $5 = $3 = 0.375 $3/$8

2. Contribution margin: ($3 × 20,000) + ($3 × 40,000)……………… Less: Fixed cost………………….………… Operating income………………….……

$180,000 146,000 $ 34,000

3. Sales mix (from Requirement 2): 1 door handle to 2 trim kits Product

Price

Door handle Trim kit Package

$12 8

–

Variable Cost

Contribution Sales Margin × Mix

$9 5

$3 3

1 2

Total CM $3.00 6.00 $9.00

Break-Even Packages = $146,000/$9 = 16,222* Door Handles = 1 × 16,222 = 16,222 Trim Kits = 2 × 16,222 = 32,444 *Rounded

4. Revenue (70,000 × $8)…………………….………………………………… Variable cost (70,000 × $5)…………………….…………………………… Contribution margin……………………………………………………… Fixed cost……………………………………………………………………… Operating income…………………………………………………………

$560,000 350,000 $210,000 111,000 $ 99,000

Yes, operating income is $65,000 higher than when both door handles and trim kits are sold.

P 7-60 1. Break-Even Units = $300,000/$14* = 21,429** *$406,000/29,000 units = $14 **Rounded

Contribution Margin Ratio

= $406,000/$1,218,000 = 0.3333

Break-Even in Sales Dollars

= $300,000/0.3333 = 900,090

2. Margin of Safety = $1,218,000 – $900,090 = $317,910

CHAPTER 7 Cost-Volume-Profit Analysis

P 7-60 (Continued) 3. Sales………………………………………………………………………… $1,218,000 Variable cost (0.45 × $1,218,000)……………….…………..…...…… 548,100 Contribution margin…………………………...…..……………… $ 669,900 Fixed cost…………………..…………………….……………………… 550,000 Operating income…………………….……………...……………… $ 119,900 Break-Even in Sales Dollars = $550,000/0.55* = $1,000,000 * $669,900/$1,218,000 = 55% Victoria should consider making this change because Operating Income increases $13,900; however, the increase in fixed cost, offset by the decrease in variable cost, increases break-even by about 11%. While this break-even level is still below current sales forecast levels, Victoria should consider that decrease in the margin of safety as she makes this decision. P 7-61 Variable Costs Sales

1. Variable Cost Ratio =

= $647,400/$830,000 = 0.78, or 78% Contribution Margin Ratio =

(Sales – Variable Costs) Sales

= ($830,000 – $647,400)/$830,000 = 0.22, or 22% 2.

Break-Even Sales Revenue = $110,000/0.22 = $500,000

Margin of Safety

= Sales – Break-Even Sales = $830,000 – $500,000 = $330,000

Contribution Margin from Increased Sales = $12,000 × 0.22 = $2,640 Cost of Advertising = $4,500 No, the advertising campaign is not a good idea, because the company’s operating income will decrease by $1,860 ($4,500 – $2,640).

CHAPTER 7 Cost-Volume-Profit Analysis

P 7-62 1. Income = Revenue – Variable Cost – Fixed Cost $0 = 2,400P – ($42 × 2,400) – $67,200 $0 = 2,400P – $100,800 – $67,200 $168,000 = 2,400P P = $70 2.

$314,400/($6.50 – Unit Variable Cost) = 131,000 Break-Even Sales Revenue = 131,000 × $6.50 = $851,500 Total Variable Cost = $851,500 – $314,400 = $537,100 Unit Variable Cost = $4.10

P 7-63 1. Contribution Margin per Unit

= $5.60 – $4.20* = $1.40

* Variable cost per unit: $0.70 + $0.35 + $1.85 + $0.34 + $0.76 + $0.20 = $4.20

Contribution Margin Ratio = $1.40/$5.60 = 0.25 2.

Break-Even Units = ($32,300 + $12,500)/$1.40 = 32,000 boxes Break-Even Sales Revenue OR

= 32,000 × $5.60 = $179,200 = ($32,300 + $12,500)/0.25 = $179,200

Sales ($5.60 × 35,000)…….…………………………..…………………… Variable cost ($4.20 × 35,000)………………………………………..…… Contribution margin………………….……………………………….… Fixed cost…………………………………………………….……………… Operating income………………………………………….……………

Margin of Safety = $196,000 – $179,200 = $16,800

Break-Even Units = $44,800/($6.20 – $4.20) = 22,400 New Operating Income

$196,000 147,000 $ 49,000 44,800 $ 4,200

= ($6.20 × 31,500) – ($4.20 × 31,500) – $44,800 = $195,300 – $132,300 – $44,800 = $18,200

Yes, operating income will increase by $14,000 ($18,200 – $4,200).

CHAPTER 7 Cost-Volume-Profit Analysis

P 7-64 1. Duncan:

$75,000/$25,000 = 3

Macduff:

$225,000/$25,000 = 9

Duncan Contribution margin ratio

= $75,000/$375,000 = 0.20

Break-even sales

= $50,000/0.20

Break-even sales

= $250,000 Macduff

Contribution margin ratio

= $225,000/$375,000 = 0.60

Break-even sales

= $200,000/0.60

Break-even sales

= $333,333 (rounded)

Macduff must sell more than Duncan to break even because it must cover $150,000 more in total fixed cost (it is more highly leveraged). 3. Duncan:

3 × 30% = 90%

Macduff:

9 × 30% = 270%

The percentage increase in profits for Macduff is much higher than Duncan's increase because Macduff has a higher degree of operating leverage (i.e., it has a larger amount of fixed costs in proportion to variable cost as compared to Duncan). Once fixed cost is covered, additional revenue must cover only variable cost, and 60% of Macduff's revenue above break-even is profit, whereas only 20% of Duncan's revenue above break-even is profit.

CHAPTER 7 Cost-Volume-Profit Analysis

P 7-65 1. Contribution margin ratios:

May of current year

= $23,910/$43,560 = 0.5489, or 54.89%

May of prior year

= $23,400/$41,700 = 0.5612, or 56.12%

Fixed costs: May of current year

= $680 + $4,300 + $5,600 + $9,750 = $20,330

May of prior year

= $500 + $4,300 + $5,000 + $4,000 = $13,800

Break-even point in sales dollars:

May of current year

= $20,330/0.5489 = $37,038

May of prior year

= $13,800/0.5612 = $24,590

Margin of safety: May of current year

= $43,560 – $37,038 = $6,522

May of prior year

= $41,700 – $24,590 = $17,110

Clearly, the sharp rise in fixed costs from the prior year to the current year has had a strong impact on the break-even point and the margin of safety. Kicker will need to ensure that tight cost control is exercised since the margin of safety is much slimmer. Still, the decision to go with the OEM investment program could pay large dividends in the future. Note that the margin of safety and break-even point give the company important information on the potential risk of the venture but do not tell it the upside potential.

CHAPTER 7 Cost-Volume-Profit Analysis

CASES Case 7-66 1. Let X be a package of 3 Grade I cabinets and 7 Grade II cabinets. 0.30X($3,400) + 0.70X($1,600)

= $1,600,000 = 748* packages

*Rounded to the nearest package.

Grade I: Grade II:

0.3 × 748 = 224* cabinets 0.7 × 748 = 524* cabinets

2. Product

Price

I II Package

$3,400 1,600

–

Variable Cost

$714 272

$2,686 1,328

Direct fixed cost—I Direct fixed cost—II Common fixed cost Total fixed cost

Contribution Margin

Sales Mix

3 7

Total CM $2,142 1,904 $4,046

$ 95,000 95,000 35,000 $225,000

$225,000/$4,046 = 56 Grade I: Grade II:

3 × 56 = 168 cabinets 7 × 56 = 392 cabinets

3. Product

Price

I II Package

$3,400 1,600

–

Variable Cost

$2,444 * 1,208 *

Contribution Margin $956 392

Sales Mix 3 7

Total CM $2,868 2,744 $5,612

[($3,400 × 3) + ($1,600 × 7)] X = $1,600,000 – $600,000 $21,400X = $1,600,000 – $600,000 X = 47* packages remaining Grade I: 3 × 47 = 141 Grade II: 7 × 47 = 329 Additional contribution margin: [141 × ($956 – $714)] + [329 × ($392 – $272)] = $73,602 Increase in fixed cost = $44,000 Break-even: ($225,000 + $44,000)/$5,612 = 48 Grade I: 3 × 48 = 144 Grade II: 7 × 48 = 336 Increase in Operating Income = $73,602 – $44,000 = $29,602 *Rounded

CHAPTER 7 Cost-Volume-Profit Analysis

Case 7-66 (Continued) If the new break-even point is interpreted as a revised break-even point for the current year, then total fixed cost must be reduced by the contribution margin already earned (through the first five months) to obtain the units that must be sold for the last seven months. These units would then be added to those sold during the first five months: Contribution Margin Earned

= $600,000 – (83* × $2,686) – (195* × $1,328) = $118,102

*224 – 141 = 83; 524 – 329 = 195

X = ($225,000 + $44,000 – $118,102)/$5,612 = 27* packages From the first five months, 28 packages were sold (83/3 or 195/7). Thus, the revised break-even point is 55 packages (27 + 28)—in units 165 of Grade I and 196 of Grade II. 4. Product

Price

I II Package

$3,400 1,600

–

Variable Cost

Contribution Margin

$2,686 1,328

$714 272

Sales Mix

1 1

Total CM $714 272 $986

New sales revenue: $1,000,000 × 1.30 = $1,300,000 $5,000X = $1,300,000 X = 260 packages Thus, 260 units of each cabinet will be sold during the rest of the year. Effect on profits: Change in contribution margin: [$714 × (260 – 141)] – [$272 × (329 – 260)]……………………… $66,198 Increase in fixed costs: $70,000 × (7/12)……………………………………………………… 40,833 * Increase in operating income……………………………………… $25,365 The break-even point (for the current year and the remaining 7 months, respectively) is computed as follows: X = Fixed Cost/(Price – Variable Cost) = $295,000/$986 = 299* packages (or 299 of each cabinet) X = ($295,000 – $118,102)/$986 = $176,898/$986 = 179* packages (179 of each) To this, add the units already sold, yielding the revised break-even point: Grade I: 83 + 179 = 262 Grade II: 195 + 179 = 374 *Rounded

CHAPTER 7 Cost-Volume-Profit Analysis

Case 7-67 1. Break-Even Point in Units First process: Second process:

Fixed Cost Unit Contribution Margin $100,000/($30 – $10) = 5,000 $200,000/($30 – $6) = 8,333 *

*Rounded

Income = X(Price – Variable Cost) – Fixed Cost X ($30 – $10) – $100,000 = X($30 – $6) – $200,000 $20X – $100,000 = 24X – $200,000 $100,000 = $4X X = 25,000 cases The manual process is more profitable if sales are less than 25,000 cases; the automated process is more profitable at a level greater than 25,000 cases. It is important for the manager to have a sales forecast to help in deciding which process should be chosen.

3. The right to decide which process should be chosen belongs to the divisional manager. Danna has an ethical obligation to report the correct information to her superior. By altering the sales forecast, Danna unfairly and unethically influenced the decision-making process. Managers certainly have a moral obligation to assess the impact of their decisions on employees, and every effort should be taken to be fair and honest with employees. Danna's behavior, however, is not justified by the fact that it helped a number of employees retain their employment. First, Danna had no right to make that decision. Danna certainly has the right to voice her concerns about the impact of automation on the employees’ well-being. In doing so, perhaps the divisional manager would come to the same conclusion even though the automated system appears to be more profitable. Second, the choice to select the manual system may not be the best for the employees anyway. The divisional manager may possess more information, making the selection of the automated system the best alternative for all concerned, provided the sales volume justifies its selection. For example, if the automated system is viable, the divisional manager may have plans to retrain and relocate the displaced workers in better jobs within the company. Third, her motivation for altering the forecast seems more driven by her friendship with Jerry Johnson than any legitimate concerns for the layoff of other employees. Danna should examine her reasoning carefully to assess the real reasons for her behavior. Perhaps in so doing, the conflict of interest that underlies her decision will become apparent.

TACTICAL DECISION MAKING AND RELEVANT ANALYSIS DISCUSSION QUESTIONS

Tactical decisions are short run in nature; they involve choosing among alternatives with an immediate or limited end in view. Strategic decisions involve selecting strategies that yield a long-term competitive advantage.

A manager can identify alternatives by using his or her own knowledge and experience and by obtaining input from others who are familiar with the problem.

Past costs can be used to help predict future costs.

Depreciation is an allocation of a sunk cost. This cost is a past cost and will never differ across alternatives.

The salary of the supervisor of an assembly line with excess capacity is an example of an irrelevant future cost for an accept-or-reject decision.

Yes. Suppose, for example, that sufficient materials are on hand for producing a part for 2 years. After 2 years, the part will be replaced by a newly engineered part. If there is no alternative use for the materials, then the cost of the materials is a sunk cost and not relevant in a make-or-buy decision.

If a firm is operating below capacity, then a price that is above variable costs will increase profits.

A segment is any subunit of sufficient importance to warrant production of performance reports.

Contribution margin is the amount available to cover fixed expenses and provide for profit. Segment margin is the amount available to cover common fixed expenses and provide for profit. Contribution margin is the difference between revenues and variable expenses. Segment margin is contribution margin less direct fixed expenses.

10. A complementary effect is the loss of revenue on a secondary product when the primary product is dropped. Thus, complementary effects may make it more expensive to drop a product. 11. No. Joint costs are irrelevant in a sell or process further decision. They occur regardless of whether the product is sold at the split-off point or processed further. 12. Yes. The incremental revenue is $1,400, and the incremental cost is only $1,000, creating a net benefit of $400. 13. No. If a scarce resource is used in producing the two products, then the product providing the greatest contribution per unit of scarce resource should be selected. For more than one scarce resource, linear programming may be used to select the optimal mix. 14. Answers will vary. One effective response would be as follows: Tactical decision making involves scenarios such as make-or-buy, special order, keep-or-drop, further processing of joint products, and product mix decisions. Each of these decisions require the decision maker to identify the relevant items (costs and revenues) of the available alternatives. All such relevant items involve future items, which must be forecasted using historical data, managerial judgment, competitor inputs, etc. Therefore, predictive data analytics can be beneficial in helping decision makers more accurately forecast the relevant items of the tactical decision at hand. 8-1

CHAPTER 8

Tactical Decision Making and Relevant Analysis

MULTIPLE-CHOICE QUESTIONS 8-1.

8-2.

8-3.

8-4.

8-5.

8-6.

8-7.

8-8.

8-9.

8-10.

8-11.

8-12.

8-13.

8-14.

8-15.

8-16.

8-2

CHAPTER 8

Tactical Decision Making and Relevant Analysis

BRIEF EXERCISES: SET A BE 8-17 1. There are two alternatives: make the ingredient in-house or purchase it externally. 2. Relevant costs of making the ingredient in-house include direct materials, direct labor, and variable overhead (both manufacturing and marketing). Relevant costs of purchasing the ingredient externally include the purchase price. 3.

Alternatives Make Buy Direct materials…………………………… Direct labor………………………………… Variable manufacturing overhead……… Variable marketing overhead…………… Purchase cost……………………………… Total relevant cost…………………………

$25,000 15,000 7,500 10,000 — $57,500

— — — — $60,000 $60,000

Differential Cost to Make $ 25,000 15,000 7,500 10,000 (60,000) $ (2,500)

It is cheaper to make the ingredient in-house. This alternative is cheaper by $2,500. Alternatives Make Buy

4. Direct materials…………………………… Direct labor………………………………… Variable manufacturing overhead……… Variable marketing overhead…………… Avoidable fixed plant overhead………… Purchase cost……………………………… Total relevant cost…………………………

$25,000 15,000 7,500 10,000 6,000 * — $63,500

— — — — — $60,000 $60,000

Differential Cost to Make $ 25,000 15,000 7,500 10,000 6,000 (60,000) $ 3,500

Now it is cheaper to purchase the ingredient. This alternative is cheaper by $3,500. * $30,000 × 0.20 = $6,000

8-3

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Tactical Decision Making and Relevant Analysis

BE 8-18 1. Relevant costs and benefits of accepting the special order include the sales price of $5, direct materials, direct labor, and variable overhead. No relevant costs or benefits are attached to rejecting the order. 2.

If the problem is analyzed on a unit basis:

Reject

Differential Benefit to Accept

$ 5.00 (1.75) (2.50) (1.50) $(0.75)

— — — — —

$ 5.00 (1.75) (2.50) (1.50) $(0.75)

Price……………………………………… Direct materials………………………… Direct labor…………………………… Variable overhead…………………… Decrease in operating income………

Operating income will decrease by $7,500 [($0.75) × 10,000 units] if the special order is accepted; therefore, the special order should be rejected.

8-4

CHAPTER 8

Tactical Decision Making and Relevant Analysis

BE 8-19 Gorman Nurseries Inc. Segmented Income Statement For the Coming Year Poinsettias

Fruit Trees

Total

Sales……………………………………… Less variable expenses: Variable cost of goods sold……… Variable selling expense…………… Contribution margin……………………

$970,000

$3,100,000

$4,070,000

460,000 38,800 $471,200

1,630,000 124,000 $1,346,000

2,090,000 162,800 $1,817,200

Less direct fixed expenses: Direct fixed overhead……………… Direct selling and administrative… Segment margin…………………………

160,000 146,000 $165,200

200,000 87,000 $1,059,000

360,000 233,000 $1,224,200

Less common fixed expenses: Common fixed overhead…………………………………………………… Common selling and administrative……………………………………… Operating income (loss)………………………………………………………

8-5

800,000 450,000 $ (25,800)

CHAPTER 8

Tactical Decision Making and Relevant Analysis

BE 8-20 1. The two alternatives are to keep the parquet flooring line or to drop it. 2.

The relevant benefits and costs of keeping the parquet flooring line include sales of $300,000, variable costs of $250,000, machine rent cost of $40,000*, and supervision cost of $20,000. None of the relevant benefits and costs of keeping the parquet flooring line would occur under the drop alternative. * The $40,000 of relevant machine rent cost is computed as 0.80 of the total $50,000 machine rent cost.

3. Keep Sales…………………………………… Less: Variable expenses…………… Contribution margin………………… Less: Machine rent*………………… Supervision…………………… Total relevant benefit (loss)…………

$300,000 250,000 $ 50,000 (40,000) (20,000) $ (10,000)

Drop

Differential Amount to Keep

— — — — — —

$300,000 250,000 $ 50,000 (40,000) (20,000) $ (10,000)

The differential amount to keep the line is ($10,000), thus, in favor of dropping the parquet flooring. * $50,000 × 0.80 = $40,000

8-6

CHAPTER 8

Tactical Decision Making and Relevant Analysis

BE 8-21 1. Previous contribution margin of the strip line was $175,000. A 10% decrease in sales implies a 10% decrease in total variable costs, so the contribution margin decreases by 10%. New Contribution Margin for Strip = $175,000 – 0.10($175,000) = $157,500. The reasoning is the same for the plank line, but the decrease is 5%. New Contribution Margin for Plank = $80,000 – 0.05($80,000) = $76,000. Therefore, if the parquet floor product line were dropped, the resulting total contribution margin for Hickory would equal $233,500 ($157,500 + $76,000). 2. Contribution margin…………… Less: Machine rent……………… Supervision……………… Total…………………………………

Keep

Drop

$305,000 (75,000) (45,000) $185,000

$233,500 (35,000) * (25,000) $173,500

Differential Amount to Keep $ 71,500 (40,000) (20,000) $ 11,500

* $50,000 × 0.20 = $10,000; $10,000 (remaining parquet) + $5,000 (strip) + $20,000 (plank) = $35,000

Notice that the contribution margin for the drop alternative equals the new contribution margins of the strip and plank lines ($157,500 + $76,000). Also, machine rent and supervision remain relevant across these alternatives. As shown in BE 8-20, the decision to drop the parquet flooring line makes Hickory better off by $10,000 (avoided relevant costs were greater than the lost contribution margin) when only the parquet line is considered. However, as shown in this exercise (BE 8-21), dropping parquet would have an $11,500 net detrimental effect on the other two lines in that Hickory would lose contribution margin of $71,500 but only avoid relevant costs of $60,000. Therefore, Hickory is better off by $11,500 if it KEEPS the parquet line.

BE 8-22 1. Revenue from Logs = (8,000 × $495) = $3,960,000 2.

Revenue from Further Processing = $0.75 × (8,000 × 800) = $4,800,000 Further Processing Cost = $0.15 × (8,000 × 800) = $960,000 Income from Further Processing = $4,800,000 – $960,000 = $3,840,000

Jack’s should sell the logs without further processing because the company will make $3,960,000 versus the $3,840,000 it would make by processing the logs further for use in regular construction framing.

8-7

CHAPTER 8

Tactical Decision Making and Relevant Analysis

BE 8-23 1.

Swoop

Contribution margin per unit……………………………… ÷ Required machine time per unit*………………………… Contribution margin per hour of machine time………… * 0.10 = 2.

6 minutes per Swoop unit 60 minutes

0.33

$ 5.00 0.10 $50.00

Rufus $15.00 0.33 $45.00

20 minutes per Rufus unit 60 minutes

Since the Swoop sweatshirt yields $50 of contribution margin per hour of machine time (which is higher than the $45 contribution margin per hour of machine time for Rufus), all machine time (i.e., 7,000 hours) should be devoted to the production of Swoop sweatshirts. Units of Swoop =

7,000 total hours 0.10 hour per Swoop sweatshirt

= 70,000 units

The optimal mix is Swoop = 70,000 units and Rufus = 0 units. 3.

Total Contribution Margin of Optimal Mix = 70,000 units Swoop × $5 = $350,000 Note: Brief Exercise 8-23 (as well as Example 8.7) clearly illustrates a fundamentally important point involving relevant decision making with a constrained resource. The point is that when making this relevant decision, one should choose the option with the highest contribution margin per unit of the constrained resource —even if that option does not have the highest contribution margin per unit. For instance, in this exercise, Rufus’s contribution margin is three times greater than Swoop’s contribution margin ($15 > $5). However, because each Rufus sweatshirt requires more than three times as much machine time to produce than each Swoop sweatshirt (0.33 machine hour per Rufus sweatshirt > 0.10 machine hour per Swoop sweatshirt), Swoop has a higher contribution margin per machine hour than does Rufus ($50 > $45).

8-8

CHAPTER 8

Tactical Decision Making and Relevant Analysis

BE 8-24 1.

Swoop

Rufus

Contribution margin per unit………………………………… $ 5.00 ÷ Required machine time per unit*…………………………… 0.10 Contribution margin per hour of machine time…………… $50.00 * 0.10 2.

6 minutes per Swoop unit

60 minutes

0.33

20 minutes per Rufus unit

60 minutes

Since Swoop yields $50 of contribution margin per hour of machine time, the first priority is to produce all of the Swoop sweatshirts that the market will take (i.e., demands). Machine time required for maximum amount of Swoop = 40,000 maximum units × 0.10 hour of machine time required per Swoop sweatshirt = 4,000 hours needed to manufacture 40,000 Swoop sweatshirts. Remaining Machine Time = 7,000 hours – 4,000 hours for Rufus Sweatshirts = 3,000 hours Units of Rufus to Be Produced = in Remaining 3,000 Hours

3,000 hours 0.33 hours per unit

= 9,091 units*

Now the optimal mix is 40,000 units of Swoop sweatshirts and 9,091 units of Rufus sweatshirts. This mix will precisely exhaust the machine time available. * Rounded 3.

Total Contribution Margin of Optimal Mix

= (40,000 units Swoop × $5) + (9,091 units Rufus × $15) = $336,365

BE 8-25 Price

= = = =

Cost + (Markup Percentage × Cost) $170,000 + 0.15($170,000) $170,000 + $25,500 $195,500

BE 8-26 1. Desired Profit

Target Cost

= 0.25 × Target Price = 0.25 × $380 = $95 = Target Price – Desired Profit = $380 – $95 = $285 8-9

$15.00 0.33 $45.00

CHAPTER 8

Tactical Decision Making and Relevant Analysis

BRIEF EXERCISES: SET B BE 8-27 1. There are two alternatives: make Two AM in-house or purchase it externally. 2. Relevant costs of making Two AM in-house include direct materials, direct labor, and variable overhead (both manufacturing and marketing). Relevant costs of purchasing Two AM externally include the purchase price. Alternatives Make Buy

3. Direct materials……………………………… Direct labor…………………………………… Variable manufacturing overhead………… Variable marketing overhead……………… Purchase cost………………………………… Total relevant cost……………………………

$2,000,000 350,000 150,000 250,000 — $2,750,000

Differential Cost to Make

— — — — $2,500,000 $2,500,000

$ 2,000,000 350,000 150,000 250,000 (2,500,000) $ 250,000

It is $250,000 cheaper to buy Two AM. Alternatives Make Buy

Direct materials……………………………… $2,000,000 350,000 Direct labor…………………………………… Variable manufacturing overhead………… 150,000 Variable marketing overhead……………… 250,000 Intellectual property theft — management cost…………………………… — Purchase cost………………………………… Total relevant cost…………………………… $2,750,000 Now it is $100,000 cheaper to make Two AM in-house.

8-10

Differential Cost to Make — — — —

$ 2,000,000 350,000 150,000 250,000

350,000 $2,500,000 $2,850,000

(350,000) (2,500,000) $ (100,000)

CHAPTER 8

Tactical Decision Making and Relevant Analysis

BE 8-28 1. Relevant costs and benefits of accepting the special order include the sales price of $18,000, direct materials, direct labor, and variable overhead. No relevant costs or benefits are attached to rejecting the order. 2.

If the problem is analyzed on a unit basis:

Accept Price………………………………… Direct materials…………………… Direct labor………………………… Variable overhead………………… Increase in operating income……

$ 18,000.00 (10,000.00) (2,000.00) (4,000.00) $ 2,000.00

Reject

Differential Benefit to Accept

— — — — —

$ 18,000.00 (10,000.00) (2,000.00) (4,000.00) $ 2,000.00

Operating income will increase by $10,000,000 [($2,000) × 5,000 units], if the special order is accepted; therefore, the special order should be accepted.

8-11

CHAPTER 8

Tactical Decision Making and Relevant Analysis

BE 8-29 Kraft Bowlen Segmented Income Statement For the Coming Year Bladers

Ballers

Total

Sales……………………………………… Less variable expenses: Variable cost of goods sold……… Variable selling expense…………… Contribution margin……………………

$80,000,000

$180,000,000

$260,000,000

10,000,000 4,000,000 $66,000,000

30,000,000 9,000,000 $141,000,000

40,000,000 13,000,000 $207,000,000

Less direct fixed expenses: Direct fixed overhead……………… Direct selling and administrative… Segment margin…………………………

20,000,000 4,000,000 $42,000,000

100,000,000 10,000,000 $ 31,000,000

120,000,000 14,000,000 $ 73,000,000

Less common fixed expenses: Common fixed overhead……………………………………………………… 18,000,000 Common selling and administrative………………………………………… 8,000,000 Operating income (loss)………………………………………………………… $ 47,000,000

8-12

CHAPTER 8

Tactical Decision Making and Relevant Analysis

BE 8-30 1. The two alternatives are to keep the Boat Maintenance line or to drop it. 2.

The relevant benefits and costs of keeping the Boat Maintenance line include sales of $6,000,000, variable costs of $5,600,000, garage/warehouse cost of $280,000*, and supervision cost of $220,000**. None of the relevant benefits and costs of keeping the Boat Maintenance line would occur under the drop alternative. * The $280,000 of relevant garage/warehouse cost is computed as 0.70 of the total $400,000 garage/warehouse cost.

** The $220,000 of relevant supervision salaries is computed as 0.40 of the total $550,000 supervision cost.

3. Keep Sales…………………………………… Less: Variable expenses…………… Contribution margin………………… Less: Garage/warehouse rent*…… Supervision**………………… Total relevant benefit (loss)…………

$6,000,000 5,600,000 $ 400,000 (280,000) (220,000) $ (100,000)

Drop

Differential Amount to Keep

— — — — — —

$6,000,000 5,600,000 $ 400,000 (280,000) (220,000) $ (100,000)

The differential amount to keep the line is a loss of $100,000. Thus, Mullett Marina should drop the line to increase operating income by $100,000. * $400,000 × 0.70 = $280,000 ** $550,000 × 0.40 = $220,000

8-13

CHAPTER 8

Tactical Decision Making and Relevant Analysis

BE 8-31 1. Previous contribution margin of the Winter Storage line was $2,000,000. A 10% decrease in sales implies a 10% decrease in total variable costs, so the contribution margin decreases by 10%. New Contribution Margin for Winter Storage = $2,000,000 – 0.10($2,000,000) = $1,800,000. The reasoning is the same for the Boat Fuel & Concessions line, but the decrease is 5%. New Contribution Margin for Boat Fuel & Concessions = $800,000 – 0.05($800,000) = $760,000. Therefore, if the Boat Maintenance line were dropped, the resulting total contribution margin for Mullett Marina would equal $2,560,000 ($1,800,000 + $760,000). 2. Keep Contribution margin………………… Less: Garage/warehouse rent……… Supervision…………………… Total relevant benefit (loss)…………

$ 3,200,000 (1,155,000) (670,000) $ 1,375,000

Drop

Differential Amount to Keep

$2,560,000 (875,000) * (450,000) ** $1,235,000

$ 640,000 (280,000) (220,000) $ 140,000

* $400,000 × 0.30 = $120,000 (remaining Boat Maintenance) + $700,000 (Winter Storage) + $55,000 (Fuel & Con) = $875,000 ** $550,000 × 0.60 = $330,000 (remaining Boat Maintenance + $50,000 (Winter Storage) + $70,000 (Fuel & Con) = $450,000

Notice that the contribution margin for the drop alternative equals the new contribution margins of the Winter Storage and Boat Fuel & Concessions lines ($1,800,000 + $760,000). Also, garage rent and supervision remain relevant across these alternatives. As shown in BE 8-30, the decision to drop the Boat Maintenance line makes Mullett better off by $100,000 (avoided relevant costs were greater than the lost contribution margin) when only the Boat Maintenance line is considered. However, as shown in this exercise (BE 8-31), dropping Boat Maintenance would have a $140,000 net detrimental effect on the other two lines in that Mullett would lose contribution margin of $640,000 but only avoid relevant costs of $500,000. Therefore, Mullett is better off by $140,000 if it KEEPS the Boat Maintenance line. BE 8-32 1. Revenue (or contribution to income) from selling consumable milk = (2,000,000 × $3.5) = $7,000,000 2.

Revenue from Further Processing = $7.00 × (2,000,000 × 0.75) = $10,500,000 Further Processing Cost = $3.00 × (2,000,000 × 0.75) = $4,500,000 Income from Further Processing = $10,500,000 – $4,500,000 = $6,000,000

Britney should NOT further process the consumable milk into butter because the company would make only $6,000,000 versus the $7,000,000 it would make by selling the milk at the split-off point (i.e., not processing further). 8-14

CHAPTER 8

BE 8-33 1.

Injury Rehabilitation

Contribution margin per unit (session)………………… ÷ Required therapist time per session*………………… Contribution margin per hour of therapist time……… * 0.25

Tactical Decision Making and Relevant Analysis

15 minutes per Injury Rehabilitation unit 60 minutes

; 0.75 =

$ 200.00 0.25 $ 800.00

60 minutes

6,000 total therapist hours 0.25 hour per Injury Rehabilitation session

= 24,000 units The optimal mix is Injury Rehabilitation = 24,000 sessions and Preventative Care = 0 sessions 3.

Total Contribution Margin of Optimal Mix

= 24,000 units Injury Rehabilitation × $200 = $4,800,000

8-15

$ 300.00 0.75 $ 400.00

45 minutes per Preventative Care unit

Since the Injury Rehabilitation session yields $800 of contribution margin per hour of therapist time (which is higher than the $400 contribution margin per hour of therapist time for Preventative Care), all therapist time (i.e., 6,000 hours, or 3 therapists x 2,000 hours per year) should be devoted to the provision of Injury Rehabilitation sessions.

Units of Injury Rehabilitation

Preventative Care

CHAPTER 8

Tactical Decision Making and Relevant Analysis

BE 8-34 Injury Rehabilitation

Contribution margin per unit (session)…………………………… ÷ Required therapist time per session*………………………… Contribution margin per hour of therapist time……………… * 0.25

15 minutes per Injury Rehabilitation unit 60 minutes

; 0.75 =

Preventative Care

$200.00 0.25 $800.00

$ 300.00 0.75 $400.00

45 minutes per Preventative Care unit 60 minutes

2. Since Injury Rehabilitation yields $800 of contribution margin per hour of therapist time, the first priority is to offer all of the Injury Rehabilitation sessions that the market will take (i.e., demands). Therapist time required for maximum amount of Injury Rehabilitation = 16,000 maximum units × 0.25 hours of therapist time required per Injury Rehabilitation = 4,000 hours needed to provide 16,000 Injury Rehabilitation sessions. Remaining Therapist Time for Preventative Care Sessions

6,000 hours – 4,000 hours

2,000 hours

Units of Preventative Care Sessions to Be Offered 2,000 hours = 2,667 units* = in Remaining 2,000 Hours 0.75 hours per unit Now the optimal mix is 16,000 units of Injury Rehabilitation sessions and 2,667 units of Preventative Care sessions. This mix will precisely exhaust the therapist time available. * Rounded. 3. Total Contribution Margin of Optimal Mix

= 16,000 units Injury Rehabilitation × $200) + (2,667 units* Preventative Care × $300) = $4,000,100

BE 8-35 Price

= Cost + (Markup Percentage × Cost) = $1,200,000 + 0.20($1,200,000) = $1,200,000 + $240,000 = $1,440,000

BE 8-36 1. Desired Profit

2. Target Cost

= 0.25 × Target Price = 0.25 × $50,000 = $12,500 = Target Price – Desired Profit = $50,000 – $12,500 = $37,500 8-16

CHAPTER 8

Tactical Decision Making and Relevant Analysis

EXERCISES E 8-37 The correct order is 4, 5, 2, 6, 3, and 1. E 8-38 Steps in Austin’s decision: Step 1:

Define the problem. The problem is whether to continue studying at his present university or to study at a university with a nationally recognized engineering program.

Step 2:

Identify the alternatives. Events a and b. (Students may want to include Event i—possible study for a graduate degree. However, future events indicate that Austin still defined his problem as in Step 1 above.)

Step 3:

Identify the costs and benefits associated with each feasible alternative. Events c, e, f, and i. (Students may also list Events e and f in Step 5—they are included here because they may help Austin estimate future income benefits.)

Step 4:

Total the relevant costs and benefits for each feasible alternative. No specific event is listed for this step, although we can assume that it was done, and that three schools were selected as feasible since Event j mentions that two of three applications met with success.

Step 5:

Assess qualitative factors. Events d, e, f, g, and h.

Step 6:

Make the decision. Event j is certainly relevant to this and Event k is the actual decision. [What did Austin ultimately decide? He decided to stay at SMWU and finish his engineering degree. He also applied for—and won— summer internships with large West Coast companies in the aerospace industry. Currently, he’s applying for jobs and (Plan B) looking into graduate programs.] a-step 2 b-step 2 c-step 3 d-step 5 e-step 3, 5 f-step 3, 5 g-step 5 h-step 3, 5 i-step 2, 3 j-step 6 k-step 6 8-17

CHAPTER 8

Tactical Decision Making and Relevant Analysis

E 8-39 1. The two alternatives are to make the component in-house or to buy it from Canyonlands Alternatives Make Buy

$25.00 6.25 15.75 — $47.00

Direct materials………………………… Direct labor……………………………… Variable overhead…………………… Purchase cost………………………… Total relevant cost…………………

Differential Cost to Make

— — — $50.00 $50.00

$ 25.00 6.25 15.75 (50.00) $ (3.00)

If Arches purchases the component, its relevant costs will be $300,000 higher (or $3.00 per unit × 100,000 units)—and therefore its operating income will be $300,000 lower—as compared to making the component in-house. 3.

Arches should continue to make the component part in-house because operating income will be $300,000 ($3.00 × 100,000) higher than if the component part were purchased from Canyonlands.

E 8-40 1.

Alternatives Make Buy

Direct materials………………………… Direct labor……………………………… Variable overhead…………………… Avoidable fixed overhead*…………… Purchase cost………………………… Total relevant cost…………………

$25.00 6.25 15.75 4.00 — $51.00

Differential Cost to Make

— — — $50.00 $50.00

$ 25.00 6.25 15.75 4.00 (50.00) $ 1.00

* Avoidable fixed overhead is the 80% of fixed overhead that would be eliminated if the component were no longer made in-house. Avoidable fixed overhead is relevant because if Arches makes the component, it will incur the cost, but if the component is purchased, then that fixed overhead will not be incurred ($5.00 × 0.80 = $4.00).

Therefore, Arches should purchase the component from Canyonlands because its relevant costs will be $100,000 lower (or $1.00 per unit x 100,000 units)—and therefore its operating income will be $100,000 higher—as compared to making the component in-house.

8-18

CHAPTER 8

Tactical Decision Making and Relevant Analysis

E 8-40 (Continued) 2. As the percentage of avoidable fixed cost increases (above 80%), total relevant costs of making the component increase, causing the “purchase” decision to be more financially appealing (compared to the “make” option) than it was when the percentage was 80%. In other words, as the percentage increases, the $100,000 difference between the “purchase” and “make” options increases resulting in the “purchase” decision being even more attractive. Alternatively, as the percentage of avoidable fixed costs decreases, the “make” option eventually is equally costly (a difference of zero) and as equally appealing financially as the “purchase” option. Finally, as the percentage of avoidable fixed cost decreases low enough and the total relevant costs of making the component decrease, the “make” option becomes the more financially appealing option (i.e., when the relevant fixed costs per unit become sufficiently small—which is explored in Requirement 3). 3.

Total relevant avoidable fixed cost would need to decrease by $100,000. Total relevant make costs of 5,100,000 (or $51 per unit x 100,000 units) need to decrease to 500,000 (or $50 per unit x 100,000 units) to equal the total relevant buy costs. Holding all other relevant make costs constant, this decrease of $100,000 ($5,100,000 – $5,000,000) in fixed cost would reduce the total relevant avoidable fixed overhead from $400,000 (0.80 x $5 per unit x 100,000 units) or $4.00 per unit ($400,000/100,000 units) to $300,000 ($400,000 – $100,000) or $3.00 per unit ($300,000/100,000 units). Therefore, the per-unit relevant fixed cost would need decrease by $1.00 (from $4.00 down to $3.00) for Arches to be indifferent between "making" versus "buying" the component. At this $3.00 per-unit relevant fixed cost, Arches would incur the same total cost to make as to purchase the component parts. At this indifferent level, management judgment would be necessary to make decisions, such as: -Could we put the space to other, profitable use? -How long will Canyonlands hold the price? -What is the quality of the parts? -What is the reliability of the company?

8-19

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Tactical Decision Making and Relevant Analysis

E 8-41 1. The two alternatives are: (1) to accept the special order (2) to reject the special order 2.

Direct materials unit cost……… Direct labor unit cost…………… Variable overhead unit cost…… Total unit cost…………………

$3.10 1.50 1.00 $5.60

Relevant manufacturing costs are $5.60 per unit so the contribution margin per unit from the special order is $1.40 ($7.00 – $5.60). The increase in total contribution margin and, therefore, operating income is $21,000 (15,000 × $1.40). Therefore, the special order should be accepted. 3.

The statement that “existing sales will not be affected” indicates that there will be no product-line cannibalization; in other words, there is sufficient excess capacity such that the acceptance of the special sales will not decrease Cool Can regular sales. Another consideration, possibly due to the geographic separation, is that existing customers are less likely to learn of the new price, which was $5 (or 42%) lower.

E 8-42 In this case, it may be easier to deal with the total costs and revenues of the special order: Revenue ($7.00 × 15,000)…………………………………………… Less variable costs: Direct materials ($3.30* × 15,000).……………………………… Direct labor ($1.50 × 15,000)…………………………………… Variable overhead ($1.00 × 15,000)…………………………… Less labeling machine…………………………………….………… Operating income on special order……………………………

$105,000 $49,500 22,500 15,000

87,000 12,000 $ 6,000

Cool Can should accept the special order because it will increase operating income by $6,000. *$3.30 equals the original $3.10 of direct materials plus the $0.20 of additional logo direct materials.

8-20

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Tactical Decision Making and Relevant Analysis

E 8-43 This exercise introduces product-line cannibalization into the Cool Can Company scenario examined in E 8-41 and E 8-42. In addition, this exercise helps students develop their data analytic skills by instructing them to create a spreadsheet to set up and interpret this special-order decision analysis. Specifically, students are instructed to use a spreadsheet software tool, such as Excel, to help them set up and solve the exercise’s requirements. For Requirement 1, the spreadsheet needs to be created to include all relevant information, or decision inputs, from the original set up in E 8-41. These inputs include the special order units of 15,000, special order per-unit price of $7.00, Cool Can’s normal production capacity of 82,000 units, planned production and selling of 65,000 normal units, direct materials per-unit cost of $3.10, direct labor per-unit cost of $1.50, and variable overhead per-unit cost of $1.00. While the spreadsheet can include the fixed overhead per-unit cost of $1.80, this amount is not relevant and, thus, its inclusion in the spreadsheet is not necessary. However, should students choose to conduct an analysis of the change in total costs (rather than a relevant analysis that includes only inputs that change with the accept or reject decision as shown in this solution), the spreadsheet would need to include fixed overhead cost. Finally, to incorporate the additional information contained in E 8-43, the spreadsheet needs to be adjusted to accommodate the higher planned normal (or regular) sales of 70,000 units (increased from the 65,000 units stated in the original set up in E 8-41). Shown below is one approach for conducting a relevant analysis of Cool Can’s special-order decision: Cool Can Company Relevant Analysis: Increased Planned Production & Sales to 70,000 Units: Revenue ($7.00 × 15,000)…………………………………………… Less variable costs: Direct materials ($3.30 × 15,000).……………………………… Direct labor ($1.50 × 15,000)…………………………………… Variable overhead ($1.00 × 15,000)…………………………… Less labeling machine…………………………………….………… Less lost contribution margin from 3,000 fewer regular sales* Operating loss on special order…………………………………

$105,000 $49,500 22,500 15,000

87,000 12,000 19,200 $ (13,200)

* 82,000 capacity − 70,000 planned normal sales = 12,000 excess capacity units; 15,000 special sales units − 12,000 excess capacity units = 3,000 lost regular sales units x $12 − ($3.10 + $1.50 + $1.00) = $19,200 lost contribution margin from normal sales

The increase in planned regular sales (from 65,000 to 70,000 units) means that if Cool Can accepts the 15,000 units special order, then it will have to turn down (or lose out on) 3,000 regular sales units that each have a contribution margin of $6.40 (for a total lost contribution margin of $19,200). Thus, Cool Can’s total operating income decreases by $13,200 if the special order is accepted.

8-21

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Tactical Decision Making and Relevant Analysis

E 8-43 (Cool Can Company): (Continued) 2. 3.

Cool Can should reject the special order because accepting the special order would decrease its total profit by $13,200. Cool Can Company Relevant Analysis: Increases in Costs and Special-Order Price:

Revenue ($10.00 × 15,000)…………………………………………… Less variable costs: $59,400 Direct materials ($3.30 × 1.20 × 15,000).……………………… Direct labor ($1.50 × 1.20 × 15,000)…………………………… 27,000 Variable overhead (or indirect) ($1.00 × 1.40 × 15,000)…… 21,000 Less labeling machine…………………………………….………… Less opportunity cost of contribution margin from lost 3,000 regular sales* Operating profit on special order………………………………

$150,000

107,400 12,000 15,240 $ 15,360

* 82,000 capacity − 70,000 planned normal sales = 12,000 excess capacity units; 15,000 special sales units − 12,000 excess capacity units = 3,000 lost regular sales units × $12 − [($3.10 × 1.20) + ($1.50 × 1.20) + ($1.00 × 1.40)] = $15,240 lost contribution margin from normal sales

The increase in planned regular sales (from 65,000 to 70,000 units) means that if Cool Can accepts the 15,000 unit special order, then it will have to turn down (or lose out on) 3,000 regular sales units that each have a contribution margin of $5.08 (for a total lost contribution margin of $15,240). Thus, Cool Can’s total profit increases by $15,360 if the special order is accepted. 4.

Cool Can should accept the special order because accepting the special order would increase its total profit by $15,360. Given that Cool Can would be cannibalizing existing sales, it might need to explain to existing customers why it can no longer service their orders.

Having a spreadsheet with formulas embedded to capture the various relevant costs and revenues allows the decision maker to enter changes to any or all of these relevant decision inputs and relatively quickly and easily observe the resulting change in profit. Accordingly, the best decision recommendation (i.e., to accept or Reject the special order in this scenario) can be altered as well. For example, a number of relevant cost and revenue inputs were changed in Requirement 3, such as increasing direct variable costs (i.e., direct materials and direct labor, as well as the special order additional logo direct materials) by 20%, indirect variable costs (i.e., variable overhead or indirect) by 40%, and the special order selling price by $3.00 (i.e., from $7.00 to $10.00). Using a spreadsheet, the impact of changing these relevant inputs can be accurately and quickly observed by examining the resulting change in Cool Can’s profits. The best decision—to accept or reject the special order—can then be made accordingly. As demonstrated in this series of exercises (E 8-41 through E 8-43), the optimal special order decision recommendation changes as the inputs change. Specifically, the best decision initially was to accept the special order as total profit would increase by $6,000. 8-22

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Tactical Decision Making and Relevant Analysis

E 8-43 (Continued) (E 8-42). However, the introduction of product-line cannibalization (in E 8-43, Requirement 1) changed the optimal decision recommendation to reject the special order as total operating income would decrease by $13,200. Finally, the introduction of relevant cost and revenue input changes again changed the optimal decision recommendation back to accept as total operating income would increase by $15,360. This process of computing and comparing “what-if” sensitivity analyses would be much more time-consuming, and possibly less accurate due to miscalculations, if it were performed manually (i.e., without the use of a spreadsheet), rather than by using formulas in Excel or other spreadsheet programs. E 8-44 1.

Chiltina Inc. Segmented Income Statement For the Coming Year Full Zip Half Zip

Sales……………………….………………… $410,000 $1,400,000 Less variable expenses: Variable cost of goods sold…………… 210,000 544,500 Variable selling expense……………… 41,000 140,000 $ 715,500 Contribution margin………………………. $159,000 Less direct fixed expenses: Direct fixed overhead…………………… 70,000 220,000 Direct selling and administrative…… 60,000 260,000 $ 235,500 Segment margin……………………….…… $ 29,000 Less common fixed expenses: Common fixed overhead……………………….………………………………… Common selling and administrative……………………….………………… Operating income……………………….…………………………………………… 2.

For the company as a whole, an increase of $40,000 in fixed expense will result in a decrease in operating income to $70,000 ($110,000 – $40,000). If the equipment is for the Full Zip line, then that line’s segment margin will be $(11,000), and management will need to consider whether the line should be dropped. If profitability is not expected to improve (either by increasing price or decreasing other costs), then the Full Zip line should be dropped. If the equipment is for the Half Zip line, while segment margin will decrease to $195,500 ($235,500 – $40,000), it remains profitable and there will be no need to drop it.

8-23

Total $ 1,810,000

754,500 181,000 874,500

290,000 320,000 264,500

80,500 74,000 110,000

CHAPTER 8

Tactical Decision Making and Relevant Analysis

E 8-45 1.

In this Walloon drop scenario, Walloon’s sales revenues and variable expenses are relevant, while its equipment depreciation and advertising are irrelevant (i.e., they will remain even if Walloon is dropped). Therefore, if Charlevoix drops Walloon, Charlevoix’s total segment margin would decrease by $20,000,000 (i.e., from $25,000,000 to $5,000,000). This decrease is represented by the amount of lost Walloon contribution margin. The segmented income statement below shows the results of dropping Walloon in this scenario: Segmented Income Statement—Charlevoix Company

Sales revenues…………………… Less: variable expenses Contribution margin……………… Less direct fixed expenses……… Equipment depreciation…… Advertising…………………… Segment margin…………………… Less common fixed expenses… Operating income

Torch $350,000,000 300,000,000 $ 50,000,000

Elk $50,000,000 10,000,000 $40,000,000

Total $400,000,000 310,000,000 $ 90,000,000

$ 12,000,000 $ 21,000,000 $ 17,000,000

$ 7,000,000 $10,000,000 $23,000,000

$ 19,000,000 $ 31,000,000 $ 40,000,000 $ 35,000,000* $ 5,000,000

* $5,000,000 equipment depreciation + $30,000,000 supervisory salary that remain even after Walloon is dropped.

Note: Typically, with no additional information to the contrary, direct fixed expenses are assumed to be relevant (i.e., go away if the associated segment is dropped). However, for various reasons, in reality, some or all of a direct fixed cost might remain even if the associated segment is dropped. Therefore, students should be prepared to assess any such additional information indicating that part or all of a direct fixed expense might remain if the segment is dropped, thereby making that direct fixed expense irrelevant to the segment drop decision. This exercise provides students with practice in making this assessment. For example, the $5,000,000 equipment depreciation expense and $30,000,000 advertising would remain even if Walloon were dropped. These expenses either would be absorbed by one of the remaining lines (Torch or Elk) if they were to be used exclusively by either line or —as shown in the solution’s segmented income statement—accounted for as common fixed costs if they are determined to be caused jointly by multiple lines. 2.

Charlevoix should keep Walloon because profits are $20,000,000 higher with Walloon ($25,000,000) than without Walloon ($5,000,000).

E 8-46 1.

In this Walloon drop scenario, Walloon’s sales revenues, variable expenses, and advertising are relevant, while its equipment depreciation is irrelevant (i.e., it will remain even if Walloon is dropped). Therefore, if Charlevoix drops Walloon, Charlevoix’s operating income would increase by $10,000,000 (i.e., from

8-24

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Tactical Decision Making and Relevant Analysis

E 8-46 (Continued) $25,000,000 to $35,000,000). This increase is represented by: (1) the $20,000,000 lost Walloon contribution margin, and (2) the avoided $30,000,000 Walloon advertising expense (which now is relevant since it will go away if Walloon is dropped). The segmented income statement below shows the results of dropping Walloon in this scenario: Segmented Income Statement—Charlevoix Company Torch Sales revenues…………………… Less: variable expenses………… Contribution margin………………

$350,000,000 300,000,000 $ 50,000,000

Elk

Total

$50,000,000 10,000,000 $40,000,000

$400,000,000 310,000,000 $ 90,000,000

Less direct fixed expenses: Equipment depreciation…… 12,000,000 7,000,000 Advertising…………………… 21,000,000 10,000,000 Segment margin………………… $ 17,000,000 $23,000,000 Less common fixed expenses Operating income……………………….………………………………………

19,000,000 31,000,000 $ 40,000,000 $ 5000000* $ 35,000,000

* $5,000,000 equipment depreciation that remains even after Walloon is dropped.

Note: Typically, with no additional information to the contrary, direct fixed expenses are assumed to be relevant (i.e., go away if the associated segment is dropped). However, for various reasons some or all of a direct fixed cost might remain even if the associated segment is dropped. This exercise provides students with practice in making this assessment. For example, the $5,000,000 equipment depreciation expense would remain even if Walloon were dropped. This expense would either be absorbed by one of the remaining lines (Torch or Elk) if it were to be used exclusively by either line or —as shown in the solution’s segmented income statement—accounted for as common fixed costs if it is determined to be caused jointly by multiple lines. 2.

Charlevoix should drop Walloon because profits are $10,000,000 higher without Walloon ($35,000,000) than with Walloon ($25,000,000).

The empirical study of past advertising cost represents an example of a diagnostic data analytic because it utilizes historical data to identify the drivers of Charlevoix’s advertising expense.

E 8-47 1.

In this Walloon drop scenario, Walloon’s sales revenues, variable expenses, and advertising expense are relevant, while its equipment depreciation is irrelevant (i.e., it will remain even if Walloon is dropped). In addition, the complementary effect of losing 30% of the Torch business means that this 30% of lost Torch contribution margin is relevant as well. Therefore, if Charlevoix drops Walloon, Charlevoix’s operating income would decrease by $5,000,000 (i.e., from $25,000,000 to $20,000,000).

8-25

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Tactical Decision Making and Relevant Analysis

E 8-47 (Continued) This decrease is represented by: (1) the $20,000,000 lost Walloon contribution margin, (2) the $15,000,000 lost Torch contribution margin (30% × $50,000,000), and (3) the avoided $30,000,000 Walloon advertising expense. The segmented income statement below shows the results of dropping Walloon in this scenario:

Segmented Income Statement—Charlevoix Company Torch

Elk

$245,000,000 210,000,000 $ 35,000,000*

$ 50,000,000 10,000,000 $ 40,000,000

$295,000,000 220,000,000 $ 75,000,000

Less direct fixed expenses: Equipment depreciation………… 12,000,000 7,000,000 Advertising……………………….… 21,000,000 10,000,000 $ 2,000,000 $ 23,000,000 Segment margin……………………… Less common fixed expenses Operating income……………………….………………………………………

19,000,000 31,000,000 $ 25,000,000 $ 5,000,000** $ 20,000,000

Sales revenues……………………… Less: variable expenses Contribution margin…………………

Total

* Only 70% of Torch’s contribution margin remains (i.e., 70% × $50,000,000) after 30% of Torch’s contribution margin is lost if Walloon is dropped. ** $5,000,000 equipment depreciation that remains even after Walloon is dropped.

Charlevoix should keep Walloon because profits are $5,000,000 higher with Walloon ($25,000,000) than without Walloon ($20,000,000).

This use of historical customer behavior data represents an example of a predictive data analytic because Charlevoix is attempting to forecast the percentage of business the company likely would lose from its other customers if it were to stop doing business with Walloon.

E 8-48 1. Contribution Margin if HS Is Sold at = $9 × 14,000 pounds = $126,000 2.

Contribution margin if HS is processed into CS Revenue ($45 × 4,000)……………… Less further processing cost……… Contribution margin…………………

$180,000 34,000 $146,000

Bozo should further process HS; profit from processing further will be $20,000 higher ($146,000 – $126,000) than if it were sold at split-off.

8-26

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Tactical Decision Making and Relevant Analysis

E 8-49 1.

Reno

Unit contribution margin………………………………………… ÷ Painting department hours…………………………………… Contribution margin per unit scarce resource……………

Tahoe

$120 5 $ 24

Assuming no other constraints, the optimal mix is zero units of Reno and 820 units of Tahoe. Total painting department time is 2,460 hours per year; if all of them are devoted to Tahoe production, then 820 units (2,460/3) of Tahoe can be produced.

Contribution Margin = ($120 × 0) + ($75 × 820) = $61,500

E 8-50 1. If 500 units of each product can be sold, then the company will first make and sell 500 units of Tahoe (the product with the higher contribution margin per hour of painting department time). This will take 1,500 hours (500 units × 3 hours) of painting department time, leaving 960 hours (2,460 hours – 1,500 hours) for Reno production. This time will yield 192 units (960 hours/5 hours per unit) of Reno. Optimal mix: 192 units Reno, 500 units Tahoe 2.

Total Contribution Margin = ($120 × 192) + ($75 × 500) = $60,540

8-27

$75 3 $25

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Tactical Decision Making and Relevant Analysis

E 8-51 1. Price of National Parks Memory Card Game = $20.00 + (0.65 × $20) = $33.00 2.

Price of Guess This Animal Track Game = $40.00 + (0.65 × $40) = $66.00

The financial manager might encounter one or more common challenges to using cost-plus (or markup) pricing. One challenge might be identifying the most appropriate percentage by which to mark up gift shop costs. For example, if the percentage is too high (and 65% seems high), the manager risks setting prices too high, thereby causing some customers to decide not to buy the gift shop’s products. One factor working in the manager’s favor in this environment is that businesses in remote locations, such as many national park gift shops, face little or no competition. This can spur customers to spend more money than they would when more competition exists. Alternatively, if the markup percentage is too low, the manager risks setting prices too low. When prices are too low, profits are less than they would be with higher prices. In extreme cases, profits can be negative if total revenues are less than total costs. Another challenge might be accurately estimating the costs on which the markup percentage is applied. Even if the markup percentage is appropriate, marking up a grossly inaccurate estimate of costs can result in consequences similar to those described in the previous paragraph. For example, if reported costs are far too low, the price and total revenues that result will be lower than they could be (or need to be) to be profitable. If reported costs are far too high, the price will be too high, and total revenues will be lower than if a more appropriate price, that customers are willing to pay, is set.

E 8-52 1. Desired Profit = 0.20 × Target Price = 0.20 × $60 = $12.00 2.

Target Cost

= Target Price – Desired Profit = $60.00 – $12.00 = $48.00

8-28

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Tactical Decision Making and Relevant Analysis

E 8-53 1. The amounts Heather has spent on purchasing and improving the Jeep Grand Cherokee are irrelevant because these are sunk costs. 2.

Alternatives Restore Grand Cherokee

Cost Item

Transmission…………………………………… Water pump…………………………………… Master cylinder………………………………… Sell Jeep Grand Cherokee…………………… Cost of new car………………………………… Total…………………………………………

Buy Traverse

$2,000 400 1,100 0 0 $3,500

0 0 0 (6,400) 9,400 $ 3,000

Heather should sell the Jeep Grand Cherokee and buy the Traverse because it provides a net savings of $3,500 – $3,000. Note: Heather should consider the qualitative factors. If she restores the Jeep Grand Cherokee how much longer will it last? What about increased license fees and insurance on the newer car? Could she remove the stereo and put it in the Traverse without greatly decreasing the Jeep Grand Cherokee's resale value?

E 8-54 1. If the analysis is performed using total costs, each variable cost as well as the purchase price will be the unit cost multiplied by 35,000 units. The direct fixed overhead of $77,000 is avoidable if the part is purchased. Make a

Direct materials ……………………………… Direct laborb…………………………………… Variable overheadc…………………………… Fixed overhead………………………………… Purchase costd………………………………… Total relevant costs………………………

$210,000 70,000 52,500 77,000 0 $409,500

Buy $

0 0 0 0 385,000 $385,000

Blasingham should purchase the part. 2.

Maximum Price = $409,500/35,000 = $11.70 per unit

Operating income would increase by $24,500 ($409,500 – $385,000). a b c d

$6.00 × 35,000 = $210,000 $2.00 × 35,000 = $70,000 $1.50 × 35,000 = $52,500 $11.00 × 35,000 = $385,000

8-29

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Tactical Decision Making and Relevant Analysis

E 8-55 1.

Direct materialsa……………………………… b Direct labor …………………………………… c Variable overhead …………………………… d Purchase cost ……………………………… Total relevant costs………………………

Make

Buy

$210,000 70,000 52,500 0 $332,500

Blasingham should continue manufacturing the part. 2.

Maximum Price = $332,500/35,000 = $9.50 per unit

Income would decrease by $52,500 ($332,500 – $385,000). a b c d

$6.00 × 35,000 = $210,000 $2.00 × 35,000 = $70,000 $1.50 × 35,000 = $52,500 $11.00 × 35,000 = $385,000

8-30

0 0 0 385,000 $385,000

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Tactical Decision Making and Relevant Analysis

PROBLEMS P 8-56 1. If the special order is accepted: Revenues ($7 × 100,000)……………………………………….………………… Direct materials ($2 × 100,000)………………………………….………………… Direct labor ($1 × 100,000)……………………………………….……………… Variable overhead ($3 × 100,000)……………………………….……………… Total net benefit…………………………………………………………………

$ 700,000 (200,000) (100,000) (300,000) $ 100,000

Fixed overhead and both selling costs are irrelevant. If the special order is rejected, there will be no impact on income. Therefore, the quantitative analysis is $100,000 in favor of accepting the special order. 2.

The qualitative factors are those that cannot be easily quantified. The company is faced with a problem of idle capacity. Accepting the special order would bring production up to near capacity and allow the company to avoid laying off employees. This would also enhance the company’s community image. The special-order price is well below the company’s normal price. Will this have a potential impact on regular customers? Considering the fact that the customer is located in a region not usually served by the company, the likelihood of an adverse impact on regular business is not high. However, if it were likely and the amount could be quantified, then it would represent a relevant item for consideration in the analysis.

8-31

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Tactical Decision Making and Relevant Analysis

P 8-57 Alard Company Segmented Income Statement

Blenders

Coffee Makers

$1,560,000 $2,175,000 Sales…………………...………………………... Less: Variable cost of goods sold…………… 1,170,000 2,025,000 Contribution margin…………………...……… $ 390,000 $ 150,000 Less: Direct fixed expenses………………… 184,000 142,500 Segment margin…………………...…………… $ 206,000 $ 7,500 Less: Common fixed expenses*…………………...………………………...… Operating income…………………...………………………...……………………

Total $3,735,000 3,195,000 $ 540,000 326,500 $ 213,500 13,500 $ 200,000

* $340,000 – $184,000 – $142,500

2. If the coffee maker line is dropped, profits will decrease by $7,500, the segment margin. If the blender line is dropped, profits will decrease by $206,000. 3. Blenders

Coffee Makers

$1,775,000 $2,175,000 Sales…………………...………………………... Less: Variable cost of goods sold…………… 1,350,000 2,025,000 Contribution margin…………………...……… $ 425,000 $ 150,000 Less: Direct fixed expenses………………… 184,000 142,500 Segment margin…………………...…………… $ 241,000 $ 7,500 Less: Common fixed expenses*…………………...………………………...… Operating income…………………...………………………...……………………

Total $3,950,000 3,375,000 $ 575,000 326,500 $ 248,500 13,500 $ 235,000

Profits increase by $35,000. * $340,000 – $184,000 – $142,500 ** Alternatively, requirement 3 could be analyzed by calculating the incremental revenues from selling 10,000 additional blenders and subtracting the incremental costs of making and selling 10,000 additional blenders: $21.50 x 10,000 - $18.00 x 10,000 = $35,000 of additional operating income.

4. Preparing segmented income statements helps decision makers identify which data are relevant and which data are irrelevant for making particular product line drop decisions. In this case, the problem does not specifically state the amount of Alard’s common fixed expenses, which is important to identify as common fixed expenses are irrelevant and, therefore, should be ignored in deciding whether to drop the coffee maker product line. However, in preparing the segmented income statement, Alard’s common fixed expenses of $13,500 ($340,000 − $184,000 − $142,500) are highlighted as a separate line item. As a result, it is easier to focus on the relevant inputs, such as the segment margins, to determine whether to keep or drop the coffee maker or blender product lines. Without such a clear visualization of the irrelevant common fixed costs, decision makers might be confused into making poor decisions. For example, if the $13,500 of 8-32

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Tactical Decision Making and Relevant Analysis

P 8-57 (Continued) irrelevant common fixed expenses were incorrectly folded into the coffee maker line’ direct expenses, the result would be a negative segment margin for the coffee maker line (i.e., a [$6,000] loss of $7,500 − $13,500) and the incorrect decision to drop an otherwise profitable coffee maker line could result. P 8-58 Scented

Musical

Regular

1. Sales…………………...……………… $13,000 $19,500 $25,000 Less: Variable expenses…………… 9,100 15,600 12,500 Contribution margin………………… $ 3,900 $ 3,900 $12,500 Less: Direct fixed expenses……… 4,250 5,750 3,000 Product margin…………………...… $ (350) $ (1,850) $ 9,500 Less: Common fixed expenses…………………...………………………...… Operating income (loss)…………………...………………………...…………

Total $57,500 37,200 $20,300 13,000 $ 7,300 7,500 $ (200)

Kathy should accept this proposal. The 30% sales increase, coupled with the increased advertising, reduces the loss from $1,000 to $200. Both scented and musical product-line profits increase. However, more must be done. If the scented and musical product margins remain negative, the two products may need to be dropped. 2. Regular: Sales………………………………………………… $20,000 Less: Variable expenses………………………… 10,000 Contribution margin……………………………… $10,000 Less: Fixed expenses*…………………………… 10,500 Operating income (loss)…………………………… $ (500) *$3,000 direct + $7,500 common

While dropping the two lines results in a $500 loss versus the original $1,000 loss, it is worse than the alternative offered in Requirement 1. Other options need to be developed. 3. Combinations would be beneficial. Dropping the musical line (which shows the greatest segment loss) and keeping the scented line while increasing advertising yields a profit (the optimal combination). Scented

Regular

Sales…………………...………………………...…… $13,000 $22,500 9,100 11,250 Less: Variable expenses…………………...……… $11,250 Contribution margin…………………...…………… $ 3,900 4,250 3,000 Less: Direct fixed expenses…………………...… $ 8,250 Product margin…………………...………………… $ (350) Less: Common fixed expenses…………………...………………………...… Operating income…………………...………………………...………………… 8-33

Total $35,500 20,350 $15,150 7,250 $ 7,900 7,500 $ 400

CHAPTER 8

Tactical Decision Making and Relevant Analysis

P 8-59 1. Cost Item

Make a

Raw materials ………………………………………………

$218,000

Direct labor ……………………………………………………

20,800

58,000

0 $367,000

340,000 $340,000

Fixed overhead ………………………………………………

Net savings by purchasing: $367,000 – $340,000 = $27,000. Hetrick should purchase the crowns rather than make them. Depreciation of $5,000 is irrelevant (and therefore excluded from the analysis here) because it will NOT change regardless of whether Hetrick makes or buys the crowns. a b c d e

($70 × 2,000 Porcelain) + ($130 × 600 Gold) = $218,000 $27 × (2,000 + 600) = $70,200 $8 × (2,000 + 600) = $20,800 $26,000 + $32,000 = $58,000 ($125 × 2,000) + ($150 × 600) = $340,000

8-34

0 0

Variable overhead …………………………………………… Purchase cost ………………………………………………

70,200

Buy

CHAPTER 8

Tactical Decision Making and Relevant Analysis

P 8-59 (Continued) 2. Qualitative factors that Hetrick should consider include quality of crowns, reliability and promptness of producer, and reduction of workforce. 3.

It reduces the cost of making the crowns to $335,000 ($367,000 – $32,000), which is less than the cost of buying because fixed overhead decreases to $26,000 for a total relevant make cost of $5,000 less than the buy cost. Therefore, Hetrick should make the crowns.

Cost Item a

Raw materials ………………………………………………… b Direct labor …………………………………………………… c Variable overhead …………………………………………… Fixed overhead………………………………………………… d Purchase cost …………………………………………………

Make

Buy

$372,000 129,600 38,400 58,000 0 $598,000

0 0 0 0 615,000 $615,000

Hetrick should produce its own crowns if demand increases to this level because the fixed overhead is spread over more units. a

($70 × 4,200 Porcelain) + ($130 × 600 Gold) = $372,000

$27 × (4,200 + 600) = $129,600

$8 × (4,200 + 600) = $38,400

($125 × 4,200) + ($150 × 600) = $615,000

P 8-60 Per 600 lbs. a

Revenues …………………………………… Bagsb…………………………………………… Shippingc……………………………………… Grindingd……………………………………… Bottlese………………………………………… a

Process Further

Sell

$24,000 0 (384) (1,500) (2,400) $19,716

$7,200 (39) (60) 0 0 $7,101

600 × 10 × $4 = $24,000; $12 × 600 = $7,200

$1.30 × (600/20)

[(10 × 600)/25] × $1.60 = $384; $0.10 × 600 = $60

$2.50 × 600 = $1,500

10 × 600 × $0.40 = $2,400

Zanda should process depryl further. 2.

$12,615/600 = $21.025 additional income per pound $21.025 × 265,000 = $5,571,625

8-35

Difference $16,800 39 (324) (1,500) (2,400) $12,615

CHAPTER 8

Tactical Decision Making and Relevant Analysis

P 8-61 1. Sales……………………………………… Variable expenses……………………… Contribution margin…………………… Direct fixed cost……………………… Segment margin…………………… Common fixed cost…………………… Operating income…………………

System A

System B

Headset

Total

$45,000 20,000 $25,000 526 * $24,474

$32,500 25,500 $ 7,000 11,158 ** $ (4,158)

$8,000 3,200 $4,800 1,016 *** $3,784

System A

Headset

Total

$58,500 26,000 $32,500 526 $31,974

$6,000 2,400 $3,600 1,016 $2,584

$64,500 28,400 $36,100 1,542 $34,558 18,000 $16,558

System A

System C

Headset

Total

$45,000 20,000 $25,000 526 $24,474

$26,000 13,000 $13,000 11,158 $ 1,842

$7,200 2,880 $4,320 1,016 $3,304

$78,200 35,880 $42,320 12,700 $29,620 18,000 $11,620

$85,500 48,700 $36,800 12,700 $24,100 18,000 $ 6,100

* $45,000/$85,500 × $18,000 = $9,474; $10,000 – $9,474 = $526

** $32,500/$85,500 × $18,000 = $6,842; $18,000 – $6,842 = $11,158

*** $8,000/$85,500 × $18,000 = $1,684; $2,700 – $1,684 = $1,016

2. Sales……………………………………… Variable expenses……………………… Contribution margin…………………… Direct fixed cost……………………… Segment margin…………………… Common fixed cost…………………… Operating income………………… System B should be dropped. 3. Sales……………………………………… Variable expenses……………………… Contribution margin…………………… Direct fixed cost*……………………… Segment margin…………………… Common fixed cost…………………… Operating income…………………

Replacing B with C is better than keeping B, but not as good as dropping B without replacement with C.

8-36

CHAPTER 8

Tactical Decision Making and Relevant Analysis

P 8-62 1. Steve should consider selling the part for $1.85 because his division’s profits would increase by $12,800: Accept Revenues (2 × $1.85 × 8,000)………………………………… Variable expenses (2 × $1.05 × 8,000)……………………… Total……………………………………………………………

$29,600 16,800 $12,800

Reject $0 0 $0

Pat’s divisional profits would increase by $18,400: Accept Revenues ($32 × 8,000)………………………………………… Variable expenses: Direct materials ($17 × 8,000)……………………………… Direct labor ($7 × 8,000)…………………………………… Overhead ($2 × 8,000)……………………………………… Component ($2 × $1.85 × 8,000)…………………………… Total relevant benefits………………………………………… 2.

Reject

$ 256,000

(136,000) (56,000) (16,000) (29,600) $ 18,400

0 0 0 0 $0

Pat should accept the $2 price. This price will increase the cost of the component from $29,600 to $32,000 (2 × $2 × 8,000) and yield an incremental benefit of $16,000 ($18,400 – $2,400). Steve’s division will see an increase in profit of $15,200 (8,000 units × 2 components per unit × $0.95 contribution margin per component).

Yes. At full price, the total cost of the component is $36,800 (2 × $2.30 × 8,000), an increase of $7,200 over the original offer. This still leaves an increase in profits of $11,200 ($18,400 – $7,200). (See the answer to Requirement 1.)

P 8-63 1. Markup based on cost of goods sold: Cost of Goods Sold + (Cost of Goods Sold × Markup) = Sell Price $48,100 + ($48,100 × Markup) = $130,000 Markup = ($130,000 – $48,100)/$48,100 = 1.703, or 170.3% 2.

Direct materials……………………………… Direct labor…………………………………… Overhead……………………………………… Total cost…………………………………… Add: Markup ($4,200 × 1.703)……………… Initial bid……………………………………

8-37

$ 1,800 1,600 800 $ 4,200 7,153 $11,353

CHAPTER 8

Tactical Decision Making and Relevant Analysis

P 8-64 1.

Basic

Standard

Deluxe

Price……………………………………………… $ 9.00 Variable cost……………………………………… 6.00 Contribution margin…………………………… $ 3.00 ÷ Machine hours………………………………… 0.10 Contribution margin per machine hour…………………………………… $30.00

$30.00 20.00 $10.00 0.50

$35.00 10.00 $25.00 0.75

$20.00

$33.33 *

The company should sell only the deluxe unit with contribution margin per machine hour of $33.33. Sealing can produce 20,000 (15,000/0.75) deluxe units per year. These 20,000 units, multiplied by the $25 contribution margin per unit, would yield a total contribution margin of $500,000. 2.

First, produce and sell 12,000 deluxe units, which would use 9,000 machine hours (12,000 × 0.75). Then, produce and sell 50,000 basic units, which would use 5,000 machine hours (50,000 × 0.10). Finally, with the remaining 1,000 machine hours, produce 2,000 standard units. Total Contribution Margin

= ($25 × 12,000) + ($3 × 50,000) + ($10 × 2,000) = $470,000

* Rounded P 8-65 1. The company should not accept the offer because the additional revenue is less than the additional costs (assuming fixed overhead is allocated and will not increase with the special order) thereby lowering operating income: Incremental revenue per box………………………………………………… Incremental cost per box…………………………………………………… Loss per box…………………………………………………………………

$ 4.20 4.25 $(0.05)

Total loss: $0.05 × 5,000 = ($250) 2.

Costs associated with the layoff: Increase state UI premiums (0.01 × $1,460,000)………………………… Notification costs ($25 × 20)………………………………………………… Rehiring and retraining costs ($150 × 20)………………………………… Total…………………………………………………………………………

$14,600 500 3,000 $18,100

The order should be accepted. The loss of $250 on the order is more than offset by the $18,100 savings by not laying off employees.

8-38

CHAPTER 8

Tactical Decision Making and Relevant Analysis

P 8-66 1. Sales………………………………………………………………………………… Costs………………………………………………………………………………… Operating profit……………………………………………………………… 2.

Sell Revenues………………………………… Further processing cost………………… Operating income (loss)……………

$40,000 0 $40,000

$263,000 223,000 $ 40,000

Process Further

Difference

$75,000 23,900 $51,100

$35,000 23,900 $11,100

The company should process Delta further because gross profit would increase by $11,100 per quarter if it were processed further. (Note: Joint costs are irrelevant to this decision because the company will incur them whether or not Delta is processed further.) P 8-67 1. ($30 × 2,000) + ($60 × 4,000) = $300,000 2.

Juno Contribution margin………………………………………… ÷ Pounds of material………………………………………… Contribution margin/pound…………………………………

$30 2 $15

Norton should make as much of Juno as can be sold and then make Hera. 2,000 units of Juno × 2 lbs. per unit = 4,000 pounds 16,000 pounds – 4,000 pounds = 12,000 pounds for Hera Hera Production = 12,000 lbs. per unit/5 lbs. per unit = 2,400 units Product mix is 2,000 Juno and 2,400 Hera. Total Contribution Margin

= ($30 × 2,000) + ($60 × 2,400) = $204,000

8-39

Hera $60 5 $12

CHAPTER 8

Tactical Decision Making and Relevant Analysis

P 8-68 1. Revenues……………………… Processing cost……………… Total…………………………

Sell

Process Further

$24,000 — $24,000

$33,000 (4,100) $28,900

Differential Amount to Process Further $ 9,000 (4,100) $ 4,900

Germain should be processed further as it will increase profit by $4,900 for every 1,000 liters. 2. Sell Revenues……………………… $24,000 Processing cost……………… — Distribution cost……………… — Commissions………………… — Total………………………… $24,000

Process Further

Differential Amount to Process Further

$33,000 (4,100) (800) (3,300) $24,800

$ 9,000 (4,100) (800) (3,300) $ 800

Germain should be processed further as it will increase profit by $800 for every 1,000 liters. Note that the liability issue was not quantified so it would need to be considered as a qualitative factor, further reducing the attractiveness of making geraiten. P 8-69 1. Monthly cost for FirstBank: Checking accounts: Maintenance fees ($5 × 6)………………………….……... Foreign DR/CR ($0.10 × 200)……………………………… Returned checks ($3 × 25)…….…………………………… Earnings on deposits ($0.50 × 300)……………………… Credit card fees ($0.50 × 4,000)……………………………… Wire transfers [($15 × 40) + ($50 × 60)]……………………… Line of credit charges (0.06/12 × $100,000)………………… Internet banking charges………………………………….…… Total monthly charges…………………………………….… One-time Internet setup fees ($15 × 6 accounts)……………

8-40

$ 30 20 75 (150)

(25) 2,000 3,600 500 20 $6,095 $

CHAPTER 8

Tactical Decision Making and Relevant Analysis

P 8-69 (Continued) Monthly cost for Community Bank: Checking accounts: Returned checks ($2 × 25)…….………… Credit card fees Per item ($0.50 × 4,000)…………………………………...……… Batch processing ($7 × 20)……………………………………… Wire transfers ($30 × 100)…….……………………………………. Line of credit charges (0.07/12)($100,000)……………………… Total monthly charges……………………………………………

$ $2,000 140

2,140 3,000 583 * $5,773

Monthly cost for RegionalOne Bank: Checking accounts: Foreign DR/CR ($0.20 × 200)…………………………………… Returned checks ($3.80 × 25)…………………………………… Earnings on deposits ($0.30 × 300)…………………………… Credit card fees ($0.50 × 4,000)…………………………………… Wire transfers [($10 × 40) + ($55 × 60)]…………………………… Line of credit charges (0.065/12)($100,000)……………………… Internet banking charges………………………………….………… Total monthly charges………………………………….…………

40 95 (90)

$ 45 2,000 3,700 542 * 20 $6,307

* Answers rounded to the nearest dollar.

Community Bank has the lowest overall monthly fees. On quantitative factors alone, it would be chosen. 2.

If the full online banking access were crucial, Community Bank would be eliminated immediately. This leaves FirstBank and RegionalOne Bank. The two sets of monthly costs are similar, $6,095 for FirstBank versus $6,307 for RegionalOne. Now, the banking relationship, comfort level of Kicker with the loan officer, and confidence in the bank’s ability to respond quickly and appropriately to Kicker’s needs will be the deciding factors. Additionally, some further negotiation would probably be conducted—for example, on the interest rate on the line of credit or the fees per wire transfer.

8-41

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Tactical Decision Making and Relevant Analysis

CASES Case 8-70 1. Pamela should not have told Roger about the deliberations concerning the power department because this is confidential information. She had been explicitly told to keep the details quiet but deliberately informed the head of the unit affected by the potential decision. (Standard II: 1) Her revelation may be interpreted as actively or passively subverting the attainment of the organization’s legitimate and ethical objectives. 2.

The romantic relationship between Pamela and Roger sets up a conflict of interest for this particular decision. Pamela should have withdrawn from any active role in it. (Standard III: 1) However, she should definitely provide the information she currently has about the cost of eliminating the power department. To not do so would be active subversion of the organization’s legitimate and ethical objectives. Moreover, she has the obligation to communicate information fairly and to disclose all relevant information that could reasonably be expected to influence an intended user’s understanding. In addition, however, Pamela should discuss the qualitative effects of eliminating the power department. The effects on workers, community relations, reliability of external service, and any ethical commitments the company may have to its workers should all enter into the decision. Pamela should communicate the short-term quantitative effects and express any concerns about the qualitative factors. She should also project what the costs of operating internally would be for the next 5 years and compare that with the estimates of the costs of external acquisition. Pamela also might consider the potential cost of laying off workers, such as unemployment insurance costs, severance pay, etc. Later, if business improves, Murray Manufacturing Inc. would then have to incur costs for training any new employees or formerly laid off employees that are hired back.C5

8-42

CHAPTER 8

Case 8-71 a 1. Sales …………………………………………………… Less: Variable expensesb…………………………… Contribution margin…………………………………… Less: Direct fixed expensesc………………………… Divisional margin……………………………………… Less: Common fixed expensesc…………………… Operating (loss)……………………………………… a

Tactical Decision Making and Relevant Analysis

$3,751,500 2,004,900 $1,746,600 1,518,250 $ 228,350 299,250 $ (70,900)

Based on sales of 41,000 units Let X = Units sold $83X/2 + $100X/2 = $3,751,500 $183X = $7,503,000 X = 41,000 units

b $83X/125.0%

– +

$66.40 20.00 $46.40 5.00 $51.40

Manufacturing cost Fixed overhead Per internal unit variable cost Selling expenses Per external unit variable cost

Variable Costs = ($46.40 × 20,500) + ($51.40 × 20,500) = $2,004,900 c

Fixed selling and admin.: $1,100,000 – $5(20,500) = $997,500 Direct fixed selling and admin.: 0.70 × $997,500 = $698,250 Direct fixed overhead: $20 × 41,000 = $820,000 Total direct fixed expenses = $698,250 + $820,000 = $1,518,250 Common fixed expenses = 0.30 × $997,500 = $299,250

Keep Sales……………………………………………………… Variable costs…………………………………………… Direct fixed expenses………………………………… Annuity…………………………………………………… Total……………………………………………………

$ 3,751,500 (2,004,900) (1,518,250) — $ 228,350

* $100 × 20,500 (The units transferred internally must be purchased externally.) The company should keep the division.

Case 8-72 Answers will vary.

8-43

Drop $ — (2,050,000) * — 100,000 $(1,950,000)

Profit Planning and Flexible Budgets DISCUSSION QUESTIONS

Budgets are the quantitative expressions of plans. Budgets are used to translate the goals and strategies of an organization into operational terms.

Control is the process of setting standards, receiving feedback on actual performance, and taking corrective action whenever actual performance deviates materially from planned performance. Budgets are standards, and they are compared with actual costs and revenues to provide feedback.

The planning and control functions of budgeting can benefit all organizations, regardless of size. All organizations need to determine what their goals are and how best to obtain or achieve, those goals. This is the planning function of budgeting. In addition, organizations can compare what actually happens with what was planned to see if the plans are unfolding as anticipated. This is the control function of budgeting.

Budgeting forces managers to plan, provides resource information for decision making, sets benchmarks for control and evaluation, and improves the functions of communication and coordination.

A master budget is the collection of all individual area and activity budgets. Operating budgets are concerned with the income-generating activities of a firm. Financial budgets are concerned with the inflows and outflows of cash and with planned capital expenditures.

The sales forecast is a critical input for building the sales budget. However, it is not necessarily equivalent to the sales budget. Upon receiving the sales forecast, management may decide that the firm can do better than the forecast indicates. Consequently, actions may be taken to increase the sales potential for the coming year (e.g., increasing advertising). This adjusted forecast then becomes the sales budget.

Yes. All budgets are founded on the sales budget. Before a production budget can be created, it must have the planned sales. The manufacturing budgets, in turn, depend on the production budget. The same is true for the financial budgets since sales is a critical input for budgets in that category.

Goal congruence is important because it means that the employees of an organization are working toward the goals of that organization.

Frequent feedback is important so that corrective action can be taken, increasing the likelihood of achieving budgetary goals.

9-1

CHAPTER 9

Profit Planning and Flexible Budgets

10. Participative budgeting is a system of budgeting that gives subordinate managers a say in how the budgets are established. Participative budgeting fosters creativity and communicates a sense of responsibility to subordinate managers. It also creates a higher likelihood of goal congruence since managers have more of a tendency to make the budget’s goals their own personal goals. 11. Agree. Individuals who are not challenged tend to lose interest and maintain a lower level of performance. A challenging, but achievable, budget tends to extract a higher level of performance. 12. By underestimating revenues and overestimating costs, the budget is more easily achieved. 13. A static budget is for a particular level of activity. A flexible budget is one that can be established for any level of activity. 14. A flexible budget is based on a simple formula: Total Costs (Y) = F + VX, where F = Fixed Costs, V = Variable Cost per Unit, and X = Number of Units; this requires knowledge of both fixed and variable components. 15. A before-the-fact flexible budget allows managers to engage in sensitivity analysis by looking at the financial outcomes possible for a number of different plausible scenarios. An after-the-fact flexible budget facilitates performance evaluation by allowing the calculation of what spending should have been for the actual level of activity. 16. The flexible budget is being used predictively since the budgeted amounts are potential future sales.

9-2

CHAPTER 9

Profit Planning and Flexible Budgets

MULTIPLE-CHOICE QUESTIONS 9-1.

9-2.

9-3.

9-4.

9-5.

9-6.

9-7.

9-8.

9-9.

9-10.

= 100 + 30 – 10 = 120

9-11.

= 220 + 20 – 50 = 190

9-12.

9-13.

9-14.

9-15.

9-16.

9-17.

9-18.

9-19.

9-20.

= (0.40 × $200,000) + (0.60 × $100,000) = $140,000

9-3

CHAPTER 9

Profit Planning and Flexible Budgets

BRIEF EXERCISES: SET A BE 9-21 Patrick Inc. Sales Budget For the Coming Quarter

Units………………………… Price………………………… Sales…………………………

January

February

March

1st Quarter Total

41,000 $35 × $1,435,000

38,000 $35 × $1,330,000

50,000 $35 × $1,750,000

129,000 $35 × $4,515,000

March

1st Quarter Total

BE 9-22 Patrick Inc. Production Budget For the Coming Quarter February

January Sales………………………… Desired ending inventory………………… Total needs………………… Less: Beginning inventory………………… Units to be produced……

41,000

38,000

50,000

129,000

9,500 50,500

12,500 50,500

12,750* 62,750

12,750 141,750

6,700 43,800

9,500 41,000

12,500 50,250

6,700 135,050

* April sales of 51,000 × 0.25 = 12,750

9-4

CHAPTER 9

BE 9-23 1. Ending Inventory for December

Profit Planning and Flexible Budgets

= 0.15 × 5.50 gal. of chemicals × 43,800 units = 36,135

Ending Inventory for January

= 0.15 × 5.50 gal. of chemicals × 41,000 units = 33,825

Ending Inventory for February

= 0.15 × 5.50 gal. of chemicals × 50,250 units = 41,456*

Beginning Inventory for January

= Ending Inventory for December

* Rounded

Direct materials purchases budget—chemicals in gallons: Production in units……………………………………… × Gallons per unit…………………………………… Gallons for production………………………………… Desired ending inventory……………………………… Needed…………………………………………………… Less: Beginning inventory*…………………………… Purchases………………………………………………… × Price per gallon…………………………………… Dollar purchases…………………………………………

January

February

43,800 5.5 240,900 33,825 274,725 36,135 238,590 $2.00 $477,180

41,000 5.5 225,500 41,456 266,956 33,825 233,131 $2.00 $466,262

* Beginning inventory for January equals ending inventory for December.

Ending Inventory for December

= 0.15 × 1 drum × 43,800 units = 6,570

Ending Inventory for January

= 0.15 × 1 drum × 41,000 units = 6,150

Ending Inventory for February

= 0.15 × 1 drum × 50,250 units = 7,538*

* Rounded

Direct materials purchases budget—drums: Production in units……………………………………… × Drums per unit……………………………………… Drums for production…………………………………… Desired ending inventory……………………………… Needed………………………………………………… Less: Beginning inventory*…………………………… Purchases………………………………………………… × Price per drum……………………………………… Dollar purchases…………………………………………

January

February

43,800 1 43,800 6,150 49,950 6,570 43,380 $1.60 $69,408

41,000 1 41,000 7,538 48,538 6,150 42,388 $1.60 $67,821 **

* Beginning inventory for January equals ending inventory for December. ** Rounded 9-5

CHAPTER 9

Profit Planning and Flexible Budgets

BE 9-24 Direct Labor Budget:

January

February

March

Total

Units to be produced………………… 43,800 0.3 × Direct labor hours per unit……… 13,140 Total direct labor hours ……………… × Wage rate………………………… $18 Direct labor cost………………………… $236,520

41,000 0.3 12,300 $18 $221,400

50,250 0.3 15,075 $18 $271,350

135,050 0.3 40,515 $18 $729,270

BE 9-25 Overhead Budget:

January

February

March

Total

Total direct labor hours ……………… × Variable overhead rate…………… Total variable overhead……………… Add: Fixed overhead…………………… Total overhead…………………………

13,140 $0.70 $ 9,198 2,750 $11,948

12,300 $0.70 $ 8,610 2,750 $11,360

15,075 $0.70 $10,553 * 2,750 $13,303

40,515 $0.70 $28,361 * 8,250 $36,611

* Rounded

BE 9-26 1. Direct materials……………………………………………………………………… Direct labor (1.9 hrs. × $16)…………………………….…………………………… Variable overhead (1.9 hrs. × $1.20)…………………………….………………… Fixed overhead (1.9 hrs. × $1.60)…………………………….…………………… Unit product cost……………………………………………………………………

$14.00 30.40 2.28 3.04 $49.72

$33,561

Cost of ending inventory ($49.72 × 675)…………………………………………

BE 9-27 Andrews Company Cost of Goods Sold Budget For the Coming Year Direct materials ($14 × 20,000)………………………………………………………… $280,000 Direct labor (1.9 hrs. × $16 × 20,000)…...…..……………………..…………………… 608,000 Variable overhead (1.9 hrs. × $1.20 × 20,000)…...…..……………………..………… 45,600 60,800 Fixed overhead (1.9 hrs. × $1.60 × 20,000)…...…..……………………..…………… Total manufacturing cost………………………………………………………………… $994,400 33,561 Less: Ending inventory ($49.72 × 675)…...…..……………………..………………… Cost of goods sold…………………………………………………………...…………… $960,839

9-6

CHAPTER 9

Profit Planning and Flexible Budgets

BE 9-28 Fazel Company Selling and Administrative Expenses Budget For the Coming Year Variable selling expenses (0.03 × $19,730,000)…………… Fixed expenses: Salaries………………………………………………………… Utilities…………………………………………...…………… Office space…………………………………………...……… Advertising…………………………………….……………… Total fixed expenses………………………………...……… Total selling and administrative expenses…………………

$ 591,900 $ 960,000 365,000 230,000 1,200,000 2,755,000 $3,346,900

BE 9-29 Oliver Company Budgeted Income Statement For the Coming Year Sales ($10.80 × 160,000)….……………..…...……....…………...……………… Cost of goods sold ($6.30 × 160,000)….……………..…...……....…………...… Gross margin……………………………….………………………………………… Less: Variable selling and administrative expenses ($1.10 × 160,000)….……………..…...……....…………...…………… Fixed selling and administrative expenses………………………………… Operating income………………………………………………………………….… Less: Income taxes (0.35 × $121,000).……………………..….……...………… Net income…………………………………………………………….………………

9-7

$1,728,000 1,008,000 $ 720,000 176,000 423,000 $ 121,000 42,350 $ 78,650

CHAPTER 9

Profit Planning and Flexible Budgets

BE 9-30 June: ($100,800 × 0.25)………………………………….……………

August

September

$25,200

—

July: ($77,000 × 0.50)………………………………….…………… ($77,000 × 0.25)………..……………………….………………

38,500

August: ($86,800 × 0.20)………………………………….…………… ($86,800 × 0.50)…...…………………………….……………

17,360

September: ($91,000 × 0.20)………………………………….…………… Total cash receipts………………………………………………

$19,250

43,400 — $81,060

18,200 $80,850

BE 9-31 1.

Payments for purchases from: April ($374,400 × 0.80)……………………….……………………………… May ($411,200 × 0.20)……………………….………………………………… Total cash needed for May……………………..…………………….…

$299,520 82,240 $381,760

Payments for purchases from: May ($411,200 × 0.80)……………………….………………………………… June ($416,000 × 0.20)……………………….……………………………… Total cash needed for June………………………………………….…

9-8

$328,960 83,200 $412,160

CHAPTER 9

Profit Planning and Flexible Budgets

BE 9-32 1.

Cash receipts in October from: Cash sales ($157,000 × 0.85)………………………………………………… Collections on September credit sales*…………………….….………… Collections on October credit sales**……………………..…….………… Total cash expected …………………..……………………….…………

$133,450 7,623 16,485 $157,558

* $181,500 × 0.15 × 0.28 = $7,623 ** $157,000 × 0.15 × 0.70 = $16,485 2.

Payments for food and supplies purchases from: September ($130,000 × 0.75)………………………………………………… October ($116,000 × 0.25)…………………………………………………… Total cash needed for October………………………...…..……………

$ 97,500 29,000 $126,500

Beginning balance………………………………………………………………… Cash receipts……………………………………………………………………… Cash available………………………………………………………………………

$ 2,147 157,558 $159,705

Less: Payments for food and supplies purchases……………………………… Owners’ draw…………………………………………………………………… Workers’ wages*……………………………………………………………… Utilities………………………………………………………………………… Rent……………………………………………………………………………… Insurance……………………………………………………………………… Total disbursements………………………………………………………………

$126,500 6,000 7,300 5,950 4,100 1,200 $151,050

Ending balance……………………………………………………………………

* September wage payments ($7,300 × 0.10) + October wage payments ($7,300 × 0.90) = $7,300

9-9

8,655

CHAPTER 9

Profit Planning and Flexible Budgets

BE 9-33 Direct materials…………………………………………… Direct labor………………………………………………… Variable overhead………………………………………… Fixed overhead: Materials handling…………………………………… Depreciation…………………………………………… Total…………………………………………………………

2,500 units

3,000 units

3,500 units

$ 4,500 20,000 2,750

$ 5,400 24,000 3,300

$ 6,300 28,000 3,850

6,200 2,600 $36,050

6,200 2,600 $41,500

6,200 2,600 $46,950

BE 9-34 1.

Budgeted for 4,000 units

Direct materials ($0.60 × 3 × 4,000)………………………………… Direct labor ($16.00 × 0.5 × 4,000)………………………………… Variable overhead ($2.20 × 0.5 × 4,000)…………………………… Fixed overhead: Materials handling………………………………………………… Depreciation………………………………………………………… Total……………………………………………………………………… 2.

$ 7,200 32,000 4,400 $6,200 2,600

8,800 $52,400

Performance Report Actual

Budgeted

Variance*

Units produced………………………………………

3,800

4,000

200 U

Direct materials……………………………………… Direct labor…………………………………………… Variable overhead…………………………………… Fixed overhead: Materials handling……………………………… Depreciation……………………………………… Total……………………………………………………

$ 6,800 30,500 4,200

$ 7,200 32,000 4,400

$ 400 F 1,500 F 200 F

6,300 2,600 $50,400

6,200 2,600 $52,400

100 U 0 $ 2,000 F

* Variances equal actual amounts less budgeted amounts. If actual cost is less than budgeted cost, the variance is F (favorable). If actual cost is more than budgeted cost, the variance is U (unfavorable).

9-10

CHAPTER 9

BE 9-34 (Continued) 3.

Profit Planning and Flexible Budgets

Performance Report Actual

Budgeted

Variance* —

Units produced………………………………………

3,800

Direct materials……………………………………… Direct labor…………………………………………… Variable overhead………………………………… Fixed overhead: Materials handling……………………………… Depreciation……………………………………… Total……………………………………………………

$ 6,800 30,500 4,200

$ 6,840 30,400 4,180

6,300 2,600 $50,400

6,200 2,600 $50,220

100 U 0 $ 180 U

40 F 100 U 20 U

* Variances equal actual amounts minus budgeted amounts. If actual cost is less than bugeted cost, the variance is F (favorable). If actual cost is more than budgeted cost, the variance is U (unfavorable).

9-11

CHAPTER 9

Profit Planning and Flexible Budgets

BRIEF EXERCISES: SET B BE 9-35 Tulum Inc. Sales Budget For the Coming Quarter

Units…………………………… Price…………………………… Sales……………………………

January

February

March

1st Quarter Total

22,000 $20 × $440,000

20,000 $20 × $400,000

30,000 $20 × $600,000

72,000 $20 × $1,440,000

March

1st Quarter Total

BE 9-36 Tulum Inc. Production Budget For the Coming Quarter February

January Sales…………………………… Desired ending inventory…………………… Total needs…………………… Less: Beginning inventory…………………… Units to be produced…………

22,000

20,000

30,000

72,000

4,000 26,000

6,000 26,000

6,200* 36,200

6,200 78,200

1,300 24,700

4,000 22,000

6,000 30,200

1,300 76,900

* April sales of 31,000 × 0.20 = 6,200

9-12

CHAPTER 9

Profit Planning and Flexible Budgets

BE 9-37 1.

Ending Inventory for December

= 0.10 × 4.2 lb. of chocolate mix × 24,700 units = 10,374

Ending Inventory for January

= 0.10 × 4.2 lb. of chocolate mix × 22,000 units = 9,240

Ending Inventory for February

= 0.10 × 4.2 lb. of chocolate mix × 30,200 units = 12,684

Beginning Inventory for January

= Ending Inventory for December

Direct materials purchases budget—chocolate mix in pounds: Production in units……………………………………… × Gallons per unit…………………………………… Gallons for production………………………………… Desired ending inventory……………………………… Needed…………………………………………………… Less: Beginning inventory*…………………………… Purchases………………………………………………… × Price per gallon…………………………………… Dollar purchases…………………………………………

January

February

24,700 4.2 103,740 9,240 112,980 10,374 102,606 $1.50 $153,909

22,000 4.2 92,400 12,684 105,084 9,240 95,844 $1.50 $143,766

* Beginning inventory for January equals ending inventory for December.

Ending Inventory for December

= 0.10 × 1 box × 24,700 units = 2,470

Ending Inventory for January

= 0.10 × 1 box × 22,000 units = 2,200

Ending Inventory for February

= 0.10 × 1 box × 30,200 units = 3,020

Direct materials purchases budget—boxes: Production in units……………………………………… × Boxes per unit……………………………………… Boxes for production…………………………………… Desired ending inventory……………………………… Needed………………………………………………… Less: Beginning inventory*…………………………… Purchases………………………………………………… × Price per box……………………………………… Dollar purchases…………………………………………

January

February

24,700 1 24,700 2,200 26,900 2,470 24,430 $0.10 $2,443

22,000 1 22,000 3,020 25,020 2,200 22,820 $0.10 $2,282

* Beginning inventory for January equals ending inventory for December.

9-13

CHAPTER 9

Profit Planning and Flexible Budgets

BE 9-38 Direct Labor Budget:

January

February

March

Total

Units to be produced………………… 24,700 0.4 × Direct labor hours per unit…… 9,880 Total direct labor hours …………… × Wage rate………………………… $17 Direct labor cost……………………… $167,960

22,000 0.4 8,800 $17 $149,600

30,200 0.4 12,080 $17 $205,360

76,900 0.4 30,760 $17 $522,920

January

February

March

Total

9,880 $0.50 $4,940 3,140 $8,080

8,800 $0.50 $4,400 3,140 $7,540

12,200 $0.50 $6,100 3,140 $9,240

30,760 $0.50 $15,380 9,420 $24,800

BE 9-39 Overhead Budget: Total direct labor hours …………… × Variable overhead rate………… Total variable overhead…………… Add: Fixed overhead………………… Total overhead…………………………

BE 9-40 1.

Direct materials………………………………………………………………………… Direct labor (0.9 hr. × $18)…………………………….……………………………… Variable overhead (0.9 hr. × $1.00)…………………………….…………………… Fixed overhead (0.9 hr. × $2.00)…………………………….………………………… Unit product cost…………………………………………………………………………

$ 5.00 16.20 0.90 1.80 $23.90

Cost of ending inventory ($23.90 × 830)……………………………………………

$19,837

BE 9-41 Lazlo Company Cost of Goods Sold Budget For the Coming Year Direct materials ($5.00 × 16,000)……………………………………………………… $ 80,000 259,200 Direct labor (0.9 hr. × $18.00 × 16,000)…...…..……………………..……………… Variable overhead (0.9 hr. × $1.00 × 16,000)…...…..……………………..………… 14,400 28,800 Fixed overhead (0.9 hr. × $2.00 × 16,000)…...…..……………………..…………… Total manufacturing cost……………………………………………………………… $382,400 19,837 Less: Ending inventory ($23.90 × 830)…...…..……………………..……………… Cost of goods sold…………………………………………………………...………… $362,563

9-14

CHAPTER 9

Profit Planning and Flexible Budgets

BE 9-42 Elwood Company Selling and Administrative Expenses Budget For the Coming Year Variable selling expenses (0.04 × $18,620,000)…………… Fixed expenses: Salaries………………………………………………………… Utilities…………………………………………...…………… Office space…………………………………………...……… Advertising…………………………………….……………… Total fixed expenses………………………………...……… Total selling and administrative expenses…………………

$ 744,800 $ 796,000 173,000 312,000 1,100,000 2,381,000 $3,125,800

BE 9-43 Jameson Company Budgeted Income Statement For the Coming Year Sales ($9.70 × 230,000)….……………..…...……....…………...………………… Cost of goods sold ($5.30 × 230,000)….……………..…...……....…………...… Gross margin……………………………….………………………………………… Less: Variable selling and administrative expenses ($1.60 × 230,000)….……………..…...……....…………...………… Fixed selling and administrative expenses………………………………… Operating income………………………………………………………………….… Less: Income taxes (0.35 × $257,000).……………………..….……...………… Net income…………………………………………………………….………………

9-15

$2,231,000 1,219,000 $1,012,000 368,000 387,000 $ 257,000 89,950 $ 167,050

CHAPTER 9

Profit Planning and Flexible Budgets

BE 9-44 June April: ($200,000 × 0.42)………………………………….……………

$ 84,000

May: ($210,000 × 0.40)………………………………….…………… ($210,000 × 0.42)………..……………………….……………

84,000

June: ($235,000 × 0.15)………………………………….…………… ($235,000 × 0.40)…...…………………………….……………

35,250

July: ($230,000 × 0.15)………………………………….…………… Total cash receipts………………………………………………

July —

$ 88,200

94,000 — $203,250

34,500 $216,700

BE 9-45 1.

Payments for purchases from: April ($320,400 × 0.75)……………………….………………………………… May ($366,000 × 0.25)……………………….………………………………… Total cash needed for May……………………..…………………….……

$272,340 54,900 $327,240

Payments for purchases from: May ($366,000 × 0.75)……………………….………………………………… June ($350,000 × 0.25)……………………….………………………………… Total cash needed for June………………………………………….……

9-16

$311,100 52,500 $363,600

CHAPTER 9

Profit Planning and Flexible Budgets

BE 9-46 1.

Cash receipts in October from: Cash sales ($395,000 × 0.80)………………………………………………… Collections on September credit sales*…………………….….…………… Collections on October credit sales**……………………..…….………… Total cash expected …………………..……………………….……………

$316,000 21,840 55,300 $393,140

* $390,000 × 0.20 × 0.28 = $21,840 ** $395,000 × 0.20 × 0.70 = $55,300 2.

Payments for food and supplies purchases from: September ($275,000 × 0.65)………………………………………………… October ($285,000 × 0.35)…………………………………………………….. Total cash needed for October………………………...…..………………

$178,750 99,750 $278,500

$ 1,916 393,140 $395,056

Less: Payments for food and supplies purchases……………………………… Owners’ draw…………………………………………………………………… Workers’ wages*………………………………………………………………… Utilities and insurance………………………………………………………… Rent……………………………………………………………………………… Freezer unit……………………………………………………………………… Total disbursements………………………………………………………………

$278,500 18,500 29,300 8,750 14,000 39,000 $388,050

Ending balance………………………………………………………………………

* September wage payments ($29,300 × 0.10) + October wage payments ($29,300 × 0.90)

9-17

7,006

CHAPTER 9

Profit Planning and Flexible Budgets

BE 9-47 Direct materials……………………………… Direct labor…………………………………… Variable overhead…………………………… Fixed overhead: Materials handling……………………… Depreciation……………………………… Total……………………………………………

4,000 units

4,500 units

5,000 units

$15,600 36,000 6,800

$17,550 40,500 7,650

$19,500 45,000 8,500

8,600 4,350 $71,350

8,600 4,350 $78,650

8,600 4,350 $85,950

BE 9-48 1.

Budgeted for 4,500 units

Direct materials ($1.30 × 3 × 4,500)…………………… Direct labor ($18.00 × 0.5 × 4,500)…………………… Variable overhead ($3.40 × 0.5 × 4,500)……………… Fixed overhead: Materials handling…………………………………… Depreciation…………………………………………… Total………………………………………………………… 2.

$17,550 40,500 7,650 $6,200 2,600

12,950 $78,650

Performance Report Actual

Budgeted

Variance*

Units produced…………………………

4,700

4,500

200 F

Direct materials………………………… Direct labor……………………………… Variable overhead…………………… Fixed overhead: Materials handling………………… Depreciation………………………… Total………………………………………

$18,320 42,400 7,900

$17,550 40,500 7,650

$ 770 U 1,900 U 250 U

8,800 4,350 $81,770

6,200 2,600 $74,500

200 U 0 $3,120 U

9-18

CHAPTER 9

BE 9-48 (Continued) 3.

Profit Planning and Flexible Budgets

Performance Report Actual

Budgeted

Variance*

Units produced…………………………

4,700

—

Direct materials………………………… Direct labor……………………………… Variable overhead……………………… Fixed overhead: Materials handling………………… Depreciation………………………… Total………………………………………

$18,320 42,400 7,900

$18,330 42,300 7,990

$ 10 F 100 U 90 F

8,800 4,350 $81,770

6,200 2,600 $77,420

200 U 0 $200 U

* Variances equal actual amounts minus budgeted amounts. If actual cost is less than budgeted cost, the variance is F (favorable). If actual cost is more than budgeted cost, the variance is U (unfavorable).

9-19

CHAPTER 9

Profit Planning and Flexible Budgets

EXERCISES E 9-49 1.

h, i

h, f

10.

E 9-50 Stillwater Designs Sales Budget For the Year Ended December 31, 20X1

S12L7 Units……… Price……… Sales……… S12L5 Units……… Price……… Sales……… Total Sales……

1st Qtr.

2nd Qtr.

3rd Qtr.

4th Qtr.

Year

800 $475 $380,000

2,200 $475 $1,045,000

5,600 $475 $2,660,000

4,600 $475 $2,185,000

13,200 $475 $6,270,000

1,300 $300 $390,000

1,400 $300 $ 420,000

5,300 $300 $1,590,000

3,900 $300 $1,170,000

11,900 $300 $3,570,000

$770,000

$1,465,000

$4,250,000

$3,355,000

$9,840,000

2. Stillwater Designs will use the sales budget in planning as the basis for the production budget and the succeeding budgets of the master budget. The company can also compare actual sales against the budget to see if expectations were achieved.

9-20

CHAPTER 9

Profit Planning and Flexible Budgets

E 9-51 Stillwater Designs Production Budget for S12L7 For the Year Ended December 31, 20X1 Sales………………….………… Desired ending inventory………………….… Total needs………………….… Less: Beginning inventory………………….… Units produced………………

1st Qtr.

2nd Qtr.

3rd Qtr.

4th Qtr.

Year

800

2,200

5,600

4,600

13,200

440 1,240

1,120 3,320

920 6,520

180 4,780

180 13,380

340 900

440 2,880

1,120 5,400

920 3,860

340 13,040

Stillwater Designs Production Budget for S12L5 For the Year Ended December 31, 20X1 Sales………………….………… Desired ending inventory………………….… Total needs………………….… Less: Beginning inventory………………….… Units produced………………

1st Qtr.

2nd Qtr.

3rd Qtr.

4th Qtr.

Year

1,300

1,400

5,300

3,900

11,900

420 1,720

1,590 2,990

1,170 6,470

360 4,260

360 12,260

170 1,550

420 2,570

1,590 4,880

1,170 3,090

170 12,090

9-21

CHAPTER 9

Profit Planning and Flexible Budgets

E 9-52 1.

Pets Plus, Inc. Production Budget For the First Quarter of the Year Sales……………………………………… Desired ending inventory…………… Total needs……………………………… Less: Beginning inventory…………… Units produced…………………………

January

February

March

Total

8,000 1,425 9,425 900 8,525

9,500 1,800 11,300 1,425 9,875

12,000 2,085 14,085 1,800 12,285

29,500 2,085 31,585 900 30,685

January

February

Total

8,525 1 8,525 988 9,513 853 8,660

9,875 1 9,875 1,229 11,104 988 10,116

18,400 1 18,400 1,229 19,629 853 18,776

8,525 8 68,200 7,900 76,100 6,820 69,280

9,875 8 79,000 9,828 88,828 7,900 80,928

18,400 8 147,200 9,828 157,028 6,820 150,208

Pet Plus, Inc. Direct Materials Purchases Budget For January and February Bottles: Production……………………………………………… × 1 jar…………….……………………………………… Bottles for production………………………………… Desired inventory……………………………………… Total needs……………………………………………… Less: Beginning inventory…………………………… Bottles purchased……………………………………… Fluid mixture: Production……………………………………………… × 8 ounces...…………………………………………… Ounces for production………………………………… Desired inventory……………………………………… Total needs……………………………………………… Less: Beginning inventory…………………………… Ounces purchased……………………………………

9-22

CHAPTER 9

Profit Planning and Flexible Budgets

E 9-53 Liang Company Production Budget For the Second Quarter Sales………………………………… Desired ending inventory………… Total needs………………………… Less: Beginning inventory……… Units produced………………………

April

May

June

Total

90,000 22,000 112,000 12,000 100,000

110,000 20,000 130,000 22,000 108,000

100,000 24,000 124,000 20,000 104,000

300,000 24,000 324,000 12,000 312,000

E 9-54 Wehner Company Direct Materials Purchases Budget For September, October, and November Units to be produced……………… × Direct materials per unit (ounces)…………………………… Production needs…………………… Desired ending inventory (ounces)…………………………… Total needs………………………… Less: Beginning inventory……… Direct materials to be purchased (ounces)…………… × Cost per ounce…………………… Total purchase cost…………………

September

October

November

3,500

4,400

4,800

12,700

15 52,500

15 66,000

15 72,000

15 190,500

15,840 68,340 12,600

17,280 83,280 15,840

25,560 97,560 17,280

25,560 216,060 12,600

55,740 $0.10 $5,574

67,440 $0.10 $6,744

80,280 $0.10 $8,028

203,460 $0.10 $20,346

9-23

Total

CHAPTER 9

Profit Planning and Flexible Budgets

E 9-55 Duran Company Direct Labor Budget For March, April, and May March Units to be produced………… × Direct labor time per unit (hours)…………………… Total hours needed…………… × Cost per hour………………… Total direct labor cost…………

April

May

Total

9,000

13,000

14,400

36,400

0.30 2,700 $20 $54,000

0.30 3,900 $20 $78,000

0.30 4,320 $20 $86,400

0.30 10,920 $20 $218,400

E 9-56 Alger Inc. Sales Budget For the Coming Year

Model

Units

Price

Total Sales

LB-1………………………………………………… LB-2………………………………………………… WE-6………………………………………………… WE-7………………………………………………… WE-8*……………………………………………… WE-9*……………………………………………… Total……………………………………………

36,750 18,900 25,200 17,010 13,800 8,000

$32.00 20.00 10.50 10.00 18.00 22.00

$1,176,000 378,000 264,600 170,100 248,400 176,000 $2,413,100

*Recall that WE-8 and WE-9 sales from last year were only from the last half of the year. Current year sales are estimated to be twice those amounts.

Alger’s team is using the previous year’s sales figures predictively to determine what the most likely sales for the coming year will be.

9-24

CHAPTER 9

Profit Planning and Flexible Budgets

E 9-57 Jani’s Flowers and Gifts Production Budget for Gift Baskets For September, October, November, and December

September Sales………………………………………… Desired ending inventory……………… Needed……………………………………… Less: Beginning inventory……………… Production………………………………

250 10 260 13 247

October

November

December

200 12 212 10 202

230 19 249 12 237

380 5 385 19 366

September

October

November

247 1 247 10 257 12 245

202 1 202 12 214 10 204

237 1 237 18 255 12 243

247 6 1,482 364 1,846 445 1,401

202 6 1,212 427 1,639 364 1,275

237 6 1,422 659 2,081 427 1,654

Jani’s Flowers and Gifts Direct Materials Purchases Budget For September, October, and November

Fruit Production……………………………………………… × Pounds of fruit ……………………………………… required for production…………………………… Desired inventory…………………………………… Total needs…………………………………………… Less: Beginning inventory………………………… Pounds purchased…………………………………… Small gifts Production……………………………………………… × Items required……………………………………… Needed for production……………………………… Desired inventory…………………………………… Total needs…………………………………………… Less: Beginning inventory………………………… Items purchased……………………………………… 3.

December includes the holiday season and is a time when many gifts are given. Jani has factored this into her budgeting. January, on the other hand, is a month with few national holidays or gift-giving occasions. As a result, Jani has forecast fewer gift baskets.

9-25

CHAPTER 9

Profit Planning and Flexible Budgets

E 9-58 1. Credit Sales in May Credit Sales in June Credit Sales in July Credit Sales in August

= $290,000 × 0.80 = $232,000 = $300,000 × 0.80 = $240,000 = $315,000 × 0.80 = $252,000 = $295,000 × 0.80 = $236,000 Selig Inc. Schedule of Cash Receipts For July and August

July

August

Cash sales……………………………………………………………

$ 63,000

$ 59,000

Collections on account: From May credit sales: (0.07 × $232,000)………………………………………………

16,240

From June credit sales: (0.68 × $240,000)……………………………………………… (0.07 × $240,000)………………………………………………

163,200

From July credit sales: (0.20 × $252,000)……………………………………………… (0.68 × $252,000)………………………………………………

50,400

From August credit sales: (0.20 × $236,000)……………………………………………… Cash receipts………………………………………..……………

16,800

171,360 0 $292,840

47,200 $294,360

From May credit sales: (0.18 × $248,000)………………………………………………………………

$ 44,640

From June credit sales: (0.50 × $260,000)………………………………………………………………

130,000

From July credit sales: (0.30 × $240,000)………………………………………………………………

72,000

Less: July cash discount (0.02 × $72,000)………………………………………………………………… Cash receipts………………………………………………………………………

(1,440) $245,200

E 9-59 Erewon Inc. Schedule of Cash Receipts For July

Collections on account:

9-26

CHAPTER 9

Profit Planning and Flexible Budgets

E 9-59 (Continued) 2.

Erewon Inc. Schedule of Cash Receipts For August Collections on account: From June credit sales: (0.18 × $260,000)………………………………………………………………

$ 46,800

From July credit sales: (0.50 × $240,000)………………………………………………………………

120,000

From August credit sales: (0.30 × $300,000)………………………………………………………………

90,000

Less: August cash discount (0.02 × $90,000)………………………………………………………………… Cash receipts………………………….…………….……….……….……………

(1,800) $255,000

E 9-60 Fein Company Schedule of Cash Payments For August Payments on accounts payable: From July purchases (0.80 × $77,000)…………………………………..…… From August purchases (0.20 × $73,000)…………………………………..…

$ 61,600 14,600

Direct labor payments: From July (0.10 × $32,300)…………………………………..………………… From August (0.90 × $35,400)…………………………………..……………… Overhead ($71,200 – $6,350)………………………………………………..……… Loan repayment [$15,000 + ($15,000 × 0.09 × 4/12)]…………………………… Cash payments……………………………………..……………………………

3,230 31,860 64,850 15,450 $191,590

9-27

CHAPTER 9

Profit Planning and Flexible Budgets

E 9-61 Cash Budget For June Beginning cash balance……………………………..……………

$ 1,800

Collections: Cash sales……………………………...…………………………

18,600

Credit sales: Current month ($58,000 × 0.30)…………………………… May credit sales ($35,000 × 0.40)………………………… April credit sales*…………………………………………… Total cash available………………………………………………

17,400 14,000 5,896

Less disbursements: Inventory purchases: Current month ($76,600 × 0.62 × 0.20)…………………… Prior month ($53,000 × 0.62 × 0.80)……………………… Salaries and wages…………………………………………… Rent……………………………………………………………… Taxes……………………………………………………………… Total cash needs…………………………………………… Excess of cash available over needs…………………………

$ 9,498 26,288 11,750 4,100 6,780

$57,696

58,416 $ (720)

* $28,900 × 0.20 = $5,780 $5,780 × 0.02 = $116 $5,780 + $116 = $5,896

Yes, the business does show a negative cash balance for the month of June. A negative budgeted cash balance is unacceptable. The easiest way to deal with it in the short term would be for the owner to consider taking less cash salary. If this is a frequent occurrence, the owner should find ways to increase sales, decrease costs, or both.

9-28

CHAPTER 9

E 9-62 1.

Flexible Budget for Cost Formula

Direct materials…………… Direct labor………………… Variable overhead………… Fixed overhead…………… Total………………………… 2.

Profit Planning and Flexible Budgets

$14.00 27.00 1.80 6,800

3,500 units

4,000 units

4,500 units

$ 49,000 94,500 6,300 6,800 $156,600

$ 56,000 108,000 7,200 6,800 $178,000

$ 63,000 121,500 8,100 6,800 $199,400

Unit cost at 3,500 units = $156,600/3,500 = $44.74 Unit cost at 4,000 units = $178,000/4,000 = $44.50 Unit cost at 4,500 units = $199,400/4,500 = $44.31 The cost per unit goes down as the number of units produced increases because fixed cost is spread over a greater number of units.

9-29

CHAPTER 9

Profit Planning and Flexible Budgets

E 9-63 1.

Cerium Inc. Overhead Budget For the Coming Year Formula Variable costs: Maintenance…………………………………………… Power…………………………………………………… Indirect labor…………………………………………… Total variable costs…………………………………… Fixed costs: Maintenance…………………………………………… Indirect labor…………………………………………… Rent……………………………………………………… Total fixed costs……………………………………… Total overhead costs………………………………………

$0.20 0.68 3.70

Activity Level 58,000 Hours $ 11,600 39,440 214,600 $265,640

$ 113,000 140,000 35,000 $288,000 $553,640

Direct Labor Hours for 15% Higher Production

= 58,000 + 0.15(58,000) = 66,700

Direct Labor Hours for 15% Lower Production

= 58,000 – 0.15(58,000) = 49,300 Activity Level

Formula Variable costs: Maintenance………………………… Power………………………………… Indirect labor……………………… Total variable costs……………… Fixed costs: Maintenance………………………… Indirect labor……………………… Rent………………………………… Total fixed costs…………………… Total overhead costs…………………

$0.20 0.68 3.70

9-30

66,700 Hours

49,300 Hours

$ 13,340 45,356 246,790 $305,486

$ 9,860 33,524 182,410 $225,794

$ 113,000 140,000 35,000 $288,000 $593,486

$ 113,000 140,000 35,000 $288,000 $513,794

CHAPTER 9

Profit Planning and Flexible Budgets

E 9-64 Performance Report Actual Direct labor hours based on actual……………………………… Overhead: Maintenance………………………………… Power………………………………………… Indirect labor……………………………… Rent…………………………………………… Total overhead………………………………… * Maintenance = ($0.20 × 60,000) + $113,000 = $125,000 Power = $0.68 × 60,000 = $40,800 Indirect labor = ($3.70 × 60,000) + $140,000 = $362,000

9-31

Budgeted*

Variance

60,000

—

$126,800 40,300 361,400 35,000 $563,500

$125,000 40,800 362,000 35,000 $562,800

$1,800 U 500 F 600 F 0 $700 U

CHAPTER 9

Profit Planning and Flexible Budgets

PROBLEMS P 9-65 Aragon and Associates Schedule of Cash Receipts For August and September August Cash fees……………………………………………..………….…… Received from sales in: June (0.75 × 0.26 × $200,000 × 1.03)………… July (0.75 × 0.60 × $190,000)………………… (0.75 × 0.26 × $190,000 × 1.03)………… August (0.75 × 0.10 × $194,000)………………… (0.75 × 0.60 × $194,000)………………… September (0.75 × 0.10 × $240,000)………………… Total……………………………………………………………………

September

$ 48,500

$ 60,000

40,170 85,500

— — 38,162

14,550

$188,720

87,300 18,000 $203,462

P 9-66 Allison Manufacturing For the Quarter Ended March 31

1. a.

Schedule 1: Sales Budget Units…………………… × Selling price………… Sales……………………

January

February

March

Total

40,000 $205 $8,200,000

50,000 $205 $10,250,000

60,000 $205 $12,300,000

150,000 $205 $30,750,000

February

March

Total

Schedule 2: Production Budget January Sales (Schedule 1)…… Desired ending inventory……………… Total needs…………… Less: Beginning inventory……………… Units to be produced………………

40,000

50,000

60,000

150,000

40,000 80,000

48,000 98,000

48,000 108,000

48,000 198,000

32,000

40,000

48,000

32,000

48,000

58,000

60,000

166,000

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Prof

P 9-66 (Continued) c.

Schedule 3: Direct Materials Purchases Budget January Metal Component Units to be produced………… × Direct materials……………… Production needs………………… Desired ending inventory…………… Total needs…………… Less: Beginning inventory…………… Direct materials to be purchased……… × Cost per unit……… Total cost

February Component Metal

March Metal Component

48,000

58,000

60,000

480,000

288,000

580,000

348,000

600,000

360,000

290,000 770,000

174,000 462,000

300,000 880,000

180,000 528,000

308,000 * 908,000

184,800 * 544,800

240,000

144,000

290,000

174,000

300,000

180,000

530,000 $8 $4,240,000

318,000 $5 $1,590,000

590,000 $8 $4,720,000

354,000 $5 $1,770,000

608,000 $8 $4,864,000

364,800 $5 $1,824,000

* April Production = 60,000 + (62,000 × 0.80) – 48,000 = 61,600 Desired Ending Inventory of Metal = (61,600 × 10) × 0.50 = 308,000 Desired Ending Inventory of Components = (61,600 × 6) × 0.50 = 184,800

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Profit Planning and Flexible Budgets

P 9-66 (Continued) d. Schedule 4: Direct Labor Budget January Units to be produced (Schedule 2)……………… × Direct labor time per unit (hours)………… Total hours needed……………………… × Cost per hour Total cost…………………

February

March

Total

48,000

58,000

60,000

166,000

144,000 $14.25 $2,052,000

174,000 $14.25 $2,479,500

180,000 $14.25 $2,565,000

498,000 $14.25 $7,096,500

January

February

March

Total

e. Schedule 5: Overhead Budget Budgeted direct labor (Schedule 4)………… × Variable overhead rate……………… Budgeted variable overhead………… Budgeted fixed overhead…………… Total overhead…………

144,000

174,000

180,000

498,000

$2.40

$345,600

$417,600

$432,000

$1,195,200

338,000 $683,600

338,000 $755,600

338,000 $770,000

1,014,000 $2,209,200

9-34

CHAPTER 9

Profit Planning and Flexible Budgets

P 9-66 (Continued) f.

Schedule 6: Selling and Administrative Expenses Budget Planned sales (Schedule 1)…………………… × Variable selling and admistrative expenses per unit……………… Total variable expenses……… Fixed selling and administrative expenses: Salaries……………………… Depreciation………………… Other…………………………… Total fixed expenses Total selling and administrative expenses……………………

January

February

40,000

50,000

60,000

150,000

$3.60 $144,000

$3.60 $180,000

$3.60 $216,000

$3.60 $540,000

$ 50,000 40,000 20,000 $110,000

$150,000 120,000 60,000 $330,000

$254,000

$290,000

$326,000

$870,000

9-35

March

Total

CHAPTER 9

Profit Planning and Flexible Budgets

P 9-66 (Continued) g. Schedule 7: Ending Finished Goods Inventory Budget Unit cost computation: Direct materials: Metal (10 lbs. × $8)…………………………… Components (6 units × $5)………………… Direct labor (3 × $14.25)…………………………

$80 30

Overhead: Variable (3 × $2.40)…………………………… Fixed [3 × ($1,014,000/498,000)]…………… Total unit cost……………………………………

$110.00 42.75 7.20 6.11 * $166.06

*Rounded

Finished goods inventory

= Units × Unit Cost = 48,000 × $166.06 = $7,970,880

h. Schedule 8: Cost of Goods Sold Budget Direct materials used (Schedule 3) Metal (1,660,000 × $8)*…………………………………… Components (996,000 × $5)**…………………………… Direct labor used (Schedule 4)……………………………… Overhead (Schedule 5)……………………………………… Budgeted manufacturing costs………………………… Add: Beginning finished goods (32,000 × $166.06)***……………………………………… Cost of goods available for sale………………………… Less: Ending finished goods (Schedule 7)……………… Budgeted cost of goods sold…………………………… * 166,000 units × 10 lbs. per unit = 1,660,000 ** 166,000 units × 6 components per unit = 996,000 *** See Schedules 2 and 7.

9-36

$13,280,000 4,980,000

$18,260,000 7,096,500 2,209,200 $27,565,700 5,313,920 $32,879,620 7,970,880 $24,908,740

CHAPTER 9

Profit Planning and Flexible Budgets

P 9-66 (Continued) i. Schedule 9: Budgeted Income Statement Sales (Schedule 1)……………………………………………………………………… $30,750,000 24,908,740 Less: Cost of goods sold (Schedule 8)……………………………………………… Gross margin………………………………………………………………………… $ 5,841,260 870,000 Less: Selling and administrative expenses (Schedule 6)………………………… Operating income…………………………………………………………………… $ 4,971,260 j. Schedule 10: Cash Budget Beginning balance………… Cash receipts……………… Cash available……………… Less disbursements: Purchases (Sch. 3)…… Direct labor (Sch. 4)…… Overhead (Sch. 5)……… Selling & admin. (Sch. 6)……… Total……………………… Tentative ending balance………… Borrowed/repaid…………… Interest paid………………… Ending balance…………

January

February

$ 400,000 8,200,000 $8,600,000

$ 50,000 10,250,000 $10,300,000

495,004 12,300,000 $12,795,004

$5,830,000 2,052,000 483,600

$ 6,490,000 2,479,500 555,600

$ 6,688,000 2,565,000 570,000

$19,008,000 7,096,500 1,609,200

214,000 $8,579,600

250,000 $ 9,775,100

286,000 $10,109,000

750,000 $28,463,700

20,400 29,600

$ 2,686,004 0

50,000

$ 2,686,300 0 (296) $ 2,686,004

524,900 (29,600) (296) * 495,004

March

$ 2,686,004

Total 400,000 30,750,000 $31,150,000

*0.12 × 1/12 × $29,600 = $296

Note: Depreciation is not a cash item and so does not appear in the cash budget. 2. Answers will vary.

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CHAPTER 9

Profit Planning and Flexible Budgets

P 9-67 1.

Direct Labor Hours

= (80,000 bags × 0.20 hour) + (80,000 bags × 0.30 hour) = 16,000 hours + 24,000 hours = 40,000 direct labor hours

Healthy Pet Company Overhead Budget For the Coming Year Formula Variable costs: Maintenance…………………………… $0.50

Activity Level 40,000 Hours* $20,000

Power……………………………………

0.40

16,000

Indirect labor………………………… Total variable costs………………… Fixed costs: Maintenance…………………………… Indirect labor………………………… Rent…………………………………… Total fixed costs……………………… Total overhead costs……………………

2.10

84,000

* Based on Requirement 1

9-38

$120,000 $57,250 43,500 39,000 139,750 $259,750

CHAPTER 9

P 9-68 1. Direct Labor Hours for 10% Higher Direct Labor Hours for 20% Lower 2.

Profit Planning and Flexible Budgets

= 40,000 + (0.10 × 40,000 hours) 44,000 = 40,000 – (0.20 × 40,000 hours) 32,000

10% higher: Healthy Pet Company Overhead Budget For the Coming Year Formula

Activity Level 44,000 Hours*

Variable costs: Maintenance……………………………

$0.50

$22,000

Power……………………………………

0.40

17,600

Indirect labor…………………………… Total variable costs…………………… Fixed costs: Maintenance…………………………… Indirect labor…………………………… Rent……………………………………… Total fixed costs………………………… Total overhead costs………………………

2.10

92,400 $132,000 $57,250 43,500 39,000 139,750 $271,750

20% lower: Healthy Pet Company Overhead Budget For the Coming Year Formula

Activity Level 32,000 Hours*

Variable costs: Maintenance……………………………

$0.50

$16,000

Power……………………………………

0.40

12,800

2.10

67,200

* Based on Requirement 1 9-39

$ 96,000 $57,250 43,500 39,000 139,750 $235,750

CHAPTER 9

Profit Planning and Flexible Budgets

P 9-69 1. Direct Labor Hours

= (100,000 bags × 0.20 hour) + (90,000 bags × 0.30 hour) = 20,000 hours + 27,000 hours = 47,000 direct labor hours

Healthy Pet Company Performance Report For the Current Year Actual

Budgeted*

Variance

Units produced…………………………

190,000

Production unit: Maintenance………………………… Power………………………………… Indirect labor………………………… Rent…………………………………… Total costs……………………………

$ 81,300 18,700 143,600 39,000 $282,600

$ 80,750 18,800 142,200 39,000 $280,750

$ 550 U 100 F 1,400 U 0 $1,850 U

* Flexible budget amounts are based on 47,000 DLH:

Maintenance:

$57,250 + ($0.50 × 47,000)

= $80,750

Power:

$0.40 × 47,000

= $18,800

Indirect labor:

$43,500 + ($2.10 × 47,000)

= $142,200

All of the variances are small (less than 1% of budgeted amounts). Most would probably view the variances as immaterial. Reasons for variances are numerous. For example, an unfavorable maintenance variance could be caused by more preventive maintenance or by decreased efficiency by individual maintenance workers. Indirect labor could be unfavorable because (among other things) higherpriced labor was used to carry out lower-skilled jobs. Power could be less expensive than planned because of a rate decrease. An investigation would be needed to know exactly why the variances occurred.

9-40

CHAPTER 9

Profit Planning and Flexible Budgets

P 9-70 1. To determine accounts payable as of June 30, a schedule of purchases will be constructed. This schedule will also be used to build the cash budget. Let X = Cost of Sales If X + 0.25X = Sales, then X = Sales/1.25. For example, for August, Cost of Sales = Sales/1.25 = $100,000/1.25 = $80,000 Cost of sales…………………… Desired end. inventory*……… Total requirements………… Less: Beg. inventory………… Purchases…………………

June

July

August

September

$ 96,000 36,000 $132,000 48,000 $ 84,000

$ 72,000 40,000 $112,000 36,000 $ 76,000

$ 80,000 54,000 $134,000 40,000 $ 94,000

$108,000 44,000 $152,000 54,000 $ 98,000

*0.50 × Next Month’s Cost of Sales

Since purchases are paid for in the following month, accounts payable at the end of June is $84,000. Inventory for June 30 is $36,000. Accounts receivable for June 30 is computed as follows: From June: 0.70 × $120,000 × 0.80……………………………………………… From May: 0.70 × $100,000 × 0.30……………………………………………… Total A/R……………………………………………………………………………

$67,200 21,000 $88,200

* By June 30, 20% of June credit sales and 70% of May credit sales have been collected, leaving 80% and 30%, respectively, to be collected.

Given accounts payable, the total liabilities plus stockholders’ equity must equal $562,750 ($84,000 + $210,000 + $268,750). Cash is the difference between total assets and all other assets except cash ($562,750 – $425,000 – $36,000 – $88,200). This difference is $13,550. Total liabilities plus stockholders’ equity……………………………………… Cash…………………………………..…………………………..…………………… Assets Cash…………………………………………...…………………… Accounts receivable………………………..…………………… Inventory…………………..………………………………………… Plant and equipment, net…………………..…………………… Accounts payable………………………...……………………… Common stock……………………………….…………………… Retained earnings……………………...………………………… Total…………………………..…………………………………

9-41

$562,750 13,550 L & OE

$ 13,550 88,200 36,000 425,000

$562,750

$ 84,000 210,000 268,750 $562,750

CHAPTER 9

Profit Planning and Flexible Budgets

P 9-70 (Continued) Grange Retailers Cash Budget For the Quarter Ending September 30

Beginning cash balance…… Cash collections*…………… Total cash available……… Cash disbursements: Purchases**………………… Salaries and wages……… Utilities……………………… Other………………………… Property taxes…………… Advertising fees…………… Lease………………………… Total disbursement……… Minimum cash balance……… Total cash needs………… Excess (deficiency)…………… Financing: Borrowings………………… Repayments……………… Interest***…………………… Total financing Ending cash balance……

July

August

September

Total

$ 13,550 102,600 $116,150

$ 10,450 100,700 $111,150

$ 10,360 113,300 $123,660

$ 13,550 316,600 $330,150

$ 84,000 10,000 1,000 1,700 15,000

$ 76,000 10,000 1,000 1,700

$ 94,000 10,000 1,000 1,700

$254,000 30,000 3,000 5,100 15,000 6,000 5,000 $318,100 10,000 $328,100 $ 2,050

6,000 $111,700 10,000 $121,700 $ (5,550) $

$ 94,700 10,000 $104,700 $ 6,450

5,000 $111,700 10,000 $121,700 $ 1,960

6,000

0 0 $ 0 $ 11,960

6,000 (6,000) (90) $ (90) $ 11,960

$ 6,000 $ 10,450

$ (6,000) (90) $ (6,090) $ 10,360

$ 27,000

$ 30,000

$ 40,500

$ 97,500

12,600 42,000 21,000 $102,600

14,000 31,500 25,200 $100,700

18,900 35,000 18,900 $113,300

45,500 108,500 65,100 $316,600

* Cash collections: Cash sales…………………… Credit sales: Current month……………… Prior month…………………… From two months ago……… Total collections………………

** Taken from the purchase schedule developed in Requirement 1 *** $6,000 × 0.09/12 × 2 months = $90 Note: Depreciation is not a cash expense and so does not appear in the budget.

9-42

CHAPTER 9

Profit Planning and Flexible Budgets

P 9-70 (Continued) 3.

Grange Retailers Balance Sheet September 30 Assets

Cash………………………………………………………………… Accounts receivable a…………………………………………… Inventory b………………………………………………………… Plant and equipment c…………………………………………… Accounts payable b……………………………………………… Common stock…………………………………………………… Retained earnings d………………………………………………

$ 11,960 96,600 44,000 413,000

Total………………………………………………………………

$565,560

L & OE

$ 98,000 210,000 257,560 $565,560

(0.70 × $135,000 × 0.80) + (0.70 × $100,000 × 0.30) = $96,600

From purchases schedule prepared in Requirement 1

$425,000 – (3 × $4,000) = $413,000

If total assets equal $565,560, then liabilities plus stockholders’ equity must also equal that amount. Subtracting accounts payable and common stock from total liabilities and stockholders’ equity gives retained earnings of $257,560.

Cash budgets are important in loan decisions to help determine the company’s ability to repay the loan. A statement of cash flows would also be helpful to see how cash has been generated and used in the past. Another key report is the balance sheet so that the loan officer can assess the current level of indebtedness and the assets that would be available to claim should the company default. Reliability of historical financial reports can be increased through an audit by an independent CPA. The CPA might also be asked to examine the assumptions and reasonableness of a cash budget.

9-43

CHAPTER 9

Profit Planning and Flexible Budgets

P 9-71 When Eisenhower said “planning is everything,” he was no doubt referring to the extensive planning process he undertook to plan the D-Day invasion of Normandy. That plan was comprehensive and took into account the manpower needed, probable German response, and even the weather. However, once the invasion grew closer, Eisenhower had to respond to changes in the assumptions underlying the plan. He had to change the plan in response to changes in important factors. It is in that sense that “the plan is nothing.” He had no problem deviating from the original plan if it seemed warranted. In business, planning is crucial. The master budgeting process is the planning process. During that process, all resources and opportunities of the firm are considered. The budget committee gathers information from all areas of the firm as well as from outsiders. Then, the best plan is developed. The plan will be used for continual planning during the coming year as well as control. If the underlying factors change (e.g., the economy, demand for the company’s products, responses of competitors), then the budget must be adapted to fit those changes. However, if the underlying factors do not change, then the plan can be used as a benchmark, and performance can be compared to it. Some might say that the process where the budget committee gathers and assesses all the inputs is the key to a well-run company. That process forces management to look 360 degrees at the resources and opportunities of the company. That knowledge, in turn, helps management make good decisions when circumstances inevitably change.

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CHAPTER 9

Profit Planning and Flexible Budgets

P 9-72 Feinberg Company Cash Budget For the Month of July Beginning cash balance………………………………………………………

27,000

Collections: Cash sales (0.40 × $1,140,000)………….………………………………

456,000

Credit sales: July: a With discount ………………………………………………………… Without discountb……………………………………………………… Junec………………………………………………………………………… Mayd………………………………………………………………………… Sale of old equipment……………………………………………………….… Total cash available………………………………………………………

150,822 153,900 162,000 87,000 25,200 $1,061,922

Less disbursements: Raw materials: e July …………………………………………………………….……… f June …………………………………………………………….……… Direct labor………………………………………………………..……… Operating expenses………………………………………………..…… Dividends…………………………………………………………..……… Equipment…………………………………………………………..……… Total disbursements…………………………………………..……… Minimum cash balance…………………………………………..…………… Total cash needs…………………………………………………..……… Excess of cash available over needs……………………………………… Ending cash balance………………………………………………………

$ 156,000 148,200 105,000 325,000 130,000 173,000 $1,037,200 20,000 $1,057,200 $ 4,722 $ 24,722

a b c d e f

(0.60 × $1,140,000) × 0.45 × 0.50 × 0.98 = $150,822 (0.60 × $1,140,000) × 0.45 × 0.50 = $153,900 (0.60 × $900,000) × 0.30 = $162,000 (0.60 × $580,000) × 0.25 = $87,000 July Payment = $1,200,000 × 0.26 × 0.50 = $156,000 June Payment = $1,140,000 × 0.26 × 0.50 = $148,200

9-45

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CHAPTER 9

Profit Planning and Flexible Budgets

P 9-73 1. Schedule 1: Sales Budget (units and budgeted sales in thousands) Units……………… Unit price………… Total sales…………

Qtr. 1

Qtr. 2

Qtr. 3

Qtr. 4

Total

65 $400 $26,000

70 $400 $28,000

75 $400 $30,000

90 $400 $36,000

300 $400 $120,000

Qtr. 1

Qtr. 2

Qtr. 3

Qtr. 4

Total

65,000

70,000

75,000

90,000

300,000

13,000 78,000

15,000 85,000

20,000 95,000

10,000 100,000

10,000 310,000

0 78,000

13,000 72,000

15,000 80,000

20,000 80,000

0 310,000

2. Schedule 2: Production Budget Sales (Sch. 1)…… Desired ending inventory………… Total needs……… Less: Beginning inventory………… Production………

9-46

CHAPTER 9

Profit Planning and Flexible Budgets

P 9-73 (Continued) 3. Schedule 3: Direct Materials Purchases Budget (in thousands) Production……………… × Materials/unit………… Production needs……… Desired ending inventory……………… Total needs……………… Less: Beginning inventory……………… Purchases……………… × Cost per unit………… Purchase cost…………

Qtr. 1

Qtr. 2

Qtr. 3

Qtr. 4

Total

78.0 3 234.0

72.0 3 216.0

80.0 3 240.0

310.0 3 930.0

63.0 297.0

67.5 283.5

81.0 321.0

65.7 305.7

65.7 995.7

65.7 231.3 $80 $18,504

63.0 220.5 $80 $17,640

67.5 253.5 $80 $20,280

81.0 224.7 $80 $17,976

65.7 930.0 $80 $74,400

4. Schedule 4: Direct Labor Budget (in thousands, except per unit/hour data) Production……………… × Hours per unit………… Hours needed…………… × Cost per hour………… Total cost………………

Qtr. 1

Qtr. 2

Qtr. 3

Qtr. 4

Total

78 5 390 $10 $3,900

72 5 360 $10 $3,600

80 5 400 $10 $4,000

310 5 1,550 $10 $15,500

5. Schedule 5: Overhead Budget (in thousands, except per unit/hour data) Qtr. 1

Qtr. 2

Qtr. 3

Qtr. 4

Total

Budgeted hours………… × Variable rate…………

390 $6

360 $6

400 $6

1,550 $6

Budgeted VOH………… Budgeted FOH………… Total OH…………………

$2,340 1,000 $3,340

$2,160 1,000 $3,160

$2,400 1,000 $3,400

$ 9,300 4,000 $13,300

6. Schedule 6: Selling and Administrative Expenses Budget (in thousands, except per unit/hour data) Planned sales…………… × Variable rate………… Variable expenses…… Fixed expenses………… Total expenses…………

Qtr. 1

Qtr. 2

Qtr. 3

Qtr. 4

Total

65 $10 $650 250 $900

70 $10 $700 250 $950

75 $10 $ 750 250 $1,000

90 $10 $ 900 250 $1,150

300 $10 $3,000 1,000 $4,000

9-47

CHAPTER 9

Profit Planning and Flexible Budgets

P 9-73 (Continued) 7. Schedule 7: Ending Finished Goods Inventory Budget Unit cost computation: Direct materials (3 units @ $80)…………………………………………… Direct labor (5 units @ $10)………………………………………………… Overhead: Variable (5 units @ $6)……………………………………………………… Fixed ($4,000,000/310,000)*………………………………………………… Total unit cost……………………………………………………………………… Finished goods (10,000 × $332.90)……………………………………………

240.00 50.00

30.00 12.90 * $ 332.90 $3,329,000

*Rounded

8. Schedule 8: Cost of Goods Sold Budget Direct materials used (Schedule 3)…………………………………………… Direct labor used (Schedule 4)…………………………………..……………… Overhead (Schedule 5)…………………………………………………………… Budgeted manufacturing costs………………………………………………… Add: Beginning finished goods inventory (Schedule 7)……………………………………………………………………… Cost of goods available for sale……………………………………………… Less: Ending finished goods inventory (Schedule 7)……………………………………………………………………… Budgeted cost of goods sold……………………………………………………

$ 74,400,000 15,500,000 13,300,000 $103,200,000 0 $103,200,000 3,329,000 $ 99,871,000

9. Cash Budget (in thousands) Beginning cash……… Collections: Credit sales: Current quarter…… Prior quarter……… Cash available……… Less disbursements: Direct materials: Current quarter…… Prior quarter……… Direct labor………… Overhead…………… Selling and admin. . Dividends…………… Equipment………… Total cash needs…… Ending cash………

Qtr. 1

Qtr. 2

Qtr. 3

Qtr. 4

Total

250

$ 1,110

$ 3,128

$ 5,568

22,100 3,300 $25,650

23,800 3,900 $28,810

25,500 4,200 $32,828

30,600 4,500 $40,668

102,000 15,900 $118,150

$ 9,252 7,248 3,900 2,990 850 300

$ 8,820 9,252 3,600 2,810 900 300

$10,140 8,820 4,000 3,050 950 300

$24,540 $ 1,110

$25,682 $ 3,128

$27,260 $ 5,568

$ 8,988 10,140 4,000 3,050 1,100 300 2,000 $29,578 $11,090

$ 37,200 35,460 15,500 11,900 3,800 1,200 2,000 $107,060 $ 11,090

9-48

250

CHAPTER 9

Profit Planning and Flexible Budgets

P 9-73 (Continued) 10.

Optima Company Pro Forma Income Statement For the Year Ending December 31, 20X1 Sales (Schedule 1)…………………………………..………………………… Less: Cost of goods sold (Schedule 8)…………………………..………… Gross margin………………………..……………………………..………… Less: Selling and administrative expenses (Schedule 6)……………… Income before taxes……………………...…………………………………

$120,000,000 99,871,000 $ 20,129,000 4,000,000 $ 16,129,000

Optima Company Pro Forma Balance Sheet December 31, 20X1

11.

Assets Cash……………………………………………...……………………………… Accounts receivable………………………………….………………………… Direct materials inventory……………………………..……………………… Finished goods inventory…………………………..………………………… Plant and equipment, neta…………………………..………………………… Total assets………………………...…………………………………………

$11,090,000 5,400,000 5,256,000 3,329,000 33,900,000 $58,975,000

Liabilities and Stockholders’ Equity Accounts payable…………………………………...………………………… Capital stock……………………………….…………………………………… Retained earningsb………………………………..…………………………… Total liabilities and stockholders’ equity…………………………………

$ 8,988,000 27,000,000 22,987,000 $58,975,000

Beginning plant and equipment Add: New equipment………………………………...……………… Less: Depreciation expense (for year)………………...………… Ending plant and equipment……………………………..…………

$33,500,000 2,000,000 (1,600,000) $33,900,000

Beginning retained earnings……………………..………………… Add: Net income……………………………………………………. Less: Dividends paid……………………………..………………… Ending retained earnings………………………...…………………

$ 8,058,000 16,129,000 (1,200,000) $22,987,000

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CHAPTER 9

Profit Planning and Flexible Budgets

P 9-74 1.

Willison Company Direct Materials Purchases Budget for Fabric For the Fourth Quarter Units to be produced………………… × DM per unit (yds.)………………….. Production needs…………………. Desired ending inventory (yds.)…… Total needs…………………..……… Less: Beg. inventory…………………. DM to be purchased (yds.)……… × Cost per yard…………………..…… Total purchase cost…………………

November

December

Total

20,000 0.2 4,000 1,200 5,200 600 4,600 $3.50 $16,100

40,000 0.2 8,000 750 8,750 1,200 7,550 $3.50 $26,425

25,000 0.2 5,000 900 5,900 750 5,150 $3.50 $18,025

85,000 0.2 17,000 900 17,900 600 17,300 $3.50 $60,550

Willison Company Direct Materials Purchases Budget for Polyfiberfill For the Fourth Quarter Units to be produced………………… × DM per unit (oz.)…………………..… Production needs…………………. Desired ending inventory (oz.)……… Total needs…………………..……… Less: Beg. inventory…………………. DM to be purchased (oz.)………… × Cost per ounce…………………..…… Total purchase cost…………………

October

November

December

Total

20,000 6 120,000 72,000 192,000 36,000 156,000 $0.05 $7,800

40,000 6 240,000 45,000 285,000 72,000 213,000 $0.05 $10,650

25,000 6 150,000 54,000 204,000 45,000 159,000 $0.05 $7,950

85,000 6 510,000 54,000 564,000 36,000 528,000 $0.05 $26,400

Total

Willison Company Direct Labor Budget For the Fourth Quarter Units to be produced………………… × Direct labor time per unit (hours)…………………..………… Total hours needed…………………..… × Wages per hour…………………..… Total direct labor cost………………

October

November

December

20,000

40,000

25,000

85,000

0.10 2,000 $15.50 $31,000

0.10 4,000 $15.50 $62,000

0.10 2,500 $15.50 $38,750

0.10 8,500 $15.50 $131,750

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Profit Planning and Flexible Budgets

P 9-75 Schedule of Cash Receipts

August

September

Cash sales: ($75,000 × 0.75)….…………………………………..……………… ($80,000 × 0.75)….…………………………………..……………… Checks*………………………………..…………………..……………… Total…………………………….…………………………..…………

$56,250 18,231 $74,481

$60,000 19,446 $79,446

* Check collections for: (0.25 × $75,000)….…………………………………..…………… (0.25 × $80,000)….…………………………………..……………

$18,750 $20,000

Less: Bad checks (0.02 × $18,750)….…………………………………..…………… (0.02 × $20,000)….…………………………………..……………

(375)

Less: Service charge [($18,750/$65) × $0.50]….…………………………………..…… [($20,000/$65) × $0.50]….…………………………………..……

(144) **

(400)

$18,231

(154) ** $19,446

**Rounded

July 2.

August

September

a. Revised cash sales estimates: ($60,000 × 1.20 × 0.05)…………………..……… ($75,000 × 1.20 × 0.05)…………………..……… ($80,000 × 1.20 × 0.05)…………………..………

$ 3,600 $ 4,500 $ 4,800

Revised credit card sales: ($60,000 × 1.20 × 0.95)…………………..……… ($75,000 × 1.20 × 0.95)…………………..……… ($80,000 × 1.20 × 0.95)…………………..……… Revised total sales…………………..……………… b. Number of credit card transactions: August ($85,500/$50) = 1,710 September ($91,200/$50) = 1,824

9-51

68,400 85,500 $72,000

$90,000

91,200 $96,000

CHAPTER 9

Profit Planning and Flexible Budgets

P 9-75 (Continued) 3.

August

September

Cash sales: ($90,000 × 0.05)….…………………………………..…… ($96,000 × 0.05)….…………………………………..……

$ 4,500 $ 4,800

Credit card receipts net of discount: 4,022 *

From July ($68,400 × 0.98 × 0.06)…………………..… From August: ($85,500 × 0.98 × 0.94)…………………..…………… ($85,500 × 0.98 × 0.06)…………………..…………… From September ($91,200 × 0.98 × 0.94)………………

78,763 *

Less: Gateway and statement fee…………………..………… Transaction fees:…………………..………………………

(19)

1,710 × $0.25…………………..……………………… 1,824 × $0.25…………………..……………………… Total…………………..………………………………..………

5,027 * 84,013 * (19)

(428) * $86,838

(456) $93,365

*Rounded

Yes, if Jordana moves away from checks to credit cards, incoming cash will be substantially higher (12,347, 13,919) for the two months analyzed. Of course, this assumes that the net 20% increase in sales is accurate. This is a substantial increase so Jordana may wish to analyze the change in cash at different levels of sales so she knows what range of sales must occur to make the change beneficial. Having this additional information will help her make a good decision.

9-52

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Profit Planning and Flexible Budgets

CASES Case 9-76 Answers will vary. Case 9-77 1.

Dr. Roger Jones Cash Budget Cash collections and cash available*…………………………………………

$21,360

Less cash disbursements: Salaries…………………………………………………………………………… Benefits………………………………………………………………………… Building lease…………………………………………………………………… Dental supplies………………………………………………………………… Janitorial………………………………………………………………………… Utilities…………………………………………………………………………… Phone…………………………………………………………………………… Office supplies………………………………………………………………… Lab fees………………………………………………………………………… Loan payments………………………………………………………………… Interest payments……………………………………………………………… Miscellaneous………………………………………………………………… Total cash needs…………………………………………………………………… Deficiency of cash available over needs………………………………………

$12,700 1,344 1,500 1,200 300 400 150 100 5,000 570 500 200 $23,964 $ (2,604)

*Total revenues for a month: Fillings ($50 × 90)……………………………… Crowns ($300 × 19)…………………………… Root canals ($170 × 8)………………………… Bridges ($500 × 7)……………………………… Extractions ($45 × 30)………………………… Cleaning ($25 × 108)………………………… X-rays ($15 × 150)………………………………

$ 4,500 5,700 1,360 3,500 1,350 2,700 2,250 $21,360

The budget shows that there is $2,604 more cash going out than coming in.

9-53

CHAPTER 9

Profit Planning and Flexible Budgets

Case 9-77 (Continued) 2.

Dr. Jones must either increase revenues to make up the deficiency or cut costs or a combination of the two. Three possible approaches are outlined as follows: a.

Extend office hours so that a total of 40 hours are worked each week. This could increase revenues by as much as $5,340. Based on a four-week month, the current revenue earned per hour is $166.88 ($21,360/128). Thus, the total revenue increase possible is $166.88 × 32 hours = $5,340. Dr. Jones would need to inform his assistants and receptionist of the increased time and indicate that each will receive a 25% increase in salary for the additional time. (The office is currently open 32 hours per week.) Benefits (primarily FICA and unemployment insurance benefits) would also increase. Other expenses that will likely increase with an increase in sales are dental supplies, lab fees, and utilities (representing about 31% of sales). The remaining expenses appear to be fixed. Thus, the increase in cash flow is computed as follows: Incremental revenues……………………….……………… Salary increases (0.25 × $3,400)…………...……………… Benefits [($1,344/$12,700) × $850]……...………………… Variable expenses (0.31 × $5,340)………………………… Cash flow increase…………………...……………………

$ 5,340 (850) (90) (1,655) $ 2,745

Approach 1 carries with it some risk. Increasing office hours may not increase business. If business does not increase as expected, the cash flow problems could be aggravated rather than relieved. The likelihood of increasing business would be increased if the additional hours are offered in the early evening instead of Friday afternoon. Evening hours are a major convenience for patients who must work during the day and are reluctant to lose work hours.

9-54

CHAPTER 9

Profit Planning and Flexible Budgets

Case 9-77 (Continued) Dr. Roger Jones Revised Cash Budget Cash collections and cash available ($21,360 + $5,340)………………...

$26,700

Less cash disbursements: Salaries ($12,700 + $850)………...…..……..……………………...…..… Benefits ($1,344 + $90)………...…..……..……………………...…..…… Building lease………………………………………………………………… Dental supplies ($1,200 + $301*)………...…..……..…………………… Janitorial……………………………………………………………………… Utilities ($400 + $100*)………...…..……..……………………...…..……. Phone………………………………………………………………………… Office supplies……………………………………………………………… Lab fees ($5,000 + $1,254*)………...…..……..……………………...…..… Loan payments……………………………………………………………… Interest payments…………………………………………………………… Miscellaneous………………………………………………………………… Total cash needs………………………………………………………………… Excess cash available over needs……………………………………………

$13,550 1,434 1,500 1,501 300 500 150 100 6,254 570 500 200 $26,559 $ 141

* Dental supplies, utilities, and lab fees are variable expenses. The proportion of total variable expenses of each is: % Dental supplies

$1,200

18.2%

Utilities

400

6.1%

Lab fees Total

5,000 $6,600

75.8%

Additional expense ($5,340 × 31%, rounded) in each category (rounded to the nearest dollar): Dental supplies ($1,655 × 18.2%) = $301 Utilities ($1,655 × 6.1%) = $100 Lab fees ($1,655 × 75.8%) = $1,254

Cut one dental assistant, eliminate the salary to Mrs. Jones and the activities she does, and cut Dr. Jones’s salary back by $1,000 per month: The savings are as follows: Assistant (salary and benefits)*……………………………………………… Salaries………………………………….………………………………………… Total…………………………………………………..…………………………

$1,051 2,000 $3,051

* ($1,900/2) + [($950/$12,700) × $1,344] = $1,051. (This provides a reasonable approximation of the benefits assigned to an assistant.)

9-55

CHAPTER 9

Profit Planning and Flexible Budgets

Case 9-77 (Continued) Although this achieves the savings, the solution may not be feasible. The solution depends to a large extent on how well the Jones family can do with a $2,000 per month cut in their income. In all likelihood, this would be unacceptable to the Jones family. Also, cutting an assistant would require the receptionist to become involved in assisting. This may not be possible without laying off the receptionist and hiring a person that has both sets of skills. Additionally, using the receptionist as an assistant woud result in phone calls going unanswered and/or incoming patients being ignored. c.

A third possibility is to increase the fees charged for the various dental services. Assuming a variable cost ratio of 31% (from the first approach), the increase in revenues needed to cover the $2,604 deficiency can be computed as follows: 0.69 R = $2,604 R = $2,604/0.69 R = $3,774 This increase would call for fees to increase an average of 17.7%. Whether this increase is possible or not depends to some extent on how Dr. Jones’s charges compare with other dentists in the area. If some increase is possible, then the increase could be combined with elements of the other two approaches (e.g., a 10% increase in fees and working an extra 4 hours per week, say, on Wednesday evening). I would expect Dr. Jones to be more likely to accept a combination like the one just mentioned rather than accepting any of the approaches in their pure form. The behavioral principles discussed in the chapter do have a role in this type of setting. Dr. Jones’s personal goals must be in line with the goals of his professional organization, and he must have the motivation to achieve those goals. There is, however, a significant difference. Dr. Jones owns and manages the organization. To a large extent, his goals are the goals of the organization.

Case 9-78 1.

Linda’s behavior is not ethical. In the budgeting process, she is deliberately misrepresenting the capabilities of her division for personal gain. To ensure that she achieves budget (either this year or next), she manipulates accounting procedures. This manipulation is in opposition to generally accepted accounting principles. Her decisions are based on her self-interest rather than on the interests of the company. Deceptive and manipulative behavior for personal gain is clearly wrong. The company's bonus program, which appears to focus on short-term results, may inadvertently be encouraging the bad behavior.

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Profit Planning and Flexible Budgets

Case 9-78 (Continued) 2.

There are few, if any, legitimate reasons for deferring the closing of sales. Thus, if a marketing manager was asked to engage in this behavior, the first response must be to find out why the request is being made. If there is no sound reason offered, then a simple refusal should suffice. If it takes on the nature of an order and no sound reason exists, then the marketing manager should consider appealing to a higher-level manager. Certainly, deferral of closings so that it increases the likelihood of meeting budget for the coming year is not a sound reason, and, in fact, is wrong.

It would be hard to go against a common practice that seems to have the approval of the plant managers. The widespread knowledge of the practice may even suggest that higher-level management is aware of it and essentially condones the practice—or at least adjusts for it. If higher-level management is aware of the practice and adjusts for it, then the ability to achieve a bonus may not be enhanced as much as believed. The plant manager could investigate and find out the extent to which upper-level management is aware of padding. At the same time, the manager could obtain some advice on what his behavior ought to be. If told that the practice is acceptable, then the manager has to decide whether to continue in an organization that accepts deceptive behavior (or go against the grain and simply report what he or she feels is really achievable by the plant).

This is a clear violation of the ethical code for management accountants. A management accountant is obligated to report information fairly and objectively and to disclose all information that can be expected to influence a user’s understanding of accounting reports. Moreover, management accountants must perform their duties in accordance with relevant laws, regulations, and technical standards. Accelerating the recognition of expenses violates generally accepted accounting principles. Your first step would be to explain to the division manager that this action is wrong. If the division manager persists, you might ask him/her to put the request in writing. This will often solve the problem, as the division manager would likely not want his/her name attached to this order. If it does not, you should continue up the chain of command and/or inform the audit committee or the board of directors.

9-57

STANDARD COSTING AND VARIANCE ANALYSIS DISCUSSION QUESTIONS

Standard costs are essentially budgeted amounts on a per-unit basis. Unit standards serve as inputs in building budgets.

Unit standards are used to build flexible budgets. Unit standards for variable costs are the variable cost component of a flexible budgeting formula.

Historical experience is often a poor choice for establishing standards because the historical amounts may include more inefficiency than is desired.

Ideal standards are perfection standards, representing the best possible outcomes. Currently attainable standards are standards that are challenging but allow some waste. Currently attainable standards are often chosen because many feel they tend to motivate rather than frustrate.

Standard costing systems are adopted because they tend to improve planning and control and facilitate product costing.

By identifying standards and assessing deviations from the standards, managers can locate areas where change or corrective behavior is needed.

Actual costing assigns actual manufacturing costs to products. Normal costing assigns actual prime costs and budgeted overhead costs to products. Standard costing assigns budgeted manufacturing costs to products.

A standard cost sheet presents the standard quantity and price for each input and uses this information to calculate the unit standard cost.

Production managers generally tend to have more control over the quantity of an input used rather than the price paid per unit of input.

10.

A standard cost variance should be investigated if the variance is material and if the benefit labor of investigating and correcting the deviation is greater than the cost of doing so.

11.

Control limits indicate how large a variance must be before it is judged to be material and the process is out of control. Control limits are usually set by judgment although statistical approaches are occasionally used.

12.

Control charts are a data visualization tool. They allow managers to see variance trends and visually signal that a process is out of control.

13.

MPV is often computed at the point of purchase rather than issuance because it provides contro information sooner. Also, the quantity purchased may be higher than the quantity issued.

14.

Disagree. A materials usage variance can be caused by factors beyond the control of the production manager, e.g., purchase of a lower (or higher) quality of material than normal.

10-1

CHAPTER 10 Standard Costing and Variance Analysis

15.

Disagree. Using higher-priced workers to perform lower-skilled tasks is an example of an event that will create a labor rate variance that is controllable.

16.

Some possible causes of an unfavorable labor efficiency variance are inefficient labor, machine downtime, and poor-quality materials.

17.

A kaizen standard is the planned improvement for the coming period. Usually, kaizen focuses on costs in the manufacturing section of the value chain. Kaizen costing is "continuous improvement" costing. Continous improvement is achieved by setting kaizen standards for each period.

18.

Target costing is a cost management method that is used to reduce costs to a level that reflects a product’s functions and market demands and management’s return requirements. Costs are reduced by such actions as working with suppliers to reduce the cost of parts and improving (redesigning) the processes that will be used.

19.

Part of a variable overhead spending variance can be caused by inefficient use of overhead resources.

20.

Agree. This variance, assuming that variable overhead costs increase as labor usage increases, is caused by the efficiency or inefficiency of labor usage.

21.

The variable overhead efficiency variance values the difference between the actual hours and the hours allowed using the standard variable overhead rate, while the labor efficiency variance values the difference using the standard labor rate.

22.

The volume variance occurs when the actual volume differs from the expected volume used to compute the predetermined standard fixed overhead rate. An unfavorable volume variance occurs when the actual volume is less than the expected volume. Thus, an unfavorable volume variance means that actual production is less than expected.

23.

If the actual volume is different from the expected, then the company has either lost or earned contribution margin. The volume variance signals this outcome, and if the variance is large, then the loss or gain is large since the volume variance understates the effect.

24.

The spending variance. This variance is computed by comparing actual expenditures with budgeted expenditures. The volume variance simply tells whether the actual volume is different from the expected volume.

10-2

CHAPTER 10 Standard Costing and Variance Analysis

MULTIPLE-CHOICE QUESTIONS 10-1.

10-2.

10-3.

10-4.

10-5.

10-6.

10-7.

10-8.

10-9.

10-10.

10-11.

10-12.

10-13.

10-14.

10-15.

10-16.

10-17.

10-18.

10-19.

10-20.

10-21.

10-3

CHAPTER 10 Standard Costing and Variance Analysis

BRIEF EXERCISES: SET A BE 10-22 1. Oats allowed:

= Unit Quantity Standard × Actual Output = 16 × 960,000 = 15,360,000 ounces

Hours allowed:

= Unit Quantity Standard × Actual Output = 0.04 × 960,000 = 38,400 hours

BE 10-23

70,000 Upper control limit

65,000 60,000

Lower control limit

55,000 50,000 45,000 40,000 0

The variances that exceed the upper limit of $66,000 should be investigated. The graph clearly signals some type of process instability. BE 10-24 Actual Costs AQ × AP 1,875,000 × $0.10 $187,500

Budgeted Costs

Total Variance

SQ × SP 450,000 × 4.7 × $0.08 $169,200

(AQ × AP) – (SQ × SP) $187,500 – $169,200 $18,300 U

10-4

CHAPTER 10 Standard Costing and Variance Analysis

BE 10-25 MPV

= (AP – SP)AQ = ($0.10 – $0.08)1,875,000 oz. = $37,500 U

MUV

= (AQ – SQ*)SP = (1,875,000 – 2,115,000)$0.08 = $19,200 F AP × AQ $0.10 × 1,875,000 $187,500

SP × AQ $0.08 × 1,875,000 $150,000 $37,500 U Price

SP × SQ* $0.08 × 2,115,000 $169,200 $19,200 F Usage

* SQ = 4.7 × 450,000 = 2,115,000

BE 10-26 Actual Costs AH × AR 25,200 hrs. × $15.00 $378,000

Budgeted Costs

Total Variance

SH × SR 900,000 × 0.03 × $13.50 $364,500

(AH × AR) – (SH × SR) $378,000 – $364,500 $13,500 U

BE 10-27 LRV

= (AR – SR)AH = ($15.00 – $13.50)25,200 = $37,800 U

LEV

= (AH – SH*)SR = (25,200 – 27,000)$13.50 = $24,300 F SR × AH $13.50 × 25,200 $340,200

AR × AH $15.00 × 25,200 $378,000

SR × SH* $13.50 × 27,000 $364,500 $24,300 F Usage

$37,800 U Price * SH = 0.03 × 900,000 = 27,000

10-5

CHAPTER 10 Standard Costing and Variance Analysis

BE 10-28 = Actual units × SH per unit

1. SH for actual production

= $15,000 × 4 = 60,000 hours 2. Applied Variable Overhead

= SH × SVOR = 60,000 × $3.75 = $225,000

3. Actual variable overhead…………………………… Applied variable overhead…………………………… Total variable overhead variance…………………

$222,816 225,000 $ 2,184

BE 10-29 1. Columnar approach: 1. Actual VOH

2. AH × SVOR

3. SH × SVOR

$222,816

57,200 × $3.75 $214,500

60,000 × $3.75 $225,000

$8,316 U

$10,500 F

Spending

Efficiency

2. Variable Overhead Spending Variance

= Actual VOH – (SVOR x AH) = $222,816 – ($3.75 × 57,200) = $(8,316) U

3. Variable Overhead Efficiency Variance

= (AH – SH) SVOR = (57,200 – 60,000)$3.75 = $10,500 F

4. Variable overhead spending variance……………………………… Variable overhead efficiency variance……………………………… Total variable overhead variance……………………………………

10-6

$ 8,316 U 10,500 F $ 2,184 F

Chapter 10

Standa

BE 10-30 Overhead Cost Item

Cost Formula

Inspection………………………… Power……………………………… Total…………………………………

$2.20 1.87 $4.07

Actual Cost

Budget for Actual Spending Variance Hours*

$123,300 104,600 $227,900

$134,640 114,444 $249,084

$11,340 F 9,844 F $21,184 F

Budge At Standard Hours**

$132,000 112,200 $244,200

* 61,200 x $2.20 = $134,640 61,200 x $1.87 = $114,444 ** 60,000 x $2.20 = $132,000 60,000 x $1.87 = $112,200

10-7

CHAPTER 10 Standard Costing and Variance Analysis

BE 10-31 1.

Standard Hours for Actual Units

= SH per Unit × Actual Units Produced = 4 × 15,000 = 60,000

Applied Fixed Overhead

= Standard Hours for Actual Units × SFOR = 60,000 × $5 = $300,000

Actual fixed overhead………………………… Applied fixed overhead……………………… Total fixed overhead variance………………

$301,680 300,000 $ 1,680 U

BE 10-32 1.

Applied FOH

Columnar approach: 1. Actual FOH $305,000

2. BFOH

3. SH × SFOR

$300,000

64,000 × $5.00 $320,000

$5,000 U Spending

$20,000 F Volume

Fixed Overhead Spending Variance

= Actual FOH – BFOH = 5,000 U

Fixed Overhead Volume Variance

= BFOH – (SH × SFOR) = $20,000 F

Fixed overhead spending variance………… Fixed overhead volume variance…………… Total fixed overhead variance………………

10-8

5,000 U 20,000 F $ 15,000 F

CHAPTER 10 Standard Costing and Variance Analysis

BRIEF EXERCISES: SET B BE 10-33 1.

Cocoa Beans Allowed

= Unit Quantity Standard × Actual Output = 400 × 700,000 = 280,000,000 beans

Hours Allowed

= Unit Quantity Standard × Actual Output = 0.12 × 700,000 = 84,000 hours

BE 10-34

Control Chart $55,000

Actual Costs

$50,000 $45,000 $40,000 $35,000 $30,000 0

Week

The variances that exceed the upper limit of $45,000 should be investigated. The graph clearly signals some type of process instability.

BE 10-35 Actual Costs AQ × AP 110,000 × $0.042 $4,620

Budgeted Costs

Total Variance

SQ × SP 240,000 × 0.45 × $0.045 $4,860

(AQ × AP) – (SQ × SP) $4,6250 – $4,860 $240 F

10-9

CHAPTER 10 Standard Costing and Variance Analysis

BE 10-36 MPV

= (AP – SP)AQ = ($0.042 – $0.045)110,000 oz. = -$330 F

MUV

= (AQ – SQ*)SP = (110,000 – 108,000)$0.045 = $90 U

AP × AQ $0.042 × 110,000 $4,620

SP × AQ $0.045 × 110,000 $4,950

SP × SQ* $0.045 × 108,000 $4,860

-$330 F Price

$90 U Usage

* SQ = 0.45 × 240,000 = 108,000

BE 10-37 Actual Costs AH × AR 19,000 hrs. × $15.50 $294,500

Budgeted Costs

Total Variance

SH × SR 500,000 × 0.04 × $15.00 $300,000

(AH × AR) – (SH × SR) $294,500 – $300,000 $5,500 F

BE 10-38 LRV

= (AR – SR)AH = ($15.50 – $15.00)19,000 = $9,500 U

LEV

= (AH – SH*)SR = (19,000 – 20,000)$15.00 = $15,000 F

AR × AH $15.50 × 19,000 $294,500

SR × AH $15.00 × 19,000 $285,000 $9,500 U Price

SR × SH* $15.00 × 20,000 $300,000 $15,000 F Usage

* SH = 0.04 × 500,000 = 20,000

10-10

CHAPTER 10 Standard Costing and Variance Analysis

BE 10-39 1.

= Actual units × SH per unit

SH for actual production

= 20,000 × 4 = 80,000 hours 2.

Applied Variable Overhead

= SH × SVOR = 80,000 × $4.00 = $320,000

Actual variable overhead…………………………………… Applied variable overhead………………………………… Total variable overhead variance…………………………

$328,000 320,000 $ 8,000 U

BE 10-40 1.

Applied FOH

Columnar approach: 1. Actual VOH

2. AH × SVOR

3. SH × SVOR

$335,750

69,200 × $4.70 $325,240

70,000 × $4.70 $329,000

$10,510 U

$3,760 F

Spending

Efficiency

Variable Overhead Spending Variance

= Actual VOH – (SVOR × AH) = $335,750 – ($4.70 × 69,200) = $(10,510) U

Variable Overhead Efficiency Variance

= (AH – SH)SVOR = (69,200 – 70,000)$4.70 = $3,760 F

Variable overhead spending variance……………………………………… Variable overhead efficiency variance……………………………………… Total variable overhead variance………………………………………………

10-11

$10,510 U 3,760 F $ 6,750 U

Chapter 10

Standard Costing and Variance Analysis

BE 10-41 Overhead Cost Item

Inspection…………………………… Power………………………………… Total……………………………………

Cost Formula

$2.00 3.00 $5.00

Budget for Spending Variance

Actual Cost

Actual Hours

$162,000 220,600 $382,600

$154,000 231,000 $385,000

$ 8,000 U 10,400 F $ 2,400 F

Bud At Standard Hours

$150,000 225,000 $375,000

10-12

CHAPTER 10 Standard Costing and Variance Analysis

BE 10-42 1.

Standard Hours for Actual Units

= SH per Unit × Actual Units Produced = 6 × 20,000 = 120,000

Applied Fixed Overhead

= Standard Hours for Actual Units × SFOR = 120,000 × $8 = $960,000

Actual fixed overhead………………………… Applied fixed overhead……………………… Total fixed overhead variance………………

$985,300 960,000 $ 25,300 U

BE 10-43 1.

Applied FOH

Columnar approach: 1. Actual FOH $425,000

2. BFOH

3. SH × SFOR

$500,000

42,500 × $10.00 $425,000

$75,000F Spending

$75,000 U Volume

Fixed Overhead Spending Variance

Actual FOH – BFOH $75,000F

Fixed Overhead Volume Variance

BFOH – SH × SFOR $75,000 U

Fixed overhead spending variance………… Fixed overhead volume variance…………… Total fixed overhead variance………………

10-13

$ 75,000 F 75,000 U $ 0

CHAPTER 10 Standard Costing and Variance Analysis

EXERCISES E 10-44 1.

SH = 5 × 15,000 = 75,000 hours

SQ = 1 × 15,000 = 15,000 kits SQ = 1 × 15,000 = 15,000 cabinets

SH = Unit Labor Standard × Units Produced Units Produced = SH/Unit Labor Standard = 15,000 hrs./5 hrs. per unit = 3,000 units

E 10-45 1.

Cases needing investigation: Week 2:

Exceeds the 10% rule.

Week 4:

Exceeds the $12,000 rule and the 10% rule.

Week 5:

Exceeds the 10% rule.

The purchasing agent is responsible. Corrective action would require a return to the purchase of the higher-quality material normally used.

Production engineering is responsible. If the relationship of the variances is expected to persist, then the new labor method should be adopted and standards for materials and labor need to be revised.

E 10-46 1. 2.

Materials: $18 × 92,000 = $1,656,000 Labor: $12 × 92,000 = $1,104,000 Actual Cost* Materials…………… $1,552,500 Labor………………… $1,290,300

Budgeted Cost

Variance

$1,656,000 $1,104,000

$103,500 F $186,300 U

* $5.40 × 287,500 = $1,552,500; $16.50 × 78,200 = $1,290,300 3.

Yes, the labor variance exceeds the budget by more than 10%, and the absolute dollar amount of the materials variance is also large enough to merit investigation, especially since the materials and labor variances can be interconnected. If there is an underlying ongoing cause, the company could continue losing money without corrective action.

The data analytic type for Requirement 1 is prescriptive as the calculation signals what the labor and materials costs should be (likely to occur). The data analytic type that best fits Requirements 2 and 3 is diagnostic as the calculation triggers an investigation into the causes of the difference between actual and budgeted costs.

10-14

CHAPTER 10 Standard Costing and Variance Analysis

E 10-47 1.

MPV

= (AP – SP)AQ = ($5.40 – $6.00)287,500 strips = $172,500 F

MUV

= (AQ – SQ*)SP = (287,500 – 276,000)$6.00 = $69,000 U

AP × AQ $5.40 × 287,500 $1,552,500

SP × AQ $6.00 × 287,500 $1,725,000 $172,500 F Price

SP × SQ* $6.00 × 276,000 $1,656,000 $69,000 U Usage

Total Variance = $172,500 F + $69,000 U = $103,500 F * SQ = 3 × 92,000 = 276,000 2.

As the plant manager realized, the suggestion of the purchasing manager is premature. A favorable materials price can produce an effect on both materials usage and labor variances. For example, if the quality of the materials is much lower, such things as more waste, more rework, and overtime may more than offset the favorable materials price variance. Thus, feedback from the production manager on the effect of the cheaper materials on materials usage and labor variances is also needed. Furthermore, variance trends are important. Checking a control chart for the past several months would also reveal potential effects of the new material, especially if the materials usage and labor variances dramatically shifted out of limits during the month the new materials were first used. Clearly, the diagnostic role of data analytics requires both subjective and objective information and interaction effects are critical.

E 10-48 1.

LRV

= (AR – SR)AH = ($16.50 – $16.00)78,200 = $39,100 U

LEV

= (AH – SH*)SR = (78,200 – 69,000)$16.00 = $147,200 U AR × AH $16.50 × 78,200 $1,290,300

SR × AH $16.00 × 78,200 $1,251,200 $39,100 U Rate

SR × SH* $16.00 × 69,000 $1,104,000 $147,200 U Efficiency

Total Variance = $39,100 U + $147,200 U = $186,300 U * SH = 0.75 × 92,000 = 69,000

10-15

CHAPTER 10 Standard Costing and Variance Analysis

E 10-48 (Continued) 2. The feedback from the production manager pinpoints the cause of the variances. The favorable materials variance is apparently due to the purchase of a much lower quality of leather strips which are causing the unfavorable materials usage, labor rate, and labor efficiency variances. The total net variance = (MPV + MUV) + LRV + LUV = $103,500 F + $39,100 U + $147,200 = $82,800 U. Based on past performance and the fact that the net variance is large and unfavorable, the corrective action needed is to return to suppliers that provide the quality corresponding to the price standard. With the correctly purchased quality of materials, the process should return to a more efficient operating state. Certainly, many of the amounts calculated describe what is (such as the actual cost of materials and labor) and, therefore, these calculations are clearly descriptive . There are also amounts calculated that show what the costs should be (such as the standard cost of materials), and so prescriptive is also present. However, the main thrust of the analysis is diagnostic, attempting to identify why the variances occurred. Predictive also plays a role as there is an implicit assumption that the net unfavorable variance will continue if the current quality of materials continues to be purchased. E 10-49 1.

MPV

= (AP – SP)AQ = ($0.035 – $0.04)2,650,000 = $13,250 F

MUV

= (AQ – SQ*)SP = (2,650,000 – 2,560,000)$0.04 = $3,600 U

* SQ = 128 × 20,000 = 2,560,000 3.

MUV = (AQ – SQ)SP $3,200 = [2,000,000 – 128(Quantity Produced)] × $0.04 80,000 = 2,000,000 – 128(Quantity Produced) 128(Quantity Produced) = 1,920,000 Quantity Produced = 15,000 gallons MPV = (AP – SP)AQ $10,000 = (AP – $0.04)2,000,000 $10,000 = 2,000,000AP – $80,000 $90,000 = 2,000,000AP AP = $0.045

E 10-50 1.

LRV

= (AR – SR)AH = ($15.50 – $15.00)540,000 = $270,000 U

LEV

= (AH – SH*)SR = (540,000 – 550,000)$15.00 = $150,000 F

* SH = 0.50 × 1,100,000 = 550,000

10-16

CHAPTER 10 Standard Costing and Variance Analysis

E 10-51 1.

MPV

= (AP – SP)AQ = ($3.95 – $4.00)2,060,000 = $103,000 F

MUV

= (AQ – SQ*)SP = (2,100,000 – 2,000,000)$4.00 = $400,000 U

Note : There is no 3-pronged analysis for materials because materials purchased is different from the materials issued. (Materials purchased is used for MPV and materials issued for MUV.) * SQ = 5 × 400,000 = 2,000,000 2.

LRV

= (AR – SR)AH = ($14.85 – $15.00)825,000 = $123,750 F

LEV

= (AH – SH**)SR = (825,000 – 800,000)$15.00 = $375,000 U AR × AH $14.85 × 825,000 $12,251,250

SR × AH $15.00 × 825,000 $12,375,000 $123,750 F Rate

SR × SH** $15.00 × 800,000 $12,000,000 $375,000 U Efficiency

** SH = 2 × 400,000 = 800,000 E 10-52 1.

Tom purchased the large quantity to obtain a lower price so that the price standard could be met. In all likelihood, given the reaction of Jackie Iverson, encouraging the use of quantity discounts was not an objective of setting price standards. Usually, material price standards are to encourage the purchasing agent to search for sources that will supply the quantity and quality of material desired at the lowest price.

It sounds like the price standard may be out of date. Revising the price standard and implementing a policy concerning quantity purchases would likely prevent this behavior from reoccurring.

Probably not. Tom was recently rewarded for meeting price standards and perhaps did not realize that the company does not have space for quantity purchases. It is a common way to save on costs. New price standards and guidelines regarding limitations on quantity purchases should prevent this type of situation from recurring. 10-17

CHAPTER 10 Standard Costing and Variance Analysis

E 10-53 Materials: AP × AQ

SP × AQ $0.95 × 79,500 $75,525

$63,000 $12,525 F Price

SP × SQ* $0.95 × 72,000 $68,400 $7,125 U Usage

Labor: AR × AH

SR × AH $7.40 × 22,450 $166,130

$163,385 $2,745 F Rate

SR × SH** $7.40 × 22,500 $166,500 $370 F Efficiency

* SQ = 2.40 × 30,000 = 72,000 ** SH = 0.75 × 30,000 = 22,500

E 10-54 Journal Date 1.

Account & Explanation Materials MPV Accounts Payable

Debit 75,525

Credit 12,525 63,000

Work in Process MUV Materials

68,400 7,125

Work in Process LRV LEV Accrued Payroll

166,500

MPV LRV LEV

12,525 2,745 370

75,525

2,745 370 163,385

MUV Cost of Goods Sold

10-18

7,125 8,515

CHAPTER 10 Standard Costing and Variance Analysis

E 10-55 1. MPV = (AP – SP)AQ = ($8.35 – $8.25)38,000 = $3,800 U MUV = (AQ – SQ*)SP = (37,500 – 38,400)$8.25 = $7,425 F (The 3-pronged variance diagram is not shown because MPV is for materials purchased and not materials issued, and the two differ.) * SQ = 12 × 3,200 = 38,400 2.

Journal Date

Account & Explanation Materials MPV Accounts Payable

Debit 313,500 3,800

Work in Process MUV Materials

316,800

Credit

317,300

7,425 309,375

E 10-56 1.

LRV = (AR* – SR)AH = ($9.80 – $9.65)25,040 = $3,756 U LEV = (AH – SH**)SR = (25,040 – 25,600)$9.65 = $5,404 F AR × AH $9.80 × 25,040 $245,392

SR × AH $9.65 × 25,040 $241,636 $3,756 U Rate

SR × SH $9.65 × 25,600 $247,040 $5,404 F Efficiency

* AR = $245,392/25,040 = $9.80 ** SH = 2 × 12,800 = 25,600 2.

Journal Date

Account & Explanation Work in Process LRV LEV Accrued Payroll

10-19

Debit 247,040 3,756

Credit

5,404 245,392

CHAPTER 10 Standard Costing and Variance Analysis

E 10-57 1.

Standard direct labor hours required:

= Actual Deliveries × Standard Direct Labor Hours = 38,600 × 0.80 = 30,880 direct labor hours

Variable overhead analysis: Actual VOH

Budgeted VOH

Applied VOH

$157,700

$5.10 × 31,000 hours $158,100

$5.10 × 30,880 hours $157,488

$400 F Spending

E 10-58 1. Standard Fixed Overhead Rate (SFOR)

$612 U Efficiency

Budgeted Fixed Overhead Practical Capacity

= $400,000/32,000 DLH = $12.50 2.

Fixed overhead analysis: Actual FOH

Budgeted FOH

Applied FOH

$403,400

$12.50 × 32,000 hours $400,000

$12.50 × 30,880 hours $386,000

$3,400 U Spending

$14,000 U Volume

10-20

CHAPTER 10 Standard Costing and Variance Analysis

E 10-59 1.

Variable overhead analysis: Actual VOH

Budgeted VOH

Applied VOH

$112,400

$0.70 × 158,900 $111,230

$0.70 × 159,200* $111,440

$1,170 U

$210 F

Spending

Efficiency

* Standard Hours = 2 hours × 79,600 units = 159,200 hours 2.

Fixed overhead analysis: Actual FOH

Budgeted FOH

Applied FOH

$831,000

$5.20 × 160,000* $832,000

$5.20 × 159,200** $827,840

$1,000 F

$4,160 U

Spending

Volume

* Practical Volume in Hours = 2 hours × 80,000 units = 160,000 hours ** Standard Hours = 2 hours × 79,600 units = 159,200 hours

E 10-60 1.

Fixed Overhead Rate = $832,500/450,000* = $1.85 per DLH SH = 594,000 units × 0.75 direct labor hour = 445,500 hours Applied FOH = $1.85 × 445,500 = $824,175 * Budgeted Hours = 600,000 units × 0.75 direct labor hours = 450,000 hours

Fixed overhead analysis: Actual FOH

Budgeted FOH

Applied FOH

$835,600

$1.85 × 450,000 $832,500

$1.85 × 445,500 $824,175

$3,100 U

$8,325 U

Spending

Volume

Variable OH Rate

Variable overhead analysis:

= ($1,777,500 – $832,500)/450,000 hours = $2.10 per DLH

Actual VOH

Budgeted VOH

Applied VOH

$928,000

$2.10 × 446,000 $936,600

$2.10 × 445,500 $935,550

$8,600 F

$1,050 U

Spending

Efficiency 10-21

CHAPTER 10 Standard Costing and Variance Analysis

E 10-61 1. Total Applied Fixed Overhead

= (Standard Hours per Unit × Actual Units) × SFOR = (0.9 × 143,000) × $11 = $1,415,700

2. Budgeted Fixed Overhead

= (Standard Hours per Unit × Budgeted Units) × SFOR = (0.9 × 140,000) × $11 = $1,386,000

3. Actual Fixed Overhead

= Budgeted Fixed Overhead + Unfavorable Overhead Spending Variance = $1,386,000 + $24,000 = $1,410,000

4. Total Applied Variable Overhead

= (Standard Hours per Unit × Actual Units) × SVOR = (0.9 × 143,000) × $6.36 = $818,532

5. Budgeted Variable Overhead Based on Actual Hours

= Applied Variable Overhead + Unfavorable Variable Overhead Efficiency Variance = $818,532 + $1,272 = $819,804

Actual Direct Labor Hours 6. Actual Variable Overhead

= $819,804/$6.36 = 128,900 = Budgeted Variable Overhead + Unfavorable Variable Overhead Spending Variance = $819,804 + $9,196 = $829,000

10-22

Chapter 10 Standa

E 10-62 Anker Company Performance Report For the Year Ended December 31 Budget for

a b c d e

Actual

Cost

Cost a Formula

Cost

Actual Hoursb

Spending c Variance

Stan Ho

Indirect labor…………………………………… Supplies………………………………………… Total…………………………………………

$24.00 2.40 $26.40

$36,000 3,800 $39,800

$35,760 3,576 $39,336

$240 U 224 U $464 U

Per direct labor hour Computed using the cost formula and 1,490 actual hours Spending Variance = Actual Costs – Budget for Actual Hours Computed using the cost formula and 1,500 standard hours for actual production Efficiency Variance = Budget for Actual Hours – Budget for Standard Hours

10-23

CHAPTER 10 Standard Costing and Variance Analysis

PROBLEMS P 10-63 1.

The managers of each cost center should be involved in setting standards. They understand the actual conditions and are the primary source for information on quantity used and wages paid. The newly designated materials purchasing manager is the information source for material prices. Since this is a new position, that individual may not have much information to share, and Annette should go directly to those that did the purchasing in the past. The Accounting Department, in conjunction with Production, should be able to develop standards and should provide information about past prices and usage.

Standards should be attainable and they should include an allowance for waste, breakdowns, etc. Market prices for materials as well as labor (unions) should be a consideration for setting standards.

Once the standards are set, actual results can be compared with the standards and variances can be calculated. Of course, the variances themselves are only indicators of potential problems. The underlying causes of the variances must be determined to decide whether or not corrective action is needed. For this reason, responsibility for the variances will be assigned to those with the most information about them. The variances that will most likely be calculated are: Materials Purchase Price Variance—responsibility for this variance lies with the supervisor who was designated the materials purchasing manager. This individual can explain why materials prices were or were not equal to the standard amounts. Materials Usage Variance—responsibility for this variance lies with the manager in charge of the production department. This individual knows how much was produced and whether or not the amount of materials used equaled the standard. Labor Rate Variance—responsibility for this variance lies with the manager in charge of the production department. Again, this individual knows whether or not the wage rate used equaled the standard. Labor Usage Variance—responsibility for this variance lies with the manager in charge of the production department. This individual knows how much was produced and whether or not the amount of labor used equaled the standard.

10-24

CHAPTER 10 Standard Costing and Variance Analysis

P 10-64 1.

Materials: AP × AQ $3.55 × 69,000 $244,950

SP × AQ $3.50 × 69,000 $241,500 $3,450 U Price

SP × SQ* $3.50 × 72,000 $252,000 $10,500 F Usage

The new process saves 0.25 × 6,000 × $3.50 = $5,250. The decision to use the higher-quality material is a trade-off between the higher material cost (price variance) and the usage variance caused by the higher-quality material. Thus, the net savings attributable to the higher-quality material is $5,250 – $3,450 = $1,800. Keep the higher-quality material! * SQ = 12 × 6,000 = 72,000 2.

Labor for new process: AR × AH

SR × AH $11 × 10,800 $118,800

$118,800 $0 Rate

SR × SH** $11 × 10,200 $112,200 $6,600 U Efficiency

The new process saves $5,250 in materials usage (see Requirement 1) but loses $6,600 from the labor effect, giving a net loss of $1,350. If this pattern is expected to persist, then the new process should be abandoned. ** SH = 1.70 × 6,000 = 10,200 3.

Labor for new process, 1 week later: AR × AH

SR × AH $11 × 9,000 $99,000

$99,000 $0 Rate

SR × SH $11 × 10,200 $112,200 $13,200 F Efficiency

If this is the pattern, then the new process should be continued. It will save $959,400 per year ($18,450*** × 52 weeks). The weekly savings of $18,450 is the materials savings of $5,250, plus labor savings of $13,200. *** (0.25 × 6,000 × $3.50) + ($13,200 – $0) = $18,450

10-25

CHAPTER 10 Standard Costing and Variance Analysis

P 10-65 1. Granite: MPV = Actual Cost – (AQ × SP) = $79,048 – (1,640 × $50) = $2,952 F MUV

= (AQ – SQ*)SP = (1,640 – 1,600)$50 = $2,000 U

* SQ = 50 × 32 = 1,600 Glue: MPV MUV

= Actual Cost – (AQ × SP) = $2,560 – (16,000 × $0.15) = $160 U = (AQ – SQ**)SP = (16,000 – 16,000)$0.15 = $0

** SQ = 50 × 32 × 10 = 16,000 2.

Cutting Labor: LRV = (AR – SR)AH = ($15 – $15)180 = $0 LEV

= (AH – SH***)SR = (180 – 160)$15 = $300 U

*** SH = 0.10 × 32 × 50 = 160 Installation Labor: LRV = (AR – SR)AH = ($25 – $25)390 = $0 U LEV

= (AH – SH****)SR = (390 – 400)$25 = $250 F

**** SH = 0.25 × 32 × 50 = 400 3.

It would probably not be worthwhile for Charlene to establish standards for every different type of installation. Tom and Tony have a small enough operation that they can mentally decide whether or not another type of installation (e.g., one with multiple sink cuts) will be more expensive than the typical one.

10-26

CHAPTER 10 Standard Costing and Variance Analysis

P 10-66 1. Direct materials………………………… Direct labor……………………………… Variable overhead……………………… Fixed overhead………………………… Standard cost per unit……………… 2.

Standard Usage

Standard Cost

$ 4 15 8 12

25.000 0.768 0.768 0.768

$100.00 11.52 6.14 9.22 $126.88

There would be unfavorable labor efficiency variances for the first 320 units because the standard hours are much lower than the actual hours at this level. Actual hours would be approximately 409.60 (320 × 1.280), and standard hours would be 245.76 (320 × 0.768). Thus, the labor efficiency variance would be: LEV

Standard Price

= (AH – SH)SR = (409.60 – 245.76)$15 = 2,457.60 U

The cumulative average time per unit is an average . For example, the first 40 units take an average of 2.50 hours per unit. The second 40 take an average of 1.5 hours per unit [(80 × 2) – (40 × 2.5)]/40 = 1.5, and, therefore, the average for the first 80 is 2.0 per unit. Thus, as more units are produced the cumulative average time per unit will decrease. The standard should be 0.768 hour per unit as this is the average time taken per unit once efficiency is achieved: [(1.024 × 640) – (1.28 × 320)]/(640 – 320) = 0.768

10-27

CHAPTER 10 Standard Costing and Variance Analysis

P 10-67 1.

Normal delivery:

Direct materials……………………… Direct labor…………………………… Variable overhead…………………… Fixed overhead……………………… Unit cost……………………………

Standard Price

Standard Usage

Standard Cost

$10.00 16.00 30.00 40.00

9.0 lbs. 2.5 hrs. 2.5 hrs. 2.5 hrs.

$ 90.00 40.00 75.00 100.00 $305.00

Standard Price

Standard Usage

Standard Cost

$10.00 16.00 30.00 40.00

21.0 lbs. 5 hrs. 5 hrs. 5 hrs.

$210.00 80.00 150.00 200.00 $640.00

Cesarean delivery:

Direct materials……………………… Direct labor…………………………… Variable overhead…………………… Fixed overhead……………………… Unit cost…………………………… 2.

MPV = (AP – SP)AQ MPV (Normal) = ($9.50 – $10.00)35,000 = $17,500 F MPV (Cesarean) = ($9.50 – $10.00)165,000 = $82,500 F MUV = (AQ – SQ)SP MUV (Normal) = [35,000 – (9 × 4,000)]$10 = $10,000 F MUV (Cesarean) = [165,000 – (21 × 8,000)]$10 = $30,000 F

LRV = (AR – SR)AH LRV (Normal) = ($11.45* – $16.00)10,200 = $46,410 F LRV (Cesarean) = ($11.45* – $16.00)40,500 = $184,275 F LEV = (AH – SH)SR LEV (Normal) = [10,200 – (2.5 × 4,000)]$16 = $3,200 U LEV (Cesarean) = [40,500 – (5 × 8,000)]$16 = $8,000 U * ($580,350/50,700) which is rounded to the nearest cent.

Yes. Computations are shown below. MUV = (200,000 – 36,000 – 168,000)$10 = $40,000 F LEV = (50,700 – 10,000 – 40,000)$16 = $11,200 U

Answers will vary.

10-28

CHAPTER 10 Standard Costing and Variance Analysis

P 10-68 1.

Liquid Standard = 4.5 × 250,000 × $0.40 = $450,000 Upper control limit (UCL): $495,000 or $470,000; lesser = $470,000 Lower control limit (LCL): $405,000 or $430,000; lesser = $430,000 Bottle Standard = 250,000 × $0.05 = $12,500 UCL: $13,750 LCL: $11,250 Direct Labor Standard = 0.2 × 250,000 × $15.00 = $750,000 UCL: $825,000 or $770,000; lesser = $770,000 LCL: $675,000 or $730,000; lesser = $730,000

Total Liquid Variance = $567,000 – $450,000 = $117,000 U MPV = ($0.42 – $0.40)1,350,000 = $27,000 U MUV = (1,350,000 – 1,125,000)$0.40 = $90,000 U The liquid variances would be investigated as the total variance exceeds $20,000, as does each individual variance. Total Bottle Variance = $12,000 – $12,500 = $500 F MPV = ($0.048 – $0.05)250,000 = $500 F MUV = (250,000 – 250,000)$0.05 = $0 The bottle variances would not be investigated as the total variance is within the accepted limits.

Total Labor Variance = $733,000 – $750,000 = $17,000 F LRV = ($15.19* – $15.00)48,250 = $9,168 U LEV = (48,250 – 50,000)$15.00 = $26,250 F The total variance is within the limits. However, the labor efficiency variance is greater than $20,000 and should be investigated. * $733,000/48,250 = $15.19** ** Rounded to the nearest cent.

10-29

CHAPTER 10 Standard Costing and Variance Analysis

P 10-69 1.

April (UCL = Upper control limit, and LCL = Lower control limit) Materials: Price standard: $0.25 × 723,000 = $180,750 UCL: (0.08 × $180,750) + $180,750 = $14,460 + $180,750 = $195,210 LCL: ($14,460) + $180,750 = $166,290 Quantity standard: 8 × 90,000 × $0.25 = $180,000 UCL: (0.08 × $180,000) + $180,000 = $14,400 + $180,000 = $194,400 LCL: ($14,400) + $180,000 = $165,600 Labor: Price standard: $7.50 × 36,000 = $270,000 UCL: (0.08 × $270,000) + $270,000 = $21,600 + $270,000 = $291,600 LCL: ($21,600) + $270,000 = $248,400 Efficiency standard: 0.4 × 90,000 × $7.50 = $270,000 UCL: (0.08 × $270,000) + $270,000 = $21,600 + $270,000 = $291,600 LCL: ($21,600) + $270,000 = $248,400 May Materials: Price standard: $0.25 × 870,000 = $217,500 UCL: (0.08 × $217,500) + $217,500 = $17,400 + $217,500 = $234,900 LCL: ($17,400) + $217,500 = $200,100 Quantity standard: 8 × 100,000 × $0.25 = $200,000 UCL: (0.08 × $200,000) + $200,000 = $16,000 + $200,000 = $216,000 LCL: ($16,000) + $200,000 = $184,000 Labor: Price standard: $7.50 × 44,000 = $330,000 UCL: (0.08 × $330,000) + $330,000 = $26,400 + $330,000 = $356,400 LCL: ($26,400) + $330,000 = $303,600 Efficiency standard: 0.4 × 100,000 × $7.50 = $300,000 UCL: (0.08 × $300,000) + $300,000 = $24,000 + $300,000 = $324,000 LCL: ($24,000) + $300,000 = $276,000

10-30

CHAPTER 10 Standard Costing and Variance Analysis

P 10-69 (Continued) June Materials: Price standard: $0.25 × 885,000 = $221,250 UCL: (0.08 × $221,250) + $221,250 = $17,700 + $221,250 = $238,950 LCL: ($17,700) + $221,250 = $203,550 Quantity standard: 8 × 110,000 × $0.25 = $220,000 UCL: (0.08 × $220,000) + $220,000 = $17,600 + $220,000 = $237,600 LCL: ($17,600) + $220,000 = $202,400 Labor: Price standard: $7.50 × 46,000 = $345,000 UCL: (0.08 × $345,000) + $345,000 = $27,600 + $345,000 = $372,600 LCL: ($27,600) + $345,000 = $317,400 Efficiency standard: 0.4 × 110,000 × $7.50 = $330,000 UCL: (0.08 × $330,000) + $330,000 = $26,400 + $330,000 = $356,400 LCL: ($26,400) + $330,000 = $303,600 2.

Limit

April

Actual**

$8,242 U $750 U $0 $0

± ± ± ±

$14,460 14,400 21,600 21,600

4.6 % 0.4 0.0 0.0

$522 U $17,500 U $7,000 F $30,000 U

± ± ± ±

17,400 16,000 *** 26,400 24,000 ***

0.2 % 8.8 (2.1) 10.0

$8,762 U $1,250 U $15,001 U $15,000 U

± ± ± ±

17,700 17,600 27,600 26,400

4.0 % 0.6 4.3 4.5

MPV = ($0.2614* – $0.25)723,000 = MUV = (723,000 – 720,000)$0.25 = LRV = ($7.5000 – $7.50)36,000 = LEV = (36,000 – 36,000)$7.50 = May MPV = ($0.2506* – $0.25)870,000 = MUV = (870,000 – 800,000)$0.25 = LRV = ($7.3409* – $7.50)44,000 = LEV = (44,000 – 40,000)$7.50 = June MPV = ($0.2599* – $0.25)885,000 = MUV = (885,000 – 880,000)$0.25 = LRV = ($7.8261* – $7.50)46,000 = LEV = (46,000 – 44,000)$7.50 =

* Rounded ** The actual deviation divided by the total price or quantity standard. *** Investigate May’s MUV and LEV.

10-31

CHAPTER 10 Standard Costing and Variance Analysis

P 10-69 (Continued) Control charts allow us to see when the variances are outside an acceptable range. They may also show a pattern that might help in pinpointing when the problem began. Control charts: To simplify the presentation, the variances are expressed as a percentage of the total quantity or price standard, and the y-axis is used for variances. April (Month 1), May (Month 2), and June (Month 3) are presented on the x-axis. These percentages were calculated in Requirement 2.

MPV:

Percentage

8.0

0.0

‐8.0 0

Month

MUV: 8.00 Percentage

0.00

‐8.00 0

1 Month

10-32

CHAPTER 10 Standard Costing and Variance Analysis

P 10-69 (Continued)

LRV: Percentage

8.0

0.0

‐8.0 0

Month

LEV:

Percentage

8.0

0.0

‐8.0 0

1 Month

There are only two charts that show deviations that should be investigated. With sufficient observations, a pattern may help show when the problem began, such as a systematic upward or downward slope where previously the values were randomly scattered around the expected value. A significant deviation without a previous pattern or insufficient observations to see pattern, may suggest a one-time problem that was corrected, such as the purchase of more expensive materials due to a supply shortage.

10-33

CHAPTER 10 Standard Costing and Variance Analysis

P 10-70 1.

MPV = (AP – SP)AQ = ($2.05 – $2.00)49,250 = $2,463* U * Rounded to the nearest dollar.

MUV = (AQ – SQ*)SP = (49,250 – 50,000)$2.00 = $1,500 F The overall materials variance is $963 U ($2,463 U – $1,500 F); therefore, the company should not buy this quality of materials, but should go back to the prior quality. * SQ = 100,000 × 0.50 = 50,000 2.

LRV = (AR × AH) – (SR × AH) = Actual Labor Cost – (SR × AH) = $227,500 – ($15 × 14,900) = $4,000 U LEV = (SR × AH) – (SR × SH**) = ($15 × 14,900) – ($15 × 15,000) = $1,500 F The overall labor variance is $2,500 U ($4,000 U – $1,500 F). If this pattern is expected to persist, then the new layout should be abandoned.

LRV = (AR × AH) – (SR × AH) = Actual Labor Cost – (SR × AH) = $220,500 – ($15 × 14,700) = $0 LEV

= (SR × AH) – (SR × SH**) = ($15 × 14,700) – ($15 × 15,000) = $4,500 F

** SH = 100,000 × 0.15 = 15,000 The overall labor variance is $4,500 F ($0 + $4,500 F). If this pattern is the one expected to persist, then the new layout should be continued. It will save $234,000 per year ($4,500 × 52 weeks). P 10-71 1.

MPV = (AQ × AP) – (SP × AQ) = Actual Materials Cost – (SP × AQ) = $75,000 – ($1.10)68,000 = $200 U MUV = (AQ – SQ*)SP = (68,000 – 64,000)($1.10) = $4,400 U

Overall Materials Variance = $200 U + $4,400 U = $4,600 U * SQ = 16,000 × 4.00 = 64,000 2. LRV = (AR × AH) – (SR × AH) = Actual Labor Cost – (SR × AH) = $348,750 – ($16 × 22,500) = $11,250 F LEV = (SR × AH) – (SR × SH**) = ($16 × 22,500) – ($16 × 20,000) = $40,000 U ** SH = 16,000 × 1.25 = 20,000 Overall Labor Variance = $11,250 F + $40,000 U = $28,750 U

10-34

CHAPTER 10 Standard Costing and Variance Analysis

P 10-71 (Continued) 3.

The basic advantages offered by a standard costing system include its use in planning, control, and decision making. A standard costing system helps in budgeting since the unit standard costs can be multiplied by the predicted level of production to obtain total costs. Standard costs are used in control to evaluate performance. A comparison of actual costs to standard costs allows management to evaluate the performances of cost centers. Finally, standard costs assist in decision making. For example, having standard costs can make pricing decisions easier. Standard costing systems also have disadvantages. For example, standards that are set too high (e.g., theoretical or perfect standards) can cause motivation to decrease, as workers believe that they can never achieve the standards. Standards may also stand in the way of continual improvement if they are not updated frequently to adjust for gradual increases in efficiency.

P 10-72 1. MPV MUV

= (AP – SP)AQ = ($4.70 – $5.00)260,000 = $78,000 F = (AQ – SQ*)SP = (320,000 – 300,000)$5 = $100,000 U

The materials usage variance is viewed as the most controllable because prices for materials are often market-driven and thus not controllable. Responsibility for the variance in this case likely would be assigned to Purchasing. The lower-quality materials (assumed, based on the lower price paid) are probably the cause of the extra usage. * SQ = 50,000 × 6.00 = 300,000 2.

LRV LEV

= (AR – SR)AH = ($13 – $12)82,000 = $82,000 U = (AH – SH**)SR = (82,000 – 80,000)$12 = $24,000 U AR × AH $13 × 82,000 $1,066,000

SR × AH $12 × 82,000 $984,000 $82,000 U Rate

SR × SH $12 × 80,000 $960,000 $24,000 U Efficiency

** SH = 50,000 × 1.60 = 80,000

10-35

CHAPTER 10 Standard Costing and Variance Analysis

P 10-72 (Continued) Production is usually responsible for labor efficiency. In this case, efficiency may have been affected by the lower-quality materials, and Purchasing, thus, may have significant responsibility for the outcome. Other possible causes are less demand than expected, poor supervision, lack of proper training, and lack of experience. 3.

Three variances are potentially affected by material quality: MPV…………………………………… MUV…………………………………… LEV…………………………………… Net effect…………………………

$ 78,000 100,000 24,000 $ 46,000

F U U U

If the variance outcomes are largely attributable to the lower-quality materials, then the company should discontinue using this material. Journal

4. Date

Account & Explanation Materials MPV Accounts Payable

Debit 1,300,000

Credit 78,000 1,222,000

Work in Process MUV Materials

1,500,000 100,000

Work in Process LRV LEV Accrued Payroll

960,000 82,000 24,000

Cost of Goods Sold MUV LRV LEV

206,000

MPV Cost of Goods Sold

78,000

1,600,000

1,066,000

100,000 82,000 24,000

78,000

10-36

CHAPTER 10 Standard Costing and Variance Analysis

P 10-73 1.

Standard Fixed Overhead Rate

= $2,160,000/(120,000 units × 5 DLH) = $3.60 per DLH

Standard Variable Overhead Rate

= $1,440,000/(120,000 units × 5 DLH) = $2.40 per DLH

Fixed: Variable:

= $2,134,800 = $1,423,200

118,600 × 5 × $3.60 118,600 × 5 × $2.40

Total FOH Variance

= $2,150,400 – $2,134,800 = $15,600 U

Total VOH Variance

= $1,422,800 – $1,423,200 = $400 F

Fixed overhead analysis: Actual FOH

Budgeted FOH

Applied FOH

$2,150,400

$2,160,000

$2,134,800

$9,600 F Spending

$25,200 U Volume

The spending variance is the difference between planned and actual costs. Each item’s variance should be analyzed to see if these costs can be reduced. The volume variance is the incorrect prediction of volume, or alternatively, it is a signal of the loss or gain that occurred because of producing at a level different from the expected level. In this case, production was less than the normal level and that produced the unfavorable variance. 4.

Variable overhead analysis: Actual VOH

Budgeted VOH

$1,422,800

$2.40 × 592,300 hours $1,421,520 $1,280 U Spending

Applied VOH $1,423,200 $1,680 F Efficiency

The variable overhead spending variance is the difference between the actual variable overhead costs and the budgeted costs for the actual hours used. Each item's variance should be analyzed to see if these costs can be reduced. The variable overhead efficiency variance is the savings or extra cost attributable to the efficiency of labor usage because the variable overhead is applied based on labor hours. If a company applied variable overhead on a different basis, this variance would measure the efficiency of that base.

10-37

CHAPTER 10 Standard Costing and Variance Analysis

P 10-74 1. Variable overhead variances: Actual VOH

Budgeted VOH

Applied VOH

$860,000

$10 × 82,000 hrs. $820,000

$10 × 80,000 hrs $800,000

$40,000 U Spending

$20,000 U Efficiency

Formula approach: VOH Spending Variance

= Actual VOH – (SVOR × AH) = $860,000 – ($10 × 82,000) = $40,000 U

VOH Efficiency Variance

= (AH – SH)SVOR = (82,000 – 80,000)$10 = $20,000 U

2. Fixed overhead variances: Actual FOH

$556,000

Budgeted FOH

Applied FOH

$6 × 1.6 hrs. × 60,000 units

$6 × 1.6 hrs. × 50,000 units

$576,000

$480,000

$20,000 F Spending

$96,000 U Volume

The volume variance is a measure of unused capacity. This cost is reduced as production increases. Thus, selling more goods is the key to reducing this capacity (at least in the short run).

10-38

CHAPTER 10 Standard Costing and Variance Analysis

P 10-75 1.

Standard Fixed Overhead Rate

= $1,286,400/(120,000 units × 4 DLH) = $2.68 per direct labor hour

Standard Variable Overhead Rate

= $888,000/(120,000 units × 4 DLH) = $1.85 per direct labor hour

Fixed: Variable:

= $1,275,680 = $880,600

119,000 × 4 × $2.68 119,000 × 4 × $1.85

Total FOH Variance

= $1,300,000 – $1,275,680 = $24,320 Underapplied

Total VOH Variance

= $927,010 – $880,600 = $46,410 Underapplied

Fixed overhead analysis: Actual FOH

Budgeted FOH

Applied FOH

$1,300,000

$1,286,400

$1,275,680 $10,720 U Volume

$13,600 U Spending

The spending variance is the difference between planned and actual costs. Each item’s variance should be analyzed to see if these costs can be reduced. The volume variance is the incorrect prediction of volume, or alternatively, it is a signal of the loss or gain that occurred because of producing at a level different from the expected level. If practical volume is used to compute the fixed overhead rate, it is a measure of unused productive capacity. 4.

Variable overhead analysis: Actual VOH

Budgeted VOH

Applied VOH

$927,010

$1.85 × 487,900 hours $902,615

$1.85 × 476,000 hours $880,600 $22,015 U Efficiency

$24,395 U Spending

The variable overhead spending variance is the difference between the actual variable overhead costs and the budgeted costs for the actual hours used. It is similar in some ways to the direct materials and direct labor price variances, but variances can also be caused by inefficiency. The variable overhead efficiency variance is the savings or extra cost attributable to the efficiency of direct labor usage.

10-39

CHAPTER 10 Standard Costing and Variance Analysis

P 10-76 1.

The budgeted overhead costs are broken down into fixed and variable costs by the high-low method: Standard VOH Rate

Change in Cost Change in Activity

= $144,000/12,000 hours = $12 per hour FOH Rate

= Total Rate – VOH Rate = $18 – $12 = $6

Budgeted Fixed Overhead

= Y2 – VX2 = $540,000 – $12(30,000) = $180,000

FOH Spending Variance

= Actual FOH – Budgeted FOH = $200,000 – $180,000 = $20,000 U

To find the VOH spending variance, we need to find the actual hours. To find AH, we first need to find the standard hours, SH: Fixed OH Volume Variance

= Budgeted Fixed Overhead – (Fixed Overhead Rate × SH) $20,000 = $180,000 – ($6.00 × SH) $160,000 = $6.00 × SH SH = 26,667* hours

* Rounded

Next, the actual hours need to be found: VOH Efficiency Variance

= (AH – SH)SVOR

$(18,000) = (AH – 26,667) × $12 (1,500) = AH – 26,667 AH = 25,167 hours VOH Spending Variance

= Actual VOH – (VOH Rate × AH) = $310,000 – ($12 × 25,167) = $310,000 – $302,004 = $7,996 U

Unit Standard (hours allowed per unit) = SH/Actual units produced = 26,667/100,000 units = 0.2667 hours per unit

10-40

CHAPTER 10 Standard Costing and Variance Analysis

P 10-77 Shumaker Company Performance Report

Direct materials……………………… Direct labor…………………………… Variable overhead…………………… Fixed overhead……………………… Total…………………………………

Actual Costs

Costs*

Budgeted Variance

$ 775,000 590,000 310,000 180,000 $1,855,000

$ 750,000 600,000 300,000 165,000 $1,815,000

$25,000 U 10,000 F 10,000 U 15,000 U $40,000 U

* Uses the variable unit standard costs for materials, labor, and variable overhead [e.g., DM = $15 × 50,000; Fixed Overhead = $3 × 55,000 (the FOH rate is based on expected production)].

FOH variances: Spending Variance

= Actual FOH – Budgeted FOH = $180,000 – $165,000 = $15,000 U

Volume Variance

= Budgeted FOH – (FOH Rate × SH) = $165,000 – ($2.50 × 60,000) = $15,000 U

* Note: FOH rate is calculated as follows:

Hours Allowed

= 60,000 hours/50,000 units = 1.20 hours per unit

Standard FOH Rate

= $3.00 per unit/1.20 hours per unit = $2.50 per hour

VOH variances: Variable OH Rate

= $300,000/60,000 hours = $5.00 per hour

Spending Variance

= Actual VOH – (SVOR × AH) = $310,000 – ($5.00 × 63,000) = $5,000 F

Efficiency Variance

= (AH – SH)SVOR = (63,000 – 60,000)$5.00 = $15,000 U

10-41

CHAPTER 10 Standard Costing and Variance Analysis

CASES Case 10-78 1.

By using a standard costing system, Crunchy Chips can increase control of its manufacturing inputs. By developing price and quantity standards for each input, management can compute price and usage variances for each input. Since a standard costing system provides more information, control is enhanced. For example, since managers have the most control over usage of inputs, knowing the usage variances provides specific information about where action is needed. Moreover, by breaking out price variances, which are not as controllable, performance evaluation is improved.

The engineering standards are ideal standards. The president’s concern is probably reflecting doubt that the labor standards can be achieved. If pressure is applied to workers to achieve perfection standards, the outcome is likely to be unsatisfactory. Workers may become frustrated and lower their performance as a consequence. Many firms elect to use currently attainable standards in lieu of ideal standards. The standard suggested by the president is a good starting point. If experience indicates that his standard is too loose, then the standard can be adjusted later on.

10-42

CHAPTER 10 Standard Costing and Variance Analysis

Case 10-78 (Continued) 3. Standard cost sheet (for one box of chips): Direct materials: Potatoes (15.9375* lbs. @ $0.238)…….................................. $3.7931 Cooking oil (49.5 oz. @ $0.04)…………………………………… 1.9800 1.6500 Bags (15 @ $0.11)………………………………………………… 0.5200 Boxes (1 @ $0.52)…………………………………………………

$7.9431

* Pounds per box = 15 × 4 × 4.25/16 = 15.9375 Price per pound = $0.245 less scrap value; scrap per box = 15 bags × {17 oz. (4 potatoes × 4.25 oz.) − 16.3 oz.} = 10.5 oz. Scrap value/oz. = $0.16/16 oz. = $0.01 per oz. Scrap savings per box is $0.01 × 10.5 oz. = $0.105, and the savings per pound of potato is $0.105/15.9375 pounds = $0.007. Thus, the standard price per pound of potato is $0.245 – $0.007 = $0.238. Direct labor:** Potato inspection (0.006 hr. @ $15.20)………………………… $0.0912 Chip inspection (0.0225 hr. @ $10.30)………………………… 0.2318 Frying monitor (0.0118 hr. @ $14.00)………………………… 0.1652 Boxing (0.0311 hr. @ $11.00)…………………………………… 0.3421 Machine operators (0.0118 hr. @ $13.00)……………………… 0.1534 Variable overhead ($0.9837 × 1.16)………………………………. Fixed overhead ($0.9837 × 1.9671)***……………………………… Direct materials……………………………………………………… Cost per box…………………………………………………………..

$ 0.9837 1.1411 1.9350 7.9431 $12.0029

Cost per bag $12.0029/15 bags……………………………………

$ 0.8002

** Number of boxes per year = 8,800,000/15 = 586,667 Hours/box: Potato inspection: Chip inspection: Frying monitor: Boxing: Machine operators:

3,200 × 1.1/586,667 = 0.0060 12,000 × 1.1/586,667 = 0.0225 6,300 × 1.1/586,667 = 0.0118 16,600 × 1.1/586,667 = 0.0311 6,300 × 1.1/586,667 = 0.0118

*** $1,135,216/($0.9837 × 586,667) = 1.9671 (Fixed OH rate based on labor dollars.) 4. MUV = (AQ – SQ****)SP = (9,500,000 – 9,350,000)$0.238 = $35,700 U **** SQ = 15.9375 × 8,800,000/15 = 9,350,000

10-43

CHAPTER 10 Standard Costing and Variance Analysis

Case 10-79 1.

Pat’s decision was wrong and not in the best interests of the company. His concern for his bonus and promotion was apparently more important than his company’s reputation for a quality product. Unfortunately, his assessment of personal risk was probably a significant input to the decision to buy the inferior component. All too often, individuals decide to take an unethical course of action based on their assessment of their chances of getting caught. This obviously should not be a factor. What is right should be the driving concern for this type of decision.

The use of standards to evaluate performance and assess rewards apparently was influential in Pat’s decision. He clearly had a desire to receive his annual bonus and wanted to present an impressive performance profile so that he could secure a position at division headquarters. Perhaps altering the factors used for evaluating and rewarding performance and increasing the tenure of managers may decrease this type of behavior. Or perhaps we ought to spend more time emphasizing ethical behavior—maybe the problem isn’t so much the systems we use for evaluating and rewarding performance but rather the lack of commitment to ethical decision making.

Purchasing agents have ethical responsibilities similar to accountants. Integrity is a universally desirable characteristic. Pat and other purchasing agents should refrain from engaging in any activity that would prejudice their abilities to carry out their duties ethically (III 2). Organizations would be well advised to adopt a set of ethical standards. All employees should understand that certain behaviors are unacceptable.

Answers will vary.

10-44

CHAPTER 10 Standard Costing and Variance Analysis

Case 10-80 1.

Fixed Overhead Rate

= $2,400,000/600,000 hours* = $4 per hour

* Standard Hours Allowed = 2 × 300,000 units = 600,000 hours 2.

Athens plant: Actual FOH $2,500,000

Budgeted FOH

Applied FOH

$2,400,000

$4 × 600,000 hours $2,400,000

$100,000 U Spending

$0 Volume

Little Rock plant: Actual FOH $2,500,000

Budgeted FOH

Applied FOH

$2,400,000

$4 × 480,000 hours $1,920,000

$100,000 U Spending

$480,000 U Volume

The spending variance is almost certainly caused by supervisor salaries (e.g., an unexpected midyear increase due to union pressures). It is unlikely that the lease payments or depreciation would be greater than budgeted. Changing the terms on a 11-year lease in the first year would be unusual (unless there is some sort of special clause permitting increased payments for something like unexpected inflation). Also, the depreciation should be on target (unless more equipment was purchased or the depreciation budget was set before the price of the equipment was known with certainty). The volume variance is easy to explain. The Little Rock plant produced less than expected, and so there was an unused capacity cost: $4 × 120,000 hours = $480,000. The Athens plant had no unused capacity.

10-45

CHAPTER 10 Standard Costing and Variance Analysis

Case 10-80 (Continued) 3.

It appears that the 120,000-hour unused capacity (60,000 subassemblies) is permanent for the Little Rock plant. This plant has 10 supervisors, each making $50,000. Supervision is a step-cost driven by the number of production lines. Unused capacity of 120,000 hours means that two lines can be shut down, saving the salaries of two supervisors ($100,000 at the original salary level). The equipment for the two lines is owned. If it could be sold, then the money could be reinvested and the depreciation charge would be reduced by 20% (2 lines shut down out of 10). There is no way to directly reduce the lease payments for the building. Perhaps the company could use the space to establish production lines for a different product. Or perhaps the space could be subleased. Another possibility is to keep the supervisors and equipment and try to fill the unused capacity with special orders for the subassembly below the regular selling price from a market not normally served. If the selling price is sufficient to cover the variable costs and cover at least the salaries and depreciation for the two lines, then the special order option may be a possibility. This option, however, is fraught with risks (e.g., the risk of finding enough orders to justify keeping the supervisors and equipment, the risk of alienating regular customers who pay full price, and the risk of violating price discrimination laws). [Note: You may wish to point out the value of the resource usage model in answering this question (see Chapter 3)].

For each plant, the standard fixed overhead rate is $4 per direct labor hour. Since each subassembly should use 2 hours, the fixed overhead cost per unit is $8, regardless of where they are produced. Should they differ? Some may argue that the rate for the Little Rock plant needs to be recalculated. For example, one possibility is to use expected actual capacity, instead of practical capacity. In this case, the Little Rock plant would have a fixed overhead rate of $2,400,000/480,000 hours = $5 per hour and a cost per subassembly of $10. The question is: Should the subassemblies be charged for the cost of the unused capacity? ABC suggests a negative response. Products should be charged for the resources they use, and the cost of unused capacity should be reported as a separate item to draw management’s attention to the need to manage this unused capacity.

10-46

PERFORMANCE EVALUATION AND DECENTRALIZATION DISCUSSION QUESTIONS

In centralized decision making, decisions are made at the very top level, and lower-level managers are responsible for implementing these decisions. For decentralized decision making, decisions are made and implemented by lower-level managers.

Decentralization is the delegation of decision-making authority to lower levels.

Reasons for decentralization include access to local information, cognitive limitations, more timely responses, focusing of central management, training, and motivation.

Margin reveals how much sales revenue remains as operating income (after subtracting expenses). Turnover reveals how many sales dollars result from each dollar invested in operating assets. Margin = Operating Income/Sales and Turnover = Sales/Average Operating Assets. By breaking ROI into margin and turnover, more information is available to assess performance. Knowledge of margin and turnover gives more insight into why the ROI may change from one period to the next.

ROI (1) encourages managers to pay attention to the relationships among sales, expenses, and investment; (2) encourages cost efficiency; and (3) discourages excessive investment in operating assets. Increased profitability can be achieved (all else being equal) by increasing revenues, decreasing expenses, or lowering investment.

Residual income is equal to operating income minus the minimum rate of return multiplied by the average operating assets. EVA (economic value added) requires the company to calculate its actual cost of capital and use it as the minimum rate of return in the residual income calculation. In addition, EVA always uses after-tax income.

Yes, residual income and EVA can be negative. This means that the company earned less than its minimum rate of return or, in the case of EVA, its actual cost of capital.

A transfer price is the price charged for goods that are transferred from one division to another.

One policy is a market price where the transfer price equals the price at which the product would sell in a competitive market outside of the organization. If a market price exists, it is generally acknowledged as the best policy. A second policy is a cost-based price where the transfer price equals some measure of the product’s cost plus a markup above cost. A third policy is a negotiated price where the transfer price equals an amount that is negotiated between the buyer and seller of the product.

10. The Balanced Scorecard is a strategic management system that defines a strategic-based responsibility accounting system. It translates an organization’s mission and strategy into operational objectives and performance measures for four different perspectives: the financial perspective, the customer perspective, the internal business process perspective, and the learning and growth (infrastructure) perspective.

11-1

CHAPTER 11

Performance Evaluation and Decentralization

11. The four perspectives of the Balanced Scorecard are financial, customer, internal business process, and learning and growth. The financial perspective describes the economic consequences of actions taken in the other three perspectives. The customer perspective defines the customer and market segments in which the business unit will compete. The internal business process perspective describes the internal processes needed to provide value for customers and owners. The learning and growth (infrastructure) perspective defines the capabilities that an organization needs to create long-term growth and improvement. 12. Answers will vary. Here is one example. The financial perspective will give data on the sales and costs for the company. Are sales declining? Are costs increasing? Has investment increased? The customer perspective can give information on customer satisfaction which could help explain any decrease in sales. The internal perspective can give insight into costs including employee turnover, increased raw material costs, and so on. Looking at what is happening across the four perspectives gives a richer understanding of why income and ROI is changing.

MULTIPLE-CHOICE QUESTIONS 11-1.

11-2.

11-3.

11-4.

11-5.

11-6.

11-7.

11-8.

11-9.

11-10. a 11-11. e 11-12. b

11-2

CHAPTER 11

Performance Evaluation and Decentralization

BRIEF EXERCISES: SET A BE 11-13 1.

Average Operating Assets

Beginning Assets + Ending Assets 2

= =

$1,600,000 + $1,400,000 2

= $1,500,000 $300,000 $3,750,000

Margin

Operating Income Sales

Turnover

Sales = Average Operating Assets

ROI = Margin × Turnover =

= 0.08, or 8%

$3,750,000 $1,500,000

= 2.50

0.08 × 2.50 = 0.20, or 20%

Alternatively, ROI = =

Operating Income Average Operating Assets $300,000 $1,500,000

= 0.20, or 20%

BE 11-14 1.

Average Operating Assets

Beginning Assets + Ending Assets 2

= =

$1,600,000 + $1,400,000 2

= $1,500,000 2.

Residual Income

= Operating Income – (Minimum Rate of Return × Average Operating Assets) = $300,000 – (0.05 × $1,500,000) = $300,000 – $75,000 = $225,000

11-3

CHAPTER 11

Performance Evaluation and Decentralization

BE 11-15 EVA = After-Tax Operating Income – (Actual Percentage Cost of Capital × Total Capital Employed) = $180,000 – (0.04 × $1,200,000) = $180,000 – $48,000 = $132,000

BE 11-16 1.

The full cost transfer price is $540. Maple Division would be delighted with that price, but Birch Division would refuse to transfer since $720 could be earned in the outside market.

The market price is $720. Both Maple and Birch divisions would be willing to transfer at that price (since neither division would be worse off than if it bought or sold in the outside market).

Minimum Transfer Price = $720 – $120 = $600 This price is set by Birch Division, the selling division. Maximum Transfer Price = $720. This price is the market price and is set by Maple Division, the buying division. Yes, both divisions would be willing to accept a transfer price within the bargaining range. Precisely what the transfer price would be depends on the negotiating skills of the Birch and Maple division managers.

BE 11-17 (Appendix) 1.

Theoretical Cycle Time

= (25,000 hours × 60 minutes per hour)/250,000 units = 6 minutes per unit

Actual Cycle Time

= (25,000 hours × 60 minutes per hour)/200,000 units = 7.5 minutes per unit

Theoretical Velocity

= 60 minutes per hour/6 minutes per unit = 10 units per hour

Actual Velocity

= 60 minutes per hour/7.5 minutes per unit = 8 units per hour

11-4

CHAPTER 11

Performance Evaluation and Decentralization

BE 11-18 (Appendix) 1.

Processing time is equal to theoretical cycle time. That is, if everything goes smoothly and there is no wasted time, it takes 6 minutes to produce one unit. Nonprocessing time, therefore, must be the difference between actual cycle time (which includes some waste) and theoretical cycle time. Processing Time = Theoretical Cycle Time = 6 minutes Nonprocessing Time

= Actual Cycle Time – Theoretical Cycle Time = 7.5 – 6.0 = 1.5 minutes

MCE = =

Processing Time Processing Time + Nonprocessing Time 6 6.0 + 1.5

= 0.8, or 80%

11-5

CHAPTER 11

Performance Evaluation and Decentralization

BRIEF EXERCISES: SET B BE 11-19 1.

Average Operating Assets

Beginning Assets + Ending Assets 2

$2,700,000 + $2,300,000 2

= $2,500,000 Operating Income Sales

Margin

Turnover

ROI = Margin × Turnover =

Sales Average Operating Assets

$800,000 $4,000,000

= 0.20, or 20%

$4,000,000 $2,500,000

= 1.60

0.20 × 1.60 = 0.32, or 32%

Alternatively, ROI = =

Operating Income Average Operating Assets $800,000 $2,500,000

= 0.32, or 32% BE 11-20 1.

Average Operating Assets

Beginning Assets + Ending Assets 2

= =

$2,700,000 + $2,300,000 2

= $2,500,000 2.

Residual Income

= Operating Income – (Minimum Rate of Return × Average Operating Assets) = $800,000 – (0.15 × $2,500,000) = $800,000 – $375,000 = $425,000

11-6

CHAPTER 11

Performance Evaluation and Decentralization

BE 11-21 EVA = After-Tax Operating Income – (Actual Percentage Cost of Capital × Total Capital Employed) = $480,000 – (0.12 × $1,400,000) = $480,000 – $168,000 = $312,000

BE 11-22 1.

The full cost transfer price is $475. Java Division would be delighted with that price, but Machina Division would refuse to transfer since $950 could be earned in the outside market.

The market price is $950. Both Java and Machina divisions would be willing to transfer at that price (since neither division would be worse off than if it bought or sold in the outside market).

Minimum Transfer Price = $950 – $135 = $815 This price is set by Machina Division, the selling division. Maximum Transfer Price = $950. This price is the market price and is set by Java Division, the buying division. Yes, both divisions would be willing to accept a transfer price within the bargaining range. Precisely what the transfer price would be depends on the negotiating skills of the Machina and Java division managers.

BE 11-23 (Appendix) 1.

Theoretical Cycle Time

= (20,000 hours × 60 minutes per hour)/400,000 units = 3 minutes per unit

Actual Cycle Time

= (20,000 hours × 60 minutes per hour)/375,000 units = 3.2 minutes per unit

Theoretical Velocity

= 60 minutes per hour/3 minutes per unit = 20 units per hour

Actual Velocity

= 60 minutes per hour/3.2 minutes per unit = 19 units per hour

11-7

CHAPTER 11

Performance Evaluation and Decentralization

BE 11-24 (Appendix) 1.

Processing time is equal to theoretical cycle time. That is, if everything goes smoothly and there is no wasted time, it takes 3 minutes to produce one unit. Nonprocessing time, therefore, must be the difference between actual cycle time (which includes some waste) and theoretical cycle time. Processing Time = Theoretical Cycle Time = 3 minutes Nonprocessing Time

= Actual Cycle Time – Theoretical Cycle Time = 3.2 – 3.0 = 0.2 minutes

MCE = =

Processing Time Processing Time + Nonprocessing Time 3 3.0 + 0.2

= 0.94, or 94%

11-8

CHAPTER 11

Performance Evaluation and Decentralization

EXERCISES E 11-25 a. b. c. d. e.

Cost center Investment center Revenue center Profit center Investment center

E 11-26 1.

Sales Less expenses Operating income

Margin

Turnover = 3.

$25,000,000 17,500,000 $ 7,500,000 Operating Income Sales

$7,500,000 $25,000,000

= 0.30, or 30%

Sales Average Operating Assets

$25,000,000 $10,000,000

= 2.5

ROI = Margin × Turnover = 0.30 × 2.5 = 0.75, or 75% Alternatively, ROI =

Operating Income Average Operating Assets

$7,500,000 $10,000,000

= 0.75, or 75%

E 11-27 1.

Average Operating Assets

$24,200,000 + $20,600,000 2

= $22,400,000 2.

$109,200,000 $728,000,000

= 0.15, or 15%

Turnover =

$728,000,000 $22,400,000

= 32.5

Margin

ROI = Margin × Turnover = 0.15 × 32.5 = 4.88, or 488% Alternatively, ROI =

Operating Income Average Operating Assets

$109,200,000 $22,400,000

= 4.88, or 488%

ROI measures a company’s ability to generate income relative to its investment in assets. The greater the ROI, the more efficiently the company is generating income from its assets. 11-9

CHAPTER 11

Performance Evaluation and Decentralization

E 11-27 (Continued) 5.

Nakamura Company might be a service organization with relatively few physical assets required to generate its sales revenue and income. For example, for many service organizations, and some manufacturers, one of the most important factors that generate revenue and income is human talent. However, human beings, while important in creating ideas and organizational value, are not recognized as assets on the balance sheet. Therefore, ROI will be higher when the factors that create a company’s sales or income are not formally recognized as assets (i.e., the denominator is deflated relative to a company that requires greater assets to generate its given level of sales and income).

E 11-28 1. Margin: $4,000,000 $46,000,000

Year 1

Year 2

0.09 or 9%

$4,000,000 $48,000,000

0.08, or 8%

Turnover: $46,000,000 $164,000,000

0.28

$48,000,000 $150,000,000 2.

0.32

ROI Year 1 = 0.09 × 0.28 = 0.02, or 2%, or $4,000,000/$164,000,000 ROI Year 2 = 0.08 × 0.32 = 0.03, or 3%, or $4,000,000/$150,000,000

E 11-29 1.

Residual Income = $118,000 – (0.07 × $1,900,000) = –$15,000

ROI must have been smaller than 7%, because residual income is negative. Actual ROI = $118,000/$1,900,000 = 0.06, or 6%

E 11-30 1.

EVA = $12,375,400 – (0.09 × $111,754,000) = $2,317,540

Falconer is creating wealth because EVA is positive.

11-10

CHAPTER 11

Performance Evaluation and Decentralization

E 11-31 1.

Leone Division EVA = $550,000 – (0.12 × $3,800,000) = $94,000

Letwo Division EVA = $314,000 – (0.12 × $3,100,000) = ($58,000)

The Leone Division is creating wealth (i.e., the cost of making the income is lower than the income) since its EVA is positive. The Letwo Division is destroying wealth (i.e., the cost of making the income is higher than the income) since its EVA is negative.

Leesum management can increase Letwo Division’s EVA by doing any of the following items: a.

Increase the after-tax operating profit that is generated from using the same amount of invested capital (i.e., find ways to “do more with the same level of capital”).

Continue to generate the same after-tax operating profit but use less capital to do so (i.e., find ways to “do the same thing but with less capital”).

Continue to generate the same after-tax operating profit using the same amount of capital, but with a lower cost of capital (i.e., obtain capital more cheaply).

The management team will use data analysis to see what is leading to declining EVA and use that information to decide which of these three general strategies should be pursued and which specific actions should be implemented for the chosen strategy. E 11-32 1.

Leone Division Residual Income = $550,000 – (0.09 × $3,800,000) = $208,000

Letwo Division Residual Income = $314,000 – (0.09 × $3,100,000) = $35,000

11-11

CHAPTER 11

Performance Evaluation and Decentralization

E 11-33 1.

The maximum transfer price is set by the buying division, in this case, the Furniture Division. The minimum transfer price is set by the selling division, in this case, the Mattress Division.

Full Cost Transfer Price = $160

The Furniture Division would love to have a transfer price of $160 per mattress (remember, it is currently paying $230 per mattress). However, the Mattress Division will refuse to transfer at that price because it can sell all the mattresses it can produce in the outside market for $230.

E 11-34 1.

The maximum transfer price, set by the Furniture Division, is $230. Remember, the Furniture Division would not pay any more than $230 because that is the price it currently pays to outside suppliers.

The minimum transfer price, set by the Mattress Division, is $230. Remember that this division is operating at capacity and can sell all that it makes to outside buyers for $230.

If the transfer takes place, the transfer price will be $230. No, it does not matter whether or not the transfer takes place, since the transfer price would be equal to the outside market price.

11-12

CHAPTER 11

Performance Evaluation and Decentralization

E 11-35 1.

The maximum transfer price, set by the Furniture Division, is $230.

The minimum transfer price, set by the Mattress Division, is $90. In this case, only variable costs of $90 per mattress are relevant because the Mattress Division has excess capacity.

Benefit to Mattress Division: Revenue ($175 × 10,000) Less: Variable cost ($90 × 10,000) Benefit

$1,750,000 900,000 $850,000

Benefit to Furniture Division: Outside supplier ($230 × 10,000) Transfer price ($175 × 10,000) Benefit

$2,300,000 1,750,000 $ 550,000

Benefit to company = $850,000 + $550,000 = $1,400,000

E 11-36 (Appendix) 1.

Theoretical Cycle Time

= (10,000 hours × 60 minutes per hour)/50,000 units = 12 minutes per unit

Actual Cycle Time

= (10,000 hours × 60 minutes per hour)/40,000 units = 15 minutes per unit

Theoretical Velocity

= 60 minutes per hour/12 minutes per unit = 5 units per hour

Actual Velocity

= 60 minutes per hour/15 minutes per unit = 4 units per hour

E 11-37 (Appendix) 1.

Theoretical Cycle Time

= (20,000 hours × 60 minutes per hour)/80,000 units = 15 minutes per unit

Actual Cycle Time

= (20,000 hours × 60 minutes per hour)/60,000 units = 20 minutes per unit

Theoretical Velocity

= 60 minutes per hour/15 minutes per unit = 4 units per hour

Actual Velocity

= 60 minutes per hour/20 minutes per unit = 3 units per hour

11-13

CHAPTER 11

Performance Evaluation and Decentralization

E 11-38 (Appendix) 1.

Processing Time = Theoretical Cycle Time = 12 minutes per unit Nonprocessing Time = Actual Cycle Time – Theoretical Cycle Time = 15 minutes – 12 minutes = 3 minutes per unit

MCE = =

Processing Time Processing Time + Nonprocessing Time 12 12 + 3

= 0.8

E 11-39 (Appendix) 1.

Processing Time = Theoretical Cycle Time = 10 minutes per unit Nonprocessing Time = Actual Cycle Time – Theoretical Cycle Time = 16 minutes – 10 minutes = 6 minutes per unit

MCE = =

Processing Time Processing Time + Nonprocessing Time 10 10 + 6

= 0.625

11-14

CHAPTER 11

Performance Evaluation and Decentralization

PROBLEMS P 11-40 1.

ROI of Division without Drone = $849,200/$3,860,000 = 0.22, or 22%

ROI of the Drone Project = $360,000/$2,000,000 = 0.18, or 18%

ROI of Division with Drone

$849,200 + $360,000 $3,860,000 + $2,000,000

$1,209,200 $5,860,000

= 21%

Residual Income of Division without Drone

= $849,200 – (0.13 × $3,860,000) = $347,400

Residual Income of the Drone Project

= $360,000 – (0.13 × $2,000,000) = $100,000

Residual Income of Division with Drone

= $1,209,200 – (0.13 × $5,860,000) = $447,400

This depends on whether division is evaluated on the basis of ROI or on the basis of residual income. Overall division ROI will decrease; so if ROI is the basis for evaluation, the division manager will decline the investment. On the other hand, residual income for the project is positive and will raise overall residual income. If the division is evaluated on the basis of residual income, the project will be accepted.

Aside from divisional performance and management evaluations, firms may have disparate goals depending on many factors including industry, corporate objectives, shareholder and market expectations, position of the product in the product life cycle and so on. Those factors will determine whether the division's focus will be on residual income or ROI.

11-15

CHAPTER 11

Performance Evaluation and Decentralization

P 11-41 1. ROI………………………………………… Margin……………………………………… Turnover…………………………………… 2.

Year 1

Year 2

Year 3

8.00% 12.00% 0.67

6.97% 11.00% 0.63

6.30% 10.50% 0.60

ROI:

$1,200,000 $15,000,000

= 0.08, or 8%

Margin:

$1,200,000 $10,000,000

= 0.12, or 12%

Turnover:

$10,000,000 $15,000,000

= 0.67

The ROI increased because expenses decreased and assets turned over at a higher rate (sales increased). 3.

Operating assets: $15,000,000 × 0.80 = $12,000,000 ROI:

$945,000 $12,000,000

= 7.88%

Margin:

$945,000 $9,000,000

= 10.5%

Turnover:

$9,000,000 $12,000,000

= 0.75

The ROI increased because assets decreased. 4.

ROI:

$1,200,000 $12,000,000

= 0.10, or 10%

Margin:

$1,200,000 $10,000,000

= 0.12, or 12%

Turnover:

$10,000,000 $12,000,000

= 0.83

The ROI increased because expenses decreased and assets turned over at a higher rate (sales increased and the amount of assets decreased). Both margin and turnover increased.

11-16

CHAPTER 11

Performance Evaluation and Decentralization

P 11-42 1. Air Conditioner ROI = $90,000/$750,000 = 0.12, or 12% Turbocharger ROI = $82,080/$540,000 = 0.15, or 15% 2. Income…………… Assets…………… ROI………………

With Air Conditioner

With Turbocharger

With Both Investments

Neither Investment

$ 4,425,000 $29,650,000 14.92%

$ 4,417,080 $29,440,000 15.00%

$ 4,507,080 $30,190,000 14.93%

$ 4,335,000 $28,900,000 15.00%

3. The manager will choose the turbocharger, but not the air conditioner. 4. a. Residual Income with Air Conditioner

= $4,425,000 – (0.14 × $29,650,000) = $274,000

b. Residual Income with Turbocharger

= $4,417,080 – (0.14 × $29,440,000) = $295,480

c. Residual Income with Both

= $4,507,080 – (0.14 × $30,190,000) = $280,480

d. Residual Income with Neither

= $4,335,000 – (0.14 × $28,900,000) = $289,000

While the residual income is positive in all four cases, the manager will choose the turbocharger, but not the air conditioner, since the residual income is highest for that alternative. 5. a. Residual Income with Air Conditioner

= $4,425,000 – (0.10 × $29,650,000) = $1,460,000

b. Residual Income with Turbocharger

= $4,417,080 – (0.10 × $29,440,000) = $1,473,080

c. Residual Income with Both

= $4,507,080 – (0.10 × $30,190,000) = $1,488,080

d. Residual Income with Neither

= $4,335,000 – (0.10 × $28,900,000) = $1,445,000

The manager will choose to invest in both the air conditioner and the turbocharger In this case, the minimum required return on investment, 10%, is lower than the ROIs of both projects. Therefore, both projects are profitable, and the highest residual income is earned by investing in both.

11-17

CHAPTER 11

Performance Evaluation and Decentralization

P 11-43 1.

$310,000/$3,000,000 = 0.1033, or 10.33%

Margin:

$310,000 $3,450,000

= 0.0899, or 8.99%

Turnover:

$3,450,000 $3,000,000

= 1.15

ROI = 1.15 × 0.0899 = 0.1034, or 10.34% 3.

$310,000 + $57,500 $3,000,000 + $500,000*

= 0.105, or 10.5%

* $600,000 + $400,000 2

Because ROI with investment is larger than ROI without it, the manager will approve the investment. 4.

Margin:

$310,000 + $57,500 $3,450,000 + $575,000

= 0.0913, or 9.13%

Turnover:

$3,450,000 + $575,000 $3,000,000 + $500,000

= 1.15

The margin has increased, and the turnover ratio has stayed the same. 5.

EVA without Investment = $310,000 – (0.07 × $3,000,000) = $100,000 EVA with Investment = $367,500 – (0.07 × $3,500,000) = $122,500 EVA has increased with the investment, so the manager would approve the investment.

11-18

CHAPTER 11

Performance Evaluation and Decentralization

P 11-44 1. Lorne should not reduce the price charged to Rosario if he can sell all he produces. It does not matter whether the two divisions trade internally or not. 2. The minimum price is $53, and the maximum is $75. Yes, Lorne should consider the transfer, since his income will increase by $59,500 [3,500 × ($70 – $53)]. 3. The transfer price would be $75.60 ($63 × 1.2). No, the transfer would not occur, since the transfer price is higher than the outside price that Rosario could get.

P 11-45 1. Sales……………………………… Variable expenses…………… Contribution margin………

Component Y34

Model SC67

Company

$260,000 160,000 $100,000

$1,680,000 920,000 $ 760,000

$1,940,000 1,080,000 $ 860,000

2. The transfer price should be the market price of $12. This is the minimum price for the Components Division and the maximum price for the PSF Division. 3. Unless the PSF Division is able to increase the price of Model SC67, the manager will discontinue production and will not purchase any of the components. (The cost of producing the scanner will increase from $38 to $43.50 ($38 – $6.50 + $12.00), a cost greater than the current selling price of $42.) 4. All 40,000 units of Component Y34 will be sold externally at the market price of $12 per unit. 5. Sales……………………………… Variable expenses……………… Contribution margin…………

$480,000 160,000 $320,000

The contribution margin decreases by $540,000. Cam made the wrong decision.

11-19

CHAPTER 11

Performance Evaluation and Decentralization

P 11-46 1.

Minimum: Maximum:

$26 $31

Negotiated Transfer Price =

$26 + $31 = $28.50 2

In terms of full cost-plus markup, $28.50 = $20.00 + (Markup Percentage × Full Cost) Markup = $28.50 – $20.00 = $8.50 Markup Percentage = $8.50/$20.00 = 0.425, or 42.5% 3.

New minimum: New maximum: $27 + $32 2

$27 $32 =

$29.50

or full cost plus 47.5% [($29.50 – $20.00)/$20.00] 4.

The two divisions would renegotiate because the buying division would probably be able to buy the necessary part at a lower price from another supplier. The Auxiliary Components Division might have to reduce its price.

11-20

CHAPTER 11

Performance Evaluation and Decentralization

P 11-47 (Appendix) 1.

Theoretical Rate

$2,700,000 600,000

= $4.50 per minute Theoretical Conversion Cost per Unit

= $4.50 × 30 = $135

Applied Conversion Cost per Unit = $4.50 × 40 = $180 Note:

60 1.5

= 40 minutes used per unit

An incentive exists to reduce product cost by reducing cycle time. For example, current cycle time is 40 minutes per unit. If cycle time could be reduced to 30 minutes per unit, conversion costs would be reduced from $180 per unit to $135 per unit, reducing the unit product cost by $45. Reducing cycle time increases the ability to meet deliveries on time as well as increasing the ability of the firm to respond quickly to customer demands.

P 11-48 (Appendix) 1.

a. b. c. d. e. f. g. h. i. j. k.

Customer Internal business process Financial Financial Learning and growth Internal business process Customer Internal business process Learning and growth Customer Financial

Answers will vary. Financial—contribution margin by product Customer—number of complaints Internal business process—number of accidents per month Learning and growth—hours of continuing education provided per month

11-21

CHAPTER 11

Performance Evaluation and Decentralization

P 11-49 (Appendix) 1.

Theoretical Velocity

Theoretical Cycle Time

1,000 repairs 500 hours

= 2 per hour

60 minutes per hour 2 repairs per hour

= 30 minutes 2.

MCE = =

Productivity Time Total Time 30 30 + 4 + 10 + 6

= 0.60, or 60%

Actual Cycle Time

= 30 + 4 + 10 + 6 = 50 minutes

Actual Velocity

60 50

= 1.20 repairs per hour

11-22

CHAPTER 11

Performance Evaluation and Decentralization

CASE Case 11-50 1.

ROI Based on Initial Estimates =

$1,870,000 = 0.1199, or 11.99% $15,600,000

ROI Based on Mel’s Estimates =

$2,340,000 = 0.15, or 15% $15,600,000

Jason is definitely facing an ethical dilemma. While it is true that the sales and expense projections are estimates, they are the best ones available to him. If he uses a sales revenue projection from the top end of the range, he will be deliberately basing the ROI estimate on a highly unlikely sales figure. Sales and expense projections are not fantasy figures. They are supposed to be management’s best estimate of what will actually happen. If Jason prepares the report in accordance with Mel’s desires, he will be knowingly fabricating data. One might wonder whether or not Mel’s offer to “back up” Jason is sufficient to let Jason off the hook. It is not. If Mel wants the false projections badly enough, let him sign them. Jason may have thought he had his dream job, but it is about to turn into a nightmare. Companies don’t take kindly to employees who lie, and this lie is sure to come out. If the project is approved, and the sales do not approach $2.34 million, you can bet that the vice president of sales will be quick to point out that she predicted only $1.87 million. Mel will surely pin the blame directly on Jason, the one whose name is on the report.

Jason should prepare the report using the figures he thinks are most descriptive of the project’s potential. He should feel free to include information about the predicted range of sales and to point out any other information that reflects favorably on the project. If Mel continues to pressure Jason, then Jason might consider looking for another job.

11-23

12 CAPITAL INVESTMENT DECISIONS DISCUSSION QUESTIONS 1.

Independent projects are such that the acceptance of one does not preclude the acceptance of another. With mutually exclusive projects, acceptance of one precludes the acceptance of others.

Two key components of capital budgeting analytics: (1) Forecasting cash flows (assessing their quantity and timing) and (2) The selection and use of analytic models to guide managers in accepting or rejecting potential investments.

The timing and quantity of cash flows determine the present value of a project. The present value is critical for assessing whether a project is acceptable or not. The further in the future the cash flow occurs, the more risk.

By ignoring the time value of money, good projects can be rejected and bad projects accepted.

The payback period is the time required to recover the initial investment. Payback = $80,000/$30,000 = 2.67 years.

(a) (b) (c)

The accounting rate of return is the average income divided by original investment. ARR = $100,000/$300,000 = 33.33%

Agree. Essentially, NPV is a measure of the return in excess of the investment and its cost of capital.

NPV measures the increase in firm value from a project.

10.

The cost of capital is the cost of investment funds and is usually viewed as the weighted average of the costs of funds from all sources. It should serve as the discount rate for calculating NPV or the benchmark for IRR analysis.

11.

For NPV, the required rate of return is the discount rate. For IRR, the required rate of return is the benchmark against which the IRR is compared to determine whether an investment is acceptable or not.

12.

If NPV > 0, then the investment is acceptable. If NPV < 0, then the investment should be rejected.

13.

Disagree. Only if the funds received each period from the investment are reinvested to earn the IRR will the IRR be the actual rate of return.

14.

Postaudits help managers determine if resources are being used wisely. Additional resources or corrective action may be needed. Postaudits serve to encourage managers to make good capital investment decisions. They also provide feedback that may help improve future decisions. The claims and benefits of advanced technology should especially be examined by a postaudit because of the uncertainty surrounding new technology.

A measure of risk. Roughly, projects with shorter paybacks are less risky. Obsolescence. If the risk of obsolescence is high, firms will want to recover funds quickly. Self-interest. Managers want quick paybacks so that short-run performance measures are affected positively, enhancing chances for bonuses and promotion.

12-1

CHAPTER 12

Capital Investment Decisions

15. NPV signals which investment maximizes firm value. IRR may provide misleading signals. IRR may be popular because it provides the correct signal most of the time and managers are accustomed to working with rates of return. 16. Often, investments must be made in assets that do not directly produce revenues. In this case, choosing the asset with the least cost (as measured by NPV) makes sense. In other words, if both projects have negative NPV, but the firm must choose one, it should choose the project with the least negative NPV.

MULTIPLE-CHOICE QUESTIONS 12-1.

12-2.

12-3.

12-4.

$6,000/$2,000

12-5.

$1,000 – $500 = $500 left after year 1; $500/$750 = 0.67; 1 + 0.67 = 1.67 years

12-6.

12-7.

12-8.

12-9.

12-10.

12-11.

12-12.

12-13.

$4,200 – $3,000

12-14.

(0.8 × $1,000) = $800; $800 – $1,000

12-15.

12-16.

12-17.

12-18.

12-19.

12-20.

12-21.

$400/$2,000

(NPV is calculated using future cash flows, and is therefore predictive. Choosing the project with the greater NPV is prescriptive.)

12-2

CHAPTER 12

Capital Investment Decisions

BRIEF EXERCISES: SET A BE 12-22 a.

Payback Period =

Payback Period:

$1,200,000 = 4.0 years $300,000

$ 150,000 150,000 400,000 400,000 100,000 $1,200,000

1.0 year 1.0 year 1.0 year 1.0 year 1.0 year 5.0 years

BE 12-23 Average Net Income

$360,000 + $360,000 + $600,000 + $1,080,000 + $1,200,000 + $2,520,000 + $1,444,000 7

= $1,080,571 Accounting Rate of Return

= =

Average Net Income Investment $1,080,571 $9,000,000

= 0.12

BE 12-24 1. Year

Item

Cash Flow

Equipment…………………………………………… Working capital……………………………………… Total………………………………………………

$(1,500,000) (200,000) $(1,700,000)

1–4

Revenues…………………………………………… Operating expenses……………………………… Total………………………………………………

$ 1,400,000 (820,000) $ 580,000

Revenues…………………………………………… Operating expenses……………………………… Salvage……………………………………………… Recovery of working capital……………………… Total………………………………………………

$ 1,400,000 (820,000) 180,000 200,000 $ 960,000

12-3

CHAPTER 12

Capital Investment Decisions

BE 12-24 (Continued) 2.

Calculation of NPV: Year

Cash Flow*

Discount Factor**

0 1.00000 $(1,700,000) 1 0.92593 580,000 2 0.85734 580,000 3 0.79383 580,000 4 0.73503 580,000 5 0.68058 960,000 Net present value………………………………………………………

Present Value $(1,700,000) 537,039 497,257 460,421 426,317 653,357 $ 874,391

* From Requirement 1. ** From Exhibit 12B.1. 3.

Calculation of NPV: Year

Cash Flow*

Discount Factor**

0 1.00000 $(1,700,000) 1–4 3.31213 580,000 5 0.68058 960,000 Net present value………………………………………………………

Present Value*** $(1,700,000) 1,921,035 653,357 $ 874,392

* From Requirement 1. ** From Exhibits 12B.1, 12B.2. *** Any difference between values in Rq. 2 and Req. 3 is rounding errror.

BE 12-25 df = I/CF

= $4,607,200/$800,000 = 5.75900

From Exhibit 12B.2, 9 years and a discount factor of 5.75900 yield an IRR ≈ 10%.

12-4

CHAPTER 12

Capital Investment Decisions

BE 12-26 1.

CAM X Model: Year

Cash Flow

Discount Factor

0 $(3,600,000) 1.00000 1–10 900,000 6.14457 NPV…………………………………………………………

Present Value $(3,600,000) 5,530,113 $ 1,930,113

CAM Y Model: Year

Cash Flow

Discount Factor

$(4,200,000) 1.00000 0 1,050,000 6.14457 1–10 NPV…………………………………………………………

Present Value $(4,200,000) 6,451,799 $ 2,251,799

CAM Y is the better choice (it has the higher NPV). 2. df (CAM X) =

I CF

$3,600,000 $900,000

= 4.00000

df (CAM Y) =

I CF

$4,200,000 $1,050,000

= 4.00000

Since CAM X and CAM Y have the same discount factor, they have the same IRR, a value between 20% and 25%; neither is a better choice than the other, based solely on IRR.

12-5

CHAPTER 12

Capital Investment Decisions

BRIEF EXERCISES: SET B BE 12-27 a.

Payback Period

Payback Period:

$2,520,000 $1,050,000

= 2.4 years

1.0 year 1.0 year 1.0 year 0.9 year 3.9 years

$ 630,000 315,000 819,000 756,000 $2,520,000

BE 12-28 Average Net Income

$280,000 + $280,000 + $420,000 + $980,000 + $1,120,000 + $1,540,000 + $2,800,000 + $1,540,000 8

= $1,120,000 Accounting Rate of Return

Average Net Income Investment

= =

$1,120,000 $11,200,000

= 0.10

BE 12-29 1. Year

Item

Cash Flow

Equipment……………………………………………………………… Working capital………………………………………………………… Total…………………………………………………………………

$(4,320,000) (540,000) $(4,860,000)

1–4

Revenues……………………………………………………………… Operating expenses…………………………………………………… Total…………………………………………………………………

$ 4,050,000 (2,430,000) $ 1,620,000

Revenues……………………………………………………………… Operating expenses…………………………………………………… Salvage………………………………………………………………… Recovery of working capital………………………………………… Total…………………………………………………………………

$ 4,050,000 (2,430,000) 540,000 540,000 $ 2,700,000

12-6

CHAPTER 12

Capital Investment Decisions

BE 12-29 (Continued) 2.

Calculation of NPV: Year

Cash Flow*

Discount Factor**

Present Value

0 1.00000 $(4,860,000) 1 0.92593 1,620,000 2 0.85734 1,620,000 3 0.79383 1,620,000 4 0.73503 1,620,000 5 0.68058 2,700,000 Net present value………………………………………………

$(4,860,000) 1,500,007 1,388,891 1,286,005 1,190,749 1,837,566 $ 2,343,218

* From Requirement 1. ** From Exhibit 12B.1. 3.

Calculation of NPV: Year

Cash Flow*

Discount Factor**

Present Value

0 1.00000 $(4,860,000) 1–4 3.31213 1,620,000 5 0.68058 2,700,000 Net present value………………………………………………

$(4,860,000) 5,365,651 1,837,566 $ 2,343,217

* From Requirement 1. ** From Exhibits 12B.1, 12B.2.

BE 12-30 df = I/CF

= $11,551,968/$1,800,000 = 6.41776

From Exhibit 12B.2, 10 years and a discount factor of 6.41776 yield an IRR ≈ 9%.

12-7

CHAPTER 12

Capital Investment Decisions

BE 12-31 1.

FLEX-1K System: Year

Cash Flow

Discount Factor

0 $(9,600,000) 1.00000 1–10 2,400,000 5.65022 NPV…………………………………………………………………………

Present Value $ (9,600,000) 13,560,528 $ 3,960,528

FLEX-2Z System: Year

Cash Flow

Discount Factor

0 $(11,200,000) 1.00000 2,800,000 5.65022 1–10 NPV…………………………………………………………………………

Present Value $(11,200,000) 15,820,616 $ 4,620,616

FLEX-2Z is the better choice (it has the higher NPV). 2.

df (FLEX-1K) =

I CF

$9,600,000 $2,400,000

= 4.00000

df (FLEX-2Z) =

I CF

$11,200,000 $2,800,000

= 4.00000

A discount factor of 4.00000 for 10 years implies that IRR is between 20% and 25%. The IRR is equal for both models and so one is not preferred over the other.

12-8

CHAPTER 12

Capital Investment Decisions

EXERCISES E 12-32 1.

Payback Period

Investment

$400,000 $120,000

= 3.33 years

= Annual Cash Flow × Payback Period = $960,000 × 4 = $3,840,000 Investment Annual Cash Flow = Payback Period $1,300,000 = 2.5 = $520,000 per year Expected Payback Period: $ 600,000 1.0 year 800,000 1.0 year 600,000 0.6 year $ 2,000,000 2.6 years Actual Payback Period: $ 800,000 1.0 year 1,000,000 1.0 year 200,000 0.2 year $ 2,000,000 2.2 years The expected payback period is an example of the predictive data analytic type. It is predictive because it uses expected future cash flows and describes what is likely to happen. The actual payback period is descriptive because it uses actual cash flows and describes what is happening.

E 12-33 1. Initial investment (Average Depreciation = $720,000): Accounting Rate of Return

Average Net Income Investment

($6,000,000 – $4,800,000 – $720,000) $3,600,000 = 13.3%

Accounting rate of return (ARR): $49,500 – $15,000 = 46% Project A: ARR = $75,000 $28,500 – $15,000 = 18% Project B: ARR = $75,000 Project A should be chosen. Both projects have the same cash flows for the first 3 years (during which the initial investment is recovered), but Project A has significantly higher cash flows the last 2 years. ARR considers the total dollar returns beyond the payback period and thus correctly picks Project A. 12-9

CHAPTER 12

Capital Investment Decisions

E 12-33 (Continued) Average Net Income 3. ARR = Initial Investment $120,000 Initial Investment

0.30 =

Initial Investment

$120,000 0.30

= $400,000 4.

ARR =

Average Net Income Initial Investment

0.50 =

Average Net Income $150,000

Average Net Income

= 0.50 × $150,000 = $75,000

E 12-34 1.

NPV = P – I = (5.65022 × $480,000) – $2,700,000 = $12,106 Yes, the company should make the investment.

NPV = P – I = (4.62288 × $52,500) – $270,000 = ($27,299) The shop should not be purchased. NPV = (4.62288 × $135,000) – $270,000 = $354,089 The shop should now be purchased. This reveals that the decision to accept or reject in this case is affected by differences in estimated cash flows. Estimating future cash flows involves uncertainty and creating different estimates based on likelihood (e.g., most likely, pessimistic, and optimistic) may help in making the decision.

NPV = P – I I = P – NPV I = (5.33493 × $135,000) – $63,900 = $656,316

12-10

CHAPTER 12

Capital Investment Decisions

E 12-35 1. P = CF(df) = I for the IRR, thus, df = =

Investment Annual Cash Flow $7,200,000 $2,000,000

= 3.60000 For 5 years and a discount factor of 3.60000, the IRR is very close to 12%. The equipment should not be purchased. 2.

P = CF(df) = I for the IRR, thus, df =

$1,248,000 $240,000

= 5.20000 For 10 years and a discount factor of 5.20000, the IRR is very close to 14%. Yes, she should acquire the new system. 3.

CF(df) = I for the IRR, thus, CF =

I df

$2,880,000 3.85926

= $746,257

12-11

CHAPTER 12

Capital Investment Decisions

E 12-36 1.

Puro equipment: Year

Discount Factor

Cash Flow

$(560,000) 1.00000 0 320,000 0.89286 1 280,000 0.79719 2 240,000 0.71178 3 0.63552 160,000 4 120,000 0.56743 5 NPV………………………………………………………………

Present Value $(560,000) 285,715 223,213 170,827 101,683 68,092 $ 289,530

Briggs equipment: Year

Discount Factor

Cash Flow

$(560,000) 0 1.00000 120,000 0.89286 1 120,000 0.79719 2 320,000 0.71178 3 400,000 0.63552 4 440,000 0.56743 5 NPV………………………………………………………………

Present Value $(560,000) 107,143 95,663 227,770 254,208 249,669 $ 374,453

Since the NPV of the Briggs equipment is greater than that of the Puro equipment, Briggs should be chosen. The data analytics types are predictive and prescriptive. Calculating the NPV for each investment is predictive as the NPV is a prediction of the profitability of each project based on expected future cash flows, the estimated life, and the required rate of return. Choosing the project with the larger NPV is prescriptive. The net present values are compared and the one with the larger NPV should be chosen. 2.

CF(df) – I

= NPV

CF(3.60478) – $560,000 = $374,453 (3.60478)CF = $934,453 $934,453 3.60478

= $259,226 per year

Thus, the annual cash flow must exceed $259,226 to be selected.

12-12

CHAPTER 12

Capital Investment Decisions

E 12-36 (Continued) 3.

a. Year

Cash Flow

Discount Factor

240,000

0.71178

Present Value **

170,827

Discount Rate 0.12

*Excel equation for DF: =ROUND(1/(1+F5)^B5,5) **Excel equation for PV: =ROUND(C5*D5,0) Note: In the Excel program, the first column (Year) is the B column, the second is the C column, etc. Thus, the last column (Discount Rate) is the F column.

Puro:

Year

Cash Flow

Discount Factor

Present Value

$(560,000)

320,000

0.89286

285,715

280,000

0.79719

223,213

240,000

0.71178

170,827

160,000

0.63552

101,683

120,000

0.56743

68,092

NPV…………………………………………………

Discount Rate

0.12

$ 289,530***

***Excel equation for summation: =SUM(E2:E7)

Briggs:

Year

Cash Flow

Discount Factor

Present Value

$(560,000)

120,000

0.89286

107,143

120,000

0.79719

95,663

320,000

0.71178

227,770

400,000

0.63552

254,208

5 440,000 0.56743 NPV…………………………………………………

12-13

249,669 $ 374,453

Discount Rate

0.12

CHAPTER 12

Capital Investment Decisions

E 12-36 (Continued) 3.

d. Puro: Year Cash Flow

Discount Factor

$(560,000) 1 0 260,000 0.87719 1 2 260,000 0.76947 3 0.67497 260,000 4 260,000 0.59208 5 260,000 0.51937 NPV…………………………………………………

Present Value

Discount Rate

$(560,000) 228,069 200,062 175,492 153,941 135,036 $ 332,600

0.14

Discount Rate

Briggs: Year

Cash Flow

Discount Factor

Present Value

0 1

$(560,000) 120,000

1 0.87719

$(560,000) 105,263

2 3

120,000 320,000

0.76947 0.67497

92,336 215,990

400,000

0.59208

236,832

440,000

0.51937

228,523

NPV…………………………………………………

12-14

$ 318,944

0.14

CHAPTER 12

Capital Investment Decisions

E 12-37 1.

Payback Period

Original Investment Annual Cash Inflow

= =

$460,800 $612,000 – $432,000

$460,800 $180,000

= 2.56 years 2.

Initial investment (Average Depreciation = $92,160): Accounting Rate of Return

Average Accounting Income Investment

$180,000 – $92,160 $460,800 $87,840 $460,800

= = 19.1% 3.

NPV = (3.79079 × $180,000) – $460,800 = $221,542

P = CF(df) = I for the IRR, thus, df =

Investment Annual Cash Flow

$460,800 $180,000

2.56000

For 5 years and a discount factor of 2.56000, the IRR is between 25% and 30%.

12-15

CHAPTER 12

Capital Investment Decisions

E 12-38 1.

Payback Period: Project A: $ 6,000 8,000 6,000 $20,000

1.00 year 1.00 year 0.60 year 2.60 years

Project B: $ 6,000 8,000 6,000 $20,000

1.00 year 1.00 year 0.60 year 2.60 years

Both projects have the same payback so the most profitable should be chosen (Project A). 2.

Accounting rate of return (ARR): Project A: ARR =

$8,800 – $4,000 $20,000

= 24%

Project B: ARR =

$6,000 – $4,000 $20,000

= 10%

Project A should be chosen. The payback period ignores the returns provided beyond the payback point. In this case, Project A has 2.4 times as much cash flow for the remaining 2.4 years as Project B. ARR considers the total profitability of a project and thus correctly selects Project A. 3.

11.46992 × $30,000 = $344,098

Wilma should take the lump sum because its Present Value is greater than the annuity. 4.

NPV

= P –I = (4.62288 × $9,000) – $30,000 = $11,606

Yes, he should make the investment. 5.

$400,000 $75,000

= 5.33333

IRR is between 12% and 14%, Thus, the IRR is greater than 8%. Yes, Patsy should acquire the equipment.

12-16

CHAPTER 12

Capital Investment Decisions

E 12-39 1.

Return of the original investment…………………

$600,000

Cost of capital ($600,000 × 0.10)……………………

60,000

Profit earned on the investment ($693,000 – $660,000)…………………………………

33,000

Present value of profit: = F × Discount Factor = $33,000 × 0.90909 = $30,000

Cash Flow

Year

Discount Factor

$(600,000) 1.00000 0 693,000 0.90909 1 Net present value…………………………………………… Net present value gives the present value of future profit.

E 12-40 P = I = df × CF

2.91371* × CF = $120,000 CF = $41,185 * From Exhibit 12B.2, 14% for 4 years. 2.

For IRR (discount factors from Exhibit 12B.2): I = df × CF = 2.40183 × CF (Equation 1) For NPV: NPV = df × CF – I = 2.57710 × CF – I (Equation 2)

12-17

Present Value $(600,000) 629,999 $ 29,999

CHAPTER 12

Capital Investment Decisions

E 12-40 (Continued) Substituting Equation 1 into Equation 2: NPV = (2.57710 × CF ) – (2.40183 × CF ) $1,750 = 0.17527 × CF CF =

$1,750 0.17527

= $9,985 in savings each year Substituting CF = $9,985 into Equation 1: I = 2.40183 × $9,985 = $23,982 original investment 3.

For IRR: I = df × CF $60,096 = df × $12,000 df =

$60,096 $12,000

= 5.00800 From Exhibit 12B.2, 18% column, the year corresponding to df = 5.00800 is 14. Thus, the lathe must last approximately 14 years. 4.

X = Cash Flow in Year 4 Investment = 2X Year

Cash Flow

Discount Factor

Present Value

(2X) 1.00000 0 $10,000 0.90909 1 12,000 0.82645 2 15,000 0.75131 3 0.68301 4 X NPV…………………………………………………………

(2X) $9,091 9,917 11,270 0.68301X $3,927

–2X + $9,091 + $9,917 + $11,270 + 0.68301X = $3,927 –1.31699X + $30,278 = $3,927 –1.31699X = ($26,351) X = $20,009 * * Rounded to nearest dollar

Cash Flow in Year 4 = X = $20,009 Cost of Project = 2X = $40,018

12-18

CHAPTER 12

Capital Investment Decisions

E 12-41 1.

NPV: Project I Year

Cash Flow

Discount Factor

0 $(100,000) 1.00000 1 — 0.90909 2 134,560 0.82645 NPV……………………………………………………………

Present Value $(100,000) — 111,207 $ 11,207

Project II Year Cash Flow Discount Factor $(100,000) 1.00000 0 1 63,857 0.90909 2 63,857 0.82645 NPV……………………………………………………………

Present Value $(100,000) 58,052 52,775 $ 10,827

Project I should be chosen using NPV. IRR: Project I = df × CF $134,560 $100,000 = (1 + i )2 $134,560 (1 + i )2 = $100,000 = 1.34560 (1 + i ) = 1.16 IRR = 16% I

Alternate solution: I = df × CF 100,000 = df × $134,560 df = 100,000/134,560 df = 0.74316 which from Exhibit 12B.1 year 2, yields a rate of 16%. Project II I df = CP $100,000 = $63,857 = 1.56600 From Exhibit 12B.2, IRR is very close to 18%. Project II should be chosen using IRR. NPV is an absolute profitability measure and reveals how much the value of the firm will change for each project. IRR gives a measure of relative profitability. Thus, since NPV reveals the total wealth change attributable to each project, it is preferred to the IRR measure. 12-19

CHAPTER 12

Capital Investment Decisions

PROBLEMS P 12-42 1.

Schedule of cash flows: Year

Item

Equipment……………………………… Working capital………………………… Cost savings…………………………… Equipment operating costs………… Overhaul………………………………… Salvage value…………………………… Recovery of working capital…………

1–7 5 7 2.

Cash Flow

$(1,200,000) (120,000) $ 400,000 (270,000)

NPV: Year

Cash Flow

Discount Factor

0 $(1,320,000) 1.00000 1–7 130,000 4.56376 5 (120,000) 0.56743 7 216,000 0.45235 NPV………………………………………………………

Present Value $(1,320,000) 593,289 (68,092) 97,708 $ (697,095)

No, the new process design should not be accepted.

P 12-43 1.

Schedule of cash flows: Year

Item

Cash Flow

Equipment……………………………… Working capital………………………… Total…………………………………

$(1,750,000) (90,000) $(1,840,000)

1–5

Revenues……………………………… Operating expenses…………………… Total…………………………………

$ 1,650,000 (1,320,000) $ 330,000

Revenues……………………………… Operating expenses…………………… Major maintenance…………………… Total…………………………………

$ 1,650,000 (1,320,000) (150,000) $ 180,000

7–9

Revenues……………………………… Operating expenses…………………… Total…………………………………

$ 1,650,000 (1,320,000) $ 330,000

12-20

Cash Flow

130,000 (120,000) 96,000 120,000

CHAPTER 12

Capital Investment Decisions

P 12-43 (Continued) 10

Revenues………………………………………………………………… $ 1,650,000 (1,320,000) Operating expenses…………………………………………………… 100,000 Salvage…………………………………………………………………… 90,000 Recovery of working capital………………………………………… Total…………………………………………………………………… $ 520,000 Cash Flow

Year

Discount Factor

0 $(1,840,000) 1.00000 1–5 330,000 3.60478 180,000 0.50663 6 330,000 0.45235 7 330,000 0.40388 8 330,000 0.36061 9 520,000 0.32197 10 NPV……………………………………………………………

Present Value $(1,840,000) 1,189,577 91,193 149,276 133,280 119,001 167,424 $ 9,751

The new product should be accepted.

P 12-44 1.

df =

Investment Annual Cash Flow $508,500 $90,000

= 5.65000 The IRR is essentially 12% which is greater than the cost of capital. The company should acquire the new system. 2.

Since I = P for the IRR: I = df × CF $508,500 = 6.71008* × CF $508,500 ÷ 6.71008 = CF $75,782 = CF * Discount factor at 8% (cost of capital) for 10 years.

For a life of 8 years: df = =

I CF $508,500 $90,000

= 5.65000

12-21

CHAPTER 12

Capital Investment Decisions

P 12-44 (Continued) The IRR is between 8% and 9%—greater than the 8% cost of capital. The company should still acquire the new system. Minimum cash flow at 8% for 8 years: I = df × CF $508,500 = 5.74664 × CF $508,500 ÷ 5.74664 = CF $88,486 = CF 4.

Requirement 2 reveals that the estimates for cash savings can be off by as much as $14,218 (over 15%) without affecting the viability of the new system. Requirement 3 reveals that the life of the new system can be 2 years less than expected and the project is still viable. In the latter case, the cash flows can also decrease by almost 2% as well without changing the outcome. Thus, the sensitivity analysis should strengthen the case for buying the new system.

P 12-45 1.

First, calculate the expected cash flows: Days of operation each year: 365 – 15 = 350 Revenue per day: $235 × 2 × 150 = $70,500 Annual revenue: $70,500 × 350 = $24,675,000 Annual Cash Flow

= Revenues – Operating Costs = $24,675,000 – $3,250,000 = $21,425,000

NPV = P – I = (7.46945 × $21,425,000) – $120,000,000 = $160,032,966 – $120,000,000 = $40,032,966 Yes, the aircraft should be purchased. 2.

Revised Cash Flow = (0.80 × $24,675,000) – $3,250,000 = $16,490,000 NPV = P – I = (7.46945 × $16,490,000) – $120,000,000 = $3,171,231 Yes, the aircraft should be purchased.

12-22

CHAPTER 12

Capital Investment Decisions

P 12-45 (Continued) 3.

NPV = (7.46945)CF – $120,000,000 = 0 CF =

$120,000,000 7.46945

= $16,065,440 Annual Revenue

= $16,065,440 + $3,250,000 = $19,315,440

Daily Revenue

$19,315,440 350

= $55,187 Seats to Be Sold

$55,187 $470

= 118 seats (rounded up per problem instruction, each way) Seating Rate Needed = 4.

118 150

= 79%

Round-Trip Average Price = (2 × $235) × 1.1 = $517 Seats to Be Sold

$55,187 = 107 (rounded up per problem instruction) $517

Seating Rate

107 150

= 71%

This seating rate is less than the most likely and above the least likely rate of 70%. There is some risk, since it is possible that the actual rate could be below 71%. However, the interval is 20% (70% to 90% ) and the 71% (rounded from 71.33%); using 71.33%, the rate is 4.02% of the way into the interval ((70.67 – 70)/(90 – 70)), suggesting a high probability of a positive NPV. There are other risks involved that were not taken into account in this analysis. Over 20 years, there could be changes in the cost of capital, competition, pricing of flights, closures or delays due to weather, changes in costs (e.g., fuel), and changes in business travel patterns (e.g., increased use of virtual meetings). What management accountants can do is provide management with the data, the assumptions that formed the basis for the data, and the information concerning risk factors. Management's job is to assess the risk and the data and to make a decision.

12-23

CHAPTER 12

Capital Investment Decisions

P 12-46 1.

1.00 year 1.00 year 1.00 year 0.13 year * 3.13 years

$20,160 28,800 35,280 4,560 $88,800

* $4,560/$35,280 = 0.13 year Note: Cash Flow = Increased Revenue – Cash Expenses of $3,600 (e.g., for the first year, CF = $23,760 – $3,600 = 20,160). 2.

Accounting rate of return: Average Cash Revenue Average Cash Expenses Average Depreciation Accounting Rate of Return

($23,760 + $32,400 + $38,880 + $38,880) 4 = $3,600 per year =

$88,800 – $7,200 4

($33,480 – $3,600 – $20,400) $88,800

= 3.

Year

Cash Flow

$9,480 $88,800

$33,480

$20,400

= 10.68%

Discount Factor

0 1.00000 $(88,800) 1 20,160 0.89286 2 28,800 0.79719 3 35,280 0.71178 0.63552 4 42,480 * NPV…………………………………………………………

Present Value $(88,800) 18,000 22,959 25,112 26,997 $ 4,268

* Includes $7,200 salvage. IRR (by trial and error): Using 14% as the first guess: Year Present Value Discount Factor Cash Flow 0 $(88,800) 1.00000 1 20,160 0.87719 2 28,800 0.76947 3 35,280 0.67497 4 42,480 0.59208 NPV…………………………………………………………

$(88,800) 17,684 22,161 23,813 25,152 10 $

The IRR is about 14%. The equipment should be purchased (the NPV is positive and the IRR is larger than the cost of capital). Dr. Gomez should not be concerned about the accounting rate of return in making this decision. The payback, however, may be of some interest, particularly if cash flow is of concern to Dr. Gomez. 12-24

CHAPTER 12

P 12-46 (Continued) 4. Year

Cash Flow

Discount Factor

$(88,800) 0 1.00000 13,440 1 0.89286 19,200 2 0.79719 23,520 3 0.71178 30,720 4 0.63552 NPV……………………………………………………………………

Capital Investment Decisions

Present Value $(88,800) 12,000 15,306 16,741 19,523 $(25,230)

For Years 1–4, the cash flows are 2/3 of the original cash flow increases. Year 4 also includes $7,200 salvage. Given the new information, Dr. Gomez should not buy the equipment.

P 12-47 1.

Annual CF (rebuild alternative)

= ($295.00 – $274.65)10,000 = $203,500

NPV = (CF × df ) – I

= ($203,500 × 3.79079) – $600,000 = $171,426

Annual CF (scrap alternative)

= $4 × 10,000 = $40,000

NPV = (CF × df ) – I

= ($40,000 × 3.79079) – $0 = $151,632

The NPV of the rebuild alternative is greater and so the new demag machine should be purchased. 2. For the rebuild alternative, df

$600,000 $203,500

= 2.94840. The IRR ≈ 20%.

For the scrap alternative, df × CF = 0 implies that the IRR is infinite (CF is $40,000 and so df = 0 is required, which can occur only if the discount rate approaches infinity). This means that the scrap alternative is better under the IRR criterion. However, this doesn’t make sense because an infinite IRR is required even if the annual cash flow is $1 per year! Clearly, the NPV approach is better as it measures the absolute improvement in dollars.

12-25

CHAPTER 12

Capital Investment Decisions

P 12-48 1.

Project

Investment

Allocation

(1) Substance abuse wing………… (2) Laboratory……………………… (3) Outpatient surgery wing………

$1,500,000 500,000 1,000,000

$1,500,000 0 0

Total Net Present Value Realized = $150,000. The ranking does not give the optimal outcome for the capital available. The optimal decision is investing in (2) and (3) yielding a total NPV of $275,000. 2.

With unlimited capital, the substance abuse wing and the laboratory would be chosen. With limited capital, the laboratory and outpatient surgery wing would be chosen.

Answers may vary, but three qualitative considerations that should generally be considered in capital budgeting evaluations include: Quicker response to market changes and flexibility in production capacity. Strategic fit and long-term competitive improvement from the project, or the negative impact to the company’s competitiveness or image if it does not make the investment. Risks inherent in the project, business, or country for the investment.

P 12-49 1. Payback Period =

Original Investment Annual Cash Flow

$3,500,000 $3,900,000 – $3,000,000

$3,500,000 $900,000

= 3.89 years 2.

NPV

= = = = =

P–I (CF × df) – I ($900,000 × 3.79079) – $3,500,000 $3,411,711 – $3,500,000 $(88,289)

12-26

CHAPTER 12

Capital Investment Decisions

P 12-49 (Continued) P = CF(df) = I for the IRR, thus, df = =

Investment Annual Cash Flow $3,500,000 $900,000

= 3.88889 For 5 years and a discount factor of 3.88889, the IRR is about 9%. 3.

Year

Cash Flow*

Discount Factor

$(3,500,000) 0 1.00000 945,000 1 0.90909 992,250 2 0.82645 1,041,863 3 0.75131 1,093,956 4 0.68301 1,148,653 5 0.62092 NPV………………………………………………………

Present Value $(3,500,000) 859,090 820,045 782,762 747,183 713,222 $ 422,302

* (1.05)n × $900,000, n = 1, 2, …, 5. The asterisk is for Years 1–5. It is very important to adjust cash flows for inflationary effects. Since the required rate of return for capital budgeting analysis reflects an inflationary component at the time NPV analysis is performed, a correct analysis also requires that the predicted operating cash flows be adjusted to reflect inflationary effects. If the operating cash flows are not adjusted, then an erroneous decision may be the outcome. Notice, for example, that after adjusting for inflation, the new system is now favored—a totally different decision.

P 12-50 1. Bond Cost = $3,000/$60,000 = 0.05 Cost of Capital = 0.05(0.60) + 0.175(0.40) = 0.03 + 0.07 = 0.10 2.

NPV = = = = =

P–I (CF × df) – I ($50,000 × 2.48685) – $100,000 $124,343 – $100,000 $24,343

It is not necessary to subtract the interest payments and the dividend payments because these are associated with the cost of capital and are included in the firm’s cost of capital of 10%. 12-27

CHAPTER 12

Capital Investment Decisions

P 12-51 1.

Original savings and investment: (14% rate): Year

0 $(45,000,000) 1.00000 1–20 4,000,000 6.62313 20 5,000,000 0.07276 NPV…………………………………………………

Present Value $(45,000,000) 26,492,520 363,800 $(18,143,680)

(20% rate): Year

0 $(45,000,000) 1.00000 1–20 4,000,000 4.86958 20 5,000,000 0.02608 NPV………………………………………………… 2.

Present Value $(45,000,000) 19,478,320 130,400 $(25,391,280)

Total benefits: ($4,000,000 + $1,000,000 + $2,400,000) (14% rate): Year

0 $(45,000,000) 1.00000 1–20 7,400,000 6.62313 20 5,000,000 0.07276 NPV…………………………………………………

Present Value $(45,000,000) 49,011,162 363,800 $ 4,374,962

(20% rate): Year

0 $(45,000,000) 1.00000 1–20 7,400,000 4.86958 20 5,000,000 0.02608 NPV………………………………………………… 3.

Present Value $(45,000,000) 36,034,892 130,400 $ (8,834,708)

Analysis with increased investment: (14% rate): Year

0 $(48,000,000) 1.00000 1–20 7,400,000 6.62313 20 5,000,000 0.07276 NPV…………………………………………………

Present Value $(48,000,000) 49,011,162 363,800 $ 1,374,962

(20% rate): Year

0 $(48,000,000) 1.00000 1–20 7,400,000 4.86958 20 5,000,000 0.02608 NPV………………………………………………… 12-28

Present Value $(48,000,000) 36,034,892 130,400 $(11,834,708)

CHAPTER 12

Capital Investment Decisions

P 12-51 (Continued) 4.

The automated plant is an attractive investment when the additional benefits are considered—it promises to return at least the cost of capital (even for the high-cost scenario). Using the hurdle rate of 20% is probably too conservative—especially given the robustness of the outcome using the cost of capital. The company should invest in the new system.

P 12-52 1. Year

Present Value

0 $(860,000) 1.00000 1–8 225,000 4.34359 NPV……………………………………………… 2.

Year

$(860,000) 977,308 $ 117,308 Present Value

0 $(920,000) 1.00000 1–8 205,000 4.34359 NPV………………………………………………

$(920,000) 890,436 $ (29,564)

After the fact, the decision was not a good one. 3.

The $60,000 per year is an annuity that produces a present value of $260,615 (4.34359 × $60,000). This restores the project to a positive NPV position ($260,615 – $29,564 = $231,051).

A postaudit can help ensure that a firm’s resources are being used wisely. It may reveal that additional resources ought to be invested or that corrective action be taken so that the performance of the investment is improved. A postaudit may even signal the need to abandon a project or replace it with a more viable alternative. Postaudits also provide information to managers so that their future capital decision making can be improved. Finally, postaudits can be used as a means to hold managers accountable for their capital investment decisions.

12-29

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Capital Investment Decisions

P 12-53 1.

Standard (Rate = 18%): Year

0 $(500,000) 1.00000 1 300,000 0.84746 2 200,000 0.71818 3–10 100,000 2.92845 * NPV………………………………………………

Present Value $(500,000) 254,238 143,636 292,845 $ 190,719

*df for Years 1–10 minus df for Years 1–2 (from Exhibit 12B.2) CAM (Rate = 18%): Year

$(2,000,000) 1.00000 0 1 100,000 0.84746 2 200,000 0.71818 3 300,000 0.60863 a 4–6 400,000 1.32333 7 500,000 0.31393 8–10 1,000,000 0.68256 b NPV……………………………………………… a

Present Value $(2,000,000) 84,746 143,636 182,589 529,332 156,965 682,560 $ (220,172)

df for Years 1–6 minus df for Years 1–3 (from Exhibit 12B.2) df for Years 1–10 minus df for Years 1–7 (from Exhibit 12B.2)

Standard (Rate = 10%): Year

0 $(500,000) 1.00000 1 300,000 0.90909 2 200,000 0.82645 c 3–10 100,000 4.40903 NPV………………………………………………

Present Value $(500,000) 272,727 165,290 440,903 $ 378,920

df for Years 1–10 minus df for Years 4–6 (from Exhibit 12B.2)

CAM (Rate = 10%): Year

0 $(2,000,000) 1.00000 1 100,000 0.90909 2 200,000 0.82645 3 300,000 0.75131 d 4–6 400,000 1.86841 7 500,000 0.51316 e 8–10 1,000,000 1.27615 NPV……………………………………………… d e

Present Value $(2,000,000) 90,909 165,290 225,393 747,364 256,580 1,276,150 $ 761,686

df for Years 1–6 minus df for Years 1–3 (from Exhibit 12B.2) df for Years 1–10 minus df for Years 1–7 (from Exhibit 12B.2) 12-30

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Capital Investment Decisions

P 12-53 (Continued) 3.

Notice how the cash flows using a 10% rate in Years 8–10 are weighted compared to the 18% rate. The difference in present value is significant. Using an excessive discount rate works against those projects that promise large cash flows later in their lives. The best course of action for a firm is to use its cost of capital as the discount rate. Otherwise, some very attractive and essential investments could be overlooked.

P 12-54 1.

Standard (Rate = 14%): Year

0 $(500,000) 1.00000 1 300,000 0.87719 2 200,000 0.76947 3–10 100,000 3.56946 NPV…………………………………………………………… CAM (Rate = 14%): Year

0 $(2,000,000) 1.00000 1 100,000 0.87719 2 200,000 0.76947 3 300,000 0.67497 4–6 400,000 1.56704 7 500,000 0.39964 0.92781 8–10 1,000,000 NPV…………………………………………………………… 2.

Standard (Rate = 14%): Year

0 $(500,000) 1.00000 1 300,000 0.87719 2 200,000 0.76947 3–10 50,000 3.56946 NPV……………………………………………………………

Present Value $(500,000) 263,157 153,894 356,946 $ 273,997 Present Value $(2,000,000) 87,719 153,894 202,491 626,816 199,820 927,810 $ 198,550 Present Value $(500,000) 263,157 153,894 178,473 $ 95,524

The decision reverses—the CAM system is now preferable. This reversal is attributable to the intangible benefit of maintaining market share. To remain competitive, managers must make good decisions, and this exercise emphasizes how intangible benefits can affect decisions.

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Capital Investment Decisions

CASES Case 12-55 The statement that Manny would normally have taken the first bid without hesitation implies that the bid met all of the formal requirements outlined by the company. If Manny’s friend had met the bid as requested, then presumably Manny would have offered the business to his friend. The motive for this was friendship and possibly carried with it past experience in dealing with Todd’s company. Perhaps there was some uncertainty in Manny’s mind about the low bidder’s ability to execute the requirements of the bid, especially since the winning bid was from out of state. If there was some legitimate concern about the winning bid and Manny was hopeful of eliminating this concern by dealing with a known quantity, then it could be argued that the call to Todd was justifiable. If, on the other hand, the only motive was friendship and Manny was confident that the winning bid could execute (as he appears to have been), then the call was improper. Confidentiality and integrity in carrying out the firm’s bidding policies are essential. The fact that Manny was tempted by Todd’s enticements and appeared to be leaning toward accepting Todd’s original offer compounds the difficulty of the issue. If Manny actually accepts Todd’s offer and grants the business at the original price and accepts the gifts, then his behavior is unquestionably unethical. Some parts of the Statement of Ethical Professional Practice (Exhibit 1-4, p. 19) that would be violated are listed below. II.

Confidentiality 1. Keep information confidential except when disclosure is authorized or legally required. 3. Refrain from using confidential information for unethical or illegal advantage.

III.

Integrity 2. Refrain from engaging in any conduct that would prejudice carrying out duties ethically.

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Case 12-56 1.

Shaftel Ready Mix Income Statement For the Proposed Plant Sales (35,000 × $45)……………………………………… Less: Variable expenses ($35.08 × 35,000).………… Contribution margin……………………………………… Less fixed expenses: Salaries………………………………………..………… Insurance……………………………………..………… Telephone…………………………………….………… Depreciation………………………………….………… Utilities………………………………………………… Net income……………………………………….…………

$1,575,000 1,227,800 $ 347,200 $135,000 75,000 5,000 56,200 * 25,000

296,200 $ 51,000

* Reported depreciation erroneously included $2,000 for the land. $51,000 $1,575,000

Ratio of Net Income to Sales =

= 3.24%

Karl is correct that the return on sales is significantly lower than the company average. 2.

Payback Period

Original Investment Annual Cash Flow

$352,000 $107,200**

= 3.28 years ** Net income of $51,000 + depreciation of $56,200 Karl is wrong. The book value of the equipment and the furniture should not be included in the amount of the original investment because there is no opportunity cost associated with them. Excluding the book value reduces the investment from $582,000 to $352,000. Karl’s payback would be correct if the equipment and furniture could be sold for their book value because there would now be an opportunity cost associated with them and that cost should be included in the original investment. 3.

NPV: Discount Factor

Present Value

$(352,000) 0 1.00000 107,200 6.14457 1–10 NPV………………………………………………………

$(352,000) 658,698 $ 306,698

Year

Cash Flow

12-33

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Capital Investment Decisions

Case 12-56 (Continued) IRR: df = =

I CF $352,000 $107,200

= 3.28358 Thus, the IRR is between 25% and 30%. If the furniture and equipment can be sold for book value: NPV: Year

Cash Flow

Discount Factor

0 $(582,000) 1.00000 1–10 107,200 6.14457 NPV……………………………………………………… IRR:

Present Value $(582,000) 658,698 $ 76,698

$582,000 $107,200

= 5.42910 Thus, the IRR is between 12% and 14%. 4.

Breakeven: $45X = $35.08X + $296,200 $9.92X = $296,200 X = 29,859 cubic yards NPV (using break-even amount): Cash Flow

Year

Discount Factor

0 $(352,000) 1.00000 1–10 56,200 6.14457 NPV……………………………………………………… IRR:

Present Value $(352,000) 345,325 $ (6,675)

$352,000 $56,200

= 6.26335 Thus, the IRR is between 9% and 10%. The investment is not acceptable, although it came close. It is possible to have a positive NPV at the break-even point. Breakeven is defined for accounting income, not for cash flow. Since there are noncash expenses deducted from revenues, accounting income understates cash income. Zero income does not mean zero cash inflows.

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Capital Investment Decisions

Case 12-56 (Continued) 5.

Cost of Capital = 10% for 10 years, so df = 6.14457 df

6.14457 =

I CF $352,000 CF

6.14457 × CF = $352,000 CF = $57,286 Cash flow……………………… Less: Depreciation………… Net income………………… Net Income

$57,286 56,200 $ 1,086

= Sales – Variable Expenses – Fixed Expenses

$1,086 = $45X – $35.08X – $296,200 $1,086 = $9.92X – $296,200 $297,286 = $9.92X X = 29,968 cubic yards Sales ($45 × 29,968)……………………………………………… Less: Variable expenses ($35.08 × 29,968)…………………… Contribution margin……………………………………………… Less: Fixed expenses…………………………………………… Net income………………………………………………………

12-35

$1,348,560 1,051,277 $ 297,283 296,200 $ 1,083

EMERGING TOPICS IN MANAGERIAL ACCOUNTING DISCUSSION QUESTIONS

1. The most important reason for an organization to use enterprise risk management is to help the organization achieve its chosen strategy more effectively and/or more quickly than if the company were managed on an ad hoc basis without consideration for how various strategic and operational decisions affected one another and the organization overall. 2. Inherent risk is the risk that exists before any action has been taken to manage the risk. Residual risk is the risk that remains after any risk management action has been taken. 3. Most risk response alternatives involve an incremental cost of some sort in order to be implemented. If management is considering between multiple response alternatives, the benefit (i.e., inherent risk minus the residual risk) is likely to vary across alternatives. However, the incremental cost of each alternative also likely varies across alternatives. Therefore, all else equal, management should choose the risk response alternative that provides the greatest net benefit, which is calculated as the benefit minus the cost of each response alternative. 4. Answers will vary. However, one large challenge in employing data analytics within an enterprise risk management setting concerns its forward-looking focus on what risks might be in the future. By definition, risks are events that might occur (likelihood ranging between 0% to 100%) and, thus, contain considerable uncertainty. Similarly, the potential impact of risks require decision makers (including management accountants) to attempt to estimate future costs, revenues, operating income or other quantitative measures of risk impact. As a result, estimates of future likelihood and future impact usually prove to be more difficult than estimates of historical performance, such as the activity drivers of past cost performance (which can be challenging in its own right). On a related note, obtaining the data regarding future risk likelihood and/or impact oftentimes is more difficult, costly, and time consuming than obtaining historical data concerning our own company or industry performance. 5. Environmental sustainability is much narrower than business sustainability. Environmental sustainability refers solely to the various environmentally oriented risks and opportunities facing a given organization, such as the amount of electricity consumed in a service facility or the size of an organization’s carbon emissions footprint. While these issues are important to many organizations, most organizations also must identify, measure, and manage a much larger number of risks and opportunities in order to thrive, or even survive, over the long term. Such additional risks and opportunities might involve financial, economic, social, employee, or regulatory issues. 6. Performance measurement is an important aspect of successful business sustainability efforts because quantifying an organization’s key stakeholder issues, which can be considered to be the same as the organization’s top risks and opportunities, improves management’s ability to manage this most important issue and report to stakeholders on their successes and challenges with such issues. Some risks and opportunities are difficult to measure and perhaps should be measured qualitatively at first and then quantitatively later on once the managerial accounting team better understands how to do so accurately. Also, quantitative sustainability measurement often is led by nonfinancial (or leading) measures, followed by financial measures, again after the managerial accounting team determines how to most accurately link key stakeholder issues (risks/opportunities) to the financial measures that shareholders and other key stakeholders most care about. 13-1

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Emerging Topics in Managerial Accounting

7. Answers will vary. However, one large challenge in employing data analytics within a business sustainability setting concerns accurately linking various business sustainability performance metrics to financial performance metrics (e.g., revenues, costs, operating income, net income, relevant profit, etc.). For example, environmental, social, and governance (ESG) initiatives receive considerable attention from many organizations. These initiatives involve various metrics such as water usage, soil pollution, greenhouse gas emissions, and employee safety. However, while accurately measuring such ESG metrics often is challenging, connecting them to changes in the organization’s financial performance can be even more challenging. Increasingly, management accountants are being relied upon inside organizations to help measure and quantify these relationships between ESG initiatives and financial performance. 8. Prevention costs are incurred to prevent defects in products; appraisal costs are costs incurred to determine whether products are conforming to specifications; internal failure costs are incurred when nonconforming products are detected prior to shipment; and external failure costs are incurred because nonconforming products are delivered to customers. 9. A quality cost report shows the amount of cost for each category as well as the relative cost of each category. This report requires managers to identify the costs that should appear in the report, to identify the current quality performance level, and to begin thinking about the level of quality performance that should be achieved. 10. Data visualization for a single period shows the current distribution of costs in total and by category, thus allowing managers to assess the relative importance of each quality cost category. It also helps them to evaluate where resources should be invested to improve quality. For multiple-period reporting, data visualization shows trends and reveals the effects of quality improvements over time. 11. A focused value stream is dedicated to one product. It includes all the activities and steps necessary to produce, deliver, and service the product after it is sold. The resources, people, and equipment to accomplish this are all exclusive to the value stream, making all the costs directly traceable to the product produced by the value stream. 12. Units shipped are used to discourage the production of excess inventories. This also encourages the reduction and elimination of existing finished goods inventories. The unit cost increases if more units are produced than sold. The unit cost decreases if more units are shipped than produced. 13. If the products in the value stream are quite similar, then the average cost will approximate the actual unit product cost. If the product mix is relatively stable over time, then the average unit cost can be a good signal of overall changes in efficiency within the value stream. 14. Differences among countries in terms of the political, legal, and cultural environment can all affect the firm. The management accountant may find that practices that work well in the home country do not work as well (or at all) in other countries. It is necessary for the management accountant to be aware of all facets of business and to be knowledgeable and creative in applying accounting concepts in various business environments. 15. A foreign trade zone is an area that is physically on U.S. soil but is considered to be outside U.S. commerce. As a result, goods imported into a foreign trade zone are free of tariff or duty until they leave the zone. Therefore, companies located in a foreign trade zone can postpone payment of tariff and the associated loss of working capital. Additionally, the company does not pay duty on defective materials or inventory that has not been included in the finished product. 16. Outsourcing is the payment by a company for a business function that was formerly done in house. In an international context, outsourcing refers to the location of business functions in another country. Frequently, the work outsourced is to a lower-wage country. The company receives a comparable quality of work but at a lower cost. 17 Forensic accounting deals with the application of accounting knowledge to legal or other cases that help resolve many different types of disputes. The major areas of practice involve Fraud, Litigation Support, and Business Valuations. 18. The fraud triangle is a model that explains the factors causing someone to commit fraud. The three components are financial need, opportunity, and the ability to rationalize the commission of fraud.

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Emerging Topics in Managerial Accounting

MULTIPLE-CHOICE QUESTIONS 13-1.

13-2.

13-3.

13-4.

13-5.

13-6.

13-7.

13-8.

13-9.

13-10.

13-11.

13-12.

13-13.

13-14.

13-15.

c (60 minutes per hour/12 minutes for drilling)

13-16.

13-17.

13-18.

13-19.

13-20.

13-3

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Emerging Topics in Managerial Accounting

BRIEF EXERCISES: SET A BE 13-21 1. The inherent risk formula takes the following form: Inherent risk = (Likelihood) × (Impact) Note: For Inherent risk, the likelihood and impact are assessed ABSENT of any response alternative being implemented Inherent risk = $24,000,000 ($80,000,000 × 0.30) 2. The residual risk formula takes the following form: Note: For Residual risk, the likelihood and impact are assessed AFTER considering the effects of a particular response alternative. Residual risk for A = $16,000,000 ($80,000,000 × 0.20) Residual risk for B = $7,500,000 ($50,000,000 × 0.15) Residual risk for C = $24,000,000 ($80,000,000 × 0.30) 3. The benefit formula takes the following form: Benefit = Inherent risk – Residual risk Benefit for A = $8,000,000 ($24,000,000 – $16,000,000) Benefit for B = $16,500,000 ($24,000,000 – $7,500,000) Benefit for C = $0 ($24,000,000 – $24,000,000) 4. The net benefit formula takes the following form: Net benefit = Response benefit – Response cost Benefit for A = $5,000,000 ($8,000,000 – $3,000,000) Benefit for B = $3,500,000 ($16,500,000 – $13,000,000) Benefit for C = $0 ($0 – $0) 5. The risk response alternative with the greatest net benefit is alternative A. It is worth noting that while alternative B had the larger response benefit (than A), B's cost was larger (than A's) by a large enough amount that A possessed the greatest net benefit (benefit minus cost). Therefore, management should be careful to consider both the cost and benefit of each risk response alternative in order to select the one that provides the most cost effective risk reduction.

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BE 13-22 1.

Whitley Company Quality Cost Report For the Year Ended 20X1 Quality Costs Prevention costs: Quality circles ...................... Prototype inspection...........

Appraisal costs: Field testing ......................... Packaging inspection .........

Internal failure costs: Design changes ................... Downtime ............................. External failure costs: Returns/allowances ............ Complaint adjustment......... Total quality costs ....................

Percentage of Salesa

2,000 13,000

$ 15,000

1.50%

6,000 14,000

20,000

2.00

$ 60,000 40,000

100,000

10.00

115,000 $250,000

11.50 25.00%b

$ 50,000 65,000

Actual sales of $1,000,000 $250,000/$1,000,000 = 25%

The report clearly indicates that quality costs are too high as 25% of sales is much greater than the desired 2% to 4% of sales that prevails for companies with good quality performance.

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BE 13-22 (Continued) 2. Quality Cost Categories: Relative Contribution Graphs

Percentage of Total Quality Costs

50.00% 45.00% 40.00% 35.00% 30.00% 25.00%

46.00%

20.00%

40.00%

15.00% 10.00% 5.00%

6.00%

8.00%

Prevention

Appraisal

0.00% Internal Failure

External Failure

Percentage of Total Quality Costs 6.00% 8.00% Prevention 46.00%

Appraisal Inernal Failure 40.00%

External Failure

The graphs reveal that failure costs are approximately 86% of the total quality costs, suggesting that Whitley needs to invest more in control activities to drive down failure costs.

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Emerging Topics in Managerial Accounting

BE 13-23 1.

Andresen Company Interim Standard Performance Report: Quality Costs For the Year Ended June 30, 20X2 Actual Costs

Budgeted Costs

$ 45,000 90,000 $135,000

$ 45,000a 90,000a $135,000

$ 67,500 54,750 $122,250

$ 67,500a 56,250a $123,750

Variance

Prevention costs: Quality audits ............................. Vendor certification ................... Total prevention costs .......... Appraisal costs: Product acceptance .................. Process acceptance .................. Total appraisal costs ............. Internal failure costs: Retesting .................................... Rework ....................................... Total internal failure costs .... External failure costs: Recalls ........................................ Warranty ..................................... Total external failure costs ... Total quality costs .........................

$ 45,000 90,000 $135,000

$ 40,800b 86,400b $127,200

$ 4,200 U 3,600 U $ 7,800 U

$ 60,000 150,000 $210,000 $602,250

$ 60,000b 132,000b $192,000 $577,950

$ 0 18,000 U $18,000 U $24,300 U

Percentage of sales .......................

10.04%

9.63%

0.41% U

$ $

0 0 0

0 1,500 F $ 1,500 F

20X1 actual control cost × 1.50 (e.g., quality audits = $30,000 × 1.50 = $45,000) 20X1 actual failure cost × 0.80 (e.g., retesting = $51,000 × 0.8 = $40,800)

Andresen has come very close to meeting the planned outcomes (only 0.41% short overall). Thus, management’s belief that investing an additional 50% in control costs would produce a 20% reduction in failure costs seems to be validated.

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Emerging Topics in Managerial Accounting

BE 13-24

Multiple‐Period Trend Graph: Total Quality Costs 25.00% 20.00%

22.00%

20.00%

15.00%

17.00% 14.00%

10.00%

11.00%

5.00% 0.00% 20X1

20X2

20X3

20X4

20X5

The trend graph reveals that quality costs have been cut in half as a percentage of sales; however, at 11.00%, there is still substantial improvement opportunity left. 2.

Trend Graph by Categories Percentage of Sales

14.00% 12.00% 10.00% 8.00%

Prevention

6.00%

Appraisal

4.00%

Internal Failure

2.00%

External Failure

0.00% 20X1

20X2

20X3

20X4

20X5

Year

This graph reveals much more detail. For example, external failure costs are only about 30% of the original amount, and internal failure costs are only 20% to 25% of their beginning levels. Clearly, the additional investment in control costs has paid off.

13-8

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Emerging Topics in Managerial Accounting

BE 13-25 1.

Total lead time for a batch of 10 units: Processing time: Cutting ..................................... Welding .................................... Polishing .................................. Finishing .................................. Total processing ............................ Move and wait times ...................... Total batch time .............................

Processing time (10 units): First unit .................................. Second unit ............................. Tenth unit ................................

50 minutes 100 minutes 80 minutes 70 minutes 300 minutes 75 minutes 375 minutes Elapsed time 30 minutes 40 minutes (processing begins 5 minutes after the first) 120 minutes (total processing time) [Processing begins 5 minutes after first but ultimately gets bottlenecked in Welding, the longest process, that takes 10 minutes per unit. Thus, each unit after the first is ten minutes behind the preceding unit, thus the total elapsed time is (9 x 10) + 30 = 120 minutes.]

Time saved over traditional manufacturing: 375 minutes – 120 minutes = 255 minutes If the cell is processing continuously, then a unit is produced every 10 minutes after the start-up unit. Thus, the production rate is 6 units per hour (60/10). At the steady state, the processing time for 10 units is 100 minutes [(10/6) × 60] and 275 minutes are saved. Welding, the bottleneck process, controls the production rate. 3.

Eight minutes (for polishing) is now the longest per-unit processing time and so the production rate is 60/8 = 7.5 units per hour. Producing 10 units will take 80 minutes [(10/7.5) × 60].

BE 13-26 1.

Unit cost = $900,000/16,000 = $56.25 per unit. The cost is very accurate as the value stream is dedicated to one product and its costs all belong to that product.

First, the unit materials cost is calculated separately: Model A: $176,800*/4,000 = $44.20 Model B: $265,200/12,000 = $22.10 *40% × $442,000

Next, the average unit conversion cost is calculated: $458,000*/16,000 = $28.63.** *($900,000 – $442,000) ** Rounded 13-9

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BE 13-26 (Continued) Finally, the unit cost is computed (sum of materials and average conversion cost): Model A: $44.20 + $28.63 = $72.83 Model B: $22.10 + $28.63 = $50.73 The accuracy of these costs depends on whether or not the 2 products consume conversion costs at the same rate. To the extent they do, these costs are accurate. Using units shipped for the unit calculation motivates managers to reduce inventories. 3.

DBC assigns the conversion cost to each product using the conversion cost rate and each product’s cycle time: Conversion Cost Rate = Conversion Cost/Total Hours = $458,000/10,000 = $45.80 per hour Conversion Cost per Unit (Model A) = Rate × Cycle Time = $45.80 × 1.09 = $49.92* Cost per Unit (Model A) = Materials Cost + Conversion Cost = $44.20 + $49.92 = $94.12 Conversion Cost per Unit (Model B) = Rate × Cycle Time = $45.80 × 0.47 = $21.53* Cost per unit (Model B) = $22.10 + $21.53 = $43.63 DBC approximates ABC cost assignments using cycle times and so better reflects the consumption of resources by the two products. *Rounded

BE 13-27 1.

80,000 pesos/19.8 = $4,040

80,000 pesos/19.6 = $4,082

Exchange loss = $4,040 − $4,082 = ($42)

13-10

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Emerging Topics in Managerial Accounting

BRIEF EXERCISES: SET B BE 13-28 1.

The residual risk formula takes the following form: Note: For Residual risk, the likelihood and impact are assessed AFTER considering the effects of a particular response alternative. Residual risk for A = $200,000 ($500,000 × 0.40) Residual risk for B = $400,000 ($800,000 × 0.50) Residual risk for C = $1,200,000 ($2,000,000 × 0.60)

The benefit formula takes the following form: Benefit = Inherent risk – Residual risk Benefit for A = $1,000,000 ($1,200,000 – $200,000) Benefit for B = $800,000 ($1,200,000 – $400,000) Benefit for C = $0 ($1,200,000 – $1,200,000)

The net benefit formula takes the following form: Net benefit = Response benefit – Response cost Net benefit for A = $400,000 ($1,000,000 – $600,000) Net benefit for B = $650,000 ($800,000 – $150,000) Net benefit for C = $0 ($0 – $0)

The risk response alternative with the greatest net benefit, $650,000, is alternative B. Therefore, Kalani should select and implement risk response alternative B (i.e., design and implement new and improved food preparation training techniques). Further, while not provided as an option in this brief exercise, Kalani might be wise to consider additional risk response alternatives, such as one that combines both A and B (i.e., both new refrigeration units AND new and improved food preparation training techniques). It is possible that such a combined risk response alternative would generate an even larger net benefit as a result of the different residual risk (likelihood and impact) estimates and incremental implementation costs.

13-11

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Emerging Topics in Managerial Accounting

BE 13-29 1.

Cruz Company Quality Cost Report For the Year Ended 20X1 Quality Costs Prevention costs: Marketing research ............. Prototype inspection ..........

9,000 21,000

$ 30,000

0.83%

Appraisal costs: Packaging inspection ......... Process acceptance ...........

$ 24,000 21,000

45,000

1.25

Internal failure costs: Rework ................................. Reinspection .......................

$180,000 45,000

225,000

6.25

450,000 $750,000

12.50 20.83%b

External failure costs: Discounts due to defects ... Product liability .................. . Total quality costs ....................

Percentage of Salesa

$150,000 300,000

Actual sales of $3,600,000 $750,000/$3,600,000 = 20.83%

The report clearly indicates that quality costs are too high as 20.83% of sales is much greater than the desired 2% to 4% of sales that prevails for companies with good quality performance.

13-12

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Emerging Topics in Managerial Accounting

BE 13-29 (Continued) Quality Cost Categories: Relative Contribution Graphs 70.00% Percentage of Total Quality Costs

60.00% 50.00% 40.00% 30.00%

60.00%

20.00% 30.00% 10.00% 0.00%

4.00%

6.00%

Prevention

Appraisal

Internal Failure External Failure

Percentage of Total Quality Costs 4.00%

6.00%

Prevention Appraisal

30.00%

Internal Failure

60.00%

External failure

The graphs reveal that failure costs are approximately 90% of the total quality costs, suggesting that Cruz needs to invest more in control activities to drive down failure costs.

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BE 13-30 1.

Matrimon, Inc. Interim Standard Performance Report: Quality Costs For the Year Ended December 31, 20X2 Actual Costs

Budgeted Costs

Variance

$ 116,200 235,200 $ 351,400

$ 117,600a 235,200a $ 352,800

$ 1,400 F 0 $ 1,400 F

$ 176,400 148,400 $ 324,800

$ 176,400a 147,000a $ 323,400

0 1,400 U $ 1,400 U

Prevention costs: Design reviews ........................... Quality audits ............................. Total prevention costs ........... Appraisal costs: Field testing ................................ Inspection of materials .............. Total appraisal costs.............. Internal failure costs: Scrap ........................................... Repairs ........................................ Total internal failure costs ..... External failure costs: Lost sales .................................... Recalls......................................... Total external failure costs .... Total quality costs ..........................

$ 106,680 233,520 $ 340,200

$ 105,000b 231,000b $ 336,000

$ 1,680 U 2,520 U $ 4,200 U

$ 170,800 387,800 $ 558,600 $1,575,000

$ 168,000b 378,000b $ 546,000 $1,558,200

$ 2,800 U 9,800 U $12,600 U $16,800 U

Percentage of sales........................

9.38%

9.28%

0.10% U

20X1 actual control cost × 1.40 (e.g., design reviews = $84,000 × 1.40 = $117,600) 20X1 actual failure cost × 0.75 (e.g., scrap = $140,000 × 0.75 = $105,000)

Matrimon has come very close to meeting the planned outcomes (only 0.10% short overall). Thus, management’s belief that investing an additional 40% in control costs would produce a 25% reduction in failure costs seems to be validated.

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BE 13-31

Trend In Total Quality Costs Percentage of Sales

30.00% 25.00% 20.00%

25.00%

23.00% 20.00%

15.00%

10.00%

12.00%

5.00% 0.00% 20X1

20X2

20X3

20X4

20X5

Year

The trend graph reveals that quality costs have been cut by a little more than half as a percentage of sales; however, at 12.00%, there is still substantial improvement opportunity left. 2.

Trend by Quality Cost Category Percentage of Sales

14.00% 12.00% 10.00% 8.00%

Prevention

6.00%

Appraisal

4.00%

Internal failure

2.00%

External failure

0.00% 20X1

20X2

20X3

20X4

20X5

Year

This graph reveals much more detail. For example, external failure costs are only about 19% of the original amount and internal failure costs are about 26% of their beginning levels. Clearly, the additional investment in control costs has paid off.

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BE 13-32 1.

Total lead time for a batch of 20 units: Processing time: Casting ..................................... Grinding.................................... Drilling ...................................... Finishing................................... Total processing............................. Move and wait times ...................... Total batch time ..............................

360 minutes 180 minutes 300 minutes 60 minutes 900 minutes 105 minutes 1,005 minutes

Processing time (20 units): First unit ................................... Second unit ..............................

Elapsed time 45 minutes 63 minutes (processing begins 18 minutes after the first) Twentieth unit .......................... 387 minutes (total processing time) [Casting is the bottleneck and is the first process. Accordingly, each unit after the first begins 18 minutes after the preceding unit; thus, total elapsed time is (18 x 19) + 45 = 387 minutes.]

Time saved over traditional manufacturing: 1,005 minutes – 387 minutes = 618 minutes If the cell is processing continuously, then a unit is produced every 18 minutes after the start-up unit. Thus, the production rate is 3.33 units per hour (60/18). At the steady state, the processing time for 20 units is 360 minutes [(20/3.33) × 60] and 645 minutes are saved. Casting, the bottleneck process, controls the production rate. 3.

Fifteen minutes (for drilling) is now the longest per-unit processing time and so the production rate is 60/15 = 4 units per hour. Producing 20 units will take 300 minutes [(20/4) × 60].

BE 13-33 1.

Unit cost = $225,000/4,000 = $56.25 per unit. The cost is very accurate as the value stream is dedicated to one product and its costs all belong to that product.

First, the unit materials cost is calculated separately: SK1: $66,300*/1,500 = $44.20 SK3: $44,200/2,500 = $17.68 *60% × $110,500

Next, the average unit conversion cost is calculated: $114,500*/4,000 = $28.63.** *($225,000 – $110,500)

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BE 13-33 (Continued) Finally, the unit cost is computed (sum of materials and average conversion cost): Tool SK1: $44.20 + $28.63 = $72.83 Tool SK3: $17.68 + $28.63 = $46.31 The accuracy of these costs depends on whether or not the 2 products consume conversion costs at the same rate. To the extent they do, these costs are accurate. Using units shipped for the unit calculation motivates managers to reduce inventories. ** Rounded

DBC assigns the conversion cost to each product using the conversion cost rate and each product’s cycle time: Conversion Cost Rate = Conversion Cost/Total Hours = $114,500/2,500 = $45.80 per hour Conversion Cost per Unit (Tool SK1) = Rate × Cycle Time = $45.80 × 0.73 = $33.43* Cost per Unit (Tool SK1) = Materials Cost + Conversion Cost = $44.20 + $33.43 = $77.63 Conversion Cost per Unit (Tool SK3) = Rate × Cycle Time = $45.80 × 0.56 = $25.65* Cost per Unit (Tool SK3) = $17.68 + $25.65 = $43.33 DBC approximates ABC cost assignments and so better reflects the consumption of resources by the two products. However, in this case, the average costing approach is reasonably close to the DBC assignments. Still, since DBC is so easy to use and has more consistent accuracy, it would be preferred. * Rounded

BE 13-34 1.

95,000 pesos/19.8 = $4,798

95,000 pesos/19.6 = $4,847

Exchange Loss = $4,798 – $4,847 = $49

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EXERCISES E 13-35  = B [Residual risk 4 (RR4)]  = A [Inherent risk 3 (IR3)]  = E [Likelihood]  = G [Risk appetite]  = D [Inherent risk 4 (IR4)]

E 13-36 Inherent Risk 1 = Accept (offset by IR5) Inherent Risk 2 = Reduce Inherent Risk 3 = Avoid (therefore, there is no reference to IR3 or RR3 on the graph) Inherent Risk 4 = Reduce Inherent Risk 5 = Accept (offset by IR1)

E 13-37 1.

The inherent risk formula takes the following form: Inherent risk = (Likelihood) × (Impact) Note: For Inherent risk, the likelihood and impact are assessed ABSENT of any response alternative being implemented. Inherent risk = $2,500,000 ($10,000,000 × 0.25) The residual risk formula takes the following form: Note: For Residual risk, the likelihood and impact are assessed AFTER considering the effects of a particular response alternative. Residual risk for A = $500,000 ($5,000,000 × 0.10) Residual risk for B = $1,500,000 ($10,000,000 × 0.15) Residual risk for C = $2,500,000 ($10,000,000 × 0.25) The benefit formula takes the following form: Benefit = Inherent risk – Residual risk Therefore: Benefit for A = $2,000,000 ($2,500,000 – $500,000) Benefit for B = $1,000,000 ($2,500,000 – $1,500,000) Benefit for C = $0 ($2,500,000 – $2,500,000) Note: This exercise uses “lost revenues” as the relevant unit of measurement, as opposed to Example 13.1 and BE 13.20 (Cooper Movie Studio Corp.) that used "increased costs" as the relevant unit of measurement for framing risks.

13-18

If The link does not work with a click, then copy the complete Download link and paste link in internet explorer/ﬁrefox/google chrome and get all ﬁles download successfully.

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E 13-37 (Continued) 2.

The net benefit formula takes the following form: Net benefit = Response benefit – Response cost Therefore, Net benefit for A = –$200,000 ($2,000,000 – $2,200,000) Net benefit for B = $300,000 ($1,000,000 – $700,000) Net benefit for C = $0 ($0 – $0) The risk response alternative with the greatest net benefit is alternative B. In fact, not only is the net benefit for alternative B, $300,000, the greatest net benefit of the three risk response alternatives, but the net benefit for risk response alternative A actually is NEGATIVE (−$200,000)! A negative net benefit means that the estimated incremental cost of implementing the response is greater than the estimated benefit of the response alternative. In other words, if all risk reduction response alternatives had a negative net benefit, then management would be better off simply accepting the risk (i.e., doing nothing) because the net benefit is $0 (which is better than being negative). Of course, the more accurate the response cost and other ERM estimates are from the management accounting team, the more effective management can be in making the best ERM-related decisions.

The risk response alternative with the greatest net benefit is alternative B. In fact, not only is the net benefit for alternative B, $300,000, the greatest net benefit of the three risk response alternatives, but the net benefit for risk response alternative A actually is NEGATIVE (−$200,000)! A negative net benefit means that the estimated incremental cost of implementing the response is greater than the estimated benefit of the response alternative. In other words, if all risk reduction response alternatives had a negative net benefit, then management would be better off simply accepting the risk (i.e., doing nothing) because the net benefit is $0 (which is better than being negative). Of course, the more accurate the response cost and other ERM estimates are from the management accounting team, the more effective management can be in making the best ERM-related decisions.

Answers will vary and could involve numerous quantitative aspects of the ERM process, including identifying possible risks, prioritizing key risks, and estimating inherent risk likelihood, inherent risk impact, residual risk likelihood, residual risk impact, and incremental risk response costs. A sample response for each of the four data analytic types appears below: Descriptive (“What is happening?”): The team could employ descriptive analytics to better understand historical company performance, which should improve the team’s ability to identify various risks (and opportunities) that could hurt (help) the company’s future performance. Diagnostic (“Why is it happening?”): The team could employ diagnostic analytics to better understand the patterns and trends in historical incremental risk response costs. Such insights should be useful in attempts to decrease risk response costs.

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E 13-37 (Continued) Predictive (“What is likely to happen?”): The team could employ predictive analytics to better forecast residual risk likelihood and/or impact levels for various risk response alternatives under consideration. For example, for each risk response alternative under consideration, the team must estimate the residual risk (both its likelihood and impact) should the given risk response in question be employed. Such residual risk estimates can be challenging and represent excellent opportunities for improvement via the use of predictive data analytics. Prescriptive (“What do I need to do?”): The team could employ prescriptive analytics to make use of previously discussed (and other) data analytics to make specific risk management suggestions regarding how best to manage risks (e.g., which risk response—or set of risk responses—should be put in place to most likely achieve optimal performance. Some risk management experts refer to such performance as risk optimization (which is quite different from risk minimization) to achieve the company’s strategy. For example, with the insights gleaned from the previously discussed analyses regarding trends and estimations of risk response costs, the team could make prescriptive action recommendations regarding the particular risk response plan with the highest positive net benefit (again to optimize the company’s overall risks). E 13-38 Requirement 1: Results of New Customer Financial Survey: Increase in new customer market sales revenue Results of Business Sustainability Analysis: Decreased sales revenue from lost regular advertisers (10% × $10,000,000) Additional fines from regulators from lost new customer data Increased sales from improved employee loyalty Increased sales from regular customers who value more diverse technology workforce = Business Sustainability Analysis results Net change in Jack’s Net Income from combining New Customer Financial Survey and Business Sustainability Analysis ($10,000,000 + $2,500,000)

13-20

$10,000,000

$ (1,000,000) $ (1,500,000) $ 2,000,000 $ 3,000,000 $ 2,500,000

$12,500,000

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E 13-38 (Continued) Requirement 2: Based on the combined results of the New Customer Financial Survey and the Business Sustainability Analysis calculated in Requirement 1, Jack’s Apps Company should pursue the new young adult market for its future apps. Doing so is expected to increase Jack’s App's total net income by $12,500,000. Interestingly, the Business Sustainability Analysis reveals that this new app development target market strategy would actually be $2,500,000 (or 25%) more favorable to Jack’s financial results than predicted based solely on the traditional financial analysis from the New Customer Financial Survey ($10,000,000). Therefore, the Business Sustainability Analysis revealed to Jack’s management that it should be even more aggressive (e.g., move more quickly, be willing to take on more costs, etc.) to pursue this new young adult app market. Requirement 3: Additional considerations that Jack’s Apps Company management might be wise to consider before making a final decision on whether or not to pursue the young adult apps market might include any of the following items:  The reliability of the nonfinancial measures included in the Business Sustainability Analysis (e.g., the degree of excitement for a more diverse workforce and whether this excitement would drive additional sales as indicated)  The reliability of the New Customer Financial Survey regarding additional sales of new apps in the target young adult market  Whether these four stakeholders were the four most important ones or whether a different, unidentified stakeholder group might possess strong stakeholder expectations with financial implications for Jack’s App Company that were not identified in the Business Sustainability Analysis  Whether or not local high schools and universities actually have a large number of technologically trained young and/or female potential employees AND, if so, that they actually want to work for Jack’s App Company as management included as an assumption in its analysis

E 13-39 1. Students’ responses will vary but likely will include five of the following stakeholder groups: shareholders (investors), customers, suppliers, regulators, employees, local communities, competitors, and nongovernmental organizations (NGOs, such as the Sierra Club). Apple has many important stakeholders that either are affected by Apple’s pursuit of its strategy and/or that can affect the success with which Apple pursues its strategy. Many organizations have developed formal stakeholder engagement programs for identifying and better understanding their key stakeholders, as well as for measuring their expectations and prioritizing them in some capacity.

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E 13-39 (Continued) 2. Stakeholder—Engagement Approach and Performance Measures to Communicate: *Shareholders (investors): Engagement Approach—Apple should interact frequently with its shareholders, through its customer trade shows (for product unveilings), earnings calls with analysts, board of director meetings that large institutional shareholders and activist shareholders are likely to attend, and other various investor relations activities. It is important for Apple’s executives and other decision makers to be sure that the company’s various investor groups have an expectation of the risks Apple should take (and the resulting generated returns) that aligns with the actual risks Apple takes (and thus the resulting actual returns it achieves). Shareholders often cause significant problems when the company in which they invest fails to generate sufficiently high returns (because it is too risk averse) or, conversely, when the company takes too many risks (is too risky) that result in unexpected return volatility, etc. Performance Measures—Apple likely should share information with its investors about its measured risk appetite (either qualitatively as low, medium, or high; or more quantitatively if possible); its history of past shareholder returns and its projection of future shareholder returns; and any other measures of anticipated financial performance that will attract and retain investor capital. *Customers: Engagement Approach—Apple product engineers or sales representatives might interact with customers via online surveys or small in-person focus groups to learn of features they enjoy and features they do not use. Such stakeholder engagement activities also could help Apple learn about additional product features or services that it does not currently offer but that customers would value (i.e., pay more money to obtain). Performance Measures—Measures of customer satisfaction, customer loyalty, number of Apple products per household, and percentage of returning customers would be effective measures for Apple to provide and receive from customers. *Suppliers: Engagement Approach—Apple most likely should formally engage with its core suppliers on a frequent basis. For example, Apple must be sure that its supply chain partners understand and adhere to Apple’s Code of Conduct regarding issues such as sourcing of raw materials, employee working conditions, and resulting product quality and safety. In addition, at least some of these stakeholder engagements between Apple and its suppliers will involve information technology functions within each organization. Performance Measures—An IT-directed exchange of performance measures might involve inventory levels for restocking, reliable and secure exchange of sensitive data (e.g., patented technologies), or shutting down production or delivery if a problem is detected. Apple has faced serious criticism from various parties regarding a perceived lack of safety and alleged poor quality working and living conditions for its suppliers’ employees in China and Bangka. Effective measurement, management, and stakeholder communication around this important issue likely will be a key aspect of Apple’s stakeholder engagement activities for the foreseeable future. 13-22

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E 13-39 (Continued) *Regulators: Engagement Approach—Apple should engage with regulators to both foresee upcoming regulations on the horizon and to help shape such future rules and regulations by informing regulators of resulting changes in projected financial and other performance data that likely would result from any proposed new regulation. Many companies practice this type of stakeholder engagement with regulators, which is commonly referred to as lobbying. Most well-run organizations have a positive image with regulators and prefer not to be known as the “bad apple” organization in their industry that pushes the envelope or cuts corners in circumventing regulations. Performance Measures—Apple might report to regulators and the general public the costs it incurs to comply with regulations and that it is not “cutting corners” in so doing. Apple might also quantify and share with regulators the degree to which it goes “beyond compliance” (i.e., more than it is required to do to comply with the given regulation) and the benefits of such behavior (improved employee or public safety, etc.). Sometimes companies choose to play the role of “going beyond” regulations in an attempt to set themselves apart from competitors in their industry. For example, Costco pursues this approach in trying to set itself apart from WalMart, and more conservative banks act similarly to differentiate themselves from more aggressive competing banks. *Employees: Engagement Approach—One could logically argue that Apple’s most critical stakeholder is its team of employees. For example, the R&D team of product designers is the lifeblood of ensuring that Apple remains innovative with its current and future products and services. In addition, the environment in each Apple Store clearly demonstrates the expertise that Apple’s sales force employees possess both in terms of understanding IT and Apple’s numerous products and also in working effectively with customers of all ages, backgrounds, and levels of IT sophistication. Performance Measures—Performance measures around employee retention, employee satisfaction, and percentage of Apple job promotions that are filled by existing employees (rather than by outside new hires) would serve as helpful metrics of Apple’s employee engagement activities. *Local communities: Engagement Approach—Apple intentionally exchanges certain types of information with local communities concerning the locations where it carries out various aspects of its value chain. For example, Apple makes a point of communicating to external stakeholders that it “designs” its products in the United States, even though it manufactures its products in overseas factories.

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E 13-39 (Continued) Performance Measures—A relevant performance measure to communicate to members of a local community might be the percentage of Apple’s work along its value chain that is performed inside a given local community rather than elsewhere around the globe (e.g., where a product is designed, where its raw materials are sourced, where the products are manufactured, where the products are sent for warranty and other servicing, etc.). *Competitors: Engagement Approach—Apple monitors closely the actions of its competitors. Also, Apple designers and executives keep very close tabs on prototype products currently under development. For example, similar to some of its most critical communications with customers, Apple uses trade shows to communicate the results of its research and development activities to competitors. Performance Measures—Performance measures could include the time it takes for new Apple products to reach given adoption levels in the consumer marketplace and the number of consumers won from, or lost to, competitors’ products. *Nongovernmental organizations: Engagement Approach—An NGO is any voluntary, nonprofit group that is formed to raise awareness or resources for a particular cause. An NGO could focus on numerous causes, such as humanitarian issues (e.g., Red Cross, Save the Children) or environmental issues (e.g., Greenpeace, the Sierra Club). Oftentimes, NGOs simply crave the attention and/or financial support of corporate leadership. Therefore, Apple might agree to meet with an NGO if Apple executives believe that the issue raised by the NGO currently (or might in the future) helps or hurts Apple’s ability to achieve its strategy. In addition, NGOs that are not impactful to strategy achievement on their own can become impactful when their voice is empowered by forming alliances with other NGOs or even other key stakeholders of interest to Apple. Performance Measures—Apple might share with NGO leaders (and maybe other interested stakeholders) the amount of time executives have spent meeting with NGO members, as well as the amount of money Apple has donated to the NGO’s cause. Furthermore, Apple would be wise to share with the NGO leadership any changes Apple makes to its value chain as a result of its engagement with the NGO. For example, if Apple changes suppliers to one that provides better working conditions to its employees, then Apple would be wise to share such performance measures with any NGO concerned about social or employee safety, etc.

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E 13-40 The given four key stakeholders for Princeville Paradise Ice Cream Shoppe are customers, employees, local suppliers, and regulators. Suggested possible solutions to requirements 1 through 3 are presented in the following table to help demonstrate their relationship to one another.

Stakeholder: Customers

Risk: Customers, especially tourists with their transient nature, do not perceive Princeville Paradise Ice Cream Shoppe as a premiere business capable of providing them with the best ice cream experience in the islands.

Employees

Paradise is unable to find a sufficient number of local workers who are motivated to deliver the consistently high level of service necessary to provide customers with the best ice cream “experience” in the islands.

Nonfinancial Performance Measure: “Percentage of tourists who recognize Princeville Paradise as a premiere ice cream business”—Paradise’s accountant also could determine if this percentage increases for tourists the longer they stay on the island or for tourists on repeat visits to the island. The percentage should increase in this fashion if Princeville is advertising adequately.

“Average tenure of Paradise’s employees relative to average tenure of competitors’ employees.” This metric measures how long the average employee has worked for Paradise as compared to how long the average employee has worked for competitors. Finding, training, and retaining the best worker talent almost always is a significant challenge in the retail industry, especially in vacation destination areas.

13-25

Financial Performance Measure: “Princeville Paradise sales per tourist visiting the island”—If Paradise’s brand or reputation is growing, this financial metric likely will increase to reflect that tourists visiting the island increasingly recognize Paradise as a premiere ice cream business (i.e., the nonfinancial measure). Note: As an interesting twist to this stakeholder discussion, ask students how this response might change if the Customer focus switched from transient tourists to local residents. “Sales per employee hour worked.” This measure shows how much sales revenue is being generated for each hour worked by a Paradise employee. If its employees are delivering the differentiating high quality experience (e.g., friendly greeting of customers as they walk in the door— perhaps by name if they are repeat customers; singing jingles as customers wait for their order to be prepared; successfully honoring customer requests for avoiding nuts or other food allergens, maintaining an exceptionally clean store environment), then customers likely will spend more per visit (and pay higher prices) as compared to customers at lower quality competitors. As Paradise employees become more experienced with Paradise, the sales per employee hour worked should increase (assuming an appropriate compensation system).

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E 13-40 (Continued) Local Suppliers

Local farmers fail to supply ingredients either of the high quality nature or in the timely manner necessary to meet Paradise’s ice cream production demands.

Regulators

Princeville Paradise’s ice cream manufacturing facility and/or its customer ice cream shop fail inspections from local health inspector agencies.

“Percentage of ingredient deliveries that meet Paradise’s high quality standards and are on time.” This measure provides insights into how effectively Paradise is managing the risk of local supplier lapses in quality and timely delivery of its critical ice cream production ingredients. Given the isolated island nature of Princeville Paradise, any supplier breakdowns in quality or quantity can lead to significant problems, such as ice cream stock outs, that cannot be overcome as quickly or easily as compared to businesses on the mainland with far greater access to alternate suppliers. “Number of Princeville Paradise health code violations occurring each year.” This measure assesses the level of success for Paradise in complying with all healthrelated laws and regulations. Failed health inspections can lead to serious consequences, such as short-term costly process reengineering and longterm negative reputational impacts.

“Production costs, including raw materials costs, raw materials waste, and product spoilage.” If local supplier quality decreases significantly (i.e., defects or tardiness), Paradise likely will experience an increase in the cost of its materials waste or ice cream spoilage as a result. If these costs remain stable, however, it suggests that Paradise’s management is effectively managing its local supply chain from a quality and timeliness of delivery perspective.

“Lost sales revenue resulting from negative ‘word of mouth’ exposure and/or temporary ice cream shop closures to address health code violations.” This measure assesses the decrease in sales resulting from health code violations. In essence, this measure is an example of an external quality failure cost and can have significant long-term implications.

E 13-41

1. Internal failure 2. Prevention 3. Internal failure 4. External failure 5. External failure 6. Appraisal 7. Prevention 8. Internal failure 9. Appraisal 10. External failure 11. External failure

12. Appraisal 13. Prevention 14. External failure 15. Prevention 16. Prevention 17. External failure 18. External failure 19. Prevention 20. Appraisal 21. Prevention 22. External failure

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E 13-42 1. Castledale Company Quality Cost Report For the Year Ended September 30, 20X1 Percentage of Sales

Quality Costs Prevention costs: Vendor certification ....... Quality training ...............

$60,900 79,100

$140,000

2.00%

Appraisal costs: Continuing supplier verification Process acceptance ....... Product inspection .........

$75,600 56,000 64,400

196,000

2.80

Internal failure costs: Rework ............................ Design changes ..............

$175,000 105,000

280,000

4.00

364,000 $980,000

5.20 14.00%

External failure costs: Warranty.......................... Recalls............................. Discounts due to defects Total quality costs ...............

$140,000 126,000 98,000

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E 13-42 (Continued) 2.

Percentage of Total Quality Costs

40.00% 35.00% 30.00% 25.00% 20.00%

37.14%

15.00%

28.57%

10.00% 5.00%

20.00% 14.29%

0.00% Prevention

Appraisal

Internal Failure External Failure

Percentage of Total Quality Costs 14.29% Prevention

37.14%

Appraisal

20.00%

Internal Failure External failure

28.57%

Failure costs are almost two-thirds of the total costs. This indicates that there is still ample opportunity for improving quality by investing more in prevention and appraisal activities. In this case, data visualization allows the president to see the existing pattern of the quality cost distribution. It certainly reveals a heavy imbalance between control and failure costs.

3. Quality costs would decrease from $980,000 to $210,000 (0.03 × $7,000,000) and so profits would increase by $770,000 ($980,000 ‒ $210,000).

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E 13-43 1.

Trend in Total Quality Costs Percentage of Sales

30.00% 25.00% 25.00% 20.00%

23.00% 19.00%

15.00%

17.00%

10.00%

12.00%

5.00% 0.00% 20X1

20X2

20X3

20X4

20X5

Year

There has been a steady downward trend in quality costs expressed as a percentage of sales. Overall, the percentage has decreased from 25% to 12%, a significant improvement.

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E 13-43 (Continued) 2. 14.00%

Percentage of Sales

12.00% 10.00% 8.00%

Prevention

6.00%

Appraisal Internal Failure

4.00%

External Failure 2.00% 0.00% 20X1

20X2

20X3

20X4

20X5

Year

There have been significant reductions in internal and external failure costs. Prevention costs increased; note that appraisal costs increased and then began to decrease, perhaps as confidence in prevention activities improved, the need for appraisal activities diminished, especially since failure costs seemed to have been dramatically reduced over the 5-year period. The graph reveals the trend for each category of costs and how management is changing the expenditure pattern for each category. In 20X1, a greater percentage of sales was spent on external and internal failure costs than for appraisal and prevention costs. By 20X5, the amount spent on internal and external failures is less than the amount spent on appraisal and prevention. The strategy of shifting more resources to appraisal and prevention seems to have worked since total quality costs have dropped from 25% to 12%.

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E 13-43 (Continued) 3. Percentage of Total Quality Costs

120.00% 100.00% 80.00% 60.00%

Control Costs Failure costs

40.00%

Failure ControlCosts Costs

20.00% 0.00% 20X1

20X2

20X3

20X4

20X5

Year

The graph above reveals a favorable trend in the relative distribution of control and failure. Control costs have gone from 16% of total quality costs to 75%. Thus, the mix of failure and control costs has gone from an 84:16 mix to 25:75. Combined with the favorable downward trend in total quality costs, it is clear that the company is making good progress. 4.

The graph for Requirement 2 provides the most detailed picture of the quality cost trends. We can see, for example, that both internal and external failure costs have significantly decreased. We can also see that prevention costs have increased the most and thus likely have had the biggest role in reducing failure costs (appraisal costs first increased and then decreased; in fact, as prevention gains continue, we would expect appraisal costs to continue to decline along with failure costs). The graph in Requirement 1 presents a visualization of the most aggregate quality cost data and that of Requirement 3 is slightly more detailed as it looks at the trend of control vs. failure costs. Both graphs have a story but the graph of Requirement 2 is the most granular and provides the most information.

E 13-44 1.

Departmental times: Processing time (12 × 30*) ........................ Wait and move times ................................. Total time ...............................................

360 minutes 84 minutes 444 minutes

*The sum of the unit production times for each department.

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E 13-44 (Continued) 2.

Cellular times: Unit First .............................. Second ......................... Third ............................. Twelfth..........................

Elapsed time 30 minutes 42 54 162 minutes

If the cell is continuously producing, then the time is 144 minutes (12 × 12). 3.

Time saved = 444 – 162 = 282 minutes (300 minutes for the continuous case) = 282/12 = 23.50 minutes per unit (25 for continuous)

60 minutes/12 = 5 units per hour is the current production rate (12 minutes is the bottleneck time).

The minimum unit production time for any process within the cell must be 5 minutes. Thus, ways must be found to reduce the processing time for all four processes to 5 minutes or less. Process redesign and product redesign are possible ways to reduce the times.

E 13-45 1.

First, calculate activity rates: Cell manufacturing: Driver is conversion time (in minutes): $19,200/(2,700 + 2,100) = $4 per minute Engineering: Driver is engineering hours: $3,400/(65 + 15) = $42.50 per engineering hour Testing: Driver is testing hours: $3,000/(25 + 55) = $37.50 per test hour Next, calculate product costs: Model K Cell manufacturing: $4 × 2,700 ..................... $4 × 2,100 ..................... Engineering: $42.50 × 65 ................... $42.50 × 15 ................... Testing: $37.50 × 25 ................... $37.50 × 55 ................... Total.................................. Units ................................. Unit cost (Cost/Units)......

Model R

$10,800.00 $ 8,400.00 2,762.50 637.50 937.50 $14,500.00 50 $290 13-32

2,062.50 $11,100.00 150 $74

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E 13-45 (Continued) 2.

Average cost = $25,600/200 = $128. The average cost is markedly different from the ABC costs, which suggests significant heterogeneity. The products may be similar in the sense that they use the same sequence of production operations but very different in terms of the demands they place on value-stream resources.

Total hours for Model K = (2,700/60) + 65 + 25 = 135; Total hours for Model R = (2,100/60) + 15 + 55 = 105 hours. Cycle Time (Model K) = 135/50 = 2.7 hours per unit Cycle Time (Model R) = 105/150 = 0.70 hour per unit Conversion Cost Rate = $25,600/(135 + 105) = $106.67 per hour Cost of Model K = Conversion Cost Rate × Cycle Time = $106.67 × 2.7 = $288.01 Cost of Model K = Conversion Cost Rate × Cycle Time = $106.67 × 0.7 = $74.67 DBC approximates ABC costs quite well and has the simplicity needed for a lean manufacturing environment. Thus, whenever there are heterogeneous products in a value stream, DBC appears to be a more desirable approach than average costing and a viable alternative to features and characteristics costing.

E 13-46 1.

3. 4.

Seven nonfinancial measures are used (four operational and three capacity): Units sold per person, on-time delivery, Dock-to-dock days, First-time through, Productive, Nonproductive, and Available. Nonfinancial measures are helpful in managing and bringing about operational improvement. Time-based: On-time delivery and dock-to-dock days; quality-based: first-time through; efficiency-based: units sold per person and average product cost. Lean firms compete on the basis of these three dimensions. They strive to supply the right quantity at the right price at the right quality at the time the customer wants the product. To supply the quantity needed at the time needed mandates shorter cycle times. Quality mandates zero defects, and lower prices mean that a lean firm must reduce its costs and become more efficient. The Planned Future State column sets targets for the various financial and nonfinancial measures and thus encourages continuous and innovative improvements. The value stream (processes within the value stream) possesses a certain amount of capacity based on resources employed. Value-added use of the resources is productive use; using resources to produce waste is nonproductive use. Thus, all nonvalue-added activities are nonproductive use of value-stream capacity. As waste is reduced, resources become available for other productive uses. 13-33

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E 13-46 (Continued) 5.

As quality, time, and efficiency increase, we would eventually expect all of this to convert into financial gains. Typically, what happens is that elimination of waste is first expressed as available capacity. Financial gains are realized when the available capacity is either reduced by reducing resources needed or they are used elsewhere for other productive purposes.

E 13-47 1. 2. 3. 4. 5.

MNC Import Export Joint venture Maquiladora

E 13-48 1. 2. 3. 4. 5.

Exchange rate Transaction risk Currency appreciation Translation risk Spot rate

E 13-49 1. 2.

$16,400,000 × 0.30 = $4,920,000 $4,920,000 × 9/12 × 0.08 = $295,200

E 13-50 1. 2.

$16,400,000 × 0.85 × 0.30 = $4,182,000 Savings = $4,920,000 – $4,182,000 + $295,200 = $1,033,200

E 13-51 a.

Yes, there is a potential problem. Susan has the opportunity to set up and pay nonexistent companies and cash the checks herself. b. No, in this case, Susan does not have the opportunity to commit fraud. c. No, while Keith appears to have the opportunity to embezzle money, teller’s cash drawers are balanced daily and shortages are traced immediately. d. While June is playing in a misleading manner, there is no opportunity for financial gain. Still, Nancy may mentally file this away and in the future, if there are problems, remember that June is not completely honest.

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PROBLEMS P 13-52 1.

The inherent risk formula takes the following form: Inherent risk = (Likelihood) × (Impact) Note: For Inherent risk, the likelihood and impact are assessed ABSENT of any response alternative being implemented. Inherent risk = $30,000,000 ($60,000,000 × 0.50) The residual risk formula takes the following form: Note: For Residual risk, the likelihood and impact are assessed AFTER considering the effects of a particular response alternative. Residual risk for A = $12,500,000 ($50,000,000 × 0.25) Residual risk for B = $6,000,000 ($15,000,000 × 0.40) Residual risk for C = $30,000,000 ($60,000,000 × 0.50) The benefit formula takes the following form: Benefit = Inherent risk – Residual risk Benefit for A = $17,500,000 ($30,000,000 – $12,500,000) Benefit for B = $24,000,000 ($30,000,000 – $6,000,000) Benefit for C = $0 ($0 – $0) The net benefit formula takes the following form: Net benefit = Response benefit – Response cost Thus: Net benefit for A = –$1,000,000 ($17,500,000 – $18,500,000) Net benefit for B = $4,000,000 ($24,000,000 – $20,000,000) Net benefit for C = $0 ($0 – $0)

The risk response alternative with the greatest net benefit is alternative B and should be the selected response. Interestingly, the net benefit for risk response alternative A is negative (–$1,000,000). A negative net benefit provides ERM managers with very useful insights. Specifically, a negative net benefit means that the estimated incremental cost of implementing alternative A is LARGER than the estimated benefit of implementing alternative A, thereby producing the NEGATIVE net benefit.

Risk response alternative C would be the preferred, or best, choice if the other risk response alternatives each had negative net benefits (i.e., their costs exceeded their benefits). In this problem, this condition would be met, for example, if the cost of alternative B increased by more than $4,000,000 (i.e., to above $24,000,000). If this increase in costs were to occur, then alternative B also would have a negative net benefit (as alternative A already has), which would make alternative C the preferred risk response alternative with a $0 net benefit. 13-35

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E 13-52 (Continued) 4. While the exact appearance of students’ risk graph (or plot) likely will differ, the following Residual Risk Plot presents a useful sample graph.

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P 13-53 Requirement 1: Tuscany Annual Op. Inc. Cumulative Op. Inc. Present Value (PV) of Op. Inc. (at 5%; Yrs 1-5) =

Year 1

Year 2

Year 3

Year 4

Year 5

Total (Yrs 1–5)

$9,000,000

$9,900,000

$10,890,000

$11,979,000

$13,176,900

$54,945,900

$18,900,000

$29,790,000

$41,769,000

$54,945,900

$47,137,811

Matarrana Annual Op. Inc. Cumulative Op. Inc. PV of Op. Inc. (at 5%; Yrs 1-5) =

[Note: PV is shown only for illustrative purposes]

Year 1

Year 2

Year 3

Year 4

Year 5

Total (Yrs 1-5)

$5,000,000

$7,500,000

$11,250,000

$16,875,000

$25,312,500

$65,937,500

$12,500,000

$23,750,000

$40,625,000

$65,937,500

$54,998,909

[Note: PV is shown only for illustrative purposes]

Based on the operating income calculations for the 5-Year Financial Plan, the Tuscany sales region would generate cumulative operating income of $54,945,900 (Note: The PV of Tuscany’s 5-Year Financial Plan operating income stream equals $47,137,811 at 5%), which is less than the cumulative operating income from the Matarrana region of $65,937,500 (Note: The PV of Matarrana’s 5-Year Financial Plan operating income stream equals $54,998,909 at 5%). Therefore, based solely on this operating income over this 5-Year Financial Plan, Stylz should select the Matarrana region because its cumulative operating income stream (as well as the PV of this stream) is greater than that for the Tuscany region. However, it should be noted that the Tuscany region actually produces the greater cumulative operating income through the first 4 years ($41,769,000 vs. $40,625,000). Thus, an important consideration for Stylz’ management is whether they (and investors) still prefer the Matarrana region since it would not outperform the Tuscany region until the business reaches its fifth year. Requirement 2: Tuscany

Year 1

Year 2

Year 3

Year 4

Year 5

Total (Yrs 1–5)

Stakeholder Impact: Suppliers

Employees

–$2,000,000 –$2,000,000 –$2,000,000 –$2,000,000

–$2,000,000

–$10,000,000

Regulators

–$1,000,000 –$1,000,000 –$1,000,000 –$1,000,000

–$1,000,000

–$ 5,000,000

Local Community = Total Stakeholder Impact on Op. Inc.

–$15,000,000

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P 13-53 (Continued) Matarrana

Year 1

Year 2

Year 3

Year 4

Year 5

Total (Yrs 1–5)

Suppliers

–$5,000,000

–$10,000,000

Employees

Regulators

–$3,000,000

–$3,000,000 –$3,000,000

–$15,000,000

–$5,000,000

–$1,500,000 –$1,500,000

–$11,000,000

Stakeholder Impact:

Local Community = Total Stakeholder Impact on Op. Inc.

–$36,000,000

Requirement 3: Tuscany Annual Op. Inc. Cumulative Op. Inc. Op. Inc. (Yrs 1-5) PV =

Year 1

Year 2

Year 3

Year 4

Year 5

Total (Yrs 1–5)

$9,000,000

$9,900,000

$10,890,000

$11,979,000

$13,176,900

$18,900,000

$29,790,000

$41,769,000

$54,945,900

$47,137,811

Stakeholder Impact: Suppliers

Employees

–$2,000,000

–$10,000,000

Regulators

–$1,000,000

–$ 5,000,000

Local Community

–$15,000,000 = Total Cumulative Oper. Inc.

$39,945,900

Matarrana Annual Op. Inc. Cumulative Op. Inc. Op. Inc. (Yrs 1-5) PV =

Year 1

Year 2

Year 3

Year 4

Year 5

Total (Yrs 1–5)

$5,000,000

$7,500,000

$11,250,000

$16,875,000

$25,312,500

$12,500,000

$23,750,000

$40,625,000

$65,937,500

$54,998,909

Stakeholder Impact: Suppliers

–$5,000,000

–$10,000,000

Employees

Regulators

–$3,000,000

–$15,000,000

Local Community

–$5,000,000

–$1,500,000

–$11,000,000

–$36,000,000 = Total Cumulative Oper. Inc.

$29,937,500

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P 13-53 (Continued) Based on the combined 5-Year Financial Plan AND the Business Sustainability Analysis, Stylz would be better off selecting the Tuscany region as its total cumulative operting income is significantly greater ($39,945,900) than that of Matarrana ($29,937,500). The combined negative operating impacts of the four key stakeholder was $21,000,000 greater for Matarrana (–$36,000,000) than for Tuscany (–$15,000,000), which turned Matarrana’s relative preference after the original 5-year plan of $10,991,600 ($65,937,500 minus $54,945,900) into a relative preference of $10,008,400 for Tuscany when considering the Total Net Effect of the four key stakeholders ($39,945,900 minus $29,937,500). This problem provides students with practice at trying to incorporate the perceptions of key stakeholders into the company’s financial business planning in an attempt to improve its overall business sustainability (i.e., increase its performance over the long term in order to survive and thrive). Requirement 4: There are many qualitative factors that Stylz management might be wise to consider to supplement its quantitative 5-Year Financial Analysis and Business Sustainability Analysis. For example, the accuracy of the data sources used for constructing both of these quantitative analyses should be considered to be sure that each source is of a sufficiently accurate nature. On a related note, management should investigate the trustworthiness of each stakeholder group that influenced the quantitative Business Sustainability Analysis. In addition, management should consider its own confidence in its analyses. For example, if management is far less confident in estimates it provided for years 3–5 than for years 1–2, it might want to place less weight or importance on the projections that are further out into the future. Regardless of the particular element under scrutiny, management would be wise to conduct a sensitivity analysis to see how different the resulting operating income would be over 5 years when management changes the various elements (e.g., number of years in the analysis time horizon, the assumed income growth rate in both Tuscany and Matarrana that was used in the 5-Year Financial Analysis, etc.). If the 50% growth rate assumed for Matarrana turns out to be too optimistic then management might find that the 5-Year Financial Plan operating income in Tuscany is greater than in Matarrana (i.e., the opposite of the estimated finding in Requirement 1 with the 50% growth rate assumption).

P 13-54 1.

One likely reason why Les believes that Dorsey Scott would be wise to look into sustainability is that he realizes that young people, such as college students, often have strong expectations regarding the various issues that affect companies’ ability to sustain over the long term. These issues of great interest to college students can include environmental concerns (e.g., clean water, air, and soil; food miles traveled by cafeteria contents; carbon footprint, etc.), social concerns (e.g., child labor, unsafe or unsavory factory working conditions, required professional dress codes at work, policies either allowing or banning checking social media sites while at work), and product/service quality (e.g., products/services that successfully and immediately provide the features desired by college students). Another reason for Dorsey to consider sustainability issues (and thus please college students) is that doing so likely 13-39

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P 13-54 (Continued) would generate profits in the near future as college students become future customers with considerable purchasing power once they graduate from college. Yet a third reason might be that engaging with college students on various business sustainability issues and adjusting business practices where appropriate can attract top college students to work for Dorsey Scott. Attracting and retaining top employee talent is one of the most important, yet challenging, issues facing most companies. 2.

Three challenges: a. Given that Dorsey Scott has never prepared or issued a corporate sustainability report, the intern team likely will face many challenges in creating the first one. For example, the team will need to engage stakeholders in some fashion in order to help determine exactly who Dorsey Scott’s top 5 to 10 stakeholders are in reality and to prioritize them in case there are decisions that cause management to please one stakeholder group while displeasing another group. b. Another challenge likely will be figuring out exactly how to measure stakeholder expectations (i.e., risks and opportunities) about Dorsey Scott’s performance and how such stakeholder expectations can hurt or help the company achieve its strategy. This challenge also requires that Dorsey Scott clearly understand its own strategy so that it can connect its strategy to key stakeholder expectations or issues. Also, the team will need to figure out how to link various, and sometimes competing, stakeholder issues to Dorsey Scott’s ultimate financial performance, as measured by cash flows, earnings, stock price, etc. c.

A third challenge likely will involve access to trustworthy data to measure the various stakeholder issues and associated firm performance discussed in the previous challenge. For example, few companies have access to accurate data regarding every environmental issue of interest (e.g., carbon footprint, food miles driven with its supply chain to deliver the beverages from Dorsey Scott facilities to the university campuses where they will be purchased and consumed, etc.). The data for conducting business sustainability analyses usually are pulled from different sources than the data used in traditional financial reporting and, therefore, can be expensive and time-consuming to obtain.

Three benefits: a. Dorsey Scott likely will grow its consumer base by issuing a meaningful CSR that speaks to college students in a manner that they understand and appreciate. It is possible that this sustainability focus for Dorsey will translate its growing college student consumer base into a subset of more loyal customers over a 50-plus year lifetime. b. Dorsey Scott’s stakeholder engagement might improve management’s understanding of exactly what current customers like and dislike about its beverages. This improved understanding of customer preferences can help management better determine which product lines to drop and how to tailor its research and development activities, as well as its business acquisitions group, to ensure that Dorsey’s future product offerings are as pleasing as possible to customers. For instance, Coca-Cola and PepsiCo have made significant changes to their beverage portfolios in recent years, moving away from traditional soda and soft drinks and toward bottled waters. 13-40

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P 13-54 (Continued) c.

Conducting sustainability activities might help Dorsey Scott discover more financially viable ways to manufacture and distribute its beverages to customers. For example, companies often find that environmentally friendly ways of conducting business produce unexpected financial benefits or produce benefits that are more significant than forecasted. For example, a “green roof” can be environmentally beneficial but also be financially beneficial through lower electricity bills for air conditioning. As another example, improving worker safety can produce happier employees with fewer injuries, fewer days off from work, and greater productivity and revenues.

P 13-55 1.

Tidwell Company Quality Cost Report For the Year Ended 20X1

Prevention costs: Quality training ....................... Appraisal costs: Product acceptance ............... Internal failure costs: Scrap ....................................... Rework .................................... External failure costs: Repair ...................................... Order cancellation .................. Customer complaints............. Sales allowance...................... Total quality costs ....................... 2.

Quality Costs

Percentage of Sales

$ 120,000

0.32%

$ 960,000

2.58

$1,800,000 1,080,000 $2,880,000

7.73

$ 360,000 600,000 486,000 180,000 $1,626,000 $5,586,000

4.37 15.00%

Profits: $4,000,000 Quality costs: $5,586,000 Quality costs/Sales = 15.00% Quality costs/Profits = 139.65% Danna should be concerned as the quality cost–sales ratio is 15%, and the quality costs are greater than income. Although the cost–sales ratio is lower than the 20% to 30% range that many companies apparently have, there is still ample opportunity for improvement.

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Prevention: $120,000/$5,586,000 = 2.1% Appraisal: $960,000/$5,586,000 = 17.2% Internal failure: $2,880,000/$5,586,000 = 51.6% External failure: $1,626,000/$5,586,000 = 29.1% The pie chart is as follows: Relative Distribution of Quality Costs

Internal Failure 51.6%

Appraisal 17.2% Prevention 2.1% External Failure 29.1%

Too much is spent on failure costs. These costs are nonvalue-added costs and should eventually be eliminated. Prevention and appraisal activities should be given much more emphasis. If anything, experiences of real-world companies indicate that the control costs should be 80% of total quality costs and the failure costs 20%. The distribution of quality costs needs to be reversed! 4.

The company should increase prevention and appraisal costs. The additional amounts spent on these programs will be recouped with additional savings from a resulting decrease in failure costs.

Quality costs: $37,240,000 × 3% = $1,117,200 Profits would increase by $4,468,800 ($5,586,000 – $1,117,200)

P 13-56 1.

20X1 Prevention: Appraisal: Internal failure: External failure:

$12,000/$3,072,000 = 0.39% $540,000/$3,072,000 = 17.58% $1,500,000/$3,072,000 = 48.83% $1,020,000/$3,072,000 = 33.20%

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P 13-56 (Continued) The pie chart for 20X1 is as follows:

Percentage of Total Quality Costs 0.39%

17.58% Prevention

33.20%

Appraisal Internal Failure External failure

48.83%

20X2 Prevention: Appraisal: Internal failure: External failure:

$240,000/$3,072,000 = 7.81% $492,000/$3,072,000 = 16.02% $1,230,000/$3,072,000 = 40.04% $1,110,000/$3,072,000 = 36.13%

The pie chart for 20X2 is as follows:

Relative Distribution of Quality Costs 7.81%

36.13%

16.02%

Prevention Appraisal Internal Failure External Failure

40.04%

Yes. More effort is clearly needed for prevention and appraisal activities. The movement is in that direction, and total failure costs have declined.

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P 13-56 (Continued) 2.

Clarkson Inc. Performance Report: Quality Costs 1-Year Trend For the Year Ended December 31, 20X2 Actual Costs Actual Costs* 20X2 20X1 Prevention costs: Quality circles ............................ Design reviews ........................... Quality improvement projects .. Total prevention costs ........... Appraisal costs: Packaging inspection ................ Product acceptance ................... Total appraisal costs ............. Internal failure costs: Scrap ........................................... Rework ........................................ Yield losses ................................ Retesting .................................... Total internal failure costs .... External failure costs: Returned materials .................... Allowances ................................. Warranty ..................................... Total external failure costs ... Total quality costs ...........................

Variance

60,000 30,000 150,000 $ 240,000

6,000 3,000 3,000 12,000

$ 54,000 U 27,000 U 147,000 U $228,000 U

$ 450,000 42,000 $ 492,000

$ 600,000 75,000 $ 675,000

$150,000 F 33,000 F $183,000 F

$ 360,000 480,000 150,000 240,000 $ 1,230,000

$ 525,000 675,000 300,000 375,000 $1,875,000

$165,000 F 195,000 F 150,000 F 135,000 F $645,000 F

$ 240,000 210,000 660,000 $ 1,110,000 $3,072,000

$ 300,000 225,000 750,000 $ 1,275,000 $3,837,000

$ 60,000 F 15,000 F 90,000 F $165,000 F $765,000 F

* To compare 20X2 costs with 20X1 costs, the costs for 20X1 must be adjusted to a sales level of $15,000,000. Thus, all variable costs will change from the 20X1 levels. For example, the adjusted product packaging inspection cost is ($480,000/$12,000,000) × $15,000,000 = $600,000.

Profits increased by $765,000. 3.

$3,072,000 – ($15,000,000 × 3%) = $2,622,000

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P 13-57 1. 20X1 ....... 20X2 ....... 20X3 ....... 20X4 ....... 20X5 .......

Prevention 1.00% 4.17 5.00 6.67 10.00

Internal Failure 16.00% 10.00 5.00 4.17 2.40

Appraisal 2.00% 2.50 4.29 2.50 1.00

External Failure 12.00% 8.33 3.57 3.33 1.60

Trend in Total Quality Costs Percentage of Sales

35.00% 30.00%

31.00%

25.00% 25.00%

20.00% 15.00%

17.86%

16.67%

10.00%

15.00%

5.00% 0.00% 20X1

20X2

20X3 Year

13-45

20X4

20X5

Total 31.00% 25.00 17.86 16.67 15.00

CHAPTER 13

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P 13-57 (Continued)

Percentage of Sales

Trend by Quality Cost Category 18.00% 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00%

Prevention Appraisal Internal Failure External Failure 20X1

20X2

20X3

20X4

20X5

Year

Yes, quality costs overall have dropped from 31.00% of sales to 15.00% of sales, a significant improvement. Real evidence for quality improvement stems from the fact that internal failure costs have gone from 16.00% to 2.40%, external failure costs from 12.00% to 1.60%, and appraisal costs from 2.00% to 1.00%. This reduction of failure costs has been achieved by putting more resources into prevention (from 1.00% to 10.00%). 3.

Quality costs at the 20X1 rates:

20X4 ........ 20X5 ........

Prevention $12,000 10,000

Internal Failure $192,000 160,000

Appraisal $24,000 20,000

Profit increase (20X4): $372,000 – $200,000 = $172,000 Profit increase (20X5): $310,000 – $150,000 = $160,000

13-46

External Failure $144,000 120,000

Total $372,000 310,000

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P 13-58 1.

Average Conversion Cost per Unit = Conversions Costs/Total Units Produced = $670,000/40,000 units = $16.75 per unit Activity rates: Order processing = $36,000/2,400 = $15 per order processing hour Purchasing = $72,000/500 = $144 per purchasing hour Lathe = $108,000/800 = $135 per lathe hour Milling = $200,000/2,000 = $100 per milling hour Drilling = $144,000/2,400 = $60 per drilling hour Assembly = $40,000/2,000 = $20 per assembly hour Inspection = $20,000/1,000 = $20 per inspection hour Shipping = $18,000/800 = $22.50 per shipping hour Invoicing = $32,000/1,500 = $21.33 per invoicing hour Conversion cost assignment: Cost Assignment Order processing: $15 × 600 $15 × 1,800 Purchasing: $144 × 200 $144 × 300 Lathe: $135 × 480 $135 × 320 Milling: $100 × 800 $100 × 1,200 Drilling: $60 × 720 $60 × 1,680 Assembly: $20 × 1,200 $20 × 800 Inspection: $20 × 800 $20 × 200 Shipping: $22.50 × 600 $22.50 × 200 Invoicing: $21.33 × 700 $21.33 × 800 Totals Units shipped Unit conversion cost

Part M15 $

Part M78

9,000 $ 27,000

$ 28,800 $ 43,200 $ 64,800 $ 43,200 $ 80,000 $120,000 $ 43,200 $100,800 $ 24,000 $ 16,000 $ 16,000 $

4,000

4,500

$ 13,500 $ 14,931 $294,231 10,000 $29.42 13-47

$ 17,064 $375,764 30,000 $12.53

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P 13-58 (Continued) The average conversion cost from Requirement 1 is $16.75 per unit. Although the products use the same sequence of operations, they consume them in quite different proportions so the average cost is not a good unit cost indicator for this value stream. Features and characteristics costing or DBC should be used. 3.

The cycle time for each product: M15 Cycle Time = Hours Available/Units Shipped = 6,100/10,000 = 0.61 hour per unit M78 Cycle Time = Hours Available/Units Shipped = 7,300/30,000 = 0.24 hour per unit Conversion Cost Rate = Conversion Costs/Total Available Hours (or net) = $670,000/13,400 = $50 per conversion hour Unit Conversion Cost = Conversion Cost Rate × Cycle Time M15 = $50 × 0.61 = $30.50 per unit M78 = $50 × 0.24 = $12.00 per unit DBC unit costs are simple to calculate and approximate reasonably well the ABC unit cost assignment ($29.42 vs. $30.50; $12.53 vs. $12.00). DBC appears to be a good candidate for multiple-product value streams because of its simplicity and avoidance of unit cost distortions.

P 13-59 1.

The operational performance measures that improved for the first 6 months all have to do with improving time-based performance. On-time delivery and dock-to-dock days showed dramatic improvements, reflecting the increased ability of the firm to produce on demand. From the capacity measures, we see that the ability to produce on demand has created additional available capacity in the value stream. For the second 6 months, the focus has been on improving quality. First-time through improved from 70% to 92%, a dramatic increase in quality. For example, eliminating scrap may explain why the materials cost dropped, giving the increase in ROS that did occur. The improvements have eliminated waste and increased the amount of available capacity. The implications are profound. The company can produce higher-quality products much more rapidly. This will enable the company to produce the kind of products demanded by customers, in the quantities needed, and delivered when they need them. This should begin to translate into increased sales and improved financial performance. The stage is now set.

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P 13-59 2.

The constant sales per person, coupled with constant total sales, suggest that the head count has not been reduced. More resources are available for use by the value stream as reflected by the increase in available capacity. The fact that financial performance has not improved dramatically is likely attributable to the fact the company is maintaining the same level of resources in the value stream. Eliminating these resources is one way to improve financial performance. However, a more preferred approach is to find ways to use them productively. New products and expanded production (which may occur because of increased quality and improved cycle time) are much better ways of improving financial performance.

P 13-60 Alternative 1: Advantages: This alternative involves working with a well-understood process in a well-understood environment. Beryl is completely familiar with the legal and social environment in Minnesota. Morale may increase because all workers will receive the higher wages. The factory is already set up, suppliers are in line, and the company knows just how long it takes to produce the fax machines. Disadvantages: Additional workers who are not trained in Paladin’s process would need to be hired. Heavier use of plant facilities will wear out plant and equipment faster. The addition of a second shift may cause labor problems because those workers assigned to the second shift may want to work on the more desirable first shift. Alternative 2: Advantages: Wages are much lower in Mexico. The burgeoning Mexican market would provide demand for Paladin’s product. Production in Mexico would satisfy Mexican demands for locally produced goods. Disadvantages: Paladin has no experience in Mexico. There is considerable uncertainty regarding the training of Mexican workers and the start-up costs of building a new plant. Language and cultural differences may cause difficulties. Alternative 3: Advantages: Location of a new plant in a foreign trade zone would save on dutyrelated costs. There is no language difference in Dallas. The opening of a plant in the Southwest would give Paladin easier access to markets in the southern and southwestern United States. Wages would be lower than those in Minnesota. Disadvantages: The Dallas plant is a considerable distance from the Minnesota plant, requiring another layer of management. Beryl may find it difficult to run both plants herself.

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P 13-61 1.

Using the spot rates in effect on July 1, the following prices can be set in francs and yen: Swiss order: $64,000 × 1.2360 = 79,104 Swiss francs Japanese order: $124,000 × 117.70 = 14,594,800 yen

On October 1, the Swiss customer should pay Custom Shutters 79,104 Swiss francs. If the 90-day forward rate anticipated on July 1 holds, Custom Shutters will receive $62,831 (79,104/1.2590). On October 1, the Japanese customer should pay Custom Shutters 14,594,800 yen. If the 90-day forward rate anticipated on July 1 holds, Custom Shutters will receive $124,000. Will Lee actually receive $186,831 ($62,831 + $124,000) on October 1? We don’t know. It depends on the exchange rates in effect on October 1. Currently, it is expected that the dollar will weaken against the Swiss franc and stay unchanged against the yen. However, this could change. If Lee is bothered by the uncertainty, he could hedge by locking in the exchange rates now. That would guarantee the $186,831 on October 1. He might want to do that since the anticipated trend is steadily upward for Swiss francs and the Swiss customer could very well pay late.

P 13-62 Yes, the deal is fraudulent. The purchasing officer is asking for a kickback. His actions are definitely fraud—he is engaging in deception for the purposes of his own financial gain. Clearly, you do not want to be a part of this. The payment of the $500 will involve you in the fraud. If there is any question of whether or not the deal is fraudulent, you might ask yourself how it would work to tell people about it. In this case, the secrecy between you (potentially) and the purchasing officer is a red flag.

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CASES Case 13-63 Given that students will select their own corporate sustainability reports (CSRs), the specific content of individual student responses will vary widely. However, the responses below provide some relevant findings that many students likely will offer in their individual responses for Requirements 1 and 2. 1.

Three Similarities: a. Students likely will find that most CSRs have a letter either from the chief executive officer or chairman of the board of directors that attempts to link the importance of the CSR to the strategy of the organization. This letter often is a good starting point for discussing with students whether they “buy into” the sincerity of the organization’s CSR, or whether it appears more like a public relations document (i.e., greenwashing). b. Another commonality between CSRs is that they are quite lengthy, oftentimes exceeding 100 pages. An optional document, like a CSR, that is nearly as voluminous as a required 10-K annual report also provides a starting point for interesting student conversations about exactly what quantity of information is optimal for a CSR to be read, understood, and perceived as effective by key stakeholders. c. Most CSRs attempt to address multiple stakeholder groups, rather than focus primarily on investors as in a traditional 10-K annual report. Therefore, students likely will read considerable content in their CSRs that is addressed specifically at environmental, social, regulatory, customer, community, and shareholder groups.

Three Differences: a. Considerable differences likely will exist in the type and amount of data contained within the two CSRs. For example, some organizations report only high-level nonfinancial statistics (e.g., amount of money spent on a particular environmental program in the area where the organization conducts business). On the other hand, other organizations disclose the “story” behind key stakeholder issues by linking (or connecting) nonfinancial performance measures to their impact on relevant financial performance measures. Such linkages usually denote a more sophisticated approach to business sustainability than one that merely reports high-level statistics that fail to connect to strategy and eventual financial performance. b. In addition, students likely will find differences in the extent and nature to which their CSRs adhere to optional reporting guidelines, the two most popular of which are the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB). Furthermore, for CSRs that adopt GRI’s sustainability reporting guidelines in preparing their CSR, they can choose to apply them at either the “core” level or at the “comprehensive” level, thereby creating additional differences between CSRs.

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Case 13-63 (Continued) c. Students also likely will find considerable differences in the existence of independent, third-party verification (i.e., auditors) between their two selected CSRs. In addition, if both CSRs do contain independent, third-party verification, then the degree and extent of such verification also likely will vary widely. For example, the nature of the verifier (e.g., an accounting firm versus an environmental consulting firm, etc.) and the scope of the verification (e.g., limited assurance versus reasonable assurance; the entire CSR being verified versus only a portion of the CSR being verified, etc.) are common differences between CSRs that contain external, third-party verification. 3.

Responses will vary.

Case 13-64 1.

Luna Company Interim Performance Report: Quality Costs For the Year Ended December 31, 20X5 Prevention costs: Quality planning .......... Quality training............ Special project ............ Quality reporting ......... Total prevention ............... Appraisal costs: Proofreading................ Other inspection ......... Total appraisal .................. Internal failure costs: Correction of typos ..... Plate revisions............. Press downtime .......... Waste ........................... Total internal failure ......... External failure costs: Returns ........................ Lost sales .................... Rework ......................... Total external failure ........ Total quality costs ............

Actual Costs

Budgeted Costs

$ 450,000 160,000 390,000 260,000 $1,260,000

$ 450,000 180,000 430,000 260,000 $1,320,000

$ 800,000 460,000 $1,260,000

$ 860,000 480,000 $1,340,000

$ 60,000 F 20,000 F $ 80,000 F

$ 350,000 100,000 200,000 70,000 $ 720,000

$ 375,000 125,000 221,000 125,000 $ 846,000

$ 25,000 25,000 21,000 55,000 $ 126,000

F F F F F

$ 400,000 200,000 120,000 $ 720,000 $ 3,960,000

$ 450,000 235,000 195,000 $ 880,000 $ 4,386,000

$ 50,000 35,000 75,000 $ 160,000 $ 426,000

F F F F F

13-52

Variance 0 20,000 F 40,000 F 0 $ 60,000 F

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Emerging Topics in Managerial Accounting

Case 13-64 (Continued) The firm failed across the board to meet its budgeted goals for control costs for the year (increasing control costs is good as they drive down failure costs). All prevention and control costs were equal to or less than the budgeted amounts. While the firm did not meet budgeted spending amounts for control costs, it did successfully decrease failure costs by more than expected, thus producing a very favorable outcome for the year. 2.

Luna Company Performance Report: Quality Costs 1-Year Trend For the Year Ended December 31, 20X5

Prevention costs: Quality planning .......... Quality training ............ Special project ............. Quality reporting ......... Total prevention................ Appraisal costs: Proofreading ................ Other inspection .......... Total appraisal .................. Internal failure costs: Correction of typos ..... Plate revisions ............. Press downtime ........... Waste............................ Total internal failure ......... External failure costs: Returns......................... Lost sales..................... Rework ......................... Total external failure ........ Total quality costs ............

Actual Costs 20X5

Actual Costs 20X4

$ 450,000 160,000 390,000 260,000 $1,260,000

$ 440,000 250,000 150,000 240,000 $1,080,000

$ 10,000 90,000 240,000 20,000 $180,000

$ 800,000 460,000 $1,260,000

$ 860,000 580,000 $1,440,000

$ 60,000 F 120,000 F $180,000 F

$ 350,000 100,000 200,000 70,000 $ 720,000

$ 200,000 380,000 260,000 120,000 $ 960,000

$150,000 280,000 60,000 50,000 $240,000

U F F F F

$ 400,000 200,000 120,000 $ 720,000 $3,960,000

$ 620,000 330,000 310,000 $1,260,000 $4,740,000

$220,000 130,000 190,000 $540,000 $780,000

F F F F F

Variance U F U U U

Profits increased $780,000 because of the reduction in quality costs from 20X4 to 20X5. Thus, even though the budgeted increases for control costs for the year were not met, there was still significant improvement. . . in fact, greater improvement than expected as failure costs decreased more than expected. Moreover, most of the improvement came from reduction of failure costs, a positive signal indicating that quality is indeed increasing.

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Case 13-64 (Continued) 3.

Trend in Total Quality Costs Percentage of Sales

25.00% 20.00% 20.00% 18.00%

15.00%

16.50% 14.00%

10.00%

11.00%

5.00% 0.00% 20X1

20X2

20X3

20X4

20X5

Year

Note: Percentages are calculated as follows: 20X1: $6,000,000/$30,000,000; 20X2: $5,400,000/$30,000,000; 20X3: $5,445,000/$33,000,000; 20X4: $4,740,000/$33,857,000; 20X5: $3,960,000/$36,000,000. 4.

Multiple Period Trend by Category Percentage of Sales

12.00% 10.00% 8.00% Prevention

6.00%

Appraisal

4.00%

Internal Failure

2.00%

External Failure

0.00% 20X1

20X2

20X3

20X4

20X5

Year

Increases in prevention and appraisal costs with simultaneous reductions in failure costs are good signals that overall quality is increasing. (Decreases in external failure costs are particularly hard to achieve without quality actually increasing.)

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Case 13-64 (Continued) 5.

Luna Company Long-Range Performance Report For the Year Ended December 31, 20X5

Prevention costs: Quality planning ............... Quality training ............ Special project ............. Quality reporting ......... Total prevention ................ Appraisal costs: Proofreading ................ Other inspection ............... Total appraisal .................. Internal failure costs: Correction of typos .......... Plate revisions ............. Press downtime ........... Waste............................ Total internal failure ......... External failure costs: Returns......................... Lost sales..................... Rework ......................... Total external failure......... Total quality costs ............ a

Actual Costs 20X5a

Long-Range Target Costsb

Variance

$ 450,000 160,000 390,000 260,000 $ 1,260,000

$ 337,500 78,750 0 0 $ 416,250

$ 112,500 U 81,250 U 390,000 U 260,000 U $ 843,750 U

$1,000,000 575,000 $ 1,575,000

$ 562,500 146,250 $ 708,750

$ 437,500 U 428,750 U $ 866,250 U

$ 437,500 125,000 250,000 87,500 $ 900,000

0 0 0 0 0

$ 437,500 U 125,000 U 250,000 U 87,500 U $ 900,000 U

0 0 0 $ 0 $ 1,125,000

500,000 U 250,000 U 150,000 U $ 900,000 U $3,510,000 U

$ 500,000 250,000 150,000 $ 900,000 $ 4,635,000

$ $

Except for prevention costs, which are fixed, actual costs of 20X5 are adjusted to a sales level of $45 million by multiplying the actual costs at $36 million by 45/36 = 5/4 = 1.25. This report is prepared at the end of 20X5.

2.5% of $45,000,000 = $1,125,000.

Quality training: 30% × $1,125,000 = $337,500 Quality reporting: 7% × $1,125,000 = $78,750 Proofreading: 50% × $1,125,000 = $562,500 Other inspection: 13% × $1,125,000 = $146,250

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Case 13-65 1.

Len should know that the bonuses are intended for those who legitimately achieve the budgeted quality goals. The three actions taken by Len were manipulative in nature—their objective was simply to massage the performance statistic so that he could receive his bonus. Since Len’s bonus is achieved simultaneously with that of his employees, there is some question whether he really had their interest in mind or simply his own. The behavior exhibited by Len is not ethical. The heart of ethical behavior is sacrificing one’s self-interest for the well-being of others. By engaging in manipulative behavior, Len is damaging the reputation of the company and providing poor services and products to customers. Len should have stressed the importance of achieving the quality goals by continuing to strive for the current year’s goal by improving quality. If the goal is not achieved this year, then the lack of financial reward should be an additional incentive for better performance for the coming year.

First and foremost, the company should attempt to hire individuals with integrity. Second, the company should make sure that the performance and reward system is fair and acceptable to managers and employees. Perhaps the company could provide a percentage of the savings from quality improvements rather than making it an all-or-nothing bonus, based on achieving some predetermined target. Finally, the company should have in place a good monitoring system to discourage the type of behavior Len is exhibiting, e.g., a good internal audit program.

Len has violated the ethical code. He has not acted in accordance with the principles of honesty, fairness, objectivity, and responsibility. For example, he has not complied with the responsibility to “refrain from engaging in any activity that would prejudice his abilities to carry out his duties ethically” (III-2); nor has he “communicated information fairly and objectively” (IV-1).

Case 13-66 1.

Some might argue that the company has an obligation to pay no more than its minimum legal tax. The actions taken by the company were clearly intended to escape taxation. And perhaps auditors would not find anything that would signal any deviation from the legal guidelines. After all, this had been done in the past with great success. Nonetheless, the propriety of the actions taken by the firm is questionable. It was made quite clear that under normal operating conditions, transfer prices were set by divisional managers. Thus, the incentive for tampering with the transfer prices appears to be motivated by expected losses for the U.S. operations. The only purpose of increasing the transfer prices was to reduce European taxes that normally would be owed and paid. This creates some suspicion about the ethical content of the transfer pricing decision. This suspicion is strengthened by the act of reassigning so-called legitimate costs to support the planned increase in transfer prices. If the costs are really that legitimate, why were they not discovered until the prospect of losses appeared? The behavior displayed by the top executives is not ethical. Debbie is not directly involved in the decision but should consider whether she wants to continue working for a company that engages in this kind of manipulation. 13-56

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Case 13-66 (Continued) 2.

Accountants have a responsibility to “perform their professional duties in accordance with relevant laws, regulations, and technical standards.” (I-2) Furthermore, they have a responsibility to “refrain from engaging in or supporting any activity that would discredit the profession.” (III-7) Finally, they must “disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations presented.” (IV-2) One wonders how willing and how comfortable the management and accountants responsible for the scheme would be in revealing the reassignment of costs and the reasons thereof. If tax accountants are asked to be involved in a questionable scheme, they should clearly refuse to do so.

13-57

14 STATEMENT OF CASH FLOWS DISCUSSION QUESTIONS 1.

Cash equivalents such as money market funds and CDs are highly liquid investments that can be readily converted into cash. They are treated as cash.

Operating activities are the ongoing, day-to-day, revenue-generating activities of an organization. Investing activities involve the sale or purchase of long-term assets. Financing activities stem from long-term liabilities and equity sources.

The operating activity category is the most useful since it provides the cash effects of ongoing operations.

Two objectives served: 1. It provides quality cash data that can serve as input for other analytic models. 2. It provides cash information that can be used for decision making, control, and strategic analysis.

The all-financial-resources approach requires disclosure of all investing and financing activities, even if they do not affect cash.

The separation ensures that cash consequences of business transactions are emphasized since the major purpose of the statement is disclosure of cash activities.

(1) (2) (3) (4) (5)

Compute the change in cash for the period. Compute the cash flows from operating activities. Identify the cash flows from investing activities. Identify the cash flows from financing activities. Prepare the statement of cash flows.

The first step provides the net cash inflow or outflow that must appear on the statement of cash flows. The next three steps provide the detail for explaining the change in cash flows. The final step summarizes all the detail. 8.

Accrual accounting allows a firm to recognize revenues before they are collected or to pay for inputs before they are expensed. This practice creates the possibility of having a negative operating cash flow while still reporting a positive net income.

Accrual accounting allows a firm to collect revenues that were recognized in a prior period and to recognize expenses not yet paid for. Additionally, noncash expenses are deducted to arrive at net income. Thus, a loss may not mean negative cash flows.

10. An increase in current liabilities means that payments to creditors were less than purchases made during the period. A decrease in a noncash current asset means that cash is freed up by using up the noncash current asset. (For example, a decrease in receivables means more cash was collected than revenues recognized.)

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Statement of Cash Flows

11. A decrease in a current liability means that cash payments to creditors were greater than the expenses recognized during the period. An increase in a noncash current asset means that more cash was paid than the expenses recognized. (As assets expire, they become expenses.) 12. Noncash expenses (such as depreciation) are added back to net income because they involve no cash outflow and have already been deducted in computing net income. 13. Since dividends are payments to owners and are equity transactions, they are reflected in the financing activities section of the cash flow statement. 14. Worksheets are an efficient, logical way of organizing the data needed to prepare a statement of cash flows. 15. The worksheet approach is based on a transaction analysis. Using the beginning and ending balances on the balance sheet, transactions that impact cash flows are analyzed. Debit and credit columns are set up for the upper and lower halves of the worksheet. The upper half corresponds to the balance sheet, and the lower half corresponds to the classifications on the statement of cash flows. A debit or credit in the balance sheet section produces a corresponding credit or debit in the cash flow columns of the lower section. Once the transactions are all analyzed, the lower section can be used to prepare the statement.

14-2

CHAPTER 14

MULTIPLE-CHOICE QUESTIONS 14-1.

14-2.

14-3.

14-4.

14-5.

14-6.

14-7.

14-8.

14-9.

14-10.

14-11.

14-12.

14-13.

14-14.

14-15.

14-16.

14-17.

14-3

Statement of Cash Flows

CHAPTER 14

Statement of Cash Flows

BRIEF EXERCISES: SET A BE 14-18 a. b. c. d. e. f. g. h. i.

Operating—use of cash Operating—source of cash Financing—source of cash Financing—use of cash Investing—source of cash Financing—use of cash Investing—source of cash Investing—use of cash Financing—source of cash

BE 14-19 1.

Change in cash: $2,260,000 – $1,400,000 = $860,000

The sum of the operating, investing, and financing cash flows must equal the change in cash from 20X1 to 20X2 ($860,000).

BE 14-20 Net income………………………………………………………………………………

$1,800,000

Add (deduct) adjusting items: Decrease in accounts receivable……………………………………………… Decrease in wages payable……………………………………………………… Increase in inventories…………………………………………………………… Depreciation expense…………………………………………………………… Gain on sale of equipment……………………………………………………… Net cash from operating activities…………………………………………

335,000 (370,000) (40,000) 540,000 (200,000) $2,065,000

BE 14-21 Sale of equipment…………………………………………………………………… Purchase of equipment……………………………………………………………… Purchase of land……………………………………………………………………… Net cash from investing activities………………………………………………

$ 760,000 (860,000) * (875,000) ** $(975,000)

* Ending Balance Plant and Equipment + Original Cost of Equipment Sold – Beginning Balance = Purchase of Equipment ($4,300,000 + $960,000 – $4,400,000 = $860,000)

** Ending Balance (land) – Beginning Balance (land)

14-4

CHAPTER 14

Statement of Cash Flows

BE 14-22 Issuance of bonds payable…………………………...…………………………. Payment of mortgage……………………………………..………………………. Payment of dividends……………………….……………………………………. Net cash from financing activities ……………………….…………………

$ 770,000 (200,000) (800,000) * $(230,000)

* Retained Earnings (20X1) + Net Income – Retained Earnings (20X2) = Dividends ($3,650,000 + $1,800,000 – $4,650,000 = $800,000)

BE 14-23 1.

Swasey Company Statement of Cash Flows For the Year Ended December 31, 20X2 Cash flows from operating activities: Net income……………………………………..……… Add (deduct) adjusting items: Decrease in accounts receivable…………………… Decrease in wages payable………………………… Increase in inventories……………………………… Depreciation expense……………………………….. Gain on sale of equipment…………………………… Net cash from operating activities………………

335,000 (370,000) (40,000) 540,000 (200,000)

Cash flows from investing activities: Sale of equipment…………………………..………… Purchase of equipment………………………….…… Purchase of land……………………………...……… Net cash from investing activities………………

$ 760,000 (860,000) (875,000)

Cash flows from financing activities: Issuance of bonds payable………………………… Payment of mortgage………………………..……… Payment of dividends……………………...………… Net cash from financing activities ……………… Net increase in cash…………………………………..… 2.

$1,800,000

$2,065,000

(975,000) $ 770,000 (200,000) (800,000) (230,000) $ 860,000

The sum of the operating, investing, and financing cash flows must equal the change in cash flow.

14-5

CHAPTER 14

Statement of Cash Flows

BE 14-24 Income Statement

Adjustments $ 137,000 * (100,000) (125,000) ** (50,000) ***

$ 2,400,000 100,000 (1,300,000)

Revenues…………………………………………… Gain on sale of equipment……………………… Cost of goods sold…………………………………

(250,000) (50,000) $ 900,000

Depreciation expense……………………………… Interest expense…………………………………… Net income…………………………………………… Net cash from operating activities………………

Cash Flows $ 2,537,000

(1,475,000)

250,000 (50,000) $ 1,012,000

* Decrease in Accounts Receivable ** Decrease in Accounts Payable *** Increase in Inventories

BE 14-25 Worksheet: Norton Company At December 31, 20X2 Transactions 20X1

Debit

$108,000 (1) 66,000 (2) 96,000 156,000 (78,000) (4) 30,000 (6) $378,000

$114,000 7,600

Credit

20X2

Assets: Cash……………………………… Accounts receivable…………… Inventory………………………… Plant and equipment………… Accumulated depreciation .… Land……………………………… Total assets…………………

18,000 50,000

$222,000 73,600 66,000 120,000 (72,000) 80,000 $489,600

(3) (4) (5)

$30,000 36,000 12,000

(7)

24,000

(10) (11)

14,000 12,000

$ 72,000 3,600 22,000 20,000 72,000

(11) (12)

38,000 60,000

98,000 202,000

Liabilities and stockholders' equity: Accounts payable……………… Wages payable………………… Bonds payable………………… Preferred stock (no par)……… Common stock………………… Paid-in capital in excess of par……………… Retained earnings……………… Total liabilities and stockholders’ equity……

$ 48,000 6,000 (8) 36,000 (9) 6,000 60,000 60,000 162,000 (13) $378,000

2,400 14,000

20,000

$489,600

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CHAPTER 14

Statement of Cash Flows

BE 14-25 (Continued) Transactions Debit

Credit

Cash flows from operating activities: Net income…………………………………………… (12) Depreciation expense*…………………………… (5) Loss on sale of equipment……………………… (4) Decrease in inventory……………………………… (3) Increase in accounts payable…………………… (7) Increase in accounts receivable………………… Decrease in wages payable………………………

$60,000 12,000 8,400 30,000 24,000 (2) (8)

7,600 2,400

Cash flows from investing activities: Sale of equipment…………………………………

(4)

9,600

Cash flows from financing activities: Reduction in bonds payable……………………… Payment of dividends……………………………… Issuance of preferred stock……………………… (10) Net increase in cash……………………………………

(9) (13)

14,000 20,000

(1)

114,000

(6)

50,000

14,000

Noncash investing and financing activities: Land acquired with common stock……………

(11)

50,000

* Beginning Balance of Accumulated Depreciation less AD of asset sold less Ending Balance of AD = Depreciation Expense

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Statement of Cash Flows

BRIEF EXERCISES: SET B BE 14-26 a. b. c. d. e. f. g. h. i.

Investing—use of cash Financing—source of cash Operating—use of cash Investing—use of cash Financing—source of cash Investing—use of cash Financing—use of cash Operating—source of cash Financing—use of cash

BE 14-27 1.

Change in cash: $760,000 – $330,000 = $430,000

The sum of the operating, investing, and financing cash flows must equal the change in cash from 20X1 to 20X2 ($430,000).

BE 14-28 Net income………………………………………………………………………

$900,000

Add (deduct) adjusting items: Decrease in accounts receivable……………………………………… Decrease in wages payable……………………………………………… Increase in inventories…………………………………………………… Depreciation expense…………………………………………………… Gain on sale of equipment……………………………………………… Net cash from operating activities…………………………………

167,500 (185,000) (20,000) 270,000 (100,000) $1,032,500

BE 14-29 Sale of equipment…………………………………………………………… Purchase of equipment……………………………………………………… Purchase of land……………………………………………………………… Net cash from investing activities………………………………………

$ 380,000 (430,000) * (437,500) ** $(487,500)

* Ending Balance Plant and Equipment + Original Cost of Equipment Sold – Beginning Balance = Purchase of Equipment ($2,150,000 + $480,000 – $2,200,000 = $430,000)

** Ending Balance (land) – Beginning Balance (land)

14-8

CHAPTER 14

Statement of Cash Flows

BE 14-30 Issuance of bonds payable…………………………...…………………………... Payment of mortgage……………………………………..………………………... Payment of dividends……………………….……………………………………... Net cash from financing activities ……………………….……………………

$ 385,000 (100,000) (400,000) * $ (115,000)

* Retained Earnings (20X1) + Net Income – Retained Earnings (20X2) = Dividends ($1,825,000 + $900,000 – $2,325,000 = $400,000)

BE 14-31 1.

Davis Company Statement of Cash Flows For the Year Ended December 31, 20X2 Cash flows from operating activities: Net income……………………………………..………… Add (deduct) adjusting items: Decrease in accounts receivable……………………… Decrease in wages payable…………………………… Increase in inventories………………………………… Depreciation expense………………………………...… Gain on sale of equipment……………………………… Net cash from operating activities…………………

167,500 (185,000) (20,000) 270,000 (100,000)

Cash flows from investing activities: Sale of equipment…………………………..…………… Purchase of equipment………………………….……… Purchase of land……………………………...………… Net cash from investing activities…………………

$ 380,000 (430,000) (437,500)

Cash flows from financing activities: Issuance of bonds payable…………………………… Payment of mortgage………………………..………… Payment of dividends……………………...…………… Net cash from financing activities ………………… Net increase in cash…………………………………..…… 2.

$ 900,000

$ 1,032,500

(487,500) $ 385,000 (100,000) (400,000) (115,000) $ 430,000

The sum of the operating, investing, and financing cash flows must equal the change in cash flow.

14-9

CHAPTER 14

Statement of Cash Flows

BE 14-32 Income Statement Revenues…………………………………………… Gain on sale of equipment……………………… Cost of goods sold……………………………… Depreciation expense…………………………… Interest expense………………………………… Net income………………………………………… Net cash from operating activities……………

Adjustments $ 27,400 * (20,000) (25,000) ** 26,000 *** 50,000

$ 480,000 20,000 (260,000) (50,000) (10,000) $ 180,000

Cash Flows $ 507,400

(259,000) (10,000) $ 238,400

* Decrease in Accounts Receivable ** Decrease in Accounts Payable *** Decrease in Inventories

BE 14-33 Worksheet: Evans Company At December 31, 20X2 Transactions 20X1

Debit

$ 32,400 (1) 19,800 (2) 28,800 46,800 (23,400) (4) 9,000 (6) $113,400

$34,200 2,280

Credit

20X2

Assets: Cash……………………………… Accounts receivable…………… Inventory………………………… Plant and equipment…………… Accumulated depreciation .…… Land……………………………… Total assets…………………

5,400 15,000

$ 66,600 22,080 19,800 36,000 (21,600) 24,000 $146,880

(3) (4) (5)

$ 9,000 10,800 3,600

(7)

7,200

(10) (11)

4,200 3,600

$ 21,600 1,080 6,600 6,000 21,600

(11) (12)

11,400 18,000

29,400 60,600

Liabilities and stockholders' equity: Accounts payable……………… Wages payable………………… Bonds payable…………………… Preferred stock (no par)……… Common stock………………… Paid-in capital in excess of par……………… Retained earnings……………… Total liabilities and stockholders’ equity………

$ 14,400 1,800 (8) 10,800 (9) 1,800 18,000 18,000 48,600 (13) $113,400

14-10

720 4,200

6,000

$146,880

CHAPTER 14

Statement of Cash Flows

BE 14-33 (Continued) Transactions Debit

Credit

Cash flows from operating activities: Net income…………………………………………… (12) Depreciation expense……………………………… (5) Loss on sale of equipment……………………… (4) Decrease in inventory……………………………… (3) Increase in accounts payable…………………… (7) Increase in accounts receivable………………… Decrease in wages payable………………………

$18,000 3,600 2,520 9,000 7,200 (2) (8)

$ 2,280 720

(9) (13)

4,200 6,000

(1)

34,200

(6)

15,000

Cash flows from investing activities: Sale of equipment…………………………………

(4)

2,880

4,200

Noncash investing and financing activities: Land acquired with common stock……………… (11)

14-11

15,000

CHAPTER 14

Statement of Cash Flows

EXERCISES E 14-34 a. b. c. d. e.

Investing—source of cash Operating—source of cash Financing—use of cash Financing—use of cash Financing—source of cash

f. g. h. i. j.

Investing—use of cash Financing—source of cash Investing—use of cash Operating—use of cash Financing—source of cash

f. g. h. i.

Added to Deducted from Deducted from Added to

E 14-35 a. b. c. d. e.

Deducted from Deducted from Added to Added to Added to

E 14-36 1.

Note: Balances refer to prepaid rent account. Cash Paid for Rent

= Rent Expense + Ending Balance – Beginning Balance = $708,750 + $343,200 – $283,500 = $768,450

In determining operating cash flow under the indirect method, any increase in a noncash current asset is deducted from net income. Thus, since prepaid rent increased by $59,700 this would be deducted from net income. The increase in prepaid rent represents a decrease in operating cash outflows.

E 14-37 1.

Cash flows from operating activities: Net income……………………………………………...………………………

$ 61,725

Add (deduct) adjusting items: Increase in accounts receivable………………………………...…………… (32,250) (16,500) Increase in inventory……………………………….………………………… (3,000) Increase in prepaid expenses…………………………………..…………… 10,125 Increase in accounts payable……………………………………..………… Decrease in wages payable………………………………….……………… (12,000) 10,500 Depreciation expense…………………………………..……………………… Net cash from operating activities…………………………….………… $ 18,600

14-12

CHAPTER 14

Statement of Cash Flows

E 14-37 (Continued) 2.

From Requirement 1, the net operating cash without the change in accounts payable is $8,475 ($61,725 – 53,250). Thus, the change in accounts payable must be $20,475 – $8,475 = $12,000, which means accounts payable must have increased by this amount. The ending balance is, therefore, $57,000: Beginning Accounts Payable + Increase = $45,000 + $12,000.

The operating cash flows are only $18,600, about half of what would be needed. However, Hepworth has a large cash balance ($126,600) including this year’s increase from operating cash flows. Accordingly, it would be easy to use the excess cash to make the investment. Alternatively, other forms of financing could be used such as loans, issuing bonds, or new stock to raise the difference.

E 14-38 1.

Cash flows from investing activities: Sale of bonds……………………………...……………………………………. Sale of equipment……………………………………………...……………… Purchase of new machinery…………………………………………..……… Sale of common stock…………………………………………..……………… Net cash from investing activities…………………………..……………

450,000 495,000 (270,000) 105,000 $ 780,000

Noncash investing activity: Land in exchange for machinery………………………………….…………

$ 135,000

The negative cash flow from investing can be covered using cash from operating and financing activities. Sources of cash for investment include operating cash flows and financing activities such as issuing bonds, issuing common stock, and taking out mortgages. Thus, it is important to know operating cash flows so that a decision can be made concerning the use of other forms of financing.

E 14-39 Cash flows from financing activities: Sold preferred stock………………………………….……………………………… Borrowed from bank………………………………….……………………………… Purchased treasury stock…………………………………..……………………… Retired bonds………………………………………..………………………………… Net cash from financing activities……………………………..………………

14-13

$ 480,000 575,000 (80,000) (400,000) $ 575,000

CHAPTER 14

Statement of Cash Flows

E 14-40 1.

Cash……………………………

20X1

20X2

Change

$36,900

$96,900

$60,000 (increase)

Mizukawa Company Operating Cash Flows Indirect Method Cash flows from operating activities: Net income……………………………………………….…………………… Add (deduct) adjusting items: Increase in accounts receivable…………………………………….…… Decrease in inventory……………………………………………..………… Depreciation expense………………………………………...……………… Increase in accounts payable………………………………………...…… Net cash from operating activities……………………………………

Change in Accounts Receivable

$60,000 (5,700) 3,000 3,000 2,100 $62,400

= Operating Cash Flows without Accounts Receivable less Net Operating Cash Flows = $68,100 – $61,500 = $6,600

Thus, accounts receivable increased by $6,600 and Ending AR = Beginning AR + Change in AR = $8,100 + $6,600 = $14,700 4. a.

Mizukawa Company Operating Cash Flows Indirect Method Cash flows from operating activities: Net income……………………………………………….…………………… Increase in accounts receivable…………………………………….…… Decrease in inventory……………………………………………..………… Depreciation expense………………………………………...……………… Increase in accounts payable………………………………………...…… Net cash from operating activities……………………………………

= T17

= –(T5–R5)

= –(T6–R6)

= –T15

= (T10–R10)

= Sum(K8:K12)

Descriptive, since it describes what is happening. 14-14

$60,000 (Cell K8)a (5,700) (Cell K9)b 3,000 (Cell K10)c 3,000 (Cell K11)d 2,100 (Cell K12)e $62,400 (Cell K13)

CHAPTER 14

Statement of Cash Flows

E 14-41 1. Mizukawa Company Operating Cash Flows Direct Method Cash flows from operating activities: Income Statement Sales……………………………………………… $ 112,500 (30,000) Cost of goods sold……………………………… Depreciation expense………………………… Other expenses………………………………… Net operating cash…………………………

(3,000) (19,500)

Adjustments $(5,700) * 3,000 ** 2,100 *** 3,000

* Increase in Accounts Receivable ** Decrease in Inventory *** Increase in Accounts Payable 2.

Excel equations for converting income items to operating cash: Sales conversion (cell k8): =T13 – (T5 - R5) (Sales + increase in accounts receivables) Cost of Goods Sold (cell k9): =T14 – (T6 - R6) + (T10 - R10) (CGS + decrease in inventory + Increase in Accounts Payable Depreciation expense (cell k10): =T15 – T15 (Zeroing out of depreciation expense) Other expenses (cell K11): =T16 (no conversion as they are cash expenses) Total operating cash (cell K12): =Sum(K8:K11)

Predictive, since the operating cash flows for 20X2 are budgeted cash flows.

E 14-42 a. Financing activities b. Operating activities—added to net income c. Operating activities—deducted from net income d. Noncash financing/investing activities e. Operating activities—added to net income f. Financing activities g. Investing activities h. Operating activities—added to net income

14-15

Cash Flows $ 106,800 (24,900) 0 (19,500) $ 62,400

CHAPTER 14

Statement of Cash Flows

E 14-43 (Continued) i. Operating activities—deducted from net income j. Operating activities—deducted from net income k. Investing activities l. Operating activities—deducted from net income m. Financing activities n. Investing activities E 14-43 Cash flows from operating activities: Net income…………………………………….……………………………

$156,000

Add (deduct) adjusting items: Decrease in accounts payable……………….………………………… Increase in accounts receivable……………………….……………… Increase in wages payable……………………….……………………… Increase in prepaid insurance…………………………..……………… Decrease in inventory………………………………………………….… Depreciation expense…………………………………………...……… Amortization of patent……………………………….…………………… Net cash from operating activities……………………………..…

(20,000) (20,000) 12,000 (24,000) 200,000 100,000 20,000 $424,000

E 14-44 Piura Merchandising Corporation Cash Flows from Operating Activities For the Year Ended December 31, 20X1 Direct Method Cash flows from operating activities: Income Statement Revenues…………………………. Cost of goods sold……………… Depreciation expense…………… Amortization of patent…………… Wages expense…………………… Insurance expense……………… Income taxes……………………… Net income………………………… Net cash from operating activities………………………

$ 1,500,000 (1,000,000) (100,000) (20,000) (80,000) (40,000) (104,000) $ 156,000

Adjustments $ (20,000) * 200,000 ** (20,000) *** 100,000 20,000 12,000 (24,000)

Cash Flows $1,480,000 (820,000) — — (68,000) (64,000) (104,000)

$ 424,000

* Increase in Accounts Receivable ** Decrease in Inventory *** Decrease in Accounts Payable 14-16

CHAPTER 14

Statement of Cash Flows

P 14-45 Solpoder Corporation Statement of Cash Flows For the Year Ended December 31, 20X2 Cash flows from operating activities: Net income………………………………...……………… Add (deduct) adjusting items: Decrease in accounts receivable……………………… Increase in inventory………………………..…………… Decrease in accounts payable……………………..… Depreciation expense………………………...………… Net cash from operating activities………………… Cash flows from financing activities: Sale of common stock…………………………...……… Payment of dividends………………………………….. Net cash from financing activities………………… Net increase in cash…………………..……………………

$ 63,000 27,000 (27,000) (39,600) 9,000 $32,400 $ 16,200 (17,100) (900) $31,500

P 14-46 Solpoder Corporation Statement of Cash Flows For the Year Ended December 31, 20X2 Direct Method Income Statement

Cash flows from operating activities:

Revenues…………………………...………… $ 297,000 (175,500) Cost of goods sold………………………… Operating expenses………………………… Net cash from operating activities…… Cash flows from financing activities: Sale of common stock………………… Payment of dividends………………… Net cash from financing activities…… Net increase in cash……………………… * Decrease in Accounts Receivable ** Increase in Inventory *** Decrease in Accounts Payable

14-17

(58,500)

Adjustments $ 27,000 * (27,000) ** (39,600) *** 9,000

Cash Flows $ 324,000 (242,100) (49,500) $ 32,400

16,200 (17,100) (900) $ 31,500

CHAPTER 14

Statement of Cash Flows

P 14-47 Roberts Company Statement of Cash Flows For the Year Ended September 30, 20X2 Cash flows from operating activities: Net loss…………………………………………………… Add (deduct) adjusting items: Depreciation expense………………………………… Increase in accounts receivable……………………… Decrease in inventory………………………………… Decrease in accounts payable………………………… Decrease in wages payable…………………………… Net cash from operating activities……………………

$ (800) 6,000 (2,000) 2,800 (1,600) (400) $ 4,000

Cash flows from investing activities: Purchase of equipment………………………………… Net decrease in cash………………………………………

(20,000) $(16,000)

P 14-48 Roberts Company Operating Cash Flows For the Year Ended September 30, 20X2 Income Statement

Cash flows from operating activities:

Revenues……………………………………… $ 40,000 (28,800) Cost of goods sold………………………… Wages expense……………………………… Advertising…………………………………… Depreciation expense……………………… Net cash from operating activities…… * Increase in Accounts Receivable ** Decrease in Inventory *** Decrease in Accounts Payable

14-18

(4,000) (2,000) (6,000)

Adjustments $(2,000) * 2,800 ** (1,600) *** (400) 6,000

Cash Flows $ 38,000 — (27,600) (4,400) (2,000) — $ 4,000

CHAPTER 14

Statement of Cash Flows

P 14-49 1. and 2. Booth Manufacturing Statement of Cash Flows For the Year Ended December 31, 20X2 Cash flows from operating activities: Net income…………………………………...……… Add (deduct) adjusting items: Decrease in accounts receivable………………… Decrease in accounts payable…………………… Increase in inventories……………………………… Depreciation expense……………………………… Gain on sale of equipment………………………… Net cash from operating activities……………

68,750 (62,500) (25,000) 125,000 (50,000)

Cash flows from investing activities: Sale of equipment…………………………………… Purchase of equipment*…………………………… Purchase of land…………………………………… Net cash from investing activities……………

$ 175,000 (250,000) (218,750)

Cash flows from financing activities: Mortgage received…………………………………. Dividends……………………………………………. Net cash from financing activities…………… Net increase in cash………………………………….… * Beginning equipment…………… Purchases………………………… Less sales………………………… Ending equipment…………………

$ 450,000

$1,000,000 250,000 (225,000) $1,025,000

Answers will vary.

14-19

$ 506,250

(293,750) $ 250,000 (225,000) 25,000 $ 237,500

CHAPTER 14

Statement of Cash Flows

P 14-50 Booth Manufacturing Operating Cash Flows For the Year Ended September 30, 20X2 Income Statement Cash flows from operating activities: Revenues…………………………….………… Gain on sale of equipment………………… Cost of goods sold…………………………… Depreciation expense………………………… Interest expense…………………………….… Net cash from operating activities…… a b c

Decrease in Accounts Receivable Increase in Inventories Decrease in Accounts Payable

14-20

$1,200,000 50,000 (640,000) (125,000) (35,000)

Adjustments a

$ 68,750 (50,000) (25,000) b (62,500) c 125,000 —

Cash Flows $1,268,750 — (727,500) — (35,000) $ 506,250

CHAPTER 14

Statement of Cash Flows

P 14-51 1. a. Indirect Method: Cash flows from operating activities: Net income…………………………………………… Add (deduct) adjusting items: Increase in accounts receivable………………… Increase in accounts payable…………………… Depreciation expense*…………………………… Loss on sale of equipment……………………… Net cash from operating activities……………… Income Statement

b. Direct Method:

$122,400 (18,000) 18,000 19,800 1,800 $144,000

Adjustments

Cash Flows

$(18,000) 18,000 19,800 1,800 Net cash from operating activities…………………………….……

$ 902,000 (602,000)

Revenues………………………… Cost of goods sold……………… Operating expenses……………

$ 920,000 (620,000) (177,600)

* Ending Depreciation

$57,600

Depreciation on asset sold

16,200

Less Beginning Depreciation

54,000

Depreciation expense

19,800

14-21

(156,000) $ 144,000

CHAPTER 14

Statement of Cash Flows

P 14-51 (Continued) 2.

Rosie-Lee Company Statement of Cash Flows For the Year Ended June 30, 20X2 Cash flows from operating activities: Net income……………………………….………………………

$ 122,400

Add (deduct) adjusting items: Increase in accounts receivable……………………………… Increase in accounts payable…………………………….… Depreciation expense*……………………………………….. Loss on sale of equipment……………………………..…… Net cash from operating activities……………………… Cash flows from investing activities: Sale of equipment……………………………...……………… Purchase of investments…………………………………….. Purchase of equipment**…………………………………….. Purchase of land………………………………………...……… Net cash from investing activities……………………… Cash flows from financing activities: Retirement of mortgage………………………………….…… Issuance of bonds…………………………………………….… Retirement of preferred stock………………………………… Payment of dividends………………………………...……… Issuance of common stock…………………………………… Net cash from financing activities……………………… Net increase in cash………………………………….…………… * Beginning accumulated depreciation………………………………… Depreciation expense……………………………………………………… Less accumulated depreciation for asset sold……………………… Ending accumulated depreciation………………………………………

** Beginning equipment……………………………………………………… Purchases…………………………………………………………………… Less sales…………………………………………………………………… Ending equipment…………………………………………………………

14-22

(18,000) 18,000 19,800 1,800 $144,000 $

3,600 (54,000) (30,600) (18,000) (99,000)

$(108,000) 90,000 (36,000) (36,000) 108,000 18,000 $ 63,000 $ 54,000 19,800 (16,200) $ 57,600 $180,000 30,600 (21,600) $189,000

CHAPTER 14

Statement of Cash Flows

P 14-52 Worksheet: Rosie-Lee Company Beginning

Ending

Transaction

Balance

Debit

$270,000 (1) 126,000 (2) — (3) 180,000 (4) (54,000) (5) 36,000 (7) $558,000

$ 63,000 18,000 54,000 30,600 16,200 18,000

Credit

Balance

Assets: Cash……………………………..………… Accounts receivable…………………… Investments……………………..………… Plant and equipment…………………… Accumulated depreciation……………… Land……………………..………………… Total assets……………………..………

(5) (6)

$ 21,600 19,800

(8)

18,000

(10)

90,000

(12) 36,000 (14)

108,000 122,400

$333,000 144,000 54,000 189,000 (57,600) 54,000 $716,400

Liabilities and equity: Accounts payable……………………..… Mortgage payable……………………..… Bonds payable……………………..…… Preferred stock……………………..…… Common stock……………………..…… Retained earnings……………………..… Total liabilities and equity……………

$ 72,000 108,000 (9) — 36,000 (11) 180,000 162,000 (13) $558,000

108,000 36,000

Cash flows from operating activities: Net income (loss)……………………..… Increase in accounts receivable……… Increase in account payable…………… Depreciation expense…………………… Loss on sale of equipment……………

(14)

122,400

(8) (6) (5)

18,000 19,800 1,800

(5)

3,600

(2)

18,000

(4) (7) (3)

30,600 18,000 54,000

(9) (11)

108,000 36,000

(13) (1)

36,000 63,000

Cash flows from investing activities: Sale of equipment……………………..… Purchase of equipment………………… Purchase of land……………………..… Purchase of investments……………… Cash flows from financing activities: Retirement of mortgage………………… Retirement of preferred stock………… Issuance of bonds……………………..… Issuance of common stock…………… Payment of dividends…………………… Net increase in cash……………………..…

(10) (12)

14-23

90,000 108,000

$ 90,000 — 90,000 — 288,000 248,400 $716,400

CHAPTER 14

Statement of Cash Flows

P 14-52 (Continued) Rosie-Lee Company Statement of Cash Flows For the Year Ended June 30, 20X2 Cash flows from operating activities: Net income……………………………..………………… Add (deduct) adjusting items: Increase in accounts receivable……………………… Increase in accounts payable………………………… Depreciation expense…………………………………… Loss on sale of equipment……………………………… Net cash from operating activities…………………

$ 122,400 (18,000) 18,000 19,800 1,800 $144,000

Cash flows from investing activities: Sale of equipment……………………………….……… $ 3,600 Purchase of investments……………………………… (54,000) (30,600) Purchase of equipment………………………………… (18,000) Purchase of land………………………………………..… Net cash from investing activities………………… Cash flows from financing activities: Retirement of mortgage………………………………… Issuance of bonds………………………………….…… Retirement of preferred stock………………………… Payment of dividends…………………………………… Issuance of common stock…………………………… Net cash from financing activities………………… Net increase in cash………………………………..………

14-24

(99,000)

$(108,000) 90,000 (36,000) (36,000) 108,000 18,000 $ 63,000

CHAPTER 14

Statement of Cash Flows

P 14-53 Brierwold Corporation Statement of Cash Flows Cash flows from operating activities: Net loss…………………………………………………

$ (15,000)

Add (deduct) adjusting items: Decrease in accounts receivable………………… Increase in inventory………………………………… Decrease in accounts payable…………………… Depreciation expense……………………………… Gain on sale of equipment………………………… Net cash from operating activities……………

20,000 (10,000) (50,000) 80,000 * (15,000)

Cash flows from investing activities: Sale of equipment…………………………………… Purchase of equipment……………………………… Purchase of land……………………………………… Net cash from investing activities……………

$ 40,000 (50,000) (50,000)

Cash flows from financing activities: Retirement of preferred stock……………………… Issuance of common stock………………………… Receipt of mortgage………………………………… Net cash from financing activities………………… Net increase in cash…………………………………… * Beginning accumulated depreciation………………………… Depreciation expense………………………………………...… Accumulated depreciation for asset sold…………………… Ending accumulated depreciation……………………………

$ 10,000

(60,000) $(110,000) 100,000 110,000 100,000 $ 50,000 ** $200,000 80,000 (35,000) $245,000

** Change in cash flow: Cash ending balance………………………………………...… Cash beginning balance……………………………………… Increase………………………………………...………………

14-25

$150,000 100,000 $ 50,000

CHAPTER 14

Statement of Cash Flows

P 14-54 Worksheet: Brierwold Corporation Beginning Balance

Debit

Transaction Credit

Ending Balance

Assets: Cash…………………………………… Accounts receivable……………… Inventory……………………………… Plant and equipment……………… Accumulated depreciation………… Land…………………………………… Total assets………………………

$ 100,000 (1) 200,000 400,000 (3) 700,000 (4) (200,000) (5) 100,000 (7) $1,300,000

$ 50,000

Accounts payable…………………… $ 300,000 (8) Mortgage payable…………………… — Preferred stock……………………… 100,000 (10) Common stock……………………… 240,000 Paid-in capital in excess of par… 360,000 Retained earnings………………… 300,000 (10) (12) Total liabilities and equity…… $1,300,000

50,000

(2) 10,000 50,000 (5) 35,000 (6) 50,000

$ 20,000 60,000 80,000

$ 150,000 180,000 410,000 690,000 (245,000) 150,000 $1,335,000

Liabilities and equity: (9)

110,000

(11) (11)

40,000 60,000

100,000

10,000 15,000

275,000 $1,335,000

Cash flows from operating activities: Net loss……………………………… Depreciation expense……………… Gain on sale of equipment………… Decrease in accounts receivable… Increase in inventory……………… Decrease in accounts payable…… Depreciation expense……………… Gain on sale of equipment…………

(2)

(6)

(12)

15,000

(3) (8)

10,000 50,000

(5)

15,000

(4) (7)

50,000 50,000

(10)

110,000

(1)

50,000

20,000

80,000

Cash flows from investing activities: Sale of equipment………………… Purchase of equipment…………… Purchase of land……………………

(5)

40,000

Cash flows from financing activities: Retirement of preferred stock…… Receipt of mortgage……………… Issuance of common stock……… Net increase in cash……………………

(9) (11)

14-26

$ 250,000 110,000 — 280,000 420,000

110,000 100,000

CHAPTER 14

Statement of Cash Flows

P14-54 (Continued) Brierwold Corporation Statement of Cash Flows For the Year Ended Cash flows from operating activities: Net loss………………………………….……………… Add (deduct) adjusting items: Decrease in accounts receivable…………………… Increase in inventory………………………………… Decrease in accounts payable……………………… Depreciation expense……………………………….… Gain on sale of equipment…………………………… Net cash from operating activities………………

$ (15,000) 20,000 (10,000) (50,000) 80,000 (15,000) $ 10,000

Cash flows from investing activities: Sale of equipment…………………………………….. $ 40,000 Purchase of equipment……………………………… (50,000) (50,000) Purchase of land…………………………………...…… Net cash from investing activities………………

(60,000)

Cash flows from financing activities: Retirement of preferred stock……………………… $(110,000) 100,000 Issuance of common stock…………………………… 110,000 Receipt of mortgage……………………………...…… Net cash from financing activities……………… Net increase in cash………………………………………

100,000 $ 50,000 *

* Change in cash flow: Cash ending balance…………………………………………… Cash beginning balance………………………………………… Increase…………………………………………….……………

14-27

$150,000 100,000 $ 50,000

CHAPTER 14

Statement of Cash Flows

P 14-55 Cash flows from operating activities: Net income………………………………………...………………………………

$ 17,500

Add (deduct) adjusting items: Increase in accounts receivable………………………………...……………. Increase in accounts payable………………………………...……………….. Decrease in inventory……………………………………………………..……… Decrease in wages payable………………………………...…………………… Decrease in prepaid insurance……………………………………..………… Discount amortization……………………………………….…………………… Depreciation expense…………………………………….……………………… Patent amortization………………………………………...…………………… Net cash from operating activities…………………………….……………

(10,000) 7,500 16,000 (3,000) 2,000 1,800 60,000 20,000 $111,800

P 14-56 1.

Golding Company Statement of Cash Flows For the Year Ended December 31, 20X2 Cash flows from operating activities: Net income………………………………...…………… Add (deduct) adjusting items: Decrease in accounts receivable…………………… Decrease in accounts payable……………………… Depreciation expense…………………………..…… Net cash from operating activities……….………

$ 25,000,000 5,000,000 (5,000,000) 5,000,000 $ 30,000,000

Cash flows from investing activities: Purchase of equipment……………………………… Cash flows from financing activities: Payment of dividends………………………………… Issuance of bonds…………………………………...… Net cash from financing activities………………… Net increase in cash……………………………………… 2.

(10,000,000) $(10,000,000) 10,000,000 — $ 20,000,000

First, some assessment of Lemmons’s value is needed. The net worth of Lemmons as of 20X2 is $640,000. What is the market value of these assets? The operating cash produced in 20X2 was $202,500. Assuming that the operating cash flow will continue at that level, then the question becomes: How much is a perpetuity of $202,500 worth? At a discount rate of 10%, the value would be a little more than $2 million. Given that Golding has free (uncommitted) cash flows from operations of $20 million, it seems that Golding could easily finance the purchase of Lemmons.

14-28

CHAPTER 14

Statement of Cash Flows

P 14-57 Blalock Company Statement of Cash Flows For the Year Ended December 31, 20X2 Cash flows from operating activities: Net income…………………………………………………

$ 68,000

Add (deduct) adjusting items: Increase in accounts receivable……………………… Increase in accounts payable…………………………… Depreciation expense*…………………………………… Loss on sale of equipment……………………………… Net cash from operating activities…………………

(10,000) 10,000 11,000 1,000

Cash flows from investing activities: Sale of equipment………………………………………… Purchase of investments………………………………… Purchase of equipment**………………………………… Purchase of land………………………………………… Net cash from investing activities…………………

$ 2,000 (30,000) (17,000) (10,000)

Cash flows from financing activities: Retirement of bonds……………………………………… Receipt of mortgage……………………………………… Retirement of preferred stock…………………………… Issuance of common stock……………………………… Payment of dividends…………………………………… Net cash from financing activities……………………… Net increase in cash………………………………………… *Beginning accumulated depreciation………………… Depreciation expense…………………………………… Less accumulated depreciation for asset sold……… Ending accumulated depreciation………………………

$ 30,000 11,000 (9,000) $ 32,000

**Beginning equipment…………………………………… $100,000 Purchases…………………………………………………… 17,000 Less sales…………………………………………………… (12,000) Ending equipment………………………………………… $105,000

14-29

$ 80,000

(55,000) $(60,000) 50,000 (20,000) 60,000 (20,000) 10,000 $ 35,000

CHAPTER 14

Statement of Cash Flows

P 14-58 Worksheet: Blalock Company For the Year Ended, December 31, 20X2 Transaction

Beginning Balance

Debit

Credit

Ending Balance

Assets: Cash……………………………………… Accounts receivable………………… Investments…………………………… Plant and equipment………………… Accumulated depreciation………… Land……………………………………… Total assets…………………………

$150,000 70,000 — 100,000 (30,000) 20,000 $310,000

(1) (2) (3) (4) (5) (7)

$35,000 10,000 30,000 17,000 9,000 10,000

(9)

60,000

(11)

20,000

(5) (6)

$12,000 11,000

(8)

10,000

(10)

50,000

(12) (14)

60,000 68,000

(2)

10,000

(4) (7) (3)

17,000 10,000 30,000

(9) (11)

60,000 20,000

(13) (1)

20,000 35,000

$185,000 80,000 30,000 105,000 (32,000) 30,000 $398,000

Liabilities and equity: Accounts payable…………………… Bonds payable………………………… Mortgage payable…………………… Preferred stock………………………… Common stock………………………… Retained earnings…………………… Total liabilities and equity………

$ 40,000 60,000 — 20,000 100,000 90,000 $310,000

(13)

20,000

(14) (6) (5)

68,000 11,000 1,000

(8)

10,000

(5)

2,000

Cash flows from operating activities: Net income (loss)……………………… Depreciation expense………………… Loss on sale of equipment………… Increase in accounts receivable…… Increase in accounts payable… Cash flows from investing activities: Sale of equipment…………………… Purchase of equipment……………… Purchase of land……………………… Purchase of investments……… Cash flows from financing activities: Retirement of bonds………………… Retirement of preferred stock……… Receipt of mortgage………………… Issuance of common stock………… Payment of dividends………………… Net increase in cash………………………

(10) (12)

14-30

50,000 60,000

$ 50,000 — 50,000 — 160,000 138,000 $398,000

CHAPTER 14

Statement of Cash Flows

P14-58 (Continued) Blalock Company Statement of Cash Flows For the Year Ended December 31, 20X2 Cash flows from operating activities: Net income……………………………………………

$ 68,000

Add (deduct) adjusting items: Increase in accounts receivable………………… Increase in accounts payable……………………. Depreciation expense……………………………… Loss on sale of equipment………………………… Net cash from operating activities………...…

(10,000) 10,000 11,000 1,000

Cash flows from investing activities: Sale of equipment…………………………………… Purchase of investments…………………………… Purchase of equipment…………………………… Purchase of land…………………………………… Net cash from investing activities……………

$ 2,000 (30,000) (17,000) (10,000)

Cash flows from financing activities: Retirement of bonds………………………………… Receipt of mortgage………………………………… Retirement of preferred stock…………………… Issuance of common stock………………………. Payment of dividends……………………………… Net cash from financing activities…………… Net increase in cash……………………………………

14-31

$ 80,000

(55,000) $(60,000) 50,000 (20,000) 60,000 (20,000) 10,000 $ 35,000

CHAPTER 14

Statement of Cash Flows

CASES Case 14-59 1. a. Indirect method: Net income…………………………………………………………………………

$32,000

Add (deduct) adjusting items: Increase in accounts receivable…………………………………………. Decrease in inventory…………………………………………...………… Increase in accounts payable…………………………………….……… Decrease in wages payable…………………………………………..…… Loss on sale of equipment………………………………………..……… Depreciation expense*…………………………….………………………… Net cash from operating activities……………………………………

(4,000) 20,000 16,000 (1,600) 6,000 8,000 $76,400

* $48,000 – ($52,000 – $12,000) [The accumulated depreciation ($12,000) on the equipment sold must be removed.]

b. Direct method: Income Statement Revenues…………………………… Cost of goods sold………………

$ 320,000 (200,000)

Operating expenses………………

(88,000)

Net operating cash…………… a b c d e f

Increase in Accounts Receivable Decrease in Inventory Increase in Accounts Payable Decrease in Wages Payable Loss on sale of equipment Depreciation expense

14-32

Adjustments a

$ (4,000) 20,000 b c 16,000 d (1,600) 6,000 e f 8,000

Cash Flows $ 316,000 (164,000)

(75,600) $ 76,400

CHAPTER 14

Statement of Cash Flows

Case 14-59 (Continued) 2.

Piura Manufacturing Statement of Cash Flows For the Year Ended June 30, 20X2 Cash flows from operating activities: Net income………………………………………………… Add (deduct) adjusting items: Increase in accounts receivable……………………… Decrease in inventory…………………………………… Increase in accounts payable………………………… Decrease in wages payable…………………………… Loss on sale of equipment……………………………… Depreciation expense…………………………………… Net cash from operating activities…………………

$32,000 (4,000) 20,000 16,000 (1,600) 6,000 8,000 $76,400

Cash flows from investing activities: Sale of equipment………………………………………… Cash flows from financing activities: Reduction in bonds payable…………………………… Payment of dividends…………………………………… Issuance of preferred stock…………………………… Net cash from financing activities………………… Net increase in cash…………………………………………

6,000 $ (8,000) (8,000) 8,000 (8,000) $74,400 *

Noncash investing and financing activities: Acquisition of equipment by issuing common stock……………………………………………

$32,000

* Computation of cash flow change: Cash…………………………

20X1 $72,000

14-33

20X2 $146,400

Net Change $74,400

CHAPTER 14

Statement of Cash Flows

Case 14-59 (Continued) 3.

Worksheet: Piura Manufacturing For the Year Ended June 30, 20X2 Transaction

Beginning Balance

Debit

$ 72,000 (1) 44,000 (2) 64,000 104,000 (4) (52,000) (5) 20,000 $252,000

$74,400 4,000

Ending

Credit

Balance

(3) 32,000 (5) 12,000 (6)

$20,000 24,000 8,000

$146,400 48,000 44,000 112,000 (48,000) 20,000 $322,400

(7)

16,000

(10) (11) (11) 8,000 (13)

8,000 6,000 26,000 32,000

Assets: Cash……………………………………… Accounts receivable………………… Inventory……………………………… Plant and equipment………………… Accumulated depreciation………… Land……………………………………… Total assets………………………… Liabilities and equity: Accounts payable…………………… Wages payable………………………… Bonds payable………………………… Preferred stock (no par)……………… Common stock………………………… Paid-in capital in excess of par…… Retained earnings…………………… Total liabilities and equity………

$ 32,000 4,000 (8) 24,000 (9) 4,000 30,000 50,000 108,000 (12) $252,000

1,600 8,000

Cash flows from operating activities: Net income …………………………… Increase in accounts receivable…… Decrease in inventory………………… Increase in account payable………… Decrease in wages payable………… Depreciation expense………………… Loss on sale of equipment…………

(13) (3) (7)

32,000 (2)

4,000

(8)

1,600

(9) (12)

8,000 8,000

(1)

74,400

32,000 (4)

32,000

20,000 16,000

(6) (5)

8,000 6,000

(5)

6,000

Cash flows from investing accounts: Sale of equipment…………………… Cash flows from financing accounts: Reduction in bonds payable………… Payment of dividends………………… Issuance of preferred stock………… Net increase in cash………………………

(10)

Noncash investing and financing activities: Equipment acquired with common stock………………………

(11)

14-34

8,000

$ 48,000 2,400 16,000 12,000 36,000 76,000 132,000 $322,400

CHAPTER 14

Statement of Cash Flows

Case 14-59 (Continued) Piura Manufacturing Statement of Cash Flows For the Year Ended June 30, 20X2 Cash flows from operating activities: Net income……………………………………..………… Add (deduct) adjusting items: Increase in accounts receivable……………………… Decrease in inventory………………………………… Increase in accounts payable………………………… Decrease in wages payable…………………………… Loss on sale of equipment…………………………… Depreciation expense………………………………… Net cash from operating activities………………

$32,000 (4,000) 20,000 16,000 (1,600) 6,000 8,000 $76,400

Cash flows from investing activities: Sale of equipment…………………………………..…… Cash flows from financing activities: Reduction in bonds payable………………………… Payment of dividends…………………………………. Issuance of preferred stock…………………………… Net cash from financing activities……………… Net increase in cash…………………………….…………… Noncash investing and financing activities: Acquisition of equipment by issuing common stock…………………………………...… 4.

6,000 $ (8,000) (8,000) 8,000 (8,000) $74,400

$32,000

Although answers may vary, the group should mention that the direct method provides much more information for investors (a detailed, line-by-line conversion of the income statement plus the indirect method), allowing them to better assess firm value. However, presenting the direct method requires more effort on the part of the firm and, thus, costs more to prepare. Further, while disclosing more information may help investors, it also may help competitors.

14-35

CHAPTER 14

Statement of Cash Flows

Case 14-60 1.

The intent of the owner is to acquire extra operating cash through an arrangement that essentially provides a side payment by the contractor in order to acquire the business. Since the cost of construction is fuzzy to begin with, the bank will not likely know that the cost is out of line. Furthermore, it is very likely that the contractor is not returning any of its profit but is simply increasing the cost of the business by the 5% that Fred is seeking. In effect, Fred is borrowing the 5% for short-term operating needs (without the bank’s knowledge). Thus, the arrangement is a deception and is not consistent with ethical behavior.

Delivering the large order early and reporting it as a cash sale and at the same time writing off other receivables as collected and borrowing money on the side from Bill (which would not appear on the balance sheet either) in order to improve the reported cash position of the firm is fraudulent behavior. It is a misrepresentation of the firm’s economic strength to obtain a loan that might otherwise not be given. The degree of risk is concerned with the likelihood of getting caught—not with what is right or wrong. It should have no bearing on the decision.

The standards that would be violated should Karla agree to Fred’s scheme: Management accountants have a responsibility to: “Provide decision support information and recommendations that are accurate, clear, concise, and timely” (I-3); “Refrain from engaging in or supporting any activity that would discredit the profession” (III-3); “Communicate information fairly and objectively” (IV-1); “Disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports” (IV-2).

Should Fred insist on implementing the plan, then consultation with the board of directors (if one exists) or owners is mandated. If this brings no resolution of the ethical conflict, then resignation is in order. If resignation is the outcome, then consultation with a lawyer may be needed since fraud may be present. If Fred is willing to consider other, ethical solutions, then no action is needed.

14-36

15 FINANCIAL STATEMENT ANALYSIS DISCUSSION QUESTIONS 1.

The two major types of financial statement analysis discussed in this chapter are common-size analysis and ratio analysis.

While answers will vary, the following general themes are likely to arise. The data generally used in financial statement analyses (i.e., common-size analyses, horizontal analyses, and various ratio analyses) typically are of a historical nature as they involve financial statements (balance sheet, income statement, etc.). Financial statements are driven by generally accepted accounting principles and are backwards looking in nature. On the contrary, managerial accounting decision analyses generally are forward-looking in nature, such as how various revenue-, cost-, or incomebased performance measures would change if a particular future decision was made. These decisions might involve whether to make or buy a product or a service, accept or reject a specialorder offer, or keep or drop an existing business segment. These sorts of managerial accounting analyses utilize forward-looking data, rather than historical data, which creates additional challenges for management accountants, such as obtaining, verifying, and analyzing the necessary forward-looking data. Students might discuss additional differences, such as the data involved in financial statement analyses typically are financial (or lagged indicators) in nature, while the data required for forwardlooking management accounting decision analyses often are nonfinancial (or leading indicators) in nature.

Horizontal analysis expresses line items of financial statements as a percentage of a priorperiod amount. Vertical analysis expresses the line item as a percentage of some other line item for the same time period. Usually, net sales is used for the income statement and total assets for the balance sheet. Both analyses should be conducted as each provides different insights into the financial strength of a company.

Horizontal analysis reveals trends—both favorable and unfavorable. Vertical analysis reveals the current strengths and weaknesses of key financial factors. In both cases, the information provided is useful for decision making. For example, vertical analysis helps managers determine the relationship of costs to sales. Horizontal analysis can show the upward or downward trend in sales and costs over time.

Liquidity ratios measure the ability of a firm to meet its short-term obligations. Leverage ratios measure the ability of a firm to meet both long- and short-term obligations. Profitability ratios measure the earning ability of a firm.

Two types of standards used in ratio analysis are historical and industrial standards. Historical standards allow one to assess trends over time. Industrial standards allow one to assess a company’s performance relative to that of other firms.

The current ratio includes all current assets, from very liquid cash to less liquid inventories. The quick ratio excludes inventories and thus provides a better measure of liquidity (inventories are sometimes obsolete or may turn over slowly).

15-1

CHAPTER 15

Financial Statement Analysis

It may indicate a need to modify credit and collection policies to speed up the conversion of receivables to cash.

A high inventory turnover ratio does not necessarily provide evidence of stockouts and disgruntled customers. In a JIT environment, a high turnover ratio is desired and viewed as a positive sign of success. As long as the company is able to produce quickly to fill customer orders, a high inventory turnover ratio may be a good sign of success.

10. The debt ratio is computed as total liabilities divided by total assets. By restricting the debt ratio, the bank is trying to reduce the risk of default by ensuring that assets remain relatively high compared with liabilities. 11. The purchase alternative would increase the liabilities reported on the balance sheet. Increasing liabilities may cause the company to violate some existing debt covenants. The lease payment, however, had an immediate impact on the income statement rather than the balance sheet. 12. The debt ratio may provide a measure of the riskiness of the investment. The higher the ratio, the more likely the company will go bankrupt, causing the investors to lose much of their investment. 13. For someone retiring, an annual income would be needed. Accordingly, companies that have high yields and moderate payout ratios would be preferred to those that have a lower yield. 14. The price-earnings ratio can be compared with an investor’s expectation of future growth. If it is low (high) based on this expectation, then the price is too low (high) and the price will change based on the bidding that results. 15. Earnings per share is calculated as (Net Income – Preferred Dividends)/Average Common Shares Outstanding. When a company participates in a stock buyback program, it reduces the number of outstanding shares of its common stock, which serves as the denominator in the earnings-per-share ratio calculation. Therefore, when a company participates in a stock buyback program, it increases its earnings per share by decreasing the denominator of Average Common Shares outstanding. Some stock market analysts believe that one of the main reasons why firms participate in stock buyback programs is to increase its earnings per share. 16. The inventory turnover ratio can signal movement toward the goal of zero inventories. 17. Yes. As inventories are reduced to insignificant levels, the current ratio approaches the quick ratio absent other short-term assets like prepaid insurance, or non-operating short-term receivables (employee loans).

15-2

CHAPTER 15

MULTIPLE-CHOICE QUESTIONS 15-1.

15-2.

15-3.

15-4.

15-5.

15-6.

15-7.

15-8.

15-9.

15-10.

15-11.

15-3

Financial Statement Analysis

CHAPTER 15

Financial Statement Analysis

BRIEF EXERCISES: SET A BE 15-12 Year 1 is the base year. Therefore, every dollar amount in Year 1 is 100% of itself. Percent for a Line Item

Dollar Amount of Line Item Dollar Amount of Base Year Line Item

Percent Year 1 Net Sales = $1,000,000/$1,000,000 = 100% Percent Year 2 Net Sales = $1,100,000/$1,000,000 = 110% Percent Year 3 Net Sales = $1,300,000/$1,000,000 = 130% Year 1 Dollars Net sales…………… $1,000,000 Less: Cost of goods sold……… 300,000 Gross margin……… $ 700,000 Less: Operating expenses………… 421,000 Income taxes……… 111,600 Net income………… $ 167,400

Year 2 Percent

Year 3

Dollars

Percent

Dollars

100%

$1,100,000

110%

$1,300,000

130%

100 100

310,000 $ 790,000

103 113

364,000 $ 936,000

121 134

100 100 100

484,000 122,400 $ 183,600

115 110 110

591,000 137,800 $ 207,200

140 123 124

Note: Percents are rounded to the nearest whole percent.

15-4

Percent

CHAPTER 15

Financial Statement Analysis

BE 15-13 Since the analysis is based on net sales, net sales in each year equals 100% of itself. Then, every line item on the income statement is expressed as a percent of that year’s net sales. Percent for a Line Item

Dollar Amount of Line Item Dollar Amount of Base Year Line Item

Percent Year 1 Net Sales = $1,000,000/$1,000,000 = 100% Percent Year 2 Net Sales = $1,100,000/$1,100,000 = 100% Percent Year 3 Net Sales = $1,300,000/$1,300,000 = 100% Year 2

Year 1 Dollars Net sales…………… $1,000,000 Less: Cost of goods sold……… 300,000 Gross margin……… $ 700,000 Less: Operating expenses………… 421,000 Income taxes……… 111,600 Net income………… $ 167,400

Year 3

Percent

Dollars

Percent

Dollars

Percent

100%

$1,100,000

100%

$1,300,000

100%

30 70

310,000 $ 790,000

28 72

364,000 $ 936,000

28 72

42 11 17

484,000 122,400 $ 183,600

44 11 17

591,000 137,800 $ 207,200

45 11 16

Note: Percents are rounded to the nearest whole percent.

BE 15-14 1.

Current Ratio

Current Assets Current Liabilities

$5,000,000 $4,000,000

= 1.25 2.

Quick Ratio

Cash + Marketable Securities + Accounts Receivable Current Liabilities

You first need to calculate marketable securities by subtracting the specific known current assets from the given total current assets. Therefore, marketable securities = $5,000,000 – $1,000,000 cash – $2,250,000 accounts receivable – $500,000 inventory. Thus, marketable securities = $1,250,000. Finally, Quick Ratio

Cash + Marketable Securities + Accounts Receivable Current Liabilities

$1,000,000 + $1,250,000 + $2,250,000 $4,000,000

= 1.13

15-5

CHAPTER 15

Financial Statement Analysis

BE 15-15 1.

Average Accounts Receivable

Beginning Receivables + Ending Receivables 2

$142,650,000 + $172,350,000 2

= $157,500,000 2.

Accounts Receivable Turnover Ratio

Net Sales Average Accounts Receivable

= =

$2,299,500,000 $157,500,000

= 14.6 times 3.

Accounts Receivable Turnover in Days

Days in a Year Accounts Receivable Turnover Ratio

365 days 14.6 times

= 25.0 days

15-6

CHAPTER 15

Financial Statement Analysis

BE 15-16 1. Average Inventory

2. Inventory Turnover Ratio

3. Inventory Turnover in Days

Beginning Inventory + Ending Inventory 2

$54,374,200 + $62,625,800 2

Cost of Goods Sold Average Inventory

$1,755,000,000 $58,500,000

Days in a Year Inventory Turnover Ratio

365 days 30.0

= $58,500,000

= 30.0 times

= 12.2 days

4. Nikkola’s inventory turnover ratio is 30.0 times, which indicates that, on average, the company converts finished goods inventory into sales 30 times a year, or about every 12 days, which is slightly more than twice per month. Without more detailed information on Nikkola and its industry, it is difficult to classify these results as outstanding, poor, or somewhere in between. For example, if Nikkola manufactures relatively expensive items with very high prices (e.g., automobiles or extremely high-end home entertainment systems), then these turnover results would be more impressive than if Nikkola manufactures relatively inexpensive items with very low prices (e.g., lawnmowers, personal computers, furniture, etc.). In addition, ratio interpretation is improved by comparing the given company’s ratio calculations to industry averages (e.g., Key Business Ratios, Dun and Bradstreet, Standard & Poor’s Industry Survey ), to prior periods of performance and/or to budgeted data.

15-7

CHAPTER 15

Financial Statement Analysis

BE 15-17 Times-Interest-Earned Ratio

Income Before Taxes + Interest Expense Interest Expense

$4,635,750 + $875,400 $875,400

Total Liabilities Total Assets

= 6.3 times

BE 15-18 1.

Debt Ratio

$32,500,000 $40,625,000

= 2.

Debt-to-Equity Ratio

= 0.80, or 80%

Total Liabilities Total Stockholders’ Equity

$32,500,000 $8,125,000

= 4.00

BE 15-19 Return on Sales

Net Income Sales

$915,197 $8,281,989

= 0.111, or 11.1%

BE 15-20 1.

Average Total Assets

Beginning Total Assets + Ending Total Assets 2

$8,121,576 + $6,521,576 = $7,321,576 2 Net Income + [Interest Expense × (1 – Tax Rate*)] = Average Total Assets

= 2.

Return on Assets

= = =

$915,197 + [$50,000* × (1 – 0.40)] $7,321,576 $915,197 + $30,000 $7,321,576 $945,197 $7,321,576

= 0.1291, or 12.91%

*Note : $50,000 of interest expense = $500,000 of bonds payable @ 10% rate as stated in Somerville’s balance sheet.

15-8

CHAPTER 15

BE 15-21 1. Average Common Stockholders’ Equity

Financial Statement Analysis

$4,316,655 + $4,949,965 2

= $4,633,310 Note: Common stockholders’ equity for each year is calculated by summing common stock, additional paid-in capital, and retained earnings. Therefore, common stockholders’ equity for 20X1 = $337,500 + $2,000,000 + $2,612,465 = $4,949,965. 2.

Return on Stockholders’ Equity

Net Income – Preferred Dividends Average Common Stockholders' Equity

$915,197 – $80,000 $4,633,310

$835,197 $4,633,310

= 0.1803, or 18.03% BE 15-22 1.

Number of Common Shares

$337,500 $1.50

Earnings per Share

Net Income – Preferred Dividends Average Common Shares

$915,197 – $80,000 225,000 shares

$835,197 225,000 shares

= 225,000 shares

= $3.71, or $3.71 of earnings per share

15-9

CHAPTER 15

Financial Statement Analysis

BE 15-23 Before the price-earnings ratio can be computed, earnings per share must be calculated for use as the denominator in the price-earnings ratio. Earnings per share for Somerville equal $3.71. Refer to Brief Exercise 15-22 for specific guidance on how to calculate earnings per share. Price-Earnings Ratio

Market Price per Share Earnings per Share

= =

$8.10 $3.71

= 2.18329, or 2.18 BE 15-24 1.

Dividends per Share =

Dividends Paid Common Stock Shares Outstanding $201,887 225,000 shares

= $0.8973

Note : Number of common shares = $337,500/$1.50 par value per common share = 225,000 common shares (see Brief Exercise 15-22 for specific guidance on how to calculate the number of common shares). 2.

Dividend Yield

= =

Dividends per Common Share Market Price per Common Share $0.8973 $8.10

= 0.1108, or 11.08% 3.

Dividend Payout Ratio= = =

Common Dividends Net Income – Preferred Dividends $201,887 $915,197 – $80,000 $201,887 $835,197

= 0.2417, or 24.17%

15-10

CHAPTER 15

Financial Statement Analysis

BRIEF EXERCISES: SET B BE 15-25 Year 1 is the base year. Therefore, every dollar amount in Year 1 is 100% of itself. Percent for a Line Item

Dollar Amount of Line Item Dollar Amount of Base Year Line Item

Percent Year 1 Net Sales = $10,000,000/$10,000,000 = 100% Percent Year 2 Net Sales = $8,000,000/$10,000,000 = 80% Percent Year 3 Net Sales = $6,500,000/$10,000,000 = 65% Year 1 Dollars Net sales…………… $ 10,000,000 Less: Cost of goods sold……… 6,000,000 Gross margin……… $ 4,000,000 Less: Operating expenses………… 2,200,000 Income taxes……… 720,000 Net income………… $ 1,080,000

Year 2

Year 3

Percent

Dollars

Percent

Dollars

Percent

100%

$ 8,000,000

80%

$ 6,500,000

65%

100 100

5,500,000 $ 2,500,000

92 63

5,500,000 $ 1,500,000

83 38

100 100 100

1,300,000 480,000 $ 720,000

59 67 67

450,000 420,000 630,000

20 58 58

Note: Percents are rounded to the nearest whole percent.

15-11

CHAPTER 15

Financial Statement Analysis

BE 15-26 Since the analysis is based on net sales, net sales in each year equals 100% of itself. Then, every line item on the income statement is expressed as a percent of that year’s net sales. Percent for a Line Item

Dollar Amount of Line Item Dollar Amount of Base Year Line Item

Percent Year 1 Net Sales = $10,000,000/$10,000,000 = 100% Percent Year 2 Net Sales = $8,000,000/$8,000,000 = 100% Percent Year 3 Net Sales = $6,500,000/$6,500,000 = 100% Year 1 Dollars Net sales……………… $ 10,000,000 Less: Cost of 6,000,000 goods sold………… $ 4,000,000 Gross margin……… Less: Operating 2,200,000 expenses…………… Income taxes………… 720,000 Net income…………… $ 1,080,000

Year 2

Year 3

Percent

Dollars

Percent

Dollars

Percent

100%

$ 8,000,000

100%

$ 6,500,000

100%

60 40

5,500,000 $ 2,500,000

69 31

5,000,000 $ 1,500,000

77 23

22 7 11

1,300,000 480,000 $ 720,000

16 6 9

450,000 420,000 630,000

7 6 10

Note: Percents are rounded to the nearest whole percent.

BE 15-27 1.

Current Assets Current Liabilities

Current Ratio = =

$1,000,000 $800,000

= 1.25 2.

Quick Ratio

Cash + Marketable Securities + Accounts Receivable Current Liabilities

You first need to calculate marketable securities by subtracting the specific known current assets from the given total current assets. Therefore, marketable securities = $1,000,000 – $500,000 cash – $200,000 accounts receivable – $175,000 inventory. Thus, marketable securities = $125,000. Finally, Quick Ratio

Cash + Marketable Securities + Accounts Receivable Current Liabilities $500,000 + $125,000 + $200,000 $800,000

= =

1.03 15-12

CHAPTER 15

Financial Statement Analysis

BE 15-28 1.

Average Accounts Receivable

Beginning Receivables + Ending Receivables 2

$10,000,000 + $9,500,000 2

= $9,750,000 2.

Accounts Receivable Turnover Ratio

Net Sales Average Accounts Receivable

= =

$400,000,000 $9,750,000

= 41.0 times 3.

Accounts Receivable Turnover in Days

Days in a Year Accounts Receivable Turnover Ratio

365 days 41.0 times

= 8.9 days

15-13

CHAPTER 15

Financial Statement Analysis

BE 15-29 1. Average Inventory

2. Inventory Turnover Ratio

3. Inventory Turnover in Days

Beginning Inventory + Ending Inventory 2

$8,000,000 + $9,000,000 2

Cost of Goods Sold Average Inventory

$300,000,000 $8,500,000

Days in a Year Inventory Turnover Ratio

365 days 35.3

= $8,500,000

= 35.3 times

= 10.3 days

4. Esmeralda’s inventory turnover ratio is 35.3 times, which indicates that, on average, the company converts finished goods inventory into sales 35 times a year. Esmeralda’s inventory turnover in days is 10.3, or about every 10 days, which is approximately three times per month. Without more detailed information on Esmeralda's and its industry, it is difficult to classify these results as outstanding, poor, or somewhere in between. For example, if Esmeralda's manufactures relatively expensive items with very high prices (e.g., automobiles or extremely high-end home entertainment systems), then these turnover results would be more impressive than if Esmeralda's manufactures inexpensive items with relatively low prices (e.g., lawnmowers, personal computers, furniture, etc.). In addition, ratio interpretation is improved by comparing the given company’s ratio calculations to industry averages (e.g., Key Business Ratios, Dun and Bradstreet, Standard & Poor’s Industry Survey ), and to prior periods of performance and/or budgeted data.

15-14

CHAPTER 15

Financial Statement Analysis

BE 15-30 Times-Interest-Earned Ratio

Income Before Taxes + Interest Expense Interest Expense

$9,600,000 + $2,500,000 $2,500,000

Total Liabilities Total Assets

$25,000,000 $75,000,000

= 4.8 times

BE 15-31 1.

Debt Ratio

Debt-to-Equity Ratio

= 0.33, or 33%

Total Liabilities Total Stockholders’ Equity $25,000,000 $50,000,000

= 0.50

BE 15-32 Return on Sales

Net Income Sales

$422,070 $5,345,000

= 0.079, or 7.9%

BE 15-33 1.

Average Total Assets

Beginning Total Assets + Ending Total Assets 2

$5,295,800 + $5,557,800 = $5,426,800 2 Net Income + [Interest Expense × (1 – Tax Rate*)] = Average Total Assets =

Return on Assets

= = =

$422,070 + [$27,000* × (1 – 0.40)] $5,426,800 $422,070 + $16,200 $5,426,800 $438,270 $5,426,800

= 0.0808, or 8.08%

* Note : $27,000 of interest expense = $300,000 of bonds payable @ 9% rate as stated in Santiago's balance sheet.

15-15

CHAPTER 15

Financial Statement Analysis

BE 15-34 1. Average Common Stockholders’ Equity

$3,855,500 + $4,087,570 2

= $3,971,535 Note: Common stockholders’ equity for each year is calculated by summing common stock, additional paid-in capital, and retained earnings. Therefore, common stockholders’ equity for 20X2 = $150,000 + $2,500,000 + $1,437,570 = $4,087,570. 2.

Return on Stockholders’ Equity

Net Income – Preferred Dividends Average Common Stockholders' Equity

$422,070 – $40,000 $3,971,535

$382,070 $3,971,535

= 0.0962, or 9.62%

BE 15-35 1.

Number of Common Shares

$150,000 $1.00

Earnings per Share

Net Income – Preferred Dividends Average Common Shares

$422,070 – $40,000 150,000 shares

$382,070 150,000 shares

= 150,000 shares

= $2.55, or $2.55 of earnings per share

15-16

CHAPTER 15

Financial Statement Analysis

BE 15-36 Before the price-earnings ratio can be computed, earnings per share must be calculated for use as the denominator in the price-earnings ratio. Earnings per share for Santiago equal $2.55. Refer to Brief Exercise 15-35 for specific guidance on how to calculate earnings per share. Price-Earnings Ratio

Market Price per Share Earnings per Share

= =

$20.00 $2.55

= 7.84314, or 7.84

BE 15-37 1.

Dividends per Share

Dividends Paid Common Stock Shares Outstanding

$150,000 150,000 shares

= $1.0000

Note : Number of common shares = $150,000/$1.00 par value per common share = 150,000 common shares (see Brief Exercise 15-35 for specific guidance on how to calculate the number of common shares). 2.

Dividend Yield

= = =

Dividend Payout Ratio

Dividends per Common Share Market Price per Common Share $1.0000 $20.00 0.05, or 5.00%

Common Dividends Net Income – Preferred Dividends

$150,000 $422,070 – $40,000

$150,000 $382,070

= 0.3926, or 39.26%

15-17

CHAPTER 15

Financial Statement Analysis

EXERCISES E 15-38

Sales…………………………………………………… Less: Cost of goods sold…………………………… Gross margin……………………………………… Less operating expenses: Selling expenses………………………………… Administrative expenses………………………… Operating income…………………………………… Less: Interest expense……………………………… Income before taxes………………………………

Year 2 Amount

Percent of Year 1 Amount

$ 1,800,000 1,200,000 $ 600,000

90.0% 85.7 100.0

$ $

300,000 110,000 190,000 40,000 150,000

E 15-39 1. Sales…………………………………………………… Less: Cost of goods sold………………..………… Gross margin……………………………………… Less operating expenses: Selling expenses……………………………….… Administrative expenses………………………. Operating income…………………………………… Less: Interest expense……………………………... Income before taxes…………………………..…

Year 1

Percent of Year 1 Sales

$ 2,000,000 1,400,000 $ 600,000

100.0% 70.0 30.0

$ $

300,000 100,000 200,000 50,000 150,000

2. Sales………………………………………………...… Less: Cost of goods sold…………………………… Gross margin…………………………………...… Less operating expenses: Selling expenses……………………………..…… Administrative expenses………………………… Operating income…………………………………… Less: Interest expense……………………………… Income before taxes……………………………… * Difference due to rounding

15-18

100.0 110.0 95.0 80.0 100.0

15.0 5.0 10.0 2.5 7.5

Year 2

Percent of Year 2 Sales

$ 1,800,000 1,200,000 $ 600,000

100.0% 66.7 33.3

300,000 110,000 190,000 40,000 150,000

16.7 6.1 10.6 2.2 8.3*

$ $

CHAPTER 15

Financial Statement Analysis

Year 2

Percent of Year 1

E 15-40 1. Sales…………………………………..……………… Less: Cost of goods sold………………………… Gross margin………………………………...…… Less operating expenses: Selling expenses…………………………..…… Administrative expenses……………………… Operating income………………………………...… Less: Interest expense…………………………… Income before taxes……………………………

$1,200,000 700,000 $ 500,000

120.0% 100.0 166.7

220,000 60,000 $ 220,000 25,000 $ 195,000

146.7 120.0 220.0 100.0 260.0

Year 3

Percent of Year 1

$ 1,700,000 1,000,000 $ 700,000

170.0% 142.9 233.3

2. Sales……………………………………………..…… Less: Cost of goods sold………………………… Gross margin…………………………………… Less operating expenses: Selling expenses………………………………. Administrative expenses……………………… Operating income…………………………………… Less: Interest expense…………………………… Income before taxes……………………………

$ $

250,000 120,000 330,000 25,000 305,000

E 15-41 1. Year 1 Sales…………………………………………..……… Less: Cost of goods sold………………………… Gross margin…………………………………… Less operating expenses: Selling expenses………………………………… Administrative expenses……………………… Operating income…………………………………… Less: Interest expense…………………………… Income before taxes……………………………

15-19

166.7 240.0 330.0 100.0 406.7

Percent of Sales in Year 1

$1,000,000 700,000 $ 300,000

100.0% 70.0 30.0

150,000 50,000 $ 100,000 25,000 $ 75,000

15.0 5.0 10.0 2.5 7.5

CHAPTER 15

Financial Statement Analysis

E 15-41 (Continued) 2. Year 2 Sales………………………………….……………………..… Less: Cost of goods sold………………………………… Gross margin……………………………………..……… Less operating expenses: Selling expenses………………………………………… Administrative expenses……………………………… Operating income…………………………………………… Less: Interest expense……………………………………… Income before taxes……………………………………

Percent of Sales in Year 2

$1,200,000 700,000 $ 500,000

100.0% 58.3 41.7

220,000 60,000 $ 220,000 25,000 $ 195,000

18.3 5.0 18.3 2.1 16.3 *

* Difference due to rounding

3. Year 3 Sales………………………………….……………………..… Less: Cost of goods sold………………………………… Gross margin……………………………………..……… Less operating expenses: Selling expenses………………………………………… Administrative expenses……………………………… Operating income…………………………………………… Less: Interest expense……………………………………… Income before taxes…………………………………… 4.

$ 1,700,000 1,000,000 $ 700,000

$ $

250,000 120,000 330,000 25,000 305,000

Percent of Sales in Year 3 100.0% 58.8 41.2 14.7 7.1 19.4 1.5 17.9

Data visualization techniques might prove helpful in showcasing the trends computed in the vertical analyses performed in responding to Requirements 1 to 3. For example, rather than hoping or expecting decision makers to detect and understand any trends in the columns of the vertical analysis, it might prove to be easier to identify any such trends if they were displayed graphically via various data visualization approaches. Pie charts, bar graphs, dashboards, or other graphical displays often are effective in helping decision makers better detect particular trends, as compared to simply viewing columns of percentages and numbers.

E 15-42 1.

Current Ratio

Current Assets Current Liabilities $68,000,000 = $42,000,000 =

= 1.6 2.

Quick (Acid-Test) Ratio

= =

Cash + Marketable Securities + Accounts Receivable Current Liabilities $26,500,000 + $0 + $20,500,000 $42,000,000

= 1.1

15-20

CHAPTER 15

Financial Statement Analysis

E 15-43 1.

Current Ratio

Current Assets Current Liabilities

$120,500,000 $42,250,000

= 2.85 2.

Quick (Acid-Test) Ratio

Cash + Marketable Securities + Accounts Receivable Current Liabilities

$42,000,000 + $15,500,000 + $28,000,000 $42,250,000

= 2.02

E 15-44 1.

Average Accounts Receivable

Beginning Accounts Receivable + Ending Accounts Receivable 2 $5,625,000 + $5,000,000 2

= $5,312,500 2.

Accounts Receivable Turnover Ratio

Net Sales Average Accounts Receivable $34,000,000 $5,312,500

= 6.4 times 3.

Accounts Receivable Turnover in Days

= =

Days in a Year Accounts Receivable Turnover Ratio 365 days 6.4 times

= 57.0 days

15-21

CHAPTER 15

Financial Statement Analysis

E 15-45 1.

Beginning Accounts Receivable + Ending Accounts Receivable 2

Average Accounts Receivable = =

$2,500,500,000 + $2,750,000,000 2

= $2,625,250,000 2.

Accounts Receivable Turnover Ratio

Net Sales Average Accounts Receivable

$125,500,250,000 $2,625,250,000

= 3.

Accounts Receivable in Days

= =

47.81 times Days in a Year Accounts Receivable Turnover Ratio 365 days 47.81 times

= 7.63 days

E 15-46 1.

Average Inventory

Beginning Inventory + Ending Inventory 2 $335,000,000 + $350,000,000 2

= $342,500,000 2.

Inventory Turnover Ratio

Cost of Goods Sold Average Inventory

$1,557,850,000 $342,500,000

= 4.55 times 3.

Inventory Turnover in Days

Days in a Year Inventory Turnover Ratio 365 days 4.55 times

= 80.22 days

15-22

CHAPTER 15

Financial Statement Analysis

E 15-47 1.

Average Inventory

Beginning Inventory + Ending Inventory 2

$53,420 + $62,640 2

Inventory Turnover Ratio

= $58,030

Cost of Goods Sold Average Inventory

However, cost of goods sold is not given. Instead, sales and gross margin are given and from these two numbers cost of goods sold can be computed. Specifically, Sales – Cost of Goods Sold = Gross Margin. Therefore, $3,948,340 – Cost of Goods Sold = $1,859,260; so Cost of Goods Sold = $2,089,080. $2,089,080 Inventory Turnover Ratio = = 36.0 times $58,030 3.

Inventory Turnover in Days

= E 15-48 1. Current Liabilities

Current Assets

Average Accounts Receivable

Days in a Year Inventory Turnover Ratio

365 days 36 times

= 10.1 days

= Total Liabilities – Long-Term Liabilities = $2,000,000 – $1,500,000 = $500,000 = Current Ratio × Current Liabilities = 2.5 × $500,000 = $1,250,000 =

Net Sales Accounts Receivable Turnover

$8,000,000 50 = $160,000

Marketable Securities

= = = =

(Quick Ratio × Current Liabilities) – (Cash + Receivables) (2.0 × $500,000) – ($600,000 + $160,000) $1,000,000 – $760,000 $240,000

Average Inventory

= Cost of Goods Sold/Inventory Turnover* = ($8,000,000 net sales – $3,000,000 gross margin)/100 = $50,000

* Inventory Turnover

= 365/Average Inventory in Days = 365/3.65 = 100 15-23

CHAPTER 15

Financial Statement Analysis

E 15-49 Times-Interest-Earned Ratio

Income Before Taxes + Interest Expense Interest Expense

$5,500,000 + $500,000 $500,000

= 12.0 times E 15-50 1.

Debt Ratio

Total Liabilities Total Assets

$510,900 $636,900

= 0.80 2.

Debt-to-Equity Ratio

Total Liabilities Total Equity

$510,900 $126,000

= 4.05 3.

The debt ratio and debt-to-equity ratio are commonly used measures of a company’s financial riskiness. As calculated in Requirement 1, Busch’s debt ratio is 0.80, which indicates that for every $1.00 of assets, Busch has taken on debt of $0.80. Stated a bit differently, Busch has chosen to finance 80% of its assets with debt. As calculated in Requirement 2, Busch’s debt-to-equity ratio is 4.05, which indicates that for every $1.00 of equity, Busch has taken on $4.05 of liabilities. Taken together, it appears as though Busch has chosen to pursue a rather high-risk financing strategy. As a side note, some investors view the retail industry as highly risky, which forces some retail organizations that need capital to take on more debt than perhaps they desire. Therefore, given what appears to be a relatively high-risk financing strategy, Busch should calculate and carefully manage its times-interest-earned ratio to ensure that its pretax earnings are sufficient to make any required interest payments on its large debt. Busch’s top executives and board of director members also should continually assess whether the company’s financing riskiness is in alignment with the company’s overall appetite for risk. If the company is taking on more financial risk than its appetite calls for, it should strive to pay down part of its debt and perhaps work harder to raise additional equity capital.

15-24

CHAPTER 15

Financial Statement Analysis

E 15-51 1.

Times-Interest-Earned Ratio

Income Before Taxes + Interest Expense Interest Expense

$3,500,000 + $1,000,000 $1,000,000

= 4.50 2.

Debt Ratio

Total Liabilities Total Assets

$10,250,000 $16,400,000

= 0.63 3.

Debt-to-Equity Ratio

Total Liabilities Total Equity

$10,250,000 $6,150,000

= 1.67 E 15-52 1.

Return on Sales

Net Income Sales

$2,100,000 $11,300,000

= 0.1858, or 18.58% 2.

The return on sales ratio illustrates the number of cents from each sales dollar that is left over after covering all expenses, including production costs (in cost of goods sold), period costs of the current period (such as supplies, research and development, etc.), and period costs that are depreciated over time (such as office building depreciation, delivery truck fleet depreciation, etc.). Juroe company's return on sales is 0.1858, or 18.58%, which indicates that for every $1.00 of sales revenue it generates, 18.58 cents are left over after subtracting all expenses. Appropriate return on sales benchmarks vary by industry and economic conditions. However, generally speaking, a return on sales of 18.58 cents is likely impressive. For example, grocery stores typically generate extremely low return on sales figures, oftentimes in the single-digit range.

15-25

CHAPTER 15

Financial Statement Analysis

E 15-53 1.

Average Total Assets

Beginning Total Assets + Ending Total Assets 2

$17,350,000 + $16,400,000 2

= $16,875,000 2.

Return on Assets

Net Income + [Interest Expense (1 – Tax Rate)] Average total assets

$2,100,000 + [$1,000,000 (1 – 0.40)] $16,875,000

$2,100,000 + $600,000 $16,875,000

= 0.16, or 16.00%

E 15-54 1.

Average Common Stockholders’ Equity

= =

Beginning Common Stockholders' Equity + Ending Common Stockholders' Equity 2 $11,800,000 + $12,050,000 2

= $11,925,000 Note: Remember that beginning (or ending) common stockholders’ equity equals total stockholders' equity minus preferred stock. 2.

Return on Common Stockholders' Equity

Net Income – Preferred Dividends Average Common Stockholders' Equity $3,182,000 – $320,000* $11,925,000

= 0.24, or 24% * Preferred Dividends = $4,000,000 × 0.08 = $320,000

15-26

CHAPTER 15

Financial Statement Analysis

E 15-55 1. Preferred Dividends

= $4,000,000 × 0.08 = $320,000

Number of Common Shares

Earnings per Share

Net Income – Preferred Dividends Average Common Shares

$3,182,000 – $320,000 1,000,000 shares

$3,000,000 $3

= 1,000,000

$2,862,000 1,000,000 shares

= $2.86 per share 4.

Price-Earnings Ratio

Market Price per Share Earnings per Share

$51.50 $2.86

= 18

E 15-56 1.

Dividends per Share

$2,600,000 1,000,000 shares

= $2.60 per share 2.

Dividend Yield

Dividends per Common Share Market Price per Common Share

$2.60 $51.50

= 0.05, or 5% 3.

Dividend Payout Ratio

Common Dividends Net Income – Preferred Dividends

$2,600,000 $3,182,000 – $320,000

$2,600,000 $2,862,000

= 0.91

15-27

CHAPTER 15

Financial Statement Analysis

PROBLEMS P 15-57 1. Current Assets

= $250,000 + $400,000 + $100,000 + $200,000 + $50,000 = $1,000,000

Current Liabilities

= $175,000 + $85,000 + $90,000 + $50,000 = $400,000

Current Ratio

Current Assets Current Liabilities

$1,000,000 $400,000

Cash + Marketable Securities + Accounts Receivable Current Liabilities

$700,000 $400,000

2. Quick or Acid-Test Ratio

3. Accounts Receivable Turnover Ratio

= =

= 2.50

= 1.75

Net Sales Average Accounts Receivable $2,450,000 $350,000*

= 7 times * Average Accounts Receivable = ($300,000 + $400,000)/2 = $350,000 4. Accounts Receivable Turnover in Days

5. Inventory Turnover Ratio

365 days Accounts Receivable Turnover

365 days = 52.14 days 7 times

Cost of Goods Sold Average Inventory*

$1,300,000 $225,000

= 5.78 times * Average Inventory = ($200,000 + $250,000)/2 = $225,000 6. Inventory Turnover in Days

365 days Inventory Turnover Ratio

365 days 5.78 times

= 63.15 days

15-28

CHAPTER 15

Financial Statement Analysis

P 15-57 (Continued) 7. Given the three assumptions of account balance changes, the ratios change as follows: Current ratio: decreases from 2.50 to 1.14 Quick (or acid-test) ratio: decreases from 1.75 to 0.71 Accounts receivable turnover ratio: increases from 7.0 to 9.80 Accounts receivable turnover in days: decreases from 52.14 to 37.24 Inventory turnover ratio: decreases from 5.78 to 4.73 Inventory turnover in days: increases from 63.15 to 77.17 Students are likely to make one or more of the following observations. First, using the spreadsheet allows for much faster ratio recalculation. Second, it allows for much easier ratio calculation. Third, it likely produces more accurate ratio recalculation, especially as the number of ratios and/or changing assumptions increases. Finally, it increases associated data visualization capabilities, such as dashboards or various graphical representations, to help decision makers more effectively understand the underlying nature and patterns within the ratios. P 15-58 1.

Times-Interest-Earned Ratio

Income Before Taxes + Interest Expense Interest Expense

= =

$200,000 + $140,000 $140,000

$340,000 $140,000

= 2.43 2.

Debt Ratio

Total Liabilities Total Assets*

$2,500,000 $7,250,000

= 0.34 * Total Assets 3.

= Total Liabilities + Total Equity = $2,500,000 + $4,750,000 = $7,250,000

The times-interest-earned ratio is very close to the lower quartile, which means that relative to most companies in the industry, Grammatico company has a significant expense burden (relative to its income). Its debt ratio is in the lower quartile, which means that the company may still have additional credit. Because of its interest expense and income level, however, Grammatico should be very careful about taking on additional debt.

15-29

CHAPTER 15

Financial Statement Analysis

P 15-59 1.

Return on Assets

Net Income + [Interest Expense (1 – Tax Rate)] Average Total Assets $5,000,000 + ($400,000 × 0.66) $60,000,000

= = 0.088 2.

Return on Common Stockholders’ Equity

Net Income – Preferred Dividends Average Common Stockholders’ Equity

$5,000,000 – $400,000 $20,000,000

$4,600,000 $20,000,000

= 0.23 3.

Earnings per Share

Net Income – Preferred Dividends Average Common Shares

$5,000,000 – $400,000 800,000 shares

= $5.75 per share 4.

Price-Earnings Ratio

= =

Market Price per Share Earning per Share $40.00 $5.75

= 6.96 5.

Dividend Yield

Dividends per Common Share Market Price per Common Share

$1,200,000/800,000 shares $40

$1.50 $40.00

= 0.0375 6.

Dividend Payout Ratio

Common Dividends Net Income – Preferred Dividends

$1,200,000 $5,000,000 – $400,000

= 0.26

15-30

CHAPTER 15

Financial Statement Analysis

P 15-60 1.

Kepler Company Comparative Balance Sheets Last Year

Percent Change

50,000 300,000 600,000 25,000 $ 975,000 125,000 $1,100,000

$100,000 150,000 400,000 30,000 $680,000 150,000 $830,000

(50.0)% 100.0 50.0 (16.7) 43.4 (16.7) 32.5

$ 400,000 200,000 $ 600,000 100,000 $ 700,000

$290,000 60,000 $350,000 150,000 $500,000

37.9 233.3 71.4 (33.3) 40.0

200,000 200,000

200,000 130,000

0.0 53.8

$1,100,000

$830,000

32.5

This Year Assets Current assets: Cash……………………………………… Accounts receivable, net……………… Inventory………………………………… Prepaid expenses……………………… Total current assets………………………… Property and equipment, net………… Total assets…………………………………

Liabilities and Stockholders’ Equity Current liabilities: Accounts payable……………………… Short-term notes payable……………… Total current liabilities…………………… Long-term bonds payable, 12%………… Total liabilities…………………………… Stockholders’ equity: Common stock (100,000 shares)…… Retained earnings……………………… Total liabilities and stockholders' equity………………………

15-31

CHAPTER 15

Financial Statement Analysis

P 15-60 (Continued) Kepler Company Comparative Income Statements

Sales………………………………………… Less: Cost of goods sold………………… Gross margin…………………………… Less: Selling and admin. expense…… Operating income……………………… Less: Interest expense…………………… Income before taxes………………… Less: Income taxes……………………… Net income……………………………… Less: Dividends…………………………… Net income, retained………………… 2.

This Year

Last Year

Percent Change

$ 950,000 500,000 $ 450,000 275,000 $ 175,000 12,000 $ 163,000 65,200 $ 97,800 27,800 $ 70,000

$ 900,000 490,000 $ 410,000 260,000 $ 150,000 18,000 $ 132,000 52,800 $ 79,200 19,200 $ 60,000

5.6% 2.0 9.8 5.8 16.7 (33.3) 23.5 23.5 23.5 44.8 16.7

Cash has decreased by 50%, accounts receivable has doubled, and inventory has increased by 50%. At the same time, liabilities have increased by 40%, mostly due to increases in short-term liabilities. Management may want to know why inventories and receivables increased so dramatically, especially since it appears that the company had to borrow short-term funds to accommodate the increases. Additionally, since sales did not increase in proportion to the change in receivables, collection procedures may need to be reviewed/revised. Finally, sales forecasts may have called for an increase in sales requiring a build-up of inventories. If actual sales fell short, the company would have been left with this disproportionate increase in inventory.

15-32

CHAPTER 15

P 15-61 1. Assets

This Year

Current assets: Cash…………………………………… $ 50,000 300,000 Accounts receivable, net………… Inventory…………………………… 600,000 Prepaid expenses………………… 25,000 Total current assets…………………… $ 975,000 Property and equipment, net…… 125,000 Total assets……………………………… $1,100,000

Financial Statement Analysis

Last Year

4.5% 27.3 54.5 2.3 88.6 11.4 100.0

$100,000 150,000 400,000 30,000 $680,000 150,000 $830,000

12.0% 18.1 48.2 3.6 81.9 18.1 100.0

2. Liabilities and Stockholders’ Equity This Year Current liabilities: Accounts payable………………… Short-term notes payable………… Total current liabilities………………… Long-term bonds payable, 12%……… Total liabilities……………………… Stockholders’ equity: Common stock (100,000 sh.)…… Retained earnings………………… Total liabilities and stockholders' equity…………………

Last Year

$ 400,000 200,000 $ 600,000 100,000 $ 700,000

36.4% 18.2 54.5 * 9.1 63.6

$290,000 60,000 $350,000 150,000 $500,000

34.9% 7.2 42.2 18.1 60.2

200,000 200,000

18.2 18.2

200,000 130,000

24.1 15.7

$1,100,000

100.0

$830,000

100.0

This Year 3. Sales……………………………………… Less: Cost of goods sold…………… Gross margin……………………… Less: Selling and admin. exp. ……… Operating income………………… Less: Interest expense………………… Income before taxes……………… Less: Income taxes…………………… Net income…………………………… Less: Dividends………………………… Net income, retained………………

$ 950,000 500,000 $ 450,000 275,000 $ 175,000 12,000 $ 163,000 65,200 $ 97,800 27,800 $ 70,000

* Difference due to rounding

15-33

100.0% 52.6 47.4 28.9 18.4 1.3 17.2 6.9 10.3 2.9 7.4

Last Year $ 900,000 490,000 $ 410,000 260,000 $ 150,000 18,000 $ 132,000 52,800 $ 79,200 19,200 $ 60,000

100.0% 54.4 45.6 28.9 16.7 2.0 14.7 5.9 8.8 2.1 6.7

CHAPTER 15

Financial Statement Analysis

P 15-62 1. a. Current Ratio

Current Assets Current Liabilities This Year

Current Ratio b. Quick Ratio

= =

$975,000 $600,000

= 1.63

Last Year =

= =

c. Receivables Turnover

= 1.94

Cash + Marketable Securities + Accounts Receivable Current Liabilities Last Year

This Year Quick Ratio

$680,000 $350,000

$50,000 + $300,000 $600,000 $350,000 $600,000

= 0.58

= =

$100,000 + $150,000 $350,000 $250,000 $350,000

= 0.71

Net Sales Average Receivables Last Year

This Year Receivables Turnover

$950,000 $225,000

= 4.22 times

$900,000 $150,000*

= 6.00 times

Turnover in Days

365 days 4.22 times

= 86.49 days

365 days 6.00 times

= 60.83 days

* Since the beginning balance is not known for receivables, the average is assumed to be the ending balance.

d. Inventory Turnover

Cost of Goods Sold Average Inventory This Year

Last Year

Inventory Turnover

$500,000 $500,000

= 1.00 time

$490,000 $400,000*

= 1.23 times

Turnover in Days

365 days 1.00 time

= 365 days

365 days 1.23 times

= 296.75 days

* Since the beginning balance is not known for inventory, the average is assumed to be the ending balance.

2. The liquidity of Kepler has declined over the past year as measured by the turnover ratios and the current and quick ratios. Industrial liquidity performance would allow us to assess what is normal for the industry and thus better assess what is a reasonable liquidity level for Kepler.

15-34

CHAPTER 15

Financial Statement Analysis

P 15-63 Last Year

This Year 1.

Times-Interest-Earned Ratio

$163,000 + $12,000 $12,000

$132,000 + $18,000 $18,000

$175,000 $12,000

$150,000 $18,000

Income Before Taxes + Interest Expense Interest Expense

= 14.58 times b.

Debt Ratio

Total Liabilities Total Assets

Debt Ratio

$700,000 $1,100,000

= 0.64 2.

= 8.33 times

$500,000 $830,000

= 0.60

There appears to be good income coverage of interest. The debt ratio is over 50%, but whether this is good or bad depends to some extent on what is normal for the firm’s industry. The fact that the proportion of debt has increased is certainly a negative factor. Knowing the industrial statistics would help in the assessment.

15-35

CHAPTER 15

Financial Statement Analysis

P 15-64 Last Year

This Year 1. a. Return on Assets

Return on Assets

a b

Net Income + [Interest Expense (1 – Tax Rate)] Average Total Assets $105,000 a $965,000

= 0.11

$90,000 b $830,000

= 0.11

$97,800 + [$12,000(1 – 0.40)] = $105,000 $79,200 + [$18,000(1 – 0.40)] = $90,000

b. Return on Stockholders’ Equity

Net Income – Preferred Dividends Average Stockholders' Equity

Return on Stockholders’ Equity

$97,800 $365,000

= 0.27, or 27% c. Earnings per Share EPS

= 0.24, or 24%

Net Income Average Common Shares

$97,800 100,000 shares

= $0.98 per share d. Price-Earnings Ratio

PE Ratio

e. Dividend Yield

Yield

Payout

= =

$79,200 100,000 shares

= $0.79 per share

Market Price per Share Earning per Share $2.98 $0.98

= 3.04

$2.98 $0.79

= 3.77

Dividends per Common Share Market Price per Share $0.278 $2.98

= 0.0933, or 9.33% f. Dividend Payout

$79,200 $330,000

$0.192 $2.98

= 0.0644, or 6.44%

Common Dividends Net Income – Preferred Dividends $27,800 $97,800

= 0.28

$19,200 $79,200

= 0.24

2. The return on assets has remained roughly the same, while returns on equity, EPS, dividend yield, and dividend payout measures have increased. However, the PE ratio decreased. Thus, the profitability measures are providing mixed signals. More information is needed before an investment decision is made. For example, how do these returns compare to other firms in the same industry? Will the dividend payout and/or net income performance continue? What is the historical performance of this firm?

15-36

CHAPTER 15

P 15-65 1. a. Return on Sales

Net Income Sales $10,500 = = 0.105, or 10.5% $100,000 =

Return on Assets

= = * Average Total Assets c.

Return on Stockholders’ Equity

= =

Earnings per Share

= =

* Average Common Shares

Price-Earnings Ratio

= =

Dividend Yield

Net Income + [Interest Expense (1 – Tax Rate)] Average Total Assets $10,500 + ($350 × 0.60) $123,000* $10,710 = 0.087, or 8.7% $123,000

$120,000 + $126,000 2

$10,500 – $300 $55,000 $10,200 = 0.185, or 18.5% $55,000 Net Income – Preferred Dividends Average Common Shares $10,500 – $300 35,000 shares* $10,200 = $0.29 per share 35,000 shares 30,000 + 40,000 2

Dividend Payout Ratio

= =

= 35,000

Market Price per Share Earning per Share $12.00 = 41.38 $0.29 Dividends per Common Share Market Price per Share $0.20* $12.00 $8,000 40,000 shares

= $123,000

Net Income – Preferred Dividends Average Stockholders' Equity

= * Dividends per Share

Financial Statement Analysis

= 0.017, or 1.7%

= $0.20

Common Dividends Income – Preferred Dividends $8,000 $10,500 – $300

15-37

= 0.7843

CHAPTER 15

Financial Statement Analysis

P 15-65 (Continued) 2. Since all the ratios are profitability ratios, they should all be of interest to investors. Some, however, may be of more interest than others, depending on the objectives of the potential investor. For example, an investor looking for retirement income may be particularly interested in the dividend yield ratio.

P 15-66 1.

Net Sales Average Receivables

Accounts Receivable Turnover

20X2 Accounts Receivable Turnover

$500,000 $100,000

$600,000 = 5.45 times $110,000*

Days

365 days = 73.00 days 5.00 times

20X3 Accounts Receivable Turnover Days

365 days = 66.97 days 5.45 times

* Average Receivables

$100,000 + $120,000 = $110,000 2

20X4 Accounts Receivable Turnover Days

$120,000 + $100,000 = $110,000 2

20X5 Accounts Receivable Turnover =

$100,000 + $150,000 = $125,000 2

20X6 Accounts Receivable Turnover =

$510,000 = 4.08 times $125,000*

365 days = 89.46 days 4.08 times

* Average Receivables

Days

$510,000 = 4.64 times $110,000*

365 days = 78.66 days 4.64 times

* Average Receivables

Days

= 5.00 times

$520,000 = 3.06 times $170,000*

365 days = 119.28 days 3.06 times

* Average Receivables

$150,000 + $190,000 = $170,000 2

15-38

CHAPTER 15

Financial Statement Analysis

P 15-66 (Continued) 2. The new credit policy reduced the accounts receivable turnover because of the fact that the customer now has 60 days before full payment of the account is required. This in turn slowed the inflow of cash to the company. The slower inflow of cash created the company’s difficulty in meeting its short-term obligations. 3.

If Ted Pendleton had known that the industry had an average receivables turnover of six times per year, he may not have liberalized the company’s credit policy because the turnover was already slower than the industry average.

15-39

CHAPTER 15

Financial Statement Analysis

P 15-67 1.

a. McGregor EPS

$2,640,000 – $300,000 1,000,000 shares

= $2.34 per share

Fasnacht EPS

$2,640,000 – $100,000 1,200,000 shares

= $2.12 per share

b. McGregor Dividends per Common Share

$840,000 – $1(300,000) 1,000,000 shares

= $0.54

McGregor Dividend Yield

$0.54 $5.00

Fasnacht Dividends per Common Share

Fasnacht Dividend Yield

$0.78 $9.80

c. McGregor Dividend Payout Ratio

$540,000 $2,640,000 – $300,000

= 0.23

Fasnacht Dividend Payout Ratio

$940,000 $2,640,000 – $100,000

= 0.37

$1,040,000 – $1(100,000) = $0.78 1,200,000 shares = 0.08

d. McGregor Price-Earnings Ratio

$5.00 $2.34

= 2.14

Fasnacht Price-Earnings Ratio

$9.80 $2.12

= 4.62

e. McGregor Return on Assets

$2,640,000 + [$1,000,000(1 – 0.34)] $20,000,000

= 0.17

Fasnacht Return on Assets

$2,640,000 + [$3,000,000(1 – 0.34)] $22,000,000

= 0.21

$2,640,000 – $300,000 $10,000,000

= 0.23

$2,640,000 – $100,000 $13,000,000

= 0.20

McGregor Return on Common Stockholders’ Equity Fasnacht Return on Common Stockholders’ Equity

= 0.11

Fasnacht dominates on every profitability measure except the EPS, dividend yield ratio, and return on equity. If this pattern is expected to persist in the future, Fasnacht appears to be the better investment.

15-40

CHAPTER 15

Financial Statement Analysis

CASES Case 15-68 1. Pete Donaldson’s behavior is not ethical. Hiding a loan and obsolete safety equipment is dishonest. The $30,000 cannot be considered to be donated when he is making interest payments of $3,000 per year and has a requirement to return the $30,000. (Standard III: 2, 3) 2.

First, consult with Pete Donaldson and tell him that you cannot prepare the statements in the way he has requested and explain why. If he insists on their preparation following his classification, then resignation is called for. Preparing the statements would violate a number of standards of ethical conduct and would be prohibited by most corporate codes of conduct. (Even if Donaldson Mining Supplies does not have a written corporate code of conduct, lying on financial statements is neither ethical nor legal.) (Standard III: 2, 3)

First, Pete Donaldson should be approached. He should be requested to withdraw the loan request or provide corrected financial statements. Should he refuse, then the ethical dilemma has been significantly compounded. Communication of the problem to outside parties is usually not considered appropriate unless legally prescribed. If a possibility of being held legally responsible for the fraudulent statements is present, then the correct action would be to notify the bank that new information has surfaced that makes the financial statements unreliable. In fact, consultation with an attorney is strongly recommended. The attorney could then determine the means by which the bank is notified.

One possible solution is to approach the father-in-law who gave the loan originally and offer part ownership in the company. The loan could then legitimately be converted to equity in exchange for an ownership share. With the legitimate reclassification, a loan application could be submitted in good conscience.

Case 15-69 Answers will vary. Note to Instructors: You can easily turn this into a group exercise by forming groups of two or three and assigning each group an industry (e.g., airlines, medical care, retail, computer hardware or software developers). Then the group members can complete this exercise and present their findings to the class.

15-41

MAKING THE CONNECTION: INTEGRATIVE EXERCISE (Chapters 2, 3, and 7) COST BEHAVIOR AND COST-VOLUME-PROFIT ANALYSIS FOR MANY GLACIER HOTEL

The variable and fixed costs for each product line—canoes and paddles— have both a manufacturing and a marketing component. Because, the manufacturing and marketing data are recorded separately, four separate high-low analyses must be conducted. The manufacturing and marketing variable costs per unit are then added together to arrive at the variable cost per unit for the canoe product line and the paddle product line. Similarly, the manufacturing and marketing total fixed costs are combined to arrive at the total fixed cost for the canoe product line and the paddle product line. a.

Canoe: High-Low (Manufacturing costs): ($167,000 – $115,000)/(500 – 240) = $200 variable cost per unit Total Fixed Cost = Total Cost – Total Variable Cost = $167,000 – ($200 variable cost per unit × 500) = $67,000 total fixed cost Canoe: High-Low (Marketing costs): ($73,000 – $47,000)/(500 – 240) = $100 variable cost per unit Total Fixed Cost = Total Cost – Total Variable Cost = $47,000 – ($100 variable cost per unit × 240) = $23,000 total fixed cost Thus, the variable cost per unit for canoes is $300 ($200 + $100), and the total fixed cost for canoes is $90,000 ($67,000 + $23,000).

Paddle: High-Low (Manufacturing costs): ($84,000 – $38,500)/(2,200 – 900) = $35 variable cost per unit Total Fixed Cost = Total Cost – Total Variable Cost = $38,500 – ($35 variable cost per unit × 900) = $7,000 total fixed cost Paddle: High-Low (Marketing costs): ($14,000 – $7,500)/(2,200 – 900) = $5 variable cost per unit Total Fixed Cost = Total Cost – Total Variable Cost = $7,500 – ($5 variable cost per unit × 900) = $3,000 total fixed cost Thus, the variable cost per unit for paddles is $40 ($35 + $5), and the total fixed cost for paddles is $10,000 ($7,000 + $3,000).

MTC1-1

Making the Connection

Integrative Exercise (Chapters 2, 3, and 7)

The operating income equation for determining the break-even in units is as follows: BE Units = Total Fixed Cost/(Price – VC per Unit)

Canoes—using the results from 1a: BE Units = $90,000/($540 – $300) = 375 canoes

Paddles—using the results from 1b: BE Units = $10,000/($60 – $40) = 500 paddles

The sales mix of canoes to paddles is 300:1,200, which can be reduced to 1:4. Product

Price

Unit VC

Unit CM

Package

Package CM

Canoe……………… Paddle………………

$540 60

$300 40

$240 20

1 4

$240 80

Package total…………………………………………………………………… $320 BE Packages = Total Fixed Cost/Package CM = $128,000/$320 = 400 packages [Remember that in Requirement 3, an additional $28,000 of common fixed costs must be incorporated into the analysis, so the total fixed cost is $90,000 for canoes + $10,000 for paddles + $28,000 for common.] Canoe BE Units = 400 × 1 = 400 canoes Paddle BE Units = 400 × 4 = 1,600 paddles 4.

All manufacturing costs are product costs. All marketing costs and customer hotline costs are period costs.

Marketing costs are selling-oriented; therefore, the marketing period costs would be further classified as Selling Expenses. Customer hotline costs relate to the customer service section of the value chain and would be further classified as General and Administrative Expenses.

The canoe production (or manufacturing) costs are as follows (see solution for Requirement 1a): $200 variable manufacturing cost per canoe and $67,000 total fixed manufacturing cost for canoes Therefore, if these costs were 0.05 higher than the above high-low estimates, they would increase to: $210 (i.e., $200 × 1.05) variable cost per canoe and $70,350 (i.e., $67,000 × 1.05) total fixed cost for canoes.

MTC1-2

Making the Connection

Integrative Exercise (Chapter 2, 3, and 7)

The sales mix of canoes to paddles is unchanged at 300:1,200, which can be reduced to 1:4. However, the increase in canoe costs reduces the package contribution margin as follows: Package Product Unit VC Unit CM Package CM Price Canoe……………… Paddle………………

$540 60

$310 40

$230 20

1 4

$230 80

Package total…………………………………………………………………… $310 The necessary adjustment to the break-even equation used in the solution to Requirement 3 is to add the target income of $96,000 to the fixed cost of $131,350 (i.e., $70,350 + $23,000 + $7,000 + $3,000 + $28,000) as follows: = (Total Fixed Cost + Target Income)/Package CM = ($131,350 + $96,000)/$310 = 733.39 packages, or 733 packages required to achieve the target income Canoe Target Income Units = 733 × 1 = 733 canoes Paddle Target Income Units = 733 × 4 = 2,932 paddles 6.

Margin of safety (MOS) is the units sold above the break-even volume. MOS = Units Sold – BE Total Units Sold (see solution to Requirement 3) Canoe MOS = 650 canoes sold – 400 canoe units at BE = 250 canoes Paddle MOS = 2,400 paddles sold – 1,600 paddle units at BE = 800 paddles At the MOS, 250 canoes and 800 paddles are sold. MOS in Sales Dollars = (250 canoes × $540 selling price per canoe) + (800 paddles  $60 selling price) = $183,000 MOS in sales dollars

Note: While not required or discussed in this Making the Connection exercise, regression analysis can be performed on the canoe data by combining the canoe manufacturing cost data and canoe marketing cost data and then regressing canoe volume (as the independent variable) onto total canoe costs (as the dependent variable). Showing students the following regression output results for the canoe data leads to an interesting discussion about when the high-low method is "good enough" (i.e., produces cost estimates of a sufficiently accurate nature) versus when the more expensive, timeconsuming, and complex regression method might be warranted due to its relatively greater cost forecasting accuracy. The resulting regression output shows that canoe volume (again, as the independent variable) is statistically significant (p < 0.0107; t = 5.27) as a driver of total canoe costs (again, as the dependent variable). The coefficient (or variable cost per unit) for canoes is $254.37 and the coefficient on the constant term (or total fixed cost) is $95,683 (and also statistically significant). Remember (from the solution to 1a) that the high-low method estimated this variable cost per canoe to be $300 and this total fixed cost for canoes to be $90,000. MTC1-3

Making the Connection

Integrative Exercise (Chapters 2, 3, and 7)

In addition, the regression output shows an R2 of 0.735, which suggests that the canoe volume (as the independent variable) explains 73.5% of the variation in the total canoe cost (as the dependent variable). Therefore, some other variable(s) appears to be responsible for the remaining 26.5% of variation in total canoe cost. A next step might be to plot the data on a scatterplot. Upon viewing the data, it appears that the data point for 480 units has a lower than expected cost. The accountant should explore that further to see what accounted for the lower cost and whether or not it can be expected to recur. One might reasonably argue that 73.5% is not sufficiently high for a not-for-profit organization like the National Park Service (that ultimately overseas the Many Glacier Hotel) because of the extremely limited and tight nature of its budget and the resulting need to understand, forecast, and reduce costs to a very high degree.

MTC1-4

MAKING THE CONNECTION: INTEGRATIVE EXERCISE (Chapters 2, 3, 5, 9, and 10) COST SYSTEM CHOICES, BUDGETING, VARIANCE ANALYSIS, PRODUCT COSTING, AND DATA ANALYTICS FOR LAWSON DENTAL PRODUCTS

Budgeting and Analysis: Using Only a Single Unit-Level Driver 1.

Expected costs for actual activity: Materials cost = $5X = $5 × 20,000 = $100,000 Labor cost = $15X = $15 × 20,000 = $300,000 Power cost = $5,000 + $4X = $5,000 + (4 × 20,000) = $85,000 Setup cost = $100,000 Total expected manufacturing costs = $100,000 + $300,000 + $85,000 + $100,000 = $585,000

Performance Report (using budgeted costs for actual level of activity): Direct Materials Direct Labor Power Setups Total

Actual $100,000 320,000 135,000 140,000 $695,000

Budgeted $100,000 300,000 85,000 100,000 $585,000

Variance 0 20,000 U 50,000 U 40,000 U $110,000 U

The performance report confirms that Amy is overbudget by $110,000. Her discomfort with the results suggests, however, that further analysis is needed to make sure that the performance measure is accurate. 3.

LRV = (AR – SR) × AH = ($16 – $15) × 20,000 = $20,000 U LEV = (AH – SH) × SR = (20,000 – 20,500) × $15 = $7,500 F

The labor rate variance is likely due to the overtime mentioned by Hector. The overtime is attributed to the greater than expected demand. The efficiency variance may be due to the “efforts” that Amy and her workers made to meet the increased demand for the products. Notice that the labor rate variance corresponds to the flexible budget variance.

MTC2-1

Making the Connection

Integrative Exercise (Chapters 2, 3, 5, 9, and 10)

4. a. The words “should have been” suggest a prescriptive data analytic type. Predictive usually refers to what “will be.” b. The calculations of 3a are descriptive in nature. They describe what is. Requirement 3a is attempting to explain the why of the variances and is, therefore, diagnostic in nature.

Budgeting, Variance Analysis, and Product Costing: Multiple Drivers Considered 5.

Expected costs for actual activity (using actual activity levels of each activity): Materials cost = $5X = $5 × 20,000 = $100,000, X = Direct labor hours Labor cost = $15X = $15 × 20,000 = $300,000, X = Direct labor hours Power cost = $68,000 + $0.9Y = $68,000 + (0.9 × 90,000) = $149,000, Y = Machine hours Setup cost = $98,000 + 400Z = $98,000 + ($400 × 110) = $142,000, Z = number of setups Total expected manufacturing costs = $100,000 + $300,000 + $149,000 + $142,000 = $691,000 The expected costs are $106,000 higher than those of Requirement 1 ($691,000 − $585,000) giving a much higher benchmark than the single-driver flexible budget formulas gave.

Performance Report (using budgeted costs for the actual levels of costs, with flexible budget formulas using different drivers): Performance Report (using budgeted costs for actual levels of each activity): Actual

Budgeted

Variance

Direct Materials

$100,000

Direct Labor

320,000

300,000

20,000 U

Power

135,000

149,000

14,000 F

Setups

140,000

142,000

2,000 F

Total

$695,000

$691,000

$ 4,000 U

This performance report is vastly different than the one originally produced. It strongly validates Amy’s concern and shows that her performance was actually very good. She is overbudget by only $4,000 instead of $110,000. The variance is less than 1% of the budgeted costs. Clearly, the variables used to set the flexible budget formulas are important.

MTC2-2

Making the Connection

Integrative Exercise (Chapters 2, 3, 5, 9, and 10)

7. a. Manufacturing cost rate = $691,000/20,000 = $34.55 per DLH Cost assigned to crimping pliers = $34.55 × 10,000 = $345,500 Cost assigned to crown scissors = $34.55 × 10,000 = $345,500 b. Materials rate = $100,000/20,000 = $5 per DLH Labor rate = $300,000/20,000 = $15 per DLH Power rate = $149,000/90,000 = $1.66 per machine hour (rounded) Setup rate = $142,000/110 = $1,291 per setup (rounded) Cost of crimping pliers = ($5 × 10,000) + ($15 × 10,000) + ($1.66 × 55,000) + ($1,291 × 70) = $381,670 Cost of crown scissors = ($5 × 10,000) + ($15 × 10,000) + ($1.66 × 35,000) + ($1,291 × 40) = $309,740 c. Using the activity-cost assignments as the benchmark, the crimping pliers are undercosted by $36,170 ($381,670 − $345,500) and the crown scissors are overcosted by $35,760 ($345,500 − $309,740). The activity-based cost assignments are likely to be more accurate as they reflect the consumption of the activity resources more completely. The consumption ratios for direct labor are 0.5 for each product line. The consumption ratios for the other two activity drivers are 0.61 and 0.64 for pliers and 0.39 and 0.36 for scissors. 8. Data analytics played a major role in Hector’s reaction to Amy’s concerns. Hector immediately saw the weakness of using only direct labor hours as a basis for creating flexible budgeting formulas for all the activities. He used the coefficient of determination to justify both his concern about the existing formulas and the basis for switching two of the formulas to use different explanatory variables. With multiple drivers in place, the ability to set more realistic budgets was created and the performance outcome was markedly different for Amy. This underscores the importance of the proper use of data analytic models such as the method of least squares. Note that both Amy and Hector used diagnostic methods that led to the creation of new flexible budgeting formulas. As a result, better predictive outcomes (for future budgeting) and prescriptive outcomes (for after-the-fact analysis) should be an ongoing benefit for Lawson Dental products.

MTC2-3

MAKING THE CONNECTION: INTEGRATIVE EXERCISES (Chapters 3, 5, 8, and 12) Relevant Analysis, Cost-Based Pricing, Cost Behavior, and Net Present Value Analysis for Superior Stay Resorts

Solution: Special-Order Offer Relevant Analysis 1. Notes: a. While student answers will vary with respect to their specific model order or appearance, the correct relevant revenue and relevant cost model inputs will not vary. One of the purposes of having students develop their own model is that doing so forces them to think carefully about each potential model input (e.g., which items are relevant, why they are relevant, the amount of each relevant item, etc.) and how it affects the resulting forecast calculation. Therefore, students can follow different model development paths but arrive at the same relevant profit forecast calculation and special-order decision recommendation. b. Variable sales commissions costs and fixed advertising costs are irrelevant because they are marketing in nature. Similarly, customer service online platform costs are irrelevant because they are customer service in nature (see first bulleted point in exercise). a) List the independent variables (without dollar amounts) in your model:  Special-order sales revenue that Superior would earn from Barnyard  Direct materials cost  Variable service overhead cost  Direct housekeeping labor cost  Facilities inspection cost  Safety approval visit cost b) Briefly explain why each variable is included in your model:  Special-order sales revenue is included because Superior would earn this revenue only if it accepts the special-order offer.  Direct materials cost is included because Superior would incur additional direct material cost only if it accepts the special-order offer.  Variable service overhead cost is included because Superior would incur additional variable service overhead cost only if it accepts the special-order offer.  Direct housekeeping labor cost is included because Superior would incur additional housekeeping labor cost only if it accepts the special-order offer.  Facility inspection cost is included because Superior would incur additional inspection costs (for the special-order rooms) only if it accepts the special-order offer.  Safety committee approval visit cost is included because Superior would incur this safety committee approval cost only if it accepts the special-order offer. c) Using your variables from Requirement 1a, write out your model: Relevant Profit = Special-Order Relevant Sales Revenues − Special-Order Relevant Costs = Special Order Sales Revenue − Relevant Direct Materials Cost − Relevant Variable Service Overhead Cost − Relevant Direct Housekeeping Labor Cost − Relevant Facilities Inspection Cost − Relevant Safety Committee Approval Visit Cost MTC3-1

Making the Connection

Integrative Exercises (Chapters 3, 5, 8, and 12)

2. a. Relevant costs from the special-order offer: Price per Room × Number of Rooms = $130 × 10,000 rooms = $1,300,000 of relevant (incremental) revenues from the special-order b. Relevant costs from the special-order offer: Relevant variable costs: Direct materials Variable service overhead Direct housekeeping labor

$25.00 30.00 70.00 $125.00/occupied room

$125.00/occupied room × 10,000 special-order rooms = $1,250,000 relevant variable costs Relevant fixed costs: [Note: The inspection cost is batch-oriented based on the number of inspections (or batches) incurred and exhibits a step-function behavior pattern.] Inspection Costs = Cost per Inspection × Number of Inspections Required by SpecialOrder Offer Inspection Cost for Special-Order Offer = (Inspection Cost/Number of Inspections) × (Special-Order Units/Number of Units per Inspection) = ($10,000,000/500) × [10,000/(1,000,000/500)] = ($20,000 cost per inspection) × (5 inspections required by special-order offer) = $100,000 Safety Committee approval visit cost if Special-order is accepted = $150,000 $100,000 fixed inspection cost + $150,000 fixed approval visit cost = $250,000 relevant fixed costs So, Relevant costs from special-order offer = $1,250,000 relevant variable costs + $250,000 relevant fixed costs = $1,500,000 c. Relevant profit or loss from special-order offer: Relevant revenues $1,300,000 − Relevant costs (1,500,000) = Relevant decrease in profit $(200,000)

MTC3-2

Making the Connection

Integrative Exercises (Chapters 3, 5, 8, and 12)

Model: Relevant Profit (or Loss): = $130 Special-order room price × 10,000 special-order rooms − $25 Direct materials cost × 10,000 special-order rooms − $30 Variable service overhead cost × 10,000 special-order rooms − $70 Direct housekeeping labor × 10,000 special-order rooms − $100,000 Inspection cost for special-order − $150,000 Safety committee approval visit cost = $1,300,000 relevant revenues − $1,250,000 relevant variable costs − $250,000 relevant fixed costs = ($200,000) relevant decrease in profit 3. The relevant cost of $1,500,000 is greater than the relevant revenue of $1,300,000 offered by Barnyard, making the relevant (or incremental) profit of ($200,000) negative, a reduction of profit—so, reject the offer. 4. Reputation of their overall brand represents a potentially important qualitative factor for Superior to consider. In particular, some (possibly a large) percentage of Superior’s loyal high-end customers might lower their perception of Superior’s overall brand quality, exclusivity, or overall level of luxury if they learned that Superior was renting its Premier Resort at a price that likely is well below the typical Superior room rate. As a result, the acceptance of Barnyard’s special-order offer might significantly decrease Superior’s occupied room volume and/or room revenue from its regular high-end customers. Cost-Based Pricing 5. Note: Given that Superior’s pricing rule is to mark up only relevant variable costs (by 40%), the fixed costs for Facility Inspection and for the Safety Committee Approval Visit are not relevant and, therefore, not included in the model for calculating the special-order price that Superior would charge to Barnyard. a) List the independent variables (without dollar amounts) in your model:  Direct materials  Variable service overhead  Direct housekeeping labor b) Briefly explain why each variable is included in your model:  Direct materials is included in the costs to be marked up to set the special-order price because this cost represents a relevant variable cost.  Variable service overhead is included in the costs to be marked up to set the specialorder price because this cost represents a relevant variable cost.  Direct housekeeping labor is included in the costs to be marked up to set the specialorder price because this cost represents a relevant variable cost. c) Using your variables from Requirement 5a, write out your model: Unit Guest Room Price = Unit Relevant Variable Cost × (1.40)

MTC3-3

Making the Connection

Integrative Exercises (Chapters 3, 5, 8, and 12)

6. Relevant variable costs to be marked up for pricing the special-order: Direct materials unit cost Variable service overhead unit cost Direct housekeeping labor unit cost

$25.00 30.00 70.00 $125.00/relevant variable unit cost

Therefore, the unit guest room price would be calculated as: $125 relevant variable unit cost × 1.40 = $175 unit guest room price 7. Total relevant profit associated with the special-order offer: Total relevant revenues from Barnyard for special-order − Total relevant costs incurred to fulfill special-order = Total relevant profit Total relevant revenues ($175 unit room price × 10,000 special-order rooms) $1,750,000 Less: relevant costs incurred (variable and fixed): Direct materials ($25 × 10,000) ($250,000) Variable service overhead ($30 × 10,000) ($300,000) Direct housekeeping labor ($70 × 10,000) ($700,000) Facility inspection (see solution to Requirement 2b for details) ($100,000) Safety committee approval visit (see solution to Requirement 2b) ($150,000) ($1,500,000) = Total relevant profit $250,000 8. The relevant cost incurred of $1,500,000 is less than the relevant revenue of $1,750,000 that would be generated from Barnyard, making the relevant (or incremental) profit of $250,000 positive. Therefore, Superior should accept the special-order offer if Barnyard will agree to pay the price of $175 per unit (guest room) that results from Superior’s cost-plus pricing method. Incorporating a Long-Term Horizon into the Decision Analysis 9. a. The dependent variable in this model is the NPV of the future cash flows associated with generating a $500,000 relevant profit from special-orders each of the next 5 years. Therefore, Annual Net Cash Inflow from Special-Order Relevant Profit × Discount Factor: = $500,000 × 3.79079 (discount factor from Exhibit 12B.2 in Appendix 12B to Chapter 12 for an annuity of uniform cash flows that corresponds to a rate of 10% and a 5-year time period). Therefore, the NPV of accepting the special-order offer over a 5-year time horizon: = $1,895,395 NPV

MTC3-4

Making the Connection

Integrative Exercises (Chapters 3, 5, 8, and 12)

b. The dependent variable in this model is the NPV of the future cash flows associated with downsizing the property capacity: (1) Cash inflow from immediate sale of the set of properties for $1,275,000 (no need to discount cash flow because it occurs at time 0) (2) Annual lease and insurance cost decreases from $4,500,000 to $4,200,000. This cost decrease of $300,000 represents an annual $300,000 increase in cash inflow. The present value of this annuity equals: $300,000 × 3.79079 (discount factor from Exhibit 12B.2 in Appendix 12B to Chapter 12 for an annuity of uniform cash flows that corresponds to a rate of 10% and a 5-year time period) = $1,137,237 Therefore, the total NPV of downsizing property capacity = $1,275,000 NPV of property sale + $1,137,237 NPV of decreased annual lease cost = $2,412,237 NPV c. Based on the NPV of requirements 9a and 9b, the downsizing alternative (i.e., Requirement 9b) appears to be the best long-term alternative for Superior to pursue because it is estimated to provide a larger positive NPV ($2,412,237) than the special sales alternative of Requirement 9a ($1,895,395) with the difference being $516,842.

MTC3-5

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