Solution Manual For Financial & Managerial Accounting, 16th Edition by Carl Warren, Jefferson Jones, by ACADEMIAMILL

SOLUTIONS MANUAL

CHAPTER 1 INTRODUCTION TO ACCOUNTING AND BUSINESS DISCUSSION QUESTIONS 1.

Some users of accounting information include managers, employees, investors, creditors, customers, and the government.

The role of accounting is to provide information for managers to use in operating the business. In addition, accounting provides information to others to use in assessing the economic performance and condition of the business.

The corporate form allows the company to obtain large amounts of resources by issuing stock. For this reason, most companies that require large investments in property, plant, and equipment are organized as corporations.

No. The business entity assumption limits the recording of economic data to transactions directly affecting the activities of the business. The payment of the interest of $4,500 is a personal transaction of Josh Reilly and should not be recorded by Dispatch Delivery Service.

The land should be recorded at its cost of $167,500 to Reliable Repair Service. This is consistent with the cost principle.

No. The offer of $2,000,000 and the increase in the assessed value should not be recognized in the accounting records.

Cash would increase by $2,125,000, land would decrease by $900,000, and stockholders’ equity would increase by $1,225,000.

An account receivable is a claim against a customer for goods or services sold. An account payable is an amount owed to a creditor for goods or services purchased. Therefore, an account receivable in the records of the seller is an account payable in the records of the purchaser.

(b) The business realized net income of $91,000 ($679,000 – $588,000).

(a) The business incurred a net loss of $75,000 ($640,000 – $715,000).

10.

(a) Net income or net loss (b) Common stock and retained earnings at the end of the period (c) Cash at the end of the period

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Introduction to Accounting and Business

BASIC EXERCISES BE 1–1 $320,000. Under the cost principle, the land should be recorded at the cost to Tin Roofing. BE 1–2 a.

A = L + SE $690,000 = $375,000 + SE SE = $315,000

A $690,000 + $80,000 $770,000 SE

= = = =

L + SE $375,000 + $51,500 + SE $426,500 + SE $343,500

BE 1–3 (2) Expense (Advertising Expense) increases by $3,500; Asset (Cash) decreases by $3,500. (3) Asset (Supplies) increases by $2,500; Liability (Accounts Payable) increases by $2,500. (4) Asset (Accounts Receivable) increases by $18,750; Revenue (Delivery Service Fees) increases by $18,750. (5) Asset (Cash) increases by $14,150; Asset (Accounts Receivable) decreases by $14,150.

BE 1–4 A-One Travel Service Income Statement For the Year Ended August 31, 20Y6 Fees earned Expenses: Wages expense Office expense Miscellaneous expense Total expenses Net income

$1,150,000 $640,000 150,000 45,000 (835,000) $ 315,000

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Introduction to Accounting and Business

BE 1–5 A-One Travel Service Statement of Stockholders’ Equity For the Year Ended August 31, 20Y6 Common Retained Stock Earnings Balances, September 1, 20Y5 $60,000 $ 775,000 Issued common stock 15,000 Net income 315,000 Dividends (50,000) Balances, August 31, 20Y6 $75,000 $1,040,000

Total $ 835,000 15,000 315,000 (50,000) $1,115,000

BE 1–6 A-One Travel Service Balance Sheet August 31, 20Y6 Assets Cash Accounts receivable Supplies Land Total assets

$ 184,500 68,000 17,500 880,000 $1,150,000 Liabilities

Accounts payable Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

35,000

$ 75,000 1,040,000 1,115,000 $1,150,000

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Introduction to Accounting and Business

BE 1–7 A-One Travel Service Statement of Cash Flows For the Year Ended August 31, 20Y6 Cash flows from (used for) operating activities: Cash received from customers $1,125,000 Cash paid for operating expenses (815,000) Net cash flows from operating activities Cash flows from (used for) investing activities: Cash paid for purchase of land Cash flows from (used for) financing activities: $ 15,000 Cash received from issuing common stock (50,000) Cash paid for dividends Net cash flows used for financing activities Net increase in cash Cash balance, September 1, 20Y5 Cash balance, August 31, 20Y6

$ 310,000 (150,000)

(35,000) $ 125,000 59,500 $ 184,500

BE 1–8 a.

Dec. 31, 20Y4 Total liabilities……………………………………………… $4,085,000 Total stockholders’ equity………………………………… $4,300,000 0.95 * Ratio of liabilities to stockholders’ equity………………

Dec. 31, 20Y3 $2,880,000 $3,600,000 0.80 **

* $4,085,000 ÷ $4,300,000 ** $2,880,000 ÷ $3,600,000 b.

Increased

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Introduction to Accounting and Business

EXERCISES Ex. 1–1 a.

1. 2. 3. 4. 5.

manufacturing manufacturing manufacturing service retail

6. 7. 8. 9. 10.

manufacturing service service manufacturing retail

11. 12. 13. 14. 15.

service service manufacturing service retail

The accounting equation is relevant to all companies. It serves as the basis of the accounting information system.

Ex. 1–2 As in many ethics issues, there is no one right answer. Oftentimes, disclosing only what is legally required may not be enough. In this case, it would be best for the company’s chief executive officer to disclose both reports to the county representatives. In doing so, the chief executive officer could point out any flaws or deficiencies in the fired researcher’s report.

Ex. 1–3 a.

1. 2. 3. 4.

M L O M

5. 6. 7. 8.

O O X L

9. 10.

X O

A business transaction is an economic event or condition that directly changes an entity’s financial condition or results of operations.

Ex. 1–4 Kroger’s stockholders’ equity: $38,118 – $30,283 = $7,835 Procter & Gamble’s stockholders’ equity: $115,095 – $67,516 = $47,579

Ex. 1–5 Dollar Tree’s stockholders’ equity: $13,501 – $7,858 = $5,643 Target’s stockholders’ equity: $41,290 – $29,993 = $11,297

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Introduction to Accounting and Business

Ex. 1–6 a. b. c.

$2,075,000 ($1,200,000 + $875,000) $2,960,000 ($3,860,000 – $900,000) $12,750,000 ($71,850,000 – $59,100,000)

Ex. 1–7 a. b. c. d. e.

$1,270,000 ($2,450,000 – $1,180,000) $1,580,000 ($1,270,000 + $825,000 – $515,000) $835,000 ($1,270,000 – $375,000 – $60,000) $2,115,000 ($1,270,000 + $725,000 + $120,000) Net income: $630,000 ($3,300,000 – $1,400,000 – $1,270,000)

Ex. 1–8 a. b. c. d. e. f.

(2) liability (1) asset (3) stockholders’ equity (revenue) (1) asset (3) stockholders’ equity (expense) (3) stockholders’ equity (expense)

Ex. 1–9 a. b. c. d. e.

Increases assets and increases stockholders’ equity. Decreases assets and decreases stockholders’ equity. Decreases assets and decreases stockholders’ equity. Increases assets and increases liabilities. Increases assets and increases stockholders’ equity.

Ex. 1–10 a.

(1) Total assets increased $183,000 ($298,000 – $115,000). (2) No change in liabilities. (3) Stockholders’ equity increased $183,000.

(1) Total assets decreased $80,000. (2) Total liabilities decreased $80,000. (3) No change in stockholders’ equity.

No, it is false that a transaction always affects at least two elements (Assets, Liabilities, or Stockholders’ Equity) of the accounting equation. Some transactions affect only one element of the accounting equation. For example, purchasing supplies for cash only affects assets.

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Introduction to Accounting and Business

Ex. 1–11 1. 2. 3. 4.

(a) increase (a) increase (b) decrease (b) decrease

Ex. 1–12 1. 2. 3. 4. 5.

c a e e c

6. 7. 8. 9. 10.

c d a e e

Ex. 1–13 a.

(1) Provided catering services for cash, $71,800. (2) Purchase of land for cash, $15,000. (3) Payment of cash for expenses, $47,500. (4) Purchase of supplies on account, $1,100. (5) Paid cash dividends, $5,000. (6) Payment of cash to creditors, $4,000. (7) Recognition of cost of supplies used, $1,500.

b. c. d. e.

$300 ($40,300 – $40,000) $17,800 (–$5,000 + $71,800 – $49,000) $22,800 ($71,800 – $49,000) $17,800 ($22,800 – $5,000)

Ex. 1–14 No. It would be incorrect to say that the business had incurred a net loss of $8,000. The excess of the dividends over the net income for the period is a decrease in the amount of stockholders’ equity (retained earnings) in the business.

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Introduction to Accounting and Business

Ex. 1–15 Amber Stockholders’ equity at end of year ($1,730,000 – $1,150,000)………………… $ 580,000 Deduct stockholders’ equity at beginning of year ($1,220,000 – $990,000)…… (230,000) Net income (increase in stockholders’ equity)………………………………… $ 350,000 Blue Increase in stockholders’ equity (as determined for Amber)…………………… $ 350,000 60,000 Add dividends…………………………………………………………………………… Net income…………………………………………………………………………… $ 410,000 Coral Increase in stockholders’ equity (as determined for Amber)…………………… $ 350,000 (140,000) Deduct additional issuance of common stock…………………………………… Net income…………………………………………………………………………… $ 210,000 Daffodil Increase in stockholders’ equity (as determined for Amber)…………………… $ 350,000 (140,000) Deduct additional issuance of common stock…………………………………… $ 210,000 60,000 Add dividends…………………………………………………………………………… Net income…………………………………………………………………………… $ 270,000

Ex. 1–16 Balance sheet items: 1, 2, 3, 5, 7, 8, 10

Ex. 1–17 Income statement items: 4, 6, 9

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Introduction to Accounting and Business

Ex. 1–18 a.

Organic Products Company Statement of Stockholders’ Equity For the Month Ended June 30, 20Y9 Common Retained Stock Earnings Balances, June 1, 20Y9 $180,000 $1,630,000 Issued common stock 50,000 Net income 115,000 Dividends (25,000) Balances, June 30, 20Y9 $230,000 $1,720,000

Total $1,810,000 50,000 115,000 (25,000) $1,950,000

The statement of stockholders’ equity is prepared before the June 30, 20Y9, balance sheet because common stock and retained earnings as of June 30, 20Y9, are needed for the June 30, 20Y9, balance sheet.

Ex. 1–19 Imaging Services Income Statement For the Month Ended March 31, 20Y5 Fees earned Expenses: Wages expense Rent expense Supplies expense Miscellaneous expense Total expenses Net income

$ 482,000 $300,000 41,500 3,600 1,900 (347,000) $ 135,000

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Ex. 1–20 In each case, solve for a single unknown, using the following equation: Stockholders’ Equity (beginning) + Additional Common Stock Issued – Dividends + Revenues – Expenses = Stockholders’ Equity (ending) Freeman Stockholders’ equity at end of year ($1,260,000 – $330,000)……… Stockholders’ equity at beginning of year ($900,000 – $360,000)… Increase in stockholders’ equity………………………………………… Deduct increase due to net income ($570,000 – $240,000)………… Add dividends………………………………………………….…………… Additional common stock issued…………………………………… (a) Heyward Stockholders’ equity at end of year ($675,000 – $220,000)………… Stockholders’ equity at beginning of year ($490,000 – $260,000)… Increase in stockholders’ equity………………………………………… Add dividends………………………………………………….…………… Deduct additional common stock issued……………………………… Increase due to net income……………………………………………… Add expenses………………………………………………….…………… Revenue………………………………………………….…………………(b) Jones Stockholders’ equity at end of year ($100,000 – $80,000)…………… Stockholders’ equity at beginning of year ($115,000 – $81,000)…… Decrease in stockholders’ equity………………………………………… Decrease in stockholders’ equity due to net loss ($115,000 – $122,500)……………………………………………………… Deduct common stock issued…………………………………………… Dividends………………………………………………………………… (c) Ramirez Stockholders’ equity at end of year ($270,000 – $136,000)………… Add decrease due to net loss ($115,000 – $128,000)………………… Add dividends………………………………………………….…………… Stockholders’ equity at beginning of year……………………………… Deduct additional investment…………………………………………… Add liabilities at beginning of year……………………………………… Assets at beginning of year…………………………………………… (d)

$ 930,000 (540,000) $ 390,000 (330,000) $ 60,000 75,000 $ 135,000 $ 455,000 (230,000) $ 225,000 32,000 $ 257,000 (150,000) $ 107,000 128,000 $ 235,000 $ 20,000 (34,000) $(14,000) 7,500 $ (6,500) (10,000) $(16,500) $134,000 13,000 $147,000 39,000 $186,000 (55,000) $131,000 120,000 $251,000

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Introduction to Accounting and Business

Ex. 1–21 a. Ebony Interiors Balance Sheet February 28, 20Y3 Assets Cash Accounts receivable Supplies Total assets

$ 320,000 800,000 30,000 $1,150,000 Liabilities

Accounts payable

$ 310,000 Stockholders’ Equity

Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$200,000 640,000* 840,000 $1,150,000

* $640,000 = $320,000 + $800,000 + $30,000 – $310,000 – $200,000

Ebony Interiors Balance Sheet March 31, 20Y3 Assets Cash Accounts receivable Supplies Total assets

$ 380,000 960,000 35,000 $1,375,000 Liabilities

Accounts payable

$ 400,000

Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$200,000 775,000* 975,000 $1,375,000

* $775,000 = $380,000 + $960,000 + $35,000 – $400,000 – $200,000

Stockholders’ equity, March 31……………………………………………… $ 975,000 Stockholders’ equity, February 28…………………….……………………… (840,000) Net income…………………………………………………………………… $ 135,000

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Introduction to Accounting and Business

Ex. 1–21 (Concluded) c.

Stockholders’ equity, March 31………………………………………………… $ 975,000 Stockholders’ equity, February 28…………………….………………………… (840,000) Increase in stockholders’ equity…………………………………………… $ 135,000 50,000 Add dividends……………………………………………………………………… Net income……………………………………………………………………… $ 185,000

Ex. 1–22 a.

Balance sheet: 1, 2, 3, 4, 6, 7, 8, 9, 10, 11, 13 Income statement: 5, 12, 14, 15

Yes, an item can appear on more than one financial statement. For example, cash appears on both the balance sheet and statement of cash flows. However, the same item cannot appear on both the income statement and balance sheet.

Yes, the accounting equation is relevant to all companies, including Exxon Mobil Corporation. The accounting equation is the basis for all accounting systems.

Ex. 1–23 1. 2. 3. 4.

Ex. 1–24 Parker Consulting Group Statement of Cash Flows For the Year Ended January 31, 20Y4 Cash flows from (used for) operating activities: $1,200,000 Cash received from customers (800,000) Cash paid for expenses Net cash flows from operating activities Cash flows from (used for) investing activities: Cash paid for purchase of land Cash flows from (used for) financing activities: $ 90,000 Cash received from issuing common stock (36,000) Cash paid for dividends Net cash flows from financing activities Net increase in cash Cash balance, February 1, 20Y3 Cash balance, January 31, 20Y4

$ 400,000 (300,000)

54,000 $ 154,000 66,000 $ 220,000

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Introduction to Accounting and Business

Ex. 1–25 a. 1.

All financial statements should contain the name of the business in their heading. The statement of stockholders’ equity is incorrectly headed as “Omar Farah” rather than We-Sell Realty. The heading of the balance sheet needs to be the name of the business.

The income statement covers a period of time and should be labeled “For the Month Ended August 31, 20Y7.”

The year in the heading for the statement of stockholders’ equity should be 20Y7 rather than 20Y6.

The balance sheet should be labeled “August 31, 20Y7,” rather than “For the Month Ended August 31, 20Y7.”

On the income statement, the miscellaneous expense amount should be listed as the last expense.

On the income statement, the total expenses are subtracted from the sales commissions, resulting in an incorrect net income amount of $25,000. The correct net income should be $24,150. This also affects the statement of stockholders’ equity and the amount of retained earnings that appears on the balance sheet.

On the statement of stockholders’ equity, there is no column for common stock. Also, the statement is for the “month” rather than for the “year” ended August 31, 20Y7.

Accounts payable should be listed as a liability on the balance sheet.

Accounts receivable and supplies should be listed as assets on the balance sheet.

10.

The balance sheet assets should equal the sum of the liabilities and stockholders’ equity.

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Introduction to Accounting and Business

Ex. 1–25 (Concluded) b.

Corrected financial statements appear as follows: We-Sell Realty Income Statement For the Month Ended August 31, 20Y7

Sales commissions Expenses: Office salaries expense Rent expense Automobile expense Supplies expense Miscellaneous expense Total expenses Net income

$ 140,000 $87,000 18,000 7,500 1,150 2,200 (115,850) $ 24,150

We-Sell Realty Statement of Stockholders’ Equity For the Month Ended August 31, 20Y7 Common Retained Stock Earnings Balances, August 1, 20Y7 $ 0 $ 0 Issued common stock 15,000 Net income 24,150 Dividends (10,000) Balances, August 31, 20Y7 $15,000 $ 14,150

Total $ 0 15,000 24,150 (10,000) $ 29,150

We-Sell Realty Balance Sheet August 31, 20Y7 Assets Cash Accounts receivable Supplies Total assets

$ 8,900 38,600 4,000 $51,500

Liabilities Accounts payable Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$22,350 $15,000 14,150 29,150 $51,500

2,200 1,650 550

6,000

75,000

Common Stock

– –

4,000 4,000

– Dividends +

25,500

19,500 6,000 25,500

19,500

19,500 19,500

Fees Earned

Rent

Salaries

Supplies

–

– –

8,000

8,000 8,000

–

– –

5,500

5,500 5,500

–

– –

1,650

1,650 1,650

– Expense – Expense – Expense –

–

– –

1,500

1,500 1,500

Auto Exp.

–

– –

800

800 800

Misc. Exp.

1-15

June’s transactions increased stockholders’ equity by $79,050, which is the common stock of $75,000 that was issued plus June’s net income of $8,050 less dividends of $4,000.

350

1,850 350

6,000

550

2,200

6,000

2,200

2,200 2,200 2,200

–

Accts. Payable

2,200

2,200 2,200

6,000 6,000

–

+ Supplies =

$8,050 ($25,500 – $8,000 – $5,500 – $1,650 – $1,500 – $800)

Accts. Rec.

Stockholders’ Equity

= Liabilities +

Stockholders’ equity is the right of stockholders (owners) to the assets of the business. These rights are increased by issuing common stock and revenues and decreased by dividends and expenses.

76,850 4,000 72,850

84,650 2,300 82,350 5,500 76,850

1,850 84,650

75,000 19,500 94,500 8,000 86,500

75,000

Cash

Assets

PROBLEMS

Introduction to Accounting and Business

e. – Bal. f. Bal. g. – Bal. h. – Bal. i. Bal. j. – Bal.

a. + b. Bal. c. + Bal. d. – Bal.

Prob. 1–1A

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Introduction to Accounting and Business

Prob. 1–2A Adventure Travel Agency Income Statement For the Year Ended December 31, 20Y5

Fees earned Expenses: Wages expense Rent expense Utilities expense Supplies expense Miscellaneous expense Total expenses Net income 2.

$ 1,400,000 $870,000 75,000 40,000 15,300 22,100 (1,022,400) $ 377,600

Adventure Travel Agency Statement of Stockholders’ Equity For the Year Ended December 31, 20Y5 Common Retained Stock Earnings Balances, January 1, 20Y5 $250,000 $1,160,400 Issued common stock 75,000 Net income 377,600 Dividends (50,000) Balances, December 31, 20Y5 $325,000 $1,488,000

Total $1,410,400 75,000 377,600 (50,000) $1,813,000

Adventure Travel Agency Balance Sheet December 31, 20Y5 Assets

Cash Accounts receivable Supplies Land Total assets

$ 198,600 310,400 6,000 1,350,000 $1,865,000 Liabilities

Accounts payable Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

52,000

$ 325,000 1,488,000 1,813,000 $1,865,000

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Introduction to Accounting and Business

Prob. 1–2A (Concluded) 4. Ending common stock and retained earnings appear on both the statement of stockholders’ equity and the balance sheet. For Adventure Travel Agency, the December 31, 20Y5, common stock of $325,000 and retained earnings of $1,488,000 appear on the statement of stockholders’ equity and balance sheet.

Prob. 1–3A 1.

Reliance Financial Services Income Statement For the Month Ended July 31, 20Y2 Fees earned Expenses: Salaries expense Rent expense Auto expense Supplies expense Miscellaneous expense Total expenses Net income

$ 144,500 $55,000 33,000 16,000 4,500 4,800 (113,300) $ 31,200

Reliance Financial Services Statement of Stockholders’ Equity For the Month Ended July 31, 20Y2 Common Retained Stock Earnings Balances, July 1, 20Y2 $ 0 $ 0 Issued common stock 50,000 Net income 31,200 Dividends (15,000) Balances, July 31, 20Y2 $50,000 $ 16,200

Total $ 0 50,000 31,200 (15,000) $ 66,200

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Introduction to Accounting and Business

Prob. 1–3A (Concluded) Reliance Financial Services Balance Sheet July 31, 20Y2 Assets

Cash Accounts receivable Supplies Total assets

$32,600 34,500 2,500 $69,600

Liabilities Accounts payable Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$ 3,400 $50,000 16,200 66,200 $69,600

4. Optional Reliance Financial Services Statement of Cash Flows For the Month Ended July 31, 20Y2 Cash flows from (used for) operating activities: Cash received from customers Cash paid for expenses and to creditors* Net cash flows used for operating activities Cash flows from (used for) investing activities Cash flows from (used for) financing activities: Cash received from issuing common stock Cash paid for dividends Net cash flows from financing activities Net increase in cash Cash balance, July 1, 20Y2 Cash balance, July 31, 20Y2

$ 110,000 (112,400) $ (2,400) 0 $ 50,000 (15,000) 35,000 $32,600 0 $32,600

* $3,600 + $33,000 + $20,800 + $55,000; these amounts are taken from the Cash column shown in the problem.

e. – Bal. f. – Bal. g. – Bal. h. – Bal. i. Bal.

a. + b. Bal. c. – Bal. d. + Bal.

70,950

4,500 81,500 3,000 78,500 2,300 76,200 5,250 70,950

35,000 1,800 33,200 52,800 86,000

–

950 950

2,750

2,750 1,000 1,750

+ +

35,000

Common Stock

–

– –

3,000

3,000 3,000

– Dividends +

1-19

52,800

52,800 52,800

Sales Comm.

–

– 5,250

– 5,250 – 5,250

Salaries Exp.

–

– –

4,500

4,500 4,500

Rent Exp.

Stockholders’ Equity

Introduction to Accounting and Business

–

– –

1,100

1,100 1,100

Auto Exp.

950

2,750

950

2,750 2,750 1,800 950

950

–

2,750

2,750 2,750

Accts. Payable

= Liabilities +

+ Supplies =

Assets

35,000

Cash

Prob. 1–4A

CHAPTER 1

–

– –

1,000 1,000

Supplies Exp.

–

– –

1,200

1,200 1,200

Misc. Exp.

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Introduction to Accounting and Business

Prob. 1–4A (Concluded) Western Realty Income Statement For the Month Ended August 31, 20Y9

Sales commissions Expenses: Salaries expense Rent expense Automobile expense Supplies expense Miscellaneous expense Total expenses Net income

$ 52,800 $5,250 4,500 1,100 1,000 1,200 (13,050) $ 39,750

Western Realty Statement of Stockholders’ Equity For the Month Ended August 31, 20Y9 Common Retained Stock Earnings Balances, August 1, 20Y9 $ 0 $ 0 Issued common stock 35,000 Net income 39,750 Dividends (3,000) Balances, August 31, 20Y9 $35,000 $36,750

Total $ 0 35,000 39,750 (3,000) $71,750

Western Realty Balance Sheet August 31, 20Y9 Assets Cash Supplies Total assets

$70,950 1,750 $72,700 Liabilities

Accounts payable Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

950

$35,000 36,750 71,750 $72,700

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Introduction to Accounting and Business

Prob. 1–5A 1.

Assets

= Liabilities + Stockholders’ Equity Common Accounts Stock Payable + +

Retained Earnings

Cash

Accounts Receivable

Supplies

Land

$45,000

$93,000

$7,000

$75,000 =

$40,000 +

$220,000 =

$100,000 + Retained Earnings

$60,000

Retained Earnings

$120,000 = Retained Earnings

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Introduction to Accounting and Business

Prob. 1–5A (Continued) 2. Cash Bal. a.

–

Bal. d.

93,000 93,000

7,000

Bal.

93,000

7,000

f. Bal.

93,000

56,125

93,000

56,125

93,000

75,000

120,000

125,000

40,000

95,000

120,000

7,000

125,000

40,000

95,000

120,000

7,000

125,000

40,000

95,000

120,000

95,000

120,000

50,000

2,500 9,500

+ 125,000

93,000 +

Bal. j.

9,500

125,000

19,700

95,000

120,000

19,700

95,000

120,000

33,325

177,750

9,500

125,000

33,325

177,750

9,500

125,000

49,200

95,000

120,000

177,750

9,500

125,000

49,200

95,000

120,000

Bal.

9,500

125,000

49,200

95,000

120,000

125,000

49,200

95,000

120,000

88,000

–

88,000

107,325

89,750

107,325

89,750

–

Bal. l. Bal.

–

29,500

14,000 19,325

22,800

84,750 +

–

2,500 42,500

–

h. i.

120,000

35,000 95,000

22,800 33,325

Bal.

60,000

6,000

g. Bal.

40,000

32,125

+ –

75,000

e. Bal.

Retained Accts. Common = Payable + + Earnings – Dividends Stock

40,000

50,000

62,125 –

7,000

Land

Stockholders’ Equity

30,000 +

+ Supplies +

35,000 80,000

Bal. c.

Accts. Rec.

45,000 +

Bal. b.

= Liabilities +

Assets

3,600 5,900

12,000 95,325

89,750

5,900

125,000

49,200

95,000

120,000

–

12,000

–

12,000

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Introduction to Accounting and Business

Prob. 1–5A (Continued) Dry Cleaning + Revenue

Stockholders’ Equity (Continued) Dry Cleaning Wages Rent Supplies Truck – – Exp. – Exp. – – Exp. Exp. Exp.

–

Utilities Exp.

Misc. Exp.

–

Bal. a. Bal. b. Bal. c.

Bal.

32,125 32,125

– 6,000

Bal.

32,125

– 6,000

32,125

– 6,000

32,125

– 6,000

e. Bal. f. Bal. g. Bal.

84,750 116,875

h. Bal.

116,875

– 6,000 –

29,500

–

29,500

i. Bal.

– 6,000 – 7,500

–

2,500

–

1,300

–

2,700

116,875

–

29,500

– 7,500

– 6,000

–

2,500

–

1,300

–

2,700

116,875

–

29,500

– 7,500

– 6,000

–

2,500

–

1,300

–

2,700

–

3,600

116,875

–

29,500

– 7,500

– 6,000

–

3,600

–

2,500

–

1,300

–

2,700

116,875

–

29,500

– 7,500

– 6,000

–

3,600

–

2,500

–

1,300

–

2,700

j. Bal. k. Bal. l. Bal.

CHAPTER 1

Introduction to Accounting and Business

Prob. 1–5A (Continued) D’Lite Dry Cleaners Income Statement For the Month Ended July 31, 20Y4

Dry cleaning revenue Expenses: Dry cleaning expense Wages expense Rent expense Supplies expense Truck expense Utilities expense Miscellaneous expense Total expenses Net income

$116,875 $29,500 7,500 6,000 3,600 2,500 1,300 2,700 (53,100) $ 63,775

D’Lite Dry Cleaners Statement of Stockholders’ Equity For the Month Ended July 31, 20Y4 Common Stock Balances, July 1, 20Y4 $60,000 Issued common stock 35,000 Net income Dividends Balances, July 31, 20Y4 $95,000

Retained Earnings $120,000 63,775 (12,000) $171,775

Total $180,000 35,000 63,775 (12,000) $266,775

D’Lite Dry Cleaners Balance Sheet July 31, 20Y4 Assets Cash Accounts receivable Supplies Land Total assets

$ 95,325 89,750 5,900 125,000 $315,975 Liabilities

Accounts payable

$ 49,200 Stockholders’ Equity

Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$ 95,000 171,775 266,775 $315,975

CHAPTER 1

Introduction to Accounting and Business

Prob. 1–5A (Concluded) 4.

Optional

D’Lite Dry Cleaners Statement of Cash Flows For the Month Ended July 31, 20Y4 Cash flows from (used for) operating activities: Cash received from customers* Cash paid for expenses and to creditors** Net cash flows from operating activities Cash flows from (used for) investing activities: Cash paid for acquisition of land Cash flows from (used for) financing activities: Cash received from issuing common stock Cash paid for dividends Net cash flows from financing activities Net increase in cash Cash balance, July 1, 20Y4 Cash balance, July 31, 20Y4

$120,125 (42,800) $ 77,325 (50,000) $ 35,000 (12,000) 23,000 $ 50,325 45,000 $ 95,325

* $32,125 + $88,000; these amounts are taken from the Cash column of the spreadsheet in Part 2. ** $6,000 + $22,800 + $14,000; these amounts are taken from the Cash column of the spreadsheet in Part 2.

CHAPTER 1

Introduction to Accounting and Business

Prob. 1–6A a.

Fees earned, $750,000 ($275,000 + $475,000)

Supplies expense, $30,000 ($475,000 – $300,000 – $100,000 – $20,000 – $25,000)

The common stock, $375,000; the amount shown on the balance sheet

Net income for April, $275,000 from the income statement

$150,000 ($275,000 – $125,000)

Total stockholders’ equity, $525,000 ($375,000 + $150,000)

Total assets, $625,000 ($462,500 + $12,500 + $150,000)

Retained earnings, $150,000; same as (e)

Total stockholders’ equity, $525,000 ($375,000 + $150,000); same as (f)

Total liabilities and stockholders’ equity, $625,000 ($100,000 + $525,000)

Cash received from customers, $750,000 ($387,500 + $362,500); this is the same as fees earned (a) since there are no accounts receivable.

Net cash flows from operating activities, $362,500 ($750,000 – $387,500)

Cash paid for land, ($150,000)

Cash received from issuing common stock, $375,000

Cash dividends, ($125,000)

Net cash flows from financing activities, $250,000 ($375,000 – $125,000)

Net increase in cash, $462,500 ($362,500 – $150,000 + $250,000)

Cash as of April 30, 20Y0, $462,500; same as (q) since Wolverine Realty was organized on April 1, 20Y0; also cash balance on the balance sheet.

50,000 2,300 47,700 13,800 61,500

5,000 56,500 1,450 55,050 2,500 52,550

Bal. c. – Bal. d. + Bal.

e. – Bal. f. – Bal. g. – Bal. h. Bal. i. Bal. j. – Bal. 50,000

50,000

– –

3,900 3,900

– Dividends +

26,300

13,800 12,500 26,300

13,800

13,800 13,800

Fees Earned

–

– –

5,000

5,000 5,000

Rent

–

– –

2,500

2,500 2,500

Salaries

Supplies

–

– –

1,300

1,300 1,300

– Expense – Expense – Expense –

–

– –

1,150

1,150 1,150

Auto Exp.

–

1-27

March’s transactions increased stockholders’ equity by $62,150, which is the common stock that was issued of $50,000 plus the excess of March’s net income of $16,050 over dividends of $3,900.

1,700

Common Stock

2,700

12,500

1,700

$16,050 ($26,300 – $5,000 – $2,500 – $1,300 – $1,150 – $300)

2,700

1,700

4,000 1,300 2,700 1,700

1,700

4,000

1,700

4,000 2,300 1,700

4,000

1,700

–

Accts. Payable

4,000

12,500 12,500

–

+ Supplies =

Stockholders’ Equity

Accts. Rec.

= Liabilities +

Stockholders’ equity is the right of stockholders (owners) to the assets of the business. These rights are increased by issuing common stock and revenues and decreased by dividends and expenses.

Assets

Introduction to Accounting and Business

52,550 3,900 48,650

52,550

50,000

Cash

a. + b.

Prob. 1–1B

CHAPTER 1

–

– –

300

300 300

Misc. Exp.

CHAPTER 1

Introduction to Accounting and Business

Prob. 1–2B Wilderness Travel Service Income Statement For the Year Ended April 30, 20Y7

Fees earned Expenses: Wages expense Rent expense Utilities expense Supplies expense Taxes expense Miscellaneous expense Total expenses Net income 2.

$ 875,000 $525,000 75,000 38,000 12,000 10,000 15,000 (675,000) $ 200,000

Wilderness Travel Service Statement of Stockholders’ Equity For the Year Ended April 30, 20Y7 Common Stock Balances, May 1, 20Y6 $25,000 Issued common stock 10,000 Net income Dividends Balances, April 30, 20Y7 $35,000

Retained Earnings $155,000 200,000 (40,000) $315,000

Total $180,000 10,000 200,000 (40,000) $350,000

Wilderness Travel Service Balance Sheet April 30, 20Y7 Assets

Cash Accounts receivable Supplies Total assets

$156,000 210,000 9,000 $375,000 Liabilities

Accounts payable Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$ 25,000 $ 35,000 315,000 350,000 $375,000

4. Net income (or net loss) appears on both the income statement and the statement of stockholders’ equity. For Wilderness Travel Service, net income for the year of $200,000 appears on the income statement and statement of stockholders’ equity. 1-28 © 2022 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 1

Introduction to Accounting and Business

Prob. 1–3B Bronco Consulting Income Statement For the Month Ended August 31, 20Y1

Fees earned Expenses: Salaries expense Rent expense Auto expense Supplies expense Miscellaneous expense Total expenses Net income 2.

$ 125,000 $58,000 27,000 15,500 6,100 7,500 (114,100) $ 10,900

Bronco Consulting Statement of Stockholders’ Equity For the Month Ended August 31, 20Y1 Common Retained Stock Earnings Balances, August 1, 20Y1 $ 0 $ 0 Issued common stock 75,000 Net income 10,900 Dividends (5,000) Balances, August 31, 20Y1 $75,000 $ 5,900

Total $ 0 75,000 10,900 (5,000) $80,900

Bronco Consulting Balance Sheet August 31, 20Y1

Assets Cash Accounts receivable Supplies Total assets

$48,000 33,000 2,900 $83,900

Liabilities Accounts payable Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$ 3,000 $75,000 5,900 80,900 $83,900

CHAPTER 1

Introduction to Accounting and Business

Prob. 1–3B (Concluded) 4.

Optional

Bronco Consulting Statement of Cash Flows For the Month Ended August 31, 20Y1 Cash flows from (used for) operating activities: Cash received from customers $ 92,000 (114,000) Cash paid for expenses and to creditors* Net cash flows used for operating activities Cash flows from (used for) investing activities Cash flows from (used for) financing activities: Cash received from issuing common stock $ 75,000 (5,000) Cash paid for dividends Net cash flows from financing activities Net increase in cash Cash balance, August 1, 20Y1 Cash balance, August 31, 20Y1

$(22,000) 0

70,000 $ 48,000 0 $ 48,000

* $27,000 + $6,000 + $23,000 + $58,000; these amounts are taken from the Cash column shown in the problem.

e. + Bal. f. – Bal. g. – Bal. h. – Bal. i. Bal.

a. + b. – Bal. c. – Bal. d. Bal.

18,450

31,500

19,800 38,250 750 37,500 2,500 35,000 3,500 31,500

–

+ +

24,000

3,500 3,500

19,800 19,800

–

3,500

1-31

19,800

–

24,000

Sales Comm.

– –

– Dividends +

24,000

Common Stock

3,600

3,600 3,600

Rent Exp.

–

– –

2,500

2,500 2,500

Salaries Exp.

Stockholders’ Equity

Introduction to Accounting and Business

–

– –

1,350

1,350 1,350

Auto Exp.

450

1,200 900 300

1,200 750 450

1,200 1,200

450

–

1,200

1,200 1,200

Accts. Payable

= Liabilities +

+ Supplies =

Assets

24,000 3,600 20,400 1,950 18,450

Cash

Prob. 1–4B

CHAPTER 1

–

– –

900 900

Supplies Exp.

–

– –

600

600 600

Misc. Exp.

CHAPTER 1

Introduction to Accounting and Business

Prob. 1–4B (Concluded) Custom Realty Income Statement For the Month Ended April 30, 20Y8

Sales commissions Expenses: Rent expense Salaries expense Automobile expense Supplies expense Miscellaneous expense Total expenses Net income

$19,800 $3,600 2,500 1,350 900 600 (8,950) $10,850

Custom Realty Statement of Stockholders’ Equity For the Month Ended April 30, 20Y8 Common Stock Balances, April 1, 20Y8 $ 0 Issued common stock 24,000 Net income Dividends Balances, April 30, 20Y8 $24,000

Retained Earnings $ 0 10,850 (3,500) $ 7,350

Total $ 0 24,000 10,850 (3,500) $31,350

Custom Realty Balance Sheet April 30, 20Y8 Assets Cash Supplies Total assets

$31,500 300 $31,800 Liabilities

Accounts payable Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

450

$24,000 7,350 31,350 $31,800

CHAPTER 1

Introduction to Accounting and Business

Prob. 1–5B 1.

Assets Cash

$39,000 +

Accounts Receivable

$80,000

= Liabilities

Accounts Payable +

Common Stock

Retained Earnings

$50,000 =

$31,500

$50,000

Retained Earnings

$180,000 =

$81,500

+ Supplies +

Land

$11,000

Stockholders’ Equity

Retained Earnings

$98,500 = Retained Earnings

CHAPTER 1

Introduction to Accounting and Business

Prob. 1–5B (Continued) 2. Cash Bal. a.

–

Bal.

80,000

11,000

80,000

11,000

80,000

98,500

85,000

31,500

71,000

98,500

11,000

85,000

31,500

71,000

98,500

152,000

11,000

85,000

31,500

71,000

98,500

152,000

11,000

85,000

71,000

98,500

72,000

8,000

152,000

19,000

85,000

19,500

71,000

98,500

152,000

19,000

85,000

19,500

71,000

98,500

77,000 116,000

–

19,000

85,000

19,500

71,000

98,500

77,000 75,000

+ 29,450

i. Bal. j.

11,500

38,000 39,000

98,500

21,000

– 20,000

1,000

Bal.

50,000 71,000

Bal.

50,000

20,000 1,000

31,500

4,000

21,000

Bal.

50,000

31,500

f. g.

Retained Accts. Common Stock = Payable + + Earnings – Dividends

+ 35,000

+ –

Land

Stockholders’ Equity

21,000

Bal.

11,000

35,000

d. Bal.

+ Supplies +

80,000

25,000 –

Accts. Rec.

21,000 60,000

Bal. c.

39,000 +

Bal. b.

= Liabilities +

Assets

116,000 –

Bal.

75,000

19,000

85,000

48,950

71,000

98,500

19,000

85,000

48,950

71,000

98,500

29,200 86,800

75,000 –

k. Bal.

86,800

– l. Bal.

5,000 81,800

7,200

75,000

11,800

85,000

48,950

71,000

98,500

75,000

11,800

85,000

48,950

71,000

98,500

–

5,000

–

5,000

CHAPTER 1

Introduction to Accounting and Business

Prob. 1–5B (Continued) Stockholders’ Equity (Continued) Dry Dry Cleaning Cleaning + Revenue – Exp. –

Wages Exp.

Supplies Exp. –

–

Rent Exp.

Truck Exp.

–

Utilities Misc. Exp. – Exp.

Bal. a. Bal. b. Bal. c.

– 4,000

Bal. d.

– 4,000 +

Bal.

72,000 72,000

– 4,000

72,000

– 4,000

72,000

– 4,000

e. Bal. f. Bal. g. Bal.

38,000 110,000

– 4,000

110,000

– 4,000

h. Bal.

– 29,450

i. Bal.

110,000

– 29,450

j. Bal.

110,000

– 29,450

– 4,000 –

24,000

–

24,000

–

7,200

–

2,100

–

1,800

– 1,300

– 4,000

–

2,100

–

1,800

– 1,300

Bal.

110,000

– 29,450

–

24,000

–

7,200

– 4,000

–

2,100

–

1,800

– 1,300

l. Bal.

110,000

– 29,450

–

24,000

–

7,200

– 4,000

–

2,100

–

1,800

– 1,300

CHAPTER 1

Introduction to Accounting and Business

Prob. 1–5B (Continued) 3.

Bev’s Dry Cleaners Income Statement For the Month Ended November 30, 20Y3 Dry cleaning revenue Expenses: Dry cleaning expense $29,450 Wages expense 24,000 Supplies expense 7,200 Rent expense 4,000 Truck expense 2,100 Utilities expense 1,800 Miscellaneous expense 1,300 Total expenses Net income Bev’s Dry Cleaners Statement of Stockholders’ Equity For the Month Ended November 30, 20Y3 Common Retained Stock Earnings Balances, November 1, 20Y3 $50,000 $ 98,500 Issued common stock 21,000 Net income 40,150 Dividends (5,000) Balances, November 30, 20Y3 $71,000 $133,650

$110,000

(69,850) $ 40,150

Total $148,500 21,000 40,150 (5,000) $204,650

Bev’s Dry Cleaners Balance Sheet November 30, 20Y3 Assets Cash Accounts receivable Supplies Land Total assets

$ 81,800 75,000 11,800 85,000 $253,600

Liabilities Accounts payable Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$ 48,950 $ 71,000 133,650 204,650 $253,600

CHAPTER 1

Introduction to Accounting and Business

Prob. 1–5B (Concluded) 4.

Optional

Bev’s Dry Cleaners Statement of Cash Flows For the Month Ended November 30, 20Y3 Cash flows from (used for) operating activities: Cash received from customers* $115,000 Cash paid for expenses and to creditors** (53,200) Net cash flows from operating activities Cash flows from (used for) investing activities: Cash paid for acquisition of land Cash flows from (used for) financing activities: Cash received from issuing common stock $ 21,000 Cash paid for dividends (5,000) Net cash flows from financing activities Net increase in cash Cash balance, November 1, 20Y3 Cash balance, November 30, 20Y3

$ 61,800 (35,000)

16,000 $ 42,800 39,000 $ 81,800

* $38,000 + $77,000; these amounts are taken from the Cash column of the spreadsheet in Part 2. ** $4,000 + $20,000 + $29,200; these amounts are taken from the Cash column of the spreadsheet in Part 2.

CHAPTER 1

Introduction to Accounting and Business

Prob. 1–6B a.

Wages expense, $203,200 ($288,000 – $48,000 – $17,600 – $14,400 – $4,800)

Net income, $112,000 ($400,000 – $288,000)

Common stock, $160,000; from statement of cash flows.

Net income for May, $112,000; from (b)

Dividends, $64,000; from statement of cash flows

Increase in retained earnings, $48,000 ($112,000 – $64,000)

Total stockholders’ equity, $208,000 ($160,000 + $48,000)

Land, $120,000; from statement of cash flows.

Total assets, $256,000 ($123,200 + $12,800 + $120,000)

Common stock, $160,000; from statement of cash flows.

Retained earnings, $48,000; same as (f)

Total stockholders’ equity, $208,000; same as (g)

m. Total liabilities and stockholders’ equity, $256,000 ($48,000 + $208,000) n.

Cash received from customers, $400,000; this is the same as fees earned since there are no accounts receivable.

Net cash flows from operating activities, $147,200 ($400,000 – $252,800)

Net cash flows from financing activities, $96,000 ($160,000 – $64,000)

Net increase in cash, $123,200 ($147,200 – $120,000 + $96,000)

Cash as of May 31, 20Y6, $123,200; same as (q) since Atlas Realty was organized on May 1, 20Y6; also the cash balance on the balance sheet.

CHAPTER 1

Introduction to Accounting and Business

CONTINUING PROBLEM 1. Cash June

4,000

June

3,500

Bal. June

–

– –

Bal. –

Bal. +

Bal.

5,375

Bal. –

Bal. +

Bal. –

Bal.

5,835

Bal. –

Bal. Bal.

–

3,500

350

4,000

3,500

350

4,000

3,500 3,500

100

350

250

4,000

350

250

4,000 +

1,000

350

250

300 3,800

4,000

1,000 4,800

500

1,000

350

250

4,000

5,300

1,000

350

250

4,000

5,300 +

900

1,000

350

250

4,000

6,200

1,000

350

250

4,000

6,200

1,000

350

250

4,000

6,200

180

1,000

170

250

4,000

6,200

1,000

170

250

4,000

6,200

1,000

170

250

4,000

6,200

1,000

170

250

4,000

1,000 4,420

June 30

4,000

415 5,420

June 30

350

1,000

– –

350

June 30 June 30

3,500

300 5,835

Bal.

4,000

400 6,135

June 30

350

900 6,535

June 30

350

240 5,635

June 30

3,500

500 5,875

June 29

4,000 350

–

+ +

3,500

300

June 22 June 25

350

5,375

Bal.

350

100 5,075

June 16

4,000

350 5,175

June 13

3,500

675 5,525

June 12

4,000

500 6,200

Bal.

Fees Earned

800 +

–

Common Stock – Dividends +

6,700 6

Stockholders’ Equity

Bal. June

Accts. Payable

+ Supplies =

6,700

Bal. June

Accts. Rec.

7,500

Bal. June

= Liabilities +

Assets

500 3,920

–

500

–

500

6,200

CHAPTER 1

Introduction to Accounting and Business

Continuing Problem (Continued) Stockholders’ Equity (Continued) Music Exp.

– June

June

Office Rent Exp.

–

Equip. Rent Exp.

–

Advertising Exp.

–

Wages Exp.

–

Utilities Supplies Exp. Exp. – –

Misc. Exp.

Bal. June

Bal.

–

500

–

350

–

800

–

675

–

500

–

350

–

800

–

675

–

500

–

350

–

800

–

675

–

500

–

350

–

800

–

675

–

500

–

350

–

800

–

675

–

500

–

240

–

590

–

800

–

675

–

500

–

590

–

800

–

675

–

500

590

–

590

–

800

–

800

–

675

–

675

–

400

500

–

400

500

–

400

–

300

–

300

30 –

590

–

800

–

675

–

500

–

400

–

300

–

180

–

180

30 30

Bal. June

675

350

–

Bal. June

–

Bal. June

675

800

–

Bal. June

– –

Bal. June

500

800

Bal. June

–

Bal. June

500

Bal. June

–

Bal. June

800

Bal. June

–

Bal. June

800

Bal. June

800

– 4

Bal. June

–

590

–

1,000

– –

–

415

–

800

–

675

–

500

–

400

–

300

–

180

–

415

1,590

–

800

–

675

–

500

–

400

–

300

–

180

–

415

1,590

–

800

–

675

–

500

–

400

–

300

–

180

–

415

CHAPTER 1

Introduction to Accounting and Business

Continuing Problem (Concluded) PS Music Income Statement For the Month Ended June 30, 20Y5

Fees earned: Expenses: Music expense Office rent expense Equipment rent expense Advertising expense Wages expense Utilities expense Supplies expense Miscellaneous expense Total expenses Net income 3.

$ 6,200 $1,590 800 675 500 400 300 180 415 (4,860) $ 1,340

PS Music Statement of Stockholders’ Equity For the Month Ended June 30, 20Y5 Common Retained Stock Earnings Balances, June 1, 20Y5 $ 0 $ 0 Issued common stock 4,000 Net income 1,340 Dividends (500) Balances, June 30, 20Y5 $4,000 $ 840

Total $ 0 4,000 1,340 (500) $4,840

PS Music Balance Sheet June 30, 20Y5

Assets Cash Accounts receivable Supplies Total assets

$3,920 1,000 170 $5,090

Liabilities Accounts payable Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$ 250 $4,000 840 4,840 $5,090

CHAPTER 1

Introduction to Accounting and Business

MAKE A DECISION MAD 1–1 Ratio of Liabilities to Stockholders’ Equity =

Amazon:

$119,099 $43,549

= 2.73

Best Buy:

$9,595 $3,306

= 2.90

Total Liabilities Total Stockholders’ Equity

b. Amazon’s ratio is 2.73, which means the total liabilities are over 2 1/2 times as great as the stockholders’ equity. For Best Buy, the ratio is higher at 2.90, which is almost three times greater than stockholders’ equity. Thus, the margin of protection is slightly more for Amazon’s creditors than it is for Best Buy’s creditors. MAD 1–2 a.

Ratio of Liabilities to Stockholders’ Equity =

Year 1:

$26,478 $10,953

= 2.42

Year 2:

$28,652 $11,651

= 2.46

Year 3:

$29,993 $11,297

= 2.65

Total Liabilities Total Stockholders’ Equity

b. The ratio of liabilities to stockholders’ equity for Target increased from 2.42 in Year 1 to 2.65 in Year 3, causing the margin of protection to creditors to decrease.

CHAPTER 1

Introduction to Accounting and Business

MAD 1–3 a.

Ratio of Liabilities to Stockholders’ Equity = Year 1:

$118,290 $80,535

= 1.47

Year 2:

$123,700 $80,822

= 1.53

Year 3:

$139,661 $79,634

= 1.75

Total Liabilities Total Stockholders’ Equity

b. The ratio of liabilities to stockholders’ equity for Walmart increased from 1.47 in Year 1 to 1.75 in Year 3, causing the margin of protection to creditors to decrease. Note to Instructor: This increase occurred because the company used debt to finance the repurchase of its common stock. This caused liabilities to increase and stockholders’ equity to decrease over the three-year period. The increased use of debt financing was probably due to the low interest rates during this threeyear period.

MAD 1–4 The ratios of liabilities to stockholders’ equity are summarized below for Target (MAD 1–2) and Walmart (MAD 1–3).

Target Walmart

Year 3 2.65 1.75

Year 2 2.46 1.53

Year 1 2.42 1.47

Target’s ratio of liabilities to stockholders’ equity is more than that of Walmart for all three years. Thus, the risk to Target’s creditors is more than that of Walmart’s creditors. The three-year trend for both companies shows that the size of this ratio is increasing. However, Target appears to be more aggressive than Walmart in its use of debt.

CHAPTER 1

Introduction to Accounting and Business

MAD 1–5 a.

Ratio of Liabilities to Stockholders’ Equity = Wendy’s:

$3,644 $648

= 5.6

Chipotle:

$824 $1,441

= 0.6

Total Liabilities Total Stockholders’ Equity

b. The ratio of liabilities to stockholders’ equity is 5.6 for Wendy’s. This ratio is relatively high and suggests that creditors have risk with their investments. Specifically, the small level of stockholders’ equity provides a low margin of protection for creditors. c.

Chipotle’s ratio of liabilities to stockholders’ equity of 0.6 is extremely low and suggests that Chipotle is not using much debt to finance its operations. Given the low interest rates that are currently available in the market, Chipotle may be able to improve its profitability by increasing its use of debt.

CHAPTER 1

Introduction to Accounting and Business

TAKE IT FURTHER TIF 1–1 1.

The car repair is a personal expense and is Marco’s personal responsibility. By using partnership funds to pay for the repair, Marco is behaving unethically because he is violating the business entity assumption. The business entity assumption treats the business as a separate entity from its owners. By taking money from the partnership for a personal expense, Marco is effectively stealing from his partners.

The partnership’s net income will be reduced by the $2,000 Marco has taken. This will reduce the amount of net income available to Marco’s partners.

Marco could ask his partners for a loan from the partnership. The loan could be repaid out of his salary or from his share of the partnership income.

CHAPTER 1

Introduction to Accounting and Business

TIF 1–2 1.

Acceptable professional conduct requires that Colleen Fernandez supply First Federal Bank with all the relevant financial statements necessary for the bank to make an informed decision. Therefore, Colleen should provide the complete set of financial statements. These can be supplemented with a discussion of the net loss in the past year or other data explaining why granting the loan is a good investment for the bank.

Owners are generally willing to provide bankers with information about the operating and financial condition of the business, such as the following: ●

Operating Information: ● Description of business operations ● Results of past operations ● Preliminary results of current operations ● Plans for future operations

●

Financial Condition: ● List of assets and liabilities (balance sheet) ● Estimated current values of assets ● Owner’s personal investment in the business ● Owner’s commitment to invest additional funds in the business

Owners are normally reluctant to provide the following types of information to bankers: Proprietary Operating Information. Such information, which might hurt ● the business if it becomes known by competitors, might include special processes used by the business or future plans to expand operations into areas that are not currently served by a competitor. ●

Personal Financial Information. Owners may have little choice here because banks often require owners of small businesses to pledge their personal assets as security for a business loan. Personal financial information requested by bankers often includes the owner’s net worth, salary, and other income. In addition, bankers usually request information about factors that might affect the personal financial condition of the owner. For example, a pending divorce by the owner might significantly affect the owner’s personal wealth.

Bankers typically want as much information as possible about the ability of the business and the owner to repay the loan with interest. Examples of such information are described above.

Both bankers and business owners share the common interest of the business doing well and being successful. If the business is successful, the bankers will receive their loan payments on time with interest, and the owners will increase their personal wealth.

CHAPTER 1

Introduction to Accounting and Business

TIF 1–3 A sample solution based on Twitter’s Form 10-K for the fiscal year ended December 31, 2016, follows: 1. Twitter, Inc. 2. San Francisco, CA 3. Jack Dorsey 4. Service 5. Twitter is a global platform for public self-expression and conversation in real time. Twitter allows people to consume, create, distribute and discover content and has democratized content creation and distribution. 6. Balance sheet, statement of operations (income statement), statement of comprehensive loss (discussed in Appendix 2 of Chapter 14), statement of stockholders’ equity, statement of cash flows.

TIF 1–4 Example Memo To: Teacher From: Student Date: Current Date Subject: Causes of Accounting Fraud Business and accounting fraud typically result from either a failure of individual character or a culture of greed within an organization. Managers and accountants often face pressure to meet or exceed a company’s financial goals. At times, supervisors can place pressure on individuals to violate accounting standards to improve a company’s reported financial results. Individuals who give in to these pressures exhibit a failure of individual character. In other situations, a company may indirectly encourage employees to violate accounting rules as part of their job. This occurs in organizations that do not value ethical decision making or fair financial reporting and exhibit a culture of ethical indifference.

TIF 1–5 The difference in the two bank balances, $55,000 ($80,000 – $25,000), may not be pure profit from an accounting perspective. To determine the accounting profit for the six-month period, the revenues for the period would need to be matched with the related expenses. The revenues minus the expenses would indicate whether the business generated net income (profit) or a net loss for the period. Using only the difference between the two bank account balances ignores such factors as amounts due from customers (receivables), liabilities (accounts payable) that need to be paid for wages or other operating expenses, additional investments that Dr. Cousins may have made in the business during the period, or dividends paid during the period that Dr. Cousins might have taken for personal reasons unrelated to the business.

CHAPTER 1

Introduction to Accounting and Business

TIF 1–5 (Concluded) Some businesses that have few, if any, receivables or payables may use a “cash” basis of accounting. The cash basis of accounting ignores receivables and payables because they are assumed to be insignificant in amount. However, even with the cash basis of accounting, additional investments during the period and any dividends paid during the period have to be considered in determining the net income (profit) or net loss for the period.

CHAPTER 2 ANALYZING TRANSACTIONS DISCUSSION QUESTIONS 1.

An account is a form designed to record changes in a particular asset, liability, stockholders’ equity, revenue, or expense. A ledger is a group of related accounts.

The terms debit and credit may signify either an increase or a decrease, depending upon the nature of the account. For example, debits signify an increase in asset, expense, and dividends accounts but a decrease in liability, common stock, retained earnings, and revenue accounts.

a. b.

Assuming no errors have occurred, the credit balance in the cash account resulted from writing checks for $1,850 in excess of the amount of cash on deposit. The $1,850 credit balance in the cash account as of December 31 is a liability owed to the bank. It is usually referred to as an “overdraft” and should be classified on the balance sheet as a liability.

a. b.

No. Errors may have been made that had the same erroneous effect on both debits and credits, such as failure to record and/or post a transaction, recording the same transaction more than once, and posting a transaction correctly but to the wrong account.

The listing of $9,800 is a transposition; the listing of $100 is a slide.

a. b.

The revenue was earned in October. (1) Debit Accounts Receivable and credit Fees Earned or another appropriately titled revenue account in October. (2) Debit Cash and credit Accounts Receivable in November.

No. Because the same error occurred on both the debit side and the credit side of the trial balance, the trial balance would not be out of balance. Yes. The trial balance would not balance. The error would cause the debit total of the trial balance to exceed the credit total by $90.

a. b.

The equality of the trial balance would not be affected. On the income statement, total operating expenses (salary expense) would be overstated by $7,500, and net income would be understated by $7,500. On the statement of stockholders’ equity, the beginning and ending retained earnings would be correct. However, net income and dividends would be understated by $7,500. These understatements offset one another, and thus, ending retained earnings is correct. The balance sheet is not affected by the error.

a. b.

The equality of the trial balance would not be affected. On the income statement, revenues (fees earned) would be overstated by $300,000, and net income would be overstated by $300,000. On the statement of stockholders’ equity, the beginning retained earnings would be correct. However, net income and ending retained earnings would be overstated by $300,000. The balance sheet total assets is correct. However, liabilities (notes payable) is understated by $300,000, and stockholders’ equity (retained earnings) is overstated by $300,000. The understatement of liabilities is offset by the overstatement of stockholders’ equity (retained earnings), and thus, total liabilities and stockholders’ equity is correct.

10.

a. b.

From the viewpoint of Surety Storage, the balance of the checking account represents an asset. From the viewpoint of Ada Savings Bank, the balance of the checking account represents a liability.

CHAPTER 2

Analyzing Transactions

BASIC EXERCISES BE 2–1 1. 2. 3. 4. 5. 6.

Debit and credit entries, normal credit balance Debit and credit entries, normal debit balance Debit entries only, normal debit balance Debit entries only, normal debit balance Debit entries only, normal debit balance Credit entries only, normal credit balance

BE 2–2 Feb.

13 Office Supplies Cash Accounts Payable

3,175

19 Cash Fees Earned

8,774

20 Dividends Cash

75,000

1,000 2,175

BE 2–3 Oct.

8,774

BE 2–4 May

75,000

BE 2–5 Using the following T account, solve for the amount of supplies expense (indicated by ? below). Supplies July 1 Bal. Supplies purchased July 31 Bal.

1,680 5,250 1,810

Supplies expense

$1,810 = $1,680 + $5,250 – Supplies expense Supplies expense = $1,680 + $5,250 – $1,810 = $5,120

BE 2–6 a.

The totals are equal because both the debit and credit entries were journalized and posted for $15,000.

b. The totals are unequal. The credit total is higher by $2,700 ($3,000 – $300). c.

The totals are unequal. The debit total is higher by $900 ($2,100 – $1,200). 2-2 © 2022 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 2

Analyzing Transactions

BE 2–7 a.

Journal Entry That Was Made in Error Accounts Receivable 10,700 Fees Earned 10,700

Journal Entry That Should Have Been Made Cash 10,700 Fees Earned 10,700

Comparison Cash instead of Accounts Receivable should have been debited.

Correcting Journal Entries 10,700

Cash Accounts Receivable

Journal Entry That Was Made in Error Office Equipment 4,300 Supplies

10,700

4,300

Journal Entry That Should Have Been Made Supplies 4,300 Accounts Payable

4,300

Comparison Supplies instead of Office Equipment should have been debited. Accounts Payable instead of Supplies should have been credited. The debit and credit amount of $4,300 is correct.

Correcting Journal Entry Supplies 4,300 Office Equipment Supplies 4,300 Accounts Payable

4,300 4,300

CHAPTER 2

Analyzing Transactions

BE 2–8 Paragon Company Income Statements For the Years Ended December 31

Fees earned Expenses Net income

20Y7

20Y6

$ 1,416,000 (1,044,000) $ 372,000

$1,200,000 (900,000) $ 300,000

Increase/(Decrease) Amount Percent

$216,000 144,000 $ 72,000

18.0% 16.0% 24.0%

CHAPTER 2

Analyzing Transactions

EXERCISES Ex. 2–1 Balance Sheet Accounts

Income Statement Accounts

Assets a Advanced Payments for Equipment Cash Flight Equipment Fuel Inventory Parts and Supplies Inventories Prepaid Expenses

Revenues Cargo Revenue Passenger Revenue Expenses Aircraft Fuel (Expense) Aircraft Maintenance (Expense) Aircraft Rent (Expense) d Contract Carrier Arrangements (Expense) Landing Fees (Expense)e Passenger Commissions (Expense)f

Liabilities Accounts Payable Air Traffic Liabilityb Frequent Flyer (Obligations)c Taxes Payable Stockholders’ Equity None a b c d e f

Advance payments (deposits) on aircraft to be delivered in the future Passenger ticket sales for future flights Obligations to provide frequent flyers future travel and other benefits Payments to other airlines for passenger travel under Delta tickets Fees paid to airports for landing rights Commissions paid to travel agents for passenger bookings

Ex. 2–2 Account

Account Number

Accounts Payable Accounts Receivable Cash Common Stock Dividends Fees Earned Land Miscellaneous Expense Retained Earnings Supplies Expense Wages Expense

21 12 11 31 33 41 13 53 32 52 51

Note: Expense accounts are normally listed in order of magnitude from largest to smallest with Miscellaneous Expense always listed last. Since Wages Expense is normally larger than Supplies Expense, Wages Expense is listed as account number 51 and Supplies Expense as account number 52. 2-5 © 2022 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 2

Analyzing Transactions

Ex. 2–3 Balance Sheet Accounts 11 12 13 14 15

Income Statement Accounts

1. Assets Cash Accounts Receivable Supplies Prepaid Insurance Equipment

4. Revenue 41 Fees Earned

51 52 53 59

2. Liabilities 21 Accounts Payable 22 Unearned Rent

5. Expenses Wages Expense Rent Expense Supplies Expense Miscellaneous Expense

3. Stockholders’ Equity 31 Common Stock 32 Retained Earnings 33 Dividends Note: The order of some of the accounts within the major classifications is somewhat arbitrary, as in accounts 13–14, accounts 21–22, and accounts 51–53. In a new business, the order of magnitude of balances in such accounts is not determinable in advance. The magnitude may also vary from period to period.

Ex. 2–4 a. b. c. d. e. f.

debit debit debit credit debit credit

g. h. i. j. k. l.

credit debit debit credit debit debit

Ex. 2–5 1. debit and credit entries (c) 2. debit and credit entries (c) 3. debit and credit entries (c) 4. credit entries only (b) 5. debit entries only (a) 6. debit entries only (a) 7. debit entries only (a)

CHAPTER 2

Analyzing Transactions

Ex. 2–6 a. b. c. d. e.

Liability—credit Asset—debit Asset—debit Stockholders’ equity (Common Stock)—credit Stockholders’ equity (Dividends)—debit

f. g. h. i. j.

Revenue—credit Asset—debit Expense—debit Asset—debit Expense—debit

Ex. 2–7 20Y2 Jan.

1 Rent Expense Cash

3,000

4 Advertising Expense Cash

2,500

5 Supplies Cash

1,800

6 Office Equipment Accounts Payable

13,900

12 Cash Accounts Receivable

14,770

20 Accounts Payable Cash

1,475

3,000

2,500

1,800

13,900

14,770

1,475

27 Miscellaneous Expense Cash

700

30 Utilities Expense Cash

610

700

610

31 Accounts Receivable Fees Earned

37,300 37,300

31 Utilities Expense Cash

900

31 Dividends Cash

800

900

800

CHAPTER 2

Analyzing Transactions

Ex. 2–8 a. JOURNAL Date

20Y9 Feb.

Post. Ref.

Description

11 Supplies Accounts Payable Purchased supplies on account.

Page

15 21

Debit

Credit

2,250 2,250

b., c., d. Account:

Date

20Y9 Feb.

Item

Date

Post. Ref.

20Y9 Feb.

 73

Debit

Credit

Debit

Balance Credit

400 2,650

2,250

Accounts Payable Item

Account No.

1 Balance 11

Account:

Supplies

Account No.

Post. Ref.

1 Balance 11

Debit

 73

Credit

Debit

Balance Credit

18,300 20,550

2,250

Yes, the rules of debit and credit apply to all companies.

Ex. 2–9 a. (1) (2) (3) (4)

Accounts Receivable Fees Earned

88,500

Supplies Accounts Payable

3,000

Cash Accounts Receivable

66,275

Accounts Payable Cash

1,950

88,500 3,000 66,275 1,950

CHAPTER 2

Analyzing Transactions

Ex. 2–9 (Concluded) b. (3)

Cash 66,275 (4)

(2)

Supplies 3,000

(1)

Accounts Receivable 88,500 (3)

1,950

(4)

Accounts Payable 1,950 (2)

3,000

Fees Earned (1)

88,500

66,275

No, an error may not have necessarily occurred. A credit balance in Accounts Receivable could occur if a customer overpaid his or her account. Regardless, the credit balance should be investigated to verify that an error has not occurred.

Ex. 2–10 a.

The increase of $270,800 ($1,245,000 – $974,200) in the cash account does not indicate net income of that amount. Net income is the net change in all assets and liabilities from operating (revenue and expense) transactions.

$150,200 ($421,000 – $270,800) or Cash X 974,200 1,245,000 421,000 X + $1,245,000 – $974,200 = $421,000 X = $421,000 – $1,245,000 + $974,200 X = $150,200

CHAPTER 2

Analyzing Transactions

Ex. 2–11 Accounts Payable Feb. 1 186,500 Feb. 28

X 201,400 59,900

X + $201,400 – $186,500 = $59,900 X = $59,900 + $186,500 – $201,400 X = $45,000 b. Oct.

Oct.

Accounts Receivable 115,800 X 130,770

449,600

$115,800 + X – $449,600 = $130,770 X = $130,770 + $449,600 – $115,800 X = $464,570 c. Apr.

Apr.

Cash 46,220 248,600 56,770

$46,220 + $248,600 – X = $56,770 X = $46,220 + $248,600 – $56,770 X = $238,050 Ex. 2–12 a.

Debit (negative) balance of $16,000 ($314,000 – $10,000 – $320,000). This negative balance means that the liabilities of the business exceed the assets.

Yes. The balance sheet prepared at December 31 will balance, with Retained Earnings being reported in the “Stockholders’ Equity” section as a debit (negative) balance of $16,000.

CHAPTER 2

Analyzing Transactions

Ex. 2–13 a. and b. Account Debited Transaction

Type

Account Credited

Effect

(1) (2) (3)

asset asset asset

+ + +

(4) (5) (6) (7) (8) (9)

expense asset liability asset expense dividend

+ + – + + +

Type

Effect

stockholders’ equity asset asset liability asset revenue asset asset asset asset

+ – – + – + – – – –

Ex. 2–14 (1) Cash Common Stock

50,000

(2) Supplies Cash

4,000

(3) Equipment Accounts Payable Cash

30,000

(4) Operating Expenses Cash

6,175

(5) Accounts Receivable Service Revenue

20,500

(6) Accounts Payable Cash

6,000

(7) Cash Accounts Receivable

13,100

(8) Operating Expenses Supplies

2,200

(9) Dividends Cash

1,500

50,000 4,000 20,000 10,000 6,175 20,500 6,000 13,100 2,200 1,500

CHAPTER 2

Analyzing Transactions

Ex. 2–15 a.

Crazy Mountain Tours Co. Unadjusted Trial Balance May 31, 20Y2 Debit Balances

Cash Accounts Receivable Supplies Equipment Accounts Payable Common Stock Dividends Service Revenue Operating Expenses

Credit Balances

35,425 7,400 1,800 30,000 14,000 50,000 1,500 20,500 8,375 84,500

84,500

Net income, $12,125 ($20,500 – $8,375)

CHAPTER 2

Analyzing Transactions

Ex. 2–16 Seaside Furniture Company Unadjusted Trial Balance August 31, 20Y5 Debit Balances

Cash Accounts Receivable Supplies Prepaid Insurance Land Accounts Payable Unearned Rent Notes Payable Common Stock Retained Earnings Dividends Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Insurance Expense Miscellaneous Expense

Credit Balances

426,800 660,500 11,200 21,600 1,850,000 118,600 12,000 75,000 150,000 1,814,400 36,000 4,330,000 2,950,000 390,000 82,000 23,700 18,000 30,200 6,500,000

6,500,000

Cash = $6,500,000 – $30,200 – $18,000 – $23,700 – $82,000 – $390,000 – $2,950,000 – $36,000 – $1,850,000 – $21,600 – $11,200 – $660,500 = $426,800

Ex. 2–17 Inequality of trial balance totals would be caused by errors described in (c) and (e). For (c), the debit total would exceed the credit total by $9,900 ($4,950 + $4,950). For (e), the credit total would exceed the debit total by $17,100 ($19,000 – $1,900). Errors (b), (c), (d), and (e) would require correcting entries. Although it is not a correcting entry, the entry that was not made in (a) should also be entered in the journal.

CHAPTER 2

Analyzing Transactions

Ex. 2–18 Ranger Co. Unadjusted Trial Balance August 31, 20Y1 Debit Balances

Cash Accounts Receivable Prepaid Insurance Equipment Accounts Payable Unearned Rent Common Stock Retained Earnings Dividends Service Revenue Wages Expense Advertising Expense Miscellaneous Expense

Credit Balances

15,500 46,750 12,000 190,000 24,600 5,400 40,000 70,000 13,000 385,000 213,000 16,350 18,400 525,000

525,000

Ex. 2–19 Error

(a) Out of Balance

(b) Difference

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

yes no yes yes no yes yes

$6,000 — 5,400 480 — 90 360

debit — credit debit — credit credit

CHAPTER 2

Analyzing Transactions

Ex. 2–20 1. 2. 3. 4. 5. 6.

The Debit column total is added incorrectly. The sum is $1,098,500 rather than $1,801,500. The trial balance should be dated “December 31, 20Y8,” not “For the Year Ending December 31, 20Y8.” The Accounts Receivable balance should be in the Debit column. The Accounts Payable balance should be in the Credit column. The Dividends balance should be in the Debit column. The Advertising Expense balance should be in the Debit column. A corrected trial balance would be as follows: Ensemble Co. Unadjusted Trial Balance December 31, 20Y8 Debit Balances

Cash Accounts Receivable Prepaid Insurance Equipment Accounts Payable Salaries Payable Common Stock Retained Earnings Dividends Service Revenue Salary Expense Advertising Expense Miscellaneous Expense

Credit Balances

42,900 123,500 27,000 300,000 52,000 4,800 40,000 137,200 5,000 1,216,000 660,000 275,000 16,600 1,450,000

1,450,000

CHAPTER 2

Analyzing Transactions

Ex. 2–21 a.

Journal Entry That Was Made in Error Insurance Expense 12,000 Prepaid Insurance

12,000

Journal Entry That Should Have Been Made Prepaid Insurance 12,000 Cash

12,000

Comparison Prepaid Insurance instead of Insurance Expense should have been debited. Cash instead of Prepaid Insurance should have been credited. The debit and credit amount of $12,000 is correct.

Correcting Journal Entries Prepaid Insurance Insurance Expense Prepaid Insurance Cash

12,000 12,000 12,000 12,000

Journal Entry That Was Made in Error Wages Expense 8,000 Cash

8,000

Journal Entry That Should Have Been Made Dividends 8,000 Cash

Comparison Dividends instead of Wages Expense should have been debited. The debit and credit amount of $8,000 is correct.

Correcting Journal Entry Dividends 8,000 Wages Expense

8,000

CHAPTER 2

Analyzing Transactions

Ex. 2–22 a.

Journal Entry That Was Made in Error Fees Earned 7,550 Cash

7,550

Journal Entry That Should Have Been Made Cash 7,550 Accounts Receivable

7,550

Comparison Cash instead of Fees Earned should have been debited. Accounts Receivable instead of Cash should have been credited. The debit and credit amount of $7,550 is correct.

Correcting Journal Entries Cash Fees Earned Cash Accounts Receivable

7,550 7,550 7,550 7,550

Journal Entry That Was Made in Error Supplies Expense 1,350 Accounts Payable

1,350

Journal Entry That Should Have Been Made Supplies 1,350 Cash

1,350

Comparison Supplies instead of Supplies Expense should have been debited. Cash instead of Accounts Payable should have been credited. The debit and credit amount of $1,350 is correct.

Correcting Journal Entries Accounts Payable 1,350 Supplies Expense Supplies 1,350 Cash

1,350 1,350

Note: The first entry reverses the incorrect entry, and the second entry is what should have been recorded initially. These two entries could have been combined into one entry; however, preparing two entries makes it easier for someone later to understand what happened and why the entries were necessary. 2-17 © 2022 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 2

Analyzing Transactions

PROBLEMS Prob. 2–1A 1. and 2.

Bal.

Cash 50,000 (b) 10,500 (c) (e) (f) (h) (i) (j) (m) (n) 28,800

(l)

Accounts Receivable 22,350

Common Stock (a)

50,000

(e)

Supplies 1,800

Professional Fees (g) (l) Bal.

10,500 22,350 32,850

(f)

Prepaid Insurance 3,600

(m)

Salary Expense 8,000

(c)

Automobiles 30,000

(k)

Blueprint Expense 5,500

(b)

Rent Expense 3,000

(n)

Automobile Expense 550

(h)

Miscellaneous Expense 1,500

(a) (g)

3,000 7,500 1,800 3,600 1,500 5,000 750 8,000 550

(d)

(j)

(i)

Equipment 9,500 Notes Payable 750 (c) Bal.

22,500 21,750

Accounts Payable 5,000 (d) (k) Bal.

9,500 5,500 10,000

CHAPTER 2

Analyzing Transactions

Prob. 2–1A (Concluded) 3.

Modern Architects Unadjusted Trial Balance January 31, 20Y4 Debit Balances

Cash Accounts Receivable Supplies Prepaid Insurance Automobiles Equipment Notes Payable Accounts Payable Common Stock Professional Fees Salary Expense Blueprint Expense Rent Expense Automobile Expense Miscellaneous Expense

Credit Balances

28,800 22,350 1,800 3,600 30,000 9,500 21,750 10,000 50,000 32,850 8,000 5,500 3,000 550 1,500 114,600

114,600

Net income, $14,300 ($32,850 – $8,000 – $5,500 – $3,000 – $550 – $1,500)

CHAPTER 2

Analyzing Transactions

Prob. 2–2A 1.

(a) (b) (c) (d) (e) (f)

(g) (h) (i)

Cash Common Stock

40,000

Rent Expense Cash

4,800

Supplies Accounts Payable

2,150

Accounts Payable Cash

1,100

Cash Sales Commissions

18,750

Automobile Expense Miscellaneous Expense Cash

1,580 800

Office Salaries Expense Cash

3,500

Supplies Expense Supplies

1,300

Dividends Cash

1,500

40,000 4,800 2,150 1,100 18,750

2,380 3,500 1,300 1,500

CHAPTER 2

Analyzing Transactions

Prob. 2–2A (Continued) 2. 4,800 1,100 2,380 3,500 1,500

Bal.

Cash 40,000 (b) 18,750 (d) (f) (g) (i) 45,470

Supplies 2,150 (h) 850

1,300

(a) (e)

(d)

Accounts Payable 1,100 (c) Bal. Common Stock (a)

(i)

2,150 1,050

40,000

Dividends 1,500

Sales Commissions (e)

(b)

Rent Expense 4,800

(g)

Office Salaries Expense 3,500

(f)

Automobile Expense 1,580

(h)

Supplies Expense 1,300

(f)

Miscellaneous Expense 800

18,750

CHAPTER 2

Analyzing Transactions

Prob. 2–2A (Concluded) 3.

Affordable Realty Unadjusted Trial Balance October 31, 20Y6 Debit Balances

Cash Supplies Accounts Payable Common Stock Dividends Sales Commissions Rent Expense Office Salaries Expense Automobile Expense Supplies Expense Miscellaneous Expense

Credit Balances

45,470 850 1,050 40,000 1,500 18,750 4,800 3,500 1,580 1,300 800 59,800

59,800

a. $18,750 b. $11,980 ($4,800 + $3,500 + $1,580 + $1,300 + $800) c. $6,770 ($18,750 – $11,980)

$5,270, which is the excess of net income of $6,770 over the dividends of $1,500.

CHAPTER 2

Analyzing Transactions

Prob. 2–3A 1. JOURNAL

20Y9 Nov.

Post. Ref.

Description

Date

11 31

50,000

1 Rent Expense Cash

53 11

4,000

6 Equipment Accounts Payable

16 22

15,000

8 Truck Cash Notes Payable

18 11 21

38,500

10 Supplies Cash

13 11

1,750

12 Cash Fees Earned

11 41

11,500

15 Prepaid Insurance Cash

14 11

2,400

23 Accounts Receivable Fees Earned

12 41

22,300

24 Truck Expense Accounts Payable

55 22

1,250

JOURNAL

20Y9 Nov.

Debit

1 Cash Common Stock

Credit

50,000

4,000

15,000

5,000 33,500

1,750

11,500

2,400

22,300

1,250 2

Page

Post. Ref.

Description

Date

Page

Debit

29 Utilities Expense Cash

54 11

4,500

29 Miscellaneous Expense Cash

59 11

1,000

Credit

4,500

1,000

CHAPTER 2

Analyzing Transactions

Prob. 2–3A (Continued) ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ 30 Cash 11 9,000 Accounts Receivable 12 9,000 30 Wages Expense Cash

51 11

6,800

30 Accounts Payable Cash

22 11

3,000

30 Dividends Cash

33 11

2,500

6,800

3,000

2,500

2. GENERAL LEDGER Cash

Account:

Item

Date

20Y9 Nov.

Post. Ref.

1 1 8 10 12 15 29 29 30 30 30 30

1 1 1 1 1 1 2 2 2 2 2 2

Debit

Credit

50,000 4,000 5,000 1,750 11,500 2,400 4,500 1,000 9,000 6,800 3,000 2,500

Accounts Receivable

Account:

Item

Date

20Y9 Nov.

Account No.

23 30

Balance Debit Credit

50,000 46,000 41,000 39,250 50,750 48,350 43,850 42,850 51,850 45,050 42,050 39,550 Account No.

Post. Ref.

1 2

Debit

Credit

22,300 9,000

Debit

Balance Credit

22,300 13,300

CHAPTER 2

Analyzing Transactions

Prob. 2–3A (Continued) Supplies

Account:

Item

Date

20Y9 Nov.

Item

Date

20Y9 Nov.

15 Equipment

Date

Item

1,750

Debit

Credit

2,400

Post. Ref.

Debit

Credit

15,000

Post. Ref.

Debit

Credit

38,500

Balance Credit

Balance Debit Credit

38,500 21

Account No.

Post. Ref.

Debit

Item

6 24 30

Debit

15,000

Credit

Debit

Balance Credit

33,500

Accounts Payable

Date

Account No.

Item

Account:

Balance Debit Credit

2,400

Notes Payable

Date

Account No.

Account:

20Y9 Nov.

Post. Ref.

Item

Date

20Y9 Nov.

Credit

Truck

Account:

20Y9 Nov.

Debit

Balance Debit Credit

Account No.

Account:

20Y9 Nov.

Post. Ref.

Prepaid Insurance

Account:

Account No.

33,500 22

Account No.

Post. Ref.

1 1 2

Debit

Credit

15,000 1,250 3,000

Balance Debit Credit

15,000 16,250 13,250

CHAPTER 2

Analyzing Transactions

Prob. 2–3A (Continued) Common Stock

Account:

Date

20Y9 Nov.

Item

Date

20Y9 Nov.

12 23

Post. Ref.

Debit

Credit

2,500

Post. Ref.

Debit

Credit

Date

Post. Ref.

Balance Credit

11,500 33,800

Debit

Credit

6,800

Post. Ref.

Debit

6,800

Credit

4,000

Debit

4,500

Balance Debit Credit

4,000 Account No.

Post. Ref.

Balance Debit Credit

Account No.

Item

Debit

11,500 22,300

Utilities Expense

Account:

Balance Debit Credit

Account No.

Item

2,500

Rent Expense

Date

50,000

Account No.

1 1

Item

Account:

20Y9 Nov.

50,000

Wages Expense

Date

Balance Debit Credit

Account No.

Item

Account:

20Y9 Nov.

Credit

Fees Earned

Date

20Y9 Nov.

Debit

Item

Account:

20Y9 Nov.

Post. Ref.

Dividends

Account:

Account No.

Credit

Debit

Balance Credit

4,500

CHAPTER 2

Analyzing Transactions

Prob. 2–3A (Continued) Truck Expense

Account:

Date

20Y9 Nov.

Item

Date

20Y9 Nov.

Post. Ref.

Balance Debit

Credit

1,250

Post. Ref.

Debit

Credit

1,250

Miscellaneous Expense

Account:

Account No.

Balance Debit

1,000

Credit

Debit

Credit

1,000

CHAPTER 2

Analyzing Transactions

Prob. 2–3A (Concluded) 3.

Heritage Designs Unadjusted Trial Balance November 30, 20Y9 Account No.

Cash Accounts Receivable Supplies Prepaid Insurance Equipment Truck Notes Payable Accounts Payable Common Stock Dividends Fees Earned Wages Expense Rent Expense Utilities Expense Truck Expense Miscellaneous Expense

11 12 13 14 16 18 21 22 31 33 41 51 53 54 55 59

Debit Balances

Credit Balances

39,550 13,300 1,750 2,400 15,000 38,500 33,500 13,250 50,000 2,500 33,800 6,800 4,000 4,500 1,250 1,000 130,550

130,550

$16,250 ($33,800 – $6,800 – $4,000 – $4,500 – $1,250 – $1,000)

Some supplies may have been used during November, but no supplies expense has been recorded. As will be discussed in Chapter 3, adjustments are necessary at the end of the accounting period to bring the accounts up to date. For example, adjustments for supplies used, insurance expired, and depreciation would probably be required by Heritage Designs. Note to Instructors: At this point, students have not been exposed to depreciation, but some insightful students might recognize the need for recording supplies used and insurance expired. You might use this as an opportunity to discuss what is coming in Chapter 3.

CHAPTER 2

Analyzing Transactions

Prob. 2–4A 2. and 3. JOURNAL

20Y3 Apr.

Post. Ref.

Description

Date

20Y3 Apr.

Debit

1 Rent Expense Cash

52 11

6,500

2 Office Supplies Accounts Payable

14 21

2,300

5 Prepaid Insurance Cash

13 11

6,000

10 Cash Accounts Receivable

11 12

52,300

15 Land Cash Notes Payable

16 11 23

200,000

17 Accounts Payable Cash

21 11

6,450

20 Accounts Payable Office Supplies

21 14

325

23 Advertising Expense Cash

53 11

4,300

JOURNAL Date

Credit

6,500

2,300

6,000

52,300

30,000 170,000

6,450

325

4,300 19

Page

Post. Ref.

Description

Page

Debit

27 Cash Salary and Commission Expense

11 51

2,500

28 Automobile Expense Cash

54 11

1,500

29 Miscellaneous Expense Cash

59 11

1,400

Credit

2,500

1,500

1,400

CHAPTER 2

Analyzing Transactions

Prob. 2–4A (Continued) ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ 30 Accounts Receivable 12 57,000 Fees Earned 41 57,000 30 Salary and Commission Expense Cash

51 11

11,900

30 Dividends Cash

33 11

4,000

30 Cash Unearned Rent

11 22

10,000

11,900

4,000

10,000

1. and 3. GENERAL LEDGER Account:

Cash Item

Date

20Y3 Apr.

1 Balance 1 5 10 15 17 23 27 28 29 30 30 30

Account:

Post. Ref.

 18 18 18 18 18 18 19 19 19 19 19 19

Debit

Credit

6,500 6,000 52,300 30,000 6,450 4,300 2,500 1,500 1,400 11,900 4,000 10,000

Accounts Receivable Item

Date

20Y3 Apr.

Account No.

1 Balance 10 30

Debit

Balance Credit

26,300 19,800 13,800 66,100 36,100 29,650 25,350 27,850 26,350 24,950 13,050 9,050 19,050 Account No.

Post. Ref.

 18 19

Debit

57,000

Balance Credit

Credit

Debit

52,300

61,500 9,200 66,200

CHAPTER 2

Analyzing Transactions

Prob. 2–4A (Continued) Prepaid Insurance

Account:

Item

Date

20Y3 Apr.

1 Balance 5

Date

20Y3 Apr.

Item

3,000 9,000

6,000

Post. Ref.

Debit

Credit

2,300 325

Post. Ref.

Debit

200,000

Credit

Item

Date

1 Balance 2 17 20

Post. Ref.

 18 18 18

Item

Date

Debit

Credit

Balance Credit

Balance Debit Credit

14,000 16,300 9,850 9,525

6,450 325

Account No.

Post. Ref.

Debit

Item

Date

Debit

2,300

Credit

Debit

Balance Credit

10,000

Notes Payable

Account:

1,800 4,100 3,775

Account No.

Unearned Rent

Account:

Balance Debit Credit

200,000

Accounts Payable

Account:

Account No.

20Y3 Apr.

Credit

Balance Debit Credit

Account No.

 18 18

Item

Date

20Y3 Apr.

Debit

Land

Account:

20Y3 Apr.

 18

1 Balance 2 20

20Y3 Apr.

Post. Ref.

Office Supplies

Account:

Account No.

10,000 23

Account No.

Post. Ref.

Debit

Credit

170,000

Balance Debit Credit

170,000

CHAPTER 2

Analyzing Transactions

Prob. 2–4A (Continued) Account:

Common Stock

Date

20Y3 Apr. Account:

Item

1 Balance

20Y3 Apr.

Item

1 Balance

Date

Item

1 Balance 30

Account:

1 Balance 30

Account:

Debit

Credit

1 Balance 27 30

Post. Ref.

Debit

Credit

Debit

Balance Credit

2,000 6,000

4,000

Account No.

Post. Ref.

 19 19

Item

Account No.

Debit

Credit

Balance Debit Credit

240,000 297,000

57,000

Debit

Account No.

Credit

2,500 11,900

Rent Expense

1 Balance 1

Balance Debit Credit

36,000

Salary and Commission Expense

Date

20Y3 Apr.

Post. Ref.

 19

Item

Account No.

 19

Item

Date

20Y3 Apr.

10,000

Fees Earned

Date

20Y3 Apr.

Credit



Dividends

Account:

Debit

Balance Debit Credit



Account:

20Y3 Apr.

Post. Ref.

Retained Earnings

Date

Account No.

Balance Debit Credit

148,200 145,700 157,600 Account No.

Post. Ref.

 18

Debit

6,500

Credit

Debit

Balance Credit

30,000 36,500

CHAPTER 2

Analyzing Transactions

Prob. 2–4A (Continued) Advertising Expense Account: Date

20Y3 Apr.

1 Balance 23

Account:

 18

Credit

Item

17,800 22,100

4,300

 19

Debit

Credit

Post. Ref.

Item

1 Balance 29

 19

Balance Debit Credit

5,500 7,000

1,500

Miscellaneous Expense

Date

Balance Debit Credit

Account No.

Post. Ref.

1 Balance 28

Account:

Debit

Automobile Expense

Date

20Y3 Apr.

Post. Ref.

Item

Account No.

Debit

Credit

Debit

Balance Credit

3,900 5,300

1,400

4. Elite Realty Unadjusted Trial Balance April 30, 20Y3

Cash Accounts Receivable Prepaid Insurance Office Supplies Land Accounts Payable Unearned Rent Notes Payable Common Stock Retained Earnings Dividends Fees Earned Salary and Commission Expense Rent Expense Advertising Expense Automobile Expense Miscellaneous Expense

Account No.

Debit Balances

11 12 13 14 16 21 22 23 31 32 33 41 51 52 53 54 59

19,050 66,200 9,000 3,775 200,000

Credit Balances

9,525 10,000 170,000 10,000 36,000 6,000 297,000 157,600 36,500 22,100 7,000 5,300 532,525

532,525

CHAPTER 2

Analyzing Transactions

Prob. 2–4A (Concluded) 5.

(a) The unadjusted trial balance in (4) still balances because the debits equaled the credits in the original journal entry. (b) The correcting entry for $7,200 ($19,100 – $11,900) would be as follows: JOURNAL Date

20Y3 Apr.

Post. Ref.

Description

30 Salary and Commission Expense Cash

Page

51 11

Debit

Credit

7,200 7,200

CHAPTER 2

Analyzing Transactions

Prob. 2–5A 1.

The Lexington Group Unadjusted Trial Balance May 31, 20Y6 Debit Balances

Cash Accounts Receivable Supplies Prepaid Insurance Equipment Notes Payable Accounts Payable Common Stock Retained Earnings Dividends Fees Earned Wages Expense Rent Expense Advertising Expense Gas, Electricity, and Water Expense Miscellaneous Expense

Credit Balances

18,750 53,500 2,225 7,400 171,175 45,000 36,000 50,000 89,150 20,000 429,850 270,000 60,300 25,200 16,350 5,100 650,000

650,000

Cash = $20,350 – $7,000 (a) + $5,400 (b) = $18,750

No. The trial balance indicates only that the debits and credits are equal. Any errors that have the same effect on debits and credits will not affect the balancing of the trial balance.

CHAPTER 2

Analyzing Transactions

Prob. 2–1B 1. and 2.

Bal.

Cash 18,000 (b) 12,000 (c) (d) (f) (h) (i) (l) (m) (n) (o) 14,475

(k)

Accounts Receivable 15,650

(d)

Supplies 1,450

(a) (g)

2,500 3,150 1,450 2,400 1,800 375 2,800 200 300 550

(h)

Accounts Payable 1,800 (e) (j) Bal.

6,500 2,500 7,200

Common Stock (a)

18,000

Professional Fees (g) (k) Bal.

12,000 15,650 27,650

(c)

Rent Expense 3,150

(l)

Salary Expense 2,800

(f)

Prepaid Insurance 2,400

(j)

Blueprint Expense 2,500

(b)

Automobiles 19,500

(o)

Automobile Expense 550

(e)

Equipment 6,500

(i) (m) Bal.

Miscellaneous Expense 375 200 575

(n)

Notes Payable 300 (b) Bal.

17,000 16,700

CHAPTER 2

Analyzing Transactions

Prob. 2–1B (Concluded) 3.

Jones Architects Unadjusted Trial Balance April 30, 20Y2 Debit Balances

Cash Accounts Receivable Supplies Prepaid Insurance Automobiles Equipment Notes Payable Accounts Payable Common Stock Professional Fees Rent Expense Salary Expense Blueprint Expense Automobile Expense Miscellaneous Expense

Credit Balances

14,475 15,650 1,450 2,400 19,500 6,500 16,700 7,200 18,000 27,650 3,150 2,800 2,500 550 575 69,550

69,550

Net income, $18,075 ($27,650 – $3,150 – $2,800 – $2,500 – $550 – $575)

CHAPTER 2

Analyzing Transactions

Prob. 2–2B 1.

(a) (b) (c) (d) (e) (f) (g)

(h) (i)

Cash Common Stock

17,500

Supplies Accounts Payable

2,300

Cash Sales Commissions

13,300

Rent Expense Cash

3,000

Accounts Payable Cash

1,150

Dividends Cash

1,800

Automobile Expense Miscellaneous Expense Cash

1,500 400

Office Salaries Expense Cash

2,800

Supplies Expense Supplies

1,050

17,500 2,300 13,300 3,000 1,150 1,800

1,900 2,800 1,050

CHAPTER 2

Analyzing Transactions

Prob. 2–2B (Continued) 2. 3,000 1,150 1,800 1,900 2,800

Bal.

Cash 17,500 (d) 13,300 (e) (f) (g) (h) 20,150

(b) Bal.

Supplies 2,300 (i) 1,250

1,050

(a) (c)

(e)

Accounts Payable 1,150 (b) Bal. Common Stock (a)

(f)

Dividends 1,800

2,300 1,150

17,500

Sales Commissions (c)

(d)

Rent Expense 3,000

(h)

Office Salaries Expense 2,800

(g)

Automobile Expense 1,500

(i)

Supplies Expense 1,050

(g)

Miscellaneous Expense 400

13,300

CHAPTER 2

Analyzing Transactions

Prob. 2–2B (Concluded) 3.

Planet Realty Unadjusted Trial Balance August 31, 20Y7 Debit Balances

Cash Supplies Accounts Payable Common Stock Dividends Sales Commissions Rent Expense Office Salaries Expense Automobile Expense Supplies Expense Miscellaneous Expense

Credit Balances

20,150 1,250 1,150 17,500 1,800 13,300 3,000 2,800 1,500 1,050 400 31,950

31,950

a. $13,300 b. $8,750 ($3,000 + $2,800 + $1,500 + $1,050 + $400) c. $4,550 ($13,300 – $8,750)

$2,750, which is the excess of net income of $4,550 over the dividends of $1,800.

CHAPTER 2

Analyzing Transactions

Prob. 2–3B 1. JOURNAL Date

20Y4 Oct.

Post. Ref.

Description

11 31

18,000

4 Rent Expense Cash

53 11

3,000

10 Truck Cash Notes Payable

18 11 21

23,750

13 Equipment Accounts Payable

16 22

10,500

14 Supplies Cash

13 11

2,100

15 Prepaid Insurance Cash

14 11

3,600

15 Cash Fees Earned

11 41

8,950

JOURNAL

20Y4 Oct.

Debit

1 Cash Common Stock

Date

Credit

18,000

3,000

3,750 20,000

10,500

2,100

3,600

8,950 2

Page

Post. Ref.

Description

Page

Debit

21 Accounts Payable Cash

22 11

2,000

24 Accounts Receivable Fees Earned

12 41

14,150

26 Truck Expense Accounts Payable

55 22

700

27 Utilities Expense Cash

54 11

2,240

Credit

2,000

14,150

700

2,240

CHAPTER 2

Analyzing Transactions

Prob. 2–3B (Continued) ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ 27 Miscellaneous Expense 59 1,100 Cash 11 1,100 29 Cash Accounts Receivable

11 12

7,600

30 Wages Expense Cash

51 11

4,800

31 Dividends Cash

33 11

3,500

7,600

4,800

3,500

2. GENERAL LEDGER Cash

Account:

Date

20Y4 Oct.

Item

1 4 10 14 15 15 21 27 27 29 30 31

Post. Ref.

1 1 1 1 1 1 2 2 2 2 2 2

Debit

Credit

18,000 3,000 3,750 2,100 3,600 8,950 2,000 2,240 1,100 7,600 4,800 3,500

Accounts Receivable

Account:

Item

Date

20Y4 Oct.

Account No.

24 29

Debit

Balance Credit

18,000 15,000 11,250 9,150 5,550 14,500 12,500 10,260 9,160 16,760 11,960 8,460 Account No.

Post. Ref.

2 2

Debit

Credit

14,150 7,600

Balance Debit Credit

14,150 6,550

CHAPTER 2

Analyzing Transactions

Prob. 2–3B (Continued) Supplies

Account:

Item

Date

20Y4 Oct.

Item

15 Equipment

Date

Item

Credit

3,600

Post. Ref.

Debit

Credit

10,500

Post. Ref.

Debit

Credit

23,750

Debit

Balance Credit

Balance Debit Credit

23,750 21

Account No.

Post. Ref.

Debit

Item

13 21 26

10,500

Credit

Debit

Balance Credit

20,000

Accounts Payable

Date

Balance Debit Credit

Account No.

Item

Account:

20Y4 Oct.

Debit

Notes Payable

Date

20Y4 Oct.

Post. Ref.

Account No.

Account:

Account No.

Item

Date

Balance Debit Credit

2,100

Truck

Account:

20Y4 Oct.

Credit

2,100

Account:

20Y4 Oct.

Debit

Date

20Y4 Oct.

Post. Ref.

Prepaid Insurance

Account:

Account No.

20,000 22

Account No.

Post. Ref.

Debit

1 2 2

Credit

10,500 2,000 700

Balance Debit Credit

10,500 8,500 9,200

CHAPTER 2

Analyzing Transactions

Prob. 2–3B (Continued) Common Stock

Account:

Date

20Y4 Oct.

Item

31 Fees Earned

Date

Item

15 24

Date

Post. Ref.

Debit

Credit

3,500

Debit

Credit

3,500 41

Balance Debit

Credit

Debit

Credit

8,950 14,150

8,950 23,100 51

Account No.

Post. Ref.

Balance Debit

Credit

4,800

Debit

Credit

4,800 53

Account No.

Post. Ref.

Item

18,000

Balance

Balance Debit

Credit

3,000

Debit

Credit

3,000

Utilities Expense

Date

Credit

Account No.

Item

Account:

20Y4 Oct.

Post. Ref.

Rent Expense

Account:

Debit

18,000

1 2

Item

Date

20Y4 Oct.

Credit

Wages Expense

Account:

20Y4 Oct.

Debit

Account No.

Account:

20Y4 Oct.

Balance

Item

Date

20Y4 Oct.

Post. Ref.

Dividends

Account:

Account No.

Post. Ref.

Balance Debit

2,240

Credit

Debit

Credit

2,240

CHAPTER 2

Analyzing Transactions

Prob. 2–3B (Continued) Truck Expense

Account:

Date

20Y4 Oct.

Item

Post. Ref.

Debit

Credit

700

Date

Item

Balance Debit Credit

Account No.

Post. Ref.

Debit

1,100

700

Miscellaneous Expense

Account:

20Y4 Oct.

Account No.

Credit

Balance Debit Credit

1,100

CHAPTER 2

Analyzing Transactions

Prob. 2–3B (Concluded) 3.

Pioneer Designs Unadjusted Trial Balance October 31, 20Y4 Account No.

11 12 13 14 16 18 21 22 31 33 41 51 53 54 55 59

Debit Balances

Credit Balances

8,460 6,550 2,100 3,600 10,500 23,750 20,000 9,200 18,000 3,500 23,100 4,800 3,000 2,240 700 1,100 70,300

70,300

$11,260 ($23,100 – $4,800 – $3,000 – $2,240 – $700 – $1,100)

Some supplies may have been used during October, but no supplies expense has been recorded. As will be discussed in Chapter 3, adjustments are necessary at the end of the accounting period to bring the accounts up to date. For example, adjustments for supplies used, insurance expired, and depreciation would probably be required by Pioneer Designs. Note to Instructors: At this point, students have not been exposed to depreciation, but some insightful students might recognize the need for recording supplies used and insurance expired. You might use this as an opportunity to discuss what is coming in Chapter 3.

CHAPTER 2

Analyzing Transactions

Prob. 2–4B 2. and 3. JOURNAL

20Y8 Aug.

Post. Ref.

Description

Date

20Y8 Aug.

Debit

1 Office Supplies Accounts Payable

14 21

3,150

2 Rent Expense Cash

52 11

7,200

3 Cash Accounts Receivable

11 12

83,900

5 Prepaid Insurance Cash

13 11

12,000

9 Accounts Payable Office Supplies

21 14

400

17 Advertising Expense Cash

53 11

8,000

23 Accounts Payable Cash

21 11

13,750

JOURNAL Date

Credit

3,150

7,200

83,900

12,000

400

8,000

13,750 19

Page

Post. Ref.

Description

Page

Debit

29 Miscellaneous Expense Cash

59 11

1,700

30 Automobile Expense Cash

54 11

2,500

31 Cash Salary and Commission Expense

11 51

2,000

31 Salary and Commission Expense Cash

51 11

53,000

Credit

1,700

2,500

2,000

53,000

CHAPTER 2

Analyzing Transactions

Prob. 2–4B (Continued) ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ 31 Accounts Receivable 12 183,500 Fees Earned 41 183,500 31 Land Cash Notes Payable

16 11 23

75,000

31 Dividends Cash

33 11

1,000

31 Cash Unearned Rent

11 22

5,000

7,500 67,500

1,000

5,000

1. and 3. GENERAL LEDGER Account:

Cash Item

Date

20Y8 Aug.

Post. Ref.

1 Balance 2 3 5 17 23 29 30 31 31 31 31 31

Account:

 18 18 18 18 18 19 19 19 19 19 19 19

Debit

Credit

7,200 83,900 12,000 8,000 13,750 1,700 2,500 2,000 53,000 7,500 1,000 5,000

Accounts Receivable Item

Date

20Y8 Aug.

Account No.

1 Balance 3 31

Debit

Balance Credit

52,500 45,300 129,200 117,200 109,200 95,450 93,750 91,250 93,250 40,250 32,750 31,750 36,750 Account No.

Post. Ref.

 18 19

Debit

Credit

83,900 183,500

Balance Debit Credit

100,100 16,200 199,700

CHAPTER 2

Analyzing Transactions

Prob. 2–4B (Continued) Prepaid Insurance

Account:

Item

Date

20Y8 Aug.

1 Balance 5

Date

20Y8 Aug.

Item

12,600 24,600

12,000

Post. Ref.

Debit

Credit

3,150 400

Post. Ref.

Debit

75,000

Credit

Item

Date

1 Balance 1 9 23

Post. Ref.

 18 18 18

Item

Date

Debit

Credit

Balance Credit

Balance Debit Credit

21,000 24,150 23,750 10,000

400 13,750

Account No.

Post. Ref.

Debit

Item

Date

Debit

3,150

Credit

Debit

Balance Credit

5,000

Notes Payable

Account:

2,800 5,950 5,550

Account No.

Unearned Rent

Account:

Balance Debit Credit

75,000

Accounts Payable

Account:

Account No.

20Y8 Aug.

Credit

Balance Debit Credit

Account No.

 18 18

Item

Date

20Y8 Aug.

Debit

Land

Account:

20Y8 Aug.

 18

1 Balance 1 9

20Y8 Aug.

Post. Ref.

Office Supplies

Account:

Account No.

5,000 23

Account No.

Post. Ref.

Debit

Credit

67,500

Balance Debit Credit

67,500

CHAPTER 2

Analyzing Transactions

Prob. 2–4B (Continued) Account:

Common Stock

Date

20Y8 Aug.

Item

1 Balance

Account:

20Y8 Aug.

Item

1 Balance 31

Account:

Item

Post. Ref.

Debit

Credit

1 Balance 2

Debit

Balance Credit

44,800 45,800

1,000

Account No.

Post. Ref.

 19 19

Item

Account No.

Debit

Credit

Balance Debit Credit

591,500 775,000

183,500

Debit

Account No.

Credit

2,000 53,000

Rent Expense

Date

20Y8 Aug.

Credit

Balance Debit Credit

70,000

 19

1 Balance 31 31

Account:

Debit

Salary and Commission Expense

Date

20Y8 Aug.

Post. Ref.

 19

Item

Account No.

Fees Earned

Date

20Y8 Aug.

17,500



1 Balance 31

Account:

Credit

Dividends

Date

20Y8 Aug.

Debit

Balance Debit Credit



1 Balance

Account:

Post. Ref.

Retained Earnings

Date

Account No.

Balance Debit Credit

385,000 383,000 436,000 Account No.

Post. Ref.

 18

Debit

7,200

Credit

Debit

Balance Credit

49,000 56,200

CHAPTER 2

Analyzing Transactions

Prob. 2–4B (Continued) Account:

Advertising Expense

Date

20Y8 Aug.

Account:

Item

1 Balance 17

Account:

 18

Item

1 Balance 30

Debit

Credit

1 Balance 29

Balance Credit

8,000

Account No.

Post. Ref.

 19

Item

Debit

Post. Ref.

Credit

 19

Balance Debit Credit

Account No.

1,700

15,750 18,250

2,500

Debit

32,200 40,200

Miscellaneous Expense

Date

20Y8 Aug.

Post. Ref.

Automobile Expense

Date

20Y8 Aug.

Account No.

Credit

Balance Debit Credit

5,250 6,950

CHAPTER 2

Analyzing Transactions

Prob. 2–4B (Concluded) 4. Valley Realty Unadjusted Trial Balance August 31, 20Y8

Account No.

Debit Balances

11 12 13 14 16 21 22 23 31 32 33 41 51 52 53 54 59

36,750 199,700 24,600 5,550 75,000

Credit Balances

10,000 5,000 67,500 17,500 70,000 45,800 775,000 436,000 56,200 40,200 18,250 6,950 945,000

945,000

(a) The unadjusted trial balance in (4) still balances because the debits equaled the credits in the original journal entry. (b) The correcting entry for $9,000 ($10,000 – $1,000) would be as follows: JOURNAL Date

20Y8 Aug.

Post. Ref.

Description

31 Dividends Cash

Page

33 11

Debit

Credit

9,000 9,000

CHAPTER 2

Analyzing Transactions

Prob. 2–5B 1.

Tech Support Services Unadjusted Trial Balance January 31, 20Y5 Debit Balances

Credit Balances

20,250 56,400 6,750 9,600 162,000 54,000 16,650 18,000 89,850 39,000 534,000 306,000 62,550 28,350 17,000 4,600 712,500

712,500

Cash = $25,550 – $8,000 (a) + $2,700 (b)

No. The trial balance indicates only that the debits and credits are equal. Any errors that have the same effect on debits and credits will not affect the balancing of the trial balance.

CHAPTER 2

Analyzing Transactions

CONTINUING PROBLEM 2. and 3. JOURNAL Date

20Y5 July

Post. Ref.

Description

Page

Debit

1 Cash Common Stock

11 31

5,000

1 Office Rent Expense Cash

51 11

1,750

1 Prepaid Insurance Cash

15 11

2,700

2 Cash Accounts Receivable

11 12

1,000

3 Cash Unearned Revenue

11 23

7,200

3 Accounts Payable Cash

21 11

250

4 Miscellaneous Expense Cash

59 11

900

5 Office Equipment Accounts Payable

17 21

7,500

8 Advertising Expense Cash

55 11

200

11 Cash Fees Earned

11 41

1,000

13 Equipment Rent Expense Cash

52 11

700

14 Wages Expense Cash

50 11

1,200

Credit

5,000

1,750

2,700

1,000

7,200

250

900

7,500

200

1,000

700

1,200

CHAPTER 2

Analyzing Transactions

Continuing Problem (Continued) 2. and 3. JOURNAL Date

20Y5 July

Post. Ref.

Description

Page

Debit

16 Cash Fees Earned

11 41

2,000

18 Supplies Accounts Payable

14 21

850

21 Music Expense Cash

54 11

620

22 Advertising Expense Cash

55 11

800

23 Cash Accounts Receivable Fees Earned

11 12 41

750 1,750

27 Utilities Expense Cash

53 11

915

28 Wages Expense Cash

50 11

1,200

29 Miscellaneous Expense Cash

59 11

540

30 Cash Accounts Receivable Fees Earned

11 12 41

500 1,000

31 Cash Fees Earned

11 41

3,000

31 Music Expense Cash

54 11

1,400

31 Dividends Cash

33 11

1,250

Credit

2,000

850

620

800

2,500

915

1,200

540

1,500

3,000

1,400

1,250

CHAPTER 2

Analyzing Transactions

Continuing Problem (Continued) 1. and 3. Cash

Account:

Item

Date

20Y5 July

1 1 1 1 2 3 3 4 8 11 13 14 16 21 22 23 27 28 29 30 31 31 31

Balance

Post. Ref.

 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 2

Debit

Credit

5,000 1,750 2,700 1,000 7,200 250 900 200 1,000 700 1,200 2,000 620 800 750 915 1,200 540 500 3,000 1,400 1,250

Accounts Receivable

Account:

Item

Date

20Y5 July

Account No.

1 2 23 30

Balance

Balance Debit Credit

3,920 8,920 7,170 4,470 5,470 12,670 12,420 11,520 11,320 12,320 11,620 10,420 12,420 11,800 11,000 11,750 10,835 9,635 9,095 9,595 12,595 11,195 9,945 Account No.

Post. Ref.

 1 2 2

Debit

Credit

1,000 1,750 1,000

Balance Debit Credit

1,000 — 1,750 2,750

—

CHAPTER 2

Analyzing Transactions

Continuing Problem (Continued) Supplies

Account:

Item

Date

20Y5 July

1 18

Balance

Item

Date

20Y5 July

Item

1 3 5 18

Balance

Date

Item

850

Post. Ref.

Debit

Credit

2,700

1 Balance 1

Balance Debit Credit

2,700

Post. Ref.

Debit

Credit

7,500

Balance Debit Credit

7,500 21

Account No.

Post. Ref.

Debit

 1 1 2

Credit

250

Balance Debit Credit

— 7,500 850

250 — 7,500 8,350 23

Account No.

Post. Ref.

Debit

Credit

Balance Debit Credit

7,200

Common Stock Item

Account No.

Date

20Y5 July

170 1,020

Unearned Revenue

Account:

Balance Debit Credit

Account No.

Date

Account:

Credit

Accounts Payable

Account:

20Y5 July

 2

Date

20Y5 July

Debit

Office Equipment

Account:

20Y5 July

Post. Ref.

Prepaid Insurance

Account:

Account No.

7,200 31

Account No.

Post. Ref.

Debit

 1

Credit

5,000

Debit

Balance Credit

4,000 9,000

CHAPTER 2

Analyzing Transactions

Continuing Problem (Continued) Dividends

Account:

Item

Date

20Y5 July

1 31

Date

Item

1 11 16 23 30 31

Date

Credit

Balance

Date

Item

1 1

Balance

1,250

Item

Date

1 13

Balance

Account No.

Post. Ref.

Debit

 1 2 2 2 2

Credit

Balance Debit Credit

6,200 7,200 9,200 11,700 13,200 16,200

1,000 2,000 2,500 1,500 3,000 Account No.

Post. Ref.

 1 2

Debit

Credit

Debit

Balance Credit

1,200 1,200

Account No.

Post. Ref.

 1

Debit

Post. Ref.

Credit

Balance Debit Credit

Account No.

 1

700

800 2,550

1,750

Debit

400 1,600 2,800

Equipment Rent Expense

Account:

Balance Debit Credit

500 1,750

Office Rent Expense

Account:

20Y5 July

Balance

Item

1 14 28

20Y5 July

 2

Debit

Wages Expense

Account:

20Y5 July

Post. Ref.

Fees Earned

Account:

20Y5 July

Balance

Account No.

Credit

Debit

Balance Credit

675 1,375

CHAPTER 2

Analyzing Transactions

Continuing Problem (Continued) Utilities Expense

Account:

Date

20Y5 July

Item

1 27

Date

Item

1 21 31

1 8 22

 2

Credit

Balance

Date

Item

Account:

Balance

915

 2 2

Debit

Credit

1,590 2,210 3,610

620 1,400

Account No.

Post. Ref.

Debit

 1 2

Credit

1 4 29

Debit

500 700 1,500

200 800

Debit

Credit

Debit

Miscellaneous Expense

Account No.

Balance

Debit

 1 2

900 540

Credit

Balance Credit

180

Post. Ref.

Balance Credit

Account No.

Post. Ref.

Balance Debit Credit



Item

Date

Balance Debit Credit

Account No.

Post. Ref.

300 1,215

Supplies Expense

Account:

20Y5 July

Balance

Item

Date

20Y5 July

Debit

Advertising Expense

Account:

20Y5 July

Post. Ref.

Music Expense

Account:

20Y5 July

Balance

Account No.

Balance Debit Credit

415 1,315 1,855

CHAPTER 2

Analyzing Transactions

Continuing Problem (Concluded) 4.

PS Music Unadjusted Trial Balance July 31, 20Y5 Account No.

Cash Accounts Receivable Supplies Prepaid Insurance Office Equipment Accounts Payable Unearned Revenue Common Stock Dividends Fees Earned Wages Expense Office Rent Expense Equipment Rent Expense Utilities Expense Music Expense Advertising Expense Supplies Expense Miscellaneous Expense

11 12 14 15 17 21 23 31 33 41 50 51 52 53 54 55 56 59

Debit Balances

Credit Balances

9,945 2,750 1,020 2,700 7,500 8,350 7,200 9,000 1,750 16,200 2,800 2,550 1,375 1,215 3,610 1,500 180 1,855 40,750

40,750

CHAPTER 2

Analyzing Transactions

MAKE A DECISION MAD 2–1 a. Amazon.com, Inc. Income Statements For the Years Ended December 31 (in millions)

Revenues: Product sales Service sales Total revenues Operating expenses: Cost of sales Fulfillment Technology and content Marketing General and administrative Other operating expense (income), net Total operating expenses Operating income

Increase/(Decrease) Amount Percent

Year 2

Year 1

$ 160,408 120,114 $ 280,522

$ 141,915 90,972 $ 232,887

$18,493 29,142 $47,635

13.0% 32.0% 20.5%

$(165,536) (40,232) (35,931) (18,878) (5,203)

$(139,156) (34,027) (28,837) (13,814) (4,336)

$26,380 6,205 7,094 5,064 867

19.0% 18.2% 24.6% 36.7% 20.0%

(201) $(265,981) $ 14,541

(296) $(220,466) $ 12,421

(95) $45,515 $ 2,120

(32.1)% 20.6% 17.1%

b. The horizontal analysis shows that total revenues increased by 20.5% between the two years, with a strong increase in service sales. Service sales are revenues earned from Amazon’s Web hosting, Web design, and order fulfillment services provided for other businesses. This part of Amazon apparently has been growing rapidly. Total operating expenses have grown by 20.6% between the two years, indicating that expenses are growing slightly more than revenues. The expense growth appears to be occurring across all the major expense categories. The net result is an increase in operating income between the two years of 17.1%.

CHAPTER 2

Analyzing Transactions

MAD 2–2 a. Chipotle Mexican Grill, Inc. Income Statements For the Years Ended December 31 (in thousands)

Revenue

Year 2 $ 5,586,369

Year 1 $ 4,864,985

Increase/(Decrease) Amount Percent $721,384 14.8%

Expenses: Food, beverage, packing Labor Rent (occupancy) General and administrative Other Total expenses Operating income

$(1,847,916) (1,472,060) (363,072) (451,552) (1,007,811) $(5,142,411) $ 443,958

$(1,600,760) (1,326,079) (347,123) (375,460) (957,195) $(4,606,617) $ 258,368

$247,156 145,981 15,949 76,092 50,616 $535,794 $185,590

15.4% 11.0% 4.6% 20.3% 5.3% 11.6% 71.8%

b. Revenue increased by 14.8% in Year 2, while total expenses increased by only 11.6%. Food, beverage, packing expense and labor increased by 15.4% and 11.0%, respectively. General and administrative expenses increased 20.3%, while rent and other expenses increased only 4.6% and 5.3%, respectively. Since the increase in total operating expenses of 11.6% was less than the increase in revenues of 14.8%, operating income increased by 71.8%. Overall, Year 2 operating results significantly improved over Year 1.

CHAPTER 2

Analyzing Transactions

MAD 2–3 a.

Vera Bradley, Inc. Income Statements For the Years Ended January 31 (in millions)

Revenue Expenses: Cost of merchandise sold Selling, general, admin. exp. (net) Total expenses Operating income

Year 2 $ 416.1

Year 1 $ 454.6

$(177.5) (211.5) $(389.0) $ 27.1

$(200.6) (239.0) $(439.6) $ 15.0

Increase/(Decrease) Amount Percent $(38.5) (8.5)% $(23.1) (27.5) $(50.6) $ 12.1

(11.5)% (11.5)% (11.5)% 80.7%

b. Operating income increased $12.1 million, or 80.7% in Year 2. This is a significant increase and would be viewed favorably by stockholders. Although revenue decreased by 8.5% ($38.5 million), it was more than offset by a larger decrease of 11.5% in cost of merchandise sold and selling, general, administrative expenses. While operating income increased, stockholders might be concerned about decreasing revenues.

MAD 2–4 a. 1. Revenue: $75,356 – $72,714 = $2,642 $2,642 $72,714

= 3.6%

2. Operating expenses: $71,246 – $68,490 = $2,756 $2,756 $68,490

= 4.0%

3. Operating income: $4,110 – $4,224 = $(114) $(114) $4,224 b.

= (2.7)%

The revenue increased by 3.6% between the two years, while the operating expenses grew by 4.0%. Thus, expenses grew more than revenues. As a result, operating income decreased (2.7)% in Year 2.

CHAPTER 2

Analyzing Transactions

MAD 2–5 a. 1. Revenue: $514,405 – $500,343 = $14,062 $14,062 $500,343 2.

Operating expenses: $492,448 – $479,906 = $12,542 $12,542 $479,906

= 2.8%

= 2.6%

Operating income: $21,957 – $20,437 = $1,520 $1,520 $20,437

= 7.4%

b. Revenue increased by 2.8%, while operating expenses increased 2.6%. As a result, operating income increased by 7.4%, which is a favorable change in Year 2.

MAD 2–6 Target’s revenue increased by 3.6%, which is more than Walmart’s increase in revenue of 2.8%. However, Target’s expenses increased by 4.0%, while Walmart’s expenses increased by only 2.6%. As a result, Target’s operating income decreased by 2.7%, while Walmart’s operating income increased by 7.4%. Overall, Walmart had better operating results in Year 2. Target should focus its attention on why its operating expenses increased more than its revenues.

CHAPTER 2

Analyzing Transactions

TAKE IT FURTHER TIF 2–1 1.

No. For financial accounting information to be useful, it must accurately reflect an entity’s business transactions and economic activity. For this to happen, each account must reflect the increases or decreases that result from each transaction. If the trial balance does not balance, it means that a transaction has not been accurately recorded in the accounts. By knowingly submitting a trial balance that does not accurately reflect the transactions in the accounts, Buddy is demonstrating a failure of individual character and is acting unethically.

The users of the financial information who rely upon this information will be affected, as the information will not be a faithful representation of the entity’s economic activity.

Buddy should have discussed the issue with his supervisor and asked for more time to find the error.

TIF 2–2 A sample solution based on Apple Inc.’s Form 10-K for the fiscal year ended September 28, 2019, follows: 1. 2. 3. 4. 5. 6.

$338,516 million $248,028 million $90,488 million ($338,516 million total assets – $248,028 million total liabilities) 3 2 The income statement reports a summary of revenues and expenses for a specific period of time, such as a month or a year. The balance sheet reports a list of assets, liabilities, and stockholders’ equity as of a specific date, usually at the close of the last day of a month or a year.

CHAPTER 2

Analyzing Transactions

TIF 2–3 Note to Instructors: The purpose of this activity is to familiarize students with the job opportunities available in accounting, and allow them to demonstrate their ability to communicate the role of accounting in the context of a specific position that requires knowledge of accounting. An example of an advertisement for such a position is shown below. Individual student answers will vary depending on the specific scenario they select. ABOUT THE COMPANY Our client is looking to add a Financial Analyst. With a large and growing finance team, there is significant opportunity for growth and advancement within the department. The company boasts a team-oriented culture and provides its employees with the tools and training necessary to perform. Our client is looking to bring on more of a junior-level candidate who is looking to gain experience in his or her field of study. There will be hands-on training for the role that will evolve from a data analyst into a financial analyst and will be reporting to the director of finance. Our client is in the consumer goods industry and is an international company that has multiple opportunities for growth. RESPONSIBILITIES OF THE FINANCIAL ANALYST The Financial Analyst will: • Conduct special studies to analyze complex financial actions and prepare recommendations for policy, procedure, control, or action. • Analyze financial information to determine present and future financial performance. • Evaluate complex profit plans, operating records, and financial statements. • Direct preparation of studies, reports, analyses, and recommendations in areas such as budgets, forecasts, financial plans, statistical reports, and business forecasts. • Coordinate with all levels of management to gather, analyze, summarize, and prepare recommendations regarding financial plans, trended future requirements, and operating forecasts. Source: CareerBuilder.com

CHAPTER 2

Analyzing Transactions

TIF 2–4 The following general journal entry should be used to record the receipt of tuition payments received in advance of classes: Cash…………………………………………………………………… Unearned Tuition Deposits……………………………………

XXX XXX

Cash is an asset account, and Unearned Tuition Deposits is a liability account. As the classes are taught throughout the term, the unearned tuition deposits become earned revenue.

TIF 2–5 The journal is called the book of original entry. It provides a time-ordered history of the transactions that have occurred for the firm. This time-ordered history is very important because it allows one to trace ledger account balances back to the original transactions that created those balances. This is called an “audit trail.” If the firm recorded transactions by posting to ledgers directly, it would be nearly impossible to reconstruct actual transactions. The debits and credits would all be separated and accumulated into the ledger balances. Once the transactions become part of the ledger balances, the original transactions would be lost. That is, there would be no audit trail, and any errors that might occur in recording transactions would be almost impossible to trace. Thus, firms first record transaction debits and credits in a journal. These transactions are then posted to the ledger to update the account balances. The journal and ledger are linked using posting references. This allows an analyst to trace the transaction flow forward or backward, depending on the need.

CHAPTER 2

Analyzing Transactions

TIF 2–6 1.

The rules of debit and credit must be memorized. Dot is correct in that the rules of debit and credit could be reversed as long as everyone accepted and abided by the rules. However, the important point is that everyone accepts the rules as the way in which transactions should be recorded. This generates uniformity across the accounting profession and reduces errors and confusion. Because the current rules of debit and credit have been used for centuries, Dot should adapt to the current rules of debit and credit, rather than devise her own. The primary reason that all accounts do not have the same rules for increases and decreases is for control of the recording process. The doubleentry accounting system, which includes both (1) the rules of debit and credit and (2) the accounting equation, guarantees that (1) debits always equal credits and (2) assets always equal liabilities plus owner’s equity. If all increases in the account were recorded by debits, then the control that debits always equal credits would be removed. In addition, the control that the normal balance of assets is a debit would also be removed. The accounting equation would still hold, but the control over recording transactions would be weakened. Dot is correct that we could call the left and right sides of an account different terms, such as “LE” or “RE.” Again, centuries of tradition dictate the current terminology used. One might note, however, that in Latin, debere (debit) means left and credere (credit) means right.

The accounting system may be designed to capture information about the buying habits of various customers or vendors, such as the quantity normally ordered, average amount ordered, number of returns, etc. Thus, in a sense, there can be other “sides” of (information about) a transaction that are recorded by the accounting system. Such information would be viewed as supplemental to the basic double-entry accounting system.

CHAPTER 3 THE ADJUSTING PROCESS DISCUSSION QUESTIONS 1.

Under the cash basis of accounting, revenues are reported in the period in which cash is received and expenses are reported in the period in which cash is paid.

Under the accrual basis of accounting, revenues are reported in the period in which they are earned and expenses are reported in the same period as the revenues to which they relate.

The matching concept is related to the accrual basis of accounting.

Adjusting entries are necessary at the end of an accounting period to bring the ledger up to date.

Adjusting entries bring the ledger up to date as a normal part of the accounting cycle. Correcting entries correct errors in the ledger.

Four different categories of adjusting entries include prepaid expenses (deferred expenses), unearned revenues (deferred revenues), accrued expenses (accrued liabilities), and accrued revenues (accrued assets).

Statement (a): Increases the balance of a revenue account.

Statement (b): Increases the balance of an expense account.

Yes, because every adjusting entry affects expenses or revenues.

The rights acquired represent an asset.

The justification for debiting Rent Expense is that when the ledger is summarized in a trial balance at the end of the month and statements are prepared, the rent will have become an expense. Hence, no adjusting entry will be necessary.

The portion of the cost of a fixed asset deducted from revenue of the period is debited to Depreciation Expense. It is the expired cost for the period. The reduction in the fixed asset account is recorded by a credit to Accumulated Depreciation rather than to the fixed asset account. The use of the contra asset account facilitates the presentation of original cost and accumulated depreciation on the balance sheet.

Depreciation Expense—debit balance; Accumulated Depreciation—credit balance.

No, it is not customary for the balances of the two accounts to be equal in amount.

Depreciation Expense appears on the income statement; Accumulated Depreciation appears on the balance sheet.

10.

CHAPTER 3

The Adjusting Process

BASIC EXERCISES BE 3–1 a. No b. No

c. d.

No No

e. f.

BE 3–2 a. Prepaid expense b. Unearned revenue

c. d.

Yes Yes

Accrued expense Accrued revenue

BE 3–3 Accounts Receivable Fees Earned Accrued fees.

6,750 6,750

BE 3–4 Salaries Expense Salaries Payable Accrued salaries [($34,500 ÷ 6 days) × 5 days].

28,750 28,750

BE 3–5 Dec. 31 Unearned Rent Rent Revenue Rent earned [($9,000 ÷ 12 months) × 7 months].

5,250 5,250

BE 3–6 Insurance Expense Prepaid Insurance Insurance expired ($6,000 + $12,500 – $13,000).

5,500 5,500

BE 3–7 Depreciation Expense Accumulated Depreciation—Equipment Depreciation on equipment.

33,200 33,200

CHAPTER 3

The Adjusting Process

BE 3–8 a. Revenues were understated by $7,500. b. Expenses were understated by $13,300 ($2,000 + $11,300). c. Net income was overstated by $5,800 ($13,300 – $7,500).

BE 3–9 a.

The totals are equal even though the credit should have been to Wages Payable instead of Accounts Payable.

b. The totals are unequal. The credit total is higher by $27 ($1,152 – $1,125).

BE 3–10 a.

Cornea Company Income Statements For the Years Ended December 31 20Y9

Fees earned Expenses Net income

20Y8

Amount

Percent

Amount

Percent

$1,640,000 (869,200) $ 770,800

100% (53)% 47%

$1,300,000 (715,000) $ 585,000

100% (55)% 45%

b. A favorable change of decreasing operating expenses and increasing operating income is indicated.

CHAPTER 3

The Adjusting Process

EXERCISES Ex. 3–1 1. 2. 3. 4.

Prepaid expense Accrued revenue Unearned revenue Accrued expense

5. 6. 7. 8.

Unearned revenue Prepaid expense Accrued expense Accrued expense

Ex. 3–2 Account

Answer

Accounts Receivable………………………Normally requires adjustment (AR). Building……………………………………… Does not normally require adjustment. Cash……………………………………………Does not normally require adjustment. Common Stock………………………………Does not normally require adjustment. Interest Receivable…………………………Normally requires adjustment (AR). Land……………………………………………Does not normally require adjustment. Prepaid Rent…………………………………Normally requires adjustment (PE). Salaries Payable…………………………… Normally requires adjustment (AE). Supplies………………………………………Normally requires adjustment (PE). Unearned Fees………………………………Normally requires adjustment (UR). Normally requires adjustment (AE). Wages Expense………………………………

Ex. 3–3 a.

Accounts Receivable Fees Earned Accrued fees.

17,950 17,950

No. If the cash basis of accounting is used, revenues are recognized only when the cash is received. Therefore, earned but unbilled revenues would not be be recognized in the accounts, and no adjusting entry would be necessary.

Ex. 3–4 a.

Wages Expense (or expenses) will be understated. Net income will be overstated.

Wages Payable (or liabilities) will be understated. Stockholders’ equity (Retained Earnings) will be overstated.

CHAPTER 3

The Adjusting Process

Ex. 3–5 a.

Salaries Expense Salaries Payable Accrued salaries [($18,500 ÷ 5 days) × 1 day].

3,700

Salaries Expense Salaries Payable Accrued salaries [($18,500 ÷ 5 days) × 4 days].

14,800

3,700

14,800

Ex. 3–6 $47,450 ($54,750 – $7,300)

Ex. 3–7 a.

Salary Expense (or expenses) will be understated. Net income will be overstated.

Salaries Payable (or liabilities) will be understated. Stockholders’ equity (Retained Earnings) will be overstated.

Ex. 3–8 a.

Salary Expense (or expenses) will be overstated. Net income will be understated.

The balance sheet will be correct. This is because salaries payable has been satisfied, and the net income errors for the two years have offset each other. Thus, stockholders’ equity (Retained Earnings) is correct on December 31, 20Y6.

Ex. 3–9 Unearned Fees Fees Earned Fees earned ($18,000 – $3,600).

14,400 14,400

Ex. 3–10 a.

Rent Revenue (or revenues) will be understated. Net income will be understated.

Unearned Rent (liabilities) will be overstated. Stockholders’ equity (Retained Earnings) at the end of the period will be understated.

CHAPTER 3

The Adjusting Process

Ex. 3–11 Supplies Expense Supplies Supplies used ($5,175 – $615).

4,560 4,560

Ex. 3–12 $9,670 ($2,550 + $7,120) Ex. 3–13 a.

Insurance Expense (or expenses) will be understated. Net income will be overstated.

Prepaid Insurance (or assets) will be overstated. Stockholders’ equity (Retained Earnings) will be overstated.

Ex. 3–14 a.

Insurance Expense Prepaid Insurance Insurance expired.

18,000

Insurance Expense Prepaid Insurance Insurance expired ($22,500 – $4,500).

18,000

Ex. 3–15 a.

Insurance Expense Prepaid Insurance Insurance expired ($3,000 + $32,500 – $4,800).

30,700

Insurance Expense Prepaid Insurance Insurance expired.

30,700

Ex. 3–16 a.

Unearned Fees Fees Earned Unearned fees earned during year.

39,750

Accounts Receivable Fees Earned Accrued fees earned.

24,650

39,750

24,650

CHAPTER 3

The Adjusting Process

Ex. 3–17 a.

Dec.

31 Taxes Expense Prepaid Taxes Prepaid taxes expired [($18,480 ÷ 12 months) × 8 months].

12,320

31 Taxes Expense Taxes Payable Accrued taxes.

45,000

12,320

45,000

$57,320 ($12,320 + $45,000)

Ex. 3–18 Depreciation Expense Accumulated Depreciation—Equipment Depreciation on equipment.

66,290 66,290

Ex. 3–19 a.

$1,075,000 ($3,150,000 – $2,075,000)

No. Depreciation is an allocation of the cost of the equipment to the periods benefiting from its use. It does not necessarily relate to value or loss of value.

Ex. 3–20 a.

$36,477 million ($71,807 – $35,330)

No. Depreciation is an allocation method, not a valuation method. That is, depreciation allocates the cost of a fixed asset over its useful life. Depreciation does not attempt to measure market values, which may vary significantly from year to year.

Ex. 3–21 Income: $7,913 million ($4,737 + $3,176)

Ex. 3–22 a.

$609 million

62.2% ($609 ÷ $979)

CHAPTER 3

The Adjusting Process

Ex. 3–23 Error (a) OverUnderstated stated $ 0 $34,900 0 0 0 34,900 0 0 34,900 0 0 34,900

1. Revenue for the year would be 2. Expenses for the year would be 3. Net income for the year would be 4. Assets at July 31 would be 5. Liabilities at July 31 would be 6. Stockholders’ equity at July 31 would be

Error (b) OverUnderstated stated $ 0 $ 0 0 12,770 12,770 0 0 0 0 12,770 12,770 0

Ex. 3–24 $218,530 ($196,400 + $34,900 – $12,770)

Ex. 3–25 a. Dec.

Depreciation Expense Accumulated Depreciation—Equipment Depreciation on equipment.

13,900 13,900

(1)

Depreciation Expense would be understated. Net income would be overstated.

(2)

Accumulated Depreciation would be understated, and total assets would be overstated. Stockholders’ equity (Retained Earnings) would be overstated.

CHAPTER 3

The Adjusting Process

Ex. 3–26 1.

Accounts Receivable Fees Earned Accrued fees earned.

Supplies Expense Supplies Supplies used.

Insurance Expense Prepaid Insurance Insurance expired.

Depreciation Expense Accumulated Depreciation—Equipment Equipment depreciation.

Wages Expense Wages Payable Accrued wages.

CHAPTER 3

The Adjusting Process

Ex. 3–27 1.

The accountant debited Accounts Receivable for $5,000 but did not credit Laundry Revenue. This adjusting entry represents accrued laundry revenue.

The accountant debited rather than credited Laundry Supplies for $3,000.

The accountant credited the prepaid insurance account for $3,600, but debited the insurance expense account for only $600.

The accountant credited Laundry Equipment for the depreciation expense of $13,000 instead of crediting the accumulated depreciation account.

The accountant did not debit Wages Expense for $1,000.

The corrected adjusted trial balance is shown below. Eva’s Laundry Adjusted Trial Balance May 31, 20Y9 Debit Balances

Cash Accounts Receivable Laundry Supplies Prepaid Insurance Laundry Equipment Accumulated Depreciation—Laundry Equipment Accounts Payable Wages Payable Common Stock Retained Earnings Dividends Laundry Revenue Wages Expense Rent Expense Utilities Expense Depreciation Expense Laundry Supplies Expense Insurance Expense Miscellaneous Expense

Credit Balances

7,500 23,250 750 1,600 190,000 61,000 9,600 1,000 35,000 75,300 28,775 187,100 50,200 25,575 18,500 13,000 3,000 3,600 3,250 369,000

369,000

CHAPTER 3

The Adjusting Process

PROBLEMS Prob. 3–1A 1. Oct.

31 Supplies Expense Supplies Supplies used ($8,125 – $1,150).

6,975

31 Unearned Rent Rent Revenue Rent earned ($7,000 ÷ 4 months).

1,750

31 Wages Expense Wages Payable Accrued wages.

3,500

31 Accounts Receivable Fees Earned Accrued fees earned.

23,000

31 Depreciation Expense Accumulated Depreciation—Office Equipment Depreciation expense.

3,000

6,975

1,750

3,500

23,000

3,000

2. Adjusting entries are a planned part of the accounting process to update the accounts. Correcting entries are not planned but arise only when necessary to correct errors.

CHAPTER 3

The Adjusting Process

Prob. 3–2A 1. July

31 Accounts Receivable Fees Earned Accrued fees earned.

11,150

31 Supplies Expense Supplies Supplies used ($3,350 – $900).

2,450

31 Rent Expense Prepaid Rent Prepaid rent expired.

6,000

31 Depreciation Expense Accumulated Depreciation—Equipment Equipment depreciation.

8,950

31 Unearned Fees Fees Earned Fees earned ($12,000 – $2,000).

10,000

31 Wages Expense Wages Payable Accrued wages.

4,840

11,150

2,450

6,000

8,950

10,000

4,840

2. Fees Earned would be understated by $11,150; Wages Expense would be understated by $4,840; and net income would be understated by $6,310 ($11,150 – $4,840). 3. Accounts Receivable would be understated by $11,150; total assets would be understated by $11,150; Wages Payable would be understated by $4,840; total liabilities would be understated by $4,840; Retained Earnings would be understated by $6,310 ($11,150 – $4,840); and total liabilities and stockholders’ equity would be understated by $11,150 ($6,310 + $4,840). 4. There is no effect on the “Net increase or decrease in cash” on the statement of cash flows because adjusting entries do not affect cash.

CHAPTER 3

The Adjusting Process

Prob. 3–3A 1. 20Y3 Nov.

30 Accounts Receivable Fees Earned Accrued fees earned.

10,500

30 Supplies Expense Supplies Supplies used ($16,200 – $1,175).

15,025

30 Depreciation Expense Accumulated Depreciation—Equipment Equipment depreciation.

9,500

30 Unearned Fees Fees Earned Fees earned.

16,800

30 Wages Expense Wages Payable Accrued wages.

2,400

10,500

15,025

9,500

16,800

2,400

2. Revenues…………………………… $369,750 296,350 ($144,500 + $92,000 + $51,750 + $8,100) Expenses…………………………… Net Income…………………………… $ 73,400 3. Revenues…………………………… $397,050 ($369,750 + $10,500 + $16,800) 323,275 ($296,350 + $15,025 + $9,500 + $2,400) Expenses…………………………… Net Income…………………………… $ 73,775 4. The effect of the adjusting entries on Retained Earnings is the difference in net income in (2) and (3) of $375 ($73,775 – $73,400), which increases Retained Earnings.

CHAPTER 3

The Adjusting Process

Prob. 3–4A 20Y6 June

30 Supplies Expense Supplies Supplies used ($11,250 – $2,400).

8,850

30 Insurance Expense Prepaid Insurance Insurance expired ($14,250 – $3,850).

10,400

30 Depreciation Expense—Equipment Accumulated Depreciation—Equipment Equipment depreciation ($106,100 – $94,500).

11,600

30 Depreciation Expense—Automobiles Accumulated Depreciation—Automobiles Automobile depreciation ($62,050 – $54,750).

7,300

30 Utilities Expense Accounts Payable Accrued utilities expense ($26,130 – $24,930, or $14,100 – $12,900).

1,200

30 Salary Expense Salaries Payable Accrued salary ($525,000 – $516,900).

8,100

30 Unearned Service Fees Service Fees Earned Service fees earned ($18,000 – $9,000, or $742,800 – $733,800).

9,000

8,850

10,400

11,600

7,300

1,200

8,100

9,000

CHAPTER 3

The Adjusting Process

Prob. 3–5A 1. 20Y1 Aug. 31 Insurance Expense Prepaid Insurance Insurance expired ($7,200 – $1,800).

5,400 5,400

31 Supplies Expense Supplies Supplies used ($1,980 – $300).

1,680

31 Depreciation Expense—Building Accumulated Depreciation—Building Building depreciation.

7,500

31 Depreciation Expense—Equipment Accumulated Depreciation—Equipment Equipment depreciation.

6,000

31 Unearned Rent Rent Revenue Rent revenue earned ($6,750 – $2,250).

4,500

31 Salaries and Wages Expense Salaries and Wages Payable Accrued salaries and wages.

2,175

31 Accounts Receivable Fees Earned Accrued fees earned.

12,700

1,680

7,500

6,000

4,500

2,175

12,700

CHAPTER 3

The Adjusting Process

Prob. 3–5A (Concluded) 2. Martin Editing Company Adjusted Trial Balance August 31, 20Y1 Debit Balances

Cash Accounts Receivable Prepaid Insurance Supplies Land Building Accumulated Depreciation—Building Equipment Accumulated Depreciation—Equipment Accounts Payable Unearned Rent Salaries and Wages Payable Common Stock Retained Earnings Dividends Fees Earned Rent Revenue Salaries and Wages Expense Utilities Expense Advertising Expense Repairs Expense Depreciation Expense—Building Depreciation Expense—Equipment Insurance Expense Supplies Expense Miscellaneous Expense

Credit Balances

7,500 51,100 1,800 300 112,500 150,250 95,050 135,300 103,950 12,150 2,250 2,175 75,000 146,000 15,000 337,300 4,500 195,545 42,375 22,800 17,250 7,500 6,000 5,400 1,680 6,075 778,375

778,375

CHAPTER 3

The Adjusting Process

Prob. 3–6A 2,750

1. Apr. 30 Supplies Expense Supplies Supplies used.

2,750

30 Accounts Receivable Fees Earned Accrued fees earned.

23,700

30 Depreciation Expense Accumulated Depreciation—Equipment Equipment depreciation.

1,800

30 Wages Expense Wages Payable Accrued wages.

1,400

23,700

1,800

1,400

Reported amounts Corrections: Supplies used Unbilled fees earned Equipment depreciation Accrued wages Corrected amounts

Total Liabilities

Total Stockholders’ + Equity

$750,000

$300,000

$450,000

(2,750) 23,700 (1,800) 0 $769,150

0 0 0 1,400 $301,400

(2,750) 23,700 (1,800) (1,400) $467,750

Net Income

Total Assets

$120,000 (2,750) 23,700 (1,800) (1,400) $137,750

CHAPTER 3

The Adjusting Process

Prob. 3–1B 1. May

31 Accounts Receivable Fees Earned Accrued fees earned.

19,750

31 Supplies Expense Supplies Supplies used ($12,300 – $4,150).

8,150

31 Wages Expense Wages Payable Accrued wages.

2,700

31 Unearned Rent Rent Revenue Rent earned ($9,000 ÷ 3 months).

3,000

31 Depreciation Expense Accumulated Depreciation—Equipment Depreciation expense.

3,200

19,750

8,150

2,700

3,000

3,200

2. Adjusting entries are a planned part of the accounting process to update the accounts. Correcting entries are not planned but arise only when necessary to correct errors.

CHAPTER 3

The Adjusting Process

Prob. 3–2B 1. Nov.

30 Supplies Expense Supplies Supplies used ($3,170 – $550).

2,620

30 Depreciation Expense Accumulated Depreciation—Equipment Depreciation for year.

1,675

30 Rent Expense Prepaid Rent Rent expired.

8,500

30 Wages Expense Wages Payable Accrued wages.

2,000

30 Unearned Fees Fees Earned Fees earned ($10,000 – $4,000).

6,000

30 Accounts Receivable Fees Earned Accrued fees.

5,380

2,620

1,675

8,500

2,000

6,000

5,380

2. Fees Earned would be understated by $6,000; Depreciation Expense would be understated by $1,675; and net income would be understated by $4,325 ($6,000 – $1,675). 3. Accumulated Depreciation—Equipment would be understated by $1,675; total assets would be overstated by $1,675; Unearned Fees would be overstated by $6,000; total liabilities would be overstated by $6,000; stockholders’ equity (Retained Earnings) would be understated by $4,325 ($6,000 – $1,675); and total liabilities and stockholders’ equity would be overstated by $1,675 ($6,000 – $4,325). 4. There is no effect on the “Net increase or decrease in cash” on the statement of cash flows because adjusting entries do not affect cash.

CHAPTER 3

The Adjusting Process

Prob. 3–3B 1.

20Y5 Apr.

30 Supplies Expense Supplies Supplies used ($7,200 – $1,380).

5,820

30 Accounts Receivable Fees Earned Accrued fees earned.

3,900

30 Depreciation Expense Accumulated Depreciation—Equipment Equipment depreciation.

3,000

30 Wages Expense Wages Payable Accrued wages.

2,475

30 Unearned Fees Fees Earned Fees earned.

14,140

5,820

3,900

3,000

2,475

14,140

2. Revenues…………………………… $305,800 261,800 ($157,800 + $55,000 + $42,000 + $7,000) Expenses…………………………… Net Income…………………………… $ 44,000 3. Revenues…………………………… $323,840 ($305,800 + $3,900 + $14,140) 273,095 ($261,800 + $5,820 + $3,000 + $2,475) Expenses…………………………… Net Income…………………………… $ 50,745 4. The effect of the adjusting entries on Retained Earnings is the difference in net income in (3) and (2) of $6,745 ($50,745 – $44,000), which would increase Retained Earnings.

CHAPTER 3

The Adjusting Process

Prob. 3–4B 20Y6 Mar.

31 Supplies Expense Supplies Supplies used ($6,200 – $2,175).

4,025

31 Insurance Expense Prepaid Insurance Insurance expired ($9,000 – $1,150).

7,850

31 Depreciation Expense—Buildings Accumulated Depreciation—Buildings Depreciation ($61,000 – $51,500).

9,500

31 Depreciation Expense—Trucks Accumulated Depreciation—Trucks Depreciation ($17,000 – $12,000).

5,000

31 Utilities Expense Accounts Payable Accrued utilities expense ($8,750 – $6,920, or $8,030 – $6,200).

1,830

31 Salary Expense Salaries Payable Accrued salaries ($81,400 – $80,000).

1,400

31 Unearned Service Fees Service Fees Earned Service fees earned ($10,500 – $3,850, or $169,330 – $162,680).

6,650

4,025

7,850

9,500

5,000

1,830

1,400

6,650

CHAPTER 3

The Adjusting Process

Prob. 3–5B 1. 20Y9 July

31 Depreciation Expense—Building Accumulated Depreciation—Building Building depreciation.

6,400

31 Depreciation Expense—Equipment Accumulated Depreciation—Equipment Equipment depreciation.

2,800

31 Salaries and Wages Expense Salaries and Wages Payable Accrued salaries and wages.

6,400

2,800

900 900

31 Insurance Expense Prepaid Insurance Insurance expired ($6,000 – $1,500).

4,500

31 Accounts Receivable Fees Earned Accrued fees earned.

10,200

31 Supplies Expense Supplies Supplies used ($1,725 – $615).

1,110

31 Unearned Rent Rent Revenue Rent revenue earned ($3,600 – $300).

3,300

4,500

10,200

1,110

3,300

CHAPTER 3

The Adjusting Process

Prob. 3–5B (Concluded) 2. Reece Financial Services Co. Adjusted Trial Balance July 31, 20Y9 Debit Balances

Cash Accounts Receivable Prepaid Insurance Supplies Land Building Accumulated Depreciation—Building Equipment Accumulated Depreciation—Equipment Accounts Payable Unearned Rent Salaries and Wages Payable Common Stock Retained Earnings Dividends Fees Earned Rent Revenue Salaries and Wages Expense Utilities Expense Advertising Expense Depreciation Expense—Building Repairs Expense Insurance Expense Depreciation Expense—Equipment Supplies Expense Miscellaneous Expense

Credit Balances

10,200 44,950 1,500 615 50,000 155,750 69,250 45,000 20,450 3,750 300 900 60,000 93,550 8,000 168,800 3,300 57,750 14,100 7,500 6,400 6,100 4,500 2,800 1,110 4,025 420,300

420,300

CHAPTER 3

The Adjusting Process

Prob. 3–6B 1. Aug.

31 Accounts Receivable Fees Earned Accrued fees earned.

31,900

31 Depreciation Expense Accumulated Depreciation—Equipment Equipment depreciation.

7,500

31 Wages Expense Wages Payable Accrued wages.

5,200

31 Supplies Expense Supplies Supplies used.

3,000

31,900

7,500

5,200

3,000

Reported amounts Corrections: Unbilled fees earned Equipment depreciation Accrued wages Supplies used Corrected amounts

Total Liabilities

Total Stockholders’ + Equity

$650,000

$225,000

$425,000

31,900 (7,500) 0 (3,000) $671,400

0 0 5,200 0 $230,200

31,900 (7,500) (5,200) (3,000) $441,200

Net Income

Total Assets

$112,500 31,900 (7,500) (5,200) (3,000) $128,700

CHAPTER 3

The Adjusting Process

CONTINUING PROBLEM 1. JOURNAL Date

20Y5 July

Post. Ref.

Description

Page

Debit

Credit

Adjusting Entries

31 Accounts Receivable Fees Earned Accrued fees earned (115 hrs. – 80 hrs.) × $40 = $1,400.

12 41

1,400

31 Supplies Expense Supplies Supplies used ($1,020 – $275).

56 14

745

31 Insurance Expense Prepaid Insurance Insurance expired ($2,700 ÷ 12 months) = $225 per month.

57 15

225

31 Depreciation Expense Accum. Depr.—Office Equipment Office equipment depreciation.

58 18

31 Unearned Revenue Fees Earned Fees earned ($7,200 ÷ 2 months).

23 41

3,600

31 Wages Expense Wages Payable Accrued wages.

50 22

140

1,400

745

225

3,600

140

CHAPTER 3

The Adjusting Process

Continuing Problem (Continued) 2. Account:

Cash

Date

20Y5 July

Item

Post. Ref.

1 Balance 1 1 1 2 3 3 4 8 11 13 14 16 21 22 23 27 28 29 30 31 31 31

Account:

Date

20Y5 July

Account No.

 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 2

Debit

Credit

5,000 1,750 2,700 1,000 7,200 250 900 200 1,000 700 1,200 2,000 620 800 750 915 1,200 540 500 3,000 1,400 1,250

Accounts Receivable Item

1 Balance 2 23 30 31 Adjusting

Balance Debit Credit

3,920 8,920 7,170 4,470 5,470 12,670 12,420 11,520 11,320 12,320 11,620 10,420 12,420 11,800 11,000 11,750 10,835 9,635 9,095 9,595 12,595 11,195 9,945 Account No.

Post. Ref.

 1 2 2 3

Debit

Credit

1,000 1,750 1,000 1,400

Debit

Balance Credit

1,000 — 1,750 2,750 4,150

—

CHAPTER 3

The Adjusting Process

Continuing Problem (Continued) Supplies

Account:

Item

Date

20Y5 July

1 Balance 18 31 Adjusting

Date

20Y5 July

Item

1 31 Adjusting

Item

Date

Account:

Item

1 Balance 3 5 18

Account:

Date

20Y5 July

850 745

Post. Ref.

1 3

Debit

Credit

2,700 225

Post. Ref.

Debit

Credit

7,500

Debit

Balance Credit

2,700 2,475 17

Post. Ref.

Debit

Balance Credit

7,500 18

Account No.

Credit

Balance Debit Credit

50 21

Account No.

Post. Ref.

Debit

Credit

250

Debit

Balance Credit

— 7,500 850

Wages Payable

31 Adjusting

170 1,020 275

Account No.

 1 1 2

Item

Balance Debit Credit

Account No.

Accounts Payable

Date

20Y5 July

Credit

Accumulated Depreciation—Office Equipment

31 Adjusting

Account:

 2 3

Date

20Y5 July

Debit

Office Equipment

Account:

20Y5 July

Post. Ref.

Prepaid Insurance

Account:

Account No.

250 — 7,500 8,350

Account No.

Post. Ref.

Debit

Credit

Balance Debit Credit

140

CHAPTER 3

The Adjusting Process

Continuing Problem (Continued) Account:

Unearned Revenue Item

Date

20Y5 July

Account:

3 31 Adjusting

20Y5 July

Account:

Item

1 Balance 1

Account:

Date

20Y5 July

1 3

Debit

Credit

1 Balance 31

Post. Ref.

Debit

Credit

Balance Debit Credit

4,000 9,000

5,000

Account No.

Post. Ref.

Debit

Credit

Balance Debit Credit

500 1,750

1,250

Fees Earned

1 Balance 11 16 23 30 31 31 Adjusting 31 Adjusting

Account No.

 2

Item

7,200 3,600

3,600

 1

Item

Balance Debit Credit

7,200

Dividends

Date

20Y5 July

Post. Ref.

Common Stock

Date

Account No.

Post. Ref.

Debit

 1 2 2 2 2 3 3

Credit

1,000 2,000 2,500 1,500 3,000 1,400 3,600

Balance Debit Credit

6,200 7,200 9,200 11,700 13,200 16,200 17,600 21,200

CHAPTER 3

The Adjusting Process

Continuing Problem (Continued) Account:

Wages Expense Item

Date

20Y5 July

Account:

Post. Ref.

1 Balance 14 28 31 Adjusting

 1 2 3

Item

1 Balance 1

Post. Ref.

 1

Equipment Rent Expense

Date

Post. Ref.

Account:

Item

1 Balance 13

Account:

1,200 1,200 140

Debit

Credit

1 Balance 27

Credit

Debit

Credit

Debit

Balance Credit

Account No.

Post. Ref.

 2 2

Debit

620 1,400

300 1,215

915

Music Expense

1 Balance 21 31

Balance Debit Credit

Account No.

Post. Ref.

675 1,375

700

 2

Item

Balance Debit Credit

Account No.

Debit

800 2,550

1,750

 1

Item

Date

20Y5 July

400 1,600 2,800 2,940

Utilities Expense

Date

20Y5 July

Credit

Balance Debit Credit

Account No.

Account:

20Y5 July

Debit

Office Rent Expense

Date

20Y5 July

Account No.

Credit

Balance Debit Credit

1,590 2,210 3,610

CHAPTER 3

The Adjusting Process

Continuing Problem (Continued) Account:

Advertising Expense Item

Date

20Y5 July

Account:

1 Balance 8 22

Account:

1 Balance 31 Adjusting

Account:

Item

Post. Ref.

500 700 1,500

200 800

Debit

 3

Credit

Debit

31 Adjusting

Credit

225

Debit

1 Balance 4 29

Post. Ref.

Credit

Balance Debit Credit

Debit

 1 2

900 540

Balance Credit

50 Account No.

Debit

225

Miscellaneous Expense Item

Balance Credit

Account No.

Post. Ref.

180 925

745

Depreciation Expense Item

Debit

Account No.

Post. Ref.

Balance Debit Credit

Account No.

31 Adjusting

Date

20Y5 July

Credit

Insurance Expense

Date

20Y5 July

Debit

 1 2

Item

Date

20Y5 July

Post. Ref.

Supplies Expense

Date

20Y5 July

Account No.

Credit

Balance Debit Credit

415 1,315 1,855

CHAPTER 3

The Adjusting Process

Continuing Problem (Concluded) 3.

PS Music Adjusted Trial Balance July 31, 20Y5 Account No.

Cash Accounts Receivable Supplies Prepaid Insurance Office Equipment Accumulated Depreciation—Office Equipment Accounts Payable Wages Payable Unearned Revenue Common Stock Dividends Fees Earned Wages Expense Office Rent Expense Equipment Rent Expense Utilities Expense Music Expense Advertising Expense Supplies Expense Insurance Expense Depreciation Expense Miscellaneous Expense

11 12 14 15 17 18 21 22 23 31 33 41 50 51 52 53 54 55 56 57 58 59

Debit Balances

Credit Balances

9,945 4,150 275 2,475 7,500 50 8,350 140 3,600 9,000 1,750 21,200 2,940 2,550 1,375 1,215 3,610 1,500 925 225 50 1,855 42,340

42,340

CHAPTER 3

The Adjusting Process

MAKE A DECISION MAD 3–1 a.

Amazon.com, Inc. Income Statements For the Years Ended December 31 (in millions) Year 2 Amount Percent

Year 1 Amount Percent

Revenues: Product sales Service sales Total revenues

$ 160,408 120,114 $ 280,522

57.2% 42.8% 100.0%

$ 141,915 90,972 $ 232,887

60.9% 39.1% 100.0%

Operating expenses: Cost of sales Fulfillment Technology and content Marketing General and administrative Other operating expense (income), net Total operating expenses Operating income

$(165,536) (40,232) (35,931) (18,878) (5,203) (201) $(265,981) $ 14,541

(59.0)% $(139,156) (14.3)% (34,027) (12.8)% (28,837) (6.7)% (13,814) (1.9)% (4,336) (0.1)% (296) (94.8)% $(220,466) 5.2% $ 12,421

(59.8)% (14.6)% (12.4)% (5.9)% (1.9)% (0.1)% (94.7)% 5.3%

b. The vertical analysis indicates that the mix of revenues has changed from Year 1 to Year 2. Product sales decreased from 60.9% to 57.2%, while service sales increased from 39.1% to 42.8% of total revenues. Operating expenses increased slightly from 94.7% to 94.8% of total revenues with the result that operating income decreased from 5.3% to 5.2% of total revenues. Of the operating expenses, marketing increased from 5.9% to 6.7% of total revenues, which might be related to the change in the mix of revenues. The other operating expenses remained relatively unchanged. Overall, the change in the mix of revenues did not seem to affect operating income.

CHAPTER 3

The Adjusting Process

MAD 3–2 a.

Netflix, Inc. Income Statements For the Years Ended December 31 (in thousands) Year 2 Amount Percent $ 20,156,447 100.0%

Revenues Operating expenses: Cost of revenues Marketing Technology and development General and administrative Total operating expenses Operating income

$(12,440,213) (2,652,462) (1,545,149) (914,369) $(17,552,193) $ 2,604,254

Year 1 Amount Percent $ 15,794,341 100.0%

(61.7)% $ (9,967,538) (13.2)% (2,369,469) (7.7)% (1,221,814) (4.5)% (630,294) (87.1)% $(14,189,115) 12.9% $ 1,605,226

(63.1)% (15.0)% (7.7)% (4.0)% (89.8)% 10.2%

b. The vertical analysis indicates that operating income increased from 10.2% to 12.9% of total revenues. This is a result of total operating expenses decreasing from 89.8% to 87.1% of total revenues. Cost of revenues decreased by 1.4% from 63.1% to 61.7% of total revenues, while marketing decreased 1.8% from 15.0% to 13.2%. Technology and development expenses remained the same at 7.7% of total revenues. The only operating expense to increase was general and administrative expenses, which increased from 4.0% to 4.5% of total revenues. Overall, Netflix improved its operations in Year 2.

CHAPTER 3

The Adjusting Process

MAD 3–3 a.

World Wrestling Entertainment, Inc. Income Statements For the Years Ended December 31 (in thousands) Year 2 Percent Amount 100.0% $ 960,442

Revenues Operating expenses: Cost of revenues Marketing and selling expenses General and administrative expenses Depreciation expense Total operating expenses Operating income

$(638,199) (84,713) (86,893) (34,127) $(843,932) $ 116,510

(66.4)% (8.8)% (9.0)% (3.6)% (87.9)%* 12.1%

Year 1 Amount Percent $ 930,160 100.0% $(609,182) (95,985) (85,446) (25,069) $(815,682) $ 114,478

(65.5)% (10.3)% (9.2)% (2.7)% (87.7)% 12.3%

* Differences due to rounding.

b. The vertical analysis indicates operating income decreased slightly from 12.3% to 12.1% of total revenues. Cost of revenues increased 0.9% from 65.5% to 66.4% of revenues. Marketing and selling expenses decreased 1.5% from 10.3% to 8.8%. General and administrative expenses stayed relatively the same (9.2% and 9.0% respectively), while depreciation increased by 0.9% from 2.7% to 3.6%. Overall, revenues increased slightly, while operating income as a percent of sales stayed relatively the same.

CHAPTER 3

The Adjusting Process

MAD 3–4 a.

Chipotle Mexican Grill, Inc. Income Statements For the Years Ended December 31 Year 2 Amount Percent $ 5,586,369 100.0%

Revenues Expenses: Food, beverage, packing Labor Rent (occupancy) General and administrative Other Total expenses Operating income

$(1,847,916) (1,472,060) (363,072) (451,552) (1,007,811) $(5,142,411) $ 443,958

Year 1 Amount Percent $ 4,864,985 100.0%

(33.1)% $(1,600,760) (26.4)% (1,326,079) (6.5)% (347,123) (8.1)% (375,460) (18.0)% (957,195) (92.1)% $(4,606,617) 7.9% $ 258,368

(32.9)% (27.3)% (7.1)% (7.7)% (19.7)% (94.7)% 5.3%

b. The vertical analysis indicates that operating income increased 2.6% from 5.3% to 7.9% of total revenues. This is equal to the decrease in total operating expenses, which decreased from 94.7% to 92.1% of total revenues. All operating expenses decreased except for food, beverage, packing, and general and administrative expenses, which increased slightly. The biggest decrease in operating expenses was in other expenses, which decreased by 1.7% from 19.7% to 18.0%. Overall, Chipotle Mexican Grill improved its operations from Year 1 to Year 2 by increasing revenues, decreasing total operating expenses, and increasing its profitability.

CHAPTER 3

The Adjusting Process

MAD 3–5 a.

AT&T Revenues……………………………………………………… Cost of services (expense)………………………………… Selling, general, and administrative expenses………… Depreciation and other expenses………………………… Operating income……………………………………………

$170,756 (79,419) (36,765) (28,476) $ 26,096

100.0% (46.5)% (21.5)% (16.7)% 15.3%

Verizon Revenues……………………………………………………… Cost of services (expense)………………………………… Selling, general, and administrative expenses………… Depreciation and other expenses………………………… Operating income……………………………………………

$130,863 (55,508) (31,083) (21,994) $ 22,278

100.0% (42.4)% (23.8)% (16.8)% 17.0%

AT&T’s operating income is 15.3%, while Verizon’s operating income is 17.0%. Verizon appears to be more efficient in generating operating income from revenues. AT&T’s cost of services (expense) is 46.5% of revenues, while Verizon’s is more than four percentage points less at 42.4% of revenues. This difference is a large contributor to Verizon’s superior operating income-to-revenues efficiency. AT&T’s other two expense items total to 38.2% (21.5% + 16.7%), which is less than Verizon’s total of 40.6% (23.8% + 16.8%). However, AT&T’s larger cost of services (expense) more than offsets these expense savings over Verizon.

CHAPTER 3

The Adjusting Process

TAKE IT FURTHER TIF 3–1 1.

No. The accrual basis of accounting requires that revenues be reported in the period in which they are earned. By reporting revenue before it is earned, the revenues do not accurately reflect the revenues for the period. By knowingly recording an adjusting entry for more than the amount of revenue that was earned during the period, Chris is demonstrating a failure of individual character and is acting unethically.

The users of the financial information who rely upon this information will be affected, as the information will not be a faithful representation of the entity’s economic activity.

TIF 3–2 It is acceptable for Daryl to prepare the financial statements for Squid Realty Co. on an accrual basis. The revision of the financial statements to include the accrual of the $30,000 commission as of December 28, 20Y3, would not be appropriate. Most real estate contracts include contingencies that can void the contract. Such contingencies include obtaining a loan, appraisals, environmental studies, and inspection results. In other words, Daryl can only be sure of earning the commission on January 5, 20Y4, when the attorney formally records the transfer of the property to the buyer, and Daryl may disclose the pending sale and related commission in a note to the financial statements. Indicating on the loan application to Free Spirit Bank that Squid Realty Co. has not been rejected previously for credit is unethical and unprofessional, and intentionally filing false loan documents is illegal.

TIF 3–3 A sample solution based on Nike Inc.’s Form 10-K for the fiscal year ended May 31, 2019, follows: 1. a. Footwear b. 3 c. $4,029 million in 2019; $1,933 million in 2018; $4,240 million in 2017 d. $39,117 million in 2019; $36,397 million in 2018; $34,350 million in 2017 e. Nike recognizes revenue when title passes and the risks and rewards of ownership have passed to the customer, based on the terms of sale. Title passes generally upon shipment or upon receipt by the customer depending on the country of the sale and the agreement with the customer. Retail store revenues are recorded at the time of sale. 2.

The company’s net income decreased from $4,240 in 2017 to $1,933 in 2018; a significant decrease of over 50%. The net income recovered in 2019 from $1,933 in 2018 to $4,029; an increase of over 100%. Although Nike recovered and improved its net income significantly in 2019, the underlying reasons for the fluctuations in net income from 2017 to 2019 is cause for concern and should be investigated.

CHAPTER 3

The Adjusting Process

TIF 3–4 To: My Instructor From: Ima Student Re: Revenue Recognition of Ticket Sales at Delta Air Lines Customers of Delta Air Lines typically purchase tickets for air travel several weeks prior to their scheduled flight and pay for their tickets using a credit card such as Visa or American Express. While the credit card company will remit payment to Delta shortly after the ticket is purchased, Delta will not record revenue from the ticket until after the air travel has taken place. This is because Delta does not earn the ticket revenue until it provides the required service. When Delta receives payment from the credit card company for an airplane ticket, Delta records a liability, called Unearned Revenue. After a customer uses the ticket for a flight, Delta records an adjusting entry to remove the liability and records revenue to reflect the fact that Delta has provided the service.

TIF 3–5 1. There are several indications that adjusting entries were not recorded before the financial statements were prepared, including: a. All expenses on the income statement are identified as “paid” items and not as “expenses.” b. No expense is reported on the income statement for depreciation, and no accumulated depreciation is reported on the balance sheet. c. No supplies, accounts payable, or wages payable are reported on the balance sheet. 2. Likely accounts requiring adjustment include: a. b. c. d. e.

Accumulated Depreciation—Truck for depreciation expense Supplies (paid) Expense for supplies on hand Insurance (paid) Expense for unexpired insurance Wages Accrued Utilities Accrued

CHAPTER 4 THE ACCOUNTING CYCLE DISCUSSION QUESTIONS 1.

The end-of-period spreadsheet illustrates the flow of accounting information from the unadjusted trial balance into the adjusted trial balance and into the financial statements. In doing so, the spreadsheet illustrates the impact of the adjustments on the financial statements.

Current assets are composed of cash and other assets that may reasonably be expected to be realized in cash or sold or used up, usually within one year or less, through the normal operations of the business.

Property, plant, and equipment is composed of assets that are used in the business and that are of a permanent or relatively fixed nature.

Current liabilities are liabilities that will be due within a short time (usually one year or less) and that are to be paid out of current assets. Liabilities that will not be due for a comparatively long time (usually more than one year) are called long-term liabilities.

Revenue, expense, and dividends accounts are generally referred to as temporary accounts.

Closing entries are necessary at the end of an accounting period (1) to transfer the balances in temporary accounts to permanent accounts and (2) to prepare the temporary accounts for use in recording transactions for the next accounting period.

Adjusting entries bring the accounts up to date, while closing entries reduce the revenue, expense, and dividends accounts to zero balances for use in recording transactions for the next accounting period.

The purpose of the post-closing trial balance is to make sure that the ledger is in balance at the beginning of the next period.

The financial statements are the most important output of the accounting cycle.

Yes, all companies have an accounting cycle that begins with analyzing and journalizing transactions and ends with a post-closing trial balance. However, companies may differ in how they implement the steps in the accounting cycle. For example, while most companies use computerized accounting systems, some companies may use manual systems.

Accrual basis accounting is required by GAAP because it better reports the underlying operating performance of a company. It does this using the revenue and expense recognition principles, which match the expenses with the revenues they generate.

10.

Liquidity is the ability of a business to convert assets into cash, while solvency is the ability of a business to pay its debts.

Working capital is the excess of the current assets of a business over its current liabilities, while the current ratio is the current assets divided by the current liabilities.

CHAPTER 4

The Accounting Cycle

BASIC EXERCISES BE 4–1 1. 2. 3. 4.

Balance sheet Balance sheet Income statement Income statement

5. 6. 7. 8.

Balance sheet Balance sheet Statement of stockholders’ equity Income statement

BE 4–2 Speedy Delivery Services Statement of Stockholders’ Equity For the Year Ended December 31, 20Y7 Common Retained Stock Earnings Balances, January 1, 20Y7 $75,000 $615,700 Issued common stock 15,000 Net income 85,300 Dividends (6,000) Balances, December 31, 20Y7 $90,000 $695,000

Total $690,700 15,000 85,300 (6,000) $785,000

BE 4–3 1. 2. 3. 4.

Current liabilities Current assets Property, plant, and equipment Current assets

5. 6. 7. 8.

Stockholders’ equity Long-term liabilities Current assets Current liabilities

BE 4–4 June

Closing Entries 30 Fees Earned Wages Expense Rent Expense Supplies Expense Miscellaneous Expense Retained Earnings 30 Retained Earnings Dividends

975,000 580,000 120,000 31,600 12,400 231,000 30,000 30,000

CHAPTER 4

The Accounting Cycle

BE 4–5 The following two steps are missing: (1) assembling and analyzing adjustment data and (2) journalizing and posting the closing entries. The adjustment data should be assembled and analyzed after step (c). The closing entries should be journalized and posted to the ledger after step (g).

BE 4–6 a. Current assets………………… Current liabilities…………… Working capital……………… Current ratio………………… b.

20Y4 $1,586,250 (705,000)

20Y3 $1,210,000 (550,000)

$ 881,250

$ 660,000

2.25 ($1,586,250 ÷ $705,000)

2.20 ($1,210,000 ÷ $550,000)

The increase from 2.20 to 2.25 indicates a favorable change.

EXERCISES Ex. 4–1 1. 2. 3.

Income statement: 5, 8, 9 Statement of stockholders’ equity: 4 Balance sheet: 1, 2, 3, 6, 7, 10

Ex. 4–2 a. b. c. d.

Asset: 1, 2, 5, 6, 10 Liability: 9, 12 Revenue: 3, 7 Expense: 4, 8, 11

Ex. 4–3 Paoli Consulting Income Statement For the Year Ended March 31, 20Y9 Fees earned Expenses: Salary expense Supplies expense Depreciation expense Miscellaneous expense Total expenses Net income

$ 1,675,000 $950,000 32,200 12,800 15,000 (1,010,000) $ 665,000

CHAPTER 4

The Accounting Cycle

Ex. 4–3 (Concluded) Paoli Consulting Statement of Stockholders’ Equity For the Year Ended March 31, 20Y9 Common Stock $ 85,000 15,000

Balances, April 1, 20Y8 Issued common stock Net income Dividends Balances, March 31, 20Y9

$100,000

Retained Earnings $1,860,000 665,000 (30,000) $2,495,000

Total $1,945,000 15,000 665,000 (30,000) $2,595,000

Paoli Consulting Balance Sheet March 31, 20Y9 Assets Current assets: Cash Accounts receivable Supplies Total current assets Property, plant, and equipment: Land Building Accumulated depreciation Book value—Building Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Salaries payable Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$ 162,500 304,500 5,000 $ 472,000 $1,400,000 $850,000 (72,000)

778,000 2,178,000 $2,650,000

36,500 18,500 $

55,000

$ 100,000 2,495,000 2,595,000 $2,650,000

CHAPTER 4

The Accounting Cycle

Ex. 4–4 Triton Consulting Income Statement For the Year Ended April 30, 20Y3 Fees earned Expenses: Salary expense Supplies expense Depreciation expense Miscellaneous expense Total expenses Net income

$ 279,000 $242,000 1,650 900 2,000 (246,550) $ 32,450

Triton Consulting Statement of Stockholders’ Equity For the Year Ended April 30, 20Y3 Common Retained Stock Earnings Balances, May 1, 20Y2 $15,000 $ 52,200 Issued common stock 5,000 Net income 32,450 Dividends (10,000) Balances, April 30, 20Y3 $20,000 $ 74,650

Total $ 67,200 5,000 32,450 (10,000) $ 94,650

CHAPTER 4

The Accounting Cycle

Ex. 4–4 (Concluded) Triton Consulting Balance Sheet April 30, 20Y3 Assets Current assets: Cash Accounts receivable Supplies Total current assets Property, plant, and equipment: Office equipment Accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Salaries payable Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$21,500 51,150 750 $ 73,400 $32,000 (5,400) 26,600 $100,000

$ 3,350 2,000 $

5,350

$20,000 74,650 94,650 $100,000

Ex. 4–5 Shaw Messenger Service Income Statement For the Year Ended April 30, 20Y1 Fees earned Expenses: Salaries expense Rent expense Utilities expense Depreciation expense Supplies expense Insurance expense Miscellaneous expense Total expenses Net income

$ 875,000 $481,300 75,000 40,850 14,500 7,150 6,000 10,200 (635,000) $ 240,000

CHAPTER 4

The Accounting Cycle

Ex. 4–6 Acorn Health Services Co. Income Statement For the Year Ended January 31, 20Y7 Service revenue Expenses: Wages expense Rent expense Utilities expense Depreciation expense Insurance expense Supplies expense Miscellaneous expense Total expenses Net loss

$ 634,900 $548,200 60,000 44,700 10,000 9,000 4,100 8,150 (684,150) $ (49,250)

Ex. 4–7 a.

FedEx Corporation Income Statement For the Year Ended May 31 (in millions) Revenues Expenses: Salaries and employee benefits Purchased transportation Rentals and landing fees Depreciation expense Fuel expense Maintenance and repairs expense Provision for income taxes Other expense (income) net Total expenses Net income

$ 50,365 $18,581 9,966 2,854 2,631 2,399 2,108 920 9,086 (48,545) $ 1,820

The income statements are very similar. The actual statement, which is for the year ended May 31, includes some additional expense and income classifications. For example, the actual statement reports income before income taxes and provision for income taxes separately. In addition, the “Other expense (income) net” item given for this exercise is a summary of several items, including interest expense and interest income.

CHAPTER 4

The Accounting Cycle

Ex. 4–8 Climate Control Systems Co. Statement of Stockholders’ Equity For the Year Ended December 31, 20Y2 Common Retained Stock Earnings Balances, January 1, 20Y2 $ 75,000 $4,150,800 Issued common stock 25,000 Net income 700,000 Dividends (160,000) Balances, December 31, 20Y2 $100,000 $4,690,800

Total $4,225,800 25,000 700,000 (160,000) $4,790,800

Ex. 4–9

Balances, May 1, 20Y4 Issued common stock Net loss Dividends Balances, April 30, 20Y5

Restoration Arts Statement of Stockholders’ Equity For the Year Ended April 30, 20Y5 Common Stock $10,000 7,500

$17,500

Retained Earnings $475,500 (31,200) (5,000) $439,300

Total $485,500 7,500 (31,200) (5,000) $456,800

Ex. 4–10 a. b.

Current asset: 1, 3, 5, 6 Property, plant, and equipment: 2, 4

Ex. 4–11 Because current liabilities are usually due within one year, $15,000 ($1,250 × 12 months) would be reported as a current liability on the balance sheet. The remainder of $360,000 ($375,000 – $15,000) would be reported as a long-term liability on the balance sheet.

CHAPTER 4

The Accounting Cycle

Ex. 4–12 Easy Weight Loss Co. Balance Sheet November 30, 20Y7 Assets Current assets: Cash Accounts receivable Supplies Prepaid insurance Prepaid rent Total current assets Property, plant, and equipment: Land Equipment Accumulated depreciation—equipment Book value—equipment Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Salaries payable Unearned fees Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$ 93,000 130,550 9,150 7,500 4,800 $245,000 $320,000 $230,000 (45,000) 185,000 505,000 $750,000

$ 41,200 3,800 13,500 $ 58,500 $ 90,000 601,500 691,500 $750,000

Cash balance determined as follows: $93,000 = $750,000 – $505,000 – $4,800 – $7,500 – $9,150 – $130,550

CHAPTER 4

The Accounting Cycle

Ex. 4–13 a.

1. The date of the statement should be “August 31, 20Y3” and not “For the Year Ended August 31, 20Y3.” 2. Accounts payable should be a current liability. 3. Land should be classified as property, plant, and equipment. 4. “Accumulated depreciation” should be deducted from the related fixed asset. 5. An adding error was made in determining the amount of the total property, plant, and equipment. 6. Accounts receivable should be a current asset. 7. Net income should be reported on the income statement and statement of stockholders’ equity. 8. Wages payable should be a current liability. Labyrinth Services Co. Balance Sheet August 31, 20Y3

Assets Current assets: Cash Accounts receivable Supplies Prepaid insurance Total current assets Property, plant, and equipment: Land Building Accumulated depreciation—building Book value—building Equipment Accumulated depreciation—equipment Book value—equipment Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Wages payable Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$ 18,500 41,400 6,500 16,600 $ 83,000 $225,000 $ 400,000 (155,000) 245,000 $ 97,000 (25,000) 72,000 542,000 $625,000

$ 31,300 6,500 $ 37,800 $ 75,000 512,200 587,200 $625,000

CHAPTER 4

The Accounting Cycle

Ex. 4–14 c. f. g. j. k.

Depreciation Expense—Equipment Dividends Fees Earned Supplies Expense Wages Expense

Ex. 4–15 Closing Entries Dec.

31 Fees Earned Wages Expense Rent Expense Supplies Expense Miscellaneous Expense Retained Earnings

614,500

31 Retained Earnings Dividends

45,000

320,000 140,000 18,200 8,700 127,600

45,000

Ex. 4–16 May

Closing Entries 31 Fees Earned Retained Earnings Wages Expense Rent Expense Supplies Expense Miscellaneous Expense 31 Retained Earnings Dividends

1,150,000 16,200 915,000 200,000 19,300 31,900 5,000 5,000

CHAPTER 4

The Accounting Cycle

Ex. 4–17 a. b. c. d. h. j. k.

Accounts Payable Accumulated Depreciation Cash Common Stock Office Equipment Salaries Payable Supplies

Ex. 4–18 SOS Services Co. Post-Closing Trial Balance December 31, 20Y0 Debit Balances

Cash Accounts Receivable Supplies Equipment Accumulated Depreciation—Equipment Accounts Payable Salaries Payable Unearned Rent Common Stock Retained Earnings

Credit Balances

33,050 261,500 5,000 115,450

415,000

20,800 52,500 3,500 6,000 65,000 267,200 415,000

Ex. 4–19 1. 2. 3. 4. 5.

i j f b e

6. 7. 8. 9. 10.

c d h g a

CHAPTER 4

The Accounting Cycle

Ex. 4–20 a.

The accrual- and cash-basis net incomes are different because they recognize revenues and expenses differently. The accrual basis recognizes revenues when they are earned, and expenses are matched against the revenues they generate. In contrast, the cash basis recognizes revenues as cash is received and expenses as cash is paid, regardless of when the revenues are earned or the expenses incurred.

Examples of cash receipts recorded differently under the accrual and cash bases of accounting include the following: On December 1, NetSolutions received cash of $360 for rent to be earned over the next three months. Under the accrual basis, the receipt was recorded as unearned revenue, while under the cash basis, it would have been recorded as rent revenue. On December 21, NetSolutions received cash of $650 from customers on account. Under the accrual basis, the receipt was recorded as a decrease in accounts receivable, while under the cash basis, it would have been recorded as fees earned.

Examples of cash payments recorded differently under the accrual and cash bases of accounting include the following: On December 1, NetSolutions paid cash of $2,400 for insurance covering a oneyear period. Under the accrual basis, the payment was recorded as prepaid insurance, while under the cash basis, it would have been recorded as insurance expense. On December 11, NetSolutions paid cash of $400 on the purchase of supplies on account in November. Under the accrual basis, the payment was recorded as a decrease in accounts payable, while under the cash basis, it would have been recorded as supplies expense. On December 20, NetSolutions paid Executive Supply Co. $900 on account for the purchase of office equipment on account on December 4. Under accrual accounting, the payment was recorded as a decrease in accounts payable, while under the cash basis, it would have been recorded as an increase in office equipment. On December 23, NetSolutions paid cash of $1,450 for the purchase of supplies. Under accrual accounting, the payment was recorded as supplies, while under the cash basis, it would have been recorded as supplies expense.

Examples of cash receipts recorded the same under the accrual and cash bases of accounting include the following: On December 16 and 31, NetSolutions received cash of $3,100 and $2,870 for fees earned. These receipts are recorded the same under the accrual and cash bases.

The accrual basis of accounting is required by GAAP because it better reports the underlying operating performance of a company. It does this using the revenue and expense recognition principles, which match the expenses with the revenues they generate. In contrast, the cash basis records revenues as cash is received and expenses as cash is paid, which often doesn’t match expenses with the revenues that they generated in the same period.

CHAPTER 4

The Accounting Cycle

Ex. 4–21 a.

Examples of cash receipts recorded differently under the accrual and cash bases of accounting include the following: On April 4, Kelly Consulting received cash of $5,000 for services to be provided in the future. Under the accrual basis, the receipt was recorded as unearned revenue, while under the cash basis, it would have been recorded as fees earned. On April 6, Kelly Consulting received cash of $1,800 from customers on account. Under the accrual basis, the receipt was recorded as a decrease in accounts receivable, while under the cash basis, it would have been recorded as fees earned. On April 26, Kelly Consulting received cash of $5,600 from customers on account. Under the accrual basis, the receipt was recorded as a decrease in accounts receivable, while under the cash basis, it would have been recorded as fees earned.

Examples of cash payments recorded differently under the accrual and cash bases of accounting include the following: On April 1, Kelly Consulting paid cash of $4,800 for three months’ rent. Under the accrual basis, the payment was recorded as prepaid rent, while under the cash basis, it would have been recorded as rent expense. On April 2, Kelly Consulting paid cash of $1,800 for insurance. Under the accrual basis, the payment was recorded as prepaid insurance, while under the cash basis, it would have been recorded as insurance expense. On April 12, Kelly Consulting paid cash of $1,200 on accounts payable on the office equipment purchased on April 5. Under the accrual basis, the payment was recorded as a decrease in accounts payable, while under the cash basis, it would have been recorded as office equipment.

CHAPTER 4

The Accounting Cycle

Ex. 4–21 (Concluded) On April 18, Kelly Consulting paid cash of $800 for supplies. Under the accrual basis, the payment was recorded as supplies, while under the cash basis, it would have been recorded as supplies expense. d.

Examples of cash payments recorded the same under the accrual and cash bases of accounting include the following: On April 10, 14, 27, 29, and 30, Kelly Consulting paid for expenses. These payments are recorded the same under the accrual and cash bases. In addition, the dividend payment on April 30 would be recorded the same under the accrual and cash bases.

Ex. 4–22 Because depreciation expense does not involve a cash payment, it is not deducted in arriving at Pepsi’s estimated cash-basis net income of $9,649 million. As a result, Pepsi’s accrual net income of $7,314 million is lower than its estimated cash-basis net income of $9,649 million. Almost all of this difference of $2,335 million ($9,649 – $7,314) is due to depreciation expense of $2,257 million. Ex. 4–23 Because depreciation-related expense does not involve a cash payment, it is not deducted in arriving at Microsoft’s estimated cash-basis net income of $52,185 million. As a result, Microsoft’s accrual net income of $39,240 million is lower than its estimated cash basis net income of $52,185 million. Almost all of this difference of $12,945 million ($52,185 – $39,240) is due to depreciation-related expense of $11,682 million.

Appendix 1 Ex. 4–24 1. 2. 3. 4. 5.

i a g d c

6. 7. 8. 9. 10.

f j e h b

The Accounting Cycle

500

200

4 36 0 50 210

Credit

10 4 3

(e)

(a)

(e)

(a)

4 10

(d)

(b) (c)

Adjustments Debit Credit

111 12 10 6 4 3 2 517

12 103 4 2 190 50

Debit

517

213

7 36 1 50 210

Credit

Adjusted Trial Balance

4-16

110 12 0 6 0 0 2 500

12 90 8 12 190 50

Debit

Unadjusted Trial Balance

Alert Security Services Co. End-of-Period Spreadsheet (Work Sheet) For the Year Ended October 31, 20Y3

Cash Accounts Receivable Supplies Prepaid Insurance Land Equipment Accum. Depr.—Equipment Accounts Payable Wages Payable Common Stock Retained Earnings Dividends Fees Earned Wages Expense Rent Expense Insurance Expense Utilities Expense Supplies Expense Depreciation Expense—Equipment Miscellaneous Expense Totals

Account Title

Appendix 1 Ex. 4–25

CHAPTER 4

The Accounting Cycle

517

213

7 36 1 50 210

Credit

111 12 10 6 4 3 2 148 65 213

369 369

213

12 103 4 2 190 50

Debit

304 65 369

7 36 1 50 210

Credit

Balance Sheet

213

Income Statement Debit Credit

4-17

111 12 10 6 4 3 2 517

12 103 4 2 190 50

Debit

Adjusted Trial Balance

Alert Security Services Co. End-of-Period Spreadsheet (Work Sheet) For the Year Ended October 31, 20Y3

Account Title

Appendix 1 Ex. 4–26

CHAPTER 4

The Accounting Cycle

Appendix 1 Ex. 4–27 Alert Security Services Co. Income Statement For the Year Ended October 31, 20Y3 Fees earned Expenses: Wages expense Rent expense Insurance expense Utilities expense Supplies expense Depreciation expense—equipment Miscellaneous expense Total expenses Net income

$ 213 $111 12 10 6 4 3 2 (148) $ 65

Alert Security Services Co. Statement of Stockholders’ Equity For the Year Ended October 31, 20Y3 Common Retained Stock Earnings Balances, November 1, 20Y2 $40 $210 Issued common stock 10 Net income 65 Dividends (8) Balances, October 31, 20Y3 $50 $267

Total $250 10 65 (8) $317

CHAPTER 4

The Accounting Cycle

Appendix 1 Ex. 4–27 (Concluded) Alert Security Services Co. Balance Sheet October 31, 20Y3 Assets Current assets: Cash Accounts receivable Supplies Prepaid insurance Total current assets Property, plant, and equipment: Land Equipment Accumulated depreciation—equipment Book value—equipment Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Wages payable Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$ 12 103 4 2 $121 $190 $50 (7) 43 233 $354

$ 36 1 $ 37 $ 50 267 317 $354

CHAPTER 4

The Accounting Cycle

Appendix 1 Ex. 4–28 20Y3 Oct.

Adjusting Entries 31 Accounts Receivable Fees Earned Accrued fees.

13 13

31 Supplies Expense Supplies Supplies used ($8 – $4).

31 Insurance Expense Prepaid Insurance Insurance expired.

31 Depreciation Expense—Equipment Accumulated Depreciation—Equipment Equipment depreciation.

31 Wages Expense Wages Payable Accrued wages.

Appendix 1 Ex. 4–29 20Y3 Oct.

Closing Entries 31 Fees Earned Wages Expense Rent Expense Insurance Expense Utilities Expense Supplies Expense Depreciation Expense—Equipment Miscellaneous Expense Retained Earnings 31 Retained Earnings Dividends

213 111 12 10 6 4 3 2 65 8 8

Received fees from clients Collected accounts receivable

Received fees from clients

Received fees from clients Collected accounts receivable

Received fees from clients

Operating Operating

Operating

Operating Operating

Operating

4-21

22,100

Apr. 30 Bal.

3,850 5,600

6,250

5,000 1,800

13,100

3,050

24 26

4 6

Apr.

Cash Apr.

27 29 30

10 12 14

1 2

The Accounting Cycle

6,000

750 130 200

800

120 1,200 750

4,800 1,800

Paid dividends

Paid salaries Paid miscellaneous expense Paid miscellaneous expense

Purchased supplies

Paid miscellaneous expense Paid accounts payable Paid salaries

Paid rent Paid insurance

Transaction

Issued common stock

Transaction

Financing

Type of Activity

Appendix 2 Ex. 4–30

CHAPTER 4

Financing

Operating Operating Operating

Operating

Operating Operating Operating

Operating Operating

Type of Activity

CHAPTER 4

The Accounting Cycle

Appendix 2 Ex. 4–30 (Concluded) b.

Kelly Consulting Statement of Cash Flows For the Month Ended April 30, 20Y8 Cash flows from (used in) operating activities: Cash received from customers $ 25,550 * Cash paid for expenses and to creditors (10,550)** Net cash flows from operating activities Cash flows from (used in) investing activities: Cash flows from (used in) financing activities: Cash received from issuing common stock $ 13,100 Cash dividends paid (6,000) Net cash flows from financing activities Net increase in cash Cash balance, April 1, 20Y8 Cash balance, April 30, 20Y8

$15,000 0

7,100 $22,100 0 $22,100

* $5,000 + $1,800 + $6,250 + $3,850 + $5,600 + $3,050 = $25,550 ** $4,800 + $1,800 + $120 + $1,200 + $750 + $800 + $750 + $130 + $200 = $10,550

Received fees from clients

Operating

Cash

4-23

33,400

Mar. 31 Bal.

2,850

9,250

13,500

50,000

4,050

Mar.

29 31

6,000

3,100 4,000

2,750

4,000

1 6,000 2 2,400 4 18,000

The Accounting Cycle

Transaction

Paid dividends

Paid expenses Paid employees

Paid expenses

Paid employees

Paid rent Paid insurance Purchased office equipment

Received fees from clients

Operating

Transaction

Issued common stock

Financing

Type of Activity

Appendix 2 Ex. 4–31

CHAPTER 4

Financing

Operating Operating

Operating

Operating Operating Investing

Type of Activity

CHAPTER 4

The Accounting Cycle

Appendix 2 Ex. 4–31 (Concluded) b.

Pryor Consulting Services Statement of Cash Flows For the Month Ended March 31, 20Y3 Cash flows from (used in) operating activities: Cash received from customers $ 29,650* Cash paid for expenses and to creditors (22,250)** Net cash flows from operating activities Cash flows from (used in) investing activities: Cash paid for purchase of office equipment Cash flows from (used in) financing activities: Cash received from issuing common stock $ 50,000 Cash dividends paid (6,000) Net cash flows from financing activities Net increase in cash Cash balance, March 1, 20Y3 Cash balance, March 31, 20Y3

$ 7,400 (18,000)

44,000 $ 33,400 0 $ 33,400

* $13,500 + $9,250 + $2,850 + $4,050 = $29,650 ** $6,000 + $2,400 + $4,000 + $2,750 + $3,100 + $4,000 = $22,250

CHAPTER 4

The Accounting Cycle

PROBLEMS Prob. 4–1A 1.

Light-It-Up Company Income Statement For the Year Ended August 31, 20Y5 Revenues: Fees earned Rent revenue Total revenues Expenses: Salaries and wages expense Advertising expense Utilities expense Depreciation expense—building Repairs expense Depreciation expense—equipment Insurance expense Supplies expense Miscellaneous expense Total expenses Net income

$430,000 900 $ 430,900 $223,500 30,700 16,400 12,000 8,850 4,800 3,150 2,180 4,320

Light-It-Up Company Statement of Stockholders’ Equity For the Year Ended August 31, 20Y5 Common Retained Stock Earnings Balances, September 1, 20Y4 $50,000 $137,100 Issued common stock 25,000 Net income 125,000 Dividends (10,000) Balances, August 31, 20Y5 $75,000 $252,100

(305,900) $ 125,000

Total $187,100 25,000 125,000 (10,000) $327,100

CHAPTER 4

The Accounting Cycle

Prob. 4–1A (Continued) Light-It-Up Company Balance Sheet August 31, 20Y5

Assets Current assets: Cash Accounts receivable Prepaid insurance Supplies Total current assets Property, plant, and equipment: Land Building Accumulated depreciation—building Book value—building Equipment Accumulated depreciation—equipment Book value—equipment Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Salaries and wages payable Unearned rent Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$ 10,800 43,900 1,050 550 $ 56,300 $ 98,000 $ 400,000 (217,300) 182,700 $ 101,000 (89,900) 11,100 291,800 $348,100

$ 15,700 4,100 1,200 $ 21,000 $ 75,000 252,100 327,100 $348,100

CHAPTER 4

The Accounting Cycle

Prob. 4–1A (Concluded) 4.

20Y5 Aug.

Closing Entries 31 Fees Earned Rent Revenue Salaries and Wages Expense Advertising Expense Utilities Expense Depreciation Expense—Building Repairs Expense Depreciation Expense—Equipment Insurance Expense Supplies Expense Miscellaneous Expense Retained Earnings

430,000 900

31 Retained Earnings Dividends

10,000

223,500 30,700 16,400 12,000 8,850 4,800 3,150 2,180 4,320 125,000

10,000

Light-It-Up Company Post-Closing Trial Balance August 31, 20Y5

Cash Accounts Receivable Prepaid Insurance Supplies Land Building Accumulated Depreciation—Building Equipment Accumulated Depreciation—Equipment Accounts Payable Salaries and Wages Payable Unearned Rent Common Stock Retained Earnings

Debit Balances 10,800 43,900 1,050 550 98,000 400,000

Credit Balances

217,300 101,000

655,300

89,900 15,700 4,100 1,200 75,000 252,100 655,300

CHAPTER 4

The Accounting Cycle

Prob. 4–2A 1.

Foxy Investigative Services Income Statement For the Year Ended November 30, 20Y8 Revenues: Service fees Rent revenue Total revenues Expenses: Salaries expense Rent expense Supplies expense Depreciation expense—building Utilities expense Repairs expense Insurance expense Miscellaneous expense Total expenses Net income

$675,500 9,000 $ 684,500 $435,000 55,000 11,850 10,000 8,800 4,250 3,000 11,100 (539,000) $ 145,500

Foxy Investigative Services Statement of Stockholders’ Equity For the Year Ended November 30, 20Y8 Common Retained Stock Earnings Balances, December 1, 20Y7 $40,000 $ 70,300 Net income 145,500 Dividends (30,000) Balances, November 30, 20Y8 $40,000 $185,800

Total $110,300 145,500 (30,000) $225,800

CHAPTER 4

The Accounting Cycle

Prob. 4–2A (Continued) Foxy Investigative Services Balance Sheet November 30, 20Y8 Assets Current assets: Cash Accounts receivable Supplies Prepaid insurance Total current assets Property, plant, and equipment: Building Accumulated depreciation—building Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Salaries payable Unearned rent Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$ 27,500 71,800 3,550 750 $103,600 $ 330,500 (184,100) 146,400 $250,000

$ 16,100 6,600 1,500 $ 24,200 $ 40,000 185,800 225,800 $250,000

CHAPTER 4

The Accounting Cycle

Prob. 4–2A (Concluded) 2.

20Y8 Nov.

Closing Entries 30 Service Fees Rent Revenue Salaries Expense Rent Expense Supplies Expense Depreciation Expense—Building Utilities Expense Repairs Expense Insurance Expense Miscellaneous Expense Retained Earnings

675,500 9,000

30 Retained Earnings Dividends

30,000

435,000 55,000 11,850 10,000 8,800 4,250 3,000 11,100 145,500

30,000

$16,000 ($46,000 – $30,000) net loss. The $46,000 decrease is caused by the $30,000 dividends and a $16,000 net loss.

CHAPTER 4

The Accounting Cycle

Prob. 4–3A 1., 3., and 6. June

June

30 30

Bal.

Cash 11,000

Bal. Adj. Bal.

Laundry Supplies 26,500 June 30 8,600

Adj.

17,900

Adj.

5,700

June

30 30

Bal. Adj. Bal.

Prepaid Insurance 9,600 June 30 3,900

June

Bal.

Laundry Equipment 232,600 Accumulated Depreciation June 30 Bal. 30 Adj. 30 Adj. Bal.

June

Clos.

Bal.

125,400 6,500 131,900

Accounts Payable June 30

Bal.

11,800

Wages Payable June 30

Adj.

1,100

Common Stock June 30

Bal.

40,000

Retained Earnings 5,000 June 30 30 30

Bal. Clos. Bal.

65,600 10,700 71,300

Dividends 5,000 June 30

Clos.

5,000

CHAPTER 4

The Accounting Cycle

Prob. 4–3A (Continued) June

June

30 30 30

Clos.

Laundry Revenue 232,200 June 30

Bal. Adj. Adj. Bal.

Wages Expense 125,200 June 30 1,100 126,300

Bal.

232,200

Clos.

126,300

Bal.

Rent Expense 40,000 June 30

Clos.

40,000

Bal.

Utilities Expense 19,700 June 30

Clos.

19,700

Adj.

Laundry Supplies Expense 17,900 June 30 Clos.

17,900

Adj.

Depreciation Expense 6,500 June 30 Clos.

6,500

Adj.

Insurance Expense 5,700 June 30

Clos.

5,700

Miscellaneous Expense 5,400 June 30 Clos.

5,400

Bal.

Net income

11,000 26,500 9,600 232,600

Cash Laundry Supplies Prepaid Insurance Laundry Equipment Accum. Depreciation Accounts Payable Wages Payable Common Stock Retained Earnings Dividends Laundry Revenue Wages Expense Rent Expense Utilities Expense Laundry Supplies Exp. Depreciation Expense Insurance Expense Miscellaneous Expense 475,000

232,200

40,000 65,600

125,400 11,800

Credit

1,100

31,200

(a) 17,900 (c) 6,500 (b) 5,700

(d)

1,100

(d)

4-33

31,200

6,500

(c)

(a) 17,900 (b) 5,700

Adjustments Debit Credit

126,300 40,000 19,700 17,900 6,500 5,700 5,400 482,600

5,000

11,000 8,600 3,900 232,600

Debit

482,600

232,200

131,900 11,800 1,100 40,000 65,600

Credit

Adjusted Trial Balance

Epicenter Laundry End-of-Period Spreadsheet (Work Sheet) For the Year Ended June 30, 20Y6

The Accounting Cycle

126,300 40,000 19,700 17,900 6,500 5,700 5,400 221,500 10,700 232,200

Debit

232,200

Credit

Income Statement

5,400 475,000

125,200 40,000 19,700

5,000

Debit

Unadjusted Trial Balance

Account Title

2. Optional (Appendix 1)

Prob. 4–3A (Continued)

CHAPTER 4

261,100

5,000

11,000 8,600 3,900 232,600

Debit

250,400 10,700 261,100

131,900 11,800 1,100 40,000 65,600

Credit

Balance Sheet

CHAPTER 4

The Accounting Cycle

Prob. 4–3A (Continued) 3.

Adjusting Entries 20Y6 June

30 Laundry Supplies Expense Laundry Supplies Supplies used ($26,500 – $8,600).

17,900

30 Insurance Expense Prepaid Insurance Insurance expired.

5,700

30 Depreciation Expense Accumulated Depreciation Equipment depreciation.

6,500

30 Wages Expense Wages Payable Accrued wages.

1,100

17,900

5,700

6,500

1,100

Epicenter Laundry Adjusted Trial Balance June 30, 20Y6

Debit Balances

Cash Laundry Supplies Prepaid Insurance Laundry Equipment Accumulated Depreciation Accounts Payable Wages Payable Common Stock Retained Earnings Dividends Laundry Revenue Wages Expense Rent Expense Utilities Expense Laundry Supplies Expense Depreciation Expense Insurance Expense Miscellaneous Expense

Credit Balances

11,000 8,600 3,900 232,600 131,900 11,800 1,100 40,000 65,600 5,000 232,200 126,300 40,000 19,700 17,900 6,500 5,700 5,400 482,600

482,600

CHAPTER 4

The Accounting Cycle

Prob. 4–3A (Continued) 5.

Epicenter Laundry Income Statement For the Year Ended June 30, 20Y6 Laundry revenue Expenses: Wages expense Rent expense Utilities expense Laundry supplies expense Depreciation expense Insurance expense Miscellaneous expense Total expenses Net income

$ 232,200 $126,300 40,000 19,700 17,900 6,500 5,700 5,400 (221,500) $ 10,700

Epicenter Laundry Statement of Stockholders’ Equity For the Year Ended June 30, 20Y6 Common Retained Stock Earnings Balances, July 1, 20Y5 $32,500 $65,600 Issued common stock 7,500 Net income 10,700 Dividends (5,000) Balances, June 30, 20Y6 $40,000 $71,300

Total $ 98,100 7,500 10,700 (5,000) $111,300

CHAPTER 4

The Accounting Cycle

Prob. 4–3A (Continued) Epicenter Laundry Balance Sheet June 30, 20Y6 Assets Current assets: Cash Laundry supplies Prepaid insurance Total current assets Property, plant, and equipment: Laundry equipment Accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Wages payable Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$ 11,000 8,600 3,900 $ 23,500 $ 232,600 (131,900) 100,700 $124,200

$ 11,800 1,100 $ 12,900 $ 40,000 71,300 111,300 $124,200

CHAPTER 4

The Accounting Cycle

Prob. 4–3A (Concluded) Closing Entries

6. 20Y6 June

30 Laundry Revenue Wages Expense Rent Expense Utilities Expense Laundry Supplies Expense Depreciation Expense Insurance Expense Miscellaneous Expense Retained Earnings 30 Retained Earnings Dividends

232,200 126,300 40,000 19,700 17,900 6,500 5,700 5,400 10,700 5,000 5,000

Epicenter Laundry Post-Closing Trial Balance June 30, 20Y6 Debit Balances

Cash Laundry Supplies Prepaid Insurance Laundry Equipment Accumulated Depreciation Accounts Payable Wages Payable Common Stock Retained Earnings

Credit Balances

11,000 8,600 3,900 232,600

256,100

131,900 11,800 1,100 40,000 71,300 256,100

CHAPTER 4

The Accounting Cycle

Prob. 4–4A 1., 3., and 6. Cash

Account:

Item

Date

20Y4 Mar.

Balance

Item

Date

20Y4 Mar.

31 31

Balance Adjusting

Date

Item

31 31

Balance Adjusting

Date

Item

Balance

Date

Item

31 31

Post. Ref.

Debit

 26

Credit

Balance Debit Credit

22,500

30,000 7,500

Account No.

Post. Ref.

Debit

 26

Credit

1,800

Debit

Balance Credit

3,600 1,800 16

Account No.

Post. Ref.

Debit

Credit

110,000



Post. Ref.

Balance Debit Credit

Debit

 26

Account No.

Credit

Balance Debit Credit

25,000 33,350

8,350 Account No.

Item

Date

Account No.

Trucks

Account:

20Y4 Mar.

Balance Adjusting

Balance Debit Credit

12,000



Accumulated Depreciation—Equipment

Account:

20Y4 Mar.

Credit

Equipment

Account:

20Y4 Mar.

Debit

Prepaid Insurance

Account:

20Y4 Mar.

Post. Ref.

Supplies

Account:

Account No.

Balance

Post. Ref.

Debit

Credit

Balance Debit Credit

60,000



CHAPTER 4

The Accounting Cycle

Prob. 4–4A (Continued) Accumulated Depreciation—Trucks

Account:

Item

Date

20Y4 Mar.

31 31

Item

Date

Item

Balance

Date

Item

31 31 31

Balance Closing Closing

Post. Ref.

Debit

Credit

Item

Date

31 31

Balance Closing

Debit

Balance Credit

4,000



Account No.

Post. Ref.

Debit

Credit

Debit

Balance Credit

600

600 31

Account No.

Post. Ref.

Debit

Credit

Debit

Balance Credit

26,000



26,000 32

Account No.

Post. Ref.

 27 27

Debit

Credit

Debit

Balance Credit

70,000 121,150 106,150

51,150 15,000

Dividends

Account:

15,000 21,200 Account No.

Retained Earnings

Account:

20Y4 Mar.

Adjusting

Balance Debit Credit

6,200

Common Stock

Account:

20Y4 Mar.

Balance

Item

20Y4 Mar.

 26

Credit

Wages Payable

Account:

20Y4 Mar.

Debit

Accounts Payable

Account:

20Y4 Mar.

Balance Adjusting

Post. Ref.

Account No.

Post. Ref.

Debit

 27

Balance Credit

Credit

Debit

15,000

15,000 —

—

CHAPTER 4

The Accounting Cycle

Prob. 4–4A (Continued) Service Revenue

Account:

Date

20Y4 Mar.

Item

31 31

Date

Item

31 31 31

Date

Balance Adjusting Closing

Item

31 31

Credit

160,000

Adjusting Closing

Item

Date

31 31

Balance Closing

Balance Debit Credit

—

160,000 —

Account No.

Post. Ref.

Debit

 26 27

Post. Ref.

26 27

Post. Ref.

45,600

45,000 45,600 —

—

Account No.

 27

Balance Credit

Credit

Debit

22,500

22,500 —

—

Account No.

22,500

Debit

Balance Credit

Debit

600

Debit

Credit

Rent Expense

Account:

20Y4 Mar.

 27

Debit

Supplies Expense

Account:

20Y4 Mar.

Post. Ref.

Wages Expense

Account:

20Y4 Mar.

Balance Closing

Account No.

Credit

Balance Debit Credit

10,600

10,600 —

—

CHAPTER 4

The Accounting Cycle

Prob. 4–4A (Continued) Truck Expense

Account:

Item

Date

20Y4 Mar.

31 31

Item

Date

31 31

Date

31 31

 27

Credit

9,000

Post. Ref.

Debit

26 27

Credit

8,350 8,350

Adjusting Closing

Post. Ref.

26 27

Debit

Credit

6,200 6,200

Insurance Expense

Date

Item

31 31

Adjusting Closing

Post. Ref.

26 27

Debit

Credit

1,800 1,800

Miscellaneous Expense

Account:

Item

Date

20Y4 Mar.

Adjusting Closing

Item

Account:

20Y4 Mar.

Debit

Depreciation Expense—Trucks

Account:

20Y4 Mar.

Post. Ref.

Depreciation Expense—Equipment

Account:

20Y4 Mar.

Balance Closing

Account No.

31 31

Balance Closing

Post. Ref.

Debit

 27

Credit

4,800

Balance Debit Credit

9,000 —

—

Account No.

Debit

Balance Credit

8,350 —

—

Account No.

Balance Debit Credit

6,200 —

—

Account No.

Debit

Balance Credit

1,800 —

—

Account No.

Balance Debit Credit

4,800 —

—

Net income

Account Title Cash Supplies Prepaid Insurance Equipment Accum. Depr.—Equip. Trucks Accum. Depr.—Trucks Accounts Payable Wages Payable Common Stock Retained Earnings Dividends Service Revenue Wages Expense Supplies Expense Rent Expense Truck Expense Depr. Exp.—Equipment Depr. Exp.—Trucks Insurance Expense Miscellaneous Expense

2. Optional (Appendix 1)

Prob. 4–4A (Continued)

300,000

160,000

4-42

45,600 22,500 10,600 9,000 8,350 6,200 1,800 4,800 108,850 51,150 160,000

160,000

Income Statement Debit Credit

4,800 300,000

10,600 9,000

45,000

15,000

26,000 70,000

Unadjusted Trial Balance Debit Credit 12,000 30,000 3,600 110,000 25,000 60,000 15,000 4,000

The Accounting Cycle

Lakota Freight Co. End-of-Period Spreadsheet (Work Sheet) For the Year Ended March 31, 20Y4 Adjusted Adjustments Trial Balance Debit Credit Debit Credit 12,000 (a) 22,500 7,500 (b) 1,800 1,800 110,000 (c) 8,350 33,350 60,000 (d) 6,200 21,200 4,000 (e) 600 600 26,000 70,000 15,000 160,000 (e) 600 45,600 (a) 22,500 22,500 10,600 9,000 (c) 8,350 8,350 (d) 6,200 6,200 (b) 1,800 1,800 4,800 39,450 39,450 315,150 315,150

CHAPTER 4

206,300

155,150 51,150 206,300

Balance Sheet Debit Credit 12,000 7,500 1,800 110,000 33,350 60,000 21,200 4,000 600 26,000 70,000 15,000

CHAPTER 4

The Accounting Cycle

Prob. 4–4A (Continued) 3.

JOURNAL Post. Ref.

Date

20Y4 Mar.

Adjusting Entries 31 Supplies Expense Supplies Supplies used ($30,000 – $7,500).

Page

Debit

52 13

22,500

31 Insurance Expense Prepaid Insurance Insurance expired.

57 14

1,800

31 Depreciation Expense—Equipment Accumulated Depr.—Equipment Equipment depreciation.

55 17

8,350

31 Depreciation Expense—Trucks Accumulated Depr.—Trucks Truck depreciation.

56 19

6,200

31 Wages Expense Wages Payable Accrued wages.

51 22

600

Credit

22,500

1,800

8,350

6,200

600

CHAPTER 4

The Accounting Cycle

Prob. 4–4A (Continued) 4.

Lakota Freight Co. Adjusted Trial Balance March 31, 20Y4

Cash Supplies Prepaid Insurance Equipment Accumulated Depreciation—Equipment Trucks Accumulated Depreciation—Trucks Accounts Payable Wages Payable Common Stock Retained Earnings Dividends Service Revenue Wages Expense Supplies Expense Rent Expense Truck Expense Depreciation Expense—Equipment Depreciation Expense—Trucks Insurance Expense Miscellaneous Expense

Account No.

Debit Balances

11 13 14 16 17 18 19 21 22 31 32 33 41 51 52 53 54 55 56 57 59

12,000 7,500 1,800 110,000

Credit Balances

33,350 60,000 21,200 4,000 600 26,000 70,000 15,000 160,000 45,600 22,500 10,600 9,000 8,350 6,200 1,800 4,800 315,150

315,150

CHAPTER 4

The Accounting Cycle

Prob. 4–4A (Continued) 5.

Lakota Freight Co. Income Statement For the Year Ended March 31, 20Y4 Service revenue Expenses: Wages expense Supplies expense Rent expense Truck expense Depreciation expense—equipment Depreciation expense—trucks Insurance expense Miscellaneous expense Total expenses Net income

$ 160,000 $45,600 22,500 10,600 9,000 8,350 6,200 1,800 4,800

Lakota Freight Co. Statement of Stockholders’ Equity For the Year Ended March 31, 20Y4 Common Retained Stock Earnings Balances, April 1, 20Y3 $20,000 $ 70,000 Issued common stock 6,000 Net income 51,150 Dividends (15,000) Balances, March 31, 20Y4 $26,000 $106,150

(108,850) $ 51,150

Total $ 90,000 6,000 51,150 (15,000) $132,150

CHAPTER 4

The Accounting Cycle

Prob. 4–4A (Continued) Lakota Freight Co. Balance Sheet March 31, 20Y4 Assets Current assets: Cash Supplies Prepaid insurance Total current assets Property, plant, and equipment: Equipment Accumulated depreciation—equipment Book value—equipment Trucks Accumulated depreciation—trucks Book value—trucks Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Wages payable Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$ 12,000 7,500 1,800 $ 21,300 $110,000 (33,350) $ 76,650 $ 60,000 (21,200) 38,800 115,450 $136,750

4,000 600 $

4,600

$ 26,000 106,150 132,150 $136,750

CHAPTER 4

The Accounting Cycle

Prob. 4–4A (Concluded) 6.

JOURNAL Post. Ref.

Date

20Y4 Mar.

Page

Debit

Closing Entries 31 Service Revenue Wages Expense Supplies Expense Rent Expense Truck Expense Depreciation Expense—Equipment Depreciation Expense—Trucks Insurance Expense Miscellaneous Expense Retained Earnings

41 51 52 53 54 55 56 57 59 32

160,000

31 Retained Earnings Dividends

32 33

15,000

Account No.

Debit Balances

11 13 14 16 17 18 19 21 22 31 32

12,000 7,500 1,800 110,000

Credit

45,600 22,500 10,600 9,000 8,350 6,200 1,800 4,800 51,150

15,000

Lakota Freight Co. Post-Closing Trial Balance March 31, 20Y4

Cash Supplies Prepaid Insurance Equipment Accumulated Depreciation—Equipment Trucks Accumulated Depreciation—Trucks Accounts Payable Wages Payable Common Stock Retained Earnings

Credit Balances

33,350 60,000

191,300

21,200 4,000 600 26,000 106,150 191,300

CHAPTER 4

The Accounting Cycle

Prob. 4–5A 1. and 2. JOURNAL Post. Ref.

Date

20Y2 July

Page

Debit

1 Cash Accounts Receivable Supplies Office Equipment Common Stock

11 12 14 18 31

13,500 20,800 3,200 7,500

1 Prepaid Rent Cash

15 11

4,800

2 Prepaid Insurance Cash

16 11

4,500

4 Cash Unearned Fees

11 23

5,500

5 Office Equipment Accounts Payable

18 21

6,500

6 Cash Accounts Receivable

11 12

15,300

10 Miscellaneous Expense Cash

59 11

400

12 Accounts Payable Cash

21 11

5,200

12 Accounts Receivable Fees Earned

12 41

13,300

14 Salary Expense Cash

51 11

1,750

Credit

45,000

4,800

4,500

5,500

6,500

15,300

400

5,200

13,300

1,750

CHAPTER 4

The Accounting Cycle

Prob. 4–5A (Continued) JOURNAL Post. Ref.

Date

20Y2 July

Page

Debit

17 Cash Fees Earned

11 41

9,450

18 Supplies Cash

14 11

600

20 Accounts Receivable Fees Earned

12 41

6,650

24 Cash Fees Earned

11 41

4,000

26 Cash Accounts Receivable

11 12

12,000

27 Salary Expense Cash

51 11

1,750

29 Miscellaneous Expense Cash

59 11

325

31 Miscellaneous Expense Cash

59 11

675

31 Cash Fees Earned

11 41

5,200

31 Accounts Receivable Fees Earned

12 41

3,000

31 Dividends Cash

33 11

12,500

Credit

9,450

600

6,650

4,000

12,000

1,750

325

675

5,200

3,000

12,500

CHAPTER 4

The Accounting Cycle

Prob. 4–5A (Continued) 2., 6., and 9. Cash

Account:

Date

20Y2 July

Item

1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2

Debit

Credit

13,500 4,800 4,500 5,500 15,300 400 5,200 1,750 9,450 600 4,000 12,000 1,750 325 675 5,200 12,500

Accounts Receivable

Date

Item

1 6 12 20 26 31

Date

Post. Ref.

1 1 1 2 2 2

Item

1 18 31

Adjusting

Debit

Credit

20,800 15,300 13,300 6,650 12,000 3,000

13,500 8,700 4,200 9,700 25,000 24,600 19,400 17,650 27,100 26,500 30,500 42,500 40,750 40,425 39,750 44,950 32,450

1 2 3

Debit

Credit

3,200 600 2,275

Balance Debit Credit

20,800 5,500 18,800 25,450 13,450 16,450 Account No.

Post. Ref.

Balance Credit

Account No.

Supplies

Account:

20Y2 July

Post. Ref.

1 1 2 4 6 10 12 14 17 18 24 26 27 29 31 31 31

Account:

20Y2 July

Account No.

Balance Debit Credit

3,200 3,800 1,525

CHAPTER 4

The Accounting Cycle

Prob. 4–5A (Continued) Prepaid Rent

Account:

Item

Date

20Y2 July

1 31

Date

Item

2 31

Date

Item

Date

4,800 2,400

Adjusting

Post. Ref.

1 3

Debit

Credit

4,500 375

Date

Item

5 12

Post. Ref.

Debit

Credit

7,500 6,500

Date

Post. Ref.

Adjusting

Debit

Balance Credit

4,500 4,125 18

Balance Debit Credit

Account No.

Debit

Credit

Debit

Balance Credit

750

750 21

Account No.

Post. Ref.

1 1

Item

7,500 14,000

Debit

Credit

Debit

Balance Credit

6,500

6,500 1,300

5,200

Salaries Payable

Account:

4,800 2,400

Account No.

Accounts Payable

Account:

Balance Debit Credit

Account No.

1 1

Item

20Y2 July

Credit

Accumulated Depreciation

Account:

20Y2 July

Adjusting

1 5

20Y2 July

1 3

Debit

Office Equipment

Account:

20Y2 July

Post. Ref.

Prepaid Insurance

Account:

20Y2 July

Adjusting

Account No.

Post. Ref.

Debit

Credit

Balance Debit Credit

175

CHAPTER 4

The Accounting Cycle

Prob. 4–5A (Continued) Unearned Fees

Account:

Item

Date

20Y2 July

4 31

Date

Item

Date

Credit

1 31 31

Closing Closing

Item

31 31

Closing

5,500 2,750

2,750

Account No.

Post. Ref.

Debit

Credit

Debit

Balance Credit

45,000

45,000 32

Account No.

Post. Ref.

4 4

Debit

Credit

Debit

Balance Credit

0 33,475 20,975

33,475 12,500

Dividends

Date

Balance Debit Credit

5,500

Item

Account:

20Y2 July

1 3

Debit

Retained Earnings

Account:

20Y2 July

Post. Ref.

Common Stock

Account:

20Y2 July

Adjusting

Account No.

Post. Ref.

2 4

Debit

Balance Credit

Credit

Debit

12,500

12,500 —

12,500

—

CHAPTER 4

The Accounting Cycle

Prob. 4–5A (Continued) Fees Earned

Account:

Date

20Y2 July

Item

12 17 20 24 31 31 31 31

Item

Date

14 27 31 31

Date

Adjusting Closing

Item

31 31

Credit

Adjusting Closing

Date

Item

31 31

Adjusting Closing

Balance Debit Credit

13,300 9,450 6,650 4,000 5,200 3,000 2,750 44,350

—

13,300 22,750 29,400 33,400 38,600 41,600 44,350 —

Account No.

Post. Ref.

1 2 3 4

Debit

Credit

1,750 1,750 175 3,675

Post. Ref.

3 4

Debit

Credit

2,400 2,400

Supplies Expense

Account:

20Y2 July

1 2 2 2 2 2 3 4

Debit

Rent Expense

Account:

20Y2 July

Post. Ref.

Salary Expense

Account:

20Y2 July

Adjusting Closing

Account No.

Post. Ref.

3 4

Debit

Credit

2,275 2,275

Balance Debit Credit

1,750 3,500 3,675 —

—

Account No.

Balance Debit Credit

2,400 —

—

Account No.

Balance Debit Credit

2,275 —

—

CHAPTER 4

The Accounting Cycle

Prob. 4–5A (Continued) Depreciation Expense

Account:

Date

20Y2 July

Item

31 31

Date

Item

31 31

Debit

3 4

Credit

750 750

Adjusting Closing

Post. Ref.

Debit

3 4

Credit

375 375

Miscellaneous Expense

Account:

Item

Date

20Y2 July

Post. Ref.

Insurance Expense

Account:

20Y2 July

Adjusting Closing

Account No.

10 29 31 31

Closing

Post. Ref.

Debit

1 2 2 4

Credit

400 325 675 1,400

Balance Debit Credit

750 —

—

Account No.

Debit

Balance Credit

375 —

—

Account No.

Balance Debit Credit

400 725 1,400 —

—

CHAPTER 4

The Accounting Cycle

Prob. 4–5A (Continued) Diamond Consulting Unadjusted Trial Balance July 31, 20Y2

Account No.

Cash Accounts Receivable Supplies Prepaid Rent Prepaid Insurance Office Equipment Accumulated Depreciation Accounts Payable Salaries Payable Unearned Fees Common Stock Retained Earnings Dividends Fees Earned Salary Expense Rent Expense Supplies Expense Depreciation Expense Insurance Expense Miscellaneous Expense

11 12 14 15 16 18 19 21 22 23 31 32 33 41 51 52 53 54 55 59

Debit Balances

Credit Balances

32,450 16,450 3,800 4,800 4,500 14,000 0 1,300 0 5,500 45,000 0 12,500 41,600 3,500 0 0 0 0 1,400 93,400

93,400

Net income

Account Title Cash Accounts Receivable Supplies Prepaid Rent Prepaid Insurance Office Equipment Accum. Depreciation Accounts Payable Salaries Payable Unearned Fees Common Stock Retained Earnings Dividends Fees Earned Salary Expense Rent Expense Supplies Expense Depreciation Expense Insurance Expense Miscellaneous Expense

5. Optional (Appendix 1)

Prob. 4–5A (Continued)

93,400

41,600 (d) (e) (b) (c) (a) 8,725

175 2,400 2,275 750 375

(f)

4-56

8,725

2,750 3,675 2,400 2,275 750 375 1,400 94,325

12,500

94,325

44,350 3,675 2,400 2,275 750 375 1,400 10,875 33,475 44,350

44,350

Income Statement Debit Credit

1,400 93,400

3,500

12,500

5,500 45,000

1,300

Unadjusted Trial Balance Debit Credit 32,450 16,450 3,800 4,800 4,500 14,000

The Accounting Cycle

Diamond Consulting End-of-Period Spreadsheet (Work Sheet) For the Month Ended July 31, 20Y2 Adjusted Adjustments Trial Balance Debit Credit Debit Credit 32,450 16,450 (b) 2,275 1,525 (e) 2,400 2,400 (a) 375 4,125 14,000 (c) 750 750 1,300 (d) 175 175 (f) 2,750 2,750 45,000

CHAPTER 4

83,450

12,500

49,975 33,475 83,450

Balance Sheet Debit Credit 32,450 16,450 1,525 2,400 4,125 14,000 750 1,300 175 2,750 45,000

CHAPTER 4

The Accounting Cycle

Prob. 4–5A (Continued) 6.

JOURNAL Post. Ref.

Date

20Y2 July

Adjusting Entries 31 Insurance Expense Prepaid Insurance Insurance expired.

Page

Debit

55 16

375

31 Supplies Expense Supplies Supplies used ($3,800 – $1,525).

53 14

2,275

31 Depreciation Expense Accumulated Depreciation Equipment depreciation.

54 19

750

31 Salary Expense Salaries Payable Accrued salaries.

51 22

175

31 Rent Expense Prepaid Rent Rent expired.

52 15

2,400

31 Unearned Fees Fees Earned Unearned fees earned ($5,500 – $2,750).

23 41

2,750

Credit

375

2,275

750

175

2,400

2,750

CHAPTER 4

The Accounting Cycle

Prob. 4–5A (Continued) Diamond Consulting Adjusted Trial Balance July 31, 20Y2

Account No.

11 12 14 15 16 18 19 21 22 23 31 32 33 41 51 52 53 54 55 59

Debit Balances

Credit Balances

32,450 16,450 1,525 2,400 4,125 14,000 750 1,300 175 2,750 45,000 0 12,500 44,350 3,675 2,400 2,275 750 375 1,400 94,325

94,325

CHAPTER 4

The Accounting Cycle

Prob. 4–5A (Continued) 8.

Diamond Consulting Income Statement For the Month Ended July 31, 20Y2 Fees earned Expenses: Salary expense Rent expense Supplies expense Depreciation expense Insurance expense Miscellaneous expense Total expenses Net income

$ 44,350 $3,675 2,400 2,275 750 375 1,400 (10,875) $ 33,475

Diamond Consulting Statement of Stockholders’ Equity For the Month Ended July 31, 20Y2 Common Retained Stock Earnings Balances, July 1, 20Y2 $ 0 $ 0 Issued common stock 45,000 Net income 33,475 Dividends (12,500) Balances, July 31, 20Y2 $45,000 $ 20,975

Total $ 0 45,000 33,475 (12,500) $ 65,975

CHAPTER 4

The Accounting Cycle

Prob. 4–5A (Continued) Diamond Consulting Balance Sheet July 31, 20Y2 Assets Current assets: Cash Accounts receivable Supplies Prepaid rent Prepaid insurance Total current assets Property, plant, and equipment: Office equipment Accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Salaries payable Unearned fees Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$32,450 16,450 1,525 2,400 4,125 $56,950 $14,000 (750) 13,250 $70,200

$ 1,300 175 2,750 $ 4,225 $45,000 20,975 65,975 $70,200

CHAPTER 4

The Accounting Cycle

Prob. 4–5A (Concluded) 9.

JOURNAL Post. Ref.

Date

20Y2 July

Page

Debit

Closing Entries 31 Fees Earned Salary Expense Rent Expense Supplies Expense Depreciation Expense Insurance Expense Miscellaneous Expense Retained Earnings

41 51 52 53 54 55 59 32

44,350

31 Retained Earnings Dividends

32 33

12,500

Account No.

Debit Balances

11 12 14 15 16 18 19 21 22 23 31 32

32,450 16,450 1,525 2,400 4,125 14,000

Credit

3,675 2,400 2,275 750 375 1,400 33,475

12,500

Diamond Consulting Post-Closing Trial Balance July 31, 20Y2

10.

Cash Accounts Receivable Supplies Prepaid Rent Prepaid Insurance Office Equipment Accumulated Depreciation Accounts Payable Salaries Payable Unearned Fees Common Stock Retained Earnings

70,950

Credit Balances

750 1,300 175 2,750 45,000 20,975 70,950

CHAPTER 4

The Accounting Cycle

Prob. 4–1B 1.

Last Chance Company Income Statement For the Year Ended June 30, 20Y3 Revenues: Fees earned Rent revenue Total revenues Expenses: Salaries and wages expense Advertising expense Utilities expense Travel expense Depreciation expense—equipment Depreciation expense—building Supplies expense Insurance expense Miscellaneous expense Total expenses Net loss

$283,750 3,000 $ 286,750 $147,000 86,800 30,000 18,750 4,550 3,000 1,500 1,300 5,875

Last Chance Company Statement of Stockholders’ Equity For the Year Ended June 30, 20Y3 Common Retained Stock Earnings Balances, July 1, 20Y2 $70,000 $271,300 Issued common stock 20,000 Net loss (12,025) Dividends (20,000) Balances, June 30, 20Y3 $90,000 $239,275

(298,775) $ (12,025)

Total $341,300 20,000 (12,025) (20,000) $329,275

CHAPTER 4

The Accounting Cycle

Prob. 4–1B (Continued) Last Chance Company Balance Sheet June 30, 20Y3

5,100 26,500 2,300 525 $ 34,425

$ 80,000 $ 340,000 (193,000) 147,000 $ 140,000 (59,000) 81,000 308,000 $342,425

9,750 1,900 1,500 $ 13,150

$ 90,000 239,275 329,275 $342,425

CHAPTER 4

The Accounting Cycle

Prob. 4–1B (Concluded) 4.

20Y3 June

Closing Entries 30 Fees Earned Rent Revenue Retained Earnings Salaries and Wages Expense Advertising Expense Utilities Expense Travel Expense Depreciation Expense—Equipment Depreciation Expense—Building Supplies Expense Insurance Expense Miscellaneous Expense

283,750 3,000 12,025

30 Retained Earnings Dividends

20,000

147,000 86,800 30,000 18,750 4,550 3,000 1,500 1,300 5,875

20,000

Last Chance Company Post-Closing Trial Balance June 30, 20Y3 Debit Balances

Credit Balances

5,100 26,500 2,300 525 80,000 340,000 193,000 140,000

594,425

59,000 9,750 1,900 1,500 90,000 239,275 594,425

CHAPTER 4

The Accounting Cycle

Prob. 4–2B 1. The Gorman Group Income Statement For the Year Ended October 31, 20Y9 Revenues: Service fees Rent revenue Total revenues Expenses: Salaries expense Depreciation expense—equipment Rent expense Supplies expense Utilities expense Depreciation expense—buildings Repairs expense Insurance expense Miscellaneous expense Total expenses Net income

$468,000 5,000 $ 473,000 $291,000 17,500 15,500 9,000 8,500 6,600 3,450 3,000 5,450 (360,000) $ 113,000

The Gorman Group Statement of Stockholders’ Equity For the Year Ended October 31, 20Y9 Common Retained Stock Earnings Balances, November 1, 20Y8 $25,000 $195,000 Net income 113,000 Dividends (20,000) Balances, October 31, 20Y9 $25,000 $288,000

Total $220,000 113,000 (20,000) $313,000

CHAPTER 4

The Accounting Cycle

Prob. 4–2B (Continued) The Gorman Group Balance Sheet October 31, 20Y9 Assets Current assets: Cash Accounts receivable Supplies Prepaid insurance Total current assets Property, plant, and equipment: Land Buildings Accumulated depreciation—buildings Book value—buildings Equipment Accumulated depreciation—equipment Book value—equipment Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Salaries payable Unearned rent Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$ 11,000 28,150 6,350 9,500 $ 55,000 $ 75,000 $ 250,000 (117,200) 132,800 $ 240,000 (151,700) 88,300 296,100 $351,100

$ 33,300 3,300 1,500 $ 38,100 $ 25,000 288,000 313,000 $351,100

CHAPTER 4

The Accounting Cycle

Prob. 4–2B (Concluded) 2.

20Y9 Oct.

Closing Entries 31 Service Fees Rent Revenue Salaries Expense Depreciation Expense—Equipment Rent Expense Supplies Expense Utilities Expense Depreciation Expense—Buildings Repairs Expense Insurance Expense Miscellaneous Expense Retained Earnings

468,000 5,000

31 Retained Earnings Dividends

20,000

291,000 17,500 15,500 9,000 8,500 6,600 3,450 3,000 5,450 113,000

20,000

$135,000 ($115,000 + $20,000) net income. The $115,000 increase is caused by the net income of $135,000 less the $20,000 dividends.

CHAPTER 4

The Accounting Cycle

Prob. 4–3B 1., 3., and 6. Aug.

Aug.

31 31

Bal.

Cash 3,800

Bal. Adj. Bal.

Laundry Supplies 9,000 Aug. 31 2,000

Adj.

7,000

Bal. Adj. Bal.

Prepaid Insurance 6,000 Aug. 31 700

Adj.

5,300

Bal.

Laundry Equipment 180,800 Accumulated Depreciation Aug. 31 Bal. 31 Adj. 31 Adj. Bal.

Aug.

Clos.

Bal.

49,200 8,150 57,350

Accounts Payable Aug. 31

Bal.

7,800

Wages Payable Aug. 31

Adj.

2,200

Common Stock Aug. 31

Bal.

15,000

Retained Earnings 2,400 Aug. 31 31 31

Bal. Clos. Bal.

80,000 27,350 104,950

Dividends 2,400 Aug. 31

Clos.

2,400

CHAPTER 4

The Accounting Cycle

Prob. 4–3B (Continued) Aug.

Aug.

31 31 31

Clos.

Laundry Revenue 248,000 Aug. 31

Bal. Adj. Adj. Bal.

Wages Expense 135,800 Aug. 31 2,200 138,000

Bal.

248,000

Clos.

138,000

Bal.

Rent Expense 43,200 Aug. 31

Clos.

43,200

Utilities Expense 16,000 Aug. 31

Clos.

16,000

Aug.

Bal.

Aug.

Adj.

Depreciation Expense 8,150 Aug. 31 Clos.

8,150

Aug.

Adj.

Laundry Supplies Expense 7,000 Aug. 31 Clos.

7,000

Aug.

Adj.

Aug.

Bal.

Insurance Expense 5,300 Aug. 31

Clos.

5,300

Miscellaneous Expense 3,000 Aug. 31 Clos.

3,000

Net income

Cash Laundry Supplies Prepaid Insurance Laundry Equipment Accum. Depreciation Accounts Payable Wages Payable Common Stock Retained Earnings Dividends Laundry Revenue Wages Expense Rent Expense Utilities Expense Depreciation Expense Laundry Supplies Exp. Insurance Expense Miscellaneous Expense

Account Title

2. Optional (Appendix 1)

Prob. 4–3B (Continued)

400,000

248,000

15,000 80,000

49,200 7,800

8,150 7,000 5,300

(b) (c) (d) 22,650

2,200

(a)

2,200

(a)

4-70

22,650

8,150

7,000 5,300

(b)

Adjustments Debit Credit

138,000 43,200 16,000 8,150 7,000 5,300 3,000 410,350

2,400

3,800 2,000 700 180,800

410,350

248,000

57,350 7,800 2,200 15,000 80,000

Adjusted Trial Balance Debit Credit

138,000 43,200 16,000 8,150 7,000 5,300 3,000 220,650 27,350 248,000

248,000

Income Statement Debit Credit

3,000 400,000

135,800 43,200 16,000

2,400

3,800 9,000 6,000 180,800

Unadjusted Trial Balance Debit Credit

The Accounting Cycle

La Mesa Laundry End-of-Period Spreadsheet (Work Sheet) For the Year Ended August 31, 20Y5

CHAPTER 4

189,700

2,400

3,800 2,000 700 180,800

162,350 27,350 189,700

57,350 7,800 2,200 15,000 80,000

Balance Sheet Debit Credit

CHAPTER 4

The Accounting Cycle

Prob. 4–3B (Continued) 3.

Adjusting Entries 20Y5 Aug.

31 Wages Expense Wages Payable Accrued wages.

2,200

31 Depreciation Expense Accumulated Depreciation Equipment depreciation.

8,150

31 Laundry Supplies Expense Laundry Supplies Supplies used ($9,000 – $2,000).

7,000

31 Insurance Expense Prepaid Insurance Insurance expired.

5,300

2,200

8,150

7,000

5,300

La Mesa Laundry Adjusted Trial Balance August 31, 20Y5

Debit Balances

Cash Laundry Supplies Prepaid Insurance Laundry Equipment Accumulated Depreciation Accounts Payable Wages Payable Common Stock Retained Earnings Dividends Laundry Revenue Wages Expense Rent Expense Utilities Expense Depreciation Expense Laundry Supplies Expense Insurance Expense Miscellaneous Expense

Credit Balances

3,800 2,000 700 180,800 57,350 7,800 2,200 15,000 80,000 2,400 248,000 138,000 43,200 16,000 8,150 7,000 5,300 3,000 410,350

410,350

CHAPTER 4

The Accounting Cycle

Prob. 4–3B (Continued) 5.

La Mesa Laundry Income Statement For the Year Ended August 31, 20Y5 Laundry revenue Expenses: Wages expense Rent expense Utilities expense Depreciation expense Laundry supplies expense Insurance expense Miscellaneous expense Total expenses Net income

$ 248,000 $138,000 43,200 16,000 8,150 7,000 5,300 3,000 (220,650) $ 27,350

La Mesa Laundry Statement of Stockholders’ Equity For the Year Ended August 31, 20Y5 Common Retained Stock Earnings Balances, September 1, 20Y4 $12,000 $ 80,000 Issued common stock 3,000 Net income 27,350 Dividends (2,400) Balances, August 31, 20Y5 $15,000 $104,950

Total $ 92,000 3,000 27,350 (2,400) $119,950

CHAPTER 4

The Accounting Cycle

Prob. 4–3B (Continued) La Mesa Laundry Balance Sheet August 31, 20Y5 Assets Current assets: Cash Laundry supplies Prepaid insurance Total current assets Property, plant, and equipment: Laundry equipment Accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Wages payable Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

3,800 2,000 700 $

6,500

$180,800 (57,350) 123,450 $129,950

7,800 2,200 $ 10,000

$ 15,000 104,950 119,950 $129,950

CHAPTER 4

The Accounting Cycle

Prob. 4–3B (Concluded) Closing Entries

6. 20Y5 Aug.

31 Laundry Revenue Wages Expense Rent Expense Utilities Expense Depreciation Expense Laundry Supplies Expense Insurance Expense Miscellaneous Expense Retained Earnings 31 Retained Earnings Dividends

248,000 138,000 43,200 16,000 8,150 7,000 5,300 3,000 27,350 2,400 2,400

La Mesa Laundry Post-Closing Trial Balance August 31, 20Y5

Debit Balances

Cash Laundry Supplies Prepaid Insurance Laundry Equipment Accumulated Depreciation Accounts Payable Wages Payable Common Stock Retained Earnings

Credit Balances

3,800 2,000 700 180,800

187,300

57,350 7,800 2,200 15,000 104,950 187,300

CHAPTER 4

The Accounting Cycle

Prob. 4–4B 1., 3., and 6. Cash

Account:

Item

Date

20Y2 Jan.

Balance

Date

20Y2 Jan.

Item

31 31

Balance Adjusting

Date

Item

31 31

Balance Adjusting

Date

Item

Balance

Date

Item

31 31

Date

Post. Ref.

Debit

 26

Credit

5,150

Balance Debit Credit

8,000 2,850 14

Account No.

Post. Ref.

Debit

 26

Credit

3,150

Debit

Balance Credit

7,500 4,350 16

Account No.

Post. Ref.

Debit

Credit

113,000



Post. Ref.

Balance Debit Credit

Debit

 26

Account No.

Credit

Balance Debit Credit

12,000 17,250

5,250 Account No.

Item

Account No.

Trucks

Account:

20Y2 Jan.

Balance Adjusting

Balance Debit Credit

13,100



Accumulated Depreciation—Equipment

Account:

20Y2 Jan.

Credit

Equipment

Account:

20Y2 Jan.

Debit

Prepaid Insurance

Account:

20Y2 Jan.

Post. Ref.

Supplies

Account:

Account No.

Balance

Post. Ref.

Debit

Credit

Balance Debit Credit

90,000



CHAPTER 4

The Accounting Cycle

Prob. 4–4B (Continued) Accumulated Depreciation—Trucks

Account:

Item

Date

20Y2 Jan.

31 31

Date

Item

Date

Item

Balance

Date

Item

31 31 31

Balance Closing Closing

Post. Ref.

Debit

Credit

Item

Date

31 31

Balance Closing

Debit

Balance Credit

4,500



Account No.

Post. Ref.

Debit

Credit

Debit

Balance Credit

900

900 31

Account No.

Post. Ref.

Debit

Credit

Debit

Balance Credit

30,000



Account No.

Post. Ref.

 27 27

Debit

Credit

Debit

Balance Credit

96,400 142,550 139,550

46,150 3,000

Dividends

Account:

27,100 31,100 Account No.

Retained Earnings

Account:

20Y2 Jan.

Adjusting

Balance Debit Credit

4,000

Common Stock

Account:

20Y2 Jan.

Balance

Item

20Y2 Jan.

 26

Credit

Wages Payable

Account:

20Y2 Jan.

Debit

Accounts Payable

Account:

20Y2 Jan.

Balance Adjusting

Post. Ref.

Account No.

Post. Ref.

Debit

 27

Credit

3,000

Debit

Balance Credit

3,000 —

—

CHAPTER 4

The Accounting Cycle

Prob. 4–4B (Continued) Service Revenue

Account:

Date

20Y2 Jan.

Item

31 31

Date

Item

31 31 31

Date

Credit

155,000

Balance Closing

Date

Item

31 31

Balance Closing

Date

Item

31 31

Adjusting Closing

155,000 —

Account No.

Post. Ref.

Debit

 26 27

Post. Ref.

 27

Post. Ref.

72,900

72,000 72,900 —

—

Account No.

Credit

7,600

Debit

 27

Post. Ref.

Credit

5,350

26 27

Debit

Balance Credit

Debit

900

Debit

Credit

Depreciation Expense—Equipment

Account:

Balance Debit Credit

—

Truck Expense

Account:

20Y2 Jan.

Balance Adjusting Closing

Item

31 31

20Y2 Jan.

 27

Debit

Rent Expense

Account:

20Y2 Jan.

Post. Ref.

Wages Expense

Account:

20Y2 Jan.

Balance Closing

Account No.

Credit

5,250 5,250

Debit

Balance Credit

7,600 —

—

Account No.

Balance Debit Credit

5,350 —

—

Account No.

Balance Debit Credit

5,250 —

—

CHAPTER 4

The Accounting Cycle

Prob. 4–4B (Continued) Supplies Expense

Account:

Date

20Y2 Jan.

Item

31 31

Date

Item

31 31

Date

Adjusting Closing

Item

31 31

26 27

Credit

5,150 5,150

Post. Ref.

26 27

Debit

Credit

4,000 4,000

Adjusting Closing

Post. Ref.

26 27

Debit

Credit

3,150 3,150

Miscellaneous Expense

Account:

Item

Date

20Y2 Jan.

Debit

Insurance Expense

Account:

20Y2 Jan.

Post. Ref.

Depreciation Expense—Trucks

Account:

20Y2 Jan.

Adjusting Closing

Account No.

31 31

Balance Closing

Post. Ref.

Debit

 27

Credit

5,450

Balance Debit Credit

5,150 —

—

Account No.

Debit

Balance Credit

4,000 —

—

Account No.

Balance Debit Credit

3,150 —

—

Account No.

Debit

Balance Credit

5,450 —

—

Net income

Account Title Cash Supplies Prepaid Insurance Equipment Accum. Depr.—Equipment Trucks Accum. Depr.—Trucks Accounts Payable Wages Payable Common Stock Retained Earnings Dividends Service Revenue Wages Expense Rent Expense Truck Expense Depr. Exp.—Equipment Supplies Expense Depr. Exp.—Trucks Insurance Expense Miscellaneous Expense

2. Optional (Appendix 1)

Prob. 4–4B (Continued)

325,000

155,000

4-79

72,900 7,600 5,350 5,250 5,150 4,000 3,150 5,450 108,850 46,150 155,000

155,000

Income Statement Debit Credit

5,450 325,000

72,000 7,600 5,350

3,000

30,000 96,400

Unadjusted Trial Balance Debit Credit 13,100 8,000 7,500 113,000 12,000 90,000 27,100 4,500

The Accounting Cycle

Recessive Interiors End-of-Period Spreadsheet (Work Sheet) For the Year Ended January 31, 20Y2 Adjusted Adjustments Trial Balance Debit Credit Debit Credit 13,100 (a) 5,150 2,850 (b) 3,150 4,350 113,000 (c) 5,250 17,250 90,000 (d) 4,000 31,100 4,500 (e) 900 900 30,000 96,400 3,000 155,000 (e) 900 72,900 7,600 5,350 (c) 5,250 5,250 (a) 5,150 5,150 (d) 4,000 4,000 (b) 3,150 3,150 5,450 18,450 18,450 335,150 335,150

CHAPTER 4

226,300

180,150 46,150 226,300

Balance Sheet Debit Credit 13,100 2,850 4,350 113,000 17,250 90,000 31,100 4,500 900 30,000 96,400 3,000

CHAPTER 4

The Accounting Cycle

Prob. 4–4B (Continued) 3.

JOURNAL Post. Ref.

Date

20Y2 Jan.

Adjusting Entries 31 Supplies Expense Supplies Supplies used ($8,000 – $2,850).

Page

Debit

55 13

5,150

31 Insurance Expense Prepaid Insurance Insurance expired.

57 14

3,150

31 Depreciation Expense—Equipment Accumulated Depr.—Equipment Equipment depreciation.

54 17

5,250

31 Depreciation Expense—Trucks Accumulated Depr.—Trucks Truck depreciation.

56 19

4,000

31 Wages Expense Wages Payable Accrued wages.

51 22

900

Credit

5,150

3,150

5,250

4,000

900

CHAPTER 4

The Accounting Cycle

Prob. 4–4B (Continued) 4.

Recessive Interiors Adjusted Trial Balance January 31, 20Y2

Cash Supplies Prepaid Insurance Equipment Accumulated Depreciation—Equipment Trucks Accumulated Depreciation—Trucks Accounts Payable Wages Payable Common Stock Retained Earnings Dividends Service Revenue Wages Expense Rent Expense Truck Expense Depreciation Expense—Equipment Supplies Expense Depreciation Expense—Trucks Insurance Expense Miscellaneous Expense

Account No.

Debit Balances

11 13 14 16 17 18 19 21 22 31 32 33 41 51 52 53 54 55 56 57 59

13,100 2,850 4,350 113,000

Credit Balances

17,250 90,000 31,100 4,500 900 30,000 96,400 3,000 155,000 72,900 7,600 5,350 5,250 5,150 4,000 3,150 5,450 335,150

335,150

CHAPTER 4

The Accounting Cycle

Prob. 4–4B (Continued) 5.

Recessive Interiors Income Statement For the Year Ended January 31, 20Y2 Service revenue Expenses: Wages expense Rent expense Truck expense Depreciation expense—equipment Supplies expense Depreciation expense—trucks Insurance expense Miscellaneous expense Total expenses Net income

$ 155,000 $72,900 7,600 5,350 5,250 5,150 4,000 3,150 5,450

Recessive Interiors Statement of Stockholders’ Equity For the Year Ended January 31, 20Y2 Common Retained Stock Earnings Balances, February 1, 20Y1 $22,500 $ 96,400 Issued common stock 7,500 Net income 46,150 Dividends (3,000) Balances, January 31, 20Y2 $30,000 $139,550

(108,850) $ 46,150

Total $118,900 7,500 46,150 (3,000) $169,550

CHAPTER 4

The Accounting Cycle

Prob. 4–4B (Continued) Recessive Interiors Balance Sheet January 31, 20Y2 Assets Current assets: Cash Supplies Prepaid insurance Total current assets Property, plant, and equipment: Equipment Accumulated depreciation—equipment Book value—equipment Trucks Accumulated depreciation—trucks Book value—trucks Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Wages payable Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$ 13,100 2,850 4,350 $ 20,300 $113,000 (17,250) $ 95,750 $ 90,000 (31,100) 58,900 154,650 $174,950

4,500 900 $

5,400

$ 30,000 139,550 169,550 $174,950

CHAPTER 4

The Accounting Cycle

Prob. 4–4B (Concluded) 6.

JOURNAL Post. Ref.

Date

20Y2 Jan.

Page

Debit

Closing Entries 31 Service Revenue Wages Expense Rent Expense Truck Expense Depreciation Expense—Equipment Supplies Expense Depreciation Expense—Trucks Insurance Expense Miscellaneous Expense Retained Earnings

41 51 52 53 54 55 56 57 59 32

155,000

31 Retained Earnings Dividends

32 33

3,000

Account No.

Debit Balances

11 13 14 16 17 18 19 21 22 31 32

13,100 2,850 4,350 113,000

Credit

72,900 7,600 5,350 5,250 5,150 4,000 3,150 5,450 46,150

3,000

Recessive Interiors Post-Closing Trial Balance January 31, 20Y2

Cash Supplies Prepaid Insurance Equipment Accumulated Depreciation—Equipment Trucks Accumulated Depreciation—Trucks Accounts Payable Wages Payable Common Stock Retained Earnings

Credit Balances

17,250 90,000

223,300

31,100 4,500 900 30,000 139,550 223,300

CHAPTER 4

The Accounting Cycle

Prob. 4–5B 1. and 2. JOURNAL Post. Ref.

Date

20Y6 Apr.

Page

Debit

1 Cash Accounts Receivable Supplies Office Equipment Common Stock

11 12 14 18 31

20,000 14,700 3,300 12,000

1 Prepaid Rent Cash

15 11

6,000

2 Prepaid Insurance Cash

16 11

4,200

4 Cash Unearned Fees

11 23

9,400

5 Office Equipment Accounts Payable

18 21

8,000

6 Cash Accounts Receivable

11 12

11,700

10 Miscellaneous Expense Cash

59 11

350

12 Accounts Payable Cash

21 11

6,400

12 Accounts Receivable Fees Earned

12 41

21,900

14 Salary Expense Cash

51 11

1,650

Credit

50,000

6,000

4,200

9,400

8,000

11,700

350

6,400

21,900

1,650

CHAPTER 4

The Accounting Cycle

Prob. 4–5B (Continued) JOURNAL Post. Ref.

Date

20Y6 Apr.

Page

Debit

17 Cash Fees Earned

11 41

6,600

18 Supplies Cash

14 11

725

20 Accounts Receivable Fees Earned

12 41

16,800

24 Cash Fees Earned

11 41

4,450

26 Cash Accounts Receivable

11 12

26,500

27 Salary Expense Cash

51 11

1,650

29 Miscellaneous Expense Cash

59 11

540

30 Miscellaneous Expense Cash

59 11

760

30 Cash Fees Earned

11 41

5,160

30 Accounts Receivable Fees Earned

12 41

2,590

30 Dividends Cash

33 11

18,000

Credit

6,600

725

16,800

4,450

26,500

1,650

540

760

5,160

2,590

18,000

CHAPTER 4

The Accounting Cycle

Prob. 4–5B (Continued) 2., 6., and 9. Cash

Account:

Item

Date

20Y6 Apr.

1 1 2 4 6 10 12 14 17 18 24 26 27 29 30 30 30

Date

1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2

Item

1 6 12 20 26 30

Debit

Credit

20,000 6,000 4,200 9,400 11,700 350 6,400 1,650 6,600 725 4,450 26,500 1,650 540 760 5,160 18,000

Post. Ref.

1 1 1 2 2 2

Debit

Credit

14,700 11,700 21,900 16,800 26,500 2,590

Date

Item

1 18 30

Adjusting

20,000 14,000 9,800 19,200 30,900 30,550 24,150 22,500 29,100 28,375 32,825 59,325 57,675 57,135 56,375 61,535 43,535

Debit

1 2 3

Debit

Credit

3,300 725 2,800

Balance Credit

14,700 3,000 24,900 41,700 15,200 17,790 Account No.

Post. Ref.

Balance Debit Credit

Account No.

Supplies

Account:

20Y6 Apr.

Post. Ref.

Accounts Receivable

Account:

20Y6 Apr.

Account No.

Balance Debit Credit

3,300 4,025 1,225

CHAPTER 4

The Accounting Cycle

Prob. 4–5B (Continued) Prepaid Rent

Account:

Item

Date

20Y6 Apr.

1 30

Item

Date

2 30

Date

Item

Date

Item

6,000 2,000

Adjusting

Date

Item

5 12

Post. Ref.

1 3

Debit

Credit

4,200 350

Post. Ref.

Debit

1 1

12,000 8,000

Post. Ref.

Adjusting

Debit

Balance Credit

4,200 3,850 18

Credit

Balance Debit Credit

12,000 20,000 19

Account No.

Debit

Credit

Debit

Balance Credit

400

400 21

Account No.

Post. Ref.

1 1

Item

Date

6,000 4,000

Account No.

Debit

Credit

Debit

Balance Credit

8,000

8,000 1,600

6,400

Salaries Payable

Account:

Balance Debit Credit

Account No.

Accounts Payable

Account:

20Y6 Apr.

Credit

Accumulated Depreciation

Account:

20Y6 Apr.

Adjusting

1 5

20Y6 Apr.

1 3

Debit

Office Equipment

Account:

20Y6 Apr.

Post. Ref.

Prepaid Insurance

Account:

20Y6 Apr.

Adjusting

Account No.

Post. Ref.

Debit

Credit

Balance Debit Credit

275

CHAPTER 4

The Accounting Cycle

Prob. 4–5B (Continued) Unearned Fees

Account:

Item

Date

20Y6 Apr.

4 30

Date

Item

Date

Credit

1 30 30

Closing Closing

Item

30 30

Closing

9,400 2,350

7,050

Account No.

Post. Ref.

Debit

Credit

Debit

Balance Credit

50,000

50,000 32

Account No.

Post. Ref.

4 4

Debit

Credit

Debit

Balance Credit

0 53,775 35,775

53,775 18,000

Dividends

Date

Balance Debit Credit

9,400

Item

Account:

20Y6 Apr.

1 3

Debit

Retained Earnings

Account:

20Y6 Apr.

Post. Ref.

Common Stock

Account:

20Y6 Apr.

Adjusting

Account No.

Post. Ref.

2 4

Debit

Balance Credit

Credit

Debit

18,000

18,000 —

18,000

—

CHAPTER 4

The Accounting Cycle

Prob. 4–5B (Continued) Fees Earned

Account:

Date

20Y6 Apr.

Item

12 17 20 24 30 30 30 30

Date

Item

14 27 30 30

Date

Adjusting Closing

Item

30 30

Credit

Adjusting Closing

Date

Item

30 30

Adjusting Closing

Balance Debit Credit

21,900 6,600 16,800 4,450 5,160 2,590 7,050 64,550

—

21,900 28,500 45,300 49,750 54,910 57,500 64,550 —

Account No.

Post. Ref.

1 2 3 4

Debit

Credit

1,650 1,650 275 3,575

Post. Ref.

3 4

Debit

Credit

2,800 2,800

Rent Expense

Account:

20Y6 Apr.

1 2 2 2 2 2 3 4

Debit

Supplies Expense

Account:

20Y6 Apr.

Post. Ref.

Salary Expense

Account:

20Y6 Apr.

Adjusting Closing

Account No.

Post. Ref.

3 4

Debit

Credit

2,000 2,000

Balance Debit Credit

1,650 3,300 3,575 —

—

Account No.

Balance Debit Credit

2,800 —

—

Account No.

Balance Debit Credit

2,000 —

—

CHAPTER 4

The Accounting Cycle

Prob. 4–5B (Continued) Depreciation Expense

Account:

Date

20Y6 Apr.

Item

30 30

Date

Adjusting Closing

Item

30 30

Debit

3 4

Credit

400 400

Post. Ref.

Adjusting Closing

Debit

3 4

Credit

350 350

Miscellaneous Expense

Account:

Date

20Y6 Apr.

Post. Ref.

Insurance Expense

Account:

20Y6 Apr.

Account No.

Item

10 29 30 30

Closing

Post. Ref.

Debit

1 2 2 4

Credit

350 540 760 1,650

Balance Debit Credit

400 —

—

Account No.

Debit

Balance Credit

350 —

—

Account No.

Balance Debit Credit

350 890 1,650 —

—

CHAPTER 4

The Accounting Cycle

Prob. 4–5B (Continued) Rosebud Consulting Unadjusted Trial Balance April 30, 20Y6

Account No.

Cash Accounts Receivable Supplies Prepaid Rent Prepaid Insurance Office Equipment Accumulated Depreciation Accounts Payable Salaries Payable Unearned Fees Common Stock Retained Earnings Dividends Fees Earned Salary Expense Supplies Expense Rent Expense Depreciation Expense Insurance Expense Miscellaneous Expense

11 12 14 15 16 18 19 21 22 23 31 32 33 41 51 52 53 54 55 59

Debit Balances

Credit Balances

43,535 17,790 4,025 6,000 4,200 20,000 0 1,600 0 9,400 50,000 0 18,000 57,500 3,300 0 0 0 0 1,650 118,500

118,500

Net income

Account Title Cash Accounts Receivable Supplies Prepaid Rent Prepaid Insurance Office Equipment Accum. Depreciation Accounts Payable Salaries Payable Unearned Fees Common Stock Retained Earnings Dividends Fees Earned Salary Expense Supplies Expense Rent Expense Depreciation Expense Insurance Expense Miscellaneous Expense

5. Optional (Appendix 1)

Prob. 4–5B (Continued)

118,500

57,500 (d) (b) (e) (c) (a) 12,875

275 2,800 2,000 400 350

(f)

4-93

12,875

7,050 3,575 2,800 2,000 400 350 1,650 119,175

18,000

119,175

64,550 3,575 2,800 2,000 400 350 1,650 10,775 53,775 64,550

64,550

Income Statement Debit Credit

1,650 118,500

3,300

18,000

9,400 50,000

1,600

Unadjusted Trial Balance Debit Credit 43,535 17,790 4,025 6,000 4,200 20,000

The Accounting Cycle

Rosebud Consulting End-of-Period Spreadsheet (Work Sheet) For the Month Ended April 30, 20Y6 Adjusted Adjustments Trial Balance Debit Credit Debit Credit 43,535 17,790 (b) 2,800 1,225 (e) 2,000 4,000 (a) 350 3,850 20,000 (c) 400 400 1,600 (d) 275 275 (f) 7,050 2,350 50,000

CHAPTER 4

108,400

18,000

54,625 53,775 108,400

Balance Sheet Debit Credit 43,535 17,790 1,225 4,000 3,850 20,000 400 1,600 275 2,350 50,000

CHAPTER 4

The Accounting Cycle

Prob. 4–5B (Continued) 6.

JOURNAL Post. Ref.

Date

20Y6 Apr.

Adjusting Entries 30 Insurance Expense Prepaid Insurance Insurance expired.

Page

Debit

55 16

350

30 Supplies Expense Supplies Supplies used ($4,025 – $1,225).

52 14

2,800

30 Depreciation Expense Accumulated Depreciation Equipment depreciation.

54 19

400

30 Salary Expense Salaries Payable Accrued salaries.

51 22

275

30 Rent Expense Prepaid Rent Rent expired.

53 15

2,000

30 Unearned Fees Fees Earned Unearned fees earned ($9,400 – $2,350).

23 41

7,050

Credit

350

2,800

400

275

2,000

7,050

CHAPTER 4

The Accounting Cycle

Prob. 4–5B (Continued) Rosebud Consulting Adjusted Trial Balance April 30, 20Y6

Account No.

Cash Accounts Receivable Supplies Prepaid Rent Prepaid Insurance Office Equipment Accumulated Depreciation Accounts Payable Salaries Payable Unearned Fees Common Stock Retained Earnings Dividends Fees Earned Salary Expense Supplies Expense Rent Expense Depreciation Expense Insurance Expense Miscellaneous Expense

11 12 14 15 16 18 19 21 22 23 31 32 33 41 51 52 53 54 55 59

Debit Balances

Credit Balances

43,535 17,790 1,225 4,000 3,850 20,000 400 1,600 275 2,350 50,000 0 18,000 64,550 3,575 2,800 2,000 400 350 1,650 119,175

119,175

CHAPTER 4

The Accounting Cycle

Prob. 4–5B (Continued) 8.

Rosebud Consulting Income Statement For the Month Ended April 30, 20Y6 Fees earned Expenses: Salary expense Supplies expense Rent expense Depreciation expense Insurance expense Miscellaneous expense Total expenses Net income

$ 64,550 $3,575 2,800 2,000 400 350 1,650 (10,775) $ 53,775

Rosebud Consulting Statement of Stockholders’ Equity For the Month Ended April 30, 20Y6 Common Retained Stock Earnings Balances, April 1, 20Y6 $ 0 $ 0 Issued common stock 50,000 Net income 53,775 Dividends (18,000) Balances, April 30, 20Y6 $50,000 $ 35,775

Total $ 0 50,000 53,775 (18,000) $ 85,775

CHAPTER 4

The Accounting Cycle

Prob. 4–5B (Continued) Rosebud Consulting Balance Sheet April 30, 20Y6 Assets Current assets: Cash Accounts receivable Supplies Prepaid rent Prepaid insurance Total current assets Property, plant, and equipment: Office equipment Accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Salaries payable Unearned fees Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$43,535 17,790 1,225 4,000 3,850 $70,400 $20,000 (400) 19,600 $90,000

$ 1,600 275 2,350 $ 4,225 $50,000 35,775 85,775 $90,000

CHAPTER 4

The Accounting Cycle

Prob. 4–5B (Concluded) 9.

JOURNAL Post. Ref.

Date

20Y6 Apr.

Page

Debit

Closing Entries 30 Fees Earned Salary Expense Supplies Expense Rent Expense Depreciation Expense Insurance Expense Miscellaneous Expense Retained Earnings

41 51 52 53 54 55 59 32

64,550

30 Retained Earnings Dividends

32 33

18,000

Account No.

Debit Balances

11 12 14 15 16 18 19 21 22 23 31 32

43,535 17,790 1,225 4,000 3,850 20,000

Credit

3,575 2,800 2,000 400 350 1,650 53,775

18,000

Rosebud Consulting Post-Closing Trial Balance April 30, 20Y6

10.

Cash Accounts Receivable Supplies Prepaid Rent Prepaid Insurance Office Equipment Accumulated Depreciation Accounts Payable Salaries Payable Unearned Fees Common Stock Retained Earnings

90,400

Credit Balances

400 1,600 275 2,350 50,000 35,775 90,400

Net income

Music Expense Wages Expense Office Rent Expense Advertising Expense Equip. Rent Expense Utilities Expense Supplies Expense Insurance Expense Depreciation Expense Miscellaneous Expense

Cash Accounts Receivable Supplies Prepaid Insurance Office Equipment Accum. Depr.—Off. Equip. Accounts Payable Wages Payable Unearned Revenue Common Stock Dividends Fees Earned

Account Title

1. Optional (Appendix 1)

40,750

16,200

7,200 9,000

8,350

Credit

745 225 50

(b) (c) (d)

6,160

140

3,600

1,400

(f)

(e)

(a)

(a) (e)

4-99

6,160

1,400 3,600

140

(d) (f)

745 225

(b) (c)

3,610 2,940 2,550 1,500 1,375 1,215 925 225 50 1,855 42,340

1,750

9,945 4,150 275 2,475 7,500

42,340

21,200

50 8,350 140 3,600 9,000

PS Music End-of-Period Spreadsheet (Work Sheet) For the Two Months Ended July 31, 20Y5 Adjusted Adjustments Trial Balance Debit Credit Debit Credit

3,610 2,940 2,550 1,500 1,375 1,215 925 225 50 1,855 16,245 4,955 21,200

Debit

21,200

Credit

Income Statement

1,855 40,750

3,610 2,800 2,550 1,500 1,375 1,215 180

1,750

9,945 2,750 1,020 2,700 7,500

Debit

Unadjusted Trial Balance

The Accounting Cycle

CONTINUING PROBLEM

CHAPTER 4

26,095

1,750

9,945 4,150 275 2,475 7,500

Debit

21,140 4,955 26,095

50 8,350 140 3,600 9,000

Credit

Balance Sheet

CHAPTER 4

The Accounting Cycle

Continuing Problem (Continued) 2.

PS Music Income Statement For the Two Months Ended July 31, 20Y5 Fees earned Expenses: Music expense Wages expense Office rent expense Advertising expense Equipment rent expense Utilities expense Supplies expense Insurance expense Depreciation expense Miscellaneous expense Total expenses Net income

$ 21,200 $3,610 2,940 2,550 1,500 1,375 1,215 925 225 50 1,855 (16,245) $ 4,955

PS Music Statement of Stockholders’ Equity For the Two Months Ended July 31, 20Y5 Common Retained Stock Earnings Balances, June 1, 20Y5 $ 0 $ 0 Issued common stock 9,000 Net income 4,955 Dividends (1,750) Balances, July 31, 20Y5 $9,000 $ 3,205

Total $ 0 9,000 4,955 (1,750) $12,205

CHAPTER 4

The Accounting Cycle

Continuing Problem (Continued) PS Music Balance Sheet July 31, 20Y5 Assets Current assets: Cash Accounts receivable Supplies Prepaid insurance Total current assets Property, plant, and equipment: Office equipment Accumulated depreciation—office equipment Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Wages payable Unearned revenue Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$9,945 4,150 275 2,475 $16,845 $7,500 (50) 7,450 $24,295

$8,350 140 3,600 $12,090 $9,000 3,205 12,205 $24,295

CHAPTER 4

The Accounting Cycle

Continuing Problem (Continued) JOURNAL

Post. Ref.

Date

20Y5 July

Page

Debit

Credit

Closing Entries 31 Fees Earned Wages Expense Office Rent Expense Equipment Rent Expense Utilities Expense Music Expense Advertising Expense Supplies Expense Insurance Expense Depreciation Expense Miscellaneous Expense Retained Earnings

41 50 51 52 53 54 55 56 57 58 59 32

21,200

31 Retained Earnings Dividends

32 33

1,750

2,940 2,550 1,375 1,215 3,610 1,500 925 225 50 1,855 4,955

1,750

CHAPTER 4

The Accounting Cycle

Continuing Problem (Continued) Cash

Account:

Item

Date

20Y5 July

1 1 1 1 2 3 3 4 8 11 13 14 16 21 22 23 27 28 29 30 31 31 31

Balance

Post. Ref.

 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 2

Debit

Credit

5,000 1,750 2,700 1,000 7,200 250 900 200 1,000 700 1,200 2,000 620 800 750 915 1,200 540 500 3,000 1,400 1,250

Accounts Receivable

Account:

Item

Date

20Y5 July

Account No.

1 2 23 30 31

Balance

Adjusting

Balance Debit Credit

3,920 8,920 7,170 4,470 5,470 12,670 12,420 11,520 11,320 12,320 11,620 10,420 12,420 11,800 11,000 11,750 10,835 9,635 9,095 9,595 12,595 11,195 9,945 Account No.

Post. Ref.

 1 2 2 3

Debit

Credit

1,000 1,750 1,000 1,400

Balance Debit Credit

1,000 — 1,750 2,750 4,150

—

CHAPTER 4

The Accounting Cycle

Continuing Problem (Continued) Supplies

Account:

Date

20Y5 July

Item

1 18 31

Date

Item

1 31

Date

 2 3

Credit

850 745

Post. Ref.

1 3

Debit

Credit

2,700 225

2,700 2,475

Post. Ref.

Debit

Credit

7,500

Debit

7,500

Post. Ref.

Debit

Balance

Balance Credit

Account No.

Adjusting

Balance Debit Credit

Accumulated Depreciation—Office Equipment

Item

1 3 5 18

170 1,020 275

Account No.

Debit

Credit

Balance Credit

Accounts Payable

Date

Balance Debit Credit

Account No.

Item

Account:

20Y5 July

Adjusting

Item

Account:

20Y5 July

Debit

Office Equipment

Account:

20Y5 July

Adjusting

Post. Ref.

Prepaid Insurance

Account:

20Y5 July

Balance

Account No.

50 21

Account No.

Post. Ref.

Debit

 1 1 2

Credit

250

Debit

Balance Credit

— 7,500 850

250 — 7,500 8,350

CHAPTER 4

The Accounting Cycle

Continuing Problem (Continued) Wages Payable Account: Date

20Y5 July

Item

Date

Item

3 31

Date

1 1

Credit

Balance

Item

1 31 31

Balance Closing Closing

Date

Item

1 31 31

Balance Closing

140 23

Account No.

Post. Ref.

1 3

Debit

Credit

Balance Debit Credit

7,200

7,200 3,600

3,600

Account No.

Post. Ref.

Debit

 1

Credit

Balance Debit Credit

4,000 9,000

5,000

Account No.

Post. Ref.

4 4

Debit

Credit

Debit

Balance Credit

0 4,955 3,205

4,955 1,750

Dividends

Account:

Balance Debit Credit

140

Retained Earnings

Date

20Y5 July

Adjusting

Item

Account:

20Y5 July

Debit

Common Stock

Account:

20Y5 July

Post. Ref.

Unearned Revenue

Account:

20Y5 July

Adjusting

Account No.

Post. Ref.

 2 4

Debit

Credit

1,250 1,750

Balance Debit Credit

500 1,750 —

—

CHAPTER 4

The Accounting Cycle

Continuing Problem (Continued) Fees Earned

Account:

Date

20Y5 July

Item

1 11 16 23 30 31 31 31 31

Item

Date

1 14 28 31 31

 1 2 2 2 2 3 3 4

Date

Credit

Balance

Adjusting Closing

Item

1 1 31

Balance Closing

Post. Ref.

 1 2 3 4

Post. Ref.

 1 4

Equipment Rent Expense

Date

Post. Ref.

Item

1 13 31

Balance Closing

Balance Debit Credit

1,000 2,000 2,500 1,500 3,000 1,400 3,600 21,200

—

6,200 7,200 9,200 11,700 13,200 16,200 17,600 21,200 —

Account No.

Account:

20Y5 July

Debit

Credit

1,200 1,200 140 2,940

Office Rent Expense

Account:

20Y5 July

Adjusting Adjusting Closing

Post. Ref.

Wages Expense

Account:

20Y5 July

Balance

Account No.

Debit

Credit

1,750 2,550

Debit

 1 4

Credit

700 1,375

Balance Debit Credit

400 1,600 2,800 2,940 —

—

Account No.

Debit

Balance Credit

800 2,550 —

—

Account No.

Balance Debit Credit

675 1,375 —

—

CHAPTER 4

The Accounting Cycle

Continuing Problem (Continued) Utilities Expense

Account:

Date

20Y5 July

Item

1 27 31

Date

Item

1 21 31 31

Date

Balance

Closing

Item

1 8 22 31

 2 4

Credit

915 1,215

Post. Ref.

 2 2 4

Debit

Credit

620 1,400 3,610

Balance

Closing

Post. Ref.

Debit

 1 2 4

Credit

200 800 1,500

Supplies Expense

Account:

Date

20Y5 July

Debit

Advertising Expense

Account:

20Y5 July

Closing

Post. Ref.

Music Expense

Account:

20Y5 July

Balance

Account No.

Item

1 31 31

Balance Adjusting Closing

Post. Ref.

Debit

 3 4

Credit

745 925

Balance Debit Credit

300 1,215 —

—

Account No.

Balance Debit Credit

1,590 2,210 3,610 —

—

Account No.

Balance Debit Credit

500 700 1,500 —

—

Account No.

Balance Debit Credit

180 925 —

—

CHAPTER 4

The Accounting Cycle

Continuing Problem (Continued) Insurance Expense

Account:

Date

20Y5 July

Item

31 31

Date

20Y5 July

31 31

Debit

3 4

Credit

225 225

Adjusting Closing

Post. Ref.

Debit

3 4

Credit

50 50

Miscellaneous Expense

Date

Adjusting Closing

Item

Account:

20Y5 July

Post. Ref.

Depreciation Expense

Account:

Item

1 4 29 31

Balance

Closing

Account No.

Post. Ref.

Debit

 1 2 4

Credit

900 540 1,855

Balance Debit Credit

225 —

—

Account No.

Debit

Balance Credit

50 —

—

Account No.

Balance Debit Credit

415 1,315 1,855 —

—

Debit Balances

Credit Balances

PS Music Post-Closing Trial Balance July 31, 20Y5 Account No.

Cash Accounts Receivable Supplies Prepaid Insurance Office Equipment Accumulated Depreciation—Office Equip. Accounts Payable Wages Payable Unearned Revenue Common Stock Retained Earnings

11 12 14 15 17 18 21 22 23 31 32

9,945 4,150 275 2,475 7,500

24,345

50 8,350 140 3,600 9,000 3,205 24,345

CHAPTER 4

The Accounting Cycle

COMPREHENSIVE PROBLEM 1 1. and 2. JOURNAL Post. Ref.

Date

20Y8 May

Page

Debit

3 Cash Unearned Fees

11 23

4,500

5 Cash Accounts Receivable

11 12

2,450

9 Miscellaneous Expense Cash

59 11

225

13 Accounts Payable Cash

21 11

640

15 Accounts Receivable Fees Earned

12 41

9,180

16 Salary Expense Salaries Payable Cash

51 22 11

630 120

17 Cash Fees Earned

11 41

8,360

Credit

4,500

2,450

225

640

9,180

750

8,360

CHAPTER 4

The Accounting Cycle

Comp. Prob. 1 (Continued) JOURNAL Post. Ref.

Date

20Y8 May

Page

Debit

20 Supplies Accounts Payable

14 21

735

21 Accounts Receivable Fees Earned

12 41

4,820

25 Cash Fees Earned

11 41

7,900

27 Cash Accounts Receivable

11 12

9,520

28 Salary Expense Cash

51 11

750

30 Miscellaneous Expense Cash

59 11

260

31 Miscellaneous Expense Cash

59 11

810

31 Cash Fees Earned

11 41

3,300

31 Accounts Receivable Fees Earned

12 41

2,650

31 Dividends Cash

33 11

10,500

Credit

735

4,820

7,900

9,520

750

260

810

3,300

2,650

10,500

CHAPTER 4

The Accounting Cycle

Comp. Prob. 1 (Continued) 2., 6., and 9. Cash

Account:

Item

Date

20Y8 May

1 3 5 9 13 16 17 25 27 28 30 31 31 31

Balance

Item

Date

1 5 15 21 27 31

 5 5 5 5 5 5 6 6 6 6 6 6 6

Debit

Credit

4,500 2,450 225 640 750 8,360 7,900 9,520 750 260 810 3,300 10,500

Balance

Post. Ref.

 5 5 6 6 6

Debit

Credit

2,450 9,180 4,820 9,520 2,650

Date

Item

1 20 31

Balance Adjusting

22,100 26,600 29,050 28,825 28,185 27,435 35,795 43,695 53,215 52,465 52,205 51,395 54,695 44,195

Debit

 6 7

Credit

735 1,370

Balance Credit

3,400 950 10,130 14,950 5,430 8,080 Account No.

Post. Ref.

Balance Debit Credit

Account No.

Supplies

Account:

20Y8 May

Post. Ref.

Accounts Receivable

Account:

20Y8 May

Account No.

Balance Debit Credit

1,350 2,085 715

CHAPTER 4

The Accounting Cycle

Comp. Prob. 1 (Continued) Prepaid Rent

Account:

Date

20Y8 May

Item

1 31

Date

Item

1 31

Date

 7

Balance Adjusting

Post. Ref.

Item

Balance

Post. Ref.

Debit

Credit

275

1 31

Balance Adjusting

Debit

Credit

Date

Item

1 13 20

Balance

Debit

 7

Credit

Date

Item

1 16 31

Balance Adjusting

1,500 1,225

Debit

 5 6

Credit

330 660

800 160 895

640 735

Debit

 5 7

Credit

Balance Debit Credit

Account No.

Post. Ref.

Balance Debit Credit

Account No.

Post. Ref.

Balance Debit Credit

330

Salaries Payable

Account:

Balance Credit

Account No.

Accounts Payable

Account:

Debit

14,500



Date

Item

3,200 1,600

Account No.

Post. Ref.

20Y8 May

1,600

 7

Accumulated Depreciation

20Y8 May

Credit

Balance Debit Credit

Account No.

Account:

20Y8 May

Debit

Office Equipment

Account:

20Y8 May

Post. Ref.

Prepaid Insurance

Account:

20Y8 May

Balance Adjusting

Account No.

Balance Debit Credit

120 325

120 — 325

CHAPTER 4

The Accounting Cycle

Comp. Prob. 1 (Continued) Unearned Fees

Account:

Item

Date

20Y8 May

1 3 31

Date

Item

Balance

Item

Date

1 31 31

Credit

Balance Closing Closing

Item

Date

31 31

Closing

Balance Debit Credit

2,500 7,000 3,210

4,500 3,790

Account No.

Post. Ref.

Debit

Credit

Balance Debit Credit

30,000



Account No.

Post. Ref.

 8 8

Debit

Credit

Balance Debit Credit

12,300 45,725 35,225

33,425 10,500

Dividends

Account:

20Y8 May

 5 7

Debit

Retained Earnings

Account:

20Y8 May

Adjusting

Post. Ref.

Common Stock

Account:

20Y8 May

Balance

Account No.

Post. Ref.

6 8

Debit

Credit

Balance Debit Credit

10,500

10,500 —

10,500

—

CHAPTER 4

The Accounting Cycle

Comp. Prob. 1 (Continued) Fees Earned

Account:

Date

20Y8 May

Item

15 17 21 25 31 31 31 31

Item

Date

16 28 31 31

Date

Adjusting Closing

Item

31 31

Credit

Adjusting Closing

Date

Item

31 31

Adjusting Closing

Balance Debit Credit

9,180 8,360 4,820 7,900 3,300 2,650 3,790 40,000

—

9,180 17,540 22,360 30,260 33,560 36,210 40,000 —

Account No.

Post. Ref.

Debit

5 6 7 8

Credit

630 750 325 1,705

Post. Ref.

7 8

Debit

Credit

1,600 1,600

Supplies Expense

Account:

20Y8 May

5 5 6 6 6 6 7 8

Debit

Rent Expense

Account:

20Y8 May

Post. Ref.

Salary Expense

Account:

20Y8 May

Adjusting Closing

Account No.

Post. Ref.

7 8

Debit

Credit

1,370 1,370

Balance Debit Credit

630 1,380 1,705 —

—

Account No.

Balance Debit Credit

1,600 —

—

Account No.

Balance Debit Credit

1,370 —

—

CHAPTER 4

The Accounting Cycle

Comp. Prob. 1 (Continued) Depreciation Expense

Account:

Date

20Y8 May

Item

31 31

Date

Item

31 31

Debit

7 8

Credit

330 330

Adjusting Closing

Post. Ref.

Debit

7 8

Credit

275 275

Miscellaneous Expense

Account:

Item

Date

20Y8 May

Post. Ref.

Insurance Expense

Account:

20Y8 May

Adjusting Closing

Account No.

9 30 31 31

Closing

Post. Ref.

Debit

5 6 6 8

Credit

225 260 810 1,295

Balance Debit Credit

330 —

—

Account No.

Debit

Balance Credit

275 —

—

Account No.

Balance Debit Credit

225 485 1,295 —

—

CHAPTER 4

The Accounting Cycle

Comp. Prob. 1 (Continued) Kelly Consulting Unadjusted Trial Balance May 31, 20Y8

Account No.

11 12 14 15 16 18 19 21 22 23 31 32 33 41 51 52 53 54 55 59

Debit Balances

Credit Balances

44,195 8,080 2,085 3,200 1,500 14,500 330 895 0 7,000 30,000 12,300 10,500 36,210 1,380 0 0 0 0 1,295 86,735

86,735

Net income

Account Title Cash Accounts Receivable Supplies Prepaid Rent Prepaid Insurance Office Equipment Accumulated Depreciation Accounts Payable Salaries Payable Unearned Fees Common Stock Retained Earnings Dividends Fees Earned Salary Expense Rent Expense Supplies Expense Depreciation Expense Insurance Expense Miscellaneous Expense

5. Optional (Appendix 1)

Comp. Prob. 1 (Continued)

86,735

36,210

4-117

1,705 1,600 1,370 330 275 1,295 6,575 33,425 40,000

40,000

Income Statement Debit Credit

1,295 86,735

1,380

10,500

7,000 30,000 12,300

Unadjusted Trial Balance Debit Credit 44,195 8,080 2,085 3,200 1,500 14,500 330 895

The Accounting Cycle

Kelly Consulting End-of-Period Spreadsheet (Work Sheet) For the Month Ended May 31, 20Y8 Adjusted Adjustments Trial Balance Debit Credit Debit Credit 44,195 8,080 (b) 1,370 715 (e) 1,600 1,600 (a) 275 1,225 14,500 (c) 330 660 895 (d) 325 325 (f) 3,790 3,210 30,000 12,300 10,500 (f) 3,790 40,000 (d) 325 1,705 (e) 1,600 1,600 (b) 1,370 1,370 (c) 330 330 (a) 275 275 1,295 7,690 7,690 87,390 87,390

CHAPTER 4

80,815

47,390 33,425 80,815

Balance Sheet Debit Credit 44,195 8,080 715 1,600 1,225 14,500 660 895 325 3,210 30,000 12,300 10,500

CHAPTER 4

The Accounting Cycle

Comp. Prob. 1 (Continued) 6.

JOURNAL Post. Ref.

Date

20Y8 May

Adjusting Entries 31 Insurance Expense Prepaid Insurance Insurance expired.

Page

Debit

55 16

275

31 Supplies Expense Supplies Supplies used ($2,085 – $715).

53 14

1,370

31 Depreciation Expense Accumulated Depreciation Equipment depreciation.

54 19

330

31 Salary Expense Salaries Payable Accrued salaries.

51 22

325

31 Rent Expense Prepaid Rent Rent expired.

52 15

1,600

31 Unearned Fees Fees Earned Unearned fees ($7,000 – $3,210).

23 41

3,790

Credit

275

1,370

330

325

1,600

3,790

CHAPTER 4

The Accounting Cycle

Comp. Prob. 1 (Continued) Kelly Consulting Adjusted Trial Balance May 31, 20Y8

Account No.

11 12 14 15 16 18 19 21 22 23 31 32 33 41 51 52 53 54 55 59

Debit Balances

Credit Balances

44,195 8,080 715 1,600 1,225 14,500 660 895 325 3,210 30,000 12,300 10,500 40,000 1,705 1,600 1,370 330 275 1,295 87,390

87,390

CHAPTER 4

The Accounting Cycle

Comp. Prob. 1 (Continued) 8.

Kelly Consulting Income Statement For the Month Ended May 31, 20Y8 Fees earned Expenses: Salary expense Rent expense Supplies expense Depreciation expense Insurance expense Miscellaneous expense Total expenses Net income

$40,000 $1,705 1,600 1,370 330 275 1,295 (6,575) $33,425

Kelly Consulting Statement of Stockholders’ Equity For the Month Ended May 31, 20Y8 Common Retained Stock Earnings Balances, May 1, 20Y8 $30,000 $ 12,300 Net income 33,425 Dividends (10,500) Balances, May 31, 20Y8 $30,000 $ 35,225

Total $ 42,300 33,425 (10,500) $ 65,225

CHAPTER 4

The Accounting Cycle

Comp. Prob. 1 (Continued) Kelly Consulting Balance Sheet May 31, 20Y8 Assets Current assets: Cash Accounts receivable Supplies Prepaid rent Prepaid insurance Total current assets Property, plant, and equipment: Office equipment Accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Salaries payable Unearned fees Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$44,195 8,080 715 1,600 1,225 $55,815 $14,500 (660) 13,840 $69,655

895 325 3,210 $ 4,430

$30,000 35,225 65,225 $69,655

Received fees from clients Received fees from clients

Received fees from clients Received fees from clients Collected accounts receivable

Received fees from clients

Operating Operating

Operating Operating Operating

Operating

17 25 27

1 Bal. 3 5

May 31 Bal.

May

4-122

44,195

_____

3,300

8,360 7,900 9,520

22,100 4,500 2,450 May

Cash

28 30 31 31

9 13 16

750 260 810 10,500

225 640 750

The Accounting Cycle

Paid salaries Paid telephone expense Paid electricity expense Paid dividends

Paid advertising expense Purchased office equipment Paid salaries

Transaction

Type of Activity

a. Optional (Appendix 2)

Comp. Prob. 1 (Continued)

CHAPTER 4

Operating Operating Operating Financing

Operating Investing Operating

Type of Activity

CHAPTER 4

The Accounting Cycle

Comp. Prob. 1 (Continued) 9.

b. Optional (Appendix 2) Kelly Consulting Statement of Cash Flows For the Month Ended May 31, 20Y8 Cash flows from (used in) operating activities: Cash received from customers $36,030* Cash paid for expenses and to creditors (2,795)** Net cash flows from operating activities Cash flows from (used in) investing activities: Cash paid for office equipment Cash flows from (used in) financing activities: Cash dividends paid Net increase in cash Cash balance, May 1, 20Y8 Cash balance, May 31, 20Y8

$ 33,235 (640) (10,500) $ 22,095 22,100 $ 44,195

* $4,500 + $2,450 + $8,360 + $7,900 + $9,520 + $3,300 = $36,030 ** $225 + $750 + $750 + $260 + $810 = $2,795

CHAPTER 4

The Accounting Cycle

Comp. Prob. 1 (Concluded) 10.

JOURNAL Post. Ref.

Date

20Y8 May

Page

Debit

Closing Entries 31 Fees Earned Salary Expense Rent Expense Supplies Expense Depreciation Expense Insurance Expense Miscellaneous Expense Retained Earnings

41 51 52 53 54 55 59 32

40,000

31 Retained Earnings Dividends

32 33

10,500

Account No.

Debit Balances

11 12 14 15 16 18 19 21 22 23 31 32

44,195 8,080 715 1,600 1,225 14,500

Credit

1,705 1,600 1,370 330 275 1,295 33,425

10,500

Kelly Consulting Post-Closing Trial Balance May 31, 20Y8

11.

Cash Accounts Receivable Supplies Prepaid Rent Prepaid Insurance Office Equipment Accumulated Depreciation Accounts Payable Salaries Payable Unearned Fees Common Stock Retained Earnings

70,315

Credit Balances

660 895 325 3,210 30,000 35,225 70,315

CHAPTER 4

The Accounting Cycle

MAKE A DECISION MAD 4–1 Amazon $ 96,334 (87,812) $ 8,522

a. Current assets Current liabilities Working capital

Best Buy $ 8,870 (7,513) $ 1,357

b. Amazon has a larger working capital balance than does Best Buy ($8,522 million compared to $1,357 million). c. Working capital is a poor measure for comparing liquidity across firms. Amazon has current assets and current liabilities that are more than ten times larger than those of Best Buy. Thus, Amazon’s working capital balance is from a much larger base than that of Best Buy. In this case, ratios, such as the current ratio, are a much better measure of relative liquidity between the two firms. d.

Current Ratio =

Current Assets Current Liabilities

Amazon:

$96,334 = 1.1 (rounded) $87,812

Best Buy:

$8,870 = 1.2 (rounded) $7,513

e. The current ratio shows that Best Buy has a slightly stronger relative short-term liquidity (1.2 compared to Amazon’s 1.1). Best Buy’s retail stores require inventory (a current asset), while Amazon does not use retail stores and often has orders shipped directly from its suppliers, thus requiring less relative inventory. This difference may explain the slightly larger relative liquidity of Best Buy over Amazon. MAD 4–2 a.

Zynga Year 1 Year 2 $ 747 $1,576 (792) (480) $ 784 $ 267

Current assets Current liabilities Working capital

Electronic Arts Year 2 Year 1 $ 6,381 $ 6,004 (2,265) (2,491) $ 4,116 $ 3,513

Take-Two Year 2 Year 1 $ 2,828 $ 2,409 (1,952) (1,727) $ 876 $ 682

Electronic Arts has the largest working capital for both years: $4,116 for Year 2 and $3,513 for Year 1.

Zynga Year 1 Year 2

Electronic Arts Year 2 Year 1

Take-Two Year 2 Year 1

Current Ratio = Current Assets Current Liabilities

$1,576 $792

$747 $480

$6,381 $2,265

$6,004 $2,491

$2,828 $1,952

$2,409 $1,727

2.0

1.6

2.8

2.4

1.4

CHAPTER 4

The Accounting Cycle

MAD 4–2 (Concluded) d. Based upon the current ratio for Year 2, Electronic Arts is the most liquid company followed by Zynga and Take-Two, as follows: Ranking 1 Electronic Arts 2 Zynga 3 Take-Two

Current Ratio for Year 2 2.8 2.0 1.4

MAD 4–3 Foot Locker Year 2 Year 1 $2,518 $2,551 (616) (764) $1,754 $1,935

a. Current assets Current liabilities Working capital b.

Dick’s Year 2 $ 2,122 (1,505) $ 617

Year 1 $ 2,006 (1,425) $ 581

Foot Locker Year 2 Year 1

Dick’s Year 2

Year 1

Current Assets Current Liabilities

$2,518 $764

$2,551 $616

$2,122 $1,505

$2,006 $1,425

Current Ratio =

3.3

4.1

1.4

For both years, it appears that Foot Locker has the greater relative liquidity, as measured by its current ratios of 3.3 and 4.1 compared to Dick’s 1.4. Foot Locker’s current ratios are above 2.5, which would be adequate under most conditions. In contrast, Dick’s current ratios of 1.4 would cause concern for short-term creditors. However, Dick’s maintains over $1 billion of credit agreements with several lenders. This allows Dick’s to borrow on a short-term basis and, thus, maintain a lower current ratio. Overall, both companies appear to have sufficient liquidity to meet short-term obligations to suppliers.

Foot Locker’s current ratio decreased from 4.1 to 3.3 and, thus, its liquidity declined. However, the decrease in Foot Locker’s current ratio should not be a concern since both ratios are above 2.0. Dick’s current ratio of 1.4 was the same for both years and, thus, its liquidity stayed the same.

CHAPTER 4

The Accounting Cycle

MAD 4–4 a. Current assets Current liabilities Working capital Current Ratio =

Dec. 31, Year 1 $ 2,337.7 (1,060.4)

Dec. 31, Year 2 $ 2,593.6 (1,316.0) $ 1,277.6

$ 1,277.3

Current Assets Current Liabilities

Year 1:

$2,337.7 $1,060.4

= 2.2 (rounded)

Year 2:

$2,593.6 $1,316.0

= 2.0 (rounded)

b. Under Armour’s working capital remained approximately the same from Year 1 of $1,277.3 million to Year 2 of $1,277.6 million. However, the current ratio decreased from 2.2 in Year 1 to 2.0 in Year 2. This decrease was primarily due to the increase in current liabilities in Year 2. However, the current ratio is 2.0 or above in each year, indicating a strong liquidity position. Thus, short-term creditors should not be concerned about receiving their payments.

MAD 4–5 a.

December 31 Current assets Current liabilities Working capital Current Ratio =

Year 2 $ 39,193 (26,621) $ 12,572

Year 1 $ 38,603 (28,218) $ 10,385

Current Assets Current Liabilities

Year 1:

$38,603 $28,218

= 1.37 (rounded)

Year 2:

$39,193 $26,621

= 1.47 (rounded)

b. Caterpillar’s working capital increased from $10,385 million in Year 1 to $12,572 million in Year 2. Likewise, the current ratio increased from 1.37 in Year 1 to 1.47 in Year 2. These results suggest that Caterpillar’s short-term debt-paying ability has improved in Year 2.

CHAPTER 4

The Accounting Cycle

MAD 4–6 a.

Microsoft Year 2 Year 1 $175,552 $169,662 (58,488) (69,420) $106,132 $111,174

Current assets Current liabilities Working capital

Alphabet Year 2 Year 1 $152,578 $135,676 (45,221) (34,620) $107,357 $101,056

b. Microsoft and Alphabet have similar amounts of working capital. Alphabet had slightly more at the end of Year 2, but slightly less at the end of Year 1. c. Working capital does not measure the “relative” liquidity between two companies. Size differences can result in large differences in amounts, which are difficult to compare. Ratios provide better relative measures of performance between companies; thus, the current ratio provides a better relative measure of liquidity between Microsoft and Alphabet. d. Current Ratio =

Microsoft:

Alphabet:

Current Assets Current Liabilities Year 1:

$169,662 $58,488

= 2.9 (rounded)

Year 2:

$175,552 $69,420

= 2.5 (rounded)

Year 1:

$135,676 $34,620

= 3.9 (rounded)

Year 2:

$152,578 $45,221

= 3.4 (rounded)

e. Alphabet has greater short-term liquidity as measured by the current ratio than does Microsoft. For Years 1 and 2, Alphabet’s current ratios are 3.9 and 3.4, respectively, while Microsoft’s current ratios are 2.9 and 2.5, respectively. Both companies are very profitable and generate a large amount of cash from their operations. Thus, the difference in the current ratio is not a concern and can be influenced by working capital and investment strategies. f.

Both companies have very high current ratios. Both companies exhibit a strong solvency position and should have no difficulties in meeting their short-term obligations.

CHAPTER 4

The Accounting Cycle

TAKE IT FURTHER TIF 4–1 1. No. By knowingly recording a personal loan as a trade account receivable, Manny is reporting financial information that does not accurately reflect the company’s financial position. Specifically, the company is reporting a noncurrent asset (a loan) as a current asset (an account receivable). This may lead the bank to incorrectly expect this amount to be converted to cash in the near term, which may impact its loan decision. Manny is demonstrating a failure of individual character and is acting unethically. 2. The users who rely upon this financial information, such as potential investors and creditors, will be affected, because the company’s balance sheet will not be a faithful representation of the entity’s economic activity and financial position. TIF 4–2 1. Zynga’s fiscal year ends on December 31. Walmart’s fiscal year ends on January 31. 2. Cash (and cash equivalents) Accounts receivable Property, plant, and equipment Goodwill (discussed in Chapter 9) Accounts payable Common stock Retained earnings 3. Inventory is the primary balance sheet account that is different. Walmart reports over $40 billion in inventory, while Zynga doesn’t report any inventory. This difference is due to the nature of each company’s operations. Walmart is a retailer with stores throughout the world, which requires a large amount of inventory. In contrast, Zynga develops, markets, and services games on mobile platforms and social networks. Zynga earns revenues by sale of virtual games and advertising and, thus, has no inventory. TIF 4–3 To: Daniel Nat From: A+ Student Re: Balance Sheet Presentation The balance sheet describes the financial condition of the company as of a given date and is useful in assessing the company’s financial soundness and liquidity. For balance sheet information to be useful, it must be presented in a consistent manner and in conformity with generally accepted accounting principles (GAAP). I have reviewed the December 31, 20Y5, balance sheet of Asheville Company and have identified several presentation errors that limit its usefulness. These errors include incorrectly presenting accounts payable and common stock as assets and incorrectly reporting equipment and retained earnings as liabilities. In addition, the order of the assets and liabilities reported on the balance sheet is incorrect. 4-129 © 2022 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 4

The Accounting Cycle

TIF 4–3 (Concluded) The “Assets” section of the balance sheet should have separate sections for current assets and property, plant, and equipment, and assets should be presented in the order in which they will be converted into cash or used in operations. Cash is presented as the first item in the “Current assets” section, followed by accounts receivable. Land and equipment should be presented under the subheading “Property, plant, and equipment.” The company has two liabilities that should be presented on the balance sheet as current liabilities: accounts payable and wages payable. In addition, the balance sheet should include a “Stockholders’ Equity” section below liabilities. This section should include common stock and retained earnings. Presuming that the amounts recorded in the accounts are accurately reported, a correctly presented balance sheet would appear as follows: Asheville Company Balance Sheet December 31, 20Y5 Assets Current assets: Cash Accounts receivable Total current assets Property, plant, and equipment: Land Equipment Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Wages payable Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$ 10,000 12,500 $ 22,500 $100,000 125,000 225,000 $247,500

$ 10,000 2,500 $ 12,500 $115,000 120,000 235,000 $247,500

CHAPTER 4

The Accounting Cycle

TIF 4–4 1.

With the decreasing cost of computers and related software, Main Street Co. may find it desirable to computerize its financial reporting system. In many cases, the computerization of a manual accounting system reduces the overall cost of the accounting function.

A computerized accounting system would allow for eliminating the end-ofperiod spreadsheet, and thus, financial statements could be prepared with “a push of a button.” However, adjustment data would still need to be recorded at the end of the accounting period before the financial statements could be prepared.

In designing a computerized financial reporting (accounting) system, proper accounting principles, concepts, and procedures must be followed. At a minimum, basic controls such as the use of the double-entry accounting system should be included. For example, debits must equal credits for all transactions, and assets must equal liabilities plus stockholders’ equity. In addition, the system should be designed to detect obvious errors, such as a credit (minus) balance for Supplies or Prepaid Insurance. In other words, to design an adequate financial reporting system, a computer programmer must have a thorough understanding of accounting and the accounting cycle. Note: Numerous accounting software packages are available. Therefore, it would probably be better for Main Street Co. to purchase existing accounting software rather than try to design its own.

Supplies cannot have a credit balance, because the supplies account is an asset account. A business cannot have a “negative” asset. Thus, the only way a credit balance could have occurred in Supplies is the result of an error in recording one or more transactions.

TIF 4–5 1.

A set of financial statements provides useful information concerning the economic condition of a company. For example, the balance sheet describes the financial condition of the company as of a given date and is useful in assessing the company’s financial soundness and liquidity. The income statement describes the results of operations for a period and indicates the profitability of the company. The statement of stockholders’ equity describes the changes in common stock and retained earnings for a period of time. Each of these statements is useful in evaluating whether to extend credit to the company.

The following adjustments might be necessary before an accurate set of financial statements could be prepared: • No supplies expense is shown. The supplies account should be adjusted for the supplies used during the year.

CHAPTER 4

The Accounting Cycle

TIF 4–5 (Concluded) • No depreciation expense or accumulated depreciation is shown for the building or equipment accounts. An adjusting entry should be prepared for depreciation expense on each of these assets. • An inquiry should be made as to whether any accrued expenses, such as wages or utilities, exist at the end of the year. • An inquiry should be made as to whether any prepaid expenses, such as rent or insurance, exist at the end of the year. • An inquiry should be made as to whether the company paid any dividends during the year. No dividends account is shown in the “Statement of Accounts.” The following items should be relabeled for greater clarity: • • • •

Billings Due from Others—Accounts Receivable Amounts Owed to Others—Accounts Payable Investment in Business—Common Stock Other Expenses—Miscellaneous Expense

Note to Instructors: The preceding items are not intended to include all adjustments that might need to be made to the accounts. The possible adjustments listed include only items that have been covered in Chapters 1–4. For example, uncollectible accounts expense (discussed in a later chapter) is not mentioned. 3.

In general, the decision to extend a loan is based on an assessment of the profitability and riskiness of the loan. Although the financial statements provide useful data for this purpose, other factors such as the following might also be significant: • The due date and payment terms of the loan. • Security for the loan. For example, whether Joan Whalen is willing to pledge personal assets (collateral) in support of the loan will affect the riskiness of the loan. • The intended use of the loan. For example, if the loan is to purchase real estate (possibly for a future building site), the real estate could be used as security for the loan. • The projected profitability of the company.

CHAPTER 5 ACCOUNTING FOR RETAIL BUSINESSES DISCUSSION QUESTIONS 1.

Retail businesses acquire merchandise for resale to customers. It is the selling of merchandise, instead of a service, that makes the activities of a retail business different from the activities of a service business.

Yes. Gross profit is the excess of sales over cost of goods sold. A net loss arises when operating expenses exceed gross profit. Therefore, a business can earn a gross profit but incur operating expenses in excess of this gross profit and end up with a net loss.

The date of sale as shown by the date of the invoice or bill.

1% discount allowed if paid within 15 days of date of invoice; entire amount of invoice due within 60 days of date of invoice.

Payment due within 30 days of date of invoice.

Payment due by the end of the month in which the sale was made.

Sales to customers who use Mastercard or Visa cards are recorded as cash sales.

A credit memo issued by the seller of merchandise indicates the amount for which the buyer’s account is to be credited (credit to Accounts Receivable) and the reason for the sales return or allowance.

A debit memo issued by the buyer of merchandise indicates the amount for which the seller’s account is to be debited (debit to Accounts Payable) and the reason for the purchases return or allowance.

The buyer

The seller

7. 8.

Answers should include any three of the following: Sales, Cost of Goods Sold, Inventory, Estimated Returns Inventory, Customer Refunds Payable, and Estimated Coupons Payable.

Cost of Goods Sold would be debited; Inventory would be credited.

10.

Loss from Inventory Shrinkage would be debited.

CHAPTER 5

Accounting for Retail Businesses

BASIC EXERCISES BE 5–1 $723,700 ($186,500 + $1,437,200 – $900,000) BE 5–2 a.

$22,275. Purchase of $27,720 [$28,000 – ($28,000 × 1%)] less the return of $5,445 [$5,500 – ($5,500 × 1%)]

Accounts Payable—Saunders Corp.

BE 5–3 a.

b. c.

Accounts Receivable Sales

18,000

Cost of Goods Sold Inventory

10,800

Cash Accounts Receivable

18,000

10,800 18,000

Customer Refunds Payable Cash

600 600

BE 5–4 a. $21,780. Purchase of $23,760 [$24,000 – ($24,000 × 1%)] less return of $1,980 [$2,000 – ($2,000 × 1%)] b.

$28,670. Purchase of $30,870 [$31,500 – ($31,500 × 2%)] less return of $2,450 [$2,500 – ($2,500 × 2%)] plus $250 of shipping

BE 5–5 Shore Co. journal entries: Accounts Receivable—Blue Star Co. Sales

112,000

Cost of Goods Sold Inventory

67,200

Accounts Receivable—Blue Star Co. Cash

1,800

Customer Refunds Payable Accounts Receivable—Blue Star Co.

7,500

Inventory Estimated Returns Inventory

4,000

112,000

67,200

1,800

7,500

4,000

Cash ($112,000 + $1,800 – $7,500) Accounts Receivable—Blue Star Co.

106,300 106,300

CHAPTER 5

Accounting for Retail Businesses

BE 5–5 (Concluded) Blue Star Co. journal entries: Inventory Accounts Payable—Shore Co.

113,800 113,800

Accounts Payable—Shore Co. Inventory

7,500

Accounts Payable—Shore Co. Cash

106,300

7,500

106,300

BE 5–6 a.

Dec. 31 Cost of Goods Sold Inventory Inventory shrinkage ($1,333,150 – $1,309,900).

23,250

Dec. 31 Sales Customer Refunds Payable

125,000

31 Estimated Returns Inventory Cost of Goods Sold BE 5–7 a. Asset turnover

23,250

125,000 80,000 80,000

20Y3 2.4

20Y2 2.2

$1,884,000 ÷ [($770,000 + $800,000) ÷ 2]

$1,562,000 ÷ [($650,000 + $770,000) ÷ 2]

The increase from 2.2 to 2.4 indicates a favorable change in using assets to generate sales.

CHAPTER 5

Accounting for Retail Businesses

EXERCISES Ex. 5–1 a. $10,656,000 ($23,680,000 – $13,024,000) b. 45% ($10,656,000 ÷ $23,680,000) c. No. If operating expenses are less than gross profit, there will be an operating income. On the other hand, if operating expenses exceed gross profit, there will be an operating loss. Ex. 5–2 $33,590 million ($43,638 million – $10,048 million) Ex. 5–3 Balance Sheet Accounts 100 Assets 110 Cash 112 Accounts Receivable 114 Inventory 115 Estimated Returns Inventory 116 Store Supplies 117 Office Supplies 118 Prepaid Insurance 120 Land 123 Store Equipment 124 Accumulated Depreciation— Store Equipment 125 Office Equipment 126 Accumulated Depreciation— Office Equipment 200 Liabilities 210 Accounts Payable 211 Customer Refunds Payable 212 Salaries Payable 213 Notes Payable 300 Stockholders’ Equity 310 Common Stock 311 Retained Earnings 312 Dividends

Income Statement Accounts 400 Revenues 410 Sales 500 Expenses 510 Cost of Goods Sold 520 Sales Salaries Expense 521 Advertising Expense 522 Depreciation Expense— Store Equipment 523 Store Supplies Expense 524 Delivery Expense 529 Miscellaneous Selling Expense 530 Office Salaries Expense 531 Rent Expense 532 Depreciation Expense— Office Equipment 533 Insurance Expense 534 Office Supplies Expense 539 Miscellaneous Administrative Expense 600 Other Income 610 Interest Revenue 700 Other Expense 710 Interest Expense

Note: The order and number of some of the accounts within subclassifications is somewhat arbitrary, as in accounts 116–118, accounts 520–524, and accounts 530–534. For example, in a new business, the order of magnitude of expense account balances often cannot be determined in advance. The magnitude may also vary from period to period. 5-4 © 2022 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 5

Accounting for Retail Businesses

Ex. 5–4 a. $10,780. Purchase of $14,500 less return of $3,500; $11,000 less 2% discount of $220 b. Inventory

Ex. 5–5 The offer of Supplier One is lower than the offer of Supplier Two. Details are as follows: Supplier One $34,800 (348) $34,452

List price Discount Freight Net cost

$34,452

Supplier Two $35,000 (700) $34,300 200 $34,500

Ex. 5–6 a. (1) (2) (3) (4)

Purchased merchandise on account, $14,000. Paid freight, $150. An allowance for return of merchandise was granted by the creditor, $2,000. Paid the balance due within the discount period: debited Accounts Payable, $12,000, credited Cash, $11,880, credited Inventory $120.

Ex. 5–7 a. b. c.

Inventory Accounts Payable

48,000

Accounts Payable Inventory

7,500

Accounts Payable Cash Inventory ($40,500 × 2%)

40,500

Accounts Payable Cash ($48,000 – $7,500)

40,500

48,000 7,500 39,690 810 40,500

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Accounting for Retail Businesses

Ex. 5–8 a. b.

c. d. e.

Inventory Accounts Payable—Schell Co.

36,000

Accounts Payable—Schell Co. Cash Inventory

36,000

Accounts Payable*—Schell Co. [$9,000 – ($9,000 × 1%)] Inventory

8,910

Inventory Accounts Payable—Schell Co.

5,000

Cash Accounts Payable—Schell Co.

3,910

36,000 35,640 360 8,910 5,000 3,910

* Note: The debit of $8,910 to Accounts Payable in entry (c) is the amount of cash refund due from Schell Co. It is computed as the amount that was paid for the returned merchandise, $9,000, less the purchase discount of $90 ($9,000 × 1%). The credit to Accounts Payable of $5,000 in entry (d) reduces the debit balance in the account to $3,910, which is the amount of the cash refund in entry (e). The alternative entries below yield the same final results.

c. d. e.

Accounts Receivable—Schell Co. Inventory

8,910

Inventory Accounts Payable—Schell Co.

5,000

Cash Accounts Payable—Schell Co. Accounts Receivable—Schell Co.

3,910 5,000

8,910 5,000

8,910

Ex. 5–9 a.

Cash Sales

25,000

Cost of Goods Sold Inventory

17,500

Accounts Receivable Sales

98,000

Cost of Goods Sold Inventory

58,800

25,000

17,500 98,000

58,800

CHAPTER 5

Accounting for Retail Businesses

Ex. 5–9 (Concluded) c.

Cash Sales

475,000

Cost of Goods Sold Inventory

280,000

Cash Sales

63,000

Cost of Goods Sold Inventory

39,000

Credit Card Expense Cash

13,450

475,000

280,000 63,000

39,000 13,450

Ex. 5–10 a.

$3.25 ($20.00 – $18.75 + $2.00 coupon)

$16.75 ($18.75 – $2.00 coupon)

No. Rosa & Gene’s Pizzeria does not incur a liability for the $2-off coupons when the $2-off coupons are printed in the local newspaper. The $2-off coupon is a pointof-sale coupon and is deducted from the price of the pizza when delivered to the customer.

CHAPTER 5

Accounting for Retail Businesses

Ex. 5–11 a.

Feb.

6 Cash Sales

170

6 Cost of Goods Sold Inventory

18 Cash Sales

18 Cost of Goods Sold Inventory

170

80 50

28 Sales Estimated Coupons Payable (12,500,000 coupons × 15% × $2).

3,750,000

31 Cash Estimated Coupons Payable* Sales

37,200,000 2,800,000

3,750,000

Ex. 5–12 a.

Mar.

Cost of Goods Sold Inventory

40,000,000 23,600,000 23,600,000

* 1,400,000 coupons × $2 b.

Apr.

30 Cash Estimated Coupons Payable* Sales Cost of Goods Sold Inventory

32,620,000 880,000 33,500,000 19,100,000 19,100,000

* 440,000 coupons × $2 c.

A credit balance of $70,000 ($3,750,000 – $2,800,000 – $880,000)

Apr.

30 Estimated Coupons Payable Sales

70,000 70,000

CHAPTER 5

Accounting for Retail Businesses

Ex. 5–13 a.

Jan.

Feb.

31 Sales Estimated Rebates Payable (800 rebates × $150).

120,000

5 Estimated Rebates Payable Cash

115,000

120,000

115,000

Ex. 5–14 A portion of the $500 ticket should be allocated to a liability for 1,500 SkyMiles. Assuming an average value of $0.012 per mile, Delta would allocate $18 of the $500 ticket to a SkyMiles liability. Instructor Note: In recent financial statements, Delta reported a liability for SkyMiles of over $6 billion. Ex. 5–15 a.

No. Goodyear does not incur a liability for the rebates until tires are purchased by the customer.

$504, computed as follows: Tires ($120 × 4 tires) Sales tax ($480 × 5%) Total

$480 24 $504

$455 ($480 – $25 rebate)

Ex. 5–16 a. b.

June June

1 Customer Refunds Payable Cash

650

1 Customer Refunds Payable Accounts Receivable—Burris Inc.

650

CHAPTER 5

Accounting for Retail Businesses

Ex. 5–17 a.

20Y3 Dec.

20Y4 Jan.

28 Accounts Receivable—Beasley Co. Sales

18,500

28 Cost of Goods Sold Inventory

11,200

3 Customer Refunds Payable Accounts Receivable—Beasley Co.

4,000

3 Inventory Estimated Returns Inventory

2,350

7 Cash Accounts Receivable—Beasley Co.

14,500

18,500

11,200

4,000

2,350

14,500

Ex. 5–18 a. $28,000 b.

Inventory Estimated Returns Inventory

16,800

Customer Refunds Payable Cash

28,000

16,800

28,000

Ex. 5–19 (1) Sold merchandise on account, $12,000. (2) Recorded the cost of the goods sold and reduced the inventory account, $7,000. (3) Granted a credit of $1,500 against a customer’s account receivable for returned merchandise. (4) Updated the inventory account for the cost of the merchandise returned, $900. (5) Received the balance due from customer of $10,500 ($12,000 – $1,500).

CHAPTER 5

Accounting for Retail Businesses

Ex. 5–20 a. b. c. d. e.

$30,400 ($32,000 – $1,600) $10,394. Purchase of $12,544 [$12,800 – ($12,800 × 2%)] less return of $2,450 [$2,500 – ($2,500 × 2%)] plus freight of $300 $16,830. Purchase of $20,790 [$21,000 – ($21,000 × 1%)] less return of $3,960 [$4,000 – ($4,000 × 1%)] $8,015. Purchase of $8,820 [$9,000 – ($9,000 × 2%)] less return of $980 [$1,000 – ($1,000 × 2%)] plus freight of $175 $76,626 [$77,400 – ($77,400 × 1%)]

Ex. 5–21 a.

Accounts Receivable—Balboa Co. Sales

254,500

Cost of Goods Sold Inventory

152,700

Customer Refunds Payable Accounts Receivable—Balboa Co.

30,000

Inventory Estimated Returns Inventory

17,500

Cash Accounts Receivable—Balboa Co.

224,500

254,500

152,700 30,000

17,500 224,500

Ex. 5–22 a. b. c.

Inventory Accounts Payable—Showcase Co.

254,500

Accounts Payable—Showcase Co. Inventory

30,000

Accounts Payable—Showcase Co. Cash

224,500

254,500 30,000 224,500

CHAPTER 5

Accounting for Retail Businesses

Ex. 5–23 a. b. c. d.

At the time of sale $36,000 $38,880 [$36,000 + ($36,000 × 8%)] Sales Tax Payable

Ex. 5–24 a.

Accounts Receivable Sales Sales Tax Payable ($640,000 × 7%)

684,800

Cost of Goods Sold Inventory

385,000

Sales Tax Payable Cash

61,750

640,000 44,800

385,000 61,750

Ex. 5–25 a. b. c. d. e. f. g.

debit credit debit debit debit credit credit

Ex. 5–26 a.

Gross profit: $18,680,000 ($46,680,000 – $28,000,000)

No, there could be other income and expense items that could affect the amount of net income.

Customer Refunds Payable is a liability account with a normal credit balance.

Estimated Returns Inventory is an asset account with a normal debit balance.

Ex. 5–27 20Y4 Aug.

31 Cost of Goods Sold Inventory Inventory shrinkage ($3,145,000 – $3,113,500).

31,500 31,500

CHAPTER 5

Accounting for Retail Businesses

Ex. 5–28 20Y8 Dec.

31 Sales Customer Refunds Payable ($12,350,000 × 0.8%).

98,800

31 Estimated Returns Inventory Cost of Goods Sold

48,000

98,800

48,000

Ex. 5–29 a.

20Y1 Dec.

20Y2 Feb.

31 Sales Customer Refunds Payable ($1,800,000 × 1.5%).

27,000

31 Estimated Returns Inventory Cost of Goods Sold

16,000

3 Customer Refunds Payable Cash

5,000

3 Inventory Estimated Returns Inventory

3,100

27,000

16,000

5,000

3,100

Ex. 5–30 a. b. c.

Selling expense, (1), (2), (7), (8) Administrative expense, (3), (5), (6) Other expense, (4)

Ex. 5–31 a. b. c. d.

$625,000 ($735,000 – $110,000) $200,000 ($42,150 + $157,850) $5,920,000 ($8,220,000 – $2,300,000) $60,000 ($44,500 + $15,500)

CHAPTER 5

Accounting for Retail Businesses

Ex. 5–32 a.

Royal Furnishings Company Income Statement For the Year Ended March 31, 20Y9 Sales Cost of goods sold Gross profit Expenses: Selling expenses Administrative expenses Total expenses Operating income Other revenue and expense: Interest expense Net income

$ 8,245,000 (5,500,000) $ 2,745,000 $575,000 435,000 (1,010,000) $ 1,735,000 (15,000) $ 1,720,000

b. The major advantage of the multiple-step form of income statement is that relationships such as gross profit to sales are indicated. The major disadvantages are that it is more complex and the total revenues and expenses are not indicated, as is the case in the single-step income statement.

Ex. 5–33 a. 1. Deducting the cost of goods sold from sales yields gross profit (not operating income). 2. Deducting the total expenses from gross profit would yield operating income (or income from operations). 3. Interest revenue should be reported under the caption “Other revenue and expense” and should be added to operating income to arrive at net income. 4. The final amount on the income statement should be labeled net income, not gross profit.

CHAPTER 5

Accounting for Retail Businesses

Ex. 5–33 (Concluded) b. A corrected income statement would be as follows: Curbstone Company Income Statement For the Year Ended August 31, 20Y5 Sales Cost of goods sold Gross profit Expenses: Selling expenses Administrative expenses Delivery expense Total expenses Operating income Other revenue and expense: Interest revenue Net income

$ 8,595,000 (6,110,000) $ 2,485,000 $800,000 575,000 425,000 (1,800,000) $ 685,000

45,000 730,000

Ex. 5–34 Custom Wire & Tubing Company Income Statement For the Year Ended April 30, 20Y2 Revenues: Sales Rent revenue Total revenues Expenses: Cost of goods sold Selling expenses Administrative expenses Interest expense Total expenses Net income

$ 9,332,500 60,000 $ 9,392,500 $6,100,000 1,250,000 740,000 25,000 (8,115,000) $ 1,277,500

Ex. 5–35 (b) Advertising Expense (c) Cost of Goods Sold (f) Sales (h) Supplies Expense

CHAPTER 5

Accounting for Retail Businesses

Ex. 5–36 20Y9 Mar.

Closing Entries 31 Sales Cost of Goods Sold Selling Expenses Administrative Expenses Interest Expense Retained Earnings

8,245,000 5,500,000 575,000 435,000 15,000 1,720,000

31 Retained Earnings Dividends

175,000 175,000

Ex. 5–37 Closing Entries July

31 Sales Administrative Expenses Cost of Goods Sold Interest Expense Selling Expenses Store Supplies Expense Retained Earnings

1,437,000 440,000 775,000 6,000 160,000 21,500 34,500

31 Retained Earnings Dividends

15,000 15,000

Appendix 1 Ex. 5–38 a.

Accounts Receivable—Bernard Retail Inc. Sales

15,000

Cost of Goods Sold Inventory

8,000

Cash Sales Discounts ($15,000 × 2%) Accounts Receivable—Bernard Retail Inc.

14,700 300

Cash Accounts Receivable—Bernard Retail Inc.

15,000

8,000

15,000 15,000

CHAPTER 5

Accounting for Retail Businesses

Appendix 1 Ex. 5–39 a.

b. c.

Accounts Receivable—Bernard Retail Inc. Sales

14,700

Cost of Goods Sold Inventory

8,000

Cash Accounts Receivable—Bernard Retail Inc.

14,700

Cash Sales Accounts Receivable—Bernard Retail Inc.

15,000

14,700

8,000

Appendix 1 Ex. 5–40 Mar. 2 Accounts Receivable—Parsley Co. Sales

14,700 300 14,700

32,000 32,000

2 Cost of Goods Sold Inventory

18,500

8 Accounts Receivable—Tabor Co. Sales

24,000

8 Cost of Goods Sold Inventory

14,400

11 Cash Sales Discounts ($32,000 × 1%) Accounts Receivable—Parsley Co.

31,680 320

20 Cash Accounts Receivable—Tabor Co.

24,000

18,500

24,000

14,400

32,000

24,000

CHAPTER 5

Accounting for Retail Businesses

Appendix 1 Ex. 5–41 Mar. 2 Accounts Receivable—Parsley Co. Sales

31,680 31,680

2 Cost of Goods Sold Inventory

18,500

8 Accounts Receivable—Tabor Co. Sales [$24,000 – ($24,000 × 2%)]

23,520

8 Cost of Goods Sold Inventory

14,400

11 Cash Accounts Receivable—Parsley Co.

31,680

20 Cash Accounts Receivable—Tabor Co. Sales

24,000

18,500

23,520

14,400

31,680

23,520 480

CHAPTER 5

Accounting for Retail Businesses

Appendix 1 Ex. 5–42 a.

Aug.

5 Accounts Receivable—M. Quinn Sales

7,500

5 Cost of Goods Sold Inventory

4,200

9 Accounts Receivable—R. Busch Sales

4,000

9 Cost of Goods Sold Inventory

2,100

15 Cash Sales Discounts ($7,500 × 2%) Accounts Receivable—M. Quinn

7,350 150

20 Accounts Receivable—S. Mooney Sales

6,000

20 Cost of Goods Sold Inventory

3,300

25 Cash Accounts Receivable—R. Busch

4,000

31 Cash Accounts Receivable—S. Mooney

6,000

7,500

4,200

4,000

2,100

7,500

6,000

3,300

4,000

6,000

CHAPTER 5

Accounting for Retail Businesses

Appendix 1 Ex. 5-42 (Concluded) b.

Aug.

5 Accounts Receivable—M. Quinn Sales [$7,500 – ($7,500 × 2%)]

7,350

5 Cost of Goods Sold Inventory

4,200

9 Accounts Receivable—R. Busch Sales [$4,000 – ($4,000 × 1%)]

3,960

9 Cost of Goods Sold Inventory

2,100

15 Cash Accounts Receivable—M. Quinn

7,350

20 Accounts Receivable—S. Mooney Sales

6,000

20 Cost of Goods Sold Inventory

3,300

25 Cash Accounts Receivable—R. Busch Sales

4,000

31 Cash Accounts Receivable—S. Mooney

6,000

7,350

4,200

3,960

2,100

7,350

6,000

3,300

3,960 40

6,000

Net sales..................$17,350 ($7,500 + $4,000 – $150 + $6,000) Under GAAP, sales discounts are offset against gross sales and only net sales are reported.

Sales........................ $17,350 ($7,350 + $3,960 + $6,000 + $40) Under the net method, sales are recorded net of sales discounts and thus, sales are reported at the sales account balance.

CHAPTER 5

Accounting for Retail Businesses

Appendix 2 Ex. 5–43 a. b. c. d. e. f. g.

credit debit debit credit debit credit credit

Appendix 2 Ex. 5–44 Jan.

2 Purchases Accounts Payable

18,200 18,200

5 Freight In Cash

190 190

6 Accounts Payable Purchases Returns and Allowances

2,750

13 Accounts Receivable Sales

37,300

2,750

37,300

15 Delivery Expense Cash

215 215

17 Accounts Payable Purchases Discounts [($18,200 – $2,750) × 2%] Cash

15,450

31 Cash Accounts Receivable

37,300

309 15,141

37,300

Appendix 2 Ex. 5–45 a. b. c. d. e.

Purchases discounts, purchases returns and allowances Freight in Inventory available for sale Inventory (ending) Estimated returns for current year

CHAPTER 5

Accounting for Retail Businesses

Appendix 2 Ex. 5–46 a. Cost of goods sold: Inventory, May 1, 20Y7 Cost of merchandise purchased: Purchases Purchases returns and allowances Purchases discounts Freight in Total cost of merchandise purchased Inventory available for sale Inventory, April 30, 20Y8 Cost of goods sold before estimated returns Estimated returns Cost of goods sold

$ 380,000 $3,800,000 (150,000) (80,000) 16,600 3,586,600 $3,966,600 (415,000) $3,551,600 (11,600) $3,540,000

b. $2,310,000 ($5,850,000 – $3,540,000) c. No. Gross profit would be the same if the perpetual inventory system was used. Appendix 2 Ex. 5–47 Cost of goods sold: Inventory, November 1 Cost of merchandise purchased: Purchases Purchases returns and allowances Purchases discounts Freight in Total cost of merchandise purchased Inventory available for sale Inventory, November 30 Cost of goods sold before estimated returns Estimated returns Cost of goods sold

$ 28,000 $475,000 (15,000) (9,000) 7,000 458,000 $486,000 (31,500) $454,500 (14,500) $440,000

CHAPTER 5

Accounting for Retail Businesses

Appendix 2 Ex. 5–48 1.

The schedule should begin with the June 1, 20Y4, not the May 31, 20Y5, inventory.

Purchases returns and allowances and purchases discounts should be deducted from (not added to) purchases.

Freight in should be added to (not deducted from) purchases.

The inventory at May 31, 20Y5, should be deducted from inventory available for sale to yield cost of goods sold before estimated returns.

The estimated returns for the year of $43,300 should be deducted from cost of goods sold before estimated returns to yield cost of goods sold.

A corrected “Cost of goods sold” section is as follows: Cost of goods sold: Inventory, June 1, 20Y4 Cost of merchandise purchased: Purchases Purchases returns and allowances Purchases discounts Freight in Total cost of merchandise purchased Inventory available for sale Inventory, May 31, 20Y5 Cost of goods sold before estimated returns Estimated returns Cost of goods sold

91,300

$1,110,000 (55,000) (30,000) 22,000 1,047,000 $1,138,300 (105,000) $1,033,300 (43,300) $ 990,000

CHAPTER 5

Accounting for Retail Businesses

Appendix 2 Ex. 5–49 Closing Entries Dec.

31 Inventory Estimated Returns Inventory Sales Purchases Discounts Purchases Returns and Allowances Inventory Purchases Freight In Salaries Expense Advertising Expense Depreciation Expense Miscellaneous Expense Retained Earnings 31 Retained Earnings Dividends

460,000 20,000 2,220,000 35,000 45,000 375,000 1,760,000 17,000 375,000 36,000 13,000 9,000 195,000 65,000 65,000

CHAPTER 5

Accounting for Retail Businesses

PROBLEMS Prob. 5–1A July

1 Inventory Accounts Payable—Sabol Imports Co.

20,500

3 Inventory ($12,000 + $75) Accounts Payable—Saxon Co.

12,075

5 Inventory Accounts Payable—Schnee Co.

8,000

6 Accounts Payable—Schnee Co. Inventory

1,500

13 Accounts Payable—Saxon Co. Cash [$12,075 – ($12,000 × 2%)] Inventory

12,075

14 Accounts Payable—Schnee Co. Cash [$6,500 – ($6,500 × 2%)] Inventory

6,500

19 Inventory Accounts Payable—Southmont Co.

18,900

19 Inventory Cash

20,500

12,075

8,000

1,500

11,835 240

6,370 130

18,900 140 140

20 Inventory Accounts Payable—Stevens Co.

33,000

30 Accounts Payable—Stevens Co. Cash [$33,000 – ($33,000 × 1%)] Inventory

33,000

31 Accounts Payable—Sabol Imports Co. Cash

20,500

31 Accounts Payable—Southmont Co. Cash

18,900

33,000

32,670 330

20,500

18,900

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–2A Mar.

2 Accounts Receivable—Equinox Co. Sales

18,900

2 Cost of Goods Sold Inventory

13,300

3 Cash Sales Sales Tax Payable

12,031

3 Cost of Goods Sold Inventory

7,000

4 Accounts Receivable—Empire Co. Sales

55,400

4 Cost of Goods Sold Inventory

33,200

5 Cash Sales Estimated Coupons Payable

30,000

5 Cost of Goods Sold Inventory

19,400

14 Cash Estimated Coupons Payable (850 × $2) Sales

16,300 1,700

14 Cost of Goods Sold Inventory

10,500

16 Accounts Receivable—Targhee Co. Sales

27,500

16 Cost of Goods Sold Inventory

16,000

18,900

13,300

11,350 681

7,000

55,400

33,200

26,000 4,000

19,400

18,000

10,500

27,500

16,000

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–2A (Concluded) Mar.

Apr.

18 Customer Refunds Payable Accounts Receivable—Targhee Co.

4,800

18 Inventory Estimated Returns Inventory

2,900

19 Accounts Receivable—Vista Co. Sales

8,250

19 Accounts Receivable—Vista Co. Cash

4,800

2,900

8,250

19 Cost of Goods Sold Inventory

5,000

31 Cash ($8,250 + $75) Accounts Receivable—Vista Co.

8,325

31 Cash Accounts Receivable—Empire Co.

55,400

31 Delivery Expense Cash

5,600

31 Advertising Expense Cash

1,200

1 Cash Accounts Receivable—Equinox Co.

18,900

5,000

8,325

55,400

5,600

1,200

3 Credit Card Expense Cash

18,900 940 940

15 Sales Tax Payable Cash

6,544

15 Cash ($27,500 – $4,800) Accounts Receivable—Targhee Co.

22,700

16 Cash [$40,000 – (300 × $15)] Sales

35,500

16 Cost of Goods Sold Inventory

18,750

6,544

22,700

35,500

18,750

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–3A 1. Nov. 3 Inventory Accounts Payable—Moonlight Co. [$85,000 – ($85,000 × 25%)].

63,750 63,750

4 Cash Sales

37,680

4 Cost of Goods Sold Inventory

22,600

5 Inventory ($47,500 + $810) Accounts Payable—Papoose Creek Co.

48,310

6 Accounts Payable—Moonlight Co. Inventory

13,500

8 Accounts Receivable—Quinn Co. Sales

15,600

8 Cost of Goods Sold Inventory

9,400

13 Accounts Payable—Moonlight Co. Cash [$50,250 – ($50,250 × 2%)] Inventory

50,250

14 Cash ($236,000 – $8,000) Sales

228,000

14 Cost of Goods Sold Inventory

140,000

15 Accounts Payable—Papoose Creek Co. Cash {[$47,500 – ($47,500 × 2%)] + $810} Inventory

48,310

23 Cash Accounts Receivable—Quinn Co.

15,600

37,680

22,600

48,310

13,500

15,600

9,400

49,245 1,005

228,000

140,000

47,360 950

15,600

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–3A (Concluded) Nov.

24 Accounts Receivable—Rabel Co. Sales

56,900

24 Cost of Goods Sold Inventory

34,000

28 Credit Card Expense Cash

3,540

30 Customer Refunds Payable Cash

6,000

30 Inventory Estimated Returns Inventory

3,300

30 Sales (20,000 × 55% × $2) Estimated Coupons Payable

22,000

31 Estimated Coupons Payable Sales [(11,000 – 10,400) × $2].

1,200

56,900

34,000

3,540

6,000

3,300

22,000

2. Dec.

1,200

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–4A 1. Aug.

Summit Company 1 Accounts Receivable—Beartooth Co. Sales

48,000

1 Cost of Goods Sold Inventory

28,800

2 Delivery Expense Cash

1,150

5 Accounts Receivable—Beartooth Co. Sales

66,000

5 Cost of Goods Sold Inventory

40,000

15 Accounts Receivable—Beartooth Co. Sales

58,700

15 Accounts Receivable—Beartooth Co. Cash

1,675

15 Cost of Goods Sold Inventory

35,000

16 Cash Accounts Receivable—Beartooth Co.

48,000

20 Customer Refunds Payable Cash

1,000

31 Cash Accounts Receivable—Beartooth Co.

66,000

31 Customer Refunds Payable Accounts Receivable—Beartooth Co.

4,000

31 Inventory Estimated Returns Inventory

2,500

48,000

28,800

1,150

66,000

40,000

58,700

1,675

35,000

48,000

1,000

66,000

4,000

2,500

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–4A (Concluded) 2. Aug.

Beartooth Co. 1 Inventory Accounts Payable—Summit Company

48,000

5 Inventory Accounts Payable—Summit Company

66,000

9 Inventory Cash

2,300

15 Inventory ($58,700 + $1,675) Accounts Payable—Summit Company

60,375

16 Accounts Payable—Summit Company Cash

48,000

20 Cash Inventory

1,000

31 Accounts Payable—Summit Company Cash

66,000

31 Accounts Payable—Summit Company Inventory

4,000

48,000

66,000

2,300

60,375

48,000

1,000

66,000

4,000

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–5A 1. Clairemont Co. Income Statement For the Year Ended May 31, 20Y2 Sales Cost of goods sold Gross profit Expenses: Selling expenses: Sales salaries expense Advertising expense Depreciation expense—store equipment Miscellaneous selling expense Total selling expenses Administrative expenses: Office salaries expense Rent expense Depreciation expense—office equipment Insurance expense Office supplies expense Miscellaneous administrative expense Total administrative expenses Total operating expenses Operating income Other revenue and expense: Interest expense Net income

$11,343,000 (7,850,000) $ 3,493,000

$916,000 550,000 140,000 38,000 $1,644,000 $650,000 94,000 50,000 48,000 28,100 14,500 884,600 (2,528,600) $ 964,400

(21,000) 943,400

2. Clairemont Co. Statement of Stockholders’ Equity For the Year Ended May 31, 20Y2 Common Retained Stock Earnings Balances, June 1, 20Y1 $425,000 $2,949,100 Issued common stock 75,000 Net income 943,400 Dividends (100,000) Balances, May 31, 20Y2 $500,000 $3,792,500

Total $3,374,100 75,000 943,400 (100,000) $4,292,500

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–5A (Concluded) 3. Clairemont Co. Balance Sheet May 31, 20Y2 Assets Current assets: Cash Accounts receivable Inventory Estimated returns inventory Office supplies Prepaid insurance Total current assets Property, plant, and equipment: Office equipment Accum. depreciation—office equipment Book value—office equipment Store equipment Accum. depreciation—store equipment Book value—store equipment Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Salaries payable Customer refunds payable Estimated coupons payable Note payable (current portion) Total current liabilities Long-term liabilities: Note payable (long-term portion) Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity 4.

$ 240,000 966,000 1,690,000 22,500 13,500 8,000 $2,940,000 $

830,000 (550,000) $ 280,000

$ 3,600,000 (1,820,000) 1,780,000 2,060,000 $5,000,000

$ 321,000 41,500 40,000 5,000 50,000 $ 457,500 250,000 $ 707,500 $ 500,000 3,792,500 4,292,500 $5,000,000

The multiple-step form of income statement contains various sections for revenues and expenses, with intermediate balances, and concludes with net income. In the single-step form, the total of all expenses is deducted from the total of all revenues. There are no intermediate balances. 5-33 © 2022 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–6A 1.

Clairemont Co. Income Statement For the Year Ended May 31, 20Y2 Sales Expenses: Cost of goods sold Selling expenses Administrative expenses Interest expense Total expenses Net income

$ 11,343,000 $7,850,000 1,644,000 884,600 21,000 (10,399,600) $ 943,400

Clairemont Co. Statement of Stockholders’ Equity For the Year Ended May 31, 20Y2 Common Retained Stock Earnings Balances, June 1, 20Y1 $425,000 $2,949,100 Issued common stock 75,000 Net income 943,400 Dividends (100,000) Balances, May 31, 20Y2 $500,000 $3,792,500

Total $3,374,100 75,000 943,400 (100,000) $4,292,500

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–6A (Continued) 3. Clairemont Co. Balance Sheet May 31, 20Y2 Assets Current assets: Cash Accounts receivable Inventory Estimated returns inventory Office supplies Prepaid insurance Total current assets Property, plant, and equipment: Office equipment Accum. depreciation—office equipment Book value—office equipment Store equipment Accum. depreciation—store equipment Book value—store equipment Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Salaries payable Customer refunds payable Estimated coupons payable Note payable (current portion) Total current liabilities Long-term liabilities: Note payable (long-term portion) Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$ 240,000 966,000 1,690,000 22,500 13,500 8,000 $2,940,000 $

830,000 (550,000) $ 280,000

$ 3,600,000 (1,820,000) 1,780,000 2,060,000 $5,000,000

$ 321,000 41,500 40,000 5,000 50,000 $ 457,500 250,000 $ 707,500 $ 500,000 3,792,500 4,292,500 $5,000,000

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–6A (Concluded) 4. 20Y2 May

Closing Entries 31 Sales Cost of Goods Sold Sales Salaries Expense Advertising Expense Depreciation Expense—Store Equipment Miscellaneous Selling Expense Office Salaries Expense Rent Expense Depreciation Expense—Office Equipment Insurance Expense Office Supplies Expense Miscellaneous Administrative Expense Interest Expense Retained Earnings 31 Retained Earnings Dividends

11,343,000 7,850,000 916,000 550,000 140,000 38,000 650,000 94,000 50,000 48,000 28,100 14,500 21,000 943,400 100,000 100,000

CHAPTER 5

Accounting for Retail Businesses

Appendix 2 Prob. 5–7A July

1 Purchases Accounts Payable—Sabol Imports Co.

20,500

3 Purchases Freight In Accounts Payable—Saxon Co.

12,000 75

5 Purchases Accounts Payable—Schnee Co.

8,000

6 Accounts Payable—Schnee Co. Purchases Returns and Allowances

1,500

13 Accounts Payable—Saxon Co. Cash Purchases Discounts ($12,000 × 2%)

12,075

14 Accounts Payable—Schnee Co. Cash Purchases Discounts ($6,500 × 2%)

6,500

19 Purchases Accounts Payable—Southmont Co.

18,900

19 Freight In Cash

20,500

12,075

8,000

1,500

11,835 240

6,370 130

18,900 140 140

20 Purchases Accounts Payable—Stevens Co.

33,000

30 Accounts Payable—Stevens Co. Cash Purchases Discounts ($33,000 × 1%)

33,000

31 Accounts Payable—Sabol Imports Co. Cash

20,500

31 Accounts Payable—Southmont Co. Cash

18,900

33,000

32,670 330

20,500

18,900

CHAPTER 5

Accounting for Retail Businesses

Appendix 2 Prob. 5–8A 1. Nov.

3 Purchases Accounts Payable—Moonlight Co. [$85,000 – ($85,000 × 25%)].

63,750

4 Cash Sales

37,680

5 Purchases Freight In Accounts Payable—Papoose Creek Co.

47,500 810

6 Accounts Payable—Moonlight Co. Purchases Returns and Allowances

13,500

8 Accounts Receivable—Quinn Co. Sales

15,600

13 Accounts Payable—Moonlight Co. Cash Purchases Discounts ($50,250 × 2%)

50,250

14 Cash ($236,000 – $8,000) Sales

228,000

15 Accounts Payable—Papoose Creek Co. Cash Purchases Discounts ($47,500 × 2%)

48,310

23 Cash Accounts Receivable—Quinn Co.

15,600

24 Accounts Receivable—Rabel Co. Sales

56,900

28 Credit Card Expense Cash

3,540

30 Customer Refunds Payable Cash

6,000

30 Sales (20,000 × 55% × $2) Estimated Coupons Payable

22,000

63,750

37,680

48,310

13,500

15,600

49,245 1,005

228,000

47,360 950

15,600

56,900

3,540

6,000

22,000

CHAPTER 5

Accounting for Retail Businesses

Appendix 2 Prob. 5–8A (Concluded) 2. Dec.

31 Estimated Coupons Payable Sales [(11,000 – 10,400) × $2].

1,200 1,200

Appendix 2 Prob. 5–9A 1. Aug.

Summit Company 1 Accounts Receivable—Beartooth Co. Sales

48,000

2 Delivery Expense Cash

1,150

5 Accounts Receivable—Beartooth Co. Sales

66,000

15 Accounts Receivable—Beartooth Co. Sales

58,700

15 Accounts Receivable—Beartooth Co. Cash

1,675

16 Cash Accounts Receivable—Beartooth Co.

48,000

20 Customer Refunds Payable Cash

1,000

31 Cash Accounts Receivable—Beartooth Co.

66,000

31 Customer Refunds Payable Accounts Receivable—Beartooth Co.

4,000

48,000

1,150

66,000

58,700

1,675

48,000

1,000

66,000

4,000

CHAPTER 5

Accounting for Retail Businesses

Appendix 2 Prob. 5–9A (Concluded) 2.

Beartooth Co.

Aug.

1 Purchases Accounts Payable—Summit Company

48,000

5 Purchases Accounts Payable—Summit Company

66,000

9 Freight In Cash

2,300

15 Purchases Freight In Accounts Payable—Summit Company

58,700 1,675

16 Accounts Payable—Summit Company Cash

48,000

20 Cash Purchases Returns and Allowances

1,000

31 Accounts Payable—Summit Company Cash

66,000

31 Accounts Payable—Summit Company Purchases Returns and Allowances

4,000

48,000

66,000

2,300

60,375

48,000

1,000

66,000

4,000

Appendix 2 Prob. 5–10A 1.

Periodic inventory system. Wyman Company uses a periodic inventory system because it maintains accounts for purchases, purchases returns and allowances, purchases discounts, and freight in.

See next page.

CHAPTER 5

Accounting for Retail Businesses

Appendix 2 Prob. 5–10A (Continued) 2. Wyman Company Income Statement For the Year Ended December 31, 20Y5 Sales Cost of goods sold: Inventory, January 1, 20Y5 Cost of merchandise purchased: Purchases Purchases returns and allowances Purchases discounts Freight in Total cost of merchandise purchased

$ 3,280,000 $ 257,000 $2,650,000 (93,000) (37,000) 48,000 2,568,000

Inventory available for sale Inventory, December 31, 20Y5

$2,825,000 (305,000)

Cost of goods sold before estimated returns Increase in estimated returns inventory Cost of goods sold Gross profit Expenses: Selling expenses: Sales salaries expense Advertising expense Delivery expense Depreciation expense—store equipment Miscellaneous selling expense Total selling expenses Administrative expenses: Office salaries expense Rent expense Insurance expense Office supplies expense Depreciation expense—office equipment Miscellaneous administrative expense Total administrative expenses Total operating expenses Operating income Other revenue and expense: Rent revenue Interest expense Net income

$2,520,000 (5,000) (2,515,000) $

765,000

$ 300,000 45,000 9,000 6,000 12,000 $ 372,000 $ 175,000 28,000 3,000 2,000 1,500 3,500 213,000 (585,000)

180,000

5,000 185,000

7,000 (2,000)

CHAPTER 5

Accounting for Retail Businesses

Appendix 2 Prob. 5–10A (Concluded) 3. 20Y5 Dec.

Closing Entries 31

Inventory Estimated Returns Inventory Sales Purchases Returns and Allowances Purchases Discounts Rent Revenue Inventory Purchases Freight In Sales Salaries Expense Advertising Expense Delivery Expense Depreciation Expense—Store Equipment Miscellaneous Selling Expense Office Salaries Expense Rent Expense Insurance Expense Office Supplies Expense Depreciation Expense—Office Equipment Miscellaneous Administrative Expense Interest Expense Retained Earnings Retained Earnings Dividends

305,000 5,000 3,280,000 93,000 37,000 7,000 257,000 2,650,000 48,000 300,000 45,000 9,000 6,000 12,000 175,000 28,000 3,000 2,000 1,500 3,500 2,000 185,000 25,000 25,000

4. $185,000. The same net income as under the periodic inventory system.

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–1B Mar.

1 Inventory ($43,250 + $650) Accounts Payable—Haas Co.

43,900

5 Inventory Accounts Payable—Whitman Co.

19,175

10 Accounts Payable—Haas Co. Cash [$43,900 – ($43,250 × 2%)] Inventory

43,900

13 Inventory Accounts Payable—Jost Co.

15,550

14 Accounts Payable—Jost Co. Inventory

3,750

18 Inventory Accounts Payable—Fairhurst Company

13,560

43,900

19,175

43,035 865

15,550

3,750

18 Inventory Cash

13,560 140 140

19 Inventory Accounts Payable—Bickle Co.

6,500

23 Accounts Payable—Jost Co. ($15,550 – $3,750) Cash [$11,800 – ($11,800 × 2%)] Inventory

11,800

29 Accounts Payable—Bickle Co. Cash [$6,500 – ($6,500 × 2%)] Inventory

6,500

31 Accounts Payable—Fairhurst Company Cash

13,560

31 Accounts Payable—Whitman Co. Cash

19,175

6,500

11,564 236

6,370 130

13,560

19,175

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–2B July

1 Accounts Receivable—Landscapes Co. Sales

33,450

1 Cost of Goods Sold Inventory

20,000

2 Cash Sales Sales Tax Payable ($86,000 × 8%)

92,880

2 Cost of Goods Sold Inventory

51,600

5 Accounts Receivable—Peacock Company Sales

17,500

5 Cost of Goods Sold Inventory

10,000

8 Cash Sales Estimated Coupons Payable (5,000 × $3)

112,000

8 Cost of Goods Sold Inventory

67,200

14 Accounts Receivable—Loeb Co. Sales

16,000

14 Cost of Goods Sold Inventory

9,000

33,450

20,000

86,000 6,880

51,600

17,500

10,000

97,000 15,000

67,200

16,000

9,000

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–2B (Continued) July

16 Customer Refunds Payable Accounts Receivable—Loeb Co.

3,000

16 Inventory Estimated Returns Inventory

1,800

18 Accounts Receivable—Jennings Company Sales

11,350

18 Accounts Receivable—Jennings Company Cash

475

18 Cost of Goods Sold Inventory

Aug.

3,000

1,800

11,350

475 6,800 6,800

20 Cash Estimated Coupons Payable (3,500 × $3) Sales

119,500 10,500

20 Cost of Goods Sold Inventory

80,000

31 Delivery Expense Cash

8,550

31 Cash Accounts Receivable—Landscapes Co.

33,450

31 Advertising Expense Cash

1,500

3 Credit Card Expense Cash

3,770

4 Cash Accounts Receivable—Peacock Company

17,500

10 Sales Tax Payable Cash

41,260

13 Cash Accounts Receivable—Loeb Co.

13,000

17 Cash ($11,350 + $475) Accounts Receivable—Jennings Company

11,825

130,000

80,000

8,550

33,450

1,500

3,770

17,500

41,260

13,000

11,825

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–2B (Concluded) Aug.

25 Cash [$175,000 – (600 × $10)] Sales

169,000

25 Cost of Goods Sold Inventory

100,000

169,000

100,000

Prob. 5–3B 1. July 3 Inventory Accounts Payable—Hamling Co. {[$72,000 – ($72,000 × 15%)] = $61,200; $61,200 + $1,450 = $62,650}.

62,650 62,650

5 Inventory Accounts Payable—Kester Co.

33,450

6 Accounts Receivable—Parsley Co. Sales

36,000

6 Cost of Goods Sold Inventory

25,000

7 Accounts Payable—Kester Co. Inventory

6,850

13 Accounts Payable—Hamling Co. Cash {[$61,200 – ($61,200 × 2%)] + $1,450} Inventory ($61,200 × 2%)

62,650

15 Accounts Payable—Kester Co. Cash [$26,600 – ($26,600 × 2%)] Inventory ($26,600 × 2%)

26,600

21 Cash Accounts Receivable—Parsley Co.

36,000

21 Cash ($108,000 – $7,500) Sales

100,500

21 Cost of Goods Sold Inventory

64,800

22 Accounts Receivable—Tabor Co. Sales

16,650

33,450

36,000

25,000

6,850

61,426 1,224

26,068 532

36,000

100,500

64,800

16,650

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–3B (Concluded) July

22 Cost of Goods Sold Inventory

10,000

23 Cash Sales

91,200

23 Cost of Goods Sold Inventory

55,000

28 Customer Refunds Payable Cash

7,150

28 Inventory Estimated Returns Inventory

4,250

31 Credit Card Expense Cash

1,650

31 Sales (30,000 × 60% × $1) Estimated Coupons Payable

18,000

31 Estimated Coupons Payable Sales [(18,000 – 17,000) × $1].

1,000

10,000

91,200

55,000

7,150

4,250

1,650

18,000

2. Aug.

1,000

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–4B 1. Apr.

Swan Company 2 Accounts Receivable—Bird Company Sales

32,000

2 Accounts Receivable—Bird Company Cash

330

32,000

330

2 Cost of Goods Sold Inventory

19,200

8 Accounts Receivable—Bird Company Sales

49,500

8 Cost of Goods Sold Inventory

29,700

8 Delivery Expense Cash

710

19,200

49,500

29,700

710

17 Cash Accounts Receivable—Bird Company ($32,000 + $330).

32,330

23 Cash Accounts Receivable—Bird Company

49,500

24 Accounts Receivable—Bird Company Sales

67,350

24 Cost of Goods Sold Inventory

40,400

25 Customer Refunds Payable Cash

1,200

30 Cash Accounts Receivable—Bird Company

67,350

32,330

49,500

67,350

40,400

1,200

67,350

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–4B (Concluded) 2. Apr.

Bird Company 2 Inventory Accounts Payable—Swan Company ($32,000 + $330).

32,330

8 Inventory Accounts Payable—Swan Company

49,500

17 Accounts Payable—Swan Company Cash

32,330

23 Accounts Payable—Swan Company Cash

49,500

24 Inventory Accounts Payable—Swan Company

67,350

25 Cash Inventory

1,200

32,330

49,500

32,330

49,500

67,350

1,200

26 Inventory Cash

875 875

30 Accounts Payable—Swan Company Cash

67,350 67,350

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–5B 1. Kanpur Co. Income Statement For the Year Ended June 30, 20Y7 Sales Cost of goods sold Gross profit Expenses: Selling expenses: Sales salaries expense Advertising expense Depreciation expense—store equipment Miscellaneous selling expense Total selling expenses Administrative expenses: Office salaries expense Rent expense Insurance expense Depreciation expense—office equipment Office supplies expense Miscellaneous administrative expense Total administrative expenses Total operating expenses Operating income Other revenue and expense: Interest expense Net income

$ 8,925,000 (5,620,000) $ 3,305,000

$850,000 420,000 33,000 18,000 $1,321,000 $540,000 48,000 24,000 10,000 4,000 6,000 632,000 (1,953,000) $ 1,352,000 (12,000) $ 1,340,000

2. Kanpur Co. Statement of Stockholders’ Equity For the Year Ended June 30, 20Y7 Common Retained Stock Earnings Balances, July 1, 20Y6 $42,500 $ 381,000 Issued common stock 7,500 Net income 1,340,000 Dividends (300,000) Balances, June 30, 20Y7 $50,000 $1,421,000

Total $ 423,500 7,500 1,340,000 (300,000) $1,471,000

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–5B (Concluded) 3. Kanpur Co. Balance Sheet June 30, 20Y7 Assets Current assets: Cash Accounts receivable Inventory Estimated returns inventory Office supplies Prepaid insurance Total current assets Property, plant, and equipment: Office equipment Accum. depreciation—office equipment Book value—office equipment Store equipment Accum. depreciation—store equipment Book value—store equipment Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Salaries payable Customer refunds payable Estimated coupons payable Note payable (current portion) Total current liabilities Long-term liabilities: Note payable (long-term portion) Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity 4.

92,000 450,000 370,000 5,000 10,000 12,000 $ 939,000

$220,000 (58,000) $ 162,000 $650,000 (87,500) 562,500 724,500 $1,663,500

35,500 4,000 10,000 3,000 7,000 $

59,500

133,000 $ 192,500 $ 50,000 1,421,000 1,471,000 $1,663,500

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–6B 1.

Kanpur Co. Income Statement For the Year Ended June 30, 20Y7 Sales Expenses: Cost of goods sold Selling expenses Administrative expenses Interest expense Total expenses Net income

$ 8,925,000 $5,620,000 1,321,000 632,000 12,000 (7,585,000) $ 1,340,000

Kanpur Co. Statement of Stockholders’ Equity For the Year Ended June 30, 20Y7 Common Retained Stock Earnings Balances, July 1, 20Y6 $42,500 $ 381,000 Issued common stock 7,500 Net income 1,340,000 Dividends (300,000) Balances, June 30, 20Y7 $50,000 $1,421,000

Total $ 423,500 7,500 1,340,000 (300,000) $1,471,000

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–6B (Continued) 3. Kanpur Co. Balance Sheet June 30, 20Y7 Assets Current assets: Cash Accounts receivable Inventory Estimated returns inventory Office supplies Prepaid insurance Total current assets Property, plant, and equipment: Office equipment Accum. depreciation—office equipment Book value—office equipment Store equipment Accum. depreciation—store equipment Book value—store equipment Total property, plant, and equipment Total assets

92,000 450,000 370,000 5,000 10,000 12,000 $ 939,000

$220,000 (58,000) $ 162,000 $650,000 (87,500) 562,500 724,500 $1,663,500

Liabilities Current liabilities: Accounts payable Salaries payable Customer refunds payable Estimated coupons payable Note payable (current portion) Total current liabilities Long-term liabilities: Note payable (long-term portion) Total liabilities Stockholders’ Equity

35,500 4,000 10,000 3,000 7,000 $

59,500

133,000 $ 192,500

Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$ 50,000 1,421,000 1,471,000 $1,663,500

CHAPTER 5

Accounting for Retail Businesses

Prob. 5–6B (Concluded) 4. 20Y7 June

Closing Entries 30 Sales Cost of Goods Sold Sales Salaries Expense Advertising Expense Depreciation Expense—Store Equipment Miscellaneous Selling Expense Office Salaries Expense Rent Expense Insurance Expense Depreciation Expense—Office Equipment Office Supplies Expense Miscellaneous Administrative Expense Interest Expense Retained Earnings 30 Retained Earnings Dividends

8,925,000 5,620,000 850,000 420,000 33,000 18,000 540,000 48,000 24,000 10,000 4,000 6,000 12,000 1,340,000 300,000 300,000

CHAPTER 5

Accounting for Retail Businesses

Appendix 2 Prob. 5–7B Mar.

1 Purchases Freight In Accounts Payable—Haas Co.

43,250 650

5 Purchases Accounts Payable—Whitman Co.

19,175

10 Accounts Payable—Haas Co. Cash Purchases Discounts ($43,250 × 2%)

43,900

13 Purchases Accounts Payable—Jost Co.

15,550

14 Accounts Payable—Jost Co. Purchases Returns and Allowances

3,750

18 Purchases Accounts Payable—Fairhurst Company

13,560

18 Freight In Cash

43,900

19,175

43,035 865

15,550

3,750

13,560 140 140

19 Purchases Accounts Payable—Bickle Co.

6,500

23 Accounts Payable—Jost Co. Cash Purchases Discounts ($11,800 × 2%)

11,800

29 Accounts Payable—Bickle Co. Cash Purchases Discounts ($6,500 × 2%)

6,500

31 Accounts Payable—Fairhurst Company Cash

13,560

31 Accounts Payable—Whitman Co. Cash

19,175

6,500

11,564 236

6,370 130

13,560

19,175

CHAPTER 5

Accounting for Retail Businesses

Appendix 2 Prob. 5–8B 1. July

3 Purchases Freight In Accounts Payable—Hamling Co. [$72,000 – ($72,000 × 15%) = $61,200].

61,200 1,450

5 Purchases Accounts Payable—Kester Co.

33,450

6 Accounts Receivable—Parsley Co. Sales

36,000

7 Accounts Payable—Kester Co. Purchases Returns and Allowances

6,850

13 Accounts Payable—Hamling Co. Cash Purchases Discounts ($61,200 × 2%)

62,650

15 Accounts Payable—Kester Co. Cash Purchases Discounts [($33,450 – $6,850) × 2%]

26,600

21 Cash Accounts Receivable—Parsley Co.

36,000

21 Cash ($108,000 – $7,500) Sales

100,500

22 Accounts Receivable—Tabor Co. Sales

16,650

23 Cash Sales

91,200

28 Customer Refunds Payable Cash

7,150

31 Credit Card Expense Cash

1,650

31 Sales (30,000 × 60% × $1) Estimated Coupons Payable

18,000

62,650

33,450

36,000

6,850

61,426 1,224

26,068 532

36,000

100,500

16,650

91,200

7,150

1,650

18,000

CHAPTER 5

Accounting for Retail Businesses

Appendix 2 Prob. 5–8B (Concluded) 2. Aug.

31 Estimated Coupons Payable Sales [(18,000 – 17,000) × $1].

1,000 1,000

Appendix 2 Prob. 5–9B 1. Apr.

Swan Company 2 Accounts Receivable—Bird Company Sales

32,000

2 Accounts Receivable—Bird Company Cash

330

8 Accounts Receivable—Bird Company Sales

49,500

8 Delivery Expense Cash

32,000

330

49,500 710 710

17 Cash ($32,000 + $330) Accounts Receivable—Bird Company

32,330

23 Cash Accounts Receivable—Bird Company

49,500

24 Accounts Receivable—Bird Company Sales

67,350

25 Customer Refunds Payable Cash

1,200

30 Cash Accounts Receivable—Bird Company

67,350

32,330

49,500

67,350

1,200

67,350

CHAPTER 5

Accounting for Retail Businesses

Appendix 2 Prob. 5–9B (Concluded) 2. Apr.

Bird Company 2 Purchases Freight In Accounts Payable—Swan Company

32,000 330

8 Purchases Accounts Payable—Swan Company

49,500

17 Accounts Payable—Swan Company Cash

32,330

23 Accounts Payable—Swan Company Cash

49,500

24 Purchases Accounts Payable—Swan Company

67,350

25 Cash Purchases Returns and Allowances

1,200

26 Freight In Cash

32,330

49,500

32,330

49,500

67,350

1,200 875 875

30 Accounts Payable—Swan Company Cash

67,350 67,350

Appendix 2 Prob. 5–10B 1. Periodic inventory system. Simkins Company uses a periodic inventory system because it maintains accounts for purchases, purchases returns and allowances, purchases discounts, and freight in. 2. See next page.

CHAPTER 5

Accounting for Retail Businesses

Appendix 2 Prob. 5–10B (Continued) 2. Simkins Company Income Statement For the Year Ended June 30, 20Y9 Sales Cost of goods sold: Inventory, July 1, 20Y8 Cost of merchandise purchased: Purchases Purchases returns and allowances Purchases discounts Freight in Total cost of merchandise purchased

$ 6,590,000 $ 415,000 $4,100,000 (32,000) (13,000) 45,000 4,100,000 $4,515,000 (508,000)

Inventory available for sale Inventory, June 30, 20Y9 Cost of goods sold before estimated returns Increase in estimated returns inventory Cost of goods sold Gross profit Expenses: Selling expenses: Sales salaries expense Advertising expense Delivery expense Depreciation expense—store equipment Miscellaneous selling expense Total selling expenses Administrative expenses: Office salaries expense Rent expense Insurance expense Office supplies expense Depreciation expense—office equipment Miscellaneous administrative expense Total administrative expenses Total operating expenses Operating income Other revenue and expense: Rent revenue Interest expense Net income

$4,007,000 (8,000) (3,999,000) $ 2,591,000

$ 580,000 315,000 18,000 12,000 28,000 $ 953,000 $ 375,000 43,000 17,000 5,000 4,000 16,000 460,000 (1,413,000) $ 1,178,000 $

32,500 (2,500)

30,000 $ 1,208,000

CHAPTER 5

Accounting for Retail Businesses

Appendix Prob. 5–10B (Concluded) 3. 20Y9 June

Closing Entries 30

508,000 8,000 6,590,000 32,000 13,000 32,500 415,000 4,100,000 45,000 580,000 315,000 18,000 12,000 28,000 375,000 43,000 17,000 5,000 4,000 16,000 2,500 1,208,000 275,000 275,000

4. $1,208,000. The same net income as under the periodic inventory system.

CHAPTER 5

Accounting for Retail Businesses

COMPREHENSIVE PROBLEM 2 1., 2., 6., and 9. Cash

Account:

Item

Date

20Y6 May

1 1 4 7 10 13 15 17 19 19 20 21 21 26 28 29 31 31

Balance

Post. Ref.

 20 20 20 20 20 20 20 20 20 20 21 21 21 21 21 21 21

Debit

Credit

Date

Item

1 2 7 17 20 21 21 30 31

Balance

Post. Ref.

 20 20 20 21 21 21 21 21

Debit

110

Balance Credit

83,600 5,000 600 22,300 54,000 35,280 11,000 68,500 18,700 33,450 13,230 2,300 42,900 7,500 85,000 2,400 112,300 82,170

Accounts Receivable

Account:

20Y6 May

Account No.

86,970 Account No.

Debit

Credit

Balance Debit Credit

233,900 68,500 22,300 68,500 110,000 2,300 42,900 78,750 112,300

112

247,450

CHAPTER 5

Accounting for Retail Businesses

Comp. Prob. 2 (Continued) Inventory Account: Date

20Y6 May

Item

1 2 3 4 10 13 19 20 20 21 24 26 30 31 31

Date

Item

1 20 26 31

Date

Balance

Adjusting

Item

1 31

Credit

Post. Ref.

 20 21 22

Balance Adjusting

Date

Item

1 29 31

Balance Adjusting

Debit

Balance Credit

624,400 36,000 600 32,000 720 18,700 8,000 70,000 88,000 5,000 4,800 47,000 830 13,950

583,950 570,000 Account No.

Debit

Credit

28,000 8,000 4,800 35,000

Debit

 22

15,200 50,200

 21 22

Debit

117

Credit

Balance Debit Credit

12,000

16,800 4,800 Account No.

Post. Ref.

116

Balance Debit Credit

Account No.

Post. Ref.

115

41,000

Store Supplies

Account:

20Y6 May

 20 20 20 20 20 20 20 21 21 21 21 21 21 22

Debit

Prepaid Insurance

Account:

20Y6 May

Adjusting

Post. Ref.

Estimated Returns Inventory

Account:

20Y6 May

Balance

Account No.

Credit

2,400 9,800

Debit

118

Balance Credit

11,400 13,800 4,000

CHAPTER 5

Accounting for Retail Businesses

Comp. Prob. 2 (Continued) Store Equipment Account: Item

Date

20Y6 May

Account:

Date

20Y6 May

1 31

1 3 13 19 21 24 31

Credit

569,500

Accumulated Depreciation—Store Equipment

Account No.

Item

Post. Ref.

Balance Adjusting

 22

Debit

Credit

Balance

Date

Post. Ref.

 20 20 20 21 21 21

1 20 26 31

Item

Adjusting

Balance

Adjusting

210

Debit

Credit

Debit

Balance Credit

96,600 36,000 36,000 33,450 88,000 5,000 83,000

63,150 211

Account No.

Post. Ref.

Item

Date

56,700 70,700 Account No.

Debit

Credit

Post. Ref.

 20 21 22

Balance Debit Credit

13,600

Customer Refunds Payable

Account:

124

Balance Debit Credit

14,000

Salaries Payable

Account:

20Y6 May

Debit

Balance Debit Credit



Item

Date

20Y6 May

Post. Ref.

Accounts Payable

Account:

20Y6 May

Balance

123

Account No.

13,600 212

Account No.

Debit

Credit

Balance Debit Credit

50,000 13,230 7,500 60,000

29,270 89,270

CHAPTER 5

Accounting for Retail Businesses

Comp. Prob. 2 (Continued) Common Stock

Account:

Date

20Y6 May

Item

Balance

Date

20Y6 May

Item

1 31 31

Balance Closing Closing

Account:

Dividends

Date

Item

20Y6 May

1 31

Debit

Credit

Balance Closing

Date

Item

1 2 10 21 30 31 31

Balance

Adjusting Closing

Balance Debit Credit

100,000



311

Account No.

Post. Ref.

 23 23

Debit

Credit

Debit

Balance Credit

585,300 745,900 135,000

1,196,200 312

Account No.

Post. Ref.

Debit

 23

Post. Ref.

 20 20 21 21 22 23

Debit

Balance Credit

Credit

Debit

135,000

135,000 —

—

Account No.

410

Sales

Account:

20Y6 May

Post. Ref.

Retained Earnings

Account:

310

Account No.

Credit

Debit

Balance Credit

5,069,000 68,500 54,000 110,000 78,750 60,000 5,320,250

—

5,380,250 5,320,250 —

CHAPTER 5

Accounting for Retail Businesses

Comp. Prob. 2 (Continued) Cost of Goods Sold Account: Date

20Y6 May

Item

1 2 10 21 30 31 31 31

Date

 20 20 21 21 22 22 23

Adjusting Adjusting Closing

Debit

Credit

Post. Ref.

Balance

 21 22 23

Adjusting Closing

Date

Item

1 15 31

Balance Closing

Post. Ref.

 20 23

Date

31 31

Item

Post. Ref.

Adjusting Closing

22 23

Balance Credit

3,013,000 35,000 2,991,950

Debit

Account No.

520

Balance Credit

727,800

664,800 720,800 727,800 —

—

Account No.

521

Credit

Balance Debit Credit

292,000

281,000 292,000 —

—

Account No.

522

11,000

Debit

—

Debit

56,000 7,000

Debit

2,991,950 —

Credit

Depreciation Expense

Account:

Debit

510

2,823,000 41,000 32,000 70,000 47,000 13,950

Advertising Expense

Account:

20Y6 May

Balance

Item

1 28 31 31

20Y6 May

Post. Ref.

Sales Salaries Expense

Account:

20Y6 May

Account No.

Credit

14,000 14,000

Debit

Balance Credit

14,000 —

—

CHAPTER 5

Accounting for Retail Businesses

Comp. Prob. 2 (Continued) Stores Supplies Expense Account: Date

20Y6 May

31 31

Date

Balance Closing

Item

1 28 31 31

Credit

9,800 9,800

Post. Ref.

Debit

 23

Credit

12,600

Balance Adjusting Closing

Post. Ref.

 21 22 23

Debit

Date

Item

1 1 31

Balance Closing

Post. Ref.

 20 23

Date

31 31

Item

Post. Ref.

Adjusting Closing

22 23

—

Account No.

529

Debit

Balance Credit

12,600 —

—

Account No.

530

Balance Credit

417,700

—

Account No.

531

Credit

5,000 88,700

Debit

9,800 —

382,100 411,100 417,700 —

Insurance Expense

Account:

Balance Credit

Debit

29,000 6,600

Debit

523

Credit

Rent Expense

Account:

20Y6 May

22 23

Debit

Office Salaries Expense

Account:

20Y6 May

Adjusting Closing

Item

1 31

20Y6 May

Post. Ref.

Miscellaneous Selling Expense

Account:

20Y6 May

Item

Account No.

Credit

12,000 12,000

Balance Debit Credit

83,700 88,700 —

—

Account No.

532

Balance Debit Credit

12,000 —

—

CHAPTER 5

Accounting for Retail Businesses

Comp. Prob. 2 (Continued) Miscellaneous Administrative Expense Account: Date

20Y6 May

Item

1 31

Balance Closing

Post. Ref.

Debit

 23

Account No.

Credit

7,800

Debit

539

Balance Credit

7,800 —

—

CHAPTER 5

Accounting for Retail Businesses

Comp. Prob. 2 (Continued) JOURNAL

1. and 2.

Post. Ref.

Date

20Y6 May

Page Debit

1 Rent Expense Cash

531 110

5,000

2 Accounts Receivable—Korman Co. Sales

112 410

68,500

2 Cost of Goods Sold Inventory

510 115

41,000

3 Inventory Accounts Payable—Martin Co.

115 210

36,000

4 Inventory Cash

115 110

600

7 Cash Accounts Receivable—Halstad Co.

110 112

22,300

10 Cash ($61,500 – $7,500) Sales

110 410

54,000

10 Cost of Goods Sold Inventory

510 115

32,000

13 Accounts Payable—Martin Co. Cash Inventory ($36,000 × 2%)

210 110 115

36,000

15 Advertising Expense Cash

521 110

11,000

17 Cash Accounts Receivable—Korman Co.

110 112

68,500

19 Inventory Cash

115 110

18,700

19 Accounts Payable—Buttons Co. Cash

210 110

33,450

20 Customer Refunds Payable Cash

212 110

13,230

20 Inventory Estimated Returns Inventory

115 116

8,000

Credit

5,000

68,500

41,000

36,000

600

22,300

54,000

32,000

35,280 720

11,000

68,500

18,700

33,450

13,230

8,000

CHAPTER 5

Accounting for Retail Businesses

Comp. Prob. 2 (Continued) 21

Page Post. Ref.

20Y6 May

Debit

21 Accounts Receivable—Crescent Co. Sales

112 410

110,000

21 Cost of Goods Sold Inventory

510 115

70,000

21 Accounts Receivable—Crescent Co. Cash

112 110

2,300

21 Cash Accounts Receivable—Gee Co.

110 112

42,900

21 Inventory Accounts Payable—Osterman Co.

115 210

88,000

24 Accounts Payable—Osterman Co. Inventory

210 115

5,000

26 Customer Refunds Payable Cash

212 110

7,500

26 Inventory Estimated Returns Inventory

115 116

4,800

28 Sales Salaries Expense Office Salaries Expense Cash

520 530 110

56,000 29,000

29 Store Supplies Cash

118 110

2,400

30 Accounts Receivable—Turner Co. Sales

112 410

78,750

30 Cost of Goods Sold Inventory

510 115

47,000

31 Cash Accounts Receivable—Crescent Co.

110 112

112,300

31 Accounts Payable—Osterman Co. Cash Inventory ($83,000 × 1%)

210 110 115

83,000

Credit

110,000

70,000

2,300

42,900

88,000

5,000

7,500

4,800

85,000

2,400

78,750

47,000

112,300

82,170 830

CHAPTER 5

Accounting for Retail Businesses

Comp. Prob. 2 (Continued) 3. Palisade Creek Co. Unadjusted Trial Balance May 31, 20Y6 Account No.

Cash Accounts Receivable Inventory Estimated Returns Inventory Prepaid Insurance Store Supplies Store Equipment Accumulated Depreciation—Store Equipment Accounts Payable Salaries Payable Customer Refunds Payable Common Stock Retained Earnings Dividends Sales Cost of Goods Sold Sales Salaries Expense Advertising Expense Depreciation Expense Store Supplies Expense Miscellaneous Selling Expense Office Salaries Expense Rent Expense Insurance Expense Miscellaneous Administrative Expense

110 112 115 116 117 118 123 124 210 211 212 310 311 312 410 510 520 521 522 523 529 530 531 532 539

Debit Balances

Credit Balances

86,970 247,450 583,950 15,200 16,800 13,800 569,500 56,700 63,150 — 29,270 100,000 585,300 135,000 5,380,250 3,013,000 720,800 292,000 — — 12,600 411,100 88,700 — 7,800 6,214,670

6,214,670

CHAPTER 5

Accounting for Retail Businesses

Comp. Prob. 2 (Continued) 4. and 6.

JOURNAL Post. Ref.

Date

20Y6 May

Adjusting Entries 31 Cost of Goods Sold Inventory Inventory shrinkage ($583,950 – $570,000).

Page

Debit

510 115

13,950

31 Insurance Expense Prepaid Insurance Insurance expired.

532 117

12,000

31 Store Supplies Expense Store Supplies Supplies used ($13,800 – $4,000).

523 118

9,800

31 Depreciation Expense Accum. Depr.—Store Equipment Store equipment depreciation.

522 124

14,000

31 Sales Salaries Expense Office Salaries Expense Salaries Payable Accrued salaries.

520 530 211

7,000 6,600

31 Sales Customer Refunds Payable

410 212

60,000

31 Estimated Returns Inventory Cost of Goods Sold

116 510

35,000

Credit

13,950

12,000

9,800

14,000

13,600

60,000

35,000

CHAPTER 5

Accounting for Retail Businesses

Comp. Prob. 2 (Continued) 7.

Palisade Creek Co. Adjusted Trial Balance May 31, 20Y6 Account No.

Cash Accounts Receivable Inventory Estimated Returns Inventory Prepaid Insurance Store Supplies Store Equipment Accum. Depreciation—Store Equipment Accounts Payable Salaries Payable Customer Refunds Payable Common Stock Retained Earnings Dividends Sales Cost of Goods Sold Sales Salaries Expense Advertising Expense Depreciation Expense Store Supplies Expense Miscellaneous Selling Expense Office Salaries Expense Rent Expense Insurance Expense Miscellaneous Administrative Expense

110 112 115 116 117 118 123 124 210 211 212 310 311 312 410 510 520 521 522 523 529 530 531 532 539

Debit Balances

Credit Balances

86,970 247,450 570,000 50,200 4,800 4,000 569,500 70,700 63,150 13,600 89,270 100,000 585,300 135,000 5,320,250 2,991,950 727,800 292,000 14,000 9,800 12,600 417,700 88,700 12,000 7,800 6,242,270

6,242,270

CHAPTER 5

Accounting for Retail Businesses

Comp. Prob. 2 (Continued) 8.

Palisade Creek Co. Income Statement For the Year Ended May 31, 20Y6 Sales Cost of goods sold Gross profit Expenses: Selling expenses: Sales salaries expense Advertising expense Depreciation expense Store supplies expense Miscellaneous selling expense Total selling expenses Administrative expenses: Office salaries expense Rent expense Insurance expense Miscellaneous administrative expense Total administrative expenses Total expenses Net income

$ 5,320,250 (2,991,950) $ 2,328,300

$727,800 292,000 14,000 9,800 12,600 $1,056,200 $417,700 88,700 12,000 7,800 526,200

Palisade Creek Co. Statement of Stockholders’ Equity For the Year Ended May 31, 20Y6 Common Retained Stock Earnings Balances, June 1, 20Y5 $ 90,000 $ 585,300 Issued common stock 10,000 Net income 745,900 Dividends (135,000) Balances, May 31, 20Y6 $100,000 $1,196,200

(1,582,400) $ 745,900

Total $ 675,300 10,000 745,900 (135,000) $1,296,200

CHAPTER 5

Accounting for Retail Businesses

Comp. Prob. 2 (Continued) Palisade Creek Co. Balance Sheet May 31, 20Y6 Assets Current assets: Cash Accounts receivable Inventory Estimated returns inventory Prepaid insurance Store supplies Total current assets Property, plant, and equipment: Store equipment Accum. depreciation—store equipment Total property, plant, and equipment Total assets

86,970 247,450 570,000 50,200 4,800 4,000 $ 963,420

$ 569,500 (70,700) 498,800 $1,462,220

Liabilities Current liabilities: Accounts payable Salaries payable Customer refunds payable Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

63,150 13,600 89,270 $ 166,020

$ 100,000 1,196,200 1,296,200 $1,462,220

CHAPTER 5

Accounting for Retail Businesses

Comp. Prob. 2 (Continued) 9.

JOURNAL Post. Ref.

Date

20Y6 May

Page

Debit

Credit

Closing Entries 31 Sales Cost of Goods Sold Sales Salaries Expense Advertising Expense Depreciation Expense Store Supplies Expense Miscellaneous Selling Expense Office Salaries Expense Rent Expense Insurance Expense Miscellaneous Administrative Expense Retained Earnings

410 510 520 521 522 523 529 530 531 532 539 311

5,320,250

31 Retained Earnings Dividends

311 312

135,000

2,991,950 727,800 292,000 14,000 9,800 12,600 417,700 88,700 12,000 7,800 745,900

135,000

10. Palisade Creek Co. Post-Closing Trial Balance May 31, 20Y6 Account No.

110 112 115 116 117 118 123 124 210 211 212 310 311

Debit Balances

Credit Balances

86,970 247,450 570,000 50,200 4,800 4,000 569,500

1,532,920

70,700 63,150 13,600 89,270 100,000 1,196,200 1,532,920

(Optional)*

Accounting for Retail Businesses

2,991,950 727,800 292,000 14,000 9,800 12,600 417,700 88,700 12,000 7,800 4,574,350 745,900 5,320,250

5,320,250

Income Statement Debit Credit

5-76

Palisade Creek Co. End-of-Period Spreadsheet (Work Sheet) For the Year Ended May 31, 20Y6 Unadjusted Adjusted Trial Balance Adjustments Trial Balance Debit Credit Debit Credit Debit Credit 86,970 86,970 247,450 247,450 583,950 (a) 13,950 570,000 15,200 (g) 35,000 50,200 16,800 (b) 12,000 4,800 13,800 (c) 9,800 4,000 569,500 569,500 56,700 (d) 14,000 70,700 63,150 63,150 (e) 13,600 13,600 29,270 (f) 60,000 89,270 100,000 100,000 585,300 585,300 135,000 135,000 5,380,250 (f) 60,000 5,320,250 3,013,000 (a) 13,950 (g) 35,000 2,991,950 720,800 (e) 7,000 727,800 292,000 292,000 (d) 14,000 14,000 (c) 9,800 9,800 12,600 12,600 411,100 (e) 6,600 417,700 88,700 88,700 (b) 12,000 12,000 7,800 7,800 6,214,670 6,214,670 158,350 158,350 6,242,270 6,242,270

* This solution is applicable only if the end-of-period spreadsheet (work sheet) is used.

Net income

Account Title Cash Accounts Receivable Inventory Estimated Returns Inventory Prepaid Insurance Store Supplies Store Equipment Accum. Depr.—Store Equip. Accounts Payable Salaries Payable Customer Refunds Payable Common Stock Retained Earnings Dividends Sales Cost of Goods Sold Sales Salaries Expense Advertising Expense Depreciation Expense Store Supplies Expense Miscellaneous Selling Expense Office Salaries Expense Rent Expense Insurance Expense Miscellaneous Admin. Expense

Comp. Prob. 2 (Concluded)

CHAPTER 5

1,667,920

922,020 745,900 1,667,920

Balance Sheet Debit Credit 86,970 247,450 570,000 50,200 4,800 4,000 569,500 70,700 63,150 13,600 89,270 100,000 585,300 135,000

CHAPTER 5

Accounting for Retail Businesses

MAKE A DECISION MAD 5–1 a.

Student answers should include at least three items from each of the following lists. Amazon.com 1. Data centers and servers 2. Product and media inventory 3. Distribution centers 4. Office space Netflix, Inc. 1. Data centers and servers 2. DVD content library 3. DVD mail-in centers 4. Office space 5. Streaming content library (This library is either developed for Netflix or licensed for a fixed fee over a period of time and, thus, is an asset over that time period.)

b. Asset turnover ratio

Amazon 1.45 {$280,522 ÷ [($162,648 + $225,248) ÷ 2]}

Netflix 0.67 {$20,156 ÷ [($25,974 + $33,976) ÷ 2]}

Amazon appears to be more efficient in generating sales from its assets than is Netflix. Amazon’s asset turnover ratio is 1.45, while Netflix’s is 0.67. Netflix has a much smaller investment in property, plant, and equipment for its revenue base than does Amazon. Thus, it would seem surprising that Amazon would have a higher asset turnover ratio. However, Netflix has a very large investment in its content libraries, both DVD and streaming. Netflix’s investment in its content libraries is more than 40 times larger than its investment in plant and equipment. As a result of this significant content investment, Netflix generates fewer sales per dollar of total assets than does Amazon.

MAD 5–2 Year 2 1.98 {$25,525 ÷ [($12,517 + $13,204) ÷ 2]}

Year 1 1.94 {$23,471 ÷ [($11,672 + $12,517) ÷ 2]}

Asset turnover ratio

These analyses indicate a slight increase in the effectiveness in the use of assets to generate revenues from $1.94 to $1.98 of revenue for each dollar of assets. A comparison with similar companies or industry averages would be helpful in making a more definitive statement on the effectiveness of the use of the assets.

CHAPTER 5

Accounting for Retail Businesses

MAD 5–3 Dollar Tree Dollar General

Year 2 1.53 1.98

Year 1 1.39 1.94

Dollar General had significantly higher asset turnover ratios than Dollar Tree. In Year 1, Dollar General’s asset turnover ratio is 1.94 compared to Dollar Tree’s ratio of 1.39. In Year 2, Dollar Tree increased its asset turnover ratio to 1.53, which was a significant improvement. However, Dollar Tree’s ratio of 1.53 is still lower than Dollar General’s ratio of 1.98. Overall, Dollar General is more efficient in using its assets to generate revenues than is Dollar Tree. MAD 5–4 a.

CSX 0.32 {$11,937 ÷ [($36,729 + $38,257) ÷ 2]}

Union Pacific 0.36 {$21,708 ÷ [($59,147 + $61,673) ÷ 2]}

YRC 2.82 {$4,871 ÷ [($1,617 + $1,832) ÷ 2]}

Union Pacific’s asset turnover ratio is 0.36, while CSX’s is 0.32. Thus, Union Pacific is more efficient in using its assets in generating revenue. For every dollar of assets, Union Pacific generates 36 cents of revenue.

YRC’s asset turnover ratio is over seven times larger than that of the railroads. Clearly, YRC is much more efficient in generating revenues from its total assets than are the railroads. Railroads are very capital intensive, which means that their operations require a large asset base. Railroads require track, engines, railcars, computers, and switching yards to maintain the rail system. A trucking company is much less capital intensive. A trucking company requires an investment in trucks, computers, and terminals. Trucks run on highways that are an asset of the government, whereas the railroads must own and maintain their own rails.

CHAPTER 5

MAD 5–5 a. Asset turnover ratio

Accounting for Retail Businesses

Year 2 2.31 {$110,225 ÷ [($44,003 + $51,236) ÷ 2]}

Year 1 2.44 {$108,203 ÷ [($44,529 + $44,003) ÷ 2]}

These ratios indicate a decrease in the effectiveness in the use of assets to generate revenues from $2.44 to $2.31 of revenue for each dollar of assets. A comparison with similar companies or industry averages would be helpful in making a more definitive statement on the effectiveness of the use of the assets.

MAD 5–6 a.

Asset turnover ratio

Although Kroger and Tiffany are both retail stores, Tiffany sells jewelry using a much longer operating cycle than Kroger uses selling groceries. Thus, Kroger is able to generate $3.22 of sales for every dollar of assets. Tiffany, however, is only able to generate $0.82 in sales per dollar of assets. This difference is reasonable when one considers the sales rate for jewelry and the cost of holding jewelry inventory, relative to groceries. Fortunately, Tiffany is able to offset its longer operating cycle with higher gross profits, relative to groceries.

3.22 {$121,162 ÷ [($37,197 + $38,118) ÷ 2]}

Note to Instructors: For a recent year, Kroger’s gross profit percentage (gross profit divided by revenues) was 21.7%, while Tiffany’s gross profit percentage was 63.3%. Kroger’s ratio of net income to revenues was 2.6%, while Tiffany’s ratio of net income to revenues was 13.2%.

MAD 5–7 a.

Year 1 1.36 {$12,547 ÷ [($9,314 + $9,118) ÷ 2]}

Year 2 1.42 {$12,506 ÷ [($9,118 + $8,454) ÷ 2]}

Year 3 1.49 {$12,019 ÷ [($8,454 + $7,721) ÷ 2]}

Year 4 1.42 {$11,167 ÷ [($7,721 + $7,989) ÷ 2]}

CHAPTER 5

Accounting for Retail Businesses

MAD 5–7 (Concluded) b. The asset turnover ratio increased from 1.36 in Year 1 to 1.42 in Year 2 to 1.49 in Year 3. This is a favorable trend in the use of assets to generate revenue; however, the asset turnover ratio decreased to 1.42 in Year 4. These ratios are some of the weakest in the retail industry. J. C. Penney has been having trouble attracting and maintaining customers. In recent years, the company has been closing stores and decreasing its assets, while sales have been relatively stable. Note to Instructors: J. C. Penney filed for bankruptcy in 2020.

CHAPTER 5

Accounting for Retail Businesses

TAKE IT FURTHER TIF 5–1 Margie has been placed in a very difficult position. Someone whom she trusts and respects has asked her to do something that is clearly unethical. If Margie makes the adjusting entry, her boss could very well be terminated. Yet, Margie’s primary responsibility has to be preparing relevant and representationally faithful financial information that is useful for decision making. Margie should, therefore, make the appropriate adjusting entry. Being right, however, doesn’t always make a decision easy. Margie’s actions could very well result in the termination of her boss and mentor. In order for financial information to be representationally faithful, it must be free of bias. The company president is clearly trying to pressure the Accounting Department to create biased financial statements, which is inappropriate. While Margie should not bend on the issue of making the adjusting entry, she should bring this issue to the attention of the Internal Audit Department or the board of directors.

TIF 5–2 Standards of Ethical Conduct for Management Accountants requires management accountants to perform in a competent manner and to comply with relevant laws, regulations, and technical standards. If Shelby intentionally subtracted the discount knowing that the discount period had expired, he would have behaved in an unprofessional manner. Such behavior could eventually jeopardize Bontanica Company’s buyer/supplier relationship with Whitetail Seed Co.

TIF 5–3 A sample solution based on Dollar Tree, Inc.’s Form 10-K for the fiscal year ended February 2, 2019, follows: 1. a. $6,947.5 million in 2019; $7,021.9 million in 2018; $6,394.7 million in 2017 b. 30.4% ($6,947.5 million ÷ $22,823.3 million) in 2019; 31.6% ($7,021.9 million ÷ $22,245.5 million) in 2018; 30.9% ($6,394.7 million ÷ $20,719.2 million) in 2017 c. $(939.5) million loss in 2019; $1,999.1 million in 2018; $1,704.8 million in 2017 d. 147.0% decrease in 2019 ($2,938.6 million ÷ $1,999.1 million) e. $(1,590.8) million loss in 2019; $1,714.3 million in 2018; $896.2 million in 2017 2. The company’s financial performance has changed significantly over the past 3 years. For the year ended February 2, 2019, Dollar Tree reported an operating loss of $(939.5) million. This loss was generated primarily by the writing off of $2,727.0 million of assets (goodwill) related to Dollar Tree’s acquisition of Family Dollar. Without this write-off, Dollar Tree would have generated $1,787.5 ($2,727.0 − $939.5) million of operating profit. As Dollar Tree integrates its acquisition of Family Dollar into its operations, its operating results will be more in line with prior years and may improve.

CHAPTER 5

Accounting for Retail Businesses

TIF 5–4 Note to Instructors: The purpose of this activity is to familiarize students with the variety of possible purchase prices for a fairly common household item. Students should report several alternative prices when they consider the source of the purchase and the other factors that affect the purchase (e.g., delivery, financing, and warranties). Consider going to www.cnet.com and entering a search for “55-inch LED, LCD TV.” Pick one TV model that offers a range of prices from different stores and compare shipping and payment differences among companies. For example, the Samsung UNJS8500 TV has a range of prices of $1,619.95 to $1,799.99. Some stores offer free shipping. You might consider offering the student group(s) that comes up with the lowest price extra credit points for homework.

TIF 5–5 To: From: Re:

Suzi Nomro President, Watercraft Supply Company A+ student Proposal to Increase Net Income

If the proposed changes in credit terms increase sales by 10% as expected, and if the ratio of cost of goods sold to sales remains at 60%, this proposal has the potential to increase net income by $64,200, from $321,000 to $385,200. This increase will be driven by a $135,000 increase in sales. Cost of goods sold is also expected to increase by 60% of the sales increase, or $81,000. While store supplies and miscellaneous selling expenses will increase proportionally to sales, total selling expenses will decrease by $10,200 because of the change in freight terms. By shipping goods FOB shipping point rather than FOB destination, the company will save $12,000 in freight costs. This will result in an increase in net income of $64,200. There are several potential risks associated with this type of proposal. First, the accuracy of the estimates used to project the effects of the proposed changes are not certain. If the increase in sales does not materialize, Watercraft Supply Company could incur significant costs of carrying excess inventory stocked in anticipation of increasing sales. At the same time it is incurring these additional inventory costs, cash collections from customers will be reduced by the amount of the discounts. This could create a liquidity problem for Watercraft Supply. Another potential risk arises from the proposed change in shipping terms. Watercraft Supply assumes that this change will have no effect on sales. However, customers may object to this change and seek other vendors with more favorable terms. Hence, an unanticipated decline in sales could occur because of this change.

CHAPTER 5

Accounting for Retail Businesses

TIF 5–5 (Concluded) While the anticipated outcomes indicate that the company should pursue the proposal, financial projections are inherently uncertain, and there is no guarantee that the actual results will match those in the projections. Management should test the proposed changes with the company’s customer base before proceeding. As with any business decision, risks such as those mentioned above must be thoroughly considered before final action is taken. Supporting projections are provided below. Watercraft Supply Company Projected Income Statement For the Year Ended October 31, 20Y4 Revenues: Sales Interest Total revenues Expenses: Cost of goods sold Selling expenses Administrative expenses Interest expense Total expenses Net income

$ 1,485,000 15,000 $ 1,500,000 $891,000 129,800 90,000 4,000 (1,114,800) $ 385,200

Notes: a. Projected sales [$1,350,000 + (10% × $1,350,000)]…………………………

$1,485,000

b. Projected cost of goods sold ($1,485,000 × 60%)……………………………………………

$ 891,000

c. Total selling expenses projected for year ended October 31, 20Y3……………………………………………… Increase in store supplies expense ($12,000 × 10%)…………………………………………… Increase in miscellaneous selling expense ($6,000 × 10%)……………………………………………… Projected reduction in delivery expenses…………………… Projected total selling expenses………………………………

$ 140,000 $1,200 600

1,800 (12,000) $ 129,800

CHAPTER 5

Accounting for Retail Businesses

TIF 5–6 Cam Pfeifer is correct. The accounts payable due to suppliers could be included on the balance sheet at an amount of $314,500 ($269,500 + $45,000). This is the amount that will be expected to be paid to satisfy the obligation (liability) to suppliers. However, this is proper only if Rustic Furniture Co. has a history of taking all purchases discounts, has a properly designed accounting system to identify available discounts, and has sufficient liquidity (cash) to pay the accounts payable within the discount period. In this case, Rustic Furniture Co. apparently meets these criteria, since it has a history of taking all available discounts, as indicated by Mitzi Wheeler. Thus, Rustic Furniture Co. could report total accounts payable of $314,500 on its balance sheet. Merchandise inventory would also need to be reduced by the discount of $5,500 in order to maintain consistency in approach.

TIF 5–7 1.

If Mark doesn’t need the stereo immediately (by the next day), Wholesale Stereo offers the best buy, as shown below. Wholesale Stereo: List price………………………………………………………… Shipping and handling (not including next-day air)…… Total………………………………………………………………

$1,200.00 49.99 $1,249.99

Tru-Sound Systems: List price………………………………………………………… Sales tax (9%).………………………………………………… Total………………………………………………………………

$1,175.00 105.75 $1,280.75

Even if the 2% cash discount offered by Tru-Sound Systems is considered, Wholesale Stereo still offers the best buy, as shown below. List price………………………………………………………… Less 2% cash discount.……………………………………… Subtotal………………………………………………………… Sales tax (9%).………………………………………………… Total………………………………………………………………

$1,175.00 (23.50) $1,151.50 103.64 $1,255.14

If Mark needs the stereo immediately (the next day), then Tru-Sound Systems has the best price. This is because a shipping and handling charge of $89.99 would be added to the Wholesale Stereo, as shown below. Wholesale Stereo list price………………………………… Next-day freight charge……………………………………… Total………………………………………………………………

$1,200.00 89.99 $1,289.99

CHAPTER 5

Accounting for Retail Businesses

TIF 5–7 (Concluded) Because both Wholesale Stereo and Tru-Sound Systems will accept Mark’s Visa, the ability to use a credit card would not affect the buying decision. Tru-Sound Systems will, however, allow Mark to pay his bill in three installments (the first due immediately). This would allow Mark to save some interest charges on his Visa for 2 months. If we assume that Mark would have otherwise used his Visa and that Mark’s Visa carries an interest of 1.5% per month on the unpaid balance, the potential interest savings would be calculated as follows: Tru-Sound Systems price (see previous page)………… Less first installment (down payment)…………………… Remaining balance……………………………………………

$1,280.75 (426.92) $ 853.83

Interest for first month at 1.5% ($853.83 × 1.5%)………… Remaining balance ($853.83 + $12.81)…………………… Less second installment…………………………………… Remaining balance……………………………………………

$ 12.81 $ 866.64 (426.92) $ 439.72

Interest for second month at 1.5% ($439.72 × 1.5%)……

6.60

The total interest savings would be $19.41 ($12.81 + $6.60). This interest savings still would not be enough to offset the price advantage of Wholesale Stereo, as shown below. Tru-Sound Systems price (see above)………………… Less interest savings……………………………………… Total………………………………………………………… 2.

$1,280.75 (19.41) $1,261.34

Other considerations in buying the stereo include the ability to have the stereo repaired locally. In addition, Tru-Sound Systems’ employees would presumably be available to answer questions on the operation and installation of the stereo. Also, if Mark purchased the stereo from Tru-Sound Systems, he would have the stereo the same day rather than the next day, which is the earliest Wholesale Stereo could deliver the stereo.

CHAPTER 5

Accounting for Retail Businesses

TIF 5–8 1.

2. Based upon the quantity sold during the past month, AAAA Office Supplies should consider discontinuing the products with the smallest quantity sold. Three products that stand out as prime candidates to discontinue include: • A12 Matte, Ream • Legal File Folders, Dark Green, Pack of 10 • Erasers, 50 count In addition to considering the quantity sold, AAAA Office Supplies should also consider the storage space required and the markup (profit) associated with each product. Data analytics could also be used to include these product attributes.

CHAPTER 6 INVENTORIES DISCUSSION QUESTIONS 1.

The receiving report should be reconciled to the initial purchase order and the vendor’s invoice before recording or paying for inventory purchases. This procedure will verify that the inventory received matches the type and quantity of inventory ordered. It also verifies that the vendor’s invoice is charging the company for the actual quantity of inventory received at the agreed-upon price.

A physical inventory should be taken periodically to test the accuracy of the perpetual records. In addition, a physical inventory will identify inventory shortages or shrinkage.

No, they are not techniques for determining physical quantities. The terms refer to cost flow assumptions, which affect the determination of the cost prices assigned to items in the inventory.

a. LIFO b. FIFO

FIFO

LIFO. In periods of rising prices, the use of LIFO will result in the lowest net income and thus the lowest income tax expense.

The inventory should be valued using the lower of its cost of $1,350 or its market (net realizable) value of $1,295 ($1,475 – $180). Thus, the inventory should be valued at its market value of $1,295.

a. Gross profit for the year was understated by $14,750.

c. LIFO d. FIFO

b. Inventory and stockholders’ equity (retained earnings) were understated by $14,750. 9.

Bibbins Company. Since the merchandise was shipped FOB shipping point, title passed to Bibbins Company when it was shipped and should be reported in Bibbins Company’s financial statements at May 31, the end of the fiscal year.

10.

Manufacturer’s. The manufacturer retains title until the goods are sold. Thus, any unsold merchandise at the end of the year is part of the manufacturer’s (consignor’s) inventory, even though the merchandise is in the hands of the retailer (consignee).

CHAPTER 6

Inventories

BASIC EXERCISES BE 6–1

a. First-in, first-out (FIFO) b. Last-in, first-out (LIFO) c. Weighted average cost

Gross Profit April

Ending Inventory April 30

$200 ($300 – $100) $160 ($300 – $140) $180 ($300 – $120)

$260 ($120 + $140) $220 ($100 + $120) $240 ($120 × 2)

BE 6–2 a.

Cost of goods sold (October 24): 20 units @ $40 130 units @ $45 150

$ 800 5,850 $6,650

b. Inventory, October 31: $2,250 = 50 units × $45

BE 6–3 a.

Cost of goods sold (July 27): $4,800 = (80 units × $60)

b. Inventory, July 31: 30 units @ $56 40 units @ $60 70

$1,680 2,400 $4,080

BE 6–4 a. Weighted average unit cost: $21.52 Inventory total cost after purchase on October 22: 120 units @ $20 380 units @ $22 500

$ 2,400 8,360 $10,760

Weighted average unit cost = $21.52 ($10,760 ÷ 500 units) b. Cost of goods sold (October 29): $6,456 (300 units × $21.52) c.

Inventory, October 31: $4,304 (200 units × $21.52)

CHAPTER 6

Inventories

BE 6–5 a.

First-in, first-out (FIFO) method: $14,700 = (60 units × $200) + (15 units × $180)

b. Last-in, first-out (LIFO) method: $12,900 = (40 units × $165) + (35 units × $180) c.

Weighted average cost method: $13,650 (75 units × $182), where average cost = $182 = $54,600 ÷ 300 units

BE 6–6 Market

Total

Value per Cost Commodity

JFW1 SAW9 Total

Inventory Quantity

per Unit

Unit (Net Realizable Value)

6,330 1,140

$10 36

$11 34

Cost

Market

LCM

$ 63,300 41,040 $104,340

$ 69,630 38,760 $108,390

$ 63,300 38,760 $102,060

BE 6–7 Amount of Misstatement Overstatement (Understatement)

Balance Sheet: Inventory overstated*………………………………… Current assets overstated…………………………… Total assets overstated……………………………… Stockholders’ equity overstated……………………

$ 8,780 8,780 8,780 8,780

Income Statement: Cost of goods sold understated…………………… Gross profit overstated……………………………… Net income overstated………………………………

$(8,780) 8,780 8,780

* $728,660 – $719,880 = $8,780

CHAPTER 6

Inventories

BE 6–8 a.

Inventory Turnover Cost of goods sold Inventories: Beginning of year End of year Average inventory Inventory turnover

b. Days’ Sales in Inventory Cost of goods sold Average daily cost of goods sold Average inventory Days’ sales in inventory c.

20Y7 $3,864,000 $770,000 $840,000 $805,000 [($770,000 + $840,000) ÷ 2] 4.8 ($3,864,000 ÷ $805,000)

20Y6 $4,001,500 $740,000 $770,000 $755,000 [($740,000 + $770,000) ÷ 2] 5.3 ($4,001,500 ÷ $755,000)

20Y7 $3,864,000

20Y6 $4,001,500

$10,586.3 ($3,864,000 ÷ 365 days)

$10,963.0 ($4,001,500 ÷ 365 days)

$805,000 [($770,000 + $840,000) ÷ 2] 76.0 days ($805,000 ÷ $10,586.3)

$755,000 [($740,000 + $770,000) ÷ 2] 68.9 days ($755,000 ÷ $10,963.0)

The decrease in inventory turnover from 5.3 to 4.8 and the increase in the days’ sales in inventory from 68.9 to 76.0 days indicate unfavorable changes in managing inventory.

CHAPTER 6

Inventories

EXERCISES Ex. 6–1 Switching to a perpetual inventory system will strengthen Triple Creek Hardware’s internal controls over inventory because the store managers will be able to keep track of how much of each item is on hand. This should minimize shortages of good-selling items and excess inventories of poor-selling items. On the other hand, switching to a perpetual inventory system will not eliminate the need to take a physical inventory count. A physical inventory must be taken to verify the accuracy of the inventory records in a perpetual inventory system. In addition, a physical inventory count is needed to detect shortages of inventory due to damage or theft.

Ex. 6–2 a.

Appropriate. The inventory tags will protect the inventory from customer theft.

b. Inappropriate. The control of using security measures to protect the inventory is violated if the stockroom is not locked. c.

Inappropriate. Good controls include a receiving report, prepared after all inventory items received have been counted and inspected. Inventory purchased should only be recorded and paid for after reconciling the receiving report, the initial purchase order, and the vendor’s invoice.

24 30

1 10 15

Balances

140

150

Quantity

4,760

4,500 30 90 35

110

29 30 30

Unit Cost

Quantity

Unit Cost

Total Cost

Cost of Goods Sold

Purchases

Inventories

7,810

870 2,700 1,050

3,190

Total Cost

25 25 140

140 30 30 150 60

Quantity

Unit Cost

6-6

Note to Instructors: Exercise 6–4 shows that the inventory is $5,485 under LIFO.

30 30 34

29 29 29 30 30

Inventory

Because the price rose from $29 for the November 1 inventory to $34 for the purchase on November 30, we would expect that under last-in, first-out the inventory would be lower.

Nov.

Date

DVD Players

Ex. 6–3

CHAPTER 6

750 750 4,760 5,510

4,060 870 870 4,500 1,800

Total Cost

Nov.

Date

4,760

110

6-7

30 29

7,835

900 145

3,600

3,190

Total Cost

25 140

140 30 30 150 30 30 25

Quantity

Unit Cost

29 34

29 29 29 30 29 30 29

Inventory

Balances

4,500

30 5

24 140

Quantity

Unit Cost

120

150

Quantity

Cost of Goods Sold Total Cost

Unit Cost

Inventories

Purchases

1 10 15

DVD Players

Ex. 6–4

CHAPTER 6

725 4,760 5,485

4,060 870 870 4,500 870 900 725

Total Cost

14 20

1 10

Balances

240

144

Quantity

23,040

12,960

200

144 96 166

90 88 88

Unit Cost

Quantity

Unit Cost

Total Cost

Cost of Goods Sold

Purchases

Inventories

55,216

19,200

12,960 8,448 14,608

Total Cost

48 48 240 48 40

310 310 144 214

Quantity

Unit Cost

6-8

Note to Instructors: Exercise 6–6 shows that the inventory is $8,448 under FIFO.

88 88 96 88 96

88 88 90 88

Inventory

Because the price rose from $88 for the December 1 inventory to $96 for the purchase on December 20, we would expect that under first-in, first-out the inventory would be higher.

Dec.

Date

Prepaid Cell Phones

Ex. 6–5

CHAPTER 6

4,224 4,224 23,040 4,224 3,840 8,064

27,280 27,280 12,960 18,832

Total Cost

Dec.

Date

23,040

6-9

48 152

90 96

88 90

4,320 14,592 54,832

6,160 8,640

21,120

Total Cost

48 48 240

310 310 144 70 144

Quantity

Unit Cost

90 90 96

88 88 90 88 90

Inventory

Balances

240

70 96

12,960

90 240

144

Unit Cost

Quantity

Cost of Goods Sold Total Cost

Unit Cost

Inventories

Purchases

1 10

Quantity

Prepaid Cell Phones

Ex. 6–6

CHAPTER 6

8,448 8,448

4,320 4,320 23,040

27,280 27,280 12,960 6,160 12,960

Total Cost

Inventories

56.50 60.00

8,000 4,000 Balances

240,000

452,000

Total Cost

8,000

7,000

54.00 56.00

4,500 2,000 Balances

Purchases Unit Quantity Cost

112,000

243,000

Total Cost

53.00

50.00

6-10

5,000

2,500

Inventory

Quantity Unit Cost 4,000 50.00 125,000 1,500 50.00 6,000 53.00 * 265,000 1,000 53.00 3,000 55.00** 390,000 3,000 55.00

Cost of Goods Sold Unit Total Quantity Cost Cost

* ($75,000 + $243,000) ÷ 6,000 units = $53 per unit ** ($53,000 + $112,000) ÷ 3,000 units = $55 per unit

Date Jan. 1 Apr. 19 June 30 Sept. 2 Nov. 15 Dec. 31

Ex. 6–9

55.20

50.00

Inventory

Quantity Unit Cost 9,000 50.00 350,000 2,000 50.00 10,000 55.20 * 441,600 2,000 55.20 6,000 58.40 ** 791,600 6,000 58.40

Cost of Goods Sold Unit Total Quantity Cost Cost

* ($100,000 + $452,000) ÷ 10,000 units = $55.20 per unit ** ($110,400 + $240,000) ÷ 6,000 units = $58.40 per unit

Date Jan. 1 Mar. 18 May 2 Aug. 9 Oct. 20 Dec. 31

Purchases Unit Quantity Cost

$1,247,400 ($162 × 7,700 units) $1,185,000 {[($150 × 3,800 units) + ($155 × 2,400 units) + ($162 × 1,500 units)] = $570,000 + $372,000 + $243,000}

Ex. 6–8

a. b.

Ex. 6–7

CHAPTER 6

Total Cost 200,000 75,000 318,000 53,000 165,000 165,000

Total Cost 450,000 100,000 552,000 110,400 350,400 350,400

15 31

Nov.

Dec.

Balances

2,000

4,500

Total Cost

56.00 112,000

54.00 243,000

Purchases Unit Quantity Cost

50.00 54.00

50.00

6-11

1,500 3,500

2,500

Inventory

Quantity Unit Cost 4,000 50.00 125,000 1,500 50.00 1,500 50.00 4,500 54.00 75,000 1,000 54.00 189,000 1,000 54.00 2,000 56.00 389,000

Cost of Goods Sold Unit Total Quantity Cost Cost

Inventories

Sept.

Date Jan. 1 Apr. 19 June 30

Ex. 6–10

CHAPTER 6

54,000 112,000 166,000

Total Cost 200,000 75,000 75,000 243,000 54,000

15 31

Nov.

Dec.

Total Cost

56.00 112,000

54.00 243,000

$15,000 (1,500 units at $10)

Balances

2,000

4,500

Purchases Unit Quantity Cost

4,500 500

2,500

54.00 50.00

50.00

Cost of goods available for sale: 5,500 units @ $4………………………………………………… $ 22,000 6,400 units @ $6………………………………………………… 38,400 6,000 units @ $8………………………………………………… 48,000 2,100 units @ $10………………………………………………… 21,000 20,000 units (at an average cost of $6.47)…………………… $129,400

6-12

Inventory

Quantity Unit Cost 4,000 50.00 125,000 1,500 50.00 1,500 50.00 4,500 54.00 243,000 1,000 50.00 25,000 1,000 50.00 2,000 56.00 393,000

Cost of Goods Sold Unit Total Quantity Cost Cost

Inventories

$9,705 (1,500 units at $6.47; $129,400 ÷ 20,000 units = $6.47)

b. $6,000 (1,500 units at $4)

Ex. 6–12

Sept.

Date Jan. 1 Apr. 19 June 30

Ex. 6–11

CHAPTER 6

50,000 112,000 162,000

Total Cost 200,000 75,000 75,000 243,000 50,000

CHAPTER 6

Inventories

Ex. 6–13 Ending Inventory

Inventory Method

a. b. c.

First-in, first-out Last-in, first-out Weighted average cost

$24,912 22,520 23,608

Cost of Goods Sold

$65,888 68,280 67,192

Cost of goods available for sale: 180 units at $108……………………………………………………...………… 224 units at $110………………………………………………...……………… 200 units at $116………………………………………………………..……… 196 units at $120………………………………………………….…………… 800 units (at an average cost of $113.50)………………………………… a.

$19,440 24,640 23,200 23,520 $90,800

First-in, first-out: Ending inventory: 196 units at $120…………………………………………………..…………… 12 units at $116………………………………………...……………………… 208 units……………………………………………………..……………………

$23,520 1,392 $24,912

Cost of goods sold: $90,800 – $24,912…………………………………….……………………………

$65,888

b. Last-in, first-out:

Ending inventory: 180 units at $108……………………………………………...………………… 28 units at $110………………………………………….…………………… 208 units…………………………………………………………...……………

$19,440 3,080 $22,520

Cost of goods sold: $90,800 – $22,520……………………………………………..……………………

$68,280

Weighted average cost: Ending inventory: 208 units at $113.50 ($90,800 ÷ 800 units)……………………………………

$23,608

Cost of goods sold: $90,800 – $23,608…………………………………...……………………………

$67,192

CHAPTER 6

Inventories

Ex. 6–14 a.

1. 2. 3. 4.

FIFO inventory FIFO cost of goods sold FIFO net income FIFO income taxes

> (greater than) < (less than) > (greater than) > (greater than)

LIFO inventory LIFO cost of goods sold LIFO net income LIFO income taxes

b. In periods of rising prices, the income shown on the company’s tax return would be lower if LIFO rather than FIFO were used; thus, there is a tax advantage of using LIFO. Note to Instructors: The federal tax laws require that if LIFO is used for tax purposes, LIFO must also be used for financial reporting purposes. This is known as the LIFO conformity rule. Thus, selecting LIFO for tax purposes means that the company’s reported income will also be lower than if FIFO had been used. Companies using LIFO believe the tax advantages from using LIFO outweigh any negative impact of reporting a lower income to shareholders. Ex. 6–15 a.

Market Value per Cost Product

Model A Model B Model C Model D Model E Total

Inventory Quantity

420 700 225 600 380

per Unit

Unit (Net Realizable Value)

$120 80 50 140 160

$105 102 48 125 172

Cost

Market

LCM

$ 50,400 56,000 11,250 84,000 60,800 $262,450

$ 44,100 71,400 10,800 75,000 65,360 $266,660

$ 44,100 56,000 10,800 75,000 60,800 $246,700

Cost

Market

LCM

$ 50,400 56,000 11,250 $117,650

$ 44,100 71,400 10,800 $126,300

$117,650

$ 84,000 60,800 $144,800 $262,450

$ 75,000 65,360 $140,360 $266,660

140,360 $258,010

Market Value per Cost Product

Class 1: Model A Model B Model C Subtotal Class 2: Model D Model E Subtotal Total

Inventory Quantity

420 700 225

600 380

per Unit

Unit (Net Realizable Value)

$120 80 50

$105 102 48

140 160

125 172

CHAPTER 6

Inventories

Ex. 6–15 (Concluded) c.

Product

Model A Model B Model C Model D Model E Total

Inventory Quantity

Cost per Unit

Market Value per Unit (Net Realizable Value)

420 700 225 600 380

$120 80 50 140 160

$105 102 48 125 172

Cost

Market

LCM

$ 50,400 56,000 11,250 84,000 60,800 $262,450

$ 44,100 71,400 10,800 75,000 65,360 $266,660

$262,450

Ex. 6–16 The inventory would appear in the “Current assets” section, as follows: Inventory—at lower of cost (FIFO) or market…………………………………

$246,700

Alternatively, the details of the method of determining cost and the method of valuation could be presented in a note. Ex. 6–17 a.

20Y8 Balance Sheet Inventory……………………………………………………………… Current assets………………………………………………………… Total assets…………………………………………………………… Stockholders’ equity…………………………………………………

$9,000 understated $9,000 understated $9,000 understated $9,000 understated

Inventory = $9,000 = $687,000 – $678,000

20Y8 Income Statement

Cost of goods sold…………………………………………………… Gross profit…………………………………………………………… Net income……………………………………………………………

$9,000 overstated $9,000 understated $9,000 understated

20Y9 Income Statement

$9,000 understated $9,000 overstated $9,000 overstated

d. The December 31, 20Y9, balance sheet would be correct, because the 20Y8 inventory error reverses itself in 20Y9.

CHAPTER 6

Inventories

Ex. 6–18 20Y1 Balance Sheet

a. Inventory………………………………………………………… Current assets…………………………………………………… Total assets……………………………………………………… Stockholders’ equity……………………………………………

$20,700 overstated $20,700 overstated $20,700 overstated $20,700 overstated

Inventory = $597,600 – $576,900 = $20,700

20Y1 Income Statement

Cost of goods sold……………………………………………… $20,700 understated Gross profit……………………………………………………… $20,700 overstated Net income……………………………………………………… $20,700 overstated 20Y2 Income Statement

Cost of goods sold……………………………………………… $20,700 overstated Gross profit……………………………………………………… $20,700 understated $20,700 understated Net income……………………………………………………… d. The December 31, 20Y2, balance sheet would be correct, since the 20Y1 inventory error reverses itself in 20Y2.

Ex. 6–19 When an error is discovered affecting the prior period, it should be corrected. In this case, the inventory account should be debited and the retained earnings account credited for $42,750. Failure to correct the error for 20Y4 and purposely misstating the inventory and the cost of goods sold in 20Y5 would cause the income statements for the two years to not be comparable. The balance sheet at the end of 20Y5 would be correct, however, because the 20Y4 inventory error reverses itself in 20Y5.

Appendix Ex. 6–20 $666,900 ($1,235,000 × 54%)

Appendix Ex. 6–21 $241,804 ($396,400 × 61%)

Appendix Ex. 6–22 $511,500 ($775,000 × 66%)

CHAPTER 6

Inventories

Appendix Ex. 6–23 Cost

Inventory, June 1 Purchases in June (net) Merchandise available for sale Ratio of cost to retail price:

$ 165,000 2,361,500 $2,526,500 $2,526,500 $4,075,000

Retail

275,000 3,800,000 $ 4,075,000

= 62%

Sales for June Inventory, June 30, at retail price Inventory, June 30, at estimated cost ($525,000 × 62%)

(3,550,000) $ 525,000 $

325,500

Appendix Ex. 6–24 a.

Inventory, January 1 Purchases (net), January 1–December 31 Merchandise available for sale Sales, January 1–December 31 Estimated gross profit ($4,440,000 × 35%) Estimated cost of goods sold Estimated inventory, December 31

350,000 2,950,000 $ 3,300,000 $4,440,000 1,554,000 $

(2,886,000) 414,000

b. The gross profit method is useful for estimating inventories for monthly or quarterly financial statements. It is also useful in estimating the cost of inventory destroyed by fire or other disasters. Appendix Ex. 6–25 Merchandise available for sale…………………………………… $ 6,125,000 Cost of goods sold [$9,250,000 × (100% – 36%)]……………… (5,920,000) Estimated ending inventory……………………………………… $ 205,000

Appendix Ex. 6–26 Merchandise available for sale…………………………………… Cost of goods sold [$1,450,000 × (100% – 42%)]……………… Estimated ending inventory………………………………………

$ 960,000 (841,000) $ 119,000

Mar.

Feb.

Jan.

Date

Prob. 6–1A

28 5

30 5 10

1 10

Quantity

88.40

82.00

75.00

70.00

884,000

2,050,000

2,962,500

1,470,000

6-18

19,000

25,000 5,000

10,500 4,500 10,000

9,000 1,250 5,750 3,500

82.00

75.00 82.00

70.00 75.00 75.00

60.00 70.00 70.00 70.00

Unit Cost

6,940,500

1,558,000

1,875,000 410,000

735,000 337,500 750,000

540,000 87,500 402,500 245,000

Total Cost

20,000 20,000 10,000 1,000 10,000

35,000 25,000 25,000 25,000

19,750 14,000 10,500 10,500 39,500

9,000 9,000 21,000

Quantity

Balances

10,000

25,000

39,500

21,000

Quantity

Cost of Goods Sold

Purchases Total Cost

Inventories

PROBLEMS

CHAPTER 6

82.00 82.00 88.40 82.00 88.40

75.00 75.00 75.00 82.00

70.00 70.00 70.00 70.00 75.00

60.00 60.00 70.00

Unit Cost

Inventory

1,640,000 1,640,000 884,000 82,000 884,000 966,000

2,625,000 1,875,000 1,875,000 2,050,000

1,382,500 980,000 735,000 735,000 2,962,500

540,000 540,000 1,470,000

Total Cost

CHAPTER 6

Inventories

Prob. 6–1A (Concluded) 2.

Accounts Receivable Sales

13,830,000

Cost of Goods Sold Inventory

6,940,500

13,830,000*

6,940,500

* $13,830,000 = $1,435,000 + $805,000 + $490,000 + $2,250,000 + $1,500,000 + $4,500,000 + $2,850,000

$6,889,500 ($13,830,000 – $6,940,500)

$966,000 ($82,000 + $884,000)

Because the price rose from $60 for the January 1 inventory to $88.40 for the purchase on March 25, we would expect that under the last-in, first-out method the inventory would be lower. Note to Instructors: Problem 6–2A shows that the inventory is $682,500 under LIFO.

CHAPTER 6

Inventories

Prob. 6–2A 1.

Purchases Date

Jan.

Feb.

Quantity

1 10 21,000

Unit

Total

Unit

Total

Cost

Quantity Cost

Cost

70.00 1,470,000

10,250

70.00

717,500

5,750

70.00

402,500

3,500

70.00

245,000

15,000

75.00

1,125,000

10,000

75.00

750,000

25,000 5,000

82.00 75.00

2,050,000 375,000

10,000 9,000

88.40 75.00

884,000 675,000

10 39,500

Mar.

Cost of Goods Sold

5 25,000

75.00 2,962,500

82.00 2,050,000

25 10,000

88.40

884,000

31 Balances

7,224,000

Inventory Unit

Total

Quantity

Cost

9,000 9,000 21,000 9,000 10,750 9,000 5,000 9,000 1,500 9,000 1,500 39,500 9,000 1,500 24,500 9,000 1,500 14,500 9,000 1,500 14,500 25,000 9,000 1,500 9,500 9,000 1,500 9,500 10,000 9,000 1,500 500

60.00 60.00 70.00 60.00 70.00 60.00 70.00 60.00 70.00 60.00 70.00 75.00 60.00 70.00 75.00 60.00 70.00 75.00 60.00 70.00 75.00 82.00 60.00 70.00 75.00 60.00 70.00 75.00 88.40 60.00 70.00 75.00

540,000 540,000 1,470,000 540,000 752,500 540,000 350,000 540,000 105,000 540,000 105,000 2,962,500 540,000 105,000 1,837,500 540,000 105,000 1,087,500 540,000 105,000 1,087,500 2,050,000 540,000 105,000 712,500 540,000 105,000 712,500 884,000 540,000 105,000 37,500 682,500

Inventories

$682,500

1 21,000 10 28 30 5 39,500 10 16 28 25,000 5 14 10,000 25 30 31 Balances

Quantity

2,050,000 884,000

88.40

2,962,500

1,470,000

Total Cost

82.00

75.00

70.00

Unit Cost

Purchases

19,000

30,000

15,000 10,000

10,250 5,750 3,500

81.24

77.66

73.32 73.32

67.00 67.00 67.00

Quantity Unit Cost

9,000 30,000 19,750 14,000 10,500 50,000 35,000 25,000 50,000 20,000 30,000 11,000

Quantity

6-21

60.00 67.00 67.00 67.00 67.00 73.32 73.32 73.32 77.66 77.66 81.24 81.24

$893,640 (11,000 × $81.24)

Inventory Unit Cost

Total Sales = $1,435,000 + $805,000 + $490,000 + $2,250,000 + $1,500,000 + $4,500,000 + $2,850,000 = $13,830,000

$13,830,000 7,012,860 $ 6,817,140

1,543,560 7,012,860

2,329,800

1,099,800 733,200

686,750 385,250 234,500

Total Cost

Cost of Goods Sold

= [(9,000 units × $60) + (1,500 units × $70) + (500 units × $75)] = $540,000 + $105,000 + $37,500

Total sales…………………………………………………………………… Total cost of goods sold…………………………………………………… Gross profit…………………………………………………………………

Mar.

Feb.

Jan.

Date

Prob. 6–3A

$13,830,000 (7,224,000) $ 6,606,000

Total Sales = $1,435,000 + $805,000 + $490,000 + $2,250,000 + $1,500,000 + $4,500,000 + $2,850,000 = $13,830,000

Prob. 6–2A (Concluded) 2. Total sales…………………………………………………………………… Total cost of goods sold…………………………………………………… Gross profit…………………………………………………………………

CHAPTER 6

540,000 2,010,000 1,323,250 938,000 703,500 3,666,000 2,566,200 1,833,000 3,883,000 1,553,200 2,437,200 893,640 893,640

Total Cost

CHAPTER 6

Inventories

Prob. 6–4A 1.

First-In, First-Out Method Inventory, March 31……………………………………………………… Cost of goods sold………………………………………………………

$ 966,000 6,940,500

Supporting computations: Inventory: Units in beginning inventory and purchased……………………… Units sold………………………………………………………………… Units in ending inventory………………………………………………

104,500 (93,500) 11,000

10,000 units @ $88.40………………………………………………… 1,000 units @ $82.00…………………………………………………

$884,000 82,000

11,000 units……………………………………………………………

$966,000

Cost of goods sold: Beginning inventory, January 1……………………………………… Purchases………………………………………………………………… Goods available for sale………………………………………………… Ending inventory, March 31…………………………………………… Cost of goods sold………………………………………………………

$ 540,000 7,366,500* $7,906,500 (966,000) $6,940,500

* $1,470,000 + $2,962,500 + $2,050,000 + $884,000

Last-In, First-Out Method Inventory, March 31……………………………………………………… Cost of goods sold………………………………………………………

$ 680,000 7,226,500

Supporting computations: Inventory: 9,000 units @ $60.00………………………………………………… 2,000 units @ $70.00………………………………………………… 11,000 units……………………………………………………………

$540,000 140,000 $680,000

$ 540,000 7,366,500 $7,906,500 (680,000) $7,226,500

CHAPTER 6

Inventories

Prob. 6–4A (Concluded) 3. Weighted Average Cost Method Inventory, March 31……………………………………………………… Cost of goods sold…………………………………………………………

$ 832,260 7,074,240

Supporting computations: Weighted Average Unit Cost

Total Cost of Goods Available for Sale Units Available for Sale

= =

$7,906,500 = $75.66 per unit (rounded) 104,500 units

Inventory: 11,000 units × $75.66 = $832,260 Cost of goods sold: Beginning inventory, January 1…………………………………...…… Purchases…………………………………………………………………. Goods available for sale………………………………………………… Ending inventory, March 31……………………………………………… Cost of goods sold…………………………………………….………… 4.

$ 540,000 7,366,500 $7,906,500 (832,260) $7,074,240

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

FIFO $13,830,000 * (6,940,500) $ 6,889,500

LIFO $13,830,000 (7,226,500) $ 6,603,500

Weighted Average $13,830,000 (7,074,240) $ 6,755,760

Inventory, March 31

966,000

680,000

832,260

* $1,435,000 + $805,000 + $490,000 + $2,250,000 + $1,500,000 + $4,500,000 + $2,850,000

CHAPTER 6

Inventories

Prob. 6–5A 1.

First-In, First-Out Method Model

A10 B15 E60 G83 J34 M90 Q70

Quantity

Unit Cost

4 2 6 2 5 9 15 3 2 7 1

$ 76 70 184 170 70 259 270 130 128 180 175

Quantity

Unit Cost

Total Cost

4 2 8 3 2 7 2 12 3 2 2 1 5 3

$ 64 70 176 75 65 242 250 240 246 108 110 128 160 170

$ 256 140 1,408 225 130 1,694 500 2,880 738 216 220 128 800 510 $9,845

Total 2.

Total Cost

304 140 1,104 340 350 2,331 4,050 390 256 1,260 175 $10,700

Last-In, First-Out Method Model

A10 B15 E60 G83 J34 M90

Q70 Total

CHAPTER 6

Inventories

Prob. 6–5A (Concluded) 3.

Weighted Average Cost Method Model

A10 B15 E60 G83 J34 M90 Q70 Total

Quantity

Unit Cost

6 8 5 9 15 5 8

$ 70 174 69 253 258 121 172

Total Cost

420 1,392 345 2,277 3,870 605 1,376 $10,285

Computations of unit costs: A10: $70 = [(4 × $64) + (4 × $70) + (4 × $76)] ÷ (4 + 4 + 4) B15: $174 = [(8 × $176) + (4 × $158) + (3 × $170) + (6 × $184)] ÷ (8 + 4 + 3 + 6) E60: $69 = [(3 × $75) + (3 × $65) + (15 × $68) + (9 × $70)] ÷ (3 + 3 + 15 + 9) G83: $253 = [(7 × $242) + (6 × $250) + (5 × $260) + (10 × $259)] ÷ (7 + 6 + 5 + 10) J34: $258 = [(12 × $240) + (10 × $246) + (16 × $267) + (16 × $270)] ÷ (12 + 10 + 16 + 16) M90: $121 = [(2 × $108) + (2 × $110) + (3 × $128) + (3 × $130)] ÷ (2 + 2 + 3 + 3) Q70: $172 = [(5 × $160) + (4 × $170) + (4 × $175) + (7 × $180)] ÷ (5 + 4 + 4 + 7)

During periods of rising prices, the LIFO method will result in a lower cost of inventory, a greater amount of cost of goods sold, and a lesser amount of net income than the other two methods. For Dymac Appliances, the LIFO method would be preferred for the current year because it would result in a lesser amount of income tax.

b. During periods of declining prices, the FIFO method will result in a lesser amount of net income and would be preferred for income tax purposes.

CHAPTER 6

Inventories

Prob. 6–6A Inventory Sheet December 31 Market Cost per Unit

Value per Unit (Net Realizable Value)

30 8

$ 60 59

$ 57 57

20 13

178 128 129

180 126 126

Description

Inventory Quantity

B12

E41 G19

18 33

L88

N94 P24

400 90

R66

10 8

80 10 5 3

563 560 8 22 21 248 260

550 550 7 18 18 250 250

T33

140

100 40

21 19

20 20

Z16

10 5

750 745

752 752

Total

Cost

Total Market

$ 1,800 472 2,272 3,204 2,560 1,677 4,237 5,630 4,480 10,110 3,200 1,760 210 1,970 1,240 780 2,020 2,100 760 2,860 7,500 3,725 11,225 $41,098

$ 1,710 456 2,166 3,240 2,520 1,638 4,158 5,500 4,400 9,900 2,800 1,440 180 1,620 1,250 750 2,000 2,000 800 2,800 7,520 3,760 11,280 $39,964

LCM

$ 2,166 3,204

4,158

9,900 2,800

1,620

2,000

2,800

11,225 $39,873

CHAPTER 6

Inventories

Appendix Prob. 6–7A 1. Celebrity Tan Co. Cost

Inventory, August 1 Net purchases Merchandise available for sale Ratio of cost to retail price:

$ 300,000 2,021,900 $2,321,900 $2,321,900 $3,745,000

Retail

575,000 3,170,000 $ 3,745,000

= 62%

Sales Inventory, August 31, at retail ($575,000 + $3,170,000 – $3,250,000) Inventory, at estimated cost ($495,000 × 62%)

$(3,250,000) $

495,000

306,900

2. Ranchworks Co. Cost

Inventory, March 1 Net purchases Merchandise available for sale Sales Estimated gross profit ($15,800,000 × 38%) Estimated cost of goods sold Estimated inventory, November 30 Estimated inventory, November 30 Physical inventory count, November 30 Estimated loss due to theft or damage, March 1–November 30

880,000 9,500,000 $10,380,000 $15,800,000 (6,004,000) $

(9,796,000) 584,000

584,000 (369,750)

214,250

June

May

Apr.

Date

Prob. 6–1B

16 21

19 28

30 8

3 8

1,264

1,260

1,240

44,240

100,800

75,600

93,000

6-28

35 9

20 20 25

30 20 20

25 15 30

1,260 1,264

1,260 1,260 1,260

1,240 1,260 1,260

1,200 1,240 1,240

Unit Cost

Quantity

Unit Cost

Total Cost

Cost of Goods Sold

Purchases

Inventories

44,100 11,376 310,776

25,200 25,200 31,500

37,200 25,200 25,200

30,000 18,600 37,200

Total Cost

60 35 35 35

40 20 20 80

60 30 30 60

25 25 75

Quantity

Balances

Quantity

CHAPTER 6

1,264

1,260 1,260 1,260 1,264

1,260 1,260 1,260 1,260

1,240 1,240 1,240 1,260

1,200 1,200 1,240

Unit Cost

Inventory

32,864 32,864

75,600 44,100 44,100 44,240

50,400 25,200 25,200 100,800

74,400 37,200 37,200 75,600

30,000 30,000 93,000

Total Cost

CHAPTER 6

Inventories

Prob. 6–1B (Concluded) 2.

Accounts Receivable Sales

525,250

Cost of Goods Sold Inventory

310,776

525,250

310,776

Sales = $80,000 + $60,000 + $100,000 + $40,000 + $90,000 + $56,250 + $99,000 = $525,250

$214,474 ($525,250 – $310,776)

$32,864 (26 units × $1,264)

Because the price rose from $1,200 for the April 3 inventory to $1,264 for the purchase on June 21, we would expect that under last-in, first-out the inventory would be lower. Note to Instructors: Problem 6–2B shows that ending inventory is $31,560 under LIFO.

June

May

Apr.

Date

Prob. 6–2B

1,264

44,240

6-30

35 9

1,264 1,260

1,260

1,260 1,240 1,200

1,260

1,240

44,240 11,340 312,080

31,500

50,400

12,600 6,200 6,000

63,000

37,200

49,600

Total Cost

20 20 80 20 40 20 15 20 15 35 20 6

25 25 75 25 35 25 5 25 5 60 25 5 10

Quantity

Balances

100,800

1,260 40

10 5 5

75,600

1,260

93,000

1,240 40

Unit Cost

Quantity

Unit Cost

Total Cost

Cost of Goods Sold

Inventories

Purchases

3 8

Quantity

CHAPTER 6

1,200 1,200 1,260 1,200 1,260 1,200 1,260 1,200 1,260 1,264 1,200 1,260

1,200 1,200 1,240 1,200 1,240 1,200 1,240 1,200 1,240 1,260 1,200 1,240 1,260

Unit Cost

Inventory

24,000 24,000 100,800 24,000 50,400 24,000 18,900 24,000 18,900 44,240 24,000 7,560 31,560

30,000 30,000 93,000 30,000 43,400 30,000 6,200 30,000 6,200 75,600 30,000 6,200 12,600

Total Cost

Inventories

3 75 8 11 30 60 8 10 19 28 80 5 16 21 35 28 30 Balances 44,240

100,800

1,260

1,264

75,600

93,000

1,260

1,240

Total Cost

40 25

50 20

40 30

1,261

1,258 1,258

1,250 1,250

1,230 1,230

55,484 310,854

50,320 31,450

62,500 25,000

49,200 36,900

Cost of Goods Sold Total Quantity Unit Cost Cost

6-31

Total Cost

1,200 30,000 1,230 123,000 1,230 73,800 1,230 36,900 1,250 112,500 1,250 50,000 1,250 25,000 1,258 125,800 1,258 75,480 1,258 44,030 1,261 88,270 1,261 32,786 32,786

Unit Cost

Inventory

$32,786 (26 units × $1,261)

25 100 60 30 90 40 20 100 60 35 70 26

Quantity

Total Sales = $80,000 + $60,000 + $100,000 + $40,000 + $90,000 + $56,250 + $99,000 = $525,250

Total sales……………………………………………………………… $ 525,250 (310,854) Total cost of goods sold…………………………………………… Gross profit…………………………………………………………… $ 214,396

June

May

Apr.

Date

Purchases Unit Quantity Cost

$31,560 = [(20 units × $1,200) + (6 units × $1,260)] = $24,000 + $7,560

Total Sales = $80,000 + $60,000 + $100,000 + $40,000 + $90,000 + $56,250 + $99,000 = $525,250

Total sales……………………………………………………………… $ 525,250 (312,080) Total cost of goods sold…………………………………………… Gross profit…………………………………………………………… $ 213,170

Prob. 6–3B

Prob. 6–2B (Concluded)

CHAPTER 6

Inventories

Prob. 6–4B 1.

First-In, First-Out Method Inventory, June 30……………………………………….………………… Cost of goods sold………………………………………..…………………

$ 32,864 310,776

Supporting computations: Inventory: 26 units @ $1,264……………………………………………...……………

$ 32,864

Units in beginning inventory and purchased…………………………… Units sold……………………………………………………………………. Units in ending inventory…………………………………………………

275 (249) 26

Cost of goods sold:

Beginning inventory, April 1………………………………………….…… Purchases ($93,000 + $75,600 + $100,800 + $44,240)………………… Goods available for sale………………………………………………..… Ending inventory, June 30………………………………………...……… Cost of goods sold…………………………………………………..………

$ 30,000 313,640 $343,640 (32,864) $310,776

Last-In, First-Out Method Inventory, June 30……………………………………………………...…… Cost of goods sold…………………………………….……………………

$ 31,240 312,400

Supporting computations: Inventory: 25 units @ $1,200……………………………………………………… 1 unit @ $1,240………………………………………………………… 26 units……………………………………………………………………

$30,000 1,240 $31,240

Cost of goods sold: Beginning inventory, April 1……………………………………………… Purchases…………………………………………………………………...… Goods available for sale…………………………..……………………… Ending inventory, June 30……………………………………….………… Cost of goods sold…………………………………………………….……

$ 30,000 313,640 $343,640 (31,240) $312,400

CHAPTER 6

Inventories

Prob. 6–4B (Concluded) 3. Weighted Average Cost Method Inventory, June 30……………………………………………………… Cost of goods sold……………………………………………………

$ 32,500 311,140

Supporting computations: Weighted Average Unit Cost = =

Total Cost of Goods Available for Sale Units Available for Sale $343,640 275 units

= $1,250 per unit (rounded)

Inventory: 26 units × $1,250 = $32,500 Cost of goods sold: Beginning inventory, April 1………………………………………... Purchases……………………………………………………………… Goods available for sale……………………………………….……… Ending inventory, June 30…………………………………………… Cost of goods sold…………………………………………………… 4.

$ 30,000 313,640 $343,640 (32,500) $311,140

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

FIFO $ 525,250 (310,776) $ 214,474

LIFO $ 525,250 (312,400) $ 212,850

Weighted Average $ 525,250 (311,140) $ 214,110

Inventory, June 30

$ 32,864

$ 31,240

$ 32,500

* ($80,000 + $60,000 + $100,000 + $40,000 + $90,000 + $56,250 + $99,000)

CHAPTER 6

Inventories

Prob. 6–5B 1.

First-In, First-Out Method Model

C55 D11 F32 H29 K47 S33 X74 Total 2.

Quantity

Unit Cost

Total Cost

3 1 6 5 1 1 4 6 2 2 7

$1,070 1,060 675 666 280 260 317 542 549 232 39

$ 3,210 1,060 4,050 3,330 280 260 1,268 3,252 1,098 464 273 $18,545

Quantity

Unit Cost

Total Cost

3 1 9 2 2 4 6 2 2 4 3

$1,040 1,054 639 645 240 305 520 531 222 35 36

$ 3,120 1,054 5,751 1,290 480 1,220 3,120 1,062 444 140 108 $17,789

Last-In, First-Out Method Model

C55 D11 F32 H29 K47 S33 X74 Total

CHAPTER 6

Inventories

Prob. 6–5B (Concluded) 3.

Weighted Average Cost Method Model

C55 D11 F32 H29 K47 S33 X74 Total

Quantity

Unit Cost

Total Cost

4 11 2 4 8 2 7

$1,056 654 252 311 534 227 37

$ 4,224 7,194 504 1,244 4,272 454 259 $18,151

Computations of unit costs: C55: $1,056 = [(3 × $1,040) + (3 × $1,054) + (3 × $1,060) + (3 × $1,070)] ÷ (3 + 3 + 3 + 3) D11: $654 = [(9 × $639) + (7 × $645) + (6 × $666) + (6 × $675)] ÷ (9 + 7 + 6 + 6) F32: $252 = [(5 × $240) + (3 × $260) + (1 × $260) + (1 × $280)] ÷ (5 + 3 + 1 + 1) H29: $311 = [(6 × $305) + (3 × $310) + (3 × $316) + (4 × $317)] ÷ (6 + 3 + 3 + 4) K47: $534 = [(6 × $520) + (8 × $531) + (4 × $549) + (6 × $542)] ÷ (6 + 8 + 4 + 6) S33: $227 = [(4 × $222) + (4 × $232)] ÷ (4 + 4) X74: $37 = [(4 × $35) + (6 × $36) + (8 × $37) + (7 × $39)] ÷ (4 + 6 + 8 + 7)

During periods of rising prices, the LIFO method will result in a lower cost of inventory, a greater amount of cost of goods sold, and a lesser amount of net income than the other two methods. For Pappa’s Appliances, the LIFO method would be preferred for the current year because it would result in a lesser amount of income tax.

b. During periods of declining prices, the FIFO method will result in a lesser amount of net income and would be preferred for income tax purposes.

CHAPTER 6

Inventories

Prob. 6–6B Inventory Sheet December 31 Market Value per Cost per Unit

Unit (Net Realizable Value)

30 7

$ 60 58

$ 56 56

20 10

174 130 128

178 132 132

Description

Inventory Quantity

A54

C77 F66

24 30

H83

K12 Q58

375 90

S36

6 15

75 15 5 3

547 540 6 25 26 256 260

545 545 5 18 18 235 235

V97

140

100 40

17 16

20 20

Y88

10 7

750 740

744 744

Total

Cost

Total Market

$ 1,800 406 2,206 4,176 2,600 1,280 3,880 3,282 8,100 11,382 2,250 1,875 390 2,265 1,280 780 2,060 1,700 640 2,340 7,500 5,180 12,680 $43,239

$ 1,680 392 2,072 4,272 2,640 1,320 3,960 3,270 8,175 11,445 1,875 1,350 270 1,620 1,175 705 1,880 2,000 800 2,800 7,440 5,208 12,648 $42,572

LCM

$ 2,072 4,176

3,880

11,382 1,875

1,620

1,880

2,340

12,648 $41,873

CHAPTER 6

Inventories

Appendix Prob. 6–7B 1. Jaffe Co. Cost

Inventory, February 1 Net purchases Merchandise available for sale Ratio of cost to retail price:

$ 400,000 4,055,000 $4,455,000 $4,455,000 $5,940,000

Retail

615,000 5,325,000 $ 5,940,000

= 75%

Sales Inventory, February 28, at retail ($615,000 + $5,325,000 – $5,100,000) Inventory, at estimated cost ($840,000 × 75%)

$(5,100,000) $

840,000

630,000

2. Coronado Co. Cost

Inventory, May 1 Net purchases Merchandise available for sale Sales Estimated gross profit ($4,750,000 × 35%) Estimated cost of goods sold Estimated inventory, October 31 Estimated inventory, October 31 Physical inventory count, October 31 Estimated loss due to theft or damage, May 1–October 31

400,000 3,150,000 $ 3,550,000 $ 4,750,000 (1,662,500) (3,087,500) $ 462,500 $

462,500 (366,500)

96,000

CHAPTER 6

Inventories

MAKE A DECISION MAD 6–1 a. Inventory Turnover Amazon.com: Target:

Cost of Goods Sold Average Inventory

$139,156 = ($16,047 + $17,147) ÷ 2

$53,299 ($8,597 + $9,497) ÷ 2

b. Days’ Sales in Inventory Amazon.com: Target:

$139,156 $16,597

$53,299 $9,047 =

= 8.4

= 5.9 Average Inventory Average Daily Cost of Goods Sold

($16,047 + $17,147) ÷ 2 $16,597 = = 43.5 days $139,156 ÷ 365 days $381.2 per day

($8,597 + $9,497) ÷ 2 $53,299 ÷ 365 days

$9,047 = $146.0 per day

62.0 days

c. Amazon appears to more efficiently manage its inventories compared to Target. Amazon has an inventory turnover of 8.4 and days’ sales in inventory of 43.5 days. This compares to Target’s inventory turnover of 5.9 and days’ sales in inventory of 62.0 days. d. The difference in inventory efficiency is likely due to the difference in the companies’ merchandising strategies. Amazon sells all of its products over the Internet. Some of its products are shipped from a warehouse system, which holds inventory. However, some products are shipped to customers directly from the manufacturer, thus bypassing Amazon’s warehouse. Direct-shipped merchandise is not handled as Amazon’s inventory. Target, in contrast, sells a majority of its merchandise off the shelves of its brick-and-mortar stores. Target’s strategy requires a significant investment in inventory as can be seen by its inventory turnover and days’ sales in inventory ratios.

CHAPTER 6

Inventories

MAD 6–2 a. Inventory Turnover Darden Restaurants: Chipotle:

$2,412.5 ($205.3 + $207.3) ÷ 2

$1,601.0 ($19.9 + $21.6) ÷ 2

b. Days’ Sales in Inventory Darden Restaurants: Chipotle:

Cost of Goods Sold Average Inventory

$1,601.0 $20.8

$2,412.5 $206.3

= 11.7

= 77.0

Average Inventory Average Daily Cost of Goods Sold

($205.3 + $207.3) ÷ 2 $2,412.5 ÷ 365 days

($19.9 + $21.6) ÷ 2 $1,601.0 ÷ 365 days

$206.3 $6.6 per day

= 31.3 days

$20.8 = 4.7 days $4.4 per day

c. Chipotle appears to manage its food, beverage, and packaging inventories more efficiently. Chipotle has an inventory turnover of 77.0 and days’ sales in inventory of 4.7 days. This compares to Darden’s inventory turnover of 11.7 and days’ sales in inventory of 31.3 days. d. One major explanation for the difference in inventory management efficiency may relate to the types of food the restaurants serve. Darden’s restaurants offer food that can be stored, refrigerated, or frozen. Thus, Darden’s food turnover can be slower. However, Chipotle offers food products that are sold fresh. Thus, Chipotle must manage its inventory more carefully.

CHAPTER 6

Inventories

MAD 6–3 a.

(In millions) Cost of goods sold Inventories: Beginning of year End of year Average inventory: ($11,040 + $11,395) ÷ 2 ($43,783 + $44,269) ÷ 2 ($2,027 + $1,978) ÷ 2 Inventory turnover: ($132,886 ÷ $11,217.5) ($385,301 ÷ $44,026.0) ($10,155 ÷ $2,002.5) (In millions) Cost of goods sold Average daily cost of goods sold: $132,886 ÷ 365 days $385,301 ÷ 365 days $10,155 ÷ 365 days Average inventory: ($11,040 + $11,395) ÷ 2 ($43,783 + $44,269) ÷ 2 ($2,027 + $1,978) ÷ 2 Days’ sales in inventory: $11,217.5 ÷ $364.1 per day $44,026.9 ÷ $1,055.6 per day $2,002.5 ÷ $27.8 per day

Costco $132,886

Walmart $385,301

Nordstrom $10,155

$11,040 11,395

$43,783 44,269

$2,027 1,978

$11,217.5 $44,026.0 $2,002.5 11.8 8.8 5.1 Costco $132,886

Walmart $385,301

Nordstrom $10,155

$364.1/day $1,055.6/day $27.8/day $11,217.5 $44,026.0 $2,002.5 30.8 days 41.7 days 72.0 days

Both the inventory turnover ratio and the days’ sales in inventory reflect the merchandising approaches of the three companies. Costco is a club warehouse. Its approach is to hold only mass appeal items that are sold quickly off the shelf. Most items are sold in bulk quantities at very attractive prices. Costco couples thin margins with very fast inventory turnover. Walmart has a traditional discounter approach. It has attractive pricing, but the inventory moves slower than would be the case at a club warehouse. For example, many purchases made at Walmart would not be packaged in the same bulk as would be the case at Costco.

CHAPTER 6

Inventories

MAD 6–3 (Concluded) Nordstrom is a high-end fashion retailer. It provides a wide assortment of specialty and unique goods that are designed for the fashion market rather than the mass market. As such, its inventory moves slower in comparison to the other two retailers (but at the highest margin).

MAD 6–4 a. (In millions) Cost of goods sold Inventories: Beginning of year End of year Average inventory: ($256 + $278) ÷ 2 ($1,379 + $1,520) ÷ 2 Inventory turnover: ($1,512 ÷ $267.0) ($973 ÷ $1,449.5)

BrownForman $973

$256 278

$1,379 1,520

$267.0 $1,449.5 5.7 0.7

Monster Beverage $1,512

(In millions) Cost of goods sold Average daily cost of goods sold: $1,512 ÷ 365 days $973 ÷ 365 days Average inventory: ($256 + $278) ÷ 2 ($1,379 + $1,520) ÷ 2 Days’ sales in inventory: $267.0 ÷ $4.1 per day $1,449.5 ÷ $2.7 per day c.

Monster Beverage $1,512

BrownForman $973

$4.1/day $2.7/day $267.0 $1,449.5 65.1 days 536.9 days

Both companies produce beverage products. However, Monster Beverage produces and sells energy drinks that do not require an aging process. Thus, the inventory turnover is over eight times faster than that of Brown-Forman. Brown-Forman’s products require a process that involves aging the beverage in barrels for a period of time. This additional time adds a significant number of days to the inventory cycle. Thus, Brown-Forman has a much lower inventory turnover ratio and a much longer days’ sales in inventory than does Monster Beverage.

CHAPTER 6

Inventories

TAKE IT FURTHER TIF 6–1 1.

In the short run, Sizemo Electroniks may benefit slightly from the inflated inventory values and higher earnings. However, at some point in the future, the inventory will either be sold at a significantly reduced price or a lower-of-cost-or-market adjustment will be made. Tina benefits from avoiding a possible altercation with the CEO, board members, and stockholders who might be unsettled by a decline in earnings. However, these benefits are only temporary, as the loss will ultimately be recorded in later periods.

The users of Sizemo’s financial statements are harmed by this decision, as it does not result in financial statements that fairly present the company’s financial results. Investors may use the information to make investment decisions. Creditors may use the information as a basis for loans to the company. Both investors and creditors may rely on the inflated values of the 537X semiconductors to predict future earnings, which could expose them to future financial losses.

No. Tina is acting unethically by instructing Jay to intentionally ignore a lowerof-cost-or-market adjustment. As Jay’s supervisor, Tina has a responsibility to ensure her employees behave ethically and apply GAAP correctly. Jay is behaving unethically by knowingly applying GAAP incorrectly. He should have reported the incident to Tina’s supervisor.

TIF 6–2 Because the title to merchandise shipped FOB shipping point passes to the buyer when the merchandise is shipped, the shipments made before midnight, October 31, should be recorded properly as sales for the fiscal year ending October 31. Hence, Ryan Frazier is behaving in a professional manner. However, Ryan should realize that recording these sales in the current year precludes them from being recognized as sales in the next year. Thus, accelerating the shipment of orders to increase sales of one period will have the effect of decreasing sales of the next period.

CHAPTER 6

Inventories

TIF 6–3 A sample solution based on Best Buy’s Form 10-K for the fiscal year ended February 2, 2019, follows: 1. a. Inventory costs primarily consist of product cost from the company’s suppliers as well as inbound freight and certain vendor allowances that are not a reimbursement of costs to promote a vendor’s product. b. Inventories are stated at lower of cost or net realizable value and valued using the average cost method. c. $5,409 million (from balance sheet) d. 61.0% ($5,409 million ÷ $8,870 million) in 2019; 53.0% ($5,209 million ÷ $9,829 million) in 2018. Inventory as a percentage of total current assets has increased between the two years. e. $32,918 million 2.

The company’s inventory turnover has decreased slightly between 2018 and 2019. (amounts in millions) 2019 2018 Cost of goods sold……………………………………… $32,918 $32,275 Beginning inventory…………………………………… 5,209 4,864 Ending inventory………………………………………… 5,409 5,209 Average inventory…………………………………… 5,309 5,037 Inventory turnover……………………………………… 6.2 6.4 Best Buy’s inventory management efficiency has remained relatively stable.

CHAPTER 6

Inventories

TIF 6–4 Memo To: From: Re:

Ms. Connie Kilmer President, Golden Eagle Company A+ Student Comparison of LIFO and FIFO inventory methods

LIFO and FIFO are alternative methods of applying unit cost to the units that are sold during the year and those units that remain in ending inventory at the end of the year. The LIFO method is often viewed as the best basis for reflecting income from operations. This is because the LIFO method matches the most current cost of merchandise purchases against current sales. The matching of current costs with current sales results in a gross profit amount that best reflects the results of current operations. For Golden Eagle Company, the gross profit of $3,025,600 reflects the matching of the most current costs of the product of $6,974,400 against the current period sales of $10,000,000. This matching of current costs with current sales also tends to minimize the effects of price trends on the results of operations. During periods of rising prices, such as for Golden Eagle Company, the LIFO method will also result in a lesser amount of net income than FIFO. Because taxes are levied as a percentage of net income, Golden Eagle Company would pay a lower income tax under the LIFO method. While the LIFO method is often viewed as the best method for matching revenues and expenses, the FIFO method is often consistent with the physical movement of merchandise in a business, since most businesses tend to dispose of commodities in the order of their acquisition. To the extent that this is the case, the FIFO method approximates the results that will be attained by a specific identification of costs. The FIFO method also provides the best reflection of the replacement cost of the ending inventory for the balance sheet. This is because the amount reported on the balance sheet for inventory will be assigned costs from the most recent purchases. These costs reflect purchases made near the end of the period. For Golden Eagle Company, the ending inventory on December 31 is assigned costs totaling $1,436,400 under the FIFO method. These costs represent purchases made during the period of August through December. This FIFO inventory amount of $1,436,400 more closely approximates the replacement cost of the ending inventory than the $1,173,600 LIFO amount.

CHAPTER 6

Inventories

TIF 6–4 (Concluded) Supporting computations: The cost of ending inventory under the last-in, first-out and first-in, first-out methods is as follows: Last-in, first-out method: 31,000 units at $36.60………………………………………………… 1,000 units at $39.00…………………………………………………

$1,134,600 39,000

32,000 units……………………………………………………………

$1,173,600

First-in, first-out method: 8,000 units at $48.00………………………………………………… 8,000 units at $44.85………………………………………………… 12,800 units at $43.50………………………………………………… 3,200 units at $42.75…………………………………………………

$ 384,000 358,800 556,800 136,800

32,000 units……………………………………………………………

$1,436,400

The cost of goods sold and gross profit under each method are as follows: LIFO

FIFO

$10,000,000 6,974,400 $ 3,025,600

$10,000,000 6,711,600 $ 3,288,400

Ending inventory………………………………………………..……

$8,148,000 1,173,600

$8,148,000 1,436,400

Cost of goods sold…………………………………………….……

$6,974,400

$6,711,600

Sales…………………………………………………………. Cost of goods sold (see below)………………………… Gross profit………………………………………………… Cost of goods sold calculation: Cost of goods available for sale…………………………………

CHAPTER 6

Inventories

TIF 6–5 1.

a. Status

Out of Stock

Row Labels Fuel Injector Oil Pump Axle Shaft Seal Automotive V-Ribbed Belt Fog Bulb Head Gasket Manifold Pressure Sensor Axle Housing Gasket Valve Lifter Transfer Case Housing Crankshaft Position Sensor Oil Pan Water Pump 10.50 Ring Gear Saginaw-American Axle Automatic Dual Clutch Transmission Power Steering Pump Radiator Fuel Pump Camshaft Position Sensor Grille Spark Plug Crankshaft Seal, Front Front Drive Shaft 315 High MHZ Door Lock Frequency Total

Sum of Quantity Ordered 64 37 21 21 19 16 15 13 13 12 11 9 9 8 8 7 6 6 5 5 5 5 3 1 319

CHAPTER 6

Inventories

TIF 6–5 (Concluded) b.

Status Row Labels Monday Tuesday Thursday Friday Grand Total

Out of Stock Sum of Quantity Ordered 20 50 85 164 319

Status Sum of Quantity Ordered

Total 200 150 100

Total

50 0 Monday

Tuesday

Thursday

Friday

Day of Week

The sales manager could use this information to better accomplish the stated goal o providing customers with ordered parts no later than 48 hours from when an order received. For example, the manager could identify the items with the most frequent stock-outs and increase the number of these items held in inventory to reduce futur stock-outs. Also, when the most stock-outs occur (Friday), the manager could bette coordinate with the company’s suppliers to restock high-demand items during the week in order to avoid the stock-outs on Thursday and Friday.

CHAPTER 7 INTERNAL CONTROL AND CASH DISCUSSION QUESTIONS 1.

The five elements of internal control are the control environment, risk assessment, control procedures, monitoring, and information and communication. The control environment is the overall attitude of management and employees about the importance of controls. Risk assessment includes evaluating various risks facing the business, including competitive threats, regulatory changes, and changes in economic factors. Control procedures are established to provide reasonable assurance that business goals will be achieved. Monitoring is the evaluation of the internal control system. Information and communication provide management with feedback about internal control.

No. One element of internal control is not more important than another element. All five elements are necessary for effective internal control.

To reduce the possibility of errors and embezzlement, the functions of operations and accounting should be separated. Thus, one employee should not be responsible for handling cash receipts (operations) and maintaining the accounts receivable records (accounting).

The control procedure requiring that responsibility for a sequence of related operations be divided among different persons is violated in this situation. This weakness in the internal control may permit irregularities. For example, the ticket seller, while acting as ticket taker, could admit friends without a ticket.

The responsibility for maintaining the accounting records should be separated from the responsibility for operations so that the accounting records can serve as an independent check on operations.

Controls that could have prevented or detected the fraud include: (1) requiring supporting documentation such as receiving reports and purchase orders of all payments, (2) requiring approval by an independent party, and (3) allowing payments to only vendors who have been previously approved by upper management.

The three documents supporting the liability are the vendor’s invoice, the purchase order, and the receiving report. The invoice should be compared with the receiving report to determine that the items billed have been received and with the purchase order to verify quantities, prices, and terms.

The cash balance and the bank statement balance are likely to differ because of (1) a delay by the bank or company in recording transactions or (2) errors by the bank or company in recording transactions.

The purpose of a bank reconciliation is to determine the reasons for the difference between the balance according to the company’s records and the balance according to the bank statement and to correct those items representing errors in recording that may have been made by the bank or by the company.

CHAPTER 7

Internal Control and Cash

DISCUSSION QUESTIONS (Concluded) 9.

10.

Yes. Even though the petty cash fund is only $750, if the fund is replenished frequently, a significant amount of cash could be stolen. For example, if the fund is replenished weekly, then $39,000 ($750 × 52 weeks) could be subject to theft.

Controls for petty cash include: (1) designating one person who is responsible for the fund, (2) maintaining a written record of all payments, (3) requiring support (receipts) for payments from the fund, and (4) periodic review of the funds on hand and the payments by an independent person.

Cash and cash equivalents are usually reported as one amount in the “Current assets” section of the balance sheet.

Examples of cash equivalents include certificates of deposit, U.S. government securities, corporate notes and bonds, and commercial paper.

CHAPTER 7

Internal Control and Cash

BASIC EXERCISES BE 7–1 1. (b) control procedures 2. (c) monitoring 3. (a) the control environment

BE 7–2

Item No.

Appears on the Bank Statement as a Debit or Credit Memo

Increases or Decreases the Balance of the Company’s Bank Account

1 2 3 4

debit memo credit memo credit memo credit memo

decreases increases increases increases

BE 7–3 a.

$24,295 as shown below. Bank section of reconciliation: $25,750 + $2,300 – $3,755 = $24,295 Company section of reconciliation: $19,140 + $5,200 – $45 = $24,295

Miscellaneous Expense Cash

45 45

Cash Notes Receivable Interest Revenue

5,200 5,000 200

BE 7–4 a. b.

Petty Cash Cash

500

Store Supplies Miscellaneous Selling Expense Cash Short and Over Cash

360 40 15

500

415

CHAPTER 7

Internal Control and Cash

BE 7–5 Days’ Cash on Hand =

Cash + Short-Term Investments (Operating Expenses – Depreciation Expense) ÷ 365 Days

20Y8:

$24,250 + $9,460 ($63,780 − $11,400) ÷ 365 days

$33,710 $143.5

= 234.9 days

20Y9:

$25,500 + $8,270 ($60,135 − $13,225) ÷ 365 days

$33,770 $128.5

= 262.8 days

CHAPTER 7

Internal Control and Cash

EXERCISES Ex. 7–1 Section 404 requires management’s internal control report to: (1) state the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting; and (2) contain an assessment, as of the end of the issuer’s fiscal year, of the effectiveness of the internal control structure and procedures of the issuer for financial reporting. The complete AICPA summary of Section 404 of Sarbanes-Oxley is as follows: Section 404: Management Assessment of Internal Controls. Requires each annual report of an issuer to contain an “internal control report,” which shall: (1) state the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting; and (2) contain an assessment, as of the end of the issuer’s fiscal year, of the effectiveness of the internal control structure and procedures of the issuer for financial reporting. Each issuer’s auditor shall attest to, and report on, the assessment made by the management of the issuer. An attestation made under this section shall be in accordance with standards for attestation engagements issued or adopted by the Board. An attestation engagement shall not be the subject of a separate engagement. The language in the report of the Committee that accompanies the bill to explain the legislative intent states, “…the Committee does not intend that the auditor’s evaluation be the subject of a separate engagement or the basis for increased charges or fees.” Directs the SEC to require each issuer to disclose whether it has adopted a code of ethics for its senior financial officers and the contents of that code. Directs the SEC to revise its regulations concerning prompt disclosure on Form 8-K to require immediate disclosure “of any change in, or waiver of,” an issuer’s code of ethics.

CHAPTER 7

Internal Control and Cash

Ex. 7–2 a. Disagree. Stealing is a serious issue. An employee who can justify taking a box of tea bags can probably justify “borrowing” cash from the cash register. b.

Agree. Faith has made one employee responsible for the cash drawer in accordance with the internal control principle of assignment of responsibility. In addition, Faith has segregated the operations (preparing the orders) from the accounting (taking orders and payments).

Disagree. It is commendable that Faith has given the employee a specific responsibility and is holding that employee accountable for it. However, after the cashier has counted the cash, another employee (or perhaps Faith) should remove the cash register tape and compare the amount on the tape with the cash in the drawer. Also, Faith’s standard of no mistakes may encourage the cashiers to overcharge a few customers in order to cover any possible shortages in the cash drawer.

Ex. 7–3 a.

The sales clerks could steal money by writing phony refunds and pocketing the cash supposedly refunded to these fictitious customers.

Ramona’s Clothing suffers from inadequate separation of responsibilities for related operations because the clerks issue refunds and restock all merchandise. In addition, there is a lack of proofs and security measures because the supervisors authorize returns two hours after they are issued.

A store credit for any merchandise returned without a receipt would reduce the possibility of theft of cash. In this case, a clerk could only issue a phony store credit rather than taking money from the cash register. A store credit is not as tempting as cash. In addition, sales clerks could only use a few store credits to purchase merchandise for themselves without management getting suspicious. An advantage of issuing a store credit for returns without a receipt is that the possibility of stealing cash is reduced. The store will also lose less revenue if customers must choose other store merchandise instead of getting a cash refund. The overall level of returns/exchanges may be reduced because customers will not return an acceptable gift simply because they need cash more than the gift. The policy will also reduce the “cash drain” during the weeks immediately following the holidays, allowing Ramona’s Clothing to keep more of its money earning interest or use that cash to purchase spring merchandise or pay creditors.

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Internal Control and Cash

Ex. 7–3 (Concluded) A disadvantage of issuing a store credit for returns without a receipt is that preholiday sales might drop as gift-givers realize that the return policy has tightened. After the holidays, customers wishing to return items for cash refunds may be frustrated when they learn the store policy has changed. The ill will may reduce future sales. It may take longer to explain the new policy and fill out the paperwork for a store credit, lengthening lines at the return counter after the holidays. Sales clerks will need to be trained to apply the new policy and write up a store credit. Sales clerks also will need to be trained to handle the redemption of the store credit on future merchandise purchases. d.

The potential for abuse in the cash refund system could be eliminated if clerks were required to get a supervisor’s authorization for a refund before giving the customer the cash. The supervisor should only authorize the refund after seeing both the customer and the merchandise that is being returned. An alternative would be to use security measures that would detect a sales clerk attempting to ring up a refund and remove cash when a customer is not present at the sales desk. These security measures could include cameras or additional security personnel discreetly monitoring the sales desk. Finally, an employee on the following work shift could be assigned the responsibility to restock returned merchandise and reconcile the returns to a refund list for the department.

Ex. 7–4 As an internal auditor, you would probably disagree with the change in policy. Pacific Bank has some normal business risk associated with default on bank loans. One way to help minimize this is to carefully evaluate loan applications. Large loans present greater risk in the event of default than do smaller loans. Thus, it is reasonable to have more than one person involved in making the decision to grant a large loan. In addition, loans should be granted on their merits, not on the basis of favoritism or mere association with the bank president. Allowing the bank president to have sole authority to grant large loans can lead to the president granting loans to friends and business associates without the required due diligence. This can result in a bank becoming exposed to very poor credit risks. Indeed, this scenario is one of the causes of the savings and loan failures of the past.

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Internal Control and Cash

Ex. 7–5 The Societe Generale trading losses show how small lapses in internal control can have large consequences. When the losses became so large that they could no longer be hidden, it was too late. The loss could have been avoided with a number of internal controls. First, the separation of duties control was overcome by the trader’s intimate knowledge of the monitoring software. This knowledge of the monitoring system allowed the trader to effectively hide trades. The design of the monitoring software would need to be improved, and access prohibited by traders. If traders have access to the monitoring software, then the separation of duties control is violated. Second, the trader should be under managerial oversight. For example, trades that exceed a certain amount of exposure should require management approval. In this way, a trader would be forced to slow down or stop once trades have reached a certain limit. This would avoid the trader’s tendency to try to “make up” losses with even larger bets. Lastly, required vacation time may have alerted managers to the hidden losses once the trader was unable to attend to the trading positions.

Ex. 7–6 This is an example of a fraud with significant collusion. Frauds that are perpetrated with multiple parties in different positions of control make detecting fraud more difficult. In this case, the fraud began with an employee responsible for authorizing claim payments. This is a sensitive position because his decisions would initiate payments. However, claims would need to be authorized and verified before payment would be made. Knowing this, the employee made sure each claim had a phony “victim.” Thus, there was a verifiable story behind each claim. Only by tracking physical evidence of the accident could it be discovered that the claim was fictitious. However, the very nature of the process was to resolve small claims quickly without excessive control. Lastly, corrupt lawyers were brought into the fraud to act as attorneys for the claimants. This gave the claims even more credibility. In actuality, the lawyers had done legitimate business with the trucking company, so all appeared normal. This fraud was discovered when the fraudulent employee’s bank noticed irregularities in his bank account and notified authorities. As the saying goes, “Follow the money!” As a side note, the corrupt claims administrator fell into this behavior due to gambling problems.

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Internal Control and Cash

Ex. 7–7 All-Around Sound Co. should not have relied on the unusual nature of the vendors and delivery frequency to uncover this fraud. The purchase and payment cycle is one of the most critical business cycles to control because the potential for abuse is so great. Purchases should be initiated by a requisition document. This document should be countersigned by a superior so that two people agree as to what is being purchased. The requisition should initiate a purchase order to a vendor for goods or services. The vendor responds to the purchase order by delivering the goods. The goods should be formally received using a receiving document. An accounts payable clerk matches the requisition, purchase order, and invoice before any payment is made. Such “triple matching” prevents unauthorized requests and payments. In this case, the requests were unauthorized, suggesting that the employee has sole authority to make a request. Second, this employee had access to the invoices. This access allowed the employee to change critical characteristics of the invoice to hide the true nature of the goods being received. The invoice should have been delivered directly to the accounts payable clerk to avoid corrupting the document. There apparently was no receiving document (common for smaller companies); thus, only the invoice provided proof of what was received and needed to be paid. If there had been a receiving report, the invoice could not have been doctored and gone undetected because it would not have matched the receiving report. Note to Instructors: This exercise is based on an actual fraud.

Ex. 7–8 a.

The most difficult frauds to detect are those that involve the senior managers of a company who are in a conspiracy to commit the fraud. The senior managers have the power to access many parts of the accounting system, while the normal separation of duties is subverted by involving many people in the fraud. In addition, the authorization control is subverted because most of the authorization power resides in the senior management.

Overall, this type of fraud can be stopped if there is a strong oversight of senior management, such as an audit committee of the board of directors. Individual “whistle blowers” in the company can make their concerns known to the independent or internal auditors who, in turn, can inform the audit committee. The audit committee should be independent of management and have the power to monitor the actions of management.

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Internal Control and Cash

Ex. 7–9 a.

The sales clerks should not have access to the cash register tapes.

The cash register tapes should be locked in the cash register and the key retained by the cashier. An employee of the cashier’s office should remove the cash register tape, record the total on the memo form, and note discrepancies.

Ex. 7–10 Big & Bad Burgers suffers from a failure to separate responsibilities for related operations. Big & Bad Burgers could stop this theft by limiting the drive-through clerk to taking customer orders, entering them on the cash register, accepting the customers’ payments, returning customers’ change, and handing customers their orders that another employee has assembled. By making another employee responsible for assembling orders, the drive-through clerk must enter the orders on the cash register. This will produce a printed receipt or an entry on a computer screen at the food bin area, specifying the items that must be assembled to fill each order. Once the drive-through clerk has entered the sale on the cash register, the clerk cannot steal the customer’s payment because the clerk’s cash drawer will not balance at the end of the shift. This change also makes the drive-through more efficient and could reduce the time it takes to service a drive-through customer. If another employee cannot be added, the weakness in internal control could be improved with more thorough supervision. The restaurant manager should be directed to keep a watchful eye on the drive-through area in order to detect when a clerk takes an order without ringing up the sale. Another option is for Big & Bad Burgers to implement a policy that any customer who does not receive a receipt is entitled to a free burger and advertise this policy at the cash register and drive-through window. This approach uses the customer as an internal control.

Ex. 7–11 a.

The remittance advices should not be sent to the cashier.

The remittance advices should be sent directly to the Accounting Department by the mailroom.

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Internal Control and Cash

Ex. 7–12 Cash Cash Short and Over Sales

78,956 39 78,995

Ex. 7–13 Cash Sales Cash Short and Over

285,280 285,050 230

Ex. 7–14 The use of the voucher system is appropriate, the essentials of which are outlined below. (Although invoices could be used instead of vouchers, the latter more satisfactorily provide for account distribution, signatures, and other significant data.) 1.

Each voucher should be approved for payment by a designated official only after completion of the following verifications: (a) that prices, quantities, terms, etc., on the invoice are in accordance with the provisions of the purchase order; (b) that all quantities billed have been received in good condition, as indicated on a receiving report; and (c) that all mathematical details are correct.

The file for unpaid vouchers should be composed of 31 compartments, one for each day of the month. Each voucher should be filed in the compartment representing the last day of the discount period or the due date if the invoice is not subject to a cash discount.

Each day, the vouchers should be removed from the appropriate section of the file and checks issued by the disbursing official. If the bank balance is insufficient to pay all of the vouchers, those that remain unpaid should be refiled according to the date when payment should next be considered.

At the time of payment, all vouchers and supporting documents should be stamped or perforated “Paid” to prevent their resubmission for payment. They should then be filed in numerical sequence for future reference. The implementation and use of a computerized system would also reduce the chance that any available cash discounts are missed. For example, when invoices are received and approved for payment, they would automatically be scheduled for payment within the discount period. However, even in a computerized system, the use of an approval process that requires supporting documents and indicating “paid” on these supporting documents is an important control for avoiding duplicate payments.

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Internal Control and Cash

Ex. 7–15 To prevent the fraud scheme described, Paragon Tech must separate responsibilities for related operations. As in the past, all service requisitions should be submitted to the Purchasing Department. After receiving the service request, Purchasing should complete a Service Verification form, stating what service has been ordered and the name of the company that will provide the service. This form should be delivered via intercompany mail to the person responsible for verifying that the service was performed. This person should be someone who has firsthand knowledge of whether the service has been performed. This person, who must be someone other than the manager requesting the service, should fill in the date and time the service was received and sign the form. In addition, the vendor providing the service should sign the form before leaving the premises. When completed, the Service Verification form should be forwarded to the Accounting Department. Accounting will authorize payment of the vendor’s invoice after the Service Verification form has been compared with the invoice.

Ex. 7–16 a. b. c. b.

Addition to the balance per bank: (4), (5) Deduction from the balance per bank: (6) Addition to the balance per company’s records: (3), (7) Deduction from the balance per company’s records: (1), (2)

Ex. 7–17 (1), (2), (3), (7) The preceding additions and deductions to the cash balance according to the company’s records require journal entries in the company’s records. Additions and deductions to the cash balance according to the bank’s records do not require the company to record journal entries.

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Internal Control and Cash

Ex. 7–18 a. Creative Design Co. Bank Reconciliation August 31, 20Y6 Cash balance according to bank statement Add: Deposit in transit on August 31 Deduct: Outstanding checks Adjusted balance

$ 46,300 16,375 (28,540) $ 34,135

Cash balance according to company’s records Add: Error in recording check as $1,800 instead of $180 Deduct: Bank service charge Adjusted balance

$ 32,560 1,620 (45) $ 34,135

$34,135; the adjusted balance from the bank reconciliation should be reported on the August 31 balance sheet for Creative Design Co.

Yes, the bank reconciliation must always balance (reconcile) to an adjusted balance.

Ex. 7–19 20Y6 Aug.

31 Cash Accounts Payable

1,620

31 Miscellaneous Expense Cash

1,620

Ex. 7–20 Cash Notes Receivable Interest Revenue

21,200 20,000 1,200

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Internal Control and Cash

Ex. 7–21 a. Chesner Co. Bank Reconciliation July 31, 20Y4 Cash balance according to bank statement Add: Deposit in transit on July 31 Deduct: Outstanding checks Adjusted balance Cash balance according to company’s records Add: Error in recording Check No. 1056 as $875 instead of $785 Note for $15,000 collected by bank, including interest Total additions Deduct: Bank service charges Adjusted balance b.

$27,645 11,300 (4,780) $34,165 $18,520 $ 90 15,600 15,690 (45) $34,165

$34,165

Ex. 7–22 a.

1. The heading should be “June 30, 20Y7,” and not “For the Month Ended June 30, 20Y7.” 2. The outstanding checks should be deducted from the balance per bank. 3. The deposit of June 30, not recorded by the bank, should be added to the balance per bank. 4. Service charges should be deducted from the balance per company’s records. 5. The error in recording the June 17 deposit of $7,150 as $1,750 should be added to the balance per company’s records. 6. The adjusted balance per the bank of $12,590 does not equal the adjusted balance per the company of $9,010.

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Internal Control and Cash

Ex. 7–22 (Concluded) b. A correct bank reconciliation would be as follows: Poway Co. Bank Reconciliation June 30, 20Y7 Cash balance according to bank statement Add: Deposit in transit on June 30 Deduct: Outstanding Check No. 1067 Outstanding Check No. 1106 Outstanding Check No. 1110 Outstanding Check No. 1113 Total deductions Adjusted balance Cash balance according to company’s records Add: Note collected by bank, including $300 interest Error in recording June 17 deposit as $1,750 instead of $7,150 Total additions Deduct: Check returned because of insufficient funds Bank service charges Total deductions Adjusted balance

$16,185 6,600 $ 575 470 1,050 910 (3,005) $19,780 $ 8,985 $6,300 5,400 11,700 $ 890 15 (905) $19,780

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Internal Control and Cash

Ex. 7–23 a.

The amount of cash receipts stolen by the sales clerk can be determined by attempting to reconcile the bank account. The bank reconciliation will not reconcile by the amount of cash receipts stolen. The amount stolen by the sales clerk is $4,135, determined as shown below.

Alaska Impressions Co. Bank Reconciliation October 31, 20Y3 Cash balance according to bank statement Deduct: Outstanding checks Adjusted balance

$13,275 (3,670) $ 9,605

Cash balance according to company’s records Add: Note collected by bank, including interest Deduct: Bank service charges Adjusted balance

$11,680 2,100 (40) $13,740

Amount stolen: $4,135 ($13,740 – $9,605) b.

The theft of the cash receipts might have been prevented by having more than one person make the daily deposits. Collusion between two individuals would then have been necessary to steal cash receipts. In addition, two employees making the daily cash deposits would tend to discourage theft of the cash receipts from the employees on the way to the bank. Daily reconciliation of the amount of cash receipts—comparing the cash register tapes to a receipt from the bank as to the amount deposited (a duplicate deposit ticket)—would also discourage theft of the cash receipts. In this latter case, if the reconciliation were prepared by an employee independent of the cash function, any theft of cash receipts from the daily deposit would be discovered immediately. That is, the daily deposit would not reconcile against the daily cash receipts.

Ex. 7–24 a. b.

Petty Cash Cash

500

Office Supplies Miscellaneous Selling Expense Miscellaneous Administrative Expense Cash Short and Over Cash

212 156 61 31

500

460

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Internal Control and Cash

PROBLEMS Prob. 7–1A Strengths: a, b, e, and f Weaknesses: c.

Employees should not be allowed to use the petty cash fund to cash personal checks. In any case, postdated checks should not be accepted. In effect, postdated checks represent a receivable from the employees.

Requiring cash register clerks to make up any cash shortages from their own funds gives the clerks an incentive to shortchange customers. That is, the clerks will want to make sure that they don’t have a shortage at the end of the day. In addition, one might also assume that the clerks can keep any overages. This would again encourage clerks to shortchange customers. The shortchanging of customers will create customer complaints, etc. The best policy is to report any cash shortages or overages at the end of each day. If a clerk is consistently short or over, then corrective action (training, removal, etc.) could be taken.

The mail clerk should prepare an initial listing of cash remittances before forwarding the cash receipts to the cashier. This establishes initial accountability for the cash receipts. The mail clerk should forward a copy of the listing of remittances to the accounts receivable clerk for recording in the accounts.

The bank reconciliation should be prepared by someone not involved with the handling or recording of cash.

Prob. 7–2A 20Y1 July

1 Petty Cash Cash

1,200

12 Cash Cash Short and Over Sales

8,389

1,200

33 8,356

31 Store Supplies Delivery Expense Office Supplies Miscellaneous Administrative Expense Cash Short and Over Cash 31 Cash Cash Short and Over Sales

510 225 140 88 20 983 10,275 14 10,289

31 Cash Petty Cash

100 100 7-17

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Internal Control and Cash

Prob. 7–3A 1. Pala Medical Co. Bank Reconciliation June 30, 20Y1 Cash balance according to bank statement Add: Deposit in transit on June 30 Bank error in charging check as $915 instead of $195 Total additions Deduct: Outstanding checks Adjusted balance Cash balance according to company’s records Add: Note collected by bank, including $1,500 interest Deduct: Error in recording check Bank service charges Total deductions Adjusted balance

$195,688 $12,300 720 13,020 (19,427) $189,281 $166,436 26,500 $ 3,600 55 (3,655) $189,281

2. 20Y1 June

30 Cash Notes Receivable Interest Revenue

26,500

30 Accounts Payable—Skyline Supply Co. Miscellaneous Expense Cash

3,600 55

25,000 1,500

3,655

3. $189,281; the adjusted balance from the bank reconciliation should be reported as cash on the June 30, 20Y1, balance sheet for Pala Medical Co.

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Internal Control and Cash

Prob. 7–4A 1. Coastal Bike Co. Bank Reconciliation October 31, 20Y9 Cash balance according to bank statement Add: Deposit in transit on October 31 Bank error in charging check as $640 instead of $460 Total additions Deduct: Outstanding checks Adjusted balance Cash balance according to company’s records* Add: Note collected by bank, including $300 interest Deduct: Check returned because of insufficient funds Bank service charges Error in recording check Total deductions Adjusted balance * Cash balance per company’s records, October 1…………………………… Cash deposited in October ……………………………………………………… Checks written in October ……………………………………………………… Cash balance per company’s records, October 31……………………………

2. 20Y9 Oct.

31 Cash Notes Receivable Interest Revenue

2,630 (3,260) $ 8,350 $ 3,795 5,300 $ 605 50 90 (745) $ 8,350 $ 5,140 39,175 (40,520) $ 3,795

5,300 5,000 300

31 Accounts Payable—Rack Pro Co. Accounts Receivable—Bay View Condos Miscellaneous Expense Cash 3.

$ 8,980 $2,450 180

90 605 50

$8,350; the adjusted balance from the bank reconciliation should be reported as cash on the October 31, 20Y9, balance sheet for Coastal Bike Co.

745

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Internal Control and Cash

Prob. 7–5A 1. Beeler Furniture Company Bank Reconciliation June 30, 20Y2 Cash balance according to bank statement Add: Deposit in transit on June 30 Deduct: Outstanding Check No. 738 Outstanding Check No. 756 Outstanding Check No. 758 Outstanding Check No. 759 Total deductions Adjusted balance Cash balance according to company’s records* Add: Note collected by bank, including $210 interest Error in recording Check No. 743 Total additions Deduct: Check returned because of insufficient funds Error in recording June 10 deposit Error in recording June 24 deposit Bank service charges Total deductions Adjusted balance

$13,624.71 1,117.74 $ 251.40 113.95 259.60 901.50 (1,526.45) $13,216.00 $10,145.50 $3,710.00 90.00 3,800.00 $ 550.00 100.00 4.50 75.00 (729.50) $13,216.00

* Cash balance per company’s records, June 1……… $ 9,317.40 June receipts……………………………………………… 9,223.76 (8,395.66) June disbursements……………………………………… $10,145.50 Cash balance per company’s records, June 30……

2. 20Y2 June

30 Cash Notes Receivable Interest Revenue Accounts Payable

3,800.00

30 Sales ($100.00 + $4.50) Accounts Receivable Miscellaneous Expense Cash

104.50 550.00 75.00

3,500.00 210.00 90.00

729.50

$13,216.00

The error of $540 ($930 – $390) in the canceled check should be added to the “cash balance according to bank statement” on the bank reconciliation. The canceled check should be presented to the bank with a request that the bank balance be corrected. 7-20 © 2022 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Internal Control and Cash

Prob. 7–1B Strengths: a, b, e, and f Weaknesses: c.

An independent person (for example, a supervisor) should count the cash in each cashier’s cash register, unlock the record, and compare the amount of cash with the amount on the record to determine cash shortages or overages.

Cash receipts should not be handled by the accounts receivable clerk. This violates the segregation of duties between the handling of cash receipts and the recording of cash receipts.

The bank reconciliation should be prepared by someone not involved with the handling or recording of cash.

Prob. 7–2B 20Y3 June

1 Petty Cash Cash

1,000

12 Cash Cash Short and Over Sales

9,506

1,000

66 9,440

30 Store Supplies Inventory Office Supplies Miscellaneous Administrative Expense Cash Short and Over Cash 30 Cash Cash Short and Over Sales

375 215 208 134 22 954 13,350 40 13,390

30 Petty Cash Cash

200 200

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Internal Control and Cash

Prob. 7–3B 1. Stone Systems Bank Reconciliation July 31, 20Y5 Cash balance according to bank statement Add: Deposit in transit on July 31 Deduct: Outstanding checks Bank error in charging check as $1,180 instead of $1,810 Total deductions Adjusted balance Cash balance according to company’s records Add: Note collected by bank, including $345 interest Error in recording check Total additions Deduct: Bank service charges Adjusted balance

$ 33,650 9,150 $17,865 630 (18,495) $ 24,305 $ 17,750 $ 6,095 540 6,635 (80) $ 24,305

2. 20Y5 July

31 Cash Notes Receivable Interest Revenue Interest Revenue

6,635 5,750 345 540

31 Miscellaneous Expense Cash

80 80

3. $24,305; the adjusted balance from the bank reconciliation should be reported as cash on the July 31, 20Y5, balance sheet for Stone Systems.

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Internal Control and Cash

Prob. 7–4B 1. Collegiate Sports Co. Bank Reconciliation November 30, 20Y9 Cash balance according to bank statement Add: Deposit in transit on November 30 Deduct: Outstanding checks Bank error in charging check as $7,250 instead of $2,750 Total deductions Adjusted balance Cash balance according to company’s records* Add: Note collected by bank, including $385 interest Error in recording check as $7,600 instead of $760 Total additions Deduct: Check returned because of insufficient funds Bank service charges Total deductions Adjusted balance * Cash balance per company’s records, November 1………… Cash deposited in November…………………………………… Checks written in November……………………………………… Cash balance per company’s records, November 30…………

$112,675 12,200 $41,840 4,500 (46,340) $ 78,535 $ 66,935 $ 7,385 6,840 14,225 $ 2,500 125 (2,625) $ 78,535

$ 81,145 293,150 (307,360) $ 66,935

2. 20Y9 Nov.

30 Cash Notes Receivable Interest Revenue Accounts Payable—Ramirez Co.

14,225

30 Accounts Receivable—Hallen Academy Miscellaneous Expense Cash

2,500 125

7,000 385 6,840

2,625

3. $78,535; the adjusted balance from the bank reconciliation should be reported as cash on the November 30, 20Y9, balance sheet for Collegiate Sports Co.

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Internal Control and Cash

Prob. 7–5B 1. Sunshine Interiors Bank Reconciliation July 31, 20Y0 Cash balance according to bank statement Add: Deposit in transit on July 31 Deduct: Outstanding Check No. 613 Outstanding Check No. 628 Outstanding Check No. 633 Total deductions Adjusted balance Cash balance according to company’s records* Add: Note collected by bank, including $160.00 interest Error in recording July deposit Error in recording Check No. 627 Total additions Deduct: Check returned because of insufficient funds Bank service charges Total deductions Adjusted balance * Cash balance per company’s records, July 1……… Add July receipts………………………………………… Deduct July disbursements…………………………… Cash balance per company’s records, July 31………

$11,601.41 1,177.87 $ 137.50 837.70 310.08 (1,285.28) $11,494.00 $ 7,664.00 $4,160.00 18.00 63.00 4,241.00 $ 375.00 36.00 (411.00) $11,494.00

$ 9,578.00 6,465.42 (8,379.42) $ 7,664.00

2. 20Y0 July

31 Cash Notes Receivable Interest Revenue Sales Accounts Payable

4,241.00

31 Accounts Receivable Miscellaneous Expense Cash

375.00 36.00

4,000.00 160.00 18.00 63.00

411.00

$11,494.00

The error of $1,620 ($1,800 – $180) in the canceled check should be added to the “cash balance according to bank statement” on the bank reconciliation. The canceled check should be presented to the bank, with a request that the bank balance be corrected.

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Internal Control and Cash

MAKE A DECISION MAD 7–1 a. Days’ Cash on Hand =

Cash and Short-Term Investments (Operating Expenses – Depreciation Expense) ÷ 365 Days

Amazon:

$36,092 + $18,929 ($265,981 – $21,789) ÷ 365 days

$55,021 $669.0 per day

= 82.2 days

Netflix:

$5,018 + $0 ($17,552 – $9,320) ÷ 365 days

$5,018 $22.6 per day

= 222.0 days

b. There is a significant difference in the days’ cash on hand between the two companies. Amazon has 82.2 days’ cash on hand, while Netflix has 222.0 days’ cash on hand. Netflix appears to have greater cash liquidity to support operations and a greater cash cushion in the event of a downturn in business or catastrophic event compared to Amazon.

MAD 7–2 a. Days’ Cash on Hand =

Cash and Short-Term Investments (Operating Expenses – Depreciation Expense) ÷ 365 Days

J. C. Penney:

$109 + $224 ($4,155 – $556) ÷ 365 days

$333 $9.9 per day

= 33.6 days

Macy’s:

$1,162 + $0 ($8,786 – $962) ÷ 365 days

$1,162 $21.4 per day

= 54.3 days

b. Macy’s has days’ cash on hand of 54.3 days, which is 20.7 days better than J. C. Penney’s 33.6 days. While Macy’s appears to have greater cash liquidity, both companies have sufficient cash to meet operating needs.

MAD 7–3 a. Days’ Cash on Hand =

Cash and Short-Term Investments (Operating Expenses – Depreciation Expense) ÷ 365 Days

Year 3:

$714 ($6,466 – $2,405) ÷ 365 days

$714 $11.1 per day

= 64.3 days

Year 2:

$1,668 ($5,505 – $2,280) ÷ 365 days

$1,668 $8.8 per day

= 189.5 days

Year 1:

$1,377 ($7,036 – $2,618) ÷ 365 days

$1,377 $12.1 per day

= 113.8 days

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Internal Control and Cash

MAD 7–3 (Concluded) b. Apache’s cash balance and days’ cash on hand is experiencing extreme fluctuations across the three years. In Year 1, the days’ cash on hand was 113.8 days. This represents an adequate level of liquidity. In Year 2, the days’ cash on hand increased to 189.5 days. In the most recent year, Year 3, the days’ cash on hand decreased to 64.3 days. The nature of the oil and gas exploration business leads to such swings in liquidity. The prices of crude oil and natural gas can change as much as 100% on the upside or 50% on the downside. Such swings will create cash flow management challenges. In addition, oil and gas exploration is inherently risky. Money spent on drilling efforts may result in dry holes. If the hit rate is low for a particular year, that will also create liquidity challenges. c. There are a number of actions a company can take to improve liquidity. Management actions may include: 1. 2. 3. 4. 5. 6.

Sell common stock to owners. Obtain bank or creditor financing. Sell off assets. Reduce dividends. Reduce exploration activities. Reduce other operating expenses.

MAD 7–4 a. Days’ Cash on Hand =

Cash and Short-Term Investments (Operating Expenses – Depreciation Expense) ÷ 365 Days

Restaurant Brands:

$1,533 ($1,783 – $185) ÷ 365 days

$1,533 = 348.4 days $4.4 per day

Dunkin’ Brands:

$621 ($862 – $18) ÷ 365 days

$621 = 270.0 days $2.3 per day

b. Restaurant Brands appears to have a stronger cash liquidity position than does Dunkin’ Brands. Dunkin’ has days’ cash on hand of 270.0 days, while Restaurant Brands has 348.4 days. Both companies appear to be very liquid.

CHAPTER 7

Internal Control and Cash

TAKE IT FURTHER TIF 7–1 Both Tehra and her supervisor are acting in an unethical manner. While Tehra’s disappointment at not receiving a raise may be justified, it is not appropriate for Tehra to submit personal expenses for reimbursement. By knowingly submitting false expense reimbursements, Tehra is effectively stealing from the company and exhibiting a failure of individual character. By allowing this behavior to happen and continue, Tehra’s supervisor is creating a culture of ethical indifference in the organization. This will likely lead to larger and more frequent incidents, potentially impacting the company’s financial results. TIF 7–2 Acceptable business and professional conduct requires Joel Knolls to notify the bank of the error. Note to Instructors: Individuals may be criminally prosecuted for knowingly using funds that are erroneously credited to their bank accounts. TIF 7–3 A sample solution based on eBay’s Form 10-K for the fiscal year ended December 31, 2019, follows: 1. a. $975 million (from balance sheet) b. 20.7% ($975 ÷ $4,706) in 2019; 30.9% ($2,202 ÷ $7,126) in 2018. Cash as a percentage of total current assets has decreased. 2. Management’s Annual Report on Internal Control Over Financial Reporting is included in the annual report as item 9A in the Form 10-K. a. Management, including the principal executive officer and principal financial officer b. Internal control is not explicitly defined in the annual report; however, the report does reference SEC rules and Committee of Sponsoring Organizations’ guidelines. According to these rules, internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. Internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets of the Company; (ii) provide reasonable assurance the transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipt and expenditures of the Company are being made only in accordance with authorizations of management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets of the Company that could have a material effect on the financial statements. 7-27 © 2022 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 7

Internal Control and Cash

TIF 7–3 (Concluded) c. A material weakness is a deficiency in internal control such that there is a reasonable possibility that a material misstatement will not be prevented or detected on a timely basis. No material weaknesses were disclosed. d. A critical audit matter is a material account or disclosure that requires challenging, subjective, or complex judgments. One matter disclosed relates to the determination of tax expense and uncertainties around the tax positions taken.

TIF 7–4 MEMO To: My Instructor From: A+ Student Re: Control Procedures for Self-Checkout Lanes Wholesome and Happy Foods could incorporate several features into the kiosks that will increase the likelihood that customers will scan all of the items in their carts for purchase. First, the scanning system should be set up so that an audible beep is heard each time an item is scanned and a sale recorded. This will alert the attendant that the item has been properly scanned. If the attendant does not hear a beep for each item, the attendant should be trained to investigate to ensure that all items have been properly scanned. Second, the kiosk should include a built-in scale that measures changes in the total weight as items are placed in the bagging area. If the weight increases without an item being scanned, the attendant should be alerted by the system. Finally, the kiosk should remind customers to check their cart’s bottom rack for any items they may have forgotten to scan.

TIF 7–5 Several control procedures could be implemented to prevent or detect the theft of cash from fictitious returns. One procedure would be to establish a policy of “no cash refunds.” That is, returns could only be exchanged for other merchandise. However, such a policy might not be popular with customers, and Turpin Meadows Electronics might lose sales from customers who would shop at other stores with a more liberal return policy. Another procedure would be to allow returns only through a centralized location, such as a customer service desk. The customer service desk clerk would issue an approved refund slip, which the customer could then take to a cash register to receive a cash refund. Because the customer service clerk does not have access to cash, the customer service clerk could not steal cash through fictitious returns. Yet another procedure would be to allow returns at the individual cash registers but require that all returns be approved by a supervisor. In this way, cash could be stolen through fictitious returns only if the supervisor and the cash register clerk collude to steal. 7-28 © 2022 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 7

Internal Control and Cash

TIF 7–6 1. a.

CHAPTER 7

Internal Control and Cash

TIF 7–6 (Continued) b.

CHAPTER 7

Internal Control and Cash

TIF 7–6 (Continued) c.

TIF 7–6 (Continued)

7-32

Internal Control and Cash

CHAPTER 7

Internal Control and Cash

TIF 7–6 (Concluded) 2.

The first two visualizations, Inventory Losses as Percent Average Inventory and Control Cost as Percent Average Inventory can be used by management to understand both Johnson’s losses and costs on a normalized basis. However, the most useful visualization is when these two calculations are put together in the cost-benefit analysis. This analysis provides management with an indication that installing cameras is the most costeffective way to stop inventory losses. The loss by store as a percentage of average inventory is also useful to identify individual stores that experience a high rate of inventory losses and provide management with opportunities to take further, more specific action.

CHAPTER 8 RECEIVABLES DISCUSSION QUESTIONS 1.

Receivables are normally classified as (1) accounts receivable, (2) notes receivable, or (3) other receivables.

Dan’s Hardware should use the direct write-off method because it is a small business that has a relatively small number and volume of accounts receivable.

Contra asset, credit balance

The accounts receivable and allowance for doubtful accounts may be reported at a net amount of $661,500 ($673,400 – $11,900) in the “Current assets” section of the balance sheet. In this case, the amount of the allowance for doubtful accounts should be shown separately in a note to the financial statements or in parentheses on the balance sheet. Alternatively, the accounts receivable may be shown at the gross amount of $673,400 less the amount of the allowance for doubtful accounts of $11,900, thus yielding net accounts receivable of $661,500.

(1) The percentage rate used is excessive in relationship to the accounts written off as uncollectible; hence, the balance in the allowance is excessive. (2) A substantial volume of old uncollectible accounts is still being carried in the accounts receivable account.

An estimate based on analysis of receivables provides the most accurate estimate of the current net realizable value.

a. b.

The interest will amount to $5,100 ($85,000 × 6%) only if the note is payable one year from the date it was created. The usual practice is to state the interest rate in terms of an annual rate, rather than in terms of the period covered by the note.

Debit Accounts Receivable for $243,600 Credit Notes Receivable for $240,000 Credit Interest Revenue for $3,600

10.

Sailfish Company Notes Receivable

Cash Accounts Receivable [$240,000 + ($240,000 × 6% × 90 ÷ 360)] Interest Revenue ($243,600 × 30 ÷ 360 × 9%)

245,427 243,600 1,827

CHAPTER 8

Receivables

BASIC EXERCISES BE 8–1 Mar.

July

17 Cash Bad Debt Expense Accounts Receivable—Shawn McNeely

325 500

29 Accounts Receivable—Shawn McNeely Bad Debt Expense

500

29 Cash Accounts Receivable—Shawn McNeely

500

17 Cash Allowance for Doubtful Accounts Accounts Receivable—Shawn McNeely

325 500

29 Accounts Receivable—Shawn McNeely Allowance for Doubtful Accounts

500

29 Cash Accounts Receivable—Shawn McNeely

500

825

500

BE 8–2 Mar.

July

825

500

BE 8–3 a.

$263,875 [$105,550,000 × (1/4 × 1%)] Adjusted Balances

Accounts Receivable………………………………………………… Allowance for Doubtful Accounts ($263,875 – $32,600)……… Bad Debt Expense……………………………………………………

$5,125,000 231,275 263,875

Net realizable value ($5,125,000 – $231,275)……………………

$4,893,725

BE 8–4 a.

$257,600 ($225,000 + $32,600) Adjusted Balances

Accounts Receivable………………………………………………… Allowance for Doubtful Accounts………………………………… Bad Debt Expense……………………………………………………

$5,125,000 225,000 257,600

Net realizable value ($5,125,000 – $225,000)……………………

$4,900,000

CHAPTER 8

Receivables

BE 8–5 a. The due date for the note is August 10, determined as follows: April…………………………………………… 18 days (30 – 12) May…………………………………………… 31 days June…………………………………………… 30 days July…………………………………………… 31 days August………………………………………… 10 days Total……………………………………… 120 days b. $510,000 [$500,000 + ($500,000 × 6% × 120 ÷ 360)] c.

Aug.

10 Cash Notes Receivable Interest Revenue

510,000 500,000 10,000

BE 8–6 a.

Accounts Receivable Turnover =

Sales Average Accounts Receivable

20Y8:

$6,726,000 ($540,000 + $600,000) ÷ 2

$6,726,000 $570,000

= 11.8

20Y9:

$7,906,000 ($600,000 + $580,000) ÷ 2

$7,906,000 $590,000

= 13.4

Days’ Sales in Receivables =

Average Accounts Receivable Average Daily Sales

20Y8:

($540,000 + $600,000) ÷ 2 $6,726,000 ÷ 365

$570,000 $18,427.4

= 30.9 days

20Y9:

($600,000 + $580,000) ÷ 2 $7,906,000 ÷ 365

$590,000 $21,660.3

= 27.2 days

c. The increase in the accounts receivable turnover from 11.8 to 13.4 and the decrease in the days’ sales in receivables from 30.9 days to 27.2 days indicate favorable changes in the efficiency of collecting receivables.

CHAPTER 8

Receivables

EXERCISES Ex. 8–1 Accounts receivable from the United States and other governments are significantly different from receivables from commercial aircraft carriers such as Delta and United. Thus, Boeing should report each type of receivable separately. In its filing with the Securities and Exchange Commission, Boeing reports the receivables together on the balance sheet, but discloses each type of receivable separately in a note to the financial statements.

Ex. 8–2 a.

MGM Resorts International: 13.4% ($94,561,000 ÷ $707,278,000)

Johnson & Johnson: 1.5% ($226,000,000 ÷ $14,707,000,000)

Casino operations experience greater bad debt risk because it is difficult to control the creditworthiness of customers entering the casino. In addition, individuals who may have adequate creditworthiness could overextend themselves and lose more than they can afford if they get caught up in the excitement of gambling. In contrast, Johnson & Johnson’s customers are primarily other businesses such as grocery store chains.

Ex. 8–3 Jan.

June

Oct.

19 Accounts Receivable—Dr. Kyle Norby Sales

5,000

19 Cost of Goods Sold Inventory

2,200

2 Cash Bad Debt Expense Accounts Receivable—Dr. Kyle Norby

400 4,600

23 Accounts Receivable—Dr. Kyle Norby Bad Debt Expense

4,600

23 Cash Accounts Receivable—Dr. Kyle Norby

4,600

5,000

2,200

5,000

4,600

CHAPTER 8

Receivables

Ex. 8–4 May

Sept.

Dec.

24 Accounts Receivable—Old Town Cafe Sales

27,250

24 Cost of Goods Sold Inventory

16,300

30 Cash Allowance for Doubtful Accounts Accounts Receivable—Old Town Cafe

10,000 17,250

7 Accounts Receivable—Old Town Cafe Allowance for Doubtful Accounts

17,250

7 Cash Accounts Receivable—Old Town Cafe

17,250

27,250

16,300

27,250

17,250

Ex. 8–5 a. b.

Bad Debt Expense Accounts Receivable—Wil Treadwell

15,220

Allowance for Doubtful Accounts Accounts Receivable—Wil Treadwell

15,220

15,220 15,220

Ex. 8–6 a. b.

$133,550 [$26,710,000 × (1/2 × 1%)] $185,200 ($175,000 + $10,200)

c. d.

$200,325 [$26,710,000 × (3/4 × 1%)] $144,660 ($170,420 – $25,760)

Ex. 8–7 Account

Avalanche Auto Bales Auto Derby Auto Repair Lucky’s Auto Repair Pit Stop Auto Reliable Auto Repair Trident Auto Valley Repair & Tow

Due Date

August 20 October 10 June 22 September 20 September 22 July 8 August 18 May 25

Number of Days Past Due

72 (11 + 30 + 31) 21 (31 – 10) 131 (8 + 31 + 31 + 30 + 31) 41 (10 + 31) 39 (8 + 31) 115 (23 + 31 + 30 + 31) 74 (13 + 30 + 31) 159 (6 + 30 + 31 + 31 + 30 + 31)

CHAPTER 8

Receivables

Ex. 8–8 a. Customer

Boyd Industries Hodges Company Kent Creek Inc. Lockwood Company Van Epps Company

Due Date

Number of Days Past Due

April 7 May 29 June 8 August 10 July 2

115 days (23 + 31 + 30 + 31) 63 days (2 + 30 + 31) 53 days (22 + 31) Not past due 29 days (31 – 2)

b. Aging of Receivables Schedule July 31 Days Past Due Customer

Balance

Acme Industries Inc. Alliance Company

3,000 4,500

Zollinger Company

5,000

Subtotals Boyd Industries Hodges Company Kent Creek Inc. Lockwood Company Van Epps Company Totals

1,050,000 36,000 11,500 6,600 7,400 13,000 1,124,500

Not Past Due

1–30

31–60

61–90

Over 90

3,000 4,500 5,000 600,000

220,000

115,000

85,000

30,000 36,000

11,500 6,600 7,400 607,400

13,000 233,000

121,600

96,500

66,000

Ex. 8–9 Days Past Due

Total receivables Percentage uncollectible Allowance for doubtful accounts

Balance

Not Past Due

1–30

31–60

61–90

Over 90

1,124,500

607,400

233,000

121,600

96,500

66,000

12%

30%

75%

6,074

6,990

14,592

28,950

49,500

106,106

CHAPTER 8

Receivables

Ex. 8–10 July

31 Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts estimate ($106,106 – $8,240).

97,866 97,866

Ex. 8–11

Age Interval

Balance

Not past due 1–30 days past due 31–60 days past due 61–90 days past due 91–180 days past due Over 180 days past due Total

$ 902,000 292,000 98,500 68,000 44,700 15,500 $1,420,700

Estimated Uncollectible Accounts Percent Amount

0.75% 1.00% 8.00% 16.00% 50.00% 80.00%

$ 6,765 2,920 7,880 10,880 22,350 12,400 $63,195

Ex. 8–12 Dec.

31 Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts estimate ($63,195 + $6,225).

69,420 69,420

CHAPTER 8

Receivables

Ex. 8–13 a.

Apr.

May

July

Dec.

13 Bad Debt Expense Accounts Receivable—Dean Sheppard

8,450

15 Cash Bad Debt Expense Accounts Receivable—Dan Pyle

500 6,600

27 Accounts Receivable—Dean Sheppard Bad Debt Expense

8,450

27 Cash Accounts Receivable—Dean Sheppard

8,450

31 Bad Debt Expense Accounts Receivable—Paul Chapman Accounts Receivable—Duane DeRosa Accounts Receivable—Teresa Galloway Accounts Receivable—Ernie Klatt Accounts Receivable—Marty Richey

13,510

8,450

7,100

8,450

2,225 3,550 4,770 1,275 1,690

31 No journal entry required.

CHAPTER 8

Receivables

Ex. 8–13 (Concluded) b.

Apr.

May

July

Dec.

13 Allowance for Doubtful Accounts Accounts Receivable—Dean Sheppard

8,450

15 Cash Allowance for Doubtful Accounts Accounts Receivable—Dan Pyle

500 6,600

27 Accounts Receivable—Dean Sheppard Allowance for Doubtful Accounts

8,450

27 Cash Accounts Receivable—Dean Sheppard

8,450

31 Allowance for Doubtful Accounts Accounts Receivable—Paul Chapman Accounts Receivable—Duane DeRosa Accounts Receivable—Teresa Galloway Accounts Receivable—Ernie Klatt Accounts Receivable—Marty Richey

13,510

31 Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts estimate ($3,778,000 × 0.75%).

28,335

8,450

7,100

8,450

2,225 3,550 4,770 1,275 1,690

28,335

Bad debt expense under: Allowance method………………………...…………………………………… Direct write-off method ($8,450 + $6,600 – $8,450 + $13,510)………… Difference ($28,335 – $20,110)………………………………………………

$28,335 20,110 $ 8,225

Shipway Company’s income would be $8,225 higher under the direct write-off method than under the allowance method.

CHAPTER 8

Receivables

Ex. 8–14 a.

June

Aug.

Oct.

Dec.

8 Bad Debt Expense Accounts Receivable—Kathy Quantel

8,440

14 Cash Bad Debt Expense Accounts Receivable—Rosalie Oakes

3,000 9,500

16 Accounts Receivable—Kathy Quantel Bad Debt Expense

8,440

16 Cash Accounts Receivable—Kathy Quantel

8,440

31 Bad Debt Expense Accounts Receivable—Wade Dolan Accounts Receivable—Greg Gagne Accounts Receivable—Amber Kisko Accounts Receivable—Shannon Poole Accounts Receivable—Niki Spence

24,955

8,440

12,500

8,440

4,600 3,600 7,150 2,975 6,630

31 No journal entry required.

CHAPTER 8

Receivables

Ex. 8–14 (Continued) b.

June

Aug.

Oct.

Dec.

8 Allowance for Doubtful Accounts Accounts Receivable—Kathy Quantel

8,440

14 Cash Allowance for Doubtful Accounts Accounts Receivable—Rosalie Oakes

3,000 9,500

16 Accounts Receivable—Kathy Quantel Allowance for Doubtful Accounts

8,440

16 Cash Accounts Receivable—Kathy Quantel

8,440

31 Allowance for Doubtful Accounts Accounts Receivable—Wade Dolan Accounts Receivable—Greg Gagne Accounts Receivable—Amber Kisko Accounts Receivable—Shannon Poole Accounts Receivable—Niki Spence

24,955

31 Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts estimate ($47,090 – $1,545).

45,545

8,440

12,500

8,440

4,600 3,600 7,150 2,975 6,630

45,545

Computations: Aging Class (Number of Days Past Due) 0–30 days 31–60 days 61–90 days 91–120 days More than 120 days Total receivables

Receivables Balance on December 31

$320,000 110,000 24,000 18,000 43,000 $515,000

Estimated Doubtful Accounts Percent Amount

1% 3% 10% 33% 75%

$ 3,200 3,300 2,400 5,940 32,250 $47,090

Estimated balance of allowance account from aging schedule………………… Unadjusted credit balance of allowance account………………………………… Adjustment………………………………………………………………………………

$47,090 (1,545) $45,545

Unadjusted credit balance of allowance account = $36,000 – $8,440 – $9,500 + $8,440 – $24,955 = $1,545

CHAPTER 8

Receivables

Ex. 8–14 (Concluded) c.

Bad debt expense under: Allowance method……………………………………………………………… Direct write-off method ($8,440 + $9,500 – $8,440 + $24,955)…………… Difference…………………………………………………………………………

$ 45,545 (34,455) $ 11,090

Rustic Tables’ income would be $11,090 higher under the direct write-off method than under the allowance method.

Ex. 8–15 $693,700 [$712,500 + $48,600 – ($6,740,000 × 1%)]

Ex. 8–16 a.

$777,500 [$800,000 + $52,000 – ($7,450,000 × 1%)]

$41,300 ($67,400 – $48,600) + ($74,500 – $52,000)

Ex. 8–17 a.

Bad Debt Expense Accounts Receivable—Shawn Brooke Accounts Receivable—Eve Denton Accounts Receivable—Art Malloy Accounts Receivable—Cassie Yost

30,000

Allowance for Doubtful Accounts Accounts Receivable—Shawn Brooke Accounts Receivable—Eve Denton Accounts Receivable—Art Malloy Accounts Receivable—Cassie Yost

30,000

Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts estimate ($5,250,000 × 0.75%).

39,375

4,650 5,180 11,050 9,120 4,650 5,180 11,050 9,120

39,375

Net income would have been $9,375 higher under the direct write-off method because bad debt expense would have been $9,375 higher under the allowance method ($39,375 expense under the allowance method versus $30,000 expense under the direct write-off method).

CHAPTER 8

Receivables

Ex. 8–18 a.

Bad Debt Expense Accounts Receivable—Kim Abel Accounts Receivable—Lee Drake Accounts Receivable—Jenny Green Accounts Receivable—Mike Lamb

103,100

Allowance for Doubtful Accounts Accounts Receivable—Kim Abel Accounts Receivable—Lee Drake Accounts Receivable—Jenny Green Accounts Receivable—Mike Lamb

103,100

Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts estimate ($107,200 + $14,100).

121,300

24,300 31,195 29,715 17,890 24,300 31,195 29,715 17,890

121,300

Computations: Aging Class (Number of Days Past Due)

Receivables Balance on December 31

$ 735,000 290,000 111,000 70,000 94,000 $1,300,000

0–30 days 31–60 days 61–90 days 91–120 days More than 120 days Total receivables

Estimated Doubtful Accounts Percent Amount

1% 2% 15% 30% 60%

Unadjusted debit balance of Allowance for Doubtful Accounts ($103,100 – $89,000)……………………………………………………… Estimated balance of Allowance for Doubtful Accounts from aging schedule……………………………………………………… Adjustment…………………………………………………………………… c.

7,350 5,800 16,650 21,000 56,400 $107,200

$ 14,100 107,200 $121,300

Net income would have been $18,200 lower under the allowance method because bad debt expense would have been $18,200 higher under the allowance method ($121,300 expense under the allowance method versus $103,100 expense under the direct write-off method).

CHAPTER 8

Receivables

Ex. 8–19 Due Date a. b. c. d. e.

May 5 Mar. 17 July 3 Nov. 18 Jan. 17

Interest $2,000 100 620 530 700

[$100,000 × 0.06 × (120 ÷ 360)] [$30,000 × 0.04 × (30 ÷ 360)] [$62,000 × 0.08 × (45 ÷ 360)] [$42,400 × 0.05 × (90 ÷ 360)] [$40,000 × 0.07 × (90 ÷ 360)]

Ex. 8–20 a.

August 8 (20 + 31 + 30 + 31 + 8)

$61,200 [($60,000 × 6% × 120 ÷ 360) + $60,000]

(1) (2)

Notes Receivable Accounts Receivable—Valley Designs

60,000

Cash Notes Receivable Interest Revenue

61,200

60,000 60,000 1,200

Ex. 8–21 a.

Sale on account.

Cost of goods sold for the sale on account.

Note received from customer on account.

Note dishonored and charged face value of note plus interest to customer’s account receivable.

Payment received from customer for dishonored note plus interest earned after due date.

CHAPTER 8

Receivables

Ex. 8–22 20Y7 Dec.

20Y8 Feb.

7 Notes Receivable Accounts Receivable—Unitarian Clothing & Bags Co.

75,000

31 Interest Receivable Interest Revenue Accrued interest ($75,000 × 0.03 × 24 ÷ 360).

150

31 Interest Revenue Retained Earnings

150

75,000

150

5 Cash Notes Receivable Interest Receivable Interest Revenue ($75,000 × 0.03 × 36 ÷ 360)

75,375

23 Notes Receivable Accounts Receivable—Radon Express Co.

48,000

21 Accounts Receivable—Radon Express Co. Notes Receivable Interest Revenue ($48,000 × 0.08 × 90 ÷ 360)

48,960

21 Cash Accounts Receivable—Radon Express Co. Interest Revenue ($48,960 × 0.10 × 30 ÷ 360)

49,368

75,000 150 225

Ex. 8–23 June

Sept.

Oct.

48,000

48,000 960

48,960 408

CHAPTER 8

Receivables

Ex. 8–24 Mar.

29 Notes Receivable Accounts Receivable—Karie Platt

30,000

30 Notes Receivable Accounts Receivable—Jon Kelly

24,000

28 Accounts Receivable—Karie Platt Notes Receivable Interest Revenue ($30,000 × 5% × 60 ÷ 360)

30,250

June 29 Accounts Receivable—Jon Kelly Notes Receivable Interest Revenue ($24,000 × 8% × 60 ÷ 360)

24,320

Aug.

26 Cash Accounts Receivable—Karie Platt Interest Revenue ($30,250 × 8% × 90 ÷ 360)

30,855

22 Allowance for Doubtful Accounts Accounts Receivable—Jon Kelly

24,320

Apr.

May

Oct.

30,000

24,000

30,000 250

24,000 320

30,250 605

24,320

Ex. 8–25 1.

The interest receivable should be reported separately as a current asset. It should not be deducted from notes receivable.

The allowance for doubtful accounts should be deducted from accounts receivable. A corrected partial balance sheet would be as follows: Napa Vino Company Balance Sheet December 31, 20Y6 Assets

Current assets: Cash Notes receivable Accounts receivable Allowance for doubtful accounts Accounts receivable, net Interest receivable

78,500 300,000

$1,200,000 (11,500) 1,188,500 4,500

CHAPTER 8

Receivables

PROBLEMS Prob. 8–1A 2.

Feb.

May

Aug.

Oct.

Dec.

8 Cash Allowance for Doubtful Accounts Accounts Receivable—DeCoy Co.

7,200 10,800

27 Accounts Receivable—Seth Nelsen Allowance for Doubtful Accounts

7,350

27 Cash Accounts Receivable—Seth Nelsen

7,350

13 Allowance for Doubtful Accounts Accounts Receivable—Kat Tracks Co.

6,400

31 Accounts Receivable—Crawford Co. Allowance for Doubtful Accounts

3,880

31 Cash Accounts Receivable—Crawford Co.

3,880

31 Allowance for Doubtful Accounts Accounts Receivable—Newbauer Co. Accounts Receivable—Bonneville Co. Accounts Receivable—Crow Distributors Accounts Receivable—Fiber Optics

23,200

31 Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts estimate ($35,700 + $3,170).

38,870

18,000

7,350

6,400

3,880

7,190 5,500 9,400 1,110

38,870

CHAPTER 8

Receivables

Prob. 8–1A (Concluded) 1. and 2. Allowance for Doubtful Accounts Feb. Aug. Dec.

8 13 31

Dec.

10,800 6,400 23,200 Unadjusted balance

Jan. 1 May 27 Oct. 31

Balance

26,000 7,350 3,880

Dec. 31

Adjusting entry

38,870

Dec. 31

Adjusted balance

35,700

3,170

Bad Debt Expense Dec.

Adjusting entry

38,870

3. $1,749,300 ($1,785,000 – $35,700) 4. a. b. c.

$45,500 [$18,200,000 × (1/4 × 1%)] $42,330 ($45,500 – $3,170) $1,742,670 ($1,785,000 – $42,330)

CHAPTER 8

Receivables

Prob. 8–2A 1. Due Date

Customer

Number of Days Past Due

Adams Sports & Flies

May 22, 20Y4

223 days (9 + 30 + 31 + 31 + 30 + 31 + 30 + 31)

Blue Dun Flies

Oct. 10, 20Y4

82 days (21 + 30 + 31)

Cicada Fish Co.

Sept. 29, 20Y4

93 days (1 + 31 + 30 + 31)

Deschutes Sports

Oct. 20, 20Y4

72 days (11 + 30 + 31)

Green River Sports

Nov. 7, 20Y4

54 days (23 + 31)

Smith River Co.

Nov. 28, 20Y4

33 days (2 + 31)

Western Trout Company

Dec. 7, 20Y4

24 days

Wolfe Sports

Jan. 20, 20Y5

Not past due

2. and 3. Aging of Receivables Schedule December 31, 20Y4 Not Customer

Balance

AAA Outfitters

20,000

Brown Trout Fly Shop

7,500

Zigs Fish Adventures

4,000

Subtotals

1,300,000

Days Past Due

Past Due

1–30

31–60

61–90

91–120

Over 120

40,000

20,000

80,000

20,000 7,500 4,000 750,000

290,000

120,000

5,000

Adams Sports & Flies

5,000

Blue Dun Flies

4,900

Cicada Fish Co.

8,400

Deschutes Sports

7,000

Green River Sports

3,500

Smith River Co.

2,400

Western Trout Company

6,800

Wolfe Sports

4,400

1,342,400

754,400

296,800

125,900

51,900

28,400

85,000

10%

30%

40%

80%

7,544

5,936

12,590

15,570

11,360

68,000

Totals Percentage uncollectible

4,900 8,400 7,000

6,800

Estimate of uncollectible accounts

20Y4 Dec.

121,000

31 Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts estimate ($121,000 + $3,600).

124,600 124,600

On the balance sheet, assets would be overstated by $124,600 because the allowance for doubtful accounts would be understated by $124,600. In addition, the stockholders’ equity (retained earnings) would be overstated by $124,600 because bad debt expense would be understated and net income overstated by $124,600 on the income statement. 8-19 © 2022 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 8

Receivables

Prob. 8–3A 1.

Bad Debt Expense

Year

Expense Actually Reported

Expense Based on Estimate

Increase (Decrease) in Amount of Expense

1 2 3 4

$ 4,500 9,600 12,800 16,550

$ 9,000 12,500 15,000 22,000

$4,500 2,900 2,200 5,450

Balance of Allowance Account, End of Year

$ 4,500 7,400 9,600 15,050

Yes. The actual write-offs of accounts originating in the first two years are reasonably close to the expense that would have been charged to those years on the basis of 1% of sales. The total write-off of receivables originating in the first year amounted to $8,500 ($4,500 + $3,000 + $1,000), as compared with bad debt expense, based on the percentage of sales, of $9,000 ($900,000 × 1%). For the second year, the comparable amounts were $11,800 ($6,600 + $3,700 + $1,500) and $12,500 ($1,250,000 × 1%).

CHAPTER 8

Receivables

Prob. 8–4A (a)

(b)

Note

Due Date

Interest Due at Maturity

1. 2. 3. 4. 5. 6.

May 5 May 22 Dec. 10 Nov. 21 Feb. 17 Jan. 29

Dec.

10 Accounts Receivable Notes Receivable Interest Revenue

Dec.

$500 300 600 180 360 450

($75,000 × 60 ÷ 360 × 4%) ($40,000 × 45 ÷ 360 × 6%) ($36,000 × 120 ÷ 360 × 5%) ($27,000 × 30 ÷ 360 × 8%) ($48,000 × 90 ÷ 360 × 3%) ($72,000 × 45 ÷ 360 × 5%) 36,600 36,000 600

31 Interest Receivable Interest Revenue Accrued interest: $48,000 × 3% × 42 ÷ 360 $72,000 × 5% × 16 ÷ 360

Jan.

Feb.

328 = $168 160 $328

Total 4.

328

29 Cash Notes Receivable Interest Receivable Interest Revenue ($72,000 × 5% × 29 ÷ 360)

72,450

17 Cash Notes Receivable Interest Receivable Interest Revenue ($48,000 × 3% × 48 ÷ 360)

48,360

72,000 160 290

48,000 168 192

CHAPTER 8

Receivables

Prob. 8–5A Apr.

May

June

Aug.

Sept.

Oct.

Nov.

Dec.

10 Notes Receivable Accounts Receivable

144,000

15 Notes Receivable Accounts Receivable

270,000

9 Cash Notes Receivable Interest Revenue ($144,000 × 5% × 60 ÷ 360)

145,200

22 Notes Receivable Accounts Receivable

150,000

12 Cash Notes Receivable Interest Revenue ($270,000 × 7% × 120 ÷ 360)

276,300

30 Notes Receivable Accounts Receivable

210,000

6 Cash Notes Receivable Interest Revenue ($150,000 × 4% × 45 ÷ 360)

150,750

18 Notes Receivable Accounts Receivable

120,000

29 Cash Notes Receivable Interest Revenue

212,800

17 Cash Notes Receivable Interest Revenue

121,000

144,000

270,000

144,000 1,200

150,000

270,000 6,300

210,000

150,000 750

120,000

210,000 2,800

120,000 1,000

CHAPTER 8

Receivables

Prob. 8–6A Jan.

Feb.

Mar.

Apr.

May

July

3 Notes Receivable Cash

18,000

10 Accounts Receivable—Bradford & Co. Sales

24,000

10 Cost of Goods Sold Inventory

14,400

13 Accounts Receivable—Dry Creek Co. Sales

60,000

13 Cost of Goods Sold Inventory

54,000

12 Notes Receivable Accounts Receivable—Bradford & Co.

24,000

14 Notes Receivable Accounts Receivable—Dry Creek Co.

60,000

3 Notes Receivable Cash Notes Receivable Interest Revenue ($18,000 × 8% × 90 ÷ 360)

18,000 360

11 Cash Notes Receivable Interest Revenue ($24,000 × 7% × 60 ÷ 360)

24,280

13 Accounts Receivable—Dry Creek Co. Notes Receivable Interest Revenue ($60,000 × 9% × 60 ÷ 360)

60,900

12 Cash Accounts Receivable—Dry Creek Co. Interest Revenue ($60,900 × 12% × 60 ÷ 360)

62,118

18,000

24,000

14,400

60,000

54,000

24,000

60,000

18,000 360

24,000 280

60,000 900

60,900 1,218

CHAPTER 8

Receivables

Prob. 8–6A (Concluded) Aug.

Oct.

1 Cash Notes Receivable Interest Revenue ($18,000 × 9% × 120 ÷ 360)

18,540

5 Accounts Receivable—Halloran Co. Sales

13,230

5 Cost of Goods Sold Inventory

8,100

15 Cash Accounts Receivable—Halloran Co.

13,230

18,000 540

13,230

8,100

13,230

CHAPTER 8

Receivables

Prob. 8–1B 2.

Jan.

Apr.

July

Nov.

Dec.

19 Accounts Receivable—Arlene Gurley Allowance for Doubtful Accounts

2,660

19 Cash Accounts Receivable—Arlene Gurley

2,660

3 Allowance for Doubtful Accounts Accounts Receivable—Premier GS Co.

12,750

16 Cash Allowance for Doubtful Accounts Accounts Receivable—Hayden Co.

5,500 16,500

23 Accounts Receivable—Harry Carr Allowance for Doubtful Accounts

4,000

23 Cash Accounts Receivable—Harry Carr

4,000

31 Allowance for Doubtful Accounts Accounts Receivable—Cavey Co. Accounts Receivable—Fogle Co. Accounts Receivable—Lake Furniture Accounts Receivable—Melinda Shryer

24,000

31 Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts estimate ($60,000 – $3,410).

56,590

2,660

12,750

22,000

4,000

3,300 8,100 11,400 1,200

56,590

CHAPTER 8

Receivables

Prob. 8–1B (Concluded) 1. and 2. Allowance for Doubtful Accounts Apr. July Dec.

3 16 31

12,750 16,500 24,000

Jan. Jan. Nov.

1 19 23

Balance

50,000 2,660 4,000

Dec. Dec.

31 31

Unadjusted balance Adjusting entry

3,410 56,590

Dec.

Adjusted balance

60,000

Bad Debt Expense Dec.

Adjusting entry

56,590

$2,290,000 ($2,350,000 – $60,000)

a. b. c.

$79,000 [$15,800,000 × (1/2 × 1%)] $82,410 ($79,000 + $3,410) $2,267,590 ($2,350,000 – $82,410)

CHAPTER 8

Receivables

Prob. 8–2B 1. Customer Arcade Beauty Creative Images Excel Hair Products First Class Hair Care Golden Images Oh That Hair One Stop Hair Designs Visions Hair & Nail

Due Date

Number of Days Past Due

Aug. 17, 20Y7 Oct. 30, 20Y7 July 3, 20Y7 Sept. 8, 20Y7 Nov. 23, 20Y7 Nov. 29, 20Y7 Dec. 7, 20Y7 Jan. 11, 20Y8

136 days (14 + 30 + 31 + 30 + 31) 62 days (1 + 30 + 31) 181 days (28 + 31 + 30 + 31 + 30 + 31) 114 days (22 + 31 + 30 + 31) 38 days (7 + 31) 32 days (1 + 31) 24 days Not past due

2. and 3. Aging of Receivables Schedule December 31, 20Y7 Not Customer

Balance

ABC Beauty

15,000

Angel Wigs

8,000

Zodiac Beauty

3,000

Subtotals

875,000

Arcade Beauty

10,000

Creative Images

8,500

Excel Hair Products

7,500

First Class Hair Care

6,600

Golden Images

3,600

Oh That Hair

1,400

One Stop Hair Designs

4,000

Visions Hair & Nail Totals

Days Past Due

Past Due

1–30

31–60

61–90

91–120

Over 120

55,000

18,000

65,000

15,000 8,000 3,000 415,000

210,000

112,000

10,000 8,500 7,500 6,600 3,600 1,400 4,000

9,000

925,600

424,000

214,000

117,000

63,500

24,600

82,500

16%

25%

40%

80%

4,240

8,560

18,720

15,875

9,840

66,000

Percentage uncollectible Estimate of uncollectible accounts

123,235

CHAPTER 8

Receivables

Prob. 8–2B (Concluded) 4.

20Y7 Dec.

31 Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts estimate ($123,235 – $7,375).

115,860 115,860

On the balance sheet, assets would be overstated by $115,860 because the allowance for doubtful accounts would be understated by $115,860. In addition, the stockholders’ equity (retained earnings) would be overstated by $115,860 because bad debt expense would be understated and net income overstated by $115,860 on the income statement.

Prob. 8–3B 1.

Bad Debt Expense

Year

Expense Actually Reported

Expense Based on Estimate

Increase (Decrease) in Amount of Expense

Balance of Allowance Account, End of Year

1 2 3 4

$18,000 30,200 39,900 52,600

$31,250 37,000 45,000 60,000

$13,250 6,800 5,100 7,400

$13,250 20,050 25,150 32,550

Yes. The actual write-offs of accounts originating in the first two years are reasonably close to the expense that would have been charged to those years on the basis of 1/4% of sales. The total write-off of receivables originating in the first year amounted to $30,600 ($18,000 + $9,000 + $3,600), as compared with bad debt expense, based on the percentage of sales, of $31,250 ($12,500,000 × 0.0025). For the second year, the comparable amounts were $35,600 ($21,200 + $9,300 + $5,100) and $37,000 ($14,800,000 × 0.0025).

CHAPTER 8

Receivables

Prob. 8–4B (a)

(b)

Note

Due Date

Interest Due at Maturity

1. 2. 3. 4. 5. 6.

Feb. 13 Apr. 23 Oct. 10 Nov. 6 Jan. 14 Feb. 8

Oct.

10 Accounts Receivable Notes Receivable Interest Revenue

Dec.

$110 525 600 200 480 240

($33,000 × 30 ÷ 360 × 4%) ($60,000 × 45 ÷ 360 × 7%) ($48,000 × 90 ÷ 360 × 5%) ($16,000 × 75 ÷ 360 × 6%) ($36,000 × 60 ÷ 360 × 8%) ($24,000 × 60 ÷ 360 × 6%) 48,600 48,000 600

31 Interest Receivable Interest Revenue Accrued interest: $36,000 × 8% × 46 ÷ 360 $24,000 × 6% × 21 ÷ 360

Jan.

Feb.

452 = $368 84 $452

Total 4.

452

14 Cash Notes Receivable Interest Receivable Interest Revenue ($36,000 × 8% × 14 ÷ 360)

36,480

8 Cash Notes Receivable Interest Receivable Interest Revenue ($24,000 × 6% × 39 ÷ 360)

24,240

36,000 368 112

24,000 84 156

CHAPTER 8

Receivables

Prob. 8–5B Mar.

May

June

July

Aug.

Dec.

8 Notes Receivable Accounts Receivable

33,000

31 Notes Receivable Accounts Receivable

80,000

7 Cash Notes Receivable Interest Revenue ($33,000 × 5% × 60 ÷ 360)

33,275

16 Notes Receivable Accounts Receivable

72,000

11 Notes Receivable Accounts Receivable

36,000

29 Cash Notes Receivable Interest Revenue ($80,000 × 7% × 90 ÷ 360)

81,400

26 Cash Notes Receivable Interest Revenue ($36,000 × 6% × 45 ÷ 360)

36,270

4 Notes Receivable Accounts Receivable

48,000

14 Cash Notes Receivable Interest Revenue ($72,000 × 7% × 90 ÷ 360)

73,260

2 Cash Notes Receivable Interest Revenue

49,440

33,000

80,000

33,000 275

72,000

36,000

80,000 1,400

36,000 270

48,000

72,000 1,260

48,000 1,440

CHAPTER 8

Receivables

Prob. 8–6B Jan.

Mar.

May

June

July

Sept.

21 Accounts Receivable—Black Tie Co. Sales

28,000

21 Cost of Goods Sold Inventory

16,800

18 Notes Receivable Accounts Receivable—Black Tie Co.

28,000

17 Cash Notes Receivable Interest Revenue ($28,000 × 6% × 60 ÷ 360)

28,280

15 Accounts Receivable—Pioneer Co. Sales

17,523

15 Cost of Goods Sold Inventory

10,600

21 Notes Receivable Cash

18,000

25 Cash Accounts Receivable—Pioneer Co.

17,523

21 Notes Receivable Cash Notes Receivable Interest Revenue ($18,000 × 8% × 30 ÷ 360)

18,000 120

19 Cash Notes Receivable Interest Revenue ($18,000 × 9% × 60 ÷ 360)

18,270

22 Accounts Receivable—Wycoff Co. Sales

20,000

28,000

16,800

28,000

28,000 280

17,523

10,600

18,000

17,523

18,000 120

18,000 270

20,000

CHAPTER 8

Receivables

Prob. 8–6B (Concluded) Sept.

Oct.

Nov.

Dec.

22 Cost of Goods Sold Inventory

12,000

14 Notes Receivable Accounts Receivable—Wycoff Co.

20,000

13 Accounts Receivable—Wycoff Co. Notes Receivable Interest Revenue ($20,000 × 6% × 30 ÷ 360)

20,100

28 Cash Accounts Receivable—Wycoff Co. Interest Revenue ($20,100 × 8% × 45 ÷ 360)

20,301

12,000

20,000

20,000 100

20,100 201

CHAPTER 8

Receivables

MAKE A DECISION MAD 8–1 a.

Sales Average Accounts Receivable

Accounts Receivable Turnover = Amazon:

$177,866 ($16,677 + $20,816) ÷ 2

$177,866 $18,746.5

= 9.5

Best Buy:

$42,879 ($1,015 + $1,049) ÷ 2

$42,879 $1,032.0

= 41.5

Average Accounts Receivable Average Daily Sales

Days’ Sales in Receivables =

Amazon:

($16,677 + $20,816) ÷ 2 $177,866 ÷ 365 days

$18,746.5 = 38.5 days $487.3 per day

Best Buy:

($1,015 + $1,049) ÷ 2 $42,879 ÷ 365 days

$1,032.0 = 8.8 days $117.5 per day

c. Best Buy turns accounts receivable into cash 41.5 times per year, while Amazon only turns the receivables into cash 9.5 times per year. Likewise, Best Buy has only 8.8 days of sales in accounts receivable, while Amazon has 38.5 days of sales in accounts receivable. By these metrics, it appears Best Buy is more efficient than Amazon in turning accounts receivable into cash. d. The large difference in the ratios between these two companies suggests that there is a fundamental difference in the accounts receivable collection policies or in the types of customers served by the two companies. The most likely explanation is a difference in their customers. Retail customers frequently purchase goods with cash or credit card; thus, no accounts receivable is established upon sale. However, accounts receivable are more frequently established with sales to business customers. Thus, it is likely the sales to business customers as a proportion of total sales is higher for Amazon than it is for Best Buy. If so, this would explain the difference between the two ratios. MAD 8–2 a.

Accounts Receivable Turnover =

Sales Average Accounts Receivable

Year 1:

$6,182.3 ($450.2 + $421.4) ÷ 2

$6,182.3 $435.8

= 14.2

Year 2:

$6,313.0 ($421.4 + $398.1) ÷ 2

$6,313.0 $409.8

= 15.4

CHAPTER 8

Receivables

MAD 8–2 (Concluded) b.

Days’ Sales in Receivables =

Average Accounts Receivable Average Daily Sales

Year 1:

($450.2 + $421.4) ÷ 2 $6,182.3 ÷ 365 days

$435.8 = 25.8 days $16.9 per day

Year 2:

($421.4 + $398.1) ÷ 2 $6,313.0 ÷ 365 days

$409.8 = 23.7 days $17.3 per day

c. The accounts receivable turnover has increased from 14.2 to 15.4 between the two years. In addition, the days’ sales in receivables decreased from 25.8 days to 23.7 days. There appears to be an increase in the efficiency in collecting accounts receivable between the two years.

MAD 8–3 a.

Accounts Receivable Turnover =

Sales Average Accounts Receivable

Year 1:

$12,632 ($294 + $310) ÷ 2

$12,632 $302.0

= 41.8

Year 2:

$13,237 ($310 + $367) ÷ 2

$13,237 $338.5

= 39.1

Days’ Sales in Receivables = Year 1:

($294 + $310) ÷ 2 $12,632 ÷ 365 days

Year 2:

($310 + $367) ÷ 2 $13,237 ÷ 365 days

Average Accounts Receivable Average Daily Sales $302.0 = 8.7 days $34.6 per day $338.5 $36.3

= 9.3 days

c. The accounts receivable turnover decreased from 41.8 to 39.1, indicating a decrease in the efficiency of collecting accounts receivable. The days’ sales in receivables increased from 8.7 days to 9.3 days, also indicating a decrease in the efficiency of collecting receivables. Before reaching a conclusion, however, the ratios should be compared with industry averages and similar firms.

CHAPTER 8

Receivables

MAD 8–4 a. The average accounts receivable turnover for each company follows: Ralph Lauren: 14.8 [(14.2 + 15.4) ÷ 2] L Brands: 40.5 [(41.8 + 39.1) ÷ 2] Note: Computations for the individual ratios are provided in the solutions to MAD 8–2 and MAD 8–3. b. L Brands has the higher average accounts receivable turnover. c. L Brands operates a specialty retail chain of stores that sell directly to individual consumers. Many of these consumers (retail customers) pay with credit cards or with cash. In contrast, Ralph Lauren sells its products to retailers, which are then sold to the final consumer. Ralph Lauren has a business-to-business relationship wherein trade accounts are a normal part of the sales cycle. Thus, we would expect Ralph Lauren to have more accounts receivable supporting its sales than would L Brands. In addition, we would expect Ralph Lauren’s business customers to take a longer period to pay their receivables. Thus, we would expect Ralph Lauren’s average accounts receivable turnover across the two years to be lower than L Brands, as shown in (a).

MAD 8–5 a.

Accounts Receivable Turnover =

Sales Average Accounts Receivable

Year 1:

$13,621 ($654 + $640) ÷ 2

$13,621 $647

= 21.1

Year 2:

$12,808 ($640 + $588) ÷ 2

$12,808 $614

= 20.9

Average Accounts Receivable Average Daily Sales

Days’ Sales in Receivables = Year 1:

($654 + $640) ÷ 2 $13,621 ÷ 365 days

$647 = 17.3 days $37.3 per day

Year 2:

($640 + $588) ÷ 2 $12,808 ÷ 365 days

$614 = 17.5 days $35.1 per day

c. The accounts receivable turnover decreased from 21.1 to 20.9, indicating a decrease in the efficiency of collecting accounts receivable. The days’ sales in receivables increased from 17.3 days to 17.5 days, also indicating a decrease in the efficiency of collecting receivables.

CHAPTER 8

Receivables

TAKE IT FURTHER TIF 8–1 Estimates of uncollectible accounts receivable create a unique financial reporting challenge. Because the company does not know with certainty the amount of accounts receivable that will be uncollectible, there is no “correct” estimate. The company must use its judgment along with historical data to develop an estimate that fairly presents the portion of credit sales that will become uncollectible. These estimates are required under GAAP and should be representationally faithful and accurately match bad debt expense to revenues generated from credit sales. In this case, both Tim and Gowen appear to be acting unethically. The historical data indicate that a higher estimate is needed, and they have both knowingly ignored these data in order to improve the company’s reported earnings. Tim and Gowen have used the subjectivity in these estimates inappropriately. The result is a bad debt expense amount that does not faithfully represent the potential losses associated with uncollectible accounts receivable. TIF 8–2 By computing interest using a 365-day year for depository accounts (liabilities), Bev is minimizing interest expense to the bank. By computing interest using a 360-day year for loans (assets), Bev is maximizing interest revenue to the bank. However, federal legislation (Truth in Lending Act) requires banks to compute interest on a 365-day year. Hence, Bev is behaving in an unprofessional manner.

TIF 8–3 A sample solution based on Under Armour's Form 10-K for the fiscal year ended December 31, 2019, follows: 1. a. $708.714 million (from balance sheet) b. $15.1 million (from Note 2 to the financial statements) c. 26.2% ($708.714 ÷ $2,702.209) in 2019; 25.2% ($652.546 ÷ $2,593.628) in 2018. Accounts receivable as a percentage of total current assets has increased. d. Under Armour did not disclose the amount of bad debt expense. 2. The company’s accounts receivable turnover has decreased between 2018 and 2019, as shown below. Amount in millions Accounts Receivable Turnover =

Sales Average Accounts Receivable

2018:

$5,193.185 $5,193.185 = = 8.2 $631.108 ($609.670 + $652.546) ÷ 2

2019:

$5,267.132 $5,267.132 = = 7.7 $680.630 ($652.546 + $708.714) ÷ 2 8-36

CHAPTER 8

Receivables

TIF 8–4 To: From: Re:

Todd Hurley, CEO A+ Student Allowance Method for Uncollectible Accounts

Accounts receivable result from the sale of goods to customers on account. Because payment is received from customers after goods are delivered, there is a risk that customers will default on their accounts. While the company does not know which customers will default, it does have historical information on the portion of accounts receivable that has become uncollectible in the past. The allowance method uses this information to estimate the amount of accounts receivable that will be uncollectible at the end of the accounting period. Based on this estimate, an adjusting entry is used to record bad debt expense. However, because the company does not know which customer accounts will be uncollectible, the specific customer accounts cannot be removed. Instead, a contra asset account, Allowance for Doubtful Accounts, is credited for the estimated bad debts in the adjusting journal entry: Bad Debt Expense Allowance for Doubtful Accounts

XXX XXX

This adjusting entry affects both the income statement and balance sheet. On the income statement, bad debt expense is matched against the revenues generated by the accounts receivable. On the balance sheet, the accounts receivable balance is reduced by the allowance for doubtful accounts, which is the portion of the accounts receivable that the company does not expect to collect. This resulting number is the amount of accounts receivable that the company expects to collect, called the net realizable value of the receivables. When a specific customer’s account is identified as uncollectible, it is written off against the allowance account. This requires the company to remove the specific account receivable from the accounts receivable ledger and an equal amount from the allowance account. Because the adjusting entry for bad debt expense is an estimate and the write-off of accounts receivable is based on actual defaults, the allowance account will rarely have a zero balance at the beginning or end of a period.

CHAPTER 8

TIF 8–5 1. Year 20Y4 20Y5 20Y6 20Y7 2.

a. Addition to Allowance for Doubtful Accounts $20,000 22,000 24,000 25,500

Receivables

b. Accounts Written Off During Year $15,000 ($20,000 – $5,000) 18,750 ($5,000 + $22,000 – $8,250) 22,050 ($8,250 + $24,000 – $10,200) 21,300 ($10,200 + $25,500 – $14,400)

a. The estimate of 1/2 of 1% of credit sales may be too large because the allowance for doubtful accounts has steadily increased each year. The increasing balance of the allowance for doubtful accounts may also be due to the failure to write off a large number of uncollectible accounts. These possibilities could be evaluated by examining the accounts in the accounts receivable subsidiary ledger for collectability and comparing the result with the balance in the allowance for doubtful accounts. Note to Instructors: Because the allowance for doubtful accounts increased by 188% [($14,400 – $5,000) ÷ $5,000] while sales increased by 27.5% [($5,100,000 – $4,000,000) ÷ $4,000,000], the increase cannot be explained by an expanding volume of sales. b. The balance of Allowance for Doubtful Accounts that should exist at December 31, 20Y7, can only be determined after all attempts have been made to collect the receivables on hand at December 31, 20Y7. However, the account balances at December 31, 20Y7, could be analyzed, perhaps using an aging schedule, to determine a reasonable amount of allowance and to determine accounts that should be written off. Also, past write-offs of uncollectible accounts could be analyzed in depth in order to develop a reasonable percentage for future adjusting entries, based on past history. Caution, however, must be exercised in using historical percentages. Specifically, inquiries should be made to determine whether any significant changes between prior years and the current year may have occurred, which might reduce the accuracy of using historical data. For example, a recent change in credit-granting policies or changes in the general economy (entering a recessionary period, for example) could reduce the usefulness of analyzing historical data. Based on the preceding analyses, a recommendation to decrease the annual rate charged as an expense may be in order (perhaps Xtreme Co. is experiencing a lower rate of uncollectibles than is the industry average), or perhaps a change to the “estimate based on analysis of receivables” method may be appropriate.

CHAPTER 8

Receivables

TIF 8–6 1. Average days’ sales in receivable by customer type: National Large regional Small regional Local Overall average

52.80 days 28.33 days 20.25 days 11.38 days 25.44 days

2. Write-offs by customer type: Large regional Local National Small regional Grand total

0.22% 10.29% 0.00% 1.02% 1.53%

$ 2,300 43,609 0 7,456 $53,365

3. Returns as a percent of credit sales by customer type: Returns as a Percent of Credit Sales

Large regional Local National Small regional

0.55% 5.43% 6.20% 1.67%

Overall percentage

3.47%

4. The first analysis of average days’ sales in receivables indicates that the national chains’ days’ sales in receivables of 52.80 days is significantly higher than the other categories of customers. The large regional chains take 28.33 days, the small regional chains take 20.25 days, while the local stores take only 11.38 days. Gene O’Neil could use this analysis as a basis for revising Landry Marine's credit terms of n/30 days by customer type. The second analysis, write-offs by customer type, indicates that write-offs are largest for locally owned stores. Gene O’Neil could use this analysis as a basis for implementing stronger credit reviews of locally owned stores. The third analysis of returns as a percent of credit sales indicates that locally owned and national chains return more merchandise. This analysis could be used by Gene O’Neil as a basis for revising sales and return policies for these customer types. For example, Landry Marine might discontinue sales to a locally owned store that returns large quantities of merchandise or implement a no return policy for locally owned stores.

CHAPTER 9 LONG-TERM ASSETS: FIXED AND INTANGIBLE DISCUSSION QUESTIONS 1.

a. b.

Real estate acquired as speculation should be listed in the balance sheet under the caption “Investments,” below the “Current assets” section.

$1,100,000

Capital expenditures include the cost of acquiring fixed assets and the cost of improving an asset. These costs are recorded by increasing (debiting) a fixed asset account. Capital expenditures also include the costs of extraordinary repairs, which are recorded by decreasing (debiting) the asset’s accumulated depreciation account. Revenue expenditures are recorded as expenses and are costs that benefit only the current period and are incurred for normal maintenance and repairs of fixed assets.

Capital expenditure

12 years

a. b.

No No

An accelerated depreciation method is most appropriate for situations in which the decline in productivity or earning power of the asset is proportionately greater in the early years of use than in later years, and the repairs tend to increase with the age of the asset.

An accelerated depreciation method reduces income tax payable to the IRS in the earlier periods of an asset’s life. Thus, cash is freed up in the earlier periods to be used for other business purposes.

No, the accumulated depreciation for an asset cannot exceed the cost of the asset. To do so would create a negative book value, which is meaningless.

The cost and accumulated depreciation should be removed from the accounts when the asset is no longer useful and is removed from service. Presumably, the asset will then be sold, traded in, or discarded.

10. a. b. c.

O’Neil Office Supplies: Property, plant, and equipment or Fixed assets Collins Auto Sales: Current assets (inventory)

The cost of a patent should be amortized over the shorter of its legal life or years of usefulness. Research and development costs should be expensed as incurred. Goodwill should not be amortized but written down when impaired.

CHAPTER 9

Long-Term Assets: Fixed and Intangible

BASIC EXERCISES BE 9–1 a. b. c.

$1,600,000 ($1,800,000 – $200,000) 5% (1 ÷ 20) $80,000 ($1,600,000 × 5%), or ($1,600,000 ÷ 20 years)

BE 9–2 a. b. c.

$58,000 ($60,000 – $2,000) $0.29 per mile ($58,000 ÷ 200,000 miles) $4,350 (15,000 miles × $0.29)

BE 9–3 a. b.

5% [(100% ÷ 40) × 2] $192,500 ($3,850,000 × 5%)

BE 9–4 a. b. c.

$18,450 [($240,000 – $18,600) ÷ 12] $55,500 [$240,000 – ($18,450 × 10)] $12,675 [($55,500 – $4,800) ÷ 4]

BE 9–5 Feb.

14 Accumulated Depreciation—Delivery Van Cash 14 Delivery Van Cash

2,300 2,300 450 450

CHAPTER 9

Long-Term Assets: Fixed and Intangible

BE 9–6 a.

$160,000 = $800,000 × [(100% ÷ 10) × 2] = $800,000 × 20.0%

$138,000 gain, computed as follows: Cost…………………………………………… $ 800,000 (160,000) First-year depreciation………………… Second-year depreciation……………… (128,000) [($800,000 – $160,000) × 20.0%] Book value at end of second year……… $ 512,000 Gain on sale ($650,000 – $512,000) = $138,000

Dec.

31 Cash Accumulated Depreciation—Equipment Equipment Gain on Sale of Equipment

650,000 288,000 800,000 138,000

BE 9–7 a.

$1.04 per ton = $494,000,000 ÷ 475,000,000 tons

$32,760,000 = 31,500,000 tons × $1.04 per ton

Dec.

31 Depletion Expense Accumulated Depletion Depletion of mineral deposit.

32,760,000 32,760,000

CHAPTER 9

Long-Term Assets: Fixed and Intangible

BE 9–8 a.

Apr.

Dec.

1 Patent Cash Acquired patent.

1,500,000 1,500,000

31 Amortization Expense—Patents Patents Amortized patent rights [($1,500,000 ÷ 12) × 9 ÷ 12]. 31 Loss from Impaired Goodwill Goodwill Impaired goodwill.

93,750 93,750

6,000,000 6,000,000

BE 9–9 a.

Fixed Asset Turnover Ratio =

Sales Average Book Value of Fixed Assets

20Y4:

$1,125,000 ($580,000 + $670,000) ÷ 2

$1,125,000 = 1.8 $625,000

20Y5:

$1,668,000 ($670,000 + $720,000) ÷ 2

$1,668,000 = 2.4 $695,000

The increase in the fixed asset turnover ratio from 1.8 to 2.4 indicates a favorable change in the efficiency of using fixed assets to generate sales.

CHAPTER 9

Long-Term Assets: Fixed and Intangible

EXERCISES Ex. 9–1 a. b.

New printing press: 1, 2, 3, 5, 6 Used printing press: 7, 8, 9, 11

Ex. 9–2 a.

Yes. All expenditures incurred for the purpose of making the land suitable for its intended use should be debited to the land account.

No. Land is not depreciated.

Ex. 9–3 Purchase price of land ($60,000 + $100,000)…………… Legal fees………………………………………………… $ 1,250 10,000 Delinquent taxes………………………………………… 8,000 Demolition of building………………………………… Total costs…………………………………………………… Salvage of materials………………………………………… Cost of land to be reported…………………………………

$160,000

19,250 $179,250 (1,500) $177,750

Ex. 9–4 a.

No. The $65,500,000 represents the original cost of the equipment. Its replacement cost, which may be more or less than $65,500,000, is not reported in the financial statements.

No. The $33,415,000 is the accumulation of the past depreciation charges on the equipment. The recognition of depreciation expense has no relationship to the cash account or accumulation of cash funds.

Ex. 9–5 (a) 25% (1 ÷ 4), (b) 12.5% (1 ÷ 8), (c) 10% (1 ÷ 10), (d) 6.25% (1 ÷ 16), (e) 4% (1 ÷ 25), (f) 2.5% (1 ÷ 40), (g) 2% (1 ÷ 50) Ex. 9–6 $10,100 [($85,000 – $4,200) ÷ 8] Ex. 9–7 $115,000 – $10,000 28,000 hours

= $3.75 depreciation per hour

160 hours at $3.75 = $600 depreciation for April

CHAPTER 9

Long-Term Assets: Fixed and Intangible

Ex. 9–8 a.

Depreciation rate per mile: Truck 1 Truck 2 Truck 3 Truck 4

($80,000 – $15,000) ($54,000 – $6,000) ($72,900 – $10,900) ($90,000 – $22,800)

÷ 250,000 = $0.26 ÷ 300,000 = $0.16 ÷ 200,000 = $0.31 ÷ 240,000 = $0.28

Credit to Accumulated Rate per Mile Depreciation Truck No. Miles Operated $ 5,460 1 $0.26 21,000 5,360 2 0.16 33,500 1,860 3 0.31 8,000 6,300 4 0.28 22,500 $18,980 Total………………………………………………………………… Note: Mileage depreciation of $2,480 (31 cents × 8,000) is limited to $1,860 for Truck 3, which reduces the book value of the truck to $10,900, its residual value.

Dec. 31 Depreciation Expense—Trucks Accumulated Depreciation—Trucks Truck depreciation.

18,980 18,980

Ex. 9–9 First Year

Second Year

10% of $90,000 = $9,000 or $90,000 ÷ 10 = $9,000

20% of $90,000 = $18,000

20% of ($90,000 – $18,000) = $14,400

Ex. 9–10 a.

$3,120 [($90,000 – $12,000) × 4%] or [($90,000 – $12,000) ÷ 25]

Year 1: 8% of $90,000 = $7,200 Year 2: 8% of ($90,000 – $7,200) = $6,624

CHAPTER 9

Long-Term Assets: Fixed and Intangible

Ex. 9–11 a.

Year 1: 8 ÷ 12 × [($105,000 – $12,000) ÷ 10] = $6,200 Year 2: ($105,000 – $12,000) ÷ 10 = $9,300

Year 1: 8 ÷ 12 × 20% of $105,000 = $14,000 Year 2: 20% of ($105,000 – $14,000) = $18,200

Ex. 9–12 a.

$52,875 [($2,200,000 – $85,000) ÷ 40] or [($2,200,000 – $85,000) × 2.5%]

$719,500 [$2,200,000 – ($52,875 × 28 yrs.)]

$131,900 [($719,500 – $60,000) ÷ 5 yrs.]

Ex. 9–13 Capital expenditures: 3, 4, 5, 6, 7, 9, 10 Revenue expenditures: 1, 2, 8

Ex. 9–14 Capital expenditures: 2, 3, 4, 8, 9, 10 Revenue expenditures: 1, 5, 6, 7

Ex. 9–15 Mar.

June

Nov.

20 Accumulated Depreciation—Delivery Truck Cash

1,890

11 Delivery Truck Cash

1,350

1,890

1,350

30 Repairs and Maintenance Expense Cash

CHAPTER 9

Long-Term Assets: Fixed and Intangible

Ex. 9–16 a.

Apr.

b. Dec.

30 Carpet Cash

18,000 18,000

31 Depreciation Expense—Carpet Accumulated Depreciation—Carpet Carpet depreciation [($18,000 ÷ 15 years) × 8 ÷ 12].

800 800

Ex. 9–17 a. Cost of equipment…………………………………………………………………… $212,000 Accumulated depreciation at end of fifth year, December 31 (66,000) (5 years at $13,200* per year)…………………………………………………… $146,000 Book value at end of fifth year, December 31…………………………………… * Yearly depreciation = ($212,000 – $14,000) ÷ 15 = $13,200 b.

Apr.

1 Depreciation Expense—Equipment Accumulated Depreciation—Equipment Equipment depreciation ($13,200 × 3 ÷ 12). 1 Cash Accumulated Depreciation—Equipment Loss on Sale of Equipment Equipment

3,300 3,300

105,800 69,300 36,900 212,000

Loss on sale of equipment = [($212,000 – $69,300) – $105,800] = $(36,900)

CHAPTER 9

Long-Term Assets: Fixed and Intangible

Ex. 9–18 a.

Year 1 depreciation expense: $19,500 [($425,000 – $35,000) ÷ 20] Year 2 depreciation expense: $19,500 Year 3 depreciation expense: $19,500

$366,500 [$425,000 – $58,500 ($19,500 × 3)]

Year 4 Jan.

3 Cash Accumulated Depreciation—Equipment Loss on Sale of Equipment Equipment

360,000 58,500 6,500 425,000

Loss on sale of equipment = $366,500 – $360,000 = $(6,500)

Year 4 Jan.

3 Cash Accumulated Depreciation—Equipment Equipment Gain on Sale of Equipment

370,000 58,500 425,000 3,500

Gain on sale of equipment = $370,000 – $366,500 = $3,500

Ex. 9–19 a.

$67,500,000 ÷ 30,000,000 tons = $2.25 depletion per ton 4,000,000 tons × $2.25 = $9,000,000 depletion expense

Dec.

31 Depletion Expense Accumulated Depletion Depletion of mineral deposit.

9,000,000 9,000,000

Ex. 9–20 a.

($2,800,000 ÷ 8) + ($38,000 ÷ 5) = $357,600 total patent amortization expense

Dec.

31 Amortization Expense—Patents Patents Amortized patent rights ($350,000 + $7,600).

357,600 357,600

CHAPTER 9

Long-Term Assets: Fixed and Intangible

Ex. 9–21 a.

Property, plant, and equipment (in millions): Current Year Land and buildings………………………………………………… $ 17,085 Machinery, equipment, and internal-use software…………… 69,797 9,075 Other fixed assets ………………………………………………… Total cost …………………………………………………………… $ 95,957 (58,579) Accumulated depreciation and amortization………………… Book value…………………………………………………………… $ 37,378

Preceding Year $ 16,216 65,982 8,205 $ 90,403 (49,099) $ 41,304

A comparison of the book values of the current and preceding years indicates that they decreased. A comparison of the total cost and accumulated depreciation reveals that Apple purchased $5,554 million ($95,957 – $90,403) of additional fixed assets, which was offset by the additional depreciation expense of $9,480 million ($58,579 – $49,099) taken during the current year. b.

We would expect Apple’s book value of fixed assets to increase during the year as its sales increase. Although additional depreciation expense for the current year will reduce the book value, most companies invest in new assets in an amount that is at least equal to the depreciation expense. However, during the current year, Apple experienced a decrease in sales. In periods of economic downturn, companies purchase fewer fixed assets, and the book value of their fixed assets may decline.

Ex. 9–22 1.

Fixed assets should be reported at cost and not replacement cost.

Land does not depreciate.

Patents and goodwill are intangible assets that should be listed in a separate section following the “Fixed assets” section. Patents should be reported at their net book values (cost less amortization to date). Goodwill should not be amortized but should be only written down upon impairment.

CHAPTER 9

Long-Term Assets: Fixed and Intangible

Appendix Ex. 9–23 a. Price (fair market value) of new equipment…………………… Trade-in allowance of old equipment…………………………… Cash paid on the date of exchange………………………………

$275,000 (90,000) $185,000

b. Fair market value (trade-in allowance) of old equipment…… Book value of old equipment……………………………………… Gain on exchange of equipment…………………………………

$ 90,000 (68,000) $ 22,000

or Price (fair market value) of new equipment…………………… Assets given up in exchange: Book value of old equipment………………………………… Cash paid on the exchange…………………………………… Gain on exchange of equipment…………………………………

$ 275,000 $ 68,000 185,000

(253,000) $ 22,000

Appendix Ex. 9–24 a. Price (fair market value) of new equipment…………………… Trade-in allowance of old equipment…………………………… Cash paid on the date of exchange………………………………

$ 275,000 (90,000) $ 185,000

b. Fair market value (trade-in allowance) of old equipment…… Book value of old equipment……………………………………… Loss on exchange of equipment…………………………………

$ 90,000 (108,500) $ (18,500)

or Price (fair market value) of new equipment…………………… Assets given up in exchange: Book value of old equipment………………………………… Cash paid on the exchange…………………………………… Loss on exchange of equipment…………………………………

$ 275,000 $108,500 185,000

(293,500) $ (18,500)

CHAPTER 9

Long-Term Assets: Fixed and Intangible

Appendix Ex. 9–25 a.

July

1 Depreciation Expense—Equipment Accumulated Depreciation—Equipment Equipment depreciation ($12,000 × 6 ÷ 12). 1 Accumulated Depreciation—Equipment Equipment Loss on Exchange of Equipment Equipment Cash

6,000 6,000 126,000 220,000 9,000 180,000 175,000

Appendix Ex. 9–26 a.

Oct.

1 Depreciation Expense—Truck Accumulated Depreciation—Truck Truck depreciation ($7,000 × 9 ÷ 12).

5,250

1 Accumulated Depreciation—Truck Truck Truck Cash Gain on Exchange of Truck

40,250 75,000

5,250

56,000 51,000 8,250

CHAPTER 9

Long-Term Assets: Fixed and Intangible

PROBLEMS Prob. 9–1A 1. Item a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q. r. s.

Land $

Building

Other Accounts

2,500 340,000 15,500 5,000 (4,000) * 29,000 $ 60,000 6,000 12,000 $(900,000)* 5,500 $32,000 11,000 2,000 2,500 (7,500)*

$400,000

Land Improvements

$45,000

800,000 34,500 (500)* $900,000

* Receipt. 3.

Land used as a plant site does not lose its ability to provide services; thus, it is not depreciated. However, land improvements do lose their ability to provide services as time passes and are, therefore, depreciated.

Because land improvements are depreciated, depreciation expense of $1,200 ($12,000 × 1 ÷ 20 × 2) would be overstated, and net income would be understated by $1,200 on the income statement. On the balance sheet, Land would be understated by $12,000, Land Improvements would be overstated by $10,800 ($12,000 – $1,200), and Retained Earnings would be understated by $1,200.

CHAPTER 9

Long-Term Assets: Fixed and Intangible

Prob. 9–2A Depreciation Expense

Year

a. StraightLine Method

b. Units-ofActivity Method

c. DoubleDeclining-Balance Method

Year 1 Year 2 Year 3 Total

$25,800 25,800 25,800 $77,400

$29,412 23,220 24,768 $77,400

$54,600 18,200 4,600 $77,400

Calculations: Straight-line method: ($81,900 – $4,500) ÷ 3 = $25,800 each year Units-of-activity method: ($81,900 – $4,500) ÷ 20,000 hours = $3.87 per hour Year 1: Year 2: Year 3:

7,600 hours × $3.87 = $29,412 6,000 hours × $3.87 = $23,220 6,400 hours × $3.87 = $24,768

Double-declining-balance method: Year 1: Year 2: Year 3:

$81,900 × (2 ÷ 3) = $54,600 ($81,900 – $54,600) × (2 ÷ 3) = $18,200 ($81,900 – $54,600 – $18,200 – $4,500) = $4,600

Note: Book value should not be reduced below the residual value of $4,500.

The double-declining-balance method yields the most depreciation expense in Year 1 of $54,600.

Over the 3-year life of the equipment, all three depreciation methods yield the same total depreciation, $77,400, which is the cost of the equipment of $81,900 less the residual value of $4,500.

CHAPTER 9

Long-Term Assets: Fixed and Intangible

Prob. 9–3A a.

Straight-line method: Year 1: Year 2: Year 3: Year 4:

Units-of-activity method: Activity rate = ($270,000 – $9,000) ÷ 18,000 hours = $14.50 per hour Year 1: Year 2: Year 3: Year 4:

[($270,000 – $9,000) ÷ 3] × 9 ÷ 12…………………………………… $65,250 ($270,000 – $9,000) ÷ 3………………………………………………… 87,000 ($270,000 – $9,000) ÷ 3………………………………………………… 87,000 [($270,000 – $9,000) ÷ 3] × 3 ÷ 12…………………………………… 21,750

7,500 hours × $14.50………………………………………………… 5,500 hours × $14.50………………………………………………… 4,000 hours × $14.50………………………………………………… 1,000 hours × $14.50…………………………………………………

$108,750 79,750 58,000 14,500

Double-declining-balance method: Year 1: Year 2: Year 3: Year 4:

$270,000 × 2 ÷ 3 × 9 ÷ 12…………...………………………………… $135,000 ($270,000 – $135,000) × 2 ÷ 3………………………………………… 90,000 ($270,000 – $135,000 – $90,000) × 2 ÷ 3…………………………… 30,000 ($270,000 – $135,000 – $90,000 – $30,000 – $9,000)……………… 6,000

Note: Book value should not be reduced below $9,000, the residual value.

CHAPTER 9

Long-Term Assets: Fixed and Intangible

Prob. 9–4A 1. Depreciation Expense

Year

Accumulated Depreciation, End of Year

Book Value, End of Year

$142,000 284,000 426,000 568,000 710,000

$658,000 516,000 374,000 232,000 90,000

$320,000 512,000 627,200 696,320 710,000

$480,000 288,000 172,800 103,680 90,000

1……………………………………………… $142,000 2……………………………………………… 142,000 3……………………………………………… 142,000 4……………………………………………… 142,000 5……………………………………………… 142,000 Yearly depreciation = [($800,000 – $90,000) ÷ 5] = $142,000

1 2 3 4 5

[$800,000 × (100% ÷ 5) × 2]………… $320,000 [$480,000 × (100% ÷ 5) × 2]………… 192,000 [$288,000 × (100% ÷ 5) × 2]………… 115,200 [$172,800 × (100% ÷ 5) × 2]………… 69,120 ($800,000 – $696,320 – $90,000)…… 13,680

Note: Book value should not be reduced below $90,000, the residual value.

Mar.

4 Cash Accumulated Depreciation—Equipment Equipment Gain on Sale of Equipment

135,000 696,320 800,000 31,320

Gain on sale of equipment = $135,000 – ($800,000 – $696,320) = $31,320

Mar.

4 Cash Accumulated Depreciation—Equipment Loss on Sale of Equipment Equipment

88,750 696,320 14,930 800,000

Loss on sale of equipment = $88,750 – ($800,000 – $696,320) = $(14,930)

CHAPTER 9

Long-Term Assets: Fixed and Intangible

Prob. 9–5A Year 1 Jan.

Nov.

Dec.

Year 2 Jan.

Apr.

4 Delivery Truck Cash

32,000 32,000

2 Truck Repair and Maintenance Expense Cash

950

31 Depreciation Expense—Delivery Truck Accum. Depreciation—Delivery Truck Delivery truck depreciation [$32,000 × (100% ÷ 4 × 2)].

16,000

6 Delivery Truck Cash

80,000

1 Depreciation Expense—Delivery Truck Accum. Depreciation—Delivery Truck Delivery truck depreciation

2,000

950

16,000

80,000

2,000

[($32,000 – $16,000) × (100% ÷ 4 × 2) × 3 ÷ 12].

June

Dec.

1 Accum. Depreciation—Delivery Truck Cash Delivery Truck Gain on Sale of Delivery Truck

18,000 16,000

11 Truck Repair and Maintenance Expense Cash

310

31 Depreciation Expense—Delivery Truck Accum. Depreciation—Delivery Truck Delivery truck depreciation [$80,000 × (100% ÷ 5 × 2)].

32,000

32,000 2,000

310

32,000

CHAPTER 9

Long-Term Assets: Fixed and Intangible

Prob. 9–5A (Concluded) Year 3 July 1 Delivery Truck Cash

85,000

Oct.

2 Depreciation Expense—Delivery Truck Accum. Depreciation—Delivery Truck Delivery truck depreciation [($80,000 – $32,000) × (100% ÷ 5 × 2) × 9 ÷ 12].

14,400

2 Cash Accum. Depreciation—Delivery Truck Loss on Sale of Delivery Truck Delivery Truck

18,250 46,400 15,350

31 Depreciation Expense—Delivery Truck Accum. Depreciation—Delivery Truck Delivery truck depreciation [$85,000 × (100% ÷ 8 × 2) × 6 ÷ 12].

10,625

Dec.

85,000

14,400

80,000

10,625

Prob. 9–6A 1. a.

$1,600,000 ÷ 5,000,000 board feet = $0.32 per board foot; 1,100,000 board feet × $0.32 per board foot = $352,000

Loss from impaired goodwill, $3,750,000

$6,600,000 ÷ 12 years = $550,000; 3/4 of $550,000 = $412,500

2. a.

Dec.

31 Depletion Expense Accumulated Depletion Depletion of timber rights.

352,000 352,000

31 Loss from Impaired Goodwill Goodwill Impaired goodwill.

3,750,000

31 Amortization Expense—Patents Patents Patent amortization.

412,500

3,750,000

412,500

CHAPTER 9

Long-Term Assets: Fixed and Intangible

Prob. 9–1B 1. Item a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q. r. s.

Land $

Building

Other Accounts

3,600 780,000 23,400 15,000 $ 75,000 10,000 (3,400) * 18,000 8,400 $(800,000) * 13,400 3,000 2,000 $14,000 21,600 40,000 (4,500) *

$860,000

Land Improvements

$35,600

800,000 (1,400)* $922,000

* Receipt. 3.

Because land improvements are depreciated, depreciation expense of $4,320 ($21,600 × 1 ÷ 10 × 2) would be understated, and net income would be overstated by $4,320 on the income statement. On the balance sheet, Land would be overstated by $21,600, Land Improvements would be understated by $17,280 ($21,600 – $4,320), and Retained Earnings would be overstated by $4,320.

CHAPTER 9

Long-Term Assets: Fixed and Intangible

Prob. 9–2B Depreciation Expense

Year

a. StraightLine Method

b. Units-ofActivity Method

c. DoubleDeclining-Balance Method

Year 1 Year 2 Year 3 Year 4 Total

$ 71,250 71,250 71,250 71,250 $285,000

$102,600 91,200 62,700 28,500 $285,000

$160,000 80,000 40,000 5,000 $285,000

Calculations: Straight-line method: ($320,000 – $35,000) ÷ 4 = $71,250 each year Units-of-activity method: ($320,000 – $35,000) ÷ 20,000 hours = $14.25 per hour Year 1: Year 2: Year 3: Year 4:

7,200 hours × $14.25 = $102,600 6,400 hours × $14.25 = $91,200 4,400 hours × $14.25 = $62,700 2,000 hours × $14.25 = $28,500

Double-declining-balance method: Year 1: Year 2: Year 3: Year 4:

$320,000 × [(100% ÷ 4) × 2] = $160,000 ($320,000 – $160,000) × [(100% ÷ 4) × 2] = $80,000 ($320,000 – $160,000 – $80,000) × [(100% ÷ 4) × 2] = $40,000 ($320,000 – $160,000 – $80,000 – $40,000 – $35,000) = $5,000

Note: Book value should not be reduced below the residual value of $35,000.

The double-declining-balance method yields the most depreciation expense in Year 1 of $160,000.

Over the 4-year life of the equipment, all three depreciation methods yield the same total depreciation, $285,000, which is the cost of the equipment of $320,000 less the residual value of $35,000.

CHAPTER 9

Long-Term Assets: Fixed and Intangible

Prob. 9–3B a.

Straight-line method: Year 1: Year 2: Year 3: Year 4:

$ 8,400 33,600 33,600 25,200

Units-of-activity method: Activity rate = ($108,000 – $7,200) ÷ 12,000 hours = $8.40 per hour Year 1: Year 2: Year 3: Year 4:

[($108,000 – $7,200) ÷ 3] × 3 ÷ 12………………………………… [($108,000 – $7,200) ÷ 3]…………………………………………… [($108,000 – $7,200) ÷ 3]…………………………………………… [($108,000 – $7,200) ÷ 3] × 9 ÷ 12…………………………………

1,350 hours × $8.40………………………………………………… 4,200 hours × $8.40………………………………………………… 3,650 hours × $8.40………………………………………………… 2,800 hours × $8.40…………………………………………………

$11,340 35,280 30,660 23,520

Double-declining-balance method: Year 1: Year 2: Year 3: Year 4:

$108,000 × [(100% ÷ 3) × 2] × 3 ÷ 12…………...………………… $18,000 ($108,000 – $18,000) × 2 ÷ 3……………………………………… 60,000 ($108,000 – $18,000 – $60,000) × 2 ÷ 3…………………………… 20,000 ($108,000 – $18,000 – $60,000 – $20,000 – $7,200)…………… 2,800

Note: Book value should not be reduced below $7,200, the residual value.

CHAPTER 9

Long-Term Assets: Fixed and Intangible

Prob. 9–4B 1.

Accumulated Depreciation Depreciation, Expense End of Year

Year a.

1………………………………………………… $25,625 2………………………………………………… 25,625 3………………………………………………… 25,625 4………………………………………………… 25,625

Book Value, End of Year

$ 25,625 51,250 76,875 102,500

$84,375 58,750 33,125 7,500

$ 55,000 82,500 96,250 102,500

$55,000 27,500 13,750 7,500

Yearly depreciation = [($110,000 – $7,500) ÷ 4] = $25,625

1 2 3 4

[$110,000 × (100% ÷ 4) × 2]………… $55,000 [$55,000 × (100% ÷ 4) × 2]………… 27,500 [$27,500 × (100% ÷ 4) × 2]………… 13,750 ($110,000 – $96,250 – $7,500)……… 6,250

Note: Book value should not be reduced below $7,500, the residual value.

Sept.

6 Cash Accumulated Depreciation—Equipment Equipment Gain on Sale of Equipment

18,000 96,250 110,000 4,250

Gain on sale of equipment = $18,000 – ($110,000 – $96,250) = $4,250

Sept.

6 Cash Accumulated Depreciation—Equipment Loss on Sale of Equipment Equipment

10,500 96,250 3,250 110,000

Loss on sale of equipment = $10,500 – ($110,000 – $96,250) = $(3,250)

CHAPTER 9

Long-Term Assets: Fixed and Intangible

Prob. 9–5B Year 1 Jan.

Mar.

Dec.

Year 2 Jan.

Feb.

Apr.

Dec.

8 Delivery Truck Cash

24,000 24,000

7 Truck Repair and Maintenance Expense Cash

900

31 Depreciation Expense—Delivery Truck Accum. Depreciation—Delivery Truck Delivery truck depreciation [$24,000 × (100% ÷ 4 × 2)].

12,000

9 Delivery Truck Cash

50,000

900

12,000

50,000

28 Truck Repair and Maintenance Expense Cash

250 250

30 Depreciation Expense—Delivery Truck Accum. Depreciation—Delivery Truck Delivery truck depreciation [($24,000 – $12,000) × (100% ÷ 4 × 2) × 4 ÷ 12].

2,000

30 Accum. Depreciation—Delivery Truck Cash Loss on Sale of Delivery Truck Delivery Truck

14,000 9,500 500

31 Depreciation Expense—Delivery Truck Accum. Depreciation—Delivery Truck Delivery truck depreciation [$50,000 × (100% ÷ 8 × 2)].

12,500

2,000

24,000

12,500

CHAPTER 9

Long-Term Assets: Fixed and Intangible

Prob. 9–5B (Concluded) Year 3 Sept.

Dec.

1 Delivery Truck Cash

58,500

4 Depreciation Expense—Delivery Truck Accum. Depreciation—Delivery Truck Delivery truck depreciation [($50,000 – $12,500) × (100% ÷ 8 × 2) × 8 ÷ 12].

6,250

4 Cash Accum. Depreciation—Delivery Truck Delivery Truck Gain on Sale of Delivery Truck

36,000 18,750

31 Depreciation Expense—Delivery Truck Accum. Depreciation—Delivery Truck Delivery truck depreciation [$58,500 × (100% ÷ 10 × 2) × 4 ÷ 12].

3,900

58,500

6,250

50,000 4,750

3,900

Prob. 9–6B 1.

Loss from impaired goodwill, $3,400,000

$4,800,000 ÷ 8 years = $600,000; 1 ÷ 4 × $600,000 = $150,000

$2,975,000 ÷ 12,500,000 board feet = $0.238 per board foot; 4,150,000 board feet × $0.238 per board foot = $987,700

Dec.

31 Loss from Impaired Goodwill Goodwill Impaired goodwill.

3,400,000

31 Amortization Expense—Patents Patents Patent amortization.

150,000

31 Depletion Expense Accumulated Depletion Depletion of timber rights.

987,700

3,400,000

150,000

987,700

CHAPTER 9

Long-Term Assets: Fixed and Intangible

MAKE A DECISION MAD 9–1 a. Fixed Asset Turnover Ratio =

Sales Average Book Value of Fixed Assets

Amazon:

$177,866 $67,251

= 2.6

Netflix:

$20,156 $492

= 41.0

b. Netflix is more efficient than Amazon in generating revenue from fixed assets. Netflix’s fixed asset turnover ratio is 41.0, which means it is able to generate $41.00 of revenue for every dollar of fixed assets. Amazon’s fixed asset turnover ratio is 2.6, which is only $2.60 of revenue for every dollar of fixed assets. Netflix’s fixed asset turnover ratio is almost 16 times larger than Amazon’s (41.0 ÷ 2.6). c. The difference in their fixed asset turnover ratios reflects the difference in their core businesses. Netflix is mostly an Internet streaming and DVD rental company. These services do not require significant fixed assets. The most significant fixed assets of Netflix are its information technology assets, followed by its headquarters and DVD mailing operations. Amazon also provides streaming services, media downloads, and other electronic products. In addition, Amazon sells a wide ® assortment of merchandise and markets Kindle products. This broader assortment of activities requires more extensive use of fixed assets beyond information technology, including warehouses and equipment. These additional fixed assets are the cause of Amazon’s lower fixed asset turnover ratio.

MAD 9–2 a. Fixed Asset Turnover Ratio =

Sales Average Book Value of Fixed Assets

Alaska Air:

$8,781 $6,842

= 1.3

Delta:

$47,007 $29,823

= 1.6

Southwest:

$22,428 $18,275

= 1.2

CHAPTER 9

Long-Term Assets: Fixed and Intangible

MAD 9–2 (Concluded) b. Delta Air Lines has the largest fixed asset turnover ratio and, thus, is more efficient in using fixed assets than the other two airlines. Delta’s sales are $1.60 for every dollar of fixed assets, which is approximately 30% better than Southwest Airlines and over 20% better than Alaska Air. c. The efficient use of aircraft can yield a higher fixed asset turnover ratio. An airline can increase aircraft efficiency by maximizing the number of seats sold on a flight. This is called the load factor. The higher the load factor, the more efficient is the aircraft’s use in generating revenues. High load factors are often obtained by matching aircraft size and capacity with the demand for seats. Other than filling seats, airlines can maximize aircraft efficiency by minimizing the ground time between flights. This can be accomplished with improved scheduling, maintenance, and operating procedures.

MAD 9–3 a. Fixed Asset Turnover Ratio = =

Sales Average Book Value of Fixed Assets $131,868 ($91,915 + $89,286) ÷ 2

= 1.5

b. Verizon earns $1.50 revenue for every dollar of fixed assets. Telecommunications requires a significant investment in the network in order to generate revenues. The industry average fixed asset turnover ratio is 1.1. Thus, Verizon is using its fixed assets more efficiently in generating revenues than the industry as a whole. The reason would require further analysis into the nature of Verizon’s fixed assets and revenues, but is likely related to having high data volume on its network.

MAD 9–4 a. Fixed Asset Turnover Ratio =

Sales Average Book Value of Fixed Assets

FedEx:

$69,693 $29,292

= 2.4

UPS:

$74,094 $28,529

= 2.6

b. The ratios show that UPS is approximately 8% more efficient at using its fixed assets than FedEx [(2.6 – 2.4) ÷ 2.4].

CHAPTER 9

Long-Term Assets: Fixed and Intangible

MAD 9–4 (Concluded) c. The fixed asset turnover is a measure of how efficiently revenue is generated from underlying fixed assets. In the case of UPS, the fixed assets represent all fixed assets necessary to deliver packages from one location to another. These include aircraft, trucks, sorting and handling facilities, and information technology. For every dollar of these fixed assets, UPS is able to generate $2.60 in sales. The fixed asset turnover ratio will be influenced by the degree these assets are utilized to their optimal capacity. So, for example, optimally filled planes, trucks, and sorting centers will cause the fixed asset turnover ratio to improve.

MAD 9–5 a.

Fixed Asset Turnover Ratio =

Sales Average Book Value of Fixed Assets

Comcast:

$108,942 $46,380

2.3

Alphabet:

$161,857 $66,683

2.4

Walmart:

$514,405 $113,107

4.5

b. Comcast and Alphabet’s fixed asset turnover is significantly less than Walmart’s. This means Comcast and Alphabet are less efficient at generating sales from fixed assets than Walmart. For Comcast, this can be explained by the nature of its business. Comcast must build a complete cable network in order to earn revenues. This includes underground cable through cities, neighborhoods, and individual residences. In addition, Comcast must provide the additional technology to carry broadband over this network. As a result, Comcast has a significant investment in fixed assets in order to earn revenues. Alphabet has a significant investment in servers; however, these servers are able to generate advertising revenue more efficiently than Comcast is able to earn subscription revenues over its cable network. As Alphabet’s business diversifies into areas requiring more fixed asset investments, its fixed asset ratio has decreased. Walmart’s major fixed assets are its stores. However, Walmart’s other major asset is merchandise inventory, which is not included in the fixed asset turnover ratio. Thus, Walmart’s higher asset efficiency is only partially explained by the fixed asset turnover ratio. The inventory turnover ratio would also need to be analyzed to fully appreciate Walmart’s efficiency in using its total assets. The other two companies do not have merchandise inventory, so the fixed asset turnover ratio is a more complete measure of their total asset efficiency relative to Walmart’s.

CHAPTER 9

Long-Term Assets: Fixed and Intangible

TAKE IT FURTHER TIF 9–1 1. Estimates of the factors determining depreciation expense create a unique financial reporting challenge. Because the useful life and residual value are estimates, there is no “correct” amount. The company must use judgment along with historical data to develop estimates that fairly reflect these items. These estimates are required under GAAP and should be representationally faithful. By subjectively changing these estimates, Mike and James are manipulating financial statement information to meet earnings targets. If this manipulation goes undetected, they will likely meet the owner’s earnings targets and save their jobs. Financial statement users, however, will be harmed by this action because they will be relying on financial statement information that is not a fair representation of the company’s underlying economics. 2. In this case, both Mike and James appear to be acting unethically. The original useful life and residual value estimates were based on good faith estimates. By changing these estimates in order to meet an earnings goal, they have both knowingly manipulated financial statement estimates to improve the company’s reported earnings. Mike and James have used the subjectivity in these estimates inappropriately. The result is a depreciation expense amount that does not faithfully represent the depreciation associated with the equipment. TIF 9–2 A sample solution based on McDonald’s Form 10-K for the fiscal year ended December 31, 2019, follows: 1. a.

c. d. e.

Depreciation is determined on a straight-line basis. The following estimated useful lives are used: buildings—up to 40 years; leasehold improvements—the lesser of useful lives or lease terms; equipment—3 to 12 years. The company does not separately report depreciation expense on the face of the income statement. However, the amount of depreciation can be obtained from footnotes to the financial statements and is reported at $1,392.2 million. $39,050.9 million (Property and Equipment Note and balance sheet). $24,160.0 million (Property and Equipment Note and balance sheet). The only intangible asset that McDonald’s reports is goodwill. Goodwill is reported at $2,677.4 million at December 31, 2019.

2. No. Book value is the difference between the fixed asset account and its related accumulated depreciation account.

CHAPTER 9

Long-Term Assets: Fixed and Intangible

TIF 9–3 To: Chief Financial Officer, Godwin Co. From: IMA Student Re: Financial Statement Effects of Modifications to Trucks 1 and 2 The modification to Truck 1 is an example of an asset improvement. After this truck was placed into service, a hydraulic lift was added to the truck. This change increased the capabilities of the truck. As a result, the cost of the hydraulic lift is added to the cost of the truck and depreciated over the truck’s remaining useful life. Because the cost of the delivery truck will be increased, depreciation expense for the truck will also increase. Truck 2 is an example of an extraordinary repair. The overhaul of the engine extends the truck’s useful life, allowing it to operate for a longer period than originally estimated. As a result, the cost of the engine overhaul is recorded as a decrease in the truck’s accumulated depreciation. The truck’s remaining book value is depreciated over the extended useful life of the truck. TIF 9–4 You should explain to Nolan and Stacy that it is acceptable to maintain two sets of records for tax and financial reporting purposes. This can happen when a company uses one method for financial statement purposes, such as straight-line depreciation, and another method for tax purposes, such as MACRS depreciation. This should not be surprising because the methods for taxes and financial statements are established by two different groups with different objectives. That is, tax laws and related accounting methods are established by Congress. The Internal Revenue Service then applies the laws and, in some cases, issues interpretations of the law and congressional intent. The primary objective of the tax laws is to generate revenue in an equitable manner for government use. Generally accepted accounting principles, on the other hand, are established primarily by the Financial Accounting Standards Board. The objective of generally accepted accounting principles is the preparation and reporting of true economic conditions and results of operations of business entities. You might note, however, that companies are required in their tax returns to reconcile differences in accounting methods. For example, income reported on the company’s financial statements must be reconciled with taxable income. Finally, you might also indicate to Nolan and Stacy that even generally accepted accounting principles allow for alternative methods of accounting for the same transactions or economic events. For example, a company could use straight-line depreciation for some assets and double-declining-balance depreciation for other assets.

CHAPTER 9

Long-Term Assets: Fixed and Intangible

TIF 9–5 Excel 1. a.

Number of unplanned shutdowns by machine type:

Maintenance costs by product type:

CHAPTER 9

Long-Term Assets: Fixed and Intangible

TIF 9–5 Tableau 1. a.

Number of unplanned shutdowns by machine type:

Maintenance costs by product type:

CHAPTER 9

Long-Term Assets: Fixed and Intangible

TIF 9–5 (Concluded) 2. The first analysis of unplanned shutdowns by machine type could be used by Natalie to isolate problem machines. For example, machine type Magna V 130 has no unplanned shutdowns. In contrast, machine type Magna V 280 has four shutdowns and Magna V 30 has three shutdowns. Of the individual machines, Magna V 280-4 and Magna V 30-2 have the most shutdowns with two unplanned shutdowns each. The second analysis provides information as to whether the shutdown costs are related to a specific product type. This analysis indicates that there were no shutdowns related to the medical devices. The highest shutdown cost of $33,602 was related to automobile products, while toys generated only $4,500 in shutdown costs. Natalie could use this analysis to consider increasing maintenance on the machines when they are being used to make automobile products. In contrast, Natalie might consider decreasing the maintenance on machines while they are being used to make medical devices. Since some unexpected shutdowns will occur and the total cost for the toys of $31,500 is the lowest, Natalie might consider monitoring the maintenance and shutdown costs for toys over a longer period.

CHAPTER 10 LIABILITIES: CURRENT, INSTALLMENT NOTES, AND CONTINGENCIES DISCUSSION QUESTIONS 1.

No. A discounted note payable has no stated interest rate, but provides interest by discounting the note proceeds. The discount, which is the difference between the proceeds and the face of the note, is the interest and is accounted for as such.

Employee’s federal income taxes, social security, and Medicare

Employees Federal Income Tax Payable, Social Security Tax Payable, and Medicare Tax Payable

The deductions from employees’ earnings are for amounts owed (liabilities) to others for such items as federal taxes, state and local income taxes, and contributions to pension plans.

1. 2. 3. 4. 5.

An advantage of using a separate payroll bank account is that reconciling the bank statements is simplified. In addition, a payroll bank account establishes control over payroll checks and, thus, prevents their theft or misuse.

The vacation pay expense should be recorded during the period in which the vacation privilege is earned.

a. b.

a c c b b

Each periodic payment includes (1) a repayment of the principal amount of the note and (2) a payment of interest on the outstanding balance. Interest expense decreases each period over the life of the note installment. This is because the outstanding balance of the note, upon which the interest is computed, decreases over the life of the note.

To match revenues and expenses properly, the liability to cover product warranties should be recorded in the period during which the sale of the product is recorded.

10.

When the defective product is repaired, the repair costs would be recorded by debiting Product Warranty Payable and crediting Cash, Supplies, or another appropriate account.

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

BASIC EXERCISES BE 10–1 a.

$300,000

$297,750 [$300,000 – ($300,000 × 45 ÷ 360 × 6%)]

BE 10–2 Total wage payment………………………………………… Deductions: Federal income tax………………………………………… Social security tax ($1,200 × 6%)……………………… Medicare tax ($1,200 × 1.5%)…………………………… Total deductions……………………………………… Net pay…………………………………………………………

$1,200.00 $193.44 72.00 18.00 (283.44) $ 916.56

BE 10–3 Salaries Expense Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Retirement Savings Deductions Payable Salaries Payable

80,000 4,800 1,200 17,540 3,200 53,260

BE 10–4 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable Federal Unemployment Tax Payable

6,868 4,800 1,200 756 112

State Unemployment Tax Payable = $14,000 × 5.4% = $756 Federal Unemployment Tax Payable = $14,000 × 0.8% = $112

BE 10–5 a.

Vacation Pay Expense Vacation Pay Payable Vacation pay accrued for the period.

25,000

Pension Expense Cash Unfunded Pension Liability To record pension cost and funding.

139,250

25,000

105,000 34,250

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

BE 10–6 a.

Cash Notes Payable Issued installment notes for cash.

45,000

Interest Expense Notes Payable Cash Paid principal and interest on installment notes.

3,600 6,134

45,000

9,734

BE 10–7 a.

July

Nov.

31 Product Warranty Expense Product Warranty Payable To record warranty expense for July (4.5% × $325,000). 11 Product Warranty Payable Cash

14,625 14,625

220 220

BE 10–8 a. Quick Ratio =

Quick Assets Current Liabilities

20Y3:

$1,140 + $1,400 + $910 $2,300

= 1.5

20Y4:

$1,000 + $1,200 + $800 $1,875

= 1.6

The quick ratio of Adieu Company has improved from 1.5 in 20Y3 to 1.6 in 20Y4. This increase is the result of small decreases in the three types of quick assets (cash, temporary investments, and accounts receivable) compared to the larger decrease in the current liability, accounts payable. The increase shows Adieu to be in a better position to pay current liabilities within a short period of time.

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

EXERCISES Ex. 10–1 Current liabilities: Advances on magazine subscriptions………………………………………… $1,800,000 276,000 Federal income taxes payable…………………………………………………… $2,076,000 Total current liabilities………………………………………………………… Advances on Magazine Subscriptions = 40,000 × $60 × 9/12 = $1,800,000 Federal Income Taxes Payable = $920,000 × 30% = $276,000

The nine months of unfilled subscriptions are a current liability because Bon Nebo received payment prior to providing the magazines.

Ex. 10–2 a.

Bennett Enterprises: Inventory Notes Payable

600,000

Notes Payable Interest Expense Cash

600,000 8,000

600,000

608,000

Spectrum Industries: Notes Receivable Sales

600,000

Cash Notes Receivable Interest Revenue

608,000

600,000 600,000 8,000

Interest Expense/Revenue = $600,000 × 4% × 120 ÷ 360 = $8,000

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Ex. 10–3 a.

$150,000 × 4% × 45 ÷ 360 = $750 for each alternative.

(1) $150,000 simple-interest note: $150,000 proceeds (2) $150,000 discounted note: $150,000 – $750 interest = $149,250 proceeds

Alternative (1) is more favorable to the borrower because the borrower has use of a greater amount of cash (proceeds of $150,000 compared to $149,250) but pays the same amount of interest ($750). This can be verified by comparing the effective interest rates for each loan as follows: Situation (1): 4.0% effective interest rate ($750 × 360 ÷ 45) ÷ $150,000 = 4% Situation (2): 4.02% effective interest rate ($750 × 360 ÷ 45) ÷ $149,250 = 4.02% The effective interest rate is higher for the discounted note because the creditor lent only $149,250 in return for $750 interest over 45 days. In the undiscounted note, the creditor must lend $150,000 for 45 days to earn the same $750 interest.

Ex. 10–4 a. b.

Accounts Payable Notes Payable

80,000

Notes Payable Interest Expense ($80,000 × 6% × 90 ÷ 360) Cash

80,000 1,200

80,000

81,200

Ex. 10–5 a.

Accounts Payable Interest Expense ($60,000 × 8% × 60 ÷ 360) Notes Payable

59,200 800

Notes Payable Cash

60,000

60,000 60,000

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Ex. 10–6 a.

June

Dec.

June

30 Building Land Notes Payable Cash

560,000 400,000

31 Notes Payable Interest Expense Cash (First installment interest = $600,000 × 5% × 6/12)

30,000 15,000

30 Notes Payable Interest Expense Cash [Second installment interest = ($600,000 – $30,000) × 5% × 6/12]

30,000 14,250

600,000 360,000

45,000

44,250

Ex. 10–7 a.

$2,848 is the amount disclosed as the current portion of long-term debt.

The current liabilities decreased by $1,105 ($2,848 – $3,953) million.

$26,300

Ex. 10–8 a.

Regular pay (40 hrs. × $25)…………………………………… Overtime pay [12 hrs. × ($25 × 1.5)]…………………………… Gross pay…………………………………………………………

$1,000.00 450.00 $1,450.00

Gross pay………………………………………………………… Deductions: Social security tax (6% × $1,450)………………………… Medicare tax (1.5% × $1,450)……………………………… Federal withholding………………………………………… Total deductions………………………………………… Net pay……………………………………………………………

$1,450.00 $ 87.00 21.75 225.00 (333.75) $1,116.25

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Ex. 10–9 Consultant

Administrator $2,800.00 1,050.00 ** $3,850.00 $ 231.00 57.75 6 642.00 $ 930.75 $2,919.25

Regular earnings………………………… Overtime earnings……………………… Gross pay…………………………………

$6,000.00

$2,200.00 660.00 * $2,860.00

Deductions: Social security tax…………………… Medicare tax…………………………… Federal income tax withheld……… Total deductions………………… Net pay………………………………………

$ 360.00 1 90.00 4 1,380.00 $1,830.00 $4,170.00

$ 171.60 2 42.90 5 452.00 $ 666.50 $2,193.50

1 2 3 4 5 6

$6,000.00

Computer Programmer

6.0% × $6,000.00 = $360.00 6.0% × $2,860.00 = $171.60 6.0% × $3,850.00 = $231.00 1.5% × $6,000.00 = $90.00 1.5% × $2,860.00 = $42.90 1.5% × $3,850.00 = $57.75

* $55 × 2 = $110 hr. 6 hours of overtime × $110 = $660 ** $70 × 1.5 = $105 hr. 10 hours of overtime × $105 = $1,050

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Ex. 10–10 a.

Summary: (1) $460,000; (3) $540,000; (8) $6,750; (12) $135,000 $ 338,850 (201,150)

Net amount paid……………………………………………… Total deductions……………………………………………… (3) Total earnings………………………………………………… Overtime……………………………………………………… (1) Regular…………………………………………………………

$ 540,000 (80,000) $ 460,000

Total deductions……………………………………………… Social security tax…………………………………………… $ 32,400 Medicare tax…………………………………………………… 8,100 Income tax withheld………………………………………… 135,000 18,900 Medical insurance…………………………………………… (8) Union dues…………………………………………………… Total earnings………………………………………………… Factory wages………………………………………………… $285,000 Office salaries………………………………………………… 120,000 (12) Sales salaries………………………………………………… b.

Factory Wages Expense Sales Salaries Expense Office Salaries Expense Social Security Tax Payable Medicare Tax Payable Employees Income Tax Payable Medical Insurance Payable Union Dues Payable Salaries Payable

285,000 135,000 120,000

Salaries Payable Cash

338,850

$ 201,150

(194,400) $ 6,750 $ 540,000 (405,000) $ 135,000

32,400 8,100 135,000 18,900 6,750 338,850 338,850

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Ex. 10–11 a.

Social security tax (6% × $120,000)……………………………………………… $ 7,200 Medicare tax (1.5% × $120,000)…………………………………………………… 1,800 State unemployment tax (5.4% × $30,000)……………………………………… 1,620 240 Federal unemployment (0.8% × $30,000)………………………………………… $10,860 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable Federal Unemployment Tax Payable

10,860 7,200 1,800 1,620 240

Ex. 10–12 a.

May

18 Salaries Expense Social Security Tax Payable ($635,000 × 6%) Medicare Tax Payable ($635,000 × 1.5%) Employees Federal Income Tax Payable Salaries Payable

635,000

18 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable Federal Unemployment Tax Payable

50,601

38,100 9,525 170,000 417,375 38,100 9,525 2,592 384

State Unemployment Tax Payable = $48,000 × 5.4% = $2,592 Federal Unemployment Tax Payable = $48,000 × 0.8% = $384

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Ex. 10–13 a.

June

17 Wages Expense Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Wages Payable

350,000 21,000 5,250 70,000 253,750

Social Security Tax Payable = $350,000 × 6.0% = $21,000 Medicare Tax Payable = $350,000 × 1.5% = $5,250

June

17 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable Federal Unemployment Tax Payable

29,505 21,000 5,250 2,835 420

State Unemployment Tax Payable = $52,500 × 5.4% = $2,835 Federal Unemployment Tax Payable = $52,500 × 0.8% = $420

Ex. 10–14 Big Howie’s Hot Dog Stand does have an internal control procedure that should detect the payroll error. Before funds are transferred from the regular bank account to the payroll account, the owner/manager authorizes the total amount of the week’s payroll. The owner/manager should catch the error, since the extra 60 hours will cause the weekly payroll to be substantially higher than usual. The owner/manager should sign the paychecks, thereby restricting access to cash by employees who are responsible for record keeping.

Ex. 10–15 a.

Appropriate. All changes to the payroll system, including wage rate increases, should be authorized by someone outside the Payroll Department.

Inappropriate. Each employee should record his or her own time out for lunch. Under the current procedures, one employee could clock in several employees who are still out to lunch. The company would be paying employees for more time than they actually worked.

Inappropriate. Payroll should be informed when any employee is fired. A supervisor or other individual could continue to clock in and out for the terminated employee and collect the extra paycheck.

Inappropriate. Access to the check-signing machine should be restricted.

Appropriate. The use of a special payroll account assists in preventing fraud and makes it easier to reconcile the company’s bank accounts.

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Ex. 10–16 a.

Jan.

31 Vacation Pay Expense Vacation Pay Payable Vacation pay accrued for January ($42,000 × 1/12).

3,500 3,500

Vacation pay is reported as a current liability on the balance sheet. If employees are allowed to accumulate their vacation pay, then the estimated vacation pay that will not be taken in the current year will be reported as a long-term liability. When employees take vacations, the liability for vacation pay is decreased.

Ex. 10–17 a.

Dec.

Jan. b.

31 Pension Expense Unfunded Pension Liability To record quarterly pension cost.

365,000

15 Unfunded Pension Liability Cash

365,000

In a defined contribution plan, the company invests contributions on behalf of the employee during the employee’s working years. Normally, the employee and employer contribute to the plan. The employee’s pension depends on the total contributions and the investment return on those contributions. In a defined benefit plan, the company pays the employee a fixed annual amount based on a formula. The employer is obligated to pay for (fund) the employee’s future pension benefits.

Ex. 10–18 The $5,622 million unfunded pension liability is the approximate amount of the pension obligation that exceeds the value of the net assets of the pension plan. Apparently, Procter & Gamble has underfunded its plan relative to the obligation that has accrued over time. This can occur when the company contributes less to the plan than the annual pension cost or the expected liability grows faster than the assets of the pension plan. The obligation grows yearly by the amount of the periodic pension cost. Thus, the $139 million periodic pension cost is a measure of the amount of pension earned by employees during the year. The annual pension cost is determined by making assumptions about employee life expectancies, employee turnover, expected compensation levels, and interest.

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Ex. 10–19 a. 1.

Cash Notes Payable

85,000

Interest Expense Notes Payable Cash

5,950 9,822

85,000

15,772

Interest Expense = $85,000 × 7% = $5,950

b. Notes payable are reported as liabilities on the balance sheet. The portion of the note payable that is due within one year is reported as a current liability. The remaining portion of the note payable that is not due within one year is reported as a long-term liability. For this company, the current and noncurrent portions of the note payable would be reported as follows: Current liabilities: Notes payable…………………………………………………………………………

$10,510

Noncurrent liabilities: Notes payable…………………………………………………………………………

$64,668

Supporting Computations: Original note payable………………………………………………………………… $ 85,000 (9,822) Principal repayment from Year 1…………………………………………………… Note payable balance at the end of Year 1……………………………………… $ 75,178 Annual payment on note…………………………………………………………… $ 15,772 (5,262) Second year interest payment ($75,178 × 7%)…………………………………… Principal repayment portion of next installment………………………………… $ 10,510 Note payable balance at the end of Year 1……………………………………… $ 75,178 Current portion of note payable (due within one year)………………………… (10,510) Noncurrent portion of note payable……………………………………………… $ 64,668

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Ex. 10–20 20Y2 Jan.

Dec.

20Y5 Dec.

1 Cash Notes Payable

175,000

31 Interest Expense Notes Payable Cash

14,000 29,830

31 Interest Expense Notes Payable Cash

6,253 37,577*

175,000

43,830

* Notes Payable = $43,830 – $6,253 = $37,577

Ex. 10–21 a. A

C Interest Expense (7% of January 1 Note Carrying Amount)

D Decrease in Notes Payable (B – C)

E Dec. 31 Carrying Amount (A – D)

For the Year Ending Dec. 31

January 1 Carrying Amount

Note Payment (Cash Paid)

Year 1

$147,750

$ 43,620

$10,343 (7% of $147,750)

$ 33,277

$114,473

Year 2 Year 3 Year 4

114,473

43,620

8,013 (7% of $114,473)

35,607

78,866

78,866 40,767

43,620 43,620

5,521 (7% of $78,866) 2,853 *

38,099 40,767

40,767 0

$174,480

$26,730

$147,750

* The interest expense in Year 4 is rounded to $2,853.

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Ex. 10–21 (Concluded) b.

Year 1 Jan.

1 Cash

147,750

Notes Payable Dec.

147,750

31 Interest Expense

10,343

Notes Payable

33,277

Cash

43,620

Year 2 Dec.

31 Interest Expense

8,013

Notes Payable

35,607

Cash

43,620

Year 3 Dec.

31 Interest Expense

5,521

Notes Payable

38,099

Cash

43,620

Year 4 Dec.

31 Interest Expense

2,853

Notes Payable

40,767 43,620

Cash c.

Interest expense of $10,343 would be reported on the income statement.

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Ex. 10–22 a.

Jan.

31 Product Warranty Expense Product Warranty Payable To record warranty expense for January ($1,800,000 × 2%).

Feb.

7 Product Warranty Payable Supplies Wages Payable

36,000 36,000

515 375 140

Ex. 10–23 a.

The warranty liability represents estimated outstanding automobile warranty claims. Of these claims, $3,487 million is estimated to be due during the current year, while the remainder ($5,792 million) is expected to be paid in a later year. The distinction between short- and long-term liabilities is important to creditors in order to accurately evaluate the near-term cash demands on the business relative to the quick current assets and other longer-term demands. 4,132,000,000

Product Warranty Expense Product Warranty Payable

4,132,000,000

$9,279 + X – $3,710 = $9,701 X = $9,701 – $9,279 + $3,710 X = $4,132 million c.

In order for a product warranty to be reported as a liability in the financial statements, it must qualify as a contingent liability. Contingent liabilities are only reported as liabilities on the balance sheet if it is probable that the liability will occur and the amount of the liability is reasonably estimable.

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Ex. 10–24 a.

Damage Awards and Fines EPA Fines Payable Litigation Claims Payable

365,000 240,000 125,000

Note to Instructors: The “Damage Awards and Fines” would be disclosed on the income statement under “Other expenses.” b.

The company experienced a hazardous materials spill at one of its plants during the previous period. This spill has resulted in a number of lawsuits to which the company is a party. The Environmental Protection Agency (EPA) has fined the company $240,000, which the company is contesting in court. Although the company does not admit fault, legal counsel believes that the fine payment is probable. In addition, an employee has sued the company. A $125,000 out-of-court settlement has been reached with the employee. The EPA fine and out-of-court settlement have been recognized as an expense for the period. There is one other outstanding lawsuit related to this incident. Counsel does not believe that the lawsuit has merit. Other lawsuits and unknown liabilities may arise from this incident.

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

PROBLEMS Prob. 10–1A 1.

Mar.

Apr.

June

July

Aug.

Dec.

1 Inventory Accounts Payable—Kirkwood Co.

215,000

31 Accounts Payable—Kirkwood Co. Notes Payable

215,000

30 Notes Payable Interest Expense ($215,000 × 30 ÷ 360 × 6%) Cash

215,000 1,075

1 Cash Notes Payable

400,000

1 Tools Interest Expense ($60,000 × 60 ÷ 360 × 6%) Notes Payable

59,400 600

16 Notes Payable Interest Expense ($400,000 × 45 ÷ 360 × 8%) Notes Payable Cash

400,000 4,000

15 Notes Payable Interest Expense ($400,000 × 30 ÷ 360 × 9%) Cash

400,000 3,000

30 Notes Payable Cash

60,000

1 Office Equipment Notes Payable Cash

320,000

22 Litigation Loss Litigation Claims Payable

50,000

31 Notes Payable Interest Expense ($20,000 × 30 ÷ 360 × 6%) Cash

20,000 100

215,000

216,075

400,000

60,000

400,000 4,000

403,000

60,000

200,000 120,000

50,000

20,100

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Prob. 10–1A (Concluded) 2.

Product Warranty Expense Product Warranty Payable Warranty expense for the current year. Interest Expense Interest Payable Interest on notes payable.

70,000 70,000 900 900

Interest Expense = ($320,000 – $120,000 – $20,000) × 6% × 30 ÷ 360, or $20,000 × 9 × 6% × 30 ÷ 360

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Prob. 10–2A 1. a.

Jan.

7 Sales Salaries Expense Warehouse Salaries Expense Office Salaries Expense Employees Income Tax Payable Social Security Tax Payable Medicare Tax Payable Bond Deductions Payable Group Insurance Payable Cash

540,000 155,000 85,000 160,000 46,800 11,700 10,500 9,000 542,000

Social Security Tax Payable = $780,000 × 6% Medicare Tax Payable = $780,000 × 1.5%

Jan.

7 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable Federal Unemployment Tax Payable

106,860 46,800 11,700 42,120 6,240

State Unemployment Tax Payable = $780,000 × 5.4% Federal Unemployment Tax Payable = $780,000 × 0.8%

2. a.

Dec.

31 Sales Salaries Expense Warehouse Salaries Expense Office Salaries Expense Employees Income Tax Payable Social Security Tax Payable ($780,000 × 6%) Medicare Tax Payable ($780,000 × 1.5%) Bond Deductions Payable Group Insurance Payable Cash

540,000 155,000 85,000

31 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable Federal Unemployment Tax Payable

61,476

160,000 46,800 11,700 10,500 9,000 542,000

46,800 11,700 2,592 384

State Unemployment Tax Payable = $48,000 × 5.4% Federal Unemployment Tax Payable = $48,000 × 0.8%

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Prob. 10–3A 1. Employee Arnett………… Cruz…………… Edwards……… Harvin………… Nicks………… Shiancoe…… Ward…………

Gross Earnings $ 9,000.00 55,200.00 24,600.00 5,900.00 132,000.00 113,000.00 7,050.00 $346,750.00

Federal Income Tax Withheld $ 1,698.00 9,576.00 4,896.00 1,052.00 31,020.00 25,330.00 1,182.00 $74,754.00

Social Security Tax Withheld $ 540.00 3,312.00 1,476.00 354.00 7,920.00 6,780.00 423.00 $20,805.00

Medicare Tax Withheld $ 135.00 828.00 369.00 88.50 1,980.00 1,695.00 105.75 $5,201.25

* The gross earnings are determined by multiplying the monthly earnings by the number of months of employment based on the date of hire.

2. a. Social security tax paid by employer…………………………………… $20,805.00 b. Medicare tax paid by employer……………………………………………

5,201.25

c. Earnings subject to unemployment compensation tax, $10,000 for all employees except Arnett, Harvin, and Ward. Thus, total earnings subject to SUTA and FUTA are $61,950 [(4 × $10,000) + $9,000 + $5,900 + $7,050]. State unemployment compensation tax: $61,950 × 5.4%……………

3,345.30

d. Federal unemployment compensation tax: $61,950 × 0.8%…………

495.60

e. Total payroll tax expense………………………………………………… $29,847.15

46 41 48 35 45

Total Hours

2,720.00 2,480.00 2,800.00 1,960.00 2,480.00 1,800.00 1,944.00 2,000.00 2,480.00 20,664.00

Regular

186.00 2,196.00

465.00

612.00 93.00 840.00

Overtime

EARNINGS

3,332.00 2,573.00 3,640.00 1,960.00 2,945.00 1,800.00 1,944.00 2,000.00 2,666.00 22,860.00

Total

19,060.00 3,800.00

199.92 154.38 218.40 117.60 176.70 108.00 116.64 120.00 159.96 1,371.60

Social Security Tax

December 9

10-21

1,371.60 342.91 4,836.37 885.00 15,424.12

49.98 38.60 54.60 29.40 44.18 27.00 29.16 30.00 39.99 342.91

750.20 537.68 832.64 366.04 641.84 342.45 382.56 398.24 584.72 4,836.37 130.00 120.00 130.00 125.00 50.00 885.00

100.00 110.00 120.00

DEDUCTIONS Federal U.S. Medicare Income Savings Tax Tax Bonds

PAYROLL FOR WEEK ENDING

1,100.10 840.66 1,225.64 513.04 992.72 597.45 658.36 673.24 834.67 7,435.88

Total

Liabilities: Current, Installment Notes, and Contingencies

2,231.90 1,732.34 2,414.36 1,446.96 1,952.28 1,202.55 1,285.64 1,326.76 1,831.33 15,424.12

Net Pay

PAID

Sales Salaries Expense Office Salaries Expense Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Bond Deductions Payable Salaries Payable

Aaron Cobb Clemente DiMaggio Griffey, Jr. Mantle Robinson Williams Vaughn

Employee

Prob. 10–4A 1.

CHAPTER 10

901 902 903 904 905 906 907 908 909

Ck. No.

2,666.00 19,060.00

1,944.00

3,332.00 2,573.00 3,640.00 1,960.00 2,945.00

3,800.00

2,000.00

1,800.00

ACCOUNT DEBITED Sales Office Salaries Salaries Expense Expense

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Prob. 10–5A 1.

Dec.

2 Bond Deductions Payable Cash

3,400

2 Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Cash

9,273 2,318 15,455

13 Operations Salaries Expense Officers Salaries Expense Office Salaries Expense Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Employees State Income Tax Payable Bond Deductions Payable Medical Insurance Payable Salaries Payable

43,200 27,200 6,800

13 Salaries Payable Cash

46,296

13 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable Federal Unemployment Tax Payable

6,265

16 Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Cash

9,264 2,316 15,440

19 Medical Insurance Payable Cash

31,500

3,400

27,046

4,632 1,158 15,440 3,474 1,700 4,500 46,296

46,296

4,632 1,158 350 125

27,020

31,500

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Prob. 10–5A (Concluded) Dec.

2. a. Dec.

27 Operations Salaries Expense Officers Salaries Expense Office Salaries Expense Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Employees State Income Tax Payable Bond Deductions Payable Salaries Payable

42,800 28,000 7,000

27 Salaries Payable Cash

51,360

27 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable Federal Unemployment Tax Payable

6,135

27 Employees State Income Tax Payable Cash

20,884

31 Bond Deductions Payable Cash

3,400

31 Pension Expense Cash Unfunded Pension Liability To record pension cost and unfunded liability.

60,000

31 Operations Salaries Expense Officers Salaries Expense Office Salaries Expense Salaries Payable Accrued wages for the period.

8,560 5,600 1,400

31 Vacation Pay Expense Vacation Pay Payable Vacation pay accrued for the period.

15,000

4,668 1,167 15,404 3,501 1,700 51,360

51,360

4,668 1,167 225 75

20,884

3,400

45,000 15,000

15,560

15,000

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Prob. 10–1B 1.

Apr.

May

July

Aug.

Sept.

Oct.

Nov.

Dec.

15 Cash Notes Payable

225,000

1 Equipment Interest Expense ($320,000 × 180 ÷ 360 × 6%) Notes Payable

310,400 9,600

15 Notes Payable Interest Expense ($225,000 × 30 ÷ 360 × 6%) Notes Payable Cash

225,000 1,125

14 Notes Payable Interest Expense ($225,000 × 60 ÷ 360 × 8%) Cash

225,000 3,000

16 Inventory Accounts Payable—Exige Co.

90,000

15 Accounts Payable—Exige Co. Notes Payable

90,000

28 Notes Payable Cash

320,000

30 Notes Payable Interest Expense ($90,000 × 45 ÷ 360 × 6%) Cash

90,000 675

16 Store Equipment Notes Payable Cash

450,000

16 Notes Payable Interest Expense ($20,000 × 30 ÷ 360 × 9%) Cash

20,000 150

28 Litigation Loss Litigation Claims Payable

87,500

225,000

320,000

225,000 1,125

228,000

90,000

320,000

90,675

400,000 50,000

20,150

87,500

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Prob. 10–1B (Concluded) 2.

Product Warranty Expense Product Warranty Payable Warranty expense for the current year.

26,800

Interest Expense Interest Payable Interest on notes ($20,000 × 9% × 30 ÷ 360 × 19).

2,850

26,800

2,850

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Prob. 10–2B 1. a.

Jan.

11 Sales Salaries Expense Warehouse Salaries Expense Office Salaries Expense Employees Income Tax Payable Social Security Tax Payable Medicare Tax Payable U.S. Savings Bond Deductions Payable Group Insurance Payable Cash

625,000 240,000 320,000 232,260 71,100 17,775 35,500 53,325 775,040

Social Security Tax Payable = $1,185,000 × 6% Medicare Tax Payable = $1,185,000 × 1.5%

Jan.

11 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable Federal Unemployment Tax Payable

162,345 71,100 17,775 63,990 9,480

State Unemployment Tax Payable = $1,185,000 × 5.4% Federal Unemployment Tax Payable = $1,185,000 × 0.8%

2. a.

Dec.

31 Sales Salaries Expense Warehouse Salaries Expense Office Salaries Expense Employees Income Tax Payable Social Security Tax Payable ($1,185,000 × 6%) Medicare Tax Payable ($1,185,000 × 1.5%) U.S. Savings Bond Deductions Payable Group Insurance Payable Cash

625,000 240,000 320,000

31 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable Federal Unemployment Tax Payable

90,735

232,260 71,100 17,775 35,500 53,325 775,040

71,100 17,775 1,620 240

State Unemployment Tax Payable = $30,000 × 5.4% Federal Unemployment Tax Payable = $30,000 × 0.8%

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Prob. 10–3B 1.

Gross Employee Earnings* Addai………………… $44,880.00 Kasay………………… 25,200.00 McGahee…………… 67,410.00 Moss………………… 55,200.00 Stewart……………… 4,500.00 Tolbert……………… 4,875.00 84,000.00 Wells…………………

Federal Income Tax Withheld $ 9,372.00 3,731.00 12,999.00 9,396.00 758.00 669.00 18,872.00

Social Security Tax Withheld $ 2,692.80 1,512.00 4,044.60 3,312.00 270.00 292.50 5,040.00 $17,163.90

Medicare Tax Withheld $ 673.20 378.00 1,011.15 828.00 67.50 73.13 1,260.00 $4,290.98

* The gross earnings are determined by multiplying the monthly earnings by the number of months of employment based on the date of hire.

Social security tax paid by employer………………………………… $17,163.90

Medicare tax paid by employer………………………………………

4,290.98

Earnings subject to unemployment compensation tax, $10,000 for all employees except Stewart and Tolbert. Thus, total earnings subject to SUTA and FUTA are $59,375 [(5 × $10,000) + $4,500 + $4,875]. State unemployment compensation tax: $59,375 × 5.4%…………

3,206.25

Federal unemployment compensation tax: $59,375 × 0.8%……

475.00

Total payroll tax expense……………………………………………… $25,136.13

46 48 43

36 45 37

Total Hours

2,000.00 4,000.00 1,872.00 2,320.00 1,665.00 3,200.00 2,080.00 2,000.00 2,160.00 21,297.00

Regular

468.00 600.00 243.00 2,646.00

435.00

900.00

Overtime

EARNINGS

2,900.00 4,000.00 1,872.00 2,755.00 1,665.00 3,200.00 2,548.00 2,600.00 2,403.00 23,943.00

Total

16,743.00 7,200.00

174.00 240.00 112.32 165.30 99.90 192.00 152.88 156.00 144.18 1,436.58

Social Security Tax

December 9,

10-28

1,436.58 359.16 5,013.68 541.00 16,592.58

43.50 60.00 28.08 41.33 24.98 48.00 38.22 39.00 36.05 359.16

667.00 860.00 355.68 578.55 349.65 768.00 382.20 572.00 480.60 5,013.68 75.00 80.00 541.00

44.00 62.00 120.00

60.00 100.00

DEDUCTIONS Federal U.S. Medicare Income Savings Tax Tax Bonds

PAYROLL FOR WEEK ENDING

944.50 1,260.00 496.08 829.18 536.53 1,128.00 573.30 842.00 740.83 7,350.42

Total

Liabilities: Current, Installment Notes, and Contingencies

1,955.50 2,740.00 1,375.92 1,925.82 1,128.47 2,072.00 1,974.70 1,758.00 1,662.17 16,592.58

Net Pay

PAID

Sales Salaries Expense Office Salaries Expense Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Bond Deductions Payable Salaries Payable

Carlton Grove Johnson Koufax Maddux Seaver Spahn Winn Young

Employee

Prob. 10–4B 1.

CHAPTER 10

328 329 330 331 332 333 334 335 336

Ck. No.

2,548.00 2,600.00 2,403.00 16,743.00

1,872.00 2,755.00 1,665.00

2,900.00

7,200.00

3,200.00

4,000.00

ACCOUNT DEBITED Sales Office Salaries Salaries Expense Expense

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Prob. 10–5B 1.

Dec.

1 Medical Insurance Payable Cash

2,520

1 Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Cash

2,913 728 4,490

2 Bond Deductions Payable Cash

2,300

12 Sales Salaries Expense Officers Salaries Expense Office Salaries Expense Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Employees State Income Tax Payable Bond Deductions Payable Medical Insurance Payable Salaries Payable

14,500 7,100 2,600

12 Salaries Payable Cash

15,418

12 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable Federal Unemployment Tax Payable

2,220

15 Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Cash

2,904 726 4,308

2,520

8,131

2,300

1,452 363 4,308 1,089 1,150 420 15,418

15,418

1,452 363 315 90

7,938

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Prob. 10–5B (Concluded) Dec.

2. a.

Dec.

26 Sales Salaries Expense Officers Salaries Expense Office Salaries Expense Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Employees State Income Tax Payable Bond Deductions Payable Salaries Payable

14,250 7,250 2,750

26 Salaries Payable Cash

15,873

26 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable Federal Unemployment Tax Payable

2,009

30 Employees State Income Tax Payable Cash

6,258

30 Bond Deductions Payable Cash

2,300

31 Pension Expense Cash Unfunded Pension Liability To record pension cost and unfunded liability.

65,500

31 Sales Salaries Expense Officers Salaries Expense Office Salaries Expense Salaries Payable Accrued wages for the period.

4,275 2,175 825

31 Vacation Pay Expense Vacation Pay Payable Vacation pay accrued for the period.

13,350

1,455 364 4,317 1,091 1,150 15,873

15,873

1,455 364 150 40

6,258

2,300

55,400 10,100

7,275

13,350

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

COMPREHENSIVE PROBLEM 3 1.

20Y5 Jan.

Feb.

Apr.

May

June

Aug.

Sept.

3 Petty Cash Cash

4,500

26 Office Supplies Miscellaneous Selling Expense Miscellaneous Administrative Expense Cash

1,680 570 880

14 Inventory Accounts Payable

31,300

13 Accounts Payable Cash

31,300

17 Cash Cash Short and Over Sales

21,200 40

2 Notes Receivable Accounts Receivable—Ryanair

180,000

1 Cash Notes Receivable Interest Revenue ($180,000 × 8% × 60 ÷ 360 = $2,400).

182,400

4,500

3,130

31,300

21,240

180,000

180,000 2,400

24 Cash Allowance for Doubtful Accounts Accounts Receivable—Finley

7,600 1,400

15 Accounts Receivable—Finley Allowance for Doubtful Accounts

1,400

15 Cash Accounts Receivable—Finley

1,400

9,000

1,400

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Comp. Prob. 3 (Continued) 20Y5 Sept.

Oct.

Nov.

Dec.

15 Land Interest Expense ($670,000 × 90 ÷ 360 × 9%) Notes Payable

654,925 15,075

17 Cash Notes Receivable Accumulated Depreciation—Office Equipment Loss on Sale of Office Equipment Office Equipment

135,000 100,000 64,000 21,000

30 Sales Salaries Expense Office Salaries Expense Employees Income Tax Payable Social Security Tax Payable Medicare Tax Payable Salaries Payable

135,000 77,250

30 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable Federal Unemployment Tax Payable

16,229

14 Notes Payable Cash

670,000

31 Pension Expense Cash Unfunded Pension Liability Pension cost of $190,400 funded at $139,700.

190,400

670,000

320,000

39,266 12,735 3,184 157,065

12,735 3,184 270 40

670,000

139,700 50,700

State Unemployment Tax Payable = $5,000 × 5.4% Federal Unemployment Tax Payable = $5,000 × 0.8%

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Comp. Prob. 3 (Continued) 2.

Kornett Company Bank Reconciliation December 31, 20Y5 Balance according to bank statement Add: Deposit in transit on December 31 Deduct: Outstanding checks Adjusted balance Balance according to company’s records Deduct: Bank service charges Error in recording check Total deductions Adjusted balance

3. 20Y5 Dec.

4. a.

31 Miscellaneous Administrative Expense Accounts Payable Cash

20Y5 Dec.

$283,000 29,500 (68,540) $243,960 $245,410 $750 700 (1,450) $243,960

750 700 1,450

31 Bad Debt Expense Allowance for Doubtful Accounts To record estimated uncollectible accounts ($16,000 + $2,000).

18,000

31 Cost of Goods Sold Inventory To record inventory shrinkage.

3,300

31 Insurance Expense Prepaid Insurance To record expired insurance.

22,820

31 Office Supplies Expense Office Supplies To record supplies used during the period.

3,920

18,000

3,300

22,820

3,920

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Comp. Prob. 3 (Continued) e.

20Y5 Dec. 31 Depreciation Expense—Buildings Depreciation Expense—Office Equipment Depreciation Expense—Store Equipment Accum. Depreciation—Buildings Accum. Depreciation—Office Equipment Accum. Depreciation—Store Equipment To record depreciation for the period.

36,000 44,000 5,000 36,000 44,000 5,000

Computations: Buildings ($900,000 × 4.0%)……………………………………… $36,000 Office Equipment [20% × ($246,000 – $26,000)]…………………………………… 44,000 Store Equipment 5,000 [6/12 × 10% × ($112,000 – $12,000)]…………………………… f.

20Y5 Dec. 31 Amortization Expense—Patents Patents To record patent amortization ($48,000 ÷ 8 years).

6,000 6,000

31 Depletion Expense Accumulated Depletion To record depletion [($546,000 ÷ 910,000 tons) × 50,000 tons].

30,000

31 Vacation Pay Expense Vacation Pay Payable To record vacation pay for the period.

10,500

31 Product Warranty Expense Product Warranty Payable To record product warranty for the period ($1,900,000 × 4%).

76,000

31 Interest Receivable Interest Revenue To record interest earned on note receivable ($100,000 × 75* ÷ 360 × 9%).

1,875

30,000

10,500

76,000

1,875

* Oct. 17 to Oct. 31 = 14 days Nov. 1 to Nov. 30 = 30 Dec. 1 to Dec. 31 = 31 Total

75 days

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Comp. Prob. 3 (Continued) 5.

Kornett Company Balance Sheet December 31, 20Y5 Assets Current assets: Petty cash Cash Notes receivable Accounts receivable Allowance for doubtful accounts Accounts receivable, net Inventory Interest receivable Prepaid insurance Office supplies Total current assets Property, plant, and equipment: Land Buildings Accumulated depreciation—buildings Book value—buildings Office equipment Accumulated depreciation— office equipment Book value—office equipment Store equipment Accumulated depreciation— store equipment Book value—store equipment Mineral rights Accumulated depletion—mineral rights Book value—mineral rights Total property, plant, and equipment Intangible assets: Patents Total assets

$ 4,500 243,960 100,000 $470,000 (16,000) 454,000 320,000 1,875 45,640 13,400 $1,183,375 $654,925 $900,000 (36,000) 864,000 $246,000 (44,000) 202,000 $112,000 (5,000) 107,000 $546,000 (30,000) 516,000 2,343,925 42,000 $3,569,300

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

Comp. Prob. 3 (Concluded) Liabilities Current liabilities: Social security tax payable Medicare tax payable Employees federal income tax payable State unemployment tax payable Federal unemployment tax payable Salaries payable Accounts payable Interest payable Product warranty payable Vacation pay payable (current portion) Notes payable (current portion) Total current liabilities Long-term liabilities: Vacation pay payable Unfunded pension liability Notes payable Total long-term liabilities Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

25,470 4,710 40,000 270 40 157,000 131,600 28,000 76,000 7,140 70,000 $ 540,230

3,360 50,700 630,000 684,060 $1,224,290

$ 500,000 1,845,010 2,345,010 $3,569,300

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

MAKE A DECISION MAD 10–1 a.

Working Capital = Current Assets – Current Liabilities Amazon:

$75,101 – $68,391 = $6,710

Best Buy:

$8,870 – $7,513 = $1,357

Current Ratio =

Current Assets Current Liabilities

Amazon:

$75,101 $68,391

= 1.1

Best Buy:

$8,870 $7,513

= 1.2

Quick Ratio =

Quick Assets Current Liabilities

Amazon:

$31,750 + $9,500 + $16,677 $68,391

= 0.8

Best Buy:

$1,980 + $1,015 $7,513

= 0.4

d. Working capital is not a good measure for comparing the liquidity of two companies of different sizes. In this case, Amazon’s current assets are over eight times larger than Best Buy’s. Thus, the comparison is not very meaningful. Ratios are a better relative measure of comparison across companies of different sizes. e. Best Buy’s current ratio is 1.2, while Amazon’s is 1.1. Thus, the current ratio indicates Best Buy has a slightly stronger liquidity position than Amazon. f. Best Buy’s quick ratio is 0.4, while Amazon’s is 0.8. Thus, the quick ratio indicates that Best Buy has a weaker short-term debt-paying ability than Amazon. g. The difference between the current ratio and the quick ratio is best understood by looking at the vertical analysis of the assets to total current assets for the two companies as follows: Amazon Best Buy Current assets: Cash……………………………………………………………… 42.3% 22.3% Short-term investments………………………………………… 12.6% 0.0% Accounts receivable…………………………………………… 22.2% 11.4% Inventories………………………………………………………… 22.9% 61.0% 0.0% 5.3% Other current assets…………………………………………… Total current assets………………………………………… 100.0% 100.0%

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

MAD 10–1 (Concluded) Amazon has 54.9% (42.3% + 12.6%) of its current assets consisting of cash and short-term investments, compared to 22.3% for Best Buy. This difference will improve Amazon’s quick ratio relative to Best Buy’s. Best Buy has 61.0% of its current assets in inventory, while Amazon only has 22.9% of current assets in inventory. This difference reflects Amazon’s pure Internet strategy, which causes the current ratio to be smaller than Best Buy’s. It also causes the relationship between the current and quick ratios to diverge between the two companies. MAD 10–2 a.

Working Capital = Current Assets – Current Liabilities (in thousands) Abercrombie: The Gap:

$1,335,950 – $558,917 = $777,033 $4,516,000 – $3,209,000 = $1,307,000

Current Ratio =

Current Assets Current Liabilities

Abercrombie:

$1,335,950 $558,917

= 2.4

The Gap:

$4,516,000 $3,209,000

= 1.4

Quick Ratio = Abercrombie:

The Gap:

Quick Assets Current Liabilities $723,135 + $73,112 $558,917

= 1.4

$1,364,000 + $290,000 = 0.5 $3,209,000

d. Working capital is not a good measure for comparing the liquidity of two companies of different sizes. In this case, The Gap’s current assets are nearly 3 1/2 times larger than Abercrombie’s. Thus, the comparison is not very meaningful. Ratios are a better relative measure of comparison across companies of different sizes. Based on both the currrent ratio and the quick ratio, Abercrombie has a stronger liquidity position than The Gap.

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

MAD 10–3 a. Working Capital = Current Assets – Current Liabilities Year 1: $2,001,910 – $2,076,543 = $(74,633) Year 2: $2,239,181 – $2,418,566 = $(179,385) Year 3: $2,117,102 – $2,008,793 = $108,309 b. Current Ratio =

Current Assets Current Liabilities

Year 1:

$2,001,910 $2,076,543

= 1.0

Year 2:

$2,239,181 $2,418,566

= 0.9

Year 3:

$2,117,102 $2,008,793

= 1.1

Quick Ratio =

Quick Assets Current Liabilities

Year 1:

$380,179 + $588,262 $2,076,543

= 0.5

Year 2:

$587,998 + $594,145 $2,418,566

= 0.5

Year 3:

$493,262 + $568,509 $2,008,793

= 0.5

d. The quick ratio at the end of Year 1 was 0.5, indicating a tight short-term coverage of current liabilities with quick assets. This is less of a concern because inventory turns into cash relatively quickly for Hershey (a food company). This ratio remained at 0.5 for both of the subsequent years. A quick ratio below 1.0 indicates Hershey maintained a tight quick asset coverage of short-term obligations. e. The current ratio shows a similar pattern of liquidity, with an improvement in Year 3. The working capital for Year 3 is the only year in which this number is positive. It appears Hershey’s overall liquidity is improving.

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

MAD 10–4 a. Kohl’s has over 3.5 times the current assets of Neiman Marcus. Thus, using working capital as a basis for making relative liquidity comparisons between the two firms would not be meaningful. b.

Quick Ratio = Neiman Marcus:

Kohl’s:

Quick Assets Current Liabilities $39 $860

= 0.05

$723 = 0.26 $2,769

c. Kohl’s quick ratio of 0.26 is 5 times that of Neiman Marcus’s 0.05. Both companies have a quick ratio less than 1.0. The small quick ratios can be partially explained by both companies only having cash as their primary quick asset. Neither company has accounts receivable because they sell to consumers using credit cards or cash. In addition, inventory is a large part of each company’s current asset structure, and inventory is not included in quick assets. Neiman Marcus is a luxury fashion brand. Kohl’s aims for a more moderately priced portion of the market. Thus, we would expect Neiman Marcus’s more costly inventory to be a larger percentage of its current assets compared to Kohl’s. These differences partly account for the difference in the quick ratios between the two companies. Even so, the quick ratios of both companies are very small and will require each to carefully manage its working capital and supplier payments.

MAD 10–5 a. The gift cards represent unearned revenue (a liability). The gift cards have been pre-purchased and represent a form of cash to the holder. As such, gift card sales are not considered revenue at the time of sale. Rather, the cash received in advance is considered unearned revenue until the holder uses the gift card to purchase merchandise.

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

MAD 10–5 (Concluded) b. Current Ratio = Hibbett:

Current Assets Current Liabilities $367,856 $173,273

Dick’s Sporting Goods: c.

= 2.1 $2,410,016 $2,076,474

Quick Ratio =

Quick Assets Current Liabilities

Hibbett:

$61,756 + $9,470 $173,273

Dick’s Sporting Goods:

= 1.2

$69,334 + $53,173 $2,076,474

= 0.4

= 0.1

d. Using both the current and quick ratios, Hibbett appears to have a stronger liquidity position than does Dick’s Sporting Goods. The current ratio for Hibbett is 2.1, compared to 1.2 for Dick’s. The quick ratio is 0.4 for Hibbett, compared to 0.1 for Dick’s. While these quick ratios indicate a tight quick asset coverage of short-term obligations, both stores have substantial amounts in inventory that should help generate cash when sales are made.

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

TAKE IT FURTHER TIF 10–1 1. Cannally and Kennedy is not obligated to pay a bonus to its employees under any circumstances. The decision to pay a bonus is entirely discretionary. Companies frequently decide to discontinue or suspend annual bonuses for a variety of reasons, including deteriorating economic conditions, poor company or divisional performance, and alternative cash needs within the business. Even though the firm paid a two-week bonus for 10 straight years, it is not obligated to pay a bonus in Year 11. Thus, the firm is not behaving unethically for reducing the bonus. 2. Tonya Latirno, on the other hand, is behaving unethically. Feeling that she is being cheated, Tonya is attempting to replace the bonus by working overtime that is not required. This behavior is fraudulent if the overtime is unnecessary, even though Tonya is actually present on the job during the overtime hours. Tonya is incorrect in thinking that her behavior is justified because she did not receive the full twoweek bonus. In fact, this behavior would not be justified even if she had a legitimate claim against the company. If she had a claim or grievance against the firm, then it should be handled through proper human resource or legal means. TIF 10–2 1.

The so-called “underground economy” hides transactions from IRS scrutiny by conducting business with cash (not check or credit card, which leaves an audit trail). The intent in many such transactions is to evade income tax illegally. However, just because a transaction is in cash does not exempt it from taxation. Tina Song also appears to perform construction services on a cash basis to evade reporting income while paying employees with cash to avoid paying social security and Medicare payroll taxes. The IRS reports that nearly 86% of the persons convicted of evading employment taxes were sentenced to an average of 17 months in prison and ordered to make restitution to the government for the taxes evaded plus interest and penalties.

Marvin should respond that he would rather receive a payroll check as a normal employee. As an employee, receiving cash rather than a payroll check subverts the U.S. tax system. That is, such cash payments do not include deductions for payroll taxes, as required by law. That is why, for example, cash tips must be formally reported to the IRS and subjected to payroll tax deductions by the employer. In addition, if Marvin followed Tina’s advice, Marvin not only would be avoiding payroll deductions but also would be underreporting income. This would subject Marvin to potential fines and possible criminal prosecution for underreporting income.

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

TIF 10–3 A sample solution based on Starbucks Corporation’s Form 10-K for the fiscal year ended September 29, 2019, follows: 1.

$6,168.7 million. The company’s current liabilities include accounts payable, accrued liabilities, accrued payroll and benefits, and stored value card liability.

The company’s current liabilities have increased from $5,684.2 million to $6,168.7 million.

Contingent liabilities are discussed in Notes 10 and 15 and include contingent rent related to leases and lawsuits.

No long-term debt will come due in the coming year (balance sheet).

TIF 10–4 Memo To: From: Re:

U. D. Mach III A+ Student Financial Reporting of Series 3 Shock Absorber Lawsuit

The customer lawsuit filed against WBM Motorworks arising from cracks in Series 3 motorcycle front shock absorbers creates a potential liability for the company. The way in which this potential liability is reported in the financial statements depends on two factors: the likelihood of losing the lawsuit and whether the amount of the loss can be measured. If the likelihood that the lawsuit will be lost is probable and the amount of the loss can be reasonably measured, then both a loss and a liability should be recorded in the accounts. If the likelihood that a loss will occur is only reasonably possible, then the potential liability should be disclosed in the notes to the financial statements but not be recorded in the accounts. Based on the information that exists at this time, it appears that a loss should be recorded on the income statement and a liability should be recorded on the balance sheet. The discovery of a manufacturing defect and the associated recall significantly increases the likelihood that the company will lose the lawsuit if it is taken to trial. While a direct link has not been made between the manufacturing defect and the shock absorber failure, the voluntary recall would make it difficult for a jury to disconnect the manufacturing defect from the product failure. As a result, I believe it is probable that the lawsuit will be lost if the case goes to trial. In addition, the amount of the loss is reasonably estimable. Similar lawsuits against other manufacturers have been settled for $2,000,000, which indicates that the amount can be estimated with reasonable accuracy. Since the potential loss is both probable and reasonably estimable, the company should record a loss on the income statement and a liability on the balance sheet.

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

TIF 10–4 (Concluded) An alternative argument could be made that the uncertainty surrounding the connection between the manufacturing defect and the cracked shock absorber is too uncertain to classify the likelihood of losing the lawsuit as probable. Rather, the likelihood of losing the lawsuit would be classified as reasonably possible. In this case, the lawsuit would be disclosed in the notes to the financial statements, but no loss or liability would be reported in the financial statements. It should be noted that considerable judgment is necessary in distinguishing between classes of contingent liabilities. This is especially true when distinguishing between probable and reasonably possible contingent liabilities, as is the case in this scenario. TIF 10–5 Sumana’s interpretation of the pension issue is correct. The employee earns the pension during the working years. The pension is part of the employee’s compensation that is deferred until retirement. Thus, Felton should record an expense equal to the amount of pension benefit earned by the employee for the period. This gives rise to the rather complex issue of estimating the amount of the pension expense. Francie indicates that the complexity of this calculation makes determining the annual pension expense impossible. This is not so. There are a number of mathematical and statistical approaches (termed “actuarial” approaches) that can reliably estimate the amount of benefits earned by the workforce for a given year. As a side note, Francie’s perspective can be summarized as “pay as you go.” In her interpretation, there is no expense until a pension is paid to the retiree. Failing to account for pension promises when they are earned is not considered sound accounting.

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

TIF 10–6 1.

CHAPTER 10

Liabilities: Current, Installment Notes, and Contingencies

TIF 10–6 (Concluded) 2.

Corwin LTD could use these analyses to improve or change its supplier relationships. The “average days to receive an order” analysis indicates that Baumbach Group with an average of over 30 days and Liberty Sales with an average of over 34 days are the slowest in filling orders. This delay in filling orders could result in out-ofstock items and lost sales. Corwin LDT should contact these suppliers for an explanation as to why their orders are taking so long. Western Supply, Inc. is not as slow as Baumbach Group and Liberty Sales in filling orders, at just over 16 days. However, since Western Supply, Inc. also had the most returns (see analysis of returns), it should be contacted and its performance closely monitored in the future. The “partial order” analysis indicates that Baumbach Group and Core-Mark each have two partial orders during the month. The fact that Baumbach Group is slow in filling orders (see analysis of average days to receive an order) and is not filling complete orders is a red flag for using this supplier. The “returns” analysis indicates that merchandise was returned to Western Supply, Inc. and Wholesale Solutions. Corwin LTD might monitor these suppliers in the future to determine whether returns to these suppliers is a continuing problem. The “back order” analysis indicates that Tradeshop LLC had one back order, while Wholesale Solutions had two back orders during the month. The fact that Wholesale Solutions also had a returned order during the month is a red flag. The performance of Wholesale Solutions should probably be monitored closely for the next several months.

CHAPTER 11 LIABILITIES: BONDS PAYABLE DISCUSSION QUESTIONS 1.

(1) To pay the face (maturity) amount of the bonds at a specified date. (2) To pay periodic interest at a specified percentage of the face amount.

Bonds that may be exchanged for other securities under specified conditions.

The issuing corporation reserves the right to redeem the bonds before the maturity date.

Less than face amount. Because comparable bonds provide a market interest rate (12%) that is greater than the rate on the bond being issued (11%), the bond will sell at a discount as the market’s means of equalizing the two interest rates.

Greater than $26,000,000

1. 2. 3. 4.

$26,000,000 7% 9% $26,000,000

More than the contract rate

Premium

$125,000 Premium

Premium on Bonds Payable

A loss of $50,000 [($5,000,000 × 0.98) – ($5,000,000 – $150,000)]

A bond is an interest-bearing note that requires periodic interest payments and repayment of the face amount of the bonds at maturity. Bonds consist of two different components: (1) interest payments made periodically over the life of the bond and (2) the face amount that must be repaid at maturity. The periodic payments consist entirely of interest, and the final payment at maturity consists entirely of principal. Installment notes, on the other hand, have periodic payments that consist partially of interest and partially of principal. Each payment reduces the principal on the note so that at maturity the entire amount borrowed will have been repaid.

As a current liability on the balance sheet.

As a long-term liability on the balance sheet.

CHAPTER 11

Liabilities: Bonds Payable

BASIC EXERCISES BE 11–1 a. Cash Bonds Payable

5,000,000

b. Interest Expense Cash

150,000

c. Bonds Payable Cash

5,000,000

150,000

5,000,000

BE 11–2 Cash Discount on Bonds Payable Bonds Payable

2,300,000 200,000 2,500,000

BE 11–3 Interest Expense Discount on Bonds Payable Cash

120,000 20,000 100,000

Discount on bonds payable = $200,000 ÷ 10 semiannual payments

BE 11–4 Cash Premium on Bonds Payable Bonds Payable

6,300,000 300,000 6,000,000

BE 11–5 Interest Expense Premium on Bonds Payable Cash

150,000 30,000 180,000

Premium on bonds payable = $300,000 ÷ 10 semiannual payments

BE 11–6 Bonds Payable Premium on Bonds Payable Gain on Redemption of Bonds Cash

2,000,000 87,000 127,000 1,960,000

CHAPTER 11

Liabilities: Bonds Payable

BE 11–7 Income Before Income Tax Expense + Interest Expense Interest Expense $4,400,000 + $400,000 = 12.0 $400,000

a. Times Interest Earned = 20Y8:

20Y9: b.

$5,544,000 + $440,000 $440,000

= 13.6

The times interest earned ratio has increased from 12.0 in 20Y8 to 13.6 in 20Y9. The increase in this ratio increases debtholders’ confidence in the company’s ability to make its interest payments.

CHAPTER 11

Liabilities: Bonds Payable

EXERCISES Ex. 11–1 The bonds were selling at a premium. This is indicated by the selling price of 102.8, which is stated as a percentage of the face amount and is more than par (100%). The market rate of interest for similar quality bonds was lower than 6.65%, and this is why the bonds were selling at a premium.

Ex. 11–2 1 Cash Bonds Payable

May

Nov.

Dec.

1,200,000 1,200,000

1 Interest Expense ($1,200,000 × 8% × 6/12) Cash

48,000

31 Interest Expense ($1,200,000 × 8% × 2/12) Interest Payable

16,000

48,000

16,000

Ex. 11–3 a.

Cash Discount on Bonds Payable Bonds Payable

14,376,255 623,745 15,000,000

Interest Expense Discount on Bonds Payable Cash

512,375

Interest Expense Discount on Bonds Payable Cash

512,375

62,375 450,000 62,375 450,000

Discount = ($15,000,000 – $14,376,255) ÷ 10 semiannual periods

CHAPTER 11

Liabilities: Bonds Payable

Ex. 11–3 (Concluded) b.

Annual interest paid ($15,000,000 × 6%)……………………………………… $ 900,000 124,750 Plus discount amortized ($62,375 + $62,375)………………………………… Interest expense for first year…………………………………………………… $1,024,750

The bonds sell for less than their face amount because the market rate of interest is greater than the contract rate of interest. Investors are not willing to pay the full face amount for bonds that pay a lower contract rate of interest than the rate they could earn on similar bonds (market rate).

Ex. 11–4 a.

20Y1 Apr.

Oct.

1 Cash Premium on Bonds Payable Bonds Payable

20,811,010

1 Interest Expense Premium on Bonds Payable Cash

818,899 81,101

811,010 20,000,000

900,000

Premium on bonds payable = $811,010 ÷ 10 semiannual payments Semiannual cash payout = $20,000,000 × 9% × 6/12

The bonds sell for more than their face amount because the market rate of interest is less than the contract rate of interest. Investors are willing to pay more for bonds that pay a higher rate of interest (contract rate) than the rate they could earn on similar bonds (market rate).

Ex. 11–5 20Y2 Mar.

Sept.

20Y4 Sept.

1 Cash Bonds Payable

10,000,000 10,000,000

1 Interest Expense ($10,000,000 × 5% × 6/12) Cash

1 Bonds Payable Loss on Redemption of Bonds Cash

250,000 250,000

10,000,000 200,000 10,200,000

Cash payout for bond redemption = $10,000,000 × 1.02

CHAPTER 11

Liabilities: Bonds Payable

Ex. 11–6 20Y5 May

1 Cash Bonds Payable

Nov.

22,000,000 22,000,000

1 Interest Expense ($22,000,000 × 4% × 6/12) Cash

20Y9 Nov.

440,000 440,000

1 Bonds Payable Gain on Redemption of Bonds Cash

22,000,000 660,000 21,340,000

Cash payout for bond redemption = $22,000,000 × 0.97

Ex. 11–7 1.

The significant loss on redemption of the Simmons Industries bonds should be reported in the “Other revenue and expense” section of the income statement.

The Hunter Corporation bonds outstanding at the end of the current year should be reported as a current liability on the balance sheet because they mature within one year.

Appendix 1 Ex. 11–8 a.

$50,000 × 0.67556 = $33,778

Cash on hand today can be invested to earn income. If $33,778 is invested at 4%, it will be worth $50,000 at the end of 10 years.

Appendix 1 Ex. 11–9 a.

First Year: Second Year: Third Year: Fourth Year: Total present value

$200,000 × 3.38721 = $677,442*

$200,000 × 0.93458 $200,000 × 0.87344 $200,000 × 0.81630 $200,000 × 0.76290

= = = =

$186,916 174,688 163,260 152,580 $677,444

* $2 difference between (a) and (b) is due to rounding.

Cash on hand today can be invested to earn income. If each of the $200,000 of cash receipts is invested at 7%, it will be worth $800,000 at the end of four years.

CHAPTER 11

Liabilities: Bonds Payable

Appendix 1 Ex. 11–10 $6,250,000 × 6.46321 = $40,395,063

Appendix 1 Ex. 11–11 No. The present value of your winnings using an interest rate of 12% is $31,047,750 ($6,250,000 × 4.96764), which is less than the present value of your winnings using an interest rate of 5% ($40,395,063; see Ex. 11–10). This is because the winnings are affected by the higher interest rate.

Appendix 1 Ex. 11–12 Present value of $1 for 10 semiannual periods at 4.5% semiannual rate………………………… 0.64393 × $25,000,000 Face amount of bonds………………………………………

$16,098,250

Present value of an annuity of $1 for 10 periods at 4.5%……………………………………… Semiannual interest payment……………………………… Total present value (proceeds)……………………………

6,923,630 $23,021,880

7.91272 × $875,000

Semiannual interest payment = $25,000,000 × 7% ÷ 2

Appendix 1 Ex. 11–13 Present value of $1 for 10 semiannual periods at 4.5% semiannual rate………………………… 0.64393 Face amount of bonds……………………………………… × $42,000,000

$27,045,060

18,278,383 $45,323,443

7.91272 × $2,310,000

Semiannual interest payment = $42,000,000 × 5.5%

Appendix 2 Ex. 11–14 a. 1.

Cash Discount on Bonds Payable Bonds Payable

43,495,895 6,504,105

Interest Expense Discount on Bonds Payable Cash

1,957,315

50,000,000 207,315 1,750,000

Semiannual interest expense = $43,495,895 × 9% × 6/12 Semiannual cash payout = $50,000,000 × 3.5%

CHAPTER 11

Liabilities: Bonds Payable

Appendix 2 Ex. 11–14 (Concluded) 3.

Interest Expense Discount on Bonds Payable Cash

1,966,644 216,644 1,750,000

Semiannual interest expense = ($43,495,895 + $207,315) × 9% × 6/12

Note: The following data in support of the proceeds of the bond issue stated in the exercise are presented for the instructor’s information. Students are not required to make the computations. Present value of $1 for 20 semiannual periods at 4.5% semiannual rate…………………… 0.41464 Face amount of bonds………………………………… × $50,000,000

$20,732,000

Present value of annuity of $1 for 20 periods at 4.5%………………………………… 13.00794 Semiannual interest payment………………………… × $1,750,000 Total present value (proceeds)………………………

22,763,895 $43,495,895

Semiannual interest payment = $50,000,000 × 3.5%

Annual interest paid………………………………………………………… Discount amortized………………………………………………………… Interest expense for first year………………………………………………

$3,500,000 423,959 $3,923,959

Discount amortization for first year = $207,315 + $216,644

Appendix 2 Ex. 11–15 a.

Cash Premium on Bonds Payable Bonds Payable

21,622,179 1,622,179 20,000,000

Interest Expense Premium on Bonds Payable Cash

864,887 135,113 1,000,000

Semiannual interest expense = $21,622,179 × 8.0% × 6/12 Semiannual cash payout = $20,000,000 × 5.0%

Interest Expense Premium on Bonds Payable Cash

859,483 140,517 1,000,000

Semiannual interest expense = ($21,622,179 – $135,113) × 8.0% × 6/12

CHAPTER 11

Liabilities: Bonds Payable

Appendix 2 Ex. 11–15 (Concluded) b.

Annual interest paid ($1,000,000 + $1,000,000)……………………………… Less premium amortized ($135,113 + $140,517)…………………………… Interest expense for first year…………………………………………………

$2,000,000 (275,630) $1,724,370

Premium amortization for first year = $135,113 + $140,517

Appendix 1 and 2 Ex. 11–16 a.

Present value of $1 for 10 semiannual periods at 5% semiannual rate……………………… 0.61391 Face amount of bonds…………………………………… × $35,000,000

$21,486,850

Present value of an annuity of $1 for 10 periods at 5%…………………………………………… 7.72173 Semiannual interest payment…………………………… × $2,100,000 Proceeds of bond sale……………………………………

16,215,633 $37,702,483

First semiannual interest payment…………………………………………… $ 2,100,000 (1,885,124) Less 5% of carrying amount of $37,702,483………………………………… Premium amortized……………………………………………………………… $ 214,876

Second semiannual interest payment………………………………………… $ 2,100,000 (1,874,380) Less 5% of carrying amount of $37,487,607………………………………… Premium amortized……………………………………………………………… $ 225,620 Bond issue carrying amount = $37,702,483 – $214,876

Annual interest paid……………………………………………………………… $4,200,000 (440,496) Less premium amortized………………………………………………………… $3,759,504 Interest expense for first year………………………………………………… Premium amortization for first year = $214,876 + $225,620

CHAPTER 11

Liabilities: Bonds Payable

Appendix 1 and 2 Ex. 11–17 a.

Present value of $1 for 10 semiannual periods at 6.0% semiannual rate……………………… 0.55839 Face amount of bonds…………………………………… × $80,000,000

$44,671,200

Present value of an annuity of $1 for 10 periods at 6.0%…………………………………………… Semiannual interest payment…………………………… Proceeds of bond sale……………………………………

26,496,324 $71,167,524

7.36009 × $3,600,000

Semiannual interest payment = $80,000,000 × 4.5%

6.0% of carrying amount of $71,167,524……………………………………… $ 4,270,051 Less first semiannual interest payment……………………………………… (3,600,000) Discount amortized……………………………………………………………… $ 670,051

6.0% of carrying amount of $71,837,575……………………………………… $ 4,310,255 (3,600,000) Less second semiannual interest payment………………………………… Discount amortized……………………………………………………………… $ 710,255 Carrying amount = $71,167,524 + $670,051

Annual interest paid……………………………………………………………… $7,200,000 1,380,306 Plus discount amortized………………………………………………………… $8,580,306 Interest expense for first year…………………………………………………… Discount amortization for first year = $670,051 + $710,255

CHAPTER 11

Liabilities: Bonds Payable

PROBLEMS Prob. 11–1A 1. 20Y1 July

2. a.

20Y1 Dec.

1 Cash Discount on Bonds Payable Bonds Payable 31 Interest Expense Discount on Bonds Payable Cash

52,522,704 7,477,296 60,000,000 2,773,865 373,865 2,400,000

Discount amortization = $7,477,296 ÷ 20 semiannual payments Cash = $60,000,000 × 8% × 6/12

20Y2 June

30 Interest Expense Discount on Bonds Payable Cash

2,773,865 373,865 2,400,000

Discount amortization = $7,477,296 ÷ 20 semiannual payments

3. $2,773,865 4. Yes. Investors will not be willing to pay the face amount of the bonds when the interest payments they will receive from the bonds are less than the amount of interest that they could receive from investing in other bonds of a similar risk. 5. Present value of $1 for 20 semiannual 0.37689 periods at 5.0% semiannual rate……………………… × $60,000,000 Face amount of bonds……………………………………

$22,613,400

Present value of annuity of $1 for 20 periods at 5.0%…………………………………………… 12.46221 × $2,400,000 Semiannual interest payment…………………………… Proceeds of bond issue……………………………………

29,909,304 $52,522,704

CHAPTER 11

Liabilities: Bonds Payable

Prob. 11–2A 1.

20Y1 July

2. a.

1 Cash Premium on Bonds Payable Bonds Payable

20Y1 Dec.

31 Interest Expense Premium on Bonds Payable Cash ($40,000,000 × 10% × 6/12)

42,601,480 2,601,480 40,000,000 1,869,926 130,074 2,000,000

Premium amortization = $2,601,480 ÷ 20 seminannual payments (rounded)

20Y2 June

30 Interest Expense Premium on Bonds Payable Cash

1,869,926 130,074 2,000,000

Premium amortization = $2,601,480 ÷ 20 semiannual payments (rounded)

3. $1,869,926 4. Yes. Investors will be willing to pay more than the face amount of the bonds when the interest payments they will receive from the bonds exceed the amount of interest that they could receive from investing in other bonds of a similar risk. 5. Present value of $1 for 20 semiannual periods at 4.5% semiannual rate………………………… 0.41464 Face amount of bonds……………………………………… × $40,000,000

$16,585,600

Present value of annuity of $1 for 20 periods at 4.5%…………………………………… 13.00794 Semiannual interest payment……………………………… × $2,000,000 Proceeds of bond issue……………………………………

26,015,880 $42,601,480

CHAPTER 11

Liabilities: Bonds Payable

Prob. 11–3A 1.

20Y1 July

Dec.

20Y2 June

Dec.

20Y3 June

1 Cash Discount on Bonds Payable Bonds Payable

63,532,267 10,467,733

31 Interest Expense Discount on Bonds Payable Cash ($74,000,000 × 11% × 6/12)

4,331,693

30 Interest Expense Discount on Bonds Payable Cash

4,331,693

31 Interest Expense Discount on Bonds Payable Cash

4,331,693

30 Bonds Payable Loss on Redemption of Bonds Discount on Bonds Payable Cash

74,000,000 7,940,961

74,000,000

261,693 4,070,000

9,420,961 72,520,000*

* Cash payout for bond redemption = $74,000,000 × 0.98 2.

a. b.

20Y1: 20Y2:

$4,331,693 $8,663,386

Initial carrying amount of bonds……………………………………………… $63,532,267 Discount amortized on December 31, 20Y1………………………………… 261,693 Discount amortized on June 30, 20Y2……………………………………… 261,693 261,693 Discount amortized on December 31, 20Y2………………………………… Carrying amount of bonds, December 31, 20Y2…………………………… $64,317,346

CHAPTER 11

Liabilities: Bonds Payable

Appendix 1 and 2 Prob. 11–4A 1.

20Y1 July

20Y1 Dec.

1 Cash Discount on Bonds Payable Bonds Payable 31 Interest Expense Discount on Bonds Payable Cash

37,282,062 2,717,938 40,000,000 1,491,282* 91,282 1,400,000

* Semiannual interest expense = $37,282,062 × 4.0% b.

20Y2 June

30 Interest Expense Discount on Bonds Payable Cash

1,494,934* 94,934 1,400,000

* Semiannual interest expense = ($37,282,062 + $91,282) × 4.0% 3.

$1,491,282

Appendix 1 and 2 Prob. 11–5A 1.

20Y1 July

20Y1 Dec.

1 Cash Premium on Bonds Payable Bonds Payable

42,601,480

31 Interest Expense Premium on Bonds Payable Cash

1,917,067* 82,933

2,601,480 40,000,000

2,000,000

* Semiannual interest expense = $42,601,480 × 4.5% b.

20Y2 June

30 Interest Expense Premium on Bonds Payable Cash

1,913,335* 86,665 2,000,000

* Semiannual interest expense = ($42,601,480 – $82,933) × 4.5% 3.

$1,917,067

CHAPTER 11

Liabilities: Bonds Payable

Prob. 11–1B 1. 20Y1 July

2. a.

20Y1 Dec.

1 Cash Discount on Bonds Payable Bonds Payable

42,309,236 3,690,764 46,000,000

31 Interest Expense Discount on Bonds Payable Cash ($46,000,000 × 10% × 6/12)

2,392,269 92,269 2,300,000

Discount amortization = $3,690,764 ÷ 40 semiannual payments

20Y2 June

30 Interest Expense Discount on Bonds Payable Cash

2,392,269 92,269 2,300,000

Discount amortization = $3,690,764 ÷ 40 semiannual payments

3. $2,392,269 4. Yes. Investors will not be willing to pay the face amount of the bonds when the interest payments they will receive from the bonds are less than the amount of interest that they could receive from investing in other bonds of a similar risk. 5. Present value of $1 for 40 semiannual 0.11746 periods at 5.5% semiannual rate……………………… Face amount of bonds…………………………………… × $46,000,000 Present value of an annuity of $1 for 40 periods at 5.5%…………………………………………… Semiannual interest payment…………………………… Proceeds of bond issue……………………………………

16.04612 × $2,300,000

$ 5,403,160

36,906,076 $42,309,236

CHAPTER 11

Liabilities: Bonds Payable

Prob. 11–2B 1. 20Y1 July

2. a.

20Y1 Dec.

1 Cash Premium on Bonds Payable Bonds Payable 31 Interest Expense Premium on Bonds Payable Cash ($65,000,000 × 12% × 6/12)

73,100,469 8,100,469 65,000,000 3,494,977 405,023 3,900,000

Premium amortization = $8,100,469 ÷ 20 semiannual periods

20Y2 June

30 Interest Expense Premium on Bonds Payable Cash

3,494,977 405,023 3,900,000

Premium amortization = $8,100,469 ÷ 20 semiannual periods

3. $3,494,977 4. Yes. Investors will be willing to pay more than the face amount of the bonds when the interest payments they will receive from the bonds exceed the amount of interest that they could receive from investing in other bonds of a similar risk. 5. Present value of $1 for 20 semiannual 0.37689 periods at 5% semiannual rate…………………………… × $65,000,000 Face amount of bonds………………………………………

$24,497,850

Present value of an annuity of $1 for 20 12.46221 periods at 5%………………………………………………… × $3,900,000 Semiannual interest payment……………………………… Proceeds of bond issue……………………………………

48,602,619 $73,100,469

CHAPTER 11

Liabilities: Bonds Payable

Prob. 11–3B 1.

20Y1 July

Dec.

20Y2 June

Dec.

20Y3 June

1 Cash Premium on Bonds Payable Bonds Payable

62,817,040

31 Interest Expense Premium on Bonds Payable Cash ($55,000,000 × 9% × 6/12)

2,084,148 390,852

30 Interest Expense Premium on Bonds Payable Cash

2,084,148 390,852

31 Interest Expense Premium on Bonds Payable Cash

2,084,148 390,852

30 Bonds Payable Premium on Bonds Payable Gain on Redemption of Bonds Cash

55,000,000 6,253,632

7,817,040 55,000,000

2,475,000

4,603,632 56,650,000 *

* Cash payout for bond redemption = $55,000,000 × 1.03 2.

a. b.

20Y1: 20Y2:

$2,084,148 $4,168,296

Initial carrying amount of bonds…………………………………………… $62,817,040 Less premium amortized on December 31, 20Y1………………………… (390,852) Less premium amortized on June 30, 20Y2……………………………… (390,852) (390,852) Less premium amortized on December 31, 20Y2………………………… Carrying amount of bonds, December 31, 20Y2………………………… $61,644,484

CHAPTER 11

Liabilities: Bonds Payable

Appendix 1 and 2 Prob. 11–4B 1.

20Y1 July

20Y1 Dec.

1 Cash Discount on Bonds Payable Bonds Payable 31 Interest Expense Discount on Bonds Payable Cash

42,309,236 3,690,764 46,000,000 2,327,008 27,008 2,300,000

Semiannual interest expense = $42,309,236 × 5.5%

20Y2 June

30 Interest Expense Discount on Bonds Payable Cash

2,328,493 28,493 2,300,000

Semiannual interest expense = ($42,309,236 + $27,008) × 5.5%

$2,327,008

Appendix 1 and 2 Prob. 11–5B 1.

20Y1 July

20Y1 Dec.

1 Cash Premium on Bonds Payable Bonds Payable

73,100,469

31 Interest Expense Premium on Bonds Payable Cash

3,655,023 244,977

8,100,469 65,000,000

3,900,000

Semiannual interest expense = $73,100,469 × 5%

20Y2 June

30 Interest Expense Premium on Bonds Payable Cash

3,642,775 257,225 3,900,000

Semiannual interest expense = ($73,100,469 – $244,977) × 5%

$3,655,023

CHAPTER 11

Liabilities: Bonds Payable

MAKE A DECISION MAD 11–1 a. Times Interest Earned =

Income Before Income Tax Expense + Interest Expense Interest Expense

Amazon: Year 1:

$11,261 + $1,417 = 8.9 $1,417

Year 2:

$13,976 + $1,600 = 9.7 $1,600

Year 1:

$11,460 + $1,975 $1,975

= 6.8

Year 2:

$20,116 + $2,262 $2,262

= 9.9

Walmart:

b. Amazon’s times interest earned ratio increased, going from 8.9 to 9.7. This increase is due to the growth in income which was double the percentage growth in interest expense. The interest coverage indicated by these ratios suggests that Amazon will be able to cover interest payments from current-period income before tax. c. A times interest earned ratio less than 1.0 does not necessarily mean that a company will default on its loans. Creditors are paid from cash, and cash can be received from owner contributions, other loans, and operations. These sources can be used to pay interest charges while operating earnings remain weak. The ability to make interest payments ultimately rests on cash flow. However, a low times interest earned ratio provides an early warning signal. A company often has time to improve operations so that a weak ratio can turn into a stronger ratio over time. However, a ratio less than 1.0 over a period of time will indicate potential problems in making interest payments. d. Walmart’s times interest earned ratio increased from 6.8 in Year 1 to 9.9 in Year 2. This increase is mainly due to the large increase in income before taxes while interest expense increased at a lower rate. Walmart’s interest coverage indicates a healthy protection for interest payments to creditors. e. Both companies have approximately the same protection for creditors as indicated by the times interest earned ratio. Both companies’ ratios show a period-to-period increase.

CHAPTER 11

Liabilities: Bonds Payable

MAD 11–2 a.

Times Interest Earned =

Income Before Income Tax Expense + Interest Expense Interest Expense

Clorox:

$1,024 + $97 $97

= 11.6

Procter & Gamble:

$6,069 + $509 $509

= 12.9

b. Procter & Gamble has a times interest earned ratio of 12.9, which is slightly higher than Clorox’s ratio of 11.6. Both companies’ ratios are more than sufficient and demonstrate protection for creditors. Neither ratio is a cause of concern. Therefore, as a lender, you would have slightly greater interest protection from Procter & Gamble, but both companies have adequate interest coverage.

MAD 11-3 a. Times Interest Earned =

Income Before Income Tax Expense + Interest Expense Interest Expense

Year 1:

$54,590 + $18,248 $18,248

Year 2:

$(3,478) + $18,666 = 0.8 $18,666

Year 3:

$55,161+ $16,889 $16,889

Year 4:

$116,367 + $10,999 = 11.6 $10,999

= 4.0

= 4.3

CHAPTER 11

Liabilities: Bonds Payable

MAD 11–3 (Concluded) b.

Times Interest Earned 14 12 10 8 6 4 2 $ — Year 1

Year 2

Year 3

Year 4

c. While the times interest earned ratio is unfavorable in Year 2, there is a positive trend in Years 3 and 4. The ratio in Year 4 clearly demonstrates adequate interest coverage. Interest expense was relatively stable in Years 1–3 and decreased in Year 4. This decreasing interest expense and increasing pretax income leads to the improvement in the times interest earned ratio. This positive trend is good news for investors. d. While interest expense remained stable between Years 1 and 2, the decrease in the ratio must have been caused by decreased income. This is caused by decreased sales as well as increased expenses between Years 1 and 2.

CHAPTER 11

Liabilities: Bonds Payable

MAD 11–4 a.

Times Interest Earned =

Income Before Income Tax Expense + Interest Expense Interest Expense

Hilton:

$1,244 + $414 $414

= 4.0

Marriott:

$1,599 + $394 $394

= 5.1

b. The times interest earned ratio is 4.0 for Hilton and 5.1 for Marriott. Using this ratio, we can conclude that Marriott’s earnings provide its creditors greater protection of their interest charges than Hilton’s earnings provide to its creditors. Marriott’s creditors’ interest is covered more than five times by earnings, while Hilton’s creditors’ interest is covered four times by earnings. While Marriott has more income than Hilton, Hilton has more interest expense than Marriott. Hilton has interest expense of $414 million, while Marriott has interest expense of only $394 million. Thus, Hilton apparently uses more debt to finance its operations than Marriott.

CHAPTER 11

Liabilities: Bonds Payable

TAKE IT FURTHER TIF 11–1 CEG’s actions were technically legal; it did not violate any laws. However, this action could damage the company’s reputation. If investors perceive that the company is not acting fairly in its dealings with them, then the company may find it difficult to issue additional debt in the future. This case is based on a real-world situation, where GE Capital, a division of General Electric, announced a follow-up long-term bond issue within days of an initial debt issue. The company’s actions created a significant public relations problem for the company. Here are some of the reactions from investors: “A lot of people feel like they have been sorely used,” said one bond fund manager. “There was nothing illegal about it, but it was nasty.” “But then to find out two days later that they had filed a $50 billion shelf?” he said. “People buy GE because it’s like buying Treasuries, not because they want to get jerked around.” “An example of a lack of candor. It was the most recent and most egregious example of how bondholders are mistreated.” In response to the criticisms, GE Capital released the following public statement: “With the $11 billion bond issuance of March 13, GE Capital exhausted its existing debt shelf registration; consequently, on March 20, GE Capital filed a $50 billion shelf registration.” The release went on to indicate that the shelf filing was not an offering and that it would be used in part to roll over $31 billion in maturing long-term debt. In retrospect, GE Capital could have been a little more forthcoming about its financing plans prior to selling the $11 billion of bonds, but there was nothing unethical or illegal about its actions. TIF 11–2 A sample solution based on Nike Inc.’s Form 10-K for the fiscal year ended May, 31, 2019, follows: 1. a. $3,464 million (balance sheet) b. Yes. See table below. (Dollar amounts are in millions.) In addition to these three bonds, the company reports promissory notes and Japanese yen notes that are not included in the table.

Due Date

Contract Rate

Original Principal

(Discount)/ Premium

5/1/2023 11/1/2026 5/1/2043 11/1/2045 11/1/2046

2.25% 2.38% 3.63% 3.88% 3.38%

$ 500 1,000 500 1,000 500

(2) (6) (5) (17) (9)

Long-term debt of $6 million will mature within one year of the balance sheet date. 2. The company has very little long-term debt relative to total assets and net income. 11-23 © 2022 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 11

Liabilities: Bonds Payable

TIF 11–3 To: From: Re:

Liz Nolan A+ Student Bond Redemption

I have reviewed the proposed redemption of the company’s 7% bonds and the subsequent issuance of new 5% bonds and have concluded that this is a good financial decision for the company. My assessment is based on a comparison of the redemption price to the proceeds from the new bond issuance and the interest savings from the new bond issue. The proceeds from the new 5% bond issue will be $30,000 less than what is needed to redeem the existing 7% bonds. The company will receive $1,000,000 from issuing the new 5% bonds at face amount, but will have to pay $1,030,000 ($1,000,000 × 103) to redeem the outstanding bonds. Thus, it will cost the company $30,000 to replace the existing 7% bonds with new 5% bonds. However, the new 5% bonds will pay less interest semiannually than the existing 7% bonds, resulting in interest savings of $100,000 over the next five years. These savings were calculated as follows:

Face amount…………………………………… × Contract rate of interest…………………… × Term…………………………………………… Semiannual interest payment………………

7% Bonds $1,000,000 7.0% 0.5 $ 35,000

5% Bonds $1,000,000 5.0% 0.5 $ 25,000

× Number of interest periods remaining…………………………………………… Total interest savings……………………………………………………………………

Interest Savings

$ 10,000 10 × $100,000

The interest savings of $100,000 are significantly larger than the $30,000 redemption premium, resulting in a $70,000 savings to the company. However, the company must also consider the impact of the time value of money on these savings. The $70,000 in interest savings occurs over the next five years, with the company saving $10,000 on every semiannual interest payment. Because these savings are in the future, they must be discounted back to today to determine their present value. Using the market rate of interest of 5%, the present value of these savings is calculated as follows: Semiannual interest savings………………………………………………………… Present value factor of an annuity of $1 at compound interest (n = 10, i = 5%)………………………………………………………………………… Present value of interest savings……………………………………………………

$10,000.00 × 7.72173

$77,217.30

On a present value basis, the company is saving $77,217.30 in interest costs, while paying a $30,000 redemption premium to repurchase the bonds. This results in a $47,217.30 savings to the company. The company should proceed with the plan.

CHAPTER 11

Liabilities: Bonds Payable

TIF 11–4 Receive $100,000,000 today: Present value of $100,000,000 today = $100,000,000 Receive $25,000,000 today, plus $9,000,000 per year for 8 years: Present value of $25,000,000 today…………………………………………

$25,000,000

Present value of annual payments: $9,000,000 × 5.97130 (PVA of $1 for 8 periods at 7%)………………… 53,741,700 Total value………………………………………………………………………… $78,741,700 Present value of $25,000,000 today = $25,000,000 Present value of annual payments = $9,000,000 × 5.97130 (Present value of an annuity of $1 for 8 periods at 7%) = $53,741,700 Total value = Present value of $25,000,000 + Present value of annual payments Total value = $25,000,000 + $53,741,700 = $78,741,700 Receive $15,000,000 per year for 10 years: Present value of annual payments = $15,000,000 × 7.02358 (Present value of an annuity of $1 for 10 periods at 7%) = $105,353,700 The option that has the highest value in terms of present value is to receive $15,000,000 a year for 10 years.

CHAPTER 12 CORPORATIONS: ORGANIZATION, STOCK TRANSACTIONS, AND DIVIDENDS DISCUSSION QUESTIONS 1.

No. Common stock with a higher par is not necessarily a better investment than common stock with a lower par because par is an amount assigned to the shares.

The broker is not correct. Corporations are not legally liable to pay dividends until the dividends are declared. If the company that issued the preferred stock has operating losses, it could omit dividends, first, on its common stock and, later, on its preferred stock.

The company may not have had enough cash on hand to pay a dividend on the common stock, or resources may be needed for plant expansion, replacement of facilities, payment of liabilities, etc.

a. b.

No change. Total equity is the same.

a. b.

Current liability Stockholders’ equity

The primary purpose of a stock split is to bring about a reduction in the market price per share and thus to encourage more investors to buy the company’s shares.

a. b.

It has no effect on revenue or expense. It reduces stockholders’ equity by $3,000,000.

a. b.

It has no effect on revenue. It increases stockholders’ equity by $3,750,000.

The three classifications of restrictions on retained earnings are legal, contractual, and discretionary. Restrictions are normally reported in the notes to the financial statements.

10.

Such prior period adjustments should be reported as an adjustment to the beginning balance of retained earnings.

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

BASIC EXERCISES BE 12–1 20Y1 Amount distributed…………………………… $ 30,000 (10,000) Preferred dividend (20,000 shares)………… Common dividend (200,000 shares)………… $ 20,000

20Y2

20Y3

$ 8,000 (8,000) $ 0

$110,000 (12,000)* $ 98,000

$0.40 None

$0.60 $0.49

* Year 3 preferred dividend = $2,000 + $10,000 Dividends per share*: Preferred stock……………………………… Common stock………………………………

$0.50 $0.10

* Dividends per Share = Amount of Dividend ÷ Number of Shares Outstanding

BE 12–2 Jan.

22 Cash Common Stock (180,000 × $12)

2,160,000

Feb. 14 Cash Preferred Stock (50,000 × $50)

2,500,000

Aug. 30 Cash (20,000 × $54) Preferred Stock (20,000 × $50) Paid-In Capital in Excess of Par— Preferred Stock [20,000 × ($54 – $50)]

1,080,000

2,160,000

2,500,000

1,000,000 80,000

BE 12–3 Oct.

Nov.

1 Cash Dividends Cash Dividends Payable

425,000 425,000

7 No entry required.

Dec. 15 Cash Dividends Payable Cash

425,000 425,000

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

BE 12–4 Aug.

2 Stock Dividends (1,200,000 × 6% × $50) Stock Dividends Distributable (1,200,000 × 6% × $10) Paid-In Capital in Excess of Par—Common Stock [(1,200,000 × 6%) × ($50 – $10)]

3,600,000 720,000

2,880,000

Sept.

15 No entry required.

Oct.

8 Stock Dividends Distributable Common Stock

720,000

27 Treasury Stock (60,000 × $8) Cash

480,000

3 Cash (42,000 × $12) Treasury Stock (42,000 × $8) Paid-In Capital from Sale of Treasury Stock [42,000 × ($12 – $8)]

504,000

14 Cash (18,000 × $6) Paid-In Capital from Sale of Treasury Stock [18,000 × ($8 – $6)] Treasury Stock (18,000 × $8)

108,000

720,000

BE 12–5 May

Aug.

Nov.

480,000

336,000 168,000

36,000 144,000

BE 12–6 Stockholders’ Equity Paid-in capital: Common stock, $120 par (500,000 shares authorized, 400,000* shares issued) Excess of issue price over par Paid-in capital, common stock From sale of treasury stock Total paid-in capital Retained earnings Total Treasury stock (40,000 shares at cost) Total stockholders’ equity

$48,000,000 6,400,000 $ 54,400,000 4,500,000 $ 58,900,000 63,680,000 $122,580,000 (5,200,000) $117,380,000

* $48,000,000 ÷ $120 par

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

BE 12–7

Balances, October 1 Issued common stock Net income Dividends Balances, October 31

Noric Cruises Inc. Statement of Stockholders’ Equity For the Month Ended October 31 Additional Retained Common Paid-In Earnings Stock Capital Total $150,000 $3,225,000 $12,400,000 $15,775,000 50,000 750,000 800,000 2,350,000 2,350,000 (475,000) (475,000) $200,000 $3,975,000 $14,275,000 $18,450,000

BE 12–8 a.

20Y5: Earnings per Share =

$1,538,000 – $50,000 80,000 shares

$1,488,000 80,000 shares

20Y6: Earnings per Share =

Net Income – Preferred Dividends Average Number of Common Shares Outstanding

= $18.60

Net Income – Preferred Dividends Average Number of Common Shares Outstanding

$2,485,700 – $50,000 115,000 shares

$2,435,700 115,000 shares

= $21.18

The increase in the earnings per share from $18.60 to $21.18 indicates a favorable change in the company’s profitability.

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

EXERCISES Ex. 12–1 1st Year

2nd Year

3rd Year

4th Year

Total dividend declared…………………

$60,000

$110,000

$100,000

$120,000

Preferred dividend (current)…………

$60,000

$ 80,000

Preferred dividend in arrears…………

—

20,000

—

Total preferred dividends………………

$60,000

$100,000

$ 80,000

Preferred shares outstanding…………

÷80,000

÷ 80,000

Preferred dividend per share…………

0.75

Dividend for common shares (total dividend declared – total preferred dividends)…………… Common shares outstanding………… Common dividend per share…………

—

$ 10,000 ÷200,000 $ 0.05

$ 20,000 ÷200,000 $ 0.10

$ 40,000 ÷200,000 $ 0.20

1st Year

2nd Year

3rd Year

4th Year

Total dividend declared…………………

$36,000

$58,000

$75,000

$124,000

Preferred dividend (current)………… Preferred dividend in arrears…………

$36,000 —

$44,000* 14,000

$50,000 6,000

$ 50,000 —

Total preferred dividends……………… Preferred shares outstanding………… Preferred dividend per share…………

$36,000 ÷40,000 $ 0.90

$58,000 ÷40,000 $ 1.45

$56,000 ÷40,000 $ 1.40

$ 50,000 ÷ 40,000 $ 1.25

$ 19,000 ÷100,000 $ 0.19

$ 74,000 ÷100,000 $ 0.74

1.25

1.00

Ex. 12–2

* Preferred dividend (current) for 2nd year = $44,000 = $58,000 – $14,000 Dividend for common shares (total dividend declared – total preferred dividends)…………… Common shares outstanding………… Common dividend per share…………

—

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Ex. 12–3 a. Jan.

Feb.

22 Cash (230,000 × $25) Common Stock (230,000 × $20) Paid-In Capital in Excess of Par—Common Stock [230,000 × ($25 – $20)]

5,750,000

27 Cash (12,000 × $14) Preferred Stock (12,000 × $8) Paid-In Capital in Excess of Par—Preferred Stock [12,000 × ($14 – $8)]

168,000

4,600,000 1,150,000

96,000 72,000

b. $5,918,000 ($5,750,000 + $168,000)

Ex. 12–4 a. May

15 Cash (625,000 × $5) Common Stock (625,000 × $2.25) Paid-In Capital in Excess of Stated Value— Common Stock [625,000 × ($5 – $2.25)]

3,125,000

June 30 Cash (22,000 × $62) Preferred Stock (22,000 × $50) Paid-In Capital in Excess of Par—Preferred Stock [22,000 × ($62 – $50)]

1,364,000

1,406,250 1,718,750

1,100,000 264,000

b. $4,489,000 ($3,125,000 + $1,364,000)

Ex. 12–5 Nov.

23 Land (14,200 × $34) Common Stock (14,200 × $25) Paid-In Capital in Excess of Par— Common Stock [14,200 × ($34 – $25)]

482,800 355,000 127,800

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Ex. 12–6 a. b.

Cash Common Stock (100,000 × $1)

100,000

Organizational Expenses Common Stock (3,000 × $1)

3,000

Cash Common Stock (45,000 × $1)

45,000

Land Building Common Stock

60,000 120,000

100,000 3,000

45,000

180,000

Ex. 12–7 Oct.

1 Cash (120,000 × $31.50) Common Stock (120,000 × $30.00) Paid-In Capital in Excess of Par— Common Stock [120,000 × ($31.50 – $30.00)]

3,780,000

1 Buildings Land Preferred Stock (35,000 × $80) Paid-In Capital in Excess of Par— Preferred Stock [35,000 × ($92 – $80)]

2,380,000 840,000

3,600,000 180,000

2,800,000 420,000

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Ex. 12–8 5 Cash Common Stock (600,000 × $8)

4,800,000

5 Organizational Expenses Common Stock (1,400 × $8)

11,200

9 Land Buildings Equipment Common Stock (60,000 × $8.00) Paid-In Capital in Excess of Par—Common Stock

200,000 310,000 80,000

June 14 Cash (32,000 × $82) Preferred Stock (32,000 × $60) Paid-In Capital in Excess of Par—Preferred Stock [32,000 × ($82 – $60)]

2,624,000

Feb.

Apr.

4,800,000

11,200

480,000 110,000

1,920,000 704,000

Ex. 12–9 July

9 Cash Dividends Cash Dividends Payable

1,525,000 1,525,000

Aug. 31 No entry required. Oct.

1 Cash Dividends Payable Cash

1,525,000 1,525,000

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Ex. 12–10 a. (1)

(2)

Stock Dividends [(2,200,000 × 5%) × $18] Stock Dividends Distributable (110,000 × $15) Paid-In Capital in Excess of Par— Common Stock [110,000 × ($18 – $15)]

1,980,000

Stock Dividends Distributable Common Stock

1,650,000

1,650,000 330,000

1,650,000

b. (1) $42,000,000 ($33,000,000 + $9,000,000) (2) $89,550,000 (3) $131,550,000 ($42,000,000 + $89,550,000) c. (1) $43,980,000 ($33,000,000 + $9,000,000 + $1,650,000 + $330,000) (2) $87,570,000 ($89,550,000 – $1,980,000) (3) $131,550,000 ($43,980,000 + $87,570,000) Ex. 12–11 a. 1,035,000 shares (345,000 × 3) b. $120 per share ($360 ÷ 3) Ex. 12–12

a. Authorizing and issuing stock certificates in a stock split b. Declaring a stock dividend c. Issuing stock certificates for the stock dividend declared in (b) d. Declaring a cash dividend e. Paying the cash dividend declared in (d)

Assets

Liabilities

Stockholders’ Equity

0 0

0 +

0 –

–

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Ex. 12–13 Jan.

8 No entry required. The stockholders’ ledger would be revised to record the increased number of shares held by each stockholder.

Apr.

30 Cash Dividends Cash Dividends Payable [(16,000 × $0.60) + (300,000 × $0.22)].

75,600

1 Cash Dividends Payable Cash

75,600

31 Cash Dividends Cash Dividends Payable [(16,000 × $0.60) + (300,000 × $0.11)].

42,600

31 Stock Dividends (300,000 × 5% × $56) Stock Dividends Distributable (300,000 × 5% × $50) Paid-In Capital in Excess of Par—Common Stock [(300,000 × 5%) × ($56 – $50)]

840,000

31 Cash Dividends Payable Cash

42,600

31 Stock Dividends Distributable Common Stock

750,000

July

Oct.

Dec.

75,600

42,600

750,000 90,000

42,600

750,000

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Ex. 12–14 a.

July

Sept.

Nov.

9 Treasury Stock (80,000 × $44) Cash

3,520,000

22 Cash (55,000 × $52) Treasury Stock (55,000 × $44) Paid-In Capital from Sale of Treasury Stock [55,000 × ($52 – $44)]

2,860,000

23 Cash (25,000 × $40) Paid-In Capital from Sale of Treasury Stock [25,000 × ($44 – $40)] Treasury Stock (25,000 × $44)

1,000,000

3,520,000

2,420,000 440,000

100,000 1,100,000

$340,000 ($440,000 – $100,000) credit

Mystic Lake may have purchased the stock to support the market price of the stock, to provide shares for resale to employees, or for reissuance to employees as a bonus according to stock purchase agreements.

Ex. 12–15 a.

Mar.

June

Nov.

9 Treasury Stock (62,000 × $51) Cash

3,162,000

9 Cash (48,000 × $60) Treasury Stock (48,000 × $51) Paid-In Capital from Sale of Treasury Stock [48,000 × ($60 – $51)]

2,880,000

13 Cash (7,500 × $54) Treasury Stock (7,500 × $51) Paid-In Capital from Sale of Treasury Stock [7,500 × ($54 – $51)]

405,000

3,162,000

2,448,000 432,000

382,500 22,500

$454,500 credit ($432,000 + $22,500)

$331,500 debit [(6,500 shares × $51) or ($3,162,000 – $2,448,000 – $382,500)]

The balance in the treasury stock account is reported as a deduction from the total of the paid-in capital and retained earnings.

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Ex. 12–16 a.

May

Sept.

Nov.

14 Treasury Stock (23,500 × $75) Cash

1,762,500

6 Cash (14,000 × $81) Treasury Stock (14,000 × $75) Paid-In Capital from Sale of Treasury Stock [14,000 × ($81 – $75)]

1,134,000

30 Cash (9,500 × $72) Paid-In Capital from Sale of Treasury Stock [9,500 × ($75 – $72)] Treasury Stock (9,500 × $75)

1,762,500

1,050,000 84,000 684,000 28,500 712,500

$55,500 ($84,000 – $28,500) credit

“Stockholders’ Equity” section

Biscayne Bay Water Inc. may have purchased the stock to support the market price of the stock, to provide shares for resale to employees, or for reissuance to employees as a bonus according to stock purchase agreements.

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Ex. 12–17 Stockholders’ Equity Paid-in capital: Preferred 2% stock, $120 par (85,000 shares authorized, 70,000 shares issued) Excess of issue price over par Paid-in capital, preferred stock Common stock, no par, $14 stated value (375,000 shares authorized, 320,000 shares issued) Excess of issue price over par Paid-in capital, common stock From sale of treasury stock Total paid-in capital

$8,400,000 210,000 $8,610,000

$4,480,000 480,000 4,960,000 45,000 $13,615,000

Ex. 12–18 Stockholders’ Equity Paid-in capital: Common stock, $45 par (80,000 shares authorized, 68,000 shares issued) Excess of issue price over par Paid-in capital, common stock From sale of treasury stock Total paid-in capital Retained earnings Total Treasury stock (9,000 shares at cost) Total stockholders’ equity

$3,060,000 272,000 $3,332,000 115,000 $ 3,447,000 20,553,000 $24,000,000 (324,000) $23,676,000

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Ex. 12–19 Stockholders’ Equity Paid-in capital: Preferred 1% stock, $150 par (50,000 shares authorized, 48,000 shares issued) Excess of issue price over par Paid-in capital, preferred stock Common stock, $36 par (300,000 shares authorized, 280,000 shares issued) Excess of issue price over par Paid-in capital, common stock From sale of treasury stock Total paid-in capital Retained earnings Total Treasury common stock (24,000 shares at cost) Total stockholders’ equity

$ 7,200,000 384,000 $ 7,584,000

$10,080,000 420,000 10,500,000 340,000 $18,424,000 71,684,000 $90,108,000 (1,008,000) $89,100,000

Ex. 12–20 Sumter Pumps Corporation Retained Earnings Statement For the Year Ended December 31, 20Y3 Retained earnings, January 1, 20Y3 Net income $ 8,160,000 Dividends (3,600,000) Change in retained earnings Retained earnings, December 31, 20Y3

$59,650,000

4,560,000 $64,210,000

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Ex. 12–21 1.

Retained earnings is not part of paid-in capital.

The cost of treasury stock should be deducted from the total stockholders’ equity.

Dividends payable should be included as part of current liabilities and not as part of stockholders’ equity.

Common stock should be included as part of paid-in capital.

The amount of shares of common stock issued of 825,000 times the par value per share of $20 should be extended as $16,500,000, not $17,655,000. The difference, $1,155,000, probably represents paid-in capital in excess of par.

Organizing costs should be expensed as Organizational Expenses when incurred and not included as a part of stockholders’ equity.

One possible corrected “Stockholders’ Equity” section of the balance sheet is as follows: Stockholders’ Equity

Paid-in capital: Preferred 2% stock, $80 par (125,000 shares authorized and issued) Excess of issue price over par Paid-in capital, preferred stock Common stock, $20 par (1,000,000 shares authorized, 825,000 shares issued) Excess of issue price over par Paid-in capital, common stock Total paid-in capital Retained earnings* Total Treasury stock (75,000 shares at cost) Total stockholders’ equity

$10,000,000 500,000 $ 10,500,000 $16,500,000 1,155,000 17,655,000 $ 28,155,000 96,400,000 $124,555,000 (1,755,000) $122,800,000

* $96,700,000 – $300,000. Since the organizing costs should have been expensed, the retained earnings should be $300,000 less.

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Ex. 12–22 I-Cards Inc. Statement of Stockholders’ Equity For the Year Ended December 31, 20Y9

Balances, Jan. 1, 20Y9 Issued 30,000 shares of common stock Purchased 12,000 shares as treasury stock Net income Dividends Balances, Dec. 31, 20Y9

Common Stock, $40 par

Paid-In Capital in Excess of Par

Treasury Stock

$4,800,000

$ 960,000

—

1,200,000

300,000

Retained Earnings $11,375,000

1,500,000 $(552,000)

$6,000,000

$1,260,000

Total $17,135,000

$(552,000)

3,780,000 (276,000) $14,879,000

(552,000) 3,780,000 (276,000) $21,587,000

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

PROBLEMS Prob. 12–1A 1. Year

Total Dividends

20Y1………… 20Y2………… 20Y3………… 20Y4………… 20Y5………… 20Y6…………

$ 60,000 80,000 160,000 160,000 170,000 180,000

Preferred Dividends Per Total Share $ 60,000 80,000 100,000* 80,000 80,000 80,000

$0.15 0.20 0.25 0.20 0.20 0.20 $1.20

Common Dividends Per Total Share $

0 0 60,000 80,000 90,000 100,000

$0.00 0.00 0.12 0.16 0.18 0.20 $0.66

* $100,000 = (20Y2 dividends in arrears of $20,000) + (20Y3 current dividend of $80,000) 2.

Average annual dividend for preferred: $0.20 per share ($1.20 ÷ 6) Average annual dividend for common: $0.11 per share ($0.66 ÷ 6)

a. b.

0.8% ($0.20 ÷ $25.00) 0.5% ($0.11 ÷ $22.00)

Prob. 12–2A May

11 Building Land Common Stock (125,000 × $35) Paid-In Capital in Excess of Par— Common Stock [125,000 × ($39* – $35)]

3,375,000 1,500,000

20 Cash (40,000 × $52) Preferred Stock (40,000 × $50) Paid-In Capital in Excess of Par— Preferred Stock [40,000 × ($52** – $50)]

2,080,000

31 Cash Mortgage Note Payable

4,000,000

4,375,000 500,000

2,000,000 80,000

4,000,000

* $39/share = $4,875,000 ÷ 125,000 shares ** $52/share = $2,080,000 ÷ 40,000 shares

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Prob. 12–3A a.

Cash (220,000 × $14) Common Stock (220,000 × $5) Paid-In Capital in Excess of Par—Common Stock [220,000 × ($14 – $5)]

3,080,000

Cash (12,000 × $110) Preferred Stock (12,000 × $100) Paid-In Capital in Excess of Par—Preferred Stock [12,000 × ($110 – $100)]

1,320,000

Treasury Stock (160,000 × $10) Cash

1,600,000

Cash (105,000 × $16) Treasury Stock (105,000 × $10) Paid-In Capital from Sale of Treasury Stock [105,000 × ($16 – $10)]

1,680,000

Cash (40,000 × $8) Paid-In Capital from Sale of Treasury Stock [40,000 × ($10 – $8)] Treasury Stock (40,000 × $10)

320,000

Cash Dividends Cash Dividends Payable

520,400*

Cash Dividends Payable Cash

520,400

* Calculation of cash dividends: Beginning of year (a) (b) (c) (d) (e) Cash dividends per share Dividends paid in (f)

1,100,000 1,980,000

1,200,000 120,000

1,600,000

1,050,000 630,000

80,000 400,000

520,400

520,400 Outstanding Shares of Stock Preferred Stock Common Stock 80,000 shares 4,000,000 shares 220,000 12,000 (160,000) 105,000 40,000 92,000 shares 4,205,000 shares $2.00 $0.08 × × $184,000 $336,400

Total dividends paid $520,400 ($184,000 + $336,400)

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Prob. 12–4A 1. and 2. Common Stock Jan. 1 Apr. 10 Aug. 15 Dec. 31

Bal.

7,500,000 1,500,000 360,000 9,360,000

Paid-In Capital in Excess of Stated Value—Common Stock Jan. 1 Bal. 825,000 Apr. 10 300,000 July 5 90,000 Dec. 31 Bal. 1,215,000

Dec.

Jan. Nov. Dec.

Retained Earnings 493,800 Jan. 1 _______ Dec. 31 Dec. 31

1 23 31

Bal. Bal.

Treasury Stock 450,000 June 6 570,000 570,000

33,600,000 1,125,000 34,231,200

450,000 ______

Paid-In Capital from Sale of Treasury Stock June 6

200,000

Aug.

Stock Dividends Distributable 360,000 July 5

360,000

July

Stock Dividends 450,000 Dec. 31

450,000

Cash Dividends 43,800 Dec. 31

43,800

Dec.

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Prob. 12–4A (Continued) 2. 20Y6 Jan.

Apr.

June

July

Aug.

Nov.

Dec.

22 Cash Dividends Payable [(375,000 – 25,000) × $0.08] Cash

28,000 28,000

10 Cash (75,000 shares × $24) Common Stock (75,000 × $20) Paid-In Capital in Excess of Stated Value— Common Stock [75,000 × ($24 – $20)]

1,800,000

6 Cash (25,000 × $26) Treasury Stock (25,000 × $18) Paid-In Capital from Sale of Treasury Stock [25,000 × ($26 – $18)]

650,000

5 Stock Dividends [(375,000 + 75,000) × 4% × $25] Stock Dividends Distributable (18,000 × $20) Paid-In Capital in Excess of Stated Value— Common Stock [18,000 × ($25 – $20)]

450,000

15 Stock Dividends Distributable Common Stock

360,000

23 Treasury Stock (30,000 × $19) Cash

570,000

28 Cash Dividends Cash Dividends Payable [(375,000 + 75,000 + 18,000 – 30,000) × $0.10].

43,800

31 Retained Earnings Stock Dividends Cash Dividends

493,800

1,500,000 300,000

450,000 200,000

360,000 90,000

360,000

570,000

43,800

450,000 43,800

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Prob. 12–4A (Concluded) 3. Morrow Enterprises Inc. Statement of Stockholders’ Equity For the Year Ended December 31, 20Y6 Paid-In Paid-In

Capital from

Capital in

Sale of

Common

Excess of

Treasury

Retained

Treasury

Stock

Stated Value

Stock

Earnings

Stock

Balances, January 1

$7,500,000

$ 825,000

Issued common stock

1,500,000

300,000

Cash dividends 360,000

90,000

Sale of treasury stock

$(450,000) $41,475,000 1,800,000

Net income Stock dividend

$33,600,000

Total

1,125,000

(43,800)

(450,000)

200,000

450,000

650,000

(570,000)

Purchase of treasury stock Balances, December 31

$9,360,000

$1,215,000

$200,000

$34,231,200

$(570,000) $44,436,200

4. Stockholders’ Equity Paid-in capital: Common stock, $20 stated value (500,000 shares authorized, 468,000 shares issued) Excess of issue price over stated value From sale of treasury stock

$9,360,000 1,215,000 200,000

Total paid-in capital Retained earnings

$10,775,000 34,231,200

Total Treasury stock (30,000 shares at cost)

$45,006,200 (570,000)

Total stockholders’ equity

$44,436,200

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Prob. 12–5A Jan.

9 No entry required. The stockholders’ ledger would be revised to record the increased number of shares held by each stockholder and new par value.

Feb. 28 Treasury Stock (40,000 × $28) Cash May

1,120,000 1,120,000

1 Cash Dividends {(75,000 × $0.80) + [(1,200,000 – 40,000) × $0.12]} Cash Dividends Payable

July 10 Cash Dividends Payable Cash Sept.

Oct.

Dec.

199,200 199,200 199,200 199,200

7 Cash (30,000 × $34) Treasury Stock (30,000 × $28) Paid-In Capital from Sale of Treasury Stock [30,000 × ($34 – $28)]

1,020,000 840,000 180,000

1 Cash Dividends Cash Dividends Payable {(75,000 × $0.80) + [(1,200,000 – 10,000) × $0.12]}.

202,800

1 Stock Dividends [(1,200,000 – 10,000) × 2% × $36] Stock Dividends Distributable (23,800 × $25) Paid-In Capital in Excess of Par— Common Stock [23,800 × ($36 – $25)]

856,800

1 Cash Dividends Payable Cash

202,800

1 Stock Dividends Distributable Common Stock

595,000

202,800

595,000 261,800

202,800

595,000

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Prob. 12–1B Preferred Dividends Per Total Share

1. Year

Total Dividends

20Y1………… 20Y2………… 20Y3………… 20Y4………… 20Y5………… 20Y6…………

$ 24,000 10,000 126,000 100,000 125,000 125,000

$ 24,000 10,000 101,000* 45,000 45,000 45,000

$ 0.96 0.40 4.04 1.80 1.80 1.80 $10.80

Common Dividends Per Total Share $ 0 $0.00 0 0.00 25,000 0.25 55,000 0.55 80,000 0.80 0.80 80,000 $2.40

* $101,000 = (20Y1 dividends in arrears of $21,000) + (20Y2 dividends in arrears of $35,000) + (20Y3 current dividend of $45,000)

Average annual dividend for preferred: $1.80 per share ($10.80 ÷ 6) Average annual dividend for common: $0.40 per share ($2.40 ÷ 6)

a. 1.8% ($1.80 ÷ $100) b. 8.0% ($0.40 ÷ $5)

Prob. 12–2B Oct.

9 Cash Mortgage Note Payable

1,500,000

17 Cash (20,000 × $126) Preferred Stock (20,000 × $120) Paid-In Capital in Excess of Par— Preferred Stock [20,000 × ($126 – $120)]

2,520,000

28 Building Land Common Stock (300,000 × $15) Paid-In Capital in Excess of Par— Common Stock [300,000 × ($16.50* – $15.00)]

4,150,000 800,000

1,500,000

2,400,000 120,000

4,500,000 450,000

* $16.50 = $4,950,000 ÷ 300,000 shares

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Prob. 12–3B a.

Treasury Stock (87,500 × $8) Cash

700,000

Cash (55,000 × $11) Treasury Stock (55,000 × $8) Paid-In Capital from Sale of Treasury Stock [55,000 × ($11 – $8)]

605,000

Cash (20,000 × $84) Preferred Stock (20,000 × $80) Paid-In Capital in Excess of Par—Preferred Stock [20,000 × ($84 – $80)]

1,680,000

Cash (400,000 × $13) Common Stock (400,000 × $9) Paid-In Capital in Excess of Par—Common Stock [400,000 × ($13 – $9)]

5,200,000

Cash (18,000 × $7.50) Paid-In Capital from Sale of Treasury Stock [18,000 × ($8.00 – $7.50)] Treasury Stock (18,000 × $8)

135,000

Cash Dividends Cash Dividends Payable

234,775 *

Cash Dividends Payable Cash

234,775

* Calculation of cash dividends: Beginning of year (a) (b) (c) (d) (e) Cash dividends per share Dividends paid in (f)

700,000

440,000 165,000

1,600,000 80,000

3,600,000 1,600,000

9,000 144,000

234,775

234,775 Outstanding Shares of Stock Preferred Stock Common Stock 60,000 shares 1,750,000 shares (87,500) 55,000 20,000 400,000 18,000 80,000 shares 2,135,500 shares $0.05 × $1.60 × $128,000 $106,775

Total dividends paid $234,775 ($128,000 + $106,775)

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Prob. 12–4B 1. and 2. Common Stock Jan. 1 Apr. 13 July 16 Dec. 31

Bal.

3,100,000 1,000,000 123,000 4,223,000

Paid-In Capital in Excess of Stated Value—Common Stock Jan. 1 Bal. 1,240,000 Apr. 13 600,000 June 14 61,500 Dec. 31 Bal. 1,901,500

Dec.

Jan. Oct. Dec.

Retained Earnings 248,068 Jan. 1 _______ Dec. 31 Dec. 31

1 30 31

Bal. Bal.

Treasury Stock 288,000 Mar. 15 300,000 300,000

4,875,000 775,000 5,401,932

288,000 ______

Paid-In Capital from Sale of Treasury Stock Mar. 15

36,000

July

Stock Dividends Distributable 123,000 June 14

123,000

June

Stock Dividends 184,500 Dec. 31

184,500

Cash Dividends 63,568 Dec. 31

63,568

Dec.

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Prob. 12–4B (Continued) 2. 20Y1 Jan.

Mar.

Apr.

June

July

Oct.

Dec.

15 Cash Dividends Payable Cash [(620,000 – 48,000) × $0.06]

34,320

15 Cash (48,000 × $6.75) Treasury Stock (48,000 × $6.00) Paid-In Capital from Sale of Treasury Stock [48,000 × ($6.75 – $6.00)]

324,000

13 Cash (200,000 × $8) Common Stock (200,000 × $5) Paid-In Capital in Excess of Stated Value— Common Stock [200,000 × ($8 – $5)]

1,600,000

34,320

288,000 36,000

1,000,000 600,000

14 Stock Dividends [(620,000 + 200,000) × 3% × $7.50] Stock Dividends Distributable (24,600 × $5) Paid-In Capital in Excess of Stated Value— Common Stock [24,600 × ($7.50 – $5.00)]

184,500

16 Stock Dividends Distributable Common Stock

123,000

30 Treasury Stock (50,000 × $6) Cash

300,000

30 Cash Dividends Cash Dividends Payable [(620,000 + 200,000 + 24,600 – 50,000) × $0.08].

63,568

31 Retained Earnings Stock Dividends Cash Dividends

248,068

123,000 61,500

123,000

300,000

63,568

184,500 63,568

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Prob. 12–4B (Concluded) 3. Nav-Go Enterprises Inc. Statement of Stockholders’ Equity For the Year Ended December 31, 20Y1 Paid-In Paid-In

Capital from

Capital in

Sale of

Common

Excess of

Treasury

Retained

Treasury

Stock

Stated Value

Stock

Earnings

Stock

Balances, January 1

$3,100,000

$1,240,000

$4,875,000

$(288,000) $ 8,927,000

Issued common stock

1,000,000

600,000

1,600,000

Net income Cash dividends Stock dividend

123,000

Total

61,500

Sale of treasury stock

775,000

(63,568)

(184,500)

36,000

288,000

324,000

(300,000)

Purchase of treasury stock Balances, December 31

$4,223,000

$1,901,500

$36,000

$5,401,932

$(300,000) $11,262,432

4. Stockholders’ Equity Paid-in capital: Common stock, $5 stated value (900,000 shares authorized, 844,600 shares issued) Excess of issue price over stated value From sale of treasury stock

$4,223,000 1,901,500 36,000

Total paid-in capital Retained earnings

$ 6,160,500 5,401,932

Total Treasury stock (50,000 shares at cost)

$11,562,432 (300,000)

Total stockholders’ equity

$11,262,432

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Prob. 12–5B Jan.

15 No entry required. The stockholders’ ledger would be revised to record the increased number of shares held by each stockholder and new par value.

Mar.

1 Cash Dividends Cash Dividends Payable [(100,000 × $0.25) + (800,000 × $0.07)].

81,000

30 Cash Dividends Payable Cash

81,000

Apr.

May

81,000

31 Treasury Stock (60,000 × $32) Cash

1,920,000 1,920,000

Aug. 17 Cash (40,000 × $38) Treasury Stock (40,000 × $32) Paid-In Capital from Sale of Treasury Stock [40,000 × ($38 – $32)] Sept.

1 Cash Dividends Cash Dividends Payable {(100,000 × $0.25) + [(800,000 – 60,000 + 40,000) × $0.09]}. 1 Stock Dividends [(800,000 – 60,000 + 40,000) × 1% × $40] Stock Dividends Distributable (7,800 × $30) Paid-In Capital in Excess of Par— Common Stock [7,800 × ($40 – $30)]

Oct.

81,000

1,520,000 1,280,000 240,000 95,200 95,200

312,000 234,000 78,000

31 Cash Dividends Payable Cash

95,200

31 Stock Dividends Distributable Common Stock

234,000

95,200

234,000

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

COMPREHENSIVE PROBLEM 4 1.

Cash (15,000 × $30) Common Stock (15,000 × $20) Paid-In Capital in Excess of Par— Common Stock [15,000 × ($30 – $20)]

450,000

Cash (4,000 shares × $100) Preferred Stock (4,000 shares × $80) Paid-In Capital in Excess of Par— Preferred Stock [4,000 shares × ($100 – $80)]

400,000

Cash ($500,000 × 1.04) Bonds Payable Premium on Bonds Payable

520,000

Cash Dividends (100,000 shares × $0.50 per share) Cash Dividends Payable

50,000

Cash Dividends (20,000 shares × $1.00 per share) Cash Dividends Payable

20,000

Cash Dividends Payable Cash

70,000

Treasury Stock (8,000 shares × $33 per share) Cash

264,000

Cash Dividends Cash Dividends Payable

20,000

Cash Dividends Payable Cash

20,000

Cash (2,600 shares × $38 per share) Treasury Stock (2,600 shares × $33 per share) Paid-In Capital from Sale of Treasury Stock

98,800

Interest Expense Premium on Bonds Payable Cash

11,500 1,000

300,000 150,000

320,000 80,000

500,000 20,000

50,000

20,000

70,000

264,000

20,000

85,800 13,000

12,500

Computations: Semiannual interest payment ($500,000 × 5% × 1/2)……………… Less amortization premium [($20,000 ÷ 10 years) × 1/2]………… Interest expense…………………………………………………………

$12,500 (1,000) $11,500

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Comp. Prob. 4 (Continued) 2.

a. Equinox Products Inc. Income Statement For the Year Ended December 31, 20Y8

Sales Cost of goods sold Gross profit Operating expenses: Selling expenses: Sales salaries expense Sales commissions Advertising expense Depreciation expense—store buildings and equipment Delivery expense Store supplies expense Miscellaneous selling expense Administrative expenses: Office salaries expense Office rent expense Depreciation expense—office buildings and equipment Office supplies expense Miscellaneous administrative expense Total operating expenses Operating income Other revenue and expense: Interest revenue Interest expense Income before income tax Income tax Net income

$ 5,313,000 (3,700,000) $ 1,613,000

$385,000 185,000 150,000 100,000 30,000 21,000 14,000

$885,000

$170,000 50,000 30,000 10,000 7,500

267,500 (1,152,500) $ 460,500 $ 30,000 (21,000)

9,000 $ 469,500 (140,500) $ 329,000

Balances, January 1 Issued common stock Issued preferred stock Net income Cash dividends Sale of treasury stock Purchase of treasury stock Balances, December 31

80,000

$150,000

320,000

$1,600,000

$2,000,000

$1,700,000 300,000

Common Stock

12-31

$886,800

$736,800 150,000

Paid-In Capital in Excess of Par— Common Stock

13,000

$13,000

Paid-In Capital from Sale of Treasury Stock

$8,271,100

329,000 (255,120)

$8,197,220

Retained Earnings

$ 70,000

Preferred Stock

Paid-in Capital in Excess of Par— Preferred Stock

Equinox Products Inc. Statement of Stockholders’ Equity For the Year Ended December 31, 20Y8

Corporations: Organization, Stock Transactions, and Dividends

$1,280,000

Comp. Prob. 4 (Continued)

CHAPTER 12

Total $11,984,020 450,000 400,000 329,000 (255,120) 85,800 98,800 (264,000) (264,000)

$(178,200) $12,742,700

Treasury Stock

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Comp. Prob. 4 (Continued) 2.

c. Equinox Products Inc. Balance Sheet December 31, 20Y8 Assets Current assets: Cash Accounts receivable Allowance for doubtful accounts Accounts receivable, net Inventory, at lower of cost (FIFO) or market Interest receivable Prepaid expenses Total current assets Property, plant, and equipment: Store buildings and equipment Accumulated depreciation Store buildings and equipment, net value Office buildings and equipment Accumulated depreciation Office buildings and equipment, net value Total property, plant, and equipment Intangible assets: Goodwill Total assets

$ 282,850 $

545,000 (8,450) 536,550 778,000 1,200 27,400 $ 1,626,000

$12,560,000 (4,126,000) $8,434,000 $ 4,320,000 (1,580,000) 2,740,000 11,174,000 700,000 $13,500,000

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

Comp. Prob. 4 (Concluded) Liabilities Current liabilities: Accounts payable Income tax payable Total current liabilities Long-term liabilities: Bonds payable, 5%, due in 10 years Premium on bonds payable Total liabilities Stockholders’ Equity Paid-in capital: Preferred 5% stock, $80 par (30,000 shares authorized; 20,000 shares issued) Excess of issue price over par Paid-in capital, preferred stock Common stock, $20 par (400,000 shares authorized; 100,000 shares issued, 94,600 shares outstanding) Excess of issue price over par Paid-in capital, common stock From sale of treasury stock Total paid-in capital Retained earnings Treasury common stock (5,400 shares at cost) Total stockholders’ equity Total liabilities and stockholders’ equity

$ 194,300 44,000 $

238,300

519,000 757,300

$ 500,000 19,000

$1,600,000 150,000 $1,750,000

$2,000,000 886,800 2,886,800 13,000 $ 4,649,800 8,271,100 (178,200) 12,742,700 $13,500,000

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

MAKE A DECISION MAD 12–1 a.

Earnings per Share =

Net Income – Preferred Dividends Average Number of Common Shares Outstanding

Amazon:

$11,588 – $0 494

= $23.46

Walmart:

$14,881 – $0 2,850

= $5.22

b. Amazon’s earnings per share is $23.46, while Walmart has an earnings per share of $5.22. While both companies are profitable, Amazon is more profitable than Walmart from an earnings-per-share perspective. c. Amazon’s market price was $1,847, while Walmart’s was $119; Amazon’s market price is more than fifteen times as large as Walmart’s ($1,847 ÷ $119). This may seem unusual, given that Amazon’s earnings per share is 4.5 times higher than Walmart’s. This illustrates that market prices can be determined by supply-and-demand forces in the stock market that respond to a company’s growth and future prospects, in addition to current performance. Such is the case with Amazon. Walmart, in contrast, is a much more mature and established company. Thus, it is valued in the stock market more closely to its present-day earnings capabilities without a premium for large future growth prospects. Market prices are influenced by future expectations, which are often, but not always, fully captured by present earnings-per-share numbers.

MAD 12–2 a.

Earnings per Share =

Net Income – Preferred Dividends Average Number of Common Shares Outstanding

Bank of America:

$27,430 – $1,432 = $2.77 9,390.5

Wells Fargo:

$19,549 – $1,611 = $4.08 4,393.1

b. Wells Fargo’s earnings per share is $4.08, compared to Bank of America’s earnings per share of $2.77. Wells Fargo is more profitable than Bank of America on an earnings-per-share basis.

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

MAD 12–2 (Concluded) c. We would expect the market price of Wells Fargo to be higher than the market price of Bank of America based on the difference in earnings per share. The market price of a stock is determined by many influences, of which earnings per share is just one. Even so, given that Wells Fargo’s earnings per share is approximately 1.5 times more than Bank of America’s, we would expect the market price to show a difference between the two companies. As expected, Bank of America’s market price was $35.22 and Wells Fargo’s market price was $53.80.

MAD 12–3 a. Net income Preferred dividends Numerator Denominator: Average number of common shares outstanding Earnings per share

Year 3 $(7,642) (14) $(7,656)

Year 2 $(6,837) (14) $(6,851)

Year 1 $1,660 (14) $1,646

÷ 528 $(14.50)

÷ 517 $(13.25)

÷ 512 $ 3.21

b. The earnings per share declined from $3.21 to $(13.25) between Year 1 and Year 2. In Year 3, the earnings per share decreased from $(13.25) to $(14.50). A horizontal analysis of the net income and the average number of common shares outstanding with Year 1 as the base year is as follows: Net income Average number of common shares outstanding

Year 3 (460)%

Year 2 (412)%

($7,642 ÷ $1,660)

($6,837 ÷ $1,660)

103%

101%

(528 ÷ 512)

(517 ÷ 512)

Year 1 100%

100%

The decrease in earnings per share in Year 2 and Year 3 is mostly explained by the increase in operating expenses (causing a decrease in net income) over the 3 years.

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

MAD 12–4 a. Net income Average number of common shares outstanding Earnings per share

Year 3 $6,093

Year 2 $6,147

Year 1 $ 754

÷561.6 $10.85

÷591.4 $10.39

÷591.8 $ 1.27

b. A horizontal analysis of the changes in net income, average common shares outstanding, and earnings per share follows: Net income Average number of common shares outstanding Earnings per share

Year 3 808%

Year 2 815%

($6,093 ÷ $754)

($6,147 ÷ $754)

95%

100%

(561.6 ÷ 591.8)

(591.4 ÷ 591.8)

854%

818%

($10.85 ÷ $1.27)

($10.39 ÷ $1.27)

Year 1 100%

100% 100%

Income in Years 2 and 3 was significantly larger than in Year 1. Earnings per share shows a similar large increase in Years 2 and 3. During this time, average number of shares outstanding has remained relatively stable. This increase was the result of large growth in income, due to increased sales and lower restructuring costs.

MAD 12–5 a. Earnings per Share =

Net Income – Preferred Dividends Average Number of Common Shares Outstanding

Truist:

$3,224 – $196 805.1

= $3.76

Regions:

$1,582 – $79 995.0

= $1.51

b. The total net income of Truist is $3,224 million, while the total net income of Regions is $1,582 million. Thus, Truist’s net income is 104% larger than Regions’ [($3,224 − $1,582) ÷ $1,582]. Truist earned more than double the net income of Regions, so it is more profitable by this measure. c. The earnings per share of Truist is $3.76, while the earnings per share of Regions is $1.51. Thus, Truist’s earnings per share is 149% larger than Regions’ [($3.76 − $1.51) ÷ $1.51]. Truist reports almost two and one-half times the earnings per share of Regions, so it is more profitable by this measure.

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

MAD 12–5 (Concluded) d. From a stockholder’s perspective, the earnings per share is a better relative measure of earnings between the two banks. Truist has stronger earnings and is able to divide those earnings among fewer shares of stock compared to Regions. Thus, the earnings-per-share figure shows Truist to have much stronger profitability than Regions. A stockholder is concerned about the “earnings pie” and the amount by which the pie is divided among the shares of stock. By implication, a share of Truist is more valuable than a share of Regions, because each share generates more earnings. This is confirmed by the market price, where Truist was recently quoted on the stock market at $56.32, while Regions was quoted at $17.16.

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

TAKE IT FURTHER TIF 12–1 Tommy is clearly acting unethically for several reasons. First, he is violating the company’s policy on stock purchases. This policy was established to ensure the fair and timely dissemination of information that gives all potential investors the same chance to participate in the stock price increases. The fact that he is purchasing the stock in partnership with his father does not get around the company policy. Second, Tommy has “inside information” that is not available to other potential investors. Purchasing the stock with knowledge of information that is not available to other investors is unethical. Ethical managers and accountants are honest and fair, which means that they do not attempt to profit from inside information that is not publicly available. Doing so would give them an unfair advantage to benefit from stock price increases. Trading on inside information is also a violation of federal securities laws, which is a crime punishable by fine and/or imprisonment. TIF 12–2 Lou and Shirley are behaving in a professional manner as long as full and complete information is provided to potential investors in accordance with federal regulations for the sale of securities to the public. If such information is provided, the marketplace will determine the fair value of the company’s stock.

TIF 12–3 A sample solution based on Alphabet’s Form 10-K for the fiscal year ended December 31, 2019, follows: 1. Delaware 2. Alphabet is a collection of businesses, the largest of which is Google. At its core, Google is an information company and seeks to empower people through information. Other Alphabet companies are described as “Other Bets” with earlier stage technologies that are further afield from the core Google business. 3. $275,909 million 4. $74,467 million 5. $201,442 million ($275,909 million total assets – $74,467 million total liabilities) 6. $161,857 million 7. $34,343 million 8. Common stock: Class A authorized, 9 million; Class B authorized, 3 million; Class C authorized, 3 million; Class A issued and outstanding, 299.828 million; Class B issued and outstanding, 46.441 million; Class C issued and outstanding, 342.066 million 9. Class A, Class B, and Class C: $0.001 par value per share 10. $1,339.39 at December 30, 2019 11. High price—$1,173.40; Low price—$1,136.72 12. Alphabet has never declared or paid a cash dividend. 12-38 © 2022 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 12

Corporations: Organization, Stock Transactions, and Dividends

TIF 12–4 Memo To: From: Re:

Chairman of the Board A+ Student Fourth Quarter 20Y8 Cash Dividend

In order to prudently declare a dividend for the fourth quarter, the company must have a sufficient retained earnings balance from which to declare the dividend. On December 31, 20Y8, Motion Designs has a $4,630,000 balance in retained earnings. This balance is more than enough to cover the $90,000 declaration of the normal quarterly cash dividend of $0.50 per share. In addition, the company must have enough cash on hand to pay the dividend while meeting the remaining cash needs of the business. The company has a December 31, 20Y8, cash balance of $250,000, of which $100,000 is committed as the compensating balance under the loan agreement. This leaves only $150,000 to pay the dividend of $90,000 and finance normal operations. Unless the cash balance can be expected to increase significantly in early 20Y9, it is questionable whether the company’s cash balance is large enough to both pay the cash dividend and provide for the company’s near-term operating needs. Before declaring a dividend, the company should also consider its working capital and the effect of plant expansion on the current ratio requirement of the loan. On December 31, 20Y8, the company has working capital of $5,000,000 ($7,000,000 – $2,000,000), resulting in a current ratio of 3.5. However, after deducting the $3,000,000 committed to store modernization and product-line expansion, the ratio drops to 2 ($4,000,000 ÷ $2,000,000). If a cash dividend is declared and paid, the current ratio will further drop to 1.955 ($3,910,000 ÷ $2,000,000), which would violate the loan agreement. Additionally, working capital commitments and potential near-term capital expenditures could further deplete the company’s working capital. As a result, I advise the company to forgo the declaration of a cash dividend in the fourth quarter of 20Y8, as this would likely result in the company violating the terms of the loan.

CHAPTER 13 STATEMENT OF CASH FLOWS DISCUSSION QUESTIONS 1.

It is costly to accumulate the data needed and to prepare the statement of cash flows.

It focuses on the differences between net income and net cash flows from operating activities, and the data needed are generally more readily available and less costly to obtain than is the case for the direct method.

In a separate schedule of noncash investing and financing activities accompanying the statement of cash flows.

The $30,000 increase must be added to operating income because the amount of cash paid to merchandise creditors was $30,000 less than the amount of purchases included in the cost of goods sold.

The $25,000 decrease in salaries payable should be deducted from income to determine the amount of net cash flows from operating activities. The effect of the decrease in the amount of salaries owed was to pay $25,000 more cash during the year than had been recorded as an expense.

$100,000 gain

Cash inflow of $600,000

The gain of $100,000 would be deducted from net income in determining net cash flows from operating activities; $600,000 would be reported as cash flows from investing activities.

Cash flows from financing activities—issuance of bonds, $1,960,000 ($2,000,000 × 98%)

Cash flows from investing activities—Cash received from the disposal of fixed assets, $15,000 The $15,000 gain on asset disposal should be deducted from net income in determining net cash flows from operating activities under the indirect method.

No effect

The same. The total amount reported as the net cash flows from operating activities is not affected by the use of the direct or indirect method.

10.

Cash received from customers, cash paid for merchandise, cash paid for operating expenses, cash paid for interest, cash paid for income taxes.

CHAPTER 13

Statement of Cash Flows

BASIC EXERCISES BE 13–1 a. b. c.

Investing Investing Operating

d. e. f.

Operating Operating Financing

BE 13–2 Net income……………………………………………………………………...………… $286,900 Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation……………………………………………………..…………………… 15,325 Amortization of patents…………………………………..………………………… 3,800 (22,420) Gain from sale of investments…………………………….……………………… Net cash flows from operating activities……………………..……………… $283,605

BE 13–3 Net income…………………………………..……………………………………………… Changes in current operating assets and liabilities: Increase in accounts receivable………………………………...………………… Increase in inventory…………………………….…………………………………… Increase in accounts payable………………………….…………………………… Net cash flows from operating activities……………………..………………

$75,800 (5,000) (7,450) 3,380 $66,730

Note: The change in dividends payable impacts the cash paid for dividends, which is disclosed under financing activities.

BE 13–4 Cash flows from (used for) operating activities: Net income…………………………………….………………………… $405,200 Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation………………………………...……………………… 81,750 Loss on disposal of equipment……………………………..… 22,300 Changes in current operating assets and liabilities: Increase in accounts receivable…………………………… (11,000) 4,710 Increase in accounts payable……………………….……… Net cash flows from operating activities…………………….

$502,960

CHAPTER 13

Statement of Cash Flows

BE 13–5 The gain on the sale of land is subtracted from net income in the operating activities section. Gain on sale of land………………………….……………………………………

$ (45,000)

The purchase and sale of land are reported as part of cash flows from investing activities as follows: Cash received from sale of land…………………..…………………………… Cash paid for purchase of land………………………..…………………………

270,000 (425,000)

BE 13–6 Cash flows from (used for) financing activities: Cash received from issuing common stock…………… Cash received from issuing bonds……………………… Cash paid for dividends…………………………………… Net cash flows from financing activities……………

$ 800,000 650,000 (110,000) $1,340,000

BE 13–7 a.

Net cash flows from operating activities…………… Cash used to purchase property, plant, and equipment………………………………………………… Free cash flow……………………………………………

20Y2 $ 520,000

20Y1 $ 485,000

(259,200)*

(236,400)**

$ 260,800

$ 248,600

* 60% × $432,000 ** 60% × $394,000 b.

The change in free cash flow from $248,600 to $260,800 represents an improvement.

Appendix 2 BE 13–8 Sales……………………………………………………………………………………… Decrease in accounts receivable…………………………………………………… Cash received from customers………………………………………………………

$225,000 14,300 $239,300

Appendix 2 BE 13–9 Cost of goods sold…………………………………………………………………… Increase in inventories……………………………………………………………… Increase in accounts payable……………………………………………………… Cash paid for merchandise…………………………………………………………

$185,000 11,100 (8,000) $188,100

CHAPTER 13

Statement of Cash Flows

EXERCISES Ex. 13–1 There were net additions to the net loss reported on the income statement to convert the net loss from the accrual basis to the cash basis. For example, depreciation is an expense in determining net income, but it does not result in a cash outflow. Thus, depreciation of $544 million is added back to the net loss in order to determine net cash flows from operations. A second large item that is added to the net loss is the decrease in inventory of $271 million. This indicates that cost of goods sold was greater than the cost of merchandise purchased during the year. The cash flows from operating activities detail is provided as follows for class discussion: J. C. Penney Company, Inc. Cash Flows from Operating Activities (Selected from Statement of Cash Flows) (in millions) Cash flows from (used for) operating activities: Net income (loss) Adjustments to reconcile net loss to net cash flows from (used for) operating activities: Depreciation and amortization Gain on sale of assets Benefit plans Share-based compensation Other, net Changes in current operating assets and liabilities: Decrease in inventory Increase in prepaid assets Decrease in accounts payable Decrease in accrued expenses Net cash flows from operating activities

$(268)

544 (9) (37) 11 16 271 (9) (61) (30) $ 428

Source: A recent Form 10-K of J. C. Penney Company, Inc.

CHAPTER 13

Statement of Cash Flows

Ex. 13–2 a. b. c. d.

Cash payment, $407,000 Cash receipt, $800,000 Cash receipt, $82,800 Cash payment, $625,000

e. f. g. h.

Cash payment, $50,000 Cash receipt, $396,000 Cash payment, $185,000 Cash payment, $1,435,000

g. h. i. j. k.

financing investing financing investing investing

g. h. i. j. k.

added added added added deducted

Ex. 13–3 a. b. c. d. e. f.

operating financing financing financing financing investing

Ex. 13–4 a. b. c. d. e. f.

added deducted added added added added

CHAPTER 13

Statement of Cash Flows

Ex. 13–5 a. Net income……………………………………………………………… $106,800 Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation……………………………………………………… 41,700 Changes in current operating assets and liabilities: Increase in accounts receivable………………………… (11,000) Decrease in inventories………………………………… 4,800 Decrease in prepaid expenses………………………… 2,750 Increase in accounts payable…………………………… 4,900 (1,700) Decrease in wages payable……………………………… Net cash flows from operating activities……………………

$148,250

b. Net cash flows from operating activities shows the cash inflow or outflow from a company’s day-to-day operations. Net income reports the excess of revenues over expenses for a company using the accrual basis of accounting. Revenues are recorded when they are earned, not necessarily when cash is received. Expenses are recorded when they are incurred and matched against revenue, not necessarily when cash is paid. As a result, the net cash flows from operating activities differs from net income because it does not use the accrual basis of accounting.

Ex. 13–6 a. Cash flows from (used for) operating activities: Net income………………………………………………………… $222,000 Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation………………………………………………… 98,400 Changes in current operating assets and liabilities: Decrease in accounts receivable……………………… 6,970 Increase in inventories………………………………… (5,700) Decrease in prepaid expenses………………………… 650 Decrease in accounts payable………………………… (16,630) 1,950 Increase in salaries payable…………………………… Net cash flows from operating activities…………………

$307,640

b. Yes. The amount of net cash flows from operating activities reported on the statement of cash flows is not affected by the method of reporting such flows.

CHAPTER 13

Statement of Cash Flows

Ex. 13–7 a.

Cash flows from (used for) operating activities: Net income………………………………………………………… $508,000 Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation………………………………………………… 57,600 Gain on disposal of equipment…………………………… (33,600) Changes in current operating assets and liabilities: Increase in accounts receivable……………………… (8,960) Decrease in inventory…………………………………… 5,120 Decrease in prepaid insurance………………………… 1,920 Decrease in accounts payable………………………… (6,080) 1,410 Increase in income taxes payable…………………… Net cash flows from operating activities…………………

$525,410

Note: The change in dividends payable would be used to adjust the dividends declared in obtaining the cash paid for dividends in the financing activities section of the statement of cash flows. b.

Net cash flows from operating activities reports the cash inflow or outflow from a company’s day-to-day operations. Net income reports the excess of revenues over expenses for a company using the accrual basis of accounting. Revenues are recorded when they are earned, not necessarily when cash is received. Expenses are recorded when they are incurred and matched against revenue, not necessarily when cash is paid. As a result, the cash flows from operating activities differs from net income because it does not use the accrual basis of accounting.

Ex. 13–8 Cash flows from (used for) investing activities: Cash received from sale of equipment……………………………………………

$108,200

The loss on the sale is $17,900 and is computed as $108,200 proceeds from sale less $126,100 ($280,000 – $153,900) book value. This loss would be added to net income in determining the net cash flows from operating activities if the indirect method of reporting cash flows from operating activities is used.

Ex. 13–9 Cash flows from (used for) investing activities: Cash received from sale of equipment……………………………………………

$26,900

The gain on the sale is $5,900 and is computed as $26,900 proceeds from sale less $21,000 ($75,000 – $54,000) book value. This gain would be deducted from net income in determining the cash flows from operating activities if the indirect method of reporting cash flows from operations is used.

CHAPTER 13

Statement of Cash Flows

Ex. 13–10 Cash flows from (used for) investing activities: Cash received from sale of land………………………………………………… $ 102,700 Cash paid for purchase of land…………………………………………………… (142,400) The gain on the sale of land, $13,300 ($102,700 – $89,400), would be deducted from net income in determining the net cash flows from operating activities if the indirect method of reporting cash flows from operating activities is used.

Ex. 13–11 Dividends declared……………………………………………………………………… $1,200,000 150,000 Decrease in dividends payable……………………………………………………… Dividends paid to stockholders during the year………………………………… $1,350,000

Ex. 13–12 Cash flows from (used for) financing activities: Cash received from sale of common stock…………………………………… $1,920,000 Cash paid for dividends…………………………………………………………… (315,000) Note: The stock dividend is not disclosed on the statement of cash flows.

Ex. 13–13 Cash flows from (used for) investing activities: Cash paid for purchase of land…………………………………………………… $(246,000) A separate schedule of noncash investing and financing activities would report the purchase of $324,000 land with a long-term mortgage note, as follows: Purchase of land by issuing long-term mortgage note…………………………

$324,000

Ex. 13–14 Cash flows from (used for) financing activities: Cash received from issuing bonds payable…………………………………… Cash paid to redeem bonds payable……………………………………………

$ 420,000* (138,000)

Note: The discount amortization of $2,625 would be shown as an adjusting item (increase) in the “Cash flows from (used for) operating activities” section under the indirect method. * $450,000 – $30,000

CHAPTER 13

Statement of Cash Flows

Ex. 13–15 a.

Net cash flows from operating activities……………………………………… Increase in accounts receivable………………………………………………… Increase in prepaid expenses…………………………………………………… Decrease in income taxes payable……………………………………………… Gain on sale of investments……………………………………………………… Depreciation………………………………………………………………………… Decrease in inventories…………………………………………………………… Increase in accounts payable…………………………………………………… Net income, per income statement………………………………………………

$357,500 14,300 2,970 7,700 13,200 (29,480) (19,140) (5,280) $341,770

Note to Instructors: The net income must be determined by working backward through the “Cash flows from (used for) operating activities” section of the statement of cash flows. Hence, those items that were added (deducted) to determine net cash flows from operating activities must be deducted (added) to determine net income. b.

Curwen’s net income differed from net cash flows from operating activities because of: ● $29,480 of depreciation expense, which has no effect on cash flows from operating activities. ● A $13,200 gain on the sale of investments. The proceeds from this sale, which include the gain, are reported in the investing activities section of the statement of cash flows. ● Changes in current operating assets and liabilities that are added or deducted, depending on their effect on cash flows: Increase in accounts receivable, $14,300 Increase in prepaid expenses, $2,970 Decrease in income taxes payable, $7,700 Decrease in inventories, $19,140 Increase in accounts payable, $5,280

CHAPTER 13

Statement of Cash Flows

Ex. 13–16 a.

Cardinas Corp. Cash Flows from Operating Activities (in thousands) Cash flows from (used for) operating activities: Net income Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation Gain on disposal of property Other items involving noncash expenses Changes in current operating assets and liabilities: Increase in accounts receivable Decrease in inventory Increase in prepaid expenses Decrease in accounts payable Decrease in accrued and other current liab. Net cash flows from operating activities

$49,311

11,580 (1,188) 1,383

(1,746) 990 (605) (710) (995) $58,020

Cardinas Corp. is doing well financially. The company has positive earnings and positive net cash flows from operating activities. The increase in accounts receivable is a positive sign, indicating an increase in sales.

CHAPTER 13

Statement of Cash Flows

Ex. 13–17 a.

Olson-Jones Industries Inc. Statement of Cash Flows For the Year Ended December 31, 20Y2 Cash flows from (used for) operating activities: Net income Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation Gain on sale of land Changes in current operating assets and liabilities: Increase in accounts receivable Increase in inventories Increase in accounts payable Net cash flows from operating activities Cash flows from (used for) investing activities: Cash received from sale of land Cash paid for purchase of equipment Net cash flows from investing activities Cash flows from (used for) financing activities: Cash received from sale of common stock Cash paid for dividends* Net cash flows from financing activities Net increase in cash Cash balance, January 1, 20Y2 Cash balance, December 31, 20Y2

$ 62

26 (40)

(6) (18) 14 $ 38 $120 (30) 90 $ 60 (19) 41 $169 14 $183

* Dividends = $24 – $5 = $19 b.

Olson-Jones Industries Inc.’s net income was more than the net cash flows from operating activities because of: ● $26 of depreciation expense, which has no effect on cash. ● A $40 gain on the sale of land. The proceeds from this sale of $120, which include the gain, are reported in the investing activities section of the statement of cash flows. ● Changes in current operating assets and liabilities that are added or deducted, depending on their effect on cash flows: Increase in accounts receivable, $6 deducted Increase in inventories, $18 deducted Increase in accounts payable, $14 added

CHAPTER 13

Statement of Cash Flows

Ex. 13–18 1.

The increase in accounts receivable should be deducted from net income in the “Cash flows from (used for) operating activities” section.

The gain on the sale of investments should be deducted from net income in the “Cash flows from (used for) operating activities” section.

The increase in accounts payable should be added to net income in the “Cash flows from (used for) operating activities” section.

The correct amount of cash at the beginning of the year, $240,000, should be added to the increase in cash.

The final amount should be the amount of cash at the end of the year, $350,160.

The final amount of net cash flows from operating activities is $381,360.

The final amount of net cash flows from investing activities is $451,200.

A correct statement of cash flows would be as follows: Shasta Inc. Statement of Cash Flows For the Year Ended December 31, 20Y9 Cash flows from (used for) operating activities: Net income Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation Gain on sale of investments Changes in current operating assets and liabilities: Increase in accounts receivable Increase in inventories Increase in accounts payable Decrease in accrued expenses payable Net cash flows from operating activities Cash flows from (used for) investing activities: Cash received from sale of investments Cash paid for purchase of land Cash paid for purchase of equipment Net cash flows used for investing activities Cash flows from (used for) financing activities: Cash received from sale of common stock Cash paid for dividends Net cash flows from financing activities Net increase in cash Cash balance, January 1, 20Y9 Cash balance, December 31, 20Y9

$ 360,000

100,800 (17,280)

(27,360) (36,000) 3,600 (2,400) $ 381,360 $ 240,000 (259,200) (432,000) (451,200) $ 312,000 (132,000) 180,000 $ 110,160 240,000 $ 350,160

CHAPTER 13

Statement of Cash Flows

Appendix 2 Ex. 13–19 a.

Sales………………………………………………………………………………… Decrease in accounts receivable balance…………………………………… Cash received from customers…………………………………………………

$753,500 48,400 $801,900

Income tax expense……………………………………………………………… Decrease in income tax payable……………………………………………… Cash payments for income taxes………………………………………………

$50,600 5,500 $56,100

Because the customers paid more than the amount of sales for the period, cash received from customers exceeded sales made on account by $48,400 during the current year.

Appendix 2 Ex. 13–20 a.

Cost of goods sold……………………………………………………………… $1,031,550 9,660 Decrease in accounts payable………………………………………………… (15,410) Decrease in inventories………………………………………………………… Cash payments for merchandise……………………………………………… $1,025,800

Operating expenses other than depreciation……………………………… Decrease in accrued expenses payable……………………………………… Decrease in prepaid expenses………………………………………………… Cash payments for operating expenses……………………………………

$179,400 1,380 (1,610) $179,170

CHAPTER 13

Statement of Cash Flows

Appendix 2 Ex. 13–21 a. Cash flows from (used for) operating activities: Cash received from customers……………………………… $ 522,7601 Cash payments for merchandise…………………………… (302,400)2 Cash payments for operating expenses…………………… (99,960)3 (24,360)4 Cash payments for income taxes…………………………… Net cash flows from operating activities………………

$ 96,040

Computations: 1.

Sales……………………………………………………………………………… $511,000 11,760 Decrease in accounts receivable……………………………………………… $522,760 Cash received from customers………………………………………………

Cost of goods sold……………………………………………………………… $290,500 Increase in inventories………………………………………………………… 3,920 7,980 Decrease in accounts payable………………………………………………… $302,400 Cash payments for merchandise………………………………………………

Operating expenses other than depreciation……………………………… $105,000 Decrease in prepaid expenses………………………………………………… (3,780) (1,260) Increase in accrued expenses payable……………………………………… $ 99,960 Cash payments for operating expenses……………………………………

Income tax expense……………………………………………………………… Add decrease in income tax payable………………………………………… Cash payments for income taxes……………………………………………

$21,700 2,660 $24,360

b. The direct method directly reports cash receipts and payments. The cash received less the cash payments is the net cash flows from operating activities. Individual cash receipts and payments are reported in the “Cash flows from (used for) operating activities” section. The indirect method adjusts accrual-basis net income for revenues and expenses that do not involve the receipt or payment of cash to arrive at net cash flows from operating activities.

CHAPTER 13

Statement of Cash Flows

Appendix 2 Ex. 13–22 Cash flows from (used for) operating activities: Cash received from customers………………………………… $ 440,440 1 Cash payments for merchandise……………………………… (161,260) 2 Cash payments for operating expenses……………………… (115,720) 3 Cash payments for income taxes……………………………… (39,600) Net cash flows from operating activities…………………

$123,860

Computations: 1.

Sales………………………………………………………………………………… Increase in accounts receivable……………………………………………… Cash received from customers…………………………………………………

$445,500 (5,060) $440,440

Cost of goods sold……………………………………………………………… Increase in inventories…………………………………………………………… Increase in accounts payable…………………………………………………… Cash payments for merchandise………………………………………………

$154,000 12,100 (4,840) $161,260

Operating expenses other than depreciation………………………………… Decrease in accrued expenses payable……………………………………… Decrease in prepaid expenses………………………………………………… Cash payments for operating expenses………………………………………

$115,280 1,760 (1,320) $115,720

CHAPTER 13

Statement of Cash Flows

PROBLEMS Prob. 13–1A Livers Inc. Statement of Cash Flows For the Year Ended December 31, 20Y3 Cash flows from (used for) operating activities: Net income Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation Gain on sale of investments Changes in current operating assets and liabilities: Increase in accounts receivable Increase in inventories Increase in accounts payable Decrease in accrued expenses payable Net cash flows from operating activities Cash flows from (used for) investing activities: Cash received from sale of investments Cash paid for purchase of land Cash paid for purchase of equipment Net cash flows used for investing activities Cash flows from (used for) financing activities: Cash received from sale of common stock Cash paid for dividends* Net cash flows from financing activities Net increase in cash Cash balance, January 1, 20Y3 Cash balance, December 31, 20Y3

$ 500,000

100,000 (75,000)

(50,000) (20,000) 40,000 (5,000) $ 490,000 $ 175,000 (500,000) (200,000) (525,000) $ 125,000 (85,000) 40,000 $ 5,000 150,000 $ 155,000

* Cash paid for dividends = $90,000 + $25,000 – $30,000 = $85,000

CHAPTER 13

Statement of Cash Flows

Prob. 13–1A (Concluded) (Optional) Livers Inc. Spreadsheet (Work Sheet) for Statement of Cash Flows For the Year Ended December 31, 20Y3 Transactions

Balance, Account Title

Cash Accounts receivable (net) Inventories Investments Land Equipment Accum. depr.—equipment Accounts payable Accrued expenses payable Dividends payable Common stock, $4 par Paid-in capital in excess of par—common stock Retained earnings Totals Operating activities: Net income Depreciation Gain on sale of investments Increase in accounts receivable Increase in inventories Increase in accounts payable Decrease in accrued expenses payable Investing activities: Purchase of equipment Purchase of land Sale of investments Financing activities: Declaration of cash dividends Sale of common stock Increase in dividends payable Net increase in cash Totals

Debit

Dec. 31, 20Y2

Balance,

Credit

Dec. 31, 20Y3

150,000 (m) 5,000 400,000 (l) 50,000 750,000 (k) 20,000 100,000 (j) 100,000 0 (i) 500,000 1,200,000 (h) 200,000 (500,000) (g) 100,000 (300,000) (f) 40,000 (50,000) (e) 5,000 (25,000) (d) 5,000 (600,000) (c) 100,000

155,000 450,000 770,000 0 500,000 1,400,000 (600,000) (340,000) (45,000) (30,000) (700,000)

(175,000) (950,000) (b) 0

(200,000) (1,360,000) 0

(a) (g)

(f)

75,000

(l) (k)

50,000 20,000

(e)

5,000

40,000

(h) 200,000 (i) 500,000 (j)

175,000

125,000 5,000 945,000

(b)

90,000

(m)

5,000 945,000

Note to Instructors: The letters in the debit and credit columns are included for reference purposes only.

CHAPTER 13

Statement of Cash Flows

Prob. 13–2A Yellow Dog Enterprises Inc. Statement of Cash Flows For the Year Ended December 31, 20Y8 Cash flows from (used for) operating activities: Net income Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation Changes in current operating assets and liabilities: Decrease in accounts receivable Increase in inventories Increase in prepaid expenses Increase in accounts payable Net cash flows from operating activities Cash flows from (used for) investing activities: Cash paid for equipment Net cash flows used for investing activities Cash flows from (used for) financing activities: Cash received from sale of common stock Cash paid for dividends Cash paid to retire mortgage note payable Net cash flows from financing activities Net decrease in cash Cash balance, January 1, 20Y8 Cash balance, December 31, 20Y8

$ 250,000

135,000

20,000 (70,000) (10,000) 25,000 $ 350,000 $(420,000) (420,000) $ 600,000 (45,000) (500,000) 55,000 $ (15,000) 110,000 $ 95,000

Note to Instructors: The disposal of fully depreciated equipment is not included in the cash flow statement because there is no associated cash flow. This transaction strictly involves the removal of $90,000 from the equipment and accumulated depreciation— equipment accounts.

CHAPTER 13

Statement of Cash Flows

Prob. 13–2A (Concluded) (Optional) Yellow Dog Enterprises Inc. Spreadsheet (Work Sheet) for Statement of Cash Flows For the Year Ended December 31, 20Y8 Transactions

Balance, Account Title

Cash Accounts receivable (net) Inventories Prepaid expenses Equipment Accum. depr.—equipment Accounts payable Mortgage note payable Common stock, $10 par Paid-in capital in excess of par—common stock Retained earnings Totals Operating activities: Net income Depreciation Decrease in accts. receivable Increase in inventories Increase in prepaid expenses Increase in accounts payable Investing activities: Purchase of equipment Financing activities: Payment of cash dividends Sale of common stock Payment of mortgage note payable Net decrease in cash Totals

Debit

Dec. 31, 20Y7

110,000 280,000 450,000 (j) 5,000 (i) 800,000 (h) (190,000) (g) (75,000) (500,000) (d) (200,000)

Balance,

Credit

300,000

95,000 260,000 520,000 15,000 1,130,000 (235,000) (100,000) 0 (500,000)

(100,000) (c) 300,000 (580,000) (b) 45,000 (a) 250,000 0 1,135,000 1,135,000

(400,000) (785,000) 0

(a) (f) (k)

(e)

(l) (k)

15,000 20,000

70,000 10,000 420,000 (g) 90,000 (f) (e) 500,000 (c)

90,000 135,000 25,000

Dec. 31, 20Y8

250,000 135,000 20,000 (j) (i)

70,000 10,000

(h)

420,000

(b)

45,000

(d)

500,000

25,000

(c)

600,000

(l)

15,000 1,045,000

1,045,000

Note to Instructors: The letters in the debit and credit columns are included for reference purposes only.

CHAPTER 13

Statement of Cash Flows

Prob. 13–3A Whitman Co. Statement of Cash Flows For the Year Ended December 31, 20Y2 Cash flows from (used for) operating activities: Net loss Adjustments to reconcile net loss to net cash flows from (used for) operating activities: Depreciation* Loss on sale of land** Changes in current operating assets and liabilities: Increase in accounts receivable Increase in inventories Decrease in prepaid expenses Decrease in accounts payable Net cash flows used for operating activities Cash flows from (used for) investing activities: Cash received from land sold Cash paid for acquisition of building Cash paid for purchase of equipment Net cash flows used for investing activities Cash flows from (used for) financing activities: Cash received from issuance of bonds payable Cash received from issuance of common stock Cash paid for dividends Net cash flows from financing activities Net decrease in cash Cash balance, January 1, 20Y2 Cash balance, December 31, 20Y2

$ (35,320)

55,620 12,600

(66,960) (105,480) 5,760 (35,820) $(169,600) $ 151,200 (561,600) (104,400) (514,800) $ 270,000 400,000 (32,400) 637,600 $ (46,800) 964,800 $ 918,000

* Depreciation = $26,280 + $29,340 ** Loss on sale of land = $151,200 – $163,800

CHAPTER 13

Statement of Cash Flows

Prob. 13–3A (Concluded) (Optional) Whitman Co. Spreadsheet (Work Sheet) for Statement of Cash Flows For the Year Ended December 31, 20Y2 Transactions

Balance, Account Title

Cash Accounts receivable (net) Inventories Prepaid expenses Land Buildings Accum. depr.—buildings Equipment Accum. depr.—equipment Accounts payable Bonds payable Common stock, $25 par Paid-in capital in excess of par—common stock Retained earnings Totals Operating activities: Net loss Depreciation—equipment Depreciation—buildings Loss on sale of land Increase in accts. receivable Increase in inventories Decrease in prepaid expenses Decrease in accounts payable Investing activities: Purchase of equipment Acquisition of building Sale of land Financing activities: Payment of cash dividends Issuance of bonds payable Issuance of common stock Net decrease in cash Totals

Debit

Dec. 31, 20Y1

964,800 761,940 (g) 1,162,980 (h) 35,100 479,700 900,900 (k) (382,320) 454,680 (i) (158,760) (j) (958,320) (c) 0 (117,000) (558,000) (2,585,700) (a) (b) 0

(d) (e) (l)

(f)

Balance,

Credit

Dec. 31, 20Y2

(o)

46,800

(f) (l)

5,760 163,800

(e) 104,400 (j) 46,800 (d) 35,820 (m) (n)

26,280 46,800 29,340 270,000 200,000

(n)

200,000

(758,000) (2,517,980)

988,780

66,960 105,480

561,600

35,320 32,400 988,780 (a)

35,320

(g) (h)

66,960 105,480

(c)

35,820

(i) (k)

104,400 561,600

(b)

(32,400)

918,000 828,900 1,268,460 29,340 315,900 1,462,500 (408,600) 512,280 (141,300) (922,500) (270,000) (317,000)

29,340 26,280 12,600

5,760

(l)

151,200

(m) (n) (o)

270,000 400,000 46,800 941,980

877,180

CHAPTER 13

Statement of Cash Flows

Appendix 2 Prob. 13–4A Canace Products Inc. Statement of Cash Flows For the Year Ended December 31, 20Y6 Cash flows from (used for) operating activities: Cash received from customers1 Cash payments for merchandise2 Cash payments for operating expenses3 Cash payments for income taxes Net cash flows from operating activities Cash flows from (used for) investing activities: Cash received from sale of investments Cash paid for purchase of land Cash paid for purchase of equipment Net cash flows used for investing activities Cash flows from (used for) financing activities: Cash received from sale of common stock Cash paid for dividends* Net cash flows from financing activities

$ 5,960,600 (2,456,800) (3,107,400) (102,800) $ 293,600 $

176,000 (520,000) (200,000) (544,000)

240,000 (25,600)

Net decrease in cash Cash balance, January 1, 20Y6 Cash balance, December 31, 20Y6

214,400 $ (36,000) 679,400 $ 643,400

Schedule Reconciling Net Income with Net Cash Flows from Operating Activities: Net income………………………………………………………………………… Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation………………………………………………………………… Loss on sale of investments……………………………………………… Changes in current operating assets and liabilities: Increase in accounts receivable……………………………………… Increase in inventories………………………………………………… Increase in accounts payable………………………………………… Decrease in accrued expenses payable…………………………… Net cash flows from operating activities………………………………

$217,200

44,000 64,000 (19,400) (28,200) 23,400 (7,400) $293,600

* Dividends paid: $28,000 + $6,400 – $8,800 = $25,600

CHAPTER 13

Statement of Cash Flows

Appendix 2 Prob. 13–4A (Concluded) Computations: 1.

Sales……………………………………………………………………………… $5,980,000 (19,400) Increase in accounts receivable…………………………………………… Cash received from customers……………………………………………… $5,960,600

Cost of goods sold…………………………………………………………… $2,452,000 Increase in inventories………………………………………………………… 28,200 (23,400) Increase in accounts payable………………………………………………… Cash payments for merchandise…………………………………………… $2,456,800

Operating expenses other than depreciation…………………………… $3,100,000 7,400 Decrease in accrued expenses payable…………………………………… Cash payments for operating expenses…………………………………… $3,107,400

CHAPTER 13

Statement of Cash Flows

Appendix 2 Prob. 13–5A Livers Inc. Statement of Cash Flows For the Year Ended December 31, 20Y3 Cash flows from (used for) operating activities: Cash received from customers1

$ 2,950,000

Cash payments for inventories

Cash payments for operating expenses Cash payments for income taxes

(1,380,000) 3

(955,000) (125,000)

Net cash flows from operating activities

$ 490,000

Cash flows from (used for) investing activities: Cash received from sale of investments

Cash paid for purchase of land Cash paid for purchase of equipment

175,000 (500,000) (200,000)

Net cash flows used for investing activities

(525,000)

Cash flows from (used for) financing activities: Cash received from sale of common stock Cash paid for dividends4

125,000 (85,000)

Net cash flows from financing activities

40,000

Net increase in cash Cash balance, January 1, 20Y3

5,000 150,000

Cash balance, December 31, 20Y3

$ 155,000

Schedule Reconciling Net Income with Net Cash Flows from Operating Activities: Net income…………………………………………………………………………………… $500,000 Adjustments to reconcile net income to net cash flows from (used for) operating activities: 100,000 Depreciation…………………………………………………………………………… (75,000) Gain on sale of investments……………………………………………………… Changes in current operating assets and liabilities: (50,000) Increase in accounts receivable……………………………………………… (20,000) Increase in inventories………………………………………………………… 40,000 Increase in accounts payable………………………………………………… (5,000) Decrease in accrued expenses payable……………………………………… Net cash flows from operating activities………………………………………… $490,000

CHAPTER 13

Statement of Cash Flows

Appendix 2 Prob. 13–5A (Concluded) Computations: 1.

Sales……………………………………………………………………………… Increase in accounts receivable……………………………………………… Cash received from customers………………………………………………

$3,000,000 (50,000) $2,950,000

Cost of goods sold……………………………………………………………… $1,400,000 Increase in inventories………………………………………………………… 20,000 (40,000) Increase in accounts payable………………………………………………… Cash payments for merchandise……………………………………………… $1,380,000

Operating expenses other than depreciation……………………………… Decrease in accrued expenses payable…………………………………… Cash payments for operating expenses……………………………………

$950,000 5,000 $955,000

Cash dividends declared……………………………………………………… Increase in dividends payable………………………………………………… Cash payments for dividends ($90,000 + $25,000 – $30,000)……………

$90,000 (5,000) $85,000

CHAPTER 13

Statement of Cash Flows

Prob. 13–1B Merrick Equipment Co. Statement of Cash Flows For the Year Ended December 31, 20Y9 Cash flows from (used for) operating activities: Net income Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation Loss on sale of investments Changes in current operating assets and liabilities: Increase in accounts receivable Increase in inventories Increase in accounts payable Increase in accrued expenses payable Net cash flows from operating activities Cash flows from (used for) investing activities: Cash received from sale of investments Cash paid for purchase of land Cash paid for purchase of equipment Net cash flows used for investing activities Cash flows from (used for) financing activities: Cash received from sale of common stock Cash paid for dividends* Net cash flows from financing activities Net increase in cash Cash balance, January 1, 20Y9 Cash balance, December 31, 20Y9

$ 141,680

14,790 10,200

(19,040) (8,670) 11,560 3,740 $ 154,260 $ 91,800 (295,800) (80,580) (284,580) $ 250,000 (96,900) 153,100 $ 22,780 47,940 $ 70,720

* $102,000 + $20,400 – $25,500 = $96,900

CHAPTER 13

Statement of Cash Flows

Prob. 13–1B (Concluded) (Optional) Merrick Equipment Co. Spreadsheet (Work Sheet) for Statement of Cash Flows For the Year Ended December 31, 20Y9 Transactions

Balance, Account Title

Cash Accounts receivable (net) Inventories Investments Land Equipment Accum. depr.—equipment Accounts payable Accrued expenses payable Dividends payable Common stock, $1 par Paid-in capital in excess of par—common stock Retained earnings Totals Operating activities: Net income Depreciation Loss on sale of investments Increase in accounts receivable Increase in inventories Increase in accounts payable Increase in accrued expenses payable Investing activities: Purchase of equipment Purchase of land Sale of investments Financing activities: Declaration of cash dividends Sale of common stock Increase in dividends payable Net increase in cash Totals

Debit

Dec. 31, 20Y8

47,940 (m) 188,190 (l) 289,850 (k) 102,000 0 (i) 358,020 (h) (84,320) (194,140) (26,860) (20,400) (102,000) (204,000) (354,280) (b) 0 (a) (g) (j)

Balance,

Credit

22,780 19,040 8,670

Dec. 31, 20Y9

(j)

102,000

(g) (f) (e) (d) (c)

14,790 11,560 3,740 5,100 100,000

70,720 207,230 298,520 0 295,800 438,600 (99,110) (205,700) (30,600) (25,500) (202,000)

150,000 141,680 528,870

(354,000) (393,960) 0

295,800 80,580

141,680 14,790 10,200

(f)

11,560

(e)

3,740

(j)

91,800

250,000 5,100 528,870

(l) (k)

19,040 8,670

(h) (i)

80,580 295,800

(b)

102,000

(m)

22,780 528,870

Note to Instructors: The letters in the debit and credit columns are included for reference purposes only.

CHAPTER 13

Statement of Cash Flows

Prob. 13–2B Harris Industries Inc. Statement of Cash Flows For the Year Ended December 31, 20Y4 Cash flows from (used for) operating activities: Net income Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation* Patent amortization Changes in current operating assets and liabilities: Increase in accounts receivable Decrease in inventories Increase in prepaid expenses Decrease in accounts payable Decrease in salaries payable Net cash flows from operating activities Cash flows from (used for) investing activities: Cash paid for construction of building Net cash flows used for investing activities Cash flows from (used for) financing activities: Cash received from issuance of mortgage note Cash paid for dividends** Net cash flows from financing activities Net increase in cash Cash balance, January 1, 20Y4 Cash balance, December 31, 20Y4 Schedule of Noncash Investing and Financing Activities: Issued common stock to retire bonds payable

$ 524,580

74,340 5,040

(73,080) 134,680 (6,440) (89,600) (8,120) $ 561,400 $(579,600) (579,600) $ 224,000 (123,480) 100,520 $ 82,320 360,920 $ 443,240

$ 390,000

* $51,660 + $22,680 ** Cash paid for dividends = $131,040 + $25,200 – $32,760 = $123,480

CHAPTER 13

Statement of Cash Flows

Prob. 13–2B (Continued) (Optional) Harris Industries Inc. Spreadsheet (Work Sheet) for Statement of Cash Flows For the Year Ended December 31, 20Y4 Balance, Account Title

Cash Accounts receivable (net) Inventories Prepaid expenses Land Buildings Accum. depr.—buildings Machinery and equipment Accum. depr.—machinery and equipment Patents Accounts payable Dividends payable Salaries payable Mortgage note payable Bonds payable Common stock, $5 par Paid-in capital in excess of par—common stock Retained earnings Totals

Dec. 31, 20Y3

360,920 (p) 592,200 (o) 1,022,560 25,200 (m) 302,400 1,134,000 (l) (414,540) 781,200 (191,520) 112,000 (927,080) (h) (25,200) (87,080) (f) 0 (390,000) (d) (50,400) (126,000) (2,118,660) (b) 0

Transactions Debit

Balance,

Credit

82,320 73,080

Dec. 31, 20Y4

443,240 665,280 887,880 31,640 302,400 1,713,600 (466,200) 781,200

(n)

134,680

(k)

51,660

(j) (i)

22,680 5,040

(g)

7,560

(e)

224,000

(c)

150,000

(214,200) 106,960 (837,480) (32,760) (78,960) (224,000) 0 (200,400)

240,000 524,580 1,360,200

(366,000) (2,512,200) 0

6,440 579,600

89,600 8,120 390,000

Note to Instructors: The letters in the debit and credit columns are included for reference purposes only.

CHAPTER 13

Statement of Cash Flows

Prob. 13–2B (Concluded) Harris Industries Inc. Spreadsheet (Work Sheet) for Statement of Cash Flows For the Year Ended December 31, 20Y4 Transactions

Balance, Account Title

Debit

Dec. 31, 20Y3

Operating activities: Net income Depreciation—buildings Depreciation—machinery and equipment Amortization of patents Increase in accounts receivable Decrease in inventories Increase in prepaid expenses Decrease in accounts payable Decrease in salaries payable Investing activities: Construction of building Financial activities: Declaration of cash dividends Issuance of mortgage note payable Increase in dividends payable Schedule of noncash investing and financing activities: Issuance of common stock to retire bonds Net increase in cash Totals

(a) (k)

524,580 51,660

(j) (i)

22,680 5,040

(n)

134,680

(e) (g)

(c)

Balance,

Credit

(o)

73,080

(m) (h) (f)

6,440 89,600 8,120

(l)

579,600

(b)

131,040

Dec. 31, 20Y4

224,000 7,560

390,000 (d) 390,000 (p) 82,320 1,360,200 1,360,200

CHAPTER 13

Statement of Cash Flows

Prob. 13–3B Coulson, Inc. Statement of Cash Flows For the Year Ended December 31, 20Y2 Cash flows from (used for) operating activities: Net income Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation* Gain on sale of land** Changes in current operating assets and liabilities: Increase in accounts receivable Increase in inventories Decrease in prepaid expenses Decrease in accounts payable Increase in income taxes payable Net cash flows from operating activities Cash flows from (used for) investing activities: Cash received from sale of land Cash paid for acquisition of building Cash paid for purchase of equipment

$ 326,600

68,400 (60,000)

(94,800) (52,800) 7,800 (37,200) 4,800 $ 162,800 $ 456,000 (990,000) (196,800)

Net cash flows used for investing activities Cash flows from (used for) financing activities: Cash received from issued bonds payable Cash received from issued common stock Cash paid for dividends Net cash flows from financing activities Net decrease in cash Cash balance, January 1, 20Y2 Cash balance, December 31, 20Y2

(730,800) $ 330,000 280,000 (79,200) 530,800 $ (37,200) 337,800 $ 300,600

* $31,200 + $37,200 ** $456,000 – $396,000

CHAPTER 13

Statement of Cash Flows

Prob. 13–3B (Concluded) (Optional) Coulson, Inc. Spreadsheet (Work Sheet) for Statement of Cash Flows For the Year Ended December 31, 20Y2 Transactions

Balance, Account Title

Cash Accounts receivable (net) Inventories Prepaid expenses Land Buildings Accum. depr.—buildings Equipment Accum. depr.—equipment Accounts payable Income taxes payable Bonds payable Common stock, $20 par Paid-in capital in excess of par—common stock Retained earnings Totals Operating activities: Net income Depreciation—equipment Depreciation—buildings Gain on sale of land Increase in accts. receivable Increase in inventories Decrease in prepaid expenses Decrease in accounts payable Increase in income taxes payable Investing activities: Purchase of equipment Acquisition of building Sale of land Financing activities: Payment of cash dividends Issuance of bonds payable Issuance of common stock Net decrease in cash Totals

Debit

Dec. 31, 20Y1

337,800 609,600 (i) 865,800 (h) 26,400 1,386,000 990,000 (l) (366,000) 529,800 (j) (162,000) (k) (631,200) (d) (21,600) 0 (180,000)

Balance,

Credit

4,800 330,000 140,000

300,600 704,400 918,600 18,600 990,000 1,980,000 (397,200) 660,600 (133,200) (594,000) (26,400) (330,000) (320,000)

(810,000) (o) 140,000 (2,574,600) (b) 79,200 (a) 326,600 0 1,516,800 1,516,800

(950,000) (2,822,000) 0

(a) (e) (f)

(p)

37,200

(g) (m)

7,800 396,000

(f) 196,800 (k) 66,000 (e) 37,200 (c) (n) (o)

31,200 66,000 37,200

Dec. 31, 20Y2

94,800 52,800

990,000

326,600 37,200 31,200 (m) (i)

(g)

(c)

(h)

60,000 94,800 52,800

(d)

37,200

(j) (l)

196,800 990,000

(b)

79,200

7,800

4,800

(m)

456,000

(n) (o) (p)

330,000 280,000 37,200 1,510,800

1,510,800

CHAPTER 13

Statement of Cash Flows

Appendix 2 Prob. 13–4B Martinez Inc. Statement of Cash Flows For the Year Ended December 31, 20Y4 Cash flows from (used for) operating activities: Cash received from customers1 Cash payments for merchandise2 Cash payments for operating expenses3 Cash payments for income tax Net cash flows from operating activities Cash flows from (used for) investing activities: Cash received from sale of investments Cash paid for land Cash paid for equipment Net cash flows used for investing activities Cash flows from (used for) financing activities: Cash received from sale of common stock Cash paid for dividends* Net cash flows from financing activities

$ 4,433,760 (2,269,200) (1,356,240) (299,100) $ 509,220 $

588,000 (960,000) (240,000) (612,000)

600,000 (518,400)

Net decrease in cash Cash balance, January 1, 20Y4 Cash balance, December 31, 20Y4

81,600 $ (21,180) 683,100 $ 661,920

Reconciliation of Net Income with Net Cash Flows from Operating Activities: Net income…………………………………………………………………………… $ 558,960 Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation expense………………………………………………………… 113,100 Gain on sale of investments………………………………………………… (156,000) Changes in current operating assets and liabilities: Increase in accounts receivable……………………………………… (78,240) Increase in inventories………………………………………………… (30,600) Increase in accounts payable………………………………………… 113,400 Decrease in accrued expenses payable……………………………… (11,400) Net cash flows from operating activities………………………………… $ 509,220 * Dividends paid: $528,000 + $91,200 – $100,800 = $518,400

CHAPTER 13

Statement of Cash Flows

Appendix 2 Prob. 13–4B (Concluded) Computations: 1.

Sales…………………………………………………………………………… Increase in accounts receivable………………………………………… Cash received from customers……………………………………………

$4,512,000 (78,240) $4,433,760

Cost of goods sold………………………………………………………… Increase in inventories…………………………………………………… Increase in accounts payable…………………………………………… Cash payments for merchandise…………………………………………

$2,352,000 30,600 (113,400) $2,269,200

Operating expenses other than depreciation………………………… Decrease in accrued expenses payable………………………………… Cash payments for operating expenses…………………………………

$1,344,840 11,400 $1,356,240

CHAPTER 13

Statement of Cash Flows

Appendix 2 Prob. 13–5B Merrick Equipment Co. Statement of Cash Flows For the Year Ended December 31, 20Y9 Cash flows from (used for) operating activities: Cash received from customers1 Cash payments for merchandise2 Cash payments for operating expenses3 Cash payments for income taxes Net cash flows from operating activities Cash flows from (used for) investing activities: Cash received from sale of investments Cash paid for purchase of land Cash paid for purchase of equipment Net cash flows used for investing activities Cash flows from (used for) financing activities: Cash received from sale of common stock Cash paid for dividends* Net cash flows from financing activities Net increase in cash Cash balance, January 1, 20Y9 Cash balance, December 31, 20Y9

$ 2,004,858 (1,242,586) (513,559) (94,453) $ 154,260 $

91,800 (295,800) (80,580) (284,580)

250,000 (96,900) 153,100 $ 22,780 47,940 $ 70,720

Reconciliation of Net Income with Net Cash Flows from Operating Activities: Net income…………………………………………………………………………… $141,680 Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation…………………………………………………………………… 14,790 Loss on sale of investments………………………………………………… 10,200 Changes in current operating assets and liabilities: Increase in accounts receivable……………………………………… (19,040) Increase in inventories…………………………………………………… (8,670) Increase in accounts payable…………………………………………… 11,560 3,740 Increase in accrued expenses payable……………………………… Net cash flows from operating activities………………………………… $154,260 * Dividends paid: $102,000 + $20,400 – $25,500 = $96,900

CHAPTER 13

Statement of Cash Flows

Appendix 2 Prob. 13–5B (Concluded) Computations: 1.

Sales……………………………………………………………………………… Increase in accounts receivable…………………………………………… Cash received from customers………………………………………………

$2,023,898 (19,040) $2,004,858

Cost of goods sold…………………………………………………………… Increase in inventories……………………………………………………… Increase in accounts payable……………………………………………… Cash payments for merchandise……………………………………………

$1,245,476 8,670 (11,560) $1,242,586

Operating expenses other than depreciation…………………………… Increase in accrued expenses payable…………………………………… Cash payments for operating expenses……………………………………

$ 517,299 (3,740) $ 513,559

CHAPTER 13

Statement of Cash Flows

MAKE A DECISION MAD 13–1 a. Net cash flows from operating activities Cash used to purchase property, plant, and equipment Free cash flow b. Ratio of free cash flow to sales

Amazon $ 38,514

Best Buy $2,565

Walmart $ 25,255

(16,861) $ 21,653

(743) $1,822

(10,705) $ 14,550

Amazon 13.5% ($21,653 ÷ $160,408)

Best Buy 4.2% ($1,822 ÷ $43,638)

Walmart 2.8% ($14,550 ÷ $523,964)

c. Amazon’s free cash flow is $21,653 million, which is higher than both Best Buy’s and Walmart’s. However, these companies vary greatly in size; thus, comparing absolute free cash flow across these companies is not very meaningful. A relative measure that can be used to compare free cash flow across the three companies is the ratio of free cash flow to sales. Using this measure, it can be seen that Amazon is stronger at generating free cash flow from sales than are Best Buy and Walmart. Amazon generates free cash flow equal to 13.5% of sales, while Best Buy generates free cash flow equal to 4.2% of sales and Walmart generates free cash flow equal to 2.8% of sales.

MAD 13–2 a. Net cash flows from operating activities Cash used to purchase property, plant, and equipment Free cash flow b. Ratio of free cash flow to sales

Apple $ 69,391

Coca-Cola $10,471

Verizon $ 35,746

(10,495) $ 58,896

(2,054) $ 8,417

(17,939) $ 17,807

Apple 22.6% ($58,896 ÷ $260,174)

Coca-Cola 22.6% ($8,417 ÷ $37,266)

Verizon 13.5% ($17,807 ÷ $131,868)

c. Apple and Verizon have the largest free cash flow. The ratio of free cash flow to sales is the best metric for comparing the three companies. In this comparison, ranking from largest to smallest, are Apple and Coca-Cola, followed by Verizon. However, all three ratios would be considered acceptable. d. Over 50% of Verizon’s cash flows are used to purchase PP&E ($17,939 ÷ $35,746), a percentage much greater than is used by the other two companies. Industries such as airlines, railroads, and telecommunications companies must invest heavily in new equipment to remain competitive. Such investments can significantly reduce free cash flow. 13-37 © 2022 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 13

Statement of Cash Flows

MAD 13–3 a. Net cash flows from operating activities Cash used to purchase property, plant, and equipment Free cash flow b. Ratio of free cash flow to sales

Year 3 $(68)

Year 2 $(56)

Year 1 $ (38)

(16) $(84)

(24) $(80)

(84) $(122)

Year 3 –5.6% [$(84) ÷ $1,507]

Year 2 –4.4% [$(80) ÷ $1,839]

Year 1 –5.8% [$(122) ÷ $2,091]

c. The free cash flow information does accurately show the financial stress on Aeropostale. The free cash flow and ratio of free cash flow to sales were negative in the most recent three years prior to bankruptcy. Moreover, the amount of cash used to purchase property, plant, and equipment declined across the three years. Thus, the free cash flow would have been even more negative if the purchases of property, plant, and equipment had remained at the Year 1 levels. It appears that Aeropostale attempted to save cash by reducing property, plant, and equipment purchases. Lastly, the sales levels were declining across the three years. This is considered an unfavorable trend.

MAD 13–4 a. Total revenue is a good measure for assessing the relative size of the two companies. AT&T is clearly the larger company, with over 2.5 times the revenue of Facebook ($181,193 ÷ $70,697) in Year 3. While total assets are not provided, AT&T is also much larger than Facebook by this measure as well (more than three times as large). b. Total revenue growth is measured horizontally for each company using Year 1 as the base year as follows: Year 3 113% 174%

AT&T Facebook

Year 2 106% 137%

Year 1 100% 100%

AT&T 113% = $181,193 ÷ $160,546 106% = $170,756 ÷ $160,546 Facebook 174% = $70,697 ÷ $40,653 137% = $55,838 ÷ $40,653

CHAPTER 13

Statement of Cash Flows

MAD 13–4 (Continued) It is clear from these data that Facebook is growing much faster than AT&T. This is not surprising in that Facebook is a young company that is expanding services and regions. AT&T is a more mature company with less opportunity for service or regional expansion. In addition, Facebook is starting from a much smaller revenue base compared to AT&T. Fast growth is easier from a smaller base than a larger base of activity. c. Cash used to purchase PP&E as a percentage of the net cash flows from operating activities: Year 3 40% 42%

AT&T Facebook

Year 2 48% 48%

Year 1 54% 28%

AT&T 40% = $19,435 ÷ $48,668 48% = $20,758 ÷ $43,602 54% = $20,647 ÷ $38,010 Facebook 42% = $15,102 ÷ $36,314 48% = $13,915 ÷ $29,274 28% = $6,733 ÷ $24,216 d. The data indicate that AT&T requires approximately the same amount of cash to purchase PP&E compared to Facebook. In Year 1, the percent of net cash flows from operations that is used to purchase PP&E is almost two times that of Facebook. However, in Years 2 and 3, the percent of net cash flows from operations that Facebook used to purchase PP&E was equal to or slightly more than that of AT&T. The net impact of cash used to purchase PP&E on free cash flow is more negative for Facebook than it is for AT&T in Year 3. This is because cash used to purchase PP&E is subtracted from net cash flows from operating activities in determining free cash flow. e. AT&T: Year 3 $ 48,668

Year 2 $ 43,602

Year 1 $ 38,010

(19,435) $ 29,233

(20,758) $ 22,844

(20,647) $ 17,363

16.1% ($29,233 ÷ $181,193)

13.4% ($22,844 ÷ $170,756)

10.8% ($17,363 ÷ $160,546)

Net cash flows from operating activities Cash used to purchase property, plant, and equipment Free cash flow Ratio of free cash flow to revenue

CHAPTER 13

Statement of Cash Flows

MAD 13–4 (Concluded) Facebook: Net cash flows from operating activities Cash used to purchase property, plant, and equipment Free cash flow Ratio of free cash flow to revenue

Year 3 $ 36,314

Year 2 $ 29,274

Year 1 $24,216

(15,102) $ 21,212

(13,915) $ 15,359

(6,733) $17,483

30.0% ($21,212 ÷ $70,697)

27.5% ($15,359 ÷ $55,838)

43.0% ($17,483 ÷ $40,653)

50.0% 45.0% 40.0% 35.0% 30.0% 25.0%

AT&T

20.0%

Facebook

15.0% 10.0% 5.0% 0.0% Year 1

Year 2

Year 3

f. Facebook appears to have a better free cash flow position than does AT&T. In Year 1, Facebook’s ratio of free cash flow to revenue is almost four times greater than AT&T’s. In Years 2 and 3, the difference is smaller; however, Facebook’s ratio of free cash flow to revenue is still approximately two times greater than AT&T’s. Over this time, both companies have increased net cash flows from operating activities. AT&T’s cash needed to purchase PP&E has remained relatively stable. However, for Facebook, the increase in cash needed to purchase PP&E has increased more than the growth in net cash flows from operating activities. This has caused the decline in the ratio of free cash flow to revenue in Year 2.

MAD 13–5 a. Net change in cash: Net cash provided by operating activities Net cash provided by (used for) investing activities Net cash used for financing activities Net change in cash for the year

Year 3 $ 4,865

Year 2 $ 5,338

Year 1 $ 4,662

7,050 (8,220) $ 3,695

2,215 (7,431) $ 122

(4,202) (79) $ 381

CHAPTER 13

Statement of Cash Flows

MAD 13–5 (Concluded) b. Free cash flow: Net cash provided by operating activities Additions to property, plant, and equipment Free cash flow

Year 3 $4,865 (368) $4,497

Year 2 $5,338 (442) $4,896

Year 1 $4,662 (288) $4,374

c. The free cash flow is over $4 billion in all three years. Over the three-year period, free cash flow grew from $4,374 million to $4,497 million, or a 3% increase [($4,497 − $4,374) ÷ $4,374]. This is excellent free cash flow performance. The free cash flow has been used to make acquisitions and investments and repurchase common stock. The acquisitions and investments help grow the company and provide for flexibility for the future. The repurchase of common stock is a method of returning cash to stockholders. d. The cash flow available for investment, dividends, debt repayments, and stock repurchases is best measured by the free cash flow. The change in cash for the period includes all of the sources and uses of cash, and thus does not say anything about the cash remaining for such uses.

CHAPTER 13

Statement of Cash Flows

TAKE IT FURTHER TIF 13–1 Although this situation might seem harmless at first, it is, in fact, a violation of generally accepted accounting principles. The operating cash flow per share figure should not be shown on the face of the income statement. The income statement is constructed under accrual accounting concepts, while operating cash flow “undoes” the accounting accruals. Thus, the inclusion of cash flow information on the income statement could be confusing to users. Some users might not be able to distinguish between earnings and operating cash flow per share—or how to interpret the difference. By agreeing with Polly, Lucas has breached his professional ethics because the disclosure would violate generally accepted accounting principles. On a more subtle note, Polly is being somewhat disingenuous. Apparently, Polly is not pleased with this year’s operating performance and would like to cover the earnings “bad news” with some “good cash flow news.” An interesting question is: Would Polly be as interested in the dual per-share disclosures in the opposite scenario—with earnings per share improving and cash flow per share deteriorating? Probably not.

TIF 13–2 A sample solution based on National Beverage Corp.’s Form 10-K for the fiscal year ended April 27, 2019, follows: 1. a. b. c. d.

$139,442 thousand $(38,315) thousand $(134,791) thousand $(33,664) thousand

2. The company has a very strong cash position, generating considerably more cash flows from operations than it requires for operations.

CHAPTER 13

Statement of Cash Flows

TIF 13–3 Memo To: From: Re:

My Instructor A+ Student Tidewater Inc. Financial Condition

Tidewater Inc. is a retailer that has been unprofitable in recent years. While the company has returned to profitability, there are several “red flags” indicating that the company’s future prospects are highly uncertain. These red flags are discussed below. • The company has initiated a new marketing campaign that significantly increased the number of customers who are purchasing merchandise on credit using the company’s branded credit card. This campaign significantly increased revenue and has helped the company return to profitability. However, it appears that the company has done a poor job of screening the creditworthiness of its new credit card customers. Increases in credit card purchases have resulted in a large accounts receivable balance. It is unlikely that the company will be able to collect a large portion of these accounts receivable, which will likely lead to a cash crisis. • The purchases of deeply discounted merchandise appear to be backfiring. The company has received some “good deals” on price. However, the merchandise is only a “good deal” if the company can resell the merchandise at a profit. The large increase in inventory indicates that this is not the case. It appears that the merchandise has little customer appeal, and it is questionable whether the company will be able to sell the merchandise. • The company has not been able to pay off its accounts payable in a timely manner, resulting in significant overdue accounts payable balances. While the company reports that most of the past-due payables have been paid, it is concerning that the company became overdue on its accounts payable. A retailer cannot afford a poor payment history, or it will be denied future merchandise shipments. This is a signal of a severe cash flow problem. These red flags suggest that the company is having severe operating cash flow difficulties, and the company’s future prospects are highly uncertain.

CHAPTER 13

Statement of Cash Flows

TIF 13–4 Start-up companies are unique in that they frequently have negative retained earnings and operating cash flows. The negative retained earnings are often due to losses from high start-up expenses. The negative operating cash flows are typical because growth requires cash. Growth must be financed with cash before the cash returns. For example, a company must expend cash to provide the service in Period 1 before selling the service and receiving cash in Period 2. The start-up company constantly faces the problem of spending cash today for the next period’s growth. For Giraffe Inc., the money spent on salaries to develop the business is a cash outflow that must occur before the service provides revenues. In addition, the company must use cash to market its service to potential customers. In this situation, the only way the company stays in business is from the capital provided by the owners. This owner-supplied capital is the lifeblood of a start-up company. Banks will not likely lend money on this type of venture (except with assets as security). Giraffe Inc. could be a good investment. It all depends on whether the new service has promise. The financial figures will not reveal this in a straightforward manner. Only actual sales will reveal whether the service is a hit. Until such a time, the company is at risk. If the service is not popular, the company will have no cash to fall back on—it will likely go bankrupt. If, however, the service is successful, then Giraffe Inc. should become self-sustaining and provide a good return for the shareholders.

CHAPTER 14 FINANCIAL STATEMENT ANALYSIS DISCUSSION QUESTIONS 1.

Liquidity is the ability of a company to convert assets into cash. Short-term creditors such as banks and financial institutions are most concerned with liquidity. Solvency is the ability of a company to pay its debts. Long-term creditors, such as bondholders, are primarily concerned with a company’s solvency. Profitability is the ability of a company to generate earnings. Investors, such as stockholders, are primarily concerned with profitability because it determines whether the company’s stock price will increase.

Comparative statements provide information about changes between dates or periods. Trends indicated by comparisons may be far more significant than the data for a single date or period.

Before this question can be answered, the increase in net income should be compared with changes in sales, expenses, and assets for the current year. The return on total assets for both periods should also be compared. If these comparisons indicate favorable trends, the operating performance has improved. If not, the apparent favorable increase in net income may be offset by unfavorable trends in other areas.

Generally, the two ratios would be very close because most service businesses sell services and hold very little inventory.

A high inventory turnover minimizes the amount invested in inventories, thus freeing funds for other uses. Storage costs, administrative expenses, losses caused by obsolescence, and potential decreases in selling prices are also kept to a minimum when inventory turnover is high.

Yes. Inventory turnover measures the “turnover” of inventory during the year, while the days’ sales in inventory measures the amount of inventory on hand at the beginning and end of the year. Therefore, a business could have a high inventory turnover during the year, yet have a high days’ sales in inventory based on the beginning and end-of-year inventory amounts.

The ratio of fixed assets to long-term liabilities increased from 3.4 ($1,360,000 ÷ $400,000) in the preceding year to 4.2 ($1,260,000 ÷ $300,000) in the current year. This indicates that the company is in a stronger position this year to borrow additional long-term debt.

The return on total assets measures the profitability of the total assets, without regard for how the assets are financed. The return on stockholders’ equity measures the profitability of the stockholders’ investment, focusing exclusively on the return to shareholders.

The return on stockholders’ equity is normally higher than the return on total assets. This is because of leverage, which compensates stockholders for the higher risk of their investments.

CHAPTER 14

Financial Statement Analysis

DISCUSSION QUESTIONS (Concluded) 8. The price-earnings ratio measures the market’s expectations of a company’s future earnings prospects. Kroger’s low price-earnings ratio compared to the industry average suggests that the market has low expectations about the company’s future earnings. 9. The dividend yield measures the return common stockholders receive from a cash dividend. The high dividend yield for Suburban Propane indicates that a significant portion of the return to its shareholders comes in the form of a cash dividend. The lack of a dividend yield for Alphabet indicates that the return to shareholders comes solely from stock price appreciation. 10. One report is the Report on Internal Control, which verifies management’s conclusions on internal control. Another report is the Report on Fairness of the Financial Statements of Independent Registered Public Accounting Firm, where the Certified Public Accounting (CPA) firm that conducts the audit renders an opinion on the fairness of the statements.

CHAPTER 14

Financial Statement Analysis

BASIC EXERCISES BE 14–1 Accounts payable…………………… $14,280 increase ($116,280 – $102,000), or 14% Long-term debt…………………..……$9,600 increase ($129,600 – $120,000), or 8%

BE 14–2 Amount Sales…………………………………… $1,500,000 900,000 Cost of goods sold…………………… Gross profit…………………………… $ 600,000

Percentage 100% ($1,500,000 ÷ $1,500,000) 60% ($900,000 ÷ $1,500,000) 40% ($600,000 ÷ $1,500,000)

BE 14–3 a. Current Ratio = Current Assets ÷ Current Liabilities = ($296,600 + $185,000 + $121,000 + $127,000) ÷ $228,000 = 3.2 b. Quick Ratio

= Quick Assets ÷ Current Liabilities = ($296,600 + $185,000 + $121,000) ÷ $228,000 = 2.6

BE 14–4 a. Accounts Receivable Turnover = Sales ÷ Average Accounts Receivable = $5,250,000 ÷ $350,000 = 15.0 b.

Average Accounts Receivable Average Daily Sales

Days’ Sales in Receivables =

= $350,000 ÷ ($5,250,000 ÷ 365) = $350,000 ÷ $14,384 = 24.3 days

CHAPTER 14

Financial Statement Analysis

BE 14–5 a.

Inventory Turnover = Cost of Goods Sold ÷ Average Inventory = $696,000 ÷ $58,000 = 12.0

Days’ Sales in Inventory =

Average Inventory Average Daily Cost of Goods Sold

= $58,000 ÷ ($696,000 ÷ 365) = $58,000 ÷ $1,907 = 30.4 days

BE 14–6 a.

Fixed Assets Long-Term Liabilities

Ratio of Fixed Assets to Long-Term Liabilities =

= $1,176,000 ÷ $280,000 = 4.2 b.

Ratio of Liabilities to Stockholders’ Equity

Total Liabilities Total Stockholders’ Equity

= $960,000 ÷ $320,000 = 3.0

BE 14–7 Times Interest Earned =

Income Before Income Tax Expense + Interest Expense Interest Expense

$9,100,000 + $650,000 $650,000

= 15.0

CHAPTER 14

Financial Statement Analysis

BE 14–8 Asset Turnover = Sales ÷ Average Total Assets = $6,750,000 ÷ $2,500,000 = 2.7

BE 14–9 Return on Total Assets =

Net Income + Interest Expense Average Total Assets

$390,000 + $60,000 $4,500,000

$450,000 $4,500,000

= 10.0%

BE 14–10 a.

Net Income Average Stockholders’ Equity

Return on Stockholders’ Equity =

= $1,225,000 ÷ $8,750,000 = 14.0% b.

Net Income – Preferred Dividends Average Common Stockholders’ Equity

Return on Common = Stockholders’ Equity

$1,225,000 – $47,800 $5,400,000

= = 21.8%

BE 14–11 a.

Net Income – Preferred Dividends Shares of Common Stock Outstanding

Earnings per Share = on Common Stock

= ($650,000 – $45,000) ÷ 110,000 = $5.50 b.

Price-Earnings Ratio =

Market Price per Share of Common Stock Earnings per Share on Common Stock

= $44.00 ÷ $5.50 = 8.0

CHAPTER 14

Financial Statement Analysis

EXERCISES Ex. 14–1 a.

Innovation Quarter Inc. Comparative Income Statement For the Years Ended December 31

Sales Cost of goods sold Gross profit Selling expenses Administrative expenses Total operating expenses Operating income Income tax expense Net income b.

Current Year Amount Percent

Previous Year Amount Percent

$ 4,000,000 (2,280,000) $ 1,720,000 $ (600,000) (520,000) $(1,120,000) $ 600,000 (240,000) $ 360,000

$ 3,600,000 (1,872,000) $ 1,728,000 $ (648,000) (360,000) $(1,008,000) $ 720,000 (216,000) $ 504,000

100% (57)% 43% (15)% (13)% (28)% 15% (6)% 9%

100% (52)% 48% (18)% (10)% (28)% 20% (6)% 14%

The vertical analysis indicates that the cost of goods sold as a percent of sales increased by 5 percentage points (57% – 52%), while selling expenses decreased by 3 percentage points (15% – 18%), and administrative expenses increased by 3% (13% – 10%). Thus, net income as a percent of sales dropped by 5% (9% – 14%).

CHAPTER 14

Financial Statement Analysis

Ex. 14–2 a.

International Speedway Corporation Comparative Income Statement (in thousands of dollars) For the Years Ended December 31

Revenues: Admissions Event-related revenue Food, beverage, and merchandise Other operating revenue Total revenues Expenses and other: Event-related expenses NASCAR event management fees Food, beverage, and merchandise General and administrative Total expenses and other Income from continuing operations

Current Year Amount Percent

Prior Year Amount Percent

$ 109,602 508,505

16.2% 75.3%

$ 121,505 491,664

35,669 21,260 $ 675,036

5.3% 3.1% 100.0%*

41,293 6.1% 16,971 2.5% $ 671,433 100.0%*

$(145,093)

(21.5)%

$(134,136) (20.0)%

(185,200) (27,278) (224,303) $(581,874)

(27.4)% (4.0)% (33.2)% (86.2)%*

(178,403) (26.6)% (29,593) (4.4)% (233,145) (34.7)% $(575,277) (85.7)%

$ 93,162

13.8%

$ 96,156

18.1% 73.2%

14.3%

* Percentages do not add vertically due to rounding. b.

Overall revenue increased between the two years, with changes in the mix of revenue sources. The event-related revenue increased 2.1% (73.2% to 75.3% of total revenue), while admissions revenue decreased by 1.9% of total revenue. One of the major expense categories, NASCAR event management fees, increased slightly to 27.4% of total revenue. The event-related expenses increased 1.5%, while food, beverage, and merchandise expense decreased by 0.4% of total revenue. General and administrative expenses decreased by 1.5% of total revenue. Overall, income from continuing operations decreased by 0.5%.

CHAPTER 14

Financial Statement Analysis

Ex. 14–3 a.

Tannenhill Company Common-Sized Income Statement For the Year Ended December 31 Tannenhill Company Amount Percent

Sales Cost of goods sold Gross profit Selling expenses Administrative expenses Total operating expenses Operating income Other revenue and expense: Other revenue Other expense Income before income tax expense Income tax expense Net income b.

Electronics Industry Average

$ 4,000,000 (2,120,000) $ 1,880,000 $(1,080,000) (640,000) $(1,720,000) $ 160,000

100% (53)% 47% (27)% (16)% (43)% 4%

100% (60)% 40% (24)% (14)% (38)% 2%

120,000 (80,000) 200,000 (80,000) 120,000

3% (2)% 5% (2)% 3%

3% (2)% 3% (2)% 1%

$ $

The cost of goods sold is 7% lower than the industry average, but the selling expenses and administrative expenses are 3% and 2% higher than the industry averages, respectively. The combined impact causes net income as a percent of sales to be 2% better than the industry average. Apparently, the company is managing the cost of manufacturing product better than the industry, but has slightly higher selling and administrative expenses relative to the industry. The cause of the higher selling and administrative expenses as a percent of sales, relative to the industry, can be investigated further.

CHAPTER 14

Financial Statement Analysis

Ex. 14–4 Alvarez Company Comparative Balance Sheet For the Years Ended December 31 Current Year Amount Percent

Previous Year Amount Percent

Current assets Property, plant, and equipment Intangible assets Total assets

$ 2,800,000 5,200,000 2,000,000 $10,000,000

28.0% 52.0% 20.0% 100.0%

$1,840,000 6,072,000 1,288,000 $9,200,000

20.0% 66.0% 14.0% 100.0%

Current liabilities Long-term liabilities Common stock Retained earnings Total liabilities and stockholders’ equity

$ 1,800,000 3,600,000 980,000 3,620,000

18.0% 36.0% 9.8% 36.2%

$1,380,000 3,680,000 920,000 3,220,000

15.0% 40.0% 10.0% 35.0%

$10,000,000

100.0%

$9,200,000

100.0%

Ex. 14–5 a.

Winthrop Company Comparative Income Statement For the Years Ended December 31

Sales Cost of goods sold Gross profit Selling expenses Administrative expenses Total operating expenses Income before income tax expense Income tax expense Net income b.

Current Year Amount

Previous Year Amount

Increase/(Decrease) Amount Percent

$ 2,240,000 (1,925,000) $ 315,000 $ (152,500) (118,000) $ (270,500)

$ 2,000,000 (1,750,000) $ 250,000 $ (125,000) (100,000) $ (225,000)

$240,000 175,000 $ 65,000 $ 27,500 18,000 $ 45,500

12.0% 10.0% 26.0% 22.0% 18.0% 20.2%

$ 19,500 7,800 $ 11,700

78.0% 78.0% 78.0%

44,500 (17,800) 26,700

25,000 (10,000) 15,000

The net income for Winthrop Company increased by 78.0% between years. This increase was the combined result of an increase in sales of 12.0% and a lower percentage increase in cost of goods sold. As a result, the percentage increase in gross profit exceeded the percentage increase in sales.

CHAPTER 14

Financial Statement Analysis

Ex. 14–6 a. (1) Working Capital = Current Assets – Current Liabilities Current year: $1,100,000 = $2,100,000 – $1,000,000 Previous year: $540,000 = $1,440,000 – $900,000 (2)

Current Ratio = Current Year:

(3)

Current Assets Current Liabilities

$2,100,000 $1,000,000

Previous Year:

$1,440,000 $900,000

= 1.6

Quick Assets (Cash, Marketable Securities, Accounts Receivable) Current Liabilities

Quick Ratio = Current Year:

= 2.1

$1,500,000 $1,000,000

= 1.5

Previous Year:

$1,080,000 $900,000

= 1.2

b. The liquidity of Nilo has improved from the preceding year to the current year The working capital, current ratio, and quick ratio have all increased. Most of these changes are the result of an increase in current assets relative to current liabilities.

Ex. 14–7 a. (1)

Current Ratio = Current Year:

(2)

Quick Ratio = Current Year:

Current Assets Current Liabilities $17,645 $20,461

= 0.9

Previous Year:

$21,893 $22,138

= 1.0

Previous Year:

$18,132 $22,138

= 0.8

Quick Assets Current Liabilities $13,560 $20,461

= 0.7

b. The liquidity of PepsiCo has decreased slightly over this time period. The current ratio and the quick ratio have both decreased 0.1. PepsiCo’s resources have remained constant during the time period. It appears PepsiCo will need to secure additional resources (e.g., short-term borrowings) to meet its short-term obligations.

CHAPTER 14

Financial Statement Analysis

Ex. 14–8 a.

The working capital, current ratio, and quick ratio are computed incorrectly. The working capital and current ratio incorrectly include intangible assets and property, plant, and equipment as a part of current assets. Both are noncurrent. The quick ratio has both an incorrect numerator and denominator. The numerator of the quick ratio is incorrectly computed as the sum of inventories, prepaid expenses, and property, plant, and equipment ($36,000 + $24,000 + $55,200). The denominator is also incorrect, as it does not include accrued liabilities. The denominator of the quick ratio should be total current liabilities. The correct computations are as follows: Working Capital = Current Assets – Current Liabilities $30,000 = $330,000 – $300,000 Current Ratio = = Quick Ratio = =

Current Assets Current Liabilities $330,000 $300,000

1.1

Quick Assets Current Liabilities $102,000 + $48,000 + $120,000 $300,000

= 0.9

Unfortunately, the working capital, current ratio, and quick ratio are below the minimum threshold required by the bond indenture. This may require the company to renegotiate the bond contract, including a possible unfavorable change in the interest rate.

CHAPTER 14

Financial Statement Analysis

Ex. 14–9 a.

(1)

Accounts Receivable Turnover = 20Y3:

$5,637,500 $687,500 *

20Y2:

= 8.2

* $687,500 = ($725,000 + $650,000) ÷ 2

20Y3: 1 2 3 4

$687,5001 $15,445 2

$4,687,500 = 7.5 $625,000 **

** $625,000 = ($650,000 + $600,000) ÷ 2

Days’ Sales in Receivables =

(2)

Sales Average Accounts Receivable

Average Accounts Receivable Average Daily Sales

= 44.5 days

20Y2:

$625,000 3 $12,842 4

= 48.7 days

Average accounts receivable = $687,500 = ($725,000 + $650,000) ÷ 2 Average daily sales = $15,445 = $5,637,500 ÷ 365 days Average accounts receivable = $625,000 = ($650,000 + $600,000) ÷ 2 Average daily sales = $12,842 = $4,687,500 ÷ 365 days

The collection of accounts receivable has improved. This can be seen in both the increase in accounts receivable turnover and the reduction in the collection period. The credit terms require payment in 45 days. In the prior year, the collection period exceeded these terms. However, the company apparently became more aggressive in collecting accounts receivable or more restrictive in granting credit to customers. Thus, in the current year, the collection period is within the credit terms of the company.

CHAPTER 14

Financial Statement Analysis

Ex. 14–10 a.

(1)

Accounts Receivable Turnover =

Sales Average Accounts Receivable

Xavier:

$8,500,000 ($820,000 + $880,000) ÷ 2

= 10.0

Lestrade:

$4,585,000 ($600,000 + $710,000) ÷ 2

= 7.0

(2)

Days’ Sales in Receivables =

Average Accounts Receivable Average Daily Sales

Xavier:

($820,000 + $880,000) ÷ 2 $23,287.7 *

= 36.5 days

Lestrade:

($600,000 + $710,000) ÷ 2 $12,561.6 **

= 52.1 days

* Average daily sales = $23,287.7 = $8,500,000 ÷ 365 days ** Average daily sales = $12,561.6 = $4,585,000 ÷ 365 days b.

Xavier’s accounts receivable turnover is much higher than Lestrade’s (10.0 for Xavier vs. 7.0 for Lestrade). The days’ sales in receivables is lower for Xavier than for Lestrade (36.5 days for Xavier vs. 52.1 days for Lestrade). These differences indicate that Xavier is able to turn over its receivables more quickly than Lestrade. As a result, it takes Xavier less time to collect its receivables.

CHAPTER 14

Financial Statement Analysis

Ex. 14–11 a.

(1)

(2)

Inventory Turnover =

Cost of Goods Sold Average Inventory

Current Year:

$9,270,000 ($1,120,000 + $940,000) ÷ 2

= 9.0

Previous Year:

$10,800,000 ($940,000 + $860,000) ÷ 2

= 12.0

Days’ Sales in Inventory = Current Year:

Previous Year:

Average Inventory Average Daily Cost of Goods Sold

($1,120,000 + $940,000) ÷ 2 $25,397.3 * ($940,000 + $860,000) ÷ 2 $29,589.0 **

= 40.6 days

= 30.4 days

* Average daily cost of goods sold = $25,397.3 = $9,270,000 ÷ 365 days ** Average daily cost of goods sold = $29,589.0 = $10,800,000 ÷ 365 days b.

The inventory position of the business has deteriorated. The inventory turnover has decreased, while the days’ sales in inventory has increased. The sales volume appears to have declined faster than the inventory, resulting in a deteriorating inventory position.

CHAPTER 14

Financial Statement Analysis

Ex. 14–12 a.

(1)

(2)

Inventory Turnover =

Cost of Goods Sold Average Inventory

QT:

$44,754 ($1,382 + $1,404) ÷ 2

= 32.1

Elppa:

$92,385 ($6,317 + $7,490) ÷ 2

= 13.4

Days’ Sales in Inventory =

Average Inventory Average Daily Cost of Goods Sold

QT:

($1,382 + $1,404) ÷ 2 $122.6 *

= 11.4 days

Elppa:

($6,317 + $7,490) ÷ 2 $253.1 **

= 27.3 days

* Average daily cost of goods sold = $122.6 = $44,754 ÷ 365 days ** Average daily cost of goods sold = $253.1 = $92,385 ÷ 365 days b.

QT has a much higher inventory turnover ratio than does Elppa (32.1 vs. 13.4). Likewise, QT has a much smaller days’ sales in inventory (11.4 days vs. 27.3 days). These significant differences are a result of QT’s make-to-order strategy. QT has successfully developed a manufacturing process that is able to fill a customer order quickly. As a result, QT does not pre-build many computers for inventory. Elppa, in contrast, pre-builds computers to be sold to retail stores and other retail channels. In this industry, there is great obsolescence risk in holding computers in inventory. New technology can make an inventory of computers difficult to sell; therefore, inventory is costly and risky.

CHAPTER 14

Financial Statement Analysis

Ex. 14–13 a.

Ratio of Liabilities to Stockholders’ Equity = Current year:

$2,124,000 $2,360,000

= 0.9

Previous year:

$2,200,000 $2,000,000

= 1.1

Times Interest Earned =

Total Liabilities Total Stockholders’ Equity

Income Before Income Tax Expense + Interest Expense Interest Expense

Current year:

$480,000 + $120,000 * $120,000

Previous year:

$420,000 + $140,000 ** = 4.0 $140,000

= 5.0

* Interest expense = ($1,000,000 + $200,000) × 10% = $120,000 ** Interest expense = ($1,200,000 + $200,000) × 10% = $140,000 c.

Both the ratio of liabilities to stockholders’ equity and the number of times bond interest charges were earned have improved from the previous year. These results are the combined result of a larger income before income taxes and lower interest expense in the current year compared to the previous year.

CHAPTER 14

Financial Statement Analysis

Ex. 14–14 a.

Ratio of Liabilities to Stockholders’ Equity = Hasbro, Inc.:

$5,860,098 $2,995,530

= 2.0

Mattel, Inc.:

$4,833,512 $491,714

= 9.8

Times Interest Earned =

Total Liabilities Total Stockholders’ Equity

Income Before Income Tax Expense + Interest Expense Interest Expense

Hasbro, Inc.:

$594,210 + $101,878 $101,878

= 6.8

Mattel, Inc.:

$(158,288) + $201,044 $201,044

= 0.2

Mattel has significantly more debt to stockholders’ equity compared to Hasbro (9.8 vs. 2.0 times stockholders’ equity). Hasbro has strong interest coverage; however, Mattel’s interest coverage is almost zero. Together, these ratios indicate that Hasbro provides creditors with a sound margin of safety and that earnings are more than enough to make interest payments. On the other hand, Mattel is in a much more precarious situation.

CHAPTER 14

Financial Statement Analysis

Ex. 14–15 a.

Ratio of Liabilities to Stockholders’ Equity =

Total Liabilities Total Stockholders’ Equity

Mondelez:

$15,322,000 + $14,207,000 + $7,669,000 $27,351,000

= 1.4

Hershey:

$2,008,793 + $3,530,813 + $855,795 $1,744,994

= 3.7

Ratio of Fixed Assets to Long-Term Liabilities = Mondelez:

$8,733,000 $21,876,000

= 0.4

Hershey:

$2,153,139 $4,386,608

= 0.5

Fixed Assets (net) Long-Term Liabilities

Hershey’s total liabilities to stockholders’ equity ratio is higher than Mondelez’s (3.7 vs. 1.4), meaning Hershey uses more debt than Mondelez. Mondelez has a lower ratio of fixed assets to long-term liabilities than Hershey. This ratio divides the property, plant, and equipment (net) by the long-term debt. The ratio for Mondelez is aggressive, with fixed assets covering only 40% of the long-term debt. That is, the creditors of Mondelez have 40 cents of property, plant, and equipment covering every dollar of long-term debt. The same ratio for Hershey shows fixed assets covering 50% of the long-term debt. That is, Hershey’s creditors have 50 cents of property, plant, and equipment covering every dollar of long-term debt. This would suggest that Hershey has slightly stronger creditor protection and borrowing capacity than does Mondelez.

CHAPTER 14

Financial Statement Analysis

Ex. 14–16 a.

Asset Turnover =

Sales Average Total Assets

YRC Worldwide:

$4,871,200 $3,448,700

= 1.4

Union Pacific:

$21,708,000 $60,410,000

= 0.4

C.H. Robinson $15,309,508 Worldwide: $4,534,236

= 3.4

The asset turnover ratio measures the number of sales dollars earned for each dollar of assets. The greater the number of sales dollars earned for every dollar of assets, the more efficient a firm is in using assets. Thus, the ratio is a measure of each company’s asset efficiency. Union Pacific earns only 40 cents for every dollar of assets. This is because railroads are very asset intensive. The company must invest in locomotives, railcars, terminals, tracks, right-of-way, and information systems in order to earn revenues. These investments are significant. YRC has a higher asset turnover ratio and is able to earn $1.40 for every dollar of assets. This is because the motor carrier invests in trucks, trailers, and terminals, which require less investment per dollar of revenue than the railroad. Moreover, the motor carrier does not invest in the highway system because the government owns the highway system. Thus, the motor carrier has no investment in the transportation network itself, unlike the railroad. C.H. Robinson, the transportation arranger, hires transportation services from motor carriers and railroads but does not own these assets itself. The transportation arranger’s assets are in the form of accounts receivable and information systems. However, the company does not require transportation assets; thus, it is able to earn the highest revenue per dollar of assets ($3.40). Note to Instructors: Students may wonder how asset-intensive companies overcome their asset efficiency disadvantages to competitors with better asset efficiencies, as in the case between railroads and motor carriers. Asset efficiency is part of the financial equation; the other part is the profit margin made on each dollar of sales. Thus, companies with high asset efficiency often operate on thinner margins than do companies with lower asset efficiency. For example, the motor carrier must pay highway taxes, which lowers its operating margins when compared to railroads that own their right-of-way, and thus do not have the tax expense of the highway. While not required in this exercise, the railroad has the highest profit margins, the motor carrier is in the middle, and the transportation arranger operates on very thin margins.

CHAPTER 14

Financial Statement Analysis

Ex. 14–17 a.

Net Income + Interest Expense Average Total Assets

Return on Total Assets =

1 2 3 4

20Y7:

$372,000 + $180,000 1 $4,600,000 2

= 12.0%

20Y6:

$492,000 + $180,000 3 $4,200,000 4

= 16.0%

Interest expense = $2,250,000 × 8% Average total assets = ($4,800,000 + $4,400,000) ÷ 2 Interest expense = $2,250,000 × 8% Average total assets = ($4,400,000 + $4,000,000) ÷ 2

Return on Stockholders’ Equity = 20Y7:

$372,000 $2,148,000 *

= 17.3%

20Y6:

$492,000 $1,736,000 **

= 28.3%

Net Income Average Total Stockholders’ Equity

* Average total stockholders’ equity = ($2,324,000 + $1,972,000) ÷ 2 ** Average total stockholders’ equity = ($1,972,000 + $1,500,000) ÷ 2 Return on Common = Stockholders’ Equity

1 2 3 4

Net Income – Preferred Dividends Average Common Stockholders’ Equity

20Y7:

$372,000 – $20,000 1 $1,648,000 2

= 21.4%

20Y6:

$492,000 – $20,000 3 $1,236,000 4

= 38.2%

Preferred dividends = $500,000 × 4% Average common stockholders’ equity = ($1,824,000 + $1,472,000) ÷ 2 Preferred dividends = $500,000 × 4% Average common stockholders’ equity = ($1,472,000 + $1,000,000) ÷ 2

The profitability ratios indicate that the company’s profitability has deteriorated. Most of this change is from net income falling from $492,000 in 20Y6 to $372,000 in 20Y7. Because the return on common stockholders’ equity exceeds the return on total assets in both years, there is positive leverage from the use of debt. However, this leverage is greater in 20Y6 because the return on total assets exceeds the return on common stockholders’ equity by a greater amount in 20Y6.

CHAPTER 14

Financial Statement Analysis

Ex. 14–18 a.

Return on Total Assets =

Net Income + Interest Expense Average Total Assets

Fiscal Year 3:

$384,300 + $17,600 = 6.1% ($7,279,900 + $5,942,800) ÷ 2

Fiscal Year 2:

$430,900 + $20,700 = 7.5% ($5,942,800 + $6,143,300) ÷ 2

Return on Stockholders’ Equity =

Net Income Average Total Stockholders’ Equity

Fiscal Year 3:

$384,300 = 12.9% ($2,693,300 + $3,287,200) ÷ 2

Fiscal Year 2:

$430,900 = 12.8% ($3,287,200 + $3,457,400) ÷ 2

The return on total assets decreased and the return on stockholders’ equity increased slightly over the two-year period. The return on total assets decreased from 7.5% to 6.1%, and the return on stockholders’ equity increased from 12.8% to 12.9%. The return on stockholders’ equity exceeds the return on total assets due to the positive use of leverage.

During fiscal Year 3, Ralph Lauren’s results were weak compared to the industry average. The return on total assets for Ralph Lauren was less than the industry average (6.1% vs. 8.0%). The return on stockholders’ equity was less than the industry average (12.9% vs. 15.0%). These relationships suggest that Ralph Lauren has less leverage than the industry, on average.

CHAPTER 14

Financial Statement Analysis

Ratio of Fixed Assets to = Long-Term Liabilities

Fixed Assets (net) Long-Term Liabilities

Ex. 14–19 a.

$3,200,000 $2,000,000 b.

Ratio of Liabilities to = Stockholders’ Equity $3,000,000 $5,000,000

= 1.6

= 0.6

Asset Turnover =

$18,900,000 $4,500,000 *

Total Liabilities Total Stockholders’ Equity

Sales Average Total Assets (excluding long-term investments) 4.2

* Average total assets = [($7,000,000 + $8,000,000) ÷ 2] – $3,000,000. The end-of-period total assets are equal to the sum of total liabilities ($3,000,000) and stockholders’ equity ($5,000,000).

Return on Total Assets = $930,000 + $120,000 * $7,500,000 **

Net Income + Interest Expense Average Total Assets

= 14.0%

* Interest expense = $2,000,000 × 6% ** Average total assets = ($7,000,000 + $8,000,000) ÷ 2 e.

Return on = Stockholders’ Equity $930,000 $4,785,000 *

Net Income Average Total Stockholders’ Equity

= 19.4%

* Average total stockholders’ equity = [($1,570,000 + $2,000,000 + $1,000,000) + $5,000,000] ÷ 2 f.

Return on Common = Stockholders’ Equity $930,000 – $100,000 * $3,785,000 **

Net Income – Preferred Dividends Average Common Stockholders’ Equity

= 21.9%

* Preferred dividends = ($1,000,000 ÷ $100) × $10 ** Average common stockholders’ equity = [($2,000,000 + $1,570,000) + ($2,000,000 + $2,000,000)] ÷ 2

CHAPTER 14

Financial Statement Analysis

Ex. 14–20 a.

Times Interest Earned =

Income Before Income Tax Expense + Interest Expense Interest Expense

$3,000,000 + $400,000* = 8.5 times $400,000 * Interest expense = $5,000,000 bonds payable × 8% b.

Net Income – Preferred Dividends Common Stock Outstanding

Earnings per Share = on Common Stock $1,800,000 – $200,000 = $3.20 500,000 shares*

* Shares of common stock outstanding = $5,000,000 ÷ $10 par value per share c.

Price-Earnings Ratio = $32.00 $3.20

= 10.0

Dividends per Share = of Common Stock $1,200,000 500,000 shares

Dividends on Common Stock Shares of Common Stock Outstanding

= $2.40

Dividend Yield = $2.40 $32.00

Market Price per Share of Common Stock Earnings per Share

Dividends per Share of Common Stock Market Price per Share of Common Stock

= 7.5%

CHAPTER 14

Financial Statement Analysis

Ex. 14–21 a.

Net Income – Preferred Dividends Shares of Common Stock Outstanding

Earnings per Share = $1,750,000 – $250,000* 500,000 shares**

= $3.00

* Preferred dividends = ($2,500,000 ÷ $40) × $4 ** Shares of common stock outstanding = $10,000,000 ÷ $20 b.

Price-Earnings Ratio = $45.00 $3.00

= 15.0

Dividends per Share = $1,125,000 500,000 shares

Common Dividends Shares of Common Stock Outstanding

= $2.25

Dividend Yield = $2.25 $45.00

Market Price per Share of Common Stock Earnings per Share of Common Stock

Dividends per Share of Common Stock Market Price per Share of Common Stock

= 5.0%

CHAPTER 14

Financial Statement Analysis

Ex. 14–22 a.

Price-Earnings Ratio = Deere & Company:

$174.14 $10.28

= 16.9

Alphabet:

$1,339.39 $49.59

= 27.0

The Coca-Cola Company:

$55.35 $2.09

= 26.5

Dividend Yield =

Market Price per Share of Common Stock Earnings per Share

Dividends per Share of Common Stock Market Price per Share of Common Stock

Deere & Company:

$3.04 $174.14

= 1.7%

Alphabet:

$0.00 $1,339.39

= 0.0%

The Coca-Cola Company:

$1.60 $55.35

= 2.9%

Coca-Cola has the highest dividend yield and second-highest price-earnings ratio of the three companies. Stock market participants value Coca-Cola common stock on the basis of both its dividend and its potential share price appreciation. Alphabet pays no dividend and, thus, has no dividend yield. Alphabet has the largest priceearnings ratio. Stock market participants are expecting a return on their investment from appreciation in the stock price. Deere & Company has the lowest price-earnings ratio. Deere & Company has a solid dividend, producing a yield of 1.7%. Deere & Company is expected to produce shareholder returns through a combination of some share price appreciation and a moderate dividend. However, the market does not expect the same share price appreciation it expects from Coca-Cola.

CHAPTER 14

Financial Statement Analysis

PROBLEMS Prob. 14–1A 1.

McDade Company Comparative Income Statement For the Years Ended December 31, 20Y2 and 20Y1

Sales Cost of goods sold Gross profit Selling expenses Administrative expenses Total operating expenses Operating income Other revenue Income before income tax expense Income tax expense Net income

Increase/(Decrease) Amount Percent

20Y2

20Y1

$ 16,800,000 (11,500,000) $ 5,300,000 $ (1,770,000) (1,220,000) $ (2,990,000) $ 2,310,000 256,950

$ 15,000,000 (10,000,000) $ 5,000,000 $ (1,500,000) (1,000,000) $ (2,500,000) $ 2,500,000 225,000

$1,800,000 1,500,000 $ 300,000 $ 270,000 220,000 $ 490,000 $ (190,000) 31,950

12.0% 15.0% 6.0% 18.0% 22.0% 19.6% (7.6)% 14.2%

$ 2,566,950 (1,413,000) $ 1,153,950

$ 2,725,000 (1,500,000) $ 1,225,000

$ (158,050) (87,000) $ (71,050)

(5.8)% (5.8)% (5.8)%

2. Net income has declined from 20Y1 to 20Y2. Sales have increased by 12.0%; however, the cost of goods sold has increased by 15.0%, causing the gross profit to increase at a slower pace than sales. In addition, total operating expenses have increased at a faster rate than sales (19.6% increase vs. 12.0% sales increase). Increases in costs and expenses that are higher than the increase in sales have caused the net income to decline by 5.8%.

CHAPTER 14

Financial Statement Analysis

Prob. 14–2A 1.

Tri-Comic Company Comparative Income Statement For the Years Ended December 31, 20Y2 and 20Y1

Sales Cost of goods sold Gross profit Selling expenses Administrative expenses Total operating expenses Operating income Other revenue Income before income tax expense Income tax expense Net income 2.

20Y2 Amount Percent

20Y1 Amount Percent

$1,500,000 (510,000) $ 990,000 $ (270,000) (180,000) $ (450,000) $ 540,000 60,000

100.0% (34.0)% 66.0% (18.0)% (12.0)% (30.0)% 36.0% 4.0%

$1,250,000 (475,000) $ 775,000 $ (200,000) (156,250) $ (356,250) $ 418,750 50,000

100.0% (38.0)% 62.0% (16.0)% (12.5)% (28.5)% 33.5% 4.0%

$ 600,000 (450,000) $ 150,000

40.0% (30.0)% 10.0%

$ 468,750 (375,000) $ 93,750

37.5% (30.0)% 7.5%

The vertical analysis indicates that the costs other than selling expenses (cost of goods sold and administrative expenses) improved as a percentage of sales. As a result, net income as a percentage of sales increased from 7.5% to 10.0%. The sales promotion campaign appears to have been successful. While selling expenses as a percent of sales increased slightly (2.0%), the increased cost was more than made up for by increased sales.

CHAPTER 14

Financial Statement Analysis

Prob. 14–3A 1.

Working Capital = Current Assets – Current Liabilities $1,650,000 – $750,000 = $900,000

Current Assets Current Liabilities

Current Ratio = $1,650,000 $750,000

= 2.2 Quick Assets Current Liabilities

Quick Ratio =

$412,500 + $187,500 + $300,000 $750,000

= 1.2

2. Transaction

Working Capital

Current Ratio

Quick Ratio

Current Assets

Supporting Data Quick Assets

a. b. c. d. e. f. g. h. i. j.

$ 900,000 900,000 900,000 900,000 750,000 900,000 1,125,000 900,000 1,500,000 900,000

2.2 2.4 2.0 2.4 1.8 2.2 2.5 2.2 3.0 2.2

1.2 1.2 1.0 1.2 1.0 1.2 1.5 1.2 2.0 1.2

$1,650,000 1,525,000 1,760,000 1,550,000 1,650,000 1,650,000 1,875,000 1,650,000 2,250,000 1,650,000

$ 900,000 775,000 900,000 800,000 900,000 900,000 1,125,000 900,000 1,500,000 890,000

Current Liabilities $750,000 625,000 860,000 650,000 900,000 750,000 750,000 750,000 750,000 750,000

18.

16. 17.

15.

14.

10. 11. 12. 13.

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

14-29

$82.60

100,000

$100,000 $1.00

$5.90

100,000

$82.60

$600,000 – $10,000

($4,694,000 + $4,204,000) ÷ 2

1.2%

$1.00

14.0

$5.90

13.3%

12.8%

($4,944,000 + $4,454,000) ÷ 2

$600,000 $600,000 – $10,000

8.7 1.4 8.5%

$132,000 ($8,224,000 + $7,454,000) ÷ 2 ($9,024,000 + $8,254,000) ÷ 2

0.8

1.8

2.8 2.2 20.0 18.3 15.0 24.3

Computed Value

$1,020,000 + $132,000 $10,850,000 $600,000 + $132,000

$4,944,000

$3,200,000

$5,760,000 $4,080,000

$880,000 $880,000 ($585,000 + $500,000) ÷ 2 $10,850,000 ÷ 365 ($420,000 + $380,000) ÷ 2 $6,000,000 ÷ 365

Denominator

$2,464,000 $1,936,000 $10,850,000 ($585,000 + $500,000) ÷ 2 $6,000,000 ($420,000 + $380,000) ÷ 2

Numerator

Financial Statement Analysis

Current ratio Quick ratio Accounts receivable turnover Days’ sales in receivables Inventory turnover Days’ sales in inventory Ratio of fixed assets to long-term liabilities Ratio of liabilities to stockholders’ equity Times interest earned Asset turnover Return on total assets Return on stockholders’ equity Return on common stockholders’ equity Earnings per share on common stock Price-earnings ratio Dividends per share of common stock Dividend yield

Ratio

Prob. 14–4A 1. Working Capital: $2,464,000 – $880,000 = $1,584,000

CHAPTER 14

Financial Statement Analysis

Prob. 14–5A 1. a.

60.0%

Return on Total Assets

50.0% 40.0% 30.0% 20.0% 10.0% 0.0% 20Y8

20Y7

20Y6

20Y5

20Y4

Year Company’s return on total assets Industry return on total assets

Return on Total Assets =

Net Income + Interest Expense Average Total Assets

20Y8:

$889,453 $4,270,764

= 20.8%

20Y5:

$1,379,000 $3,044,250

= 45.3%

20Y7:

$939,979 $3,928,397

= 23.9%

20Y4:

$1,240,000 $2,475,000

= 50.1%

20Y6:

$1,159,341 $3,535,472

= 32.8%

CHAPTER 14

Financial Statement Analysis

Prob. 14–5A (Continued) 1. b.

80.0%

Return on Stockholders’ Equity

70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% 20Y8

20Y7

20Y6

20Y5

20Y4

Year Company’s return on stockholders’ equity Industry return on stockholders’ equity

Net Income Average Total Stockholders’ Equity

Return on Stockholders’ Equity = 20Y8:

$273,406 $3,569,855

= 7.7%

20Y5:

$884,000 $1,992,000

= 44.4%

20Y7:

$367,976 $3,249,164

= 11.3%

20Y4:

$800,000 $1,150,000

= 69.6%

20Y6:

$631,176 $2,749,588

= 23.0%

CHAPTER 14

Financial Statement Analysis

Prob. 14–5A (Continued) 1. c.

3.5

Times Interest Earned Ratio

3.0 2.5 2.0 1.5 1.0 0.5 0.0 20Y8

20Y7

20Y6

20Y5

20Y4

Year Company’s times interest earned

Times Interest Earned =

Industry times interest earned

Net Income + Income Tax Expense + Interest Expense Interest Expense

20Y8:

$921,202 $616,047

= 1.5

20Y5:

$1,539,000 $495,000

= 3.1

20Y7:

$993,539 $572,003

= 1.7

20Y4:

$1,440,000 $440,000

= 3.3

20Y6:

$1,266,061 = 2.4 $528,165

CHAPTER 14

Financial Statement Analysis

Prob. 14–5A (Continued) 1. d.

0.9

Ratio of Liabilities to Stockholders’ Equity

0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 20Y8

20Y7

20Y6

20Y5

20Y4

Year Company’s liabilities to equity Industry liabilities to equity

Ratio of Liabilities to = Stockholders’ Equity

Total Liabilities Total Stockholders’ Equity

20Y8:

$710,621 $3,706,557

0.2

20Y5:

$904,500 $2,434,000

= 0.4

20Y7:

$691,198 $3,433,152

0.2

20Y4:

$1,200,000 $1,550,000

= 0.8

20Y6:

$667,267 $3,065,176

0.2

Note: The total liabilities are the difference between the total assets and total stockholders’ equity ending balances.

CHAPTER 14

Financial Statement Analysis

Prob. 14–5A (Concluded) 2.

Both the return on total assets and the return on stockholders’ equity have been moving in a negative direction in the last five years. Both measures have moved below the industry average over the last two years. The cause of this decline is driven by a rapid decline in earnings. The use of debt can be seen from the ratio of liabilities to stockholders’ equity. The ratio has declined over the time period and has declined below the industry average. Thus, the level of debt relative to the stockholders’ equity has gradually improved over the five years. The times interest earned has been falling below the industry average for several years. This is the result of low profitability combined with high interest costs. The times interest earned fell to a dangerously low level in 20Y8.

CHAPTER 14

Financial Statement Analysis

Prob. 14–1B 1.

Macklin Inc. Comparative Income Statement For the Years Ended December 31, 20Y2 and 20Y1

Increase/(Decrease) Amount Percent

20Y2

20Y1

$ 910,000 (441,000) $ 469,000 $(139,150) (99,450) $(238,600) $ 230,400 65,000

$ 700,000 (350,000) $ 350,000 $(115,000) (85,000) $(200,000) $ 150,000 50,000

$210,000 91,000 $119,000 $ 24,150 14,450 $ 38,600 $ 80,400 15,000

30.0% 26.0% 34.0% 21.0% 17.0% 19.3% 53.6% 30.0%

$ 295,400 (65,000) $ 230,400

$ 200,000 (50,000) $ 150,000

$ 95,400 15,000 $ 80,400

47.7% 30.0% 53.6%

The profitability has significantly improved from 20Y1 to 20Y2. Sales have increased by 30.0% over the 20Y1 base year. However, the cost of goods sold, selling expenses, and administrative expenses grew at a slower rate. Increasing sales combined with costs that increase at a slower rate results in strong earnings growth. In this case, net income grew 53.6% over the base year.

CHAPTER 14

Financial Statement Analysis

Prob. 14–2B 1.

Fielder Industries Inc. Comparative Income Statement For the Years Ended December 31, 20Y2 and 20Y1

20Y2 Amount Percent

20Y1 Amount Percent

$1,300,000 (682,500) $ 617,500 $ (260,000) (169,000) $ (429,000) $ 188,500 78,000

100.0% (52.5)% 47.5% (20.0)% (13.0)% (33.0)% 14.5% 6.0%

$1,180,000 (613,600) $ 566,400 $ (188,800) (177,000) $ (365,800) $ 200,600 70,800

100.0% (52.0)% 48.0% (16.0)% (15.0)% (31.0)% 17.0% 6.0%

$ 266,500 (117,000) $ 149,500

20.5% (9.0)% 11.5%

$ 271,400 (106,200) $ 165,200

23.0% (9.0)% 14.0%

The net income as a percent of sales has declined. All the costs and expenses, other than selling expenses, have maintained their approximate cost as a percent of sales between 20Y1 and 20Y2. Selling expenses as a percent of sales, however, have grown from 16.0% to 20.0% of sales. Apparently, the new advertising campaign has not been successful. The increased expense has not produced sufficient sales to maintain relative profitability. Thus, selling expenses as a percent of sales have increased.

CHAPTER 14

Financial Statement Analysis

Prob. 14–3B 1.

Working Capital = Current Assets – Current Liabilities $3,200,000 – $2,000,000 = $1,200,000

Current Assets Current Liabilities

Current Ratio = $3,200,000 $2,000,000

= 1.6 Quick Assets Current Liabilities

Quick Ratio =

$800,000 + $550,000 + $850,000 $2,000,000

= 1.1

2. Transaction

Working Capital

Current Ratio

Quick Ratio

Current Assets

Supporting Data Quick Assets

a. b. c. d. e. f. g. h. i. j.

$1,200,000 1,200,000 1,200,000 1,200,000 875,000 1,200,000 2,200,000 1,200,000 3,200,000 1,200,000

1.6 1.7 1.5 1.6 1.4 1.6 2.1 1.6 2.6 1.6

1.1 1.1 0.9 1.1 0.9 1.1 1.6 1.1 2.1 1.0

$3,200,000 2,912,500 3,600,000 3,075,000 3,200,000 3,200,000 4,200,000 3,200,000 5,200,000 3,200,000

$2,200,000 1,912,500 2,200,000 2,075,000 2,200,000 2,200,000 3,200,000 2,200,000 4,200,000 2,000,000

Current Liabilities $2,000,000 1,712,500 2,400,000 1,875,000 2,325,000 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000

18.

16. 17.

15.

14.

10. 11. 12. 13.

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

14-38

$119.70

100,000

$50,000 $0.50

$8.55

100,000

$119.70

$900,000 – $45,000

($6,680,000 + $5,875,000) ÷ 2

($7,180,000 + $6,375,000) ÷ 2

$900,000 $900,000 – $45,000

$170,000 ($7,430,000 + $6,455,000) ÷ 2 ($9,780,000 + $8,755,000) ÷ 2

$1,130,000 + $170,000 $10,000,000 $900,000 + $170,000

$7,180,000

$1,700,000

$3,740,000 $2,600,000

$900,000 $900,000 ($740,000 + $510,000) ÷ 2 $10,000,000 ÷ 365 ($1,190,000 + $950,000) ÷ 2 $5,350,000 ÷ 365

Denominator

$3,690,000 $2,250,000 $10,000,000 ($740,000 + $510,000) ÷ 2 $5,350,000 ($1,190,000 + $950,000) ÷ 2

Numerator

Financial Statement Analysis

Ratio

Prob. 14–4B 1. Working Capital: $3,690,000 – $900,000 = $2,790,000

CHAPTER 14

0.4%

$0.50

14.0

$8.55

13.6%

13.3%

7.6 1.4 11.5%

0.4

2.2

4.1 2.5 16.0 22.8 5.0 73.0

Computed Value

CHAPTER 14

Financial Statement Analysis

Prob. 14–5B a.

30.0% 25.0% Return on Total Assets

20.0% 15.0% 10.0% 5.0% 0.0% 20Y8

20Y7

20Y6

20Y5

20Y4

Year Company’s return on total assets Industry return on total assets

Return on Total Assets =

Net Income + Interest Expense Average Total Assets

20Y8:

$6,623,780 $25,988,665

= 25.5%

20Y5:

$2,458,000 $11,370,240

= 21.6%

20Y7:

$4,606,056 $19,859,586

= 23.2%

20Y4:

$1,900,000 $8,676,000

= 21.9%

20Y6:

$3,540,600 $14,854,406

= 23.8%

CHAPTER 14

Financial Statement Analysis

Prob. 14–5B (Continued) b. 40.0% 35.0% Return on Stockholders’ Equity

30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 20Y8

20Y7

20Y6

20Y5

20Y4

Year Company’s return on stockholders’ equity Industry return on stockholders’ equity

Return on Stockholders’ Equity =

Net Income Average Total Stockholders’ Equity

20Y8:

$5,571,720 $15,920,340

= 35.0%

20Y5:

$1,848,000 $5,724,000

= 32.3%

20Y7:

$3,714,480 $11,277,240

= 32.9%

20Y4:

$1,400,000 $4,100,000

= 34.1%

20Y6:

$2,772,000 $8,034,000

= 34.5%

CHAPTER 14

Financial Statement Analysis

Prob. 14–5B (Continued) c.

8.0 7.0 6.0 Times Interest Earned

5.0 4.0 3.0 2.0 1.0 0.0 20Y8

20Y7

20Y6

20Y5

20Y4

Year Company’s times interest earned

Times Interest Earned =

Industry times interest earned

Net Income + Income Tax Expense + Interest Expense Interest Expense

20Y8:

$7,849,352 $1,052,060

= 7.5

20Y5:

$2,899,600 $610,000

= 4.8

20Y7:

$5,451,278 $891,576

= 6.1

20Y4:

$2,220,000 $500,000

= 4.4

20Y6:

$4,180,920 $768,600

= 5.4

CHAPTER 14

Financial Statement Analysis

Prob. 14–5B (Continued) d. 1.6 1.4 Ratio of Liabilities to Stockholders’ Equity

1.2 1.0 0.8 0.6 0.4 0.2 0.0 20Y8

20Y7

20Y6

20Y5

20Y4

Year Company’s liabilities to equity Industry liabilities to equity

Ratio of Liabilities to = Stockholders’ Equity

Total Liabilities Total Stockholders’ Equity

20Y8:

$10,672,291 $18,706,200

= 0.6

20Y5:

$5,940,480 $6,648,000

= 0.9

20Y7:

$9,464,359 $13,134,480

= 0.7

20Y4:

$5,352,000 $4,800,000

= 1.1

20Y6:

$7,700,333 $9,420,000

= 0.8

Note: Total liabilities are determined by subtracting stockholders’ equity (ending balance) from the total assets (ending balance).

CHAPTER 14

Financial Statement Analysis

Prob. 14–5B (Concluded) 2.

Both the return on total assets and the return on stockholders’ equity are above the industry average for all five years. The return on total assets is actually improving gradually. The return on stockholders’ equity exceeds the return earned on total assets, providing evidence of the positive use of leverage. The company is clearly growing earnings as fast as the asset and equity base. In addition, the ratio of liabilities to stockholders’ equity indicates that the proportion of debt to stockholders’ equity has been declining over the period. The firm is adding to debt at a slower rate than the assets are growing from earnings. The times interest earned ratio is improving during this time period. Again, the firm is increasing earnings faster than the increase in interest charges. Overall, these ratios indicate excellent financial performance coupled with appropriate use of debt (leverage).

CHAPTER 14

Financial Statement Analysis

MAKE A DECISION MAD 14–1 1. Sales Cost of sales Gross profit Selling, general, and administrative expenses Operating expenses Operating income

Amazon 100.0% (59.0)%

Best Buy 100.0% (77.0)%

Walmart 100.0% (75.3)%

41.0%

23.0%

24.7%

(35.7)% (0.1)% 5.2%

(18.3)% (0.1)% 4.6%

(20.8)% (0.0)% 3.9%

2. Amazon has the highest gross profit and operating income on a percentage basis. Walmart has a lower gross profit than Amazon on a percentage basis (24.7% vs. 41.0%), but generates a very strong operating income that is much closer to Amazon on a percentage basis. This is consistent with the company’s business strategy, in that it seeks to sell a large quantity of items at a very low margin. Comparatively, Best Buy has gross profit similar to Walmart on a percentage basis but much smaller in terms of total dollars. This reflects a decreasing margin on the product mix sold by Best Buy.

MAD 14–2 1. Earnings per share

Alphabet $ 49.59

PepsiCo $ 5.23

Caterpillar $ 10.85

Market price per share of common stock Earnings per share Price-earnings ratio (a)

$1,339.39 ÷ 49.59 27.01

$136.67 ÷ 5.23 26.13

$147.68 ÷ 10.85 13.61

Dividends per share Market price per share of common stock Dividend yield (b)

0.00

÷ 1,339.39 0.0%

3.79

÷ 136.67 2.8%

3.80

÷ 147.68 2.6%

2. PepsiCo has the largest dividend yield and the lowest earnings per share, but it has a price-earnings ratio similar to Alphabet. Stock market participants seem to be optimistic about PepsiCo’s future prospects, which is reflected in a relatively high stock price. Alphabet pays no dividend and, thus, has no dividend yield. However, Alphabet has the largest price-earnings ratio. Stock market participants are expecting a strong return on their investment from appreciation in Alphabet’s stock price. Caterpillar has the lowest price-earnings ratio and a lower dividend yield but higher earnings per share than PepsiCo. This suggests that the market expects Caterpillar's combination of earnings and dividends to decline in the coming years. 14-44 © 2022 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 14

Financial Statement Analysis

MAD 14–3 1. a.

Net Income + Interest Expense Average Total Assets

Return on Total Assets = Year 3:

$3,253 + $1,466 $71,560

= 6.6%

Year 2:

$2,368 + $1,204 $67,947

= 5.3%

Year 1:

$2,159 + $899 $61,852

= 4.9%

Return on = Stockholders’ Equity

Net Income Average Stockholders’ Equity

Year 3:

$3,253 $11,354

= 28.7%

Year 2:

$2,368 $10,426

= 22.7%

Year 1:

$2,159 $8,046

= 26.8%

Earnings per Share =

Net Income – Preferred Dividends Shares of Common Stock Outstanding

Year 3:

$3,253 – $0 317

= $10.26

Year 2:

$2,368 – $0 323

= $7.33

Year 1:

$2,159 – $0 320

= $6.75

Dividend Yield = Year 3:

$2.98 $158.92

= 1.9%

Year 2:

$2.50 $138.38

= 1.8%

Year 1:

$2.39 $111.10

= 2.2%

Dividend per Share of Common Stock Market Price per Share of Common Stock

CHAPTER 14

Financial Statement Analysis

MAD 14–3 (Concluded) e.

Market Price per Share of Common Stock Earnings per Share

Price-Earnings Ratio = Year 3:

$158.92 $10.26

= 15.5

Year 2:

$138.38 $7.33

= 18.9

Year 1:

$111.10 $6.75

= 16.5

2. Deere’s profitability, as measured by earnings per share, has improved significantly during the three-year period presented. The returns on total assets and stockholders’ equity have also improved during this period. This is most likely due to overall strength in the agricultural and construction equipment sectors of the economy. During this time, Deere has been able to maintain a relatively stable dividend yield. Additionally, the price-earnings ratio has remained relatively stable, indicating that market participants view Deere’s future prospects favorably.

MAD 14–4 Net Income + Interest Expense Average Total Assets

1. a. Return on Total Assets = Marriott: Hyatt: b.

$1,273 + $394 = 6.8% $24,374 $766 + $75 $8,030

= 10.5%

Return on = Stockholders’ Equity Marriott:

$1,273 $1,464

= 87.0%

Hyatt:

$766 $3,822

= 20.0%

Net Income Average Total Stockholders’ Equity

Times Interest Earned = Income Before Income Tax Expense + Interest Expense Interest Expense Marriott:

$1,599 + $394 = 5.1 $394

Hyatt:

$1,006 + $75 = 14.4 $75

CHAPTER 14

Financial Statement Analysis

MAD 14–4 (Concluded) d.

Ratio of Liabilities to = Stockholders’ Equity Marriott:

$24,348 $703

= 34.6

Hyatt:

$4,450 $3,967

= 1.1

Total Liabilities Total Stockholders’ Equity

Summary Table: a. Return on total assets b. Return on stockholders’ equity c. Times interest earned d. Ratio of liabilities to stockholders’ equity

Marriott 6.8% 87.0% 5.1 34.6

Hyatt 10.5% 20.0% 14.4 1.1

2. Hyatt has a higher return on total assets (10.5% vs. 6.8%), but Marriott has a higher return on stockholders’ equity (87.0% vs. 20.0%). These results appear to be due to Hyatt’s earnings relative to its debt level. Hyatt has less leverage than Marriott. This is confirmed by the ratio of liabilities to stockholders’ equity, which shows that the relative debt held by Marriott is 34.6 times stockholders’ equity, compared to 1.1 times for Hyatt. The times interest earned ratio shows that Marriott covers its interest charges 5.1 times. The comparable number for Hyatt is 14.4. Both companies have sufficient coverage. Marriott is not covering the interest expense on its debt as well as Hyatt, which is negatively affecting the return on total assets. In addition, Marriott’s small equity value is due to its stock buyback program, which appears as treasury stock on its balance sheet. This amount significantly reduces Marriott’s equity, contributing to the higher return on equity.

CHAPTER 14

Financial Statement Analysis

TAKE IT FURTHER TIF 14–1 No, Josh did not behave ethically. The Sarbanes-Oxley Act of 2002 requires a report on internal control by management. This report acknowledges management’s responsibility for establishing and maintaining internal control. In addition, management’s assessment of the effectiveness of internal controls over financial reporting is included in the report. Josh committed a violation of the Sarbanes-Oxley Act when he falsely reported that the company’s internal controls were effective. This is punishable by both fines and imprisonment.

CHAPTER 14

Financial Statement Analysis

TIF 14–2 Answers will vary according to the most recent year at the time of completing the activity. A sample solution is provided based on the fiscal years ended in 2019 and 2018.

Fiscal 2019 Current assets…………………………………………… $28,124 31,341 Current liabilities……………………………………… Working capital………………………………………… $ (3,217)

$16,825 17,860 $ (1,035)

Current assets…………………………………………… $28,124.0 ÷ Current liabilities……………………………………… 31,341.0 0.9 Current ratio………………………………………………

$16,825.0 17,860.0 0.9

Quick assets: Cash……………………………………………………… $ 5,418 Short-term investments……………………………… — 15,481 Accounts receivable………………………………… Total quick assets…………………………………… $20,899 31,341 ÷ Current liabilities……………………………………… 0.7 Quick ratio…………………………………………………

$ 4,150 — 9,334 $13,484 17,860 0.8

$69,570

$59,434

$ 9,334 15,481 $24,815 12,408

$ 8,633 9,334 $17,967 8,984

5.6

6.6

$69,570 365 $ 190.6

$59,434 365 $ 162.8

Average accounts receivable (Total ÷ 2)…………… $12,408 190.6 ÷ Average daily sales…………………………………… 65.1 Days’ sales in receivables………………………………

$ 8,984 162.8 55.2

$5,568

$5,198

$1,392 1,649 $3,041 1,521

$1,373 1,392 $2,765 1,383

3.7

3.8

Sales……………………………………………………… Accounts receivable (net): Beginning of year…………………………………… End of year…………………………………………… Total………………………………………………… Average accounts receivable (Total ÷ 2)…………… Accounts receivable turnover (Sales ÷ Average accounts receivable)…………… Average daily sales: Sales…………………………………………………… ÷ 365…………………………………………………… Average daily sales (Sales ÷ 365)…………………

Cost of goods sold……………………………………… Inventories: Beginning of year…………………………………… End of year…………………………………………… Total………………………………………………… Average inventory (Total ÷ 2)………………………… Inventory turnover (Cost of goods sold ÷ Average inventory)………

Fiscal 2018

CHAPTER 14

Financial Statement Analysis

TIF 14–2 (Continued) Fiscal 2019

Fiscal 2018

$1,521 5,568 15.3

$1,383 5,198 14.2

99.4

97.4

Total liabilities……………………………………………… $100,095 93,889 ÷ Total stockholders’ equity……………………………… 1.1 Ratio of liabilities to stockholders’ equity……………

$45,766 52,832 0.9

Sales………………………………………………………… $ 69,570 Total assets (excluding long-term investments): Beginning of year……………………………………… $ 98,598 193,984 End of year……………………………………………… Total…………………………………………………… $292,582 146,291 Average total assets……………………………………… 0.5 Asset turnover………………………………………………

$ 59,434

Inventory (average)……………………………………… Cost of goods sold………………………………………… Average daily cost of goods sold……………………… Days’ sales in inventory (Average inventory ÷ Average daily cost of goods sold)……

$ 95,789 98,598 $194,387 97,194 0.6

Net income………………………………………………… Interest expense…………………………………………… Total……………………………………………………… Total assets: Beginning of year……………………………………… End of year……………………………………………… Total…………………………………………………… Average total assets……………………………………… Return on total assets [(Net income + Interest expense) ÷ Average total assets]…………………………………

$ 11,584 978 $ 12,562

$ 13,066 574 $ 13,640

$ 98,598 193,984 $292,582 146,291

$ 95,789 98,598 $194,387 97,194

Net income………………………………………………… Stockholders’ equity: Beginning of year……………………………………… End of year……………………………………………… Total…………………………………………………… Average common stockholders’ equity……………… Return on common stockholders’ equity……………

$ 11,584

$13,066

$ 52,832 93,889 $146,721 73,361 15.8%

$45,004 52,832 $97,836 48,918 26.7%

Market price per share of common stock…………… Earnings per share on common stock………………… Price-earnings ratio………………………………………

$130.32 6.68 19.5

$116.94 8.40 13.9

8.6%

14.0%

CHAPTER 14

Financial Statement Analysis

TIF 14–2 (Concluded) Fiscal 2019 m. Net income……………………………………………… $11,584.0 Sales……………………………………………………… 69,570.0 16.7% Net income to sales…………………………………… 2.

Fiscal 2018 $13,066.0 59,434.0 22.0%

Before reaching definitive conclusions, each measure should be compared with past years, industry averages, and similar firms in the industry. a.

The working capital decreased between 2018 and 2019.

b. and c.

The current and quick ratios both remained relatively stable, with a slight decrease in the quick ratio.

d. and e.

The accounts receivable turnover and the days’ sales in receivables indicate a decrease in the efficiency of collecting accounts receivable. The accounts receivable turnover decreased from 6.6 to 5.6. The days’ sales in receivables increased slightly from 55.2 to 65.1. Thus, it takes the company about 8 weeks to collect its accounts receivable from credit sales. These numbers should be compared to their competitors, industry averages, and Disney’s credit policy to draw definitive conclusions.

f. and g.

The results of these two analyses show a slight decrease in inventory turnover from 3.8 to 3.7, and an increase in the days’ sales in inventory from 97.4 to 99.4. Inventory management is not a critical driver of revenue for Disney. While these changes are not favorable, it is not likely to a be a big concern.

The margin of protection to creditors declined slightly as liabilities increased relative to stockholders’ equity. Overall, Disney still provides sound protection to its creditors.

These analyses indicate that the effectiveness in the use of assets to generate revenues was very similar in both years.

The return on total assets decreased during 2019. This decrease was from Disney’s total assets increasing significantly due to the acquisition of Hulu.

The return on common stockholders’ equity decreased. This decrease was due to the increase in equity relative to net income.

The price-earnings ratio increased from 2018 to 2019. This increase was driven primarily by an increase in Disney’s stock price.

m. The percent of net income to sales decreased during 2019.

CHAPTER 14

Financial Statement Analysis

TIF 14–3 To: From: Re:

Boss Freeman A+ Student Debt vs. Equity Financing

I have reviewed your company history and appreciate the challenges your company has faced during economic downturns. While your conservative approach to debt financing is commendable, your unwillingness to issue debt could limit your potential for future success. Financing future growth exclusively through retained earnings and additional stock sales does not allow the shareholders to take advantage of leverage. As a result, the return on stockholders’ equity is limited. While no debt does provide the company great flexibility in the event of a national calamity, the probability of this happening is very low. During normal business operations, your company can assume some debt without significantly increasing the risk of losing control of the company. Freeman Industries is competing against companies that will not be so inclined to avoid debt. As a result, your competitors will likely be able to grow faster. Management should carefully consider the strategic risks that could result from the company’s conservative financing policies when establishing the company’s debt load.

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN) INTRODUCTION TO MANAGERIAL ACCOUNTING DISCUSSION QUESTIONS 1.

4. 5. 6.

Managerial accounting is the process of developing information and management tools to achieve an organization’s objectives. The management process is composed of four basic functions: strategic planning, measurement, evaluation, and control. Strategic planning is the process of developing long-term objectives. Measurement is the process of developing and agreeing upon performance metrics on how well the company is achieving its objectives. Evaluation is the process by which management monitors operations by comparing actual and expected results. Control is the process by which management takes actions to encourage specific behaviors or outcomes. Financial accounting and managerial accounting are different in several ways. Financial accounting information is reported in statements that are useful to persons or groups outside of a company. These statements objectively report the results of operations for fixed periods of time and the financial condition of the business under generally accepted accounting principles. Managerial accounting information uses both subjective and objective information to meet the specific needs of management. This non-GAAP information can be reported periodically or as needed by management and can be reported for the entire entity or for segments of the organization. This information includes (i) historical data, which provide objective measures of past operations, and (ii) estimated data, which provide subjective estimates about future decisions. a. Vertical units are structured as separate businesses within a company and normally develop and sell products directly to customers. Horizontal units are not responsible for developing and selling products, but provide services to other horizontal and vertical units within the company. b. The accounting and legal departments are horizontal units within a company. c. A consumer products division would be considered a vertical unit within a company. Direct materials cost Prime costs are the combination of direct materials and direct labor costs, while conversion costs are the combination of direct labor costs and factory overhead costs. Product costs are composed of three elements of manufacturing costs: direct materials cost, direct labor cost, and factory overhead cost. These costs are treated as assets until the product is sold. Period costs consist of selling and administrative expenses that are used in generating revenue during the current period. They are recognized as expenses on the current period’s income statement. The three inventory accounts for a manufacturing business are as follows: a. Finished goods inventory consists of completed (or finished) products that have not been sold. b. Work in process inventory consists of the direct materials, direct labor, and factory overhead costs for products that have entered the manufacturing process, but are not yet completed. c. Materials inventory consists of the costs of the direct and indirect materials that have not entered the manufacturing process. The cost of finished goods and the cost of work in process include the following: a. Direct materials—the costs of materials that enter directly into the finished product. b. Direct labor—the wages of factory workers who convert materials into a finished product. c. Factory overhead—the costs, other than direct materials and direct labor, that are incurred in the manufacturing process.

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

DISCUSSION QUESTIONS (Continued) 9.

The manufacturing costs incurred during a period include direct materials used in production plus the direct labor and factory overhead costs incurred during the period. The cost of goods manufactured for a period is computed by adjusting the manufacturing costs incurred during the period for the effects of beginning and ending work in process. Beginning work in process inventory is added and ending work in process is subtracted from the manufacturing costs incurred during a period to arrive at the cost of goods manufactured for the period.

10.

A retail business purchases merchandise (products) in a finished state for resale to customers. The cost of product sold is called cost of goods sold. A manufacturer makes the product it sells using direct materials, direct labor, and factory overhead, which make up the cost of goods manufactured included in the “Cost of goods sold” section of the income statement.

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

BASIC EXERCISES BE 15–1 (FIN MAN); BE 1–1 (MAN) Strategic planning (a) Evaluation (c) Control (b) BE 15–2 (FIN MAN); BE 1–2 (MAN) a. b. c. d.

DM DL FO FO

BE 15–3 (FIN MAN); BE 1–3 (MAN) a. b. c. d.

P B C C

BE 15–4 (FIN MAN); BE 1–4 (MAN) a. b. c. d.

Period cost Product cost Period cost Product cost

BE 15–5 (FIN MAN); BE 1–5 (MAN) a.

Work in process inventory, June 1……………………………… Cost of direct materials used in production…………………… $260,000 Direct labor…………………………………………………………… 340,000 Factory overhead…………………………………………………… 182,300 Total manufacturing costs incurred in June…………………… Total manufacturing costs………………………………………… Work in process inventory, June 30…………………………… Cost of goods manufactured…………………………………… Finished goods inventory, June 1……………………………… Cost of goods manufactured…………………………………… Cost of finished goods available for sale……………………… Finished goods inventory, June 30……………………………… Cost of goods sold…………………………………………………

$ 70,200

782,300 $852,500 (74,000) $778,500 $ 33,300 778,500 $811,800 (44,100) $767,700

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

BE 15–6 (FIN MAN); BE 1–6 (MAN) Nights per Visit 1 2 3 4 5

Guest Nights 4,400 3,600 2,250 2,400 100 12,750

Number of Guests 4,400 1,800 750 600 20

15,000 available room nights (500 rooms × 30 nights in June)

Occupancy Rate =

Guest Nights Available Room Nights

Occupancy Rate =

12,750 = 85% 15,000

The utilization (occupancy) rate has improved from 82% in the prior year to 85% in the current year.

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

EXERCISES Ex. 15–1 (FIN MAN); Ex. 1–1 (MAN) a. b. c. d. e.

Direct materials cost Factory overhead cost Direct materials cost Direct materials cost Direct materials cost

f. g. h. i.

Factory overhead cost Direct materials cost Factory overhead cost Direct labor cost

f. g. h. i. j.

Factory overhead cost Direct materials cost Factory overhead cost Direct materials cost Direct labor cost

j. k. l. m. n. o. p. q.

Period cost Period cost Product cost Product cost Period cost Period cost Product cost Product cost

e. f. g.

cost work in process inventory decreases

e. f. g.

evaluation indirect product

Ex. 15–2 (FIN MAN); Ex. 1–2 (MAN) a. b. c. d. e.

Factory overhead cost Direct materials cost Factory overhead cost Factory overhead cost Direct materials cost

Ex. 15–3 (FIN MAN); Ex. 1–3 (MAN) b, e, g, h Ex. 15–4 (FIN MAN); Ex. 1–4 (MAN) a. b. c. d. e. f. g. h. i.

Period cost Period cost Product cost Product cost Product cost Period cost Product cost Period cost Product cost

Ex. 15–5 (FIN MAN); Ex. 1–5 (MAN) a. b. c. d.

cost object product conversion operational planning

Ex. 15–6 (FIN MAN); Ex. 1–6 (MAN) a. b. c. d.

electricity used to run assembly line prime strategic period

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

Ex. 15–7 (FIN MAN); Ex. 1–7 (MAN) a. b. c. d. e. f.

indirect direct indirect indirect direct indirect

g. h. i. j. k. l.

indirect indirect indirect indirect indirect direct

Ex. 15–8 (FIN MAN); Ex. 1–8 (MAN) a.

The errors in the manufacturing cost report are as follows: 1. The maintenance salaries of $84,400 and indirect materials of $56,200 should be included as factory overhead. 2.

The factory overhead incorrectly includes the following items: sales salaries of $348,750, promotional expenses of $315,000, corporate office insurance and property taxes of $219,400, and corporate office depreciation of $90,000. These items should not be included as factory overhead.

The corrected report is as follows: Marching Ants Inc. Manufacturing Costs For the Quarter Ended June 30 Cost of direct materials used in production Direct labor Factory overhead: Maintenance salaries Indirect materials Supervisor salaries Heat, light, and power Insurance and property taxes—plant Depreciation—plant and equipment Total factory overhead Total

$ 551,300 478,100 $ 84,400 56,200 517,500 140,650 151,900 123,750 1,074,400 $2,103,800

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

Ex. 15–9 (FIN MAN); Ex. 1–9 (MAN) a.

Sorensen Manufacturing Company Income Statement For the Month Ended January 31 Revenues Cost of goods sold Gross profit Operating expenses: Selling expenses Administrative expenses Total operating expenses Net income

$1,200,000 (675,000) $ 525,000 $215,000 125,000 (340,000) $ 185,000

Inventory balances on January 31: Materials ($250,000 – $180,000)………………………………………………… Work in Process ($180,000 + $450,000 + $180,000 – $760,000)…………… Finished Goods ($760,000 – $675,000)…………………………………………

$70,000 $50,000 $85,000

Ex. 15–10 (FIN MAN); Ex. 1–10 (MAN) Diesel Additives Company Balance Sheet August 31 Current assets: Cash Accounts receivable Inventories: Materials Work in process Finished goods Total inventories Supplies Prepaid insurance Total current assets

$167,500 348,200 $26,800 61,100 89,400 177,300 13,800 9,000 $715,800

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

Ex. 15–11 (FIN MAN); Ex. 1–11 (MAN) Materials inventory, September 1…………………………………………………… $ 235,200 815,900 Materials purchased during September…………………………………………… Cost of materials available for use………………………………………………… $1,051,100 (203,000) Materials inventory, September 30………………………………………………… $ 848,100 Cost of direct materials used in production…………………………………

Ex. 15–12 (FIN MAN); Ex. 1–12 (MAN) a. b. c. d. e. f.

$352,410 $328,910 $474,120 $461,770 $165,000 $172,000

($19,660 + $332,750) ($352,410 – $23,500) ($515,770 – $41,650) ($515,770 – $54,000) ($1,240,000 – $1,075,000) ($1,240,000 – $1,068,000)

Ex. 15–13 (FIN MAN); Ex. 1–13 (MAN) Work in process inventory, January 1………………………… Manufacturing costs incurred during January: Cost of direct materials used in production……………… $1,287,200 Direct labor……………………………………………………… 1,720,500 3,600,700 Factory overhead……………………………………………… Total manufacturing costs incurred………………………… Total manufacturing costs……………………………………… Work in process inventory, January 31………………………… Cost of goods manufactured……………………………………

$ 430,400

6,608,400 $7,038,800 (391,200) $6,647,600

Ex. 15–14 (FIN MAN); Ex. 1–14 (MAN) a. b. c. d. e. f.

$942,500 $812,500 $501,120 $470,000 $920,000 $155,000

($116,600 + $825,900) ($942,500 – $130,000) ($540,000 – $38,880) ($540,000 – $70,000) ($1,100,000 – $180,000) ($1,100,000 – $945,000)

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

Ex. 15–15 (FIN MAN); Ex. 1–15 (MAN) a.

Firetree Manufacturing Company Statement of Cost of Goods Manufactured For the Month Ended March 31 Work in process inventory, March 1 Direct materials: Materials inventory, March 1 Purchases

$ 428,700 $ 240,000 2,673,500

Cost of materials available for use Materials inventory, March 31

$2,913,500 (195,200)

Cost of direct materials used in production Direct labor Factory overhead: Indirect labor Machinery depreciation Heat, light, and power Supplies Property taxes Miscellaneous costs Total factory overhead Total manufacturing costs incurred in March Total manufacturing costs Work in process inventory, March 31 Cost of goods manufactured

$2,718,300 3,200,000 $ 320,000 213,000 174,000 36,100 30,000 48,200 821,300 6,739,600 $7,168,300 (510,400) $6,657,900

b. Finished goods inventory, March 1…………………………………………… $ 582,100 Cost of goods manufactured……………………………………………………… 6,657,900 Cost of finished goods available for sale……………………………………… $7,240,000 (614,400) Finished goods inventory, March 31…………………………………………… Cost of goods sold………………………………………………………………… $6,625,600

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

Ex. 15–16 (FIN MAN); Ex. 1–16 (MAN) a.

Finished goods inventory, January 1………………………… Cost of goods manufactured…………………………………… Cost of finished goods available for sale…………………… Finished goods inventory, January 31……………………… Cost of goods sold………………………………………………

$ 880,000 4,490,000

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

$ 6,600,000 (4,595,000) $ 2,005,000

Gross profit………………………………………………………… Operating expenses: Selling expenses……………………………………………… $530,000 Administrative expenses…………………………………… 340,000 Total operating expenses……………………………… Net income…………………………………………………………

$2,005,000

$5,370,000 (775,000) $4,595,000

(870,000) $1,135,000

Ex. 15–17 (FIN MAN); Ex. 1–17 (MAN) a.

Sales………………………………………………………………… Less gross profit………………………………………………… Cost of goods sold………………………………………………

$ 792,000 (462,000) $ 330,000

Cost of goods manufactured…………………………………… Less cost of goods sold………………………………………… Finished goods inventory………………………………………

$ 396,000 (330,000) $ 66,000

Purchased materials…………………………………………… Less materials inventory………………………………………… Direct materials cost……………………………………………

$244,200 (33,000) $211,200

Total manufacturing costs……………………………………… Less: Direct materials………………………………………… $211,200 Factory overhead costs (indirect labor and factory depreciation)*…………………………… 198,000

$ 455,400

Direct labor cost…………………………………………………

(409,200) $ 46,200

* $171,600 + $26,400 e.

Total manufacturing costs……………………………………… Less cost of goods manufactured…………………………… Work in process inventory………………………………………

$ 455,400 (396,000) $ 59,400

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

PROBLEMS Prob. 15–1A (FIN MAN); Prob. 1–1A (MAN) Product Costs

Cost a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q. r. s. t. u. v. w. x. y. z.

Direct Materials Cost

Direct Labor Cost

Period Costs Factory Overhead Cost

Selling Expense

Administrative Expense

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

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

Prob. 15–2A (FIN MAN); Prob. 1–2A (MAN) Product Costs

Cost a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q. r. s. t. u. v. w. x.

Direct Materials Cost

Direct Labor Cost

Period Costs Factory Overhead Cost

Selling Expense

Administrative Expense

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

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

Prob. 15–3A (FIN MAN); Prob. 1–3A (MAN) 1.

The most logical definition for the final cost object would be the patient. The reason is that the cost can be accumulated at the patient level for billing and insurance reimbursement purposes. Cost a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q. r. s. t. u.

Direct

Indirect

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

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

Prob. 15–4A (FIN MAN); Prob. 1–4A (MAN) 1. Rainier Company a. b. c. d. e. f.

$111,500 $5,598,500 $5,616,500 $5,635,000 $3,585,000 $2,585,000

($950,000 + $100,000 – $938,500) ($938,500 + $2,860,000 + $1,800,000) ($5,598,500 + $400,000 – $382,000) ($615,000 + $5,616,500 – $596,500) ($9,220,000 – $5,635,000) ($3,585,000 – $1,000,000)

Yakima Company a. b. c. d. e. f. 2.

$708,200 $1,330,000 $169,100 $211,500 $2,080,000 $580,000

($48,200 + $710,000 – $50,000) ($2,484,200 – $708,200 – $446,000) ($2,660,600 – $2,491,500) ($2,491,500 + $190,000 – $2,470,000) ($4,550,000 – $2,470,000) ($2,080,000 – $1,500,000) Yakima Company Statement of Cost of Goods Manufactured For the Month Ended May 31

Work in process inventory, May 1 Direct materials: Materials inventory, May 1 Purchases

$ 176,400 $ 48,200 710,000 $758,200 (50,000)

Cost of materials available for use Materials inventory, May 31 Cost of direct materials used Direct labor Factory overhead Total manufacturing costs incurred in May Total manufacturing costs Work in process inventory, May 31 Cost of goods manufactured

$ 708,200 1,330,000 446,000 2,484,200 $2,660,600 (169,100) $2,491,500

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

Prob. 15–4A (FIN MAN); Prob. 1–4A (MAN) (Concluded) 3.

Yakima Company Income Statement For the Month Ended May 31 Sales Cost of goods sold: Finished goods inventory, May 1 Cost of goods manufactured

$ 4,550,000

Cost of finished goods available for sale Finished goods inventory, May 31 Cost of goods sold Gross profit Operating expenses Net income

$ 190,000 2,491,500 $2,681,500 (211,500) (2,470,000) $ 2,080,000 (580,000) $ 1,500,000

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

Prob. 15–5A (FIN MAN); Prob. 1–5A (MAN) 1.

Robstown Corporation Statement of Cost of Goods Manufactured For the Year Ended December 31, 20Y8 Work in process inventory, January 1, 20Y8 Direct materials: Materials inventory, January 1, 20Y8 Purchases Cost of materials available for use Materials inventory, December 31, 20Y8 Cost of direct materials used in production Direct labor Factory overhead: Indirect labor Depreciation expense—factory equipment Heat, light, and power—factory Property taxes—factory Rent expense—factory Supplies—factory Miscellaneous costs—factory Total factory overhead Total manufacturing costs incurred in 20Y8 Total manufacturing costs Work in process inventory, December 31, 20Y8 Cost of goods manufactured

63,900

$ 44,250 556,600 $600,850 (31,700) $ 569,150 1,100,000 $115,000 80,000 53,300 40,000 27,000 9,500 11,400 336,200 2,005,350 $2,069,250 (80,000) $1,989,250

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

Prob. 15–5A (FIN MAN); Prob. 1–5A (MAN) (Concluded) 2.

Robstown Corporation Income Statement For the Year Ended December 31, 20Y8 Sales Cost of goods sold: Finished goods inventory, January 1, 20Y8 Cost of goods manufactured

$ 3,850,000 $ 101,200 1,989,250

Cost of finished goods available for sale Finished goods inventory, December 31, 20Y8 Cost of goods sold Gross profit Operating expenses: Administrative expenses: Office salaries expense Depreciation expense—office equipment Property taxes—office building

$2,090,450 (99,800) (1,990,650) $ 1,859,350

$318,000

Selling expenses: Advertising expense Sales salaries expense Total operating expenses Net income

30,000 25,000

$ 373,000

$400,000 200,000

600,000 $

(973,000) 886,350

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

Prob. 15–1B (FIN MAN); Prob. 1–1B (MAN) Product Costs

Cost a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q. r. s. t. u. v. w. x. y. z.

Direct Materials Cost

Direct Labor Cost

Period Costs Factory Overhead Cost

Selling Expense

Administrative Expense

X X X X X X X X* X X X X X X X X X X X X X X X X X X

* Item h might also be classified as direct materials cost if the cost is significant because it can be directly traced to the end product.

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

Prob. 15–2B (FIN MAN); Prob. 1–2B (MAN) Product Costs

Cost a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q. r. s. t. u. v. w. x.

Direct Materials Cost

Direct Labor Cost

Period Costs Factory Overhead Cost

Selling Expense

Administrative Expense

X X X X X X X X* X X X X X X X X X X X X X X X X

* Health insurance premiums are employment benefits for direct labor and are included as part of the direct labor cost.

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

Prob. 15–3B (FIN MAN); Prob. 1–3B (MAN) 1.

The most logical definition for the final cost object would be a hotel guest. Guests consume services such as a meal, a night’s stay in a hotel room, room service, a telephone call, etc. Cost a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q. r. s. t. u. v. w.

Direct

Indirect

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

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

Prob. 15–4B (FIN MAN); Prob. 1–4B (MAN) 1.

On Company a. b. c. d. e. f.

$30,800 $854,000 $800,800 $827,400 $299,600 $182,000

($282,800 + $65,800 – $317,800) ($317,800 + $387,800 + $148,400) ($854,000 + $119,000 – $172,200) ($224,000 + $800,800 – $197,400) ($1,127,000 – $827,400) ($299,600 – $117,600)

Off Company a. b. c. d. e. f.

$581,560 $685,720 $195,300 $256,060 $399,280 $234,360

($685,720* + $91,140 – $195,300) ($1,519,000 – $256,060 – $577,220) ($1,727,320 – $1,532,020) ($1,532,020 + $269,080 – $1,545,040) ($1,944,320 – $1,545,040) ($399,280 – $164,920)

* Note: The student must calculate part (b) prior to calculating part (a) because the solution to part (b) is needed as an input to part (a). 2.

On Company Statement of Cost of Goods Manufactured For the Month Ended December 31 Work in process inventory, December 1 Direct materials: Materials inventory, December 1 Purchases Cost of materials available for use Materials inventory, December 31 Cost of direct materials used in production Direct labor Factory overhead Total manufacturing costs incurred in December Total manufacturing costs Work in process inventory, December 31 Cost of goods manufactured

$ 119,000 $ 65,800 282,800 $348,600 (30,800) $317,800 387,800 148,400 854,000 $ 973,000 (172,200) $ 800,800

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

Prob. 15–4B (FIN MAN); Prob. 1–4B (MAN) (Concluded) 3.

On Company Income Statement For the Month Ended December 31 Sales Cost of goods sold: Finished goods inventory, December 1 Cost of goods manufactured Cost of finished goods available for sale Finished goods inventory, December 31 Cost of goods sold Gross profit Operating expenses Net income

$1,127,000 $ 224,000 800,800 $1,024,800 (197,400) (827,400) $ 299,600 (117,600) $ 182,000

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

Prob. 15–5B (FIN MAN); Prob. 1–5B (MAN) 1.

Shanika Company Statement of Cost of Goods Manufactured For the Year Ended December 31, 20Y6 Work in process inventory, January 1, 20Y6 Direct materials: Materials inventory, January 1, 20Y6 Purchases Cost of materials available for use Materials inventory, December 31, 20Y6 Cost of direct materials used in production Direct labor Factory overhead: Indirect labor Depreciation expense—factory equipment Heat, light, and power—factory Property taxes—factory Rent expense—factory Supplies—factory Miscellaneous costs—factory Total factory overhead Total manufacturing costs incurred in 20Y6

$109,200 $ 77,350 123,500 $200,850 (95,550) $105,300 186,550 $ 23,660 14,560 5,850 4,095 6,825 3,250 4,420 62,660

Total manufacturing costs Work in process inventory, December 31, 20Y6 Cost of goods manufactured

354,510 $463,710 (96,200) $367,510

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

Prob. 15–5B (FIN MAN); Prob. 1–5B (MAN) (Concluded) 2.

Shanika Company Income Statement For the Year Ended December 31, 20Y6 Sales Cost of goods sold: Finished goods inventory, January 1, 20Y6 Cost of goods manufactured

$ 864,500 $ 113,750 367,510

Cost of finished goods available for sale Finished goods inventory, December 31, 20Y6 Cost of goods sold Gross profit Operating expenses: Administrative expenses: Office salaries expense Depreciation expense—office equipment Property taxes—headquarters building Selling expenses: Advertising expense Sales salaries expense Total operating expenses Net income

$ 481,260 (100,100) (381,160) $ 483,340

$ 77,350 22,750 13,650

$ 113,750

$ 68,250 136,500

204,750 (318,500) $ 164,840

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

MAKE A DECISION MAD 15–1 (FIN MAN); MAD 1–1 (MAN) a. Comfort Plus: Number of Guests 3,680 1,100 500 Total guest nights

× × ×

Nights per Visit 1 2 3

× × ×

Nights per Visit 1 2 3

= = =

Guest Nights 3,680 2,200 1,500 7,380

= = =

Guest Nights 4,390 1,400 2,400 8,190

Connors: Number of Guests 4,390 700 800 Total guest nights

b. Comfort Plus: 300 rooms × 30 days = 9,000 available room nights for April Connors: 350 rooms × 30 days = 10,500 available room nights for April c.

Occupancy Rate =

Guest Nights Available Room Nights

Comfort Plus:

7,380 9,000

= 82%

Connors:

8,190 10,500

= 78%

d. Comfort Plus has the better occupancy rate at 82% of capacity, compared to Connors’ occupancy rate of 78%.

MAD 15–2 (FIN MAN); MAD 1–2 (MAN) a. The occupancy change is unfavorable for Hilton Hotels. Occupancy for Hilton decreased from 75.7% to 40.3%, or a 35.4 percentage point decrease over the year. b. The occupancy change is unfavorable for Marriott International. Occupancy for Marriott decreased from 73.7% to 31.4%, or a 42.3 percentage point decrease over the year. c. Hilton Hotels has a better occupancy rate than Marriott International for the two years provided. This can be seen both by the occupancy percentage comparisons for each year (75.7% vs. 73.7% in 2019 and 40.3% vs. 31.4% in 2020) and by the slightly smaller decrease in occupancy for the year (35.4 percentage points for Hilton vs. 42.3 percentage points for Marriott).

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

MAD 15–2 (FIN MAN); MAD 1–2 (MAN) (Concluded) d. An important question beyond occupancy is the price at which the rooms are sold. Price will influence occupancy. For example, it is possible to increase occupancy by reducing price. However, a reduced price may reduce revenue by more than the revenue increase achieved by increased occupancy. Thus, hotels also need to monitor the average daily price for which room nights are sold. Note: In this case, Hilton Hotels had an average room price of $114.03 in 2020 (down from $144.79 in 2019), while Marriott had an average room price of $151.51 in 2020 (down from $182.60 in 2019). Thus, while both hotels saw a decrease in price, and while Marriott had a lower occupancy rate, Marriott made more revenue per room night in 2020 than did Hilton. Thus, Marriott’s overall performance appears more favorable than what could be determined by just the occupancy data. Further, understanding the long-term impact of pandemic-related demand at Hilton and Marriott is important. For example, it is important to investigate how travel was affected in the areas served by Hilton and Marriott, and how sanitation changes at these hotels could influence future demand.

MAD 15–3 (FIN MAN); MAD 1–3 (MAN) a. Number of Guests 183,600 × 228,000 ×

Sunrise Suites Nationwide Inns b.

Number of Hotels 120 150

Sunrise Suites Nationwide Inns c.

Occupancy Rate =

× ×

Average Length of Visit (in Nights) 1.5 1.2

Guest Nights (Number of Guests × Average Length of Visit) = 275,400 = 273,600

Average Number of of Rooms per Hotel 90 × 76 ×

Days in June 30 30

Room Nights for June = 324,000 = 342,000

Guest Nights Available Room Nights

Sunrise Suites:

275,400 = 85% 324,000

Nationwide Inns:

273,600 = 80% 342,000

d. Sunrise Suites had the better occupancy rate during June, with 85% compared to Nationwide Inns’ occupancy rate of 80%. Additional analyses should evaluate the average price per room, since price can influence the occupancy rate and there can be a trade-off between average room price and occupancy. 15-26 © 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

MAD 15–4 (FIN MAN); MAD 1–4 (MAN) a. Admitted patients Average length of stay per patient In-patient days

April 1,440 × 4.0 5,760

May 1,860 × 3.5 6,510

June 2,250 × 3.0 6,750

Private 100 × 1 100

SemiPrivate 100 × 2 200

April 300 × 30 9,000

May 300 × 31 9,300

June 300 × 30 9,000

April 5,760 ÷ 9,000 64%

May 6,510 ÷ 9,300 70%

June 6,750 ÷ 9,000 75%

b. Available beds:

Number of rooms Beds per room Total bed capacity

Total

300

Available bed days: Bed capacity Days per month Available bed days c. Occupancy rate: In-patient days [from (a)] Available bed days [from (b)] Occupancy rate

d. The occupancy rate increased from April to May and again from May to June. This suggests the hospital bed capacity is being utilized more efficiently over time. A closer examination of the data reveals that the average length of stay is declining, while the number of admissions is increasing. The average length of stay may be declining because of greater efficiency in delivering health care, assuming no change in treatment mix is being provided over the three months. This potential improvement provides greater capacity to accept new patients, as can be seen from the three-month data. Thus, the reduced length of stay and greater occupancy are both contributing to the hospital’s ability to serve more patients per month.

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

MAD 15–5 (FIN MAN); MAD 1–5 (MAN) a. Available seat capacity for each flight number for June: Number of seats per flight Number of flights in June (one per day) Total seat capacity per flight number (June) b.

Flight Number 57 85 94

Number of Seats Sold 5,130 2,592 2,376

180 × 30 5,400 Available Seat Capacity [from (a)] 5,400 5,400 5,400

Passenger Load* 95% 48% 44%

* Number of seats sold ÷ Available seat capacity c. The passenger load information indicates that Flight 57 flies very near to capacity, but Flights 85 and 94 fly at less than half of capacity. This suggests the management of Eastern Skies is offering too much capacity for the morning flights to Chicago. One solution would be to use smaller aircraft for Flights 85 and 94 so as to better match capacity with demand. Alternatively, Eastern could consolidate the two flights into one flight that could depart at some time between the two original times, such as 10:45 AM. Passengers could then migrate to the new flight, resulting in a better utilization of the remaining flight.

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

TAKE IT FURTHER TIF 15–1 (FIN MAN); TIF 1–1 (MAN) Brian has behaved unethically and violated several of the IMA’s principles of ethical conduct. By determining the price of the lumber that he is buying, Brian has created a conflict-of-interest situation that violates the principle of objectivity. For professionals to be objective, they must make decisions that are not influenced by their personal feelings or result in personal gains. Since Brian is in a position to directly influence the price that he will pay for the lumber, he cannot be objective. Thus, although it is appropriate for Brian to take advantage of Avett’s policy of allowing employees to purchase materials at cost, he should have had someone else (such as his supervisor) determine the amount that he owed for the lumber. Clearly, selecting the lowest price has opened the door for criticism. TIF 15–2 (FIN MAN); TIF 1–2 (MAN) Answers may vary slightly by restaurant chosen. A suggested answer for a pizza restaurant follows: Direct Cost Materials X Ingredients…………………………………… Cook wages………………………………… Manager salary……………………………… Depreciation on equipment and fixtures………………………………… Coupon costs………………………………… Advertising…………………………………. To-go boxes………………………………… X Disposable plates, utensils, cups………… X Nondisposable plates, utensils, cups…… Repair costs………………………………… Property taxes……………………………… Store depreciation………………………… Cashier salary……………………………… Beverages…………………………………… X Building heat and A/C……………………… Salad ingredients…………………………… X Delivery person wages…………………… Power costs for ovens………………………

Direct Labor

Overhead

Selling Expenses

X X X X X

X X X X X X X X

In service businesses, the distinction between direct labor and overhead will not always be clear.

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

TIF 15–3 (FIN MAN); TIF 1–3 (MAN) Memo To:

Todd Johnson

From:

A+ Student

Re:

Financial vs. Managerial Accounting Information

The objectives of financial and managerial accounting are quite different, and your statement does not fully consider these differences. In one sense, your statement may be appropriate at high levels in the organization. For example, it is appropriate to evaluate a division manager who is responsible for the overall performance of a division using the same financial performance measures that shareholders use to evaluate the company. However, these measures are not appropriate for evaluating managerial decision making below the division level. At these levels, summary financial performance measures do not provide the relevant information needed to direct and control the company’s operations. Operational performance measures need to focus on measuring cost, quality, delivery time, equipment availability, inventory levels, scrap, waste, and efficiency. This list is much broader and more detailed than the financial statement numbers provided to the stockholders. The stockholders’ interest in profit is related to increasing shareholder value. Managers must increase long-term shareholder value by engaging in strategies that enhance people, product, and processes in the delivery of value to customers. These strategies can be measured by both financial and nonfinancial means. Therefore, managerial accounting information needs a much broader set of objective and subjective measures used internally in the organization to guide strategy and operations.

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

TIF 15–4 (FIN MAN); TIF 1–4 (MAN) a.

The vice president of the Information Systems Division can use managerial accounting information in a number of ways. For example, the vice president might use these data to determine resources that will be needed based on a projection of the amount and type of work required for the next period. Managerial accounting information would also be used to determine whether the bank should lease additional processing capacity or purchase a new central processing unit. In addition, managerial accounting information could be used to achieve better control over information systems activities by evaluating the costs of ongoing operations, based on the demand for information services.

The hospital administrator can use managerial accounting information in a number of ways. One way is for cost planning and control. The administrator could use managerial information to keep costs commensurate with services provided and to plan for staffing and nursing levels. This information can be used to determine the cost of various services and, thereby, in making decisions with respect to the amount of service that is appropriate in each case. The administrator can also use managerial accounting information to determine whether the hospital’s costs are being covered by fixed payments from Medicare, Medicaid, or insurance. If not, the administrator needs to know the source of the cost overruns. Does the hospital allow too many procedures? Require longer bed days? Have resources that are underutilized (e.g., a cancer wing with three patients)?

The CEO of the food company will use managerial accounting information to support the control of the three divisions. Each of the three divisions will be subject to a number of financial goals. The CEO also needs to support strategic decision making. In this regard, the CEO needs managerial accounting information on the profitability of various product families, profitability of different regions, and profitability of various customer segments. This information can guide the CEO in allocating future effort and resources.

The copy shop manager needs fairly simple managerial accounting information. At the most basic level, the copy shop manager needs to know the costs of performing various copy tasks, such as one-sided copy, two-sided copy, collating, and binding. These activities will have some direct costs, such as paper, and some indirect costs, such as copy machine time. The manager will need to estimate the impact of both of these costs in order to price the various copy jobs to the public. Managerial accounting information will include the cost details necessary to price the various copy shop services at a level needed to cover equipment costs, lease expenses, and profit.

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

TIF 15–5 (FIN MAN); TIF 1–5 (MAN) a.

The High Times manager will use managerial accounting information to accumulate the costs associated with different menu items. The costs, direct and indirect, will help in determining the pricing strategy.

The plant manager is going to use cost information on scrap and rework to identify the amount of waste occurring in the plant. This measure of waste is fairly common in fabrication-type facilities. The measures can guide the plant manager to locations or products where significant waste is occurring. The plant manager can use the scrap and rework measures to guide operational improvement toward the location that is experiencing the greatest level of scrap or rework. The measures can also monitor improvement in rework and control the number of network hours charged by floor personnel.

The cost of ending inventory must be determined as financial statements are prepared. The division controller will likely require inventory valuation at the close of every month in order to have a good understanding of the month-by-month earnings of the division. The division controller will provide the ending inventory information by using managerial accounting information in determining the cost of products. To determine the appropriate cost, the product cost is multiplied by the units left in inventory.

The Maintenance Department manager needs to be able to plan the resources used by his department. The planning process involves identifying the required resources to fulfill the department’s objective(s). For example, the Maintenance Department manager may know the repair histories of various machines. These histories can be used to forecast the repairs anticipated during the next year. The manager may also know that a new process will be brought online during the next year. New processes are frequently troublesome, so the manager will need to budget additional resources to accommodate introduction of the new technology.

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

TIF 15–6 (FIN MAN); TIF 1–6 (MAN) 1.

Obie’s bill has a number of points that should be considered. Some of the points, with the appropriate argument, are identified below. ●

The trip back to the shop resulted in an $80 labor charge. Obie should argue that the whole hour should not be billed. The hour is the result of stocking out of a circuit board on the truck. The circuit board should have been with the repair person. There was a board for the previous customer. However, because only one was stocked, the repair person had to go back to the shop. The trip back to the shop was nonproductive time that should not have been charged directly to Obie but should be part of Geek Gang’s overhead cost to all customers. In other words, Obie should not be responsible for this mistake.

●

The overtime premium should not have been charged to Obie. What if Obie was the first appointment in the morning? If he was, there would be no overtime premium. It’s only random misfortune that Obie was the last client of the day and therefore received the overtime premium. Add to this the fact that the overtime would not have been necessary without the trip back to the shop, and the conclusion is that Obie should not be charged directly for overtime. The overtime premium should be part of Geek Gang’s overhead charged to all clients equally. Obie should be charged the overtime only if the decision for overtime was caused by or required by Obie.

Thus, the labor portion of the bill should only be $70 + $60 + $60 = $190. There are other parts of the bill that should not be in dispute. ●

The materials storage and handling charge is a normal charge of maintaining a parts inventory for the benefit of clients that need parts.

●

The fringe benefits and overhead added to the hourly rate are both reasonable. The fringe benefit attaches directly to the direct labor. Fringe benefits are just another form of compensation. The overhead must be covered by all customers. Therefore, including overhead in the hourly rate is the most logical method of covering these costs.

●

The additional charge for the first hour is also reasonable. The first hour charge covers the costs of transit, which are directly attributable to making a home visit. Obie requires a home visit, so Obie should be responsible for the costs of making the visit. If Obie brought the computer to the shop, this cost would not be incurred.

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

TIF 15–6 (FIN MAN); TIF 1–6 (MAN) (Concluded) 2.

Cost Circuit board…………………………………… Storage and handling………………………… Straight-time labor……………………………… Fringe benefits*………………………………… Overhead………………………………………… Vehicle depreciation and fuel………………… Overtime premium………………………………

Direct Materials X

Direct Labor

Overhead X

X X X X X

* Could be considered overhead. TIF 15–7 (FIN MAN); TIF 1–7 (MAN) Tableau Cost Classifications Product Period Costs

Costs Administrative Expenses

Product Costs

Selling Expenses Total Direct Labor Costs Direct Materials Costs Factory Overhead Costs

Charge Type Administrative Wages External Auditor Fees Management Salaries Total Advertising Total Manufacturing Employees Total Freight Raw Materials, Steel Raw Materials, Vinyl Total Electricity Factory Equipment Packaging Materials Warehouse Lease Total

Total

$ 225,945.00 42,256.00 753,767.00 $1,021,968.00 $ 25,235.00 $ 25,235.00 $1,047,203.00 $1,685,285.00 $1,685,285.00 $ 102,577.00 1,452,127.00 553,153.00 $2,107,857.00 $ 671,121.00 357,125.00 449,915.00 239,632.00 $1,717,793.00 $5,510,935.00

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

TIF 15–7 (FIN MAN); TIF 1–7 (MAN) Excel Cost Classifications

CHAPTER 15 (FIN MAN); CHAPTER 1 (MAN)

Introduction to Managerial Accounting

CERTIFIED MANAGEMENT ACCOUNTANT (CMA®) EXAMINATION QUESTIONS (ADAPTED) 1. b. Sales commissions on cars would be part of the selling expense for the car dealership, not a manufacturing cost. Options (a) and (d) are direct material costs, while option (c) would be charged to factory overhead. 2. c. Plunkett’s product costs are $656,100, and the period costs are $493,000, as follows: Product Costs $ 56,000 179,100 421,000

Direct materials Direct labor Overhead Total

$656,100

Selling expenses Administrative expenses Fire loss

Period Costs $235,900 229,400 27,700

Total

$493,000

3. c. Prime costs of $150,000 are the combination of direct material costs of $100,000 and direct labor costs of $50,000. Conversion costs of $130,000 are the combination of direct labor costs of $50,000 and overhead costs of $80,000. 4. c. Factory overhead includes those items that cannot be directly traced to any one particular product and/or is an insignificant part of the total cost. In this case, the wood screws and glue used in the production of school desks and chairs would most likely be classified as factory overhead.

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN) JOB ORDER COSTING DISCUSSION QUESTIONS 1.

Job order costing and process costing.

Job order costing provides a separate record of each quantity of product that passes through the factory.

Process costing accumulates costs for each department or process within a factory.

Hybrid costing, or operations costing, incorporates elements of both job order costing and process costing.

Job order costing is used by firms that sell custom goods and services to customers. Job order costing is frequently associated with firms that will produce a product or service specifically to a customer order.

Work in Process

a. b.

A job cost sheet is the subsidiary ledger to the work in process control account. The cost of materials, labor, and overhead are listed on each separate job cost sheet for each job. A summary of all the job cost sheets during an accounting period is the basis for journal entries to the control accounts.

The clock card is a means of recording the hours spent by employees in the factory. The time ticket is a means of recording the time the employee spends on a specific job.

The predetermined overhead rate is computed using estimated amounts at the beginning of the period. This is because managers need timely information on the product costs of each job. If a company waited until all overhead costs were known at the end of the period, the allocated factory overhead would be accurate, but not timely. Only through timely reporting can managers adjust manufacturing methods or product pricing.

The predetermined factory overhead rate is determined by dividing the estimated total factory overhead costs for the forthcoming year by an estimated activity base, one that reflects the consumption or use of factory overhead costs.

Direct labor cost, direct labor hours, and machine hours.

(1) If the amount of factory overhead applied is greater than the actual factory overhead incurred, factory overhead is overapplied.

Purchase invoice or receiving report Materials requisition

(2) If the amount of actual factory overhead is greater than the amount applied, factory overhead incurred is underapplied. b.

Underapplied

Deferred credit

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

DISCUSSION QUESTIONS (Continued) 10.

Job order cost accumulation would be most appropriate for professional service firms that provide extended, project-type services for clients. Examples would be architectural, consulting, advertising, or legal services. Job cost sheets would accumulate all direct costs of servicing the client. Such costs would include labor, materials, travel, and subcontracted services. In addition, overhead would be applied using a predetermined overhead rate. The costs accumulated by the job cost sheet would be treated as work in process (a current asset) until the service is completed. Once completed, the cost would be transferred to the cost of services on the income statement.

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

BASIC EXERCISES BE 16–1 (FIN MAN); BE 2–1 (MAN) May

May

7 Materials Accounts Payable $80,000 = 10,000 × $8.

80,000

31 Work in Process* Materials

67,400

* Job 200 Job 305 Total

$60,000 7,400

80,000

67,400 = 7,500 × $8 = 1,480 × $5

$67,400

BE 16–2 (FIN MAN); BE 2–2 (MAN) Work in Process* Wages Payable * Job 200 Job 305 Total

142,000 142,000 $ 70,000 = 2,500 hours × $28 72,000 = 3,000 hours × $24 $142,000

BE 16–3 (FIN MAN); BE 2–3 (MAN) Factory Overhead Materials Wages Payable Utilities Payable Accumulated Depreciation—Factory

29,200 8,800 6,600 4,800 9,000

BE 16–4 (FIN MAN); BE 2–4 (MAN) a.

$7.75 per direct labor hour = $620,000 ÷ 80,000 direct labor hours

Job 200 $19,375 = 2,500 hours × $7.75 per hour 23,250 = 3,000 hours × $7.75 per hour Job 305 $42,625

Work in Process Factory Overhead

42,625 42,625

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

BE 16–5 (FIN MAN); BE 2–5 (MAN) a.

Job 200 Direct materials……………………………………………… $ 60,000 Direct labor…………………………………………………… 70,000 19,375 Factory overhead…………………………………………… $149,375 Total costs………………………………………………

Job 200 Job 305

Job 305 $

7,400 72,000 23,250 $102,650

$62.50 = $149,375 ÷ 2,390 units $50.00 = $102,650 ÷ 2,053 units

BE 16–6 (FIN MAN); BE 2–6 (MAN) $2,630,000 = $390,000 + (140,000 × $16.00*) * Cost per unit of goods produced during the year = $16.00 = $4,800,000 ÷ 300,000 units

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

EXERCISES Ex. 16–1 (FIN MAN); Ex. 2–1 (MAN) a. b. c. d. e. f. g.

Direct materials requisitioned for use Indirect materials requisitioned for use Direct labor used Indirect labor used Application of factory overhead costs to jobs Jobs completed Goods sold

Ex. 16–2 (FIN MAN); Ex. 2–2 (MAN) a.

Cost of goods sold: Sales…………………………………………………………… $13,150,000 (6,000,000) Less gross profit……………………………………………… Cost of goods sold…………………………………………… $ 7,150,000

Direct materials cost: Materials purchased………………………………………… Less: Indirect materials…………………………………… Materials inventory………………………………… Direct materials cost…………………………………………

Direct labor cost: Total manufacturing costs for the period……………… Less: Direct materials cost……………………………… Factory overhead*…………………………………… Direct labor cost………………………………………………

$3,975,000 $ 175,000 310,000

(485,000) $3,490,000 $ 8,110,000

$3,490,000 1,370,000

(4,860,000) $ 3,250,000

* $375,000 + $175,000 + $820,000

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

Ex. 16–3 (FIN MAN); Ex. 2–3 (MAN) a.

RECEIVED

ISSUED

BALANCE

Materials Receiving

Requi-

Report Number

Quantity

Unit

sition

Price

Number

Unit Quantity

130 $32.00 91

Amount

110

* May 10 issuance

365

38.00 97

100

285 at $30.00 80 at $32.00

$ 8,550 2,560

$11,110*

Date

Quantity

Price

Amount

May

285

$30.00

$8,550

May

285

$30.00

8,550

130

$32.00

4,160

May

$32.00

1,600

May

$32.00

1,600

$38.00 $38.00

4,180

110 60

3,500** May

2,280

$11,110

** May 27 issuance

50 at $32.00 50 at $38.00

$ 1,600 1,900 $ 3,500

b. Ending inventory balance: 60 at $38.00……………………………………………………………………… $2,280 c.

14,610

Work in Process ($11,110 + $3,500) Materials

14,610

d. Comparing quantities on hand as reported in the materials ledger with predetermined order points enables management to order materials before a lack of materials causes idle time. Also, the subsidiary ledger can include columns for recording quantities ordered so that management can have easy access to information about materials on order.

Ex. 16–4 (FIN MAN); Ex. 2–4 (MAN) 2,162,100 170,000

Work in Process Factory Overhead Materials

2,332,100

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

Ex. 16–5 (FIN MAN); Ex. 2–5 (MAN) a.

Materials* Accounts Payable

1,770,000 1,770,000

* $820,000 + $315,000 + $555,000 + $80,000 b.

Work in Process* Factory Overhead Materials

1,664,000 83,600 1,747,600

* $374,700 + $736,400 + $552,900 c. Fabric Balance, April 1………………… $ 58,300 820,000 April purchases………………… (810,000) April requisitions……………… Balance, April 30………………… $ 68,300

Polyester Filling

Lumber

Glue

$ 30,000 315,000 (320,000) $ 25,000

$ 58,800 555,000 (534,000) $ 79,800

$ 9,950 80,000 (83,600) $ 6,350

Ex. 16–6 (FIN MAN); Ex. 2–6 (MAN) Work in Process Factory Overhead Wages Payable

69,795 9,300 79,095

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

Ex. 16–7 (FIN MAN); Ex. 2–7 (MAN) a.

Work in Process Factory Overhead Wages Payable

3,676 164 3,840

Supporting calculations:

Hourly Rate

Job 301

Labor Costs (Hourly Rate × Hours) Direct Labor (sum of Job Job 302 303 job costs)

Tom Couro……… $32 36 David Clancy…… Jose Cano……… 28

$320 432 308

$480 432 364

$416 504 420

Indirect Labor

$1,216 1,368 1,092 $3,676

$ 64 72 28 $164

The direct labor costs for the completed jobs would become part of the finished goods inventory. The direct labor costs for Job 303 would remain part of the work in process inventory.

Ex. 16–8 (FIN MAN); Ex. 2–8 (MAN) a.

Work in Process Factory Overhead Wages Payable

47,792 12,500

Work in Process Factory Overhead

37,904

60,292 37,904

$47,792 ÷ $29 per hour = 1,648 hours 1,648 hours × $23 per hour = $37,904

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

Ex. 16–9 (FIN MAN); Ex. 2–9 (MAN) a.

Factory 1: $14.80 per machine hour ($18,500,000 ÷ 1,250,000 machine hours)

Factory 2: $55.00 per direct labor hour ($44,000,000 ÷ 800,000 direct labor hours)

Factory 1: Work in Process Factory Overhead ($14.80 × 105,000).

1,554,000 1,554,000

Factory 2: Work in Process Factory Overhead ($55.00 × 64,500). d.

3,547,500 3,547,500

Factory 1—$38,200 credit (overapplied) ($1,515,800 – $1,554,000) Factory 2—$58,800 debit (underapplied) ($3,606,300 – $3,547,500)

Ex. 16–10 (FIN MAN); Ex. 2–10 (MAN) The estimated shop overhead is determined as follows: Shop and repair equipment depreciation………………………………………… Shop supervisor salaries…………………………………………………………… Shop property taxes………………………………………………………………… Shop supplies………………………………………………………………………… Total shop overhead………………………………………………………………

$ 64,220 210,000 57,390 14,500 $346,110

The engine parts and shop labor are direct to the jobs and are not included in the shop overhead rate. The advertising and administrative expenses are selling and administrative expenses that are not included in the shop overhead but are treated as period expenses. The estimated activity base is determined by dividing the shop direct labor cost by the direct labor rate, as follows: $1,992,000 $40.00 per hour

= 49,800 hours

The predetermined shop overhead rate is: $346,110 49,800 hours

= $6.95 per direct labor hour

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

Ex. 16–11 (FIN MAN); Ex. 2–11 (MAN) a.

Estimated annual operating room overhead:

$812,000

Estimated operating room activity base, number of operating room hours: Hours per day……………………………………………………… Days per week…………………………………………………… Weeks per year (net of maintenance weeks)………………… Estimated annual operating room hours……………………

8 × 7 × 50 2,800

Predetermined surgical overhead rate: $812,000 2,800 hours b.

= $290 per hour

Ebony Jones’s procedure: Number of surgical room hours……………………………… Predetermined surgical room overhead rate………………… Procedure overhead………………………………………………

5 × $290 $1,450

Actual hours used in January…………………………………………………… Predetermined surgical room overhead rate………………………………… Surgical room overhead applied, January……………………………………… Actual surgical room overhead incurred, January…………………………… Overapplied surgical room overhead (credit balance)………………………

240 $290

× $ 69,600 (67,250) $ 2,350

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

Ex. 16–12 (FIN MAN); Ex. 2–12 (MAN) a.

Finished Goods* Work in Process

553,700 553,700

* $165,200 + $75,000 + $239,600 + $73,900 b.

Work in process inventory, March 1………………………… Cost of direct materials used in production……………… Direct labor……………………………………………………… Factory overhead……………………………………………… Total manufacturing costs incurred………………………… Total manufacturing costs…………………………………… Jobs finished during March…………………………………… Work in process inventory, March 31………………………

$ 60,200 $ 93,000 123,000 305,000 521,000 $ 581,200 (553,700) $ 27,500

Ex. 16–13 (FIN MAN); Ex. 2–13 (MAN) a.

Work in Process Factory Overhead Materials

55,500 4,500

Work in Process Factory Overhead Wages Payable

106,800 8,200

Work in Process Factory Overhead

26,700

60,000

115,000 26,700*

Predetermined overhead rate: Job 301: $7,750 ÷ $31,000 = 25% or Job 302: $10,550 ÷ $42,200 = 25% * Direct labor cost × Predetermined factory overhead rate: $106,800 × 25% = $26,700 d.

Finished Goods* Work in Process

122,750 122,750

* $51,250 + $71,500

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

Ex. 16–14 (FIN MAN); Ex. 2–14 (MAN) a.

Rockhaven Biking Inc. Income Statement For the Month Ended February 28 Revenues Cost of goods sold Gross profit Selling and administrative expenses: Selling expenses Administrative expenses Total selling and administrative expenses Operating income

$ 935,000 (520,000) $ 415,000 $180,000 95,000 (275,000) $ 140,000

Materials inventory: Purchased materials………………………………………………………… Less: Materials used in production……………………………………… Materials inventory, February 28……………………………………………

$ 450,000 (423,200) $ 26,800

Work in process inventory: Materials used in production……………………………………………… Direct labor……………………………………………………………………. Factory overhead ($127,000 × 30%)………………………………………… Total manufacturing costs incurred ……………………………………… Less: Transferred to finished goods……………………………………… Work in process inventory, Februay 28……………………………………

$ 423,200 127,000 38,100 $ 588,300 (565,000) $ 23,300

Finished goods inventory: Transferred to finished goods……………………………………………… Less: Cost of goods sold…………………………………………………… Finished goods inventory, February 28……………………………………

$ 565,000 (520,000) $ 45,000

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

Ex. 16–15 (FIN MAN); Ex. 2–15 (MAN) a.

Aug.

3 Work in Process (160 hrs. × $200) Salaries Payable

32,000

10 Work in Process Cash

13,000

14 Work in Process (260 hrs. × $185) Salaries Payable

48,100

18 Work in Process Consultant Fees Payable

40,000

27 Work in Process (420 hrs. × $70) Office Overhead

29,400

31 Office Overhead Cash

34,800

31 Office Overhead Supplies

3,500

31 Salaries Payable Cash

80,100

31 Accounts Receivable Fees Earned

180,900

31 Cost of Services Work in Process*

162,500

32,000

13,000

48,100

40,000

29,400

34,800

3,500

80,100

180,900

162,500

* $32,000 + $13,000 + $48,100 + $40,000 + $29,400 b.

Office overhead incurred ($34,800 + $3,500)……………… Office overhead applied……………………………………… Underapplied overhead…………………………………………

Fees earned……………………………………………………… $ 180,900 (171,400) Cost of services*………………………………………………… Gross profit……………………………………………………… $ 9,500

$ 38,300 (29,400) $ 8,900

* $162,500 + $8,900. Assumes the over- or underapplied office overhead is closed to cost of services monthly.

Note to Instructors: The consultant fees and travel costs can be directly assigned to the case and thus are not treated as office overhead. Costs such as secretarial and administrative salaries and supplies would be part of office overhead incurred.

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

Ex. 16–16 (FIN MAN); Ex. 2–16 (MAN) a. b. c. d.

Work in Process Salaries Payable

1,068,000

Work in Process Accounts Payable

2,130,000

Work in Process (65% × $2,130,000) Agency Overhead

1,384,500

Cost of Services Work in Process

2,827,750

1,068,000 2,130,000 1,384,500 2,827,750

Cost of completed jobs, $2,827,750: Vault Bank

August 1 balance………………………………………… August costs: Direct labor…………………………………………… Media…………………………………………………… Overhead……………………………………………… Total costs…………………………………………………

Take Off Airlines

$ 270,000

190,000 710,000 461,500 * $1,631,500

85,000 625,000 406,250 ** $1,196,250

* 65% × $710,000 ** 65% × $625,000

80,000

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

PROBLEMS Prob. 16–1A (FIN MAN); Prob. 2–1A (MAN) a. b.

g. h. i.

Materials Accounts Payable

320,000

Work in Process Factory Overhead Materials

283,500 8,600

Work in Process Factory Overhead Wages Payable

454,500 33,000

Factory Overhead Selling Expenses Administrative Expenses Accounts Payable

610,000 142,000 105,000

Factory Overhead Selling Expenses Administrative Expenses Prepaid Expenses

22,000 5,000 4,000

Depreciation Expense—Office Building Depreciation Expense—Office Equipment Factory Overhead Accum. Depr.—Buildings and Equipment

29,000 6,500 68,000

Work in Process Factory Overhead

712,000

Finished Goods Work in Process

1,426,000

Cost of Goods Sold Finished Goods

1,378,000

320,000

292,100

487,500

857,000

31,000

103,500 712,000 1,426,000 1,378,000

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

Prob. 16–2A (FIN MAN); Prob. 2–2A (MAN) 1. a. b.

c. d.

e. f.

Materials Accounts Payable

50,000

Work in Process Factory Overhead Materials Wages Payable

41,595 6,200

Factory Overhead Accounts Payable

1,800

Factory Overhead Accumulated Depreciation—Machinery and Equipment

2,700

Work in Process Factory Overhead (300 hours × $40)

12,000

Finished Goods Work in Process

40,765

50,000

16,300 31,495 1,800

2,700 12,000 40,765

Computation of cost of jobs finished: Job

Direct Materials

Direct Labor

Factory Overhead

Total

No. 301…… $1,850 $2,500 $1,200 $ 5,550 No. 302…… 3,150 7,220 2,400 12,770 No. 303…… 2,200 5,350 1,640 9,190 13,255 No. 305…… 4,230 6,225 2,800 Total…………………………………………………… $40,765 g.

Accounts Receivable Sales

37,950

Cost of Goods Sold Finished Goods

27,510

37,950

27,510

Computation of cost of goods sold and sales: Costs of Goods Sold

Sales

No. 301…………………………………… $ 5,550 No. 302…………………………………… 12,770 No. 303…………………………………… 9,190 Total……………………………………… $27,510

$ 9,000 16,150 12,800 $37,950

Job

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

Prob. 16–2A (FIN MAN); Prob. 2–2A (MAN) (Concluded) 2.

Work in Process (b) (e) Bal.

41,595 12,000 12,830

(f)

Finished Goods 40,765

(f)

40,765

Bal.

13,255

(g)

Schedule of unfinished jobs: Direct Materials

Job

Direct Labor

Factory Overhead

Total

No. 304……………………………… $1,900 $2,300 $2,520 $ 6,720 6,110 1,770 2,900 1,440 No. 306……………………………… Balance of Work in Process, December 31………………………………………………… $12,830 4.

Schedule of completed jobs: Direct Materials

Direct Labor

Factory Overhead

Total

Finished Goods, December 31 (Job 305)…………………………… $4,230

$6,225

$2,800

$13,255

Job

27,510

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

Prob. 16–3A (FIN MAN); Prob. 2–3A (MAN) 1. and 2. JOB COST SHEET Customer

Jackson Consulting

Date Date wanted Date completed Job. No.

October 1 October 10 October 10

ESTIMATE Direct Materials

Direct Labor

Amount 200 meters at $35

Total

Summary

Amount

7,000 16 hours at $20

320 Direct materials

7,000

7,000 Total

Direct labor Factory overhead 320 Total cost

320 240 7,560

ACTUAL Direct Materials

Direct Labor

Summary

Mat. Time Req. DescripTicket DescripNo. tion Amount No. tion Amount Item 112 140 meters H10 10 hours at $35 4,900 at $20 200 Direct materials Direct labor 114 68 meters H11 10 hours Factory overhead at $35 2,380 at $20 200 Total 7,280 Total 400 Total cost

Amount

Comments: The direct materials cost exceeded the estimate by $280 because 8 meters of materials were spoiled. The direct labor cost exceeded the estimate by $80 because an additional 4 hours of labor were used by an inexperienced employee. The factory overhead cost exceeded the estimate because an additional $60 of factory overhead was allocated because of the increase in direct labor.

7,280 400 300 7,980

Job. No.

$264,450. From table above.

$370,230. ($264,450 × 1.4) and from table above.

$903,620. ($170,500 + $309,100 + $248,820 + $175,200)

$751,870. From table above.

$65,550. Wages incurred less direct labor applied to production in June. ($330,000 – $264,450)

$ 170,500 309,100 91,300 248,820 175,200 51,760 $1,046,680

16-19

$351,500. From table above.

$ 57,750 100,100 30,800 97,020 67,200 17,360 $370,230

Total Cost

Job Order Costing

Factory Overhead

$60,500. From table above and problem.

$ 41,250 71,500 22,000 69,300 48,000 12,400 $264,450

Direct Labor

$ 55,000 93,500 38,500 82,500 60,000 22,000 $351,500

Direct Materials

$395,500. Materials applied to production in June + indirect materials. ($351,500 + $44,000)

$60,500

$16,500 44,000

June 1 Work in Process

550 1,100 550 660 480 380 3,720

Quantity

Supporting calculations:

No. 201 No. 202 No. 203 No. 204 No. 205 No. 206 Total

Prob. 16–4A (FIN MAN); Prob. 2–4A (MAN)

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

377.00 365.00

$310.00 281.00

Unit Cost

440 880 0 570 420 0

Units Sold

$136,400 247,280 0 214,890 153,300 0 $751,870

Cost of Goods Sold

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

Prob. 16–4A (FIN MAN); Prob. 2–4A (MAN) (Concluded) 2.

June 30 balances: ($82,500 + $330,000 – $395,500) Materials……………………… $ 17,000 ($91,300 + $51,760, Job 203 & Job 206) Work in Process*…………… 143,060 ($903,620 – $751,870) Finished Goods**…………… 151,750 Factory Overhead…………… 9,820 Dr. underapplied ($33,000 + $65,550 + $44,000 + $237,500 – $370,230) * $60,500 + $351,500 + $264,450 + $370,230 – $903,620 = $143,060 ** Job. No. No. 201 No. 202 No. 204 No. 205 Total

Units in Inventory

Unit Cost

Total Cost

110 220 90 60

$310.00 281.00 377.00 365.00

$ 34,100 61,820 33,930 21,900 $151,750

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

Prob. 16–5A (FIN MAN); Prob. 2–5A (MAN) 1.

Ginocera Inc. Income Statement For the Year Ended December 31, 20Y8 Sales Cost of goods sold Gross profit Selling and administrative expenses: Selling expenses: Infomercial campaign Promotional materials Shipping expenses Total selling expenses Administrative expenses: Legal expenses Total selling and administrative expenses Operating income

$ 17,920,000 (10,864,000) $ 7,056,000

$2,000,000 3,600,000 224,000 $5,824,000 800,000

(6,624,000) 432,000

Supporting calculations: Sales: 1,120,000 units × $16 = $17,920,000 Cost of goods sold: 1,120,000 units × $9.70 = $10,864,000 Manufacturing cost per unit: Direct materials: Hardened steel blanks……………………………… $4.00 Wood (for handle)…………………………………… 1.50 Packaging……………………………………………… 0.50 Total direct materials………………………………… Direct labor……………………………………………… Factory overhead*……………………………………… Total manufacturing cost per knife………………

$6.00 0.50 3.20 $9.70

* $800 ÷ 250 knives per hour Promotional materials: 60,000 stores × $60 = $3,600,000 Shipping expenses: 1,120,000 units × $0.20 = $224,000 2.

Finished Goods balance, December 31, 20Y8: (1,200,000 units – 1,120,000 units) × $9.70 = $776,000 Work in Process, December 31, 20Y8: 25,000 units × ($6.00 + $3.20) = $230,000 The materials, stamping, and factory overhead have already been applied to the 25,000 units. Only the direct assembly labor has yet to be applied for these units.

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

Prob. 16–1B (FIN MAN); Prob. 2–1B (MAN) a. b.

g. h. i.

Materials Accounts Payable

770,000

Work in Process Factory Overhead Materials

604,200 75,800

Work in Process Factory Overhead Wages Payable

574,000 182,000

Factory Overhead Selling Expenses Administrative Expenses Accounts Payable

245,000 171,500 110,600

Factory Overhead Selling Expenses Administrative Expenses Prepaid Expenses

24,500 28,420 16,660

Factory Overhead Depreciation Expense—Office Equipment Depreciation Expense—Office Building Accumulated Depreciation—Buildings and Equipment

49,500 61,800 14,900

Work in Process Factory Overhead

568,500

Finished Goods Work in Process

1,500,000

Cost of Goods Sold Finished Goods

1,375,000

770,000

680,000

756,000

527,100

69,580

126,200 568,500 1,500,000 1,375,000

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

Prob. 16–2B (FIN MAN); Prob. 2–2B (MAN) 1.

a. b.

c. d.

e. f.

Materials Accounts Payable

147,000

Work in Process Factory Overhead Materials Wages Payable

262,490 29,160

Factory Overhead Accounts Payable

6,000

Factory Overhead Accumulated Depreciation—Machinery and Equipment

4,100

Work in Process Factory Overhead (1,012 hours × $40)

40,480

Finished Goods Work in Process

175,090

147,000

139,110 152,540 6,000

4,100 40,480 175,090

Computation of cost of jobs finished: Job

Direct Materials

Direct Labor

Factory Overhead

Total

No. 101…… $19,320 $19,500 $6,160 $ 44,980 No. 102…… 23,100 28,140 6,400 57,640 No. 103…… 13,440 14,000 5,040 32,480 39,990 No. 105…… 18,050 15,540 6,400 Total……………………………………………………… $175,090 g.

Accounts Receivable Sales

189,100

Cost of Goods Sold Finished Goods

142,610

189,100

142,610

Computation of cost of goods sold and sales: Job

No. 101………………………………………………… No. 102………………………………………………… No. 105………………………………………………… Total……………………………………………………

Cost of Goods Sold

Sales

$ 44,980 57,640 39,990 $142,610

$ 62,900 80,700 45,500 $189,100

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

Prob. 16–2B (FIN MAN); Prob. 2–2B (MAN) (Concluded) 2.

Work in Process (b) (e) Bal.

262,490 40,480 127,880

(f)

Finished Goods 175,090

(f)

175,090

Bal.

32,480

(g)

Schedule of unfinished jobs: Job Materials

Direct Materials

Direct Labor

Factory Overhead

Total

No. 104……………………… $38,200 $36,500 $9,520 $ 84,220 43,660 18,700 6,960 No. 106……………………… 18,000 Balance of Work in Process, April 30…………………………………………………… $127,880 4.

Schedule of completed jobs: Direct Materials

Direct Labor

Factory Overhead

Total

Finished Goods, April 30 (Job 103)…………………… $13,440

$14,000

$5,040

$32,480

Job

142,610

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

Prob. 16–3B (FIN MAN); Prob. 2–3B (MAN) 1. and 2. JOB COST SHEET Customer

Lunden Consulting

Date Date wanted Date completed Job. No.

May 9 May 15 May 15

ESTIMATE Direct Materials

Direct Labor

Amount 400 meters at $32

Total

Summary

Amount

12,800 30 hours at $20

600 Direct materials

12,800

12,800 Total

Direct labor Factory overhead 600 Total cost

600 480 13,880

ACTUAL Direct Materials Mat. Req. DescripNo. tion 132 360 meters at $32 134 Total

50 meters at $32

Direct Labor

Time Ticket DescripAmount No. tion H9 18 hours 11,520 at $19 H12 1,600 13,120 Total

18 hours at $19

Summary

Amount

Item

Amount

342 Direct materials Direct labor Factory overhead 342 684 Total cost

13,120 684 547 14,351

Comments: The direct materials cost exceeded the estimate by $320 because 10 meters of materials were spoiled. The direct labor cost exceeded the estimate by $84 because an additional 6 hours of labor were used by inexperienced employees who worked for $1 less per hour. The factory overhead cost exceeded the estimate because an additional $67 of factory overhead was allocated because of the increase in direct labor.

Job. No.

$378,400. From table above.

$189,200. ($378,400 × 0.50) and from table above.

$801,500. ($198,000 + $260,300 + $125,400 + $217,800)

$700,284. From table above.

$17,600. Wages incurred less direct labor applied to production in May. ($396,000 – $378,400)

$ 198,000 260,300 297,000 125,400 217,800 112,200 $1,210,700

Unit Cost

313.50 330.00

$600.00 685.00

16-26

$570,700. From table above.

$ 29,700 36,300 55,000 19,800 33,000 15,400 $189,200

Total Cost

Job Order Costing

Factory Overhead

$72,400. From table above and problem.

$ 59,400 72,600 110,000 39,600 66,000 30,800 $378,400

Direct Labor

$ 82,500 105,400 132,000 66,000 118,800 66,000 $570,700

Direct Materials

$586,100. Materials applied to production in May + indirect materials. ($570,700 + $15,400)

$72,400

$26,400 46,000

May 1 Work in Process

330 380 500 400 660 330 2,600

Quantity

Supporting calculations:

No. 101 No. 102 No. 103 No. 104 No. 105 No. 106 Total

Prob. 16–4B (FIN MAN); Prob. 2–4B (MAN)

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

264 360 0 384 530 0

Units Sold

$158,400 246,600 0 120,384 174,900 0 $700,284

Cost of Goods Sold

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

Prob. 16–4B (FIN MAN); Prob. 2–4B (MAN) (Concluded) 2. May 31 balances: ($105,600 + $500,000 – $586,100) Materials……………………… $ 19,500 ($297,000 + $112,200, Job 103 & Job 106) Work in Process*…………… 409,200 ($801,500 – $700,284) Finished Goods**…………… 101,216 Factory Overhead…………… (7,300) Cr. overapplied ($26,400 + $17,600 + $15,400 + $122,500 – $189,200) * $72,400 + $570,700 + $378,400 + $189,200 – $801,500 = $409,200 ** Job. No. No. 101 No. 102 No. 104 No. 105 Total

Units in Inventory

Unit Cost

Total Cost

66 20 16 130

$600.00 685.00 313.50 330.00

$ 39,600 13,700 5,016 42,900 $101,216

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

Prob. 16–5B (FIN MAN); Prob. 2–5B (MAN) 1.

Technology Accessories Inc. Income Statement For the Year Ended December 31, 20Y3 Sales Cost of goods sold Gross profit Selling expenses: Salespersons commissions Advertising design Advertising expenses Total selling expenses Operating income

$ 18,400,000 (11,914,000) $ 6,486,000 $3,680,000 750,000 1,400,000 $

(5,830,000) 656,000

Supporting calculations: Sales: 460,000 units × $40 = $18,400,000 Cost of goods sold: 460,000 units × $25.90 = $11,914,000 Manufacturing cost per unit: Direct materials: Leather………………………………………………… $10.00 Velvet (for interior)…………………………………… 5.00 Packaging……………………………………………… 0.40 Total direct materials………………………………… Direct labor……………………………………………… Factory overhead cost*………………………………… Total manufacturing cost per unit…………………

$15.40 0.50 10.00 $25.90

* $1,250 ÷ 125 units per hour Salespersons commissions: $18,400,000 × 20% = $3,680,000 2.

Finished Goods balance, December 31, 20Y3: (500,000 units – 460,000 units) × $25.90 = $1,036,000 Work in Process, December 31, 20Y3: 22,000 units × ($15.40 + $10.00) = $558,800 The materials, stitching, and factory overhead have already been applied to the 22,000 units. Only the direct assembly labor has yet to be applied for these units.

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

MAKE A DECISION MAD 16–1 (FIN MAN); MAD 2–1 (MAN) a.

Divide the total direct labor cost by the count to determine the direct labor cost per unit for each job:

Job 107 Job 125 Job 160 Job 192

Total Direct Labor Cost $ 63.00 98.00 123.20 51.20

Count 10 14 16 8

Direct Labor Cost per Sports Coat $6.30 7.00 7.70 6.40

The direct labor cost per sports coat increased over the first three jobs, then declined with the last job. The increase for the first three jobs is not related to a change in the direct labor rate, which was the same for all three jobs. Thus, the increase in labor cost must be related to an increase in labor time to make the coats. This is confirmed in (c).

The direct labor hours per sports coat is determined by dividing the total direct labor hours by the count as follows:

Job 107 Job 125 Job 160 Job 192

Direct Labor Hours 4.50 7.00 8.80 3.20

Count 10 14 16 8

Direct Labor Hours per Sports Coat 0.45 0.50 0.55 0.40

The direct labor hours per sports coat have increased over the first three jobs, which has led to the increased direct labor cost per coat noted in (b). Management would want to investigate why the direct labor hours per coat are increasing. d.

The direct labor rate for Job 192 increased from $14 to $16. This may be due to a raise in pay or the use of a more skilled and higher-paid employee. Regardless, the result was a significant drop in the direct labor hours per sports coat, down to 0.40 hour, which is the best of all the jobs. The net result of the higher efficiency, combined with the higher direct labor cost, was a direct labor cost per sports coat that was only ten cents higher than Job 107 and a significant improvement over Job 160.

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

MAD 16–2 (FIN MAN); MAD 2–2 (MAN) a. Date

Job. No.

Quantity

Product

Amount

Unit Cost

Jan. 2 Jan. 15 Feb. 3 Mar. 7 Mar. 24 May 19 June 12 Aug. 18 Sept. 2 Nov. 14 Dec. 12

1 22 30 41 49 58 65 78 82 92 98

520 1,610 1,420 670 2,210 2,550 620 3,110 1,210 750 2,700

TT SS SS TT SLK SLK TT SLK SS TT SLK

$16,120 20,125 25,560 15,075 22,100 31,875 10,540 48,205 16,940 8,250 52,650

$31.00 12.50 18.00 22.50 10.00 12.50 17.00 15.50 14.00 11.00 19.50

Unit Cost

Unit Costs for TT 35 30 25 20 15 10 5 — 1

Job Number

Unit Cost

Unit Costs for SS 20 18 16 14 12 10 8 6 4 2 — 22

Job Number

Unit Cost

Unit Costs for SLK 22 20 18 16 14 12 10 8 6 4 2 — 49

Job Number

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

MAD 16–2 (FIN MAN); MAD 2–2 (MAN) (Concluded) As can be seen, the unit costs behave differently for each product. SLK has increasing unit costs during the year, SS is steady, and TT has decreasing unit costs during the year. b.

Management should want to determine why SLK costs are increasing and why TT costs are decreasing. This information can be determined from the job cost sheets for each job. By comparing the cost sheets from job to job (for a particular product), management can isolate the cause of the cost changes. The cost sheets will show how materials, labor, and overhead are consumed across the production process for each job. This information can isolate the problem or opportunity areas.

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

MAD 16–3 (FIN MAN); MAD 2–3 (MAN) a.

The first item to note is that the cost did not go up due to any increases in the cost of labor or materials. Rather, the cost of the plaques increased because Job 238 used more labor and materials per unit than did Job 230. Specifically, Job 230 required exactly the same number of backboards and brass plates as the number of actual plaques shipped. However, Job 238 required six more backboards and brass plates than the number actually shipped (36 versus 30). This is illustrated as follows: Job 230: Materials Walnut plaques: Actual units used Expected units needed to produce 40 plaques Difference

40 units (40) 0 units

Brass plates: Actual units used Expected units needed to produce 40 plaques Difference

40 units (40) 0 units

Labor Engraving: Actual labor hours used Expected labor hours to produce 40 plaques (40 units × 30 min. per unit) ÷ 60 min. per hour Difference Assembly: Actual labor hours used Expected labor hours to produce 40 plaques (40 units × 15 min. per unit) ÷ 60 min. per hour Difference

20 hours (20) 0 hours

10 hours (10) 0 hours

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

MAD 16–3 (FIN MAN); MAD 2–3 (MAN) (Concluded) Job 238: Materials Walnut plaques: Actual units used Expected units needed to produce 30 plaques Difference

36 units (30) 6 units

Brass plates: Actual units used Expected units needed to produce 30 plaques Difference

36 units (30) 6 units

Labor Engraving: Actual labor hours used Expected labor hours to produce 30 plaques (30 units × 30 min. per unit) ÷ 60 min. per hour Difference Assembly: Actual labor hours used Expected labor hours to produce 30 plaques (30 units × 15 min. per unit) ÷ 60 min. per hour Difference

17 hours (15) 2 hours

9.0 hours (7.5) 1.5 hours

Job 238’s 26 labor hours are 3.5 more (26.0 hrs. – 22.5 hrs.) than should have been expected for a job of 30 plaques [(30 × 45 min.) ÷ 60 min. = 22.5 hrs.]. As a result, the additional hours of labor cost, applied factory overhead, and direct materials cost caused the unit cost of Job 238 to increase. b.

Apparently, the engraving and assembly work is becoming sloppy. Job 238 required 36 engraved brass plates in order to get 30 with acceptable quality. It is likely that the engraver is not being careful in correctly spelling the names. The names should be supplied to the engraver, using large typewritten fonts, so that it is easy to read the names. The engraver should be instructed to be careful in engraving the names. The assembly operation also needs some improvement. It took 36 assembly operations to properly assemble 30 plaques. It may be that the plates are assembled off-register (crooked) to the backboard. This could be improved by using a fixture to properly align the plate to the backboard. Alternatively, it’s possible misengraved plaques were assembled to backboards and needed to be disassembled, reengraved, and reassembled to new backboards.

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

MAD 16–4 (FIN MAN); MAD 2–4 (MAN) a. A

Job. No. Job 102 Job 106 Job 107 Job 203 Job 205 Job 206 Job 289 Job 294 Job 295 Job 389 Job 391 Job 392 Job 570 Job 573 Job 574

Date Jan. 20 Jan. 20 Jan. 20 Apr. 21 Apr. 21 Apr. 21 July 20 July 20 July 20 Oct. 18 Oct. 18 Oct. 18 Dec. 11 Dec. 11 Dec. 11

Style Dining tables Coffee tables Chairs Dining tables Coffee tables Chairs Dining tables Coffee tables Chairs Dining tables Coffee tables Chairs Dining tables Coffee tables Chairs

Count 20 100 50 20 100 52 20 140 60 22 160 80 25 180 90

Total Direct Material Cost $ 2,000 5,000 1,250 2,020 4,950 1,295 2,688 8,484 1,872 3,102 9,600 2,400 3,690 11,016 2,700

Jan. 100% 100% 100%

July 134.4% 121.2% 124.8%

Oct. 141.0% 120.0% 120.0%

F Material Cost per Unit [Col. E ÷ Col. D] $100.00 50.00 25.00 101.00 49.50 24.90 134.40 60.60 31.20 141.00 60.00 30.00 147.60 61.20 30.00

b. Dining tables Coffee tables Chairs

Apr. 101.0% 99.0% 99.6%

Dec. 147.6% 122.4% 120.0%

Dining tables: Jan. $100 ÷ $100 Apr. $101 ÷ $100 July $134.4 ÷ $100 Oct. $141 ÷ $100 Dec. $147.6 ÷ $100 Coffee tables: Jan. $50 ÷ $50 Apr. $49.5 ÷ $50 July $60.6 ÷ $50 Oct. $60 ÷ $50 Dec. $61.2 ÷ $50 Chairs: Jan. Apr. July Oct. Dec.

$25 ÷ $25 $24.9 ÷ $25 $31.2 ÷ $25 $30 ÷ $25 $30 ÷ $25 16-34

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

MAD 16–4 (FIN MAN); MAD 2–4 (MAN) (Continued) c.

d. The cost of all styles went up in July relative to the previous months because of the change in the cost of the lumber from $5 per board foot to $6 per board foot. This may have been unavoidable and merely a function of market conditions for oak lumber. Regardless, the cause of the price increase should be investigated. However, the material cost per unit for dining tables deviated to the high side relative to the other two styles, beyond the increased cost of lumber. This must be the result of using more lumber per unit in October and December, than during January and April. The case indicates that the dining tables require more skilled workers because they are more difficult to manufacture. We see that the volume for chairs and coffee tables seemed to have dramatically increased from July to the end of the year. It is possible that this increased demand may have created labor-scheduling problems, and less experienced employees were scheduled to the dining table jobs. This might explain the increased material consumption per unit for dining tables during the remainder of the year. This hypothesis should be investigated further. Note to Instructors: While not asked in the case specifically, the material consumption pattern for dining tables is as follows: Dining Tables

Job. No. Job 102 Job 203 Job 289 Job 389 Job 570

Date Jan. 20 Apr. 21 July 20 Oct. 18 Dec. 11

Total Board Feet 400 404 448 517 615

Units 20 20 20 22 25

Material Consumption per Unit (in board feet)* 20.0 20.2 22.4 23.5 24.6

*The material consumption is the total board feet divided by the number of units in the job.

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

MAD 16–4 (FIN MAN); MAD 2–4 (MAN) (Concluded) For comparison, the other two styles are as follows: Coffee Tables

Job. No. Job 106 Job 205 Job 294 Job 391 Job 573

Date Jan. 20 Apr. 21 July 20 Oct. 18 Dec. 11

Total Board Feet 1,000 990 1,414 1,600 1,836

Units 100 100 140 160 180

Material Consumption per Unit (in board feet)* 10.0 9.9 10.1 10.0 10.2

Units 50 52 60 80 90

Material Consumption per Unit (in board feet)* 5.00 4.98 5.20 5.00 5.00

Chairs

Job. No. Job 107 Job 206 Job 295 Job 392 Job 574

Date Jan. 20 Apr. 21 July 20 Oct. 18 Dec. 11

Total Board Feet 250 259 312 400 450

*The material consumption is the total board feet divided by the number of units in the job.

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

TAKE IT FURTHER TIF 16–1 (FIN MAN); TIF 2–1 (MAN) No. Tandy’s plan is not ethical. Job order costing accumulates and records product costs by jobs. The resulting total and unit product costs can be compared to similar jobs, compared over time, or compared to expected costs. In this way, job order costing can be used by managers for cost evaluation and control. By transferring costs from corporate jobs to government jobs, Tandy’s plan would falsify the job cost information for the individual jobs. This is highly unethical and deteriorates the usefulness of job cost information for management decision making. Tandy’s plan is also illegal, as it falsely inflates the purchase price for the government jobs. This plan is a very bad idea.

TIF 16–2 (FIN MAN); TIF 2–2 (MAN) 1.

Direct labor cost: Total actual (applied) overhead, Years 1–5………………… $ 4,200,000 21,000,000 Total direct labor cost, Years 1–5…………………………… Predetermined overhead rate ($4,200,000 ÷ $21,000,000)……………………………… 20% of direct labor cost Machine cost: Total actual (applied) overhead, Years 1–5………………… $4,200,000 500,000 hours Total machine hours, Years 1–5…………………………… Predetermined overhead rate ($4,200,000 ÷ 500,000 hours)…………………………… $8.40 per machine hour

$ 13,000

$ (12,000)

$870,000 882,000

16-38

$ (17,000)

$760,000 777,000

1,640

5,000

$845,000 843,360

$845,000 840,000

$ 11,000

$935,000 924,000

$ (9,440)

$760,000 769,440

2,600

$935,000 932,400

Year 3 Direct Labor Machine Cost Hours

Year 1 Direct Labor Machine Cost Hours

$ (3,600)

$870,000 873,600

Year 4 Direct Labor Machine Cost Hours

Job Order Costing

Year 2 Direct Labor Machine Cost Hours

8,800

$790,000 781,200

$790,000 777,000

Actual overhead Applied overhead (Over-) underapplied overhead

Year 5 Direct Labor Machine Cost Hours

TIF 16–2 (FIN MAN); TIF 2–2 (MAN) (Continued)

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

TIF 16–2 (FIN MAN); TIF 2–2 (MAN) (Concluded) 3.

The best predetermined overhead rate is machine hours. Although the total overhead applied for each rate developed in part (a) is the same over the entire five-year period (as a result of the method by which the predetermined overhead rates were developed), the predetermined overhead rate based on machine hours yields the least fluctuations in the amounts of over- or underapplied overhead considered on a year-by-year basis. With the rate based on machine hours, the over- or underapplied overhead ranges from $9,440 overapplied to $8,800 underapplied. This fluctuation in the over- or underapplied overhead compares favorably with the fluctuation resulting from using the current overhead base of direct labor cost ($17,000 overapplied to $13,000 underapplied during the past five years).

TIF 16–3 (FIN MAN); TIF 2–3 (MAN) Memo To:

Carol Creedence

From:

A+ Student

Re:

Product CCR Job Cost

The graph of job costs for Product CCR indicates two significant trends in job cost. First, there appears to be a strong and consistent “Friday effect.” Unit cost increases significantly on Fridays, then falls on Monday. Each Friday effect is also larger than the previous week. There also appears to be a steady increase in the unit cost over time, with the unit cost increasing significantly over the reported time period. The Friday effect could be caused by a reduction in the efficiency of the workforce on Fridays, as it is the last day of the work week. If this is the case and the trend is not product related, then it should also appear throughout the plant. To test this explanation, management should collect job cost data for other products in the plant. If the trend appears in other products as well, it is a strong indicator that the Friday effect is related to the workforce. Additional analysis should also sort the job cost data by shift and employee. It’s possible that the effect is stronger on one shift than on another, or that just a few employees are responsible for the effect. Sorting by shift and employee will help isolate the source of the Friday effect. The increasing trend in job costs is potentially more complicated. This could be caused by any number of factors, including increased raw materials cost, decreased quality of raw materials, or decreased labor efficiency. To evaluate these potential explanations, management should collect additional data on the cost per unit of direct materials, quantity of materials used, labor and machine hours used, and overhead applied. These data will provide critical insight into the factors driving up job cost.

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

TIF 16–4 (FIN MAN); TIF 2–4 (MAN) 1.

The unit costs are influenced by both the price and quantity of inputs. On the price side, the cost of steel has dropped from $1,200 to $1,100 per ton. This is apparently the result of the purchasing manager’s decision to reduce the cost of raw materials by going to a new vendor. No other input prices change. Some of the input quantities changed for the worse. Specifically, the following: Input Quantity per Unit Job 206 Job 228 1 2.10 tons Steel input……………………………………… 3 Foundry labor…………………………………… 8.00 hours 5 Welding labor…………………………………… 11.00 hours 1 2 3 4 5 6

2.60 tons 4 10.00 hours 6 14.00 hours

105 tons ÷ 50 units 195 tons ÷ 75 units 400 hours ÷ 50 units 750 hours ÷ 75 units 550 hours ÷ 50 units 1,050 hours ÷ 75 units

These numbers were determined by dividing the total input quantities by the number of units produced to discover the inputs per unit. The inputs for the components were unchanged between the two jobs. 2.

A possible reason for this deterioration in performance is related to the purchasing manager’s decision to change vendors in order to secure a lower price per ton. The new vendor is apparently delivering a lower-quality steel product to the company. As a result, the foundry operation is spending more time forming the steel parts. Moreover, the increased steel tons per unit is likely to be caused by scrapping some of the formed parts. The scrapped parts would need to be replaced with additional steel inputs, which would have the effect of increasing the number of tons required to make a unit of product. The welding operators are also apparently having difficulty welding the lowerquality steel parts. As a result, longer welding time is required to assemble a completed unit. Overall, management has learned that the drive for a lower raw materials price was a poor decision. The overall net result was higher costs from the additional waste caused by lower-quality steel.

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

TIF 16–5 (FIN MAN); TIF 2–5 (MAN) 1.

Terrance should record the debits for factory wages as a debit to Work in Process. The factory wages are product costs that must be accumulated in the cost of producing the product. Eventually, these wage costs will become part of the finished goods inventory and the cost of goods sold when the gift items are sold. Likewise, the depreciation should be recorded as a debit to Factory Overhead. The overhead is then applied to production work in process. Like the wages, the depreciation will also eventually become part of the finished goods inventory and the cost of goods sold when the gift items are sold. Thus, both the wages and depreciation will end up on the income statement as part of the cost of goods sold, not as individual expenses. The reason is because the accountant wants to match revenues and costs. Costs that are accumulated in the manufacture of products do not become expenses until the items are sold. Until that time, the costs are capitalized as inventory. If these costs were expensed immediately, the period’s income for the firm would be understated to the extent there were any increases in the work in process or finished goods inventories.

Tanisha would not be concerned about expensing administrative wages and depreciation immediately because the benefits received from these costs are not product costs. Instead, these costs benefit a period of time. Thus, these costs should be expensed during the period.

TIF 16–6 (FIN MAN); TIF 2–6 (MAN) 1.

Sales price data for each of the different types of tanks could be incorporated into the visualization to provide management with a visual depiction of how pricing corresponds to the job costing. Additional cost data such as overhead charge rates could improve the job cost estimates.

CHAPTER 16 (FIN MAN); CHAPTER 2 (MAN)

Job Order Costing

CERTIFIED MANAGEMENT ACCOUNTANT (CMA®) EXAMINATION QUESTIONS (ADAPTED) 1. b.

Baldwin’s annual budgeted overhead is $600,000, computed as follows: Overhead cost per unit: $4.30 – ($1,000 ÷ 1,000) – ($1,500 ÷ 1,000) = $1.80 Overhead hours per unit: 450 ÷ 1,000 = 0.45 hr. Overhead budget per unit: $1.80 ÷ 0.45 = $4.00 Total overhead budget: 150,000 × $4.00 = $600,000

2. b.

Total overhead applied to Job 231 is $303, computed as follows: Tooling overhead per hour: $8,625 ÷ 460 hours = $18.75 Fabricating overhead per hour: $16,120 ÷ 620 hours = $26.00 Job 231 overhead: ($18.75 × 12) + ($26.00 × 3) = $303.00

3. c.

The unit costs for Job ICU2 would consist of direct materials, direct labor, and applied overhead per unit. Applied Overhead = Overhead Rate × Number of Machine Hours = $25 × 800 machine hours = $20,000 Cost of Goods = Sold per Unit = = =

4. d.

(Direct Materials Costs + Direct Labor Costs + Applied Overhead) ÷ Number of Units ($13,700 + $4,800 + $20,000) ÷ 7,000 units $38,500 ÷ 7,000 units $5.50 per unit

The overhead applied to a job incurring 20 direct labor hours would be $140, computed as follows: Direct labor hours: $50,000 total labor costs ÷ $5 per hour = 10,000 hours Overhead rate: $70,000 total factory overhead ÷ 10,000 direct labor hours = $7 per direct labor hour Overhead applied to a job incurring 20 direct labor hours: $7 × 20 direct labor hours = $140

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN) PROCESS COSTING DISCUSSION QUESTIONS 1.

a. An assembly-type industry using mass production methods, such as TV assembly, would use process costing because the products are somewhat standard and lose their identities as individual items. In such industries, it is neither practical nor necessary to identify output by jobs. b. Job order costing would be used by a building contractor to accumulate the costs for each individual building because the costs can be identified with each job without great difficulty. c.

Job order costing is best suited for an automobile repair shop because costs can be reasonably identified with each job.

d. Process costing would be best suited for a paper manufacturer because the processes are continuous and the products are homogeneous. e.

Job order costing is best suited for a custom jewelry manufacturer because most of the production consists of job orders and costs can be reasonably identified with each job.

Because all goods produced in process costing are identical units, it is not necessary to classify production costs into job orders.

In process costing, the direct labor and factory overhead applied are debited to the work in process accounts of the individual production departments in which they occur. The reason is that all products produced by the department are similar. Thus, there is no need to charge these costs to individual jobs. For the process manufacturer, the direct materials and conversion costs are charged to the department and divided by the completed production of the department to determine a cost per unit.

The cost per equivalent unit is frequently determined separately for direct materials and conversion costs because these two costs are frequently added at different rates in the production process. For example, materials may be incurred entirely at the beginning of the process, while conversion costs are typically incurred evenly throughout the process.

The cost per equivalent unit is used to allocate direct materials and conversion costs between completed and partially completed units.

The transferred-in cost from Blending to Filling includes the materials costs, direct labor, and applied factory overhead incurred to complete units in Blending.

The most important purpose of the cost of production report is to assist in the control of costs. This is accomplished by holding each department head responsible for the costs incurred in the department.

Cost of production reports can provide detailed data about the process. The reports can provide information on the department by individual cost elements. This can enable management to investigate problems and opportunities.

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

BASIC EXERCISES BE 17–1 (FIN MAN); BE 3–1 (MAN) Steel manufacturing Business consulting Web designer Computer chip manufacturing Candy making Designer clothes manufacturing

Process Job order Job order Process Process Job order

BE 17–2 (FIN MAN); BE 3–2 (MAN) 14,800 tons started and completed (15,600 tons completed – 800 tons beginning work in process), or (16,000 tons started – 1,200 tons ending work in process) BE 17–3 (FIN MAN); BE 3–3 (MAN)

Whole Units

Inventory in process, October 1……………………… 800 * 14,800 Started and completed during October……………… Transferred out of Rolling (completed)……………… 15,600 Inventory in process, October 31……………………… 1,200 Total units to be assigned costs……………………… 16,800

Percent Materials Added in October

Equivalent Units for Materials

0% 100%

0 14,800

100%

14,800 1,200 16,000

* 15,600 – 800 BE 17–4 (FIN MAN); BE 3–4 (MAN)

Whole Units

Inventory in process, October 1……………………… 800 Started and completed during October……………… 14,800* Transferred out of Rolling (completed)……………… 15,600 Inventory in process, October 31……………………… 1,200 Total units to be assigned costs……………………… 16,800

Percent Conversion Completed in October

Equivalent Units for Conversion

40% 100%

320 14,800

25%

15,120 300 15,420

* 15,600 – 800 BE 17–5 (FIN MAN); BE 3–5 (MAN) Direct materials cost per equivalent unit:

$6,000,000 16,000

= $375 per ton

Conversion cost per equivalent unit:

$925,200 15,420

= $60 per ton

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

BE 17–6 (FIN MAN); BE 3–6 (MAN) Direct Materials Costs

Conversion Costs

Inventory in process, balance………………………… 0 To completed inventory in process, October 1……… $ Cost of completed beginning work in process……… Started and completed during October ……………… 5,550,000 2 Transferred out of Rolling (completed)……………… Inventory in process, October 31……………………… 450,000 4 Total costs assigned by the Rolling Department.…

Total Costs

19,200 1

$ 318,560 19,200

888,0003

$ 337,760 6,438,000

$6,775,760 468,000

18,000

$7,243,760

Completed and transferred-out production…………………………………………………… $6,775,760 $468,000 Inventory in process, October 31……………………………………………………………… 1

320 × $60

14,800 × $375

14,800 × $60

1,200 × $375

300 × $60

BE 17–7 (FIN MAN); BE 3–7 (MAN) a.

1. 2.

3. b.

Work in Process—Rolling Work in Process—Casting

6,000,000

Work in Process—Rolling Factory Overhead—Rolling Wages Payable

925,200

Finished Goods Work in Process—Rolling

6,775,760

6,000,000 725,200 200,000 6,775,760

$468,000 ($318,560 + $6,000,000 + $925,200 – $6,775,760)

BE 17–8 (FIN MAN); BE 3–8 (MAN) Material cost per ton, September:

$76,000 800

= $95

Material cost per ton, October:

$77,350 850

= $91

The cost of materials has decreased by $4 per ton between September and October, indicating an improvement in the cost of materials.

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

EXERCISES Ex. 17–1 (FIN MAN); Ex. 3–1 (MAN) a.

b. c. d. e.

Work in Process—Blending Department Materials—Cocoa Materials—Sugar Materials—Dehydrated Milk

XXX

Work in Process—Molding Department Work in Process—Blending Department

XXX

Work in Process—Packing Department Work in Process—Molding Department

XXX

Finished Goods Work in Process—Packing Department

XXX

Cost of Goods Sold Finished Goods

XXX

XXX XXX XXX XXX XXX XXX XXX

Materials

Work in Process— Rolling Dept.

Work in Process— Converting Dept.

Factory Overhead— Rolling Dept.

Factory Overhead— Converting Dept.

Finished Goods— Sheared Sheet

Finished Goods— Rolled Sheet

Process Costing

17-5

Work in Process— Smelting Dept.

Factory Overhead— Smelting Dept.

Ex. 17–2 (FIN MAN); Ex. 3–2 (MAN)

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Cost of Goods Sold

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Ex. 17–3 (FIN MAN); Ex. 3–3 (MAN) a.

1. 2. 3.

Work in Process—Refining Department Materials

900,000

Work in Process—Refining Department Wages Payable

375,000

900,000 375,000

Work in Process—Refining Department Factory Overhead—Refining Department

Work in Process—Sifting Department* Work in Process—Refining Department

2,860,000 2,860,000 4,090,000 4,090,000

* $175,000 + $900,000 + $375,000 + $2,860,000 – $220,000

Ex. 17–4 (FIN MAN); Ex. 3–4 (MAN) a.

Factory overhead rate: $3,150,000 ÷ $1,800,000 = 175%

Work in Process—Blending Department Factory Overhead—Blending Department $160,000 × 175% = $280,000

$3,900 debit ($283,900 – $280,000)

Underapplied factory overhead

280,000 280,000

Ex. 17–5 (FIN MAN); Ex. 3–5 (MAN) Equivalent Units Whole Units Inventory in process, beginning (35% completed) Started and completed Transferred to Packing Department Inventory in process, ending (60% completed) Total 1 2 3

Direct Materials

Conversion

19,200 67,200 2 86,400

0 67,200 67,200

12,4801 67,200 79,680

15,200 101,600

15,200 82,400

9,120 3 88,800

19,200 units × (100% – 35%) 86,400 units – 19,200 units 15,200 units × 60%

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Ex. 17–6 (FIN MAN); Ex. 3–6 (MAN) a. Drawing Department Equivalent Units

Inventory in process, September 1 (38% completed) Started and completed in September Transferred to Winding Department in September Inventory in process, September 30 (70% completed) Total 1 2 3

Whole Units

Direct Materials

Conversion

40,000 560,000 2 600,000

0 560,000 560,000

24,800 1 560,000 584,800

52,000 652,000

52,000 612,000

36,400 3 621,200

40,000 units × (100% – 38%) 600,000 units – 40,000 units 52,000 units × 70%

b. Winding Department Equivalent Units

Inventory in process, September 1 (35% completed) Started and completed in September Transferred to finished goods in September Inventory in process, September 30 (60% completed) Total 1 2 3

Whole Units

Direct Materials

Conversion

12,000 579,000 2 591,000

0 579,000 579,000

7,8001 579,000 586,800

21,000 612,000

21,000 600,000

12,600 3 599,400

12,000 units × (100% – 35%) 591,000 units – 12,000 units 21,000 units × 60%

Note: Of the 600,000 units transferred in from Drawing, 579,000 units were started and completed in Winding and 21,000 units are in Winding ending work in process.

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Ex. 17–7 (FIN MAN); Ex. 3–7 (MAN) a.

Units in process, August 1……………………………………………………… Units placed into production for August ……………………………………… Units finished during August…………………………………………………… Units in process, August 31………………………………………………………

36,000 200,000 (196,000) 40,000

Equivalent Units

Inventory in process, August 1 (3/4 completed) Started and completed in August Transferred to finished goods in August Inventory in process, August 31 (1/2 completed) Total 1 2 3 4

Whole Units

Direct Materials

Conversion

36,000 160,000 2 196,000

0 160,000 160,000

9,000 1 160,000 169,000

40,000 236,000

40,000 3 200,000

20,000 4 189,000

36,000 units × (100% – 75%) 196,000 units – 36,000 units or 200,000 units – 40,000 units 200,000 units – 160,000 units 40,000 units × 50%

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Ex. 17–8 (FIN MAN); Ex. 3–8 (MAN) a.

$2.25 ($450,000 ÷ 200,000 units)

$4.70 [($207,900 + $680,400) ÷ 189,000 units]

$249,660, determined as follows: Work in Process—Baking Department balance, August 1……………… $207,360 Conversion costs incurred during August 42,300 (9,000 equivalent units × $4.70)…………………………………………… Cost of beginning work in process completed during August ……… $249,660

$1,112,000 [($2.25 + $4.70) × 160,000 units] Note to Instructors: The cost of the beginning work in process completed during August, $249,660 (a. 3), plus the cost of the units started and completed during August, $1,112,000 (a. 4), equal the cost of the units finished during August, $1,361,660, which is the amount of goods finished in August (Aug. 31 credit to Work in Process—Baking Department).

$184,000, determined as follows: Direct materials ($2.25 × 40,000 units)……………………………………… $ 90,000 94,000 Conversion costs ($4.70 × 20,000 equivalent units)…………………… Cost of ending work in process…………………………………………… $184,000 Note: The cost of the ending work in process is also the balance of Work in Process—Baking Department as of December 31.

The conversion costs in August increased by $0.02 per equivalent unit, determined as follows: Work in Process—Baking Department balance, August 1…………………… $207,360 Deduct direct materials cost incurred in July (81,000) ($2.25 × 36,000 units, same cost per unit as August)……………………… Conversion costs incurred in July ……………………………………………… $126,360 July conversion cost per equivalent unit [$126,360 ÷ (36,000 units × 3/4)]…………………………………………………

$ 4.68

August conversion cost per equivalent unit…………………………………… Less July conversion cost per equivalent unit………………………………… Increase in conversion cost per equivalent unit………………………………

$ 4.70 (4.68) $ 0.02

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Ex. 17–9 (FIN MAN); Ex. 3–9 (MAN) Equivalent units of production: Cereal (in pounds)

Inventory in process, March 1……………… 0 96,900 Started and completed in March…………… Transferred to finished goods in March……………………………………… 96,900 900 Inventory in process, March 31…………… 97,800 Total……………………………………………

Boxes (in boxes)

Conversion Cost (in boxes)

0 64,600

800 64,600

64,600 600 65,200

65,400 0 65,400

Supporting explanation: The whole unit inventory in process on March 1 includes both the cereal in the hopper and the boxes in the carousel and, thus, includes no equivalent units for the material during the current period. The reason is because the costs for the cereal and boxes were introduced to the Packing Department in February. Because conversion costs are incurred only when the cereal is filled into boxes, all 800 boxes of the March 1 inventory in process will have conversion costs incurred in March. The product started and completed in March includes 64,600 boxes (65,400 boxes completed less the 800 in the carousel on March 1). These boxes represent 96,900 pounds of cereal [64,600 × (24 oz. ÷ 16 oz.)] because there are 16 ounces to a pound. The inventory in process on March 31 includes the remaining pounds of cereal in the hopper and boxes in the carousel that are properly included in the equivalent unit computation for March (because the costs were incurred in the department in March). No conversion costs have been applied to these boxes because they remain unfilled. Note to Instructors: An actual cereal-filling line begins with the empty box carousel. The box carousel holds flattened boxes that are fed into a high-speed line that opens the box up and places it on a conveyor. The conveyor brings the opened box under a filler head. The cereal pours from the hopper through the filler head into the open box (actually into the inner sealer bag). The box then moves down the line to be boxed into a large shipping carton, which is then moved to the warehouse.

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Ex. 17–10 (FIN MAN); Ex. 3–10 (MAN) a.

Direct labor…………………………………………………………………………… $127,150 Factory overhead applied………………………………………………………… 221,450 Total conversion cost……………………………………………………………… $348,600

Equivalent units of production for conversion costs: Beginning inventory…………………………………………………………… 0 Started and completed………………………………………………………… 120,000 4,500 Ending inventory (3/5 × 7,500 units)………………………………………… Total equivalent units for conversion costs………………………………… 124,500 Conversion cost per equivalent unit: $348,600 124,500

= $2.80 conversion cost per equivalent unit

Equivalent units of production for direct materials costs: Beginning inventory…………………………………………………………… 0 Started and completed………………………………………………………… 120,000 7,500 Ending inventory (all units completed as to direct materials)…………… Total equivalent units for direct materials costs…………………………… 127,500 Direct materials cost per equivalent unit: $61,200 127,500

= $0.48 direct materials cost per equivalent unit

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Ex. 17–11 (FIN MAN); Ex. 3–11 (MAN) a.

30,000 400,000 (406,000) 24,000

Units in process at beginning of period…………………………………… Units placed in production during period………………………………… Units finished during period………………………………………………… Units in process at end of period……………………………………………

b. Whole Units

Inventory in process, beginning (40% completed) Started and completed Transferred to finished goods Inventory in process, ending (30% completed) Total units 1 2 3

Equivalent Units Direct Materials Conversion

30,000 376,000 2 406,000

0 376,000 376,000

18,0001 376,000 394,000

24,000 430,000

24,000 400,000

7,200 3 401,200

30,000 units × (100% – 40%) 400,000 units – 24,000 units 24,000 units × 30%

Costs

Total costs for period in Assembly Department Total equivalent units (from above) Cost per equivalent unit

Direct Materials

Conversion

$4,500,000 ÷ 400,000 $ 11.25

$24,072,000* ÷ 401,200 $ 60.00

* $4,012,000 + $20,060,000 d.

$26,790,000 [($11.25 + $60.00) × 376,000 units]

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Ex. 17–12 (FIN MAN); Ex. 3–12 (MAN) a.

$2,155,500; determined as follows: Beginning work in process balance……………………………………… $1,075,500 Conversion costs incurred during period 1,080,000 (18,000 equivalent units × $60.00)……………………………………… Cost of beginning work in process completed during period……… $2,155,500

Cost of beginning work in process……………………………………… $ 2,155,500 Cost of units started and completed during period*………………… 26,790,000 Cost of units transferred to finished goods during period………… $28,945,500 * ($11.25 + $60.00) × 376,000 units

$702,000; determined as follows: Direct materials ($11.25 × 24,000 units)………………………………… Conversion costs ($60.00 × 7,200 equivalent units)…………………… Cost of ending work in process inventory………………………………

$270,000 432,000 $702,000

Note: The cost of the ending work in process is also the ending balance of Work in Process—Assembly Department. 4.

$71.85 ($2,155,500 ÷ 30,000 units)

Yes. The production costs per unit decreased during the current period. The cost per unit of the units started and completed during the period is $71.25 ($11.25 + $60.00). Because the cost per unit of the beginning work in process is $71.85 [see a. 4 above], the production costs during the current period must have decreased.

The conversion cost in the current period decreased by $1.50 per equivalent unit, determined as follows: Beginning work in process……………………………………………………… $1,075,500 Deduct direct materials cost incurred in prior period (337,500) ($11.25 × 30,000 units, cost per unit unchanged)………………………… Conversion costs incurred in prior period…………………………………… $ 738,000 Current-period conversion cost per equivalent unit……………………… Less prior-period conversion cost per equivalent unit [$738,000 ÷ (30,000 units × 40%)]…………………………………………… Decrease in conversion cost per equivalent unit during current period……………………………………………………………………

$ 60.00 (61.50) $ (1.50)

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Ex. 17–13 (FIN MAN); Ex. 3–13 (MAN) The errors are listed below. 1. In computing the equivalent units for conversion costs applicable to the June 1 inventory, the 6,400 units are multiplied by 3/5 rather than 2/5, which is the portion of the work completed in June. Therefore, the equivalent units should be 2,560 (6,400 × 2/5) instead of 3,840. 2.

In computing the equivalent units for conversion costs for units started and completed in June, the June 1 inventory of 6,400 units, rather than the June 30 inventory of 5,200 units, was subtracted from 55,000 units started in the department during June. Therefore, the equivalent units started and completed should be 49,800 instead of 48,600.

The correct equivalent units for conversion costs should be 53,400, instead of 53,480, as computed below. To process units in inventory on June 1: 6,400 × 2/5………………………………………………………………………… 2,560 To process units started and completed in June: 55,000 – 5,200…………………………………………………………………… 49,800 To process units in inventory on June 30: 5,200 × 1/5………………………………………………………………………… 1,040 Equivalent units of production………………………………………………… 53,400

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Ex. 17–14 (FIN MAN); Ex. 3–14 (MAN) a.

24,800 units (1,800 + 25,800 – 2,800)

b. Whole Units

Inventory in process, June 1 (60% completed) Started and completed in June Transferred to next department in June Inventory in process, June 30 (70% completed) Total units 1 2 3

Equivalent Units Direct Materials Conversion

1,800 23,000 2 24,800

0 23,000 23,000

720 1 23,000 23,720

2,800 27,600

2,800 25,800

1,960 3 25,680

1,800 units × (100% – 60%) 25,800 – 2,800 2,800 units × 70%

Costs

Total costs for June in Forging Department Total equivalent units (from above) Cost per equivalent unit

Direct Materials

Conversion

$247,680 ÷ 25,800 $ 9.60

$77,040 * ÷ 25,680 $ 3.00

* $43,300 + $33,740 c.

$289,800 [23,000 units × ($9.60 + $3.00)]

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Ex. 17–15 (FIN MAN); Ex. 3–15 (MAN) a.

$23,292; determined as follows: Beginning work in process balance……………………………………………… Conversion costs incurred during June (720 equivalent units × $3.00)…………………………………………………… Cost of beginning work in process completed during June…………………

$21,132 2,160 $23,292

Cost of beginning work in process……………………………………………… $ 23,292 Cost of units started and completed during June*…………………………… 289,800 Cost of units transferred to next department during period………………… $313,092 * ($9.60 + $3.00) × 23,000 units

$32,760; determined as follows: Direct materials ($9.60 × 2,800 units)…………………………………………… Conversion costs ($3.00 × 1,960 equivalent units)…………………………… Cost of ending work in process inventory………………………………………

$26,880 5,880 $32,760

Note: The cost of the ending work in process is also the ending balance of the Work in Process—Forging Department as of June 30. d.

Direct materials cost per equivalent unit: $10.00 ($18,000 ÷ 1,800 units) Conversion cost per equivalent unit: $2.90 ($3,132* ÷ 1,080 units**) * Work in process, June 1……………………………………………………… Less direct materials cost……………………………………………………… Conversion cost included in June 1, work in process……………………

$ 21,132 (18,000) $ 3,132

** Equivalent units in June 1, work in process (1,800 × 60%) = 1,080 units e.

Direct materials: Decrease of $0.40 ($9.60 – $10.00) Conversion: Increase of $0.10 ($3.00 – $2.90)

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Ex. 17–16 (FIN MAN); Ex. 3–16 (MAN) a. Morning Brew Coffee Company Cost of Production Report—Roasting Department For the Month Ended August 31 Equivalent Units

Units charged to production: Inventory in process, August 1 Received from materials storeroom Total units accounted for by the Roasting Department

700 13,900 2 14,600

0 13,900 13,900

560 1 13,900 14,460

400 15,000

400 14,300

168 3 14,628

700 14,300 15,000

Units to be assigned costs: Inventory in process, August 1 (20% completed) Started and completed in August Transferred to finished goods in August Inventory in process, August 31 (42% completed) Total units to be assigned costs

Conversion (1)

Whole Units

UNITS

Direct Materials (1)

700 units × (100% – 20%) 14,300 units – 400 units 400 units × 42%

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Ex. 17–16 (FIN MAN); Ex. 3–16 (MAN) (Concluded) Costs COSTS

Direct Materials

Conversion

Costs per equivalent unit: Total costs for August in Roasting Department Total equivalent units Cost per equivalent unit (2)

$65,780 ÷ 14,300 $ 4.60

$21,942 ÷ 14,628 $ 1.50

Costs assigned to production: Inventory in process, August 1 Costs incurred in August Total costs accounted for by the Roasting Department

$ 3,479 87,722 1 $91,201

Costs allocated to completed and partially completed units: Inventory in process, August 1 balance To complete inventory in process, August 1 Cost of completed August 1 work in process Started and completed in August Transferred to finished goods in August (3) Inventory in process, August 31 (4) Total costs assigned by the Roasting Department 1 2 3 4 5 6

Total

$ 3,479 $

840 2

63,940 3

20,850 4

1,840 5

252 6

840 $ 4,319 84,790 $89,109 2,092 $91,201

$65,780 + $21,942 560 units × $1.50 13,900 units × $4.60 13,900 units × $1.50 400 units × $4.60 168 units × $1.50

Materials:

From current period……………………………………………… From beginning inventory……………………………………… Decrease……………………………………………………………

$ 4.60 (4.70) $(0.10)

Conversion: From current period……………………………………………… $ 1.50 (1.35) From beginning inventory……………………………………… Increase……………………………………………………………… $ 0.15 The cost per equivalent unit of materials decreased by $0.10 per pound, and the cost per equivalent unit of conversion cost increased by $0.15 per pound. Management may wish to investigate the causes for the increase in the conversion cost. 17-18 © 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Ex. 17–17 (FIN MAN); Ex. 3–17 (MAN) a. Karachi Carpet Company Cost of Production Report—Cutting Department For the Month Ended January 31 Equivalent Units Whole Units

UNITS Units charged to production: Inventory in process, January 1 Received from Weaving Department Total units accounted for by the Cutting Department

2 3

Conversion

1,400 54,800 2

0 54,800

350 1 54,800

56,200

54,800

55,150

3,200 59,400

3,200 58,000

960 3 56,110

1,400 58,000 59,400

Units to be assigned costs: Inventory in process, January 1 (75% completed) Started and completed in January Transferred to finished goods in January Inventory in process, January 31 (30% completed) Total units to be assigned costs 1

Direct Materials

1,400 units × (100% – 75%) 58,000 units – 3,200 units 3,200 units × 30%

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Ex. 17–17 (FIN MAN); Ex. 3–17 (MAN) (Concluded) Costs COSTS Costs per equivalent unit: Total costs for January in Cutting Department Total equivalent units Cost per equivalent unit

Direct Materials

Conversion

$742,400 ÷ 58,000

$286,161 1 ÷ 56,110

12.80

5.10

Costs assigned to production: Inventory in process, January 1 Costs incurred in January

Total costs accounted for by the Cutting Department

Cost of completed January 1 work in process Started and completed in January Transferred to finished goods in January Inventory in process, January 31

3 4 5 6 7

22,960

24,745

1,785 3

1,785

$701,440 4

279,480 5

980,920

40,960 6

4,896 7

$1,005,665 45,856

Total costs assigned by the Cutting Department

22,960 1,028,561 2

$1,051,521

Cost allocated to completed and partially completed units: Inventory in process, January 1 balance To complete inventory in process, January 1

Total

$1,051,521

$134,550 + $151,611 $742,400 + $134,550 + $151,611 350 units × $5.10 54,800 units × $12.80 54,800 units × $5.10 3,200 units × $12.80 960 units × $5.10

Materials:

From current period…………………………………………… From beginning inventory…………………………………… Increase…………………………………………………………

$ 12.80 (12.65) $ 0.15

Conversion:

$ 5.10 (5.00) $ 0.10

The cost per equivalent unit of materials increased by $0.15 per unit, and the cost per equivalent unit of conversion cost increased by $0.10 per unit. Management may wish to investigate the causes for these changes in cost. 17-20 © 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Ex. 17–18 (FIN MAN); Ex. 3–18 (MAN) a.

1. 2.

Work in Process—Casting Department Materials—Alloy

350,000

Work in Process—Casting Department Wages Payable Factory Overhead*

49,600

350,000 19,840 29,760

* $19,840 × 150% 3.

Work in Process—Machining Department* Work in Process—Casting Department

402,684 402,684

* Supporting calculations: Cost of 2,530 transferred-out pounds: Inventory in process, May 1………………………………………………………… $ 32,844 Cost to complete May 1 inventory: 1,840 92 pounds × $20/lb. (see calculations below)………………………………… Pounds started and completed in May [2,300 lbs. × ($140 + $20)]………………………………………………………… 368,000 Transferred to Machining Department…………………………………………… $402,684 Supporting equivalent unit and cost per equivalent unit calculations: Equivalent Units

Inventory in process, May 1 (60% completed) Started and completed in May Transferred to Machining Department in May Inventory in process, May 31 (44% completed) Total 1 2 3 4

Whole Units

Materials

Conversion

230 2,300 2

0 2,300

92 1 2,300

2,530

2,300

2,392

200 3 2,730

200 2,500

88 4 2,480

230 units × (100% – 60%) 2,530 units – 230 units 230 units + 2,500 units – 2,530 units 200 units × 44%

Cost per equivalent unit of materials:

$350,000 2,500

= $140 per pound

Cost per equivalent unit of conversion:

$49,600 2,480

= $20 per pound

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Ex. 17–18 (FIN MAN); Ex. 3–18 (MAN) (Concluded) b.

$29,760; determined as follows: Direct materials (200 × $140)……………………………… $28,000 1,760 Conversion (200 × 44% × $20)…………………………… $29,760 or $29,760 = $32,844 + $350,000 + $49,600 – $402,684

Materials:

From current period…………………………………… From beginning inventory……………………………… Increase……………………………………………………

$ 140 (132) $ 8

Conversion:

From current period…………………………………… From beginning inventory……………………………… Increase……………………………………………………

$ 20 (18) $ 2

The cost per equivalent unit of materials increased by $8 per pound, and the cost per equivalent unit of conversion cost increased by $2 per pound. Management may wish to investigate the causes for these increases in cost.

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Ex. 17–19 (FIN MAN); Ex. 3–19 (MAN) a.

1. 2.

Work in Process—Papermaking Department Materials—Pulp

330,750

Work in Process—Papermaking Department Wages Payable Factory Overhead

95,355

Work in Process—Converting Department* Work in Process—Papermaking Department

420,925

330,750 40,560 54,795 420,925

* Supporting calculations: Cost of 103,900 transferred-out units: Inventory in process, March 1……………………………………………………… Cost to complete March 1 inventory: 1,690 units × $0.90/unit (see calculations below)……………………………… Pounds started and completed in March [101,300 units × ($3.15 + $0.90)]………………………………………………… Transferred to Converting Department……………………………………………

9,139 1,521

410,265 $420,925

Supporting equivalent unit and cost per equivalent unit calculations: Equivalent Units

Inventory in process, March 1 (35% completed) Started and completed in March Transferred to Converting Department in March Inventory in process, March 31 (80% completed) Total 1 2

Whole Units

Materials

Conversion

2,600 101,300

0 101,300

1,690 1 101,300

103,900

101,300

102,990

3,700 107,600

3,700 105,000

2,960 2 105,950

2,600 units × (100% – 35%) 3,700 units × 80%

Cost per equivalent unit of materials:

$330,750 105,000

= $3.15 per unit

Cost per equivalent unit of conversion:

$95,355 105,950

= $0.90 per unit

$14,319; determined as follows: Direct materials (3,700 × $3.15)……………… Conversion (3,700 × 80% × $0.90)……………

$11,655 2,664 $14,319

or $14,319 = $9,139 + $330,750 + $95,355 – $420,925

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Ex. 17–20 (FIN MAN); Ex. 3–20 (MAN) a. Cost per megawatt hour (MWh): Fossil plant costs: Conversion costs…………………………………… Fuel…………………………………………………… Total…………………………………………………… Fossil plant megawatt hours (MWh): Megawatts…………………………………………… × Hours………………………………………………… Total…………………………………………………… Cost per Megawatt Hour = Wind farm costs: Conversion costs…………………………………… Wind farm megawatt hours (MWh): Megawatts…………………………………………… × Hours………………………………………………… Total…………………………………………………… Cost per Megawatt Hour =

$40,500,000 10,800,000 $51,300,000 900 600 540,000 MWhs $51,300,000 540,000

= $95 per MWh

$2,700,000 100 300 30,000 MWhs $2,700,000 30,000

= $90 per MWh

The wind farm, with a cost per megawatt hour of $90 as compared to the fossil plant cost of $95 per megawatt hour, is the less costly resource. Note: These figures are close to the national average and show the slight advantage of wind farms. b. Equivalent units of production are calculated when there are beginning or ending inventories that are partially completed to either conversion costs or materials. There are no beginning or ending inventories for generating electricity; thus, there is no need to determine equivalent units of production. c. While the wind farm has a cost advantage over the fossil fuel plant, the wind farm is subject to the presence of wind. Thus, the wind farm is not as reliable as the fossil fuel plant for generating electricity. The fossil fuel plant can be turned on and off on a schedule, while the wind farm is subject to the varieties of nature.

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Appendix Ex. 17–21 (FIN MAN); Appendix Ex. 3–21 (MAN) a. and b. a. Whole Units

Units to be accounted for: Beginning work in process Units started during period Total

4,500 31,3001 35,800

Units to be assigned costs: Transferred to Packing Department Inventory in process, ending (30% completed) Total 1 2

b. Equivalent Units of Production

32,000

3,800 35,800

1,140 2 33,140

32,000 units – 4,500 units + 3,800 units 30% × 3,800 units

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Appendix Ex. 17–22 (FIN MAN); Appendix Ex. 3–22 (MAN) a.

Drawing Department Whole Units

Units to be accounted for: Beginning work in process Units started during period Total

500 11,600 1 12,100

Units to be assigned costs: Transferred to Winding Department in July Inventory in process, July 31 (55% completed) Total 1 2

Equivalent Units of Production

11,400

700 12,100

385 2 11,785

11,400 units – 500 units + 700 units 55% × 700 units

Winding Department Whole Units

Units to be accounted for: Beginning work in process Units started during period Total

350 11,400 1 11,750

Units to be assigned costs: Transferred to finished goods in July Inventory in process, July 31 (25% completed) Total 1 2

Equivalent Units of Production

10,950

800 11,750

200 2 11,150

10,950 units – 350 units + 800 units 25% × 800 units

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Appendix Ex. 17–23 (FIN MAN); Appendix Ex. 3–23 (MAN) a.

Units in process, May 1…………………………………………………………… Units placed into production for May………………………………………… Units finished during May………………………………………………………… Units in process, May 31…………………………………………………………

b. Whole Units

Units to be accounted for: Beginning work in process Units started during the period Total

8,000 40,000 (41,800) 6,200 Equivalent Units of Production

8,000 40,000 48,000

Units to be assigned costs: Transferred to finished goods in May Inventory in process, May 31 (30% completed) Total

41,800

6,200 48,000

1,860* 43,660

* 30% × 6,200 units

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Appendix Ex. 17–24 (FIN MAN); Appendix Ex. 3–24 (MAN) a. and b. a. Whole Units

Units to be accounted for: Beginning work in process Units started during the period Total

900 8,400 9,300

Units to be assigned costs: Transferred to finished goods Inventory in process, ending Total units

8,100 1,200 9,300

b. Equivalent Units of Production

* 60% × 1,200 units c.

Cost per Equivalent Unit =

Total Production Costs Total Equivalent Units

Cost per Equivalent Unit =

$61,740* 8,820 units

= $7.00

* $2,466 + $34,500 + $16,200 + $8,574 d.

Cost of units transferred to Finished Goods: $56,700 (8,100 units × $7.00)

Cost of units in ending Work in Process: $5,040 (1,200 units × 60% × $7.00)

8,100 720 * 8,820

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Appendix Ex. 17–25 (FIN MAN); Appendix Ex. 3–25 (MAN) a. Whole Units

Units to be accounted for: Beginning work in process Units started during the period Total

Equivalent Units of Production

500 3,700 4,200

Units to be assigned costs: Transferred to finished goods in June Inventory in process, June 30 (70% completed) Total units

3,600

600 4,200

420 * 4,020

* 70% × 600 units Cost per Equivalent Unit =

Total Production Costs Total Equivalent Units

Cost per Equivalent Unit =

$104,520** 4,020 units

= $26.00

** $5,000 + $49,200 + $25,200 + $25,120 b.

Cost of units transferred to Finished Goods: $93,600 (3,600 units × $26.00)

Cost of units in ending Work in Process: $10,920 (600 units × 70% × $26.00)

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Appendix Ex. 17–26 (FIN MAN); Appendix Ex. 3–26 (MAN) Highlands Coffee Company Cost of Production Report—Roasting Department For the Month Ended May 31 Whole Units

UNITS

Units charged to production: Inventory in process, May 1 Received from materials storeroom Total units accounted for by the Roasting Department

Equivalent Units of Production

1,150 10,900 12,050

Units to be assigned costs: Transferred to finished goods in May Inventory in process, May 31 (80% completed) Total units to be assigned costs

11,250

800 12,050

640* 11,890

* 80% × 800 units COSTS

Costs

Cost per equivalent unit: Total costs for May in Roasting Department Total equivalent units Cost per equivalent unit

$42,8041 ÷ 11,890 $ 3.60

Costs assigned to production: Inventory in process, May 1 Costs incurred in May Total costs accounted for by the Roasting Department

$ 1,700 41,1042 $42,804

Costs allocated to completed and partially completed units: Transferred to finished goods in May (11,250 units × $3.60) Inventory in process, May 31 (800 units × 80% × $3.60) Total costs assigned by the Roasting Department

$40,500 2,304 $42,804

1 $1,700 + $28,600 + $12,504 2 $28,600 + $12,504

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Appendix Ex. 17–27 (FIN MAN); Appendix Ex. 3–27 (MAN) Dalton Carpet Company Cost of Production Report—Cutting Department For the Month Ended January 31 Whole Units

UNITS

Units charged to production: Inventory in process, January 1 Received from Weaving Department Total units accounted for by the Cutting Department Units to be assigned costs: Transferred to finished goods in January Inventory in process, January 31 (10% completed) Total units to be assigned costs

Equivalent Units of Production

3,400 64,000 67,400 63,500

63,500

3,900 67,400

390 * 63,890

* 10% × 3,900 units COSTS

Cost per equivalent unit: Total costs for January in Cutting Department Total equivalent units Cost per equivalent unit

$575,010 1 ÷ 63,890 $ 9.00

Costs assigned to production: Inventory in process, January 1 Costs incurred in January Total costs accounted for by the Cutting Department

$ 23,000 552,010 2 $575,010

Costs allocated to completed and partially completed units: Transferred to finished goods in January (63,500 units × $9.00) Inventory in process, January 31 (3,900 units × 10% × $9.00) Total costs assigned by the Cutting Department 1 2

$571,500 3,510 $575,010

$23,000 + $366,200 + $105,100 + $80,710 $366,200 + $105,100 + $80,710

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

PROBLEMS Prob. 17–1A (FIN MAN); Prob. 3–1A (MAN) 1.

a. b.

g. h. i.

Materials Accounts Payable

500,000

Work in Process—Spinning Department Work in Process—Tufting Department Factory Overhead—Spinning Department Factory Overhead—Tufting Department Materials

275,000 110,000 46,000 39,500

Work in Process—Spinning Department Work in Process—Tufting Department Factory Overhead—Spinning Department Factory Overhead—Tufting Department Wages Payable

185,000 98,000 18,500 9,000

Factory Overhead—Spinning Department Factory Overhead—Tufting Department Accumulated Depreciation

12,500 8,500

Factory Overhead—Spinning Department Factory Overhead—Tufting Department Prepaid Insurance

2,000 1,000

Work in Process—Spinning Department Work in Process—Tufting Department Factory Overhead—Spinning Department Factory Overhead—Tufting Department

80,000 55,000

Work in Process—Tufting Department Work in Process—Spinning Department

547,000

Finished Goods Work in Process—Tufting Department

807,200

Cost of Goods Sold Finished Goods

795,200

500,000

470,500

310,500

21,000

3,000

80,000 55,000 547,000 807,200 795,200

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–1A (FIN MAN); Prob. 3–1A (MAN) (Concluded) 2. Materials

Balance, January 1…… $ 17,000 Debits…………………… 500,000 Credits………………… (470,500) Balance, January 31… $ 46,500 1 2

Work in Process— Spinning Dept.

Work in Process— Tufting Dept.

Finished Goods

$ 35,000 540,0001 (547,000)

$ 28,500 810,000 2 (807,200)

$ 62,000 807,200 (795,200)

$ 28,000

$ 31,300

$ 74,000

$275,000 + $185,000 + $80,000 $110,000 + $98,000 + $55,000 + $547,000

Factory Overhead— Spinning Dept.

1 2

Balance, January 1…… Debits…………………… Credits…………………

0 79,000 1 (80,000)

Balance, January 31…

$ (1,000) Cr.

Factory Overhead— Tufting Dept.

0 58,000 2 (55,000) $ 3,000 Dr.

$46,000 + $18,500 + $12,500 + $2,000 $39,500 + $9,000 + $8,500 + $1,000

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–2A (FIN MAN); Prob. 3–2A (MAN) 1. Lui Coffee Company Cost of Production Report—Roasting Department For the Month Ended March 31 Equivalent Units Whole Units

UNITS

Units charged to production: Inventory in process, March 1 Received from materials storeroom Total units accounted for by the Roasting Department

2 3 4

Conversion

25,000 580,000 2 605,000

0 580,000 580,000

22,500 1 580,000 602,500

20,000 3 625,000

20,000 600,000

9,000 4 611,500

25,000 600,000 625,000

Units to be assigned costs: Inventory in process, March 1 (10% completed) Started and completed in March Transferred to Packing Department in March Inventory in process, March 31 (45% completed) Total units to be assigned costs 1

Direct Materials

25,000 units × (100% – 10%) 600,000 units – 20,000 units or 605,000 units – 25,000 units 25,000 units + 600,000 units – 605,000 units 20,000 units × 45%

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–2A (FIN MAN); Prob. 3–2A (MAN) (Continued) Costs COSTS

Direct Materials

Conversion

Cost per equivalent unit: Total costs for March in Roasting Department Total equivalent units Cost per equivalent unit

$450,000 ÷ 600,000 $ 0.75

$660,420 1 ÷ 611,500 $ 1.08

Costs assigned to production: Inventory in process, March 1 Costs incurred in March Total costs accounted for by the Roasting Department

Total

21,250 1,110,420 2

$1,131,670

Costs allocated to completed and partially completed units: Inventory in process, March 1 balance To complete inventory in process, March 1 Cost of completed March 1 work in process Started and completed in March Transferred to Packing Department in March Inventory in process, March 31 Total costs assigned by the Roasting Department

21,250

24,300 45,550

$ 24,300 3

435,000 4

626,400 5

1,061,400

15,000 6

9,720 7

$1,106,950 24,720 $1,131,670

Costs transferred to Packing Department: $1,106,950 Work in process, March 31: 20,000 units at a cost of $24,720 1 2 3 4 5 6 7

$244,600 + $415,820 $450,000 + $244,600 + $415,820 22,500 units × $1.08 580,000 units × $0.75 580,000 units × $1.08 20,000 units × $0.75 9,000 units × $1.08

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–2A (FIN MAN); Prob. 3–2A (MAN) (Concluded) 2.

Direct materials cost increased from $0.74 in February to $0.75 in March. Conversion cost decreased from $1.10 in February to $1.08 in March. Computations: Direct materials: Conversion:

$0.74 ($18,500 ÷ 25,000 units) $1.10; determined as follows:

March 1, work in process……………………………………………… Less direct materials…………………………………………………… Conversion costs…………………………………………………………

$ 21,250 (18,500) $ 2,750

Conversion cost equivalent units: (25,000 × 10%) = 2,500 units Conversion cost per equivalent unit: $1.10 ($2,750 ÷ 2,500)

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–3A (FIN MAN); Prob. 3–3A (MAN) 1. White Diamond Flour Company Cost of Production Report—Sifting Department For the Month Ended July 31 Equivalent Units Whole Units

UNITS

Units charged to production: Inventory in process, July 1 Received from Milling Department Total units accounted for by the Sifting Department

2 3

Conversion

900 14,600 2

0 14,600

360 1 14,600

15,500

14,600

14,960

1,100 16,600

1,100 15,700

880 3 15,840

900 15,700 16,600

Units to be assigned costs: Inventory in process, July 1 (3/5 completed) Started and completed in July Transferred to Packaging Department in July Inventory in process, July 31 (4/5 completed) Total units to be assigned costs 1

Direct Materials

900 units × (1 – 3/5) 15,700 units – 1,100 units or 15,500 – 900 1,100 units × 4/5

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–3A (FIN MAN); Prob. 3–3A (MAN) (Continued) Costs COSTS

Direct Materials

Conversion

Cost per equivalent unit: Total costs for July in Sifting Department Total equivalent units Cost per equivalent unit

$33,755 ÷15,700 $ 2.15

$ 7,128 1 ÷15,840 $ 0.45

Costs assigned to production: Inventory in process, July 1 Costs incurred in July Total costs accounted for by the Sifting Department

$ 2,061 40,883 2 $42,944

Costs allocated to completed and partially completed units: Inventory in process, July 1 balance To complete inventory in process, July 1 Cost of completed July 1 work in process Started and completed in July Transferred to Packaging Department in July Inventory in process, July 31 Total costs assigned by the Sifting Department 1 2 3 4 5 6 7

Total

$ 2,061 162 3

162

31,390 4

6,570 5

$ 2,223 37,960

2,365 6

396 7

$40,183 2,761

$42,944

$4,420 + $2,708 $33,755 + $4,420 + $2,708 360 units × $0.45 14,600 units × $2.15 14,600 units × $0.45 1,100 units × $2.15 880 units × $0.45

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–3A (FIN MAN); Prob. 3–3A (MAN) (Concluded) 2.

Work in Process—Sifting Department Work in Process—Milling Department

33,755

Work in Process—Packaging Department Work in Process—Sifting Department

40,183

33,755 40,183

Direct materials: Conversion:

$0.10 increase ($2.15 – $2.05) $0.05 increase ($0.45 – $0.40)

The cost of production report may be used as the basis for allocating product costs between Work in Process and Transferred-Out (or Finished) Goods. The report can also be used to control costs by holding each department head responsible for the units entering production and the costs incurred in the department. Any differences in unit product costs from one month to another, such as those in part (3), can be studied carefully and any significant differences investigated.

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–4A (FIN MAN); Prob. 3–4A (MAN) 1. and 2. Work in Process—Filling Balance Date Apr.

May

Item 1 30 30 30 30 30 31 31 31 31 31

Dr.

Bal., 800 units, 30% completed Cooking Dept., 7,800 units at $4.40 Direct labor Factory overhead Finished goods* Bal., 550 units, 90% completed Cooking Dept., 9,600 units at $4.60 Direct labor Factory overhead Finished goods* Bal., 300 units, 35% completed

Cr.

34,320 8,562 6,387 49,818 44,160 12,042 6,878 64,801

Dr. 3,860 38,180 46,742 53,129 3,311 3,311 47,471 59,513 66,391 1,590 1,590

* The credits are determined from the supporting cost of production reports.

Cr.

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–4A (FIN MAN); Prob. 3–4A (MAN) (Continued) Hearty Soup Co. Cost of Production Report—Filling Department For the Month Ended April 30 Equivalent Units

Units charged to production: Inventory in process, April 1 Received from Cooking Department Total units accounted for by the Filling Department

800 7,250 2 8,050

0 7,250 7,250

560 1 7,250 7,810

550 8,600

550 7,800

495 3 8,305

800 7,800 8,600

Units to be assigned costs: Inventory in process, April 1 (30% completed) Started and completed in April Transferred to finished goods in April Inventory in process, April 30 (90% completed) Total units to be assigned costs

Conversion (a)

Whole Units

UNITS

Direct Materials (a)

800 units × (100% – 30%) 7,800 units – 550 units 550 units × 90%

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–4A (FIN MAN); Prob. 3–4A (MAN) (Continued) Costs COSTS

Direct Materials

Conversion

Cost per equivalent unit: Total costs for April in Filling Department Total equivalent units Cost per equivalent unit (b)

$34,320 ÷ 7,800 $ 4.40

$14,949 1 ÷ 8,305 $ 1.80

Costs assigned to production: Inventory in process, April 1 Costs incurred in April Total costs accounted for by the Filling Department

$ 3,860 49,269 2 $53,129

Costs allocated to completed and partially completed units: Inventory in process, April 1 balance (c) To complete inventory in process, April 1 (c) Cost of completed April 1 work in process Started and completed in April (c) Transferred to finished goods in April (c) Inventory in process, April 30 (d) Total costs assigned by the Fillng Department 1 2 3 4 5 6 7

Total

$ 3,860 $

$ 1,008 3

31,900

2,420 6

13,050

891 7

1,008 $ 4,868 44,950 $49,818 3,311 $53,129

$8,562 + $6,387 $34,320 + $8,562 + $6,387 560 units × $1.80 7,250 units × $4.40 7,250 units × $1.80 550 units × $4.40 495 units × $1.80

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–4A (FIN MAN); Prob. 3–4A (MAN) (Continued) 2. Hearty Soup Co. Cost of Production Report—Filling Department For the Month Ended May 31 Equivalent Units

Units charged to production: Inventory in process, May 1 Received from Cooking Department Total units accounted for by the Filling Department

550 9,300 2 9,850

0 9,300 9,300

55 1 9,300 9,355

300 10,150

300 9,600

105 3 9,460

550 9,600 10,150

Units to be assigned costs: Inventory in process, May 1 (90% completed) Started and completed in May Transferred to finished goods in May Inventory in process, May 31 (35% completed) Total units to be assigned costs

Conversion (a)

Whole Units

UNITS

Direct Materials (a)

550 units × (100% – 90%) 9,600 units – 300 units 300 units × 35%

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–4A (FIN MAN); Prob. 3–4A (MAN) (Concluded) Costs COSTS

Direct Materials

Conversion

Cost per equivalent unit: Total costs for May in Filling Department Total equivalent units Cost per equivalent unit (b)

$44,160 ÷ 9,600 $ 4.60

$18,920 1 ÷ 9,460 $ 2.00

Costs charged to production: Inventory in process, May 1 Costs incurred in May Total costs accounted for by the Filling Department

$ 3,311 63,080 2 $66,391

Costs allocated to completed and partially completed units: Inventory in process, May 1 balance (c) To complete inventory in process, May 1 (c) Cost of completed May 1 work in process Started and completed in May (c) Transferred to finished goods in May (c) Inventory in process, May 31 (d) Total costs assigned by the Filling Department 1 2 3 4 5 6 7

Total

$ 3,311 110 3

110 $ 3,421

42,780 4

18,600 5

61,380

1,380 6

210 7

$64,801 1,590

$66,391

$12,042 + $6,878 $44,160 + $12,042 + $6,878 55 units × $2.00 9,300 units × $4.60 9,300 units × $2.00 300 units × $4.60 105 units × $2.00

The cost per equivalent unit for direct materials increased from $4.30 in March to $4.40 in April to $4.60 in May. Similarly, the cost per equivalent unit for conversion costs increased from $1.75 in March to $1.80 in April to $2.00 in May. These increases should be investigated for their underlying causes, and any necessary corrective actions should be taken.

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Appendix Prob. 17–5A (FIN MAN); Appendix Prob. 3–5A (MAN) Sunrise Coffee Company Cost of Production Report—Roasting Department For the Month Ended December 31 Whole Units

UNITS

Units charged to production: Inventory in process, December 1 Received from materials storeroom Total units accounted for by the Roasting Department

10,500 210,400 220,900

Units to be assigned costs: Transferred to Packing Department in December Inventory in process, December 31 (25% completed) Total units to be assigned costs 1 2

Equivalent Units of Production

208,900

12,0001 220,900

3,000 2 211,900

10,500 units + 210,400 units – 208,900 units 25% units × 12,000 units

COSTS

Cost per equivalent unit: Total costs for December in Roasting Department Total equivalent units Cost per equivalent unit

$572,130 ÷ 211,900 $ 2.70

Costs charged to production: Inventory in process, December 1 Costs incurred in December Total costs accounted for by the Roasting Department

$ 21,000 551,130 * $572,130

Costs allocated to completed and partially completed units: Transferred to Packing Department in December (208,900 units × $2.70) Inventory in process, December 31 (12,000 units × 25% × $2.70) Total costs assigned by the Roasting Department

$564,030 8,100 $572,130

* $246,800 + $135,700 + $168,630

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–1B (FIN MAN); Prob. 3–1B (MAN) 1.

a. b.

g. h. i.

Materials Accounts Payable

149,800

Work in Process—Making Department Work in Process—Packing Department Factory Overhead—Making Department Factory Overhead—Packing Department Materials

105,700 31,300 4,980 1,530

Work in Process—Making Department Work in Process—Packing Department Factory Overhead—Making Department Factory Overhead—Packing Department Wages Payable

32,400 40,900 15,400 18,300

Factory Overhead—Making Department Factory Overhead—Packing Department Accumulated Depreciation

10,700 7,900

Factory Overhead—Making Department Factory Overhead—Packing Department Prepaid Insurance

2,000 1,500

Work in Process—Making Department Work in Process—Packing Department Factory Overhead—Making Department Factory Overhead—Packing Department

32,570 30,050

Work in Process—Packing Department Work in Process—Making Department

166,790

Finished Goods Work in Process—Packing Department

263,400

Cost of Goods Sold Finished Goods

265,200

149,800

143,510

107,000

18,600

3,500

32,570 30,050 166,790 263,400 265,200

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–1B (FIN MAN); Prob. 3–1B (MAN) (Concluded) 2.

Work in Process— Making Dept.

Materials

Balance, July 1…… $ 5,100 Debits……………… 149,800 (143,510) Credits……………… Balance, July 31… $ 11,390 1 2

6,790 170,670 1 (166,790)

7,350 269,040 2 (263,400)

$ 13,500 263,400 (265,200)

$ 10,670

$ 12,990

$ 11,700

$31,300 + $40,900 + $30,050 + $166,790

Factory Overhead— Making Dept.

Finished Goods

$105,700 + $32,400 + $32,570

Work in Process— Packing Dept.

Balance, July 1…… Debits……………… Credits………………

Balance, July 31…

0 33,080 1 (32,570) 510 Dr.

Factory Overhead— Packing Dept.

0 29,230 2 (30,050) (820) Cr.

$4,980 + $15,400 + $10,700 + $2,000 $1,530 + $18,300 + $7,900 + $1,500

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–2B (FIN MAN); Prob. 3–2B (MAN) 1. Bavarian Chocolate Company Cost of Production Report—Blending Department For the Month Ended October 31 Equivalent Units Whole Units

UNITS

Units charged to production: Inventory in process, October 1 Received from materials storeroom Total units accounted for by the Blending Department

2 3 4

Conversion

2,300 23,400 2

0 23,400

920 1 23,400

25,700

23,400

24,320

2,600 3 28,300

2,600 26,000

520 4 24,840

2,300 26,000 28,300

Units to be assigned costs: Inventory in process, October 1 (3/5 completed) Started and completed in October Transferred to Molding Department in October Inventory in process, October 31 (1/5 completed) Total units to be assigned costs 1

Direct Materials

2,300 units × (1 – 3/5) 25,700 units – 2,300 units 2,300 units + 26,000 units – 25,700 units 2,600 units × 1/5

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–2B (FIN MAN); Prob. 3–2B (MAN) (Continued) Costs COSTS

Direct Materials

Conversion

Cost per equivalent unit: Total costs for October in Blending Department Total equivalent units Cost per equivalent unit

$429,000 ÷ 26,000 $ 16.50

$149,040 1 ÷ 24,840 $ 6.00

Costs charged to production: Inventory in process, October 1 Costs incurred in October Total costs accounted for by the Blending Department

Total

$ 46,368 578,040 2 $624,408

Costs allocated to completed and partially completed units: Inventory in process, October 1 balance To complete inventory in process, October 1 Cost of completed October 1 work in process Started and completed in October Transferred to Molding Department in October Inventory in process, October 31 Total costs assigned by the Blending Department

$ 46,368 5,520 3

5,520 $ 51,888

$386,100 4

140,400 5

526,500

42,900 6

3,120 7

$578,388 46,020

$624,408

Costs transferred to Molding Department: $578,388 Work in process, October 31: 2,600 units at a cost of $46,020 1 2 3 4 5 6 7

$100,560 + $48,480 $429,000 + $100,560 + $48,480 920 units × $6.00 23,400 units × $16.50 23,400 units × $6.00 2,600 units × $16.50 520 units × $6.00

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–2B (FIN MAN); Prob. 3–2B (MAN) (Concluded) 2.

Direct materials: Conversion:

Decrease of $0.15 ($16.50 – $16.65) Increase of $0.15 ($6.00 – $5.85)

Computations: Direct materials cost per equivalent unit: $16.65 ($38,295 ÷ 2,300 units) Conversion cost per equivalent unit: $5.85 ($8,073* ÷ 1,380 units**) * Work in process, October 1……………………………………………………………………… Less direct materials cost…………………………………………………………………………

$ 46,368 (38,295)

Conversion cost included in October 1, work in process…………………………………… $ 8,073

** Equivalent units in October 1, work in process (2,300 × 3/5) = 1,380 units

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–3B (FIN MAN); Prob. 3–3B (MAN) 1. Dover Chemical Company Cost of Production Report—Filling Department For the Month Ended January 31 Equivalent Units Whole Units

UNITS

Units charged to production: Inventory in process, January 1 Received from Reaction Department Total units accounted for by the Filling Department

2 3

Conversion

3,400 49,600 2 53,000

0 49,600 49,600

1,360 1 49,600 50,960

2,700 55,700

2,700 52,300

810 3 51,770

3,400 52,300 55,700

Units to be assigned costs: Inventory in process, January 1 (60% completed) Started and completed in January Transferred to finished goods in January Inventory in process, January 31 (30% completed) Total units to be assigned costs 1

Direct Materials

3,400 units × (100% – 60%) 52,300 units – 2,700 units 2,700 units × 30%

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–3B (FIN MAN); Prob. 3–3B (MAN) (Continued) Costs COSTS

Direct Materials

Conversion

Cost per equivalent unit: Total costs for January in Filling Department Total equivalent units Cost per equivalent unit

$496,850 ÷ 52,300 $ 9.50

$196,7261 ÷ 51,770 $ 3.80

Costs charged to production: Inventory in process, January 1 Costs incurred in January Total costs accounted for by the Filling Department

$ 40,528 693,576 2 $734,104

Costs allocated to completed and partially completed units: Inventory in process, January 1 balance To complete inventory in process, January 1 Cost of completed January 1 work in process Started and completed in January Transferred to finished goods in January Inventory in process, January 31 Total costs assigned by the Filling Department 1 2 3 4 5 6 7

Total

$ 40,528 5,168 3

5,168

471,200 4

188,4805

$ 45,696 659,680

25,650 6

3,078 7

$705,376 28,728

$734,104

$101,560 + $95,166 $496,850 + $101,560 + $95,166 1,360 units × $3.80 49,600 units × $9.50 49,600 units × $3.80 2,700 units × $9.50 810 units × $3.80

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–3B (FIN MAN); Prob. 3–3B (MAN) (Concluded) 2.

Work in Process—Filling Department Work in Process—Reaction Department

496,850

Finished Goods Work in Process—Filling Department

705,376

496,850 705,376

Direct materials: Conversion:

$(0.08) decrease ($9.50 – $9.58) $(0.10) decrease ($3.80 – $3.90)

The cost of production report may be used as the basis for allocating product costs between Work in Process and Finished Goods. The report can also be used to control costs by holding each department head responsible for the units entering production and the costs incurred in the department. Any differences in unit product costs from one month to another, such as those in part (3), can be studied carefully and any significant differences investigated.

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–4B (FIN MAN); Prob. 3–4B (MAN) 1. and 2. Work in Process—Rolling Balance Date Sept.

Oct.

Item 1 30 30 30 30 30 31 31 31 31 31

Dr.

Bal., 2,600 units, 1/4 completed Smelting Dept., 28,900 units at $16.00/unit Direct labor Factory overhead Finished goods* Bal., 2,900 units, 4/5 completed Smelting Dept., 31,000 units at $16.50/unit Direct labor Factory overhead Finished goods* Bal., 2,000 units, 2/5 completed

Cr.

Dr. 45,825

462,400 158,920 101,402 702,195

511,500 162,850 104,494 805,156

508,225 667,145 768,547 66,352 66,352 577,852 740,702 845,196 40,040 40,040

* The credits are determined from the supporting cost of production reports.

Cr.

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–4B (FIN MAN); Prob. 3–4B (MAN) (Continued) Pittsburgh Aluminum Company Cost of Production Report—Rolling Department For the Month Ended September 30 Equivalent Units

Units charged to production: Inventory in process, September 1 Received from Smelting Department Total units accounted for by the Rolling Department Units to be assigned costs: Inventory in process, September 1 (1/4 completed) Started and completed in September Transferred to finished goods in September Inventory in process, September 30 (4/5 completed) Total units to be assigned costs

2 3

Conversion (a)

2,600 26,000 2

0 26,000

1,950 1 26,000

28,600

26,000

27,950

2,900 31,500

2,900 28,900

2,320 3 30,270

Whole Units

UNITS

Direct Materials (a)

2,600 28,900 31,500

2,600 units × (1 – 1/4) 28,900 units – 2,900 units 2,900 units × 4/5

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–4B (FIN MAN); Prob. 3–4B (MAN) (Continued) Costs COSTS

Direct Materials

Conversion

Cost per equivalent unit: Total costs for September in Rolling Department Total equivalent units Cost per equivalent unit (b)

$462,400 ÷ 28,900 $ 16.00

$260,3221 ÷ 30,270 $ 8.60

Costs assigned to production: Inventory in process, September 1 Costs incurred in September Total costs accounted for by the Rolling Department

$ 45,825 722,722 2 $768,547

Costs allocated to completed and partially completed units: Inventory in process, September 1 balance (c) To complete inventory in process, September 1 (c) Cost of completed September 1 work in process Started and completed in September (c) Transferred to finished goods in September (c) Inventory in process, September 30 (d) Total costs assigned by the Rolling Department 1 2 3 4 5 6 7

Total

$ 45,825 $

$ 16,7703

16,770

223,600

$ 62,595 639,600

46,400 6

19,9527

$702,195 66,352

416,000

$768,547

$158,920 + $101,402 $462,400 + $158,920 + $101,402 1,950 units × $8.60 26,000 units × $16.00 26,000 units × $8.60 2,900 units × $16.00 2,320 units × $8.60

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–4B (FIN MAN); Prob. 3–4B (MAN) (Continued) 2. Pittsburgh Aluminum Company Cost of Production Report—Rolling Department For the Month Ended October 31 Equivalent Units

Units charged to production: Inventory in process, October 1 Received from Smelting Department Total units accounted for by the Rolling Department

2,900 29,000 2 31,900

0 29,000 29,000

5801 29,000 29,580

2,000 33,900

2,000 31,000

800 3 30,380

2,900 31,000 33,900

Units to be assigned costs: Inventory in process, October 1 (4/5 completed) Started and completed in October Transferred to finished goods in October Inventory in process, October 31 (2/5 completed) Total units to be assigned costs

Conversion (a)

Whole Units

UNITS

Direct Materials (a)

2,900 units × (1 – 4/5) 31,000 units – 2,000 units 2,000 units × 2/5

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Prob. 17–4B (FIN MAN); Prob. 3–4B (MAN) (Concluded) Costs COSTS

Direct Materials

Conversion

Cost per equivalent unit: Total costs for October in Rolling Department Total equivalent units Cost per equivalent unit (b)

$511,500 ÷ 31,000 $ 16.50

$267,3441 ÷ 30,380 $ 8.80

Costs charged to production: Inventory in process, October 1 Costs incurred in October Total costs accounted for by the Rolling Department

$ 66,352 778,844 2 $845,196

Costs allocated to completed and partially completed units: Inventory in process, October 1 balance (c) To complete inventory in process, October 1 (c) Cost of completed October 1 work in process Started and completed in October (c) Transferred to finished goods in October (c) Inventory in process, October 31 (d) Total costs assigned by the Rolling Department 1 2 3 4 5 6 7

Total

$ 66,352 $

5,104 3

5,104

478,500 4

255,200 5

$ 71,456 733,700

33,000 6

7,040 7

$805,156 40,040 $845,196

$162,850 + $104,494 $511,500 + $162,850 + $104,494 580 units × $8.80 29,000 units × $16.50 29,000 units × $8.80 2,000 units × $16.50 800 units × $8.80

The cost per equivalent unit for direct materials increased from $15.50 in August to $16.00 in September to $16.50 in October. The cost per equivalent unit for conversion costs increased from $8.50 in August to $8.60 in September to $8.80 in October. These increases should be investigated for their underlying causes, and any necessary corrective actions should be taken.

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

Appendix Prob. 17–5B (FIN MAN); Appendix Prob. 3–5B (MAN) Blue Ribbon Flour Company Cost of Production Report—Sifting Department For the Month Ended May 31 Whole Units

UNITS

Units charged to production: Inventory in process, May 1 Received from Milling Department Total units accounted for by the Sifting Department

Equivalent Units of Production

1,500 18,300 19,800

Units to be assigned costs: Transferred to Packaging Department in May Inventory in process, May 31 (75% completed) Total units to be assigned costs

18,000

1,800 19,800

1,350* 19,350

* 75% units × 1,800 units COSTS

Costs

Cost per equivalent unit: Total costs for May in Sifting Department Total equivalent units Cost per equivalent unit

$58,0501 ÷ 19,350 $ 3.00

Costs charged to production: Inventory in process, May 1 Costs incurred in May Total costs accounted for by the Sifting Department

$ 3,400 54,650 2 $58,050

Costs allocated to completed and partially completed units: Transferred to Packaging Department in May (18,000 units × $3.00) Inventory in process, May 31 (1,800 units × 75% × $3.00) Total costs assigned by the Sifting Department

$54,000 4,050 $58,050

1 $3,400 + $32,600 + $14,560 + $7,490 2

$32,600 + $14,560 + $7,490

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

MAKE A DECISION MAD 17–1 (FIN MAN); MAD 3–1 (MAN) a. Resin cost per foot

May $0.54

June $0.57

July $0.60

$483,000 ÷ 900,000 ft.

$630,000 ÷ 1,100,000 ft.

$672,000 ÷ 1,120,000 ft.

May 900,000 0.5 × 450,000

June 1,100,000 0.5 × 550,000

July 1,120,000 0.5 × 560,000

June

July

Pounds of resin: Conduit output (feet) Pounds of resin per foot Pounds of resin output

Ratio of output pounds to input pounds: May Resin output pounds divided by input pounds

97.8%

91.7%

87.5%

450,000 ÷ 460,000

550,000 ÷ 600,000

560,000 ÷ 640,000

The resin materials cost per foot of finished product is increasing over the three months, from $0.54 per foot in May to $0.60 per foot in July. This increased cost is not the result of a change in the price, which remained constant at $1.05 per pound. Rather, the increased cost is the result of the ratio of output pounds to input pounds deteriorating. Apparently, the level of scrap in the process is growing as fewer output pounds are being produced from input pounds.

d. Conversion cost per foot

May $0.10

June $0.10

July $0.10

$90,000 ÷ 900,000 ft.

$110,000 ÷ 1,100,000 ft.

$112,000 ÷ 1,120,000 ft.

The conversion cost per foot has remained constant and, thus, does not appear to need management attention.

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

MAD 17–2 (FIN MAN); MAD 3–2 (MAN) Memo To: Production Manager The cost of production report is used to identify the cost per case for each of the four flavors as follows:

Total cost Number of cases Cost per case

Orange

Cola

Lemon-Lime

Root Beer

$19,125 ÷ 2,500

$391,800 ÷ 60,000

$324,000

÷ 50,000

$36,000 ÷ 4,000

7.65

6.53

6.48

9.00

As can be seen, the cost per case of Root Beer is significantly above the cost per case of the other three flavors. A more detailed analysis is necessary to understand the causes of this difference. The individual cost elements that determine the total cost can be divided by the number of cases. This analysis follows: Cost per Case by Cost Element Orange

Concentrate Water Sugar Bottles Flavor changeover Conversion cost Total cost per case

$1.85 0.50 1.20 2.20 1.20 0.70 $7.65

Cola $2.15 0.50 1.20 2.20 0.08 0.40 $6.53

Lemon-Lime

Root Beer

$2.10 0.50 1.20 2.20 0.08 0.40 $6.48

$1.90 0.50 1.20 2.20 2.50 0.70 $9.00

This table indicates that the concentrate per case is actually less for Orange and Root Beer than for Cola and Lemon-Lime. This is because the concentrate supplier charges a higher price for the more popular flavors. The costs per case for water, sugar, and bottles are the same for each flavor. However, the costs per case for changeover are much greater for Orange and Root Beer than for the other two flavors. In addition, the conversion costs per unit for Orange and Root Beer are $0.30 higher than for Cola and Lemon-Lime. These last two cost elements are sufficient to cause the cost per case of Orange and Root Beer to be greater than Cola and Lemon-Lime. Although further analysis is necessary, it appears that Orange and Root Beer are either bottled in short production runs, meaning more frequent changeovers, or that each Orange and Root Beer changeover is very difficult and expensive. The conversion cost per case is larger because the bottling line rate appears slower for Orange and Root Beer compared to Cola and Lemon-Lime. It’s possible that shorter run sizes are related to the slower line rate because it takes some run time to work the line rate up to a fast speed after a changeover. Root Beer costs more per case than Orange because it may have the shortest run length. 17-61 © 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

MAD 17–3 (FIN MAN); MAD 3–3 (MAN) The solution to this exercise is to determine if the cost per pound trends in paper stock, conversion, and coating costs are remaining stable over time. The following table can be developed from the data: a.

January February Paper stock ($ ÷ pounds output) Coating ($ ÷ pounds output) Conversion cost ($ ÷ pounds output) Yield (pounds transferred out ÷ pounds input)

March

April

May

June

$0.70

$0.12

$0.13

$0.15

$0.17

$0.20

$0.24

$0.40

96%

The cost per pound information is determined by dividing the costs by the pounds transferred out. The yield is determined by dividing the pounds transferred out by the pounds input. b.

Operator 1 believes that energy consumption is becoming less efficient. The energy cost is part of the conversion cost. The conversion cost per output pound has remained constant for the six months. If the energy efficiency were declining, it would take more energy per pound of output over time. Thus, we would expect to see the conversion rate per pound increasing if Operator 1 were correct. Operator 2 believes that there are increasing materials losses from increasing startup and shutdown activity. Yield data would help determine if this were true. If materials losses were growing, then there would be less materials transferred out per pound of inputs over time. The yield has remained constant over the six-month period. Thus, Operator 2’s hypothesis is not validated. The stable cost of the paper stock per output pound also suggests that the yields are remaining stable. Operator 3 is concerned about coating costs. The coating cost per output pound is increasing over time. Thus, we can conclude that the coating efficiency is declining over time. Apparently, twice the coating material was being spread per pound of output in June than in January. The coating operation may need to be repaired or recalibrated. Too much coating is being spread on the paper stock.

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

MAD 17–4 (FIN MAN); MAD 3–4 (MAN) This case is abstracted from a real situation, where higher raw materials costs due to tin content were more than offset by lower energy costs. The cost system used in the real situation was a sophisticated “real-time” expense tracking system. The subtlety of this trade-off analysis is impressive. The first step is to translate the monthly materials and energy costs into their respective costs per unit of monthly production. In this way, the costs can be compared across the months. Apr. Materials cost per unit………………… $0.28 Energy cost per unit…………………… 0.26 Total cost per unit……………………… $0.54

May

June

July

Aug.

Sept.

$0.29 0.24

$0.30 0.22

$0.31 0.20

$0.32 0.19

$0.33 0.16

$0.53

$0.52

$0.51

$0.49

The graph below shows the total unit cost data for each month. $0.60

Cost per Unit

$0.50 $0.40 Materials cost per unit Energy cost per unit

$0.30

Total cost per unit

$0.20 $0.10 $0.00 Apr.

May

June

July

Aug.

Sept.

Month

The graph reveals that the tin content and energy costs are inversely related. That is, as the materials cost increased due to higher tin content, the energy costs dropped by more. In fact, the total cost line shows that the energy savings exceeds the additional materials cost, due to higher tin content. Thus, the recommendation should be to purchase raw can stock with the tin content at the $0.33-per-unit level (September level). This is the material that minimizes the total production cost for this set of data. Additional data could be used to determine the optimal tin content, or the point where energy cost savings fail to overcome additional material costs.

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

TAKE IT FURTHER TIF 17–1 (FIN MAN); TIF 3–1 (MAN) 1. This case comes from a real story. In the real story, the first reduction in chips had no impact on market demand. The manager was promoted, and the next manager attempted the same strategy—reduce chips by 10%. Again, it worked. The next manager did the same thing. All of a sudden, the market demand for the cookie dropped. A threshold was reached, the cookie was no longer “full of chips,” and it began to lose market share. The reduced chip cookie was nothing like the original recipe. The cookie’s integrity was slowly eroded until it did not live up to its brand name “Full of Chips.” Because the brand erosion occurred slowly over a period of many years, senior management did not notice the product change until the threshold was reached. 2. There are several options that you, as the controller, have: a. Do nothing. This is a safe strategy. It would be highly unlikely that failing to reveal this information to anybody would ever be discovered or “pinned” on you. Unfortunately, this is one of those situations where silence has very little penalty yet speaking up entails some risk. However, silence may not be the best option. Silence may allow the product quality erosion to continue, which could be harmful to the company. b. Talk to Brandon. This is also a reasonably safe strategy and probably the best start. For example, you may discover that the reduction in chips was approved by the vice president or that there was a market study that revealed that the market thought the cookie had too many chips. This kind of information could be discovered very easily and without any risk through a personal conversation with Brandon. c. Talk to the vice president. You could also go right over Brandon’s head to the vice president. This strategy might label you as “not a team player,” so some caution is in order here. You might get Brandon in trouble, or you may get yourself in some trouble. This is probably not the best first move. It is within Brandon’s authority to make the chip decision, so you are, in a sense, secondguessing Brandon when you go to the vice president. You could be accused of being out of your expertise. After all, what do you know about chips and the marketplace? Probably the best move is to talk to Brandon. If you discover that Brandon is acting independently, with his primary motivation being to improve the “bottom line,” then you may need to talk to the vice president. This is a delicate situation. You would need to make your case that the reduction in chips strikes you as a short-term decision that may have short-term benefits but may result in long-term consequences. Again, Brandon has the prerogative to make the chip decision; so, in a sense, you are second-guessing Brandon. Your objections should be done lightly and with care.

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

TIF 17–2 (FIN MAN); TIF 3–2 (MAN) This activity can be accomplished with multiple groups assigned to one or more of the industry categories. Assign at least one group to each industry category. (Some are easier than others, so some groups may be assigned multiple categories.) Have the groups report their research back to the class. The class’s final product should be a table identifying a company, products, materials, and processes used by these industries. The most difficult information to obtain is the processes and the materials used in the processes. However, the Internet and annual reports provide good information for answers. The text problems also provide examples of processes used in these industries. Use this case to familiarize students with process industries. Note that a set of example companies is provided for these industry categories early in the chapter. The instructor may require that the groups select different companies than those already listed in the text. A suggested solution following this approach is provided on the next page.

E. I. du Pont de Nemours and Company

H.J. Heinz Company International Paper Company AK Steel Holding Corporation BP Eli Lilly and Company Unilever

Chemicals

Food

Forest and paper products

Metals

Petroleum refining

Pharmaceuticals

Soap and cosmetics

17-66

® Lever 2000 soap

Prozac , Humulin

Gasoline, diesel, kerosene

Steel

Paper, paperboard, cardboard

Ketchup

Stainmaster , Kevlar , Lycra®, Teflon®, refrigerants, electronic materials

Pepsi, Diet Pepsi

Products

Fatty acids, water, fragrances

Hydrochloride

Oil

Iron ore, coke

Wood, wood chips, water, sulfuric acid

Tomato, sugar, salt, spices

Petroleum and petroleumbased intermediates (esters and olefins)

Sugar, carbonated water, concentrate

Materials

Process Costing

PepsiCo, Inc.

Example Company

Beverages

Industry Category

TIF 17–2 (FIN MAN); TIF 3–2 (MAN) (Concluded)

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Making, column blowing, packing

Blending, distilling, packing, pelletizing

Catalytic converting, distilling

Melting, casting, rolling

Chipping, pulping, papermaking, pressing, cutting

Cooking, blending, packaging

Reaction, blending, distilling, extruding

Mixing, bottling

Processes

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

TIF 17–3 (FIN MAN); TIF 3–3 (MAN) Memo To:

Andrei Bradshaw

From:

[Student]

Re:

Analysis of August Increase in Unit Cost for Papermaking Department

The increase in the unit costs from July to August occurred for both the materials (pulp and chemicals) and conversion costs in the Papermaking Department, as indicated in the table below. Materials cost per ton………………………….…………… Conversion cost per ton……………………………..…… Total……………………...……………………………………

July $246.33 121.67 $368.00

August $269.12 132.39 $401.51

An analysis was done to isolate the cause of the increased cost per ton. My interviews indicate that there are two possible causes. First, we changed the specification of the green paper in early August. This may have altered the way the machines process the green paper. Thus, it is possible that the paper machines have improper settings for the new specification and are overapplying materials. Second, there is some question as to whether paper Machine 201 is in need of repairs. It is possible that our problem is caused by inefficiencies in this machine. Fortunately, we run both colors on paper Machine 201. Thus, we can separate the analysis between these two possible explanations. I have provided the following costper-ton data for the two paper machines and the two product colors: Paper machine analysis: Materials Cost per Ton Paper Machine 201 ………………………… $290.54 248.07 Paper Machine 301…………………………… Difference……………………………………… $ 42.47

Conversion Cost per Ton $143.04 121.93 $ 21.11

Total $433.58 370.00 $ 63.58

Conversion Cost per Ton $132.37 132.41 $ (0.04)

Total $401.52 401.48 $ 0.04

Product color analysis: Materials Cost per Ton $269.15 Green…………………………………………… 269.07 Yellow…………………………………………… Difference……………………………………… $ 0.08

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

TIF 17–3 (FIN MAN); TIF 3–3 (MAN) (Continued) The results are clear. Paper Machine 201 had a much higher materials and conversion cost per ton in August. Apparently, the paper machine is overapplying pulp. This is resulting in an increase in both the materials and conversion cost per ton. Paper Machine 301 is running at a cost near our historical cost per ton. There is no evidence of a color problem. Both color papers are running at or near the same materials and conversion cost per ton. Thus, the specification change for green has not appeared to cause a problem in the paper-making operation. I predict that if we improve the operation of paper Machine 201, we will be able to run the department near the historical average cost per ton. Supporting calculations: Machine 201: Machine 1 1 1 1

Color Green Yellow Green Yellow

Total cost  Tons Cost per ton

Materials Cost $ 40,300 41,700 44,600 36,100 $162,700 560 $ 290.54

Conversion Cost $18,300 21,200 22,500 18,100 $80,100 560 $143.04

Materials Cost $ 38,300 33,900 35,600 33,600 $141,400 570 $ 248.07

Conversion Cost $18,900 15,200 18,400 17,000 $69,500 570 $121.93

Tons 150 140 150 120 560

Machine 301: Machine 2 2 2 2 Total cost  Tons Cost per ton

Color Green Yellow Green Yellow

Tons 160 140 130 140 570

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

TIF 17–3 (FIN MAN); TIF 3–3 (MAN) (Concluded) Green Paper Color:

Machine 1 1 2 2

Color Green Green Green Green

Total cost  Tons Cost per ton

Materials Cost $ 40,300 44,600 38,300 35,600

Conversion Cost $18,300 22,500 18,900 18,400

$158,800 590 $ 269.15

$78,100 590 $132.37

Materials Cost $ 41,700 36,100 33,900 33,600

Conversion Cost $21,200 18,100 15,200 17,000

$145,300 540 $ 269.07

$71,500 540 $132.41

Tons 150 150 160 130 590

Yellow Paper Color:

Machine 1 1 2 2 Total cost  Tons Cost per ton

Color Yellow Yellow Yellow Yellow

Tons 140 120 140 140

540

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

TIF 17–4 (FIN MAN); TIF 3–4 (MAN) 1.

This accounting procedure has the effect of rewarding the production of broke. In essence, the procedure communicates to operating personnel that broke is a normal part of doing business. In fact, besides broke being a normal part of business, its production is attractive because of the favorable impact on direct materials costs of the papermaking operation. Recording broke as acceptable and favorable is inconsistent with a total quality perspective, which is based on the concept of producing the product right the first time, every time. Recycling is considered non-value-added in the context of a total quality perspective.

The accounting for broke that is typical in the industry fails to account for the total impact of broke. It is true that the use of recycled materials may reduce the direct materials cost to the operation. However, such a view is very limited. For example, the production of broke has a cost. Machine capacity was used to produce the broke in the first place. Therefore, broke has an original materials cost and a machine cost. Both of these together are likely to be greater than the cost of virgin material. One mill manager once commented, “There is a free paper machine out there.” What he was implying is that if all the machine capacity used to produce broke could be harnessed for good production, it would have been equal to a “free” paper machine. The cost of misused capacity is not captured by most accounting systems in the accounting for broke. There are other hidden costs. Broke production makes the total amount produced difficult to predict. As a result of this source of variation (broke), production schedules are difficult to maintain. For example, if a particular production run has a high amount of broke, then the scheduled run will need to be longer. The longer run, however, has ripple effects throughout the mill, because all of the subsequent production runs will be delayed, as will downstream operations. Also, the complete recycle operation has a cost associated with it (flow control, piping, maintenance, etc.). Typical accounting systems aggregate the cost of the recycle operation with papermaking. Therefore, it is not made visible as a source of wasted resources.

CHAPTER 17 (FIN MAN); CHAPTER 3 (MAN)

Process Costing

CERTIFIED MANAGEMENT ACCOUNTANT (CMA®) EXAMINATION QUESTIONS (ADAPTED) 1.

d. Krause’s equivalent units for conversion costs are 92 units, computed as follows: Beginning work in process (20 units × 40%) ………………...……… Units started and completed (100 units – 20 units)…………………… Ending work in process (10 units × 40%)……………………………… Total………………………………………………………………………

8 units 80 4 92 units

Jones’s equivalent units for conversion costs is 87,300 units, computed as follows: Beginning inventory [10,000 units × (100% – 75%)]………………… 2,500 units Started and completed in August (90,000 units – 10,000 units)… 80,000 Ending inventory (8,000 units × 60%) ………………………………… 4,800 Total……………………………………………………………………… 87,300 units

Kimbeth’s equivalent units for conversion costs is 98,400 units, computed as follows: Beginning inventory [16,000 units × (100% − 20%)]………………… 12,800 units Started and completed in May (100,000 units – 24,000 units)……… 76,000 Ending inventory (24,000 units × 40%) ……………………………….. 9,600 Total……………………………………………………………………… 98,400 units

Equivalent units for the period are 24,500 units, computed as follows: Beginning inventory [5,000 units × (100% − 30%)]…………………… 3,500 units Started and completed during period (25,000 units – 10,000 units)…………………………………………… 15,000 Ending inventory (10,000 units × 60%) ………………………………… 6,000 Total……………………………………………………………………… 24,500 units

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN) ACTIVITY-BASED COSTING DISCUSSION QUESTIONS 1.

Management desires accurate product costs so that its decisions regarding products are correct. Managers are concerned about the accuracy of product costs, which are used for decisions such as determining product mix, establishing product price, and determining whether to discontinue a product line.

A single plantwide overhead rate will provide accurate product costing if products use production department activity-base quantities in nearly the same ratio across departments. For example, if Product X used 2 hours of Department A and 4 hours of Department B activity-base quantities and Product Y used 1 hour of Department A and 2 hours of Department B activity-base quantities, then a single-rate approach would not cause distortion. This is true because the ratio of activity-base usage quantity is 1:2 for both products across the two departments. Additionally, if the production departments have nearly the same factory overhead rate, then there would be no need to use the multiple production department rate method.

Under the multiple production department rate method, factory overhead rates are determined for each production department. Factory overhead is allocated to products depending on the amount of allocation base used in each department. Under the single plantwide rate method, one factory overhead rate is determined for the whole factory and is allocated to products depending on the amount of allocation base used in the factory.

The multiple production department factory overhead rate method would provide more accurate product costs than the single plantwide factory overhead method when there are significant differences in the factory overhead rates across different production departments, and when the products require different proportions of allocation-base usage in each production department.

Under activity-based costing, factory overhead costs are assigned to activity cost pools rather than production departments. The budgeted factory overhead in the activity pools is allocated to products based upon their own unique activity rates.

These activities are part of selling and administrative expenses, which must be treated as period expenses under generally accepted accounting principles (GAAP). Thus, they cannot be included as product costs under GAAP.

If the costs listed in Discussion Question 6 were included as product costs, then they would be part of the cost of inventory. If inventory increased, then the net income would be more than it would be under GAAP, since these selling and administrative expenses would be capitalized in inventory rather than being expensed as required.

Calculating product costs using activity rates may result in greater accuracy than using multiple production department overhead rates when products consume activities in proportions that are unrelated to departmental allocation bases.

Activity-based costing would be preferred when products use selling and administrative activities in proportions that are unrelated to their sales volumes.

10.

Service companies can use activity-based costing to determine the cost of service offerings. This information can be used to determine customer service profitability, which in turn can be used to guide service pricing and strategy.

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

BASIC EXERCISES BE 18–1 (FIN MAN); BE 4–1 (MAN) a.

Speedboat: Bass boat: Total

Single plantwide factory overhead rate: $900,000 ÷ 8,000 dlh = $112.50 per dlh

Speedboat: Bass boat:

400 units × 10 direct labor hours = 400 units × 10 direct labor hours =

4,000 direct labor hours 4,000 8,000 direct labor hours

$112.50 per direct labor hour × 10 dlh per unit = $1,125 per unit $112.50 per direct labor hour × 10 dlh per unit = $1,125 per unit

BE 18–2 (FIN MAN); BE 4–2 (MAN) a.

Fabrication:

(400 speedboats × 7 dlh) + (400 bass boats × 5 dlh) = 4,800 direct labor hours

Assembly:

(400 speedboats × 3 dlh) + (400 bass boats × 5 dlh) = 3,200 direct labor hours

Fabrication Department rate: $624,000 ÷ 4,800 dlh = $130.00 per dlh Assembly Department rate: $276,000 ÷ 3,200 dlh = $86.25 per dlh

Speedboat:

Fabrication Department: 7 dlh × $130.00 = Assembly Department: 3 dlh × $86.25 = Total factory overhead per speedboat

$ 910.00 258.75 $1,168.75

Bass boat:

Fabrication Department: 5 dlh × $130.00 = Assembly Department: 5 dlh × $86.25 = Total factory overhead per bass boat

$ 650.00 431.25 $1,081.25

ActivityBase Usage

$50 per dlh $40 per dlh $400 per setup $248 per insp.

18-3

$140,000 48,000 120,000 272,800 $580,800 400 ÷ $ 1,452

Activity Cost

2,000 dlh 2,000 dlh 100 setups 400 insp.

ActivityBase Usage ×

Activity-Based Costing

$50 per dlh $40 per dlh $400 per setup $248 per insp.

Activity Rate

Bass Boat

Activity Rate

Speedboat

$240,000 ÷ 4,800 direct labor hours = $50 per dlh $128,000 ÷ 3,200 direct labor hours = $40 per dlh $160,000 ÷ 400 setups = $400 per setup $372,000 ÷ 1,500 inspections = $248 per inspection

Fabrication 2,800 dlh Assembly 1,200 dlh Setup 300 setups 1,100 insp. Inspections Total ÷ Budgeted items Factory overhead per unit

Activity

Fabrication: Assembly: Setup: Inspection:

BE 18–3 (FIN MAN); BE 4–3 (MAN)

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

$100,000 80,000 40,000 99,200 $319,200 400 ÷ $ 798

Activity Cost

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

BE 18–4 (FIN MAN); BE 4–4 (MAN) a.

Sales order processing activity: Customer return activity: Total activity cost

1,000 orders × $18 per order = 75 returns × $60 per return =

$18,000 4,500 $22,500

$18.00 per unit ($22,500 ÷ 1,250 units)

BE 18–5 (FIN MAN); BE 4–5 (MAN) Guest check-in…………………………………………… $ 9.00 Room cleaning…………………………………………… 45.00 15.00 Meal service……………………………………………… $69.00 Total activity cost…………………………………………

(1 check-in × $9.00) (3 nights × $15.00) (3 meals × $5.00)

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

EXERCISES Ex. 18–1 (FIN MAN); Ex. 4–1 (MAN) ($1,125,000 ÷ 50,000) × 18,000 = $405,000

Ex. 18–2 (FIN MAN); Ex. 4–2 (MAN) a.

Single Plantwide Factory Overhead Rate =

$1,874,400 21,300 direct labor hours*

= $88 per direct labor hour * Total direct labor hours: Budgeted Production Volume Flutes……………………… Clarinets…………………… Oboes……………………… Total…………………………

b. Direct Labor Hours Clarinets… Oboes……

Total………

21,300

Direct Labor Hours

× × ×

2.0 3.0 1.5

= = =

15,000 4,500 1,800 21,300

Single Plantwide Rate per Direct × Labor Hour =

15,000 × 4,500 × 1,800 ×

Flutes………

7,500 units 1,500 1,200

Direct Labor Hours per Unit

$88 88 88

Factory Overhead

Factory Overhead per Unit (Factory Overhead ÷ Budgeted Production Volume)

= $1,320,000 396,000 = 158,400 =

$1,320,000 ÷ 7,500 units = $176 $396,000 ÷ 1,500 units = $264 $158,400 ÷ 1,200 units = $132

$1,874,400

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Ex. 18–3 (FIN MAN); Ex. 4–3 (MAN) a.

Single Plantwide Factory Overhead Rate =

$156,000* 2,400 processing hours**

= $65 per processing hour * $207,000 – $22,000 – $29,000 The selling and administrative expenses are not factory overhead.

** Total processing hours:

Tortilla chips………………… Potato chips………………… Pretzels……………………… Total……………………………

Budgeted Production Volume (Cases)

Processing Hours per Case

3,000 6,000 3,500

× × ×

0.25 0.10 0.30

× × ×

Processing Hours 750 600 1,050 2,400

Single Plantwide Factory Overhead Rate per Processing Processing Hours × Hour =

Tortilla chips…… 750 Potato chips…… 600 Pretzels………… 1,050 Total……………… 2,400

= = = =

$65 65 65

Factory Overhead

= $ 48,750 39,000 = 68,250 =

Factory Overhead per Case (Factory Overhead ÷ Budgeted Production Volume)

$48,750 $39,000 $68,250

÷ 3,000 cases = $16.25 ÷ 6,000 cases = $6.50 ÷ 3,500 cases = $19.50

$156,000

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Ex. 18–4 (FIN MAN); Ex. 4–4 (MAN) a. First, determine the total estimated labor hours consumed by the three products:

Total Labor Hours

Pistons………………………………… 7,500 × 0.40 = 16,000 Valves………………………………… × = 0.50 4,000 × = Cams…………………………………… 0.20 Total estimated direct labor hours………………………………………………

3,000 8,000 800 11,800

Volume

Direct Labor Hours per Unit

Next, determine the plantwide overhead rate: Budgeted Factory Overhead Plantwide Allocation Base

$377,600 11,800 direct labor hours

b. Direct Labor Hours per Unit

Factory Overhead Cost per Unit ($32.00 × Direct Labor Hours per Unit)

Direct Labor Cost per Unit ($25.00 × Direct Labor Hours per Unit)

$12.80 16.00 6.40

$10.00 12.50 5.00

Pistons………………… 0.40 Valves………………… 0.50 Cams………………… 0.20

Kao Engines Inc. Product Line Budgeted Gross Profit Reports For the Year Ended December 31, 20Y2

Pistons

Valves

$ 240,000 3

(96,000) 5

$ (80,000) 6

(75,000) 7

(200,000) 8

(20,000) 9

(96,000)10 $(261,000)

(256,000)11 $ (552,000)

(25,600)12 $(125,600)

$ 39,000

$ 648,000

$ 114,400

13.0%

54.0%

47.7%

Revenues (price × unit volume) Direct materials (direct materials cost per unit × unit volume) Direct labor [direct labor cost per unit (b) × unit volume] Factory overhead [factory overhead cost per unit (b) × unit volume] Total product costs

$1,200,000

$ (90,000) 4

Gross profit

7,500 × $40.00

Cams 2

$ 300,0001

Gross profit percentage of sales 1

= $32.00 per dlh

16,000 × $6.00

4,000 × $5.00 7,500 × $12.80

16,000 × $75.00

4,000 × $20.00

4,000 × $60.00

7,500 × $10.00

16,000 × $16.00

7,500 × $12.00

16,000 × $12.50

4,000 × $6.40

d. Pistons have the lowest gross profit as a percent of sales of 13.0%. Pistons may require a higher price or lower cost to manufacture in order to achieve a higher profitability similar to the other two products. 18-7 © 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Ex. 18–5 (FIN MAN); Ex. 4–5 (MAN) a.

Production department factory overhead rates: Pattern Department

Total factory overhead…………………… $180,000 36,000 dlh ÷ Direct labor hours……………………… 5.00 per dlh Departmental overhead rate…………… $ b.

Cut and Sew Department

$756,000 84,000 dlh $ 9.00 per dlh

Product cost allocation: Small Glove 0.25 dir. labor hr. × $5 per dlh = Pattern Department…………………… 0.40 dir. labor hr. × $9 per dlh = Cut and Sew Department……………… Total factory overhead per small glove……………………………………………

$1.25 3.60 $4.85

Medium Glove 0.35 dir. labor hr. × $5 per dlh = Pattern Department…………………… 0.55 dir. labor hr. × $9 per dlh = Cut and Sew Department……………… Total factory overhead per medium glove…………………………………………

$1.75 4.95 $6.70

Large Glove 0.45 dir. labor hr. × $5 per dlh = Pattern Department…………………… 0.70 dir. labor hr. × $9 per dlh = Cut and Sew Department……………… Total factory overhead per large glove……………………………………………

$2.25 6.30 $8.55

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Ex. 18–6 (FIN MAN); Ex. 4–6 (MAN) a.

Plantwide overhead rate: Budgeted Factory Overhead Plantwide Allocation Base

$1,080,000 9,000 direct machine hours

$120.00 per dmh

Product costs: Commercial…………$120 per dir. mach. hr. × 8.0 dmh = $960 Residential…………$120 per dir. mach. hr. × 4.5 dmh = $540 b.

Department factory overhead rates: Assembly Department

Production department overhead………… $280,000 4,000 dmh ÷ Direct machine hours…………………… Production department overhead rate…… $ 70.00 per dmh

Testing Department

$800,000 5,000 dmh $ 160.00 per dmh

Product cost allocation: Commercial Motor 2.0 dir. mach. hrs. × $70 per dmh = $ 140 Assembly Department……………… 960 Testing Department…………………… 6.0 dir. mach. hrs. × $160 per dmh = Total factory overhead per commercial motor……………………………………… $1,100 Residential Motor $210 Assembly Department……………… 3.0 dir. mach. hrs. × $70 per dmh = 240 Testing Department…………………… 1.5 dir. mach. hrs. × $160 per dmh = Total factory overhead per residential motor………………………………………… $450 c.

The factory overhead amounts determined under the single plantwide factory overhead rate and multiple production department factory overhead rate methods are different. The multiple production department factory overhead rate method more accurately calculates the true cost of the products. The single plantwide rate ignores the fact that the commercial product uses more of the more costly overhead in the Testing Department than the residential product. Thus, management should consider using the more complex multiple production department factory overhead method.

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Ex. 18–7 (FIN MAN); Ex. 4–7 (MAN) a.

Plantwide factory overhead rate: Budgeted Factory Overhead Plantwide Allocation Base

$640,000 8,000 direct labor hours

$80 per dlh

Product costs: Gasoline engine…… $80 per dir. labor hr. × 10.0 dlh = $800 $80 per dir. labor hr. × 10.0 dlh = $800 Diesel engine………… b.

Department factory overhead rates: Fabrication Department

Total production department factory overhead……………………………… $440,000 4,000 dlh ÷ Direct labor hours……………………………… 110 per dlh Production department overhead rate……… $

Assembly Department

$200,000 4,000 dlh $ 50 per dlh

Product cost allocation: Gasoline engine Fabrication Department……… 6.0 dir. labor hrs. × $110 per dlh = Assembly Department………… 4.0 dir. labor hrs. × $50 per dlh = Total factory overhead per gasoline engine……………………………………………………………

$660 200 $860

Diesel engine Fabrication Department……… 4.0 dir. labor hrs. × $110 per dlh = Assembly Department………… 6.0 dir. labor hrs. × $50 per dlh = Total factory overhead per diesel engine……………………………………………………………… c.

$440 300 $740

Management should select the multiple department factory overhead rate method of allocating overhead costs. The single plantwide factory overhead rate method indicates that both products have the same factory overhead of $800 per unit. This is because each product uses a total of 10.0 direct labor hours per unit. However, each product uses these 10.0 direct labor hours much differently. The gasoline engine consumes 6.0 hours in the expensive Fabrication Department and 4.0 hours in the less expensive Assembly Department. The opposite is the case for diesel engines. Thus, the multiple production department rate method avoids the cost distortions of the single plantwide rate method by accounting for the overhead in each production department separately. In this case, there are both production department rate differences across the departments and differences in the ratios of allocation-base usage of the products across the departments (6:4 vs. 4:6). These conditions will cause the single plantwide rate method to distort product costs.

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Ex. 18–8 (FIN MAN); Ex. 4–8 (MAN) Activity

Activity Base

Cafeteria Customer return processing Electric power Human resources Inventory control Invoice and collecting Machine depreciation Materials handling Order shipping Payroll Performance reports Production control Production setup Purchasing Quality control Sales order processing

Number of employees Number of customer returns Kilowatt hours used Number of employees Number of inventory transactions Number of customer orders Number of machine hours Number of material moves Number of customer orders Number of payroll checks processed Number of performance reports Number of production orders Number of setups Number of purchase orders Number of inspections Number of sales orders

Ex. 18–9 (FIN MAN); Ex. 4–9 (MAN) a.

Sales order processing activity rate: $875,000 ÷ 50,000 sales orders = $17.50 per sales order

Sales order processing cost: $17.50 × 28,750 sales orders = $503,125

Fabrication Assembly Setup Inspecting Production scheduling Purchasing Total activity cost ÷ Number of units Activity cost per unit

Activity

× $38 per mh $20 per dlh $75 per setup $60 per insp. $40 per prod. ord. $10 per purch. ord.

Activity Rate

Elliptical Machines

18-12

= $19,000 4,000 1,500 1,800 600 400 $27,300 ÷ 400 $ 68.25

Activity Cost

700 mh 300 dlh 35 setups 45 insp. 30 prod. ord. 60 purch. ord.

ActivityBase Usage

Activity-Based Costing

$38 per mh $20 per dlh $75 per setup $60 per insp. $40 per prod. ord. $10 per purch. ord.

Activity Rate

Treadmills

500 mh 200 dlh 20 setups 30 insp. 15 prod. ord. 40 purch. ord.

ActivityBase Usage

Ex. 18–10 (FIN MAN); Ex. 4–10 (MAN)

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

$26,600 6,000 2,625 2,700 1,200 600 $39,725 ÷ 250 $158.90

Activity Cost

Casting Assembly Inspecting Setup Materials handling Total activity cost ÷ Number of units Activity cost per unit

Activity

Casting Assembly Inspecting Setup Materials handling

Activity

20,000 mh 5,000 dlh 600 insp. 350 setups 1,000 loads

× $32 per mh $25 per dlh $50 per insp. $80 per setup $20 per load

Activity Rate

Entry Lighting Fixtures

Total Activity Base

18-13

$240,000 75,000 10,000 12,000 8,000 $345,000 ÷ 5,000 $ 69.00

Activity Cost

$32 per mh $25 per dlh $50 per insp. $80 per setup $20 per load

Activity Rate

12,500 mh 2,000 dlh 400 insp. 200 setups 600 loads

ActivityBase Usage

$32 per mh $25 per dlh $50 per insp. $80 per setup $20 per load

Activity Rate

Dining Room Lighting Fixtures

Activity-Based Costing

7,500 mh 3,000 dlh 200 insp. 150 setups 400 loads

ActivityBase Usage

$640,000 125,000 30,000 28,000 20,000

Budgeted Activity Cost

Ex. 18–11 (FIN MAN); Ex. 4–11 (MAN)

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

$400,000 50,000 20,000 16,000 12,000 $498,000 ÷ 4,000 $ 124.50

Activity Cost

Factory overhead ÷ Activity base Activity rate

Procurement Scheduling Materials handling Product development Total ÷ Unit volume Activity cost per unit

Activity

* Engineering change order

Activity Rate

18-14

$18 per purch. ord. $75 per prod. ord. $22 per move $250 per ECO

Ovens

$90,000 ÷ 1,200 prod. ords. $ 75 per prod. ord.

Scheduling

= $ 7,200 60,000 6,600 20,000 $93,800 ÷ 1,000 $ 93.80

Activity Cost

300 purch. ords. 400 prod. ords. 200 moves 120 ECOs

$18 per purch. ord. $75 per prod. ord. $22 per move $250 per ECO

Activity Rate

Refrigerators

$50,000 ÷ 200 ECOs* $ 250 per ECO

Product Development

ActivityBase Usage

$11,000 ÷ 500 moves $ 22 per move

Materials Handling

Activity-Based Costing

400 purch. ords. 800 prod. ords. 300 moves 80 ECOs

ActivityBase Usage

$12,600 ÷ 700 purch. ords. $ 18.00 per purch. ord.

Procurement

Ex. 18–12 (FIN MAN); Ex. 4–12 (MAN)

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

$ 5,400 30,000 4,400 30,000 $69,800 ÷ 500 $139.60

Activity Cost

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Ex. 18–13 (FIN MAN); Ex. 4–13 (MAN) a. Single plantwide rate: Indirect Labor Plantwide Allocation Base

$480,000 2,000 direct labor hours

= $240 per direct labor hour Direct Labor Hours Cell phones… 1,000 Tablets………

1,000

× ×

Plantwide Rate = $240 per dlh =

Indirect Labor Cost $240,000

÷ ÷

Units = 80,000 =

Indirect Labor Cost per Unit $3.00

$240 per dlh =

$240,000

80,000 =

$3.00

b. Activity-based rates: Setup $144,000 ÷ 4,000 setups $ 36.00 per setup

Budgeted activity cost*……………… Activity base…………………………… Activity rate………………………………

Production Support $336,000 ÷ 2,000 dlh $ 168.00 per dlh

* Setup activity cost = $480,000 × 30% = $144,000 Production support activity cost = $480,000 × 70% = $336,000

1,200 setups 1,000 dlh

× $36.00 per setup $168.00 per dlh

Activity Rate

Cell Phones

= $ 43,200 168,000 $211,200 ÷ 80,000 $ 2.64

Activity Cost

2,800 setups 1,000 dlh

ActivityBase Usage

Activity-Based Costing

$36.00 per setup $168.00 per dlh

Activity Rate

Tablets

$100,800 168,000 $268,800 ÷ 80,000 $ 3.36

Activity Cost

18-16

The per-unit indirect labor costs in (a) are distorted because setup activity is consumed by the products in a different ratio from the direct labor. Cell phones required 1,200 setups over a volume of 80,000 units (approximately 67 units per production run), while tablets required 2,800 setups over the same volume (approximately 29 units per production run). The activity-based costing method properly allocates the setup-related activity so that the tablets, the setup-intensive product, receive a larger portion of the setup activity cost, while the cell phones receive a smaller portion. The single-rate system allocates overhead only on the basis of direct labor hours. Since the direct labor hours are equal for each product, the allocated indirect labor will also be equal. Again, this is clearly a distortion, since the setup activity (30% of the indirect labor) is not consumed equally by each product.

Setup Production support Total ÷ Units Activity cost per unit

Activity

ActivityBase Usage

Ex. 18–13 (FIN MAN); Ex. 4–13 (MAN) (Concluded)

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

a. Assembly Department

750 dlh 2,250 dlh

18-17

$62 per dlh $40 per dlh

Activity Rate

$ 46,500 90,000 $136,500 ÷ 7,500 $ 18.20

Activity Cost

2,250 dlh 750 dlh

AllocationBase Usage

$120,000 ÷ 3,000 $ 40 per dlh

Test and Pack Department

Activity-Based Costing

$62 per dlh $40 per dlh

Activity Rate

Toaster Oven

Assembly Department Test and Pack Department Total ÷ Units Factory overhead cost per unit

Activity

AllocationBase Usage

Blender

Factory overhead………………………………………… $186,000 Direct labor hours……………………………………… ÷ 3,000 62 per dlh Production department factory overhead rate……… $

Production department factory overhead rates:

Ex. 18–14 (FIN MAN); Ex. 4–14 (MAN)

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

$139,500 30,000 $169,500 ÷ 7,500 $ 22.60

Activity Cost

a. Assembly Activity

$120,000 – $81,000

ActivityBase Usage

18-18

$35 per dlh $13 per dlh $900 per setup

Activity Rate

Blender

= $ 26,250 29,250 121,500 $177,000 ÷ 7,500 $ 23.60

Activity Cost

Setup Activity

2,250 dlh 750 dlh 45 setups

$35 per dlh $13 per dlh $900 per setup

Activity Rate

Toaster Oven

$162,000 180 setups ÷ $ 900 per setup

ActivityBase Usage

$39,000 2 ÷ 3,000 dlh $ 13 per dlh

Test and Pack Activity

Activity-Based Costing

Assembly activity 750 dlh 2,250 dlh Test and pack activity 135 setups Setup activity Total ÷ Units Factory overhead cost per unit

Activity

$186,000 – $81,000

Budgeted activity cost……………………………………$105,000 1 Activity base……………………………………………… ÷ 3,000 dlh 35 per dlh Activity rate…………………………………………………$

Activity rates:

Ex. 18–15 (FIN MAN); Ex. 4–15 (MAN)

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

$ 78,750 9,750 40,500 $129,000 ÷ 7,500 $ 17.20

Activity Cost

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Ex. 18–15 (FIN MAN); Ex. 4–15 (MAN) (Concluded) Note to Instructors: If you assigned both Ex. 18–14 and Ex. 18–15, then you can make the following observations: The activity-based costing approach provides unit factory overhead cost information that is opposite to that of the multiple production department factory overhead rate method. The reason is that the multiple production department factory overhead rate method allocates all factory overhead to the products on the basis of direct labor hours. However, factory overhead includes the setup activity. Setup activity is consumed by the products in ratios that are not equal to their direct labor consumption. Indeed, the blender uses three times as much setup activity as the toaster oven. The activity-based costing method correctly accounts for this difference, while the multiple production department factory overhead rate method incorrectly assumes that this activity is equal to both products (proportional to the direct labor hours or volume of production). Thus, the management of Four Finger Appliance should be encouraged to use activity-based costing information for product-based decisions.

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Ex. 18–16 (FIN MAN); Ex. 4–16 (MAN) a.

Product Volume Class

Low Medium High 1 2

Column A

Column B

Column C

Single Rate Overhead Allocation per Unit

ABC Overhead Allocation per Unit

Percent Change in Allocation (Col. B – Col. A)/Col. A

$30.001 30.00 3 30.005

$58.06 2 29.31 4 25.46 6

93.5% (2.3)% (15.1)%

(24 hours × $200 per hour) ÷ 160 units [(24 hours × $160 per hour) + (14 setups × $240 per setup) + (38 sales orders × $55 per sales order)] ÷ 160 units

3 4

(225 hours × $200 per hour) ÷ 1,500 units [(225 hours × $160 per hour) + (13 setups × $240 per setup) + (88 sales orders × $55 per sales order)] ÷ 1,500 units

5 6

(900 hours × $200 per hour) ÷ 6,000 units [(900 hours × $160 per hour) + (9 setups × $240 per setup) + (120 sales orders × $55 per sales order)] ÷ 6,000 units

b. The machine hour rate is greater under the single-rate method than under the activitybased method because all the factory overhead is allocated by machine hours under the single-rate method. However, only a portion of the factory overhead is allocated under the machine rate method using activity-based costing. The remaining factory overhead is allocated using the other two activity rates. Thus, the numerator for determining the machine hour rate under activity-based costing must be less than the numerator under the single machine hour rate method. c. Column C indicates that under activity-based costing the low-volume product has a higher per-unit cost than calculated under the single-rate method. In contrast, under activity-based costing the high-volume product has a lower per-unit cost than calculated under the single-rate method. This result happens when there are activities that occur in proportions different from their volumes. In this case, lower-volume products have setups and sales orders occurring in higher proportions of total setups and sales orders than their proportion of machine hours to total machine hours. The opposite is the case for the high-volume product. Thus, the lower-volume products are produced and ordered in smaller batch sizes compared to the higher-volume product. This implies that Whirlpool may wish to simplify its product line by eliminating some of the low-volume products or by attempting to reduce the overall cost of setup and sales order processing activities. Note: The sum of the total overhead from Columns A and B is not equal because there are only three representative products, not all of the products.

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Ex. 18–17 (FIN MAN); Ex. 4–17 (MAN) The selling and administrative expenses should not be allocated on the basis of relative sales dollars. The two product lines have very different attributes. The commercial product is relatively inexpensive to sell, while the home product has a number of additional costs associated with it. As a result, allocating selling and administrative expenses using sales volumes would allocate too much selling and administrative expenses to the commercial product and too little to the home product. The commercial product would receive twice as much selling and administrative expenses as the home product because it has twice the sales. An activity-based approach would trace the selling and administrative costs to the products based upon their actual consumption of activities. Such an allocation would show the commercial product to be more profitable than indicated and the home product to be less profitable than indicated.

Ex. 18–18 (FIN MAN); Ex. 4–18 (MAN) a.

Sales order processing activities: Number of Sales Orders

× ×

Activity Rate

Activity Cost

Generators………………………… 3,000 $65 $195,000 260,000 4,000 × Air compressors…………………… 65 Total…………………………………………………………………………………… $455,000 Post-sale customer service activities: Number of Service Requests

Activity Rate

Activity Cost

Generators………………………… 225 × $200 $ 45,000 110,000 Air compressors…………………… 550 × 200 $155,000 Total…………………………………………………………………………………… Note to Instructors: $455,000 + $155,000 = $610,000, which is the total selling and administrative expenses reported in the exercise.

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Ex. 18–18 (FIN MAN); Ex. 4–18 (MAN) (Concluded) Naper Inc. Product Profitability Report For the Year Ended December 31

Revenues Cost of goods sold Gross profit Selling and administrative expenses: Sales order processing Post-sale customer service Total selling and administrative expenses Operating income Gross profit as a percentage of sales Operating income as a percentage of sales 1 2 3 4 5 6 7 8

Generators

Air Compressors

Total

$ 4,200,000 (2,940,000) $ 1,260,000

$ 3,000,000 (2,100,000) $ 900,000

$ 7,200,000 (5,040,000) $ 2,160,000

$ (195,000) 1 (45,000) 2

$ (260,000) 3 (110,000) 4

$ (455,000) (155,000)

$ (240,000) $ 1,020,000

$ (370,000) $ 530,000

$ (610,000) $ 1,550,000

30.00%5

30.00%7

24.29%6

17.67%8

$195,000 = 3,000 sales orders × $65 per sales order $45,000 = 225 service requests × $200 per service request $260,000 = 4,000 sales orders × $65 per sales order $110,000 = 550 service requests × $200 per service request $1,260,000 ÷ $4,200,000 $1,020,000 ÷ $4,200,000 $900,000 ÷ $3,000,000 $530,000 ÷ $3,000,000

The complete product profitability report provides much greater insight than did the original report. The air compressors have the lower operating income to sales percentage because the product is a heavy user of Naper’s sales and service activities. The air compressors are ordered in small quantities (hence a high number of sales orders) and have a high amount of post-sale service. All of these factors cause the air compressors to have less operating income as a percent of sales than generators. In contrast, relative to the sales volume, the generators have much less activity and thus have the higher operating income as a percent of sales. Naper can respond to this situation by rationing the amount of service to the air compressor product line, charging air compressor customers for some of the services, reducing the number of service requests by improving the product, or raising the price on the air compressors.

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Ex. 18–19 (FIN MAN); Ex. 4–19 (MAN) a.

Metroid Electric Customer Profitability Report For the Year Ended December 31, 20Y8 Revenue Cost of goods sold Gross profit Customer service activities: Bid preparation Shipment Support standard items Support nonstandard items Total customer service activities Operating income after customer service activities Gross profit as a percent of sales Operating income after customer service activities as a percent of sales

Customer 1

Customer 2

Customer 3

$130,000 (81,900) $ 48,100

$ 210,000 (113,400) $ 96,600

$180,000 (90,000) $ 90,000

$ (6,300) 1 (2,250) 2 (600) 3 (1,080)4 $ (10,230)

$ (16,800) 5 (4,950) 6 (1,050) 7 (11,700) 8 $ (34,500)

$ (25,200) 9 (4,500)10 (1,560)11 (15,300)12 $ (46,560)

$ 37,870 37%

$ 62,100 46%

$ 43,440 50%

29%

30%

24%

$420 × 15 bid requests $90 × 25 shipments 3 $30 × 20 standard items 4 $180 × 6 nonstandard items 5 $420 × 40 bid requests 6 $90 × 55 shipments 7 $30 × 35 standard items 8 $180 × 65 nonstandard items 9 $420 × 60 bid requests 10 $90 × 50 shipments 11 $30 × 52 standard items 12 $180 × 85 nonstandard items 2

The gross profit as a percent of sales indicated that Customer 1 was the least profitable, while Customer 3 was the most profitable. After deducting the activity costs associated with customer service activities, Customer 3 became the least profitable, while Customer 1 became nearly as profitable as Customer 2. The reason is because Customer 3 consumed much more customer service activities than did either Customer 1 or Customer 2. Apparently, Customer 3 ordered nonstandard products that required specialized bid requests. In addition, Customer 3 required more shipments, indicating smaller shipments to the customer’s location, rather than a few large shipments.

5 tests 8 hours

Chemistry lab $80 per test $1,000 per hour

400 8,000 $11,000

300

860

$ 1,440

Activity Cost

4 tests 4 hours

2 orders

3 images

4 days

Activity Usage

Activity-Based Costing

$80 per test $1,000 per hour

$50 per order

$215 per image

$240 per day

Activity Rate

Cheryl Umit

320 4,000 $6,025

100

645

$ 960

Activity Cost

Abel Putin apparently had a different condition that required more extensive treatment than did Cheryl Umit. Abel Putin required more operating room hours, more tests and images, and more days to recover than did Cheryl Umit. Thus, the activity cost to Abel Putin is almost two times that of Cheryl Umit.

Operating room Total cost

6 orders

$50 per order

$215 per image

4 images

Pharmacy

Activity Rate

$240 per day

6 days

Activity Usage

Abel Putin

Room and meals Radiology

Activity

Ex. 18–20 (FIN MAN); Ex. 4–20 (MAN)

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Ex. 18–21 (FIN MAN); Ex. 4–21 (MAN) Five-Stars Insurance Company Product Profitability Report For the Year Ended December 31

Workers’ Comp.

Auto

Premium revenue Estimated claims Underwriting income Administrative activities:* New policy processing Cancellation processing Claim audits Claim disbursements processing Premium collection processing Total administrative expenses Operating income Operating income as a percent of premium revenue

Homeowners

$ 5,800,000 (4,060,000) $ 1,740,000

$ 6,250,000 (4,375,000) $ 1,875,000

$ 8,200,000 (5,740,000) $ 2,460,000

$ (120,000) (49,000) (97,500) (37,600) (170,000) $ (474,100) $ 1,265,900

(84,000) (30,000) (27,500) (17,600) (38,000) $ (197,100) $ 1,677,900

$ (246,000) (220,000) (237,500) (68,000) (304,000) $(1,075,500) $ 1,384,500

22%

27%

17%

* The activity costs are determined by multiplying the activity rate by the activity-base usage quantity. For example, the administrative activity costs for the Auto line are as follows: $120,000 = 2,000 new policies × $60 per new policy $49,000 = 490 cancellations × $100 per cancellation $97,500 = 390 audits × $250 per claim audit $37,600 = 470 disbursements × $80 per disbursement $170,000 = 8,500 premiums collected × $20 per premium collected

All three insurance lines have the same percentage of underwriting income to premium revenue (30%). The differences among the insurance lines are in the way they consume administrative activities. For example, the Homeowners insurance line has the least profitability due to its high use of administrative activities. Specifically, the Homeowners line has smaller and more frequent claims that require more auditing and disbursement processing than do the other two lines. In addition, the Homeowners line has a much higher rate of cancellation relative to the other two lines (over 50% of new policies). Lastly, the Homeowners line has more premium collections compared to the other two lines. Possibly, the Homeowners line is collected in smaller amounts from more customers than the other two lines. In contrast, the Workers’ Compensation line consumes the fewest administrative activities, causing it to be the most profitable. The Auto line is in between these two.

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

PROBLEMS Prob. 18–1A (FIN MAN); Prob. 4–1A (MAN) 1. a.

Direct labor overhead rate: $239,200 1,840 direct labor hours

$130 per direct labor hour

$52 per machine hour

b. Machine hour overhead rate: $239,200 4,600 machine hours 2.

Automobile Bumpers a.

Wheels

Direct labor hours: Stamping Department…………… 590 dlh 195 Plating Department……………… Total direct labor hours………… 785 dlh $130 per dlh × Direct labor overhead rate…… $102,050 Allocated factory overhead………

Valve Covers 310 dlh 200

350 dlh 195

510 dlh $130 per dlh

545 dlh $130 per dlh

$66,300

$70,850

Machine hours: Stamping Department…………… 810 mh 1,150 Plating Department……………… Total machine hours……………… 1,960 mh $52 per mh × Machine hour overhead rate… Allocated factory overhead……… $101,920

570 mh 700

620 mh 750

1,270 mh $52 per mh

1,370 mh $52 per mh

$66,040

$71,240

Note to Instructors: The allocated factory overhead is approximately the same for both allocation bases because their usage is proportional across product.

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Prob. 18–2A (FIN MAN); Prob. 4–2A (MAN) 1. Production department factory overhead totals…………………………………………… ÷ Activity rate……………………………………………… Production department rate………………………………

Stamping Dept.

Plating Dept.

$120,000 1,250 dlh

$104,000 2,600 mh

96 per dlh

40 per mh

2. Automobile bumpers $ 56,640 Stamping Department…………… 590 dir. labor hrs. × $96 per dlh = 46,000 Plating Department………………… 1,150 mach. hrs. × $40 per mh = Total factory overhead for bumpers……………………………………………… $102,640 Valve covers 310 dir. labor hrs. × $96 per dlh = Stamping Department…………… Plating Department………………… 700 mach. hrs. × $40 per mh = Total factory overhead for valve covers…………………………………………

$ 29,760 28,000 $ 57,760

Wheels $ 33,600 Stamping Department…………… 350 dir. labor hrs. × $96 per dlh = 30,000 Plating Department………………… 750 mach. hrs. × $40 per mh = Total factory overhead for wheels………………………………………………… $ 63,600

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Prob. 18–3A (FIN MAN); Prob. 4–3A (MAN) 1.

Direct labor overhead rate:

$1,170,000 12,000

Factory Overhead = Direct Labor Hours

= $97.50 per direct labor hour 2. Snowboards

Skis

Cutting Department…………… 2,000 dlh 4,000 Finishing Department………… Total direct labor hours……… 6,000 dlh $97.50 per dlh × Direct labor overhead rate… Allocated factory overhead $585,000 5,000 ÷ Units produced………………

$585,000 5,000

Factory overhead per unit…… $ 117.00

$ 117.00

Total

3,000 dlh 3,000

5,000 dlh 7,000

6,000 dlh $97.50 per dlh

12,000 dlh $1,170,000

3. Production department rates:

Factory overhead………………………………………… ÷ Direct labor hours……………………………………… Production department rate………………………………

Cutting

Finishing

Department

$435,000 5,000

$735,000 7,000

$ 105.00 per dlh

87.00 per dlh

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Prob. 18–3A (FIN MAN); Prob. 4–3A (MAN) (Continued) 4. Direct Labor Hours

Production Department Rate

2,000 4,000

× ×

$87.00 per dlh= $105.00 per dlh=

Factory Overhead

Snowboards: Cutting Department…………………… Finishing Department…………………

$174,000 420,000

Total factory overhead……………… ÷ Number of units……………………… Factory overhead per unit……………

$594,000 5,000 $ 118.80

Skis: Cutting Department…………………… Finishing Department………………… Total factory overhead……………… ÷ Number of units……………………… Factory overhead per unit…………… 5.

3,000 3,000

× ×

$261,000 315,000

$87.00 per dlh= $105.00 per dlh=

$576,000 5,000 $ 115.20

Activity-based rates: Materials Handling

Production Control Factory overhead…… ÷ Activity base… Activity rate……

Cutting Department

Finishing Department

$90,000 500 prod. runs

$270,000 $250,000 7,500 moves 5,000 dlh

$560,000 7,000 dlh

$180.00

per prod. run

36.00

per move

50.00

per dlh

80.00

per dlh

2,000 dlh 4,000 dlh

5,000 moves

450 prod. runs

Activity Usage

$50 per dlh $80 per dlh

$36 per move

$180 per prod. run

Activity Rate

100,000 320,000 $681,000 ÷ 5,000 $ 136.20

180,000

$ 81,000

Activity Cost

3,000 dlh 3,000 dlh

2,500 moves

50 prod. runs

Activity Usage

Activity-Based Costing

$50 per dlh $80 per dlh

$36 per move

$180 per prod. run

Activity Rate

Skis

90,000

9,000 150,000 240,000 $489,000 ÷ 5,000 $ 97.80

Activity Cost

18-30

The plantwide overhead method allocates $117 of overhead to each product, while the multiple production department method allocates $118.80 overhead to snowboards and $115.20 to skis. Both the plantwide and multiple production department methods distort the allocation of overhead because they do not adequately account for how each product consumes overhead. In contrast, activity-based costing allocates $136.20 of factory overhead to snowboards and $97.80 to skis. Activity-based costing more accurately allocates factory overhead because it better accounts for how each product consumes overhead. For example, snowboards consume more direct labor hours in the Finishing Department, which has more overhead. In addition, snowboards consume more production control and materials handling overhead than do skis. This is because snowboards are made in smaller lots, representing a wide variety of styles. Thus, snowboards have higher activity costs than skis.

Finishing Department Total ÷ Number of units Activity cost per unit

Cutting Department

Production control Materials handling

Activity

Snowboards

Prob. 18–3A (FIN MAN); Prob. 4–3A (MAN) (Concluded)

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Production Setup Materials handling Inspection Engineering Total activity cost ÷ Number of units Activity cost per unit

Activity

Production Setup Materials handling Inspection Engineering Total activity cost ÷ Number of units Activity cost per unit

Activity

$80 per mh $100 per setup $30 per part $50 per hour $280 per hour

Activity Rate

Omega

$80 per mh $100 per setup $30 per part $50 per hour $280 per hour

Activity Rate

Alpha

30 per part

$ 57,600 31,000 5,400 25,000 39,200 $158,200 900 ÷ $ 175.78

Activity Cost

$115,200 7,500 1,950 20,000 35,000 $179,650 ÷ 1,800 $ 99.81

Activity Cost

18-31

$9,750 325 parts

Materials Handling

1,080 mh 165 setups 80 parts 300 insp. hours 175 eng. hours

ActivityBase Usage ×

$80 per mh $100 per setup $30 per part $50 per hour $280 per hour

Activity Rate

Beta

280 per hour

50 per hour

Engineering $123,200 440 eng. hours

$60,000 1,200 insp. hours

Inspection

Activity-Based Costing

720 mh 310 setups 180 parts 500 insp. hours 140 eng. hours

ActivityBase Usage

1,440 mh 75 setups 65 parts 400 insp. hours 125 eng. hours

ActivityBase Usage

100 per setup

÷ Total activity base…………

Activity rate…………………

80 per mh

$55,000 550 setups

Setup

$259,200 3,240 mh

Total activity cost……………

Production

Prob. 18–4A (FIN MAN); Prob. 4–4A (MAN)

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

$ 86,400 16,500 2,400 15,000 49,000 $169,300 ÷ 1,350 $ 125.41

Activity Cost

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Prob. 18–4A (FIN MAN); Prob. 4–4A (MAN) (Concluded) 3.

The unit costs are different even though each product requires 0.8 machine hour because the products consume many activities in ratios different from the volume. For example, Omega consumes setup, materials handling, inspection, and product engineering activities proportionately greater than its volume as compared to Alpha.

Prob. 18–5A (FIN MAN); Prob. 4–5A (MAN) 1. Customer

Project Bidding

Engineering Support

$74,000 185 bids

$120,750 161 dc*

Service Activity cost…………………… $31,500 180 sr* ÷ Activity base………………… Activity rate…………………… $ 175 per sr

400 per bid

750 per dc

2. Gough Industries Customer service……………… 36 sr × $175 per sr = Project bidding………………… = 50 bids × $400 per bid Engineering support………… = 18 dc × $750 per dc Total nonmanufacturing activity costs…………………………………………

6,300 20,000 13,500

$ 39,800

Breen Inc. Customer service……………… 28 sr × $175 per sr = Project bidding………………… = 40 bids × $400 per bid Engineering support………… = 35 dc × $750 per dc Total nonmanufacturing activity costs…………………………………………

4,900 16,000 26,250

$ 47,150

The Martin Group Customer service……………… 116 sr × $175 per sr = Project bidding………………… = 95 bids × $400 per bid Engineering support………… = 108 dc × $750 per dc Total nonmanufacturing activity costs…………………………………………

$ 20,300 38,000 81,000 $139,300

* “sr” stands for service request; “dc” stands for design change.

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Prob. 18–5A (FIN MAN); Prob. 4–5A (MAN) (Concluded) 3.

Arctic Air Inc. Customer Profitability Report For the Year Ended December 31

Revenues Cost of goods sold Gross profit Selling and administrative activities: Customer service Project bidding Engineering support Total selling and administrative activities Operating income (loss) 1 2 3

$60,000 × 30 units $60,000 × 16 units $60,000 × 4 units

Gough Industries

Breen Inc.

The Martin Group

$1,800,0001 (840,000) 4 $ 960,000

$ 960,000 2 (448,000) 5 $ 512,000

$ 240,000 3 (112,000) 6 $ 128,000

(4,900) (16,000) (26,250)

$ (20,300) (38,000) (81,000)

$ (47,150) $ 464,850

$(139,300) $ (11,300)

(6,300) (20,000) (13,500)

$ (39,800) $ 920,200 4 5 6

$28,000 × 30 units $28,000 × 16 units $28,000 × 4 units

4. The Martin Group is unprofitable, while the other two customers have acceptable margins. This is because The Martin Group requires many customer service, project bidding, and engineering support activities. For example, The Martin Group awards contracts on only 4.2% of the bid efforts (4 contracts ÷ 95 bids); it requests a large amount of service; and it requires extensive design change effort. The company’s options include: a. Stop bidding The Martin Group projects. This does not necessarily mean that all the costs can be avoided. The costs only will be eliminated if the reduced activity translates into lower headcount (dismissals). b. Reprice The Martin Group work. Charge The Martin Group a higher price to compensate for the higher activities required to serve it. However, the customer may not accept the price increase required to move it to a profitable relationship. c. Encourage The Martin Group to reduce the amount of design changes and customer service requests. The design changes are probably driving the customer service requests. This may be appealing, but there may be no incentive for The Martin Group to change its behavior. d. Charge a price for customer service and design change separately. That is, unbundle the pricing of goods from the support services. This is a good longterm solution. In addition, improve the bidding process in order to improve the “hit rate” or the percentage of awarded contracts to bids.

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Prob. 18–6A (FIN MAN); Prob. 4–6A (MAN) 1.

Activity Scheduling and admitting…… Housekeeping………………… Nursing………………………… Total………………………………

Activity Cost

Activity Base

Activity Rate

÷ ÷ ÷

6,000 patients 27,000 pds* 192,000 wcus*

= = =

$72 per patient $156 per pd $28 per wcu

Total Activity Cost by Procedure

432,000 4,212,000 5,376,000

$10,020,000

* “pd” stands for patient day; “wcu” stands for weighted care unit 2. Activity

Activity Usage

Activity Rate

Procedure A Scheduling and admitting Housekeeping Nursing

280 patients 1,680 pds 19,200 wcus

$72 per patient $156 per pd $28 per wcu

$ 20,160 262,080 537,600 $819,840

650 patients 3,250 pds 6,000 wcus

$72 per patient $156 per pd $28 per wcu

$ 46,800 507,000 168,000 $721,800

1,200 patients 4,800 pds 24,000 wcus

$72 per patient $156 per pd $28 per wcu

Procedure B Scheduling and admitting Housekeeping Nursing

Procedure C Scheduling and admitting Housekeeping Nursing

86,400 748,800 672,000 $1,507,200

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Prob. 18–6A (FIN MAN); Prob. 4–6A (MAN) (Concluded) 3. Reimbursement (patient days × reimbursement rate)* Total activity cost [from (2)] Excess (deficiency) of reimbursement over activity cost

Procedure A

Procedure B

Procedure C

$ 682,080 (819,840)

$1,319,500 (721,800)

$ 1,948,800 (1,507,200)

$(137,760)

$ 597,700

441,600

* 1,680 patient days × $406 per patient day = $682,080 3,250 patient days × $406 per patient day = $1,319,500 4,800 patient days × $406 per patient day = $1,948,800

Procedure A requires more activity cost than is being reimbursed by the insurance company. As a result, the hospital may wish to determine if the costs of providing Procedure A are too high. Hospital management may wish to investigate the nursing effort, because the weighted average care units are averaging nearly 11.4 (19,200 ÷ 1,680) wcus per patient day for Procedure A, which compares to 1.8 (6,000 ÷ 3,250) and 5.0 (24,000 ÷ 4,800) wcus per patient day for Procedures B and C, respectively. Alternatively, the hospital may wish to negotiate for a higher reimbursement from the insurance company for Procedure A. Note to Instructors: The total activity costs and activity-base quantities for the three procedures are less than the totals because these are only three “selected” procedures out of a larger population.

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Prob. 18–1B (FIN MAN); Prob. 4–1B (MAN) 1.

Direct labor overhead rate: $299,700 1,620 direct labor hours

$185 per direct labor hour

$111 per machine hour

b. Machine hour overhead rate: $299,700 2,700 machine hours 2. Whole Milk a.

Cream

Direct labor hours: Blending Department………… 260 dlh 470 Packing Department…………… Total direct labor hours……… 730 dlh × Direct labor overhead $185 per dlh rate……………………………… Allocated factory overhead…… $135,050

Skim Milk 245 dlh 300

215 dlh 130

545 dlh

345 dlh

$185 per dlh

$100,825

$63,825

Machine hours: Blending Department………… 650 mh 500 Packing Department…………… Total machine hours…………… 1,150 mh × Machine hour overhead $111 per mh rate……………………………… Allocated factory overhead…… $127,650

710 mh 415

260 mh 165

1,125 mh

425 mh

$111 per mh

$124,875

$47,175

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Prob. 18–2B (FIN MAN); Prob. 4–2B (MAN) 1.

Blending Dept. Production department factory overhead totals…………………………………………… ÷ Activity base……………………………………………… Production department rate………………………………

Packing Dept.

$178,200 1,620 mh

$121,500 900 dlh

110 per mh

135 per dlh

2. Whole milk 650 mach. hrs. × $110 per mh = Blending Department………… Packing Department…………… 470 dir. labor hrs. × $135 per dlh = Total factory overhead for whole milk……………………………………………

$ 71,500 63,450 $134,950

Skim milk $ 78,100 710 mach. hrs. × $110 per mh = Blending Department………… 40,500 Packing Department…………… 300 dir. labor hrs. × $135 per dlh = Total factory overhead for skim milk……………………………………………… $118,600 Cream Blending Department………… 260 mach. hrs. × $110 per mh = Packing Department…………… 130 dir. labor hrs. × $135 per dlh = Total factory overhead for cream…………………………………………………

$ 28,600 17,550 $ 46,150

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Prob. 18–3B (FIN MAN); Prob. 4–3B (MAN) 1.

Direct labor overhead rate:

$400,400 2,800

Factory Overhead = Direct Labor Hours

= $143.00 per direct labor hour 2. Receivers

Loudspeakers

Subassembly Department…… 875 dlh 525 Final Assembly Department… Total direct labor hours……… 1,400 dlh $143.00 per dlh × Direct labor overhead rate… Allocated factory overhead $200,200 7,000 ÷ Units produced………………

$200,200 7,000

Factory overhead per unit…… $

28.60

Total

525 dlh 875

1,400 dlh 1,400

1,400 dlh $143.00 per dlh

2,800 dlh $400,400

28.60

3. Production department rates: Subassembly

Final Assembly

Department

Factory overhead……………………………………………… $420,000 1,400 ÷ Direct labor hours…………………………………………… $ 300.00 per dlh Production department rate…………………………………

$294,000 1,400 $ 210.00 per dlh

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Prob. 18–3B (FIN MAN); Prob. 4–3B (MAN) (Continued) 4. Direct Labor Hours ×

Production Department Rate =

Factory Overhead

$300 per dlh = $210 per dlh =

$262,500 110,250

Receivers: Subassembly Department……… Final Assembly Department…… Total factory overhead………… ÷ Number of units………………… Factory overhead per unit……… Loudspeakers: Subassembly Department……… Final Assembly Department…… Total factory overhead………… ÷ Number of units………………… Factory overhead per unit………

875 525

× ×

$372,750 7,000 $ 53.25 525 875

× ×

$157,500 183,750

$300 per dlh = $210 per dlh =

$341,250 7,000 $ 48.75

5. Activity-based rates:

Factory overhead…… ÷ Activity base… Activity rate……

Setup

Quality Control

Subassembly Department

Final Assembly Department

$138,600 400 setups

$261,800 2,200 insp.

$198,800 1,400 dlh

$114,800 1,400 dlh

$ 346.50

$ 119.00

$ 142.00

per setup

per insp.

per dlh

82.00

875 dlh 525 dlh

450 insp.

80 setups

Activity Usage

124,250 43,050 $248,570 ÷ 7,000 $ 35.51

53,550

$142 per dlh $82 per dlh

$119 per insp.

Activity Cost

$ 27,720

$346.50 per setup

Activity Rate

Receivers

525 dlh 875 dlh

1,750 insp.

320 setups

Activity Usage

Activity-Based Costing

$142 per dlh $82 per dlh

$119 per insp.

$346.50 per setup

Activity Rate

Loudspeakers

74,550 71,750 $465,430 ÷ 7,000 $ 66.49

208,250

$110,880

Activity Cost

18-40

The plantwide overhead method allocates $28.60 of overhead to each product, while the multiple production department method allocates $53.25 overhead to receivers and $48.75 to loudspeakers. Both the plantwide and multiple production department overhead methods distort the allocation of overhead because they do not adequately account for how each product consumes overhead. In contrast, activitybased costing allocates $35.51 of factory overhead to receivers and $66.49 to loudspeakers. Activity-based costing more accurately allocates factory overhead because it better accounts for how each product consumes overhead. For example, loudspeakers have four times (320 ÷ 80) more setups than do receivers. In addition, loudspeakers require over 3.8 times (1,750 ÷ 450) more quality control inspections than do receivers. As a result, loudspeakers have higher activity costs than receivers.

Final Assembly Dept. Total ÷ Number of units Activity cost per unit

Subassembly Dept.

Setup Quality control

Activity

Prob. 18–3B (FIN MAN); Prob. 4–3B (MAN) (Concluded)

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Production Setup Inspection Shipping Customer service Total activity cost ÷ Units Activity cost per unit

Activity

Production Setup Inspection Shipping Customer service Total activity cost ÷ Units Activity cost per unit

Activity

Activity rate………………… $

Setup

$50 per mh $320 per setup $40 per insp. $20 per cust. ord. $140 per request

Activity Rate

White Sugar

320 per setup

$50 per mh $320 per setup $40 per insp. $20 per cust. ord. $140 per request

Activity Rate

Powdered Sugar

$144,000 450 setups

Activity Cost

$125,000 62,400 22,000 40,000 26,600 $276,000 ÷ 5,000 $ 55.20

Activity Cost

Shipping

2,500 mh 170 setups 330 insp. 2,600 cust. ord. 350 requests

ActivityBase Usage ×

20 per cust. ord.

$115,000 5,750 cust. ord.

40 per insp. $

$250,000 27,200 8,800 23,000 8,400 $317,400 ÷ 10,000 $ 31.74

18-41

Inspection $44,000 1,100 insp.

Activity-Based Costing

2,500 mh 195 setups 550 insp. 2,000 cust. ord. 190 requests

ActivityBase Usage

5,000 mh 85 setups 220 insp. 1,150 cust. ord. 60 requests

ActivityBase Usage

50 per mh

Total activity cost………… $500,000 10,000 mh ÷ Total activity base………

Production

Prob. 18–4B (FIN MAN); Prob. 4–4B (MAN)

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Customer Service

140 per req.

$50 per mh $320 per setup $40 per insp. $20 per cust. ord. $140 per request

Activity Rate

Brown Sugar

$84,000 600 req.

$125,000 54,400 13,200 52,000 49,000 $293,600 ÷ 5,000 $ 58.72

Activity Cost

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Prob. 18–4B (FIN MAN); Prob. 4–4B (MAN) (Concluded) 3.

The unit costs are different even though each product requires 0.5 machine hour because the products consume many activities in ratios different from the volume. For example, brown sugar consumes setup, inspection, shipping, and customer service activities proportionately greater than its volume, while white sugar consumes the same activities proportionately less than its volume.

Prob. 18–5B (FIN MAN); Prob. 4–5B (MAN) 1. Customer Service Activity cost pool……………… $76,860 427 sr* ÷ Activity base…………………… Activity rate……………………… $ 180 per sr

Sales Order Processing

Advertising Support

$25,920 1,080 so*

$311,250 249 ads

24 per so

1,250 per ad

2. The Warehouse Customer service……………… 62 sr × $180 per sr = Sales order processing………… = 300 so × $24 per so Advertising support…………… = 25 ads × $1,250 per ad Total nonmanufacturing activity costs…………………………………………

$11,160 7,200 31,250 $49,610

Kosmo Co. Customer service……………… 340 sr × $180 per sr = Sales order processing………… = 640 so × $24 per so Advertising support…………… = 180 ads × $1,250 per ad Total nonmanufacturing activity costs…………………………………………

$ 61,200 15,360 225,000 $301,560

Supply Universe Customer service……………… 25 sr × $180 per sr = Sales order processing………… = 140 so × $24 per so Advertising support…………… = 44 ads × $1,250 per ad Total nonmanufacturing activity costs…………………………………………

$ 4,500 3,360 55,000 $62,860

* “sr” stands for service request; “so” stands for sales order

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Prob. 18–5B (FIN MAN); Prob. 4–5B (MAN) (Concluded) 3.

Shrute Inc. Customer Profitability Report For the Year Ended December 31

Revenues Cost of goods sold Gross profit Selling and administrative activities: Customer service Sales order processing Advertising support Total selling and administrative activities Operating income 1 2

The Warehouse

Kosmo Co.

Supply Universe

$ 899,1001 (552,420)2 $ 346,680

$ 899,100 (552,420) $ 346,680

$ (11,160) (7,200) (31,250)

$ (61,200) (15,360) (225,000)

$ (49,610) $ 297,070

$(301,560) $ 45,120

$ (62,860) $ 283,820

(4,500) (3,360) (55,000)

$1,110 × 810 units $682 × 810 units

Kosmo Co. has low profitability, while the other two customers have acceptable margins. This is because Kosmo Co. requires many customer service, sales order processing, and advertising support activities. For example, Kosmo Co. orders frequently in small order sizes, which increases the sales order processing costs; it requests a large amount of service; and it requires extensive promotional support. The company’s options include: a.

Drop Kosmo Co. This does not necessarily mean that all the costs can be avoided. The costs will only be eliminated if the reduced activity translates into lower spending.

Reprice Kosmo Co. Charge Kosmo Co. a higher price to compensate for the higher activities required to serve it. The customer may not accept the price increase required to move this to a profitable relationship.

Encourage Kosmo Co. to order in larger quantities. This may be appealing. However, if Kosmo Co. wishes to keep its inventories low, it will avoid making large infrequent orders but instead will prefer smaller frequent orders.

Improve the internal operations of Shrute Inc. to reduce the impact of the sales order-related activities. Reduce the cost of sales order processing.

Unbundle pricing. Price customer service and advertising support as separate services. That is, unbundle the pricing of goods from the support services. This is a good long-term solution.

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

Prob. 18–6B (FIN MAN); Prob. 4–6B (MAN) 1.

The depreciation and maintenance cost per mile is calculated as follows:* Monthly Fuel, Crew, and Depreciation Monthly Number of Miles Flown

$2,120,000 + $850,000 + $430,000 170,000 miles

= $20 per mile *Ground personnel costs are not included. They are allocated separately below.

Terminal City

Charlotte……………… Pittsburgh……………… Detroit…………………… San Francisco………… Total……………………

Monthly Ground Personnel Cost per City

$256,000 97,500 129,000 306,000 $788,500

Number of Arrivals/Departures

÷ ÷ ÷ ÷

320 130 150 340 940

Arrival/Departure Rate per City

= = = =

$800 750 860 900

Blue Star Airline Flight Profitability Report For Three Representative Flights

Passenger revenue (passengers × ticket price) Fuel, crew, and depreciation costs (miles × $20 per mile) Ground personnel (sum of departure plus arrival charges) Total costs Flight operating income (loss) 1 2 3

Flight 101

Flight 102

Flight 103

$ 55,600

$ 22,075

$ 7,640

$(40,000)

$(16,000)

$(8,000)

(1,700)1 $(41,700) $ 13,900

(1,660) 2 $(17,660) $ 4,415

(1,550)3 $(9,550) $(1,910)

$800 + $900 (Charlotte + San Francisco) $860 + $800 (Detroit + Charlotte) $800 + $750 (Charlotte + Pittsburgh)

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

MAKE A DECISION MAD 18–1 (FIN MAN); MAD 4–1 (MAN) a.

The average rework per unit will be improved by one-quarter, or 25%. Thus, the new average rework time will be reduced from 0.40 to 0.30 hour [0.40 × (1 – 0.25)].

Activity

Activity-Base Usage (hrs. per unit)

Motor assembly Final assembly Testing Rework Moving Activity cost per unit b.

1.50 1.00 0.25 0.30 0.20

Activity Rate per Hour

$20.00 18.00 22.00 22.00 15.00

Activity Cost

$30.00 18.00 5.50 6.60 3.00 $63.10

The rework improvement reduces the cost per unit by $2.20 ($65.30 – $63.10), which meets management’s $2.00 per unit cost improvement objective. Halving the moving activity would reduce the moving activity cost by $1.50 per unit (0.10 hour × $15 per hour), which is $0.70 less than the rework improvement ($2.20 – $1.50). Thus, management should select the rework improvement project.

MAD 18–2 (FIN MAN); MAD 4–2 (MAN) a. Activity

Activity-Base Usage (hrs. per unit)

Fabrication Assembly Inspection Moving Total activity cost per unit

Activity Rate per Hour

$24.00 20.00 25.00 12.00

1.00 1.10 0.30 0.25

Activity Cost

$24.00 22.00 7.50 3.00 $56.50

The shaded areas are impacted by the proposed change. Fabrication increases to 1.0 hour per unit, while Assembly declines to 1.10 hours per unit. b.

Yes, the proposed improvement plan appears to provide a $2.00 per unit cost savings ($58.50 − $56.50).

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

MAD 18–3 (FIN MAN); MAD 4–3 (MAN) a. Activity

Activity-Base Usage (hrs. per unit)

Assembly b.

0.35

Activity Rate per Hour (S-3)

Activity Cost

$7.70

$22.00

The analysis shows that the 0.05 hour per-unit savings is not sufficient to offset the higher labor cost per hour. Thus, the total assembly activity cost per unit increases from $7.20 to $7.70 per unit. The engineer’s solution is not supported.

MAD 18–4 (FIN MAN); MAD 4–4 (MAN) a. Activity

Activity-Base Usage

Fabrication 250 dlh 20 setups Setup 20 prod. runs Production control 20 moves Moving Total activity cost Estimated units of production Activity cost per unit

Activity Rate*

$80 per dlh $48 per setup $12 per prod. run $15 per move

Activity Cost

$20,000 960 240 300 $21,500 ÷ 500 $ 43.00

* $80 × 60% = $48 $30 × (1 – 60%) = $12 $25 × (1 – 40%) = $15

The activity cost per unit increased from $42.70 to $43.00 per unit; thus, the improvements increased the activity cost per unit. Further changes would be required in order for the proposed plan to be cost neutral.

The activity cost per setup would need to decline in order for the revised activity cost per unit to remain unchanged from the base scenario. The revised activity cost per setup can be determined as follows: $0.30 = (x × 20) ÷ 500 units where “x” is the reduction in the setup activity rate required to cover the $0.30 perunit activity cost increment ($43.00 − $42.70). $0.30 × 500 units = (x × 20) $150 ÷ 20 = x x = $7.50

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

MAD 18–4 (FIN MAN); MAD 4–4 (MAN) (Concluded) Thus, the setup rate would need to decline another $7.50, to $40.50, in order for the activity cost per unit to remain unchanged under the new scenario. This is verified as follows:

Activity

Activity-Base Usage

Fabrication 250 dlh 20 setups Setup 20 prod. runs Production control 20 moves Moving Total activity cost per unit Estimated units of production Activity cost per unit

Activity Rate*

$80 per dlh $40.50 per setup $12 per prod. run $15 per move

Activity Cost

$20,000 810 240 300 $21,350 ÷ 500 $ 42.70

MAD 18–5 (FIN MAN); MAD 4–5 (MAN) a. Activity

Activity-Base Usage (per patient)

Activity Rate

$ 150 3,000 50 100

Admission 1 3 hours Operating room 60 care units* Nursing 1 Discharge Total activity cost per patient

Activity Cost

150 9,000 3,000 100 $12,250

* 6 days × 10 nursing care units per day = 60 nursing care units b. Activity

Activity-Base Usage (per patient)

Activity Rate

Admission 1 2.5 hours Operating room 50 care units* Nursing 1 Discharge Total activity cost per patient

$ 150 3,000 50 100

Activity Cost

150 7,500 2,500 100 $10,250

* 5 days × 10 nursing care units per day = 50 nursing care units The cost of treating a patient for a coronary bypass declined from $12,250 to $10,250, or $2,000.

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

TAKE IT FURTHER TIF 18–1 (FIN MAN); TIF 4–1 (MAN) 1.

The net income is larger because the controller took period costs and treated them as product costs for financial reporting purposes. All of the post-manufacturing costs should be treated as an expense in the period incurred according to generally accepted accounting principles (GAAP). If treated as product costs for financial reporting purposes, some of these period costs are included in inventory while the rest are included in the cost of goods sold. As a result, the net income would be higher by the amount of period cost included (capitalized) in inventory.

The controller is not behaving ethically, because the financial statements do not present fairly the results of operations according to GAAP. The new activity-based costing information may be very useful for internal decision making, but the postmanufacturing period costs cannot be included as a product cost. These costs must be treated as a period cost on the financial statements. This is a situation where GAAP requires a method that provides less decision relevance for managers inside the firm. This is because GAAP is focused on providing information that has decision relevance for external users. Thus, one could argue that expensing product costs is prohibited in financial reporting (but not management reporting) in order to provide useful information to external users. The controller should have known that period costs cannot be treated as product costs on the financial statements. Supporting such treatment is considered a breach of professional ethics.

TIF 18–2 (FIN MAN); TIF 4–2 (MAN) Answers will vary depending on the company selected. A potential solution for a company in the banking industry follows. Activity

Activity Base

Opening an account Teller deposit transaction Teller withdrawal transaction ATM withdrawal transaction ATM deposit transaction Online bill pay Providing a monthly statement Direct deposit transaction Making a correction Providing a balance Electronic funds transfer (EFT) Closing an account

Number of accounts opened Number of teller deposits Number of teller withdrawals Number of ATM withdrawals Number of ATM deposits Number of online bill pay transactions Number of statements Number of direct deposits Number of corrections Number of balance inquiries Number of EFT transactions Number of accounts closed

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

TIF 18–3 (FIN MAN); TIF 4–3 (MAN) 1.

Gross profit as a percentage of sales Operating income as a percentage of sales 2.

Home Theater Speakers 30%

Wireless Speakers 40%

Wireless Headphones 10%

(10)%

30%

Memo To:

Management of New Wave Sounds Inc.

From:

Controller

Re:

Product Strategy Recommendations

The product profitability report provided indicates that our product lines generate varying degrees of profitability. By far, our most profitable product line is wireless speakers. The home theater speakers provide a healthy gross profit. However, our marketing costs associated with this product line exceed our gross profit. As a result, the product line is unprofitable as a whole. The wireless headphones, on the other hand, have a very weak gross profit. Consequently, the product line is just barely profitable. Based on this analysis, I offer the following recommendations: Home Theater Speakers We should retain the home theater speakers in our product portfolio. The product generates a healthy gross profit. Unfortunately, we spend too much on marketing this high-volume product. The vice president of marketing assures me that the product has strong recognition in the marketplace. As such, I recommend that we reduce our marketing effort for this product to manage its profitability more carefully. Wireless Speakers Wireless speakers provide both a healthy gross profit and return on sales. Wireless Headphones Wireless headphones are one of our “up-and-comers.” No other competitor has a similar product. Thus, we have the market to ourselves. Yet, this product does not meet our profitability objectives. We are unable to spend much on marketing because our gross profit is too low. This suggests that we have either priced the product too low or the costs associated with making the product are too high. Upon review of the cost information, the costs do not appear to be out of line. Thus, I recommend a significant price increase and an increase in the marketing budget for this important product. I believe the market will accept the price increase, since there are no similar products in the marketplace and customers have been pleased with the product.

CHAPTER 18 (FIN MAN); CHAPTER 4 (MAN)

Activity-Based Costing

CERTIFIED MANAGEMENT ACCOUNTANT (CMA®) EXAMINATION QUESTIONS (ADAPTED) 1. b. Using activity-based costing, the cost to manufacture one ultrasound machine is $264, determined as follows: Cost per engineering change: $6,000 ÷ (2 + 1) = $2,000 Materials handling per part: $5,000 ÷ (400 + 600) = $5 Cost per product setup: $3,000 ÷ (8 + 7) = $200 Manufacturing costs: Ultrasound direct materials ($8,000 ÷ 100)……………………………… Ultrasound direct labor ($12,000 ÷ 100)………………………………… Materials handling [(600 ÷ 100) × $5]…………………………………… Engineering change [(1 ÷ 100) × $2,000]………………………………… Setups [(7 ÷ 100) × $200]…………………………………………………… Total manufacturing costs………………………………………………

$ 80 120 30 20 14 $264

2. c. The muffins are $1,925 more profitable, determined as follows: Cost of muffin delivery: [(150 × 10) ÷ 60] × $20 = $500 Cost of cheesecake delivery: [(85 × 15) ÷ 60] × $20 = $425 $ 26,500 Muffin profit ($53,000 − $26,000 − $500)…………………………………… (24,575) Cheesecake profit ($46,000 − $21,000 − $425) …………………………… Profit difference………………………………………..………………………… $ 1,925 3. d. Only in the situation where all overhead costs were expensed, e.g., zero inventory balances, would the reported net income be the same. 4. b. The Tooling Department overhead applied to Job 231 is $197.50, determined as follows: Tooling overhead per hour: $8,690 ÷ 440 hrs. = $19.75 per hour Job 231 overhead: $19.75 × 10 hrs. = $197.50

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN) SUPPORT DEPARTMENT AND JOINT COST ALLOCATION DISCUSSION QUESTIONS 1. Support department costs are only indirectly related to production, so it can be difficult to find an appropriate cost driver for applying these costs to a product. For example, maintenance services are necessary for safe and efficient production, but applying maintenance costs to products based on units produced, batches run, or the number of product lines is not entirely accurate, because none of these potential drivers cause, by themselves, the maintenance cost to occur. 2. Support departments often constitute much of the overall costs for service businesses. Because these costs are difficult to directly trace back to individual divisions of the business, the costs are instead allocated using support department cost allocation methods. Thus, the allocation of support department costs is very important for service businesses. 3. When a single driver is used for all overhead costs, it is unlikely that the driver selected is appropriate for every type of overhead. Further, this method ignores the fact that the processes used in manufacturing one product may differ from those used for other products. For example, some processes require more support activities than others and thus should be allocated more support department costs. 4. By allocating all support department costs directly to production departments, the direct method ignores the possibility that some support departments may also serve other support departments. In contrast, the sequential and reciprocal services methods consider inter-support-department service costs. 5. Management normally determines the order based on the following: Departments with higher costs are allocated earlier, departments serving a large number of support departments are allocated earlier, and departments with more accurate cost drivers are allocated earlier. 6. Small companies are more likely to use the direct method. This is because the smaller a company is, the less likely it is that cost allocation methods will yield substantially different results. Thus, the cost of using the more accurate sequential or reciprocal services methods is less likely to be justified, given the complexity of these methods. 7. The physical units method allocates joint costs using a physical measure of the products at the split-off point. The weighted average method also uses a physical measure of the products at the split-off point, but then multiplies these measures by weight factors for each product. These weighted average units are then used to allocate the joint costs to the products. 8. Management would be most likely to use the net realizable value method of joint cost allocation when management wants joint cost allocations to be based on the final market value of products. When using this method, more joint costs are allocated to the products that are better able to cover those costs. 9. Revenue from by-products is most often either used to offset the cost of the joint production process or reported as other reveue on the income statement with no related cost of goods sold. 10. Production employees are often evaluated, at least in part, on their ability to keep production costs down. How support department and joint costs are allocated to different products affects the overall cost of production, which is used to evaluate production employees. If the way in which support department and joint costs are allocated assigns high costs of production largely outside of production employees’ control, the resulting overall costs of production will lead to inaccurate performance evaluations of those production employees. 19-1 © 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

BASIC EXERCISES BE 19–1 (FIN MAN); BE 5–1 (MAN) a.

Percentage of Janitorial costs to be allocated to the Assembly Department: 46,400 ÷ (33,600 + 46,400) = 58%

Percentage of Security costs to be allocated to the Cutting Department: $140,000 ÷ ($140,000 + $60,000) = 70%

BE 19–2 (FIN MAN); BE 5–2 (MAN) a.

Percentage of Cafeteria costs to be allocated to the Molding Department: 30 ÷ (30 + 25 + 5) = 50%

Percentage of Materials Management costs to be allocated to the Finishing Department: $3,100 ÷ ($1,900 + $3,100) = 62%

Joint Product Standard door handle Curved door handle Totals

Proportion 60% 40%

Joint Costs $4,000 4,000

Door Handles at Split-Off 2,000 1,000 3,000

19-3

Selling Price per Door Handle at Split-Off $4 2

Total Market Value at Split-Off $ 8,000 2,000 $10,000

Weighted Casings Casings at Split-Off Weight Factor of Molding Time 500 2 1,000 250 1 250 750 1,250

Swords per Batch 30 20 50

Percent of Total Market Value at Split-Off 80% 20%

Weighted Percent of Molding Time 80% 20%

Allocation $2,400 1,600 $4,000

Joint Costs $29,000 29,000

Joint Costs $7,200 7,200

Support Department and Joint Cost Allocation

BE 19–5 (FIN MAN); BE 5–5 (MAN)

Joint Product Red oak casing Walnut casing Totals

BE 19–4 (FIN MAN); BE 5–4 (MAN)

Joint Product Broadsword Longsword Totals

BE 19–3 (FIN MAN); BE 5–3 (MAN)

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Allocation $23,200 5,800 $29,000

Allocation $5,760 1,440 $7,200

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

EXERCISES Ex. 19–1 (FIN MAN); Ex. 5–1 (MAN) Support Department 1 cost allocation: Production Department 1:

1,500 ÷ (1,500 + 200 + 300) = 75% 75% × $157,000 = $117,750

Production Department 2:

200 ÷ (1,500 + 200 + 300) = 10% 10% × $157,000 = $15,700

Production Department 3:

300 ÷ (1,500 + 200 + 300) = 15% 15% × $157,000 = $23,550

Ex. 19–2 (FIN MAN); Ex. 5–2 (MAN) Support Department 1 cost allocation: Support Department 2:

10 ÷ (10 + 15 + 25) = 20% 20% × $35,000 = $7,000

Production Department 1:

15 ÷ (10 + 15 + 25) = 30% 30% × $35,000 = $10,500

Production Department 2:

25 ÷ (10 + 15 + 25) = 50% 50% × $35,000 = $17,500

Ex. 19–3 (FIN MAN); Ex. 5–3 (MAN) Maintenance Department cost allocation: Cutting Department:

9 ÷ (9 + 1) = 90% 90% × $7,800 = $7,020

Pruning Department:

1 ÷ (9 + 1) = 10% 10% × $7,800 = $780

Janitorial Department cost allocation: Cutting Department:

20 ÷ (20 + 60) = 25% 25% × $5,000 = $1,250

Pruning Department:

60 ÷ (20 + 60) = 75% 75% × $5,000 = $3,750

Production departmentsʼ total costs: Cutting Department:

$7,020 + $1,250 + $54,500 = $62,770

Pruning Department:

$780 + $3,750 + $11,000 = $15,530 19-4

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

Ex. 19–4 (FIN MAN); Ex. 5–4 (MAN) Security Department cost allocation: Maintenance Department:

600 ÷ (600 + 2,400 + 3,000) = 10% 10% × $4,500 = $450

Cutting Department:

2,400 ÷ (600 + 2,400 + 3,000) = 40% 40% × $4,500 = $1,800

Sewing Department:

3,000 ÷ (600 + 2,400 + 3,000) = 50% 50% × $4,500 = $2,250

Maintenance Department total cost to be allocated: $2,200 + $450 = $2,650 Maintenance Department cost allocation: Cutting Department:

3,600 ÷ (3,600 + 5,400) = 40% 40% × $2,650 = $1,060

Sewing Department:

5,400 ÷ (3,600 + 5,400) = 60% 60% × $2,650 = $1,590

Production departmentsʼ total costs: Cutting Department:

$1,800 + $1,060 + $21,200 = $24,060

Sewing Department:

$2,250 + $1,590 + $24,900 = $28,740

Ex. 19–5 (FIN MAN); Ex. 5–5 (MAN) Janitorial Department cost allocation: Cutting Department:

1,000 ÷ (1,000 + 4,000) = 20% 20% × $310,000 = $62,000

Assembly Department:

4,000 ÷ (1,000 + 4,000) = 80% 80% × $310,000 = $248,000

Cafeteria Department cost allocation: Cutting Department:

30 ÷ (30 + 10) = 75% 75% × $169,000 = $126,750

Assembly Department:

10 ÷ (30 + 10) = 25% 25% × $169,000 = $42,250

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

Ex. 19–6 (FIN MAN); Ex. 5–6 (MAN) Janitorial Department cost allocation: Cafeteria Department:

5,000 ÷ (5,000 + 1,000 + 4,000) = 50% 50% × $310,000 = $155,000

Cutting Department:

1,000 ÷ (5,000 + 1,000 + 4,000) = 10% 10% × $310,000 = $31,000

Assembly Department:

4,000 ÷ (5,000 + 1,000 + 4,000) = 40% 40% × $310,000 = $124,000

Cafeteria Department total cost to be allocated: $169,000 + $155,000 = $324,000 Cafeteria Department cost allocation: Cutting Department:

30 ÷ (30 + 10) = 75% 75% × $324,000 = $243,000

Assembly Department:

10 ÷ (30 + 10) = 25% 25% × $324,000 = $81,000

Cubic Yards per Batch 6,000 2,000 8,000

Joint Product Raw sugar Granulated sugar Caster sugar Totals

Market Value per Pound at Split-Off $0.24 0.25 0.25

Weight Factor 2 14

Proportion 50% 30% 20%

Allocation $1,750 1,050 700 $3,500

Total Market Value at Split-Off $ 600 900 500 $2,000

19-7

Percent of Total Market Value at Split-Off 30% 45% 25%

Weighted Weighted Cubic Percent of Yards of Production Production Time Time 30% 12,000 70% 28,000 40,000

Joint Costs $3,500 3,500 3,500

Joint Costs $1,700 1,700 1,700

Joint Costs $27,300 27,300

Allocation $ 510 765 425 $1,700

Allocation $ 8,190 19,110 $27,300

Support Department and Joint Cost Allocation

Pounds at Split-Off 2,500 3,600 2,000 8,100

Ex. 19–9 (FIN MAN); Ex. 5–9 (MAN)

Joint Product Sawdust Wood chips Totals

Ex. 19–8 (FIN MAN); Ex. 5–8 (MAN)

Joint Product Washed Stained Pressure treated Totals

Boards per Batch 100 60 40 200

Ex. 19–7 (FIN MAN); Ex. 5–7 (MAN)

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Market Price per Cubic Yard $25 30 27

Net Realizable Value per Cubic Yard $25 25 23

19-8

Added Cost per Cubic Yard — 5 4 Total Net Realizable Value $510,000 230,000 239,200

Greater of Total NRV and Market Value at Split-Off $ 510,000 230,000 260,000 $1,000,000

Support Department and Joint Cost Allocation

Market Value Total Market per Cubic Value at Yard at Cubic Yards Split-Off Split-Off per Batch Joint Product Wood chips 20,400 $25 $510,000 Wood pulp 9,200 22 202,400 Mulch 10,400 25 260,000 Totals 40,000

Ex. 19–10 (FIN MAN); Ex. 5–10 (MAN)

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Proportion Joint Costs 51% $34,000 23% 34,000 26% 34,000

Allocation $17,340 7,820 8,840 $34,000

Cups per Batch 21.75 29.00 36.25 87.00

Joint Product Gasoline Diesel Kerosene Totals

Allocation $ 675 375 450 $1,500

Total Market Value at Split-Off $ 6,830 2,732 4,098 $13,660

Percent of Total MV at Split-Off 50% 20% 30%

Joint Costs $15,800 15,800 15,800

Weighted Weighted Cups of Percent of Mixing Time Mixing Time Joint Costs 30% $43 43.50 20% 43 29.00 50% 43 72.50 145.00

Joint Costs $1,500 1,500 1,500

19-9

Market Value per Gallon at Split-Off $2 1 3

Weight Factor 2 1 2

Proportion 45% 25% 30%

Support Department and Joint Cost Allocation

Gallons per Batch 3,415 2,732 1,366 7,513

Ex. 19–13 (FIN MAN); Ex. 5–13 (MAN)

Joint Product Blueberry lemon Orange swirl Triple berry Totals

Ex. 19–12 (FIN MAN); Ex. 5–12 (MAN)

Joint Product Sirloin steak Ribeye steak T-bone steak Totals

Pounds at Split-Off 99 55 66 220

Ex. 19–11 (FIN MAN); Ex. 5–11 (MAN)

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Allocation $ 7,900 3,160 4,740 $15,800

Allocation $12.90 8.60 21.50 $43.00

Joint Product Pure lemonade Strawberry lemonade Raspberry lemonade Totals 0.80

21 74

16.80

Total Market Value at Split-Off $25.60

1.00

0.95 19.20

1.80

19-10

19.20

0.75 19.20 $64.00

19.20

Greater of Total Net Total NRV and Market Price Added Cost Realizable Market Value at Split-Off Value per Cup per Batch $ — $25.60 $25.60 $0.80

30%

Proportion Joint Costs 40% $30

Support Department and Joint Cost Allocation

0.80

Market Value per Cups per Cup at SplitOff Batch 32 $0.80

Ex. 19–14 (FIN MAN); Ex. 5–14 (MAN)

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

9 $30

Allocation $12

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

Appendix Ex. 19–15 (FIN MAN); Appendix Ex. 5–15 (MAN) Let X = the total cost to be allocated from the Janitorial Department, and let Y = the total cost to be allocated from the Cafeteria Department. The total costs of the Janitorial Department include 10 ÷ (10 + 30 + 60) = 10% of the Cafeteria Department’s costs. The total costs of the Cafeteria Department include 500 ÷ (500 + 1,000 + 1,000) = 20% of the Janitorial Department’s costs. Thus, Equation 1: X = $3,030 + (0.1 × Y) Equation 2: Y = $4,000 + (0.2 × X) Equation 2 can be rewritten in terms of X, as follows: Y = $4,000 + (0.2 × X) Y – $4,000 = 0.2 × X (Y – $4,000) = X 0.2 Replace the X in Equation 1 with The resulting equation is:

(Y – $4,000) , since this value equals X. 0.2 (Y – $4,000) = $3,030 + (0.1 × Y) 0.2

Solving this equation for Y yields the following: (Y – $4,000) = $3,030 + (0.1 × Y) 0.2 Y – $4,000 = (0.2 × $3,030) + [(0.2 × 0.1) × Y] Y = $4,000 + (0.2 × $3,030) + [(0.2 × 0.1) × Y] Y = $4,000 + $606 + (0.02 × Y) Y – (0.02 × Y) = $4,000 + $606 0.98 × Y = $4,606 $4,606 Y = 0.98 Y = $4,700 Now that Y is known, it can be plugged into Equation 1 to find X, as follows: X = $3,030 + (0.1 × Y) = $3,030 + (0.1 × $4,700) = $3,030 + $470 = $3,500

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

Appendix Ex. 19–16 (FIN MAN); Appendix Ex. 5–16 (MAN) a.

Percentage of Janitorial costs to be allocated to the Security Department: 1,600 ÷ (1,600 + 4,800 + 1,600) = 20%

Percentage of Security costs to be allocated to the Janitorial Department: $200 ÷ ($1,800 + $2,000 + $200) = 5%

Appendix Ex. 19–17 (FIN MAN); Appendix Ex. 5–17 (MAN) Total cost to be allocated from Security Department (S): Total costs of Security Department include 10 ÷ (10 + 40 + 50) = 10% of Cafeteria Department costs Thus, S = $273,000 + (0.1 × C) Total cost to be allocated from Cafeteria Department (C): Total costs of Cafeteria Department include 2,400 ÷ (2,400 + 4,000 + 1,600) = 30% of Security Department costs Thus, C = $180,000 + (0.3 × S) Substitute the equation for C into the S equation: S = $273,000 + {0.1 × [$180,000 + (0.3 × S)]} S = $273,000 + $18,000 + (0.03 × S) 0.97 × S = $291,000 S = $300,000 Security Department cost allocation: Cafeteria Department:

2,400 ÷ (2,400 + 4,000 + 1,600) = 30% 30% × $300,000 = $90,000

Laser Department:

4,000 ÷ (2,400 + 4,000 + 1,600) = 50% 50% × $300,000 = $150,000

Forming Department:

1,600 ÷ (2,400 + 4,000 + 1,600) = 20% 20% × $300,000 = $60,000

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

Appendix Ex. 19–18 (FIN MAN); Appendix Ex. 5–18 (MAN) Total cost to be allocated from Maintenance Department (M): Total costs of Maintenance include $2,000 ÷ ($2,000 + $2,500 + $5,500) = 20% of Security costs Thus, M = $36,000 + (0.2 × S) Total cost to be allocated from Security Department (S): Total costs of Security include 2,000 ÷ (2,000 + 7,200 + 10,800) = 10% of Maintenance costs Thus, S = $16,000 + (0.1 × M) Substitute the equation for M into the S equation: S = $16,000 + {0.1 × [$36,000 + (0.2 × S)]} S = $16,000 + $3,600 + (0.02 × S) 0.98 × S = $19,600 S = $20,000 Now plug the value for S into the M equation: M = $36,000 + (0.2 × $20,000) = $36,000 + $4,000 = $40,000 Maintenance Department cost allocation: Security Department:

2,000 ÷ (2,000 + 7,200 + 10,800) = 10% 10% × $40,000 = $4,000

Cutting Department:

7,200 ÷ (2,000 + 7,200 + 10,800) = 36% 36% × $40,000 = $14,400

Molding Department:

10,800 ÷ (2,000 + 7,200 + 10,800) = 54% 54% × $40,000 = $21,600

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

Appendix Ex. 19–18 (FIN MAN); Appendix Ex. 5–18 (MAN) (Concluded) Security Department cost allocation: Maintenance Department:

$2,000 ÷ ($2,000 + $2,500 + $5,500) = 20% 20% × $20,000 = $4,000

Cutting Department:

$2,500 ÷ ($2,000 + $2,500 + $5,500) = 25% 25% × $20,000 = $5,000

Molding Department:

$5,500 ÷ ($2,000 + $2,500 + $5,500) = 55% 55% × $20,000 = $11,000

Production departmentsʼ total costs: Cutting Department:

$14,400 + $5,000 + $64,000 = $83,400

Molding Department:

$21,600 + $11,000 + $82,000 = $114,600

Appendix Ex. 19–19 (FIN MAN); Appendix Ex. 5–19 (MAN) Total cost to be allocated from the Janitorial Department (J): Total costs of Janitorial include 10 ÷ (10 + 30 + 10) = 20% of Cafeteria costs J = $310,000 + (0.2 × C) Total cost to be allocated from Cafeteria Department (C): Total costs of Cafeteria include 5,000 ÷ (5,000 + 1,000 + 4,000) = 50% of Janitorial costs C = $169,000 + (0.5 × J) Substitute the equation for J into the C equation: C = $169,000 + {0.5 × [$310,000 + (0.2 × C)]} C = $169,000 + $155,000 + (0.1 × C) 0.9 × C = $324,000 C = $360,000 Now plug the value for C into the J equation: J = $310,000 + (0.2 × $360,000) = $310,000 + $72,000 = $382,000 Janitorial Department cost allocation: Cafeteria Department:

5,000 ÷ (5,000 + 1,000 + 4,000) = 50% 50% × $382,000 = $191,000

Cutting Department:

1,000 ÷ (5,000 + 1,000 + 4,000) = 10% 10% × $382,000 = $38,200

Assembly Department:

4,000 ÷ (5,000 + 1,000 + 4,000) = 40% 40% × $382,000 = $152,800

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

Appendix Ex. 19–19 (FIN MAN); Appendix Ex. 5–19 (MAN) (Concluded) Cafeteria Department cost allocation: Janitorial Department:

10 ÷ (10 + 30 + 10) = 20% 20% × $360,000 = $72,000

Cutting Department:

30 ÷ (10 + 30 + 10) = 60% 60% × $360,000 = $216,000

Assembly Department:

10 ÷ (10 + 30 + 10) = 20% 20% × $360,000 = $72,000

Appendix Ex. 19–20 (FIN MAN); Appendix Ex. 5–20 (MAN) a.

Under the direct method, the Assembly Department is allocated the most support department costs, as follows: Cutting Department: Assembly Department:

Under the sequential method, the Cutting Department is allocated the most support department costs, as follows: Cutting Department: Assembly Department:

$62,000 + $126,750 = $188,750 $248,000 + $42,250 = $290,250

$31,000 + $243,000 = $274,000 $124,000 + $81,000 = $205,000

Under the reciprocal services method, the Cutting Department is allocated the most support department costs, although slightly less than the allocation it received under the sequential method, as follows: Cutting Department: Assembly Department:

$38,200 + $216,000 = $254,200 $152,800 + $72,000 = $224,800

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

PROBLEMS Prob. 19–1A (FIN MAN); Prob. 5–1A (MAN) 1.

Blue Mountain Masterpieces would most likely use the direct method, because its past experience with different cost allocation methods didn’t result in significant cost allocation differences. With little difference, the company can afford to use a less accurate support department cost allocation method and will do so because the direct method is simple and easy to use in comparison to the other methods.

Janitorial Department cost allocation: Printing Department:

4,230 ÷ (4,230 + 4,770) = 47% 47% × $5,200 = $2,444

Framing Department:

4,770 ÷ (4,230 + 4,770) = 53% 53% × $5,200 = $2,756

Security Department cost allocation:

Printing Department:

$12,390 ÷ ($12,390 + $8,610) = 59% 59% × $6,600 = $3,894

Framing Department:

$8,610 ÷ ($12,390 + $8,610) = 41% 41% × $6,600 = $2,706

Using asset value, the Printing Department receives more of the Security Department costs than the Framing Department, because the Printing Department has higher asset value than the Framing Department. However, because the Framing Department has more square footage than the Printing Department, the Framing Department would receive more of the costs from the Security Department than the Printing Department if square feet were used as the cost driver. So, using square feet instead of asset value to allocate Security Department costs would lead to an increase in the costs allocated to the Framing Department.

1. Market Value per Bottle at Split-Off $2.50 3.00 3.20

Total Market Value at Split-Off $200 120 80 $400

Percent of Total MV at Split-Off 50% 30% 20% Joint Costs $250 250 250

Allocation $125 75 50 $250

Support Department and Joint Cost Allocation

19-17

Lovely Lotion Inc. processes body lotion after the split-off point at a cost of $0.25 per bottle and then sells it for $2.75 more per bottle than its market value at split-off ($5.75 − $3.00), providing a $2.50 extra profit ($2.75 − $0.25) per bottle due to further processing after the split-off point. So, Lovely Lotion Inc. should continue to process body lotion after the split-off point. In contrast, Lovely Lotion Inc. processes foot lotion after the split-off point at a cost of $0.85 per bottle and then sells it for only $0.80 more per bottle than its market value at split-off ($4.00 − $3.20), causing a $0.05 loss ($0.80 − $0.85) per bottle due to further processing after the split-off point. So, Lovely Lotion Inc. should not continue to process foot lotion after the split-off point.

Joint Product Hand lotion Body lotion Foot lotion Totals

Bottles per Batch 80 40 25 145

Prob. 19–2A (FIN MAN); Prob. 5–2A (MAN)

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Joint Product Hand lotion Body lotion Foot lotion Totals

Bottles per Batch 80 40 25 145

Market Value per Bottle at Split-Off $2.50 3.00 3.20

19-18

Total Net Realizable Value $200.00 220.00 78.75

NRV per Bottle $2.50 5.50 3.15

Greater of Total NRV and Total Market Value at Split-Off $200.00 220.00 80.00 $500.00

Support Department and Joint Cost Allocation

Total Market Value Market Price Added Cost at Split-Off per Bottle per Bottle $ — $200.00 $2.50 120.00 0.25 5.75 80.00 0.85 4.00 $400.00

Prob. 19–2A (FIN MAN); Prob. 5–2A (MAN) (Concluded)

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Proportion Joint Costs Allocation 40% $250.00 $100.00 44% 250.00 110.00 16% 250.00 40.00 $250.00

1. Proportion 20% 40% 40%

Joint Costs $30 30 30

Weight Factor 2 1 3

Weighted Flowers of Water 20 20 60 100 Weighted Percent of Water 20% 20% 60%

Joint Costs $30 30 30

Allocation $ 6 6 18 $30

19-19

As we saw from the answers to parts (1) and (2), using the weighted average method substantially changes the allocation of the joint costs. Given this discrepancy, considering whether the amount of watering is an appropriate weight factor is important, because using it to weight the allocation of joint costs to each product assigns a larger portion of joint costs to flowers that are watered more. This allocation accounts for the fact that watering costs would be lower if the garden had the same number of flowers, but all flowers were lilies. If the amount of watering a flower needs is not a good representation of the joint costs of production (i.e., if watering the flowers is only a very small and noncorrelating portion of the joint costs of production), using it as a weight factor will cause an inaccurate allocation of joint costs.

Daisies received the largest portion of the joint costs.

Joint Product Tulip Lily Daisy Totals

Flowers per Harvest 10 20 20 50

Allocation $ 6 12 12 $30

Support Department and Joint Cost Allocation

Lilies and daisies received the largest portion of the joint costs.

Joint Product Tulip Lily Daisy Totals

Flowers per Harvest 10 20 20 50

Prob. 19–3A (FIN MAN); Prob. 5–3A (MAN)

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

Appendix Prob. 19–4A (FIN MAN); Appendix Prob. 5–4A (MAN) 1.

Maintenance costs should not continue to be allocated based on machine hours, because a more accurate cost driver for maintenance costs has been identified (number of service calls). The information in the problem tells us that the maintenance costs correlate more with the number of service calls. We can infer from this that the number of service calls is a more legitimate cost driver of maintenance costs than machine hours. Using the number of service calls as the cost driver for maintenance costs should provide a more accurate allocation of those costs.

Total cost to be allocated from Maintenance (M): Total costs of Maintenance include $200,000 ÷ ($200,000 + $120,000 + $480,000) = 25% of Security costs Thus, M = $25,000 + (0.25 × S) Total cost to be allocated from Security (S): Total costs of Security include 20 ÷ (20 + 60 + 20) = 20% of Maintenance costs Thus, S = $42,500 + (0.2 × M) Substitute the equation for M into the S equation: S = $42,500 + {0.2 × [$25,000 + (0.25 × S)]} S = $42,500 + $5,000 + (0.05 × S) 0.95 × S = $47,500 S = $50,000 Now plug the value for S into the M equation: M = $25,000 + (0.25 × $50,000) = $25,000 + $12,500 = $37,500 Maintenance cost allocation: Security:

20 ÷ (20 + 60 + 20) = 20% 20% × $37,500 = $7,500

Mining:

60 ÷ (20 + 60 + 20) = 60% 60% × $37,500 = $22,500

Cutting:

20 ÷ (20 + 60 + 20) = 20% 20% × $37,500 = $7,500

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

Appendix Prob. 19–4A (FIN MAN); Appendix Prob. 5–4A (MAN) (Concluded) Security cost allocation: Maintenance: $200,000 ÷ ($200,000 + $120,000 + $480,000) = 25% 25% × $50,000 = $12,500 Mining:

$120,000 ÷ ($200,000 + $120,000 + $480,000) = 15% 15% × $50,000 = $7,500

Cutting:

$480,000 ÷ ($200,000 + $120,000 + $480,000) = 60% 60% × $50,000 = $30,000

Production activities total costs:

Mining:

$22,500 + $7,500 + $160,000 = $190,000

Cutting:

$7,500 + $30,000 + $95,000 = $132,500

Maintenance cost allocation: Mining:

60 ÷ (60 + 20) = 75% 75% × $25,000 = $18,750

Cutting:

20 ÷ (60 + 20) = 25% 25% × $25,000 = $6,250

Security cost allocation: Mining:

$120,000 ÷ ($120,000 + $480,000) = 20% 20% × $42,500 = $8,500

Cutting:

$480,000 ÷ ($120,000 + $480,000) = 80% 80% × $42,500 = $34,000

Production activities total costs: Mining:

$18,750 + $8,500 + $160,000 = $187,250

Cutting:

$6,250 + $34,000 + $95,000 = $135,250

The direct method of cost allocation results in only slightly different total costs for production activities compared to the reciprocal services method. Given this information, switching to the direct method of support activity cost allocation, which is far more simple than the reciprocal services method, would probably be a good idea.

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

Prob. 19–1B (FIN MAN); Prob. 5–1B (MAN) 1.

When using the sequential method, the support departments are often allocated in order of highest to lowest cost. Preference is also given to departments that serve a larger number of other support departments and departments with more accurate cost drivers. In this case, Hooligan Adventure Supply would most likely allocate the Personnel Department first, because it has the highest cost and an accurate cost driver.

Personnel Department cost allocation: Maintenance Department:

10 ÷ (10 + 41 + 49) = 10% 10% × $15,000 = $1,500

Molding Department:

41 ÷ (10 + 41 + 49) = 41% 41% × $15,000 = $6,150

Assembly Department:

49 ÷ (10 + 41 + 49) = 49% 49% × $15,000 = $7,350

Maintenance Department total cost to be allocated: $11,400 + $1,500 = $12,900 Maintenance Department cost allocation:

Molding Department:

168 ÷ (168 + 112) = 60% 60% × $12,900 = $7,740

Assembly Department:

112 ÷ (168 + 112) = 40% 40% × $12,900 = $5,160

The reciprocal services method is the most accurate method of support department cost allocation. However, Hooligan Adventure Supply may be discouraged from using this method because of its high level of complexity. In addition, if using this method does not result in significant differences in cost allocation in comparison to the other methods, the company may believe that the extra cost of using the reciprocal services method is not worth its only slight improvement to cost allocation accuracy.

10,000 36,800

Snowflake sparkle hand soap

Sea breeze hand soap Totals 1.25

1.25

$1.25

12,500

15,000

$18,500

2.40

2.20

$2.00

0.60

0.55

$0.50

1.80

1.65

$1.50

NRV per Bottle

18,000

19,800

$22,200

18,000 $60,000

19,800

$22,200

30%

33%

37%

30,000

$30,000

Proportion Joint Costs

9,000 $30,000

9,900

$11,100

Allocation

19-23

Given a similar demand for each of the joint products, McKenzie’s Soap Sensations, Inc., should produce as much sea breeze hand soap as possible, because it has the greatest net realizable value after processing. The company makes a higher margin of profit per bottle on this variety of hand soap than on the other varieties of hand soap.

12,000

Morning glory hand soap

Market Added Cost per Price per Bottle Bottle

14,800

Joint Product

Market Value per Bottle at Split-Off

Greater of Total NRV Total Net and Market Realizable Value at Value Split-Off

McKenzie’s Soap Sensations, Inc., always processes each variety of hand soap beyond the split-off point, because the net realizable value of each variety of hand soap after further processing (beyond the split-off point) is higher than the market value of each variety of hand soap at the split-off point.

Bottles per Batch

Total Market Value at Split-Off

Support Department and Joint Cost Allocation

Prob. 19–2B (FIN MAN); Prob. 5–2B (MAN)

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Roses per Harvest 80 70 50 200

Weight Factor 1 1 2

Proportion 40% 35% 25%

Weighted Roses of Fertilizer 80 70 100 250

Joint Costs $110 110 110

Weighted Percent of Fertilizer 32% 28% 40%

Allocation $ 44.00 38.50 27.50 $110.00

Joint Costs $110 110 110

Support Department and Joint Cost Allocation

Allocation $ 35.20 30.80 44.00 $110.00

19-24

The cost of the type of fertilizer required by each type of rose may be a good weight factor. If fertilizer is a significant cost of the joint production process, then it is a good weight factor, because using it will direct the company to allocate more of the joint process costs to the product(s) that truly incur more of them. However, if fertilizer is a minimal or insignificant cost of production, then it will direct the company to allocate more of the joint process costs to product(s) that do not truly incur higher costs.

Joint Product Red roses White roses Peach roses Totals

Prob. 19–3B (FIN MAN); Prob. 5–3B (MAN)

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

Appendix Prob. 19–4B (FIN MAN); Appendix Prob. 5–4B (MAN) 1.

In choosing a cost driver, Kizzle’s management should consider how well the driver represents the costs of the department. For example, Janitorial costs are often allocated based on square feet because the square footage required by an activity represents the size of the area that must be cleaned. Additionally, Kizzle’s management must choose a driver that can be practically measured. In this case, Kizzle’s management could use either the number of service calls or machine hours, because both can be practically measured and either one may correlate to how often machines have to be repaired. However, Kizzle’s management should most likely not use the asset value of production equipment as a driver, because it gives no indication of how often machines are used or have to be repaired.

Total cost to be allocated from Maintenance (M): Total costs of Maintenance include 1 ÷ (1 + 2 + 2) = 20% of Janitorial costs Thus, M = $4,200 + (0.2 × J) Total cost to be allocated from Janitorial (J): Total costs of Janitorial include 16 ÷ (16 + 40 + 24) = 20% of Maintenance costs Thus, J = $3,000 + (0.2 × M) Substitute the equation for M into the J equation: J = $3,000 + {0.2 × [$4,200 + (0.2 × J)]} J = $3,000 + $840 + (0.04 × J) 0.96 × J = $3,840 J = $4,000 Now plug the value for J into the M equation: M = $4,200 + (0.2 × $4,000) = $4,200 + $800 = $5,000 Maintenance cost allocation: Janitorial:

16 ÷ (16 + 40 + 24) = 20% 20% × $5,000 = $1,000

Mixing:

40 ÷ (16 + 40 + 24) = 50% 50% × $5,000 = $2,500

Cooking:

24 ÷ (16 + 40 + 24) = 30% 30% × $5,000 = $1,500

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

Appendix Prob. 19–4B (FIN MAN); Appendix Prob. 5–4B (MAN) (Concluded) Janitorial cost allocation:

Maintenance:

1 ÷ (1 + 2 + 2) = 20% 20% × $4,000 = $800

Mixing:

2 ÷ (1 + 2 + 2) = 40% 40% × $4,000 = $1,600

Cooking:

2 ÷ (1 + 2 + 2) = 40% 40% × $4,000 = $1,600

The reciprocal services method is the most difficult of the three support department cost allocation methods. However, it is also the most accurate method. As Kizzle’s Crepes Co. grows, the discrepancy (and inaccuracy) of the direct or sequential methods in comparison to the reciprocal services method will also grow because of growing support department costs that must be allocated. As long as it has sufficient capacity and resources, Kizzle’s Crepes Co. may do well to keep using the reciprocal services method to maintain accurate costing.

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

MAKE A DECISION MAD 19–1 (FIN MAN); MAD 5–1 (MAN) a.

Because company bonuses are based on cost allocations, an accurate cost allocation is important. Thus, either the sequential method or the reciprocal services method is advisable.

There isn’t a cost driver that varies from period to period that truly causes Janitorial costs. These costs are probably higher with more area to clean, but the areas (measured in square feet) stay constant from quarter to quarter. Thus, if these costs must be allocated, they are likely best allocated using square feet.

Maintenance costs are best allocated using the driver of these costs: maintenance calls.

Maintenance costs are likely controllable by the GMs and should be allocated for performance evaluation purposes. The GMs can’t control the square footage their plant uses, so the Janitorial costs should likely be ignored when evaluating GM performance.

Using the market value at split-off and the net realizable value methods punishes the GM who has higher margins (the GM of yogurt). Because both products are equally difficult to make, using the weighted average method is probably inappropriate. The physical units method would be the most fair method for allocating costs.

f. Joint Product Yogurt Cheese Totals

Pounds per Quarter 198,000 102,000 300,000

Proportion 66% 34%

Joint Costs $755,000 755,000

Allocation $498,300 256,700 $755,000

MAD 19–2 (FIN MAN); MAD 5–2 (MAN) a.

Management has noted the need for highly accurate support department cost allocation because cost management performance affects a portion of company bonuses. In addition, management is not worried about using a highly complex method. Thus, either the sequential method or the reciprocal services method should be used because they are more accurate than the direct method, and the complexity of these methods is not expected to pose significant problems.

Janitorial costs vary with the number of vehicles produced, and should therefore be allocated based on this driver: number of vehicles produced.

Security costs are based on the size of the lot, so square footage would be an accurate cost driver of this department. Security costs do not depend on asset value, as the number of vehicles in the lot or warehouse does not affect them, so asset value should not be used as a cost driver.

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

MAD 19–2 (FIN MAN); MAD 5–2 (MAN) (Concluded) d.

Security Department cost allocation: $10,000 ÷ ($10,000 + $450,000 + $540,000) = 1% Janitorial Department: $450,000 ÷ ($10,000 + $450,000 + $540,000) = 45% Production Department 1: Production Department 2: $540,000 ÷ ($10,000 + $450,000 + $540,000) = 54% Janitorial Department cost allocation: 54,000 ÷ (54,000 + 36,000) = 60% Production Department 1: Production Department 2: 36,000 ÷ (54,000 + 36,000) = 40%

Because Janitorial costs increase with the number of vehicles produced (a decision made by a production manager), these costs are controllable by the managers and should be allocated for performance evaluation purposes. Security costs are fixed based on square footage, and this cannot be controlled by production managers, so these costs should not be considered for performance evaluation purposes.

The market value at split-off and net present value methods may not fairly allocate joint costs because all joint products are produced and sold at similar margins. Because certain models and colors are more difficult to produce during the joint production process, using the physical units method would not fairly allocate joint costs to the units that were more difficult to produce. The weighted average method fixes this issue by assigning a larger weight factor to these difficult-to-make units and is most likely to fairly allocate joint costs of production in this case.

19-29

The most profitable flavors to Joyous Julius appear to be mango orange and raspberry orange. The additional processing of these flavors increases their value by $0.20 each (see table above). All other factors constant, the company should keep raspberry orange and mango orange to go along with its pure orange flavor.

Net Realizable Value per Cup $3.00 3.20 3.20 3.10 2.70 2.60

Yes. Joyous Julius, Inc., should discontinue processing its tropical orange and coconut orange flavors, because they are worth more at the split-off point than after further processing (see table above).

Added Cost per Cup $ — 0.15 0.10 0.20 0.40 0.65

Greater of NRV and Market Value at Split-Off per Cup $3.00 3.20 3.20 3.10 3.00 3.00

Support Department and Joint Cost Allocation

Orange Julius Flavor Pure orange Raspberry orange Mango orange Strawberry orange Tropical orange Coconut orange

Market Price per Market Value Cup After per Cup at Further Split-Off Processing $3.00 $3.00 3.00 3.35 3.00 3.30 3.00 3.30 3.00 3.10 3.00 3.25

MAD 19–3 (FIN MAN); MAD 5–3 (MAN)

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Cups per Batch 1,280 500 300 2,080

Market Price per Cup $3.00 3.35 3.30 Added Cost per Cup $ — 0.15 0.10

Net Realizable Value per Cup $3.00 3.20 3.20 Total Net Realizable Value $3,840 1,600 960

Greater of NRV or Market Value at Split-Off $3,840 1,600 960 $6,400

Support Department and Joint Cost Allocation

Proportion 60% 25% 15%

Joint Costs $2,500 2,500 2,500

Allocation $1,500 625 375 $2,500

19-30

One of the most common ways to account for revenues from by-products is to use them to offset the cost of the joint production process, which would be entirely appropriate in this case. Another way Joyous Julius, Inc., could account for these revenues is to report them as other revenue on the income statement with no related cost of goods sold.

Orange Julius Flavor Pure orange Raspberry orange Mango orange Totals

Market Value Total Market per Cup at Value at Split-Off Split-Off $3,840 $3.00 1,500 3.00 900 3.00

Pure orange: 900 + 150 + 130 + 100 = 1,280

MAD 19–3 (FIN MAN); MAD 5–3 (MAN) (Concluded)

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

MAD 19–4 (FIN MAN); MAD 5–4 (MAN) a.

Management’s highest priority with regard to the cost allocation process is to keep it simple and cost-effective. In addition, performance evaluations do not depend on them, and William’s Ball & Jersey Shop is a small company, so the different support department cost allocation methods are unlikely to yield significant cost allocation differences. Thus, the direct method should be used, because it is the simplest and most cost-effective method.

Using the weighted average method of joint cost allocation, instead of the physical units method, would improve the accuracy of William’s Ball & Jersey Shop’s current joint cost allocation. This method would allow the company to place a weight factor on the joint products, thereby allocating more of the joint costs to those products that cost more to produce during the joint production process (e.g., adult-size jerseys).

William needs to know the market value of the toddler-size jersey at the split-off point and the market price of the toddler-size jersey after further processing. In addition, it would be helpful to know the current exact share of the joint production costs that the toddler-size jersey will incur. Finally, any information about market demand for the product and whether or not there may be risks of cannabilization costs (sales of other products decreasing as a result of the new product line) should also be considered.

Given the fact that the toddler-size jersey will be increasing its value by $4.99 ($17.99 − $10 − $3) after processing beyond the split-off point, it is likely that adding the jersey will be profitable for the company. Although the product’s joint production cost is just less than its market value at the split-off point, the company’s new weighted average method of joint cost allocation will likely result in a decreased share of the joint costs for the toddler-size jersey, because it will require less material, cutting, and sewing than the adult- and youth-size jerseys. The increase in value after further processing should more than compensate for the product’s high joint production cost. Thus, William should add the jersey.

Support Department 1 cost allocation: 22 ÷ (22 + 18) = 55% Production Department 1: Production Department 2: 18 ÷ (22 + 18) = 45% Support Department 2 cost allocation: 2,280 ÷ (2,280 + 1,720) = 57% Production Department 1: Production Department 2: 1,720 ÷ (2,280 + 1,720) = 43%

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

TAKE IT FURTHER TIF 19–1 (FIN MAN); TIF 5–1 (MAN) 1.

The line manager exhibited motivated reasoning; that is, she ignored evidence against her preference and overweighted evidence for her preference. She acted out of her own self-interest rather than considering what the best decision would be, given all the facts. Even though her motivated reasoning may not have been a conscious decision, motivated reasoning can lead people to make unethical choices without feeling unethical about them.

As illustrated in this example, the allocation of joint costs often affects manager performance evaluations. With this in mind, company management should consider factors including each joint product’s final market value, split-off market value, production difficulty level or cost, and what the company wants the joint cost allocations to reflect.

TIF 19–2 (FIN MAN); TIF 5–2 (MAN) Liam: The direct method is simple and easy to use. It is easily implemented and communicated, so choosing this method will likely result in few cost accounting errors or misunderstandings throughout the company. The major con of this method is that it is the least accurate. In a company that has many support department costs, the resultant cost allocation of this method is likely to largely differ from the other more accurate methods. The best case for Quetzal Inc. choosing this method is that it will allow the company to revamp its cost accounting system quickly and without too many hiccups. Rose: The sequential method is a compromise between practicality and accuracy. It is more difficult to implement and use than the direct method, but it is not as complex as the reciprocal services method. For a company with some but not a lot of technical expertise and computational resources, this method may be the best choice. It provides more accurate results but does not take into account all of the inter-support-department services. The best case for Quetzal Inc. choosing this method is that it is likely to provide fairly accurate cost allocations without necessitating too much technical expertise and computational resources.

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

TIF 19–3 (FIN MAN); TIF 5–3 (MAN) The content of the memo should be similar to the following response: I disagree with the Mackalite production manager’s argument. Although the two products come from an inseparable process, Mackalite is more costly to make because it requires more heat than Jemmerite in the joint production process. In other words, if only Jemmerite were being produced, the heating process would only rise to 300 degrees Fahrenheit, and would therefore cost less. Additionally, the joint production process produces 2.5 times more gallons of Mackalite than Jemmerite. Since both products are sold immediately at the split-off point for the same price, they should receive a share of joint costs proportionate to their share of total gallons yielded from the joint production process. In summary, because Mackalite increases the cost of the joint production process and makes up the majority of the units produced from the joint production process, it should be allocated a higher percentage of the joint production costs than Jemmerite.

TIF 19–4 (FIN MAN); TIF 5–4 (MAN) 1.

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

TIF 19–4 (FIN MAN); TIF 5–4 (MAN) (Concluded) 2.

The most apparent difference between the two cost allocation methods is the cost allocated to the ceramic tile adhesive sold in a 3.5-gallon container. If management chooses to use the physical units method, they might be underallocating joint costs to this product and over-allocating joint costs to its sister product ceramic tile adhesive sold in a 1-gallon container.

Management should be cautioned against using this analysis as a silver bullet. As with virtually every data analytic process, there is a measure of subjectivity (e.g., the mixing time weight factor) as well as variability. Thus, while the analysis can assist management in making a cost allocation decision, the data does not live in a “vacuum” and the decision could easily be influenced by countless other factors.

CHAPTER 19 (FIN MAN); CHAPTER 5 (MAN)

Support Department and Joint Cost Allocation

CERTIFIED MANAGEMENT ACCOUNTANT (CMA®) EXAMINATION QUESTIONS (ADAPTED) 1.

Using the direct method of allocation, only the hours of the production departments would be included in the allocation base. 3,600 + 1,800 + 2,700 = 8,100

Total overhead in the Machining Department would be $407,500, determined as follows: Machining overhead Maintenance ($350,000 × 0.5) Systems [($95,000 + $35,000*) × 0.25**] Total overhead

$200,000 175,000 32,500 $407,500

* Maintenance allocated to Systems ** 20% ÷ (20% + 60%) 3.

The units should be processed after the split-off point only if the additional cost is less than the additional revenue. Only J-60 units warrant further processing.

Additional revenue Additional cost 4.

B-40 $2.25 3.05

J-60 $1.70 1.00

H-102 $2.50 2.50

The total cost allocated to produce Mini is $1,000, determined as follows: ($3,000 + $2,000) × (200 ÷ 1,000) = $1,000

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN) COST-VOLUME-PROFIT ANALYSIS DISCUSSION QUESTIONS 1.

Total variable costs change in proportion to changes in the level of activity. Unit variable costs remain the same regardless of the level of activity.

a. b.

Total fixed cost remains the same regardless of changes in the level of activity. Fixed cost per unit decreases as the activity level increases and increases as the activity level decreases.

Mixed costs are costs that have characteristics of both a variable and a fixed cost. The high-low method uses the highest and lowest activity levels and their related costs to estimate the variable cost per unit and the fixed cost. The total fixed cost does not change with changes in activity level. Thus, the difference in the total cost between the highest and lowest levels of activity is the change in the total variable cost. Dividing this difference by the difference in activity level is an estimate of the variable cost per unit. The fixed cost is then estimated by subtracting the total variable costs from the total costs for the level of activity.

a. b.

A high contribution margin ratio, coupled with idle capacity, indicates a potential for increased operating income if additional sales can be made. A large percentage of each additional sales dollar would be available, after providing for variable costs, to cover promotion efforts and to increase operating income. Thus, a substantial sales promotion campaign should be considered in order to expand sales to maximum capacity and to take advantage of the low ratio of variable costs to sales.

Decreases in unit variable costs, such as a decrease in the unit cost of direct materials, will decrease the break-even point.

Austin Company had lower fixed costs and a higher percentage of variable costs to sales than did Hill Company. Such a situation resulted in a lower break-even point for Austin Company.

The individual products are treated as components of one overall company product. These components are weighted by the sales mix percentages when determining the contribution margin. Therefore, the sales mix affects the contribution margin and thus the break-even point.

10.

Operating leverage measures the relationship between a company’s contribution margin and operating income. The difference between contribution margin and operating income is fixed costs. Thus, companies with high fixed costs will normally have a high operating leverage. Low operating leverage is normal for companies that are labor intensive, such as professional service companies, which have low fixed costs.

Variable costs Variable costs

No impact on the contribution margin. Operating income would decrease.

It is computed as follows: Operating Leverage =

Contribution Margin Operating Income

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

BASIC EXERCISES BE 20–1 (FIN MAN); BE 6–1 (MAN) a.

$25 per unit = ($4,250,000 – $3,750,000) ÷ (60,000 units – 40,000 units)

$2,750,000 = $4,250,000 – ($25 × 60,000 units), or $3,750,000 – ($25 × 40,000 units)

BE 20–2 (FIN MAN); BE 6–2 (MAN) a.

40% = ($185 – $111) ÷ $185, or ($33,300,000 – $19,980,000) ÷ $33,300,000

$74 per unit = $185 – $111

Sales……………………………………… Variable costs…………………………… Contribution margin…………………… Fixed costs……………………………… Operating income………………………

$ 33,300,000 (180,000 units × $185 per unit) (19,980,000) (180,000 units × $111 per unit) $ 13,320,000 (180,000 units × $74 per unit) (8,175,000) $ 5,145,000

BE 20–3 (FIN MAN); BE 6–3 (MAN) a.

216,000 units = $5,400,000 ÷ ($75 – $50)

180,000 units = $5,400,000 ÷ ($80 – $50)

BE 20–4 (FIN MAN); BE 6–4 (MAN) a.

52,500 units = $1,890,000 ÷ ($120 – $84)

70,000 units = ($1,890,000 + $630,000) ÷ ($120 – $84)

BE 20–5 (FIN MAN); BE 6–5 (MAN) Unit selling price of M [($180 × 0.80) + ($225 × 0.20)]……………………………… Unit variable cost of M [($99 × 0.80) + ($135 × 0.20)]……………………………… Unit contribution margin of M…………………………………………………………

$ 189.00 (106.20) $ 82.80

Break-Even Sales (units) = 215,000 units = $17,802,000 ÷ $82.80 Break-Even Sales (units) for Yankee Model = 215,000 units of M × 80% = 172,000 units Break-Even Sales (units) for Zoro Model = 215,000 units of M × 20% = 43,000 units

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

BE 20–6 (FIN MAN); BE 6–6 (MAN) Contribution Margin Operating Leverage = Operating Income

Cost-Volume-Profit Analysis

$1,540,000 $1,100,000

= 1.4

BE 20–7 (FIN MAN); BE 6–7 (MAN) Margin of Safety =

Sales – Sales at Break-Even Point Sales ($380,000,000 – $323,000,000) = $380,000,000

$57,000,000 $380,000,000

= 15%

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

EXERCISES Ex. 20–1 (FIN MAN); Ex. 6–1 (MAN) 1. 2. 3. 4. 5. 6. 7. 8.

Variable Variable Fixed Fixed Variable Variable Fixed Variable

9. 10. 11. 12. 13. 14. 15.

Mixed Mixed Fixed Variable Variable Variable Variable

d. e.

Cost Graph Two Cost Graph Two

4. 5. 6.

f d a

Ex. 20–2 (FIN MAN); Ex. 6–2 (MAN) a. b. c.

Cost Graph Three Cost Graph Four Cost Graph One

Ex. 20–3 (FIN MAN); Ex. 6–3 (MAN) 1. 2. 3.

e b c

Ex. 20–4 (FIN MAN); Ex. 6–4 (MAN) 1. 2. 3.

e f c

For 3, (c) is better than (b) because the administrative costs would be the same for expensive and inexpensive cars.

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Ex. 20–5 (FIN MAN); Ex. 6–5 (MAN) a. b. c. d. e. f.

Variable Variable Fixed Variable Fixed Fixed

g. h. i. j. k.

Fixed* Fixed Variable Variable Variable

* The developer salaries are fixed because they are more variable to the number of titles or releases rather than the number of units sold. For example, a title could sell one copy or a million copies, and the salaries of the developers would not be affected.

Ex. 20–6 (FIN MAN); Ex. 6–6 (MAN) 40,000

Toys produced…………………… Total costs: Total variable costs………… Total fixed costs……………… Total costs…………………… Cost per unit: Variable cost per unit……… (a) Fixed cost per unit…………… (b) Total cost per unit……………(c)

80,000

120,000

$ 720,000 600,000 $1,320,000

(d) (e) (f)

$1,440,000 600,000 $2,040,000

(j) (k) (l)

$2,160,000 600,000 $2,760,000

$18.00 15.00 $33.00

(g) (h) (i)

$18.00 7.50 $25.50

(m) (n) (o)

$18.00 5.00 $23.00

Supporting calculations: a.

$18.00 ($720,000 ÷ 40,000 units)

$15.00 ($600,000 ÷ 40,000 units)

$33.00 ($18.00 + $15.00)

$1,440,000 ($18.00 × 80,000)

$600,000 (fixed costs do not change with volume)

$2,040,000 ($1,440,000 + $600,000)

$18.00 ($1,440,000 ÷ 80,000 units; variable costs per unit do not change with changes in volume)

$7.50 ($600,000 ÷ 80,000 units)

$25.50 ($18.00 + $7.50)

$2,160,000 ($18.00 × 120,000 units)

$600,000 (fixed costs do not change with volume)

$2,760,000 ($2,160,000 + $600,000)

m. $18.00 ($2,160,000 ÷ 120,000 units; variable costs per unit do not change with changes in volume) n.

$5.00 ($600,000 ÷ 120,000 units)

$23.00 ($18.00 + $5.00)

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Ex. 20–7 (FIN MAN); Ex. 6–7 (MAN) a.

Variable Cost per Unit =

Difference in Total Costs Difference in Units Produced

$21,100,000 – $11,200,000 475,000 units – 200,000 units

$9,900,000 275,000 units

= $36 per unit

The fixed cost can be determined by subtracting the estimated total variable cost from the total cost at either the highest or lowest level of production, as follows: Total Cost = (Variable Cost per Unit × Units Produced) + Fixed Costs Highest level: $21,100,000 = ($36 × 475,000 units) + Fixed Costs $21,100,000 = $17,100,000 + Fixed Costs $4,000,000 = Fixed Costs Lowest level: $11,200,000 = ($36 × 200,000 units) + Fixed Costs $11,200,000 = $7,200,000 + Fixed Costs $4,000,000 = Fixed Costs b.

Total Cost = (Variable Cost per Unit × Units Produced) + Fixed Costs Total cost for 400,000 units: Variable cost: Units……………………………………………… Variable cost per unit………………………… Total variable cost…………………………… Fixed costs……………………………………… Total cost………………………………………

400,000 $36 × $14,400,000 4,000,000 $18,400,000

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Ex. 20–8 (FIN MAN); Ex. 6–8 (MAN) Difference in Total Costs Difference in Gross-Ton Miles

Variable Cost per = Gross-Ton Mile

$3,387,500 – $2,875,000 12,750,000 gross-ton miles – 2,500,000 gross-ton miles

$512,500 = $0.05 per gross-ton mile 10,250,000 gross-ton miles

The fixed costs can be determined by subtracting the estimated total variable cost from the total cost at either the highest or lowest level of gross-ton mile, as follows: Total Cost = (Variable Cost per Gross-Ton Mile × Gross-Ton Miles) + Fixed Costs Highest level: $3,387,500 = ($0.05 × 12,750,000 gross-ton miles) + Fixed Costs $3,387,500 = $637,500 + Fixed Costs $2,750,000 = Fixed Costs Lowest level: $2,875,000 = ($0.05 × 2,500,000 gross-ton miles) + Fixed Costs $2,875,000 = $125,000 + Fixed Costs $2,750,000 = Fixed Costs

Ex. 20–9 (FIN MAN); Ex. 6–9 (MAN) a.

Sales……………………… Variable costs…………… Contribution margin…… Contribution = Margin Ratio =

$ 38,600,000 (23,932,000) $ 14,668,000 Sales – Variable Costs Sales $14,668,000 $38,600,000

= 38%

Sales…………………………………………………………… Contribution margin ratio……………………………….…… Contribution margin………………………………………… Fixed costs…………………………………………………… Operating income……………………………………………

$ 50,000,000 48% × $ 24,000,000 (18,400,000) $ 5,600,000

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Ex. 20–10 (FIN MAN); Ex. 6–10 (MAN) a.

Sales (in millions)………………………………………………………………… $19,207.8 Variable costs (in millions): Food and paper……………………………………………………………… $ (2,564.2) Payroll and employee benefits…………………………………………… (2,416.4) Occupancy and other expenses (25% × $4,357.6)……………………… (1,089.4) (1,018.2) General, selling, and administrative expenses (40% × $2,545.6)…… Total variable costs……………………………………………………… $ (7,088.2) Contribution margin (in millions)……………………………………………… $12,119.6

Contribution Margin Ratio = =

Sales – Variable Costs Sales $12,119.6 million = 63.1% $19,207.8 million

Same-store sales increase (in millions)……………………………………… Contribution margin ratio [from part (b)]…………………………………… Increase in operating income (in millions)…………………………………

$800.0 × 63.1% $504.8

Note to Instructors: Part (c) emphasizes “same-store sales” because of the assumption of no change in fixed costs. McDonald’s will also increase sales from opening new stores. However, the impact on operating income for these additional store sales would need to include an increase in fixed costs.

Ex. 20–11 (FIN MAN); Ex. 6–11 (MAN) a.

Break-Even Sales (units) = =

Sales (units) = =

Fixed Costs Unit Contribution Margin $34,200,000 $1,500 – $930

= 60,000 units

Fixed Costs + Target Profit Unit Contribution Margin $34,200,000 + $5,700,000 = 70,000 units $1,500 – $930

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Ex. 20–12 (FIN MAN); Ex. 6–12 (MAN) Total Cost Variable Cost (in thousands) Percentage $921,980 × 75% = Cost of goods sold…………………… Selling, general, and $565,779 × 40% = administrative expenses……………

Variable Cost (in thousands) $691,485

Total Cost Variable Cost (in thousands) (in thousands) $921,980 – $691,485 = Cost of goods sold…………………… Selling, general, and $226,312 $565,779 – = administrative expenses…………… Total fixed costs……………………

Fixed Cost (in thousands) $230,495

Number of Total Amount Barrels (in thousands) (in thousands) Sales…………………………………… $1,736,432 ÷ 7,400 = Variable cost of goods sold………… $691,485 ÷ 7,400 = Variable selling, general, and $226,312 ÷ 7,400 = administrative expenses…………… a.

Break-Even Sales (units) =

Fixed Costs Unit Contribution Margin

$569,962 $234.65 – $93.44 – $30.58

$226,312

339,467 $569,962 Per-Barrel Amount $234.65 93.44 30.58

= 5,152 thousand barrels The variable costs per unit are determined by multiplying the total amount of each cost by the variable cost percentage (75% for cost of goods sold and 40% for selling, general, and administrative expenses), then dividing by the number of barrels. b.

Break-Even Sales (units) =

$569,962 + $50,000 $234.65 – $93.44 – $30.58

= 5,604 thousand barrels Ex. 20–13 (FIN MAN); Ex. 6–13 (MAN) a.

Break-Even Sales (units) = =

Fixed Costs Unit Contribution Margin $21,600,000 $1,000 – $600

= 54,000 units

Fixed Costs Unit Contribution Margin $21,600,000 $1,200 – $600

= 36,000 units

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Ex. 20–14 (FIN MAN); Ex. 6–14 (MAN) Break-Even Sales (units) = =

Fixed Costs Unit Contribution Margin $3,600 $20 – X

= 800 units

Variable Cost per Unit = $3,600 = 800 × ($20 – X) =

$3,600 800 units

= $20 – X

= $4.50 = $20 – X = $15.50

Ex. 20–15 (FIN MAN); Ex. 6–15 (MAN) The cost of the promotional campaign is the fixed cost in this analysis because we’re trying to determine the break-even adoption rate of the campaign. The contribution margin earned per new subscriber is essentially the revenue earned less the variable cost over the 14-month subscription period. Revenue: (14 mos. – 2 free mos.) × $10/mo. = $120 per new account Variable cost: 14 mos. × $5/mo. = $70 per new account Note: The variable cost is for 14 months because the costs are incurred, even during the free months. The break-even number of subscribers necessary to cover the fixed cost of the promotion would be computed as follows: Break-Even = =

Fixed Costs Contribution Margin per Unit $4,200,000 $120 – $70

= 84,000 accounts

Therefore, if ESPN.com yielded more than 84,000 new subscribers out of the promotional campaign, the costs of the campaign would be covered.

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Ex. 20–16 (FIN MAN); Ex. 6–16 (MAN) a.

Break-Even = =

Fixed Costs Revenue per Account – Variable Cost per Account $30,962.6 million 1 $493.6 2 – $137.0 3

= 86.8 million (rounded) accounts 1

Fixed costs (in millions): Cost of revenue………………………………………………

$11,878

30% = $ 3,563.4

Selling, general, and administrative expenses…………

18,926

70% =

Depreciation and amortization………………………………

14,151

× 100% =

$30,962.6

Total fixed costs……………………………………………… 2

Revenue per account (in millions): $50,395 million ÷ 102.1 million = $493.6 (rounded)

Variable cost per account (in millions, except variable cost per account): Cost of revenue………………………………………………

$11,878

Selling, general, and administrative expenses…………

18,926

70% = $ 8,314.6 5,677.8 30% =

Divided by number of accounts……………………………

$13,992.4 ÷ 102.1

Variable cost per account (rounded)………………………

Total variable cost……………………………………………

13,248.2 14,151.0

Break-Even =

137.0

Fixed Cost Revenue per Account – Variable Cost per Account

102.1 million accounts =

$30,962.6 million X – $137.0

102.1 million (X – $137.0) =

$30,962.6 million

102.1X – $13,987.7 =

$30,962.6 million

102.1X = X =

$44,950.3 $440.3 (rounded)

Note to Instructors: The rate charged per minute and the number of average minutes of digital service influence the revenue per account. An interesting question is whether the costs are variable to the number of minutes or number of accounts. If we assume that the costs are variable to the number of minutes, then the break-even analysis revolves around the number of minutes. More likely, the costs are more variable to the number of accounts for this business (mostly customer acquisition and service costs), while the variable cost per minute is likely to be small.

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Ex. 20–17 (FIN MAN); Ex. 6–17 (MAN) a. Total Sales Line $2,500,000

Operating Profit Area

BreakEven Point

Sales and Costs

$2,000,000

$1,500,000

Total Costs

$1,000,000 $600,000 $500,000

Operating Loss Area $0 0

4,000

8,000

12,000

16,000

20,000

Units of Sales

$1,500,000 (the intersection of the total sales line and the total costs line)

The graphic format permits the user (management) to visually determine the break-even point and the operating profit or loss for any given level of sales.

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Ex. 20–18 (FIN MAN); Ex. 6–18 (MAN) a.

$600,000 (total fixed costs)

Sales (20,000 units × $125)……………………………… Fixed costs………………………………………………… $ 600,000 Variable costs (20,000 units × $75)……………………… 1,500,000 Operating income…………………………………………

$ 2,500,000 *

(2,100,000) 400,000

* 20,000 units = $2,500,000 maximum sales ÷ $125 unit selling price

12,000 units (the intersection of the profit line and the horizontal axis)

Ex. 20–19 (FIN MAN); Ex. 6–19 (MAN) Cost-volume-profit chart a. b. c.

break-even point operating loss area total fixed costs

d. e. f.

total costs line operating profit area total sales line

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Ex. 20–20 (FIN MAN); Ex. 6–20 (MAN) Profit-volume chart a. b. c. d. e. f.

break-even point total fixed costs operating loss area maximum operating profit profit line operating profit area

Ex. 20–21 (FIN MAN); Ex. 6–21 (MAN) a.

Unit Selling Price of M = ($85 × 40%) + ($60 × 60%) = $34 + $36 = $70 Unit Variable Cost of M = ($50 × 40%) + ($35 × 60%) = $20 + $21 = $41 Unit Contribution Margin of M = $70 – $41 = $29 Break-Even Sales (units) = =

Fixed Costs Unit Contribution Margin $1,450,000 $29

= 50,000 units

20,000 units of baseball bats (50,000 units × 40%) 30,000 units of baseball gloves (50,000 units × 60%)

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Ex. 20–22 (FIN MAN); Ex. 6–22 (MAN) a.

Unit contribution margin of overall product (M): Unit selling price of M [(10% × $800) + (90% × $300)]……………………… Unit variable cost of M [(10% × $140) + (90% × $120)]……………………… Unit contribution margin of M……………………………………………………

$ 350 (122) $ 228

Fixed costs of the Los Angeles to Kona round-trip flight: Fuel……………………………………………… Flight crew salaries………………………… Airplane depreciation……………………… Total fixed costs………………………………

$ 7,000 3,200 3,480 $13,680

Break-even sales (units) of overall product: Break-Even Sales (units) = = b.

Fixed Costs Unit Contribution Margin $13,680 $228 per seat

= 60 seats (tickets)

Business class break-even (60 seats × 10%)………………………… Economy class break-even (60 seats × 90%)………………………… Total break-even……………………………………………………………

6 seats 54 seats 60 seats

Ex. 20–23 (FIN MAN); Ex. 6–23 (MAN) a.

(1)

Margin of Safety (dollars)

= Sales – Sales at Break-Even Point = $3,200,000 – $2,080,000 = $1,120,000

(2)

Margin of Safety (percentage)

Sales – Sales at Break-Even Point Sales

= $1,120,000 ÷ $3,200,000 = 35% b.

The break-even point sales (S) is determined as follows: Break-Even Sales (dollars) = Total Fixed Costs + Total Variable Costs (at Break-Even) Break-Even Sales (dollars) = Total Fixed Costs + 60% Break-Even Sales (dollars) Break-Even Sales (dollars) = $1,500,000 + 60% Break-Even Sales (dollars) Break-Even Sales (dollars) – 60% Break-Even Sales (dollars) = $1,500,000 40% Break-Even Sales (dollars) = $1,500,000 Break-Even Sales (dollars) = $3,750,000 If the margin of safety is 25%, the actual sales are determined as follows: Sales = Break-Even Sales (dollars) + (Sales × Margin of Safety) Sales (dollars) = $3,750,000 + 25% Sales Sales – 25% Sales = $3,750,000 75% Sales = $3,750,000 Sales = $5,000,000

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Ex. 20–24 (FIN MAN); Ex. 6–24 (MAN) If 420,000 units are sold and sales at the break-even point are 472,500 units, there is no margin of safety.

Ex. 20–25 (FIN MAN); Ex. 6–25 (MAN) a.

Asha Inc.: Operating Leverage = =

Contribution Margin Operating Income $1,000,000 $200,000

= 5.0

Samir Inc.: Operating Leverage = =

Contribution Margin Operating Income $1,500,000 $600,000

= 2.5

Asha Inc.’s operating income would increase by 150% (5.0 × 30%), or $300,000 (150% × $200,000), and Samir Inc.’s operating income would increase by 75% (2.5 × 30%), or $450,000 (75% × $600,000).

The difference in the increases of operating income is due to the difference in the operating leverages. Asha Inc.’s higher operating leverage means that its fixed costs are a larger percentage of contribution margin than are Samir Inc.’s. Thus, increases in sales increase operating profit at a faster rate for Asha Inc. than for Samir Inc.

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

PROBLEMS Prob. 20–1A (FIN MAN); Prob. 6–1A (MAN) Cost a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q. r. s. t.

Fixed Cost

Variable Cost

Mixed Cost

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

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–2A (FIN MAN); Prob. 6–2A (MAN) 1.

Variable Cost Percentage

Total Cost Cost of goods sold…………… Selling expenses…………… Administrative expenses…… Total variable cost…………

$100,000,000 16,000,000 12,000,000

× × ×

2. Sales…………………………… Variable costs………………… Contribution margin…………

$100,000,000 16,000,000 12,000,000

Total Amount $188,000,000 (88,000,000) $100,000,000

= = =

Variable Cost

Total Cost Cost of goods sold…………… Selling expenses…………… Administrative expenses…… Total cost……………………

70% 75% 50%

Variable Cost

– – –

$70,000,000 12,000,000 6,000,000

÷ ÷

Number of Units 1,000,000 1,000,000

$70,000,000 12,000,000 6,000,000 $88,000,000 Fixed Cost

= = = =

$30,000,000 4,000,000 6,000,000 $40,000,000

= =

Per Unit $188.00 (88.00) $100.00

a. $88 ($88,000,000 ÷ 1,000,000 units) b. $100 ($188 – $88) 3.

Fixed Costs Break-Even = Sales (units) Unit Contribution Margin =

$40,000,000 $100 per unit

Break-Even = Sales (units)

Fixed Costs Unit Contribution Margin

$40,000,000 + $5,000,000 $100 per unit

Sales (units) = =

= 400,000 units

= 450,000 units

Fixed Costs + Target Profit Unit Contribution Margin $45,000,000 + $60,000,000 $100 per unit

= 1,050,000 units

6. Sales ($188,000,000 + $11,280,000)…………………… Fixed costs………………………………………………… Variable costs (1,060,000* units × $88)………………… Operating income………………………………………… * ($11,280,000 ÷ $188) + 1,000,000 7. Present operating income……………………………… Less additional fixed costs……………………………… Operating income …………………………………………

$ 199,280,000 $45,000,000 93,280,000

(138,280,000) $ 61,000,000 $60,000,000 (5,000,000) $55,000,000

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–2A (FIN MAN); Prob. 6–2A (MAN) (Concluded) 8.

In favor of the proposal is the possibility of increasing operating income from $60,000,000 to $61,000,000. However, there are many points against the proposal, including:

• The break-even point increases by 50,000 units (from 400,000 to 450,000). • The sales necessary to maintain the current operating income of $60,000,000 would be 1,050,000 units, or $9,400,000 (50,000 units × $188) in excess of current sales.

• If future sales remain at the current level, the operating income of $60,000,000 will decline to $55,000,000. The company should determine the sales potential if the additional product is produced and then evaluate the advantages and disadvantages enumerated above, in light of these sales possibilities.

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–3A (FIN MAN); Prob. 6–3A (MAN) 1.

Break-Even = Sales (units) =

Total Fixed Costs Unit Contribution Margin $480,000 $40*

Total Fixed Costs Unit Selling Price – Unit Variable Cost

= 12,000 units

* $100 unit selling price – $60 unit variable cost

Sales (units) =

Fixed Costs + Target Profit Unit Contribution Margin $480,000 + $240,000 $40 $720,000 $40

= 18,000 units

4. Sales (16,000 × $100)………………………… Total fixed costs……………………………… Total variable costs (16,000 × $60)………… Operating income……………………………

$ 1,600,000 $480,000 960,000

(1,440,000) $ 160,000

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–4A (FIN MAN); Prob. 6–4A (MAN) 1.

$75,000 30%

Unit Selling Price – Unit Variable Cost Unit Selling Price

1,000 units

= 30%

Total Fixed Costs Unit Selling Price – Unit Variable Cost

20-22

= $250,000

Total Fixed Costs Contribution Margin Ratio

$250 Unit Selling Price – $175 Unit Variable Cost $250 Unit Selling Price

Unit Contribution Margin Unit Selling Price

Cost-Volume-Profit Analysis

$75,000 $250 Unit Selling Price – $175 Unit Variable Cost

Unit Contribution Margin

Total Fixed Costs

or Break-Even (dollars) = 1,000 units × $250 per unit = $250,000

Break-Even (dollars) =

Contribution Margin Ratio =

Break-Even Dollars:

Break-Even Sales (units) =

Break-Even Units:

Prob. 20–4A (FIN MAN); Prob. 6–4A (MAN) (Continued)

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–4A (FIN MAN); Prob. 6–4A (MAN) (Continued) 2. $625,000

$600,000

Operating Profit Area

b. b.

$512,500

$500,000

a. .

$425,000

Sales and Costs

$400,000 Total Sales Total Costs

$300,000

$200,000

Break-Even Point

$100,000 $75,000

Operating Loss Area

$0 0

500

1,000

1,500

2,000

2,500

Units of Sales

Units sold: $500,000 ÷ $250 per unit = 2,000 units

Sales………………………………………………………… Variable costs……………………………………………… Fixed costs…………………………………………………… Total costs…………………………………………………… Operating income……………………………………………

(a) 2,000 units

(b) 2,500 units

$ 500,000

$ 625,000

$(350,000) (75,000) $(425,000) $ 75,000

$(437,500) (75,000) $(512,500) $ 112,500

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–4A (FIN MAN); Prob. 6–4A (MAN) (Continued) 3.

$75,000 + $33,750 30% =

Total Fixed Costs Contribution Margin Ratio $362,500

$250 Unit Selling Price – $175 Unit Variable Cost $250 Unit Selling Price

$75,000 + $33,750 $250 – $175 Unit Contribution Margin Unit Selling Price

= 30%

Unit Selling Price – Unit Variable Cost Unit Selling Price

1,450 units

Total Fixed Costs Unit Selling Price – Unit Variable Cost

Cost-Volume-Profit Analysis

Total Fixed Costs Unit Contribution Margin

or Break-Even (dollars) = 1,450 units × $250 per unit = $362,500

Break-Even (dollars) =

Contribution Margin Ratio =

Break-Even Dollars:

Break-Even Sales (units) =

Break-Even Units:

Prob. 20–4A (FIN MAN); Prob. 6–4A (MAN) (Continued)

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–4A (FIN MAN); Prob. 6–4A (MAN) (Concluded) 4.

Sales………………………………………………………… Variable costs……………………………………………… Fixed costs………………………………………………… Total costs………………………………………………… Operating income…………………………………………

(a) 2,000 units

(b) 2,500 units

$ 500,000

$ 625,000

$(350,000) (108,750) $(458,750) $ 41,250

$(437,500) (108,750) $(546,250) $ 78,750

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–5A (FIN MAN); Prob. 6–5A (MAN) (Overall product is labeled M.) 1.

Unit selling price of M [($1,600 × 40%) + ($850 × 60%)]………………………… Unit variable cost of M [($800 × 40%) + ($350 × 60%)]………………………… Unit contribution margin of M……………………………………………………… Fixed Costs Unit Contribution Margin

Break-Even Sales (units) = =

$2,498,600 = 4,030 units $620 per unit

4,030 units of M × 40% = 1,612 units of laptops 4,030 units of M × 60% = 2,418 units of tablets

Unit selling price of M [($1,600 × 50%) + ($850 × 50%)]………………………… Unit variable cost of M [($800 × 50%) + ($350 × 50%)]………………………… Unit contribution margin of M………………………………………………………

$1,225 (575) $ 650

Fixed Costs Unit Contribution Margin

Break-Even Sales (units) = =

$1,150 (530) $ 620

$2,498,600 $650

= 3,844 units

3,844 units of M × 50% = 1,922 units of laptops 3,844 units of M × 50% = 1,922 units of tablets The break-even point is lower in this scenario than in part (1) because the sales mix is weighted more heavily toward the product with the higher contribution margin per unit of product.

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–6A (FIN MAN); Prob. 6–6A (MAN) 1. Wolsey Industries Inc. Estimated Income Statement For the Year Ended December 31, 20Y3 Sales (21,875 × $160) Cost of goods sold: Direct materials (21,875 × $46) Direct labor (21,875 × $40) Factory overhead [$200,000 + (21,875 × $20)] Total cost of goods sold Gross profit Expenses: Selling expenses: Sales salaries and commissions [$110,000 + (21,875 × $8)] Advertising Travel Miscellaneous selling expense [$7,600 + (21,875 × $1)]

$ 3,500,000 $1,006,250 875,000 637,500 (2,518,750) $

981,250

(631,250) 350,000

$285,000 40,000 12,000 29,475

Total selling expenses Administrative expenses: Office and officers’ salaries Supplies [$10,000 + (21,875 × $4)] Miscellaneous administrative expense [$13,400 + (21,875 × $1)] Total administrative expenses Total expenses Operating income

$ 366,475 $132,000 97,500 35,275 264,775

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–6A (FIN MAN); Prob. 6–6A (MAN) (Continued) Sales – Variable Costs 2. Contribution Margin Ratio = Sales = = 3.

Break-Even Sales (units) = = Break-Even Sales (dollars) = =

$3,500,000 – (21,875 × $120) $3,500,000 $875,000 $3,500,000

= 25%

Fixed Costs Unit Contribution Margin $525,000 $160 – $120

= 13,125 units

Fixed Costs Contribution Margin Ratio $525,000 25%

= $2,100,000

or Break-Even Sales (dollars) = 13,125 units × $160 per unit = $2,100,000

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–6A (FIN MAN); Prob. 6–6A (MAN) (Concluded) 4.

Units of Sales

Margin of safety: In dollars: Expected sales (21,875 × $160)……………………………… $ 3,500,000 Break-even point (13,125 × $160)……………………………… (2,100,000) Margin of safety………………………………………………… $ 1,400,000 As a percentage of sales: Margin of Safety = =

Sales – Sales at Break-Even Point Sales $1,400,000 $3,500,000

= 40%

Operating Leverage =

Contribution Margin Operating Income

21,875 units × $40 $350,000

$875,000 $350,000

= 2.5

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–1B (FIN MAN); Prob. 6–1B (MAN) Cost a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q. r. s. t.

Fixed Cost

Variable Cost

Mixed Cost

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

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–2B (FIN MAN); Prob. 6–2B (MAN) 1.

Total Cost Cost of goods sold…………………… Selling expenses……………………… Administrative expenses…………… Total variable costs………………

Cost of goods sold…………………… Selling expenses……………………… Administrative expenses…………… Total fixed costs……………………

$1,400,000 400,000 387,500

Variable Cost Percentage × × ×

a. b. 3.

Break-Even = Sales (units)

Break-Even = Sales (units) =

Sales (units) =

Total Cost $1,400,000 400,000 387,500

– – –

Variable Cost $1,050,000 240,000 310,000

= = =

Fixed Cost $350,000 160,000 77,500 $587,500

Total Amount $ 2,880,000 (1,600,000)

÷ ÷

Number of Units 64,000 64,000

= =

Per Unit $ 45.00 (25.00) $ 20.00

$ 1,280,000

Fixed Costs Unit Contribution Margin $587,500 $20 per unit

= 29,375 units

Fixed Costs Unit Contribution Margin $587,500 + $212,500 $20 per unit

= 40,000 units

Fixed Costs + Target Profit Unit Contribution Margin $800,000 + $692,500 $20 per unit

$1,492,500 $20 per unit

Sales ($2,880,000 + $900,000)……………………………… Fixed costs……………………………………………………… Variable costs (84,000* units × $25)………………………… Operating income………………………………………………

$ 800,000 2,100,000

= 6.

$1,050,000 240,000 310,000

$25 ($1,600,000 ÷ 64,000 units) $20 ($45 – $25)

= 4.

= = =

$1,600,000

2. Sales……………………………………… Variable costs………………………… Contribution margin……………………

75% 60% 80%

Variable Cost

74,625 units $ 3,780,000 (2,900,000) $

880,000

* ($900,000 ÷ $45) + 64,000 7.

Present operating income…………………………………… Less additional fixed costs…………………………………… Operating income………………………………………………

$ 692,500 (212,500) $ 480,000

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–2B (FIN MAN); Prob. 6–2B (MAN) (Concluded) 8.

In favor of the proposal is the possibility of increasing operating income from $692,500 to $880,000. However, there are many points against the proposal, including:

• The break-even point increases by 10,625 units (from 29,375 to 40,000). • The sales necessary to maintain the current operating income of $692,500 would be 74,625 units, or $478,125 (10,625 units × $45) in excess of current sales.

• If future sales remain at the current level, the operating income of $692,500 will decline to $480,000. The company should determine the sales potential if the additional product is produced and then evaluate the advantages and disadvantages enumerated above, in light of these sales possibilities.

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–3B (FIN MAN); Prob. 6–3B (MAN) 1.

Break-Even Sales (units)

Total Fixed Costs = Unit Contribution Margin $800,000 $40*

Total Fixed Costs Unit Selling Price – Unit Variable Cost

= 20,000 units

* $150 unit selling price – $110 unit variable cost

Sales (units) =

Total Fixed Costs + Target Profit Unit Contribution Margin

$800,000 + $300,000 $40 per unit

$1,100,000 $40 per unit

= 27,500 units

Sales (32,000 × $150)…………………………… Total fixed costs………………………………… Total variable costs (32,000 × $110)………… Operating income………………………………

$ 4,800,000 $ 800,000 3,520,000

(4,320,000) $ 480,000

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–4B (FIN MAN); Prob. 6–4B (MAN) 1.

1. Total Fixed Costs =

$225,000 37.5% = $600,000

Total Fixed Costs Contribution Margin Ratio

= 37.5%

Unit Selling Price – Unit Variable Cost Unit Selling Price

$200 Unit Selling Price – $125 Unit Variable Cost $200 Unit Selling Price

Unit Contribution Margin Unit Selling Price

= 3,000 units

Unit Selling Price – Unit Variable Cost

Total Fixed Costs

Cost-Volume-Profit Analysis

$225,000 $200 Unit Selling Price – $125 Unit Variable Cost

Unit Contribution Margin

or Break-Even (dollars) = 3,000 units × $200 per unit = $600,000

Break-Even (dollars) =

Contribution Margin Ratio =

Break-Even Dollars:

Break-Even Sales (units) =

Break-Even Units:

Prob. 20–4B (FIN MAN); Prob. 6–4B (MAN) (Continued)

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–4B (FIN MAN); Prob. 6–4B (MAN) (Continued) 2.

Sales……………………………………………………… Variable costs………………………………………… Fixed costs……………………………………………… Total costs……………………………………………… Operating income………………………………………

(a) 4,500 units

(b) 7,500 units

$ 900,000

$ 1,500,000

$(562,500) (225,000) $(787,500) $ 112,500

$ (937,500) (225,000) $(1,162,500) $ 337,500

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–4B (FIN MAN); Prob. 6–4B (MAN) (Continued) 3.

$225,000 + $112,500 37.5%

= 37.5%

20-39

or Break-Even (dollars) = 4,500 units × $200 per unit = $900,000

= $900,000

$200 Unit Selling Price – $125 Unit Variable Cost $200 Unit Selling Price

= Total Fixed Costs Contribution Margin Ratio

= 4,500 units

Unit Selling Price – Unit Variable Cost Unit Selling Price

Unit Contribution Margin Unit Selling Price

$225,000 + $112,500 $200 Unit Selling Price – $125 Unit Variable Cost

Total Fixed Costs Unit Selling Price – Unit Variable Cost

Total Fixed Costs Unit Contribution Margin =

Cost-Volume-Profit Analysis

Break-Even (dollars) =

Contribution Margin Ratio

Break-Even Dollars:

Break-Even Sales (units)

Break-Even Units:

Prob. 20–4B (FIN MAN); Prob. 6–4B (MAN) (Continued)

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–4B (FIN MAN); Prob. 6–4B (MAN) (Concluded) 4. b.

Sales…………………………………………………… Variable costs………………………………………… Fixed costs…………………………………………… Total costs…………………………………………… Operating income……………………………………

(a) 6,000 units

(b) 7,500 units

$ 1,200,000

$ 1,500,000

$ (750,000) (337,500) $(1,087,500) $ 112,500

$ (937,500) (337,500) $(1,275,000) $ 225,000

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–5B (FIN MAN); Prob. 6–5B (MAN) (Overall enterprise product is labeled M.) 1.

Unit selling price of M [($12 × 30%) + ($15 × 70%)]……………………………… $14.10 Unit variable cost of M [($3 × 30%) + ($4 × 70%)]………………………………… (3.70) Unit contribution margin of M……………………………………………………… $10.40 Break-Even Sales (units) =

Fixed Costs Unit Contribution Margin

$46,800 = 4,500 units $10.40 per unit

4,500 units of M × 30% = 1,350 units of 12" pizza 4,500 units of M × 70% = 3,150 units of 16" pizza

Unit selling price of M [($12 × 50%) + ($15 × 50%)]……………………………… $13.50 Unit variable cost of M [($3 × 50%) + ($4 × 50%)]………………………………… (3.50) Unit contribution margin of M……………………………………………………… $10.00 Fixed Costs Unit Contribution Margin

Break-Even Sales (units) = =

$46,800 $10.00

= 4,680 units

4,680 units of M × 50% = 2,340 units of 12" pizza 4,680 units of M × 50% = 2,340 units of 16" pizza The break-even point is higher in scenario 2 because the mix changes to be less weighted toward the higher contribution margin per unit product in part (3).

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–6B (FIN MAN); Prob. 6–6B (MAN) 1. Belmain Co. Estimated Income Statement For the Year Ended December 31, 20Y7 Sales (12,000 × $240) Cost of goods sold: Direct materials (12,000 × $50) Direct labor (12,000 × $30) Factory overhead [$350,000 + (12,000 × $6)] Total cost of goods sold Gross profit Expenses: Selling expenses: Sales salaries and commissions [$340,000 + (12,000 × $4)] Advertising Travel Miscellaneous selling expense [$2,300 + (12,000 × $1)]

$ 2,880,000 $600,000 360,000 422,000 (1,382,000) $ 1,498,000

$388,000 116,000 4,000 14,300

Total selling expenses Administrative expenses: Office and officers’ salaries Supplies [$6,000 + (12,000 × $4)] Miscellaneous administrative expense [$8,700 + (12,000 × $1)] Total administrative expenses Total expenses Operating income

$522,300 $325,000 54,000 20,700 399,700 $

(922,000) 576,000

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–6B (FIN MAN); Prob. 6–6B (MAN) (Continued) Sales – Variable Costs 2. Contribution Margin Ratio = Sales = = 3.

Break-Even Sales (units) = = Break-Even Sales (dollars) = =

$2,880,000 – (12,000 × $96) $2,880,000 $1,728,000 $2,880,000

= 60%

Fixed Costs Unit Contribution Margin $1,152,000 $240 – $96

= 8,000 units

Fixed Costs Contribution Margin Ratio $1,152,000 60%

= $1,920,000

or Break-Even Sales (dollars) = 8,000 units × $240 per unit = $1,920,000

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

Prob. 20–6B (FIN MAN); Prob. 6–6B (MAN) (Concluded) 4.

Units of Sales

Margin of safety: In dollars: Expected sales (12,000 units × $240)………………………… $ 2,880,000 (1,920,000) Break-even point (8,000 units × $240)……………………… Margin of safety………………………………………………… $ 960,000 As a percentage of sales: Margin of Safety = =

Sales – Sales at Break-Even Point Sales $960,000 $2,880,000

= 33.3%

Operating Leverage =

Contribution Margin Operating Income

12,000 units × $144* $576,000

$1,728,000 $576,000

* Unit Contribution = Unit Selling Price – Unit Variable Cost $144 = $240 – $96

= 3

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

MAKE A DECISION MAD 20–1 (FIN MAN); MAD 6–1 (MAN) a.

Break-Even Sales (units) =

Fixed Costs Unit Contribution Margin

Break-Even Sales (units) =

$80,000 $760 – $120

= 125 passengers

The airline should consider adding the flight. The number of passengers (175) is well above the break-even number of passengers for the flight (125).

Each flight should cover fixed costs and produce a contribution margin for 50 additional passengers above break-even. Thus, the profit for the flight would be computed as: (175 passengers – 125 passengers) × ($760 – $120) = $32,000

First, the airline should consider the impact of the new flight on other flights to Los Angeles. That is, the airline should determine whether the seats sold on the new flight are truly incremental seats for the airline, or whether passengers are shifting from one of the airline’s other flights to this new flight. Second, the airline should consider the impact of the new flight on system load. For example, is there sufficient gate, runway, maintenance, and baggage handling capacity to support the additional flight? If not, the fixed costs of adding the flight could be much higher than $80,000.

MAD 20–2 (FIN MAN); MAD 6–2 (MAN) a.

Total fixed costs per cruise: Crew………………………………………………………………… Fuel…………………………………………………………………… Fixed operating costs……………………………………………… Total fixed costs per cruise……………………………………

$ 240,000 60,000 800,000 $1,100,000

Total variable costs per passenger: Meals………………………………………………………………… Variable operating costs………………………………………… Total variable costs per passenger…………………………

$ 900 400 $1,300

Break-Even Sales (units) =

Fixed Costs Unit Contribution Margin

Break-Even Sales (units) =

$1,100,000 = 1,000 passengers $2,400 – $1,300

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

MAD 20–2 (FIN MAN); MAD 6–2 (MAN) (Concluded) b. The break-even point is 1,000 passengers [from (a)]. If 900 passengers book the cruise, that will be 100 passengers under the break-even point. The loss can be calculated as: (900 passengers – 1,000 passengers) × ($2,400 – $1,300) = $(110,000) c. The break-even point is 1,000 passengers [from (a)]. If 1,200 passengers book the cruise, that will be 200 passengers over the break-even point. The profit can be calculated as: (1,200 passengers – 1,000 passengers) × ($2,400 – $1,300) = $220,000 d. If the cruise is operating under break-even, the cruise line can take a number of actions to improve the financial performance of the cruise: 1. The cruise line could cancel the cruise. This is an extreme response and would require finding an alternative use for the boat, which is a significant investment that cannot remain idle. 2. The cruise line could change the price of the cruise to find the sensitivity of price to the underlying demand. Possibly, the price could be reduced and the additional revenue from volume could compensate for the lost revenue on the price. The opposite could be the case. The price could be increased and the revenue loss in volume would be less than the increased revenue from price. 3. The cruise line could improve variable operating efficiencies and attempt to reduce the variable cost per passenger. 4. The cruise line could improve fixed cost efficiencies and attempt to reduce the fixed cost of the cruise. 5. The cruise line could increase advertising efforts to fill the cruise.

MAD 20–3 (FIN MAN); MAD 6–3 (MAN) a. Break-Even Sales (units)

Fixed Costs Unit Contribution Margin

Break-Even Sales (units)

$3,000,000,000 $120 – $40

= 37,500,000 subscribers

Fixed costs: $100,000,000 + $2,000,000,000 + $900,000,000 = $3,000,000,000 b. Break-Even Sales (units)

Fixed Costs Unit Contribution Margin

Break-Even Sales (units)

$3,600,000,000 $120 – $40

= 45,000,000 subscribers

Fixed costs: $100,000,000 + $2,600,000,000 + $900,000,000 = $3,600,000,000 20-46 © 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

MAD 20–3 (FIN MAN); MAD 6–3 (MAN) (Concluded) $3,600,000,000 c. Break-Even Sales (units) = X – $40 $3,600,000,000 = (X – $40)37,500,000

= 37,500,000 subscribers

$3,600,000,000 = 37,500,000X – $1,500,000,000 $5,100,000,000 = 37,500,000X X = $136 The annual subscription would need to increase from $120 to $136 per year to maintain the break-even in (a) with the increased annual content costs to $2,600,000,000. MAD 20–4 (FIN MAN); MAD 6–4 (MAN) a. Break-Even Sales (units)

Fixed Costs Unit Contribution Margin

The unit contribution margin consists of both the per-guest contribution margin from ticket sales and the per-guest contribution margin from concession sales, as follows: ($60 + $30) – ($24 + $16) = $50 contribution margin per guest per day Therefore, $750,000 = 15,000 guests per day $50 b. The daily weekday profit can be determined by multiplying the number of units over break-even by the contribution margin per guest per day, as follows: Break-Even Sales (units)

(24,000 guests – 15,000 guests) × $50 per guest* = $450,000 * See the calculation in (a).

c. The daily weekend profit can be determined by multiplying the number of units over break-even by the contribution margin per guest per day, as follows: (40,000 guests – 15,000 guests) × $50 per guest* = $1,250,000 * See the calculation in (a).

d. Revised break-even number of guests per day if the fixed costs increase to $1,000,000 per day: Break-Even Sales (units)

Break-Even Sales (units)

Fixed Costs Unit Contribution Margin $1,000,000 $50 per guest*

= 20,000 guests per day

* See the calculation in (a).

e. The average daily admissions are 24,000 for the average weekday. Thus, the park still operates above break-even and is therefore profitable with the increased fixed costs. The daily profit would be $200,000 (4,000 guests above break-even per day × $50 contribution margin per guest per day). 20-47 © 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

TAKE IT FURTHER TIF 20–1 (FIN MAN); TIF 6–1 (MAN) In an absolute sense, Rashonda’s actions are devious. She is clearly attempting to use the first four years, which are favorable, as a way to market the partnerships. However, in substance, these are longer-term investments. After the first four years, the risk increases dramatically. The break-even occupancy becomes much more difficult to achieve at 95% than it does at 65%. Focusing on the 65% and remaining silent about the increase to 95% is deceptive. One might argue “let the buyer beware.” After all, the information is in the fine print. A full review of the prospectus would reveal the longerterm reality of these partnerships. This is not a compelling argument. Clearly, Rashonda is putting some favorable spin on this offering. It’s likely that this will come back to haunt her in a court of law. Some investors may claim they were defrauded by lessthan-complete disclosure. Rashonda has a responsibility to provide clear, objective information. The integrity standard requires that Rashonda communicate constraints that would preclude the successful performance of an activity. Also, Rashonda must communicate unfavorable as well as favorable information. Clearly, the increase in the mortgage rate and its impact on the break-even point is unfavorable information that should be given as much visibility as the favorable 65% break-even information. TIF 20–2 (FIN MAN); TIF 6–2 (MAN) There are many possible applications of break-even analysis in a university environment. Below are just a few possible ideas. Break-Even Analysis 1. Break-even number of students in a class

Revenues Student tuition for a class

Fixed Costs Faculty salary, facilities (space, classroom technology) costs

Variable Costs Classroom supplies, classroom cleaning costs

2. Break-even number of students in a dorm

Room revenue

Facilities (space, room fixtures)

Operating supplies, cleaning costs

3. Break-even daily meal revenues

Meal revenue

Food service salaries, facilities (kitchen space, dining space)

Food costs

4. Break-even number of users on a computer network

Network user fees

Network fixed asset cost (depreciation), trunk line lease costs

Technical support, electricity

Athletics and facilities staff salaries, facilities (stadium/arena costs)

Cleanup costs, event staff wages, concession costs

5. Break-even number of Ticket revenue tickets sold for a football or basketball game

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

TIF 20–3 (FIN MAN); TIF 6–3 (MAN) Memo To:

Neil Armstrong, CEO Sun Airlines

From:

Ima Student

Re:

Increasing Ticket Prices

In recent months, Sun Airlines has struggled to stay above break-even sales volume, which has led to a string of monthly losses. Sun’s break-even volume is 75% of capacity, which is significantly higher than the industry average of 65% of capacity. To address this problem, the airline is considering a strategy of increasing ticket prices. This strategy will reduce the break-even sales volume, because higher ticket prices will generate a higher contribution margin. However, higher ticket prices could also reduce the number of tickets sold (passenger volume). If the drop in sales volume exceeds the drop in break-even volume, the strategy will fail and losses will increase. For this strategy to succeed, the airline will have to minimize the impact of the ticket price increase on sales volume. The airline might consider targeting business travelers who need to fly regardless of ticket price. If successful, this strategy can reduce the break-even point without significantly decreasing ticket sales. Restrictions such as only allowing reduced fares on round-trip tickets that include a Saturday night stayover achieve this objective, because business travelers do not wish to be out of town over the weekend. Another way to target business travelers might be to require higher fares for tickets purchased with little advance notice, because business travel is often planned with very short notice.

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

TIF 20–4 (FIN MAN); TIF 6–4 (MAN) Do-Nothing Strategy: Revenue – Variable Costs – Fixed Costs ($80 × 1,000,000) – ($35 × 1,000,000) – $35,000,000 $80,000,000 – $35,000,000 – $35,000,000

= Profit = Profit = $10,000,000

Thomas’s Strategy: Revenue – Variable Costs – Fixed Costs ($60 × 2,000,000) – ($35 × 2,000,000) – $35,000,000 $120,000,000 – $70,000,000 – $35,000,000

= Profit = Profit = $15,000,000

Anita’s Strategy: Revenue – Variable Costs – Fixed Costs ($80 × 1,400,000) – ($35 × 1,400,000) – $45,000,000 $112,000,000 – $49,000,000 – $45,000,000

= Profit = Profit = $18,000,000

Anita’s strategy, which is to maintain the price but increase advertising, appears superior.

TIF 20–5 (FIN MAN); TIF 6–5 (MAN) The direct labor costs are not variable to the increase in unit volume. The unit volume is the wrong activity base for direct labor costs. The “number of impressions” is a more accurate reflection of the direct labor cost. An impression is a separate printing color application on the banners. Thus, the analysis should be done as follows: Two Four One Three Color Color Color Color Total 274 698 Number of banners 212 616 1,800 Number of impressions 212 548 1,848 2,792 5,400 Last year’s impressions: 1,800 (180 + 480 + 1,140) Total increase:

5,400 – 1,800 1,800

= 200%

Thus, a 125% assumed increase from the unit volume information will understate the potential increase in direct labor cost.

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

TIF 20–6 (FIN MAN); TIF 6–6 (MAN) The Shipping Department manager should respond by pointing out that the activities performed by his department are not related to sales volume but to sales orders. The orders require inventory pulling and sorting activities as well as paperwork activities. Thus, even though the sales volume is decreasing, the number of sales orders processed has increased from 1,180 to 1,475 (25%) during the last eight months. The reason for this increase in sales orders is that customers are ordering lower quantities per order than in the past. Thus, it is no wonder the Shipping Department manager is experiencing financial pressure. The amount of work performed by the department is increasing even though sales volume is down.

Cost-Volume-Profit Analysis

20-52

Therefore, fixed costs are $38,073.55 and variable costs are $8.33 per unit (rounded to two decimal places).

Cost = 38,073.5477 + 8.330145293x, where X represents the quantity of units produced.

1. In the regression output, Intercept represents the portion of costs which are fixed. In other words, this is the cost of producing zero units. The independent variable, Quantity, represents the variable costs. The mathematical model to estimate fixed and variable cost for the first dataset is as follows:

TIF 20–7 (FIN MAN); TIF 6–7 (MAN)

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

20-53

3. The estimate will not provide 100% accuracy. First, in the Regression Statistics box, the R Square is a measure of how closely correlated the provided variables are. As a rule of thumb, the closer to 1, the more closely correlated. For Regression 1 and Regression 2, an R Square of approximately 0.87 and 0.85, respectively, could be considered moderately to highly correlated. However, this is not 100% accurate. Second, the Standard Error of 15,179.42589 in Regression 1 and 123,645.0291 in Regression 2 provides important context. The standard error essentially describes the amount of variation that can happen within outcomes of the regression. Any prediction within this standard error value can be reasonably expected. Third, another indicator of accuracy is Observations. Observations are the number of data pairs provided to the regression. Generally, the higher number of observations, the more accurate the regression can become.

Therefore, fixed costs are $102,530.16 and variable costs are $10.42 per unit (rounded to two decimal places).

Cost = 102,530.157 + 10.42328526x, where X represents the quantity of units produced.

2. In the regression output, Intercept represents the portion of costs which are fixed. In other words, this is the cost of producing zero units. The independent variable, Quantity, represents the variable costs. The mathematical model to estimate fixed and variable cost for the second dataset is as follows:

TIF 20–7 (FIN MAN); TIF 6–7 (MAN) (Continued)

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

TIF 20–7 (FIN MAN); TIF 6–7 (MAN) (Concluded) Finally, it is important for management accountants and data analysts alike to think through the effects the underlying business may have on the analytical output. In this case, Steam Precision’s products are made of precious and rare metals, as well as materials such as silicon and carbon fiber. All of these materials have extremely volatile prices in commodity markets. In the regression, we are attempting to assign one single variable cost to all outputs, when in reality there are many different variable costs outside of the control of management. 4. More records as well as additional dimensions (variables) of data could improve the ability of the regression analysis to more accurately predict cost behavior. 5. Management should be warned that there is a margin of error in the regression analysis and the variations may be significant, depending on management’s subjective view.

CHAPTER 20 (FIN MAN); CHAPTER 6 (MAN)

Cost-Volume-Profit Analysis

CERTIFIED MANAGEMENT ACCOUNTANT (CMA®) EXAMINATION QUESTIONS (ADAPTED) 1.

A costs are semivariable or mixed, because they vary between quantities but do not vary consistently, so a portion must be fixed and a portion variable. B costs are fixed in the relevant range (14,000 units). C costs vary consistently for all quantities and thus, are variable.

Kimber's total manufacturing cost is expected to be $615,000, computed as follows: Variable cost [9,000 units × ($20 + $25 + $10)] Fixed cost (8,000 units × $15) Total expected manufacturing cost

Bolger's break-even point would increase by 375 units, computed as follows: Revised break-even point [$350,000 ÷ ($300 – $220)] Current break-even point [$360,000 ÷ ($300 – $210)] Increase in break-even point

$495,000 120,000 $615,000

4,375 units (4,000) units 375 units

b. To maximize contribution margin, Eagle Brand should produce 250 units of Product X at $20 contribution margin per unit for a total of $5,000. The total contribution margin for each of the alternatives is as follows: Alternative A: Alternative B: Alternative C: Alternative D:

100 units × ($130 – $100) = $3,000 250 units × ($100 – $80) = $5,000 [200 units × ($100 – $80)] + [20 units × ($130 – $100)] = $4,000 + $600 = $4,600 Not possible since 200 units of Product X require 800 lbs. (200 units × 4 lbs.) of raw materials and 50 units of Product Y require 500 lbs. (50 units × 10 lbs.), which total 1,300 lbs. and exceed the 1,000 lbs. of raw materials that are available.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN) VARIABLE COSTING FOR MANAGEMENT ANALYSIS DISCUSSION QUESTIONS 1.

a. Under absorption costing, both variable and fixed manufacturing costs are included as a part of the cost of the product manufactured. b. Under variable costing, only the variable manufacturing costs are included as a part of the cost of the product manufactured. The fixed manufacturing costs are treated as an expense of the period in which they are incurred.

Fixed factory overhead.

Included as part of the cost of product manufactured: (b), (d), (g).

In the variable costing income statement, the fixed manufacturing costs and the fixed selling and administrative expenses are reported in a special section for fixed costs and are deducted from the contribution margin.

a. Manufacturing more than expected sales will have the effect of increasing operating income under the absorption costing concept. b. Manufacturing more than expected sales will have no effect on operating income under the variable costing concept.

All costs are controllable by someone within the business but not necessarily by the same level of management. For a specific level of management, noncontrollable costs are costs for which another level of management is responsible.

In the short run, operating income is maximized if the revenue from the sale of the product exceeds the variable cost of making and selling the product. Under variable costing, these relevant costs are readily available.

Product profitability analysis can be used by management to set product prices, to emphasize promotional activity toward more profitable products or away from less profitable products, and to make decisions about keeping products or eliminating products from the product line.

Rewarding sales personnel on the basis of total sales will normally motivate the sales staff to expend their efforts promoting high-volume products, which will produce a large total amount of sales dollars. In some cases, more profit may be earned by promoting specialty products with lower sales volume but which have higher profit margins on each product sold. For example, grocery stores must generate a large volume of sales to earn the same profit as a jewelry store, because the profit margin for the grocery industry is low, while the profit margin for the jewelry industry is high. A better measure of sales performance is the total dollar contribution margin of each salesperson (total sales less variable cost of goods sold and variable selling expenses) to overall company profit.

10.

Costs are classified as fixed or variable according to how they change relative to an activity base. A common activity base for manufacturing firms is the number of units produced. Since service companies do not produce a product, they must rely on other activity measures such as miles flown.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

BASIC EXERCISES BE 21–1 (FIN MAN); BE 7–1 (MAN) a. b. c.

$4,720,000 = $7,150,000 – $2,430,000 $3,820,000 = $4,720,000 – $900,000 $2,460,000 = $3,820,000 – $1,250,000 – $110,000

BE 21–2 (FIN MAN); BE 7–2 (MAN) a.

Variable costing operating income is less than absorption costing operating income because the units manufactured are greater than the units sold.

$605,000 ($55 per unit × 11,000 units)

BE 21–3 (FIN MAN); BE 7–3 (MAN) a.

Variable costing operating income is greater than absorption costing operating income because the units manufactured are less than the units sold.

$118,900 ($8.20 per unit × 14,500 units)

BE 21–4 (FIN MAN); BE 7–4 (MAN) a.

$45,000 greater in producing 36,000 units. 30,000 units × ($9.00* – $7.50**), or [6,000 units × ($270,000 ÷ 36,000 units)]. * $270,000 ÷ 30,000 units ** $270,000 ÷ 36,000 units

There would be no difference in variable costing operating income.

BE 21–5 (FIN MAN); BE 7–5 (MAN) a. Sales Variable expenses Contribution margin b.

East $ 37,500,000 1 (20,775,000) 2

West $ 34,050,000 4 (17,450,000) 5

$ 16,725,000

$ 16,600,000

44.6% 3

Contribution margin ratio 1

(45,000 units × $500) + (60,000 units × $250)

(45,000 units × $275) + (60,000 units × $140) $16,725,000 ÷ $37,500,000 (38,000 units × $600) + (50,000 units × $225) (38,000 units × $275) + (50,000 units × $140) $16,600,000 ÷ $34,050,000

3 4 5 6

48.8%6

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

EXERCISES Ex. 21–1 (FIN MAN); Ex. 7–1 (MAN) a.

The inventory valuation under the absorption costing concept would include the fixed factory overhead cost, as follows: 18,000 units × $80* = $1,440,000

* Direct materials……………………………………………………………………………………

$25

Direct labor…………………………………………………………………………………………

Fixed factory overhead………………………………………………………………………… Variable factory overhead………………………………………………………………………

30 5

Total…………………………………………………………………………………………………

$80

The inventory valuation under the variable costing concept would not include the fixed factory overhead cost, as follows: 18,000 units × $50* = $900,000 * Direct materials……………………………………………………………………………………

$25

Direct labor………………………………………………………………………………………… Variable factory overhead………………………………………………………………………

20 5

Total…………………………………………………………………………………………………

$50

All of the fixed factory overhead cost would be expensed in the variable costing income statement as a period cost. Thus, the absorption costing income statement would have a higher operating income than would the variable costing income statement.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Ex. 21–2 (FIN MAN); Ex. 7–2 (MAN) Crazy Mountain Sports Inc. Absorption Costing Income Statement For the Month Ended March 31

Sales Cost of goods sold (12,500 units × $260*) Gross profit Selling and administrative expenses ($125,000 + $45,000) Operating income

$ 6,250,000 (3,250,000) $ 3,000,000 (170,000) $ 2,830,000

* Production costs per unit: Direct materials per unit ($1,800,000 ÷ 15,000 units)…………………… Direct labor per unit ($1,275,000 ÷ 15,000 units)……………………… Variable factory overhead per unit ($225,000 ÷ 15,000 units)………… Fixed factory overhead per unit ($600,000 ÷ 15,000 units)……………

$120 85 15 40

Total production costs per unit……………………………………………

$260

Crazy Mountain Sports Inc. Variable Costing Income Statement For the Month Ended March 31 Sales Variable cost of goods sold (12,500 units × $220* per unit) Manufacturing margin Variable selling and administrative expenses Contribution margin Fixed costs: Fixed factory overhead costs Fixed selling and administrative expenses Total fixed costs Operating income

$ 6,250,000 (2,750,000) $ 3,500,000 (125,000) $ 3,375,000 $600,000 45,000 (645,000) $ 2,730,000

* $120 + $85 + $15 = $220

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Ex. 21–2 (FIN MAN); Ex. 7–2 (MAN) (Concluded) c.

The difference between the absorption and variable costing operating income of $100,000 ($2,830,000 – $2,730,000) can be explained as follows: Increase in inventory……………………………………………………………… 2,500 $40 × Fixed factory overhead per unit……………………………………………… × $100,000 Difference in operating income………………………………………………… Under the absorption costing concept, the fixed factory overhead cost included in the cost of goods sold is matched with the revenues. As a result, 2,500 units that were produced but unsold (inventory) include fixed factory overhead cost of $100,000, which is not included in the cost of goods sold. Under variable costing, all of the fixed factory overhead cost is deducted in the period in which it is incurred, regardless of the amount of inventory change. Thus, when inventory increases, the absorption costing income statement will have a higher operating income than will the variable costing income statement.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Ex. 21–3 (FIN MAN); Ex. 7–3 (MAN) a.

Fresno Industries Inc. Absorption Costing Income Statement For the Month Ended February 28 Sales (150,000 × $500.00) Cost of goods sold: Beginning inventory (20,000 × $301.00) Cost of goods manufactured (130,000 × $305.00) Total cost of goods sold Gross profit Selling and administrative expenses Operating income

$ 6,020,000 39,650,000 (45,670,000) $ 29,330,000 (3,195,000) $ 26,135,000

Fresno Industries Inc. Variable Costing Income Statement For the Month Ended February 28 Sales Variable cost of goods sold (150,000 units × $275.00 per unit) Manufacturing margin Variable selling and administrative expenses Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and administrative expenses Total fixed costs Operating income

$ 75,000,000

$ 75,000,000 (41,250,000) $ 33,750,000 (3,000,000) $ 30,750,000 $3,900,000 195,000 (4,095,000) $ 26,655,000

The difference between the absorption and variable costing operating income of $520,000 ($26,655,000 – $26,135,000) can be explained as follows: Beginning inventory…………………………………………………………… Fixed manufacturing cost per unit in January……………………………… Difference in operating income………………………………………………

20,000 $26.00 × $520,000

Under the absorption costing concept, the fixed manufacturing cost included in the cost of goods sold is matched with the revenues. As a result, 20,000 units that were produced but unsold in January (beginning inventory February 1) include fixed manufacturing cost, which is included in the cost of goods sold for February. Under variable costing, all of the fixed manufacturing cost is deducted in the period in which it is incurred, regardless of the amount of inventory change. Thus, when inventory decreases, the absorption costing income statement will have a lower operating income than will the variable costing income statement.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Ex. 21–4 (FIN MAN); Ex. 7–4 (MAN) a.

Variable Cost of Goods Manufactured Number of Units Produced

Variable Cost of Goods = Manufactured per Unit =

$9,000,000 75,000 units

= $120

Total Cost of Goods Manufactured (Variable + Fixed) Number of Units Produced

Absorption Cost of Goods = Manufactured per Unit

($9,000,000 + $600,000) 75,000 units

= = $128

Ex. 21–5 (FIN MAN); Ex. 7–5 (MAN) Joplin Company Variable Costing Income Statement For the Month Ended April 30 Sales (275,000 units) Variable cost of goods sold: Variable cost of goods manufactured* Inventory, April 30 (25,000 units)** Total variable cost of goods sold Manufacturing margin Variable selling and administrative expenses*** Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and administrative expenses Total fixed costs Operating income

$ 4,950,000 $3,600,000 (300,000) (3,300,000) $ 1,650,000 (110,000) $ 1,540,000 $ 450,000 165,000 $

(615,000) 925,000

* $4,050,000 – $450,000 (total manufacturing cost less fixed manufacturing cost) ** $3,600,000 ÷ 300,000 units manufactured = $12; $12 × 25,000 units = $300,000

*** $275,000 – $165,000 = $110,000

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Ex. 21–6 (FIN MAN); Ex. 7–6 (MAN) Maryville Equipment Company Absorption Costing Income Statement For the Month Ended October 31 Sales (220,000 units) Cost of goods sold: Cost of goods manufactured* Inventory, October 31 (45,000 units)** Total cost of goods sold Gross profit Selling and administrative expenses ($330,000 + $100,000) Operating income

$ 7,920,000 $ 6,890,000 (1,170,000) (5,720,000) $ 2,200,000 (430,000) $ 1,770,000

* $6,360,000 + $530,000 (total variable plus fixed manufacturing cost) ** $6,890,000 ÷ 265,000 units manufactured = $26 per unit; $26 × 45,000 units = $1,170,000 Ex. 21–7 (FIN MAN); Ex. 7–7 (MAN) a.

The Procter & Gamble Company Variable Costing Income Statement (assumed) (in millions) Sales Variable cost of products sold Manufacturing margin Variable marketing, administrative, and other expenses Contribution margin Fixed costs: Fixed manufacturing costs* Fixed marketing, administrative, and other expenses** Total fixed costs Operating income

$ 70,950 (21,150) $ 49,800 (14,000) $ 35,800 $14,100 5,994 (20,094) $ 15,706

* $35,250 – $21,150 ** $19,994 – $14,000

If The Procter & Gamble Company reduced its inventories during the period, then the cost of products sold would include fixed costs allocated to the beginning inventories. These would not be fixed costs of the current period. Thus, the total fixed costs of products sold on the absorption costing income statement would be higher, and operating income would be lower.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Ex. 21–8 (FIN MAN); Ex. 7–8 (MAN) a.

1. Lemke Inc. Absorption Costing Income Statement For the Month Ending January 31

Sales Cost of goods sold: Cost of goods manufactured: 25,000 units × $62* 30,000 units × $60** Inventory, January 31 (5,000 units × $60) Total cost of goods sold Gross profit Selling and administrative expenses Operating income

25,000 Units Manufactured

30,000 Units Manufactured

$ 2,000,000

$(1,550,000)

$(1,550,000) $ 450,000 (275,000) $ 175,000

$(1,800,000) 300,000 $(1,500,000) $ 500,000 (275,000) $ 225,000

* Unit cost of goods manufactured: Direct materials ($450,000 ÷ 25,000)…………………………… Direct labor ($750,000 ÷ 25,000)………………………………… Variable factory overhead cost ($50,000 ÷ 25,000)…………… Fixed factory overhead cost ($300,000 ÷ 25,000)……………… Total unit cost………………………………………………………

$18 30 2 12 $62

** Unit cost of goods manufactured: Direct materials……………………………………………………… Direct labor…………………………………………………………… Variable factory overhead cost…………………………………… Fixed factory overhead cost ($300,000 ÷ 30,000)……………… Total unit cost………………………………………………………

$18 30 2 10 $60

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Ex. 21–8 (FIN MAN); Ex. 7–8 (MAN) (Concluded) 2. Lemke Inc. Variable Costing Income Statement For the Month Ending January 31

Sales Variable cost of goods sold: Variable cost of goods manufactured: 25,000 units × $50* 30,000 units × $50* Inventory, January 31 (5,000 units × $50) Total variable cost of goods sold Manufacturing margin Variable selling and administrative expenses** Contribution margin Fixed costs: Fixed factory overhead Fixed selling and administrative expenses Total fixed costs Operating income

25,000 Units Manufactured

30,000 Units Manufactured

$ 2,000,000

$(1,250,000)

$(1,250,000) $ 750,000 (200,000) $ 550,000

$(1,500,000) 250,000 $(1,250,000) $ 750,000 (200,000) $ 550,000

$ (300,000) (75,000) $ (375,000) $ 175,000

* Unit variable cost of goods manufactured: Direct materials ($450,000 ÷ 25,000)…………………………… Direct labor ($750,000 ÷ 25,000)………………………………… Variable factory overhead cost ($50,000 ÷ 25,000)…………… Total unit variable cost……………………………………………

$18 30 2 $50

** Variable selling and administrative expenses are constant with constant sales levels. b.

If 30,000 units rather than 25,000 units are manufactured, the increase in operating income of $50,000 ($225,000 – $175,000) under absorption costing is caused by the allocation of $300,000 of fixed factory overhead cost over a larger number of units. If 30,000 units are manufactured, the fixed factory overhead cost is $12 per unit ($300,000 ÷ 25,000) compared to $10 per unit ($300,000 ÷ 30,000) if 30,000 units are manufactured. Thus, the cost of goods sold is $50,000 less by the amount of $2 per unit ($12 – $10) times the number of units sold, or $2 × 25,000 units = $50,000. The $50,000 difference can also be explained by the amount of fixed factory overhead cost included in the ending inventory if the additional 5,000 units are manufactured ($10 per unit × 5,000 units).

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Ex. 21–9 (FIN MAN); Ex. 7–9 (MAN) a.

Caterpillar Inc. Variable Costing Income Statement (assumed) For the Year Ended December 31 (In millions) Sales Variable cost of goods sold: Beginning inventory (70% × $11,266) Variable cost of goods manufactured* Ending inventory (70% × $11,402)** Total variable cost of goods sold Manufacturing margin Variable selling and administrative expenses*** Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and administrative expenses Total fixed costs Operating Income

$ 41,748 $ 7,886 18,643 (7,981) (18,548) $ 23,200 (3,113) $ 20,087 $10,575 5,000 (15,575) $ 4,512

* Variable cost of goods manufactured: Cost of goods sold……………………………………………………… Plus: Ending inventory………………………………………………… Less: Beginning inventory…………………………………………… Cost of goods manufactured………………………………………… Less: Fixed manufacturing costs…………………………………… Variable cost of goods manufactured………………………………

$ 29,082 11,402 (11,266) $ 29,218 (10,575) $ 18,643

** Rounded *** Variable selling and administrative expenses: Selling, administrative, and other expenses………………………… Less: Fixed selling, administrative, and other expenses………… Variable selling and administrative expenses………………………

$ 8,113 (5,000) $ 3,113

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Ex. 21–9 (FIN MAN); Ex. 7–9 (MAN) (Concluded) b. The operating income under the variable costing concept will not be the same as the operating income under the absorption costing concept when the inventories either increase or decrease during the year. In this case, Caterpillar’s inventory increased, meaning it sold less than it manufactured. As a result, the operating income under the variable costing concept will be less than the operating income under the absorption costing concept. The reason is because the variable costing concept will deduct the fixed costs in the period that they are incurred, regardless of changes in inventory balances. In contrast, absorption costing will match costs with sales by allocating the fixed costs to the beginning and ending inventories. When units sold are less than units manufactured (when inventories increase), fixed costs are allocated to ending inventory in determining cost of goods sold under absorption costing. Thus, less fixed costs will be included in cost of goods sold than were actually incurred during the period. This will result in a higher operating income than would be reported under the variable costing concept. The difference between the operating income under the two concepts can be shown as follows (rounded): Fixed cost portion of January 1 inventory (30% × $11,266)*………………… Less: Fixed cost portion of December 31 inventory (30% × $11,402)*……… Difference in operating income……………………………………………………

$ 3,380 (3,421) $ (41)

Operating income—variable costing……………………………………………… Operating income—absorption costing…………………………………………… Difference in operating income……………………………………………………

$ 4,512 (4,553) $ (41)

* Rounded

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Ex. 21–10 (FIN MAN); Ex. 7–10 (MAN) a. Management’s decision and conclusion are incorrect. The profit will not be improved by $240,000 because the fixed costs used in manufacturing and selling cross training shoes will not be avoided if the line is eliminated. These fixed costs total $3,240,000 for the cross training shoe line. Thus, the actual profit will go down by $3,000,000 ($3,240,000 – $240,000) if the cross training shoe line is eliminated. This is shown in the variable costing income statements in (b). The absorption costing product profit reports should not be used for making this type of decision. b.

Fleet-of-Foot Inc. Variable Costing Income Statements—Three Product Lines For the Year Ended December 31 Cross Training Shoes

Golf Shoes

Running Shoes

$12,000,000 (4,200,000) $ 7,800,000

$14,000,000 (5,600,000) $ 8,400,000

$ 9,000,000 (2,700,000) $ 6,300,000

(4,800,000) $ 3,000,000

(2,800,000) $ 5,600,000

(2,300,000) $ 4,000,000

Revenues Variable cost of goods sold* Manufacturing margin Variable selling and administrative expenses** Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and administrative expenses Total fixed costs

$ (1,800,000)

$ (1,400,000)

$(1,710,000)

(1,440,000) $ (3,240,000)

(700,000) $ (2,100,000)

(900,000) $(2,610,000)

Operating income

$ 3,500,000

$ 1,390,000

(240,000)

* Cross Training: $6,000,000 – $1,800,000; Golf Shoes: $7,000,000 – $1,400,000; Running Shoes: $4,410,000 – $1,710,000

** Cross Training: $6,240,000 – $1,440,000; Golf Shoes: $3,500,000 – $700,000; Running Shoes: $3,200,000 – $900,000

c. If the cross training shoe line were eliminated, then the contribution margin of the product line also would be eliminated. The fixed costs would not be eliminated. Thus, the profit of the company would actually decline by $3,000,000. Management should keep the line and attempt to improve the profitability of the product by increasing prices, increasing volume, or reducing costs. Alternatively, if the volume of the other two products were to increase, then the cross training shoe line could be eliminated and replaced with volume from the other two products.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Ex. 21–11 (FIN MAN); Ex. 7–11 (MAN)

Unit volume increase…………………………………………… × Contribution margin per unit………………………………… Increase in profitability…………………………………………

Sun Sound Headphones

Ear Bling Headphones

28,000 × $33.60 $940,800

30,000 × $30.00 $900,000

The increase in total profitability would be $1,840,800 ($940,800 + $900,000). Note that the operating income per-unit figures are not used in the analysis, since the fixed costs should be excluded in determining the incremental operating income to be earned from the incremental sales. This is because the company has sufficient capacity for the additional production. Thus, fixed costs will not be affected by the decision.

Ex. 21–12 (FIN MAN); Ex. 7–12 (MAN) a.

Galaxy Sports Inc. Contribution Margin by Product Conquistador

Sales Variable cost of goods sold Manufacturing margin Variable selling and administrative expenses Contribution margin Contribution margin ratio

$ 60,000,000 (36,000,000) $ 24,000,000 (9,000,000) $ 15,000,000 25%

Hurricane

$ 46,000,000 (23,000,000) $ 23,000,000 (4,600,000) $ 18,400,000 40%

b. The Hurricane line provides the largest total contribution margin and the largest contribution margin ratio. If the sales mix were shifted more toward the Hurricane line, the overall profitability of the company would increase.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Ex. 21–13 (FIN MAN); Ex. 7–13 (MAN) a.

Pipeline Surfboards Inc. Contribution Margin by Territory East Coast

West Coast

Sales Variable cost of goods sold Manufacturing margin Variable selling expenses Contribution margin

$ 40,000,000 (24,000,000) $ 16,000,000 (6,000,000) $ 10,000,000

$ 48,000,000 (30,000,000) $ 18,000,000 (3,600,000) $ 14,400,000

Contribution margin ratio *

25%

30%

* 25% = $10,000,000 ÷ $40,000,000 30% = $14,400,000 ÷ $48,000,000

The total contribution margin is $4,400,000 ($14,400,000 – $10,000,000) lower for the East Coast. This is primarily because East Coast sells only Atlantic Waves, which have a lower unit contribution margin of $115 ($240 – $125) than the West Coast. Likewise, the contribution margin ratio for the East Coast is 5% lower (30% – 25%) than the West Coast. Although the East Coast sells 20,000 more surfboards (80,000 vs. 60,000) than the West Coast, the East Coast cannot make up for the West Coast’s higher unit contribution margin and contribution margin ratio. In attempting to improve the company’s profitability, it is unlikely that changing the mix of products in the two territories will have much effect. The East Coast will sell few Pacific Pounders due to surf style of the East Coast. In contrast, the West Coast has a mixed surf. However, there may be a number of opportunities to improve the profitability of the East Coast. First, the selling price of Atlantic Wave is $300 ($800 – $500) lower than the Pacific Pounder. Why such a difference? Maybe the price of the Atlantic Wave could be increased, which would improve its manufacturing margin per unit, contribution margin ratio, and profitability. In addition, the variable selling expenses of the Atlantic Wave are $15 per unit ($75 – $60) more than the Pacific Pounder. Reducing these variable selling expenses could significantly improve profitability of the East Coast.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Ex. 21–14 (FIN MAN); Ex. 7–14 (MAN) a. 1.

Havasu Off-Road Inc. Contribution Margin by Salesperson Sales Variable cost of goods sold Manufacturing margin Variable commission expense Contribution margin Contribution margin ratio

Rene

Steve

Colleen

Paul

$ 558,000 (334,800) $ 223,200

$ 384,000 (192,000) $ 192,000

$ 560,000 (336,000) $ 224,000

$1,080,000 (540,000) $ 540,000

(44,640) $ 178,560 32%

(46,080) $ 145,920 38%

(56,000) $ 168,000 30%

(86,400) $ 453,600 42%

2. Paul earns the highest contribution margin and has the highest contribution margin ratio. This is because he sells the most units, has a low commission rate, and sells a product mix with a high manufacturing margin (50% of sales, $540,000 ÷ $1,080,000). Steve also sells products with a high average manufacturing margin (50% of sales, $192,000 ÷ $384,000) but at a high commission rate. This accounts for the fourpercentage point difference in the contribution margin ratio between Paul and Steve. The other two salespersons sell products with lower average manufacturing margins (40% of sales). Combining this with the high commission rate causes Colleen to have the poorest contribution margin ratio among the four salespersons. Although Rene has a high variable cost of goods sold and also sells products with a low average sales price per unit, she has the second highest total contribution margin of $178,560.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Ex. 21–14 (FIN MAN); Ex. 7–14 (MAN) (Concluded) b.

Havasu Off-Road Inc. Contribution Margin by Territory Sales Variable cost of goods sold Manufacturing margin Variable commission expense Contribution margin Contribution margin ratio

Northeast

Southwest

$ 942,000 (526,800) $ 415,200 (90,720) $ 324,480 34.4%

$1,640,000 (876,000) $ 764,000 (142,400) $ 621,600 37.9%

2. The Southwest Region has $698,000 more sales and $297,120 more contribution margin. In addition, the Southwest Region has the largest contribution margin ratio. In the Southwest Region, the salesperson with the highest sales unit volume also has the highest contribution margin ratio (Paul). The Southwest Region has the highest performance, even though it also has the salesperson with the lowest contribution margin ratio (Colleen). In the Northeast Region, both salespersons are performing similarly. The Northeast Region contribution margin is less than the Southwest Region because of the outstanding performance of Paul. Paul is driving the Southwest Region’s performance.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Ex. 21–15 (FIN MAN); Ex. 7–15 (MAN) Amazon.com, Inc. Variable Costing Income Statement (in millions)

North America

Sales Variable operating expenses * Contribution margin

$ 236,282 (193,486) $ 42,796

Fixed operating expenses ** Operating income

(34,145) 8,651

International

AWS

Total

$104,412 (82,956) $ 21,456

$ 45,370 $ 386,064 (23,879) (300,321) $ 21,491 $ 85,743

(20,739) 717

(7,960) (62,844) $ 13,531 $ 22,899

* North America: $227,631 × 85% International: $103,695 × 80% AWS: $31,839 × 75%

** North America: $227,631 − $193,486 International: $103,695 − $82,956 AWS: $31,839 − $23,879

Contribution Margin Ratio 18.1% 20.5% 47.4%

North America ($42,796 ÷ $236,282) International ($21,456 ÷ $104,412) AWS ($21,491 ÷ $45,370) c.

The North America segment’s contribution margin ratio of 18.1% is slightly lower than International’s contribution margin ratio of 20.5%. In contrast, AWS has a contribution margin ratio of 47.4%, which is more than twice that of the North America and International segments. These differences reflect the underlying operations of each segment. The North America and International segments are based primarily upon consumer retail sales, which is highly competitive with low operating margins. In contrast, AWS focuses on a broad set of technology services, which allows for higher operating margins. In addition, Amazon.com was one of the first companies to focus on developing cloud-based technology services. However, Amazon.com is facing increasing competition in its AWS cloud-based services from companies such as Microsoft (MSFT). Overall, Amazon.com earns a contribution margin ratio of 22.2% ($85,743 ÷ $386,064) with over half ($13,531) of its total operating income of $22,899 generated by the AWS segment.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Ex. 21–16 (FIN MAN); Ex. 7–16 (MAN) a.

The Walt Disney Company Variable Costing Income Statement (in millions) Media Networks

Sales Variable operating expenses * Contribution margin Fixed operating expenses ** Operating income

$ 28,393 (14,528) $ 13,865 (4,843) $ 9,022

Parks, Experiences, and Products

Studio Entertainment

Direct-toConsumer & International

$16,502 (9,950) $ 6,552 (6,633) $ (81)

$ 9,636 (5,708) $ 3,928 (1,427) $ 2,501

$ 16,967 (13,841) $ 3,126 (5,932) $ (2,806)

* Media Networks: $19,371 × 75% Parks, Experiences, and Products: $16,583 × 60% Studio Entertainment: $7,135 × 80% Direct-to-Consumer & International: $19,773 × 70%

** Media Networks: $19,371 − $14,528 Parks, Experiences, and Products: $16,583 − $9,950 Studio Entertainment: $7,135 − $5,708 Direct-to-Consumer & International: $19,773 − $13,841

b. Media Networks ($13,865 ÷ $28,393) Parks, Experiences, and Products ($6,552 ÷ $16,502) Studio Entertainment ($3,928 ÷ $9,636) Direct-to-Consumer & International ($3,126 ÷ $16,967)

Contribution Margin Ratio 48.8% 39.7% 40.8% 18.4%

c. All segments generated a positive contribution margin, even though the Parks, Experiences, and Products and Direct-to-Consumer & International segments generated operating losses of $(81) and $(2,806), respectively. The Media Networks segment generated the highest contribution margin of $13,865 and contribution margin ratio of 48.8%. The Parks, Experiences, and Products and Studio Entertainment segments generated approximately the same contribution margin ratios of 39.7% and 40.8%, respectively. However, because of its size, the Parks, Experiences, and Products segment generated $2,624 ($6,552 − $3,928) more contribution margin than the Studio Entertainment segment. The Direct-to-Consumer & International segment generated the lowest contribution margin ratio of 18.4% and lowest contribution margin of $3,126. The recent COVID-19 pandemic adversely affected the preceding results. The Parks, Experiences, and Products and Studio Entertainment segments were particularly affected. Thus, the preceding results are not indicative of Disney’s normal operations for these segments.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Ex. 21–17 (FIN MAN); Ex. 7–17 (MAN) a.

East Coast Railroad Company Contribution Margin by Route For the Month Ended April 30 Atlanta/ Baltimore

Baltimore/ Pittsburgh

Pittsburgh/ Atlanta

Total

Revenues

$ 255,000

$ 594,000

$ 542,080

$ 1,391,080

Variable costs: Labor costs for loading and unloading railcars Fuel costs Train crew labor costs Switchyard labor costs Total variable costs

$ (19,550) (159,154) (92,412) (13,175) $(284,291)

$ (99,360) (126,480) (73,440) (66,960) $(366,240)

$ (56,672) (174,592) (101,376) (38,192) $(370,832)

$ (175,582) (460,226) (267,228) (118,327) $(1,021,363)

Contribution margin

$ (29,291)

$ 227,760

$ 171,248

(11.5)%

38.3%

31.6%

Contribution margin ratio

369,717 26.6%

Revenues: Revenue per railcar × Number of railcars Labor costs for loading and unloading railcars: $46.00 × Number of railcars Fuel costs: $12.40 × Number of train-miles Train crew labor costs: $7.20 × Number of train-miles Switchyard labor costs: $31.00 × Number of railcars b. The Atlanta/Baltimore route performs significantly worse than do the other two routes. A close examination of the operating statistics indicates that this route runs very few railcars, combined with fairly high total mileage. This combination suggests that the railroad is running many short trains on the railroad. That is, the railroad’s profitability is very sensitive to the size, or length, of the train in railcar terms. A short train costs nearly as much fuel and crewing costs as does a longer train. Thus, short trains will be inherently less profitable than longer trains. The other two routes have much better ratios of train-miles to railcars, indicating that their train sizes are larger. Note to Instructors: Part (b) is somewhat subtle but a worthy discussion. The cost behavior issues discussed in (b) are common in service companies. For example, large classes in a university are inherently more profitable than small classes, dense data traffic on a telecommunication system is more profitable than less traffic, full airplanes are more profitable than empty airplanes, and faster table turns in a restaurant create greater profitability than do slower turns, etc.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Ex. 21–18 (FIN MAN); Ex. 7–18 (MAN) Broadwater Institute & Technical School Variable Costing Income Statement For the Fall Term Revenue Variable costs: Registration, records, and marketing costs Instructional costs Total variable costs Contribution margin Depreciation on classrooms and equipment Operating income

$ 9,200,000 $(1,500,000) (3,600,000) $(5,100,000) $ 4,100,000 (1,875,000) $ 2,225,000

Supporting calculations: Revenue: $115 × 80,000 credit hours Registration, records, and marketing costs: $300 × 5,000 students Instructional costs: $45 × 80,000 credit hours

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

PROBLEMS Prob. 21–1A (FIN MAN); Prob. 7–1A (MAN) 1.

IceBox Fridgeration Company Absorption Costing Income Statement For the Month Ended March 31 Sales Cost of goods sold: Cost of goods manufactured Inventory, March 31 (15,000 units × $55.50*) Total cost of goods sold Gross profit Selling and administrative expenses Operating income

$11,250,000 $9,157,500 (832,500) (8,325,000) $ 2,925,000 (1,575,000) $ 1,350,000

* $9,157,500 ÷ 165,000 units = $55.50 2.

IceBox Fridgeration Company Variable Costing Income Statement For the Month Ended March 31 Sales Variable cost of goods sold: Variable cost of goods manufactured* Inventory, March 31 (15,000 units × $40.50**) Total variable cost of goods sold Manufacturing margin Variable selling and administrative expenses Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and administrative expenses Total fixed costs Operating income

$11,250,000 $6,682,500 (607,500) (6,075,000) $ 5,175,000 (450,000) $ 4,725,000 $2,475,000 1,125,000 (3,600,000) $ 1,125,000

* $9,157,500 – $2,475,000 = $6,682,500 ** $6,682,500 ÷ 165,000 units = $40.50 3.

The operating income reported under absorption costing exceeds the operating income reported under variable costing by $225,000 ($1,350,00 – $1,125,000). This is due to including $225,000 of fixed manufacturing cost in inventory under absorption costing [15,000 units × $15.00 ($2,475,000 ÷ 165,000)]. The $225,000 was thus deferred to a future month under absorption costing, while it was included as an expense of March (part of fixed costs) under variable costing.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Prob. 21–2A (FIN MAN); Prob. 7–2A (MAN) 1.

Celecia Industries Inc. Estimated Income Statement—Absorption Costing—Solvent For the Month Ending June 30 Sales (15,000 units) Cost of goods sold: Direct materials Direct labor Variable manufacturing cost Fixed manufacturing cost Total cost of goods sold Gross profit Selling and administrative expenses: Variable selling and administrative expenses Fixed selling and administrative expenses Total selling and administrative expenses Operating loss

$ 225,000 $ 37,500 45,000 11,250 100,000 (193,750) $ 31,250 $ 22,500 40,000 (62,500) $ (31,250)

Celecia Industries Inc. Estimated Income Statement—Variable Costing—Solvent For the Month Ending June 30 Sales (15,000 units) Variable cost of goods sold: Direct materials Direct labor Variable manufacturing cost Total variable cost of goods sold Manufacturing margin Variable selling and administrative expenses Contribution margin Fixed costs: Fixed manufacturing cost Fixed selling and administrative expenses Total fixed costs Operating loss

$ 225,000 $ 37,500 45,000 11,250 (93,750) $ 131,250 (22,500) $ 108,750 $100,000 40,000 (140,000) $ (31,250)

3. $140,000. The operating loss from temporarily closing the portion of the plant associated with solvent would be $140,000 (fixed manufacturing cost of $100,000 plus fixed selling and administrative expenses of $40,000). 4. Production of solvent should be continued. Temporary suspension of production would result in an operating loss of $140,000 [from (3) above], compared with an operating loss of $31,250 if production is continued. The savings of $108,750, measured by the excess of $140,000 over $31,250, is the amount reported as contribution margin on the variable costing income statement. 21-23 © 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Prob. 21–3A (FIN MAN); Prob. 7–3A (MAN) 1. a.

Big Sky Creations Company Absorption Costing Income Statement For the Month Ended May 31 Sales Cost of goods sold: Cost of goods manufactured Inventory, May 31 (4,000 units × $90*) Total cost of goods sold Gross profit Selling and administrative expenses Operating income

$ 4,500,000 $3,600,000 (360,000) (3,240,000) $ 1,260,000 (152,000) $ 1,108,000

* $3,600,000 ÷ 40,000 units = $90 b.

Big Sky Creations Company Absorption Costing Income Statement For the Month Ended June 30 Sales Cost of goods sold: Inventory, June 1 (4,000 units × $90) Cost of goods manufactured Total cost of goods sold Gross profit Selling and administrative expenses Operating income

2. a.

$ 4,500,000 $ 360,000 2,904,000 (3,264,000) $ 1,236,000 (152,000) $ 1,084,000

Big Sky Creations Company Variable Costing Income Statement For the Month Ended May 31 Sales Variable cost of goods sold: Variable cost of goods manufactured Inventory, May 31 (4,000 units × $87*) Total variable cost of goods sold Manufacturing margin Variable selling and administrative expenses Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and administrative expenses Total fixed costs Operating income

$ 4,500,000 $3,480,000 (348,000) (3,132,000) $ 1,368,000 (72,000) $ 1,296,000 $ 120,000 80,000 (200,000) $ 1,096,000

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Prob. 21–3A (FIN MAN); Prob. 7–3A (MAN) (Concluded) 2. b.

Big Sky Creations Company Variable Costing Income Statement For the Month Ended June 30 Sales Variable cost of goods sold: Inventory, June 1 (4,000 units × $87) Variable cost of goods manufactured Total variable cost of goods sold Manufacturing margin Variable selling and administrative expenses Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and administrative expenses Operating income

$ 4,500,000 $ 348,000 2,784,000 (3,132,000) $ 1,368,000 (72,000) $ 1,296,000 $ 120,000 80,000

(200,000) $ 1,096,000

3. a.

For May, the operating income reported under absorption costing exceeds the operating income reported under variable costing by $12,000 ($1,108,000 – $1,096,000). This difference is due to including $12,000 of fixed manufacturing cost in inventory under absorption costing [4,000 units × $3.00 ($120,000 ÷ 40,000)]. The $12,000 was thus deferred to June under absorption costing, while it was included as an expense of May (part of fixed costs) under variable costing.

For June, the operating income reported under absorption costing is less than the operating income reported under variable costing by $12,000 ($1,096,000 – $1,084,000). This difference is due to including $12,000 of fixed manufacturing cost in the June 1 inventory under absorption costing (4,000 units × $3.00). Thus, this $12,000 was included in June’s cost of goods sold under absorption costing. Under variable costing, this $12,000 was included as an expense of May (part of the fixed costs) and thus is excluded from June’s income statement.

4. Big Sky Creations Company was equally profitable in May and June under the variable costing concept. Sales and the variable cost per unit were the same for both May and June. The difference in operating income reported under the absorption costing concept is due to allocating $12,000 of fixed manufacturing cost to the May 31 ending inventory. Note: The combined operating income reported for May and June ($2,192,000) is the same for both absorption costing and variable costing. This problem illustrates the need for management to exercise care in interpreting operating income reported under absorption costing when large changes in inventory levels occur.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Prob. 21–4A (FIN MAN); Prob. 7–4A (MAN) Waltham Industries Inc. Salespersons’ Analysis For the Year Ended December 31

Salesperson

Case Dix Johnson LaFave Orcas Sussman Willbond

Contribution Margin

Variable Cost of Goods Sold as a Percent of Sales

Variable Selling Expenses as a Percent of Sales

Contribution Margin Ratio

$231,800 265,320 176,400 181,660 308,000 186,000 230,880

44% 40% 52% 48% 36% 50% 46%

18% 16% 18% 21% 14% 20% 15%

38% 44% 30% 31% 50% 30% 39%

2. Orcas has the highest contribution margin and contribution margin ratio for the year. This is because of two factors. First, Orcas has the smallest variable cost of goods sold as a percent of sales. This is probably due to selling a favorable mix of product that has high manufacturing margins as a percent of sales. Second, Orcas has the lowest variable selling expenses as a percent of sales. This could be due to a lower sales commission or selling support costs. 3. Other factors that should be considered in evaluating the performance of salespersons include rate of growth in sales for the current year compared with past years, years of experience for salespersons, size of sales territory, and actual sales compared with budgeted sales.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Prob. 21–5A (FIN MAN); Prob. 7–5A (MAN) Valdespin Company Variable Costing Income Statement For the Year Ended June 30, 20Y9

Size M

Total

Sales Variable cost of goods sold

$ 668,000 (300,000)

$ 737,300 (357,120)

$ 956,160 (437,760)

$ 2,361,460 (1,094,880)

Manufacturing margin Variable operating expenses Contribution margin

$ 368,000 (132,480) $ 235,520

$ 380,180 (155,500) $ 224,680

$ 518,400 (195,840) $ 322,560

$ 1,266,580 (483,820) $ 782,760

Fixed costs: Manufacturing costs Operating expenses Total fixed costs Operating income

$ (385,930) (311,040) $ (696,970) $ 85,790

2. Annual operating income would be reduced below its present level by $146,360 if Size M were to be discontinued (Proposal 2), as indicated below. Contribution margin for Size M Less reduction in fixed production costs and fixed operating expenses ($46,080 + $32,240) Reduction in annual operating income

$224,680 (78,320) $146,360

If Size M is discontinued, $224,680 of contribution margin would be forgone and only $78,320 in fixed costs would be saved, resulting in a decrease of $146,360 in operating income.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Prob. 21–5A (FIN MAN); Prob. 7–5A (MAN) (Concluded) 3.

Valdespin Company Variable Costing Income Statement For the Year Ended June 30, 20Y9 Size S

Total

Sales* Variable cost of goods sold**

$1,536,400 (690,000)

$ 956,160 (437,760)

$ 2,492,560 (1,127,760)

Manufacturing margin Variable operating expenses***

$ 846,400 (304,704)

$ 518,400 (195,840)

$ 1,364,800 (500,544)

Contribution margin

$ 541,696

$ 322,560

Fixed costs: Manufacturing costs Operating expenses (including $34,560 additional rent) Total fixed costs Operating income

864,256

$ (385,930) (345,600) $ (731,530) $ 132,726

* $668,000 + ($668,000 × 130%) ** $300,000 + ($300,000 × 130%) *** $132,480 + ($132,480 × 130%) 4.

$46,936. A comparison of the amount of operating income under present conditions, as indicated in (1), and under Proposal 3, as indicated in (3), suggests an increase of $46,936 if Proposal 3 is accepted, as illustrated below. Operating income, Proposal 3 Operating income, present conditions Increase in operating income

$132,726 (85,790) $ 46,936

Alternatively, the $46,936 increase can be determined as follows: Contribution margin, Size S, Proposal 3 Contribution margin, Size S, present operations

$ 541,696 (235,520)

Increase in contribution margin Less: Contribution margin, Size M, present operations Additional rent Increase in operating income

$ 306,176 $224,680 34,560

(259,240) $ 46,936

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Prob. 21–1B (FIN MAN); Prob. 7–1B (MAN) 1.

YoSan Inc. Absorption Costing Income Statement For the Month Ended July 31 Sales Cost of goods sold: Cost of goods manufactured Inventory, July 31 (400 units × $760*) Total cost of goods sold Gross profit Selling and administrative expenses Operating income

$ 2,150,000 $1,824,000 (304,000) (1,520,000) $ 630,000 (300,000) $ 330,000

* $1,824,000 ÷ 2,400 units = $760 2.

YoSan Inc. Variable Costing Income Statement For the Month Ended July 31 Sales Variable cost of goods sold: Variable cost of goods manufactured Inventory, July 31 (400 units × $640*) Total variable cost of goods sold Manufacturing margin Variable selling and administrative expenses Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and administrative expenses Total fixed costs Operating income

$ 2,150,000 $1,536,000 (256,000) (1,280,000) $ 870,000 (204,000) $ 666,000 $ 288,000 96,000 $

(384,000) 282,000

* $1,536,000 ÷ 2,400 units = $640 3.

The operating income reported under absorption costing exceeds the operating income reported under variable costing by $48,000 ($330,000 – $282,000). This difference is due to including $48,000 of fixed manufacturing cost in inventory under absorption costing [400 units × $120 ($288,000 ÷ 2,400)]. The $48,000 was thus deferred to a future month under absorption costing, while it was included as an expense of July (part of fixed costs) under variable costing.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Prob. 21–2B (FIN MAN); Prob. 7–2B (MAN) 1.

Smooth Skin Care Products Inc. Estimated Income Statement—Absorption Costing—Aloe Vera Hand Lotion For the Month Ending November 30 Sales (320,000 units) Cost of goods sold: Direct materials Direct labor Variable manufacturing cost Fixed manufacturing cost Total cost of goods sold Gross profit Selling and administrative expenses: Variable selling and administrative expenses Fixed selling and administrative expenses Total selling and administrative expenses Operating loss

$ 25,600,000 $ 4,800,000 5,440,000 11,200,000 1,530,000 (22,970,000) $ 2,630,000 $ 3,200,000 270,000 $

(3,470,000) (840,000)

Smooth Skin Care Products Inc. Estimated Income Statement—Variable Costing—Aloe Vera Hand Lotion For the Month Ending November 30 Sales (320,000 units) Variable cost of goods sold: Direct materials Direct labor Variable manufacturing cost Total variable cost of goods sold Manufacturing margin Variable selling and administrative expenses Contribution margin Fixed costs: Fixed manufacturing cost Fixed selling and administrative expenses Total fixed costs Operating loss

$ 25,600,000 $ 4,800,000 5,440,000 11,200,000 (21,440,000) $ 4,160,000 (3,200,000) $ 960,000 $ 1,530,000 270,000 (1,800,000) $ (840,000)

$1,800,000. The operating loss from temporarily closing the portion of the plant associated with A.V. lotion would be $1,800,000 (fixed manufacturing cost of $1,530,000 plus fixed selling and administrative expenses of $270,000). This assumes that the variable costs would be eliminated with the shutdown.

Production of A.V. lotion should be continued. Temporary suspension of production would result in an operating loss of $1,800,000 [from (3) above], compared with an operating loss of $840,000 if production is continued. The savings of $960,000, measured by the excess of $1,800,000 over $840,000, is the amount reported as contribution margin on the variable costing income statement. 21-30 © 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Prob. 21–3B (FIN MAN); Prob. 7–3B (MAN) 1. a.

Head Gear Inc. Absorption Costing Income Statement For the Month Ended July 31 Sales Cost of goods sold: Cost of goods manufactured Inventory, July 31 (1,200 units × $15.20*) Total cost of goods sold Gross profit Selling and administrative expenses Operating income

$104,000 $ 97,280 (18,240) (79,040) $ 24,960 (16,120) $ 8,840

* $97,280 ÷ 6,400 units = $15.20 b.

Head Gear Inc. Absorption Costing Income Statement For the Month Ended August 31 Sales Cost of goods sold: Inventory, August 1 (1,200 units × $15.20) Cost of goods manufactured Total cost of goods sold Gross profit Selling and administrative expenses Operating income

2. a.

$104,000 $18,240 66,560 (84,800) $ 19,200 (16,120) $ 3,080

Head Gear Inc. Variable Costing Income Statement For the Month Ended July 31 Sales Variable cost of goods sold: Variable cost of goods manufactured Inventory, July 31 (1,200 units × $12.80*) Total variable cost of goods sold Manufacturing margin Variable selling and administrative expenses Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and administrative expenses Total fixed costs Operating income

$104,000 $ 81,920 (15,360) (66,560) $ 37,440 (10,920) $ 26,520 $ 15,360 5,200 $

(20,560) 5,960

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Prob. 21–3B (FIN MAN); Prob. 7–3B (MAN) (Concluded) b.

Head Gear Inc. Variable Costing Income Statement For the Month Ended August 31 Sales Variable cost of goods sold: Inventory, August 1 (1,200 units × $12.80) Variable cost of goods manufactured Total variable cost of goods sold Manufacturing margin Variable selling and administrative expenses Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and administrative expenses Total fixed costs Operating income

$104,000 $15,360 51,200 (66,560) $ 37,440 (10,920) $ 26,520 $15,360 5,200 (20,560) $ 5,960

For July, the operating income reported under absorption costing exceeds the operating income reported under variable costing by $2,880. This difference is due to including $2,880 of fixed cost in inventory under absorption costing [1,200 units × $2.40 ($15,360 ÷ 6,400)]. The $2,880 was thus deferred to August under absorption costing, while it was included as an expense of July (part of fixed costs) under variable costing.

For August, the operating income reported under absorption costing is less than the operating income reported under variable costing by $2,880. This difference is due to including $2,880 of fixed cost in the August 1 inventory under absorption costing (1,200 units × $2.40). Thus, this $2,880 was included in August’s cost of goods sold under absorption costing. Under variable costing, this $2,880 was included as an expense of July (part of the fixed costs) and thus is excluded from August’s income statement.

Head Gear Inc. was equally profitable in July and in August under the variable costing concept. Sales and the variable cost per unit were the same for both July and August. The difference in income reported under the absorption costing concept is due to allocating $2,880 of fixed manufacturing cost to the July 31 ending inventory. Note: The combined operating income reported for July and August ($11,920) is the same for both absorption costing and variable costing. This problem illustrates the need for management to exercise care in interpreting operating income reported under absorption costing when large changes in inventory levels occur.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Prob. 21–4B (FIN MAN); Prob. 7–4B (MAN) Pachec Inc. Salespersons’ Analysis For the Year Ended June 30

Salesperson

Contribution Margin

Variable Cost of Goods Sold as a Percent of Sales

Variable Selling Expenses as a Percent of Sales

Contribution Margin Ratio

Asarenka Crowell Dempster MacLean Ortiz Sullivan Williams

$157,500 250,800 222,750 217,375 183,750 240,875 207,000

45% 40% 46% 42% 41% 42% 44%

19% 16% 21% 21% 24% 17% 20%

36% 44% 33% 37% 35% 41% 36%

Crowell has the highest contribution margin and contribution margin ratio for the year. This is because of two factors. First, Crowell had the smallest variable cost of goods sold as a percent of sales. This is probably due to selling a favorable mix of product that has high manufacturing margins as a percent of sales. Second, Crowell has the lowest variable selling expenses as a percent of sales. This could be due to a lower sales commission or selling support costs.

Other factors that should be considered in evaluating the performance of salespersons include rate of growth in sales for the current year compared with past years, years of experience for salespersons, size of sales territory, and actual sales compared with budgeted sales.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Prob. 21–5B (FIN MAN); Prob. 7–5B (MAN) 1.

Kimbrell Inc. Variable Costing Income Statement For the Year Ended December 31, 20Y8 Size M

Total

Sales Variable cost of goods sold

$ 990,000 (538,500)

$1,087,500 (718,500)

$ 945,000 (567,000)

$ 3,022,500 (1,824,000)

Manufacturing margin Variable operating expenses Contribution margin

$ 451,500 (118,100) $ 333,400

$ 369,000 (108,750) $ 260,250

$ 378,000 (85,050) $ 292,950

$ 1,198,500 (311,900) $ 886,600

Fixed costs: Manufacturing costs Operating expenses Total fixed costs Operating income

$ (779,000) (88,900) $ (867,900) $ 18,700

2. Annual operating income would be reduced below its present level by $89,400 if Size M were to be discontinued (Proposal 2), as indicated below. Contribution margin for Size M Less reduction in fixed production costs and fixed operating expenses ($142,500 + $28,350) Reduction in annual operating income

$ 260,250 (170,850) $ 89,400

If Size M is discontinued, $260,250 of contribution margin would be forgone and only $170,850 in fixed costs would be saved, resulting in a decrease of $89,400 in operating income.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

Prob. 21–5B (FIN MAN); Prob. 7–5B (MAN) (Concluded) 3.

Kimbrell Inc. Variable Costing Income Statement For the Year Ended December 31, 20Y8 Size S

Total

Sales* Variable cost of goods sold**

$ 2,277,000 (1,238,550)

$ 945,000 (567,000)

$ 3,222,000 (1,805,550)

Manufacturing margin Variable operating expenses*** Contribution margin

$ 1,038,450 (271,630) $ 766,820

$ 378,000 (85,050) $ 292,950

$ 1,416,450 (356,680) $ 1,059,770

Fixed costs: Manufacturing costs Operating expenses (including $85,050 additional salary) Total fixed costs

$ (779,000) (173,950) $ (952,950)

Operating income

106,820

* $990,000 + ($990,000 × 130%) ** $538,500 + ($538,500 × 130%) *** $118,100 + ($118,100 × 130%)

$88,120. A comparison of the amount of operating income under present conditions, as indicated in (1), and under Proposal 3, as indicated in (3), suggests an increase of $88,120 if Proposal 3 is accepted, as illustrated below. Operating income, Proposal 3 Operating income, present conditions

$106,820 (18,700)

Increase in operating income

$ 88,120

Alternatively, the $88,120 increase can be determined as follows: Contribution margin, Size S, Proposal 3 Contribution margin, Size S, present operations

$ 766,820 (333,400)

Increase in contribution margin Less: Contribution margin, Size M, present operations Additional salaries

$ 433,420

Increase in operating income

$260,250 85,050

(345,300) $ 88,120

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

MAKE A DECISION MAD 21–1 (FIN MAN); MAD 7–1 (MAN) a. Segment Cable Communications NBCUniversal Sky Total

Revenue $ 60,051 28,082 18,594 $106,727

Revenues as a Percent of Total Revenues 56% 26% 18% 100%

b. The Cable Communications segment has the largest revenue as a percent (56%) of total revenues. This segment provides more revenue than do all the other remaining segments combined. c. 1. and 2.

Segment Cable Communications NBCUniversal Sky Total

Revenue $ 60,051 28,082 18,594 $106,727

Operating Income (Loss) $17,517 3,991 (1,080) $20,428

Depr. and Amort. $ 7,753 2,278 3,034 $13,065

(1) EBITDA $25,270 6,269 1,954 $33,493

(2) EBITDA as a Percent of Revenue 42% 22% 11%

d. The Cable Communications segment provides the greatest EBITDA as a percent of revenue of 42%. The NBCUniversal segment is less profitable and generates EBITDA as a percent of revenue of 22%. The Sky segment is least profitable and generates EBITDA as a percent of revenue of only 11%. The results of the NBCUniversal and Sky segments were adversely affected by the recent COVID-19 pandemic and will likely be more profitable in future years.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

MAD 21–2 (FIN MAN); MAD 7–2 (MAN) a. Segment KFC Pizza Hut Taco Bell Habit Burger Grill Total

Percent of Total 40% 18% 36% 6% 100%

Revenue $2,272 1,002 2,031 347 $5,652

The KFC segment has the largest revenue as a percent of the total. b. Segment KFC Pizza Hut Taco Bell Habit Burger Grill

Operating Income (Loss) $922 335 696 (22)

Depreciation and Amortization Expense $29 24 56 25

EBITDA (Operating Income Plus Depr. and Amort.) $951 359 752 3

Revenue $2,272 1,002 2,031 347

EBITDA (Operating Income Plus Depr. and Amort.) $951 359 752 3

EBITDA as a Percent of Revenue 42% 36% 37% 1%

c. Segment KFC Pizza Hut Taco Bell Habit Burger Grill

d. The KFC, Pizza Hut, and Taco Bell segments generate EBITDA above 35%, which is considered strong. The Habit Burger Grill segment is the least profitable, but is a new concept for Yum! Brands and was recently acquired. Hopefully, Yum! Brands will be able to use its restaurant expertise to increase the profitability of Habit Burger.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

MAD 21–3 (FIN MAN); MAD 7–3 (MAN) Percentage Change In Revenue from Prior Year Year 2 Year 1 Year 3

a. Automotive: ($29,542 − $23,047) ÷ $23,047 ($23,047 − $19,906) ÷ $19,906 ($19,906 − $10,643) ÷ $10,643

28.2% 15.8% 87.0%

Energy Generation and Storage: ($1,994 − $1,531) ÷ $1,531 ($1,531 − $1,555) ÷ $1,555 ($1,555 − $1,116) ÷ $1,116

30.2% (1.5)% 39.3%

Gross Profit Percentage Year 2 Year 1 Year 3 Automotive: $6,612 ÷ $29,542 $3,879 ÷ $23,047 $3,852 ÷ $19,906

22.4% 16.8% 19.4%

Energy Generation and Storage: $18 ÷ $1,994 $190 ÷ $1,531 $190 ÷ $1,555

0.9% 12.4% 12.2%

c. Year 1 was an extraordinary year for both segments where revenues increased 87.0% for the Automotive segment and 39.3% for the Energy Generation and Storage segment from the prior year. In Year 1, the gross profit percentage was 19.4% for the Automotive segment and 12.2% for the Energy Generation and Storage segment. The increase in revenues in Year 1 was likely due to the increased demand for electric vehicles and green energy. The percentage change in revenues decreased in Year 2 but rebounded in Year 3 for both segments. The gross profit percentages indicate that the Automotive segment is more profitable than the Energy Generation and Storage segment. The Year 3 decrease in the gross profit percentage for Energy Generation and Storage was largely due to the COVID-19 pandemic, which included the suspension of production at its “gigafactory” in New York.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

MAD 21–4 (FIN MAN); MAD 7–4 (MAN) The analysis requires both a vertical analysis of Year 3 sales and a horizontal analysis of the change in sales from Year 1 to Year 3. a.

Percent of Year 3 Sales Total Sales $137,781 50% 28,622 10% 23,724 9% 30,620 11% 53,768 20% $274,515 100%

Segment iPhone Mac iPad Wearables, Home Accessories Services Total sales

The iPhone had the largest percent of total sales at 50%. The iPad had the least, at 9% of sales. b. Segment iPhone Mac iPad Wearables, Home Accessories Services Total sales

Year 3 $137,781 28,622 23,724 30,620 53,768 $274,515

Year 1 $164,888 25,198 18,380 17,381 39,748 $265,595

Increase (Decrease) Amount Percent $(27,107) (16)% 3,424 14% 5,344 29% 13,239 76% 14,020 35% $ 8,920 3%

The iPhone decreased by (16)% over the three-year period. In contrast, the Wearables and Home Accessories segment increased by 76% over the three-year period, which is partially explained by the introduction and promotion of new products during this period, including the Apple Watch and Apple TV. However, the importance of iPhone sales for Apple and the Services segment should not be underestimated. Specifically, iPhone sales drive additional sales of music and other software, which increases sales of Services. In addition, iPhone sales also drive additional sales of the Wearables, including the sales of Airpods.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

TAKE IT FURTHER TIF 21–1 (FIN MAN); TIF 7–1 (MAN) Aston Melon has performed the task requested by the division manager. However, Aston has not exercised good judgment, to the point of bordering on unethical behavior. Aston should question the wisdom of manipulating the amount of inventory solely for purposes of meeting numerical profit targets. The absorption costing income statements could mislead the senior management overseeing the division. Senior management may erroneously conclude that the division has become more efficient. Moreover, it may not be wise for the division to build more inventory. The excess inventory may need to be sold at a later date at “fire sale” prices. Thus, the division actually may be worse off in the long run by building the excess inventory. Aston has a responsibility to communicate these concerns to the general manager. As a last resort, Aston may need to report the concerns to the company’s senior management if the division manager refuses to respond favorably. TIF 21–2 (FIN MAN); TIF 7–2 (MAN) 1.

Absorption costing is required under generally accepted accounting principles. Under this approach, the fixed manufacturing costs are allocated to sold and unsold units. Thus, if production exceeds sales, a portion of the fixed manufacturing cost is included in the ending inventory balance and not matched against current period sales. This has the effect of reducing cost of goods sold by the amount of fixed costs allocated to the ending inventory. Thus, net income is improved by increasing inventory. Likewise, when sales exceed production and the inventory is liquidated, the cost of goods sold is increased by the amount of fixed costs included in the beginning inventory being liquidated. Thus, net income is reduced when inventory is liquidated.

Gordon is incorrect in implying that nothing can be done because of generally accepted accounting principles (GAAP). GAAP is required for external financial reporting. However, the income reports used to guide management may be developed under the variable costing concept. Under variable costing, the fixed manufacturing cost is not allocated to sold goods and inventory. Rather, fixed manufacturing cost is allocated to the period in which it is incurred. Treating fixed manufacturing cost in this way causes net income to be unaffected by either inventory building or reduction. Changes in net income under variable costing only occur from business events such as changes in volume, price, or cost. Reporting under variable costing would address Matt’s concern by tying profit more directly to profit-changing business events rather than inventory decisions.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

TIF 21–3 (FIN MAN); TIF 7–3 (MAN) Memo To:

Anna Berenson, Vice President of Marketing

From:

Ima Student

Re:

Sales Team: Performance Analysis

The sales portfolios of the two salespeople have the same contribution margin ratio, with Martin generating a higher total contribution margin. This is not surprising, given that Martin’s total sales are higher than Dean’s. However, the manufacturing margin ratio differs significantly between the two salespeople. Dean is selling products with a much higher manufacturing margin than Martin. This indicates that Dean’s product mix is more profitable before considering selling costs. Unfortunately, Dean’s attractive manufacturing margin is offset by very high promotional costs as a percent of sales. As a result, Dean’s final contribution margin ratio is no better than Martin’s. Both employees earn the same commission rate of 14% of sales. Thus, the promotion expenses as a percent of sales for Dean (18%) are much greater than for Martin (9%). Going forward, Martin should be encouraged to sell products with higher manufacturing margins, while Dean should be encouraged to trim promotional costs. Both salespersons should be encouraged to improve total sales volume, with a little more encouragement going to Dean. It may be the case that the high manufacturing margin product mix sold by Dean requires extensive promotional support. For example, Dean may be selling newly introduced products that have high margins but require extensive launch-related promotional expenses. In this case, there may be little opportunity for Dean to improve profitability, except by increasing total sales.

CHAPTER 21 (FIN MAN); CHAPTER 7 (MAN)

Variable Costing for Management Analysis

CERTIFIED MANAGEMENT ACCOUNTANT (CMA®) EXAMINATION QUESTIONS (ADAPTED) 1.

b. Merlene’s operating income under variable costing is $22,500, computed as follows: Sales (750 units × $200) Cost of goods sold (750 units × $90) Contribution margin Fixed manufacturing costs (750 units × $20) Selling and administrative costs Operating income

$150,000 (67,500) $ 82,500 (15,000) (45,000) $ 22,500

b. Chassen’s finished goods inventory would total $70,000 as absorption costing includes both variable ($5.00) and fixed ($2.00) manufacturing costs. ($7.00 × 10,000 units = $70,000).

a. Mill’s absorption costing income would be $2,400 lower than variable costing income, because 800 units that had been previously inventoried were sold. These 800 units multiplied by the $3.00 of fixed manufacturing overhead unit cost account for the $2,400.

a. The value of Bethany’s inventory is $5,000,000, which is equal to the variable manufacturing costs.

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN) BUDGETING DISCUSSION QUESTIONS 1.

The three major objectives of budgeting are (1) to establish specific goals for future operations, (2) to execute plans to achieve the goals, and (3) to periodically compare actual results with the goals.

If goals set by the budgets are viewed as unrealistic or unachievable, employees and managers may become discouraged and may not be committed to the achievement of the goals, resulting in the budget becoming less effective as a planning and control tool.

A budget that is set too loosely may fail to motivate managers and other employees to perform efficiently. In addition, a loose budget may cause a “spend it or lose it” mentality, where excess budget resources are spent in order to protect the budget from future reductions.

Conflicting goals can cause employees or department managers to act in their own selfinterests to the detriment of the organization’s objectives.

A static budget is most appropriate in situations where costs are not variable to an underlying activity level. As a result, it is reasonable to plan spending on the basis of a fixed quantity of resources for the year. This will occur in some administrative functions, such as human resources, accounting, or public relations.

Spreadsheet and B&P software not only speed up the budgeting process, but they also reduce the cost of budget preparation when large quantities of data need to be processed. In addition, by using simulation models, management can determine the impact of various operating alternatives on the master budget.

The production requirements must be carefully coordinated with the sales budget to ensure that production and sales are kept in balance during the period. Ideally, manufacturing operations should be maintained at 100% of capacity, with no idle time or overtime, and there should be neither excessive inventories nor inventories insufficient to fill sales orders.

Purchases of direct materials should be closely coordinated with the production budget so that inventory levels can be maintained within reasonable limits.

The cash budget contributes to effective cash planning. This involves advance planning so that a cash shortage does not arise and excess cash is not permitted to remain “idle.”

The excess cash can be invested in readily marketable income-producing securities or used to reduce loans.

10.

The plans for financing the capital expenditures budget may affect the cash budget.

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

BASIC EXERCISES BE 22–1 (FIN MAN); BE 8–1 (MAN) Variable cost: Direct labor (2,200 hours × $32* per hour)………………………………………

$70,400

Fixed cost: Equipment depreciation……………………………………………………………… 16,500 Total department costs………………………………………………………………… $86,900 * $76,800 ÷ 2,400 hours

BE 22–2 (FIN MAN); BE 8–2 (MAN) Quetzaltenango Candle Inc. Production Budget For the Month Ending March 31 Expected units to be sold Desired ending inventory, March 31 Total units available Estimated beginning inventory, March 1 Total units to be produced in March

700,000 25,000 725,000 (40,000) 685,000

BE 22–3 (FIN MAN); BE 8–3 (MAN) Quetzaltenango Candle Inc. Direct Materials Purchases Budget For the Month Ending March 31 Pounds of wax required for production: Candles [(685,000 × 8 oz.) ÷ 16 oz.] Desired ending inventory, March 31 Total units available Estimated beginning inventory, March 1 Total pounds to be purchased Unit price (per lb.) Total direct materials to be purchased in March

342,500 14,500 357,000 (15,000) 342,000 × $1.20 $410,400

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

BE 22–4 (FIN MAN); BE 8–4 (MAN) Quetzaltenango Candle Inc. Direct Labor Cost Budget For the Month Ending March 31 Hours required for assembly: Candles (685,000 × 6 min.) Convert minutes to hours Molding hours Hourly rate Total direct labor cost

4,110,000 min. 60 min. ÷ 68,500 hrs. × $15.00 $1,027,500

BE 22–5 (FIN MAN); BE 8–5 (MAN) Quetzaltenango Candle Inc. Cost of Goods Sold Budget For the Month Ending March 31 Finished goods inventory, March 1 Work in process inventory, March 1 Direct materials: Direct materials inventory, March 1 (15,000 × $1.20) Direct materials purchases Cost of direct materials available for use Direct materials inventory, March 31 (14,500 × $1.20) Cost of direct materials placed in production Direct labor Factory overhead Total manufacturing costs Total work in process during period Work in process inventory, March 31 Cost of goods manufactured Cost of finished goods available for sale Finished goods inventory, March 31 Cost of goods sold

$ 300,000 $

41,250

18,000 410,400

$ 428,400 (17,400) $ 411,000 1,027,500 400,000 1,838,500 $1,879,750 (28,500) 1,851,250 $2,151,250 (200,000) $1,951,250

BE 22–6 (FIN MAN); BE 8–6 (MAN) September Payments for August purchases (70% × $50,000)………………………………… Payments for September purchases (30% × $60,000)…………………………… Total payments for purchases on account…………………………………………

$35,000 18,000 $53,000

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

EXERCISES Ex. 22–1 (FIN MAN); Ex. 8–1 (MAN) a.

Craig Kovar Cash Budget For the Four Months Ending December 31 Estimated cash receipts from: Part-time job Deposit Total cash receipts Less estimated cash payments for: Season football tickets Additional entertainment Tuition Rent Food Deposit Total cash payments Cash increase (decrease) Plus cash balance at beginning of month Cash balance at end of month

September

October

November

December

$ 1,200

$ 1,200 600 $ 1,800

$ (250)

$ (160) (250) (4,800) (600) (550) (600) $(6,960) $(5,760)

(600) (550)

$(1,400) $ (200)

$(1,400) $ 400

9,250 $ 3,490

3,490 $ 3,290

3,290 $ 3,090

3,090 $ 3,490

The four-month budgets do not change with any identified activity level; thus, they are static budgets.

While Craig’s budget might first appear satisfactory, Craig must earn enough cash in order to pay for the spring semester tuition. His present budget shows that he will be $1,310 short of the tuition amount ($4,800 – $3,490) by the time he needs to pay his spring tuition. Thus, Craig will likely need to adjust the plan before the fall term even begins. Some possibilities would be to rent a lower-cost apartment or to get a roommate. Other considerations include increasing his part-time job hours and reducing his monthly entertainment and food allowance, or making up the income difference with additional hours during Christmas break. Craig might also see about scholarship opportunities to reduce the tuition payment. The budget gives Craig time to adjust his plans to future events. In this case, Craig can see that his present plan will not provide sufficient cash, thus giving him four months to adjust. If Craig did not budget but went ahead with the original plan, he would be $1,310 ($4,800 – $3,490) short at the end of December, with no time left to adjust.

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Ex. 22–2 (FIN MAN); Ex. 8–2 (MAN) Digital Solutions Inc. Flexible Selling and Administrative Expenses Budget For the Month Ending October 31 Total sales Variable cost: Sales commissions (8% of sales) Advertising expense (15% of sales) Miscellaneous administrative expense (4% of sales) Customer support expense (30% of sales) Total variable cost Fixed cost: Miscellaneous administrative expense Office salaries expense Customer support expense Research and development expense Total fixed cost Total selling and administrative expenses

$500,000

$750,000

$1,000,000

$ 40,000 75,000

$ 60,000 112,500

20,000 150,000 $285,000

30,000 225,000 $427,500

40,000 300,000 $ 570,000

$ 10,000 50,000 20,000 75,000 $155,000 $440,000

$ 10,000 50,000 20,000 75,000 $155,000 $582,500

80,000 150,000

10,000 50,000 20,000 75,000 $ 155,000 $ 725,000

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Ex. 22–3 (FIN MAN); Ex. 8–3 (MAN) Hagerstown Company Machining Department Budget For the Three Months Ending July 31

May

Units of production

June

July

40,000

48,000

52,000

Wages Utilities Depreciation Total

$1,500,000 48,000 36,000 $1,584,000

$1,800,000 57,600 36,000 $1,893,600

$1,950,000 62,400 36,000 $2,048,400

Supporting calculations: Units of production Hours per unit Total hours of production Wages per hour Total wages

40,000 1.50 × 60,000 × $25.00 $1,500,000

48,000 1.50 × 72,000 × $25.00 $1,800,000

52,000 1.50 × 78,000 × $25.00 $1,950,000

60,000 $0.80 48,000

72,000 $0.80 57,600

78,000 $0.80 62,400

Total hours of production Utility costs per hour Total utilities

× $

Depreciation is a fixed cost, so it does not “flex” with changes in production. Because it is the only fixed cost, the variable and fixed costs are not classified in the budget. b.

May

Total flexible budget……………………… $ 1,584,000 (1,600,000) Actual cost………………………………… Excess of actual cost over budget…… $ (16,000)

June

July

$ 1,893,600 (1,950,000) $ (56,400)

$ 2,048,400 (2,200,000) $ (151,600)

The excess of actual cost over the flexible budget suggests that the Machining Department has not performed as well as originally thought. The department is spending more than would be expected. In addition, the actual costs over the budget increased from $16,000 in May to $56,400 in June to $151,600 in July. The flexible budget is a superior budgeting approach in this situation because wages and utility costs vary with production. Thus, the budget for these costs should adjust (flex) to the actual level of production. Actual costs can rightfully be compared to the flexible budget because both numbers are based on actual volumes.

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Ex. 22–4 (FIN MAN); Ex. 8–4 (MAN) Steelcase Inc. Assembly Department Budget For the Month Ending February 28 (assumed data) Units of production

70,000

80,000

90,000

Variable cost: Direct labor Total variable cost

$588,000 1 $588,000

$672,000 2 $672,000

$ 756,000 3 $ 756,000

Fixed cost: Supervisor salaries Depreciation Total fixed cost Total department costs

$250,000 18,500 $268,500 $856,500

$250,000 18,500 $268,500 $940,500

$ 250,000 18,500 $ 268,500 $1,024,500

1 2 3

70,000 × 18/60 min. × $28 80,000 × 18/60 min. × $28 90,000 × 18/60 min. × $28

Ex. 22–5 (FIN MAN); Ex. 8–5 (MAN) Healthy Habits Inc. Production Budget For the Month Ending January 31 Units

Expected units to be sold Desired inventory, January 31 Total units available Estimated inventory, January 1 Total units to be produced

Bath Scale

Gym Scale

135,000 15,000 150,000 (11,800) 138,200

80,000 7,500 87,500 (8,100) 79,400

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Ex. 22–6 (FIN MAN); Ex. 8–6 (MAN) a.

Bowser Inc. Sales Budget For the Month Ending June 30 Product and Area

Unit Sales Volume

Unit Selling Price

11,000 14,000 25,000

$70 70

$ 770,000 980,000 $1,750,000

3,500 5,500 9,000

$90 90

$ 315,000 495,000 $ 810,000 $2,560,000

Model: Rumble North Region South Region Total Model: Thunder North Region South Region Total Total revenue from sales b.

Total Sales

Bowser Inc. Production Budget For the Month Ending June 30 Units Rumble

Expected units to be sold Desired inventory, June 30 Total units available Estimated inventory, June 1 Total units to be produced

Thunder

25,000 500 25,500 (800) 24,700

9,000 400 9,400 (300) 9,100

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Ex. 22–7 (FIN MAN); Ex. 8–7 (MAN) Lundquist & Fretwell, CPAs Professional Fees Earned Budget For the Year Ending May 31, 20Y8

Audit Department: Staff Partners Total Tax Department: Staff Partners Total Small Business Accounting Department: Staff Partners Total Total professional fees earned

Billable Hours

Hourly Rate

Total Revenue

25,000 6,000 31,000

$140 450

$ 3,500,000 2,700,000 $ 6,200,000

40,000 8,500 48,500

$140 450

$ 5,600,000 3,825,000 $ 9,425,000

5,000 500 5,500

$140 450

700,000 225,000 $ 925,000 $16,550,000

Staff

Partners

25,000 40,000 5,000 70,000 × $40 $2,800,000

6,000 8,500 500 15,000 × $175 $2,625,000

Ex. 22–8 (FIN MAN); Ex. 8–8 (MAN) Lundquist & Fretwell, CPAs Professional Labor Cost Budget For the Year Ending May 31, 20Y8 Audit Department hours Tax Department hours Small Business Accounting Department hours Total hours Average compensation per hour Total professional labor cost

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Ex. 22–9 (FIN MAN); Ex. 8–9 (MAN) Tobin’s Frozen Pizza Inc. Direct Materials Purchases Budget For the Month Ending November 30 Units required for production: 12" pizza 16" pizza Desired inventory, November 30 Total units available Estimated inventory, November 1 Total units to be purchased Unit price Total direct materials to be purchased 1 2 3 4 5 6

Dough

Tomato

Cheese

38,5001 40,0004

17,500 2 20,000 5

49,000 3 60,000 6

2,000 80,500

1,200 38,700

2,800 111,800

(2,500) 78,000 × $0.50

(1,000) 37,700 × $0.60

(3,000) 108,800 × $0.85

$39,000

$22,620

$92,480

Total

$154,100

70,000 × 0.55 lb. 70,000 × 0.25 lb. 70,000 × 0.70 lb. 50,000 × 0.80 lb. 50,000 × 0.40 lb. 50,000 × 1.20 lbs.

Ex. 22–10 (FIN MAN); Ex. 8–10 (MAN) Coca-Cola Enterprises—Wakefield Plant Direct Materials Purchases Budget For the Month Ending May 31 (assumed data) Concentrate

2-Liter Bottles

Carbonated Water

Materials required for production: Coke

459 * lbs.

153,000 btls. 306,000 ltrs.

173 *

86,500

632 lbs. $75

239,500 btls. 479,000 ltrs. × $0.08 × $0.06

Sprite

Total materials Direct materials unit price

Total direct materials to be purchased

$47,400

$19,160

* Production in liters (bottles × 2 liters/bottle)……………………………… Divide by 100……………………………………………………………………… Multiply by concentrate pounds per 100 liters……………………………… Concentrate pounds required for production………………………………

173,000

$28,740 Coke

Sprite®

306,000 ÷ 100 3,060 × 0.15

173,000 ÷ 100

459

1,730 0.10 173

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Ex. 22–11 (FIN MAN); Ex. 8–11 (MAN) Safety Grip Company Direct Materials Purchases Budget For the Year Ending December 31, 20Y9 Rubber

Pounds required for production: Passenger tires Truck tires Desired inventory, December 31, 20Y9 Total Estimated inventory, January 1, 20Y9 Total units purchased Unit price Total direct materials to be purchased 1 2 3 4

Steel Belts

Total

1,470,000 lbs.1 1,482,000 3

210,000 lbs.2 152,000 4

40,000 2,992,000 lbs.

10,000 372,000 lbs.

(46,000) 2,946,000 lbs. $1.20 ×

(8,000) 364,000 lbs. × $0.80

$3,535,200

$291,200

$3,826,400

Rubber: 42,000 units × 35 lbs. per unit = 1,470,000 lbs. Steel belts: 42,000 units × 5 lbs. per unit = 210,000 lbs. Rubber: 19,000 units × 78 lbs. per unit = 1,482,000 lbs. Steel belts: 19,000 units × 8 lbs. per unit = 152,000 lbs.

Ex. 22–12 (FIN MAN); Ex. 8–12 (MAN) Provo Racket Company Direct Labor Cost Budget For the Month Ending July 31

Hours required for production: Youth Adult Total Hourly rate Total direct labor cost 1 2 3 4

Forming Department

Assembly Department

160 1 1,280 3 1,440 ×$18.00 $25,920

240 2 1,920 4 2,160 $15.00 × $32,400

Youth: 0.10 hr. × 1,600 = 160 hrs. Youth: 0.15 hr. × 1,600 = 240 hrs. Adult: 0.20 hr. × 6,400 = 1,280 hrs. Adult: 0.30 hr. × 6,400 = 1,920 hrs.

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Ex. 22–13 (FIN MAN); Ex. 8–13 (MAN) a. Levi Strauss & Co. Production Budget For the Month Ending May 31 (assumed data) Dockers®

501 Jeans®

23,600 420 24,020 (670) 23,350

53,100 1,860 54,960 (1,660) 53,300

Expected units to be sold May 31 desired inventory Total units available May 1 estimated inventory Total units to be produced b.

Levi Strauss & Co. Direct Labor Cost Budget For the Month Ending May 31 (assumed data)

Dockers

Inseam

Outerseam

Pockets

Zipper

42,030 1

46,700 2

14,010 3

28,020 4

31,980

501 Jeans®

47,970

Total minutes

90,000

121,320

61,980

60,000

1,500

2,022

1,033

1,000

74,620

47,970

Total 8

Total direct labor hours (÷ 60 minutes) × Direct labor rate

$13

× $13

× $15

Total direct labor cost

$19,500

$26,286

$15,495

$15,000

1 2 3 4 5 6 7 8

$15 $76,281

(23,350 ÷ 10 pairs) × 18 min. = 42,030 min. (23,350 ÷ 10 pairs) × 20 min. = 46,700 min. (23,350 ÷ 10 pairs) × 6 min. = 14,010 min. (23,350 ÷ 10 pairs) × 12 min. = 28,020 min. (53,300 ÷ 10 pairs) × 9 min. = 47,970 min. (53,300 ÷ 10 pairs) × 14 min. = 74,620 min. (53,300 ÷ 10 pairs) × 9 min. = 47,970 min. (53,300 ÷ 10 pairs) × 6 min. = 31,980 min.

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Ex. 22–14 (FIN MAN); Ex. 8–14 (MAN) Anderson Candy Company Factory Overhead Cost Budget For the Month Ending October 31 Variable factory overhead costs: Manufacturing supplies Power and light Production supervisor wages Production control wages Materials management wages Total variable factory overhead costs Fixed factory overhead costs: Factory insurance Factory depreciation Total fixed factory overhead costs Total factory overhead costs

$ 14,000 50,000 140,000 32,000 39,000 $275,000 $ 35,000 25,000 60,000 $335,000

Note: Advertising expenses, sales commissions, and executive officer salaries are selling and administrative expenses. Ex. 22–15 (FIN MAN); Ex. 8–15 (MAN) Delaware Chemical Company Cost of Goods Sold Budget For the Month Ending June 30 Finished goods inventory, June 11

Work in process inventory, June 1 Direct materials: Direct materials inventory, June 1

Direct materials purchases Cost of direct materials available for use Direct materials inventory, June 30 Cost of direct materials placed in production Direct labor Factory overhead Total manufacturing costs

2 3

$ 15,200 3,150,000 $3,165,200 (16,100)

3,789,100 $3,802,000 (13,500) 3,788,500

Cost of finished goods available for sale

12,900

$3,149,100 240,000 400,000

Total work in process during the period Work in process inventory, June 30 Cost of goods manufactured Finished goods inventory, June 30 Cost of goods sold

16,900

$3,805,400 (17,300) $3,788,100

$8,300 + $8,600 35,000 barrels × $90 per barrel $9,400 + $7,900

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Ex. 22–16 (FIN MAN); Ex. 8–16 (MAN) MingWare Ceramics Inc. Cost of Goods Sold Budget For the Month Ending September 30 Finished goods inventory, September 1 Work in process inventory, September 1 Direct materials: Direct materials inventory, September 1 Direct materials purchases

$ 11,500 $ $

3,400

6,440 188,410

Cost of direct materials available for use Direct materials inventory, September 30

$194,850 (8,830)

Cost of direct materials placed in production Direct labor Factory overhead Total manufacturing costs

$186,020 193,600 105,500 485,120

Total work in process during the period Work in process inventory, September 30 Cost of goods manufactured

$488,520 (1,990) 486,530

Cost of finished goods available for sale Finished goods inventory, September 30 Cost of goods sold

$498,030 (9,670) $488,360

Ex. 22–17 (FIN MAN); Ex. 8–17 (MAN) Pampered Pal Inc. Schedule of Collections from Sales For the Three Months Ending March 31 January

January sales on account: Collected in January ($400,000 × 75%) Collected in February ($400,000 × 15%) Collected in March ($400,000 × 10%)

March

$300,000 $ 60,000 $ 40,000

February sales on account: Collected in February ($600,000 × 75%) Collected in March ($600,000 × 15%) March sales on account: Collected in March ($850,000 × 75%) Total cash collected

February

450,000 90,000

$300,000

$510,000

637,500 $767,500

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Ex. 22–18 (FIN MAN); Ex. 8–18 (MAN) OfficeMart Inc. Schedule of Cash Collections from Sales For the Three Months Ending December 31 Receipts from cash sales: Cash sales (25% × current month’s sales) September sales on account: Collected in October (Accounts Receivable balance) 1 October sales on account: Collected in October ($43,500 × 30%) Collected in November ($43,500 × 70%)

October

November

December

$14,500

$16,250

$18,000

35,000 13,050 30,450

November sales on account: Collected in November ($48,750 × 30%) Collected in December ($48,750 × 70%)

14,625 34,125

December sales on account: Collected in December ($54,000 × 30%) Total cash collected 1 2 3

$62,550

$61,325

16,200 $68,325

$58,000 × 75% = $43,500 $65,000 × 75% = $48,750 $72,000 × 75% = $54,000

Ex. 22–19 (FIN MAN); Ex. 8–19 (MAN) Horizon Financial Inc. Schedule of Cash Payments for Selling and Administrative Expenses For the Three Months Ending May 31 March

April

May

March expenses: Paid in March ($43,400 × 60%) Paid in April ($43,400 × 40%)

$26,040 $17,360

April expenses: Paid in April ($55,200 × 60%) Paid in May ($55,200 × 40%)

33,120 $22,080

May expenses: Paid in May ($59,900 × 60%) Total cash payments 1 2 3

$26,040

$50,480

35,940 $58,020

$53,400 – $10,000 = $43,400 $65,200 – $10,000 = $55,200 $69,900 – $10,000 = $59,900

Note: Insurance, property taxes, and depreciation are expenses that do not result in cash payments in March, April, or May. 22-15 © 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Ex. 22–20 (FIN MAN); Ex. 8–20 (MAN) EastGate Physical Therapy Inc. Schedule of Cash Payments for Operations For the Three Months Ending March 31 Payments of prior month’s expense

Payments of current month’s expense Total cash payments 1

January

February

March

$15,000

$ 26,430

$ 32,610

61,670

76,090

81,130

$76,670

$102,520

$113,740

$15,000, given as Accrued Expenses Payable, January 1 $26,430 = ($91,600 – $3,000 – $500) × 30% $32,610 = ($112,200 – $3,000 – $500) × 30%

$61,670 = ($91,600 – $3,000 – $500) × 70% $76,090 = ($112,200 – $3,000 – $500) × 70% $81,130 = ($119,400 – $3,000 – $500) × 70%

Note: Insurance and depreciation are expenses that do not result in cash payments in January, February, or March.

Ex. 22–21 (FIN MAN); Ex. 8–21 (MAN) Omicron Inc. Capital Expenditures Budget For the Four Years Ending December 31, 20Y6–20Y9 Building Equipment Information systems Total 1 2

20Y6

20Y7

$4,000,000

$6,000,000 1,500,000

$4,000,000

$7,500,000

20Y8 $200,000 450,000 2 $650,000

20Y9 $3,500,000 1 1,000,000 $4,500,000

$10,000,000 × 35% = $3,500,000 $800,000 × 75% × 75% = $450,000

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

PROBLEMS Prob. 22–1A (FIN MAN); Prob. 8–1A (MAN) 1. Unit Sales, Year Ended 20Y8 Budget Actual Sales

Increase (Decrease) Actual Over Budget Amount Percent

8" × 10" Frame: East Central West

8,500 6,200 12,600

8,755 6,510 12,348

255 310 (252)

3% 5% (2)%

12" × 16" Frame: East Central West

3,800 3,000 5,400

3,686 3,090 5,616

(114) 90 216

(3)% 3% 4%

Percentage Increase (Decrease)

20Y9 Budgeted Units (rounded)

2. 20Y8 Actual Units

8" × 10" Frame: East Central West

8,755 6,510 12,348

3% 5% (2)%

9,018 6,836 12,101

12" × 16" Frame: East Central West

3,686 3,090 5,616

(3)% 3% 4%

3,575 3,183 5,841

Unit Selling Price

Total Sales

Raphael Frame Company Sales Budget For the Year Ending December 31, 20Y9

Product and Area

Unit Sales Volume

8" × 10" Frame: East Central West Total 12" × 16" Frame: East Central West Total Total revenue from sales

9,018 6,836 12,101 27,955

$17 17 17

$153,306 116,212 205,717 $475,235

3,575 3,183 5,841 12,599

$32 32 32

$114,400 101,856 186,912 $403,168 $878,403

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–2A (FIN MAN); Prob. 8–2A (MAN) 1.

Gourmet Grill Company Sales Budget For the Month Ending July 31 Product and Area

Unit Sales Volume

Backyard Chef: Maine Vermont New Hampshire Total Master Chef: Maine Vermont New Hampshire Total Total revenue from sales 2.

Unit Selling Price

Total Sales

310 240 360 910

$ 700 750 750

$ 217,000 180,000 270,000 $ 667,000

150 110 180 440

$1,200 1,300 1,400

$ 180,000 143,000 252,000 $ 575,000 $1,242,000

Gourmet Grill Company Production Budget For the Month Ending July 31 Units Backyard Chef

Expected units to be sold Desired inventory, July 31 Total units available Estimated inventory, July 1 Total units to be produced

Master Chef

910 40 950 (30) 920

440 22 462 (32) 430

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–2A (FIN MAN); Prob. 8–2A (MAN) (Continued) 3. Gourmet Grill Company Direct Materials Purchases Budget For the Month Ending July 31 Stainless Burner SubGrates Steel assemblies (units) (lbs.) (units) Required units for production: Backyard Chef Master Chef Desired inventory, July 31

Shelves (units)

2,760 1 2,580 5

22,0802 18,0606

1,8403 1,7207

3,680 4 2,150 8

340

1,800

155

315

5,680

41,940

3,715

6,145

(290)

(1,500)

(170)

(340)

Total units to be purchased Unit price

5,390 × $15.00

40,440 × $6.00

3,545 ×$110.00

5,805 ×$10.00

Total direct materials to be purchased

$80,850

$242,640

$389,950

$58,050

Total Estimated inventory, July 1

1 2 3 4 5 6 7 8

Total

$771,490

920 × 3 grates = 2,760 grates 920 × 24 lbs. = 22,080 lbs. 920 × 2 subassemblies = 1,840 subassemblies 920 × 4 shelves = 3,680 shelves 430 × 6 grates = 2,580 grates 430 × 42 lbs. = 18,060 lbs. 430 × 4 subassemblies = 1,720 subassemblies 430 × 5 shelves = 2,150 shelves

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–2A (FIN MAN); Prob. 8–2A (MAN) (Concluded) 4. Gourmet Grill Company Direct Labor Cost Budget For the Month Ending July 31 Stamping Department

Forming Department

Assembly Department

460

552

920

258

344

645

718 × $17 $12,206

896 × $15 $13,440

1,565 × $14 $21,910

Total

Hours required for production: Backyard Chef 1 Master Chef

Total Hourly rate Total direct labor cost 1

This line is calculated as 920 Backyard Chef units from the production budget multiplied by the hours per unit in each department estimated for the Backyard Chef. 460 = 920 × 0.5; 552 = 920 × 0.6; 920 = 920 × 1.0 This line is calculated as 430 Master Chef units from the production budget multiplied by the hours per unit in each department estimated for the Master Chef. 258 = 430 × 0.6; 344 = 430 × 0.8; 645 = 430 × 1.5

$47,556

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–3A (FIN MAN); Prob. 8–3A (MAN) 1.

Birding Homes & Feeders Inc. Sales Budget For the Month Ending January 31

Bird house Bird feeder Total revenue from sales 2.

Unit Sales Volume

Unit Selling Price

15,000 40,000

$25.00 15.00

Total Sales

$375,000 600,000 $975,000

Birding Homes & Feeders Inc. Production Budget For the Month Ending January 31 Units

Expected units to be sold Desired inventory, January 31 Total units available Estimated inventory, January 1 Total units to be produced

Bird House

Bird Feeder

15,000 1,500 16,500 (1,000) 15,500

40,000 3,000 43,000 (2,500) 40,500

Plastic

Total

Birding Homes & Feeders Inc. Direct Materials Purchases Budget For the Month Ending January 31

Wood

Required units for production: Bird house Bird feeder Desired units of inventory, January 31 Total units available Estimated units of inventory, January 1 Total units to be purchased Unit price Total direct materials to be purchased 1 2 3 4

12,4001 8,1003 500 21,000

1,550 2 40,500 4 1,250 43,300

(600) 20,400 × $2.50 $51,000

(1,000) 42,300 × $0.80 $33,840

15,500 × 0.80 ft. = 12,400 ft. 15,500 × 0.10 lb. = 1,550 lbs. 40,500 × 0.20 ft. = 8,100 ft. 40,500 × 1.00 lb. = 40,500 lbs.

$84,840

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–3A (FIN MAN); Prob. 8–3A (MAN) (Continued) 4.

Birding Homes & Feeders Inc. Direct Labor Cost Budget For the Month Ending January 31 Fabrication Department

Assembly Department

Total

Hours required for production: Bird house

6,2001

3,1002

Bird feeder

10,1253

4,0504

Total Hourly rate Total direct labor cost 1 2 3 4

16,325 $18 $293,850

7,150 $12 $85,800

$379,650

15,500 × 0.40 hr. = 6,200 hrs. 15,500 × 0.20 hr. = 3,100 hrs. 40,500 × 0.25 hr. = 10,125 hrs. 40,500 × 0.10 hr. = 4,050 hrs.

Birding Homes & Feeders Inc. Factory Overhead Cost Budget For the Month Ending January 31 Indirect factory wages Depreciation of plant and equipment Power and light Insurance and property tax Total factory overhead cost

$40,000 20,000 10,000 5,000 $75,000

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–3A (FIN MAN); Prob. 8–3A (MAN) (Continued) 6. Birding Homes & Feeders Inc. Cost of Goods Sold Budget For the Month Ending January 31 Finished goods inventory, January 11

$ 35,000

Work in process inventory, January 1 Direct materials:

Direct materials inventory, January 12 Direct materials purchases (from part 3)

Cost of direct materials available for use

$ 87,140 (2,250)

Direct materials inventory, January 31 Cost of direct materials placed in production Direct labor (from part 4) Factory overhead (from part 5) Total manufacturing costs

9,000

2,300 84,840

$ 84,890 379,650 75,000 539,540

Total work in process during period Work in process, January 31 Cost of goods manufactured

$548,540 (10,500) 538,040

Cost of finished goods available for sale Finished goods inventory, January 31 Cost of goods sold 1

$573,040 (46,500) $526,540

Bird house (1,000 × $15)………………………………………………………… Bird feeder (2,500 × $8)…………………………………………………………… Finished goods inventory, December 1………………………………………

$15,000 20,000 $35,000

Wood (600 × $2.50)………………………………………………………………… Plastic (1,000 × $0.80)…………………………………………………………… Direct materials inventory, December 1………………………………………

$ 1,500 800 $ 2,300

Wood (500 × $2.50)………………………………………………………………… Plastic (1,250 × $0.80)…………………………………………………………… Direct materials inventory, December 31………………………………………

$ 1,250 1,000 $ 2,250

Bird house (1,500 × $15)………………………………………………………… Bird feeder (3,000 × $8)…………………………………………………………… Finished goods inventory, December 31………………………………………

$22,500 24,000 $46,500

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–3A (FIN MAN); Prob. 8–3A (MAN) (Concluded) 7.

Birding Homes & Feeders Inc. Selling and Administrative Expenses Budget For the Month Ending January 31 Selling expenses: Sales salaries expense Advertising expense Travel expense—selling

$125,000 80,000 25,000

Total selling expenses

$230,000

Administrative expenses: Office salaries expense Depreciation expense—office equipment Office supplies expense Miscellaneous administrative expense Total administrative expenses Total operating expenses

$ 40,000 4,000 2,500 3,500 50,000 $280,000

Birding Homes & Feeders Inc. Budgeted Income Statement For the Month Ending January 31 Revenue from sales (from part 1) Cost of goods sold (from part 6)

$ 975,000 (526,540)

Gross profit Operating expenses: Selling expenses (from part 7) Administrative expenses (from part 7) Total operating expenses

$ 448,460

Operating income Other revenue and expense: Interest revenue Interest expense

$230,000 50,000 (280,000) $ 168,460 $

Income before income tax Income tax expense (25% rate) Net income

4,540 (3,000)

1,540 $ 170,000 (42,500) $ 127,500

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–4A (FIN MAN); Prob. 8–4A (MAN) 1.

Bridgeport Housewares Inc. Cash Budget For the Three Months Ending November 30 September

October

November

$ 25,000

$ 30,000

$ 31,500

228,000

229,500

256,500

$ 253,000

$ 259,500

$ 288,000

$(120,000)

$(124,000)

$(134,000)

(42,000)

(48,000)

(51,000)

Estimated cash receipts from: Cash sales Collection of accounts receivablea Total cash receipts Less estimated cash payments for: Manufacturing costsb Selling and administrative expenses Capital expenditures

(200,000)

Other purposes: Income tax

(55,000)

Dividends

(25,000)

Total cash payments

$(162,000)

$(227,000)

$(410,000)

$ 91,000

$ 32,500

$(122,000)

40,000

131,000

163,500

Cash balance at end of month

$ 131,000

$ 163,500

$ 41,500

Less minimum cash balance

(50,000)

$ 81,000

$ 113,500

Cash increase (decrease) Plus cash balance at beginning of month

Excess (deficiency)

(8,500)

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–4A (FIN MAN); Prob. 8–4A (MAN) (Concluded) Computations: a

Collections of accounts receivable:

September

July sales…………………………………………

$ 60,0001

August sales………………………………………

168,000 2

September sales…………………………………

October $ 72,000 3 157,500

October sales…………………………………… Total…………………………………………… 1 2 3 4 5 6 b

November

$ 67,5005 6 189,000

$228,000

$229,500

$256,500

September

October

November

$ 40,000 80,000

$ 20,000 104,000

$ 26,000 108,000

$120,000

$124,000

$134,000

$200,000 × 30% = $60,000 $240,000 × 70% = $168,000 $240,000 × 30% = $72,000 $250,000 × 90% × 70% = $157,500 $250,000 × 90% × 30% = $67,500 $300,000 × 90% × 70% = $189,000

Payments for manufacturing costs: Payment of accounts payable, beginning c

of month balance …………………………… d

Payment of current month’s cost …………… Total…………………………………………… c

Accounts payable, September 1 balance = $40,000 ($150,000 – $50,000) × 20% = $20,000 ($180,000 – $50,000) × 20% = $26,000

($150,000 – $50,000) × 80% = $80,000 ($180,000 – $50,000) × 80% = $104,000 ($185,000 – $50,000) × 80% = $108,000

The budget indicates that the minimum cash balance will not be maintained in November. This is due to the capital expenditures requiring significant cash outflows during this month. This situation can be corrected by borrowing and/or by the sale of the marketable securities, if they are held for such purposes. At the end of September and October, the cash balance will exceed the minimum desired balance, and the excess could be considered for temporary investment.

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–5A (FIN MAN); Prob. 8–5A (MAN) 1. Regina Soap Co. Budgeted Income Statement For the Year Ending December 31, 20Y9 1

Sales Cost of goods sold: 2 Direct materials 3 Direct labor Factory overhead4 Cost of goods sold Gross profit Operating expenses: Selling expenses: 5 Sales salaries and commissions Advertising 6 Miscellaneous selling expenses Total selling expenses Administrative expenses: 7 Office and officers salaries 8 Supplies 9 Miscellaneous administrative expense Total administrative expenses Total operating expenses Income before income tax Income tax expense Net income 1 2 3 4 5 6 7 8 9

$1,000,000 $220,000 130,000 132,000 (482,000) $ 518,000

$136,000 64,000 56,000 $256,000 $ 96,400 25,000 14,000 135,400 (391,400) $ 126,600 (30,000) $ 96,600

200,000 units × $5.00 200,000 units × $1.10 200,000 units × $0.65 (200,000 units × $0.40) + $40,000 + $12,000 (200,000 units × $0.45) + $46,000 (200,000 units × $0.25) + $6,000 (200,000 units × $0.12) + $72,400 (200,000 units × $0.10) + $5,000 (200,000 units × $0.05) + $4,000

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–5A (FIN MAN); Prob. 8–5A (MAN) (Concluded) 2. Regina Soap Co. Budgeted Balance Sheet December 31, 20Y9 ASSETS Current assets: Cash 1 Accounts receivable Inventories: Finished goods Work in process Materials Prepaid expenses Total current assets Property, plant, and equipment:

$ 135,800 125,600 $69,300 32,500 48,900

150,700 2,600 $414,700

Plant and equipment 2 Accumulated depreciation 3 Total property, plant, and equipment Total assets

$ 400,000 (196,200) 203,800 $618,500

LIABILITIES Current liabilities: Accounts payable

$ 62,000 STOCKHOLDERS’ EQUITY

Common stock

$ 180,000 376,500

Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity 1

556,500 $618,500

Cash balance, December 31, 20Y9: Balance, January 1, 20Y9……………………………………………………… Add cash from operations: Net income……………………………………………………………… Depreciation of plant and equipment……………………………… Less: Dividends to be paid in 20Y9 (18,000 × $0.15 × 4 qtrs.)………… Plant and equipment to be acquired in 20Y9………………………

$ 85,000 $96,600 40,000 $10,800 75,000

Cash balance, December 31, 20Y9…………………………………………… 2 3

136,600 (85,800) $135,800

$325,000 + $75,000 = $400,000 $156,200 + $40,000 = $196,200

4 Retained earnings balance, December 31, 20Y9:

Balance, January 1, 20Y9…………………………………………………… Plus: Net income for 20Y9…………………………………………………… Less: Dividends to be paid in 20Y9 (18,000 × $0.15 × 4 qtrs.)………… Balance, December 31, 20Y9…………………………………………………

$290,700 96,600 (10,800) $376,500

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Appendix Prob. 22–6A (FIN MAN); Appendix Prob. 8–6A (MAN) 1.

Bellaire Inc. Sales Budget For the First Quarter Ending March 31 January

February

25,000 $125

Estimated units sold Selling price per unit

Total budgeted sales

$3,125,000

March

30,000 $125

45,000 $125

$3,750,000

First Quarter 100,000 $125

$5,625,000

$12,500,000

March

First Quarter

Bellaire Inc. Production Budget For the First Quarter Ending March 31 February

January Estimated units sold Desired ending inventory

25,000 3,0001

30,000 4,500 2

45,000 5,000 3

100,000 5,000 4

Total units available for sale

28,000

34,500

50,000

105,000

Less estimated beginning inventory

(2,000)

(3,000)

(4,500)

Total units to be produced

26,000

31,500

45,500

(2,000) 5 103,000

30,000 units × 10% = 3,000 units

45,000 units × 10% = 4,500 units

50,000 units × 10% = 5,000 units

Ending finished goods inventory as of March 31, the end of the first quarter.

Beginning finished goods inventory as of January 1, the beginning of the first quarter.

Bellaire Inc. Direct Materials Purchases Budget For the First Quarter Ending March 31 January

February

March

First Quarter

26,000 0.8 lb. ×

31,500 0.8 lb. ×

45,500 0.8 lb. ×

103,000 0.8 lb. ×

20,800 lbs. 1,500 lbs.

25,200 lbs. 2,000 lbs.

36,400 lbs. 2,500 lbs.

82,400 lbs. 2,500 lbs.1

22,300 lbs.

27,200 lbs.

38,900 lbs.

84,900 lbs.

(1,000) lbs.

(1,500) lbs.

(2,000) lbs.

(1,000) lbs. 2

purchased Cost per pound

21,300 lbs. $15 ×

25,700 lbs. $15 ×

36,900 lbs. $15 ×

83,900 lbs. $15

Cost of materials to be purchased

$319,500

$385,500

$553,500

$1,258,500

Units to be produced Materials required per unit Materials required for production Desired ending inventory Total materials available for use Less estimated beginning inventory Total materials to be

Ending materials inventory as of March 31, the end of the first quarter.

Beginning materials inventory as of January 1, the beginning of the first quarter.

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Appendix Prob. 22–6A (FIN MAN); Appendix Prob. 8–6A (MAN) (Continued) 4.

Bellaire Inc. Direct Labor Cost Budget For the First Quarter Ending March 31 Units to be produced Direct labor hours required per unit

January

February

March

First Quarter

26,000

31,500

45,500

103,000

2.5 hrs.

for production Direct labor hourly rate

65,000 hrs. $24

78,750 hrs. $24

113,750 hrs. $24

257,500 hrs. $24

Direct labor cost

$1,560,000

Direct labor hours required

$1,890,000

$2,730,000

$6,180,000

Bellaire Inc. Factory Overhead Cost Budget For the First Quarter Ending March 31 January

February

March

First Quarter

Variable factory overhead: Budgeted direct labor hours Variable factory overhead rate

65,000 hrs.

$1.20

78,750 hrs.

113,750 hrs.

$1.20

257,500 hrs.

$1.20

× $1.20

$136,500

$309,000

Budgeted variable factory overhead

$ 78,000

$ 94,500

Fixed factory overhead: Budgeted fixed factory overhead

200,000

600,000

Total factory overhead cost

$278,000

$294,500

$336,500

$909,000

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Appendix Prob. 22–6A (FIN MAN); Appendix Prob. 8–6A (MAN) (Continued) 6.

Bellaire Inc. Cost of Goods Sold Budget For the First Quarter Ending March 31 January Beginning finished goods inventory

160,000 1

February $

March

240,000 2

First Quarter

360,000 3

$ 160,000

$ 546,000

$1,236,000

2,730,000 336,500

6,180,000 909,000

Cost of goods manufactured: $ 378,000

278,000

1,890,000 294,500

Total cost of goods manufactured

$2,150,000

$2,562,500

$3,612,500

$8,325,000

Cost of goods available for sale Ending finished goods inventory

$2,310,000 (240,000)10

$2,802,500 (360,000)11

$3,972,500 (400,000) 12

$8,485,000 (400,000)

Cost of goods sold

$2,070,000

$2,442,500

$3,572,500

$8,085,000

1 2 3 4 5 6 7 8 9 10 11 12

Direct materials

$ 312,000 4

Direct labor Factory overhead (from part 5)

1,560,000 7

2,000 units (from part 2) × $80 3,000 units (from part 2) × $80 4,500 units (from part 2) × $80 20,800 lbs. (from part 3) × $15 25,200 lbs. (from part 3) × $15 36,400 lbs. (from part 3) × $15 65,000 hrs. (from part 4) × $24 78,750 hrs. (from part 4) × $24 113,750 hrs. (from part 4) × $24 3,000 units (from part 2) × $80 4,500 units (from part 2) × $80 5,000 units (from part 2) × $80

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Appendix Prob. 22–6A (FIN MAN); Appendix Prob. 8–6A (MAN) (Concluded) 7.

Bellaire Inc. Selling and Administrative Expenses Budget For the First Quarter Ending March 31 January

February

March

First Quarter

Selling expenses: Budgeted sales units

25,000

30,000

45,000

100,000

Variable selling expenses per unit sold

Total variable selling expenses Fixed selling expenses

$100,000 150,000

$120,000 150,000

$180,000 150,000

$ 400,000 450,000

Total selling expenses

$250,000

$270,000

$330,000

$ 850,000

400,000

1,200,000

$650,000

$670,000

$730,000

$2,050,000

Administrative expenses: Budgeted fixed administrative expenses Total selling and administrative expenses

Bellaire Inc. Budgeted Income Statement For the First Quarter Ending March 31 January

February

March

First Quarter

Sales (from part 1) Cost of goods sold (from part 6)

$ 3,125,000 (2,070,000)

$ 3,750,000 (2,442,500)

$ 5,625,000 (3,572,500)

$12,500,000 (8,085,000)

Gross profit

$ 1,055,000

$ 1,307,500

$ 2,052,500

$ 4,415,000

$ (250,000)

$ (270,000)

$ (330,000)

(400,000)

(1,200,000)

$ (650,000)

$ (670,000)

$ (730,000)

$ (2,050,000)

$ 1,322,500

$ 2,365,000

Selling and administrative expenses: Selling expenses (from part 7) Administrative expenses (from part 7) Total selling and administrative expenses Operating income

405,000

637,500

(850,000)

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–1B (FIN MAN); Prob. 8–1B (MAN) 1. Unit Sales, Year Ended 20Y8 Budget Actual Sales

Home Alert System: United States Europe Asia Business Alert System: United States Europe Asia

Increase (Decrease) Actual Over Budget Amount Percent

1,700 580 450

1,734 609 432

34 29 (18)

2% 5% (4)%

980 350 240

1,078 329 252

98 (21) 12

10% (6)% 5%

Percentage Increase (Decrease)

20Y9 Budgeted Units (rounded)

2. 20Y8 Actual Units

Home Alert System: United States Europe Asia

1,734 609 432

2% 5% (4)%

1,769 639 415

Business Alert System: United States Europe Asia

1,078 329 252

10% (6)% 5%

1,186 309 265

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–1B (FIN MAN); Prob. 8–1B (MAN) (Concluded) 3.

Sentinel Systems Inc. Sales Budget For the Year Ending December 31, 20Y9 Product and Area

Unit Sales Volume

Home Alert System: United States Europe Asia Total Business Alert System: United States Europe Asia Total Total revenue from sales

Unit Selling Price

Total Sales

1,769 639 415 2,823

$250 250 250

$ 442,250 159,750 103,750 $ 705,750

1,186 309 265 1,760

$820 820 820

$ 972,520 253,380 217,300 $1,443,200 $2,148,950

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–2B (FIN MAN); Prob. 8–2B (MAN) 1.

Royal Furniture Company Sales Budget For the Month Ending February 28 Product and Area

King: Northern Domestic Southern Domestic International Total Prince: Northern Domestic Southern Domestic International Total Total revenue from sales 2.

Unit Sales Volume

Unit Selling Price

610 340 360 1,310

$780 780 850

$ 475,800 265,200 306,000 $1,047,000

750 440 290 1,480

$550 550 600

$ 412,500 242,000 174,000 $ 828,500 $1,875,500

Total Sales

Royal Furniture Company Production Budget For the Month Ending February 28 Units King

Expected units to be sold Desired inventory, February 28 Total units available Estimated inventory, February 1 Total units to be produced

Prince

1,310 80 1,390 (90) 1,300

1,480 35 1,515 (25) 1,490

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–2B (FIN MAN); Prob. 8–2B (MAN) (Continued) 3. Royal Furniture Company Direct Materials Purchases Budget For the Month Ending February 28 Direct Materials Fabric (sq. yds.)

Wood (linear ft.)

Filler (cu. ft.)

Springs (units)

Total

Required units for production: King

49,400 2

5,4603

20,800 4

17,880 8

7,800

Prince

5,960

38,740

5,066

Desired inventory, February 28 Total

390

650

300

540

14,150

88,790

10,826

39,220

(420)

(580)

(250)

(660)

Estimated inventory, February 1 Total units to be purchased Unit price

13,730

88,210

10,576

38,560

× $12.00

× $7.00

× $3.00

× $4.50

$164,760

$617,470

$31,728

$173,520

Total direct materials to be purchased 1 2 3 4 5 6 7 8

$987,478

1,300 × 6.0 sq. yds. = 7,800 sq. yds. 1,300 × 38 linear ft. = 49,400 linear ft. 1,300 × 4.2 cu. ft. = 5,460 cu. ft. 1,300 × 16 units = 20,800 units 1,490 × 4.0 sq. yds. = 5,960 sq. yds. 1,490 × 26 linear ft. = 38,740 linear ft. 1,490 × 3.4 cu. ft. = 5,066 cu. ft. 1,490 × 12 units = 17,880 units

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–2B (FIN MAN); Prob. 8–2B (MAN) (Concluded) 4. Royal Furniture Company Direct Labor Cost Budget For the Month Ending February 28 Framing Department

Cutting Department

Upholstery Department

1,560

650

1,040

1,490

596

894

3,050 × $12 $36,600

1,246 × $14 $17,444

1,934 × $15 $29,010

Total

Hours required for production: King1 Prince

Total Hourly rate Total direct labor cost 1

This line is calculated as 1,300 King chairs from the production budget multiplied by the hours per unit in each department estimated for the King chairs. 1,560 = 1,300 × 1.2; 650 = 1,300 × 0.5; 1,040 = 1,300 × 0.8 This line is calculated as 1,490 Prince chairs from the production budget multiplied by the hours per unit in each department estimated for the Prince chairs. 1,490 = 1,490 × 1.0; 596 = 1,490 × 0.4; 894 = 1,490 × 0.6

$83,054

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–3B (FIN MAN); Prob. 8–3B (MAN) 1.

Gold Medal Athletic Co. Sales Budget For the Month Ending March 31 Unit Sales Volume

Unit Selling Price

1,200 6,500

$ 40 160

Batting helmet Football helmet Total revenue from sales 2.

Total Sales

48,000 1,040,000 $1,088,000

Gold Medal Athletic Co. Production Budget For the Month Ending March 31 Units Batting Helmet

Expected units to be sold Desired inventory, March 31 Total units available Estimated inventory, March 1 Total units to be produced

Football Helmet

1,200 50 1,250 (40) 1,210

6,500 220 6,720 (240) 6,480

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–3B (FIN MAN); Prob. 8–3B (MAN) (Continued) 3.

Gold Medal Athletic Co. Direct Materials Purchases Budget For the Month Ending March 31 Units required for production: Batting helmet Football helmet Desired units of inventory, March 31 Total units available Estimated units of inventory, March 1 Total units to be purchased Unit price Total direct materials to be purchased 1 2 3 4

Plastic

Foam Lining

Total

1,4521 22,680 3 50 24,182 (90) 24,092 $6 × $144,552

6052 9,7204 65 10,390 (80) 10,310 $4 × $41,240

$185,792

1,210 × 1.2 lbs. = 1,452 lbs. 1,210 × 0.5 lb. = 605 lbs. 6,480 × 3.5 lbs. = 22,680 lbs. 6,480 × 1.5 lbs. = 9,720 lbs.

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–3B (FIN MAN); Prob. 8–3B (MAN) (Continued) 4.

Gold Medal Athletic Co. Direct Labor Cost Budget For the Month Ending March 31 Molding Department

Assembly Department

Total

Hours required for production: Batting helmet

242 1

605 2

Football helmet

3,240 3

11,664 4

3,482 $20 $69,640

12,269 $14 $171,766

Total Hourly rate Total direct labor cost 1 2 3 4

$241,406

1,210 × 0.2 hr. = 242 hrs. 1,210 × 0.5 hr. = 605 hrs. 6,480 × 0.5 hr. = 3,240 hrs. 6,480 × 1.8 hrs. = 11,664 hrs.

Gold Medal Athletic Co. Factory Overhead Cost Budget For the Month Ending March 31 Indirect factory wages Depreciation of plant and equipment Power and light Insurance and property tax Total factory overhead cost

$ 86,000 12,000 4,000 2,300 $104,300

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–3B (FIN MAN); Prob. 8–3B (MAN) (Continued) 6. Gold Medal Athletic Co. Cost of Goods Sold Budget For the Month Ending March 31 Finished goods inventory, March 11

$ 19,480

Work in process inventory, March 1 Direct materials:

$ 15,300

Direct materials inventory, March 12 Direct materials purchases (from part 3)

Cost of direct materials available for use

$186,652 (560)

Direct materials inventory, March 31 Cost of direct materials placed in production Direct labor (from part 4) Factory overhead (from part 5) Total manufacturing costs

860 185,792

$186,092 241,406 104,300 531,798

Total work in process during period Work in process, March 31 Cost of goods manufactured

$547,098 (14,800) 532,298

Cost of finished goods available for sale

$551,778 (18,410) $533,368

Finished goods inventory, March 31 Cost of goods sold 1

Batting helmet (40 × $25)……………………………………………………… Football helmet (240 × $77)…………………………………………………… Finished goods inventory, March 1…………………………………………

$ 1,000 18,480

Plastic (90 × $6)………………………………………………………………… Foam lining (80 × $4)…………………………………………………………… Direct materials inventory, March 1…………………………………………

$19,480

$ $

540 320 860 300 260 560

Plastic (50 × $6)………………………………………………………………… Foam lining (65 × $4)…………………………………………………………… Direct materials inventory, March 31…………………………………………

Batting helmet (50 × $25)……………………………………………………… Football helmet (220 × $78)…………………………………………………… Finished goods inventory, March 31…………………………………………

$ 1,250 17,160 $18,410

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–3B (FIN MAN); Prob. 8–3B (MAN) (Concluded) 7.

Gold Medal Athletic Co. Selling and Administrative Expenses Budget For the Month Ending March 31 Selling expenses: Sales salaries expense Advertising expense Telephone expense—selling Travel expense—selling

$184,300 87,200 5,800 9,000

Total selling expenses

$286,300

Administrative expenses: Office salaries expense Depreciation expense—office equipment Telephone expense—administrative Office supplies expense Miscellaneous administrative expense Total administrative expenses Total operating expenses

$ 32,400 3,800 1,200 1,100 1,000 39,500 $325,800

Gold Medal Athletic Co. Budgeted Income Statement For the Month Ending March 31 Revenue from sales (from part 1) Cost of goods sold (from part 6)

$1,088,000 (533,368)

Gross profit Operating expenses: Selling expenses (from part 7) Administrative expenses (from part 7) Total operating expenses

$ 554,632

Operating income Other revenue and expense: Interest revenue Interest expense

$286,300 39,500 (325,800) $ 228,832 $

Income before income tax Income tax expense (30% rate) Net income

940 (872)

68 $ 228,900 (68,670) $ 160,230

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–4B (FIN MAN); Prob. 8–4B (MAN) 1.

Mercury Shoes Inc. Cash Budget For the Three Months Ending August 31 June July Estimated cash receipts from: Cash sales Collection of accounts receivable Total cash receipts

August

$ 16,000 138,000 $154,000

$ 18,500 146,400 $ 164,900

$ 20,000 157,500 $ 177,500

$ (56,200) (40,000)

$ (66,800) (46,000)

$ (88,400) (51,000) (120,000)

Less estimated cash payments for: Manufacturing costsb Selling and administrative expenses Capital expenditures Other purposes: Income tax Dividends Total cash payments

$ (96,200)

$(136,800)

(15,000) $(274,400)

Cash increase (decrease) Plus cash balance at beginning of month

$ 57,800 42,000

$ 28,100 99,800

$ (96,900) 127,900

Cash balance at end of month Less minimum cash balance Excess (deficiency)

$ 99,800 (40,000) $ 59,800

$ 127,900 (40,000) $ 87,900

$ 31,000 (40,000) $ (9,000)

(24,000)

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–4B (FIN MAN); Prob. 8–4B (MAN) (Concluded) Computations: a

Collections of accounts receivable:

June

July

April sales…………………………………………

$ 48,000 1

May sales…………………………………………

90,000

$ 60,000

August 3

86,400 4

$ 57,600 5 99,900 6

$138,000

$146,400

$157,500

June

July

August

$13,000 43,200

$10,800 56,000

$14,000 74,400

$56,200

$66,800

$88,400

June sales………………………………………… July sales………………………………………… Total…………………………………………… 1 2 3 4 5 6 b

$120,000 × 40% = $48,000 $150,000 × 60% = $90,000 $150,000 × 40% = $60,000 $160,000 × 90% × 60% = $86,400 $160,000 × 90% × 40% = $57,600 $185,000 × 90% × 60% = $99,900

Payments for manufacturing costs: Payment of accounts payable, c

beginning of month balance ……………… d

Payment of current month’s cost …………… Total…………………………………………… c

Accounts payable, June 1 balance = $13,000 ($66,000 – $12,000) × 20% = $10,800 ($82,000 – $12,000) × 20% = $14,000

($66,000 – $12,000) × 80% = $43,200 ($82,000 – $12,000) × 80% = $56,000 ($105,000 – $12,000) × 80% = $74,400

The budget indicates that the minimum cash balance will not be maintained in August. This is due to the capital expenditures requiring significant cash outflows during this month. This situation can be corrected by borrowing and/or by the sale of the marketable securities, if they are held for such purposes. At the end of June and July, the cash balance will exceed the minimum desired balance, and the excess could be considered for temporary investment.

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–5B (FIN MAN); Prob. 8–5B (MAN) 1. Mesa Publishing Co. Budgeted Income Statement For the Year Ending December 31, 20Y9 1

$ 456,000 $114,000 31,920 23,640 (169,560) $ 286,440

$64,100 13,200 10,500 $ 87,800 $34,400 5,060 9,520 48,980 (136,780) $ 149,660 (35,000) $ 114,660

3,800 units × $120 3,800 units × $30 3,800 units × $8.40 (3,800 units × $4.80) + $4,000 + $1,400 (3,800 units × $13.50) + $12,800 (3,800 units × $2.50) + $1,000 (3,800 units × $7.00) + $7,800 (3,800 units × $1.20) + $500 (3,800 units × $2.40) + $400

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Prob. 22–5B (FIN MAN); Prob. 8–5B (MAN) (Concluded) 2. Mesa Publishing Co. Budgeted Balance Sheet December 31, 20Y9 ASSETS Current assets: Cash 1 Accounts receivable Inventories: Finished goods Work in process Materials Prepaid expenses Total current assets Property, plant, and equipment:

$106,660 23,800 $16,900 4,200 6,400

27,500 600 $158,560

Plant and equipment 2 Accumulated depreciation 3 Total property, plant, and equipment Total assets

$104,000 (36,000) 68,000 $226,560

LIABILITIES Current liabilities: Accounts payable

$ 14,800 STOCKHOLDERS’ EQUITY

Common stock

$ 30,000 181,760

Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity 1

211,760 $226,560

Cash balance, December 31, 20Y9: Balance, January 1, 20Y9………………………………………………………… Add: Cash from operations Net income……………………………………………………………… Depreciation of plant and equipment………………………………… Less: Dividends to be paid in 20Y9………………………………………… Plant and equipment to be acquired in 20Y9………………………

$ 26,000 $114,660 4,000 $ 16,000 22,000

Cash balance, December 31, 20Y9……………………………………………… 2 3

118,660 (38,000) $106,660

$82,000 + $22,000 = $104,000 $32,000 + $4,000 = $36,000

4 Retained earnings balance, December 31, 20Y9:

Balance, January 1, 20Y9……………………………………………………… Plus: Net income for 20Y9……………………………………………………… Less: Dividends to be paid in 20Y9 (20,000 shares × $0.20 × 4 qtrs.)… Balance, December 31, 20Y9…………………………………………………

$ 83,100 114,660 (16,000) $181,760

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Appendix Prob. 22–6B (FIN MAN); Appendix Prob. 8–6B (MAN) 1.

Newport Inc. Sales Budget For the First Quarter Ending August 31 June

July

300,000 $36

400,000 $36

Estimated units sold Selling price per unit

Total budgeted sales

$10,800,000

$14,400,000

August

First Quarter

500,000 $36

1,200,000 $36 ×

$18,000,000

$43,200,000

Newport Inc. Production Budget For the First Quarter Ending August 31 August

June

July

Estimated units sold Desired ending inventory

300,000 20,0001

400,000 25,000 2

500,000 25,000 3

1,200,000 25,0004

Total units available for sale

320,000

425,000

525,000

1,225,000

Less estimated beginning inventory

(16,000)

(20,000)

(25,000)

304,000

405,000

500,000

Total units to be produced

First Quarter

(16,000) 5 1,209,000

400,000 units × 5% = 20,000 units

500,000 units × 5% = 25,000 units

Ending finished goods inventory as of August 31, the end of the first quarter.

Beginning finished goods inventory as of June 1, the beginning of the first quarter.

Newport Inc. Direct Materials Purchases Budget For the First Quarter Ending August 31 June Units to be produced Materials required per unit

July

August

304,000 405,000 500,000 1.5 lbs. 1.5 lbs. 1.5 lbs. × × ×

First Quarter 1,209,000 1.5 lbs. ×

Materials required for production Desired ending inventory

456,000 lbs. 40,000 lbs.

607,500 lbs. 45,000 lbs.

750,000 lbs. 50,000 lbs.

1,813,500 lbs. 50,000 1 lbs.

496,000 lbs.

652,500 lbs.

800,000 lbs.

1,863,500 lbs.

(35,000) lbs.

(40,000) lbs.

(45,000) lbs.

(35,000)2lbs.

purchased Cost per pound

461,000 lbs. 612,500 lbs. 755,000 lbs. $4 $4 $4 × × ×

1,828,500 lbs. $4 ×

Cost of materials to be purchased

$1,844,000

$7,314,000

Total materials available for use Less estimated beginning inventory Total materials to be

$2,450,000

$3,020,000

Ending finished goods inventory as of August 31, the end of the first quarter.

Beginning finished goods inventory as of June 1, the beginning of the first quarter.

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Appendix Prob. 22–6B (FIN MAN); Appendix Prob. 8–6B (MAN) (Continued) 4.

Newport Inc. Direct Labor Cost Budget For the First Quarter Ending August 31 June

July

August

First Quarter

304,000 0.4 hr. ×

405,000 0.4 hr. ×

500,000 0.4 hr. ×

1,209,000 0.4 hr. ×

required for production Direct labor hourly rate

121,600 hrs. $25 ×

Direct labor cost

$3,040,000

162,000 hrs. 200,000 hrs. 483,600 hrs. $25 $25 $25 × × × $4,050,000 $5,000,000 $12,090,000

Units to be produced Direct labor required per unit Direct labor hours

Newport Inc. Factory Overhead Cost Budget For the First Quarter Ending August 31 June

July

August

First Quarter

121,600

162,000

200,000

483,600

Variable factory overhead: Budgeted direct labor hours Variable factory overhead rate

Budgeted variable factory overhead

$ 486,400

$ 648,000

$ 800,000

$1,934,400

Fixed factory overhead: Budgeted fixed factory overhead

1,200,000

3,600,000

Total factory overhead cost

$1,686,400

$1,848,000

$2,000,000

$5,534,400

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Appendix Prob. 22–6B (FIN MAN); Appendix Prob. 8–6B (MAN) (Continued) 6.

Newport Inc. Cost of Goods Sold Budget For the First Quarter Ending August 31 Beginning finished goods inventory

June

July

August

First Quarter

320,000 1

400,0002

500,000 3

320,000

Cost of goods manufactured: Direct materials

$1,824,000 4

$2,430,0005

$ 3,000,0006

$ 7,254,000

Direct labor Factory overhead (from part 5)

3,040,000 7

4,050,000 8

5,000,000 9

1,686,400

1,848,000

2,000,000

12,090,000 5,534,400

Total cost of goods manufactured

$6,550,400

$8,328,000

$10,000,000

$24,878,400

Cost of goods available for sale Ending finished goods inventory

$6,870,400 (400,000) 10

$8,728,000 (500,000)11

$10,500,000 (500,000)12

$25,198,400 (500,000)

Cost of goods sold

$6,470,400

$8,228,000

$10,000,000

$24,698,400

1 2 3 4 5 6 7 8 9 10 11 12

16,000 units (from part 2) × $20 20,000 units (from part 2) × $20 25,000 units (from part 2) × $20 456,000 lbs. (from part 3) × $4 607,500 lbs. (from part 3) × $4 750,000 lbs. (from part 3) × $4 121,600 hrs. (from part 4) × $25 162,000 hrs. (from part 4) × $25 200,000 hrs. (from part 4) × $25 20,000 units (from part 2) × $20 25,000 units (from part 2) × $20 25,000 units (from part 2) × $20

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

Appendix Prob. 22–6B (FIN MAN); Appendix Prob. 8–6B (MAN) (Concluded) 7.

Newport Inc. Selling and Administrative Expenses Budget For the First Quarter Ending August 31 June

July

August

First Quarter

Selling expenses: Budgeted sales units

300,000

400,000

500,000

1,200,000

Variable selling expenses per unit sold

Total variable selling expenses Fixed selling expenses

$ 900,000 800,000

$1,200,000 800,000

$1,500,000 800,000

$3,600,000 2,400,000

Total selling expenses

$1,700,000

$2,000,000

$2,300,000

$6,000,000

550,000

1,650,000

$2,250,000

$2,550,000

$2,850,000

$7,650,000

Administrative expenses: Budgeted fixed administrative expenses Total selling and administrative expenses

Newport Inc. Budgeted Income Statement For the First Quarter Ending August 31 June

July

August

First Quarter

Sales (from part 1) Cost of goods sold (from part 6)

$10,800,000 (6,470,400)

$14,400,000 $ 18,000,000 $ 43,200,000 (8,228,000) (10,000,000) (24,698,400)

Gross profit

$ 4,329,600

$ 6,172,000

$ (1,700,000)

$ (2,000,000) $ (2,300,000) $ (6,000,000)

$ 8,000,000

$ 18,501,600

Selling and administrative expenses: Selling expenses (from part 7) Administrative expenses (from part 7) Total selling and administrative expenses Operating income

(550,000)

(1,650,000)

$ (2,250,000)

$ (2,550,000) $ (2,850,000) $ (7,650,000)

$ 2,079,600

$ 3,622,000

$ 5,150,000

$ 10,851,600

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

MAKE A DECISION MAD 22–1 (FIN MAN); MAD 8–1 (MAN) a.

Increase in daily revenue Revenue per clerk Number of additional sales clerks Hours per day per clerk Number of additional sales clerk hours per day Number of shopping days Number of total additional hours Rate per hour Holiday staff budget for additional clerks

$90,000 ÷15,000 6 8 × ×

48 27

1,296 × $15 $19,440

Lakeridge Stores should add the staff because it will be profitable. Increase in daily revenue $ 90,000 40% × Gross profit percentage Increase in daily gross profit $ 36,000 Number of shopping days 27 × Additional gross profit Staff budget increase [from (a)] Additional profit

$972,000 (19,440) $952,560

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

MAD 22–2 (FIN MAN); MAD 8–2 (MAN) a. There are 680 expected RVUs per day for the coming week. Number of Patients 5 8 10 2 Total b.

RVUs per Day 20 25 30 40

Total daily RVUs…………………………………… Daily RVUs per nurse…………………………… Number of nurses………………………………… Daily wage per nurse……………………………… Days per week……………………………………… Weekly nurse staff budget………………………

MAD 22–3 (FIN MAN); MAD 8–3 (MAN) a. School Days 3,000 Number of vehicles per day ÷ 200 Vehicles per staff member 15 Number of staff × $110 Daily wage per staff $ 1,650 Daily staff expense Number of days per year × 165 $272,250 Total parking lot staff expense b. Number of vehicles per day Number of days per year Parking fee per day Total parking annual revenues

School Days 3,000 × 165 × $10 $4,950,000

Total Daily RVUs 100 200 300 80 680

680 40 17 × $180 × 7 $21,420 ÷

Nonschool Days 8,000 ÷ 200 40 × $110 $ 4,400 × 200 $880,000 Nonschool Days 8,000 × 200 × $10 $16,000,000

c. Total budgeted revenues [from (b)]…………………………………………… Parking lot staff expenses [from (a)]…………………………………………… Other expenses……………………………………………………..……………… Budgeted parking lot profit………………………………………………………

Total

$1,152,250 Total

$20,950,000 $20,950,000 (1,152,250) (2,000,000) $17,797,750

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

MAD 22–4 (FIN MAN); MAD 8–4 (MAN) a.

Weekday Room occupancy Room capacity Occupancy Rooms occupied (1)

Weekend Day

300 × 80% 240

Housekeeping Number of minutes to clean a room (2) Total minutes [(a) × (b)] Total hours (Total minutes ÷ 60 min.) Labor rate per hour Housekeeping staff budget per day (3) Restaurant staff Base restaurant staff Incremental staff for room blocks [(1) ÷ 60 room blocks] Total staff Hours per day Total hours Labor rate per hour Restaurant staff budget per day (4) Total staff budget per day [(3) + (4)]

300 ×40% 120

7,200 120 × $14 $1,680

3,600 60 × $14 $ 840

+4 10 ×8 80 × $12 $960

+2 8 ×8 64 × $12 $768

$2,640

$1,608

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

TAKE IT FURTHER TIF 22–1 (FIN MAN); TIF 8–1 (MAN) Cam should reject Megan’s request to charge the convention-related costs against July’s budget. This is just one example of many attempts to slide expenses into different budget periods than when actually incurred. This is a common issue that controllers face. Often, operating managers will attempt to accelerate future expenditures into low-expenditure months or delay present expenditures into future periods in order to avoid going over budget. These attempts to “slide” expenditures should not be supported or else the whole concept of the budget will begin to become an accounting game. The integrity of the budget process must be defended by the controller. Thus, expenditures should be accrued to the period in which the benefit is received. Cam should reassure Megan that management will not take a single month’s results as an indication of either good or poor management. Month-to-month variation should be expected. Rather, management will take a long-term perspective and evaluate whether the department is staying within budget over the long term. Abnormal month-to-month variations from budget can “wash out” over time. TIF 22–2 (FIN MAN); TIF 8–2 (MAN) Answers will vary per state selected. Examples from the state of Tennessee are shown here. 1.

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

TIF 22–3 (FIN MAN); TIF 8–3 (MAN) Memo To:

Stacy Poindexter

From:

Ima Student

Re:

Evaluating City of Milton Budget

After reviewing the city of Milton’s budget data, it appears that considerable goal conflict exists within departments, resulting in department managers making poor budgeting and spending decisions. The amount of actual expenditures was less than budgeted for the first 10 months of the budget year. As the budget year-end approached, department managers appear to have spent the remaining excess budget, going over budget in May and June. The amount spent for the year was equal to the total amount budgeted because the difference between the annual actual and budgeted totals is zero. Thus, the managers did not spend more than was authorized for the year. However, the managers appear to have spent the remaining available annual authorization in the last two months to avoid returning those amounts to the General Fund. This is an example of a “spend it or lose it” mentality. The managers appear to be holding back spending during the year to create a small cushion. If an emergency arises, then the manager has resources available to address it. If the emergency doesn’t arise, then the manager uses the amount held back in a flurry of year-end spending, some of which is likely to be wasteful. There are a number of techniques that the city could undertake to more effectively budget and align departmental behavior with the city’s goals. First, departments could adopt flexible budgets, which allow for monthly budgets to change with underlying activity. For example, if the number of prisoners in the jail increased, then the budget would increase proportionately. Department managers with a flexible budget would be less likely to “reserve” a large portion of the budget during the year because an activity change would automatically be reflected in the monthly budget. This reduces the department managers’ ability to create budgetary slack. Another solution would be to allow a manager to request additional funds after the budget year has begun. With this solution, department managers would not need to hold back spending for emergencies, because emergencies could be handled with a separate request. For example, if the town had a natural disaster, police and fire departments could request additional funding to meet the increased budget need. Lastly, the budget could be designed to encourage thrift. For example, the budget could be designed so that managers could carry forward a portion of their unspent budget to future years. This system would reward departmental thrift by allowing the department to keep a portion of the savings for future needs while reducing the incentive for aggressive year-end spending. This would allow the department manager to spend the budgetary slack when needed, rather than forcing the manager to spend this amount frivolously at year-end.

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

TIF 22–4 (FIN MAN); TIF 8–4 (MAN) 1.

The hospital’s new budget method is clearly an example of a flexible budget. The budget changes with changes in underlying activity, such as patient days. Patient days are the number of patients multiplied by the number of days in the hospital. As the number of patient days changes, it would be reasonable to expect that the hospital’s variable costs should also change. In addition, the last quote suggests that the new budget approach is a monthly continuous budget. The budget helps the managers plan month-by-month expenditures.

The advantage of a flexible budget is to accurately plan variable costs of the hospital with changes in the underlying activity base. Using a static budget would create actual deviations from budget that would be difficult to interpret. Managers would not be able to determine if the deviations were the result of cost (in)efficiencies or whether they were due to changes in activity level. A flexible budget causes the budget to “flex” with changes in underlying activity level so that any remaining actual deviations from budget can be identified more clearly with (in)efficiency or other special causes. The continuous budget also provides timely information to managers so that they can adjust actual spending patterns to the budgeted amounts.

TIF 22–5 (FIN MAN); TIF 8–5 (MAN) 1.

The budget information indicates that the actual expenditures by the Operations Department exceeded what was planned by $12,000. The bank manager may ask the operations manager why the travel and training expenditures exceeded the plan by a total of $20,000. It may be that the additional expenditures were necessary, but an explanation is in order.

The bank manager does not know if the actual resources consumed by the Operations Department are the right amount of resources for doing the right things. In other words, this budget doesn’t say anything about the actual work of the Operations Department and how much cost this work consumes. The bank manager doesn’t have a good sense if there is waste in the department or not. The $12,000 excess expenditure over budget raises several questions. If the department did twice as much work as planned, then the $12,000 is a bargain. If, on the other hand, the department did much less work than planned, then the $12,000 understates how poorly the department used resources. Again, how much work the department actually did is unknown, so these questions cannot be answered. A flexible budget would provide more information about the work of the department. Examples of the kind of work conducted by the department might include processing credit card statements, processing checking statements, processing loan repayments, and correcting errors.

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

TIF 22–5 (FIN MAN); TIF 8–5 (MAN) (Concluded) The budget doesn’t indicate why there was more travel and training than expected. Maybe the department introduced a new computer system, and all employees needed off-site training in order to use the system. This would explain the additional spending on travel and training. The training needed to be done, regardless of the budget. The lower-than-expected overtime may be a favorable result. However, there may have been less overtime because employees were involved in more training days than expected or performed less work than planned. Again, a flexible budget would provide more information for evaluating the department’s performance.

TIF 22–6 (FIN MAN); TIF 8–6 (MAN) Domino’s could use a master budget to plan operations consistent with the sales forecast. The sales forecast could be used to develop the production budget for pizzas. The sales and production budgets would be identical because there would be no finished goods inventory for cooked pizzas. The sales (production) budget would be used to develop a direct materials purchases budget. For example, the pizza ingredients, packaging materials, beverages, and other materials could be planned from the sales budget. In addition, the cost of delivery fuel (driver reimbursement for gas) could be planned from the sales budget. The sales (production) budget could also be used to develop the direct labor budget for cooks, counter staff, dough makers, and drivers. Much of the overhead is related to the number of restaurants, rather than the number of pizzas sold. That is, the number of restaurant locations will drive management salaries, rent, utilities, insurance, and other overhead costs. The drivers own the delivery vehicles; thus, vehicle depreciation and maintenance costs are not part of Domino’s overhead budget. The budget process could be used to direct and coordinate all the various restaurants. In this way, all the managers would be operating under the same set of assumptions. The actual performance of the company and the individual stores could be compared with the budget in order to provide all levels of the organization appropriate feedback and control. This feedback can be used to adjust operations to any changes that may be occurring. Thus, if sales are expanding faster or slower than planned, costs could be brought into line rapidly. This would help prevent the company from becoming either short of drivers and food due to sales outpacing projections or overbuilding stores before sales have materialized in sufficient volume to justify the cost.

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

TIF 22–7 (FIN MAN); TIF 8–7 (MAN) Pounds Required for Planned Production 45 lb. bumper plate 45 lb. competition plate 25 lb. bumper plate 25 lb. competition plate 50 lb. hex dumbbell, coated 50 lb. hex dumbbell 30 lb. round dumbbell Desired direct materials, end of period Total materials available for production Estimated direct materials, beginning of period Direct materials to be purchased Unit price Budgeted purchases of direct materials

Iron 40,000 33,750 9,200 100,000 161,000 175,000 140,000 20,000 678,950 (15,000) 663,950 $0.75 × $497,962.50

Rubber 5,000 — 800 — 14,000 — 10,000 5,000 34,800 (7,000) 27,800 $5.00 × $139,000.00

CHAPTER 22 (FIN MAN); CHAPTER 8 (MAN)

Budgeting

CERTIFIED MANAGEMENT ACCOUNTANT (CMA®) EXAMINATION QUESTIONS (ADAPTED) 1. d. Flexible budgets are based on the output actually achieved and therefore provide a realistic comparison of budgeted and actual revenue and costs. 2. b. Hannon’s budget for the purchase of inventory should be $540,000, computed as follows: 75% of the cost of inventory to be sold in August [($728,000 ÷ 1.3)* = $560,000; $560,000 × 75%]………………………… $420,000 25% of the cost of inventory to be sold in September [($624,000 ÷ 1.3)* = $480,000; $480,000 × 25%]………………………… 120,000 Budget for purchase of inventory in August…………………………… $540,000 * Sales = Cost of Inventory + (30% × Cost of Inventory) = 1.3 × Cost of Inventory Thus, Cost of Inventory = (Sales ÷ 1.3)

3. c. Ming should plan to produce 7,133 units in July, computed as follows: Sales – Beginning Inventory + Ending Inventory 6,300 − 470 + 590 = 6,420 units before allowing for scrap 6,420 ÷ 0.9 = 7,133 units to produce, allowing for 10% scrap 4. c. The cost of one laminated putter head is $52, computed as follows: Laminated putter head cost per unit: Steel Copper Direct labor Variable OH Fixed OH Total cost

$ 5.00 15.00 22.00 6.25 * 3.75 ** $52.00

Direct labor hours required for production: Forged units: 8,200 – 300 + 100 = 8,000 units; 8,000 units × 0.25 hr. per unit = Laminated units: 2,000 – 60 + 60 = 2,000 units; 2,000 units × 1.0 hr. per unit = 2,000 hours Total direct labor hours

2,000 hours

2,000 hours 4,000 hours

Variable overhead rate per hr. = $25,000 ÷ 4,000 hrs. = $6.25 Fixed overhead rate per hr. = $15,000 ÷ 4,000 hrs. = $3.75 * 1 direct labor hour per laminated putter head × $6.25 = $6.25 ** 1 direct labor hour per laminated putter head × $3.75 = $3.75

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN) EVALUATING VARIANCES FROM STANDARD COSTS DISCUSSION QUESTIONS 1.

Standards are performance goals. Manufacturing companies normally use standard cost for each of the three following product costs: • Direct materials • Direct labor • Factory overhead Standard cost systems enable management to determine the following: • How much a product should cost (standard cost) • How much it does cost (actual cost)

Reporting by the “principle of exceptions” is the reporting of only variances (or “exceptions”) between standard and actual costs to the individual responsible for cost control. This reporting allows management to focus on correcting cost variances.

The two variances in direct materials cost are: • Direct materials price • Direct materials quantity

The offsetting variances might have been caused by the purchase of low-priced, inferior materials. The low price of the materials would generate a favorable materials price variance, while the inferior quality of the materials would cause abnormal spoilage and waste, thus generating an unfavorable materials quantity variance.

The two variances in direct labor costs are: (1) Direct labor rate (2) Direct labor time

The direct labor cost variance is usually under the control of the production supervisor.

No. Even though the assembly workers are covered by union contracts, direct labor cost variances still might result. For example, direct labor rate variances could be caused by scheduling overtime to meet production demands or by assigning higher-paid workers to jobs normally performed by lower-paid workers. Likewise, direct labor time variances could result during the training of new workers or from a shortage of skilled employees.

Standards can be very appropriate in repetitive service operations. Fast-food restaurants can use standards for evaluating the productivity of the counter and food preparation employees. In addition, standards could be used to plan staffing patterns around various times of the day (e.g., increasing staff during the lunch hour).

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

DISCUSSION QUESTIONS (Continued) 8.

10.

The variable factory overhead controllable variance results from incurring a total amount of variable factory overhead cost greater or less than the amount budgeted for the level of operations achieved. The fixed factory overhead volume variance results from operating at a level above or below 100% of normal capacity.

The factory overhead cost variance report presents the standard factory overhead cost variance data (i.e., the volume and the controllable variance).

Favorable variance. A credit balance in the factory overhead account at the end of the period means that applied factory overhead is larger than the actual factory overhead, which indicates a favorable total factory overhead variance.

The individual controllable and volume variances could be favorable or unfavorable. The favorable total factory overhead variance only means that the “net” of the controllable and volume variances is favorable. Both variances could be favorable or one favorable and the other unfavorable.

A debit balance in the account represents a net unfavorable direct materials price variance.

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

BASIC EXERCISES BE 23–1 (FIN MAN); BE 9–1 (MAN) a.

Direct materials price variance (unfavorable)

$4,780

[($6.20 – $6.00) × 23,900 lbs.]

Direct materials quantity variance (favorable)

$(600)

[(23,900 lbs. – 24,000 lbs.) × $6.00]

Direct materials cost variance (unfavorable)

$4,180

[$4,780 + ($600)] or [($6.20 × 23,900 lbs.) – ($6.00 × 24,000 lbs.)] = $148,180 – $144,000

BE 23–2 (FIN MAN); BE 9–2 (MAN) a.

Direct labor rate variance (favorable)

$(33,110)

Direct labor time variance (unfavorable)

$4,500

Direct labor cost variance (favorable)

$(28,610)

[($21.95 – $22.50) × 60,200 hrs.] [(60,200 hrs. – 60,000 hrs.) × $22.50] [$(33,110) + $4,500] or [($21.95 × 60,200 hrs.) – ($22.50 × 60,000 hrs.)] = $1,321,390 – $1,350,000

BE 23–3 (FIN MAN); BE 9–3 (MAN) Variable Factory Overhead = $85,900 – [$1.45 × (8,000 units × 7.5 hrs.)] Controllable Variance = $85,900 – $87,000 = $(1,100) Favorable

BE 23–4 (FIN MAN); BE 9–4 (MAN) $(10,000) Favorable = $2.00 × [55,000 hrs. – (8,000 units × 7.5 hrs.)]

BE 23–5 (FIN MAN); BE 9–5 (MAN) Work in Process (24,000* lbs. × $6.00) Direct Materials Quantity Variance** Materials (23,900 lbs. × $6.00)

144,000 600 143,400

* 8,000 units × 3.0 standard lbs. per unit ** [(23,900 lbs. – 24,000 lbs.) × $6.00]

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

BE 23–6 (FIN MAN); BE 9–6 (MAN) Alvarado Company Income Statement Through Gross Profit For the Month Ended March 31 Sales (8,000 units × $250) Cost of goods sold—at standard* Gross profit—at standard

$2,000,000 1,701,000 $ 299,000 Unfavorable

Variances from standard cost: Direct materials price (BE 23–1) Direct materials quantity (BE 23–1) Direct labor rate (BE 23–2) Direct labor time (BE 23–2) Factory overhead controllable (BE 23–3) Factory overhead volume (BE 23–4) Net variances from standard cost—favorable Gross profit

Favorable

$4,780 $

(600) (33,110)

4,500 (1,100) (10,000) (35,530) $ 263,470

* Direct materials (8,000 units × 3.0 lbs. × $6.00)…………………………………………………… Direct labor (8,000 units × 7.5 hrs. × $22.50)……………………………………………………… Factory overhead [8,000 units × 7.5 hrs. × ($1.45 + $2.00)]……………………………………… Cost of goods sold at standard………………………………………………………………………

$ 144,000 1,350,000 207,000 $1,701,000

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

EXERCISES Ex. 23–1 (FIN MAN); Ex. 9–1 (MAN) Ingredient

Cocoa Sugar Milk Total cost

Quantity

Price

Total

500 lbs. 100 lbs. 200 gal.

× × ×

$1.04 per lb. $0.60 per lb. $0.85 per gal.

$520 60 170 $750

Standard direct materials cost per bar of chocolate: $750 per batch 5,000 bars

= $0.15 per bar

Ex. 23–2 (FIN MAN); Ex. 9–2 (MAN) a.

Direct labor………………………………………… $30.00 × 5.0 hrs. Direct materials…………………………………… $8.00 × 20 bd. ft. Variable factory overhead………………………… $0.75 × 5.0 hrs. Fixed factory overhead…………………………… $1.15 × 5.0 hrs. Total cost per unit………………………………

A standard cost system provides the company’s management a cost control tool using the principle of management by exception. Using this principle, costs that deviate significantly from standards can be investigated and corrected. The standard cost system also can be used to motivate employees to work efficiently with their time, use of materials, and other factory overhead resources.

$150.00 160.00 3.75 5.75 $319.50

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–3 (FIN MAN); Ex. 9–3 (MAN) Lanier Bottle Company Manufacturing Cost Budget For the Month Ended January 31

Standard Cost at Planned Volume (3,500,000 Bottles)

Manufacturing costs: Direct labor Direct materials Factory overhead Total

$ 43,750 168,000 52,500 $264,250

$1.25 × (3,500,000 ÷ 100) = $43,750 $4.80 × (3,500,000 ÷ 100) = $168,000 $1.50 × (3,500,000 ÷ 100) = $52,500 Note: The cost standards are expressed as “per 100 bottles.” b.

Lanier Bottle Company Manufacturing Costs—Budget Performance Report For the Month Ended January 31

Manufacturing costs: Direct labor Direct materials Factory overhead Total manufacturing cost

Standard Cost

Cost Variance—

Actual

at Actual Volume

(Favorable)

Costs

(3,600,000 Bottles)

Unfavorable

$ 46,750 175,000 52,900 $274,650

$ 45,000 172,800 54,000 $271,800

$ 1,750 2,200 (1,100) $ 2,850

$1.25 × (3,600,000 ÷ 100) = $45,000 $4.80 × (3,600,000 ÷ 100) = $172,800 $1.50 × (3,600,000 ÷ 100) = $54,000 c.

Lanier Bottle Company’s actual costs were $2,850 more than budgeted. The unfavorable direct labor and direct materials cost variances of $1,750 and $2,200 more than offset the favorable factory overhead cost variance of $(1,100).

Note to Instructors: The budget prepared in part (a) at the beginning of the month should not be used in the budget performance report because actual volumes were greater than planned (3,600,000 bottles vs. 3,500,000 bottles).

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–4 (FIN MAN); Ex. 9–4 (MAN) a.

Price variance: Direct Materials Price Variance

= (Actual Price – Standard Price) × Actual Quantity = ($2.75 per lb. – $2.70 per lb.) × 900,000 lbs. = $45,000 Unfavorable

Quantity variance: Direct Materials Quantity Variance

= (Actual Quantity – Standard Quantity) × Standard Price = (900,000 lbs. – 916,000 lbs.) × $2.70 per lb. = $(43,200) Favorable

Total direct materials cost variance: Direct Materials Cost Variance

Direct Materials Price Variance + Direct Materials Quantity Variance

= $45,000 Unfavorable + $(43,200) Favorable = $1,800 Unfavorable

The direct materials price variance should normally be reported to the Purchasing Department, which may or may not be able to control this variance. If materials of the same quality were purchased from another supplier at a price higher than the standard price, the variance was controllable. However, if the variance resulted from a market-wide price increase, the variance was not subject to control. The direct materials quantity variance should be reported to the proper level of operating management. For example, if lower amounts of direct materials had been used because of production efficiencies, the variance would be reported to the production supervisor. However, if the favorable use of raw materials had been caused by the purchase of higher-quality raw materials, the variance should be reported to the Purchasing Department. The total materials cost variance should be reported to senior plant management, such as the plant manager or materials manager.

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–5 (FIN MAN); Ex. 9–5 (MAN) Price variance: Direct Materials Price Variance

= (Actual Price – Standard Price) × Actual Quantity = ($1.80 per unit* – $1.90 per unit) × 15,250 = $(1,525) Favorable

* $27,450 ÷ 15,250 units = $1.80 per unit Quantity variance: Direct Materials Quantity Variance

= (Actual Quantity – Standard Quantity) × Standard Price = (15,250 units – 15,000 units) × $1.90 per unit = $475 Unfavorable

Total direct materials cost variance: Direct Materials Cost Variance

Direct Materials Price Variance + Direct Materials Quantity Variance

= $(1,525) + $475 = $(1,050) Favorable

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–6 (FIN MAN); Ex. 9–6 (MAN) 1,400 units

Product finished……………………………………………………… Standard finished product for direct materials used (3,000 lbs. ÷ 2 lbs.)………………………………………………… Deficiency of finished product for materials used…………

(1,500) (100) units

Standard cost for direct materials: Quantity variance divided by deficiency of product for materials used ($1,000 ÷ 100 units)………………………

$10.00 per unit

Alternate solution: Price variance, unfavorable…………………………………… ÷ Materials used…………………………………………………… Price variance per lb., unfavorable…………………………… Unit price of direct materials…………………………………… Less price variance (unfavorable) per lb. (from above)…… Standard price per lb. …………………………………………… × Pounds per unit of product…………………………………… Standard direct materials cost per unit of product…………

$1,500 ÷ 3,000 lbs. $ 0.50 $ 5.50 (0.50) $ 5.00 2 × $10.00

Proof: Direct Materials Price Variance

= (Actual Price – Standard Price) × Actual Quantity = ($5.50 – $5.00) × 3,000 = $1,500 Unfavorable

Direct Materials Quantity Variance

= (Actual Quantity – Standard Quantity) × Standard Price = (3,000 lbs. – 2,800 lbs.) × $5.00 = $1,000 Unfavorable

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–7 (FIN MAN); Ex. 9–7 (MAN) a.

Whole tomatoes…… Vinegar……………… Corn syrup………… Salt…………………

Standard Quantity ×

Standard Price

5,000 lbs. 350 gal. 40 gal. 125 lbs.

$0.75 per lb. 0.90 per gal. 7.50 per gal. 1.80 per lb.

Standard Cost per Batch $3,750 315 300 225

$4,590 ÷ ÷ Pounds per batch………………………………………… 7,650 lbs. $ 0.60 per lb. b.

Actual Quantity for Batch 08-99 – 4,900 375 36 140

lbs. gal. gal. lbs.

Standard Quantity per = Batch

Quantity Difference

5,000 lbs. 350 gal. 40 gal. 125 lbs.

(100) lbs. 25 gal. (4) gal. 15 lbs.

Standard Price $0.75 per lb. 0.90 per gal. 7.50 per gal. 1.80 per lb.

Materials Quantity Variance $(75.00) F 22.50 U (30.00) F 27.00 U $(55.50) F

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–8 (FIN MAN); Ex. 9–8 (MAN) a.

Rate variance: Direct Labor Rate Variance

(Actual Rate per Hour – Standard Rate per Hour) × Actual Hours

= ($29.50 – $30.00) × 9,300 hours = $(4,650) Favorable

Time variance: Direct Labor Time Variance

(Actual Direct Labor Hours – Standard Direct Labor Hours) × Standard Rate per Hour

= (9,300 hrs. – 9,000 hrs.) × $30.00 per hour = $9,000 Unfavorable

Total direct labor cost variance: Direct Labor Cost Variance

= Direct Labor Rate Variance + Direct Labor Time Variance = $(4,650) Favorable + $9,000 Unfavorable = $4,350 Unfavorable

The employees may have been less-experienced workers who were paid less than more-experienced workers or poorly trained, thereby resulting in a lower labor rate than planned. The lower level of experience or training may have resulted in less efficient performance. Thus, the actual time required was more than standard. Unfortunately, the lost efficiency was not offset by the lower labor rate.

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–9 (FIN MAN); Ex. 9–9 (MAN) a.

Rate variance: Direct Labor Rate Variance

(Actual Rate per Hour – Standard Rate per Hour) × Actual Hours

= ($32.00 – $30.00) × 2,600 hrs. = $5,200 Unfavorable

Time variance: Direct Labor Time Variance

(Actual Direct Labor Hours – Standard Direct Labor Hours) × Standard Rate per Hour

= (2,600 hrs. – 2,500 hrs.*) × $30.00 per hour = $3,000 Unfavorable

* 5.0 hrs. × 500 units Total direct labor cost variance: Direct Labor Cost Variance

= Direct Labor Rate Variance + Direct Labor Time Variance = $5,200 Unfavorable + $3,000 Unfavorable = $8,200 Unfavorable

Debit to Work in Process: $75,000 Standard hours at actual production…………………………………… × Standard rate……………………………………………………………… Standard direct labor cost…………………………………………………

2,500 hrs. ×$30.00 $75,000

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–10 (FIN MAN); Ex. 9–10 (MAN) a.

(1) Cutting Department Rate variance: Direct Labor Rate Variance

(Actual Rate per Hour – Standard Rate per Hour) × Actual Hours

= ($16.50 – $18.00) × 12,800 hours = $(19,200) Favorable

Time variance: Direct Labor Time Variance

(Actual Direct Labor Hours – Standard Direct Labor Hours) × Standard Rate per Hour

= (12,800 hrs. – 12,000 hrs.*) × $18.00 per hour = $14,400 Unfavorable

* 0.3 hr. × 40,000 units Total direct labor cost variance: Direct Labor Cost Variance

= Direct Labor Rate Variance + Direct Labor Time Variance = $(19,200) Favorable + $14,400 Unfavorable = $(4,800) Favorable

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–10 (FIN MAN); Ex. 9–10 (MAN) (Concluded) (2) Sewing Department Rate variance: Direct Labor Rate Variance

(Actual Rate per Hour – Standard Rate per Hour) × Actual Hours

= ($19.25 – $18.00) × 19,600 hours = $24,500 Unfavorable

Time variance: Direct Labor Time Variance

(Actual Direct Labor Hours – Standard Direct Labor Hours) × Standard Rate per Hour

= (19,600 hrs. – 20,000 hrs.*) × $18.00 per hour = $(7,200) Favorable

* 0.5 hr. × 40,000 units Total direct labor cost variance: Direct Labor Cost Variance

= Direct Labor Rate Variance + Direct Labor Time Variance = $24,500 Unfavorable + $(7,200) Favorable = $17,300 Unfavorable

The two departments have opposite results. The Cutting Department has a favorable rate variance and an unfavorable time variance, resulting in a total favorable cost variance of $4,800. In contrast, the Sewing Department has an unfavorable rate variance but has a favorable time variance, resulting in a total unfavorable cost variance of $17,300. The causes of this disparity are worthy of investigation. There are many possible causes including tight or loose standards, inferior or superior operating methods, and inappropriate or appropriate use of overtime. Combining both departments, the overall operation shows an unfavorable cost variance of $12,500 ($17,300 – $4,800) as a result of the weak performance in the Sewing Department.

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–11 (FIN MAN); Ex. 9–11 (MAN) a.

Rate variance: Direct Labor Rate Variance

(Actual Rate per Hour – Standard Rate per Hour) × Actual Hours = ($15.40 – $16.00) × 16 hours

= $(9.60) Favorable

Time variance: Direct Labor Time Variance

(Actual Direct Labor Hours – Standard Direct Labor Hours) × Standard Rate per Hour

= (16 hrs. – 14 hrs.*) × $16.00 per hour = $32.00 Unfavorable * The standard direct labor hours for 70 meals is 14 hours, computed as follows: 70 meals × 0.2 hour (standard direct labor per meal) = 14 hours.

Total direct labor cost variance: Direct Labor Cost Variance

= Direct Labor Rate Variance + Direct Labor Time Variance = $(9.60) Favorable + $32.00 Unfavorable = $22.40 Unfavorable

The mobile kitchen must be staffed with at least two employees to meet demand (70 meals). Employees are unable to move to another truck once they are assigned for the day. As a result, an unfavorable time variance will occur any time the number of meals actually made falls below the maximum number of meals that could be generated by two employees. In this case, two employees were assigned to the truck with the potential to make 80 meals [16 standard hours (2 employees × 8 hours per day) ÷ 0.2 standard hour per meal]. Mexicali On the Go could reduce the time variance and improve the profitability of the Donna’s Mobile Fiesta by targeting locations that could allow it to increase sales volume to 80 meals, the maximum that could be produced by two employees.

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–12 (FIN MAN); Ex. 9–12 (MAN) Step 1: Determine the standard direct materials and direct labor per unit. Standard direct materials quantity per unit: Direct materials lbs. budgeted for April: $40,000 $2.00 per lb.

= 20,000 lbs.

Standard pounds per unit: 20,000 lbs. 50,000 units

= 0.4 standard lb. per unit

Standard direct labor time per unit: Direct labor hrs. budgeted for April: $600,000 $16.00 per hr.

= 37,500 direct labor hrs.

Standard direct labor hrs. per unit: 37,500 hrs. 50,000 units

= 0.75 standard direct labor hr. per unit

Step 2: Using the standard quantity and time rates in Step 1, determine the standard costs for the actual April production. Standard direct materials at actual volume: 48,500 units × 0.4 lb. per unit × $2.00………………………………………… Standard direct labor at actual volume: 48,500 units × 0.75 direct labor hr. per unit × $16.00……………………… Total……………………………………………………………………………………

$ 38,800 582,000 $620,800

Step 3: Determine the direct materials quantity and direct labor time variances, assuming no direct materials price or direct labor rate variances. Actual direct materials used in production……………………………………… Standard direct materials (Step 2)………………………………………………… Direct materials quantity variance—unfavorable*………………………………

$ 41,800 (38,800) $ 3,000

* (20,900 lbs. – 19,400 lbs.) × $2.00 = 3,000 U $41,800 ÷ $2.00 = 20,900 lbs. $38,800 ÷ $2.00 = 19,400 lbs.

Actual direct labor…………………………………………………………………… $ 572,800 Standard direct labor (Step 2)……………………………………………………… (582,000) Direct labor time variance—favorable**………………………………………… $ (9,200) ** 48,500 units × 0.75 hr. = 36,375 standard hrs. $572,800 ÷ $16.00 = 35,800 actual hrs. (35,800 hrs. – 36,375 hrs.) × $16.00 = $(9,200) F

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–13 (FIN MAN); Ex. 9–13 (MAN) Leno Manufacturing Company Factory Overhead Cost Budget—Press Department For the Month Ended November 30 Direct labor hours Variable overhead costs: Indirect factory labor1 2 Power and light 3 Indirect materials Total variable factory overhead cost Fixed factory overhead costs: Supervisory salaries Depreciation of plant and equipment Insurance and property taxes Total fixed factory overhead cost Total factory overhead cost 1 2 3

18,000

20,000

22,000

$162,000 10,800 57,600 $230,400

$180,000 12,000 64,000 $256,000

$198,000 13,200 70,400 $281,600

$ 80,000 50,000 32,000 $162,000 $392,400

$ 80,000 50,000 32,000 $162,000 $418,000

$ 80,000 50,000 32,000 $162,000 $443,600

$9.00 per hr. = $180,000 ÷ 20,000 hrs. $0.60 per hr. = $12,000 ÷ 20,000 hrs. $3.20 per hr. = $64,000 ÷ 20,000 hrs.

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–14 (FIN MAN); Ex. 9–14 (MAN) a.

Wiki Wiki Company Monthly Factory Overhead Cost Budget—Fabrication Department Direct labor hours Variable factory overhead cost Fixed factory overhead cost Total factory overhead cost

9,000

10,000

11,000

$ 40,500 60,000 $100,500

$ 45,000 60,000 $105,000

$ 49,500 60,000 $109,500

Overhead applied at actual production: Actual hours…………………………………………………………………… × Overhead application rate*………………………………………………… Factory overhead applied………………………………………………………

9,000 hrs. × $10.50 $94,500

* Total factory overhead rate to be applied to production: Variable factory overhead…………………………………………… $ 4.50 6.00 Fixed factory overhead**…………………………………………… Total……………………………………………………………………… $10.50

** Fixed factory overhead rate:

$60,000 10,000 hrs.

= $6.00 per hr.

Note: The fixed factory overhead rate is determined at normal production.

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–15 (FIN MAN); Ex. 9–15 (MAN) Variable factory overhead controllable variance: Actual variable factory overhead cost incurred………… Budgeted variable factory overhead for 14,000 hrs. [14,000 × ($25.00 – $6.00)]………………………………… Variance—favorable………………………………………

$ 262,000 (266,000) $(4,000)

Fixed factory overhead volume variance: Productive capacity at 100%……………………………… Standard for amount produced…………………………… Productive capacity not used……………………………… × Standard fixed factory overhead rate………………… Variance—unfavorable………………………………… Total factory overhead cost variance—unfavorable*………

15,000 hrs. (14,000) hrs. 1,000 hrs. × $6.00

* Actual Overhead – Applied Overhead = Total Overhead Variance: ($262,000 + $90,000) – $350,000 = $2,000

6,000 $ 2,000

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–15 (FIN MAN); Ex. 9–15 (MAN) (Concluded) Alternative Computation of Overhead Variances Factory Overhead Actual costs Balance (underapplied) Actual Factory Overhead $352,000

352,000

Applied costs

350,000

2,000 Applied Factory Overhead

Budgeted Factory Overhead for Amount Produced Variable cost [14,000 × ($25.00 – $6.00)]……… $266,000 90,000 Fixed cost…………………………………………… Total…………………………………………………… $356,000 $(4,000) F Controllable Variance

$6,000 U Volume Variance $2,000 U Total Factory Overhead Cost Variance

$350,000

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–16 (FIN MAN); Ex. 9–16 (MAN) a. Controllable variance: Actual variable factory overhead ($1,280,000 – $720,000)…………………… $ 560,000 Standard variable factory overhead at actual production: Standard hours at actual production……………………… 141,300 hrs. × Variable factory overhead rate1…… × $3.75 (529,875) Standard variable factory overhead…… Controllable variance—unfavorable………

$30,125

b. Volume variance: Volume at 100% of normal capacity………………………… 150,000 hrs. Less standard hours…………………………………………… (141,300) hrs. Idle capacity…………………………………………………… 8,700 hrs. × Fixed overhead rate2………………………………………… × $4.80 Volume variance—unfavorable……………………………… Total factory overhead cost variance—unfavorable……………………………………… 1

Variable factory overhead rate:

Fixed factory overhead rate:

$525,000 140,000 hrs. $720,000 150,000 hrs.

= $3.75 per hour

= $4.80 per hour

Actual Overhead – Applied Overhead = Total Overhead Variance: $1,280,000 – [($3.75 + $4.80) × 141,300 hrs.] = $71,885

41,760 $71,885

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–16 (FIN MAN); Ex. 9–16 (MAN) (Concluded) Alternative Computation of Overhead Variances Factory Overhead Actual costs Balance (underapplied) Actual Factory Overhead

1,280,000 71,885

Applied costs

Applied Factory Overhead

Budgeted Factory Overhead for Amount Produced

$1,280,000

Variable cost (141,300 × $3.75)…………………$ 529,875 720,000 Fixed cost………………………………………… Total………………………………………………… $1,249,875 $30,125 U Controllable Variance

1,208,115 *

$1,208,115 *

$41,760 U Volume Variance $71,885 U Total Factory Overhead Cost Variance

* ($3.75 + $4.80) × 141,300

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–17 (FIN MAN); Ex. 9–17 (MAN) In determining the volume variance, the productive capacity overemployed (2,000 hours) should be multiplied by the standard fixed factory overhead rate of $3.80 ($7.30 – $3.50) to yield a favorable variance of $7,600. The variance analysis provided by the chief cost accountant incorrectly multiplied the 2,000 hours by the total factory overhead rate of $7.30 per hour and reported it as unfavorable. A correct determination of the factory overhead cost variances is as follows: Variable factory overhead controllable variance: Actual variable factory overhead cost incurred………… Budgeted variable factory overhead for 132,000 hours (132,000 × $3.50)…………………………………… Variance—favorable………………………………………

$ 458,000 (462,000) $ (4,000)

Fixed factory overhead volume variance: Productive capacity at 100%………………………………… Standard for amount produced…………………………… Productive capacity overemployed………………………… × Standard fixed factory overhead rate…………………… Variance—favorable……………………………………… Total factory overhead cost variance—favorable……………

130,000 hrs. (132,000) (2,000) hrs. × $3.80

(7,600) $(11,600)

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–17 (FIN MAN); Ex. 9–17 (MAN) (Concluded) Alternative Computation of Overhead Variances

Actual costs ($458,000 + $494,000)

Factory Overhead 952,000 Applied costs

963,600

[($3.50 + $3.80) × 132,000] Balance (overapplied) 11,600

Actual Factory Overhead

Budgeted Factory Overhead for Amount Produced

Applied Factory Overhead

$952,000

Variable cost (132,000 × $3.50)……… $462,000 494,000 Fixed cost………………………………… $956,000 Total………………………………………

$963,600

$(4,000) F Controllable Variance

$(7,600) F Volume Variance $(11,600) F Total Factory Overhead Cost Variance

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–18 (FIN MAN); Ex. 9–18 (MAN) Tannin Products Inc. Factory Overhead Cost Variance Report—Trim Department For the Month Ended July 31 Productive capacity for the month Actual productive capacity used for the month

25,000 hrs. 22,000 hrs. Actual Cost

Budget (at Actual Variances Production) Unfavorable (Favorable)

Variable factory overhead costs:1 Indirect factory labor Power and light Indirect materials Total variable factory overhead cost Fixed factory overhead costs: Supervisory salaries Depreciation of plant and equipment Insurance and property taxes Total fixed factory overhead cost Total factory overhead cost Total controllable variances

$ 49,700 13,000 24,000

$ 50,600 13,200 22,000

$ 86,700

$ 85,800

$ 54,500

40,000 35,500

$130,000 $216,700

$130,000 $215,800

$ 2,000

Net controllable variance—unfavorable Volume variance—unfavorable:

Idle hours at the standard rate for fixed factory overhead:2 (25,000 hrs. – 22,000 hrs.) × $5.20 Total factory overhead cost variance—unfavorable 1

$ (900) (200)

900

15,600 $16,500

The budgeted variable factory overhead costs are determined by multiplying 22,000 hours by the variable factory overhead cost rate for each variable cost category. These rates are determined by dividing each budgeted amount (estimated at the beginning of the month) by the planned (budgeted) volume of 20,000 hours. Thus, for example: $50,600 = ($46,000 ÷ 20,000 hrs.) × 22,000 hrs. $13,200 = ($12,000 ÷ 20,000 hrs.) × 22,000 hrs. $22,000 = ($20,000 ÷ 20,000 hrs.) × 22,000 hrs.

Fixed factory overhead rate:

$130,000 25,000 hrs.

$(1,100)

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–18 (FIN MAN); Ex. 9–18 (MAN) (Concluded) Alternative Computation of Overhead Variances Actual costs

Factory Overhead 216,700 Applied costs

Balance (underapplied)

16,500

200,200

[22,000 × ($3.90* + $5.20)]

Actual Factory Overhead

Budgeted Factory Overhead for Amount Produced

Applied Factory Overhead

$216,700

Variable cost (22,000 × $3.90)…………… $ 85,800 Fixed cost…………………………………… 130,000 Total………………………………………… $215,800

$200,200

$900 U Controllable Variance

$15,600 U Volume Variance $16,500 U Total Factory Overhead Cost Variance

*$78,000 ÷ 20,000 hours budgeted at the beginning of the month

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–19 (FIN MAN); Ex. 9–19 (MAN) Materials1 2 Direct Materials Price Variance

118,825 8,575

127,400

Accounts Payable 1 2 3

2,450 × $48.50 2,450 × $3.50 ($52.00 – $48.50) 2,450 × $52.00 1

Work in Process

97,000 2

4,850

Direct Materials Quantity Variance 3

92,150

Materials 1 2 3

200 × 10 units × $48.50 (2,000 units – 1,900 units) × $48.50 1,900 × $48.50

Ex. 23–20 (FIN MAN); Ex. 9–20 (MAN) Mar.

31 Work in Process

198,000

Direct Labor Time Variance

9,000

Direct Labor Rate Variance Wages Payable2 1

5,000 × 2.20 hrs. × $18.00 Direct labor time variance: (11,500 – 11,000) × $18.00 = $9,000 U Direct labor rate variance: ($17.60 – $18.00) × 11,500 = $(4,600) F

11,500 hours × $17.60 per hour

4,600 202,400

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Ex. 23–21 (FIN MAN); Ex. 9–21 (MAN) Griggs Company Income Statement For the Month Ended December 31 Sales Cost of goods sold—at standard Gross profit—at standard

$ 868,000 (550,000) $ 318,000 Unfavorable

Variances from standard cost: Direct materials price Direct materials quantity Direct labor rate Direct labor time Variable factory overhead controllable Fixed factory overhead volume Net variance from standard cost— unfavorable Gross profit Operating expenses: Selling expenses Administrative expenses Total operating expenses Income from operations Other expense: Interest expense Operating income

1,680 — — 490 — 3,080

Favorable $

— (560) (1,120) — (210) — (3,360) $ 314,640

$125,000 100,800 (225,800) $ 88,840 (2,940) $ 85,900

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Appendix Ex. 23–22 (FIN MAN); Ex. 9–22 (MAN) a.

Revenue Price Variance =

(Planned Selling Price − Actual Selling Price) × Actual Units Sold

= ($150 − $144) × 12,900 units = 77,400 Unfavorable b.

Revenue Volume Variance

(Planned Units Sold − Actual Units Sold) × Planned Selling Price

= (12,500 units − 12,900 units) × $150 = $(60,000) Favorable c.

Total Revenue Variance = Revenue Price Variance + Revenue Volume Variance = $77,400 + $(60,000) = $17,400 Unfavorable

Appendix Ex. 23–23 (FIN MAN); Ex. 9–23 (MAN) a.

Revenue Price Variance =

(Planned Selling Price − Actual Selling Price) × Actual Units Sold

= ($5.80 − $6.00) × 805,000 units = $(161,000) Favorable b.

Revenue Volume Variance

(Planned Units Sold − Actual Units Sold) × Planned Selling Price

= (820,000 units − 805,000 units) × $5.80 = $87,000 Unfavorable c.

Total Revenue Variance = Revenue Price Variance + Revenue Volume Variance = $(161,000) + $87,000 = $(74,000) Favorable

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Appendix Ex. 23–24 (FIN MAN); Ex. 9–24 (MAN) a.

$12, computed as follows: (Planned Selling Price − Actual Selling Price) = Revenue Price Variance × Actual Units Sold (Planned Selling Price − Actual Selling Price) = $(350,000) × 175,000 units ($10 × 175,000 units) − = $(350,000) (Actual Selling Price × 175,000 units) $1,750,000 − (Actual Selling Price × 175,000 units) = $(350,000) (Actual Selling Price × 175,000 units) = $(350,000) + $(1,750,000) (Actual Selling Price × 175,000 units) = $(2,100,000) Actual Selling Price = $(2,100,000) ÷ 175,000 units Actual Selling Price = $12

180,000 units, computed as follows: (Planned Units to Be Sold − Actual Units Sold) = Revenue Volume Variance × Planned Selling Price (Planned Units to Be Sold − 175,000 units ) × $10 = $50,000 (Planned Units to Be Sold × $10) − $1,750,000 = $50,000 (Planned Units to Be Sold × $10) = $50,000 + $1,750,000 Planned Units to Be Sold = $1,800,000 ÷ $10 Planned Units to Be Sold = 180,000 units

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Appendix Ex. 23–25 (FIN MAN); Ex. 9–25 (MAN) a.

Normal Revenue = Normal Selling Price × Normal Units Sold = $20 × 125,000 units = $2,500,000

Planned Revenue = Planned Selling Price × Planned Units Sold = $19 × [125,000 units + (125,000 units × 16%)] = $19 × 145,000 units = $2,755,000

Actual Revenue for Nov. = Actual Selling Price × Actual Units Sold = $19 × 135,000 units = $2,565,000

Revenue Price Variance =

(Planned Selling Price − Actual Selling Price) × Actual Units Sold

= ($19 − $19) × 135,000 units = $0 e.

Revenue Volume Variance =

(Planned Units Sold − Actual Units Sold) × Planned Selling Price

= (145,000 units − 135,000 units) × $19 = $190,000 Unfavorable f.

Decreasing the selling price to $19 did increase total revenue to $2,565,000 from $2,500,000, but it did not increase the revenues by 16% as planned. Instead, revenues only increased by $65,000 ($2,565,000 − $2,500,000) or 2.6% ($65,000 ÷ $2,500,000). This resulted in an unfavorable revenue volume variance of $190,000.

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

PROBLEMS Prob. 23–1A (FIN MAN); Prob. 9–1A (MAN) a.

Standard Materials and Labor Cost per Faucet

Direct materials ($0.80 × 0.4 lb.)……………………………………………… Direct labor [$21.00 × (15 min. ÷ 60 min.)]……………………………………

$0.32 5.25 $5.57

Direct Materials Cost Variance Price variance: Direct Materials = (Actual Price – Standard Price) × Actual Quantity Price Variance = ($0.90 per lb. – $0.80 per lb.) × 4,500 lbs. = $450 Unfavorable

Quantity variance: Direct Materials = (Actual Quantity – Standard Quantity) × Standard Price Quantity Variance = (4,500 lbs. – 4,000 lbs.*) × $0.80 per lb. = $400 Unfavorable

* 10,000 units × 0.4 lb. Total direct materials cost variance: Direct Materials Direct Materials Price Variance + = Cost Variance Direct Materials Quantity Variance = $450 Unfavorable + $400 Unfavorable = $850 Unfavorable

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Prob. 23–1A (FIN MAN); Prob. 9–1A (MAN) (Concluded) Direct Labor Cost Variance

c. Rate variance: Direct Labor Rate Variance

(Actual Rate per Hour – Standard Rate per Hour) × Actual Hours

= ($22.00 – $21.00) × 1,710* hrs. = $1,710 Unfavorable

* 45 employees × 38 hrs. Time variance: Direct Labor Time Variance

(Actual Direct Labor Hours – Standard Direct Labor Hours) × Standard Rate per Hour

= (1,710 hrs.* – 2,500 hrs.**) × $21.00 per hour =

$(16,590) Favorable

* 45 employees × 38 hrs. ** 10,000 units × (15 min. ÷ 60 min.) Total direct labor cost variance: Direct Labor Cost Variance

= Direct Labor Rate Variance + Direct Labor Time Variance = $1,710 Unfavorable + $(16,590) Favorable = $(14,880) Favorable

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Prob. 23–2A (FIN MAN); Prob. 9–2A (MAN) 1.

Direct Materials Variance

Cocoa

Sugar

Total

Price variance: Actual price……………………………………… Standard price………………………………… Variance………………………………………… × Actual quantity……………………………… Direct materials price variance…………

4.90 (4.75)

1.24 (1.20)

$ 0.15 ×85,000

$ 0.04 ×53,000

$12,750 U

$ 2,120 U

Actual quantity used…………………………… Standard quantity1………………………………

85,000 (84,000)

53,000 (54,500)

Variance………………………………………… × Standard price………………………………… Direct materials quantity variance………

1,000 × $4.75

(1,500) × $1.20 $(1,800) F

$14,870 U

Quantity variance:

$ 4,750 U

2,950 U $17,820 U

Total direct materials cost variance…………… Alternatively, total direct materials cost variance: Actual cost 2…………………………………… Standard cost 3………………………………… Total direct materials cost variance…… 1

$ 416,500 (399,000)

$ 65,720 (65,400)

$ 17,500 U

320 U

$17,820 U

84,000 = (8 lbs. × 4,500 actual production of dark chocolate) + (6 lbs. × 8,000 actual production of light chocolate) 54,500 = (5 lbs. × 4,500 actual production of dark chocolate) + (4 lbs. × 8,000 actual production of light chocolate)

$416,500 = $4.90 × 85,000 lbs. $65,720 = $1.24 × 53,000 lbs.

$399,000 = $4.75 × 84,000 lbs. $65,400 = $1.20 × 54,500 lbs.

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Prob. 23–2A (FIN MAN); Prob. 9–2A (MAN) (Concluded) 1.

b. Dark Chocolate

Light Chocolate

$ 15.25 (15.50)

$ 15.80 (15.50)

$ (0.25) × 2,200 $ (550) F

$ 0.30 × 4,400 $ 1,320 U

Actual time…………………………………… Standard time 1………………………………

2,200 (2,250)

4,400 (4,800)

Variance……………………………………… × Standard rate……………………………… Direct labor time variance………………

(50) ×$15.50 $ (775) F

(400) ×$15.50 $ (6,200) F

Direct Labor Variance

Total

Rate variance: Actual rate…………………………………… Standard rate………………………………… Variance……………………………………… × Actual time………………………………… Direct labor rate variance………………

770 U

Time variance:

(6,975) F $(6,205) F

Total direct labor cost variance……………… Alternatively, total direct labor cost variance: Actual cost 2………………………………… Standard cost 3……………………………… Total direct labor cost variance……… 1

$ 33,550 (34,875)

$ 69,520 (74,400)

$ (1,325) F

$ (4,880) F

$(6,205) F

2,250 = 0.50 hr. × 4,500 actual production of dark chocolate 4,800 = 0.60 hr. × 8,000 actual production of light chocolate

$33,550 = 2,200 hrs. × $15.25 $69,520 = 4,400 hrs. × $15.80

$34,875 = 2,250 hrs. × $15.50 $74,400 = 4,800 hrs. × $15.50

The variance analyses should be based on the standard amounts at actual volumes. The budget must flex with the volume changes. If the actual volume is different from the planned volume, as it was in this case, then the budget used for performance evaluation should reflect the amount of direct materials and direct labor that will be required for the actual production. In this way, spending from volume changes can be separated from efficiency and price variances.

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Prob. 23–3A (FIN MAN); Prob. 9–3A (MAN) Direct Materials Cost Variance

a. Price variance: Direct Materials Price Variance

= (Actual Price – Standard Price) × Actual Quantity = ($6.50 per lb. – $6.40 per lb.) × 237,000 lbs. = $23,700 Unfavorable

Quantity variance: Direct Materials Quantity Variance

= (Actual Quantity – Standard Quantity) × Standard Price = (237,000 lbs. – 240,000 lbs.) × $6.40 per lb. = $(19,200) Favorable

Total direct materials cost variance: Direct Materials Cost Variance

Direct Materials Price Variance + Direct Materials Quantity Variance

= $23,700 + $(19,200) = $4,500 Unfavorable

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Prob. 23–3A (FIN MAN); Prob. 9–3A (MAN) (Continued) Direct Labor Cost Variance

b. Rate variance: Direct Labor Rate Variance

(Actual Rate per Hour – Standard Rate per Hour) × Actual Hours

= ($25.00 – $24.20) × 11,500 hrs. = $9,200 Unfavorable

Time variance: Direct Labor Time Variance

(Actual Direct Labor Hours – Standard Direct Labor Hours) × Standard Rate per Hour

= (11,500 hrs. – 12,000 hrs.) × $24.20 per hour =

$(12,100) Favorable

Total direct labor cost variance: Direct Labor Cost Variance

= Direct Labor Rate Variance + Direct Labor Time Variance = $9,200 + $(12,100) = $(2,900) Favorable

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Prob. 23–3A (FIN MAN); Prob. 9–3A (MAN) (Continued) c.

Factory Overhead Cost Variance Variable factory overhead controllable variance: Actual variable factory overhead cost incurred…………… Budgeted variable factory overhead for 12,000 hrs.* ……… Variance—unfavorable………………………………………

$ 32,400 (30,000) ** $ 2,400

Fixed factory overhead volume variance: Normal capacity at 100%………………………………………… Standard for amount produced………………………………… Productive capacity not used………………………………… × Standard fixed factory overhead cost rate………………… Variance—unfavorable………………………………………

15,000 hrs. (12,000) hrs. 3,000 hrs. × $5.00

Total factory overhead cost variance—unfavorable……………

* 40,000 units × 0.3 hour per unit ** 12,000 hrs. × $2.50

15,000 $17,400

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Prob. 23–3A (FIN MAN); Prob. 9–3A (MAN) (Concluded) Alternative Computation of Overhead Variances Actual costs ($32,400 + $75,000) Balance (underapplied)

90,000

[12,000 × ($2.50 + $5.00)] 17,400 Budgeted Factory Overhead for Amount Produced

Actual Factory Overhead $107,400

Factory Overhead 107,400 Applied costs

Applied Factory Overhead

Variable cost (12,000 × $2.50)………… Fixed cost…………………………………

$ 30,000 75,000

Total…………………………………………

$105,000

$2,400 U Controllable Variance

$15,000 U Volume Variance $17,400 U Total Factory Overhead Cost Variance

$90,000

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Prob. 23–4A (FIN MAN); Prob. 9–4A (MAN) Tiger Equipment Inc. Factory Overhead Cost Variance Report—Welding Department For the Month Ended May 31 8,400 hrs. 8,860 hrs.

Normal capacity for the month Actual production for the month

Actual Cost

Budget Variances (at Actual Production) Unfavorable (Favorable)

Variable factory overhead costs:1 Indirect factory wages Power and light Indirect materials Total variable cost Fixed factory overhead costs: Supervisory salaries Depreciation of plant and equipment Insurance and property taxes Total fixed cost Total factory overhead cost Total controllable variances

$ 32,400 21,000 18,250 $ 71,650

$ 31,896 21,264 17,720 $ 70,880

$ 20,000

36,200 15,200 $ 71,400 $143,050

36,200 15,200 $ 71,400 $142,280

504 $(264) 530

$ 1,034 $

Net controllable variance—unfavorable Volume variance—favorable: Excess hours used over normal at the standard rate for fixed factory overhead:2 (8,400 hrs. – 8,860 hrs.) × $8.50

770

(3,910)

Total factory overhead cost variance—favorable 1

$(3,140)

The budgeted variable costs are determined by multiplying the 8,860 actual hours by the variable overhead rate (the May budget divided by 8,400 hours for each variable overhead cost). Thus, Indirect factory wages, $31,896 = 8,860 hrs. × ($30,240 ÷ 8,400 hrs.) Power and light, $21,264 = 8,860 hrs. × ($20,160 ÷ 8,400 hrs.) Indirect materials, $17,720 = 8,860 hrs. × ($16,800 ÷ 8,400 hrs.)

Fixed factory overhead rate:

$71,400 8,400 hrs.

= $8.50 per hr.

$(264)

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Prob. 23–4A (FIN MAN); Prob. 9–4A (MAN) (Concluded) Alternative Computation of Overhead Variances Factory Overhead Actual costs

143,050

Applied costs* [8,860 × ($8.00 + $8.50)] Balance (overapplied)

146,190 3,140

Actual Factory Overhead

Budgeted Factory Overhead for Amount Produced

Applied Factory Overhead

$143,050

Variable cost (8,860 × $8.00)…………… $ 70,880 71,400 Fixed cost…………………………………… Total………………………………………… $142,280

$146,190

$770 U Controllable Variance

$(3,910) F Volume Variance $(3,140) F Total Factory Overhead Cost Variance

*$67,200 ÷ 8,400 hrs. = $8.00 $71,400 ÷ 8,400 hrs. = $8.50

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Prob. 23–5A (FIN MAN); Prob. 9–5A (MAN) 1.

* 2.

4,650 lines 25 lines per hr.

14 $32 × $ 448

= 186 hrs. 200 (226)

Actual hours provided (5 × 40 hrs.)……………………………………………… Standard hours required for the actual results*……………………………… Labor time difference……………………………………………………………… × Standard labor rate……………………………………………………………… Direct labor time variance—favorable…………………………………………… *

200 (186)

Actual hours provided (5 × 40 hrs.)……………………………………………… Standard hours required for the original plan*………………………………… Labor time difference……………………………………………………………… × Standard labor rate……………………………………………………………… Direct labor time variance—unfavorable………………………………………

5,650 lines 25 lines per hr.

(26) $32 × $(832)

= 226 hrs.

Actual labor rate…………………………………………………………………… Standard labor rate………………………………………………………………… Difference…………………………………………………………………………… × Actual hours provided (5 × 40 hrs.)…………………………………………… Direct labor rate variance—unfavorable…………………………………………

40 (32)

$ 8 × 200 $1,600

The labor cost variance is $768 unfavorable [$(832) favorable time variance + $1,600 unfavorable rate variance]. 4.

Actual hours provided (6 × 40 hrs.)……………………………………………… Standard hours required for the actual results*……………………………… Labor time difference……………………………………………………………… × Standard labor rate……………………………………………………………… Direct labor time variance—unfavorable………………………………………

240 (226) 14 × $32 $ 448

* From part (2) above 5.

Hiring an extra employee is less costly than the bonus by $320. The direct labor cost variance for paying the bonus was $768 unfavorable, which is the sum of the time variance and the rate variance [$(832) F + $1,600 U] shown in parts (2) and (3) above. The cost variance that would result from hiring another employee would have been $448 unfavorable, shown in part (4) above. Thus, the net benefit for hiring another employee over paying the bonus is $320 ($768 U – $448 U).

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Prob. 23–1B (FIN MAN); Prob. 9–1B (MAN) a.

Standard Materials and Labor Cost per Unit

Direct materials ($5.00 × 5.0 yds.)……………………………………………… Direct labor [$12.00 × (12 min. ÷ 60 min.)]……………………………………

$25.00 2.40 $27.40

Direct Materials Cost Variance Price variance: Direct Materials Price Variance

= (Actual Price – Standard Price) × Actual Quantity = ($5.10 per yd. – $5.00 per yd.) × 26,200 yds. = $2,620 Unfavorable

Quantity variance: Direct Materials Quantity Variance

= (Actual Quantity – Standard Quantity) × Standard Price = (26,200 yds. – 26,100 yds.*) × $5.00 per yd. = $500 Unfavorable

* 5,220 units × 5.0 yds. Total direct materials cost variance: Direct Materials Cost Variance

Direct Materials Price Variance + Direct Materials Quantity Variance

= $2,620 + $500 = $3,120 Unfavorable

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Prob. 23–1B (FIN MAN); Prob. 9–1B (MAN) (Concluded) Direct Labor Cost Variance

c. Rate variance: Direct Labor Rate Variance

(Actual Rate per Hour – Standard Rate per Hour) × Actual Hours

= ($11.80 – $12.00) × 1,000 hrs.* = $(200) Favorable

* 25 employees × 40 hrs. Time variance: Direct Labor Time Variance

(Actual Direct Labor Hours – Standard Direct Labor Hours) × Standard Rate per Hour

= (1,000 hrs. – 1,044 hrs.*) × $12.00 per hour = $(528) Favorable

* (12 min. ÷ 60 min.) × 5,220 Total direct labor cost variance: Direct Labor Cost Variance

= Direct Labor Rate Variance + Direct Labor Time Variance = $(200) + $(528) = $(728) Favorable

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Prob. 23–2B (FIN MAN); Prob. 9–2B (MAN) 1.

Direct Materials Variance

Filler

Liner

Total

Price variance: Actual price………………………………… Standard price……………………………… Variance……………………………………… × Actual quantity…………………………… Direct materials price variance………

1.90 (2.00)

8.20 (8.00)

$ (0.10) × 48,000 $ (4,800) F

$ 0.20 × 85,100 $17,020 U

Actual quantity used……………………… Standard quantity used 1…………………

48,000 (47,760)

85,100 (85,320)

Variance……………………………………… × Standard price…………………………… Direct materials quantity variance…

240 × $2.00 $ 480 U

(220) × $8.00 $(1,760) F

$12,220 U

Quantity variance:

(1,280) F $10,940 U

Total direct materials cost variance………… Alternatively, total direct materials cost variance: Actual cost 2………………………………… Standard cost 3……………………………… Total direct materials cost variance… 1

$ 91,200 (95,520)

$ 697,820 (682,560)

$ (4,320) F

$ 15,260 U

$10,940 U

47,760 = (4.0 lbs. × 4,400 actual production of women's coats) + (5.20 lbs. × 5,800 actual production of of men’s coats) 85,320 = (7.00 yds. × 4,400 actual production of women's coats) + (9.40 yds. × 5,800 actual production of men’s coats)

$91,200 = $1.90 × 48,000 lbs. $697,820 = $8.20 × 85,100 yds.

$95,520 = $2.00 × 47,760 lbs. $682,560 = $8.00 × 85,320 yds.

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Prob. 23–2B (FIN MAN); Prob. 9–2B (MAN) (Concluded) 1.

Direct Labor Variance

Women's Coats

Men's Coats

Total

Rate variance: $ 14.10 (14.00)

$ 13.30 (13.00)

$ 0.10 × 1,825 $182.50 U

$ 0.30 × 2,800 $840.00 U

Actual time…………………………………… Standard time 1………………………………

1,825 (1,760)

2,800 (2,900)

Variance……………………………………… × Standard rate……………………………… Direct labor time variance……………

65 ×$14.00 $910.00 U

(100) × $13.00 $(1,300.00) F

Actual rate…………………………………… Standard rate………………………………… Variance……………………………………… × Actual time………………………………… Direct labor rate variance………………

$1,022.50 U

Time variance:

(390.00) F $ 632.50 U

Total direct labor cost variance……………… Alternatively, total direct labor cost variance: Actual cost 2………………………………… Standard cost 3………………………………

$ 25,732.50 (24,640.00)

Total direct labor cost variance……… $ 1,092.50 U 1

$ 37,240.00 (37,700.00) $

(460.00) F

$ 632.50 U

1,760 = 0.40 hr. × 4,400 actual production of women’s coats 2,900 = 0.50 hr. × 5,800 actual production of men’s coats

$25,732.50 = 1,825 hrs. × $14.10 $37,240.00 = 2,800 hrs. × $13.30

$24,640.00 = 1,760 hrs. × $14.00 $37,700.00 = 2,900 hrs. × $13.00

The variance analyses should be based on the standard amounts at actual volumes. The budget must flex with the volume changes. If the actual volume is different from the planned volume, as it was in this case, then the budget used for performance evaluation should reflect the change in direct materials and direct labor that will be required for the actual production. In this way, spending from volume changes can be isolated from efficiency and price variances.

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Prob. 23–3B (FIN MAN); Prob. 9–3B (MAN) Direct Materials Cost Variance

a. Price variance: Direct Materials Price Variance

= (Actual Price – Standard Price) × Actual Quantity = ($6.50 per lb. – $6.40 per lb.) × 101,000 lbs. = $10,100 Unfavorable

Quantity variance: Direct Materials Quantity Variance

= (Actual Quantity – Standard Quantity) × Standard Price = (101,000 lbs. – 100,000 lbs.) × $6.40 per lb. = $6,400 Unfavorable

Total direct materials cost variance: Direct Materials Cost Variance

Direct Materials Price Variance + Direct Materials Quantity Variance

= $10,100 Unfavorable + $6,400 Unfavorable = $16,500 Unfavorable

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Prob. 23–3B (FIN MAN); Prob. 9–3B (MAN) (Continued) Direct Labor Cost Variance

b. Rate variance: Direct Labor Rate Variance

(Actual Rate per Hour – Standard Rate per Hour) × Actual Hours

= ($15.40 – $15.75) × 2,000 hrs. = $(700) Favorable

Time variance: Direct Labor Time Variance

(Actual Direct Labor Hours – Standard Direct Labor Hours) × Standard Rate per Hour

= (2,000 hrs. – 2,080 hrs.) × $15.75 per hour = $(1,260) Favorable

Total direct labor cost variance: Direct Labor Cost Variance

= Direct Labor Rate Variance + Direct Labor Time Variance = $(700) + $(1,260) = $(1,960) Favorable

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Prob. 23–3B (FIN MAN); Prob. 9–3B (MAN) (Continued) c.

Factory Overhead Cost Variance Variable factory overhead controllable variance: Actual variable factory overhead cost incurred…………… Budgeted variable factory overhead for 2,080 hrs.* ……… Variance—favorable…………………………………………

$ 8,200 (8,320)** $(120)

Fixed factory overhead volume variance: Normal capacity at 100%……………………………………… Standard for amount produced……………………………… Productive capacity overemployed…………………………… × Standard fixed factory overhead cost rate……………… Variance—favorable…………………………………………

2,000 hrs. (2,080) hrs. (80) hrs. $6.00 ×

Total factory overhead cost variance—favorable………………

* 4,160 units × 0.5 hr. ** 2,080 hrs. × $4.00

(480) $(600)

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Prob. 23–3B (FIN MAN); Prob. 9–3B (MAN) (Concluded) Alternative Computation of Overhead Variances Factory Overhead Actual costs

20,200

($8,200 + $12,000)

20,800

[2,080 × ($4.00 + $6.00)] Balance (overapplied) Budgeted Factory Overhead for Amount Produced

Actual Factory Overhead $20,200

Applied costs

Variable cost (2,080 × $4.00)…………… Fixed cost…………………………………… Total………………………………………… $(120) F Controllable Variance

(600) Applied Factory Overhead

$ 8,320 12,000 $20,320 $(480) F Volume Variance

$(600) F Total Factory Overhead Cost Variance

$20,800

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Prob. 23–4B (FIN MAN); Prob. 9–4B (MAN) Feeling Better Medical Inc. Factory Overhead Cost Variance Report—Assembly Department For the Month Ended October 31 30,000 hrs. 28,500 hrs.

Normal capacity for the month Actual production for the month

Actual Cost

Budget (at Actual Production)

$234,000 178,500 50,600 $463,100

$235,125 179,550 49,875 $464,550

$126,000

70,000 44,000 $240,000 $703,100

70,000 44,000 $240,000 $704,550

Variances Unfavorable (Favorable)

Net controllable variance—favorable Volume variance—unfavorable: Idle hours at the standard rate for fixed factory overhead:2 (30,000 hrs. – 28,500 hrs.) × $8.00 Total factory overhead cost variance—unfavorable 1

$(1,125) (1,050) $

725

$ (1,450)

12,000 $10,550

The budgeted variable costs are determined by multiplying 28,500 actual hours by the variable overhead rate (the October budget divided by 30,000 hours for each variable overhead cost). Thus, Indirect factory wages, $235,125 = 28,500 hrs. × ($247,500 ÷ 30,000 hrs.) Power and light, $179,550 = 28,500 hrs. × ($189,000 ÷ 30,000 hrs.) Indirect materials, $49,875 = 28,500 hrs. × ($52,500 ÷ 30,000 hrs.)

Fixed factory overhead rate:

$240,000 = $8.00 per hr. 30,000 hrs.

$(2,175)

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Prob. 23–4B (FIN MAN); Prob. 9–4B (MAN) (Concluded) Alternative Computation of Overhead Variances Factory Overhead Actual costs

703,100

Balance (underapplied)

10,550

Applied costs*

692,550

[28,500 × ($16.30 + $8.00)]

Actual Factory Overhead

Budgeted Factory Overhead for Amount Produced

Applied Factory Overhead

$703,100

Variable cost (28,500 × $16.30)………… $464,550 Fixed cost…………………………………… 240,000 Total………………………………………… $704,550

$692,550

$(1,450) F Controllable Variance

$12,000 U Volume Variance $10,550 U Total Factory Overhead Cost Variance

* $489,000 ÷ 30,000 hrs. = $16.30 $240,000 ÷ 30,000 hrs. = $8.00

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

Prob. 23–5B (FIN MAN); Prob. 9–5B (MAN) 1.

Actual hours provided (3 × 40 hrs.)……………………………………………… Standard hours required for the original plan*………………………………… Labor time difference………………………………………………………………… × Standard labor rate………………………………………………………………… Direct labor time variance—unfavorable………………………………………… *

88,900 lines 700 lines per hr.

3 $23 × $ 69

= 117 hrs.

Actual hours provided (3 × 40 hrs.)……………………………………………… Standard hours required for the actual results*………………………………… Labor time difference………………………………………………………………… × Standard labor rate………………………………………………………………… Direct labor time variance—favorable…………………………………………… *

81,900 lines 700 lines per hr.

120 (117)

120 (127) (7) × $23

$(161)

= 127 hrs.

Actual labor rate……………………………………………………………………… Standard labor rate…………………………………………………………………… Difference……………………………………………………………………………… × Actual hours provided (3 × 40 hrs.)…………………………………………… Direct labor rate variance—unfavorable…………………………………………

$ 30 (23) $

× 120

$ 840

The labor cost variance is $679 unfavorable [$(161) favorable time variance + $840 unfavorable rate variance]. 4.

Actual hours provided (4 × 40 hrs.)……………………………………………… Standard hours required for the actual results………………………………… Labor time difference………………………………………………………………… × Standard labor rate………………………………………………………………… Direct labor time variance—unfavorable…………………………………………

160 (127) 33 $23 × $ 759

The bonus is the better approach by $80. The direct labor cost variance for paying the bonus was $679 unfavorable which is the sum of the time variance and rate variance from parts (2) and (3) above [$(161) F + $840 U]. The cost variance that would result from hiring another employee would have been $759 unfavorable from part (4) above. Thus, the net benefit for paying the bonus over hiring another employee is $80 ($679 U – $759 U).

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

COMPREHENSIVE PROBLEM 5 Part A 1.

Variable Cost per Unit =

Difference in Total Cost Difference in Production $740 – $600 = $0.20 per case 1,200 cases – 500 cases

Total Cost = (Variable Cost per Unit × Units of Production) + Fixed Cost

At the high point:

At the low point:

$740 = ($0.20 × 1,200 units) + Fixed Cost

$600 = ($0.20 × 500 units) + Fixed Cost

Fixed Cost = $500

Selling price…………………………………………………………… Variable costs per case: Direct materials…………………………………………………… Direct labor………………………………………………………… Utilities [see part (1)]……………………………………………… Selling expenses…………………………………………………… Total variable costs per case……………………………………… Contribution margin per case………………………………………

$100.00 $17.00 7.20 0.20 20.00

Total fixed costs: Utilities [see part (1)]…………………………………………………………… Facility lease……………………………………………………………………… Equipment depreciation………………………………………………………… Supplies……………………………………………………………………………

Break-Even Sales (units) =

Fixed Costs Unit Contribution Margin

Break-Even Sales (units) =

$19,460 $55.60

= 350 cases

(44.40) $ 55.60

$ 500 14,000 4,300 660 $19,460

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

COMPREHENSIVE PROBLEM 5 (Continued) Part B Genuine Spice Inc. Production Budget For the Month Ended August 31

Cases

Expected cases to be sold Desired ending inventory Total units available Estimated beginning inventory Total units to be produced

1,500 175 1,675 (300) 1,375

Genuine Spice Inc. Direct Materials Purchases Budget For the Month Ended August 31

1 2 3

Cream Base (ozs.)

Natural Oils (ozs.)

Bottles (bottles)

Units required for production Desired ending inventory Estimated beginning inventory

137,5001 1,000 (250)

41,2502 360 (290)

16,500 3 240 (600)

Direct materials to be purchased × Unit price Total direct materials to be purchased

138,250 $0.02 $2,765

41,320 $0.30 $12,396

16,140 $0.50 $8,070

$23,231

Mixing

Filling

Total

4581 $18.00 $8,244

1152 $14.40 $1,656

$9,900

Total

Cream base: 1,375 cases × 100 ozs. = 137,500 ozs. Natural oils: 1,375 cases × 30 ozs. = 41,250 ozs. Bottles: 1,375 cases × 12 bottles = 16,500 bottles

Genuine Spice Inc. Direct Labor Budget For the Month Ended August 31 Hours required for production of: Hand and body lotion × Hourly rate Total direct labor cost 1 2

Mixing: (1,375 cases × 20 min.) ÷ 60 min. = 458 hrs. Filling: (1,375 cases × 5 min.) ÷ 60 min. = 115 hrs.

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

COMPREHENSIVE PROBLEM 5 (Continued) Genuine Spice Inc. Factory Overhead Budget For the Month Ended August 31

Factory overhead: Utilities Facility lease Equipment depreciation Supplies Total 1 2

Fixed1

Variable2

$ 500 14,000 4,300 660 $19,460

$275

Total

775 14,000 4,300 660 $19,735

$275

Fixed costs [from part (3)] Variable utility cost: $0.20 × 1,375 cases = $275

Genuine Spice Inc. Budgeted Income Statement For the Month Ended August 31

Sales Finished goods inventory, August 1 Direct materials inventory, August 12 Direct materials purchases [from part (6)] 3

Direct materials inventory, August 31 Cost of direct materials for production Direct labor [from part (7)] Factory overhead [from part (8)] Finished goods inventory, August 31 Cost of goods sold Gross profit

$150,000 $12,000 $ 392 23,231 (248) $23,375 9,900 19,735

53,010 (7,000)

Selling expenses Operating income 1 2 3 4

(58,010) $ 91,990 (30,000) $ 61,990

Sales: 1,500 cases × $100 per case = $150,000 Direct materials inventory, August 1: (250 × $0.02) + (290 × $0.30) + (600 × $0.50) = $392 Direct materials inventory, August 31: (1,000 × $0.02) + (360 × $0.30) + (240 × $0.50) = $248 Selling expenses: 1,500 cases × $20 per case = $30,000

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

COMPREHENSIVE PROBLEM 5 (Continued) Part C 10. Direct materials price variance: Cream Base

Actual price………………………… Standard price……………………… Difference…………………………… × Actual quantity (units)*………… Direct materials price variance…

0.016 (0.020) $ (0.004) × 153,000 ozs. $ (612) F

Natural Oils

0.32 (0.30)

$ 0.02 ×46,500 ozs. $ 930 U

Bottles

0.42 (0.50)

$ (0.08) × 18,750 btls. $ (1,500) F

* Actual quantity: Cream base: 1,500 cases × 102 ozs. = 153,000 ozs. Natural oils: 1,500 cases × 31 ozs. = 46,500 ozs. Bottles: 1,500 cases × 12.5 bottles = 18,750 bottles

The fluctuation in market prices caused the direct materials price variances. Prices increased for natural oils compared to standard and declined for cream base and bottles compared to standard.

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

COMPREHENSIVE PROBLEM 5 (Continued) Direct materials quantity variance: Cream Base 1

Actual quantity …………………………

153,000 ozs. 2 Standard quantity ……………………… (150,000) Difference………………………………… 3,000 ozs. × Standard price………………………… × $0.02 60 U Direct materials quantity variance…… $

Natural Oils

Bottles

46,500 ozs. (45,000)

18,750 btls. (18,000)

1,500 ozs. × $0.30 $ 450 U

750 btls. $0.50 × $ 375 U

Note: All the direct materials quantity variances were unfavorable, indicating some material losses, scrap, and quality rejections. All the quantity variances were unfavorable because the standards were set at ideal quantity amounts. Thus, only unfavorable variances were possible. The standard quantities were ideal standards for 12 8-ounce bottles per case (96 ozs. total), as shown below. 1

Actual quantity: Cream base: 1,500 cases × 102 ozs. = 153,000 ozs. Natural oils: 1,500 cases × 31 ozs. = 46,500 ozs. Bottles: 1,500 cases × 12.5 bottles = 18,750 bottles Standard quantity: Cream base: 1,500 cases × 100 ozs. = 150,000 ozs. Natural oils: 1,500 cases × 30 ozs. = 45,000 ozs. Bottles: 1,500 cases × 12 bottles = 18,000 bottles

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

COMPREHENSIVE PROBLEM 5 (Continued) 11. Direct labor rate variance: Actual rate…………………………………………… Standard rate………………………………………… Difference……………………………………………… × Actual time (hours)1……………………………… Direct labor rate variance……………………………

Mixing Department

Filling Department

$ 18.20 (18.00)

$ 14.00 (14.40)

$ 0.20 × 487.5 hrs. $ 97.50 U

$ (0.40) × 140.00 hrs. $ (56.00) F

The Mixing Department has an unfavorable direct labor rate variance from using a higher classification of labor. The higher labor classification costs an additional $0.20 per hour. The Filling Department has a favorable direct labor rate variance due to using a lower classification of labor. The lower labor classification saved $0.40 per hour. Direct labor time variance:

Mixing Department

Actual time (hours) ………………………………… 2

Standard time (hours) ……………………………… Difference……………………………………………… × Standard rate……………………………………… Direct labor time variance………………………… 1

Filling Department

487.5 hrs. (500.0) hrs.

140.0 hrs. (125.0) hrs.

(12.5) hrs. × $18.00 $ (225) F

15.0 hrs. ×$14.40 $ 216 U

Actual time: Mixing: (1,500 units × 19.50 min.) ÷ 60 min. = 487.5 hrs. Filling: (1,500 units × 5.60 min.) ÷ 60 min. = 140.0 hrs. Standard time: Mixing: (1,500 units × 20.00 min.) ÷ 60 min. = 500.0 hrs. Filling: (1,500 units × 5.00 min.) ÷ 60 min. = 125.0 hrs.

The Mixing Department is producing at a labor time that is slightly better than standard, thus producing a favorable direct labor time variance. This may be the result of using a higher grade of labor. The net impact for the Mixing Department is favorable by $127.50 [$97.50 + $(225)]. The Filling Department had an unfavorable direct labor time variance. This may be the result of using a lower grade of labor in the department. The net impact for the department is unfavorable by $160.00 [$216.00 + $(56.00)]. Thus, the savings in the labor rate from using a lower grade classification of labor was insufficient to offset the loss of efficiency from such labor.

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

COMPREHENSIVE PROBLEM 5 (Continued) 12. Factory overhead controllable variance: Actual variable overhead……………………………………………… Variable overhead at standard cost*………………………………… Factory overhead controllable variance……………………………

$ 305 (300) $ 5 U

* Variance overhead (utility cost) at standard cost: $0.20 × 1,500 cases = $300 The unfavorable controllable variance indicates actual variable overhead exceeded the budgeted variable overhead for the actual production of 1,500 cases. 13. Factory overhead volume variance: 1,600 cases Normal volume……………………………………..…………………… Actual volume………………………………………………..………… (1,500) cases Difference………………………………………………………………… 100 cases × Fixed factory overhead rate*………………………………………… × $12.1625 $1,216.25 U * Fixed factory overhead rate: $19,460** ÷ 1,600 cases = $12.1625 per case ** Total fixed factory overhead shown in part (8) The unfavorable volume variance indicates the cost of underused capacity of 100 cases per month.

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

COMPREHENSIVE PROBLEM 5 (Concluded) Alternative Computation of Overhead Variances Factory Overhead Actual costs

19,765.00

($19,460 + $305) Balance (underapplied)

1,221.25

Applied costs

18,543.75

[1,500 × ($12.1625 + $0.20)]

Actual

Budgeted Factory

Factory

Overhead for Amount

Factory

Overhead

Produced

Overhead

$19,765.00

Applied

Variable cost (1,500 × $0.20)…………… $ Fixed cost…………………………………

300.00 19,460.00

$18,543.75

Total………………………………………… $19,760.00 $5.00 U

$1,216.25 U

Controllable

Volume

Variance

Variance $1,221.25 U Total Factory Overhead Cost Variance

14. The production volume of 1,375 cases determined in part (5) was planned at the beginning of August. The variances compare the actual cost and the standard cost of actual production for the month. Thus, the standard cost must be based on the 1,500 units of actual production. This amount is compared with an actual cost also based on 1,500 units. The variable costs of the budget must flex to the actual production volume so that variances are compared across the same production volume.

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

MAKE A DECISION MAD 23–1 (FIN MAN); MAD 9–1 (MAN) a. Standard hours for coding: Lines of code ÷ Level 2 standard lines per hour Standard hours at Level 2 coding standard

1,400 ÷ 50 28

Direct Labor Time Variance = (Actual Staff Hours – Standard Staff Hours) × Standard Rate per Hour = (40 hrs. – 28 hrs.) × $35 per hour = $420 Unfavorable Note that the standard rate per hour is set at the Level 2 rate for this Level 2 project. We are comparing the Level 1 performance to the Level 2 standard. The Level 1 programmer is not as efficient as a Level 2 programmer on a Level 2 project. Therefore, there is an unfavorable labor time variance. b.

Direct Labor Rate Variance = (Actual Rate per Hour – Standard Rate per Hour) × Actual Hours = ($25 – $35) × 40 hrs. = $(400) Favorable The Level 1 programmer has a lower labor rate than the Level 2 programmer. Thus, there is a favorable direct labor rate variance.

c. The amount of the unfavorable time variance is greater than the amount of the favorable rate variance. Thus, this analysis suggests that it is not cost effective to use a Level 1 programmer on a Level 2 project. The Level 1 programmer’s lower cost per hour does not make up for the slower coding performance.

MAD 23–2 (FIN MAN); MAD 9–2 (MAN) a.

Number of employees Hours per week Total actual hours for the week Labor rate per hour Actual staff cost

b. Standard time (in minutes) Number of admissions Total minutes Divide by 60 min. Number of standard hours

4 40 160 × $15 $2,400 ×

Unscheduled 30 × 140 4,200 ÷ 60 min. 70

Scheduled 15 × 340 5,100 ÷ 60 min. 85

Total

9,300 ÷ 60 min. 155

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

MAD 23–2 (FIN MAN); MAD 9–2 (MAN) (Concluded) c.

Direct Labor Time Variance = (Actual Staff Hours – Standard Staff Hours) × Standard Rate per Hour = (160 hrs. – 155 hrs.) × $15 per hour = $75 Unfavorable The actual hours exceeded the standard hours; thus, the variance is unfavorable.

The first, and most obvious, factor is the mix of admissions. If the mix of admissions becomes more heavily weighted toward unscheduled admissions, then the variance will be negatively impacted. This mix is not controllable by the department. Additional causes for an unfavorable variance would be labor inefficiency, incomplete data, lack of staff training, lack of standard operating procedures in the Admissions Department, computer downtime, and difficult admissions caused by age, illness, or language.

MAD 23–3 (FIN MAN); MAD 9–3 (MAN) a.

Standard Sorts per Minute × Standard Sorts per Hour = Standard Minutes per Hour (per employee) 90 sorts per min. × 60 min. per hr. = 5,400 standard sorts per hr. Pieces of Mail ÷ = Number of Hours Planned Standard Sorts per Hour 24,192,000 letters ÷ 5,400 sorts per hr. = 4,480 hrs. planned Number of Hours Planned ÷ Hours per = Number of Hires Temporary Employee per Month 4,480 hrs. ÷ 160 hrs. = 28 temporary hires for December

Actual pieces sorted = 23,895,000 Standard Number of Hours Actual Pieces of Mail Sorted ÷ = for Actual Production Standard Sorts per Hour 23,895,000 ÷ 5,400 standard sorts per hr. =

4,425 standard hrs. for actual production

Actual hours staffed…………………………………………………………… Standard hours for actual production……………………………………… Excess of actual over standard hours……………………………………… × Standard hourly rate………………………………………………………… Direct labor time variance—unfavorable……………………………………

4,480 hrs. (4,425) hrs. 55 hrs. × $17 $ 935

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

MAD 23–4 (FIN MAN); MAD 9–4 (MAN) a. 33,900 hours × $25 per hour = $847,500 total budgeted cost b. Police Activity Theft Arrest Patrol activities Number of standard hours

Actual Hours per Activity 0.75 2.00 0.40

Actual Activities for Year 7,000 18,000 9,000

Total Employee Hours 5,250 36,000 3,600 44,850

44,850 × $25 per hour = $1,121,250 c

Direct labor time variance Actual cost Budgeted cost Time variance (unfavorable)

$1,121,250 (847,500) $ 273,750

d. All three police activities are consuming more time per activity than planned. This creates an unfavorable time variance. The causes for this variance should be identified. Possible considerations are changes in legal and arrest procedures, improper training, improper staffing, crime congestion, or other impacts that would cause the time per activity to increase.

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

TAKE IT FURTHER TIF 23–1 (FIN MAN); TIF 9–1 (MAN) The use of ideal standards is a legitimate concern for Henry. It is likely that such standards are too tight and do not include the necessary fatigue factors that are typical in this type of operation. It seems as though Henry is arguing for practical standards that can be attained if the operation is running well. Maybe some standard in between is warranted, but that is not the issue. The issue is Dash’s method of operation. Dash has effectively agreed to have this dispute decided by a senior official. However, Dash is trying to seal the fate of the argument behind the scenes, before the issue is discussed openly as agreed. Moreover, Dash is attributing poor motives to Henry behind his back. Dash may have short-term success with this method of operation, but in the long term, he will likely alienate himself within the organization. He may create a distrustful environment that would eventually hamper his ability to provide open, honest feedback. People eventually may avoid him and hide the truth from him. TIF 23–2 (FIN MAN); TIF 9–2 (MAN) This is a case where there is strong evidence that the poor performance that is occurring inside the Assembly Department may be the result of behaviors outside of the department. This is one of the classic problems with variance analysis. Often, the variances reflect causes outside of the responsibility center manager’s control. That is what appears to be happening here. The Assembly supervisor complains that both the purchased parts and incoming material from the Fabrication Department have been giving them trouble. A review of performance reports reveals the following: (1) the materials price variance is very favorable; (2) the Fabrication Department’s labor time variance is also very favorable. A possible explanation is that the Purchasing Department found a low-price supplier. The low price translated into a favorable variance. Unfortunately, it appears the company is “getting what it paid for.” Specifically, it appears that the quality of the purchased parts has gone down, thus making assembly much more difficult in the Assembly Department. The Fabrication Department may be performing work faster than standard—again, resulting in a favorable labor time variance. It may be that the department is working too fast. Specifically, the speed is resulting in poor fabrication quality. Again, the Assembly Department is bearing the cost of poorly fabricated parts. The problem in both instances is that the variances measure only productivity and price savings but not quality. As a result, there are strong incentives to purchase from lowest bidders, work fast, cut corners, and push work on through. Unfortunately, the company is worse off, as a whole, due to this set of situations. The sum of the unfavorable variances in Assembly exceeds the favorable variances in the other departments. The analyst will need to confirm these suspicions. If they are supported, the company may wish to introduce quality measures in addition to the variance information in order to avoid the counterproductive behaviors in Purchasing and Fabrication. 23-65 © 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

TIF 23–3 (FIN MAN); TIF 9–3 (MAN) To:

Plant Manager

From: Controller Re:

Variable Factory Overhead Variances

I have reviewed your concerns related to the recent variable overhead cost variance report that indicates the plant incurred a total variable factory overhead unfavorable variance of $12,320. My analysis of the variable nature of the three costs covered in the report follows. The supplies costs are likely variable to machine usage and number of units produced. Likewise, except for the power required to keep the business open, power and light costs vary with the amount of energy used in the plant, which varies with the number of units produced. However, these two costs are not where most of the unfavorable variance of $12,320 arises. The major cause of the unfavorable variance appears to originate with indirect factory wages. Indirect factory wages generated $8,500 of the $12,320 unfavorable variance, which is almost 70% of the total variance. The variance of $8,500 is 28% ($8,500 ÷ $30,600) higher than the standard. This is much greater than the 10% difference between the existing production volume and full capacity. In other words, more is being spent on indirect wages than would even be implied by 100% production. You may be correct that indirect factory wages are not completely variable. Let’s schedule a meeting to discuss this further, including what actions we might take to better control and report indirect factory wages costs. TIF 23–4 (FIN MAN); TIF 9–4 (MAN) 1. Direct materials variance:

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

TIF 23–4 (FIN MAN); TIF 9–4 (MAN) (Continued) Direct labor variance:

Both visualizations show that the actual costs have outpaced the standard costs. However, neither visualization shows whether this is the result of a price/rate variance or an input (direct labor hours, direct materials quantity) variance.

Direct materials price variance:

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

TIF 23–4 (FIN MAN); TIF 9–4 (MAN) (Continued) Direct materials quantity variance:

Because 13 of the 18 direct materials price variances are favorable, this indicates that the actual price is lower than the standard price. However, the more recent trend is toward unfavorable variances (actual price greater than standard price). Because the computed direct materials quantity variances are (on median) always greater than zero, this indicates that employees are consistently using more than the standard 350 pounds of stainless steel per unit.

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

TIF 23–4 (FIN MAN); TIF 9–4 (MAN) (Continued) 5.

Direct labor price variance:

Direct labor time variance:

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

TIF 23–4 (FIN MAN); TIF 9–4 (MAN) (Concluded) 6.

The direct labor price variances are generally unfavorable. Additionally, all recent direct labor price variances are unfavorable. This indicates that the actual price for labor is greater than the standard price. Because the computed direct labor time variances are (on median) always greater than zero, this indicates that employees are consistently spending more time than the standard 12 hours of labor per unit.

CHAPTER 23 (FIN MAN); CHAPTER 9 (MAN)

Evaluating Variances from Standard Costs

CERTIFIED MANAGEMENT ACCOUNTANT (CMA®) EXAMINATION QUESTIONS (ADAPTED) 1.

d. The actual wage rate per hour is $7.50, and the actual hours worked equal 38, computed as follows: Actual hours: (X − 40 hours) × $7.00 = $(14.00) X − 40 hours = (2) X = 38 hours Wage rate: (X − $7.00) × 38 hours = (X − $7.00) = X =

$19.00 $0.50 $7.50

b. The materials variance of $11,000 should be investigated, because it exceeds 10% of the budgeted amount ($100,000 × 0.10). The direct labor variance is $4,000, which is less than 10% of budget ($50,000 × 0.10), so it would not be investigated under the company policy.

d. Frisco’s direct materials price variance is $10,800 favorable, computed as follows: Actual price per unit: Standard price per unit: Direct materials price variance:

$583,200 ÷ 108,000 units = $5.40 $16.50 ÷ 3 units = $5.50 ($5.40 − $5.50) × 108,000 units = $(10,800) Favorable

b. JoyT’s variable factory overhead controllable variance is $2,000 unfavorable, computed as follows: Variable Factory Overhead = Controllable Variance

Actual Variable Factory Overhead

–

Budgeted Variable Factory Overhead

= $596,000 − (9,900 × $60*) = $596,000 − $594,000 = $2,000 Unfavorable * $600,000 ÷ 10,000 = $60

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN) EVALUATING DECENTRALIZED OPERATIONS DISCUSSION QUESTIONS 1.

In a centralized operation, all major planning and operating decisions are made by top management. In a decentralized operation, managers of separate divisions or units are delegated operating responsibility. The division (unit) managers are responsible for planning and controlling the operations of their divisions. Divisions are often structured around products, customers, or regions.

The department manager of a profit center has responsibility for and authority over costs and revenues, while the manager of an investment center has responsibility for and authority over controlling investments in assets as well as costs and revenues.

Payroll: Number of checks issued. Accounts payable: Number of invoices paid. Accounts receivable: Number of sales invoice payments collected. Database administration: Number of reports generated.

The major shortcoming of using operating income as a measure of investment center performance is that it ignores the amount of investment committed to each center. Because investment center managers also control the amount of assets invested in their centers, they should be held accountable for the use of invested assets.

A division of a decentralized company could be considered the least profitable, even though it earned the largest amount of operating income, when its return on investment is the lowest. In this situation, the division would be considered the least profitable per dollar invested in the division because it generated less profit out of each dollar of assets invested.

By dividing operating income by the amount of invested assets, each division is placed on a comparable basis of operating income per dollar invested.

(a) Although a new investment’s rate of return exceeds the minimum acceptable for the company as a whole, a divisional manager might reject the investment if it would decrease the manager’s current rate of return. (b) The use of residual income as a performance measure can overcome this disadvantage of the return on investment.

The objective of transfer pricing is to encourage each division manager to work in the best interests of the company. Thus, transfer prices should encourage managers to transfer goods between divisions if the overall company income can be increased.

When unused capacity exists in the supplying division, the negotiated price approach is preferred over the market price approach.

10.

When using the negotiated price approach to transfer pricing, the transfer price should be less than the market price but greater than the supplying division’s variable cost per unit.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

BASIC EXERCISES BE 24–1 (FIN MAN); BE 10–1 (MAN) $81,000 under budget ($36,000 + $45,000)

BE 24–2 (FIN MAN); BE 10–2 (MAN) Retail Division Service Charge for Data Analytics Department: $85,000 = 2,000 billed hours × ($340,000 ÷ 8,000 hours billed) Commercial Division Service Charge for Data Analytics Department: $255,000 = 6,000 billed hours × ($340,000 ÷ 8,000 hours billed)

BE 24–3 (FIN MAN); BE 10–3 (MAN)

Sales……………………………………………………… Cost of goods sold…………………………………… Gross profit……………………………………………… Selling expenses……………………………………… Operating income before support department allocations……………………………… Service department allocations……………………… Operating income………………………………………

Retail Division

Commercial Division

$ 2,550,000 (1,450,000)

$1,700,000 (750,000)

$ 1,100,000 (230,000)

$ 950,000 (170,000)

$ 780,000 (255,000) $ 525,000

870,000 (85,000) 785,000

BE 24–4 (FIN MAN); BE 10–4 (MAN) a. b. c.

Profit Margin = $44,000 ÷ $800,000 = 5.5% Investment Turnover = $800,000 ÷ $200,000 = 4.0 Return on Investment = 5.5% × 4.0 = 22%

BE 24–5 (FIN MAN); BE 10–5 (MAN) Operating income……………………………………………………………… Minimum acceptable operating income as a percent of assets ($80,500,000 × 15%)…………………………………… Residual income…………………………………………………………………

$ 12,680,000 (12,075,000) $ 605,000

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

BE 24–6 (FIN MAN); BE 10–6 (MAN) Increase in Nauvoo (Supplying) (Transfer Price – Variable Cost per Unit) = Division’s Operating Income × Units Transferred = ($72 – $65) × 15,000 units = $105,000 Increase in Harmony (Purchasing) (Market Price – Transfer Price) = Division’s Operating Income × Units Transferred = ($80 – $72) × 15,000 units = $120,000

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

EXERCISES Ex. 24–1 (FIN MAN); Ex. 10–1 (MAN) a. (a) $4,300,000 (b) $4,000,000 (c) $300,000 (d) $8,515,000 (e) $8,200,000 (f) $375,000

(g) (h) (i) (j) (k) (l)

$8,515,000 $8,200,000 $315,000 $18,890,000 $18,650,000 $315,000

Schedules of supporting calculations (answers in italics; the solution requires working from the department level, up to the plant level, then to the vice president of production level): Delmar Company Budget Performance Report—Vice President, Production For the Month Ended June 30 Plant

Eastern Region Central Region Western Region

Actual

Budget

$ 4,200,000 6,175,000 8,515,000 (g) $18,890,000 (j)

$ 4,250,000 6,200,000 8,200,000 (h) $18,650,000 (k)

(Under) Budget

Over Budget

$(50,000) (25,000) $315,000 (i) $315,000 (l)

$(75,000)

Delmar Company Budget Performance Report—Manager, Western Region Plant For the Month Ended June 30 Department

Chip Fabrication Electronic Assembly Final Assembly

Actual

Budget

$4,300,000 (a) 2,575,000 1,640,000 $8,515,000 (d)

$4,000,000 (b) 2,500,000 1,700,000 $8,200,000 (e)

(Under) Budget

Over Budget $300,000 (c) 75,000 $375,000 (f)

$(60,000) $(60,000)

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Ex. 24–1 (FIN MAN); Ex. 10–1 (MAN) (Concluded) Delmar Company Budget Performance Report—Supervisor, Chip Fabrication For the Month Ended June 30 Cost

Factory wages Materials Power and light Maintenance

Actual

Budget

$1,450,000 1,575,000 945,000 330,000 $4,300,000

$1,200,000 1,600,000 900,000 300,000 $4,000,000

Over Budget

(Under) Budget

$250,000 $(25,000) 45,000 30,000 $325,000

$(25,000)

MEMO To: Randi Wilkes, Vice President of Production The Western Region plant has experienced a budget overrun, while the Eastern and Central region plants have experienced a budget surplus. The budget of the Western Region plant reveals that the Chip Fabrication Department caused the majority of the budget overrun. The budget for the Chip Fabrication Department indicates that the budget overrun was caused by a combination of budget overruns in wages, power and light, and maintenance that exceeded a budget surplus in materials. The supervisor of the Chip Fabrication Department should investigate the reasons for the budget overruns in wages, power and light, and maintenance. It is possible that all three of these budget overruns have the same cause, such as a need for unplanned overtime or weekend work to meet schedules.

Ex. 24–2 (FIN MAN); Ex. 10–2 (MAN) Gonzaga Industries Inc. Divisional Income Statements For the Year Ended November 30, 20Y8

Sales Cost of goods sold Gross profit Administrative expenses Operating income before support department allocations Support department allocations Operating income

Commercial Division

Residential Division

$ 5,980,000 (3,550,000) $ 2,430,000 (740,000)

$ 2,825,000 (1,655,000) $ 1,170,000 (389,000)

$ 1,690,000 (800,000) $ 890,000

781,000 (200,000) $ 581,000

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Ex. 24–3 (FIN MAN); Ex. 10–3 (MAN) Support Department Costs

Cost Driver

a. b. c.

Legal Duplication services Electronic data processing

Central purchasing

e. f.

Telecommunications Accounts receivable

Number of hours of legal service Number of pages copied Central processing unit (CPU) time, number of printed pages, amount of memory usage Number of requisitions, number of purchase orders Number of phones, number of minutes used Number of invoices, number of customers

Ex. 24–4 (FIN MAN); Ex. 10–4 (MAN) a. b. c. d.

5 6 2 1

e. f. g. h.

7 8 4 3

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Ex. 24–5 (FIN MAN); Ex. 10–5 (MAN) a.

Government Residential

Commercial

Contract

Total

20,800 960 21,760

13,000 360 13,360

7,800 120 7,920

43,040

7,500

3,000

2,000

12,500

Service Dept. Cost

Cost Driver

Allocation = Rate

Support department allocation rates: Payroll Department…………………………

$64,560

43,040

Purchasing Department……………………

$40,000

12,500

= $1.50 per distribution = $3.20 per req.

Number of payroll checks: Weekly payroll × 52………… Monthly payroll × 12……… Total……………………… Number of purchase requisitions per year………… b.

Residential

Commercial

Government Contract

Support department allocations: Payroll Department………… $32,640 1 4 Purchasing Department…… 24,000 Total……………………… $56,640

$20,040 2 9,600 5 $29,640

$11,880 6,400 6 $18,280

21,760 checks × $1.50 per distribution

13,360 checks × $1.50 per distribution

7,920 checks × $1.50 per distribution

7,500 requisitions × $3.20 per requisition

3,000 requisitions × $3.20 per requisition

2,000 requisitions × $3.20 per requisition

Total

$64,560 40,000

The support department allocations are determined by multiplying the support department allocation rate by the cost driver for each division. c.

Residential’s support department allocations are higher than the other two divisions because Residential is a heavy user of support department services. Residential has many employees on a weekly payroll, which translates into a larger number of payroll transactions. This may be because residential jobs are less productive per labor hour compared to larger commercial and government contract jobs. In addition, Residential uses purchasing services more than the other two divisions. This may be because the division has many different smaller jobs requiring frequent purchase transactions.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Ex. 24–6 (FIN MAN); Ex. 10–6 (MAN) a.

= $25 per call

Network center:

$120,000 1,500 devices

= $80 per device monitored

Electronic mail:

$160,000 5,000 accounts

= $32 per user or email account

$72,000 4,000 smartphones

= $18 per smartphone issued

Smartphone support: b.

$90,000 3,600 calls

Help desk:

August allocations to COMM: Help desk allocation: (2,500 employees × 20% × 95% × 0.6) × $25/call = $7,125 Network center allocation: [(2,500 employees × 20% × 95%) + 400] × $80/device = $70,000 Electronic mail allocation: (2,500 employees × 20% × 95% × 100%) × $32/user or email account = $15,200 Smartphone support allocation: (2,500 employees × 20%) × $18/smartphone = $9,000

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Ex. 24–7 (FIN MAN); Ex. 10–7 (MAN) HortonTechnology Divisional Income Statements For the Year Ended December 31, 20Y7

Revenues Cost of goods sold Gross profit Operating expenses Operating income before support department allocations Support department allocations: Tech Services Department (Note 1) Purchasing Department (Note 2) Total support department allocations Operating income

Consumer

Commercial

Division

$ 15,500,000 (10,000,000) $ 5,500,000 (3,000,000)

$ 33,250,000 (15,800,000) $ 17,450,000 (1,750,000)

$ 2,500,000

$ 15,700,000

(715,000) (150,000) $ (865,000) $ 1,635,000

(455,000) (300,000) $ (755,000) $ 14,945,000

Supporting calculations for controllable support department allocations: Note 1:

Consumer Division ($1,170,000 ÷ 1,800 computers) × 1,100 computers = $715,000 Commercial Division ($1,170,000 ÷ 1,800 computers) × 700 computers = $455,000

Note 2:

Consumer Division ($450,000 ÷ 12,000 orders) × 4,000 orders = $150,000 Commercial Division ($450,000 ÷ 12,000 orders) × 8,000 orders = $300,000

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Ex. 24–8 (FIN MAN); Ex. 10–8 (MAN) a. The reported operating income does not accurately measure performance because the support department allocations are based on revenues. Revenues are not associated with the profit center manager’s use of the support department services. For example, the Reservations Department serves only the Passenger Division. Thus, by allocating this cost on the basis of revenues, these costs are incorrectly allocated to the Cargo Division. In addition, the Passenger Division requires additional personnel. Because these personnel must be trained, the training costs assigned to the Passenger Division should be greater than the Cargo Division. b. Rocky Mountain Airlines Inc. Divisional Income Statements For the Year Ended December 31, 20Y9

Revenues Operating expenses Operating income before support department allocations: Support department allocations: Training (Note 1) Flight scheduling (Note 2) Reservations (Note 3) Total support department allocations Operating income

Passenger

Cargo

Division

$ 4,200,000 (2,700,000)

$ 4,200,000 (3,500,000)

$ 1,500,000

$ (270,000) (220,000) (750,000) $(1,240,000) $ 260,000

700,000

(90,000) (330,000) 0 $ (420,000) $ 280,000

Supporting calculations for controllable support department allocations: (Note 1) Training:

Passenger Division, ($360,000 ÷ 800 personnel trained) × 600 personnel trained Cargo Division, ($360,000 ÷ 800 personnel trained) × 200 personnel trained

(Note 2) Flight Scheduling:

Passenger Division, ($550,000 ÷ 2,500 flights) × 1,000 flights Cargo Division, ($550,000 ÷ 2,500 flights) × 1,500 flights

(Note 3) Reservations:

Passenger Division, ($750,000 ÷ 30,000 reservations) × 30,000 reservations Cargo Division, ($750,000 ÷ 30,000 reservations) × 0 reservations

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Ex. 24–9 (FIN MAN); Ex. 10–9 (MAN) Championship Sports Inc. Divisional Income Statements For the Year Ended December 31, 20Y9

Sales Cost of goods sold Gross profit Divisional selling and administrative expenses: Divisional selling expenses Divisional administrative expenses Total divisional selling and administrative expenses Operating income before support department allocations Support department allocations: Advertising expense (Note 1) Transportation expense (Note 2) Accounts receivable collection expense (Note 3) Warehouse expense (Note 4) Total support department allocations Operating income Supporting calculations: Note (1) Winter Sports Division: Summer Sports Division:

Winter Sports Division $ 8,900,000 (5,000,000) $ 3,900,000

Summer Sports Division $16,400,000 (9,000,000) $ 7,400,000

$ (650,000) (800,000) $(1,450,000) $ 2,450,000

$ (1,200,000) (1,450,000) $ (2,650,000) $ 4,750,000

$ (375,000) (70,000) (25,000) (720,000) $(1,190,000) $ 1,260,000

(715,000) (122,000) (43,000) (1,080,000) $ (1,960,000) $ 2,790,000

$375,000 $715,000

Note (2)

Winter Sports Division: Summer Sports Division:

(17,500 bills of lading × $4.00 per bill of lading) (30,500 bills of lading × $4.00 per bill of lading)

Note (3)

Winter Sports Division: Summer Sports Division:

(25,000 invoices × $1.00 per invoice) (43,000 invoices × $1.00 per invoice)

Note (4)

Winter Sports Division: Summer Sports Division:

($1,800,000 ÷ 150,000 sq. ft.) × 60,000 sq. ft. ($1,800,000 ÷ 150,000 sq. ft.) × 90,000 sq. ft.

Support Department Allocations Winter Sports Division

Summer Sports Division

Total

Advertising expense……………………………

$375,000

$715,000

$1,090,000

Transportation rate per bill of lading……… × Number of bills of lading…………………… Transportation expense………………………

$4.00 17,500 $70,000

$4.00 30,500 $122,000

$192,000

Accounts receivable collection rate………… × Number of sales invoices………………… Accounts receivable collection expense…

$1.00 25,000 $25,000

$1.00 43,000 $43,000

$68,000

Warehouse rate per sq. ft. ($1,800,000 ÷ 150,000 sq. ft.)……………… × Number of square feet……………………… Warehouse expense……………………………

$12.00 60,000 $720,000

$12.00 90,000 $1,080,000

$1,800,000

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Ex. 24–10 (FIN MAN); Ex. 10–10 (MAN) a.

Retail Division: Commercial Division: Data Analytics Division:

Retail Division

26% ($11,700,000 ÷ $45,000,000) 20% ($12,600,000 ÷ $63,000,000) 16% ($1,920,000 ÷ $12,000,000)

Ex. 24–11 (FIN MAN); Ex. 10–11 (MAN) a. Operating income………………… Minimum amount of operating income: $45,000,000 × 12%…………… $63,000,000 × 12%…………… $12,000,000 × 12%…………… Residual income………………… b.

Retail Division

Commercial Division

Internet Division

$11,700,000

$12,600,000

$ 1,920,000

(5,400,000) (7,560,000) $ 6,300,000

$ 5,040,000

(1,440,000) $ 480,000

Retail Division

Ex. 24–12 (FIN MAN); Ex. 10–12 (MAN) a. b. c. d. e.

2.20 = 13.2% ÷ 6% 18% = 10% × 1.80 7% = 10.5% ÷ 1.50 3.00 = 15% ÷ 5% 13.2% = 12% × 1.10

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Ex. 24–13 (FIN MAN); Ex. 10–13 (MAN) a.

Return = Profit Margin × Investment Turnover on Investment Operating Income Sales

Return = on Investment =

$42,400,000 $265,000,000

Sales Invested Assets

$265,000,000 $106,000,000

= 16% × 2.50 = 40% b.

The profit margin would increase from 16% to 18%, the investment turnover would remain unchanged, and the return on investment would increase from 40% to 45%, as shown below. Return = Profit Margin × Investment Turnover on Investment Operating Income Sales

Return = on Investment =

$47,700,000* $265,000,000

Sales Invested Assets

$265,000,000 $106,000,000

= 18% × 2.50 = 45% * $42,400,000 + $5,300,000 = $47,700,000

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Ex. 24–14 (FIN MAN); Ex. 10–14 (MAN) a.

Return = on Investment Media Networks:

Operating Income Revenues $7,755 $23,689

Revenues Invested Assets

$23,689 $32,706

= 32.7% × 0.72 = 23.5% (rounded) Parks and Resorts:

$3,298 $16,974

$16,974 $28,275

= 19.4% × 0.60 = 11.6% (rounded) Studio Entertainment:

$2,703 $9,441

$9,441 $15,359

= 28.6% × 0.61 = 17.4% (rounded) Consumer Products & Interactive Media:

$1,965 $5,528

$5,528 $9,332

= 35.5% × 0.59 = 20.9% (rounded) b.

The four segments are different from each other. Media Networks combines a good profit margin of 32.7% with an investment turnover of 0.72. Media Networks is sensitive to advertising revenue, while the Studio Entertainment segment is sensitive to producing box office hits. The Parks and Resorts segment has a profit margin of 19.4% with an investment turnover of 0.60. The combination produces an ROI of 11.6%. Studio Entertainment has a profit margin of 28.6% and an investment turnover of 0.61, which generates a 17.4% return on investment. The Consumer Products & Interactive Media division combines a good profit margin of 35.5% with an investment turnover of 0.59, which produces an ROI of 20.9%. In terms of overall ROI, Media Networks is most profitable per dollar invested with a return of 23.5% followed by Consumer Products & Interactive Media with 20.9%, Studio Entertainment with 17.4%, and Parks and Resorts with 11.6%.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Ex. 24–15 (FIN MAN); Ex. 10–15 (MAN) a. b. c. d. e. f.

16.5% ($198,000 ÷ $1,200,000) $144,000 ($1,200,000 × 12%) $54,000 ($198,000 – $144,000) $160,000 ($120,000 + $40,000) 20.0% ($160,000 ÷ $800,000) 15.0% ($120,000 ÷ $800,000)

g. h. i. j. k. l.

$105,000 ($750,000 × 14%) 12.0% ($90,000 ÷ $750,000) $15,000 ($105,000 – $90,000) 24.5% ($441,000 ÷ $1,800,000) $270,000 ($1,800,000 × 15%) $171,000 ($441,000 – $270,000)

Ex. 24–16 (FIN MAN); Ex. 10–16 (MAN) a.

(a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l)

$60,200 ($860,000 × 7.0%) $344,000 ($60,200 ÷ 17.5%) 2.5 (17.5% ÷ 7.0%) or $860,000 ÷ $344,000 $1,140,000 ($51,300 ÷ 4.5%) $300,000 ($1,140,000 ÷ 3.8) 17.1% (4.5% × 3.8) $102,000 ($680,000 × 15.0%) 10.0% ($102,000 ÷ $1,020,000) 1.5 ($1,020,000 ÷ $680,000) 16.0% ($89,600 ÷ $560,000) 8.0% ($89,600 ÷ $1,120,000) 2.0 ($1,120,000 ÷ $560,000)

North Division: South Division: East Division: West Division:

(1) (2)

$18,920 [$60,200 – ($344,000 × 12%)] $15,300 [$51,300 – ($300,000 × 12%)] $20,400 [$102,000 – ($680,000 × 12%)] $22,400 [$89,600 – ($560,000 × 12%)]

The North Division has the highest return on investment (17.5%). The West Division has the largest residual income.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Ex. 24–17 (FIN MAN); Ex. 10–17 (MAN) a.

Increase in Ziegler Inc.’s Operating Income

Market Price

Variable Cost Units × – per Unit Transferred

$33,750,000

($1,350

–

$900)

Increase in the Instrument Division’s Operating Income

Market Price

–

Transfer Price

× Transferred

$26,250,000

($1,350

–

$1,000)

Increase in the Components Division’s Operating Income

Transfer Price

–

$7,500,000

($1,000

–

Increase in Ziegler Inc.’s Operating Income

Market Price

Variable Cost Units × Transferred – per Unit

$33,750,000

($1,350

–

75,000 Units

75,000

Variable Cost Units × Transferred per Unit

$900)

75,000

Ex. 24–18 (FIN MAN); Ex. 10–18 (MAN) a.

$900)

75,000

This amount is the same amount by which Ziegler Inc.’s operating income increased in Ex. 24–17, when a transfer price of $1,000 was used. b.

Increase in the Instrument Division’s Operating Income

$11,250,000

Market Price

($1,350

–

Transfer Price

Units × Transferred

–

$1,200)

75,000

This is the amount the Instrument Division saves by purchasing from the Components Division at an internal price that is lower than the market price. c.

Increase in the Components Division’s Operating Income

Transfer Price

–

$22,500,000

($1,200

–

Variable Cost Units × Transferred per Unit

$900)

75,000

This is the amount the Components Division earns by using available excess capacity to produce and sell products above variable cost to the Instrument Division. d.

Any transfer price will cause the total income of the company to increase, as long as the supplier division capacity is used toward making materials for products that are ultimately sold to the outside. However, transfer prices should be set between variable cost and the market price in order to give the division managers proper incentives. A transfer price set below variable cost would cause the supplier division to incur a loss, while a transfer price set above market price would cause the purchasing division to decrease its operating income. Neither situation is an attractive alternative for an investment center manager. Thus, the general rule is to negotiate transfer prices between variable cost and market price when the supplier division has excess capacity. The range of acceptable transfer prices for Ziegler Inc. would be between $1,350 (market price) and $900 (variable cost). 24-16 © 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

PROBLEMS Prob. 24–1A (FIN MAN); Prob. 10–1A (MAN) 1.

GHT Tech Inc. Budget Performance Report—Director, Consumer Products Division For the Month Ended July 31

Customer service salaries Insurance and property taxes Distribution salaries Marketing salaries Engineer salaries Warehouse wages Equipment depreciation Total 2.

Actual

Budget

$ 642,800 110,240 861,200 1,085,230 815,012 562,632 183,610 $4,260,724

$ 546,840 114,660 872,340 1,025,130 836,850 586,110 185,120 $4,167,050

Over Budget

(Under) Budget

$ 95,960 $ (4,420) (11,140) 60,100

$156,060

(21,838) (23,478) (1,510) $(62,386)

The customer service and marketing salaries are significantly over budget. The director should investigate the cause of these results. One possibility is that the company is having an increase in sales, requiring greater marketing effort and customer service. However, the warehouse and distribution costs have not shown similar increases. Thus, it’s also possible that marketing and customer service salaries are increasing because of service problems and unplanned efforts to market the company’s service.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–2A (FIN MAN); Prob. 10–2A (MAN) 1. Red Line Railroad Inc. Divisional Income Statements For the Quarter Ended December 31 East

Revenues Operating expenses Operating income before support department allocations Support department allocations: Customer Support (Note A) Legal (Note B) Total support department allocations Operating income

West

Central

$1,400,000 $ 2,000,000 $ 3,200,000 (800,000) (1,350,000) (1,900,000) $ 600,000

650,000

$ 1,300,000

(48,000) $ (89,600) $ (182,400) (218,750) (187,500) (93,750) $ (141,750) $ (308,350) $ (369,900) $ 458,250 $ 341,650 $ 930,100 $

Supporting computations: Support department allocation rates for Customer Support and Legal are determined as follows: Number of customer contacts… Number of hours billed……………

East

West

Central

Total

1,500 750

2,800 1,750

5,700 1,500

10,000 4,000

Note (A)

East Division: West Division: Central Division:

($320,000 ÷ 10,000 contacts) × 1,500 contacts ($320,000 ÷ 10,000 contacts) × 2,800 contacts ($320,000 ÷ 10,000 contacts) × 5,700 contacts

Note (B)

East Division: West Division: Central Division:

($500,000 ÷ 4,000 hours) × 750 hours ($500,000 ÷ 4,000 hours) × 1,750 hours ($500,000 ÷ 4,000 hours) × 1,500 hours

Note: The Shareholder Relations Department and general corporate officers’ salaries are not controllable by division management and thus are not included in determining division operating income.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–2A (FIN MAN); Prob. 10–2A (MAN) (Concluded) 2.

The CEO evaluates the three divisions using operating income as a percent of revenues (profit margin). This measure is computed for the three divisions as follows: East Division: West Division: Central Division:

33% ($458,250 ÷ $1,400,000) 17% ($341,650 ÷ $2,000,000) 29% ($930,100 ÷ $3,200,000)

According to the CEO’s measure, the East Division has the highest performance. 3.

To: CEO The method used to evaluate the performance of the divisions should be reevaluated. The present method identifies the amount of operating income per dollar of earned revenue. However, this company requires a significant investment in fixed assets for production and distribution facilities. The amount of assets may not be related to the revenue earned. The present measure fails to incorporate these differences in asset utilization into the measure. Naturally, the amount of assets used by a division in earning a return is a very important consideration in evaluating divisional performance. Therefore, a better divisional performance measure would be either (a) return on investment (operating income divided by divisional assets) or (b) residual income (operating income less a minimal return on divisional assets). Both measures incorporate the assets used by the divisions.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–3A (FIN MAN); Prob. 10–3A (MAN) The Crunchy Granola Company Divisional Income Statements For the Year Ended June 30, 20Y7

Sales Cost of goods sold Gross profit Operating expenses Operating income 2.

Cereal Division

Snack Cake Division

Retail Bakeries Division

$ 25,000,000 (16,670,000) $ 8,330,000 (7,330,000) $ 1,000,000

$ 8,000,000 (5,575,000) $ 2,425,000 (1,945,000) $ 480,000

$ 9,750,000 (6,795,000) $ 2,955,000 (2,272,500) $ 682,500

Return on Investment = Profit Margin × Investment Turnover Operating Income Sales

Return on Investment =

Sales Invested Assets

Cereal Division: ROI =

$1,000,000 $25,000,000

$25,000,000 $10,000,000

= 4% × 2.5 = 10.0% Snack Cake Division: ROI =

$480,000 $8,000,000

$8,000,000 $4,000,000

$9,750,000 $6,500,000

= 6% × 2.0 = 12.0% Retail Bakeries Division: ROI =

$682,500 $9,750,000

= 7% × 1.5 = 10.5%

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–3A (FIN MAN); Prob. 10–3A (MAN) (Concluded) 3.

Per dollar of invested assets, the Snack Cake Division is the most profitable of the three divisions. Assuming that the returns on investment do not change in the future, an expansion of the Snack Cake Division will return 12.0 cents (12.0%) on each dollar of invested assets, while the Cereal and Retail Bakeries divisions will return only 10.0 cents (10.0%) and 10.5 cents (10.5%), respectively. Thus, when faced with limited funds for expansion, management should consider an expansion of the Snack Cake Division first.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–4A (FIN MAN); Prob. 10–4A (MAN) Return on Investment = Profit Margin × Investment Turnover

Operating Income Sales

Return on Investment =

Sales Invested Assets

Commercial Division: ROI =

$420,000 $3,500,000

$3,500,000 $2,500,000

= 12.0% × 1.40 = 16.8% Maxell Manufacturing Inc.—Commercial Division Estimated Income Statements For the Year Ended December 31, 20Y9

1 2 3 4 5 6 7 8

Proposal 1

Proposal 2

Proposal 3

Sales Cost of goods sold Gross profit Operating expenses Operating income

$ 3,500,000 (2,585,000) 1 $ 915,000 (600,000) $ 315,000

$ 3,500,000 (1,920,000) 3 $ 1,580,000 (600,000) $ 980,000

$ 2,905,000 5 (2,073,300) 6 $ 831,700 (425,000) 7 $ 406,700

Invested assets

$ 2,187,500 2

$ 4,375,000 4

$ 1,162,000 8

$2,480,000 + $105,000 $2,500,000 – $312,500 $2,480,000 – $560,000 $2,500,000 + $1,875,000 $3,500,000 – $595,000 $2,480,000 – $406,700 $600,000 – $175,000 $2,500,000 – $1,338,000

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–4A (FIN MAN); Prob. 10–4A (MAN) (Concluded) 3.

Return on Investment = Profit Margin × Investment Turnover Operating Income Sales

Return on Investment = Proposal 1:

ROI =

$315,000 $3,500,000

$3,500,000 $2,187,500

$3,500,000 $4,375,000

$2,905,000 $1,162,000

Sales Invested Assets

= 9.0% × 1.6 = 14.4% Proposal 2:

ROI =

$980,000 $3,500,000

= 28.0% × 0.8 = 22.4% Proposal 3:

ROI =

$406,700 $2,905,000

= 14.0% × 2.5 = 35.0% 4. 5.

Proposal 3 would yield a return on investment of 35.0%. Proposal 2 would yield a return on investment of 22.4%. Return on Investment = Profit Margin × Investment Turnover 21% = 12% × Required Investment Turnover Required Investment = 1.75 (21% ÷ 12%) Turnover Current Investment = 1.40 Turnover Increase in = 0.35 Investment Turnover or 25.0% Increase (0.35 ÷ 1.40)

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–5A (FIN MAN); Prob. 10–5A (MAN) 1.

Recycling Industries Divisional Income Statements For the Year Ended December 31, 20Y8

Sales Cost of goods sold Gross profit Operating expenses Operating income 2.

Business Division

Consumer Division

$ 42,800,000 (23,500,000) $ 19,300,000 (11,424,800) $ 7,875,200

$ 56,000,000 (30,500,000) $ 25,500,000 (14,300,000) $ 11,200,000

Return on Investment = Profit Margin × Investment Turnover Operating Income Sales

Return on Investment =

Sales Invested Assets

Business Division: ROI =

$7,875,200 $42,800,000

$42,800,000 $34,240,000

$56,000,000 $70,000,000

= 18.4% × 1.25 = 23.0% Consumer Division: ROI =

$11,200,000 $56,000,000

= 20.0% × 0.80 = 16.0% 3.

Business Division: $4,451,200 [$7,875,200 – ($34,240,000 × 10%)] Consumer Division: $4,200,000 [$11,200,000 – ($70,000,000 × 10%)]

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–5A (FIN MAN); Prob. 10–5A (MAN) (Concluded) 4.

On the basis of operating income, the Consumer Division generated $3,324,800 ($11,200,000 – $7,875,200) more operating income than did the Business Division. However, operating income does not consider the amount of invested assets in each division. On the basis of the return on investment, the Business Division earned 23.0 cents (23.0%) on each dollar of invested assets, while the Consumer Division earned only 16.0 cents (16.0%) on each dollar of invested assets. Although the Consumer Division has a higher profit margin than the Business Division (20.0% vs. 18.4%), the Business Division has a higher investment turnover (1.25 vs. 0.80), which generated its higher return on investment. Residual income can be viewed as a combination of the preceding two performance measures. Residual income considers the absolute dollar amount of operating income generated by each division and also considers a minimum return on investment to be earned by each division. On the basis of residual income, the Business Division is $251,200 ($4,451,200 – $4,200,000) more profitable than the Consumer Division.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–6A (FIN MAN); Prob. 10–6A (MAN) 1.

No. When unused capacity exists in the supplying division (the Consumer Division), the use of the market price approach may not lead to the maximization of total company income.

The Consumer Division’s operating income would increase by $31,680: Increase in Consumer (Supplying) Division’s Operating Income

$31,680

Transfer Price

($115

–

Variable Cost per Unit

Units × Transferred

–

$104)

2,880

By selling to the Commercial Division, the Consumer Division earns $11 per unit on these sales. The Commercial Division’s operating income would increase by $100,800: Increase in Commercial (Purchasing) Division’s Operating Income

Market Price

–

Transfer Price

× Transferred

$100,800

($150

–

$115)

Units

2,880

By purchasing from the Consumer Division, the Commercial Division saves $35 per unit on its purchases. Garcon Inc.’s total operating income would increase by $132,480: Increase in Garcon’s Operating Income

$132,480

Market Price

–

Variable Cost per Unit

($150

–

$104)

Units × Transferred

The increase in total company operating income is also equal to the sum of the increases in the division operating incomes.

2,880

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–6A (FIN MAN); Prob. 10–6A (MAN) (Continued) 3.

Garcon Inc. Divisional Income Statements For the Year Ended December 31, 20Y2 Consumer Division

Sales: 14,400 units × $144 per unit 2,880 units × $115 per unit 21,600 units × $275 per unit Total sales Expenses: Variable: 17,280 units × $104 per unit 2,880 units × $158* per unit 18,720 units × $193** per unit Fixed Total expenses Operating income

Commercial Division

Total

$ 5,940,000 $ 5,940,000

$ 2,073,600 331,200 5,940,000 $ 8,344,800

$ (455,040) (3,612,960) (520,000) $(4,588,000) $ 1,352,000

$(1,797,120) (455,040) (3,612,960) (720,000) $(6,585,120) $ 1,759,680

$ 2,073,600 331,200 $ 2,404,800

$(1,797,120)

(200,000) $(1,997,120) $ 407,680

* The 2,880 units are transferred in at $115 per unit plus $43 operating expense in the division. ** The remaining 18,720 (21,600 – 2,880) units are purchased on the outside at a market price of $150 per unit plus $43 operating expenses in the division.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–6A (FIN MAN); Prob. 10–6A (MAN) (Concluded) 4.

The Consumer Division’s operating income would increase by $63,360: Increase in Consumer (Supplying) Division’s Operating Income

$63,360

Transfer Price

($126

–

Variable Cost per Unit

Units × Transferred

–

$104)

2,880

By selling to the Commercial Division, the Consumer Division earns $22 per unit on these sales. The Commercial Division’s operating income would increase by $69,120: Increase in Commercial (Purchasing) Division’s Operating Income

Market Price

–

Transfer Price

× Transferred

$69,120

($150

–

$126)

Units

2,880

By purchasing from the Consumer Division, the Commercial Division saves $24 per unit on its purchases. Garcon Inc.’s total operating income would increase by the same amount as in part (2), $132,480: Increase in Garcon’s Operating Income

Market Price

–

Variable Cost per Unit

$132,480

($150

–

$104)

Units

× Transferred ×

2,880

The increase in total company operating income is also equal to the sum of the increases in the division operating incomes. 5.

Any transfer price greater than the Consumer Division’s variable expenses per unit of $104 but less than the market price of $150 would be acceptable.

If the division managers cannot agree on a transfer price, a price of $127* would be the best compromise. In this way, each division’s operating income would increase by $66,240.

* $150 – $104 = $46 $46 ÷ 2 = $23 $150 – $23 = $127 $104 + $23 = $127

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–1B (FIN MAN); Prob. 10–1B (MAN) 1.

Adelson Inc. Budget Performance Report—Manager, Eastern District For the Month Ended December 31

Sales salaries System administration salaries Customer service salaries Billing salaries Maintenance Depreciation of plant and equipment Insurance and property taxes Total 2.

Actual

Budget

$ 818,880 447,720 183,120 98,100 273,000

$ 819,840 448,152 152,600 98,760 271,104

92,232 41,400 $1,954,452

92,232 41,280 $1,923,968

Over Budget

(Under) Budget

$ (960) (432) $30,520 (660) 1,896

120 $32,536

$(2,052)

The customer service salaries exceed the budget by 20% of budget ($30,520 ÷ $152,600). The manager should request additional detailed information about the customer service department. There are several possible reasons for the budget variance. The manager should determine if the cause is related to an increase in salaries or an increase in time incurred by additional employees. If the latter, the manager may wish to determine if there has been an increase in customer service problems, hence a need to hire additional people. Such information could be used by the manager to solve customer service complaints and to reduce the number of future complaints.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–2B (FIN MAN); Prob. 10–2B (MAN) 1. Thomas Railroad Company Divisional Income Statements For the Quarter Ended December 31 North

Revenues Operating expenses Operating income before support department allocations Support department allocations: Dispatching (Note A) Equipment Management (Note B) Total support department allocations Operating income

South

West

$ 3,780,000 $ 5,673,000 (2,678,500) (4,494,890)

$ 5,130,000 (3,770,050)

$ 1,178,110

$ 1,359,950

$ 1,101,500

(45,500) $ (77,350) (420,000) (300,000) $ (345,500) $ (497,350) $ 756,000 $ 680,760 $

(59,150) (480,000) $ (539,150) $ 820,800

Supporting computations: Support department allocations rates for Dispatching and Equipment Management are determined as follows: Number of scheduled trains……… Number of railroad cars in inventory……………………………

North

South

West

Total

650

1,105

845

2,600

6,000

8,400

9,600

24,000

Note (A)

North Region: South Region: West Region:

($182,000 ÷ 2,600 scheduled trains) × 650 trains ($182,000 ÷ 2,600 scheduled trains) × 1,105 trains ($182,000 ÷ 2,600 scheduled trains) × 845 trains

Note (B)

North Region: South Region: West Region:

($1,200,000 ÷ 24,000 railroad cars) × 6,000 railroad cars ($1,200,000 ÷ 24,000 railroad cars) × 8,400 railroad cars ($1,200,000 ÷ 24,000 railroad cars) × 9,600 railroad cars

Note: The Treasurer’s Department and general corporate officers’ salaries are not controllable by division management and thus are not included in determining division operating income.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–2B (FIN MAN); Prob. 10–2B (MAN) (Concluded) 2.

The CEO evaluates the three regions using operating income as a percent of revenues. This measure is calculated for the three regions as follows: North Region: South Region: West Region:

20% ($756,000 ÷ $3,780,000) 12% ($680,760 ÷ $5,673,000) 16% ($820,800 ÷ $5,130,000)

Thus, according to the CEO’s measure, the North Region has the highest performance. 3.

To: CEO The method used to evaluate the performance of the regions should be reevaluated. The present method identifies the amount of operating income per dollar of earned revenue. However, a railroad company requires a significant investment in fixed assets, such as track, engines, and railcars. In addition, the amount of assets may not be related to the revenue earned. For example, some regions may be able to concentrate assets in a densely populated regional area and run a high amount of traffic over those assets. Other regions, however, may have widely distributed assets over sparsely populated areas that run a small amount of traffic over those assets. The present measure fails to incorporate these differences in asset utilization into the measure. Naturally, the amount of assets used by a region in earning a return is a very important consideration in evaluating regional performance. Therefore, a better regional performance measure would be either (a) return on investment (operating income divided by regional assets) or (b) residual income (operating income less a minimal return on regional assets). Both measures incorporate the assets used by the regions.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–3B (FIN MAN); Prob. 10–3B (MAN) 1.

E.F. Lynch Company Divisional Income Statements For the Year Ended June 30, 20Y8

Fee revenue Operating expenses Operating income 2.

Mutual Fund Division

Electronic Brokerage Division

Investment Banking Division

$ 4,140,000 (2,980,800) $ 1,159,200

$ 3,360,000 (3,091,200) $ 268,800

$ 4,560,000 (3,739,200) $ 820,800

Return on Investment = Profit Margin × Investment Turnover Operating Income Sales

Return on Investment =

Sales Invested Assets

Mutual Fund Division: ROI =

$1,159,200 $4,140,000

$4,140,000 $5,175,000

$3,360,000 $1,120,000

$4,560,000 $3,800,000

= 28.0% × 0.8 = 22.4% Electronic Brokerage Division: ROI =

$268,800 $3,360,000

= 8.0% × 3.0 = 24.0% Investment Banking Division: ROI =

$820,800 $4,560,000

= 18.0% × 1.2 = 21.6%

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–3B (FIN MAN); Prob. 10–3B (MAN) (Concluded) 3.

Per dollar of invested assets, the Electronic Brokerage Division is the most profitable of the three divisions. Assuming that the returns on investment do not change in the future, an expansion of the Electronic Brokerage Division will return 24.0 cents (24.0%) on each dollar of invested assets, while the Mutual Fund and Investment Banking divisions will return only 22.4 cents (22.4%) and 21.6 cents (21.6%), respectively. Thus, when faced with limited funds for expansion, management should consider an expansion of the Electronic Brokerage Division first. Note to Instructors: The Mutual Fund Division has excellent profit margins, but the investment turnover is low. The investment in the “bricks and mortar” of the Mutual Fund Division offices causes the investment turnover and return on investment to be lower. The Electronic Brokerage Division has thin margins because the fees earned per trade are small. However, the assets required to execute trades are less than the Mutual Fund Division because there is no need for offices (trades are executed over the Internet). As a result of the high investment turnover in the Electronic Brokerage Division, the return on investment is higher.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–4B (FIN MAN); Prob. 10–4B (MAN) Return on Investment = Profit Margin × Investment Turnover

Operating Income Sales

Return on Investment =

Sales Invested Assets

Electronics Division: ROI =

$126,000 $1,575,000

$1,575,000 $1,050,000

= 8.0% × 1.5 = 12.0% Gihbli Industries Inc.—Electronics Division Estimated Income Statements For the Year Ended December 31, 20Y9

Proposal 1

Sales Cost of goods sold Gross profit Operating expenses Operating income Invested assets 1

$891,000 – $31,400

$1,050,000 – $300,000

$1,575,000 – $180,000

$891,000 – $119,550

$558,000 – $60,000

$1,050,000 – $112,500

$891,000 – $189,000

$1,050,000 + $918,750

$1,575,000 (859,600)1 $ 715,400 (558,000) $ 157,400 $ 750,000 2

Proposal 2

Proposal 3 3

$1,395,000 (771,450)4 $ 623,550 (498,000)5 $ 125,550 $ 937,500 6

$1,575,000 (702,000) 7 $ 873,000 (558,000) $ 315,000 $1,968,750 8

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–4B (FIN MAN); Prob. 10–4B (MAN) (Concluded) 3.

Return on Investment = Profit Margin × Investment Turnover Operating Income Sales

Return on Investment = Proposal 1:

ROI =

$157,400 $1,575,000

$1,575,000 $750,000

$1,395,000 $937,500

$1,575,000 $1,968,750

Sales Invested Assets

= 10.0% × 2.1 = 21.0% Proposal 2:

ROI =

$125,550 $1,395,000

= 9.0% × 1.5 = 13.5% Proposal 3:

ROI =

$315,000 $1,575,000

= 20.0% × 0.8 = 16.0% 4. 5.

Proposal 1 would yield a return on investment of 21.0%. Return on Investment = Profit Margin × Required Investment Turnover 20% = 8% × Required Investment Turnover Required Investment = 2.5 (20% ÷ 8%) rounded Turnover Current Investment = 1.5 Turnover Increase in = 1.0 Investment Turnover or 66.7% Increase (1.0 ÷ 1.5)

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–5B (FIN MAN); Prob. 10–5B (MAN) 1.

Free Ride Bike Company Divisional Income Statements For the Year Ended December 31, 20Y7

Sales Cost of goods sold Gross profit Operating expenses Operating income 2.

Road Bike Division

Mountain Bike Division

$ 1,728,000 (1,380,000) $ 348,000 (175,200) $ 172,800

$ 1,760,000 (1,400,000) $ 360,000 (236,800) $ 123,200

Return on Investment = Profit Margin × Investment Turnover Operating Income Sales

Return on Investment =

Sales Invested Assets

Road Bike Division: ROI =

$172,800 $1,728,000

$1,728,000 $1,440,000

$1,760,000 $800,000

= 10.0% × 1.2 = 12.0% Mountain Bike Division: ROI =

$123,200 $1,760,000

= 7.0% × 2.2 = 15.4% 3.

Road Bike Division: $28,800 [$172,800 – ($1,440,000 × 10%)] Mountain Bike Division: $43,200 [$123,200 – ($800,000 × 10%)]

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–5B (FIN MAN); Prob. 10–5B (MAN) (Concluded) 4.

On the basis of operating income, the Road Bike Division generated $49,600 ($172,800 – $123,200) more operating income than did the Mountain Bike Division. However, operating income does not consider the amount of invested assets in each division. On the basis of the return on investment, the Road Bike Division earned 12.0 cents (12.0%) on each dollar of invested assets, while the Mountain Bike Division earned 15.4 cents (15.4%) on each dollar of invested assets. Although the profit margin of the Road Bike Division exceeds the Mountain Bike Division (10.0% vs. 7.0%), the investment turnover in the Road Bike Division is much less than the Mountain Bike Division (1.2 vs. 2.2). The combination of these factors caused the Mountain Bike Division to have a higher return on investment than did the Road Bike Division. Residual income can be viewed as a combination of the absolute dollar amount of operating income generated by each division and also considers a minimum return on investment to be earned by each division. On the basis of residual income, the Mountain Bike Division is the more profitable of the two divisions.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–6B (FIN MAN); Prob. 10–6B (MAN) 1. No. When unused capacity exists in the supplying division (the Semiconductors Division), the use of the market price approach may not lead to the maximization of total company income. 2. The Semiconductors Division’s operating income would increase by $45,240: Increase in Semiconductors (Supplying) Division’s Operating Income

$45,240

Transfer Price

($310

–

Variable Cost per Unit

Units Transferred

–

$232)

580

By selling to the Navigational Systems Division, the Semiconductors Division earns $78 per unit on these sales. The Navigational Systems Division’s operating income would increase by $70,760: Increase in Navigational Systems (Purchasing) Division’s Operating Income =

$70,760

Market Price

–

Transfer Price

Units Transferred

($432

–

$310)

580

By purchasing from the Semiconductors Division, the Navigational Systems Division saves $122 per unit on its purchases. Exoplex Industries Inc.’s total operating income would increase by $116,000: Increase in Exoplex Industries’ Operating Income

$116,000

Market Price

–

Variable Cost per Unit

($432

–

$232)

Units Transferred

580

The increase in total company operating income is also equal to the sum of the increases in the division operating incomes.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–6B (FIN MAN); Prob. 10–6B (MAN) (Continued) 3.

Exoplex Industries Inc. Divisional Income Statements For the Year Ended December 31, 20Y8 Semiconductors

Sales: 2,240 units × $396 per unit 580 units × $310 per unit 3,675 units × $590 per unit Total sales

Navigational Systems

$ 887,040 179,800 $1,066,840

Expenses: Variable: 2,820 units × $232 per unit 580 units × $350* per unit 3,095 units × $472** per unit Fixed Total expenses Operating income

$ 2,168,250 $ 2,168,250

887,040 179,800 2,168,250 $ 3,235,090

$ (203,000) (1,460,840) (325,000) $(1,988,840) $ 179,410

$ (654,240) (203,000) (1,460,840) (545,000) $(2,863,080) $ 372,010

$ (654,240)

(220,000) $ (874,240) $ 192,600

Total

* The 580 units are transferred in at $310 per unit plus $40 operating expenses in the division. ** The remaining 3,095 (3,675 – 580) units are purchased on the outside at a market price of $432 per unit plus $40 operating expenses in the division.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

Prob. 24–6B (FIN MAN); Prob. 10–6B (MAN) (Concluded) 4.

The Semiconductors Division’s operating income would increase by $62,640: Increase in Semiconductors (Supplying) Division’s Operating Income

$62,640

Transfer Price

–

Variable Cost per Unit

($340

–

$232)

Units

× Transferred ×

580

By selling to the Navigational Systems Division, the Semiconductors Division earns $108 per unit on these sales. The Navigational Systems Division’s operating income would increase by $53,360: Increase in Navigational Systems (Purchasing) Division’s Operating Income =

$53,360

Market Price

($432

–

Transfer Price

Units × Transferred

–

$340)

580

By purchasing from the Semiconductors Division, the Navigational Systems Division saves $92 per unit on its purchases. Exoplex Industries Inc.’s total operating income would increase by the same amount as in (2), $116,000: Increase in Ecoplex Industries’ Operating Income

$116,000

Market Price

–

Variable Cost per Unit

($432

–

$232)

Units × Transferred

580

The increase in total company operating income is also equal to the sum of the increases in the division operating incomes. 5.

Any transfer price greater than the Semiconductors Division’s variable expenses per unit of $232 but less than the market price of $432 would be acceptable.

If the division managers cannot agree on a transfer price, a price of $332* would be the best compromise. In this way, each division’s operating income would increase by $58,000.

* $432 – $232 = $200 $200 ÷ 2 = $100 $432 – $100 = $332 $232 + $100 = $332

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

MAKE A DECISION MAD 24–1 (FIN MAN); MAD 10–1 (MAN) a.

Profit Margin =

Operating Income Sales

Company-Operated:

$180,000 $600,000

= 30%

Franchised:

$192,000 $240,000

= 80%

Sales Invested Assets

Investment Turnover =

Company-Operated:

$600,000 $1,500,000

= 0.40

Franchised:

$240,000 $150,000

= 1.60

Return on Investment (ROI) = Profit Margin × Investment Turnover Company-Operated: 30% × 0.40 = 12% Franchised: 80% × 1.60 = 128%

The profit margin, investment turnover, and ROI favor franchised over companyoperated restaurants. Thus, from a financial perspective, franchising appears to be a more favorable route for expanding into the Midwest. In addition, Kingston may be able to expand faster using franchisees rather than using its own funds for constructing restaurants. Kingston Kitchens may view company-operated restaurants as a way to protect the brand and control the customer experience. However, franchise agreements can be designed to provide for quality control and consistency of customer experience. Thus, Kingston can still protect the brand while expanding through franchisees.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

MAD 24–2 (FIN MAN); MAD 10–2 (MAN) a.

Profit Margin =

Operating Income Sales

Company-Operated:

$62 $374

= 16.6%

Franchised:

$1 $29

= 3.4%

Investment Turnover =

Sales Invested Assets

Company-Operated:

$374 $79

= 4.73

Franchised:

$29 $2

= 14.50

Return on Investment (ROI) = Profit Margin × Investment Turnover Company-Operated: 16.6% × 4.73 = 78.5% Franchised: 3.4% × 14.50 = 49.3%

The franchised restaurants have a lower profit margin (3.4%) than companyoperated restaurants (16.6%). Franchised restaurants do have a higher investment turnover (14.50) than company-operated restaurants (4.73), but the overall ROI for company-operated restaurants (78.5%) is higher than the ROI for franchised restaurants (49.3%). Typically, franchised restaurants would be expected to be more profitable because El Pollo Loco incurs no cost of goods sold or operating expenses in generating this revenue; thus, there is typically a high profit margin for franchised restaurants. However, El Pollo Loco has a small number of franchised restaurants, and a small proportion of franchised restaurants relative to company-operated restaurants. So it likely isn’t yet reaping the full benefit of a franchised-restaurant structure.

In order to franchise operations, a company must first establish a brand reputation by operating company-owned restaurants and stores. In addition, franchisors often use their company-owned restaurants and stores to test new products and improve operating efficiencies.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

MAD 24–3 (FIN MAN); MAD 10–3 (MAN) a.

Operating Income Sales

Profit Margin = Company-Operated:

$37 $700

= 5.3%

North America Franchised:

$90 $97

= 92.8% Sales Invested Assets

Investment Turnover = Company-Operated:

$700 $228

= 3.07

North America Franchised:

$97 $10

= 9.70

c. Return on Investment (ROI) = Profit Margin × Investment Turnover Company-Operated: 5.3% × 3.07 = 16.3% North America Franchised: 92.8% × 9.70 = 900.2% d. The franchised restaurants have the highest profit margin of 92.8% and investment turnover of 9.70, thus yielding the highest return on investment of 900.2%. The franchised restaurants are extremely profitable because Papa John’s incurs no cost of goods sold or operating expenses in generating this revenue; thus, there is a high profit margin for franchised restaurants. Likewise, the franchisee incurs most of the cost of the investment in property and equipment; thus, the high investment turnover.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

MAD 24–4 (FIN MAN); MAD 10–4 (MAN) The profit margin, investment turnover, and return on investment for El Pollo Loco (MAD 2) and Papa John’s (MAD 3) are summarized as follows: Profit Margin

Investment Turnover

Return on Investment

El Pollo Loco: Company-operated Franchised

16.6% 3.4%

4.73 14.50

78.5% 49.3%

Papa John’s: Company-operated Franchised

5.3% 92.8%

3.07 9.70

16.3% 900.2%

For company-operated restaurants, El Pollo Loco’s profit margin of 16.6% is higher than Papa John’s profit margin of 5.3%. This may be due to more competition in the market for pizzas. El Pollo Loco’s investment turnover of 4.73 is also higher than Papa John’s investment turnover of 3.07. Overall, El Pollo Loco has a higher return on investment (ROI) of 78.5% compared to Papa John’s of 16.3%. Again, the higher ROI for El Pollo Loco may be due to less competition in the fast-food chicken market compared to the pizza market. Unlike El Pollo Loco, Papa John’s generates significantly higher ROIs from its franchised operations than from the company-operated stores. This is a result of higher profit margins and investment turnovers for the franchised operations at Papa John’s. It is likely that Papa John’s, which is largely made up of franchised operations, is realizing the economies of scale of the franchised-restaurant structure better than El Pollo Loco, which has relatively few franchised operations. For franchised operations, El Pollo Loco has a lower profit margin of 3.4% than Papa John’s 92.8%, but has a higher investment turnover of 14.50 compared to Papa John’s 9.70. Overall, Papa John’s ROI of 900.2% is much higher than El Pollo Loco’s ROI of 49.3%.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

MAD 24–5 (FIN MAN); MAD 10–5 (MAN) a.

Operating Income Sales

Profit Margin = United States:

$3,789 $7,829

= 48.4%

International Operated Markets:

$3,315 $9,571

= 34.6%

International Developmental Licensed Markets & Corporate:

$220 $1,809

= 12.2%

Sales Invested Assets

Investment Turnover = United States:

$7,829 $21,010

= 0.37

International Operated Markets:

$9,571 $24,744

= 0.39

International Developmental Licensed Markets & Corporate:

$1,809 $6,873

= 0.26

c. Return on Investment (ROI) = Profit Margin × Investment Turnover United States: 48.4% × 0.37 = 17.9% International Operated Markets: 34.6% × 0.39 = 13.5% International Developmental Licensed Markets & Corporate: 12.2% × 0.26 = 3.2% d. The U.S. segment has the highest profit margin of the three segments at 48.4%. The U.S. segment’s investment turnover is also relatively high at 0.37, which yields a return on investment of 17.9%. The International Operated Markets segment’s profit margin of 34.6% is lower than the U.S. segment’s, but it has a similar investment turnover of 0.39, yielding only a slightly lower return on investment of 13.5%. The International Developmental Licensed Markets & Corporate segment has the lowest profit margin at 12.2%. This may be due to promotions and a low-pricing strategy that attempts to grow market share. This segment also has a low investment turnover of 0.26, which yields a return on investment of 3.2%. McDonald’s will monitor the operations of the International Developmental Licensed Markets & Corporate segment to see if it can meet its high growth and profit expectations.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

TAKE IT FURTHER TIF 24–1 (FIN MAN); TIF 10–1 (MAN) This scenario is a negotiation between two divisions. Maya is not behaving unethically by attempting to get a better price from the Semiconductor Division than from the market, or by refusing market price. This may not seem “fair,” but price negotiation is both a typical business activity and part of Maya’s job. It would be unethical only if the X-ray Division refused a financially beneficial deal with the Semiconductor Division in order to purposefully hurt the Semiconductor Division’s performance, making the X-ray Division look good in comparison. This claim could only be supported if the X-ray Division’s refusal to purchase from the Semiconductor Division was economically unsound. For example, maybe there are no transportation costs because the Semiconductor Division plant is on site. In this case, the total cost to the X-ray Division would be less by purchasing from the Semiconductor Division. Refusing to do so could be the basis for claiming an ethical breach. Because the X-ray Division has overall profit responsibility and authority, the division has the choice of purchasing from inside or outside the company. The company should establish incentives for the X-ray Division to purchase from inside the company in order to maximize overall corporate income. Thus, the transfer price should be set below market price in order to give Maya an incentive to purchase from the Semiconductor Division. Howard’s refusal to budge on market price will likely hurt the Semiconductor Division and the company as a whole. If there are no alternative buyers, the Semiconductor Division should negotiate with the X-ray Division and accept a price lower than market price. This would be beneficial to both divisions. Thus, although neither party appears to be behaving unethically, Howard’s price position appears to be the weakest. TIF 24–2 (FIN MAN); TIF 10–2 (MAN) The Customer Service Department head is responsible for the quantity of service but not the source of the service (i.e., not the price). Most accountants would hold the department head responsible for the cost by transferring the cost of the brochures to the Customer Service Department, even though the price is 25% higher than could be obtained from the outside. This may not seem fair, but it does control the use of internal services to some degree. If there were no internal transfer price, departments would view the Publications Department as a “free good.” This would likely result in an overdemand for the service, because there would be no pricing discipline on the user groups. This does not mean that all is well. On the contrary, the Publications Department is free to pass on its inefficiencies because it has a captive client. A possible change in policy would be to allow internal users to go to outside vendors for printing services. This would have the effect of bringing the pressures of competition to the internal service group. It would have to offer the service competitively or watch its demand disappear. In this way, the internal publications group would have an incentive to be as cost effective as outside printers. Another possible change in policy would be to charge Publications Department services at standard cost. In this way, inefficiencies in the Publications Department would not be transferred to user departments.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

TIF 24–3 (FIN MAN); TIF 10–3 (MAN) Memo To:

Knute Holz

From:

Ima Student

Re:

Norse Division Financial Performance

The Norse Division’s revenues, gross profit, and operating income have increased significantly from 20Y4 to 20Y6. While these increases indicate that the division is growing profitability, return on investment is falling. The division’s profit margin, investment turnover, and return on investment are as follows: Profit margin Investment turnover Return on investment

20Y4 15.0% × 2.0 30.0%

20Y5 18.0% × 1.4 25.2%

20Y6 22.0% × 0.7 15.4%

The detailed breakdown of return on investment shows that investment turnover is dropping faster than profit margin is increasing, causing return on investment to fall. It appears as though the Norse Division has made very large investments in the business, but has not been able to reap the returns required to support these investments. The invested asset base more than quadrupled during the period, while revenue has not even doubled. Revenues are not growing fast enough to support the underlying asset investment. While profit margins have improved, the increase in profit margin for each revenue dollar has not been sufficient to make up for the revenue shortfall. If this trend continues, the division may not be able to maintain the division’s minimum required return on investment going forward.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

TIF 24–4 (FIN MAN); TIF 10–4 (MAN) 1.

The return on invested assets is computed as follows:

Operating income……………… ÷ Invested assets……………… ROI………………………………

Snack Goods

Cereal

Frozen Foods

$ 396,000 2,000,000 19.8%

$ 554,400 1,680,000 33.0%

$ 420,000 1,750,000 24.0%

The Cereal Division appears to be making the best use of invested assets because its ROI is the highest. 2.

Not all projects that have a greater than 19% return would be accepted. This is because all three divisions have an ROI that is greater than 19%. Thus, any project that is accepted between the 19% minimum and their existing ROI would cause their ROI to drop. This is true because of averaging. There would be little incentive to accept such projects if the divisions know they are competing against each other on the basis of ROI.

There are two approaches to improving ROI: (1) improve the profit margin or (2) improve the investment turnover. For all three divisions, the profit margin is excellent: Snack Goods Cereal Frozen Foods

18% ($396,000 ÷ $2,200,000) 22% ($554,400 ÷ $2,520,000) 20% ($420,000 ÷ $2,100,000)

However, the investment turnover is slow in all three divisions. The company doesn’t return many sales dollars per dollar invested in assets, as shown below. Snack Goods Cereal Frozen Foods

1.1 ($2,200,000 ÷ $2,000,000) 1.5 ($2,520,000 ÷ $1,680,000) 1.2 ($2,100,000 ÷ $1,750,000)

The divisions need to work on increasing revenues or reducing invested assets in order to improve ROI.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

TIF 24–5 (FIN MAN); TIF 10–5 (MAN) 1.

Operating Income Invested Assets

Return on = Investment (ROI) =

$4,860,000 $27,000,000

= 18.0% or Operating Income Sales

Return on = Investment (ROI) =

$4,860,000 $32,400,000

Sales Invested Assets

$32,400,000 $27,000,000

= 15.0% × 1.2 = 18.0% 2. 3.

$64,000 (8.0 × $8,000 = $64,000, where 8.0 = 18.0% – 10.0%) Operating Income Invested Assets

Return on = Investment (ROI) =

$2,332,800 $14,400,000

= 16.2% or Operating Income Sales

Return on = Investment (ROI) =

$2,332,800 $12,960,000

$12,960,000 $14,400,000

= 18.0% × 0.90 = 16.2% 4.

Even though the addition of the new product line would increase the overall company return on investment, its addition would decrease the Specialty Products Division’s return on investment from 18.0% to 17.4% ($7,192,800 ÷ $41,400,000). This decrease could negatively influence management’s evaluation of the division manager. In addition, this decrease in the division’s return on investment would also decrease the division manager’s bonus by $8,000 (1 × $8,000, where 1 = 18% – 17%).

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

TIF 24–5 (FIN MAN); TIF 10–5 (MAN) (Concluded) 5.

Use of residual income as a performance measure and as the basis for granting bonuses would motivate division managers to accept investment opportunities that exceed a minimum rate of return. If the minimum rate of return was set at 10%, the overall company average rate of return, any investment opportunity whose rate exceeded 10% would be viewed as acceptable. If this performance measure had been used, the Specialty Products Division manager would have increased the division’s residual income by $892,800 through the addition of the new product line, as shown below. Projected income from operations of new product line……………… Less minimum amount of desired operating income

$ 2,332,800

($14,400,000 × 10%)………………………………………………………… Residual income from new product line…………………………………

(1,440,000) $

892,800

The manager’s bonus could then be calculated as a percent of residual income. In this case, a bonus equal to 3% of residual income would achieve a bonus similar to the initial plan: Operating income…………………………………………………………… Less minimum desired income (10% × $27,000,000)………………… Residual income……………………………………………………………… × Bonus percentage………………………………………………………… Bonus……………………………………………………………………………

$ 4,860,000 (2,700,000) $ 2,160,000 3.0% $ 64,800

The new project would add $26,784 (3% × $892,800) to the bonus. Operating income with new product line………………………………… Less minimum desired income (10% × $14,400,000)………………… Residual income……………………………………………………………… × Bonus percentage………………………………………………………… Bonus……………………………………………………………………………

$ 2,332,800 (1,440,000) $ 892,800 3.0% $ 26,784

In addition, nonfinancial performance indicators about product quality and customer satisfaction can be used to supplement the financial numbers.

CHAPTER 24 (FIN MAN); CHAPTER 10 (MAN)

Evaluating Decentralized Operations

CERTIFIED MANAGEMENT ACCOUNTANT (CMA®) EXAMINATION QUESTIONS (ADAPTED) 1. b. A sales team is generally only accountable for sales dollars; this type of responsibility center is, therefore, a revenue center. 2. b. If corporate and support costs are being allocated to divisions and departments, there is very little incentive for central managers to control costs no matter how much pressure they receive from profit center managers. 3. c. The management of the two divisions should negotiate the transfer price. Negotiation is most likely to ensure that both managers are satisfied with the resultant price. 4. c. Selling the product internally allows the division to avoid paying sales commissions and incurring the cost of collections, thus justifying a transfer price that is lower than the market price. Other costs such as promotion and advertising might also be avoided.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN) DIFFERENTIAL ANALYSIS AND PRODUCT PRICING DISCUSSION QUESTIONS 1.

Differential revenue is the amount of increase or decrease in revenue expected from a particular course of action compared with an alternative.

Differential cost is the amount of increase or decrease in cost expected from a particular course of action compared with an alternative.

Differential profit (loss) is the difference between differential revenue and differential cost.

The differential revenues and costs of the lease option should be compared against selling the building. The differential revenue would be the lease revenue compared to the proceeds from sale. The differential expenses would be the costs associated with leasing the building, including maintenance, property tax, and insurance, compared to the expenses of selling, such as sales commissions. The opportunity cost of money should also be considered in the analysis.

If there is demand for the premium-grade product, the differential revenue (premium less commodity) may exceed the differential cost to process the product to premium grade.

A company should only accept business at a special price if the lower price will not contaminate the regular pricing for other customers or induce other customers to demand the special price. In addition, the company must be careful not to violate the Robinson-Patman Act, which prohibits uncompetitive price differences across different markets for the same product within the United States. Lastly, the company must consider the longer-term ramifications of offering discount business to a customer that may wish to order in the future.

It would be reasonable to purchase from the supplier if the fixed cost per unit was less than 50 cents. That is, if the fixed cost is less than 50 cents per unit, then the variable cost per unit would exceed the supplier’s price, making the supplier price more attractive.

Some of the financial considerations include the profitability of the store, including all the revenues and the variable and fixed costs associated with the store because they would all be differential to the decision. In addition, any costs of closing the store and preparing the store for disposal would need to be considered (legal costs, demolition costs, employee severance costs). Lastly, the opportunity cost of the value of the equipment and land (either in cash or rental income) should be considered. For example, if the opportunity value of the assets were $500 per month, then the store would need to have a profitability exceeding this amount to remain an attractive alternative.

In the long run, the normal selling price must be set high enough to cover all costs (both fixed and variable) and provide a reasonable amount for profit.

In setting prices, managers should also consider such factors as the prices of competing products and the general economic conditions of the marketplace.

The target cost concept begins with a price that can be sustained in the marketplace, then subtracts a target profit, thus determining the target cost. The cost is made to conform to the price required in the market. In contrast, under cost-plus, a markup is added to the cost. The resulting price is assumed to be acceptable in the market.

10.

The proper measure of product value in a bottlenecked process is the contribution margin per bottleneck hour.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

BASIC EXERCISES BE 25–1 (FIN MAN); BE 11–1 (MAN) Differential Analysis Lease (Alt. 1) or Sell (Alt. 2) Equipment October 29 Lease Equipment (Alternative 1)

Sell Equipment (Alternative 2)

Differential Effects (Alternative 2)

$225,000 (45,000) $180,000

$200,000 (10,000)* $190,000

$(25,000) 35,000 $ 10,000

Revenues Costs Profit (loss) * $200,000 × 5% Toccoa Company should sell the equipment. BE 25–2 (FIN MAN); BE 11–2 (MAN)

Differential Analysis Continue (Alt. 1) or Discontinue (Alt. 2) Product Omega January 15

Revenues Costs: Variable cost of goods sold Variable selling and admin. expenses Fixed costs Profit (loss)

Continue Discontinue Product Omega Product Omega (Alternative 1) (Alternative 2)

Differential Effects (Alternative 2)

$ 2,375,000

$(2,375,000)

(1,900,000)

1,900,000

(250,000) (300,000) $ (75,000)

0 (300,000) $(300,000)

250,000 0 $ (225,000)

Product Omega should be continued.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

BE 25–3 (FIN MAN); BE 11–3 (MAN) Differential Analysis Make (Alt. 1) or Buy (Alt. 2) Bottles February 18 Make Bottles (Alternative 1)

Unit costs: Purchase price Freight Variable costs ($30 – $14) Fixed factory overhead Total unit costs

$ 0 0 16 14 $30

Buy Bottles (Alternative 2)

Differential Effects (Alternative 2)

$20 1 0 14 $35

$ 20 1 (16) 0 $ 5

The company should make the bottles.

BE 25–4 (FIN MAN); BE 11–4 (MAN) Differential Analysis Continue (Alt. 1) or Replace (Alt. 2) Old Machine June 2 Continue with Old Machine (Alternative 1)

Revenues: Proceeds from sale of old machine Costs: Purchase price Direct labor (5 years) Profit (loss) 1

$17,500 × 5 years

$9,000 × 5 years

0 (87,500)1 $(87,500)

Replace Old Machine (Alternative 2)

Differential Effects (Alternative 2)

$ 18,800

(40,000) (45,000) 2 $(66,200)

(40,000) 42,500 $ 21,300

The company should buy the new machine.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

BE 25–5 (FIN MAN); BE 11–5 (MAN) Differential Analysis Sell Product Tango (Alt. 1) or Process Further into Product Zulu (Alt. 2) October 3 Sell Product Tango (Alternative 1)

Process Further into Product Zulu (Alternative 2)

Differential Effects (Alternative 2)

$ 40 (24) $ 16

$ 55 (33)* $ 22

$15 (9) $ 6

Revenues, per unit Costs, per unit Profit (loss), per unit * $24 + $9

The company should process Product Tango further into Product Zulu. BE 25–6 (FIN MAN); BE 11–6 (MAN) Differential Analysis Reject (Alt. 1) or Accept (Alt. 2) Order December 15 Reject Order (Alternative 1)

Revenues, per unit Costs: Variable manufacturing costs, per unit Export tariff, per unit Profit (loss), per unit

Accept Order (Alternative 2)

Differential Effects (Alternative 2)

$0.00

$ 35.00

0.00 0.00 $0.00

(21.00) (3.50)* $ 10.50

(21.00) (3.50) $ 10.50

* $35.00 × 10% The company should accept the special order.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

BE 25–7 (FIN MAN); BE 11–7 (MAN) Markup Percentage on Product Cost:

Desired Profit + Selling and Admin. Exp. Total Product Cost $58 + $70 $160*

= 80%

* $230 – $70

BE 25–8 (FIN MAN); BE 11–8 (MAN) Unit contribution margin……………………………………………… Furnace hours per unit………………………………………………… Unit contribution margin per production bottleneck hour………

Product K

Product L

$120 ÷ 5 $ 24

$100 ÷ 4 $ 25

Product L is the most profitable in using bottleneck resources.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

EXERCISES Ex. 25–1 (FIN MAN); Ex. 11–1 (MAN) a.

Differential Analysis Lease (Alt. 1) or Sell (Alt. 2) Machinery March 21 Lease Machinery (Alternative 1)

Sell Machinery (Alternative 2)

Differential Effects (Alternative 2)

$ 48,000 (12,000) $ 36,000

$35,000 (1,750) * $33,250

$(13,000) 10,250 $ (2,750)

Revenues Costs Profit (loss) * $35,000 × 5%

b. Lease the machinery. The net gain from leasing is $2,750.

Ex. 25–2 (FIN MAN); Ex. 11–2 (MAN) Note to Instructors: This differential analysis is a “lease or buy ” decision, which is from the user perspective. The “lease or sell ” decision is from the perspective of the equipment owner. Thus, the analysis is similar to the text examples but must be set up from the user’s, rather than the owner’s, perspective. Differential Analysis Lease (Alt. 1) or Buy (Alt. 2) Equipment February 12 Lease Equipment (Alternative 1)

Costs: Purchase price Freight and installation Repair and maintenance (6 years) Lease (6 years) Total costs 1

$8,000 × 6 years

$95,000 × 6 years

0 0 0 570,000 2 $570,000

Buy Equipment (Alternative 2)

Differential Effects (Alternative 2)

$550,000 15,000 48,0001 0 $613,000

$ 550,000 15,000 48,000 (570,000) $ 43,000

The company should lease the equipment.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Ex. 25–3 (FIN MAN); Ex. 11–3 (MAN) a.

Differential Analysis Continue (Alt. 1) or Discontinue (Alt. 2) Vim Cola November 2

Revenues Costs: Variable cost of goods sold Variable operating expenses Fixed costs Profit (loss)

(1 – 25%) × $10,000,000

(1 – 10%) × $3,500,000

(25% × $10,000,000) + (10% × $3,500,000)

Continue Vim Cola (Alternative 1)

Discontinue Vim Cola (Alternative 2)

Differential Effects (Alternative 2)

$12,500,000

$(12,500,000)

(7,500,000)1 (3,150,000) 2 (2,850,000) 3 $ (1,000,000)

0 0 (2,850,000) $(2,850,000)

7,500,000 3,150,000 0 $ (1,850,000)

Vim Cola should be retained. As indicated by the differential analysis in part (a), the income would decrease by $1,850,000 if the product is discontinued.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Ex. 25–4 (FIN MAN); Ex. 11–4 (MAN) a.

Differential Analysis Continue (Alt. 1) or Discontinue (Alt. 2) Socks September 14 Continue Socks (Alternative 1)

Revenues Costs: Variable cost of goods sold Variable selling and admin. expenses Fixed costs Profit (loss)

$345,000 × (1 – 30%)

$50,000 × (1 – 15%)

($345,000 × 30%) + ($50,000 × 15%)

$ 375,000

Discontinue Differential Socks Effects (Alternative 2) (Alternative 2)

$(375,000)

(241,500)1

241,500

(42,500) 2 (111,000) 3 $ (20,000)

0 (111,000) $(111,000)

42,500 0 $ (91,000)

The Socks should be retained. As indicated by the differential analysis in part (a), profit will decrease by $91,000 if the Socks line is discontinued.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Ex. 25–5 (FIN MAN); Ex. 11–5 (MAN) Note to Instructors: Many students may be unfamiliar with the financial services industry. This exercise provides an opportunity to introduce students to some basic terms and concepts used within the industry. a.

The Investor Services segment serves the retail customer, you and me. These are the brokerage, Internet, and mutual fund services used by individual investors. The Advisor Services segment includes the same services provided for financial institutions, such as banks, mutual fund managers, insurance companies, and pension plan administrators.

Variable costs in the Investor Services segment include: 1.

Commissions to brokers

Fees paid to exchanges for executing trades

Transaction fees incurred by Schwab mutual funds to purchase and sell shares

Advertising

Fixed costs in the Investor Services segment include: 1.

Depreciation on brokerage offices

Depreciation on brokerage office equipment, such as computers and computer networks

Property taxes on brokerage offices

Amortization of intangible assets

Operating income……………………………………………… Depreciation……………………………………………………… Estimated contribution margin……………………………… d.

Investor Services (in millions)

Advisor Services (in millions)

$3,079 288 $3,367

$1,221 126 $1,347

If one assumes that the assets and related fixed costs that serve advisor investors (computers, servers, and facilities) would not be sold but would be used by the other sector, then the contribution margin of $1,347 million would be an estimate of the reduced profitability. If the fixed assets were sold for no gain or loss, then the operating income decline would approach $1,221 million. Because the advisor and retail investors use nearly the same assets, the $1,347 million answer is probably the better estimate.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Ex. 25–6 (FIN MAN); Ex. 11–6 (MAN) The flaw in the decision is the failure to focus on the differential revenues and costs, which indicate that operating income would be reduced by $45,000 if Children’s Shoes were discontinued. This differential income from sales of Children’s Shoes can be determined from the following differential analysis: Differential Analysis Continue (Alt. 1) or Discontinue (Alt. 2) Children’s Shoes Continue Discontinue Children’s Children’s Shoes Shoes (Alternative 1) (Alternative 2)

Revenues Costs: Variable cost of goods sold Variable selling and admin. expenses Fixed costs Profit (loss)

Differential Effects (Alternative 2)

$ 280,000

$(280,000)

(135,000) (100,000) (75,000) * $ (30,000)

0 0 (75,000) $(75,000)

135,000 100,000 0 $ (45,000)

* $45,000 + $30,000

Ex. 25–7 (FIN MAN); Ex. 11–7 (MAN) a.

Differential Analysis Make (Alt. 1) or Buy (Alt. 2) Carrying Case May 31 Make Buy Carrying Carrying Case Case (Alternative 1) (Alternative 2)

Unit costs: Purchase price Direct materials Direct labor Variable factory overhead Fixed factory overhead Total unit costs 1

$8.00 × 25%

$3.20 – $2.00

$ 0.00 (5.00) (8.00) (2.00)1 (1.20) 2 $(16.20)

Differential Effects (Alternative 2)

$(18.00) 0.00 0.00 0.00 (1.20) $(19.20)

$(18.00) 5.00 8.00 2.00 0.00 $ (3.00)

b. Assuming there were no better alternative uses for the spare capacity, it would be advisable to manufacture the carrying cases because the cost savings would be $3.00 per unit. Fixed factory overhead is irrelevant because it will continue whether the carrying cases are purchased or manufactured.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Ex. 25–8 (FIN MAN); Ex. 11–8 (MAN) a.

Differential Analysis Lay Out Pages Internally (Alt. 1) or Purchase Layout Services (Alt. 2) February 22 Lay Out Pages Internally (Alternative 1)

Costs: Purchase price of layout work Salaries Benefits Supplies Office expenses Office depreciation Computer depreciation Total costs

0 224,000 36,000 21,000 39,000

$320,000

Purchase Layout Services (Alternative 2)

Differential Effects (Alternative 2)

$312,000* 0 0 0 0 0 0 $312,000

$ 312,000 (224,000) (36,000) (21,000) (39,000) 0 0 $ (8,000)

* 24,000 pages × $13 per page b.

The benefit from using an outside service is shown to be $8,000 greater than performing the layout work internally. The fixed costs (depreciation expenses) in the budget are irrelevant to the decision. Thus, the work should be purchased from the outside on a strictly financial basis.

Before electing to lay off the five employees, TAG-D should consider the long-run impact of the decision. Specifically, future page layout rates may grow faster than the cost of internal salaries, thus favoring the use of employees over the long term. This would especially be the case if the outside company provided a low bid in order to win the initial business. In addition, TAG-D may wish to consider non-economic factors, such as the ability to more directly control the quality and timing of the layout work by internal employees.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Ex. 25–9 (FIN MAN); Ex. 11–9 (MAN) a.

Differential Analysis Continue with (Alt. 1) or Replace (Alt. 2) Old Machine December 10 Continue with Old Machine (Alternative 1)

Revenues: Proceeds from sale of old machine Costs: Purchase price Variable production costs (8 years) Profit (loss) 1

$85,000 × 8 years

$25,000 × 8 years

0 (680,000)1 $(680,000)

Replace Old Machine (Alternative 2)

Differential Effects (Alternative 2)

$ 300,000

(825,000) (200,000) 2 $(725,000)

(825,000) 480,000 $ (45,000)

The company should continue with the old machine. b. The sunk cost is the $295,000 book value ($675,000 cost less $380,000 accumulated depreciation) of the present machine. The original cost and accumulated depreciation were incurred in the past and are irrelevant to the decision to replace the machine.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Ex. 25–10 (FIN MAN); Ex. 11–10 (MAN) a.

Differential Analysis Continue with (Alt. 1) or Replace (Alt. 2) Old Machine October 1 Continue with Old Machine (Alternative 1)

Revenues: Sales (6 years)* Costs: Purchase price Direct materials (6 years)* Direct labor (6 years)* Power and maintenance (6 years)* Taxes, insurance, etc. (6 years)* Selling and admin. expenses (6 years)* Profit (loss)

Replace Old Differential Machine Effects (Alternative 2) (Alternative 2)

$2,400,000

0 (720,000) (540,000) (54,000) (6,000)

(500,000) (720,000) 0 (156,000) (24,000)

(500,000) 0 540,000 (102,000) (18,000)

(300,000) $ 780,000

(300,000) $ 700,000

0 $ (80,000)

* Each annual revenue and cost is multiplied by 6 years. b.

The proposal should not be accepted.

In addition to the factors given, consideration should be given to such factors as: Do both present and proposed operations provide the same capacity? What opportunity costs are associated with alternative uses of the $500,000 outlay required to purchase the automatic machine? Is the product improved by using automatic machinery? Does the federal income tax have an effect on the decision?

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Ex. 25–11 (FIN MAN); Ex. 11–11 (MAN) Differential Analysis Sell Rough-Cut (Alt. 1) or Process Further into Finished-Cut (Alt. 2) April 21 Process Sell Further into Differential Rough-Cut Finished-Cut Effects (Alternative 1) (Alternative 2) (Alternative 2)

Revenues, per 100 board ft. Costs, per 100 board ft. Profit (loss), per 100 board ft.

$ 300 (250) $ 50

$ 375 (315) $ 60

$ 75 (65) $ 10

Northern Lumber Company should process further and sell finished-cut lumber.

Ex. 25–12 (FIN MAN); Ex. 11–12 (MAN) a.

Differential Analysis Sell Regular (Alt. 1) or Process Further into Decaf (Alt. 2) December 11 Process Sell Further into Differential Regular Decaf Effects (Alternative 1) (Alternative 2) (Alternative 2)

Revenues Costs Profit (loss) 1

$9.80 × 7,500 lbs.

$11.60 × (7,500 lbs. × 95%)

$6.00 × 7,500 lbs.

$45,000 + $6,300

$ 73,500 1 (45,000)3 $ 28,500

$ 82,650 2 (51,300) 4 $ 31,350

$ 9,150 (6,300) $ 2,850

b. The differential revenue from processing further to Decaf Columbian is $2,850. Thus, Dakota Coffee Company should process further to Decaf Columbian.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Ex. 25–12 (FIN MAN); Ex. 11–12 (MAN) (Concluded) c.

The price of Decaf Columbian would need to decrease from $11.60 to $11.20 per pound in order for the differential analysis to yield neither an advantage nor a disadvantage (indifference). This is determined as follows: Net Advantage of Further Processing Volume of Decaf Columbian

$2,850 7,125 lbs.

= $0.40 per lb.

The price of Decaf Columbian would need to be $0.40 lower, or $11.20, to yield no net differential profit or loss. This is verified by the following differential analysis: Differential Analysis Sell Regular (Alt. 1) or Process Further into Decaf (Alt. 2) December 11

Revenues Costs Profit (loss)

Sell Regular (Alternative 1)

Process Further into Decaf (Alternative 2)

Differential Effects (Alternative 2)

$ 73,500 (45,000) $ 28,500

$ 79,800 * (51,300) $ 28,500

$ 6,300 (6,300) $ 0

* $11.20 × (7,500 lbs. × 95%)

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Ex. 25–13 (FIN MAN); Ex. 11–13 (MAN) a.

Differential Analysis Reject (Alt. 1) or Accept (Alt. 2) Order July 6 Reject Order (Alternative 1)

Accept Order (Alternative 2)

Differential Effects (Alternative 2)

$ 650,000 1

$ 650,000

0 $0

(450,000) 2 $ 200,000

(450,000) $ 200,000

Revenues Costs: Variable manufacturing costs Profit (loss) 1

50,000 units × $13 per unit

50,000 units × $9 per unit

b. The additional units can be sold for $13 each, and because unused capacity is available, the only costs that would be added if this additional production were accepted are the variable costs of $9 per unit. The differential revenue is therefore $13 per unit, and the differential cost is $9 per unit. Thus, the net profit is $4 per unit × 50,000 units, or $200,000. c. $9.01. Any selling price above $9 (variable costs per unit) will produce a positive contribution margin.

Ex. 25–14 (FIN MAN); Ex. 11–14 (MAN) Total costs……………………………………………………………………………… $ 522,000 Fixed costs……………………………………………………………………………… (150,000) Total variable costs…………………………………………………………………… $ 372,000 Variable cost per unit: $372,000 ÷ 40,000 batteries = $9.30 The lowest bid should be sufficient to cover the variable cost of $9.30 per unit.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Ex. 25–15 (FIN MAN); Ex. 11–15 (MAN) a.

Differential Analysis Reject (Alt. 1) or Accept (Alt. 2) Order July 31 Reject Order (Alternative 1)

Accept Order (Alternative 2)

Differential Effects (Alternative 2)

$15,000,000 1

$15,000,000

0 0 0

(7,500,000)2 (2,000,000) 3 (2,100,000) 4

(7,500,000) (2,000,000) (2,100,000)

0 0 0 $0

(480,000)5 (300,000) 6 (400,000) $ 2,220,000

(480,000) (300,000) (400,000) $ 2,220,000

Revenues Costs: Direct materials Direct labor Variable factory overhead Variable selling and admin. expenses Shipping costs Certification costs Profit (loss) 1

100,000 tires × $150 per tire

100,000 tires × $75 per tire

100,000 tires × $20 per tire

100,000 tires × ($30 per tire × 70%)

100,000 tires × [($18 per tire × 60%) – ($200 × 3%)*]

100,000 tires × $3 per tire

* 3% × $200. The avoided sales commission should not be computed on the basis of the $150 price to Autobahn Motors, but on the existing domestic sales price of $200.

Talladega should accept the special order from Autobahn Motors. b.

$150 –

$2,220,000 100,000

= $150.00 – $22.20 = $127.80

This is the price at which the differential profit would be zero.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Ex. 25–16 (FIN MAN); Ex. 11–16 (MAN) a.

Desired profit = $250,000 × 22% = $55,000

Cost amount (product cost) per unit: $32,000 ÷ 800 units = $40

Markup Percentage

Desired Profit + Total Selling and Administrative Expenses Total Manufacturing Costs

= =

$55,000 + $17,000 $32,000

= 225% d.

Cost amount (product cost) per unit……………………………………………… Markup ($40 × 225%)………………………………………………………………… Selling price……………………………………………………………………………

$ 40 90 $130

Ex. 25–17 (FIN MAN); Ex. 11–17 (MAN) a.

Desired profit = $1,200,000 × 30% = $360,000

Cost amount (product cost) per unit: $2,500,000* ÷ 10,000 units = $250 * ($215 manufacturing variable cost per unit × 10,000 units) + $350,000 manfacturing fixed cost

Markup Percentage

Desired Profit + Total Selling and Administrative Expenses Total Manufacturing Costs

$360,000 + $140,000 + ($25 × 10,000) $2,500,000

$360,000 + $140,000 + $250,000 $2,500,000

$750,000 $2,500,000

= 30% d.

Cost amount per unit………………………………………………………………… $250 75 Markup ($250 × 30%)………………………………………………………………… Selling price…………………………………………………………………………… $325

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Ex. 25–18 (FIN MAN); Ex. 11–18 (MAN) a.

The price will be set at the estimated market price required to remain competitive, or $27,000. Under the target cost concept, the market dictates the price, not the markup on cost.

The required profit margin of 20% of the estimated $27,000 selling price implies a $21,600 target product cost as follows: Target Product Cost

= $27,000 – ($27,000 × 20%) = $27,000 – $5,400 = $21,600

Because the estimated manufacturing cost of $22,500 exceeds the target cost of $21,600, Toyota must reduce $900 from its total costs in order to maintain competitive pricing within its profit objectives. Note to Instructors: Target costing provides pressure to keep costs competitive. The method assumes that the company may not be able to successfully add a markup to its costs because the resulting price may be too high in the marketplace. For example, merely adding the 25% markup on the $22,500 product cost would result in an uncompetitive price of $28,125. The target cost concept moves backward by taking the selling price as given and then determining the cost that is required for a given profit objective.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Ex. 25–19 (FIN MAN); Ex. 11–19 (MAN) a.

Historical markup percentage on product cost: or,

$230 $460

$460 – $230 $230

= 100%

= 50% of selling price

$400 revised selling price × 50% = $200 amount of markup on target product cost $400 selling price – $200 markup = $200 target product cost (Also, $200 × 100% = $200 markup on product cost; $200 + $200 = $400 selling price) b.

Required cost reduction: $230 – $200 = $30

Direct labor reduction:

$30 60 min.

× 15 min. =

Additional inspection:

$30 60 min.

× 6 min. =

$ 7.50 $ (3.00) 20.00

17.00

$ 4.00 1.80

5.80

Direct material reduction: 3.

Injection molding productivity improvement: Direct labor improvement (25%* × 40% × $40) Factory overhead improvement (25%* × 48% × $15) Total savings per unit

* Improving the cycle time from four minutes to three minutes is a 25% reduction. The total savings exceeds the required target cost reduction by $0.30. Thus, these improvements are sufficient to meet the target cost.

$30.30

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Ex. 25–20 (FIN MAN); Ex. 11–20 (MAN) Determine the contribution margin per furnace hour as follows: Type 5

Type 10

Type 20

Revenues………………………………… $ 43,000 Variable cost…………………………… (34,000) Contribution margin…………………… $ 9,000 Divide by number of units…………… ÷ 5,000 units Unit contribution margin……………… $ 1.80

$ 49,000 (28,000)

$ 56,500 (26,500)

$ 21,000 ÷ 5,000 units $ 4.20

$ 30,000 ÷ 5,000 units $ 6.00

Unit contribution margin per furnace hour*………………………$

0.30

0.70

0.50

* Calculated as follows: Type 5:

$1.80 6 hours

= $0.30 per furnace hour

Type 10:

$4.20 6 hours

= $0.70 per furnace hour

Type 20:

$6.00 12 hours

= $0.50 per furnace hour

Emphasize Type 10. In a production-constrained environment, Type 10 generates the most unit contribution margin per hour of furnace resource and, thus, is the most profitable. While Type 20 has the largest profit per unit ($4.40) and unit contribution margin ($6.00), these would not be the correct metrics for determining the product to emphasize in the marketing campaign, assuming the furnace is a bottleneck resource.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Ex. 25–21 (FIN MAN); Ex. 11–21 (MAN) a.

Large

Units produced………………

Medium

Small

3,000

Revenues……………………… $ 552,000 Variable costs………………… (390,000) Contribution margin………… $ 162,000 Fixed costs…………………… Operating income……………

$ 480,000 (360,000) $ 120,000

$ 300,000 (228,000) $ 72,000

Total

$1,332,000 (978,000) $ 354,000 (85,000) $ 269,000

The Small glass product is the most profitable in a bottleneck operation, demonstrated as follows: Contribution margin…………………………… Autoclave hours per unit……………………… Unit contribution margin per production bottleneck hour………………………………

Large

Medium

Small

$54 ÷ 3

$40 ÷ 2

$24 ÷ 1

$18

$20

$24

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Appendix Ex. 25–22 (FIN MAN); Appendix Ex. 11–22 (MAN) a.

Total costs: Variable ($240 × 10,000 units)………………………………………………… $2,400,000 490,000 Fixed ($350,000 + $140,000)………………………………………………… Total…………………………………………………………………………… $2,890,000 Cost amount per unit: $2,890,000 ÷ 10,000 units = $289

Markup Percentage = = =

Desired Profit Total Costs $360,000* $2,890,000 12.46% (rounded)

* $1,200,000 × 30% = $360,000 c.

Cost amount per unit……………………………………………………………… Markup ($289 × 12.46%)…………………………………………………………… Selling price…………………………………………………………………………

$289 36 * $325

* Rounded

Appendix Ex. 25–23 (FIN MAN); Appendix Ex. 11–23 (MAN) a.

Total variable costs: ($240 × 10,000 units)…………………………………… $2,400,000 Cost amount per unit: $2,400,000 ÷ 10,000 units = $240

Markup Percentage =

Desired Profit + Total Fixed Costs and Expenses Total Variable Cost

$360,000* + $350,000 + $140,000 $2,400,000

$850,000 $2,400,000

= 35.42% * $1,200,000 × 30% = $360,000 c.

Cost amount per unit……………………………………………………………… Markup ($240 × 35.42%)…………………………………………………………… Selling price…………………………………………………………………………

$240 85 $325

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

PROBLEMS Prob. 25–1A (FIN MAN); Prob. 11–1A (MAN) 1.

Differential Analysis Operate Retail Store (Alt. 1) or Invest in Bonds (Alt. 2) July 1

Revenues Costs: Costs to operate store Cost of equipment less residual value Profit (loss) 1

(6 yrs. × $400,000) + (9 yrs. × $600,000)

2% × $1,500,000 × 15 yrs.

$320,000 × 15 yrs.

$1,500,000 – $75,000

Operate Retail Store (Alternative 1)

Invest in Bonds (Alternative 2)

Differential Effects (Alternative 2)

$ 7,800,0001

$450,000 2

$(7,350,000)

(4,800,000)3

4,800,000

(1,425,000)4 $ 1,575,000

0 $450,000

1,425,000 $(1,125,000)

2. The proposal to operate the retail store should be accepted. 3. Total estimated revenue from operating store………… Total estimated expenses to operate store: Costs to operate store, excluding depreciation…… Cost of store equipment less residual value……… Total estimated expenses………………………… Total estimated income from operating store*…………

$ 7,800,000 $4,800,000 1,425,000 (6,225,000) $ 1,575,000

* The $1,575,000 income could also be determined by adding the $1,125,000 differential profit from operating the store as derived in part (1) to the $450,000 of investment income forgone by electing to operate the store.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Prob. 25–2A (FIN MAN); Prob. 11–2A (MAN) 1.

Differential Analysis Continue with (Alt. 1) or Replace (Alt. 2) Old Machine November 30 Continue with Old Machine (Alternative 1)

Revenues: Proceeds from sale of old machine Costs: Purchase price Annual manufacturing costs (6 yrs.) Profit (loss) 1

$30,000 × 6 years

$7,500 × 6 years

Replace Old Machine (Alternative 2)

Differential Effects (Alternative 2)

$ 40,000

(160,000)

(45,000) 2 $(165,000)

135,000 $ 15,000

(180,000)1 $(180,000)

Note: Revenues and nonmanufacturing operating expenses are not affected by the decision to replace the old machine and, thus, are not included in the analysis. If they were included, both alternatives would include them, causing the differential effect on income to net to zero for both items. Depreciation is ignored because it is a sunk cost for the old machine and is incorporated in the purchase price for the new machine. Gutenberg Publishers should replace the old machine with the new machine. 2. Other factors to be considered include: a. Are there any improvements in the quality of work turned out by the new machine? b. What effect does the federal income tax have on the decision? c. What opportunities are available for the use of the $120,000 of funds ($160,000 less $40,000 proceeds from the old machine) that are required to purchase the new machine? After considering such factors as those listed above, the net cost reduction anticipated over the six-year period may not be sufficient to justify the replacement. For example, if there is an opportunity to invest the $120,000 ($160,000 – $40,000) of additional funds required for the replacement in a project that earns a return of 5% (assumed for illustration), the amount of the return over the six-year period would be $36,000 ($120,000 × 5% × 6), which is more advantageous than the replacement, other factors being equal.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Prob. 25–3A (FIN MAN); Prob. 11–3A (MAN) Differential Analysis Promote Moisturizer (Alt. 1) or Promote Perfume (Alt. 2) February 17

Revenues Costs:* Direct materials Direct labor Variable factory overhead Variable selling expenses Sales promotion Profit (loss) 1

75,000 units × $15

60,000 units × $24

Promote Moisturizer (Alternative 1)

Promote Perfume (Alternative 2)

Differential Effects (Alternative 2)

$1,125,000 1

$1,440,000 2

$ 315,000

(150,000) (150,000) (75,000) (75,000) (200,000) $ 475,000

(240,000) (240,000) (120,000) (120,000) (200,000) $ 520,000

(90,000) (90,000) (45,000) (45,000) 0 $ 45,000

* Costs, except sales promotion, are the costs per unit multiplied by the increase in unit volume for each cosmetic. Fixed costs are not relevant to the decision, so are not included.

Raisa Cosmetics should promote perfume. 2. The sales manager’s tentative decision should be opposed. The sales manager erroneously considered the full unit costs instead of the differential (additional) revenue and differential (additional) costs. An analysis similar to that presented in part (1) would lead to the selection of perfume for the promotional campaign because this alternative will contribute $45,000 ($520,000 – $475,000) more to operating income than would be contributed by promoting moisturizer.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Prob. 25–4A (FIN MAN); Prob. 11–4A (MAN) Differential Analysis Sell Raw Sugar (Alt. 1) or Process Further into Refined Sugar (Alt. 2) March 24

Sell Raw Sugar (Alternative 1)

Process Further into Refined Sugar (Alternative 2)

Differential Effects (Alternative 2)

$ 58,8001 (35,000)3 $ 23,800

$ 73,920 2 (56,000)4 $ 17,920

$ 15,120 (21,000) $ (5,880)

Revenues, per batch Costs, per batch Profit (loss), per batch 1

$1.40 per pound × 42,000 pounds

$2.20 per pound × (42,000 pounds ÷ 1.25)

$0.35 per pound × 100,000 pounds

$35,000 + ($0.50 per pound × 42,000 pounds)

2. Dominican Sugar Company should not process raw sugar further to produce refined sugar because profits would be reduced by $5,880 per batch.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Prob. 25–5A (FIN MAN); Prob. 11–5A (MAN) 1. Selling price………………………………………… Variable conversion cost per unit……………… Direct materials cost per unit…………………… Total unit costs……………………………………… Contribution margin per unit………………………

High Grade

Good Grade

Regular Grade

$ 280

$ 270

$ 250

$(180)* (90) $(270) $ 10

$(165) ** (84) $(249) $ 21

$(150)*** (80) $(230) $ 20

* $15 × 12 process hours = $180 ** $15 × 11 process hours = $165 *** $15 × 10 process hours = $150 2. The contribution margin per unit may give false signals when an organization has production bottlenecks. Instead, Hercules should use the contribution margin per bottleneck hour to determine relative product profitability, as follows:

Contribution margin per unit……………………… Furnace (bottleneck) hours per unit…………… Contribution margin per furnace hour…………

High Grade

Good Grade

Regular Grade

$ 10 4 ÷ $2.50

$ 21 3 $7.00

÷ 2.5

$ 20 $8.00

The Good Grade steel has the largest contribution margin per unit ($21); however, the Regular Grade has the largest contribution margin per furnace hour ($8). Thus, using production bottleneck analysis indicates that the Regular Grade is actually more profitable at an $8.00 contribution margin per furnace hour than High Grade’s $2.50 or Good Grade’s $7.00 contribution margin per furnace hour. Therefore, the company would want to sell product in the following preference order: 1. Regular Grade 2. Good Grade 3. High Grade

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Prob. 25–6A (FIN MAN); Prob. 11–6A (MAN) 1. $900,000 ($6,000,000 × 15%) 2. a. Total manufacturing costs: Variable ($200* × 20,000 units)………………………………………… $4,000,000 Fixed factory overhead…………………………………………………… 1,000,000 Total……………………………………………………………………… $5,000,000 Cost amount per unit: $5,000,000 ÷ 20,000 units………………………

250

* $120 + $30 + $50

Desired Profit + Total Selling and Administrative Expenses Total Manufacturing Costs

Markup Percentage = =

$900,000 + $400,000 + ($35 × 20,000 units) $5,000,000

$900,000 + $400,000 + $700,000 $5,000,000

$2,000,000 $5,000,000

= 40% c. Cost amount per unit………………………………………………………… Markup ($250 × 40%)………………………………………………………… Selling price……………………………………………………………………

$250 100 $350

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Prob. 25–6A (FIN MAN); Prob. 11–6A (MAN) (Continued) 3. (Appendix) a. Total costs: Variable ($235 × 20,000 units)………………………………………… Fixed ($1,000,000 + $400,000)………………………………………… Total…………………………………………………………………… Cost amount per unit: $6,100,000 ÷ 20,000 units……………………… b.

Markup Percentage = = =

$4,700,000 1,400,000 $6,100,000 $

305

Desired Profit Total Costs $900,000 $6,100,000 14.75% (rounded)

c. Cost amount per unit……………………………………………………… Markup ($305 × 14.75%)…………………………………………………… Selling price……………………………………………………………………

$305 45 $350

4. (Appendix) a. Variable cost amount per unit: $235 Total variable costs: $235 × 20,000 units = $4,700,000 b.

Markup Percentage =

Desired Profit + Total Fixed Costs Total Variable Costs

$900,000 + $1,000,000 + $400,000 $4,700,000

$2,300,000 $4,700,000

= 48.94% (rounded) c. Cost amount per unit……………………………………………………… Markup ($235 × 48.94%)…………………………………………………… Selling price……………………………………………………………………

$235 115 $350

5. The cost-plus approach price of $350 should be viewed as a general guideline for establishing long-run normal prices. Other considerations, such as the price of competing products and general economic conditions of the marketplace, could lead management to establish a short-run price more or less than $350.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Prob. 25–6A (FIN MAN); Prob. 11–6A (MAN) (Concluded) 6. a. Differential Analysis Reject (Alt. 1) or Accept (Alt. 2) Order November 5 Reject Order (Alternative 1)

Accept Order (Alternative 2)

Differential Effects (Alternative 2)

$ 225,000

0 $0

(200,000) 1 $ 25,000

(200,000) $ 25,000

Revenues Costs: Variable manufacturing costs Profit (loss) 1

1,000 units × ($235 – $35*)

* Excluding variable selling and administrative expenses b. The proposal should be accepted.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Prob. 25–1B (FIN MAN); Prob. 11–1B (MAN) 1.

Differential Analysis Operate Warehouse (Alt. 1) or Invest in Bonds (Alt. 2) July 1

Revenues Costs: Costs to operate warehouse Cost of equipment less residual value Profit (loss) 1

(7 yrs. × $280,000) + (7 yrs. × $240,000)

5% × $740,000 × 14 years

$175,000 × 14 years

$740,000 – $75,000

Operate Warehouse (Alternative 1)

Invest in Bonds (Alternative 2)

Differential Effects (Alternative 2)

$ 3,640,0001

$518,000 2

$(3,122,000)

(2,450,000)3

2,450,000

(665,000)4 $ 525,000

0 $518,000

665,000 (7,000)

2. The proposal to operate the warehouse should be accepted. 3. Total estimated revenue from operating warehouse……… Total estimated expenses to operate warehouse: Costs to operate warehouse, excluding depreciation… Cost of warehouse equipment less residual value…… Total estimated expenses……………………………… Total estimated income from operating warehouse*………

$ 3,640,000 $2,450,000 665,000 (3,115,000) $

525,000

* The $525,000 operating income could also be determined by adding the $7,000 differential profit from operating the warehouse as derived in part (1) to the $518,000 of investment income forgone by electing to operate the warehouse.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Prob. 25–2B (FIN MAN); Prob. 11–2B (MAN) 1.

Differential Analysis Continue with (Alt. 1) or Replace (Alt. 2) Old Machine November 8 Continue Replace with Old Old Differential Machine Machine Effects (Alternative 1) (Alternative 2) (Alternative 2)

Revenues: Proceeds from sale of old machine Costs: Purchase price Annual manufacturing costs (6 yrs.) Profit (loss) 1

$12,400 × 6 years

$3,400 × 6 years

$ 12,900

(57,000)

(74,400)1 $(74,400)

(20,400) 2 $(64,500)

54,000 $ 9,900

Note: Revenues and nonmanufacturing operating expenses are not affected by the decision to replace the old machine and, thus, are not included in the analysis. If they were, both alternatives would include them, causing the differential effect on profit to net to zero for both items. Depreciation is ignored because it is a sunk cost for the old machine and is incorporated in the purchase price for the new machine. Flint Tooling Company should replace the old machine with the new machine. 2. Other factors to be considered include the following: a. Are there any improvements in the quality of work turned out by the new machine? b. What effect does the federal income tax have on the decision? c. What opportunities are available for the use of the $44,100 of funds ($57,000 less $12,900 proceeds from the old machine) that are required to purchase the new machine? After considering such factors as those listed above, the net cost reduction anticipated over the six-year period may not be sufficient to justify the replacement. For example, if there is an opportunity to invest the $44,100 ($57,000 – $12,900) of additional funds required for the replacement in a project that earns a return of 3% (assumed for illustration), the amount of the return over the six-year period would be $7,938 ($44,100 × 3% × 6). However, this is less than differential profit determined in part (1), suggesting the proposal to replace is still preferred.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Prob. 25–3B (FIN MAN); Prob. 11–3B (MAN) Differential Analysis Promote Tennis (Alt. 1) or Walking (Alt. 2) Shoes June 19

Revenues Costs:* Direct materials Direct labor Variable factory overhead Variable operating expenses Sales promotion Profit (loss) 1

7,000 shoes × $85

7,000 shoes × $100

Promote Tennis Shoes (Alternative 1)

Promote Walking Shoes (Alternative 2)

Differential Effects (Alternative 2)

$ 595,0001

$ 700,000 2

$105,000

(133,000) (56,000) (49,000) (42,000) (100,000) $ 215,000

(224,000) (84,000) (35,000) (70,000) (100,000) $ 187,000

(91,000) (28,000) 14,000 (28,000) 0 $ (28,000)

* Costs, except sales promotion, are the costs per unit multiplied by the increase in unit volume for each pair of shoes. Fixed costs are not relevant to the decision so are not included.

Sole Mates Inc. should promote tennis shoes. 2. The sales manager’s tentative decision should be opposed. The sales manager erroneously considered the full unit costs instead of the differential (additional) revenue and differential (additional) costs. An analysis similar to that presented in part (1) would lead to the selection of tennis shoes for the promotional campaign because this alternative will contribute $28,000 ($215,000 – $187,000) more to operating income than would be contributed by promoting walking shoes.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Prob. 25–4B (FIN MAN); Prob. 11–4B (MAN) Differential Analysis Sell Ingot (Alt. 1) or Process Further into Rolled Aluminum (Alt. 2) February 5

Sell Ingot (Alternative 1)

Revenues Costs Profit (loss) 1

$1,100 per ton × 80 tons

$2,200 per ton × (80 tons ÷ 1.25)

$105 per ton × 500 tons

$52,500 + ($620 per ton × 80 tons)

$ 88,000 (52,500)3 $ 35,500

Process Further into Rolled Aluminium (Alternative 2) 2

$ 140,800 (102,100)4 $ 38,700

Differential Effects (Alternative 2)

$ 52,800 (49,600) $ 3,200

2. International Aluminum Co. should decide to process aluminum ingot further, rather than sell aluminum ingot, because profits would be increased by $3,200 per batch if ingot was processed further into rolled aluminum.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Prob. 25–5B (FIN MAN); Prob. 11–5B (MAN) 1. Selling price…………………………………………… Variable conversion cost per unit………………… Direct materials cost per unit……………………… Total unit costs……………………………………… Contribution margin per unit………………………

Ethylene

Butane

Ester

$ 170

$ 155

$ 130

$ (40) * (115) $(155) $ 15

$ (40) * (88) $(128) $ 27

$ (30) ** (85) $(115) $ 15

* $10 × 4.0 process hours = $40 ** $10 × 3.0 process hours = $30 2. The contribution margin per unit may give false signals when an organization has production bottlenecks. Instead, Wilmington Chemical Company should use the contribution margin per bottleneck hour to determine relative product profitability as follows: Contribution margin per unit……………………… Reactor (bottleneck) hours per unit……………… Contribution margin per reactor hour……………

Ethylene

Butane

Ester

$15 ÷1.5 $10

$27 ÷1.0 $27

$15 ÷0.5 $30

Butane has the largest contribution margin per unit ($27); however, Ester has the largest contribution margin per reactor hour ($30). Thus, using production bottleneck analysis indicates that Ester is actually more profitable at a $30 contribution margin per reactor hour than Butane's $27 or Ethylene's $10 contribution margin per reactor hour. Therefore, the company would want to sell product in the following preference order: 1. Ester 2. Butane 3. Ethylene

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Prob. 25–6B (FIN MAN); Prob. 11–6B (MAN) 1. $60,000 ($600,000 × 10%) 2. a. Total manufacturing costs: Variable ($52* × 10,000 units)…………………………………………… Fixed factory overhead…………………………………………………… Total………………………………………………………………………

$520,000 180,000 $700,000

Cost amount per unit: $700,000 ÷ 10,000 units…………………………… $

* $32 + $12 + $8

Desired Profit + Total Selling and Administrative Expenses Total Manufacturing Costs

Markup Percentage = =

$60,000 + $80,000 + ($7 × 10,000 units) $520,000 + $180,000

$60,000 + $80,000 + $70,000 $700,000

$210,000 $700,000

= 30% c. Cost amount per unit………………………………………………………… Markup ($70 × 30%)…………………………………………………………… Selling price………………………………………………………………………

$70 21 $91

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Prob. 25–6B (FIN MAN); Prob. 11–6B (MAN) (Continued) 3. (Appendix) a. Total costs: Variable ($59 × 10,000 units)…………………………………………… Fixed ($180,000 + $80,000)……………………………………………… Total……………………………………………………………………… Cost amount per unit: $850,000 ÷ 10,000 units………………………… b.

Markup Percentage =

$590,000 260,000 $850,000 $

85.00

Desired Profit Total Costs

$60,000 $850,000

7.06% (rounded)

c. Cost amount per unit………………………………………………………… Markup ($85.00 × 7.06%)……………………………………………………… Selling price……………………………………………………………………

$85 6 $91

4. (Appendix) a. Variable cost amount per unit: $59 Total variable costs: $59 × 10,000 units = $590,000 b.

Markup Percentage =

Desired Profit + Total Fixed Costs Total Variable Costs

$60,000 + $180,000 + $80,000 $590,000

$320,000 $590,000

= 54.24% (rounded) c. Cost amount per unit………………………………………………………… Markup ($59 × 54.24%)………………………………………………………… Selling price……………………………………………………………………

$59 32 $91

5. The cost-plus approach price of $91 should be viewed as a general guideline for establishing long-run normal prices. Other considerations, such as the price of competing products and general economic conditions of the marketplace, could lead management to establish a short-run price more or less than $91.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

Prob. 25–6B (FIN MAN); Prob. 11–6B (MAN) (Concluded) 6. a. Differential Analysis Reject (Alt. 1) or Accept (Alt. 2) Order September 5 Reject Order (Alternative 1)

Accept Order (Alternative 2)

Differential Effects (Alternative 2)

$ 91,200 1

$ 91,200

0 $0

(83,200) 2 $ 8,000

(83,200) $ 8,000

Revenues Costs: Variable manufacturing costs Profit (loss) 1

1,600 units × $57

2 1,600 units × ($59 – $7*)

* Excluding variable selling and administrative expenses

b. The proposal should be accepted.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

MAKE A DECISION MAD 25–1 (FIN MAN); MAD 11–1 (MAN) a.

Contribution Margin = Ticket Price – Variable Costs per Passenger per Passenger = $180 – $40 = $140

Break-Even Seats = per Flight =

Fixed Costs per Flight Contribution Margin per Passenger $16,100 $140

= 115 seats c.

Contribution Margin = Discounted Ticket Price – Variable Costs per Passenger = $90 – $40 = $50

Lost contribution margin from customers who switch tickets: 8 × $140 = $1,120 Gained contribution margin from discount customers: (8 + 15) × $50 = $1,150 Incremental contribution per flight from the discounted ticket plan: $1,150 – $1,120 = $30 The new ticket plan will produce a positive contribution margin per flight and should be implemented based on these assumptions.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

MAD 25–1 (FIN MAN); MAD 11–1 (MAN) (Concluded) The same answer can be determined from a differential analysis table, as follows: Differential Analysis Continue with No Change (Alt. 1) or Offer the Discount Plan (Alt. 2)

No Change (Alternative 1)

Discount Plan (Alternative 2)

Differential Effects (Alternative 2)

$22,500

$23,130

$ 630

(9,500) (900) (4,750) (2,600) (2,100) (1,250) $ 1,400

(9,500) (900) (5,020) (2,780) (2,100) (1,400) $ 1,430

0 0 (270) (180) 0 (150) $ 30

Ticket Price

No. of Tickets

Revenue

$180 90

117* 23**

$21,060 2,070

140

$23,130

Revenues per flight Costs per flight: Plane depreciation Crew salaries Fuel2 3 Ground salaries Airport fees Passenger services4 Income per flight 1

Revenues: No change revenues: $180 × 125 seats Discount plan revenues: Full price Discount price Total

* 125 – 8 ** 15 + 8 2

Fuel: No change: $2,500 + ($18 × 125 seats) Discount plan: $2,500 + ($18 × 140 seats)

Ground salaries: No change: $1,100 + ($12 × 125 seats) Discount plan: $1,100 + ($12 × 140 seats)

Passenger services: No change: $10 × 125 seats Discount plan: $10 × 140 seats

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

MAD 25–2 (FIN MAN); MAD 11–2 (MAN) a.

Contribution margin per room night: Rate per room night

$180

Variable costs per room night: Housekeeping service Utilities Amenities Total variable cost per room night Contribution margin per room night

$ (23) (7) (3) $ (33) $147

Rate per room night

$120

Variable costs per room night: Housekeeping service Utilities Amenities Total variable cost per room night Contribution margin per room night

$ (23) (7) (3) $ (33) $ 87

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

MAD 25–2 (FIN MAN); MAD 11–2 (MAN) (Concluded) c.

Differential Analysis Continue with Existing Plan (Alt. 1) or Execute the Discount Plan (Alt. 2) Continue with Execute the Existing Plan Discount Plan (Alternative 1) (Alternative 2)

Revenues per weekend1

Differential Effects (Alternative 2)

$32,400

$36,000

$ 3,600

$ (4,140) (1,260) (540)

$ (6,900) (2,100) (900)

$(2,760) (840) (360)

$ (5,940) $26,460

$ (9,900) $26,100

$(3,960) $ (360)

Variable costs per weekend: 2

Housekeeping service 3 Utilities 4 Amenities Total variable cost per weekend Contribution margin per weekend 1

Existing plan: $180 × 200 rooms × 30% × 3 weekend days = $32,400 Discount plan: $120 × 200 rooms × 50% × 3 weekend days = $36,000 Existing plan: $23 × 200 rooms × 30% × 3 weekend days = $4,140 Discount plan: $23 × 200 rooms × 50% × 3 weekend days = $6,900 Existing plan: $7 × 200 rooms × 30% × 3 weekend days = $1,260 Discount plan: $7 × 200 rooms × 50% × 3 weekend days = $2,100 Existing plan: $3 × 200 rooms × 30% × 3 weekend days = $540 Discount plan: $3 × 200 rooms × 50% × 3 weekend days = $900

The differential analysis indicates that the discount plan will result in a lower contribution margin per weekend than the existing pricing plan. It is possible that other discount pricing assumptions may provide a more favorable outcome, depending on the sensitivity of demand to changes in discount prices. For example, any discount price greater than $121.20 would favor the discount price plan if the occupancy remained at 50%.

MAD 25–3 (FIN MAN); MAD 11–3 (MAN) a.

Operating income per megawatt hour for industrial customers: $150* (80) (50) $ 20

Revenues Variable operating costs Fixed operating costs Operating income

* A megawatt hour is equal to 1,000 kilowatt-hours; thus, 1,000 kilowatt-hours × $0.15 per kilowatthour = $150 per megawatt hour

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

MAD 25–3 (FIN MAN); MAD 11–3 (MAN) (Concluded) b.

Contribution margin per megawatt hour for industrial customers: Revenues per unit Variable operating costs per unit Contribution margin per unit

$150 (80) $ 70

The lowest acceptable price that would provide a positive contribution margin would be anything over 8 cents per kilowatt-hour, determined as follows: Variable cost per megawatt hour Divided by 1,000 kilowatts per megawatt Equivalent variable cost per kilowatt-hour

÷ 1,000

$ 0.08

The discount pricing may become known. Thus, other industrial customers may request a similar pricing opportunity. This may cause industrial demand to shift from peak hours to off-peak hours. If the shifted peak hour demand could not be replaced by new incremental demand, the overall profits of the power company would decline. This is because the $0.15 per kilowatt price would be replaced by the discounted price as customers shifted to off-peak periods. Valley Power would likely want to establish a discount price significantly higher than variable cost in order to provide a significant contribution to fixed costs. In the long-term, the overall revenues of the business must cover the fixed costs.

MAD 25–4 (FIN MAN); MAD 11–4 (MAN) a.

$ 6,000,000

Revenues Expenses: Crew Food Amenity and excursion Depreciation Fuel Total expenses Operating income per cruise

$(2,700,000) (1,500,000) (400,000) (120,000) (50,000) $(4,770,000) $ 1,230,000

Divide the variable costs by the number of passengers: Crew to serve passengers Food Amenity and excursion

$1,200,000 ÷ 1,000 passengers = $1,200 per passenger 1,500,000 ÷ 1,000 passengers = 1,500 per passenger 400,000 ÷ 1,000 passengers = 400 per passenger

Note to Instructors: The fuel and crew costs to run the ship are fixed costs at the cruise level, because it is assumed that they will be incurred regardless of the number of passengers booked for the cruise.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

MAD 25–4 (FIN MAN); MAD 11–4 (MAN) (Concluded) c. Ticket price…………………………………………………… Variable costs per passenger [from (b)]: Crew to serve passengers……………………………… Food………………………………………………………… Amenity and excursion…………………………………… Total variable costs per passenger………………… Contribution margin per passenger………………………

$ 6,000 $(1,200) (1,500) (400) $(3,100) $ 2,900

This calculation suggests that the discount ticket price can be no lower than $3,100 and that the discount can be no more than $2,900. The proposed discount satisfies these constraints. Differential Analysis Existing Plan (Alt. 1) or Early Booking Program (Alt. 2)

Revenues per cruise Variable costs per cruise: Crew to serve passengers Food Amenity and excursion Advertising Total variable costs per cruise Contribution margin per cruise

Existing Plan (Alternative 1)

Early Booking Program (Alternative 2)

Differential Effects (Alternative 2)

$ 6,000,000

$ 6,630,000 1

$ 630,000

$(1,200,000) (1,500,000) (400,000)

$(1,416,000) 2 (1,770,000) 2 (472,000) 2 (15,000) $(3,673,000) $ 2,957,000

$(216,000) (270,000) (72,000) (15,000) $(573,000) $ 57,000

$(3,100,000) $ 2,900,000

Discount tickets from early booking, 300 tickets × $4,500 Remaining tickets, (1,180 tickets – 300 tickets) × $6,000 Total revenue

$1,350,000 5,280,000 $6,630,000

Variable costs per cruise [see (b) for variable cost per passenger]: Crew to serve passengers 1,180 passengers × $1,200 var. cost per passenger = $1,416,000 Food 1,180 passengers × $1,500 var. cost per passenger = $1,770,000 Amenity and excursion 1,180 passengers × $400 var. cost per passenger = $472,000 The proposed early booking plan is financially acceptable. The income gained from the increased volume of passengers offsets the income lost from the discount price.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

TAKE IT FURTHER TIF 25–1 (FIN MAN); TIF 11–1 (MAN) No, it would not be ethical for Aaron to attend the meeting. Such a meeting would be considered price fixing and would be a violation of federal law. Thus, Aaron’s attendance would be a criminal act. His actions would also discredit his reputation and that of the profession.

TIF 25–2 (FIN MAN); TIF 11–2 (MAN) This activity is designed to have students access a number of products and services on the Internet to see their commercial potential. Each of the listed sites will provide product descriptions (1). The list of costs (2) for the products will not be directly obtainable from the company’s website, but can be assumed based on the company and industry. Some examples include: Delta Air Lines—Airline tickets

Fixed or Variable?

Fuel…………………………………………………………………… Crew salaries………………………………………………………… Plane depreciation…………………………………………………… Landing fees………………………………………………………… Travel agent commissions………………………………………… Lease costs (gates)………………………………………………… Ground salaries……………………………………………………… Equipment depreciation……………………………………………

V F F V V F F F

For Delta Air Lines, employee salaries are relatively fixed and only become variable when there are significant changes to the flight schedule. Amazon—Various consumer products

Fixed or Variable?

Cost of products (purchased for resale)………………………… Web page design and programming…………………………… Computer depreciation…………………………………………… Order handling and packing wages……………………………… Freight…………………………………………………………………

V F F V V

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

TIF 25–2 (FIN MAN); TIF 11–2 (MAN) (Concluded) HP Inc.—Computers

Fixed or Variable?

Cost of computers (dl, dm, and foh)……………………………… Web page design and programming…………………………… Advertising…………………………………………………………… Order handling and packing wages……………………………… Freight………………………………………………………………… Bundled software*……………………………………………………

V (mostly) F F V V V

* Depends on contract terms with software vendor The product with the largest markup on variable cost is the airline ticket. The portion of variable cost to total cost for an airline flight will be much smaller (more fixed cost) than the other two products. Thus, the markup on variable cost will be a greater percent. As a result, the airline product has a larger contribution margin, but it also has a larger fixed cost to cover. This creates larger operating leverage (and risk) than exists for the other two products.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

TIF 25–3 (FIN MAN); TIF 11–3 (MAN) Memo To:

Juanita Jackson

From: Les Miles Re:

New Product Pricing

Thank you again for taking the time to meet with me and discuss the pricing of our new computer. While I understand your desire to set an appropriate price for this new product, it would be inappropriate not to include fixed costs in the pricing decision. Ignoring fixed costs would be the equivalent of treating the new computer as an incremental decision, which is not the case. The new computer was designed and developed to be part of the company’s core product portfolio. As a result, the revenues from the sale of this product must contribute to covering fixed costs. If the sales price does not cover fixed costs and provide a profit, then the company will not be competitive in the long term. Target costing provides a potential solution to the pricing issue. This approach treats the market price as given and adjusts the cost in order to yield the required profitability. Target costing is particularly effective in highly competitive product markets where declining prices require cost reduction in order to compete. Under target costing, the company would begin with the price the market is willing to pay, which is $1,250. This price should then be reduced by the required profit markup. This would yield a target cost of $1,000 ($1,250 ÷ 1.25), which is $200 lower than the current product cost. The new target cost would then be established as a cost-reduction target. Our focus should then be on improving product design and processes in order to reduce the product cost to $1,000.This will allow the company to develop a competitive price and cost structure for the new computer.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

TIF 25–4 (FIN MAN); TIF 11–4 (MAN) The contribution margin is $4 ($22 – $18) per dozen on the special order. Thus, Varden’s manager can contribute to fixed costs by accepting the order. However, there are some additional considerations the manager must consider before accepting this order. 1. Have we ever done business overseas? Exports require additional administrative activities. Have these additional administrative costs been considered in the differential analysis? 2. Will the customer sell the golf balls overseas, or will they relabel the golf balls and have them imported back into the United States? Such a situation would cause Varden to be competing against itself. 3. Is it likely that other customers will learn of the “special deal” the overseas company received and demand equal treatment? That is, is there a risk that we’ll spoil the pricing structure in the domestic market? 4. Will the overseas customer want to do business in the future, or is this just a single sale? If the overseas customer is expected to purchase more golf balls in the future, then it is likely that the customer will come to expect the $22 price in the future. 5. Is there a possibility of another customer being willing to purchase the golf balls at the $35 price? If so, Varden may not want to commit capacity to the overseas customer. Once the capacity is committed, it will be difficult to sell to anyone else. 6. Will we help the overseas customer establish a presence in the overseas golf ball market where we may want to compete in the future?

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

TIF 25–5 (FIN MAN); TIF 11–5 (MAN) First, Marriott has excess capacity for this day, so it should be willing to accept additional customers. The Priceline.com customer generates incremental revenue that will not reduce other business. Given this, however, the price must at least cover variable cost; otherwise, Marriott will incur a loss. The variable cost per room night is as follows: Housekeeping labor cost………………………………………………………………… Cost of room supplies (soap, paper, etc.)……………………………………………… Laundry labor and material cost………………………………………………………… Utility cost (mostly air conditioning)…………………………………………………… Total variable cost per day per room……………………………………………………

$38 8 10 5 $61

These costs are mostly avoidable or are variable to room nights. This answer assumes that the maid and laundry staff hours are highly flexible and can be staffed to demand. Likewise, the air conditioning and lights can be turned off if the room is not rented for the night, saving most of the utility cost. The desk staff and hotel depreciation are either sunk (depreciation) or mostly fixed to the number of room nights. Therefore, they are not relevant to accepting this business. The total variable costs are $61 per night, so the $85 customer bid should be accepted. Note to Instructors: There could be some discussion about the degree to which some of these costs are fully variable. For example, it’s likely that some utility cost must be incurred for the room, whether it is occupied or not. Likewise, the housekeeping and laundry staff hours may not be as flexible to demand as assumed here. There should be very little question about the room supplies (full variable) or the hotel depreciation (sunk). Regardless of the assumptions, the decision would remain the same. TIF 25–6 (FIN MAN); TIF 11–6 (MAN) The product profitability report indicates that the two products are equal in terms of profitability (on a per-case basis). However, the additional information indicates that there will be more activities required for Jamaican Punch than for King Kola. Apparently, the factory overhead costs are being allocated on the basis of a single activity base that does not capture these product differences. Because the direct labor costs are equal for producing a case of each product, the factory overhead allocated to each case would also be the same under the single factory overhead rate method. Thus, they would appear to have similar cost and profitability. An activity-based costing approach would likely demonstrate that the Jamaican Punch is less profitable and the King Kola is more profitable than indicated by the single plantwide factory overhead rate method. In addition, activity-based costing information would guide management in more accurate pricing decisions based on markup on product cost.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

TIF 25–7 (FIN MAN); TIF 11–7 (MAN) 1. Make or Buy This visualization compares the costs associated with making or buying each respective component. Each bar represents the cost to make the component, while the reference line represents the cost to buy. The cost to buy is calculated using the cost to purchase the component and the fixed overhead cost associated with the component.

2. Another important data point that could improve the quality of data for use in management’s decision would be any costs or additional incomes that would arise because production capacity among these components is freed up. For example, if by forgoing the production of the assembled radar motherboard, Coley Avionics could sell 50 more radar units each month, this income would increase the incentive to buy this product as opposing to making it. 25-51 © 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 25 (FIN MAN); CHAPTER 11 (MAN)

Differential Analysis and Product Pricing

CERTIFIED MANAGEMENT ACCOUNTANT (CMA®) EXAMINATION QUESTIONS (ADAPTED) 1.

The cost of the crane to move materials would most likely be treated as a sunk cost in differential cost analysis as this cost is not likely to differ among alternatives.

If Johnson accepted the special order, the company’s operating income would increase by $37,500, computed as follows. Special order price Less variable cost* Contribution margin

$7.50 5.00 $2.50

Contribution to operating income: 15,000 × $2.50 = $37,500 * Fixed costs and selling costs are not relevant.

For Aril to benefit from purchasing the units rather than making the units, the purchase price must be less than $14, computed as follows. Remaining fixed cost/unit = ($150,000 × 60%) ÷ 30,000 = $3 Relevant cost to make unit = $3 + $11 = $14

Oakes should continue to process Beracyl as the incremental revenue exceeds the incremental cost of processing; Mononate should be sold at split-off as the incremental revenue is less than the incremental cost of further processing. Beracyl: [60,000 × ($18 – $15)] – $115,000 = $65,000 Mononate: [40,000 × ($10 – $7)] – $125,000 = $(5,000)

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN) CAPITAL INVESTMENT ANALYSIS DISCUSSION QUESTIONS 1.

The principal objections to the use of the average rate of return method are its failure to consider the expected cash flows from the proposals and the timing of these flows.

The principal limitations of the cash payback method are its failure to consider cash flows occurring after the payback period and its failure to use present value concepts.

The average rate of return is not based on cash flows, but on operating income. Thus, for example, the average rate of return will include the average annual income after deducting depreciation, but the internal rate of return will not. In addition, the internal rate of return approach will use time value of money concepts, while the average rate of return does not.

A one-year payback will not equal a 100% average rate of return because the payback period is based on cash flows, while the average rate of return is based on income. The depreciation on the project will prevent the two methods from reconciling.

The cash payback period ignores cash flows occurring after the payback period, which will often include large residual values.

The majority of the cash flows of a new motion picture are earned within two years of release. Thus, the time value of money aspect of the cash flows is less significant for motion pictures than for projects with time-extended cash flows. This would favor the use of a cash payback period for evaluating the cash flows of the project.

The $7,900 net present value indicates that the proposal is desirable because the proposal is expected to recover the investment and provide more than the minimum rate of return.

The net present values indicate that both projects are desirable, but not necessarily equal in desirability. The present value index can be used to compare the two projects. For example, assume one project required an investment of $10,000 and the other an investment of $100,000. The present value indexes would be calculated as 0.9 and 0.09, respectively, for the two projects. That is, a $9,000 net present value on a $10,000 investment would be more desirable than the same net present value on a $100,000 investment.

The computations for the net present value method are more complex than those for the methods that ignore present value. Also, the method assumes that the cash received from the proposal during its useful life will be reinvested at the rate of return used to compute the present value of the proposal. This assumption may not always be reasonable.

10.

The computations for the internal rate of return method are more complex than those for the methods that ignore present value. Also, the method assumes that the cash received from the proposal during its useful life will be reinvested at the internal rate of return. This assumption may not always be reasonable.

11.

The major advantages of leasing are that it avoids the need to use funds to purchase assets and reduces some of the risk of loss if the asset becomes obsolete. There may also be some income tax advantages to leasing.

12.

Quicker delivery of products, higher production quality, and greater manufacturing flexibility are examples of qualitative factors that should be considered.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

BASIC EXERCISES BE 26–1 (FIN MAN); BE 12–1 (MAN) Estimate average annual income Average investment Average rate of return

$72,000 ($720,000 ÷ 10 years) $600,000 [($1,100,000 + $100,000) ÷ 2] 12% ($72,000 ÷ $600,000)

BE 26–2 (FIN MAN); BE 12–2 (MAN) 8.5 years ($510,000 ÷ $60,000)

BE 26–3 (FIN MAN); BE 12–3 (MAN) a. b.

$597,250 1.75

[($225,000 × 6.210) – $800,000] ($1,397,250 ÷ $800,000)

BE 26–4 (FIN MAN); BE 12–4 (MAN) 15%

[($402,360 ÷ $120,000) = 3.353, the present value of an annuity factor for 5 periods at 15%, from Exhibit 5]

BE 26–5 (FIN MAN); BE 12–5 (MAN) a.

Present value of $90,000 per year at 10% for 6 years*……………………… Present value of $40,000 at 10% at the end of 6 years**…………………… Total present value of Project 1………………………………………………… Total cost of Project 1…………………………………………………………… Net present value of Project 1……………………………………………………

$ 391,950 22,560 $ 414,510 (375,000) $ 39,510

* [$90,000 × 4.355 (Exhibit 5, 10%, 6 years)] ** [$40,000 × 0.564 (Exhibit 2, 10%, 6 years)] b.

Project 2. Project 1’s net present value of $39,510 is less than the net present value of Project 2, $50,000.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

EXERCISES Ex. 26–1 (FIN MAN); Ex. 12–1 (MAN) Project C

Project T

Average annual income: $65,000 ÷ 10………………………………………………………… $108,000 ÷ 12…………………………………………………………

$6,500 $9,000

Average investment: ($125,000 + $5,000) ÷ 2…………………………………………… ($140,000 + $10,000) ÷ 2……………………………………………

$65,000 $75,000

Average rate of return: $6,500 ÷ $65,000…………………………………………………… $9,000 ÷ $75,000……………………………………………………

10% 12%

Ex. 26–2 (FIN MAN); Ex. 12–2 (MAN) Average Annual Income Average Investment

Average Rate = of Return

Average Savings* – Annual Depreciation – Additional Operating Costs (Beginning Cost + Residual Value) ÷ 2

$28,000 – [($125,000 – $15,000) ÷ 8 years] – $5,150 ($125,000 + $15,000) ÷ 2

$9,100 $70,000

= 13% * The effect of the savings in wages expense is an increase in income.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Ex. 26–3 (FIN MAN); Ex. 12–3 (MAN) Average Annual Income Average Investment

Average Rate = of Return =

Average Revenues – Annual Product Costs* (Beginning Cost + Residual Value) ÷ 2

($80 × 40,000 units) – ($50 × 40,000 units) ($7,400,000 + $600,000) ÷ 2

$1,200,000 $4,000,000

= 30% * The depreciation of the equipment is included in the factory overhead cost per unit.

Ex. 26–4 (FIN MAN); Ex. 12–4 (MAN) Year 1

Initial investment………………………………… Operating cash flows: Annual revenues (20,000 units × $10)…… Selling expenses (2% × $200,000)………… Cost to manufacture (20,000 × $5.70)*…………………………… Net operating cash flows…………………… Total for Year 1…………………………………… Total for Years 2–9 (operating cash flow)…… Residual value………………………………… Total for last year…………………………………

Years 2–9

Last Year

$ 200,000 (4,000)

(114,000) $ 82,000 $ (68,000)

(114,000) $ 82,000

$(150,000)

$ 82,000 30,000 $ 112,000

* The fixed overhead relates to the depreciation on the equipment. Depreciation is not a cash flow and should not be considered in the analysis. Thus, $2.75 + $1.80 + $1.15 = $5.70.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Ex. 26–5 (FIN MAN); Ex. 12–5 (MAN) Location 1: $980,000 ÷ $175,000 = 5.6-year cash payback period. Location 2: 5-year cash payback period, as follows:

Year 1…………………………………………………………………… Year 2…………………………………………………………………… Year 3…………………………………………………………………… Year 4…………………………………………………………………… Year 5……………………………………………………………………

Net Cash Flow

Cumulative Net Cash Flows

$175,000 180,000 200,000 225,000 200,000

$175,000 355,000 555,000 780,000 980,000

Ex. 26–6 (FIN MAN); Ex. 12–6 (MAN) a.

The Liquid Soap product line is recommended, based on its shorter cash payback period. The cash payback period for both products can be determined using the following schedule: Initial investment: $750,000

Year 1………………………… Year 2………………………… Year 3………………………… Year 4………………………… Year 5………………………… Year 6…………………………

Liquid Soap Cumulative Net Cash Net Cash Flow Flows

Body Lotion Cumulative Net Cash Net Cash Flow Flows

$140,000 150,000 160,000 150,000 150,000

$125,000 125,000 125,000 125,000 125,000 125,000

$140,000 290,000 450,000 600,000 750,000

$125,000 250,000 375,000 500,000 625,000 750,000

Liquid Soap has a five-year cash payback period, and Body Lotion has a sixyear cash payback. b.

The cash payback periods are different between the two product lines because Liquid Soap earns cash faster than does Body Lotion. Even though both products earn the same total net cash flow over the eight-year planning horizon, Liquid Soap returns cash faster in the earlier years. The cash payback method emphasizes the initial years’ net cash flows in determining the cash payback period. Thus, the project with the greatest net cash flows in the early years of the project life will be favored over the one with less net cash flows in the initial years.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Ex. 26–7 (FIN MAN); Ex. 12–7 (MAN) a. Year

Present Value of $1 at 15%

1 0.870 0.756 2 0.658 3 0.572 4 Total…………………………………… Amount to be invested……………… Net present value……………………

Net Cash Flow

Present Value of Net Cash Flow

$ 80,000 75,000 65,000 60,000 $280,000

$ 69,600 56,700 42,770 34,320 $ 203,390 (200,000) $ 3,390

b. Yes. The $3,390 net present value indicates that the return on the proposal is greater than the minimum desired rate of return of 15%.

Ex. 26–8 (FIN MAN); Ex. 12–8 (MAN) a.

20Y1 Revenues………………… $ 65,000 Driver salary…………… (40,000) Operating costs………… (6,000) Residual value…………… Annual net cash flow…… $ 19,000

Year

Net Cash Flow [from part (a)]

20Y2

20Y3

20Y4

20Y5

$ 65,000 (42,000) (6,000)

$ 65,000 (44,000) (6,000)

$ 65,000 (46,000) (6,000)

$ 17,000

$ 15,000

$ 13,000

$ 65,000 (48,000) (6,000) 15,000 $ 26,000

Present Value of $1 at 12%

20Y1 $19,000 0.893 0.797 20Y2 17,000 0.712 20Y3 15,000 0.636 20Y4 13,000 0.567 20Y5 26,000 Total present value of cash flows……………………………………… Investment in delivery truck……………………………………………… Net present value of delivery truck………………………………………

Present Value of Net Cash Flow $ 16,967 13,549 10,680 8,268 14,742 $ 64,206 (70,000) $ (5,794)

c. The total present value of cash flows from the delivery truck investment is less than the total purchase price of the truck. That is, the net present value is negative. Thus, this analysis does not support investment in the truck.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Ex. 26–9 (FIN MAN); Ex. 12–9 (MAN) a.

(in millions)

Annual revenues…………………………………………………………… Annual cash expenses……………………………………………………… Annual net cash flow………………………………………………………

$ 25 (17)* $ 8

* Annual depreciation expense, $30 million ÷ 10 years = $3 million per year; Total expenses, including depreciation, $20 less depreciation expense of $3 equals $17 annual cash expenses.

(in millions except present value factor)

b. Annual cash flows…………………………………………………………… Present value of an annuity of $1 at 20% for 10 periods…………… Present value of hotel project cash flows, rounded………………… Hotel construction costs…………………………………………………… Net present value of hotel project…………………………………………

$ 8 ×4.192 * $ 34 (30) $ 4

* From Exhibit 5 in the text c.

The present value of the hotel’s operating cash flows exceeds the construction costs by $4 million. That is, the net present value is positive. Therefore, construction of the new hotel can be supported by this analysis.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Ex. 26–10 (FIN MAN); Ex. 12–10 (MAN) a.

Cash inflows: 1,000 × $90

Hours of operation…………………………………… Revenue per hour…………………………………… Revenue per year……………………………………

$ 90,000

Cash outflows: Hours of operation…………………………………… Fuel cost per hour………………………………… Labor cost per hour……………………………… Total fuel and labor costs per hour…………… Fuel and labor costs per year……………………… Maintenance costs per year………………………… Annual net cash flow…………………………………

1,000 $15 30 × $45

(45,000) (7,500) $ 37,500 $ 37,500 × 3.791 $ 142,163 (125,000) $ 17,163

Annual net cash flow (at the end of each of 5 years)………… Present value of annuity of $1 at 10% for 5 periods…………… Present value of annual net cash flows………………………… Amount to be invested……………………………………………… Net present value……………………………………………………

Yes. Jones should accept the investment because the bulldozer cost is less than the present value of the cash flows at the minimum desired rate of return of 10%.

3.791 [(Hrs. × $90) – (Hrs. × $45) – $7,500] = $125,000 (Hrs. × $341*) – (Hrs. × $171*) – $28,433 = $125,000 Hrs. × $170 = $153,433 Hrs. = 903 * Rounded

Thus, the bulldozer operating hours must exceed 903 annually in order for the investment to be justified.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Ex. 26–11 (FIN MAN); Ex. 12–11 (MAN) a.

Revenues (3,600 × 340 days × $280)……………………………………… $ 342,720,000 Variable expenses (3,600 × 340 days × $100)…………………………… (122,400,000) (90,000,000) Fixed expenses (other than depreciation)………………………………… Annual net cash flow………………………………………………………… $ 130,320,000

Present value of annual net cash flows ($130,320,000 × 5.650)……… $ 736,308,000 19,320,000 Present value of residual value ($60,000,000 × 0.322)………………… Total present value…………………………………………………………… $ 755,628,000 (750,000,000) Amount to be invested……………………………………………………… Net present value……………………………………………………………… $ 5,628,000

Ex. 26–12 (FIN MAN); Ex. 12–12 (MAN) a.

Present Value Index =

Total Present Value of Net Cash Flow Amount to Be Invested

Des Moines:

$712,500 $750,000

= 0.95

Cedar Rapids:

$848,000 $800,000

= 1.06

The analysis supports investing in Cedar Rapids because the present value index is greater than 1. The Des Moines investment is not supported.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Ex. 26–13 (FIN MAN); Ex. 12–13 (MAN) a.

Annual net cash flow—Sewing Machine: $80,640 = 1,800 hours × (290 baseballs – 150 baseballs) × $0.32 per baseball Annual net cash flow—Packing Machine: $29,400 = 1,400 hours × $21 labor cost saved per hour Sewing Machine: Annual net cash flow (at the end of each of 8 years)………………………… $ 80,640 Present value of an annuity of $1 at 15% for 8 years (Exhibit 5)…………… × 4.487 Present value of annual net cash flows………………………………………… $ 361,832 (260,000) Amount to be invested…………………………………………………………… $ 101,832 Net present value…………………………………………………………………… Packing Machine: Annual net cash flow (at the end of each of 8 years)………………………… $ 29,400 Present value of an annuity of $1 at 15% for 8 years (Exhibit 5)…………… × 4.487 Present value of annual net cash flows………………………………………… $ 131,918 (85,000) Amount to be invested…………………………………………………………… Net present value…………………………………………………………………… $ 46,918

Present Value Index =

Total Present Value of Net Cash Flow Amount to Be Invested

Sewing machine:

$361,832 $260,000

= 1.39

Packing machine:

$131,918 $85,000

= 1.55

The present value index indicates that the packing machine would be the preferred investment, assuming that all other qualitative considerations are equal. Note that the net present value of the sewing machine is greater than the packing machine’s. However, the sewing machine requires more than triple the investment than the packing machine ($260,000 vs. $85,000), for barely double the extra net present value ($101,832 vs. $46,918). Thus, the present value index indicates the packing machine is favored. If there were sufficient capital for both investments, then they would both be attractive opportunities. This solution does not consider the alternative use of remaining cash, which is an additional complexity beyond the scope of this text.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Ex. 26–14 (FIN MAN); Ex. 12–14 (MAN) a.

Average rate of return on investment:

$300,000 * = 16.7% ($3,600,000 + $0) ÷ 2

* The annual earnings are equal to the cash flow less the annual depreciation expense, shown as follows: $750,000 – ($3,600,000 ÷ 8 years) = $300,000

Cash payback period:

$3,600,000 $750,000

= 4.8 years

c. Present value of annual net cash flows ($750,000 × 4.968*)……………… $ 3,726,000 Amount to be invested…………………………………………………………… (3,600,000) Net present value…………………………………………………………………… $ 126,000 * Present value of an annuity of $1 at 12% for 8 periods from Exhibit 5. Ex. 26–15 (FIN MAN); Ex. 12–15 (MAN) a.

Payback period:

$1,125,000 $250,000

= 4.5 years

b. Net present value: Present value factor for an annuity of $1, 10 periods at 10%: 6.145 Net present value = (6.145 × $250,000) – $1,125,000 = $411,250 c. Some critical elements that are missing from this analysis are: ● The manager is viewing the acquisition of automated assembly equipment as a labor-saving device. This is probably a limited way to view the investment. Instead, the equipment should allow the company to assemble the product with higher quality and higher flexibility. This should translate into greater sales volume, better pricing, and lower inventories. All of these could be brought into the analysis. ●

The cost of the automated assembly equipment does not stop with the initial purchase price and installation costs. The equipment will require the company to hire engineers and support personnel to keep the machines running, to program the software, and to debug new programs. The operators will require new training. Thus, extensive training costs will likely be incurred. It would not be surprising to see a large portion of the direct labor savings lost by hiring expensive indirect labor support for the technology.

●

There will likely be a start-up or learning curve with this new technology that will cause the benefits to be delayed.

●

The analysis fails to account for taxes.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Ex. 26–16 (FIN MAN); Ex. 12–16 (MAN) a.

Present Value Factor for an = Annuity of $1 for 6 Periods = =

Amount to Be Invested Annual Net Cash Flow $108,875 $25,000 4.355

10% Row 6 in Exhibit 5. The column associated with the factor 4.355 is 10%.

Ex. 26–17 (FIN MAN); Ex. 12–17 (MAN) a.

Present Value Factor for an = Annuity of $1 for 10 Periods

Amount to Be Invested Annual Net Cash Flow

$415 million $99 million

4.192

4.192 is the present value of an annuity factor for 10 years at 20% from Exhibit 5; thus, the internal rate of return on the cash flows for 10 years is 20%. b.

There are many uncertainties that could adversely impact a project of this scale and scope. There are uncertainties affecting the initial investment and the annual cash flow assumptions. Regarding the initial investment, the construction cost could be higher than $415 million, due to delays, labor issues, and other construction site problems. The annual cash flow assumptions could be adversely impacted by uncertainties such as: 1. Warm weather conditions, or no snow 2. Recessionary economic conditions that reduce the demand for ski holidays 3. Competitor property improvements that siphon demand from the project 4. Increased fuel costs that increase the cost of travel to ski resorts, thus reducing demand from nonlocal patrons 5. Industry overbuilding that causes a price war to maintain volume

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Ex. 26–18 (FIN MAN); Ex. 12–18 (MAN) a.

Delivery Truck Cash received from additional delivery (95,000 bags × $0.45)……………… $ 42,750 Cash used for operating expenses (24,000 miles × $1.35)…………………… (32,400) Net cash flow for delivery truck…………………………………………………… $ 10,350 Amount to Be Invested Annual Net Cash Flow

Present Value Factor for an Annuity = of $1 for 7 Periods

$43,056 $10,350

= =

4.160

Internal Rate of Return = 15% (from text Exhibit 5 for 7 periods) Bagging Machine Direct labor savings (3 hrs./day × $18/hr. × 250 days/yr.)…………………… $13,500 Amount to Be Invested Annual Net Cash Flow

Present Value Factor for an Annuity = of $1 for 7 Periods

$61,614 $13,500

= =

4.564

Internal Rate of Return = 12% (from text Exhibit 5 for 7 periods) b.

To: Re:

Management Investment Recommendation

An internal rate of return analysis was performed for the delivery truck and bagging machine investments. The internal rate of return for the bagging machine is 12%, while the delivery truck is 15% (detailed analysis available). The bagging machine fails to exceed our minimum rate of return requirement of 13%. In addition, there do not appear to be any qualitative considerations that would favor the bagging machine. Therefore, the recommendation is to invest in the delivery truck.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Ex. 26–19 (FIN MAN); Ex. 12–19 (MAN) a.

Present value of annual net cash flows ($35,000 × 4.968*)………………… $ 173,880 Amount to be invested…………………………………………………………… (186,725) Net present value………………………………………………………………… $ (12,845) * Present value of an annuity of $1 at 12% for 8 periods from text Exhibit 5.

The rate of return is less than 12% because there is a negative net present value.

Present Value Factor for an = Annuity of $1

Amount to Be Invested Annual Net Cash Flow $186,725 $35,000

= =

5.335

Internal Rate of Return = 10% (from text Exhibit 5, 8 periods)

Ex. 26–20 (FIN MAN); Ex. 12–20 (MAN) With an expected useful life of five years, the cash payback period cannot be greater than five years. This would indicate that the cost of the initial investment would not be recovered during the useful life of the asset. In addition, there would be no positive average rate of return because a net loss would result. If the 20% average rate of return and useful life are correct, the cash payback period must be less than five years. Alternatively, if both the 20% average rate of return and 5.5 years for the cash payback period are correct, the machinery must have a useful life of much more than five years.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Ex. 26–21 (FIN MAN); Ex. 12–21 (MAN) Diamond Core Drill Year

Present Value of $1 at 15%

1 0.870 2 0.756 3 0.658 4 0.572 4 (residual value) 0.572 Total…………………………………………… Amount to be invested…………………… Net present value……………………………

Net Cash Flow

Present Value of Net Cash Flow

$ 300,000 300,000 275,000 250,000 450,000 $1,575,000

$ 261,000 226,800 180,950 143,000 257,400

Net Cash Flow

Present Value of Net Cash Flow

$ 475,000 450,000 350,000 200,000 $1,475,000

$ 413,250 340,200 230,300 114,400

$1,069,150 (900,000) $ 169,150

Hydraulic Excavator Year

Present Value of $1 at 15%

1 0.870 2 0.756 3 0.658 4 0.572 Total…………………………………………… Amount to be invested…………………… Net present value……………………………

$1,098,150 (900,000) $ 198,150

The net present value of both proposals is positive; thus, both pieces of equipment are acceptable. However, the net present value of the hydraulic excavator exceeds that of the diamond core drill. Thus, the hydraulic excavator should be preferred if there is enough investment money for only one of the projects. Note to Instructors: Because the investment amount is the same, the net present value can be compared to determine preference. That is, the present value index will show the same preference ordering.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Ex. 26–22 (FIN MAN); Ex. 12–22 (MAN) a. Blending Equipment Equal annual cash flows for Years 1–5……………………………… $19,000 Present value of a $1 annuity at 10% for 5 periods (Exhibit 5)……………………………………………………… × 3.791 Present value of operating cash flows……………………………… Residual value at end of fifth year…………………………………… $15,000 Present value of $1 at 10% for 5 periods (Exhibit 2)……………… × 0.621 Present value of residual value……………………………………… Total present value of cash flows…………………………………… Amount to be invested………………………………………………… Net present value…………………………………………………………

$ 72,029

9,315 $ 81,344 (75,000) $ 6,344

Computer System Equal annual cash flows for Years 1–5……………………………… $27,000 Present value of a $1 annuity at 10% for 5 periods (Exhibit 5)……………………………………………………… × 3.791 Present value of operating cash flows……………………………… Amount to be invested………………………………………………… Net present value………………………………………………………… b.

Present value index of blending equipment:

$81,344 $75,000

= 1.08

Present value index of computer system:

$102,357 $90,000

= 1.14

$102,357 (90,000) $ 12,357

Both the net present value calculations in part (a) and the present value index calculations in part (b) suggest that the computer system should be selected between the two options if there is sufficient capital for only one project investment.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

PROBLEMS Prob. 26–1A (FIN MAN); Prob. 12–1A (MAN) 1.

Average annual rate of return for both projects: $105,000 ÷ 5 ($150,000 + $0) ÷ 2

$21,000 $75,000

= 28%

Net present value analysis:

Year

Present Value of $1 at 12%

Net Cash Flow Robotic Warehouse Assembler

1 0.893 $ 65,000 0.797 2 55,000 0.712 3 50,000 0.636 4 45,000 40,000 0.567 5 Total…………………………$255,000 Amount to be invested… Net present value………… 2.

$ 51,000 51,000 51,000 51,000 51,000 $255,000

Present Value of Net Cash Flow Robotic Assembler Warehouse

$ 58,045 43,835 35,600 28,620 22,680 $ 188,780 (150,000) $ 38,780

$ 45,543 40,647 36,312 32,436 28,917 $ 183,855 (150,000) $ 33,855

The report to the capital investment committee can take many forms. The report should, as a minimum, present the following points: a.

Both projects offer the same average annual rate of return.

Although both projects exceed the selected rate established for discounted cash flows, the robotic assembler offers a larger net present value. The robotic assembler has a larger net present value because larger cash flows occur earlier in time compared to the warehouse. Thus, if only one of the two projects can be accepted, the robotic assembler would be the more attractive.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Prob. 26–2A (FIN MAN); Prob. 12–2A (MAN) 1. a. Cash payback period for both projects: 2 years (the year in which accumulated net cash flows equal $900,000), shown as follows:

Year

1 2

Plant Expansion Net Cash Cumulative Flow Net Cash Flow

$450,000 450,000

$450,000 900,000

Year

1 2

Retail Store Expansion Net Cash Cumulative Flow Net Cash Flow

$500,000 400,000

$500,000 900,000

b. Net present value analysis:

Year

Present Value of $1 at 15%

1 0.870 2 0.756 3 0.658 4 0.572 5 0.497 Total………………………… Amount to be invested…… Net present value…………

Net Cash Flow Plant Retail Store Expansion Expansion

Present Value of Net Cash Flow Plant Retail Store Expansion Expansion

$ 450,000 450,000 340,000 280,000 180,000

$ 500,000 400,000 350,000 250,000 200,000

$ 391,500 340,200 223,720 160,160 89,460

$ 435,000 302,400 230,300 143,000 99,400

$1,700,000

$1,205,040 (900,000)

$1,210,100 (900,000)

$ 305,040

$ 310,100

2. The report can take many forms and should include, as a minimum, the following points: a. Both projects offer the same total net cash flow. b. Both projects offer the same cash payback period. c. Because of the timing of the receipt of the net cash flows, the retail store expansion offers a higher net present value. d. Both projects provide a positive net present value. This means both projects would be acceptable because they exceed the minimum rate of return.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Prob. 26–3A (FIN MAN); Prob. 12–3A (MAN) 1.

Maintenance Equipment Present Value Net Cash of $1 at 20% Flow

Present Value of Net Cash Flow

1 0.833 $ 4,000,000 2 0.694 3,500,000 2,500,000 3 0.579 Total……………………………………………… $10,000,000 Amount to be invested……………………… Net present value………………………………

$ 3,332,000 2,429,000 1,447,500 $ 7,208,500 (8,000,000) $ (791,500)

Ramp Facilities Present Value Net Cash of $1 at 20% Flow

Present Value of Net Cash Flow

1 0.833 $12,000,000 2 0.694 10,000,000 9,000,000 3 0.579 Total……………………………………………… $31,000,000 Amount to be invested……………………… Net present value………………………………

$ 9,996,000 6,940,000 5,211,000 $ 22,147,000 (20,000,000) $ 2,147,000

Computer Network Present Value Net Cash of $1 at 20% Flow

Present Value of Net Cash Flow

1 0.833 $ 6,000,000 2 0.694 5,000,000 4,000,000 3 0.579 Total……………………………………………… $15,000,000 Amount to be invested……………………… Net present value………………………………

$ 4,998,000 3,470,000 2,316,000 $10,784,000 (9,000,000) $ 1,784,000

Year

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Prob. 26–3A (FIN MAN); Prob. 12–3A (MAN) (Concluded) 2.

Present Value Index =

Total Present Value of Net Cash Flow Amount to Be Invested

Maintenance equipment:

$7,208,500 $8,000,000

0.90*

Ramp facilities:

$22,147,000 $20,000,000

1.11*

Computer network:

$10,784,000 $9,000,000

1.20*

* Rounded 3.

The computer network has the largest present value index. Although ramp facilities has the largest net present value, it returns less present value per dollar invested than does the computer network, as revealed by the present value indexes (1.20 compared to 1.11). (The present value index for maintenance equipment is less than 1, indicating that it does not meet the minimum rate of return standard.)

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Prob. 26–4A (FIN MAN); Prob. 12–4A (MAN) 1. a. Wind Turbines: Annual net cash flow (at the end of each of 4 years)……………………… $ 280,000 Present value of an annuity of $1 at 6% for 4 years (Exhibit 5)………… × 3.465 Present value of annual net cash flows……………………………………… $ 970,200 (887,600) Amount to be invested………………………………………………………… Net present value………………………………………………………………… $ 82,600 Biofuel Equipment: Annual net cash flow (at the end of each of 4 years)……………………… $ 300,000 3.465 Present value of an annuity of $1 at 6% for 4 years (Exhibit 5)………… × Present value of annual net cash flows……………………………………… $1,039,500 (911,100) Amount to be invested………………………………………………………… Net present value………………………………………………………………… $ 128,400 b.

Present Value Index =

Total Present Value of Net Cash Flow Amount to Be Invested

Wind turbines:

$970,200 $887,600

= 1.09*

Biofuel equipment:

$1,039,500 $911,100

= 1.14*

* Rounded 2. a. Present Value Factor for an Annuity of $1 = Wind turbines:

$887,600 $280,000

= 3.170

Biofuel equipment:

$911,100 $300,000

= 3.037

Amount to Be Invested Annual Net Cash Flow

b. Internal rate of return (determined from Exhibit 5 for 4 years in text) Wind turbines: 10% Biofuel equipment: 12%

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Prob. 26–4A (FIN MAN); Prob. 12–4A (MAN) (Concluded) 3.

The net present value, present value index, and internal rate of return all indicate that the biofuel equipment is a better financial opportunity compared to the wind turbines, although both investments meet the minimum return criterion of 6%. The present value index indicates that the biofuel equipment has a greater present value per dollar of investment. The internal rate of return method places all proposals on a common basis. As a result, it is possible to compare proposals with different investment amounts, cash flows, and time periods, using the internal rate of return method. The internal rate of return method indicates that the biofuel equipment internal rate of return of 12% is greater than the wind turbine internal rate of return of 10%.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Prob. 26–5A (FIN MAN); Prob. 12–5A (MAN) 1.

Net present value analysis: Office Expansion: Annual net cash flow (at the end of each of 6 years)………………………… $ 125,000 Present value of an annuity of $1 at 12% for 6 years (Exhibit 5)…………… × 4.111 Present value of annual net cash flows………………………………………… $ 513,875 (490,000) Amount to be invested…………………………………………………………… Net present value…………………………………………………………………… $ 23,875 Servers Upgrade: Annual net cash flow (at the end of each of 4 years)………………………… $ 165,000 Present value of an annuity of $1 at 12% for 4 years (Exhibit 5)…………… × 3.037 Present value of annual net cash flows………………………………………… $ 501,105 (490,000) Amount to be invested…………………………………………………………… Net present value…………………………………………………………………… $ 11,105

Net present value analysis:

Year

Present Value of $1 at 12%

Net Cash Flow Expansion Servers

1 $125,000 0.893 0.797 2 125,000 0.712 3 125,000 0.636 4 125,000 180,000 4 (residual value) 0.636 Total………………………………… $680,000 Amount to be invested………… Net present value…………………

$165,000 165,000 165,000 165,000 0 $660,000

Present Value of Net Cash Flow Servers Expansion

$ 111,625 99,625 89,000 79,500 114,480 $ 494,230 (490,000) $ 4,230

$ 147,345 131,505 117,480 104,940 0 $ 501,270 (490,000) $ 11,270 *

* This amount differs from the net present value calculation in part (1) due to rounding errors in the present value factors.

To: Investment Committee Both projects have a positive net present value. This means that both projects meet our minimum expected return of 12% and would be acceptable investments. However, if funds are limited and only one of the two projects can be funded, then the two projects must be compared over equal lives. Thus, the residual value of the office expansion at the end of period 4 is used to equalize the two lives. The net present value of the two projects over equal lives indicates that the server upgrade has a higher net present value and would be a superior investment.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Prob. 26–6A (FIN MAN); Prob. 12–6A (MAN) 1.

Proposal A: 3-year, 9-month cash payback period, as follows: Year 1 2 3 9 months*

Net Cash Flow

Cumulative Net Cash Flows

$145,000 140,000 125,000 90,000

$145,000 285,000 410,000 500,000

* The cash flow required is $90,000 out of $120,000 in Year 4. Thus, 3/4 of 12 months is 9 months.

Proposal B: 4-year cash payback period, as follows: Year 1 2 3 4

Net Cash Flow

Cumulative Net Cash Flows

$120,000 100,000 90,000 90,000

$120,000 220,000 310,000 400,000

Proposal C: 3-year cash payback period, as follows: Year

Net Cash Flow

Cumulative Net Cash Flows

1 2 3

$130,000 125,000 125,000

$130,000 255,000 380,000

Proposal D: 2-year, 8-month cash payback period, as follows:

Year 1 2 8 months*

Net Cash Flow

Cumulative Net Cash Flows

$270,000 255,000 150,000

$270,000 525,000 675,000

* The cash flow required is $150,000 out of $225,000 in Year 3. Thus, 2/3 of 12 months is 8 months.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Prob. 26–6A (FIN MAN); Prob. 12–6A (MAN) (Continued) 2.

Proposal A: 10.8% average rate of return, determined as follows: $135,000 ÷ 5 ($500,000 + $0) ÷ 2

$27,000 $250,000

= 10.8%

Proposal B: 8.6% average rate of return, determined as follows: $86,000 ÷ 5 ($400,000 + $0) ÷ 2

$17,200 $200,000

= 8.6%

Proposal C: 25.3% average rate of return, determined as follows: $240,000 ÷ 5 ($380,000 + $0) ÷ 2

$48,000 $190,000

= 25.3% (rounded)

Proposal D: 21.9% average rate of return, determined as follows: $370,000 ÷ 5 ($675,000 + $0) ÷ 2

$74,000 $337,500

= 21.9% (rounded)

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Prob. 26–6A (FIN MAN); Prob. 12–6A (MAN) (Continued) 3.

Of the four proposed investments, only Proposals C and D meet the company’s requirements, as the following table indicates: Proposal

Cash Payback Period

Average Rate of Return

A B C D

3 yrs., 9 mos. 4 yrs. 3 yrs. 2 yrs., 8 mos.

10.8% 8.6% 25.3% 21.9%

Accept for Further Analysis

Reject

* *  

* Proposals A and B are rejected because they fail to meet the maximum payback period requirement. Proposal B also fails to meet the average rate of return requirement.

Proposal C

Year

Present Value of $1 at 15%

Net Cash Flow

1 0.870 $130,000 2 0.756 125,000 3 0.658 125,000 4 0.572 120,000 120,000 5 0.497 Total………………………………………………………… $620,000 Amount to be invested…………………………………… Net present value…………………………………………

Present Value of Net Cash Flow

$ 113,100 94,500 82,250 68,640 59,640 $ 418,130 (380,000) $ 38,130

Proposal D

Year

Present Value of $1 at 15%

Net Cash Flow

1 0.870 $ 270,000 2 0.756 255,000 3 0.658 225,000 4 0.572 150,000 145,000 5 0.497 Total………………………………………………………… $1,045,000 Amount to be invested…………………………………… Net present value…………………………………………

Present Value of Net Cash Flow

$ 234,900 192,780 148,050 85,800 72,065 $ 733,595 (675,000) $ 58,595

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Prob. 26–6A (FIN MAN); Prob. 12–6A (MAN) (Concluded) 5.

Present Value Index =

Total Present Value of Net Cash Flow Amount to Be Invested

Proposal C:

$418,130 $380,000

= 1.10*

Proposal D:

$733,595 $675,000

= 1.09*

* Rounded 6.

Based on the net present value, the proposals should be ranked as follows: Proposal D: $58,595 Proposal C: $38,130

Based on the present value index (the amount of present value per dollar invested), the proposals should be ranked as follows: Proposal C: 1.10 Proposal D: 1.09

The analyses indicate that although Proposal D has the larger net present value, it is not as attractive as Proposal C in terms of the amount of present value per dollar invested. Also, Proposal D requires a much larger investment. Thus, management should use investment resources for Proposal C before investing in Proposal D, absent any other qualitative considerations that may impact the decision.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Prob. 26–1B (FIN MAN); Prob. 12–1B (MAN) 1.

Average annual rate of return for both projects: $172,000 ÷ 5 ($368,000 + $0) ÷ 2

$34,400 $184,000

Net present value analysis:

Year

Present Value of $1 at 15%

Net Cash Flow Tracking Warehouse Technology

0.870 1 $135,000 0.756 2 125,000 0.658 3 110,000 0.572 4 100,000 70,000 0.497 5 Total………………………… $540,000 Amount to be invested…… Net present value………… 2.

= 18.7%

$108,000 108,000 108,000 108,000 108,000 $540,000

Present Value of Net Cash Flow Tracking Warehouse Technology

$ 117,450 94,500 72,380 57,200 34,790 $ 376,320 (368,000) $ 8,320

$ 93,960 81,648 71,064 61,776 53,676 $ 362,124 (368,000) $ (5,876)

The report to the capital investment committee can take many forms. The report should, as a minimum, present the following points: a.

Both projects offer the same average annual rate of return.

The warehouse net present value exceeds the selected rate established for discounted cash flows (15%), while the tracking technology does not. Thus, considering only quantitative factors, the warehouse investment should be selected.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Prob. 26–2B (FIN MAN); Prob. 12–2B (MAN) 1. a.

Cash payback period for both projects: 2 years (the year in which accumulated net cash flows equal $125,000), shown as follows:

Year

1 2

Sound Cellar Net Cash Cumulative Flow Net Cash Flow

$65,000 60,000

$ 65,000 125,000

Year

Pro Gamer Net Cash Flow

Cumulative Net Cash Flow

1 2

$70,000 55,000

$ 70,000 125,000

Net present value analysis:

Year

Present Value of $1 at 10%

Net Cash Flow Sound Pro Cellar Gamer

1 0.909 $ 65,000 2 0.826 60,000 3 0.751 25,000 4 0.683 25,000 45,000 5 0.621 Total…………………………… $220,000 Amount to be invested……… Net present value……………

Present Value of Net Cash Flow Sound Pro Cellar Gamer

$ 70,000 55,000 35,000 30,000 30,000

$ 59,085 49,560 18,775 17,075 27,945

$ 63,630 45,430 26,285 20,490 18,630

$220,000

$ 172,440 (125,000)

$ 174,465 (125,000)

$ 47,440

$ 49,465

2. The report can take many forms and should include, as a minimum, the following points: a.

Both projects offer the same total net cash flow.

Both projects offer the same cash payback period.

Because of the timing of the receipt of the net cash flows, Pro Gamer magazine expansion offers a higher net present value.

Both projects provide a positive net present value. This means both projects would be acceptable because they exceed the minimum rate of return.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Prob. 26–3B (FIN MAN); Prob. 12–3B (MAN) 1.

Branch Office Expansion Present Value Net Cash of $1 at 15% Flow

Year 1 0.870 2 0.756 3 0.658 Total……………………………………………… Amount to be invested……………………… Net present value………………………………

Year

Computer System Upgrade Present Value Net Cash of $1 at 15% Flow

1 0.870 2 0.756 3 0.658 Total……………………………………………… Amount to be invested……………………… Net present value………………………………

Year

$200,000 160,000 160,000 $520,000

$190,000 180,000 170,000 $540,000

ATM Kiosk Expansion Present Value Net Cash of $1 at 15% Flow

1 0.870 2 0.756 3 0.658 Total……………………………………………… Amount to be invested……………………… Net present value………………………………

$275,000 250,000 250,000 $775,000

Present Value of Net Cash Flow

$ 174,000 120,960 105,280 $ 400,240 (420,000) $ (19,760) Present Value of Net Cash Flow

$ 165,300 136,080 111,860 $ 413,240 (350,000) $ 63,240 Present Value of Net Cash Flow

$ 239,250 189,000 164,500 $ 592,750 (520,000) $ 72,750

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Prob. 26–3B (FIN MAN); Prob. 12–3B (MAN) (Concluded) 2.

Present Value Index =

Total Present Value of Net Cash Flow Amount to Be Invested

Branch office:

$400,240 $420,000

= 0.95*

Computer system:

$413,240 $350,000

= 1.18*

ATM kiosk:

$592,750 $520,000

= 1.14*

* Rounded 3.

The computer system upgrade has the largest present value index. Although the ATM kiosk expansion has the largest net present value, it returns less present value per dollar invested than does the computer system upgrade, as revealed by the present value indexes (1.18 compared to 1.14). (The present value index for the branch office expansion is less than 1, indicating that it does not meet the minimum rate of return standard.)

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Prob. 26–4B (FIN MAN); Prob. 12–4B (MAN) 1. a. After Hours: Annual net cash flow (at the end of each of 4 years)………………… $ 320,000 3.170 Present value of an annuity of $1 at 10% for 4 years (Exhibit 5)…… × Present value of annual net cash flows………………………………… $1,014,400 (913,600) Amount to be invested……………………………………………………… Net present value…………………………………………………………… $ 100,800 Sun Fun: Annual net cash flow (at the end of each of 4 years)………………… Present value of an annuity of $1 at 10% for 4 years (Exhibit 5)…… Present value of annual net cash flows………………………………… Amount to be invested……………………………………………………… Net present value…………………………………………………………… b.

Present Value Index =

$ 290,000 × 3.170 $ 919,300 (880,730) $ 38,570

Total Present Value of Net Cash Flow Amount to Be Invested

After Hours:

$1,014,400 $913,600

= 1.11*

Sun Fun:

$919,300 $880,730

= 1.04*

* Rounded 2. a.

Present Value Factor = for an Annuity of $1

Amount to Be Invested Annual Net Cash Flow

After Hours:

$913,600 $320,000

= 2.855

Sun Fun:

$880,730 $290,000

= 3.037

b. Internal rate of return (determined from Exhibit 5 for 4 years in text) After Hours: 15% Sun Fun: 12%

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Prob. 26–4B (FIN MAN); Prob. 12–4B (MAN) (Concluded) 3.

The net present value, present value index, and internal rate of return all indicate that After Hours is a better financial opportunity compared to Sun Fun, although both investments meet the minimum return criterion of 10%. The present value index indicates that After Hours has a greater present value per dollar of investment. The internal rate of return method places all proposals on a common basis. As a result, it is possible to compare proposals with different investment amounts, cash flows, and time periods, using the internal rate of return method. The internal rate of return method indicates that After Hours ’ internal rate of return of 15% is greater than Sun Fun ’s internal rate of return of 12%.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Prob. 26–5B (FIN MAN); Prob. 12–5B (MAN) 1. Net present value analysis: Wichita: Annual net cash flow (at the end of each of 6 years)………………………… $ 310,000 3.326 Present value of an annuity of $1 at 20% for 6 years (Exhibit 5)…………… × Present value of annual net cash flows………………………………………… $1,031,060 (900,000) Amount to be invested…………………………………………………………… Net present value…………………………………………………………………… $ 131,060 Topeka: Annual net cash flow (at the end of each of 4 years)………………………… $ 400,000 2.589 Present value of an annuity of $1 at 20% for 4 years (Exhibit 5)…………… × Present value of annual net cash flows………………………………………… $1,035,600 (900,000) Amount to be invested…………………………………………………………… Net present value…………………………………………………………………… $ 135,600 2. Net present value analysis: Present Value of $1 at 20%

Year

Net Cash Flow Wichita Topeka

1 $ 310,000 0.833 0.694 2 310,000 0.579 3 310,000 0.482 4 310,000 500,000 4 (residual value) 0.482 Total…………………………… $1,740,000 Amount to be invested……… Net present value……………

$ 400,000 400,000 400,000 400,000 0 $1,600,000

Present Value of Net Cash Flow Topeka Wichita

$ 258,230 215,140 179,490 149,420 241,000

$ 333,200 277,600 231,600 192,800 0

$1,043,280 (900,000) $ 143,280

$1,035,200 (900,000) $ 135,200 *

* This amount differs from the net present value calculation in part (1) due to rounding of present value factors.

3. To: Investment Committee Both Wichita and Topeka have a positive net present value. This means that both projects meet our minimum expected return of 20% and would be acceptable investments. However, if funds are limited and only one of the two projects can be funded, then the two projects must be compared over equal lives. Thus, the residual value of Wichita at the end of period 4 is used to equalize the two lives. The net present value of the two projects over equal lives indicates that Witchita has a higher net present value and would be a superior investment.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Prob. 26–6B (FIN MAN); Prob. 12–6B (MAN) 1.

Proposal A: 4-year cash payback period, as follows: Year

Net Cash Flow

Cumulative Net Cash Flows

1 2 3 4

$120,000 120,000 110,000 100,000

$120,000 240,000 350,000 450,000

Proposal B: 2-year, 4-month cash payback period, as follows: Year 1 2 4 months*

Net Cash Flow

Cumulative Net Cash Flows

$100,000 80,000 20,000

$100,000 180,000 200,000

* The net cash flow required is $20,000 out of $60,000 in Year 3 or 1/3. Thus, 1/3 of 12 months is 4 months.

Proposal C: 3-year, 6-month cash payback period, as follows: Year 1 2 3 6 months*

Net Cash Flow

Cumulative Net Cash Flows

$100,000 90,000 90,000 40,000

$100,000 190,000 280,000 320,000

* The net cash flow required is $40,000 out of $80,000 in Year 4 or 1/2. Thus, 1/2 of 12 months is 6 months.

Proposal D: 3-year payback period, as follows: Year

Net Cash Flow

Cumulative Net Cash Flows

1 2 3

$200,000 180,000 160,000

$200,000 380,000 540,000

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Prob. 26–6B (FIN MAN); Prob. 12–6B (MAN) (Continued) 2.

Proposal A: 5.3% average rate of return, determined as follows: $60,000 ÷ 5 ($450,000 + $0) ÷ 2

$12,000 $225,000

= 5.3% (rounded)

Proposal B: 18.0% average rate of return, determined as follows: $90,000 ÷ 5 ($200,000 + $0) ÷ 2

$18,000 $100,000

= 18.0%

Proposal C: 15.0% average rate of return, determined as follows: $120,000 ÷ 5 ($320,000 + $0) ÷ 2

$24,000 $160,000

= 15.0%

Proposal D: 16.3% average rate of return, determined as follows: $220,000 ÷ 5 ($540,000 + $0) ÷ 2

$44,000 $270,000

= 16.3% (rounded)

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Prob. 26–6B (FIN MAN); Prob. 12–6B (MAN) (Continued) 3.

Of the four proposed investments, only Proposals B and D meet the company’s requirements, as the following table indicates: Proposal

Cash Payback Period

Average Rate of Return

A B C D

4 yrs. 2 yrs., 4 mos. 3 yrs., 6 mos. 3 yrs.

5.3% 18.0% 15.0% 16.3%

Accept for Further Analysis

Reject

*  * 

* Proposals A and C are rejected because they fail to meet the maximum payback period requirement. Proposal A also fails to meet the average rate of return requirement.

Proposal B

Year

Present Value of $1 at 12%

Net Cash Flow

1 0.893 $100,000 2 0.797 80,000 3 0.712 60,000 4 0.636 30,000 20,000 5 0.567 Total………………………………………………………… $290,000 Amount to be invested…………………………………… Net present value…………………………………………

Present Value of Net Cash Flow

$ 89,300 63,760 42,720 19,080 11,340 $ 226,200 (200,000) $ 26,200

Proposal D

Year

Present Value of $1 at 12%

Net Cash Flow

1 0.893 $200,000 2 0.797 180,000 3 0.712 160,000 4 0.636 120,000 100,000 5 0.567 Total………………………………………………………… $760,000 Amount to be invested…………………………………… Net present value…………………………………………

Present Value of Net Cash Flow

$ 178,600 143,460 113,920 76,320 56,700 $ 569,000 (540,000) $ 29,000

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

Prob. 26–6B (FIN MAN); Prob. 12–6B (MAN) (Concluded) 5.

Present Value Index =

Total Present Value of Net Cash Flow Amount to Be Invested

Proposal B:

$226,200 $200,000

= 1.13*

Proposal D:

$569,000 $540,000

= 1.05*

* Rounded 6.

Based on the net present value, the proposals should be ranked as follows: Proposal D: $29,000 Proposal B: $26,200

Based on the present value index (the amount of present value per dollar invested), the proposals should be ranked as follows: Proposal B: 1.13 Proposal D: 1.05

The analyses indicate that although Proposal D has the larger net present value, it is not as attractive as Proposal B in terms of the amount of present value per dollar invested. Proposal D requires the larger investment. Thus, management should use investment resources for Proposal B before investing in Proposal D, absent any other qualitative considerations that may impact the decision.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

MAKE A DECISION MAD 26–1 (FIN MAN); MAD 12–1 (MAN) a.

Present value of annual net cash flows ($700,000 × 6.145)……………………… $ 4,301,500 Present value of residual value ($300,000 × 0.386)……………………………… 115,800 Total present value……………………………………………………………………… $ 4,417,300 Amount to be invested………………………………………………………………… (4,000,000) Net present value………………………………………………………………………… $ 417,300

b. $

Estimated annual net cash flows Present value factor from Exhibit 5 Present value of annual net cash flows Present value of residual value using Exhibit 2 ($300,000 × 0.386) Total present value Amount to be invested Net present value

Estimated Annual Net Cash Flow 500,000 $ 700,000 $ 900,000 6.145 6.145 6.145 × ×

× $ 3,072,500

$ 4,301,500

$ 5,530,500

115,800 $ 3,188,300 (4,000,000) $ (811,700)

115,800 $ 4,417,300 (4,000,000) $ 417,300

115,800 $ 5,646,300 (4,000,000) $ 1,646,300

(Annual Net Cash Flow × 6.145) + $115,800 − $4,000,000 = 0 Annual Net Cash Flow × 6.145 = $4,000,000 − $115,800 Annual Net Cash Flow × 6.145 = $3,884,200 Annual Net Cash Flow = $3,884,200 ÷ 6.145 Annual Net Cash Flow = $632,091

Based upon annual net cash flows of $700,000, San Lucas Corporation should invest in the robotic machinery. The annual net cash flows necessary to generate a positive net present value is $632,091. If the annual net cash flows drop to $500,000, a negative net present value of $(811,700) results. If annual net cash flows rise to $900,000, a positive net present value of $1,646,300 results.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

MAD 26–2 (FIN MAN); MAD 12–2 (MAN) a.

Annual Net Cash Flow $900,000 700,000 500,000 Total

Probability of Occurring 0.10 0.50 0.40 1.00

Expected Value $ 90,000 350,000 200,000 $640,000

Present value of annual net cash flows ($640,000 × 6.145)…………… $ 3,932,800 115,800 Present value of residual value ($300,000 × 0.386)……………………… Total present value…………………………………………………………… $ 4,048,600 Amount to be invested………………………………………………………… (4,000,000) Net present value……………………………………………………………… $ 48,600

The expected net present value of $48,600 justifies San Lucas Corporation investing in the robotic machinery.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

MAD 26–3 (FIN MAN); MAD 12–3 (MAN) a.

Present value of annual net cash flows ($800,000 × 5.650)………………………… $ 4,520,000 Present value of residual value ($200,000 × 0.322)………………………………… 64,400 Total present value………………………………………………………………………… $ 4,584,400 Amount to be invested…………………………………………………………………… (3,000,000) Net present value…………………………………………………………………………… $ 1,584,400

b. Estimated annual net cash flows Present value factor from Exhibit 5 Present value of annual net cash flows Present value of residual value using Exhibit 2 ($200,000 × 0.322) Total present value Amount to be invested Net present value

c. Estimated annual net cash flows Present value factor from Exhibit 5 Present value of annual net cash flows Present value of residual value using Exhibit 2 ($200,000 × 0.247) Total present value Amount to be invested Net present value

Estimated Annual Net Cash Flow 400,000 $ 600,000 $ 800,000 5.650 5.650 5.650 × ×

× $ 2,260,000

$ 3,390,000

$ 4,520,000

64,400 $ 2,324,400 (3,000,000) $ (675,600)

64,400 $ 3,454,400 (3,000,000) $ 454,400

64,400 $ 4,584,400 (3,000,000) $ 1,584,400

Estimated Annual Net Cash Flow 400,000 $ 600,000 $ 800,000 5.019 5.019 5.019 × × × $ 2,007,600 $ 3,011,400 $ 4,015,200 $

49,400

$ 2,057,000 (3,000,000) $ (943,000)

$ 3,060,800 (3,000,000) $ 60,800

$ 4,064,600 (3,000,000) $ 1,064,600

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

MAD 26–3 (FIN MAN); MAD 12–3 (MAN) (Concluded) d.

(Annual Net Cash Flow × 5.650) + $64,400 − $3,000,000 = 0 Annual Net Cash Flow × 5.650 = $3,000,000 − $64,400 Annual Net Cash Flow × 5.650 = $2,935,600 Annual Net Cash Flow = $2,935,600 ÷ 5.650 Annual Net Cash Flow = $519,575

Using a desired rate of return of 12%, the net present values are positive for annual net cash flows of $600,000 and $800,000, which justifies the investing in the equipment. However, if the annual net cash flows drop to $400,000, the net present value is a negative $675,600. With a desired rate of return of 12%, annual net cash flows need to be more than $519,575 to generate a positive net present value. Using a desired rate of return of 15% lowers the net present values, which are still positive for annual net cash flows of $600,000 and $800,000. However, the lower net present values at a 15% desired rate of return make investing in the equipment less attractive.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

MAD 26–4 (FIN MAN); MAD 12–4 (MAN) a.

Annual Net Cash Flow $800,000 600,000 400,000 Total

Probability of Occurring 0.60 0.25 0.15 1.00

Expected Value $480,000 150,000 60,000 $690,000

Present value of annual net cash flows ($690,000 × 5.650)…………… $ 3,898,500 Present value of residual value ($200,000 × 0.322)…………………… 64,400 Total present value…………………………………………………………… $ 3,962,900 Amount to be invested……………………………………………………… (3,000,000) Net present value…………………………………………………………… $ 962,900

The expected net present value of $962,900 justifies Boulder Creek investing in the equipment.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

MAD 26–5 (FIN MAN); MAD 12–5 (MAN) a. Present value of annual net cost savings ($4,000,000 × 6.87293)……… $ 27,491,720 Present value of residual value ($3,000,000 × 0.03779)………………… 113,370 Total present value……………………………………………………………… $ 27,605,090 Amount to be invested………………………………………………………… (20,000,000) Net present value……………………………………………………………… $ 7,605,090 b. Present value of annual net cost savings ($2,500,000 × 6.87293)……… $ 17,182,325 Present value of residual value ($3,000,000 × 0.03779)………………… 113,370 Total present value……………………………………………………………… $ 17,295,695 Amount to be invested………………………………………………………… (25,000,000) Net present value……………………………………………………………… $ (7,704,305) c. The answers to (a) and (b) represent opposite ends of the possible outcomes. The answer to (a) yields a positive net present value of $7,605,090 and represents the best possible outcome with the lowest construction cost of $20,000,000 and the highest annual net cost savings of $4,000,000. In contrast, the answer to (b) yields a negative net present value of $(7,704,305) and represents the worst possible outcome with the highest construction cost of $25,000,000 and the lowest annual net cost savings of $2,500,000. The answers to (a) and (b) present a dilemma for the management of Home Garden with the choice of either being optimistic (answer a) or pessimistic (answer b). Instructor Note: MAD 26–6 illustrates the use of expected values to address this dilemma for Home Garden’s management.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

MAD 26–6 (FIN MAN); MAD 12–6 (MAN) a.

Construction Cost $20,000,000 23,000,000 25,000,000 Total Annual Net Cash Flow $4,000,000 3,000,000 2,500,000 Total

Probability of Occurring 0.55 0.30 0.15 1.00 Probability of Occurring 0.50 0.36 0.14 1.00

Expected Value $11,000,000 6,900,000 3,750,000 $21,650,000 Expected Value $2,000,000 1,080,000 350,000 $3,430,000

Present value of annual net cost savings ($3,430,000 × 6.87293)…… $ 23,574,150 113,370 Present value of residual value ($3,000,000 × 0.03779)………………… Total present value…………………………………………………………… $ 23,687,520 (21,650,000) Amount to be invested……………………………………………………… Net present value……………………………………………………………… $ 2,037,520

d. The positive expected net present value of $2,037,520 justifies building the distribution warehouse.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

TAKE IT FURTHER TIF 26–1 (FIN MAN); TIF 12–1 (MAN) The plant manager wants a project to be accepted and places pressure on the analyst to come up with the “right numbers.” Jerrod is right when he states that the net present value analysis has many assumptions and room for interpretation. Many use this room for interpretation to work the numbers until they satisfy the minimum return (hurdle) rate. In fact, some analysts state that they start with the hurdle rate and work back into the numbers. Clearly, this is not what should be expected of Danielle. Danielle made an honest effort to discuss the assumptions. Danielle’s last statement was an open attempt to begin a conversation around assumptions. This is legitimate. Notice that Jerrod jumped on that opening and dictated a course of action. Instead of discussing assumptions, Jerrod stated what the assumptions are to be and how they are to be reflected in the analysis. This is no more than “cooking” the analysis. Danielle needs to respond strongly to this attempt by Jerrod to circumvent the process by countering his argument. For example, Danielle might point out that it is by no means clear that more storage space translates into more sales. In fact, it is probably just the opposite. More storage space means that more product waits a long time before being shipped to the customer. This means that the customer is guaranteed to receive dated product that may be inferior to product that has been recently produced. More warehouse space is counter to a just-in-time orientation. Danielle is really trying to prevent the plant manager from going down the wrong path. Jerrod needs to work on his systems so that he doesn’t need the warehouse space. This very difficult issue revolves around the nature of ethical dilemmas. Danielle has brief tenure with the organization. She has very little organizational clout and could easily find her career short-circuited by crossing Jerrod. It might be tempting for Danielle to slide on this one—after all, who would know? If the project is eventually a failure, it’s unlikely that the decision would come back to haunt Danielle. Much time will have passed, and Danielle will likely be in another job in the company. The decision to confront Jerrod has immediate repercussions. This is the heart of real-world ethical dilemmas. The dilemma occurs when the ethical decision has grave short-term consequences (Jerrod short-circuits Danielle’s career) and few seemingly long-term rewards (no one sees the ethical decision), while the unethical decision looks appealing in the short term (Jerrod is my friend) and potentially safe in the long term (who’s going to find out?). The ethical management accountant will recognize these pressures and make the difficult decisions in order to build a strong reputation that can be a very powerful asset later in one’s career. The key is to recognize that trading off short-term gain for one’s long-term reputation can be very harmful. Thus, enlightened self-interest indicates that the ethical course of action to rebuff Jerrod is rational and correct.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

TIF 26–2 (FIN MAN); TIF 12–2 (MAN) This activity could be assigned individually or in groups. This activity has the student(s) perform a capital investment analysis for a desktop computer, using information available to them on the Internet and from a local business. The actual answer depends on the actual numbers determined by the student(s). Have a number of students (or groups) provide their answers to the class and note the variation (or lack thereof) between the various analyses. Use this to show that there are often many answers to even simple problems, depending on the assumptions (e.g., what is considered a “mid-range” computer) and underlying data (e.g., rental rate). Below is a sample answer based on our hypothetical data and assumptions: Assumed hourly rental rate………………………………………………… $8 per hour Semester cost (40 hours × $8)…………………………………………… $320 Present value of $320 for 6 semiannual periods at 5% ($320 × 5.07569)…………………………………………………………… $ 1,624 (1,200) Assumed price of a mid-range computer………………………………… $ 424 Net present value…………………………………………………………… The computer should be purchased.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

TIF 26–3 (FIN MAN); TIF 12–3 (MAN) Memo To:

Tom Greene

From:

Ima Student

Re:

Effect of exchange rate changes on internal rate of return

I have reviewed the impact of possible exchange rate changes on the company’s internal rate of return and determined that the impact will be significantly different depending on where the product is ultimately sold. If the product is sold locally, it is likely that the internal rate of return on the new plant will decline because all net cash flows are incurred in the local economy. This is because the cash profits earned on the plant will be less in U.S. dollars as a result of the devaluation. For example, if the product sold for a profit of 10 units of local currency, it would need to double to 20 units of local currency in order to generate the same amount of U.S. dollar profit. This could be done with a large price increase. However, such a price increase would probably significantly reduce demand. If the price stayed the same, then the number of U.S. dollars earned in profit would be halved. If, however, the plant produced for export only, then the expenses would be incurred in local currency, while the revenues would be earned in U.S. dollars. This could work in favor of the project because the expenses in U.S. dollar terms would decline. For example, if the local wages were 16 units of local currency per hour, then after the devaluation, these 16 units would cost half as much in U.S. dollar terms. Because the product is sold in the United States, the currency exchange rate would have no impact on revenues. The net result is that the cash flows in U.S. dollar terms would potentially increase, increasing the internal rate of return.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

TIF 26–4 (FIN MAN); TIF 12–4 (MAN) 1.

Annual salary………………………………………………………………………… × Present value of $1 annuity for 10 years at 10%…………………………… Present value of undergraduate option as of the end of undergraduate degree (beginning of graduate degree)………………………………………………………………………………

$ 50,000 6.145

Annual tuition at the beginning of graduate year……………………………… Annual salary………………………………………………………………………… × Present value of $1 annuity for 9 years at 10%……………………………… Present value salary to end of graduate year…………………………………… × Present value of $1 for 1 year at 10%………………………………………… Present value of salary at the beginning of graduate year…………………… Present value of graduate option at the beginning of graduate year (salary less tuition)………………………………………………

$ (12,000)

$307,250 $ 66,000 5.759 $380,094 0.909 $345,505 $333,505

Note: The present values of parts (1) and (2) must both be determined as of the beginning of the graduate year in order to be compared. Thus, the present value of the salary at the end of graduate school must be brought back one period to the beginning of the graduate year, since this salary stream is delayed by one year of schooling. The timeline below shows the calculation. 0

$ (12,000) $345,505

66K

($66,000 × 5.759 × 0.909)

$333,505

Present value of graduate option………………………………………………… $ 333,505 (307,250) Present value of undergraduate option………………………………………… Net benefit of graduate option…………………………………………………… $ 26,255 Note to Instructors: This solution accounts for the opportunity cost of graduate school in terms of lost earnings during the graduate year. To maintain simplicity, the solution does not account for likely growth in earnings over time or income tax effects. In addition, the undergraduate tuition and opportunity cost to obtain the undergraduate degree are treated as sunk costs relative to the decision to attend graduate school and, thus, are not relevant to the analysis.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

TIF 26–5 (FIN MAN); TIF 12–5 (MAN) In all three companies, the executives indicate that financial investment analysis plays a minor role in the selection of projects. The reason is that all three companies deal with products that have highly uncertain future cash flows. Thus, any attempt at a financial investment analysis could be highly suspect. Instead, these managers rely on strategic considerations. These considerations include responding to competitors, developing new markets and products for customers, and improving quality. The executives indicate that business judgment is more important for these strategic, longer-term decisions than is financial investment analysis. This suggests that financial investment analysis is better suited for investments that have more predictable cash flows with possible short duration.

TIF 26–6 (FIN MAN); TIF 12–6 (MAN) 1.

All cash flows assumed to occur at the end of the year. 20Y5 cash flow:

in millions

Gross ticket sales…………………………………………………………… Production cost……………………………………………………………… Marketing cost……………………………………………………………… Net cash flow from theatrical release………………………………

$ 420 (340) (90) $ (10)

20Y6 Online download sales………………………………………………… 20Y7 Pay TV……………………………………………………………………… 20Y8 Syndication………………………………………………………………

$ 60 20 10

Net present value: Year

Present Value of $1 at 20%

Net Cash Flow

Present Value of Net Cash Flow

20Y5 0.833 $(10) 20Y6 0.694 60 20Y7 0.579 20 20Y8 0.482 10 Net present value……………………………………………………………… 2.

$ (8) 42 12 5 $51

Even though the film lost money at the box office, the project was financially successful as a whole, due to additional cash flows from online downloads, pay TV, and network TV syndication.

CHAPTER 26 (FIN MAN); CHAPTER 12 (MAN)

Capital Investment Analysis

CERTIFIED MANAGEMENT ACCOUNTANT (CMA®) EXAMINATION QUESTIONS (ADAPTED) 1.

c. Using trial and error, an internal rate of return of 14% equates Foster’s cash flows to the initial investment as follows: ($6,000 × 0.87719) + ($6,000 × 0.76947) + ($8,000 × 0.67497) + ($8,000 × 0.59208) = $20,016.36 Initial cash outflow of $20,000 ≈ $20,016.36 Note: The optimal trial-and-error strategy is to start with the two closest rates of returns of 12% and 14%. A return of 12% yields a present value of $20,918.70 [($6,000 × 0.89286) + ($6,000 × 0.79719) + ($8,000 × 0.71178) + ($8,000 × 0.63552)]. Thus, 14% is the next logical choice.

a. Since the projects are mutually exclusive, Staten should accept Project X (higher net present value) and reject Project Y. Net present value Project X = ($47,000 × 3.79079) – $150,000 = $28,167.13 Net present value Project Y = ($280,000 × 0.62092) – $150,000 = $23,857.60

c. Allstar’s initial investment is $26,160 as shown below. Present value of cash inflows Initial investment

$9,000 × 3.23972 = $29,157.48 $29,157.48 – $3,000.00 = $26,157.48

Rounded to $26,160

c. The payback period for Foster’s project is 3.0 years ($20,000 – $6,000 – $6,000 – $8,000 = $0).

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN) LEAN MANUFACTURING AND ACTIVITY ANALYSIS DISCUSSION QUESTIONS 1.

The lean philosophy focuses on reducing time, cost, and poor quality within manufacturing and nonmanufacturing processes.

Move time and wait time in inventory are examples of non-value-added lead time.

A product-oriented layout can be designed to minimize materials movements and reduce (or eliminate) setup time. As a result, a product-oriented layout should have a shorter lead time than a process-oriented layout.

Long setup times lead to large production runs (batch sizes) in order to amortize the cost of the setup. Large batch sizes result in larger inventories, which in turn lead to long wait times. Thus, long setup times can lead directly to long lead times.

Pull or “make to order” manufacturing requires the manufacturer to build product only as it is needed for actual customer orders. As a result, finished goods, work in process, and materials inventories are minimized. Make to order manufacturing requires a high degree of flexibility and insignificant setup costs.

Product defects can cause additional costs and unpredictability in the process in the form of scrap, rework, record keeping, and inspection. In addition, product defects can cause a process to shut down, because there is very little work in process inventory to keep the next (downstream) operations running. Thus, a lean manufacturer would wish to eliminate the negative consequences of product defects.

With supply chain management, long-term relationships are established with suppliers and customers to improve quality, cost, and delivery. Traditional relationships are usually focused on reducing price through supplier or customer competitive bidding. Thus, the traditional supplier and customer relationship can be very short-term oriented (until a better “deal” comes along).

A lean environment will result in fewer (or no) work in process control points. As a result, there are no in-process transactions into and out of work in process inventory locations throughout the process. The lean accounting system backflushes cost to finished product rather than pushing cost through intermediate work in process departments.

The raw and in process inventory account combines the materials and work in process inventories because the materials are often introduced directly into the process. Thus, the materials are not recorded in a separate materials account before being introduced to work in process because there is no materials inventory.

10.

Direct labor and indirect labor activities become combined in a lean environment. Employees perform both direct and indirect labor tasks. In addition, direct labor can be a small part of the cost of producing product. As such, the direct labor is included as overall conversion cost (much like in a process cost system).

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

DISCUSSION QUESTIONS (Concluded) 11.

Non-value-added activities are activities that are viewed as unnecessary from the customer’s perspective. These activities are generally considered wasteful and are candidates for elimination through process improvements.

12.

The cost of a process can be improved by improving processing methods or eliminating unnecessary or wasteful work.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

BASIC EXERCISES BE 27–1 (FIN MAN); BE 13–1 (MAN) a.

Value-added lead time……………………… Non-value-added lead time: Total within-batch wait time…………… Move time………………………………… Total lead time……………………………… Value-added ratio:

16 min. 500 min.

16 min. (4 min. + 12 min.) 464 (4 min. + 12 min.) × (30 – 1) 20 500 min.

= 3.2%

BE 27–2 (FIN MAN); BE 13–2 (MAN) a. Smaller batch sizes c. Employee involvement d. Less wasted movement of material and people BE 27–3 (FIN MAN); BE 13–3 (MAN) a.

Raw and In Process Inventory Accounts Payable To record materials purchases ($30 per unit × 500 units).

15,000

Raw and In Process Inventory Conversion Costs To record applied conversion costs

36,000

15,000

36,000

{[($180,000 ÷ 1,000 hours) × (20 min. ÷ 60 min.)] × 600 units}.

Finished Goods Inventory Raw and In Process Inventory To transfer the cost of completed units to finished goods [($30 + $60) × 450 units].

40,500 40,500

BE 27–4 (FIN MAN); BE 13–4 (MAN) Cost of Quality Report

Quality Cost Classification

Prevention (employee training)……………… Appraisal (inspecting rooms)……………… Internal failure (reworking room service meals)………………………………… External failure (processing lost reservations)………………………………… Totals…………………………………………

Quality Cost

Percent of Total Quality Cost

Percent of Total Sales

$230,000 180,000

46.0% 36.0

9.2% 7.2

30,000

6.0

1.2

60,000

12.0

2.4

$500,000

100.0%

20.0%

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

BE 27–5 (FIN MAN); BE 13–5 (MAN) Inspection activity before improvement…… $103,500 ÷ 30,000 units = $3.45 per unit Inspection activity after improvement: Revised inspection cost…………………… 4,000 inspections × $3.45 per unit = $13,800 Revised inspection cost per unit………… $13,800 ÷ 30,000 units = $0.46 per unit

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

EXERCISES Ex. 27–1 (FIN MAN); Ex. 13–1 (MAN) The CEO must not have been reading the article very carefully. Lean manufacturing is not primarily an inventory reduction method. Lean manufacturing is a process improvement philosophy that focuses on reducing time, cost, poor quality, and uncertainty from a process. Large inventories are merely a symptom of poorly designed processes. Thus, the CEO’s statement is naive. The company must first remove the reasons for inventory. These causes are poor quality, large setup times, unreliable equipment, poor employee relationships, poor layout design (process focus), and poor supplier relationships. When these are improved, then the inventory level can be reduced, lead times can be shortened, and the company can begin pull manufacturing. If the employees follow the CEO’s orders without making the process improvements, the plant will likely suffer reduced productivity. In addition, the CEO has not provided the training or action plan for moving to lean manufacturing. The CEO has only commanded that it be done. This will create anxiety in the workforce, and it is not consistent with employee involvement. It may also lead to significant problems if employees reduce inventories without applying other necessary principles of lean manufacturing. Shortages and delays will likely occur, hurting customer relations and sales.

Ex. 27–2 (FIN MAN); Ex. 13–2 (MAN) This is an actual situation facing the U.S. apparel industry. Warren Featherbone and other U.S.-based apparel manufacturers are discovering the strategic power of lean manufacturing. Rather than competing with the offshore manufacturers on price, these companies are providing smaller quantities with much faster delivery. The retailer is able to order and receive goods in smaller, more frequent batch sizes. As a result, the retailer is able to move with fashion trends much more quickly. For example, if a particular style is proving popular, the domestic manufacturer can immediately produce and deliver more of this item. The offshore operation manufactures in batch sizes that are too large and too far away to respond quickly. In addition, the retailer does not have to commit significant inventory to unknown fashion trends when purchasing from the local company. As a result, the retailer is able to avoid markdowns on slow-moving goods. Markdowns represent the second-largest cost to retailing operations (next to cost of goods sold). The retailer must make large order commitments to the offshore manufacturer. If the product eventually proves to be disappointing in the market, the retailer has no choice but to incur severe markdowns to move the excess inventory. Because of significant benefits, the retailer will be willing to pay a higher cost for manufactured items from the domestic company. The German and Italian apparel industries are positioning themselves in this way.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Ex. 27–3 (FIN MAN); Ex. 13–3 (MAN) Piecework compensation is a characteristic of a traditional manufacturing philosophy that is inconsistent with lean manufacturing. Under lean manufacturing, workers are viewed not just as laborers but as valuable assets of the company. The company wants workers to also bring their minds to the job. Thus, workers should be compensated for contributing to process improvements, for training themselves to work other jobs in the cell, and for managing themselves. This might involve an hourly rate system plus bonus incentives. Piecework payments would not pay workers for these contributions because the pay arrangement is a very simple “produce for pay” arrangement. Moreover, piecework encourages workers to make product regardless of whether there is demand for the product. Workers do not get paid for idle time, so they will continue to work and build inventory. However, under pull manufacturing, the cell will work only if there is demand. If there is no demand, the cell employees should work in other cells or work on improving themselves or the process. Piecework compensation is very inconsistent with this philosophy. Employees should not be penalized just because the cell is operating at a slower pace (or is shut down) due to decreases in demand. The employee has no control over the demand placed on the cell. Ex. 27–4 (FIN MAN); Ex. 13–4 (MAN) Management is incorrect in stating that the direct labor time is equal to the lead time. The lead time also includes the wait time and other non-value-added time required to make the product. The different batch sizes create within-batch wait time for each unit. Thus, the lion, which is made in batch sizes of 40 units, has assembly lead time of 320 minutes (40 units × 8 minutes per unit). Of this amount, only 8 minutes are valueadded. The remaining 312 minutes (39 units × 8 min.) are non-value-added within-batch wait time. The bear has assembly lead time of 80 minutes (10 units × 8 minutes per unit). Of this amount, 8 minutes are value-added. The remaining 72 minutes (9 units × 8 min.) are non-value-added within-batch wait time.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Ex. 27–5 (FIN MAN); Ex. 13–5 (MAN) a.

Long setup times have two negative consequences. First, a long setup time consumes valuable machine capacity that could be used for productive purposes. Second, a long setup time results in large production batch sizes to recover the economic cost of the setup. As a result, a long setup will result in a large production batch, which increases work in process inventory, which increases lead time. Large work in process inventory commits working capital that could be used for other purposes. Long lead times reduce the company’s ability to respond to changes in customer demand.

One obvious improvement would be to limit the trips to the tool room to one round trip, rather than two. However, even this could be improved upon by changing the location of the fixtures. Changing the location of the fixtures could significantly reduce the lathe setup time. Instead of using a tool room to control the fixtures, the appropriate fixtures for the lathe could be located at the lathe operation. In this case, the operator would not need to walk to a tool room and retrieve and replace fixtures (along with paperwork). Rather, the operator would have the tools required for a setup right at the lathe location. In this situation, the company would trade off somewhat less control over fixtures for faster setup time. Many companies are eliminating tool rooms for just this reason. These companies are finding that tool room control is not necessary if tools are stored at a designated location near the point of use (i.e., they won’t be lost or stolen if they have a visible storage point). An intermediate solution is to retain the tool room and have the operator make only one trip to the tool room to return the old fixture and retrieve the new one.

Turn off machine and remove fixture from lathe………… 15 minutes Clean lathe……………………………………………………… 20 Install new fixture and turn on machine…………………… 5 Total setup time…………………………………………… 40 minutes* * Plus time for replacing and retrieving a tool at a point of use.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Ex. 27–6 (FIN MAN); Ex. 13–6 (MAN) Traditional Philosophy Value-Added Time

16 1

Value-added time……………………………… Within-batch wait time………………………… Move time……………………………………… Totals………………………………………… Value-added ratio: 1

16 minutes 484 minutes

464 4 468

__ 16

Total Time

16 464 4 484

= 3.3%, rounded

Total value-added time per unit: 7 minutes 9 16 minutes

Milling………………………………………………… Finishing…………………………………………… Total……………………………………………… 2

Non-ValueAdded Time

Within-batch wait time: Multiply the value-added time by the remaining units in the batch (waiting their turn) 16 minutes × (30 – 1 units) = 464 minutes

Lean Manufacturing Philosophy Value-Added Time

16 minutes 32 minutes

161 16 0 16

__ 16

= 50.0%

Total value-added time per unit: Milling………………………………………………… Finishing…………………………………………… Total………………………………………………

Non-ValueAdded Time

7 minutes 9 16 minutes

Within-batch wait time: Multiply the value-added time by the remaining units in the batch (waiting their turn) 16 minutes × (2 – 1 units) = 16 minutes

Total Time

16 16 0 32

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Ex. 27–7 (FIN MAN); Ex. 13–7 (MAN) Present Approach

Value-Added Time

301

Value-added time…………………………… Within-batch wait time……………………… Move time……………………………………… Totals……………………………………… Value-added ratio: 1

30 minutes 1,530 minutes

1,470 30 3 1,500

__ 30

Total Time

30 1,470 30 1,530

= 2.0%, rounded

Total value-added time per unit: Process Step 1…………………………………… Process Step 2…………………………………… Process Step 3…………………………………… Process Step 4…………………………………… Total……………………………………………

Non-ValueAdded Time

6 minutes 12 9 3 30 minutes

Within-batch wait time: Multiply the value-added time by the remaining units in the batch (waiting their turn): 30 minutes × (50 – 1 units) = 1,470 minutes

Move time: 5 moves (from raw materials to finished goods) × 6 minutes = 30 minutes

Proposed Lean Approach Value-Added Time

30 minutes 65 minutes

Total Time

30 1

Value-added time…………………………… Within-batch wait time……………………… Move time……………………………………… Totals……………………………………… Value-added ratio:

Non-ValueAdded Time 2

30 53 35

__ 30

= 46.2%, rounded

Total value-added time per unit: Process Step 1……………………………………

6 minutes

Process Step 2……………………………………

Process Step 3…………………………………… Process Step 4…………………………………… Total……………………………………………

9 3 30 minutes

Within-batch wait time: Multiply the value-added time by the remaining units in the batch (waiting their turn) 30 minutes × (2 – 1 units) = 30 minutes

Move time: 5 moves × 1 minute = 5 minutes

30 30 5 65

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Ex. 27–8 (FIN MAN); Ex. 13–8 (MAN) Quickie’s team approaches are very different from using a manager to hire and evaluate employees. First, the input of many individuals goes into the hiring decision. In this way, the viewpoints of a variety of people are brought into the decision. Moreover, the new hire needs to “fit” with the culture of the team. Team-based hiring can produce a higher probability of having an effective team member by having a good fit. A possible concern is the team hiring only people that are like themselves. The peer evaluation may be more effective than the supervisor evaluation, since the team may be more familiar with the team member’s input to the goals of the team. In addition, it will be difficult to hide unwanted behavior from the team. Team members work with each other every day and may best be able to evaluate performance. A concern would arise if the team members are not trained in making evaluations. The process should be helpful and not threatening to the employee. Team-based evaluation practices increase employee involvement. Employees have input into decisions that affect the team, rather than having these decisions handed down to them. This should increase the amount of empowerment and job satisfaction enjoyed by the team members.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Ex. 27–9 (FIN MAN); Ex. 13–9 (MAN) a.

The present Daddy-O’s service delivery system is an example of a push system. Special orders are “pushed” through the system. The order is placed at the beginning of the process and the hamburger is cooked, dressed, and then delivered to the “inventory” of finished hamburgers placed under the hot lamps. Customers are sold burgers from this finished goods inventory. Under this system, the customer wait time would be small only if the customer ordered a “standard” burger from the inventory. If the customer placed a special order, then he or she would have to wait for the complete cook and dress cycle to be completed.

A new system could be designed so that a custom order is introduced after cooking the burger, rather than prior to cooking. In this way, hamburgers are made to order without the use of finished goods inventory. Under this process, assume a customer ordered a hamburger with ketchup and pickles only. The order would be received at the dressing station. Here, a food preparer would take a hamburger off the grill and place ketchup and pickles on the burger using materials at the dressing station (termed point-of-use materials). The hamburger that is pulled from the grill would create a signal (the space on the grill) for a new hamburger to be placed on the grill. In this way, hamburgers that are cooking do not have orders assigned to them. Rather, they are available to be pulled by the food preparer to satisfy customer orders. In addition, burgers that are not used to satisfy an order are taken off the grill and are ground up to make chili, so waste is minimized. Under this system, the lead time for cooking the hamburger is eliminated from the customer wait time. The customer has only to wait for the burger to be dressed. The attractiveness of this approach is that customers can have the burgers “their way” without using finished goods inventory to provide fast response. A variation on this answer is to have plain hamburgers pulled directly off the grill by the customer order (as above) but place the dressing stations among the customers (similar to Fuddruckers). In this way, the customers dress their own burgers after purchasing them.

Note to Instructors: You may recognize that the first system described in this exercise is similar to the method invented by McDonald’s, while Wendy’s uses the second method. McDonald’s indicated that it was switching its method to work more like Wendy’s because of its superior service characteristics. You might also note that Dell’s manufacturing strategy is very similar to Wendy’s. It produces computers to order using pull signals. This allows Dell to build the computer to a user specification yet still deliver it within a matter of days.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Ex. 27–10 (FIN MAN); Ex. 13–10 (MAN) The production manager probably has some good points. If the accounting system does not change when an organization embraces a lean strategy, then there will likely be complaints. A conventional accounting system needs to have a strong accounting control orientation. Under lean manufacturing, the accounting system can be designed with much wider transaction control intervals. The company could have a very wide transaction interval—such as between purchased parts transacted in and finished goods transacted out. Thus, many transactions into and out of intermediate work in process inventory locations would not be needed. In addition, a raw and in process inventory account would allow the company to eliminate separate raw materials release transactions. Eliminating accounting controls would be foolhardy unless the company has strong visible controls. Otherwise, there is simply too much room for waste and very large unexplained cost variances. Under lean manufacturing, visible controls such as the amount of inventory, production line stoppages, statistical control charts, or emergency lights replace accounting controls. The direct labor reporting can be eliminated. Using lean accounting practices, the direct labor employees are assigned to production cells. Their wages are treated as part of the cell’s conversion costs and are not separately traced or reported. The traditional financial measures should be supplemented with nonfinancial measures, such as schedule attainment, lead time, quality, machine uptime (availability), safety, and setup time. The nonfinancial measures can be collected and reported immediately without the need for additional effort to translate the numbers into financial terms. In addition, cost of quality or value-added/non-value-added activity analyses can provide financial information that can be used by the production department manager.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Ex. 27–11 (FIN MAN); Ex. 13–11 (MAN) a.

Budgeted Cell Conversion = Cost Rate

$600,000 2,000 hours

= $300 per hour

Budgeted Cell Conversion = Cost per Unit

21 minutes 60 minutes

× $300 per hour

$105 per unit

Raw and In Process Inventory Accounts Payable To record materials purchases (500 units × $60 per unit).

30,000

Raw and In Process Inventory Conversion Costs To record applied conversion costs (500 units × $105 per unit).

52,500

Finished Goods Inventory Raw and In Process Inventory To transfer the cost of completed units to finished goods [500 units × ($60 + $105)].

82,500

Accounts Receivable Sales To record sales on account (480 units × $240 per unit).

115,200

Cost of Goods Sold Finished Goods Inventory To record cost of goods sold [480 units × ($60 + $105)].

79,200

30,000

52,500

82,500

115,200

79,200

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Ex. 27–12 (FIN MAN); Ex. 13–12 (MAN) a.

$308,000 Budgeted Cell Conversion = = $140 per hour Cost Rate 2,200 hours

Budgeted Cell Conversion = Cost per Unit

18 minutes 60 minutes

× $140 per hour

= $42 per unit c.

Raw and In Process Inventory Accounts Payable To record materials purchases (620 units × $16 per unit).

9,920

Raw and In Process Inventory Conversion Costs To record applied conversion costs (620 units × $42 per unit).

26,040

Finished Goods Inventory Raw and In Process Inventory To transfer the cost of completed units to finished goods [600 units × ($16 + $42)].

34,800

Accounts Receivable Sales To record sales on account (580 units × $100 per unit).

58,000

Cost of Goods Sold Finished Goods Inventory To record cost of goods sold [580 units × ($16 + $42)].

33,640

9,920

26,040

34,800

58,000

33,640

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Ex. 27–13 (FIN MAN); Ex. 13–13 (MAN) a. 1.

Raw and In Process Inventory Accounts Payable To record materials purchases (2,000 units × $52 per unit).

104,000

Raw and In Process Inventory Conversion Costs To record applied conversion costs ($12.50* × 1,800 units).

22,500

104,000

22,500

* ($50,000 ÷ 800 hours) × (12 min. ÷ 60 min.) 3.

Finished Goods Inventory Raw and In Process Inventory To transfer the cost of completed units to finished goods [($52 + $12.50) × 1,800 units].

116,100

Accounts Receivable Sales To record sales on account ($60 per unit × 1,600 units).

96,000

Cost of Goods Sold Finished Goods Inventory To record cost of goods sold [($52 + $12.50) × 1,600 units].

103,200

116,100

96,000

103,200

b. Raw and In Process Inventory, ending balance ……………………………… 2

Finished Goods Inventory, ending balance …………………………………… 1

$104,000 + $22,500 – $116,100, or Materials [52 per unit × (2,000 units – 1,800 units)]……………………………………… Production [($52 + $12.50) × (1,800 units – 1,800 units)]………………………………… Total………………………………………………………………………………………………

$10,400 12,900

$116,100 – $103,200 = $12,900, or ($52 + $12.50) × (1,800 units – 1,600 units) = $12,900

$10,400 — $10,400

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Ex. 27–14 (FIN MAN); Ex. 13–14 (MAN) a.

Activities classified by cost of quality: Quality Activities

Activity Cost

Correct shipment errors……………………………… $ 150,000 95,000 Disposing of scrap…………………………………… 125,000 Emergency equipment maintenance……………… 50,000 Employee training……………………………………… 80,000 Final inspection………………………………………… 60,000 Inspecting incoming materials……………………… 40,000 Preventive equipment maintenance……………… 90,000 Processing customer returns……………………… 45,000 Scrap reporting………………………………………… 15,000 Supplier development………………………………… 250,000 Warranty claims………………………………………… Total………………………………………………… $1,000,000

Quality Cost Classification

External failure Internal failure Internal failure Prevention Appraisal Appraisal Prevention External failure Internal failure Prevention External failure

Hammerhead Solutions Inc. Cost of Quality Report

Cost Summary

Quality Cost Classification

Prevention Appraisal Internal failure External failure Totals 1 2

Quality Cost

Percent of Total Quality Cost

Percent of Total Sales

$ 105,000 140,000 265,000 490,000 $1,000,000

10.5% 1 14.0 26.5 49.0 100.0%

2.6% 2 3.5 6.6 12.3 25.0%

$105,000 ÷ $1,000,000 $105,000 ÷ $4,000,000

The majority of the company’s quality efforts are in correcting quality problems. This is evident by the high percentage of quality costs associated with internal and external failure (26.5% + 49.0% = 75.5% of total quality costs). The highest cost activities are warranty claims, which indicates significant field failures for the product. Emergency equipment maintenance is an internal failure because it indicates that the company is failing to preventively maintain the equipment. Emergency repairs create significant disruptions and quality problems.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Ex. 27–15 (FIN MAN); Ex. 13–15 (MAN) a. Quality cost and value-added/non-value-added classifications: Activity Cost

Quality Cost Classification

Value-Added/ Non-Value-Added Classification

Billing error correction…………… $ 60,000 Cable signal testing……………… 140,000 Reinstalling service (installed incorrectly the first time)……… 40,000 Repairing satellite equipment…… 50,000 Repairing underground cable connections to the customer… 25,000 Replacing old technology cable with higher quality cable……… 175,000 Replacing old technology signal switches with higher quality switches…………………………… 150,000 Responding to customer home repair requests…………………… 30,000 80,000 Training employees……………… $750,000 Total………………………………

External failure Appraisal

Non-value-added Value-added

External failure Internal failure

Non-value-added Non-value-added

Quality Activities

External failure* Non-value-added Prevention

Value-added

Prevention

Value-added

External failure Prevention

Non-value-added Value-added

* This is an external failure because the underground cable connection needs to be repaired after receiving notification of disrupted service from a customer.

Seven Seas Inc. Cost of Quality Report Cost Summary

Quality Cost Classification

Prevention Appraisal Internal failure External failure Totals

Quality Cost

$405,000 140,000 50,000 155,000 $750,000

Percent of Total Quality Cost

Percent of Total Sales

54.0%1 18.7 6.73 20.7 100.0%

13.5%2 4.7 1.7 5.2 25.1%

$405,000 ÷ $750,000 $405,000 ÷ $3,000,000 3 Unrounded percentages total to 100.0%. 2

Seven Seas Inc. Value-Added/Non-Value-Added Activity Analysis Category

Value-added Non-value-added Total

Amount

Percent

$545,000 205,000 $750,000

72.7% 27.3 100.0%

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Ex. 27–15 (FIN MAN); Ex. 13–15 (MAN) (Concluded) d.

The reports indicate that Seven Seas Inc.’s total costs of quality are 25.1% of total sales. In addition, 54.0% of the activity cost goes toward prevention activities. As a result, Seven Seas is able to avoid high internal and external failure activities. Only 27.3% of the activities are non-value-added, compared to 72.7% that are valueadded. Although there is some room for improvement, the company appears to be effectively managing its quality activities.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Ex. 27–16 (FIN MAN); Ex. 13–16 (MAN) a.

Activity Cost per Can = =

Activity Cost Number of Completed Cans $480,000 6,000,000 cans

= $0.08 per can

In this improvement scenario, 250,000 (300,000 – 50,000) additional cans will be processed through the packaging operation. The same number of cans still will be processed by the mixing and filling activities. Additional cost to packaging activity from improved process: 0.03 Packaging activity cost per can*………………………… $ Number of additional cans from improvement effort………………………………………… × 250,000 cans Additional packaging activity cost……………………… $ 7,500 *

Packaging Activity Cost per Can

= =

Packaging Activity Cost Number of Completed Cans $180,000 6,000,000 cans

= $0.03 per can c.

Expected activity cost per can after improvement: Activity Cost per Can = =

Activity Cost Number of Completed Cans $480,000 + $7,500 6,250,000 cans = $0.08 per can

The activity cost per can of the new process is improved because the number of cans completed through the mixing and filling process increased by 250,000 cans at a small additional cost of $7,500 in the packaging activity. The mixing and filling activity costs do not change because the improvement only impacts the number of cans processed after the filling activity, not prior to this activity. This solution simplifies by assuming the refrigeration did not require additional activity cost. While not analyzed in this exercise, there are additional savings from less waste of materials from fewer kicks.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Ex. 27–17 (FIN MAN); Ex. 13–17 (MAN) a. Activity

Receiving claim……………………………………………… Adjusting claim……………………………………………… Paying claim………………………………………………… Total………………………………………………………

Cost

Percent of Total Process

$120,000 260,000 120,000 $500,000

24% 52 24 100%

The “adjusting claim” activity is the most significant activity in this process. b.

Average process cost per paid claim: $500,000 2,000 claims

= $250 per paid claim

c. Activity

Receiving claim…………………………… Adjusting claim…………………………… Paying claim……………………………… Totals……………………………………

Activity Cost Prior to Improvement

Activity Cost After Improvement

Activity Cost Savings (Cost)

$120,000 260,000 120,000 $500,000

$132,000 * 52,000 ** 120,000 $304,000

$ (12,000) 208,000 0 $196,000

* $120,000 × 110% ** $260,000 × (100% – 80%) Note: Sometimes an activity cost within a process will need to increase in order to realize additional benefits in another part of a process, as illustrated here. d.

Average process cost per paid claim: $304,000 2,000 claims

= $152 per paid claim

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Ex. 27–18 (FIN MAN); Ex. 13–18 (MAN) a. Activity

Cost

Preparing materials request……………………………… Requesting, receiving, and selecting vendor bids………………………………………………… Preparing purchase order………………………………… Preparing receiving ticket………………………………… Matching M/R, R/T, and vendor invoice………………… Correcting reconciliation differences………………… Preparing and delivering vendor payment…………… Total process activity cost……………………………

Percent of Total Process

$ 32,000

92,000 20,000 24,000 52,000 148,000 32,000 $400,000

23 5 6 13 37 8 100%

“Requesting, receiving, and selecting vendor bids” and “correcting reconciliation differences” total 60% of the total process cost. This indicates that these two activities are good candidates for improvement efforts. b.

Average process cost per payment: $400,000 10,000 payments

= $40 per payment

c. Activity

Preparing materials request………… Requesting, receiving, and selecting vendor bids……………… Preparing purchase order…………… Preparing receiving ticket…………… Matching M/R, R/T, and vendor invoice……………………… Correcting reconciliation differences…………………………… Preparing and delivering vendor payment……………………… Totals…………………………………

Activity Cost Prior to Improvement

Activity Cost After Improvement

$ 32,000

92,000 20,000 24,000

23,000* 20,000 24,000

69,000 — —

52,000

—

148,000

37,000 **

32,000 $400,000

32,000 $220,000

Activity Cost Savings

111,000 — $180,000

* $92,000 × (100% – 75%) ** $148,000 × (10% ÷ 40%) d.

Average process cost per paid claim: $220,000 10,000 payments

—

= $22 per payment

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

PROBLEMS Prob. 27–1A (FIN MAN); Prob. 13–1A (MAN) 1.

Ceiling Stars’ purchasing policy is very short-sighted. It does not involve developing partnerships with suppliers. Ceiling Stars should consider changing its arm’s-length policy and work on building a long-term supply chain strategy with its suppliers. With a supply chain strategy, Ceiling Stars can begin to consider more than just the price of its glass. It can work with the supplier on quality, responsive delivery, electronic data interchange invoicing, supplier raw materials logistical support, sharing of research and development efforts, and sharing of production schedules, to name a few. The arm’s-length approach is more costly in the long run, even if it squeezes the last penny out of each supplier. The arm’s-length approach reduces the possibility of working on issues that go across organizational boundaries (such as electronic data interchange, sharing demand forecasts, or more frequent just-in-time deliveries), which hold the promise of reducing the total delivered cost.

The hidden costs beyond the price include the costs associated with the higher inventory required by Provo’s delivery schedule. These inventory costs include additional space, handling, obsolescence, financing, and materials management costs. These costs were not considered because they are not obvious. They are also difficult to determine. The price is obvious, so it is easy to build a purchasing policy around “getting the best price.” This policy ignores the additional internal costs of the higher inventory imposed by Provo’s delivery schedule. These are costs incurred by other parts of the organization, not Purchasing. In a functional organization, Purchasing would respond by saying that the additional internal inventory costs are not its problem. Those are costs incurred in another manager’s responsibility center. Of course, this is part of the problem of such simple “low-price bid” policies.

If the financing costs are 8%, then the additional cost of the inventory could be determined as follows: At the beginning of July, the new shipment of 45,000 pounds arrives. Assuming that the glass supply runs out by the end of the quarter, the average inventory for the quarter is: Beginning of July……………………………………………………… End of September……………………………………………………… Total…………………………………………………………………… Number of observations (i.e., one at the beginning of the quarter and one at the end of the quarter)……………… Average inventory for the quarter……………………………………

45,000 lbs. 0 45,000 lbs. 2 ÷ 22,500 lbs.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Prob. 27–1A (FIN MAN); Prob. 13–1A (MAN) (Concluded) The inventory carrying cost can be estimated as follows: Average pounds in inventory for the quarter…………………………… Price per pound………………………………………………………………… Total inventory investment…………………………………………………… Interest rate per quarter (8% ÷ 4)…………………………………………… Inventory financing cost per quarter……………………………………… Number of pounds ordered for the quarter……………………………… Additional cost per pound……………………………………………………

22,500 $30 × $675,000 2% × $ 13,500 ÷ 45,000 lbs. $ 0.30 per lb.

The financing cost is 2% of the average quarterly inventory value, or $13,500 per quarter. This translates into an additional 30¢ per pound ($13,500 ÷ 45,000 lbs.) purchased during the quarter. Thus, just considering the financing cost by itself makes Orem Glass the “real” low-cost bidder. Note to Instructors: As a point of comparison, the financing cost for Orem Glass’s daily deliveries is less than a cent per pound (500 × $30.20 × 2% = $302.00; $302.00 ÷ 45,000 lbs. = $0.0067). [This calculation would be half this amount if it was assumed the average daily inventory was half the daily shipment, or 250 pounds (500 pounds per day ÷ 2).]

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Prob. 27–2A (FIN MAN); Prob. 13–2A (MAN) 1.

Value-added time: Assembly of PC board…………………………………………… Stereo assembly…………………………………………………… Time to test one unit……………………………………………… Pack and label……………………………………………………… Total………………………………………………………………

5 min. 16 8 10 39 min.

Non-value-added time: Wait time: Within-batch wait time—PC board assembly (19 × 5 min.)………………………………………………………… Within-batch wait time—final assembly (19 × 16 min.)……………………………………………………… Within-batch wait time—testing (19 × 8 min.)………………… Within-batch wait time—shipping (19 × 10 min.)……………… Test setup…………………………………………………………… Total wait time……………………………………………………

95 min. 304 152 190 25 766 min.

Move time: Move from PC board assembly to final assembly…………… Move from final assembly to testing…………………………… Total move time………………………………………………… Total non-value-added time………………………………………

10 min. 20 30 min. 796 min.

Total lead time (39 min. + 796 min.)………………………………

835 min.

Value-Added Ratio = =

Value-Added Lead Time Total Lead Time 39 min. 835 min.

= 4.7% 2.

The existing process is very wasteful. The company could improve the process by changing the layout from a process orientation to a product orientation. Each stereo model could be formed into a production cell. Each cell would have PC board assembly, final assembly, and testing next to each other. In this way, the batch sizes could be reduced significantly. Workers could practice one-at-a-time processing and merely pass a single completed assembly through the cell. The work content would need to be made more balanced before implementing this solution. As a result, the move time and within-batch wait time would be eliminated. The company could also initiate total quality principles. Moving toward zero defects would allow the company to reduce testing activities (and time), and as a result, the setup time for the test area might be eliminated or reduced.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Prob. 27–3A (FIN MAN); Prob. 13–3A (MAN) $1,600,000 2,000 hours

Budgeted Cell Conversion = Cost Rate

Budgeted Cell Conversion = $800 per hr. × (24 min. ÷ 60 min.) Cost per Unit =

= $800 per hour

$320 per unit

Raw and In Process Inventory Accounts Payable To record materials purchases (470 units × $250 per unit).

117,500

Raw and In Process Inventory Conversion Costs To record applied conversion costs (420 units × $320 per unit).

134,400

Finished Goods Inventory Raw and In Process Inventory To transfer the cost of completed units to finished goods [400 units × ($250 + $320)].

228,000

Accounts Receivable Sales To record sales on account (370 units × $800 per unit).

296,000

Cost of Goods Sold Finished Goods Inventory To record cost of goods sold [370 units × ($250 + $320)].

210,900

117,500

134,400

228,000

296,000

Raw and In Process Inventory: $117,500 + $134,400 – $228,000 = $23,900 Finished Goods Inventory: $228,000 – $210,900 = $17,100 or (400 units – 370 units) × ($250 + $320) = $17,100

210,900

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Prob. 27–3A (FIN MAN); Prob. 13–3A (MAN) (Concluded) 5.

Lean accounting is different from traditional accounting in a number of respects. Most importantly, lean accounting is simplified and uses minimal control. As a result, the number of transactions is reduced, and the control intervals between adjacent work in process transaction points are widened. In many lean operations, there are no separate materials or work in process inventories. Rather, purchased materials are charged to an account that combines raw materials and work in process, termed the “raw and in process inventory” account. Direct labor is frequently eliminated as a cost category and is instead included as a conversion cost of the cell. The cell conversion cost is applied to the raw and in process inventory account. Indirect labor can frequently be assigned to a production cell. As a result, these costs do not need to be allocated, since they are included directly in the cell’s conversion cost. Often, nonfinancial performance measures, such as lead time or quality measures, are used to monitor performance.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Prob. 27–4A (FIN MAN); Prob. 13–4A (MAN) 1. Activity classifications:

Activity Patient registration……………… Verifying patient information…… Assigning patients……………… Searching/waiting for doctor…… Doctor exam……………………… Waiting for transport…………… Transporting patients…………… Verifying lab orders……………… Searching for equipment……… Incorrect labs……………………… Lab tests…………………………… Counting supplies………………… Looking for supplies…………… Staff training……………………… Total……………………………

Activity Cost $ 6,500 9,700 13,000 9,200 4,900 17,500 16,200 14,500 8,200 11,300 17,000 19,000 8,200 4,800

Cost of Quality Classification Other patient care Appraisal Other patient care Internal failure Other patient care External failure Other patient care Appraisal Internal failure External failure Other patient care Appraisal Internal failure Prevention

Value-Added/ Non-Value-Added Classification Value-added Value-added Value-added Non-value-added Value-added Non-value-added Value-added Value-added Non-value-added Non-value-added Value-added Value-added Non-value-added Value-added

$160,000

2. Percent of total activity cost for each quality cost (and other patient care cost) classification: Activity Cost

Quality Cost Classification

Prevention………………………………………… Appraisal………………………………………… Internal failure…………………………………… External failure…………………………………… Other patient care……………………………… Total……………………………………………

4,800 43,200 25,600 28,800 57,600 $160,000

Percent of Total Department Cost

3% 27 16 18 36 100%

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Prob. 27–4A (FIN MAN); Prob. 13–4A (MAN) (Concluded) 3.

Percentages of total activity cost that are value- and non-value-added:

Value-added………………………………………… Non-value-added………………………………… Total……………………………………………… 4.

Activity Cost

Percent of Total Department Cost

$105,600 54,400 $160,000

66% 34 100%

The ER has 34% of its total costs as non-value-added. This represents a significant opportunity for cost savings. There is potential for significant improvement in the operations of the ER by using lean principles.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Prob. 27–1B (FIN MAN); Prob. 13–1B (MAN) 1.

J. Burns’s purchasing policy is very short-sighted. It does not involve developing partnerships with suppliers. J. Burns should consider changing its arm’s-length policy and work on building a long-term supply chain strategy with its suppliers. With a supply chain strategy, J. Burns can begin to consider more than just the price of its frames. It can work with the supplier on quality, responsive delivery, electronic data interchange invoicing, supplier raw materials logistical support, sharing of research and development efforts, and sharing of production schedules, to name a few. The arm’s-length approach is more costly in the long run, even if it squeezes the last penny out of each supplier. The arm’s-length approach reduces the possibility of working on issues that go across organizational boundaries (such as electronic data interchange, sharing forecast information, or more frequent just-in-time deliveries), which hold the promise of reducing the total delivered cost.

The hidden costs beyond the price include the costs associated with the higher inventory required by Iron Fist Frames’ delivery schedule. These inventory costs include additional space, handling, obsolescence, financing, and materials management costs. These costs were not considered because they are not obvious. They are also difficult to determine. The price is obvious, so it is easy to build a purchasing policy around “getting the best price.” This policy ignores the additional internal costs of the higher inventory imposed by Iron Fist Frames’ delivery schedule. These are costs incurred by other parts of the organization, not Purchasing. In a functional organization, Purchasing would respond by saying that the additional internal inventory costs are not its problem. Those are costs incurred in another manager’s responsibility center. Of course, this is part of the problem of such simple “low-price bid” policies.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Prob. 27–1B (FIN MAN); Prob. 13–1B (MAN) (Concluded) 3.

If the financing costs are 8%, then the additional cost of the inventory could be determined as follows: At the beginning of July, the new shipment of 3,600 frames arrives. Assuming that the frame supply runs out by the end of the quarter, the average inventory for the quarter is: 3,600 frames 0 3,600 frames

Beginning of July………………………………………………… End of September………………………………………………… Total……………………………………………………………… Number of observations (i.e., one at the beginning of the quarter and one at the end of the quarter)………… Average inventory for the quarter………………………………

÷ 2 frames 1,800

The inventory carrying cost can be estimated as follows: Average frames in inventory for the quarter………………… Price per frame…………………………………………………… Total inventory investment……………………………………… Interest rate per quarter (8% ÷ 4)……………………………… Inventory financing cost per quarter………………………… Number of frames ordered for the quarter…………………… Additional cost per frame………………………………………

1,800 $400

$720,000 2% × $ 14,400 ÷ 3,600 frames $ 4.00 per frame

The financing cost is 2% of the average quarterly inventory value, or $14,400 per quarter. This translates into an additional $4.00 per frame ($14,400 ÷ 3,600 frames) purchased during the quarter. Thus, just considering the financing cost by itself makes Midnight Frames the “real” low-cost bidder. Note to Instructors: As a point of comparison, the financing cost for Midnight Frames’ daily deliveries is less than 10¢ per frame ($16,040 × 2% = $320.80; $320.80 ÷ 3,600 frames = $0.089), because the average daily inventory investment would be only $16,040 [(40 frames per day) × $401]. [This calculation would be half this amount if it was assumed the average daily inventory was half the daily shipment, or 20 frames (40 frames per day ÷ 2).]

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Prob. 27–2B (FIN MAN); Prob. 13–2B (MAN) 1.

Value-added time: Stamping……………………………………………………………… Appliance assembly……………………………………………… Time to test one unit……………………………………………… Pack and shipment labeling……………………………………… Total………………………………………………………………

5 min. 22 8 15 50 min.

Non-value-added time: Wait time: 195 min. Within-batch wait time—stamping (39 × 5 min.)……………… Within-batch wait time—final assembly (39 × 22 min.)……………………………………………………… 858 Within-batch wait time—testing (39 × 8 min.)………………… 312 Within-batch wait time—shipping (39 × 15 min.)……………… 585 60 Stamping setup……………………………………………………… Total wait time…………………………………………………… 2,010 min. Move time: 10 min. Move from stamping to final assembly………………………… 25 Move from final assembly to testing…………………………… 35 min. Total move time………………………………………………… Total non-value-added time……………………………………… 2,045 min. Total lead time (50 min. + 2,045 min.)…………………………… 2,095 min. Value-Added Ratio = =

Value-Added Lead Time Total Lead Time 50 min. 2,095 min.

= 2.4% 2.

The existing process is very wasteful. The company could improve the process by changing the layout from a process orientation to a product orientation. Each appliance model could be formed into a production cell. Each cell would have stamping, final assembly, testing, and shipping next to each other. In this way, the batch sizes could be reduced significantly. Workers could practice one-at-a-time processing and merely pass a single completed assembly through the cell. As a result, the move time and within-batch wait time would be eliminated. The company could also initiate total quality principles. Moving toward zero defects would allow the company to reduce inspecting activities. A product-dedicated flow would also eliminate the need to perform stamping machine setups, since all the stampings would be the same for a given product model.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Prob. 27–3B (FIN MAN); Prob. 13–3B (MAN) $189,000 Budgeted Cell Conversion = = $90 per hour Cost Rate 2,100 hours

Budgeted Conversion = $90 per hr. × (12 min. ÷ 60 min.) Cost per Unit

= $18 per unit 3.

Raw and In Process Inventory Accounts Payable To record materials purchases (900 units × $185 per unit).

166,500

Raw and In Process Inventory Conversion Costs To record applied conversion costs (875 units × $18 per unit).

15,750

Finished Goods Inventory Raw and In Process Inventory To transfer the cost of completed units to finished goods [850 units × ($185 + $18)].

172,550

Accounts Receivable Sales To record sales on account (800 units × $500 per unit).

400,000

Cost of Goods Sold Finished Goods Inventory To record cost of goods sold [800 units × ($185 + $18)].

162,400

166,500

15,750

172,550

400,000

Raw and In Process Inventory: $166,500 + $15,750 – $172,550 = $9,700 Finished Goods Inventory: $172,550 – $162,400 = $10,150 or (850 units – 800 units) × ($185 + $18) = $10,150

162,400

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Prob. 27–3B (FIN MAN); Prob. 13–3B (MAN) (Concluded) 5.

Lean accounting is different from traditional accounting in a number of respects. Most importantly, lean accounting is simplified and uses minimal control. As a result, the number of transactions is reduced, and the control intervals between adjacent work in process transaction points are widened. In many lean operations, there are no separate materials or work in process inventories. Rather, purchased materials are charged to an account that combines raw materials and work in process, termed the “raw and in process inventory” account. Direct labor is frequently eliminated as a cost category and is instead included as a conversion cost of the cell. The cell conversion cost is also applied to the raw and in process inventory account. Indirect labor can frequently be assigned to a production cell. As a result, these costs do not need to be allocated, since they are included directly in the cell’s conversion cost. Often, nonfinancial performance measures, such as lead time or quality measures, are used to monitor performance.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Prob. 27–4B (FIN MAN); Prob. 13–4B (MAN) 1. Activity classifications:

Activity

Correcting invoice errors…… Disposing of incoming materials with poor quality… Disposing of scrap…………… Expediting late production…… Final inspection………………… Inspecting incoming materials……………………… Inspecting work in process… Preventive machine maintenance…………………… Producing product…………… Responding to customer quality complaints…………… Total……………………………

Cost of Quality Classification

Value-Added/ Non-Value-Added Classification

7,500

External failure

Non-value-added

15,000 27,500 22,500 20,000

Internal failure Internal failure Internal failure Appraisal

Non-value-added Non-value-added Non-value-added Value-added

5,000 25,000

Appraisal Appraisal

Value-added Value-added

15,000 97,500

Prevention Value-added Not a quality cost Value-added

Activity Cost

15,000 $250,000

External failure

Non-value-added

2. Percent of total activity cost for each quality cost (and nonquality cost) classification: Quality Cost Classification

Activity Cost

Percent of Total Department Cost

Prevention…………………………………………… Appraisal…………………………………………… Internal failure……………………………………… External failure……………………………………… Not a cost of quality……………………………… Total………………………………………………

$ 15,000 50,000 65,000 22,500 97,500 $250,000

6% 20 26 9 39 100%

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

Prob. 27–4B (FIN MAN); Prob. 13–4B (MAN) (Concluded) 3.

Percentages of total activity cost that are value- and non-value-added:

Value-added………………………………………… Non-value-added…………………………………… Total……………………………………………… 4.

Activity Cost

Percent of Total Department Cost

$162,500 87,500 $250,000

65% 35 100%

The company has 65% of its total costs as value-added. However, there is still room for significant improvement. Internal failure represents 26% of the total costs. This represents significant opportunity for cost savings. In addition, the external failure costs of 9% of the total may understate the true damage caused by external failure. The potential dissatisfaction, ill will, and lost future sales are not accounted for in this analysis.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

MAKE A DECISION MAD 27–1 (FIN MAN); MAD 13–1 (MAN) a.

Average Lead Time 15 min. Wait in line at check-in window…………………………………………… 30 Wait in check-in area for admissions desk……………………………… 15 Wait for escort in check-in area…………………………………………… 60 min. Total non-value-added lead time to arrive at clinical area…………

Value-Added Lead Time Total Lead Time 20 min.* = = 25% 80 min. * 20 min. = 80 min. – 60 min. Value-Added Ratio =

The non-value-added lead time is related to waiting between each process element. Adding resources to the process during the busier times of the day can reduce the waiting. The check-in window could be expanded to multiple service lines, and the admissions desk could be expanded to multiple desks. This would reduce the waiting time between these activities. Adding more escorts could reduce the amount of time waiting to be escorted to a clinical area. A more radical approach would be to provide patients access to an admissions website prior to arriving at the hospital. In this way, admissions information could be input by the patient prior to coming to the hospital. In this scenario, the patient would check in and be escorted directly to a clinical area, because admissions information would have been captured previously. A complete redesign could decentralize the check-in process and make it part of the clinical areas. In this way, the patient could just go directly to the appropriate clinical area to check in. Combining preadmission with decentralized check-in at the clinical areas would virtually eliminate the existing process.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

MAD 27–2 (FIN MAN); MAD 13–2 (MAN) Serenity Insurance Company should adopt lean principles in its claims payment operations. Management should first consider changing the layout for this process. Instead of processing the claims payments through three different departments that are organized by process, the company could design claims payment “cells” that are organized around different types of insurance products or customers and consolidated in one building. For example, a cell could be created for all marine insurance. The cell would have data input, claims audit, and claims adjustment personnel all located together (co-located) to process marine insurance claims. This would reduce the move time between the departments considerably. In addition, the claims batches should be reduced. If the claims were processed one or two at a time in a product-focused cell, then payments might be possible on the same day that the claim is submitted, rather than 15 days later. Thus, as claims came into the cell, they would be worked on. This would be an example of “pull manufacturing (scheduling).” The cell is activated by work (demand for claim payments). The work is “pulled” through each process step in the cell until a check is delivered to the insurance customer. Note to Instructors: Insurance companies, such as Aetna and Mutual Benefit Life, are actually employing lean principles in their claims payment and insurance application processes.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

MAD 27–3 (FIN MAN); MAD 13–3 (MAN) a.

Sterilization…………………………………………………… Equipment and supply setup……………………………… Patient preparation………………………………………… Total TAT…………………………………………………

Ratio of Improvement =

15 minutes 2 3 20 minutes

New Process TAT Old Process TAT 20 minutes 40 minutes

= = 50% c.

Number of minutes in an eight-hour day: 480 minutes (8 hours × 60 minutes) Sum of TAT and surgical time per procedure under the old process: 40 minutes TAT + 40 minutes surgical time = 80 minutes Number of surgeries under the old process:

480 minutes per day = 6 surgeries 80 minutes total time per surgery

Sum of TAT and surgical time per procedure under the new process: 20 minutes TAT + 40 minutes surgical time = 60 minutes Number of surgeries under the new process:

480 minutes per day = 8 surgeries 60 minutes total time per surgery

Thus, the new process increases the efficiency of the operating room by expanding the operating room capacity from six to eight surgeries, or two additional surgeries per day.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

MAD 27–4 (FIN MAN); MAD 13–4 (MAN) a. and b. Elapsed Time (a)

1:00 P.M. 1:25 1:30 1:40 2:10 2:15 2:25 2:30 2:50 2:55 3:10

Value-Added Time

Activity

Arrives at doctor office Waits in waiting room (5 × 5 min.) Waits in examining room Nurse takes readings Waits in examining room Doctor performs diagnosis Waits to pay for services Walks to pharmacy Waits to fill prescription (4 × 5 min.) Prescription is filled Drives home Totals

NonValue-Added Time (b)

25 min. 5 10 min. 30 5 10 5 20 5 15 40 min.

__ 90 min.

Simmons arrives home at 3:10 P.M. Of the total elapsed time of 130 minutes, 90 minutes is non-value-added time. c. d.

Value-Added Ratio =

Value-Added Lead Time Total Lead Time

40 min. (40 min. + 90 min.)

= 30.8%

The doctor requires patients to wait in order to increase the productivity of the office. The patients represent the “work in process inventory” of the office, while the physician and nurses are the critical productive resources. The clinical staff remains productive because there is always a supply of patients to serve. The physician never loses productive minutes providing patient care by waiting for a patient. Unfortunately, the physician’s productivity comes at the cost of the patient. The patients must wait for the nurse and physician before being served. Additional causes of patient waiting are due to variation in the patient service delivery process. If there are uncertainties or variation in service requirements, such as some patients needing more time with the doctor and others needing less, then the amount of “work in process” will tend to increase in order to buffer the “throughput” of the office. Likewise, the doctor being called out for emergencies causes disruption in the patient flow in the office.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

TAKE IT FURTHER TIF 27–1 (FIN MAN); TIF 13–1 (MAN) The controller should confront the plant manager. The plant manager is attempting to skew the sampling results by giving the sampled items special treatment. The original intent of the sampling plan is to represent the average performance of the manufacturing process. Thus, the tagged items should receive no better treatment than the average product being produced. The plant manager’s memo will cause the lead times reported to central management to be much better than they actually are. Thus, it is possible that salespersons and marketing personnel will begin to make shipping commitments to customers based on the reported lead times. Since the plant will be unable to perform for all products at the reported levels, customers may be angry when the commitments are not met. The controller should first insist that the plant manager issue a new memo to all employees, reversing the first memo. The controller should help the plant manager see that skewing the results will provide only a short-term benefit. Eventually, this action will come back to haunt them as the real performance of the plant becomes evident to customers and top management. Top management will be very displeased with a deliberate attempt on the part of the plant manager to “cook the numbers.” If the plant manager fails to agree to this, the controller may need to report this incident to the company’s chief financial officer. It would be unethical for the controller to fail to address this issue. The Standards of Ethical Conduct for Practitioners of Management Accounting and Financial Management state that the management accountant must communicate information fairly and objectively and disclose all fully relevant information that could reasonably be expected to influence the intended user’s understanding of the information.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

TIF 27–2 (FIN MAN); TIF 13–2 (MAN) This would be a good assignment for the teams to report back to the class. Each of the groups will likely go to different restaurants at different times of the day and will have different results. The results could be shared with the class, and “averages” could be determined for the various non-value-added categories. Note to Instructors: The following types of activities will likely be noted in students’ reports: Waiting to be seated………………………………………… Non-value-added Being seated………………………………………………… Value-added Waiting to give drink order………………………………… Non-value-added Giving drink order…………………………………………… Value-added Waiting to receive drink…………………………………… Non-value-added Giving meal order…………………………………………… Value-added Waiting for meal order……………………………………… Non-value-added Eating meal…………………………………………………… Value-added Waiting for check (after meal is finished)……………… Non-value-added Reviewing check (appraisal)……………………………… Value-added Waiting to pay with credit card…………………………… Non-value-added Waiting to get receipt and credit card back…………… Non-value-added Walking out of restaurant………………………………… Value-added It is useful to note that the restaurant experience involves conversation during the “non-value-added” wait time. Naturally, this is part of the fun of restaurants. Thus, this analysis is an extreme interpretation of effectiveness and efficiency in this industry. TIF 27–3 (FIN MAN); TIF 13–3 (MAN) Memo To:

Ethan Fromme

From:

Ima Student

Re:

Analysis of quality, cost, availability, and response time

A review of Maximal’s three performance charts indicates a steadily deteriorating situation. Chart A shows that inventory steadily increased during the year, while Chart B shows that the company’s ability to meet sales orders on time has steadily decreased. This combination indicates that the company is doing a poor job of forecasting product demand. As a result, the company continues to build inventory, but the product mix that it is building does not match consumer demand. Chart C further illustrates that lead times continue to expand, making the problem more severe. The long lead times force the company to rely even more on forecasts, which in turn leads to a deterioration in schedule performance. The result is a company that is consistently short of the products that are in high demand and has a growing inventory of products with low demand. A lean manufacturing approach would help the company. 27-41 © 2023 Cengage®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

TIF 27–4 (FIN MAN); TIF 13–4 (MAN) Individual lists of causes for supply chain disruptions will vary widely. Some lists may include the following: war, pandemics, natural disasters, terrorist attacks, civil disorder, protests, employee strikes, cyberattacks, widespread Internet outages, and other events that affect travel, production, and communication.

CHAPTER 27 (FIN MAN); CHAPTER 13 (MAN)

Lean Manufacturing and Activity Analysis

CERTIFIED MANAGEMENT ACCOUNTANT (CMA®) EXAMINATION QUESTIONS (ADAPTED) 1. c. Prevention costs include design engineering ($300,000), supplier evaluation ($240,000), and labor training ($150,000) for a total of $690,000. All of these activities would likely take place prior to production to improve quality and prevent costly errors. 2. b. Appraisal costs are incurred to detect individual units that do not conform to specifications, e.g., inspecting raw materials. 3. b. Appraisal costs are incurred to detect individual units that do not conform to specifications, e.g., product testing costs. 4. d. External failure costs are the result of defective products shipped to customers. Product field testing would occur during the design phase and therefore prior to shipment.

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN) THE BALANCED SCORECARD AND CORPORATE SOCIAL RESPONSIBILITY DISCUSSION QUESTIONS 1.

A strategic performance measurement system defines and links strategic objectives to the performance metrics that a company uses. This system helps a company to align metrics with overall goals and objectives (both financial and nonfinancial) and thereby measure performance relating to company strategy. The balanced scorecard is the most well-known example of a strategic performance management system.

Leading indicators are metrics that indicate something about performance in the future. For example, poor customer satisfaction may indicate that sales will be down next month. Lagging indicators are metrics that indicate something about performance that has already happened. For example, this month’s actual sales is a lagging indicator of last month’s customer satisfaction.

The purpose of the performance perspectives is primarily to help management look beyond the typical financial measures of performance, such as sales and profits, encouraging a more balanced view of performance. Performance perspectives also help to organize the balanced scorecard into types of performance.

Strategic objectives define the purpose of an action taken within the company. They are essentially subcomponents of the organization’s overall mission statement or strategy. Strategic initiatives are action plans that management implements to achieve the strategic objectives. In other words, strategic objectives are different goals a company wants to achieve, and strategic initiatives are the plans a company makes to achieve those goals.

Strategy maps show the expected cause-and-effect relationships among strategic objectives. For example, a strategy map may illustrate that fulfilling the strategic objective to reduce delivery times will cause customers to be more satisfied, contributing to a separate strategic objective to please the customer. Strategy maps add value to the balanced scorecard by illustrating how each strategic objective contributes to the overall mission or strategy of the company.

Some objectives on a company-wide scorecard may not specifically relate well to the company’s specific departments (e.g., Shipping & Receiving, Sales, Production, etc.). However, to be effective, balanced scorecards should be relevant for each level of management in the company. Scorecard cascading accomplishes this purpose by using multiple scorecards that are divided up into smaller, division- and job-specific scorecards.

People subject to motivated reasoning tend to ignore bad news, rely too heavily on good news, stop gathering information when results look good, continue searching for good news when things look bad, and interpret ambiguous news as good news.

A company using scorecard cascading will have unique scorecards for each division or department of the company and for each level of management. This makes it difficult for top-level managers to compare the performance of employees or managers in different divisions, because their performance will likely be measured by different metrics. This will tempt top-level managers to place more weight on performance metrics that these employees have in common and possibly ignore performance metrics unique to each employee. This constitutes common measures bias.

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

DISCUSSION QUESTIONS (Concluded) 9.

Corporate social responsibility is the general term for the efforts of companies to take responsibility for the impact their operations have on society and to improve social well-being within and outside the firm. Sustainability efforts are corporate social responsibility activities that involve ensuring the ability to meet current needs without compromising the ability of future generations to meet their needs (e.g., efforts to protect the environment).

10. Companies can use the balanced scorecard to address CSR objectives in a variety of ways. One way is to include CSR objectives and activities in a separate CSR performance perspective. Alternatively, companies can integrate CSR strategic objectives into the four perspectives of the balanced scorecard, creating what is called a sustainability balanced scorecard.

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

BASIC EXERCISES BE 28–1 (FIN MAN); BE 14–1 (MAN) Leading indicators: Employee turnover Average shipping time Median training hours per employee Lagging indicators: Number of returning customers Total sales Market share Remember: A leading indicator can be any metric where performance is predictive of performance in another metric. Similarly, a lagging indicator can be any metric where performance is predicted by performance in another metric.

BE 28–2 (FIN MAN); BE 14–2 (MAN) Performance Perspective Strategic Objective Increase profits Financial

Increase market share

Customer

Improve production Internal efficiency processes Attract top talent

Learning and growth

Possible Performance Metrics (Not an exhaustive list) • Market share • Operating profit • Gross profit • Number of new customers • Percentage of sales from new customers • Number of leads • Average production time per product • Total costs of production • Average cost of production per product • Percentage of entry-level hires with master’s degree • Percentage of entry-level hires from top 10 colleges • Percentage of interns from top 10 colleges who become full-time hires

BE 28–3 (FIN MAN); BE 14–3 (MAN) Sales Cost of goods sold Depreciation expense Other expense Net income Cost of shipping error: Break-even shipping errors:

$ 230,000 (150,000) (30,000) (20,000) $ 30,000 $3,000 + $2,000 = $5,000 $30,000 ÷ $5,000 = 6 28-3

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

BE 28–4 (FIN MAN); BE 14–4 (MAN) a.

The owner made her decision entirely based on the number of orders of the gumbo dish at each location. She mistakenly ignored the number of customer complaints about the dish. Some simple data analysis reveals that while the number of orders was about 32% higher [(1,331 + 1,427 + 1,515 + 1,383) ÷ (1,106 + 1,024 + 1,215 + 929) = 132%] where the new gumbo dish recipe was used, the number of complaints about the gumbo dish was significantly higher [(39 + 36 + 47 + 32) ÷ (3 + 9 + 6 + 8) = 592%] at these locations. So the new recipe was ordered more, but also complained about much more, yielding mixed results. Considering this information, the owner should have investigated the effects of the new recipe further before deciding to implement it at all locations.

The cognitive bias at play in this situation was motivated reasoning. Because the owner developed the new recipe herself and wanted it to succeed, she overvalued the positive feedback about it and ignored the negative feedback.

BE 28–5 (FIN MAN); BE 14–5 (MAN) a.

Minimizing emissions by switching to an all-electric fleet is an internal operations change and, therefore, falls under the internal processes performance perspective.

The percentage of electric-powered trucks in the fleet would be a helpful performance metric for the company’s strategic objective.

A 10% increase per year (i.e., replace 20 old trucks with electric trucks per year) would be an appropriate yearly performance target. Given that the company wants to gradually switch to an all-electric fleet over the next 5 years, and that currently 100 of the company’s 200 trucks are not electric-powered, it will need to see a 10% increase per year in the percentage of electric-powered trucks in the fleet before it reaches its goal of 100% after 5 years (50% increase needed ÷ 5 years = 10% increase per year).

The Balanced Scorecard and Corporate Social Responsibility

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

EXERCISES Ex. 28–1 (FIN MAN); Ex. 14–1 (MAN) a.

Internal processes

All of the following are performance metrics that could be used to measure the strategic objective to efficiently produce meals: • Minutes from ordered to delivered

• Labor hours per meal • Number of erroneous meals prepared per hour • Cost of ingredients per meal • Number of meals produced per hour (e.g., during the busiest hour of the day) c.

Performance Metric Minutes from ordered to delivered Labor hours per meal Number of erroneous meals prepared per hour Cost of ingredients per meal Number of meals produced per hour

Type of Indicator Lagging Lagging Lagging Lagging Lagging

Ex. 28–2 (FIN MAN); Ex. 14–2 (MAN) a.

Performance Measure Average card member spending Number of Internet features Cards in force Number of merchant signings Earnings growth Number of new card launches Hours of credit consultant training Return on equity Investment in information technology Revenue growth Number of card choices

Revenue growth, earnings growth, and return on equity are all lagging indicators, relative to the other metrics listed.

Performance Perspective Customer Internal processes Internal processes Customer Financial Learning and growth Learning and growth Financial Learning and growth Financial Learning and growth

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The Balanced Scorecard and Corporate Social Responsibility

Ex. 28–3 (FIN MAN); Ex. 14–3 (MAN) Possible Balanced Scorecard Measures Average ingredients cost per order Number of meals purchased Online customer review ratings Number of customer complaints Average employee wage Average training hours per new employee Quality ratings of ingredients suppliers Gross profit Profit margin Number of unique meals on the menu

Performance Perspective Financial Customer Customer Customer Internal processes Learning and growth Internal processes Financial Financial Learning and growth

Note to Instructor: This list contains several possible answers, but is not an exhaustive list of all possible answers students may give.

Ex. 28–4 (FIN MAN); Ex. 14–4 (MAN) a.

(1) Average hours of employee training: Program A:

21 + 24 + 30 + 21 + 25 + 9 + 8 + 8 + 9 + 11 = 166 hrs. 166 ÷ 5 chefs = 33.2 hrs. per chef

Program B:

26 + 24 + 30 + 31 + 26 + 5 + 3 + 0 + 1 + 2 = 148 hrs. 148 ÷ 5 chefs = 29.6 hrs. per chef

(2) Average number of chef mistakes:

Program A:

13 + 14 + 13 + 16 + 12 = 68 mistakes 68 ÷ 5 chefs = 13.6 mistakes per chef

Program B:

6 + 6 + 7 + 4 + 6 = 29 mistakes 29 ÷ 5 chefs = 5.8 mistakes per chef

After calculating the performance metrics, it is clear that the restaurant should implement Program B moving forward, because it required fewer total training hours per chef and yielded fewer mistakes per chef.

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

Ex. 28–5 (FIN MAN); Ex. 14–5 (MAN) a.

(1) Average number of shipping errors per shipment: Procedure A: 105 ÷ 306 = 0.343 error per shipment Procedure B: 132 ÷ 315 = 0.419 error per shipment (2) Hours from ordered to delivered: Procedure A: 16.3 + 8.7 = 25.0 hours from ordered to delivered Procedure B: 19.2 + 8.5 = 27.7 hours from ordered to delivered (3) Average pounds of goods per shipment: Procedure A: 860,000 ÷ 306 = 2,810.46 lbs. of goods per shipment Procedure B: 797,000 ÷ 315 = 2,530.16 lbs. of goods per shipment

Given the performance metrics, the company should probably implement Procedure A moving forward, because it had fewer errors per shipment, fewer hours from ordered to delivered, and more pounds of goods per shipment.

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

Ex. 28–6 (FIN MAN); Ex. 14–6 (MAN) a.

Increase profits

Ex. 28–7 (FIN MAN); Ex. 14–7 (MAN) a.

Training employees better and improving employee satisfaction can both be expected to improve inventory management and reduce delivery time. They will also likely help to improve customer service in general. Improving inventory management can be expected to improve customer service as it will help with order filling times. In addition, reducing delivery time will directly improve customer service. Improving customer service will increase profits by increasing sales.

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

Ex. 28–8 (FIN MAN); Ex. 14–8 (MAN) a.

Scorecard cascading

Forbes'

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

Ex. 28–9 (FIN MAN); Ex. 14–9 (MAN) a. Days from ordered to delivered: 4.0 − 2.0 = 2.0 days above 2 days from order to delivery 2.0 × 1.0% = 2.0% decrease in customer retention rate Shipping errors: 5.0 − 3.0 = 2.0 errors above 3 per month 2.0 × 2.0% = 4.0% decrease in customer retention rate New customer retention rate: 70.0% − 2.0% − 4.0% = 64.0% b.

New market share: 70.0% − 64.0% = 6.0% total decrease in customer retention rate 6.0% × 0.5 = 3.0% decrease in market share 20.0% − 3.0% = 17.0%

Ex. 28–10 (FIN MAN); Ex. 14–10 (MAN) Decrease in percentage of customers who shop again: 28.0 average hours from ordered to shipped + 17.2 average hours from shipped to delivered 45.2 average hours from ordered to delivered 45.2 − 42.0 = 3.2 hours above target average 3.2 × 0.5% = 1.6% decrease in percentage of customers who shop again Effects of erroneous shipments above target: 81 − 65 = 16 errors above target 16 × 0.5 = 8.0 decrease in overall online customer satisfaction rating 16 × $500 = $8,000 added future financial loss Effects of the decrease in the percentage of customers who shop again: 1.6 × $4,000 = $6,400 decrease in future profit 1.6 × 0.3% = 0.48% decrease in future market share Effects of the decrease in overall online customer satisfaction rating: 8.0 × $3,000 = $24,000 decrease in future profit 8.0 × 0.1% = 0.80% decrease in future market share Total decrease in future profit: $ 8,000 6,400 24,000 $38,400

Total decrease in future market share: 0.48% 0.80 1.28% 28-10

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

Ex. 28–11 (FIN MAN); Ex. 14–11 (MAN) a.

The cognitive bias at play in this situation is the common measures bias. The common measures bias occurs when management underweights performance metrics unique to individual departments or divisions and focuses primarily on common performance metrics for all departments or divisions.

If management had avoided the common measures bias by focusing on all performance metrics for each division, the larger bonus would have most likely been assigned to the Sales Department. This is because the Sales Department performed very well on its unique metrics and fell only slightly short of its targets for the common metrics. In addition, the Production Department, while just beating its targets for the common metrics, performed poorly on its unique metrics. Taking into account all of this information, the Sales Department would have been given the larger bonus.

One advantage of unique balanced scorecards is that they allow companies to evaluate different divisions based on objectives and metrics that are most relevant to each individual division. This enables companies to more accurately measure the performance of each individual division. One disadvantage of unique balanced scorecards is that they limit companies’ ability to compare performances of different divisions to one another and can sometimes lead to the common measures bias.

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

Ex. 28–12 (FIN MAN); Ex. 14–12 (MAN) a.

While switching to a greener fuel source is an internal processes change, because it is being done for the purpose of improving the public’s perception of the company’s social responsibility, this CSR activity more likely would fall under the customer performance perspective.

Measuring the percentage of power from solar and wind energy would help management know if the company is completely independent from the city power grid. However, inasmuch as the objective is to improve CSR perceptions, another appropriate measure would be a CSR perception survey.

For the percentage of power from solar and wind energy metric, a good target would be a 10% increase per year, which would result in 100% within the 10-year target (100% increase needed ÷ 10 years = 10% increase per year). For the public perception of CSR metric, the company could state its goal in terms of a percentage increase from current perceptions; for example, a 10% increase from presolar perceptions.

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

PROBLEMS Prob. 28–1A (FIN MAN); Prob. 14–1A (MAN) 1.

Acquiring up-to-date technology and reducing employee turnover can both be expected to reduce production errors. Additionally, reducing employee turnover can be expected to improve delivery times. Improving delivery times can be expected to better satisfy the customer, and satisfying the customer can be expected to increase profits. Finally, reducing production errors can be expected to directly increase profits.

Reducing the average age of production machinery and increasing average employee tenure can both be expected to reduce the number of production errors. Additionally, increasing average employee tenure can be expected to decrease hours from ordered to delivered. Decreasing hours from ordered to delivered can be expected to increase both the percentage of returning customers and the online customer survey rating. Increasing these two measures can be expected to increase market share and gross profit. Finally, reducing the number of production errors can be expected to directly increase gross profit.

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

Prob. 28–2A (FIN MAN); Prob. 14–2A (MAN) 1.

Target gross profit percentage…………………… Total cost of production percentage……………… Total sales…………………………………………… Total cost of production percentage……………… Target cost of production……………………………

45% of sales 55% of sales $1,500,000 55% × $ 825,000

Total Cost of Production = Cost of Procedure 1 (P1) + Cost of Procedure 2 (P2) Total cost of Procedure 1 is twice that of Procedure 2: P1 = 2(P2) Substitute for P1 in the formula: $825,000 = 2(P2) + P2 $825,000 = 3(P2) $275,000 = P2 P1 = 2(P2) = (2 × $275,000) = $550,000

Cost makeup of Procedure 1: Labor (50%)……………………………………………………………… Materials (45%)…………………………………………………………… Overhead (5%)…………………………………………………………… Total………………………………………………………………………

$275,000 247,500 27,500 $550,000

Cost makeup of Procedure 2: Labor (40%)……………………………………………………………… Materials (25%)…………………………………………………………… Overhead (35%)………………………………………………………… Total………………………………………………………………………

$110,000 68,750 96,250 $275,000

Materials cost of Procedure 1………………………………………………

$270,000

Materials cost = 45% of P1, so P1 = $270,000 ÷ 45% =

$600,000

Procedure 1 cost twice as much as Procedure 2, so P2 = P1 ÷ 2 =

$300,000

$300,000 270,000 30,000 $600,000

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

Prob. 28–2A (FIN MAN); Prob. 14–2A (MAN) (Concluded) Cost makeup of Procedure 2: Labor (40%)…………………………………………………………………… Materials (25%)……………………………………………………………… Overhead (35%)……………………………………………………………… Total…………………………………………………………………………… 3.

Current total cost of production (P1 + P2)…………………………………. Less target total cost of production………………………………………… P2 materials cost savings needed…………………………………………… Current P2 overhead materials cost (75% of total overhead)………………………………………………… Less P2 overhead materials cost savings needed………………………………………………………………… Maximum new cost of P2 overhead materials…………………………………………………………………………

$120,000 75,000 105,000 $300,000 $ 900,000 (825,000) $ 75,000

$ 78,750 (75,000) $ 3,750

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

Prob. 28–3A (FIN MAN); Prob. 14–3A (MAN) 1.

The data show that while the online customer survey score increased (from 7.3 to 9.5), the company’s market share decreased (from 10.9% to 10.5%). This does not support the relationship between the online customer survey score and market share, which suggests that a higher online customer survey score should increase market share.

Three possible reasons for the unsupported relationship between the online customer survey score and market share are as follows: Reason 1: Satisfying the customer has no effect on increasing market share. Reason 2: Market share is a poor performance metric for increasing market share. Reason 3: The online customer survey score is a poor performance metric for satisfying the customer.

Reasons 1 and 2 do not seem logical. Customer satisfaction should lead to an increase in customers, sales, and market share (Reason 1). Likewise, market share is a direct measure of increasing market share (Reason 2). This leaves as the most likely reason that the online customer survey rating is a poor metric for customer satisfaction (Reason 3). These findings are summarized as follows:

Note: Another possible reason for the unsupported relationship is a possible lag time in the relationship. For example, it may take months or years for satisfied customers to translate into increased market share. A time-based balanced scorecard (which is beyond the scope of this textbook) could be used to estimate lag time in the relationships between strategic objectives (and the associated lag times between performance metrics).

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

Prob. 28–1B (FIN MAN); Prob. 14–1B (MAN) 1.–3.

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

Prob. 28–2B (FIN MAN); Prob. 14–2B (MAN) 1.

Target gross profit percentage………………………… Total cost of production percentage………………… Total sales………………………………………………… Total cost of production percentage………………… Target cost of production………………………………

30% of sales 70% of sales $600,000 70% × $420,000

Total Cost of Production = Cost of Procedure 1 (P1) + Cost of Procedure 2 (P2) Total cost of Procedure 1 is twice that of Procedure 2: P1 = 2(P2) Substitute for P1 in the formula: $420,000 = 2(P2) + P2 $420,000 = 3(P2) $140,000 = P2 P1 = 2(P2) = (2 × $140,000) = $280,000

Cost makeup of Procedure 1: Labor (40%)………………………………………………………………… Materials (45%)…………………………………………………………… Overhead (15%)…………………………………………………………… Total…………………………………………………………………………

$112,000 126,000 42,000 $280,000

Cost makeup of Procedure 2: Labor (60%)………………………………………………………………… Materials (30%)…………………………………………………………… Overhead (10%)…………………………………………………………… Total…………………………………………………………………………

$ 84,000 42,000 14,000 $140,000

Labor cost of Procedure 1……………………………………………………

$114,000

Labor cost = 40% of P1, so P1 = $114,000 ÷ 40% =

$285,000

Procedure 1 cost twice as much as Procedure 2, so P2 = P1 ÷ 2 =

$142,500

$114,000 128,250 42,750 $285,000

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

Prob. 28–2B (FIN MAN); Prob. 14–2B (MAN) (Concluded) Cost makeup of Procedure 2: $ 85,500 Labor (60%)……………………………………………………………… 42,750 Materials (30%)…………………………………………………………… 14,250 Overhead (10%)…………………………………………………………… Total………………………………………………………………………… $142,500 3.

Current total cost of production (P1 + P2)……………………………… Less target total cost of production………………………………………

$ 427,500 (420,000) P1 materials cost savings needed………………………………………… $ 7,500

Current P1 overhead materials cost (70% of total overhead)……………………………………………… Less P1 overhead materials cost savings needed………………………………………………………… Maximum new cost of P1 overhead materials…………………………………………………………

$29,925 (7,500) $22,425

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

Prob. 28–3B (FIN MAN); Prob. 14–3B (MAN) 1.

The statistics show that while the percentage of management hired from within the company increased (from 7% to 10%), the hours from ordered to delivered also increased (from 39.7 to 42.5). This does not support the relationship between inhouse employee promotions and hours from ordered to delivered, which shows that more in-house employee promotions should improve delivery times.

Three possible reasons for the unsupported relationship between in-house employee promotions and hours from ordered to delivered are the following: Reason 1: Improving employee morale has no effect on improving delivery times. Reason 2: Hours from ordered to delivered is a poor performance metric for improving delivery times. Reason 3: The percentage of managers hired from within the company is a poor performance metric of improving employee morale.

Reasons 1 and 2 do not seem logical. Higher employee morale (Reason 1) should lead to improved employee performance, and thereby improved delivery times. Likewise, hours from ordered to delivered (Reason 2) is a direct measure of improving delivery times. This leaves as the most likely reason that in-house employee promotions (Reason 3) is a poor metric for improving employee morale. These findings are summarized as follows:

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

MAKE A DECISION MAD 28–1 (FIN MAN); MAD 14–1 (MAN) a.

Lifetime investment cost to replace each HID fixture with LED………… Number of fixtures…………………………………………….………………… Investment cost……………………………………………………………………

HID kilowatt-hour consumption per fixture………………………………… LED kilowatt-hour consumption per fixture………………………………… Kilowatt-hour savings per fixture……………………………………………… Number of operating hours per day………………………………………… Number of operating days per year…………………………………………… Number of fixtures……………………………………………………………… Kilowatt-hour savings per year………………………………………………. Metered utility rate per kwh……………………………………………….……

$ 300 800 × $240,000

× × ×

0.5 * (0.3) ** 0.2 10 300 800

480,000 × $0.12 $ 57,600

Annual utility cost savings……………………………………………………… * 500 watts ÷ 1,000 watts = 0.5 kilowatt ** 300 watts ÷ 1,000 watts = 0.3 kilowatt c.

Annual net cash flow savings from installing LED………………………… Present value factor for an annuity of $1 at 8% for 15 periods………… Present value of annual savings (rounded)………………………………… Amount to be invested………………………………………………………… Net present value………………………………………………………………..

$ 57,600 × 8.55948 $ 493,026 (240,000) $ 253,026

The net present value is positive; thus, the proposal should be accepted.

MAD 28–2 (FIN MAN); MAD 14–2 (MAN) a.

Both CSR initiatives best fit under the internal processes performance perspective.

Replacing old fans initiative: Cost of each new fan………………………………………………………… Cost of replacing each old fan with new fan…………………………… Total cost of replacing each old fan with new fan……………………… Number of units……………………………………………………………… Initial investment cost……………………………………………………… Replacing ATVs initiative: Cost of new electric-powered ATV per unit……………………………… Number of units (ATVs)……………………………………………………… Initial investment cost………………………………………………………

750 100

$ 850 × 80 $68,000 $ 24,000 15 × $360,000

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

MAD 28–2 (FIN MAN); MAD 14–2 (MAN) (Concluded) c.

Replacing old fans initiative: Old fan kilowatt-hour consumption per unit…………………….……… New fan kilowatt-hour consumption per unit…………………………… Kilowatt-hour savings per unit……………………………………………… Number of operating hours per day……………………………………… Number of operating days per year………………………………………… Number of units………………………………………………………………… Kilowatt-hour savings per year……………………………………………… Metered utility rate per kwh………………………………………………… Annual utility cost savings……………………………………………………

0.8 * (0.5) ** 0.3 × 8 × 180 × 80 34,560 ×$0.10 $3,456

* 800 watts ÷ 1,000 watts = 0.8 kilowatt ** 500 watts ÷ 1,000 watts = 0.5 kilowatt Replacing ATVs initiative: Fuel, repair, other cost savings per ATV per hour of use……………… Number of operating hours per day per ATV…………………………… Number of operating days per year per ATV……………………………… Annual cost savings per ATV……………………………………………… Number of ATVs…………………………………..…………………………… Annual ATV cost savings………………………………………...………… d.

$ × ×

1.70 5 270

$ 2,295 15 × $34,425

Replacing old fans initiative: Initial Investment Cost Annual Utility Cost Savings $68,000 $3,456

Years before Initiative Pays Off Initial Investment Cost

= 19.68

Replacing ATVs initiative: Initial Investment Cost Annual Utility Cost Savings $360,000 $34,425 e.

= Years before Initiative Pays Off Initial Investment Cost = 10.46

The initiative to replace old fans with new energy-efficient fans should be adopted because it will pay for itself before the end of the new fans’ useful lives. The initiative to replace gasoline-powered ATVs with electric-powered ATVs should not be adopted because it will not pay for itself before the end of the useful lives of the new ATVs.

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

MAD 28–3 (FIN MAN); MAD 14–3 (MAN) a.

Recycling and reuse of production materials: Variable savings $ 0.15 per lb. of recycled material (0.10) per lb. of recycled material Variable cost $ 0.05 per lb. of recycled material Variable profit Recycled material required to pay back initial cost: $5,000 ÷ $0.05 = 100,000 lbs. The company will make up its added initial cost by the time it recycles 100,000 lbs. of materials, and then every pound recycled after that will result in net savings of $0.05 per lb. Based on this analysis, and because it can carry on this activity indefinitely, Green Manufacturing should implement this activity because it will lead to savings in the long run. Adding solar panels as a source of power: Variable savings $33,000 per year (1,000) per year Variable cost $32,000 per year Variable profit Years until initial cost is paid back: $700,000 ÷ $32,000 = 21.875 years The company will make up its added initial cost in 21.875 years, and then every subsequent year will have a net savings of $32,000 per year. Based on this analysis, and because the solar panels are expected to have a useful life of 30 years, Green Manufacturing should implement this activity because it will lead to savings in the long run. Replacing assembly room light fixtures with natural light: Variable savings $ 220 per month (180) per month Variable cost $ 40 per month Variable profit Years until initial cost is paid back:

$120,000 ÷ $40 = 3,000 months 3,000 ÷ 12 = 250 years The company will make up its added initial cost in 250 years, and then every subsequent year will have a net savings of $480 per year. Based on this analysis, and because the project is expected to have a useful life of 80 years, Green Manufacturing should not implement this activity because it will not lead to savings in the long run. b.

CSR Activity Recycle and reuse production materials Add solar panels as a source of power

Performance Metric Pounds of material recycled Utility costs

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

TAKE IT FURTHER TIF 28–1 (FIN MAN); TIF 14–1 (MAN) 1.

The motivated reasoning and surrogation biases can both have large negative effects on the use of the balanced scorecard, even to the point that the balanced scorecard becomes useless. Consider motivated reasoning: When a manager motivated to evaluate his or her product positively ignores substantially negative metrics of performance and heavily weights insignificant but positive metrics of performance, an incorrect evaluation of performance is made, and the balanced scorecard fails to help the business make strategic and objective decisions that will lead the business to achieve its goals. Now consider surrogation: When a company incentivizes the achievement of a performance target and employees achieve the target via unethical means, no strategc objective is actually being met, and the company fails to achieve its overall mission.

Some possible suggestions for avoiding or mitigating the motivated reasoning bias: a. Be aware of the tendency and incentive you have to be motivated to see things favorably for yourself. b. Understand what your motivated case is, and make the opposing case. c. Ask others (particularly third parties) for their opinion regarding the issue and associated evidence. d. Always consider alternative explanations and conflicting information before making a decision. Some possible suggestions for avoiding or mitigating the surrogation bias: a. Always act ethically and honestly. Ask yourself if you would feel comfortable having your actions broadcast across all news media outlets. b. Keep in mind the strategic objective a performance metric is meant to measure. c. Be careful about tying compensation to performance measures. Consider all activities you may be incentivizing. d. Ensure that employees connect and understand the purpose of the performance measures in accomplishing their associated strategic objectives.

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

TIF 28–2 (FIN MAN); TIF 14–2 (MAN) 1.

The online client review and client growth percentage metrics likely relate to a strategic objective to satisfy and increase clients. The market share and profit margin metrics likely relate to a strategic objective to increase profits.

New clients during the month Lost clients during the month Increase in clients Total clients at the beginning of last month Client growth percentage last month

Number of 5-star reviews Number of 4-star reviews Number of 3-star reviews Number of 2-star reviews Number of 1-star reviews Sum total of stars Total number of reviews Average online client satisfaction rating

7 (4) 3 ÷ 72 4.17% target met 55 × 5 = 10 × 4 = 3×3= 1×2= 1×1=

275 40 9 2 1 327 ÷ 70 4.67 stars, target not met

Possible strategic initiatives for the strategic objective to satisfy clients: • Implement additional training course on serving and interacting with clients • Invite clients to provide additional feedback through a brief online survey • Have the company owner send a personal apology to any clients providing a review of 2 stars or less, and offer them some kind of compensation; also ask for their feedback regarding what caused them dissatisfaction

TIF 28–3 (FIN MAN); TIF 14–3 (MAN) 1.

Performance Perspective Financial Customer Internal processes

Possible Strategic Objective(s) Increase profits Maintain current customers

Learning and growth

Cut production costs Decrease production times Recruit and train quality employees

Possible Strategic Objective Increase profits Maintain current customers Cut production costs Decrease production times Recruit and train quality employees

Possible Performance Metric(s) Gross profit Number of lost customers Variable production costs Production process times Employee wages/salaries

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

TIF 28–3 (FIN MAN); TIF 14–3 (MAN) (Concluded) 3.

High-quality employees would be expected to decrease production times and cut production costs. Lower production costs would directly increase profits. Decreased production times would likely satisfy and maintain current customers, which would also contribute to increased profits.

Higher employee wages and salaries (relative to the industry) generally indicate higher-quality employees, which affects variable production costs and production process times. Variable production costs are a direct input of gross profit. Production process times will likely influence customer satisfaction, and thereby the number of lost customers. The number of lost customers will, in turn, affect the company’s gross profit.

TIF 28–4 (FIN MAN); TIF 14–4 (MAN) People care about what is on the financial statements because of what these statements communicate about the health and success of the firm. People do not care about the financial statements in and of themselves, but rather value them as a useful tool in evaluating a firm. Managers, analysts, investors, creditors, and others use the information conveyed by financial statements to evaluate a firm and learn about the issues they care about. As examples, managers will refer to them in creating internal budgets, investers will use them to evaluate the firm’s value and profitability, and creditors, suppliers, and contractors will use them to assess the firm’s solvency.

CHAPTER 28 (FIN MAN); CHAPTER 14 (MAN)

The Balanced Scorecard and Corporate Social Responsibility

CERTIFIED MANAGEMENT ACCOUNTANT (CMA®) EXAMINATION QUESTIONS (ADAPTED) 1. d. The balanced scorecard is not based on scientific management theory but is a flexible means of translating a company’s strategy into a comprehensive set of performance measures. 2. a. The four perspectives of the balanced scorecard include options b, c, and d plus the customer perspective. Competitor business strategies are not included. 3. d. The balanced scorecard includes both financial and nonfinancial performance measures. 4. d. The positive customer reviews have an effect on the hotel’s financial performance.