SOLUTIONS MANUAL for Cost Accountated Data Analytics 1st Edition Karen Congo Farmer SOLUTIONS MANUAL by StudyGuide

Chapter 1 Cost Accounting Has Purpose Note: the end of chapter brief exercises, exercises, and problems are coded K (knowledge), C (comprehension), AP (application), AN (analysis), S (synthesize), and E (evaluation) according to the original Blooms Taxonomy published in 1956.

Assignment Classification Table (By Learning Objective) Brief Exercises

Learning Objectives

Questions

Exercises Problems

1. Explore the elements that support a company’s purpose, as well as your own.

1, 2, 3, 4

1, 2, 3, 4, 5, 6

1, 2, 3

1, 2, 3, 4

2. Connect the purpose of cost accounting with the role of accountants in organizations.

5, 6, 7

7, 8, 9

4, 5, 6

5, 6

3. Outline the frameworks, including ethics, that guide the profession.

8, 9, 10, 11, 12

10, 11, 12

7, 8, 9, 10

7, 8, 9

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Assignment Characteristics Table Item E1.1 E1.2 E1.3 E1.4 E1.5 E1.6 E1.7 E1.8 E1.9 E1.10 P1.1 P1.2 P1.3 P1.4 P1.5 P1.6 P1.7 P1.8 P1.9

Case

Description Get to know the mission and vision of each of the Big 4 firms and their underlying values. Evaluate the state of competition within an industry given a company’s SWOT analysis. Explain how a balanced scorecard reveals a company’s strategy. Get to know how cost accounting skill sets are valued as consulting services in the Big 4. Use the decision-making framework to make a personal decision. Use the decision-making framework to make a business decision. Get to know the IMA. Get to know the continuing education requirements for IMA’s flagship certification. Get to know IMA’s Statement of Ethical Professional Practice. Get to know the AICPA. What is your own personal purpose? What are your goals in this course? What strategies will you use to achieve your course goals? Conduct your own personal SWOT analysis related to your role as a student. Determine which data analytics approaches would be useful in addressing a business question. Explain the steps in the value chain. Get to know IMA’s Statements on Management Accounting. Get to know the CPE requirements for CPAs in your state. Get to know how NASBA supports the State Boards of Accountancy. Sort out the issues in an ethical dilemma using IMA’s Statement of Ethical Professional Practice alongside the decision-making framework.

Level of Difficulty Moderate

Time (minutes) 10–15

Moderate

10–15

Moderate

10–15

Moderate

10–15

Moderate

10–15

Simple

10–15

Simple Moderate

5–10 10–15

Moderate

15–20

Simple Simple Simple Simple

5–10 5–10 5–10 10–15

Moderate

10–15

Moderate

10–15

Moderate Moderate

5–10 10–15

Moderate

10–15

Moderate Moderate

15–20 10–15

Answers to Questions 1.

A vision reflects what you strive to be (or what an organization strives to be) or what you strive to achieve by some future date. In contrast, a mission (i.e., a purpose) is the reason you exist (or an organization exists). Your mission, or purpose, is what drives you. A strategy reflects the chosen method(s) and technique(s) to get you to the end goal (the vision). You can think of a vision as being your destination, a mission (i.e., purpose) as your vehicle (what drives you!), and a strategy is the road you take to get there. Being aware of these key pieces as well as how they work together can help you stay motivated and adjust course as needed. By keeping your end goal in mind, you will be more motivated and driven as you travel the road there.

LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Reflective Thinking, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: N/A

A SWOT analysis is a survey of a company’s internal Strengths and Weaknesses along with its external Opportunities and Threats. Companies use this type of analysis to evaluate their position in the market so they can work to capitalize on their strengths and address their weaknesses in an effort to take advantage of opportunities in the market while also addressing the threats. In the process of conducting a SWOT analysis, managers often recognize Porter’s Five Forces among the company’s strengths, weaknesses, opportunities, and threats. The five forces are customer power, supplier power, threat of substitute products, threat of new entrants, and industry rivalry. Through a formal SWOT analysis or a formal evaluation of Porter’s Five Forces, a company will have a very thorough understanding of where it is positioned in the market and in the industry, which can help decision-makers determine the best course forward in order to live the company’s mission and reach its vision.

LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Enterprise Risk Management

A balanced scorecard is a performance management tool in which managers can comprehensively evaluate their organization’s performance. Within the balanced scorecard, four traditional perspectives are often used (described below). Within each perspective, the company recognizes its key objectives, key initiatives for each objective, and specific metrics for each objective, using both financial and non-financial metrics—hence the term “balanced” scorecard. Targets are specified for each objective, and at the end of the month/quarter/year, managers can compare actual results against the company’s stated objectives and targets. A balanced scorecard can be implemented for the entire entity, for sub-units, and/or for individuals. The four perspectives of a traditional balanced scorecard include: o Financial perspective—considers the shareholder’s perspective and how metrics like growth, profit, and risk that impact shareholder value translate into company objectives. o Customer perspective—considers the customer and includes the metrics that create value for the customer, while also often measuring customer satisfaction and retention. o Internal business process perspective—considers processes internal to a company that are responsible for creating value for the customer and shareholder. o Learning and growth perspective—considers how an organization supports its people and infrastructure to drive and maintain new products and service development and growth. The objectives within each of the four perspectives should be linked such that improvement in more foundational areas of the scorecard, such as learning and growth or internal business process perspectives, will lead to expected improvement in customer and financial areas, as well.

LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: Strategic Perspective, Process and Resource Management Perspectives, AICPA AC: Reporting, Systems and Process Management, AICPA PC: Communication, IMA: Business Acumen & Operations: Quality Management and Continuous Improvement

Questions Chapter 1 (Continued) 4.

Health goals are linked to friends/family goals, suggesting that once a basic level of health is achieved, one can pursue healthy relationships with family and friends. Friends/family goals are then linked to self-enrichment goals, suggesting once one has healthy relationships with friends/family, one can pursue self-enrichment goals. Self-enrichment goals are then linked to career goals, suggesting that once one has self-enrichment in his or her life, he or she can pursue career goals. The lower levels are considered more foundational, allowing a person to progressively pursue higher-level goals. Responses here will likely vary by student. A student’s response to the order of the proposed scorecard might be to move the career perspective a bit lower in the list, with self-enrichment at the top, as an ultimate goal. Others may put certain social or environmental goals at the very top of their scorecard, suggesting the ultimate reward would be contributing to world peace, for example.

LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Communication, Reflective Thinking, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: N/A

Cost accounting and financial accounting differ in their purpose, scope, and reporting as follows: Cost accounting’s purpose is to support internal decision-making. Financial accounting’s purpose is to present financial information to external users and decisionmakers, who might be investors, stock analysts, regulators, lenders, suppliers, competitors, customers, or others. Cost accounting’s scope is far broader than simply costing products. Cost accountants analyze activities and transactions of every aspect of an organization’s value chain, from inception of idea through to sales and customer service. Cost accounting’s reporting is unlimited, as reports can be arranged and presented in any reasonable way that supports managers’ needs. Managers’ feedback further modifies the type of reports created. Financial accounting’s scope and reporting includes the details, format, and content required by GAAP or IFRS.

LO: 2, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: N/A

Questions Chapter 1 (Continued) 6.

The main steps of the complete value chain are: (1) Inception of an idea and its resulting development (R&D)—this is where a company explores new product and/or service ideas and conducts research on the viability of such an idea. (2) Design—this is where designers collaborate to find the best possible solution for a new product idea. (3) Supply of inputs like direct materials and direct labor—this is where manufacturers procure the raw materials and labor resources needed in order to produce a given product. This is where service providers hire laborers to provide the company’s services. (4) Production—this is where manufacturers actually produce the product, or where service providers actually provide the service. Much value is added in this key step. (5) Marketing—this is where organizations of all types provide education to potential customers about their available products/services, as well as where they make an appeal to customers for why they need the given product or service. (6) Distribution—this includes the physical movement of goods to customers, to intermediaries, or to retail locations. (7) Customer service—this includes handling post-sale activities, including returns and warranty support. While most of these activities work best in this specific order, particularly for manufacturing companies that would be unable to produce a product without raw materials and labor, it is not set in stone that they must always be completed in this order. For example, marketing activities may take place before or during production, and sourcing of raw materials and labor could take place while designers are fine-tuning the specifications of a product. Also, not all companies participate in all steps of the value chain. Pure retailers, for example, might not take part in steps 1 and 2.

LO: 2, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: Process and Resource Management Perspectives, AICPA AC: Reporting, Systems and Process Management, AICPA PC: Communication, IMA: N/A

Some decision-making tools available to cost accountants include: o Break-even analysis—can help managers determine the volume of units to be sold to break even or to generate a target amount of income. o Budgeting—can help managers plan and allocate resources to different priorities across the organization. o Net present value—can help managers evaluate the viability of different investment opportunities. o Contribution margin—can help managers determine the amount left over from each different type of unit sold that contributes to fixed costs and operating profit. o Regression—can help managers evaluate which cost driver/s (independent variable/s) best explains/predicts a mixed cost (dependent variable). o Segment margin—can help managers determine the profitability of each division within the company before common or allocated fixed costs are considered. o Transfer pricing—can help managers determine the viability of inter-departmental sales, and if viable, the range within which the transfer price should land. o Variance analysis—can help managers evaluate differences between standard and actual prices and/or quantities used for key resources, which can facilitate more targeted investigation for continuous improvement efforts. o Data analytics—can help managers gain insights from data available, by generating descriptive, diagnostic, predictive, and/or prescriptive information.

LO: 2, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Data Analytics, AICPA BC: Process and Resource Management Perspectives, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Questions Chapter 1 (Continued) 8.

The Sarbanes Oxley Act of 2002 (SOX) has forever changed the accounting profession by addressing many previous weaknesses in the financial reporting process. While the financial reporting process is primarily under the purview of financial accountants, there are a few sections of SOX that are particularly relevant to cost accountants. • Section 302 requires CFOs and CEOs of publicly traded companies to certify the accuracy of their reported financial information, creating heightened awareness of the significant impacts that financial information has on a company’s stakeholders. Cost accountants are intimately involved in, and often directly responsible for, many fundamental business processes reflected in the company’s financial statements. Specific examples include production and processing costs, inventory costs, and overhead allocation just to name a few. If cost accountants provide clear, accurate, and reliable information to their fellow financial accountants, the financial accountants will feel confident presenting that information to the controller and CFO, in turn, allowing the CFO and CEO to feel confident signing the financial statements release to external users. • Section 404 requires management of public companies to recognize their responsibility for establishing internal controls. Further, they are required to provide an assessment of the effectiveness of those internal controls in their external reporting, as well. Since cost accountants are often intimately involved in many fundamental business processes that support transactional reporting and information sharing, cost accountants are often important participants in these internal control discussions. • Section 406 requires public companies to disclose if they adopted a code of ethics for their senior officers. Espousing an ethical climate throughout the organization is a key tenet of cost accounting, thus making this section of SOX relevant to cost accountants, as well.

LO: 3, Bloom: C, Difficulty: Simple, Time: 5-10, AACSB: Knowledge, Communication, AICPA BC: Governance Perspective, AICPA AC: Reporting, AICPA PC: Professional Behavior, Communication, IMA: Professional Ethics & Values: Legal and Regulatory Requirements

The IMA’s key activities areas as it guides the profession include: o Serving as a thought leader in research and industry best practices. o Issuing Statements on Management Accounting (SMAs)—publications on best practices within management accounting. o Offering the Certified Management Accounting (CMA) credential, which reflects best-inclass competencies related to organizations’ internal financial management. o Helping members build a professional network. o Creating and offering CPE-eligible education programs that help its members improve their industry knowledge and leadership potential. o Advocating for the profession, even in a challenging regulatory environment. The IMA’s mission is to provide a forum for research, practice development, education, knowledge sharing, and advocacy of the highest ethical and best business practices in management accounting and finance. Each of the above key activities helps the IMA achieve one or more of the different facets of its mission.

LO: 3, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: Governance Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Business Acumen & Operations: Industry-Specific Knowledge

Questions Chapter 1 (Continued) 10. The AICPA guides the profession through the following key activities: o Advocacy—protecting and promoting the profession’s best interests as the national representative of CPAs before government, regulatory bodies, and other organizations. o Certification and licensing—setting forth the highest possible level of uniform certification and licensing standards and promoting and protecting the CPA designation. o Communications—promoting public awareness of and confidence in the integrity, objectivity, competence, and professionalism of CPAs. o Recruitment and education—encouraging individuals to become CPAs and supporting academic programs that support this effort. o Standards and performance—establishing professional standards; assisting members in continually improving their professional conduct, performance, and expertise; and monitoring its members’ performance to ensure they adhere to current standards and requirements. The AICPA’s mission is to power the success of global business, CPAs, Chartered Global Management Accountants (CGMAs), and specialty credentials by providing the most relevant knowledge, resources, and advocacy, and by protecting the evolving public interest. All of the above key activities help the AICPA to achieve its mission along one or more fronts. LO: 3, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: Governance Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Professional Ethics & Values: Legal and Regulatory Requirements

Questions Chapter 1 (Continued) 11. IMA’s Statement of Ethical Professional Practice includes overarching ethical principles along with specific standards: Principles: Honesty, Fairness, Objectivity, and Responsibility. Standards: Competence, Confidentiality, Integrity, and Credibility. The AICPA Code of Professional Conduct reflects the AICPA’s basic expectations of ethical and professional conduct. This code expresses the profession’s recognition of its responsibilities to the public, to clients, and to colleagues through the following principles (some additional context is provided here for each principle, per the AICPA Code of Professional Conduct, itself): o Responsibilities principle—members should exercise sensitive professional and moral judgments in all their activities. o Public interest principle—members should accept the obligation to act in a way that will serve the public interest, honor the public trust, and demonstrate a commitment to professionalism. o Integrity principle—to maintain and broaden public confidence, members should perform all professional responsibilities with the highest sense of integrity. o Objectivity and independence principle—members should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities; members in public practice should be independent in fact and appearance when providing auditing and other attestation services. o Due care principle—members should observe the profession’s technical and ethical standards, strive continually to improve competence and the quality of services, and discharge professional responsibility to the best of their ability. o Scope and nature of services principle—members in public practice should observe the principles of the Code of Professional Conduct in determining the scope and nature of services to be provided. Both the IMA and the AICPA explicitly recognize objectivity, responsibility, and integrity within their key principles or standards. The other principles or standards are unique to each organization, although a few of them have similar underlying tones, such as: IMA principle or standard AICPA principle • Competence Due care • Confidentiality Public interest • Credibility Public interest LO: 3, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Ethics, AICPA BC: Governance Perspective, AICPA AC: Reporting, AICPA PC: Ethical Conduct, Communication, IMA: Professional Ethics & Values: Professional Ethical Behavior

Questions Chapter 1 (Continued) 12. In the IMA, all members are expected to act in accordance with IMA’s Statement of Ethical Professional Practice, whether the individual holds any certification or not. In the AICPA, as well, the Code of Professional Conduct applies to all members of the organization. Two of the AICPA Code of Professional Conduct principles explicitly note, however, that they apply only to members in public practice (per additional details in the Code of Professional Conduct). • Objectivity and independence principle—members should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities; members in public practice should be independent in fact and appearance when providing auditing and other attestation services. • Scope and nature of services principle—members in public practice should observe the principles of the Code of Professional Conduct in determining the scope and nature of services to be provided. LO: 3, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Ethics, AICPA BC: Governance Perspective, AICPA AC: Reporting, AICPA PC: Ethical Conduct, Communication, IMA: Professional Ethics & Values: Professional Ethical Behavior

Solutions to Brief Exercises Brief Exercise 1.1 (a) Strategy: The selected action(s) or path to get you to your desired state. (b) Mission: Your purpose; it’s what drives you. (c) Vision: The future destination or updated status you’re heading for. LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, AICPA BC: Strategic Perspective, AICPA AC: Reporting, Systems and Process Management, AICPA PC: N/A, IMA: Strategy, Planning, & Performance: Strategic and Tactical Planning

Brief Exercise 1.2 Student responses here will vary. One sample solution is provided. Strategic plan for coffee shop on campus: Goal: To increase sales volume during the year. Initiative: Introduce loyalty cards, with which customers can redeem a reward (like a free coffee) after a certain number of purchases. Specific metric and target: A 10% increase in sales volume over the prior year. Actual results (hypothetical): At the end of the year, sales volume was up by 11%! Goal met. LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, Systems and Process Management, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Strategic and Tactical Planning

Brief Exercise 1.3 Student responses will vary. One possible set of SMARTER goals for Rocco is provided below. Specific: To earn a B+ or higher in the course. Meaningful: He wants to pursue an internship in the cost accounting area, so having a thorough understanding of the material will be very important to bring to that experience. Achievable: Since he did well in his introductory managerial accounting class, he thinks it is reasonable to expect to do well in this class, as well. Relevant: Earning a top grade in the course should reflect a great deal of learning on his part, which is the ultimate reason for his goal. Time-bound: By nature, the length of the semester is fixed. Rocco must complete the course and earn his desired grade within that time frame. In order to stay on track, though, he carefully keeps track of due dates and plans to turn in all assignments on time. Evaluate: At least once per month, and after each test, Rocco will compare his performance on all assignments to his goal to see if he is still on track for earning at least a B+ in the course. Readjust: If during one of his evaluations Rocco realizes he is not on track, he will evaluate the amount of time and effort put into the course thus far to determine if he believes it to be adequate. If not, he will find a way to dedicate more time and effort to the course going forward. He may also visit with the professor to get his or her advice on better ways to study and learn the material, and to get additional help on topics that he may be struggling with. LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Strategic and Tactical Planning

Brief Exercise 1.4 Bargaining power of the customer: This force is not described in the exercise, but we could assume customers have little power in this setting. Customers could presumably barter with the store manager if better online prices are available, though. Bargaining power of the suppliers: The company is said to have good relationships with its suppliers. Gertrude & Sons will likely need to keep nurturing these relationships so it can maintain favorable terms, particularly since big box stores are vying for many of the same products. Threat of new entrants: Since the area is described as a fully developed metropolitan area, we can assume there would be high barriers to entry for a new competitor in terms of location. Presumably, there are not open lots in prime locations just waiting for a potential entrant to set up shop. Further, Gertrude & Sons and the box stores are already established entities in the neighborhood. Threat of substitute products: This not described. Many of the products at the hardware store, such as a kitchen faucet, or paint, or a hammer, would not have readily available substitutes. Customers would have alternative sources by which to purchase similar products, though. While the products themselves may not have substitutes, customers would have a variety of other brands of these products that they could purchase elsewhere, as well. Industry rivalry: There are big box stores within a few miles of Gertrude & Sons. Since hardware products are therefore readily available for consumers via a few different stores, at least, in this geographic area, Gertrude & Sons has worked to set itself apart by providing exceptional customer service. Still, it is likely customers could find many if not all of the Gertrude & Sons’ products at one of the neighboring big box stores at a lower price. The owner will need to make sure to keep abreast of the competition and continue to set the company apart with its customer service (or along some other differentiation aspect). LO: 1, Bloom: AP, Difficulty: Moderate, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Strategic and Tactical Planning

Brief Exercise 1.5 Balanced Scorecard Perspective Customer Learning & Growth Financial Internal Business Process Learning & Growth Internal Business Processes

Objective Increase customer satisfaction Improve employee wellbeing Increase profit margin Improve efficiency in delivering recommendations to clients Increase training/continuing education for employees Improve professionalism while on-site with clients

LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: N/A, IMA: Business Acumen & Operations: Quality Management and Continuous Improvement

Brief Exercise 1.6 Student responses may vary. In the chapter, the four personal balanced scorecard perspectives were presented in the following order: 1. Career 2. Self-enrichment 3. Family and friends 4. Health and wellbeing The philosophy behind the above order recognizes that achievement of goals in a lower perspective leads to the potential for goal achievement in the next perspective above it. The above order assumes that our health is the most foundational requirement, which then supports our relationships with family and friends, which allows for self-enrichment, which allows for career success. Students could also make the case to order it as such: 1. Self-enrichment 2. Career 3. Family and friends 4. Health and wellbeing This order assumes the same foundational health and wellbeing connections to healthy relationships with family and friends, but puts career goals before self-enrichment, suggesting that achieving goals in our career may support our self-enrichment activities and accomplishments. These are two of several possible orderings. There is no single correct answer. LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Communication, Reflective Thinking, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: N/A

Brief Exercise 1.7 1. Clearly outline the problem and its related unknowns. Parties/expertise needed: (1) finance/accounting to evaluate quantitative costs and benefits associated with selling the space versus alternative uses of the space; (2) executive leaders in management, sales and marketing, production, research, and design to evaluate potential alternative uses of the space. 2. Identify suitable options and gather relevant qualitative and quantitative information, making informed assumptions as needed. Parties/expertise needed: (1) finance/accounting to help the remaining team members consider the information needed; and (2), the same executive leaders as above to make estimates for various options considered. 3. Calculate relevant quantitative and qualitative costs and benefits for each option. Parties/expertise needed: (1) finance/accounting to calculate the relevant costs and benefits of each option considered. 4. Select the option that maximizes benefit to the organization and meets required qualitative criteria. Parties/expertise needed: executive leaders, considering quantitative and qualitative information summarized thus far. 5. Implement your decision. Parties/expertise needed: will depend on option selected. If they decide to sell the space and not use it for a different purpose, (1) finance/accounting will be involved in the sale to provide appropriate documentation for the sale and record the transaction after the sale. LO: 2, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Strategic and Tactical Planning

Brief Exercise 1.8 Ahmad is utilizing descriptive analytics to better understand how the different marketing campaigns have affected and are still affecting product sales for this company. This type of analytics allows him to see trends in the data associated with each type of marketing campaign, which is a signature characteristic of descriptive analytics. If Ahmad wants to understand why certain products might respond differently to each type of marketing campaign, he would be utilizing diagnostic analytics. Diagnostic analytics allow users to make sense of patterns and observations in data, essentially diagnosing the cause(s) for observed findings. LO: 2, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Knowledge, Communication, Data Analytics, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

Brief Exercise 1.9 The first four steps in the value chain for a manufacturing entity like Bellvin would include the following: (at least one sample activity is provided, as well; the specific activity listed within each value chain step may vary by student) 1. 2.

Research and development: Bellvin hires researchers to determine appropriate features for rugged, durable hiking boots; this research includes talking to hiking enthusiasts. Design: Bellvin hires designers to create a model of the boots that the researchers envision and suggest, including the types of raw materials needed for each aspect of the product. The designers bring to life the ideas generated from the research process. Supply: Bellvin sources the key raw materials for its hiking boots based on the design specifications—most likely leather, canvas, water-proofing material, and durable rubber product for the soles. Bellvin also sources its direct labor workers in this step of the value chain. Production: Bellvin puts the production line into operation, making sure it has the proper equipment and appropriate facilities to produce the boots. Production will also schedule laborers and the transfer of materials to make sure the production of its high-quality products can operate as intended.

LO: 2, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, Systems and Process Management, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Strategic and Tactical Planning

Brief Exercise 1.10 The stated mission belongs to the Institute of Management Accountants (IMA). Five key activities this organization works on to achieve its mission include: (1) Serving as a thought leader in cutting-edge research and industry best practices and issuing Statements on Management Accounting (SMAs). (2) Offering the Certified Management Accountant (CMA) credential. (3) Helping members build a professional network. (4) Creating and offering CPE-eligible education programs. (5) Advocating for the profession in a challenging regulatory environment (worthy of note: the IMA supports accounting students at various stages of their academic program through several scholarships; specific criteria apply to each scholarship). Each of these activities supports the organization’s stated mission associated with research, practice development, education, knowledge sharing, and advocacy of the highest ethical and best business practices in management accounting and finance. LO: 3, Bloom: C, Difficulty: Simple, Time: 5-7, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: N/A

Brief Exercise 1.11 The stated mission belongs to the American Institute of Certified Public Accountants (AICPA). Five key activities this organization works on to achieve its mission are: (1) Advocacy—It protects and promotes the profession’s interests as the national representative of CPAs before government, regulatory bodies, and other organizations. (2) Certification and licensing—It sets forth the highest possible level of uniform certification and licensing standards and promotes and protects the CPA designation. (3) Communications—It promotes public awareness of and confidence in the integrity, objectivity, competence, and professionalism of CPAs. (4) Recruitment and education—It encourages highly qualified individuals to become CPAs and supports development of outstanding academic programs (worthy of note: the AICPA supports accounting students at various stages of their academic program through several scholarships and fellowships; specific criteria apply to each scholarship). (5) Standards and performance—It establishes professional standards; assists members in continually improving their professional conduct, performance, and expertise; and monitors its members’ performance to ensure they adhere to current standards and requirements. These activities support the organization’s mission of powering the success of global business, CPAs, CGMAs and specialty credentials by providing relevant knowledge, resources, and advocacy, and protecting the evolving public interest. The above activities explicitly refer to CPAs most commonly, although activities related to CGMAs and to other specialty credentials are embedded within the certification and licensing space. LO: 3, Bloom: C, Difficulty: Simple, Time: 5-7, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: N/A

Brief Exercise 1.12 According to the IMA’s Statement of Ethical Professional Practice, the noted terms fit into the following categories: Principles Honesty Fairness Objectivity Responsibility

Standards Competence Confidentiality Integrity Credibility

The Principles in IMA’s Statement of Ethical Professional Practice are overarching ideals for individuals to uphold and to encourage others within their organizations to adhere to. The Standards in IMA’s Statement of Ethical Professional Practice are enforceable, whereby all members have a responsibility to comply and uphold. Members that do not comply with the standards may face disciplinary action. LO: 3, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Ethics, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Ethical Conduct, Professional Behavior, IMA: Professional Ethics & Values: Professional Ethical Behavior

Solutions to Exercises Exercise 1.1 (15–20 minutes) Please note: the information provided on these firms’ websites is subject to change. a. Deloitte’s vision statement is provided in the question. Deloitte’s purpose is to “make an impact that matters.” Deloitte’s complete vision and strategy is more fully described here: “Our vision and strategy, developed in collaboration with leadership and member firm partners from around the world, focuses on working together As One across geographic, functional, and business borders to deliver excellence in all of the services provided by the member firms.” EY’s mission statement is provided in the question. EY’s full mission statement is “Building a better working world. The insights and quality services we provide help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all our stakeholders.” EY’s vision statement is presented here: “We’re building the workplace of the future at EY. A place that’s smarter, more inclusive, more dynamic and more flexible.” KPMG’s mission statement is provided in the question. KPMG’s mission statement is: “At KPMG, we inspire confidence and empower change in all we do.” KPMG’s vision statement is provided below: “At KPMG, our goal is not to be the biggest professional services firm. Our goal is to be the best professional services firm. And we define this in a very tangible way through our vision of being the Clear Choice.” For KPMG, being the clear choice means that our people are extraordinary; our clients see a difference in us; and the public trusts us. PwC’s mission statement is provided in the question. PwC’s vision is: “To become the leading firm to build trust in a digital society.” b.

Deloitte’s values are recognized to be timeless; they succinctly describe the core principles that distinguish the Deloitte culture: o Integrity, o Outstanding value to markets and clients, o Commitment to each other, and o Strength from cultural diversity. EY states its core values as: o People who demonstrate integrity, respect, teaming, and inclusiveness, o People with energy, enthusiasm, and the courage to lead, and o People who build relationships based on doing the right thing. KPMG values are: o Integrity: We do what is right. o Excellence: We never stop learning and improving. o Courage: We think and act boldly. o Together: We respect each other and draw strength from our differences. o For Better: We do what matters. 1-15

Exercise 1.1 (Continued) PWC values are: o Act with integrity, o Make a difference, o Care, o Work together, and o Reimagine the possible. c.

Yes, the visions, missions, and values espoused by each firm do appear very complementary. Each has a main focus on quality and integrity from the purpose statements to the vision/mission statements to their values.

LO: 1, Bloom: S, Difficulty: Moderate, Time: 15-20, AACSB: Communication, Analytic, Technology, AICPA BC: N/A, AICPA AC: Reporting, Research, AICPA PC: Communication, IMA: N/A

Exercise 1.2 (10–15 minutes) a.

The competitive environment, explained in the framework of Porter’s Five Forces, is as follows: Customer power—Not explicitly referenced. The end consumers (individuals) would likely have little power in this exchange, but large dealerships may have some power. Supplier power—The company has deep supplier relationships noted as a strength, which suggests supplier power is low. Threat of substitute products—Not explicitly referenced. However, end consumers’ primary need for an automobile is transportation. Instead of owning/leasing a vehicle, individuals could take the bus or use other forms of public transportation, ride their bike, use a ride share service, or walk. Threat of new entrants—Not explicitly referenced. Given the huge capital investment necessary to start up a new automobile manufacturing plant, however, it seems the threat level for new entrants would be low. Industry rivalry—There is very stiff competition, given that foreign competitors are making headway in the local market.

See descriptions for customer power, threat of substitute products, and threat of new entrants described in part (a).

In the environment described here, industry rivalry would be a very important force for a manufacturing company like this one. Here, competitors have more power than customers and suppliers. If a competitor comes out with a new vehicle model that exhibits all the specifications a customer could ask for and at a price point that is more attractive than what this company can meet, this company will be at a disadvantage. All remaining forces are still very important for a manufacturing company like this. Customers and dealerships have ultimate power in deciding what they will buy (based on what’s available). If the company cannot meet their demands, customers and dealers will find a different vehicle that can meet their needs. Supplier power is important if certain key inputs (raw materials or labor) become scarce or difficult to retain. As environmental issues become top-of-mind for more consumers, substitute forms of transportation will gain momentum. These efforts are part of the reason for some auto manufacturers to pledge to be carbon neutral by a specific date, which puts tremendous pressure on the manufacturers to adjust their methods. The threat of new entrants, while still low, could be a source of worry for an auto manufacturer at this time, particularly if a new manufacturer could set up a carbon neutral operation from its inception.

LO: 1, Bloom: S, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Business Acumen & Operations: Industry-Specific Knowledge

Exercise 1.3 (10–15 minutes) a.

This balanced scorecard reveals specific objectives within each of four traditional perspectives of the company’s performance. These objectives are revealing in terms of management’s strategy or approach for generating higher returns for the owners. According to the objectives, management plans to use increased employee training to improve efficiency in the restaurant, which should provide a better experience for customers. This better customer experience should lead to improved financial performance for the company. If we could see information on the specific initiatives for meeting each of the objectives, that information would provide even more insight into the company’s plans for achieving its goals.

Student responses will vary, as they are asked to fill in just three of the eight open initiatives. Further, many reasonable initiatives could be appropriate for each objective. Below is an example of a plausible initiative that corresponds to each objective in the scorecard: Increase revenues: Invest time and dollars into a social media campaign to increase sales volume. Increase margins: Decrease costs by working with suppliers to negotiate better terms. Increase customer satisfaction: Offer a different special menu item (or special price on an existing menu item) for every weekday lunch; offer a loyalty card with reward points. Increase number of new customers: Offer a referral discount for returning customers to bring their new customer friends with them to lunch. Decrease time from order placed to meal served: Develop and train employees on best practices for the most efficient ways to prepare the company’s most popular meals. Reduce rework: Offer rewards to employees with the lowest rework occurrences. Increase employee training: Allow employees to choose from a variety of relevant training options to improve their skills. Increase employee satisfaction: Offer an employee discount (if not done already) or open a suggestion box for employees to offer their ideas of what might make it a better place to work, or provide awards for an employee of the week/month/year.

Yes, causal links appear to exist between the objectives in this balanced scorecard. The Learning & Growth objectives should help to boost employee satisfaction, morale, and skill level. These more satisfied and skilled employees should, in turn, be able to prepare the meals in less time and supply their customers with their desired meal with less rework. Having better meals served more quickly should help to improve customer satisfaction, which should help encourage positive word of mouth marketing as well as positive customer reviews left online. All of these actions should lead to more business for the company, thus helping the financial objectives of increased revenue and margins to be achieved.

LO: 1, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Business Acumen & Operations: Quality Management and Continuous Improvement

Exercise 1.4 (10–15 minutes) Student responses may vary, as there are numerous consulting and advisory services offered by these firms, and students are asked to provide a sample of them. Additionally, the consulting and advisory services provided by these firms are subject to change.

PwC offers advisory consulting services around benchmarking, digital, forensics, strategy, data and analytics, finance, operations, and technology.

Exercise 1.4 (Continued) EY offers a multitude of advisory services, such as blockchain, analytics, customer experience, customer engagement, strategy, program management, supply chain and operations, and risk transformation (to name a few). Deloitte offers consulting around strategy, analytics and M&A, customer and marketing, core business operations, human capital, enterprise technology and performance, and global operations services. KPMG offers consulting around business performance, business protection, digital adoption and transformation, environmental, social, governance and sustainability, and government and regulatory. b.

PwC. Cost accounting skill sets would be valuable in at least the following consulting services noted in part (a): Finance, strategy, operations, and data and analytics. EY. Cost accounting skill sets would be valuable in at least the following consulting services noted in part (a): analytics, strategy, program management, and supply chain and operations. Deloitte. Cost accounting skill sets would be valuable in at least the following consulting services noted in part (a): strategy, analytics and M&A, and core business operations. KPMG. Cost accounting skill sets would be valuable in at least the following consulting services noted in part (a): Business performance and business protection.

All of the firms recruit both new hires and experienced professionals into their consulting or advisory practices. The careers/jobs site for each of the Big 4 lists out the available positions.

LO: 2, Bloom: S, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, Technology, AICPA BC: N/A, AICPA AC: Reporting, Research, AICPA PC: Communication, IMA: Business Acumen & Operations: Industry-Specific Knowledge

Exercise 1.5 (10–15 minutes) a.

Step 1: Clearly outline the problem and its related unknowns. The problem is that Kushal has been offered an internship that he is both excited about in terms of the opportunity it provides, but also nervous about it in terms of adequate preparation. Step 2: Identify suitable options and gather relevant qualitative and quantitative information, making informed assumptions as needed. Option 1: Accept the internship We can assume that the firm will train Kushal on what he needs to know to do this job. The firm likely does not expect interns (or full-time new hires) to have learned and/or retained every piece of accounting knowledge from their coursework. Further, much of what he will need to know will be taught on the job. Option 2: Decline the internship

Kushal will have to take more accounting courses over the next year and will feel more confident going into an internship the following busy season (assuming he will receive an offer for an internship at that time).

Exercise 1.5 (Continued) b.

Step 3: Calculate relevant quantitative and qualitative costs and benefits for each option. Option 1: As stated in the scenario, Kushal will be renting an apartment for three months, but still has a net $1,500 benefit per month, or $4,500 total financial benefit over three months. If he is taking the internship for credit, he will also have the cost of the internship credits. Option 2: He will forego the $1,500 per month financial benefit of the paid internship less his living expenses. Kushal will instead incur a full semester’s tuition cost during the upcoming semester (the same tuition cost that he will incur further down the road if he chooses Option 1, as the full course load tuition is simply deferred in that option).

Step 4: Select the option that maximizes benefit to Kushal and meets his required qualitative criteria. Student responses may vary. Either option might be appropriate for Kushal depending on his comfort level with his intermediate and cost accounting courses during this current semester. If he feels quite confident with his performance in both courses and is emotionally ready to experience the professional world for a few months, Option 1 would be a good option. Kushal would be gaining experience, learning more about how accounting works in practice, and building his network. He would want to make sure the firm is fully aware of where he stands with his coursework, though, so there are no surprises. If Kushal feels somewhat less confident with his performance in both courses and/or is not quite emotionally prepared to experience the professional world yet, Option 2 may be the better choice. He could give himself another year to gain confidence in his technical and professional skills so that he can go into an internship with more confidence one year from now (assuming he could land an internship at that time). The firm would likely understand and respect his decision to wait.

Responses will vary by student but will likely follow one of the perspectives considered in part (c).

LO: 2, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Risk Assessment, Analysis and Management, Reporting, AICPA PC: Decision Making, Communication, IMA: N/A

Exercise 1.6 (10–15 minutes) a.

Step 1: Clearly outline the problem and its related unknowns. The problem is whether to purchase a new piece of equipment that is capable of producing a new product for the company. The unknown is whether the company can be profitable upon producing and selling the new product. Step 2: Identify suitable options and gather relevant qualitative and quantitative information, making informed assumptions as needed. Option 1: Purchase the new equipment • Potential for new customers and increased sales • Satisfies the risk-tolerant members of the management team

Exercise 1.6 (Continued) Option 2: Do not purchase the new equipment • Avoids risk of new product not paying off • Saves money on the initial cash outlay • Satisfies the risk-averse members of the management team Step 3: Calculate relevant quantitative and qualitative costs and benefits for each option. The team has conducted a net present value analysis and determined the quantifiable costs and benefits of the purchase to be nearly equal. Therefore, neither option has a cost/benefit advantage over the other. Cost accountants would be most involved in determining quantitative factors and determining the costs and benefits in steps 2 & 3, so far. b.

Step 4: Select the option that maximizes benefit to the organization and meets required qualitative criteria. Student responses may vary. This decision would depend on the company’s values, how well-positioned it currently is in the market, and whether the company prefers to take the risk in trying to expand its market, or whether the company prefers to remain in the relative safety of its known products and market. Since the quantitative factors are roughly the same between both options (the purchase is expected to have a zero net present value), this decision will likely hinge on the qualitative factors. Here, we will assume that the company is in a good position to take a calculated risk, and they decide to recommend the purchase.

If the company decides to move forward with the purchase, it could communicate this as an exciting new opportunity for everyone involved. To the rest of the management team, it provides yet another opportunity for the company to surpass expectations (assuming performance to date has been good) while explaining the decision-making process. This may help put the entire team at ease to know that due diligence was performed prior to this investment. To the customers and other stakeholders, the company would want to emphasize that it is bringing the same level of quality and expertise to this new venture that it already brings to its existing products. It would want to further stress that it has the capacity to move into this new product line without limiting its existing operations.

Exercise 1.7 (10–15 minutes) a.

IMA’s flagship certification/designation is the Certified Management Accountant (CMA).

The CMA exam has 2 parts: • Part 1: Financial Planning, Performance, and Analytics • Part 2: Strategic Financial Management

Exercise 1.7 (Continued) c.

The 12 competency areas are: • External financial reporting decisions • Planning, budgeting, and forecasting • Performance management • Cost management • Internal controls • Technology and analytics • Financial statement analysis • Corporate finance • Decision analysis • Risk management • Investment decisions • Professional ethics

The scholarship program is intended to help student members of the IMA to take the CMA exam. The scholarship includes the entrance fee to the CMA program, an exam support package, registration fees for both parts of the exam, a Wiley CMA Excel online test bank, and up to three years of IMA membership while pursuing the certification. The scholarship is for high-achieving students (undergraduate through PhD) who attend an accredited college or university in the U.S. or around the world. Ten students per school per academic year may be nominated for this scholarship. Students must be nominated by a professor, and cannot self-nominate, but all students who are nominated (up to the 10-student maximum per school per year) will earn the scholarship.

Yes, the IMA has a student membership option. It costs roughly $40 per year. A student membership offers many of the benefits of a regular membership, and allows students to learn more about the accounting and financial management profession, to explore future career options, and to build their resumes and professional networks.

LO: 3, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Communication, Analytic, Technology, AICPA BC: N/A, AICPA AC: Reporting, Research, AICPA PC: Professional Behavior, Communication, IMA: N/A

Exercise 1.8 (5–10 minutes) a.

Certified Management Accountants (CMAs) and members Certified in Financial Management (CFMs) must fulfill 30 hours of continuing education per year, including 2 hours of ethics-focused continuing education every year. (Note: the CFM designation was first available from the IMA in 1996 but was discontinued in 2007. The CFM credential is still considered active for the nearly 4,000 individuals with this designation, however, and the IMA continues to keep records and accepts renewals for its CFM holders.)

The topics/subjects that are acceptable for continuing education hours should be related to the topics covered on IMA’s exams and/or to an individual’s job responsibilities. This could include: all aspects of accounting, financial management, business applications of mathematics and statistics, computer science, economics, management, production, marketing, business law, and organizational behavior, and ethics.

Exercise 1.8 (Continued) c.

There are many options for obtaining continuing education credit. Individuals may take courses sponsored by the IMA, its councils, chapters, employers, businesses, educational institutions, and other professional accounting organizations and trade associations. Continuing education credit may be earned from college courses, seminars, workshops, or technical meetings. These courses or seminars can be delivered by lecture, discussion, case studies, and teaching aids such as training films, video tapes, audio cassettes, and computers. Credit may also be granted for home study courses, service as a speaker or discussion leader, service as a college teacher, publication of technical articles, and examinations.

Two hours per year of the 30-hour annual total requirement must be on the subject of ethics.

LO: 3, Bloom: S, Difficulty: Simple, Time: 5-10, AACSB: Communication, Analytic, Technology, AICPA BC: N/A, AICPA AC: Reporting, Research, AICPA PC: Professional Behavior, Communication, IMA: Professional Ethics & Values: Legal and Regulatory Requirements

Exercise 1.9 (10–15 minutes) a.

The IMA’s overarching ethical principles are honesty, fairness, objectivity, and responsibility.

The standards that IMA members have a responsibility to uphold include: o Competence o Maintain an appropriate level of professional leadership and expertise by enhancing knowledge and skills; o Perform professional duties in accordance with relevant laws, regulations, and technical standards; o Provide decision support information and recommendations that are accurate, clear, concise, and timely; o Recognize and help manage risk. o Confidentiality o Keep information confidential except when disclosure is authorized or legally required; o Inform all relevant parties regarding appropriate use of confidential information; monitor to ensure compliance; o Refrain from using confidential information for unethical or illegal advantage. o Integrity o Mitigate actual conflicts of interest; Regularly communicate with business associates to avoid apparent conflicts of interest; Advise all parties of any potential conflicts of interest; o Refrain from engaging in conduct that would prejudice carrying out duties ethically; o Abstain from engaging in or supporting any activity that might discredit the profession; o Contribute to a positive ethical culture and place integrity of the profession above personal interest. o Credibility o Communicate information fairly and objectively;

Provide all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, analyses, or recommendations;

Exercise 1.9 (Continued) o

Report any delays or deficiencies in information, timeliness, processing, or internal controls in conformance with organization policy and/or applicable law; Communicate professional limitations or other constraints that would preclude responsible judgement or successful performance of an activity.

In the event a member encounters unethical conduct, the IMA’s position is that the issue must be addressed, not ignored. The IMA recommends its members consider all risks involved and whether there are protections in place to counter retaliation. Should the member’s own organization not have ethical guidelines addressing resolution of the issue, the member should consider the following steps as outlined by the IMA: o Step 1. Discuss the issue with the member’s immediate supervisor (or the next level of management if the supervisor appears to be involved); o Step 2. The member may call the IMA’s anonymous helpline to determine how key elements of the IMA Statement of Ethical Professional Practice could be applied to the ethical issue; o Step 3. The member may want to consult an attorney to learn of any legal obligations, rights, and/or risks concerning the issue Student responses here may vary: If a new professional encounters an ethical dilemma in their first job after graduation, it would likely be a very stressful experience. The process outlined here could help them to step back and process the situation one step at a time. While talking about these issues is difficult, the professional might feel most comfortable speaking to their supervisor about the issue, which is the first step described above. Of course, if the supervisor appears to be part of the issue, then this is not a good option. Speaking to someone from IMA’s anonymous helpline could also be helpful in sorting out the issue. Students should recognize now that ethical lapses do happen. They may encounter such a situation at work, and they should be alert to these situations and have a plan for processing the situation. IMA’s process may be helpful in their journey to resolution. Hopefully students will never need to use it.

The IMA’s helpline can be reached at (800) 245-1383. It is available worldwide, but outside the U.S. and Canada the caller should take additional steps, dialing the AT&T USA Direct Access Number.

LO: 3, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Communication, Analytic, Technology, AICPA BC: N/A, AICPA AC: Reporting, Research, AICPA PC: Ethical Conduct, Communication, IMA: Professional Ethics & Values: Professional Ethical Behavior

Exercise 1.10 (15–20 minutes) a.

The AICPA is responsible for content development and scoring of the Uniform CPA exam. The AICPA also encourages efforts to adopt uniform, high level requirements governing the issuance of the CPA certificate.

The Board of Accountancy for each state/jurisdiction determines which individuals meet the criteria to become a licensed CPA. Each state Board of Accountancy also issues those licenses. Every state/jurisdiction has their own set of education and experience requirements that individuals must meet.

Exercise 1.10 (Continued) c.

The AICPA’s major programs as listed on its website include (the activities particularly related to cost accounting are in bold): o Evaluating international, national, and local issues and trends, and tracking and analysis of challenges and opportunities for the profession. o Undertaking recruitment efforts to attract highly qualified and diverse individuals into the profession and position the profession as offering a rich array of work and career paths. o Promoting outstanding academic programs and an emphasis on teaching quality. o Preparing and grading the Uniform CPA Examination and encouragement of efforts to adopt uniform, high level requirements governing the issuance of the CPA certificate. o Promulgating standards, setting of requirements for, and membership assistance in the continuous improvement of professional and ethical conduct, performance, and expertise. o Chartered Global Management Accountant ® (CGMA®). Two of the world’s most prestigious accounting bodies, the AICPA and the Chartered Institute of Management Accountants (CIMA), have formed a joint-venture to establish the Chartered Global Management Accountant (CGMA) designation. In elevating management accounting, the designation recognizes the most talented and committed management accountants with the discipline and skill to drive strong business performance. o Supporting efforts of the Financial Accounting Foundation’s Private Company Council to develop alternatives in U.S. GAAP to reflect the private company environment. o Encouraging America's Main Street businesses and their stakeholders to use the AICPA's Financial Reporting Framework for Small- and Medium-Sized Entities, a non-GAAP financial reporting option that delivers streamlined, relevant, and consistent financial statements in a cost-beneficial way. o Supporting the development of international convergence, including accounting standards, auditing standards, and ethics. o Developing measures to continually improve the financial reporting system and to detect, expose and prevent fraud. o Operating comprehensive Continuing Professional Education (CPE) programs for CPAs. o Managing 360 Degrees of Financial Literacy, a national volunteer effort of the nation’s Certified Public Accountants to help Americans understand their personal finances and develop money management skills. It focuses on financial education as a lifelong endeavor—from children learning about the value of money to adults reaching a secure retirement. o Promoting federal financial awareness through What's at Stake? A CPA's Insights into the Federal Government's Finances, a video that shows the financial sustainability of our country could be in jeopardy. It offers guidance for policymakers and the public on how the U.S. government’s financial statements can be used for greater understanding of the nation’s fiscal health.

Exercise 1.10 (Continued) d.

The AICPA’s mission is to power the success of global business, CPAs, Chartered Global Management Accountants (CGMAs), and specialty credentials by providing the most relevant knowledge, resources, and advocacy, and by protecting the evolving public interest. Yes, there appear to be clear linkages between the specific activities identified in part (c) and the organization’s mission.

LO: 3, Bloom: S, Difficulty: Moderate, Time: 15-20, AACSB: Communication, Analytic, Technology, AICPA BC: Governance Perspective, AICPA AC: Reporting, Research, AICPA PC: Communication, IMA: N/A

Solutions to Problems Problem 1.1 Student responses will differ. Some sample student responses are provided as possible examples. a.

My purpose as a human is to find joy in life, to help others improve their position in life so they can find joy in their own lives, and to be a good custodian of the earth.

My purpose as a friend is to support my friends (while maintaining healthy boundaries). My purpose as a parent is to raise my child: to be an independent and kind contributor to society; to be grateful for what they have; to be generous with their gifts and talents. My purpose as a sibling is to support my brothers and sisters and to love them unconditionally.

My purpose as a student is to learn and retain knowledge for the long-term, making connections between topics, concepts, and courses so that I can draw upon this knowledge and this experience in my professional career and in my personal life.

My educational goals are to graduate with an accounting degree (preferably with honors), to become a well-rounded accountant in the process, to sit for at least one section of the CMA or CPA exam (finishing and passing all sections within one year of starting the process), and to begin a professional accounting career.

LO: 1, Bloom: S, Difficulty: Simple, Time: 5-10, AACSB: Communication, Reflective Thinking, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: N/A

Problem 1.2 Student responses will differ. Some sample student responses are provided as possible examples. a.

My goals for this course are to gain a deeper understanding of cost accounting, making connections between this course material and my other coursework, so that I can use this knowledge and these experiences in my professional career and in my personal life.

Assuming my goal is to gain a better understanding of the course content for the sake of learning (and not just to pass tests), this would likely impact: (i) How I study. I would consider the how’s and why’s of cost accounting techniques rather than memorizing them. (ii) How much time I study. I would take more time with each topic, as feasible, and try to study with other students to help me see other perspectives. These different learning approaches will likely help me grasp the material at a deeper level, giving me a better chance of retaining this knowledge. (iii) How I approach the course. I would seek out conversations with my instructor to gain her perspective and ask questions during class. I would also participate in outside of class activities that are related to the course to help make connections from the classroom to the profession.

LO: 1, Bloom: S, Difficulty: Simple, Time: 5-10, AACSB: Communication, Reflective Thinking, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: N/A

Problem 1.3 Student responses will differ. Some sample student responses are provided as possible examples. a.

In the past, I have employed the following study strategies to help me achieve my goals: I have read the chapters and created review sheets and concept maps; I’ve tried explaining a topic to a friend until I am sure I understand it; I have studied with friends where we quiz each other; I have worked and re-worked homework problems and attempted extra problems.

Yes, I believe many of the strategies I’ve used in the past will be effective in this course and in future courses because these approaches have worked for me in the past. The basic structure of most of my courses is similar, so I expect similar strategies to work going forward. Alternatively, if students have struggled in previous coursework, they may answer no to this question as they are still searching for strategies that will work well for them.

Other strategies I could consider in an effort to increase the likelihood of achieving my educational goals include: Talking to my instructor more; participating more in class and going to office hours; being brave to reach out to students in class who seem to “get” the material to see if they’d be interested in forming a study group, and talking myself through the material to better understand it.

Yes, there are costs involved in employing such strategies as noted in part (c). These strategies might take more time, and might make me feel nervous at first, as they will push me outside of my comfort zone. The payoff could be high, though, resulting in a better understanding of the material, which should help me earn a good grade in the course and also should help me with my certification exam later. The additional effort should further help me use these skills and experiences in my career. I might even make some new friends in the process.

LO: 1, Bloom: S, Difficulty: Simple, Time: 5-10, AACSB: Communication, Analytic, Reflective Thinking, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: N/A

Problem 1.4 Student responses will differ. Some sample student responses are provided as possible examples. a.

Strengths: Strong performance in introductory coursework, determination, test taking skills, and critical thinking skills. Weaknesses: Easily distracted, and a procrastinator. Opportunities: Supplemental Instruction, instructor office hours, and internships. Threats: Job, friends, Netflix, and Instagram.

I can use my background knowledge to help me get started in new topics, trying to make connections to what I already know. I can use my critical thinking skills when I both study and review to try to think more in-depth about the concepts learned in class, trying to make new connections. My critical thinking skills also should assist my test taking skills, giving me the ability to reason my way through an answer when I’m not completely sure about it at first.

I can use my background knowledge and ability to make connections to help me ask relevant questions during class and during office hours with my professor. If I’m able to add to my previous knowledge and learn the new material well, it may help me gain confidence in the material so that I can seek out an internship!

I can address my weakness of being easily distracted by going to the library to study and by turning my phone off when I’m in full study mode. I can address my weakness of procrastination by setting a solid study plan, and really trying to stick to it. I could set up rewards for myself every time I complete an assignment or other important task ahead of schedule (even a simple reward such as treating myself to a specialty coffee or giving myself time to watch an episode of my favorite show). I can also address that weakness by setting a recurring group study session with my classmates so we can all help each other be accountable for our learning.

I can address the threat of my job taking too much time away from my studies by having an open and honest conversation with my boss about when my classes meet and how many hours each week I can work. I can address the threat of my friends pulling me away from my studies by making sure they understand how important academic success is to me, and by having friends who are supportive of that goal (while also making sure I give myself some down time so that I can stay connected with my friends and stay balanced in my life). I can address the threat of Netflix and Instagram distracting me from my plan by turning off my phone when studying and by using those activities as rewards after completing an assignment (as noted, above). I could also consider following educational or accounting related accounts on Instagram. (Yes, they exist!)

LO: 1, Bloom: S, Simple, Time: 10-15, AACSB: Communication, Analytic, Reflective Thinking, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: N/A

Problem 1.5 a.

Step 1: Clearly outline the problem and its related unknowns: The problem is the university needs to reduce costs so that it can stay on budget. The specific problem is whether to consider reducing the temperature in campus buildings to save utility costs. The related unknowns might include whether the temperature would make an uncomfortable learning environment for students and faculty. Another unknown might be whether certain research projects being conducted on campus might require specific controlled temperature ranges.

The four data analytics techniques are: o Descriptive analytics—describes what has already happened or what is currently happening; helps detect patterns in data. o Diagnostic analytics—attempts to make sense of the observations and/or patterns detected. o Predictive analytics—uses observations and patterns detected to shape future decisions. o Prescriptive analytics—involves understanding the outputs of predictive analytics in order to figure out what should be done to reach the desired end state.

Step 2: Identify suitable options and gather relevant qualitative and quantitative information, making informed assumptions as needed. We could use descriptive analytics to evaluate the utility costs at a given thermostat setting. If the campus uses different settings for different times of the year, a variety of data points might be available. The university could ask students to complete a survey regarding the temperature at which they keep their apartments, and then conduct descriptive analytics on the results to find the average temperature, for example. They could also ask students if they are frequently hot or cold when attending class to better evaluate the current situation and use descriptive analytics to summarize their responses. We could use diagnostic analytics to better understand the trends in the information gathered. For example, can we diagnose that utility costs in the fall were less than utility costs in the summer because the campus buildings did not need as much air conditioning due to cooler temperatures? We could then use predictive analytics to anticipate what the change in utility cost might be given the previous relationships and given the current winter season described here. Perhaps these predictive analytics would allow the university to project the 3% drop in utility costs given a one-degree reduction in temperature, rather than relying on someone’s conjecture that such a relationship might exist. Once a predictive model is available, the university could use prescriptive analytics to determine how many degrees it would need to reduce the average building temperature to reach its goal of $X in utility cost savings. We must keep in mind that many assumptions would go into such a prescriptive model, so full disclosure of these reliability concerns should be made.

Problem 1.5 (Continued) d.

Step 3: Calculate relevant quantitative and qualitative costs and benefits for each option. A combination of descriptive, diagnostic, and predictive analytics, as described in part (b), would allow the university to estimate relevant costs and benefits associated with different temperature settings. Prescriptive analytics could allow them to plan a specific temperature adjustment in building temperatures to achieve a target amount of utility savings. They would need to consider the qualitative factors of such a decision, however, before moving forward with this plan.

LO: 2, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, Data Analytics, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Problem 1.6 a.

(1) Research & Development (2) Design (3) Supply (4) Production (5) Marketing (6) Distribution (7) Customer Service

(1) Research & Development—researching new product ideas and features and turning ideas into prototypes. (2) Design—finding the best solution for the given product idea, including style, functionality of features, and raw materials to name a few. (3) Supply—sourcing the materials and labor needed to create the product. (4) Production—transforming raw materials into a finished good or providing a service. (5) Marketing—educating stakeholders about the product or service. (6) Distribution—transporting the product to customers or retail outlets. (7) Customer Service—supporting customers once the product is in their hands or once the service is complete. The order is important because a company can’t produce a product without raw materials; a company can’t market a product that it has not yet conceived; a company can’t support its customers unless the customers already have the product or have been provided the service.

Each company needs to consider its own competitive advantage(s), and whether operating throughout the whole value chain on its own would be beneficial, or whether it would be too big of an undertaking. Smaller companies might operate in just one area of the value chain, whereas larger companies might have the resources to undertake the full spectrum of activities and therefore be less dependent on other companies. By operating across multiple steps of the value chain, a company has more control over its environment. It potentially can control all steps in the chain or at least have significant influence over all steps in the chain.

LO: 2, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, Systems and Process Management, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Strategic and Tactical Planning

Problem 1.7 This solution describes information available at the time of publication per the IMA website. The details are subject to change. a.

Key topic areas for SMAs include (found at https://www.imanet.org/insights-andtrends/statements-on-management-accounting?ssopc=1) : o Business leadership & ethics o Strategic cost management o Planning & analysis o The future of management accounting o External reporting & disclosure management o Technology enablement o Operations, process management & innovation o Performance measurement incentives & alignment o Risk management

To date, 61 SMAs have been published; 16 of these are included in the Strategic Cost Management topic area. A few examples of the SMAs within this category include: o Developing an Effective Managerial Costing Model o Focuses on cost modeling and describes a six-step methodology that organizations can use to develop a costing model appropriate for their specific needs o Implementing Activity-Based Costing o Gives an overview of the process for designing and implementing an ABC system o Costing Methodologies and Cost Management Practices in China o Presents the results of an IMA study comparing international and Chinese accounting policies, procedures, and methods, examining both the regulations and the actual practices companies follow.

In addition to SMAs, the IMA also supports the following reports and publications: Strategic Finance, Management Accounting Quarterly, IMA Educational Case Journal, C-Suite reports, Global Economic Conditions Survey, White Papers, Community Resource Library, and IMA books. The IMA also supports a podcast and several blogs.

LO: 3, Bloom: S, Difficulty: Moderate, Time: 5-10, AACSB: Communication, Analytic, Technology, AICPA BC: N/A, AICPA AC: Reporting, Research, AICPA PC: Communication, IMA: N/A

Problem 1.8 Note: nasbaregistry.org is a helpful site for gathering this information. Each state’s requirements may vary; the following is an example of the relevant information for Texas and for Minnesota, as samples. a.

In the state of Texas, the CPE requirement for CPAs is 120 hours over 3 years, with a minimum of 20 hours per year. Certificate holders must complete a 4-hour ethics course every 2 years. In the state of Minnesota, the CPE requirement for CPAs is 120 hours over 3 years, with a minimum of 20 hours per year. Certificate holders must complete 8 hours of ethics coverage during that 3-year period.

Texas uses the NASBA registry, but all sponsors are also required to register with the Texas State Board of Public Accountants. Minnesota has a listing of approved providers for group programs, which includes all providers on the NASBA Registry, along with several other options, including Colleges and Universities whose academic programs qualify an applicant to sit for the CPA exam. Minnesota’s approved providers for self-study, blended learning and nano learning programs must be on NASBA’s Registry for that particular delivery method.

Oklahoma and New Mexico have very similar requirements to Texas, with the exception of requiring the sponsors to be registered in the state. Iowa also requires 120 total hours every three years but does not have a minimum number for any one of those years, and it requires 4 hours of ethics coverage during the three-year period. Wisconsin requires reporting every two years, with 80 total hours to be completed within that period, minimum of 20 hours per year. Wisconsin requires 3 hours of ethics coverage during the two-year cycle.

LO: 3, Bloom: S, Difficulty: Moderate, Time: 10-15, AACSB: Communication, Analytic, Technology, AICPA BC: Governance Perspective, AICPA AC: Reporting, Research, AICPA PC: Communication, IMA: Professional Ethics & Values: Legal and Regulatory Requirements

Problem 1.9 a.

NASBA’s mission is to enhance the effectiveness and advance the common interests of the Boards of Accountancy.

NASBA’s objectives allow it to make progress toward its mission. The objectives are organized into several categories, as listed here: • Relationships, • Advocate for effective state-based regulation, • Enforcement, • Effective communication, • Operational sustainability, • Diversity, • Legislative & regulatory support, • Ethics, • Education & training, • Emerging issues, • CPA pipeline, • Leadership development, and • Technology support.

The NASBA Fields of Study information is accessible at nasbaregistry.org/the-standards. At the time of publication, the most current Fields of Study document is dated Dec. 2019. Technical fields of study include: o Accounting o Accounting (Governmental) o Auditing o Auditing (Governmental) o Business Law o Economics o Finance o Information Technology o Management Services o Regulatory Ethics o Specialized Knowledge o Statistics o Taxes Non-technical fields of study include: o Behavioral Ethics o Business Management & Organization o Communications & Marketing o Computer Software & Applications o Personal Development o Personnel/Human Resources o Production 1-37

Problem 1.9 (Continued) d.

Accounting—Technical involves: o Accounting—General o Accounting Research o Accounting Services for Small Business o Financial Statements and Reports o Forensic Accounting o Measurement, Recognition, and Presentation of Specific Financial Statement Items o SEC Practice o Technical Computer Software and Applications The bolded item above, Accounting—General, would coincide with cost and management accounting. Others may also crossover between financial and cost accounting, including Measurement, Recognition, and Presentation of Specific Financial Statement Items.

Student responses here will vary, depending upon which fields the student chooses to focus. Two fields that would certainly overlap financial and cost accounting topics include the following: Business Management & Organization would coincide with cost and management accounting, with subjects such as: o Organization of a Public Accounting Practice o Administration of a Public Accounting Practice o Management Planning in Industry Finance (technical) would also coincide with cost and management accounting. Its key subject areas include: o Asset Management o Budgeting and Cost Analysis o Contracting for Goods and Service o Financial Management o Financial Planning and Analysis o Quantitative Analysis

Solution to Analysis and Decision-Making Case Case a.

Decision-making framework: (1) Clearly outline the problem and its relevant unknowns. (2) Identify suitable options and gather relevant qualitative and quantitative information, making informed assumptions as needed. (3) Calculate relevant quantitative and qualitative costs and benefits for each option. (4) Select the option that maximizes benefit to the organization and meets required qualitative criteria. (5) Implement your decision. Step 1: Clearly outline the problem and its relevant unknowns. Leah and Jahn’s problem is figuring how they are going to meet the unattainable sales quota they are being held to. Unknowns include management’s intent behind these goals, and the repercussions if they don’t meet them.

Step 2: Identify suitable options and gather relevant qualitative and quantitative information, making informed assumptions as needed. Option 1: Leah and Jahn could discuss this issue with their supervisor, explaining that these goals are not attainable through ethical means. (IMA framework: Discussion with the member’s immediate supervisor, or the next level of management if the supervisor is involved.) Option 2: They could do their best to meet the quotas, but risk losing their jobs. If Leah and Jahn end up meeting the quotas, all will be good for them, at least for now. The stress of wondering what will happen next month could weigh significantly on them, however, which could cause mental and physical health concerns. If these health concerns materialize, it could impact their ability to do their jobs, it could impact their relationships at home, and it could impact other employees’ abilities to stay focused. If they don’t meet the quotas and if the company lets them go due to failure to meet the standard, they and their families will be significantly impacted. Their community would be indirectly and negatively impacted, as well, if they lose their jobs. The company could be negatively affected due to having fewer employees available in which to spread the workload. The higher workload for the remaining employees, along with the stress of having lost their coworkers due to unattainable standards could lead to a spiraling effect of low morale, reduced output, and additional layoffs.

Case (Continued) d.

Step 3: Calculate the relevant quantitative and qualitative costs and benefits for each option. Option 1: Benefits: Follows the IMA ethical framework and follows the IMA ethical principles and standards of honesty and integrity. This option also opens up a dialogue of why these quotas are not an effective goal. Costs: Leah’s and Jahn’s supervisor might not care, or might not be able to do anything about it, so the cost of this option is potentially their job. Alternatively, the supervisor might encourage them to take an unethical route, thus costing them their integrity (and/or their job). Option 2: Benefit: Leah and Jahn don’t cause a stir, and they still follow the IMA ethical principles and standards of honesty and integrity. Cost: If they don’t meet the quotas, the cost is potentially their jobs, which would be devastating to them and each of their families. The stress of working under these pressures is also costly in terms of their mental and physical health.

Step 4: Select the option that maximizes benefit to the organization and meets required qualitative criteria. The best option of these two would be to talk to their supervisor. With this option, they have at least tried to get management to understand the situation from the employee’s perspective.

Step 5: Implement your decision. Leah and Jahn should schedule time with their immediate supervisor to explain why these quotas are not possible to meet. It might help to get feedback from other salespeople to get their opinions, which would hopefully provide additional support for their position. If the supervisor tells them no, or suggests they consider doing whatever it takes to meet the quota, they should consider going to the next level in the chain of command. Alternatively, Leah and Jahn should be prepared to leave their jobs at the risk of being part of something fraudulent that could ultimately cost them their long-term career. While in the thick of it, though, leaving a well-paying position while supporting a family seems like an incredibly difficult thing to do. Accountants must be brave and stand up for what they know is right; it’s why the IMA and the AICPA both have solid ethical standards that its members are required to uphold. Hopefully, Leah and Jahn’s supervisor is willing to talk to upper management to adjust the sales quotas. Hopefully, also, Leah and Jahn each have a significant amount of savings to fall back on should they decide to leave the company if it looks like there is no ethical or legal route to achieving the quota, and/or if leaving the company is the best option for their long-term happiness. Even if a job change means taking a pay cut, it may be worth it for each of them and for their families well-being, as well.

LO: 3, Bloom: S, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Communication, Ethics, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Ethical Conduct, Decision Making, Communication, IMA: Strategy, Planning, & Performance: Decision Analysis, Professional Ethics & Values: Professional Ethical Behavior

Chapter 2 So Many Costs, So Many Terms Assignment Classification Table (By Learning Objective) Questions

Brief Exercises

Exercises

Problems

1. Review financial statement terms to interpret a company’s results.

1, 2, 3, 4

1, 2, 3

1, 2, 3, 4

2. Examine financial statements to differentiate between service providers, merchandisers, and manufacturers.

5, 6

4, 5

3, 4, 5

1, 2, 5

3. Interpret commonly used cost terms used in decision-making.

7, 8, 9

5, 6

6, 7

2, 3, 4, 5, 6, 7

4. Describe the basics of cost behavior within the relevant range.

5, 8

3, 8, 9

5. Trace the flow of costs from the balance sheet to the income statement.

8, 9

9, 10, 11

4, 6, 7, 10

6. Contrast gross margin with contribution margin.

12, 13, 14, 15

10, 11, 12, 13

12, 13, 14, 15

2, 3, 4, 5, 7, 8, 9

Learning Objectives

Assignment Characteristics Table

Item E2.1 E2.2 E2.3 E2.4 E2.5 E2.6 E2.7 E2.8 E2.9 E2.10 E2.11 E2.12 E2.13 E2.14 E2.15 P2.1 P2.2 P2.3 P2.4 P2.5 P2.6 P2.7 P2.8 P2.9 P2.10 Case

Level of Time Description Difficulty (minutes) Determine appropriate classifications of costs and expenses. Moderate 10–15 Determine the opportunity cost associated with selecting an Moderate 10–15 option. Interpret various accounts within an existing set of financial Simple 5–10 statements for a service entity. Determine the profitability and sunk cost for a product that Moderate 10–15 needs to be reworked. Determine profitability of a service organization given variable Simple 5–10 and fixed costs. Classify costs as product or period and determine total Simple 5–10 manufacturing costs. Determine missing cost and expense components for a Simple 10–15 manufacturing company. Manipulate variable and fixed cost information to address Moderate 15–20 profitability questions. Determine product cost components and ending inventory Moderate 10–15 balances. Prepare schedules of COGM and COGS plus additional Moderate 10–15 considerations. Follow the flow of costs through inventory accounts to Moderate 10–15 determine COGS. Prepare income statements for one year using the contribution Simple 5–10 margin and traditional formats. Recast a traditional income statement into a contribution Moderate 15–20 margin income statement format. Recast a contribution margin income statement into a Moderate 10–15 traditional income statement format. Distinguish product costs from period costs and determine full Moderate 5–10 costs plus additional considerations. Classify costs for a merchandiser and complete the income Moderate 10–15 statement. Determine full costs from a merchandiser’s income statement Moderate 10–15 plus additional considerations. Classify costs as product or period, variable or fixed, and Moderate 15–20 prepare income statements. Determine product costs to calculate COGM and COGS plus Moderate 20–25 additional considerations. Evaluate the profitability of a company’s product and service Moderate 10–15 lines, and its overall profitability. Trace the flow of product costs through the inventory accounts Moderate 15–20 plus additional considerations. Use select financial statement information to solve for missing Complex 20–25 components. Interpret profitability as well as fixed and variable cost Moderate 15–20 information from a graph. Create corrected income statements using both a traditional Complex 20–25 and contribution margin format. Fill in missing T-account detail given beginning and ending Complex 20–25 balances plus additional information. Compare the benefits of the traditional and contribution margin Moderate 10–15 income statement formats. 2-3

Answers to Questions 1.

The foregone benefits from the options not chosen are opportunity costs—the net benefits minus costs given up in order to go with the option you choose. For example, if you choose audit, you forego the benefits of being in the office a lot, as many tax professionals appreciate the consistency of their office environment. If you choose tax, on the other hand, you forego the benefits of working at the client’s location, as many audit professionals enjoy being in a variety of settings while conducting their work.

LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Reflective Thinking, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: N/A

The amount your friend originally paid for his car is a sunk cost—a cost that was incurred in the past that he is now stuck with. If he recovered some of the cost by selling it (potentially for less than he paid for it) that would represent a new relevant cost, but the original cost of the car is still sunk. If his car broke down, he shouldn’t automatically fix it. It would depend on a few factors. • If he fixes it, how long will the repair last? • Would he be better off getting rid of this car now and getting something more reliable? The subsequent decision should not hinge on how much was originally paid for the car. That cost is a sunk cost, and while it can cloud his perspective, it should not affect his decision-making going forward.

LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: N/A

Yes. All of COGS is an expense because it represents inventory items that have been sold. In other words, there is no future benefit anymore. The customer now has title to these goods, so the expense is matched against the revenue of this period (i.e., accrual accounting).

LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Salaries and wages expense and advertising expense are both cash expenditures. Depreciation and amortization expenses are not cash expenditures. Even though depreciation and amortization expenses are non-cash expenditures, they are still properly considered expenses on the income statement because they are “costs” of the current period. They each reflect a portion of an asset’s initial cost that was used up, and therefore recognized as an expense this period. That portion of the computers and software cost helped to generate revenue this period—hence the matching principle in financial accounting.

5. Service Provider Merchandiser

Manufacturer

Some service providers will have no inventory on their balance sheets; other service providers, like Dish Network will have component Raw Material (RM) Inventory (for items such as wiring, satellite receivers, remote controls, etc.). They would only have “Merchandise Inventory.” Ace Hardware specifically, though, would have many specific types of merchandise inventory (paint, lawn equipment, tools, etc.). Raw Materials (RM) Inventory, Work in Process (WIP) Inventory, and Finished Goods (FG) Inventory

LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Questions Chapter 2 (Continued) 6.

For the two finished projects, assuming the clients have now paid for them or at least have been billed for them, the costs would be held in COGS. For the project that is only 2/3 complete, the costs would be held in WIP Inventory and would include DM, DL, and MOH costs. She wouldn’t have anything in inventory for the project that hasn’t been started yet, though she might have some costs in RM Inventory if she keeps some basic raw materials on-hand for these projects.

LO: 2, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Direct labor costs for a manufacturer are initially recorded as part of WIP Inventory, which is an asset. These costs are combined with other direct and indirect product costs to determine the total cost (asset) of the inventory item(s). When these inventory items are sold, those assets transition to expenses on the income statement as COGS.

LO: 3, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Ping’s friend is incorrect. The inverse is true: product costs are the same thing as manufacturing costs, and period costs are the same thing as non-manufacturing costs. Examples of these costs for a dining room furniture manufacturer could include: DM—oak (lumber), wood varnish, felt pads for legs Product/Manufacturing Costs DL—workers’ time used to cut wood, assemble MOH—glue, ink to stamp manufacturing date, factory utilities Advertising Period/Non-Manufacturing Costs Salaries for company executives Commission for salespeople

LO: 3, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Prime costs = DM + DL (the direct, traceable [primary] costs in a product) Conversion costs = DL + MOH (costs incurred to convert the direct materials into the final product) Prime costs DM + DL DL + MOH (examples such as depreciation on machinery and Conversion costs equipment, factory utilities, indirect materials, and indirect labor)

LO: 3, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

10. Some examples of fixed production costs for a manufacturer such as Wilford Company are depreciation on plant and equipment, supervisor salaries, and rent, insurance, and taxes on the plant. All of these costs supply the relevant range of capacity noted in the question. Direct material costs, on the other hand, are variable product costs. They are incurred for each unit that is produced. They do not supply capacity, rather, they reflect the necessary material cost that is needed in each unit manufactured. LO: 4, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

11. Raw materials (RM) Inventory, WIP Inventory, and FG Inventory store product costs on the balance sheet before the products are sold. RM Inventory recognizes only raw material costs that are available for production. WIP Inventory recognizes all production costs that are being used to produce the products. Once the products are complete, FG Inventory houses the total cost of goods available for sale. Once the finished units are sold, COGS recognizes the product costs as expenses on the income statement. LO: 5, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Recordkeeping, Reporting & Control: Cost Accounting

Questions Chapter 2 (Continued) 12.

The full cost of a product is the per-unit cost of all activities in the company’s value chain (all valueadded business functions). This means that a product’s full cost includes both product and period costs, and both variable and fixed costs. This information would be critical when setting the product’s selling price and evaluating the profitability of the product (we would want the selling price to be higher than the full cost of the product to generate a profit).

LO: 6, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Recordkeeping, Reporting & Control: Cost Accounting

13. When costs are grouped by behavior (variable vs. fixed), the key subtotal is contribution margin, as presented on a contribution margin income statement. When costs are grouped by function (product vs. period), the subtotal is gross margin, as presented on a traditional GAAP income statement. LO: 6, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Statement Preparation

14. No. While the traditional and contribution margin income statements show different subtotals (gross margin and contribution margin), both have the same total amount of operating income*. All of the same expenses are included in each; they are just organized and presented differently. The contribution margin income statement is generally recognized to be the more appropriate income for internal decision-making, however, as it can easily be adjusted to reflect a different volume of units, a different selling price, a different variable cost per unit, and a different amount of fixed costs. Chapter 4 in this text, on Cost-Volume-Profit, elaborates more fully on the decision-making usefulness of this income statement format. *This holds true when the quantity of units produced equals the quantity of units sold. We assume this to be the case throughout this chapter but relax this assumption in later chapters. LO: 6, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Statement Preparation

15. (d) Both. MOH costs are product costs and can consist of both variable and fixed costs. Contribution margin income statements organize costs by behavior (first variable, then fixed), so variable MOH costs would be reported above the contribution margin subtotal, while fixed MOH costs would be reported below the contribution margin subtotal. LO: 6, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Statement Preparation

Solutions to Brief Exercises Brief Exercise 2.1 Revenue ($15 × 450 hours) Less: Expenses Profit

$ $

6,750 (3,900) 2,850

His expenses would not include COGS, because he is not selling any goods. He is providing a service. Five expenses Eli would have recognized in his business might include: 1. 2. 3. 4. 5.

Gas/oil for lawnmower Depreciation on mower/trailer/truck Maintenance on mower/trailer/truck Labor cost, if others are hired Insurance on his business

And yes, all of these expenses are costs. LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Brief Exercise 2.2 The only sunk cost is the five-year-old purchase price of $45,000. Sunk costs are costs that were incurred in the past. The truck purchase has already been made, and therefore those costs should not be considered in future decision-making. LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Capital Investment Decisions

Brief Exercise 2.3 Item Forklift purchase

Asset or Expense Asset (beginning of month) Expense (depreciation expense) Asset (end of month)

Calculation $32,000 ÷ 8 ÷ 12 = $32,000 − $333.33 =

Amount $ 32,000.00 333.33 31,666.67

Purchase of materials

Expense (all materials were used; included in COGS)

114,000.00

Payroll

Expense (production payroll in COGS, other in SG&A)

45,000.00

Investment in mutual fund

Asset (will benefit future periods)

65,000.00

Total expenses: $333.33 + $114,000.00 + $45,000.00 = $159,333.33 Total assets: $31,667.67 + $65,000.00 = $96,667.67 LO: 1, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Reporting & Control: Financial Recordkeeping, Reporting & Control: Cost Accounting

Brief Exercise 2.4 The firm will recognize labor cost for this job of $1,100 (20 hours × $55 per hour). These labor costs will be included in the firm’s Cost of Services or Cost of Sales on its income statement (depending on its preference in terminology). LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Reporting & Control: Financial Recordkeeping

Brief Exercise 2.5 As a retailer (merchandiser) last year, Xelda’s COGS consisted of the cost of the products (such as reams of paper, toner for printers, shelving units, etc.) it purchased from suppliers and subsequently sold to consumers. This year, Xelda would have many of the same COGS for all of the items it still purchases from suppliers and turns around and sells to its consumers. But for the products it manufactures itself, the COGS would include DM, DL, and MOH costs. DM costs would include the shelving kits as purchased; DL costs would include Xelda’s cost of labor to assemble the shelving units; MOH cost would include any other indirect materials or indirect labor Xelda incurred in the assembly of the shelving units. The key difference in product costs between merchandisers and manufacturers is the additional conversion cost (DL and MOH) needed in a manufacturing environment. These conversion costs, along with DM costs, are included in the company’s COGS when the manufactured products are sold. LO: 2, 3, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Recordkeeping, Reporting & Control: Cost Accounting

Brief Exercise 2.6 Prime costs include direct material costs and direct labor costs: $10,000 + $15,000 = $25,000 Conversion costs include direct labor costs and manufacturing overhead (MOH) costs. In this case, MOH includes the production supervisor’s salary, production utilities, and depreciation on production equipment. $15,000 + $3,000 + $1,500 + $8,000 = $27,500 LO: 3, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

Brief Exercise 2.7 Last Year Total variable costs ($4.50 × 40,000) Total fixed costs Total cost Per-unit cost ($260,000 ÷ 40,000)

180,000 80,000 260,000

6.50

This Year Total variable costs ($4.50 × 50,000) Total fixed costs Total cost Per-unit cost ($305,000 ÷ 50,000)

225,000 80,000 305,000

6.10

LO: 4, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

Brief Exercise 2.8 Baked Goods Inventory Beg. 390 Purchases 875 ? COGS End. 530 Solve for COGS: $390 + $875 − COGS = $530 $1,265 − COGS = 530 COGS = $735 LO: 5, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Reporting & Control: Financial Recordkeeping

Brief Exercise 2.9 Merchandise Inventory Beg. 24,000 Purchases 89,000 105,000 End. ?

COGS

Solve for the ending balance: $24,000 + $89,000 − $105,000 = Ending Balance Ending Balance = $8,000 LO: 5, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Reporting & Control: Financial Recordkeeping

Brief Exercise 2.10 Contribution Margin Income Statement Revenue $ 21,000 Less: Variable costs 7,500 Contribution margin 13,500 Less: Fixed costs 3,900 Operating income $ 9,600

Traditional Income Statement Revenue $ 21,000 Less: COGS 6,000 Gross margin 15,000 Less: SG&A expenses 5,400 Operating income $ 9,600

Note: Notice that operating income is the same, regardless of which income statement format is used*. Each format includes the same items but has its own way of organizing the information. *This holds true when the quantity of units produced equals the quantity of units sold. We assume this to be the case throughout this chapter but relax this assumption in later chapters. LO: 6, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: N/A, IMA: Reporting & Control: Financial Statement Preparation

Brief Exercise 2.11 Revenue ÷ Volume of units Average selling price

$ $

340,000 170 2,000

Total variable costs = 170 units × $950 variable cost/unit = $161,500 Contribution Margin Income Statement Revenue $ 340,000 Less: Variable costs 161,500 Contribution margin $ 178,500 ÷ Volume of units 170 CM/unit $ 1,050 LO: 6, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: N/A, IMA: Reporting & Control: Financial Statement Preparation

Brief Exercise 2.12 To determine the missing amounts, set up a traditional income statement and fill in the given amounts. Work backwards from operating income to solve for gross margin, first. Then, work backwards from gross margin to solve for total revenue. Traditional Income Statement Revenue ($227,000 + $77,500) $ 304,500 Less: COGS 77,500 Gross margin ($185,000 + $42,000) $ 227,000 Less: SG&A expenses 42,000 Operating income $ 185,000 LO: 6, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: N/A, IMA: Reporting & Control: Financial Statement Preparation

Brief Exercise 2.13 The full cost of Nora’s waffle cone activity this month includes all costs in the company’s value chain (product and period, fixed and variable). Total Full cost = $2,500 + $1,300 + $400 + $1,000 + $500 = $5,700 Full cost/unit = $5,700 ÷ 2,280 cones = $2.50/cone LO: 6, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

Solutions to Exercises Exercise 2.1 (10–15 minutes) a. Account Cost of merchandise sold Salaries and wages expense Uncollectible accounts expense Depreciation expense Rent expense Marketing expense Research and development Cost of land for new office building Total

Total $ 420,000 238,000

Expense $ 420,000 238,000

19,500

85,600 76,300 25,800 44,000

320,000

Asset

$ 320,000

$ 1,229,200

$ 909,200

$ 320,000

The total for the “Expense” column from part (a) = $909,200 Operating income = Revenue − Expenses Operating income = $1,315,000 − $909,200 = $405,800

It is common for companies to use a variety of names for different types of costs and expenses. In many cases, multiple terms can be appropriately used to describe the same expense—such as the uncollectible accounts expense shown above. Many different account titles are used and accepted for this type of expense; each company determines its preferred term and then will use that consistently going forward. In other cases, due to a lack of understanding or a lack of care some individuals will loosely throw terms around without realizing they are causing confusion. Any individual who would like to have a clear(er) understanding of a company’s accounts should ask to speak with a professional in the accounting department so he or she can ask questions and get clarification on account names, meanings, placement on the financial statements, etc. Accounting professionals enjoy speaking this language of business and are generally more than happy to help others learn the language, as well.

LO: 1, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Recordkeeping

Exercise 2.2 (10–15 minutes) a. Driving Mileage reimbursement 1,200 mi × $0.51/mi Meal reimbursement 3 days × $44/day Total

$ 612 132 $ 744

Flying Flight Meal reimbursement Parking at airport Total

2.5 days × $44/day

$ 300 110 80 $ 490

Exercise 2.2 (Continued) Flying would be the least costly option. b.

This information further makes flying the least costly option. His ability to be productive will not reduce the travel cost of either option, but his productive time will allow the firm to generate profit from his ability to work while on the flight (Sales − Cost of Services).

Opportunity costs are the foregone benefits of the option(s) not chosen. In this case, the opportunity costs of choosing to drive are the actual difference in travel cost ($744 − $490 = $254), and the lost profit that could have been generated while on the flight. But no, these opportunity costs will not show up on the firm’s financial statements. Opportunity costs are not actually incurred by the firm.

LO: 1, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Decision Making, Communication, IMA: N/A

Exercise 2.3 (5–10 minutes) a.

Yes, Cost of revenue is an expense. It is the cost of earning the revenue this year, or the expense that matches the revenue earned this year. It may not include the word “expense” in the name because the company chose the name based on industry trends, or just preference. This is common language, though, similar to COGS, which is also an expense.

Another name for this category would be Selling, General, and Administrative Expenses (SG&A). All of these listed are expenses, but not all of them are cash expenses: Cash Non-Cash - Selling and marketing - Depreciation & amortization - R&D - General & administrative expenses - Restructuring charges

Prepaid expenses and other current assets increased by $2,340 from 2020 to 2021. The only way this account could increase is if more prepaid assets were purchased (paid for) than the existing prepaid assets were used (expensed).

LO: 1, 2, Bloom: AN, Difficulty: Simple, Time: 5-10, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Statement Analysis

Exercise 2.4 (10–15 minutes) a.

Total cost/volume of shirts = $125,000 ÷ 20,000 shirts = $6.25 cost/unit GM/unit = selling price − cost/unit = $13.00 − $6.25 = $6.75/unit

b. Cost of collar New DL cost Original cost

New total cost/unit

0.50 2.00 6.25

Selling price Less: Cost/unit New GM/unit

$ $

13.00 8.75 4.25

8.75

Exercise 2.4 (Continued) c.

The sunk cost in this situation was the original cost of $6.25/shirt. Selling price Less: Cost/unit New GM/unit

$ $

11.00 6.25 4.75

The GM/unit selling them as-is for $11 is $4.75 per unit. This is greater than the GM/unit of $4.25 after fixing them and selling them for $13. The difference in GM between the two scenarios is $0.50, which would result in extra total margin of $10,000 ($0.50 × 20,000 units) for the company. So, yes, Trihs-T would have been better off selling them as-is. LO: 1, 2, Bloom: AN, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Strategic Cost Management

Exercise 2.5 (5–10 minutes) a.

The snorkeling excursion business is a service organization. The only product that is provided as part of the deal is the snack to the customer.

There are a lot of examples that students could give, including the following: depreciation expense on the boat, cost for the tour guide (or the boat driver, if Isaiah’s going to be the guide), depreciation on life jackets, insurance on the boat, and liability insurance on his business, for example. Fuel expense would be a fixed cost per trip,

The only variable cost described is the cost of food for each person.

2 trips/day × 15 days/month = 30 trips/month × 12 customers/trip = 360 customers/month × $125/customer =

30 trips/month 360 customers/month $45,000 revenue/month

Subtract total fixed costs ($15,000) from revenue ($45,000), and you’ll get the total variable costs he would need in order to break even ($30,000). If we divide these total variable costs ($30,000) by the total number of customers (360), we get the variable cost per customer of $83.33. As long as Isaiah can keep the cost of snacks below $83.33 per person, he will make a profit on each snorkeling customer. It seems very likely that he could keep his snack costs below that level. LO: 2, 4, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Exercise 2.6 (5–10 minutes) 1

Cost Description

Amount

Wages for hourly factory workers Social media marketing Canvas material Thread for sewing the bags Executive salaries Factory supervisor salaries Depreciation on factory assets Wages and commission to salespeople Utility costs for the factory

$ 45,000 13,000 32,500 1,000 87,000 63,500 39,000 45,000 9,300

3 (a) Product or Period Product Period Product Product Period Product Product Period Product

4 (b) Direct or Indirect Direct Direct Indirect Indirect Indirect Indirect

5 (b) Prime or Conversion Both Prime Conv. Conv. Conv. Conv.

Total manufacturing costs = DM + DL + MOH DM (canvas material) DL (factory worker wages) MOH Thread Factory supervisor salaries Depreciation on factory assets Utility costs for the factory Total MOH Total manufacturing costs

32,500 45,000

1,000 63,500 39,000 9,300 112,800 $ 190,300

LO: 3, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

Exercise 2.7 (10–15 minutes) a.

COGS is made up of DM, DL, and MOH, and DM is the only amount not known. So, set up an equation and solve it algebraically. COGS = DM + DL + MOH $33,800 = DM + $8,200 + $14,000 $33,800 = DM + $22,200 DM = $11,600 Period costs are another name for operating expenses, so period costs = $9,100. Product costs are just equal to COGS in this case because there were no beginning/ending inventories: $33,800. Total expenses = product costs + period costs Total expenses = $33,800 + $9,100 = $42,900

Since there are no beginning or ending inventories, the DM cost expensed is equal to the total DM cost incurred: $11,600. It is included in COGS.

Exercise 2.7 (Continued) c. Total operating expenses Less: Advertising expense Less: Executive/administrative salaries Unaccounted-for operating expenses

9,100 1,500 4,000 3,600

That $3,600 could be comprised of: - Insurance, depreciation, and/or utilities on office space and equipment, - Rent on office space, - Commissions to salespeople, and/or - Shipping to customers, for example. LO: 3, Bloom: AN, Difficulty: Simple, Time: 10-15, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

Exercise 2.8 (15–20 minutes) a.

Total fixed costs = Fixed MOH/unit × volume of units Total fixed costs = $0.40 × 2,000,000 units = $800,000 Gross Margin = Revenue − COGS COGS = product cost/unit × volume of units sold GM = (2,000,000 × $1.95) − (2,000,000 × $0.80) = $2,300,000

New FC/unit = total FC ÷ new volume of units New FC/unit = $800,000 ÷ 1,600,000 = $0.50 (it increased by $0.10) DM DL Variable MOH Fixed MOH New total cost/unit

0.10 0.20 0.10 0.50

0.90

GM = Revenue − COGS GM = (1,600,000 × $1.95) − (1,600,000 × $0.90) = $1,680,000 c.

New FC/unit = total FC ÷ new volume of units New FC/unit = $800,000 ÷ 2,500,000 = $0.32 (it decreased by $0.08 from the original) DM DL Variable MOH Fixed MOH New total cost/unit

0.10 0.20 0.10 0.32 0.72

GM = Revenue − COGS GM = (2,500,000 × $1.95) − (2,500,000 × $0.72) = $3,075,000

Exercise 2.8 (Continued) d.

The salespeople would have more flexibility to give discounts under scenario (c), as cost is lower. So, if the selling price stays the same, the company would profit more for every unit sold. But, if the salespeople give deep discounts under option (c), the company may not be any better off. If, for example, salespeople discounted the selling price to $1.80, the company would be better off, generating GM of $2,700,000: Selling price Less: Cost per unit GM/unit × volume (C) New GM

1.80 0.72 $ 1.08 2,500,000 $ 2,700,000

To generate the same GM as last year, we can work backwards to determine the selling price: Selling price ($0.92 + $0.72) Less: Cost per unit GM/unit ($2,300,000 ÷ 2,500,000) × volume (C) New GM

1.64 0.72 $ 0.92 2,500,000 $ 2,300,000

Work backward. Divide GM needed by the volume to get the GM/unit needed, then add back the cost/unit from (c) to get the selling price needed.

Compared to the regular selling price of $1.95, this is $0.31 per unit lower, which is a 16% discount: $0.31 ÷ $1.95 = 0.16 → 16% discount. LO: 4, Bloom: AN, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Analytic, AICPA BC: Process and Resource Management Perspectives, AICPA AC: Reporting, Systems and Process Management, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

Exercise 2.9 (10–15 minutes) a.

Set up a T-account and solve for DM used.

Beg. Purchases End.

DM Inventory 10,000 90,000 ? DM used 5,000

$10,000 + $90,000 − DM used = $5,000 $100,000 − DM used = $5,000 DM used = $95,000 b.

Total manufacturing costs = DM used + DL + MOH $95,000 + $130,000 + $110,000 = $335,000

Exercise 2.9 (Continued) c.

Set up T-accounts and solve for the ending balances. WIP Inventory 14,000 95,000 130,000 110,000 327,000 End. ?

Beg. DM used DL MOH

COGM

$14,000 + $335,000 − $327,000 = WIP Inventory ending balance WIP Inventory ending balance = $22,000

Beg. COGM

FG Inventory 3,000 327,000 315,000

End.

COGS

$3,000 + $327,000 − $315,000 = FG Inventory ending balance FG Inventory ending balance = $15,000 LO: 5, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Reporting & Control: Financial Statement Preparation, Reporting & Control: Cost Accounting

Exercise 2.10 (10–15 minutes) a. Schedule of COGM & COGS Beginning Direct Materials Inventory Purchases of direct materials

Direct materials available for use

$ 148,500

Less: Ending Direct Materials Inventory

8,500 140,000 10,300

Direct materials used

$ 138,200

Direct labor Manufacturing overhead Production supervisor salary Utility costs in production space Depreciation on manufacturing facility and equipment Indirect materials

220,000 60,000 13,000 45,000 8,000

Indirect labor

15,000

141,000

Total manufacturing costs Beginning WIP Inventory

499,200 20,000

Less: Ending WIP Inventory

12,000

Cost of goods manufactured Beginning Finished Goods Inventory

507,200 6,500

Less: Ending Finished Goods Inventory

8,000

Cost of Goods Sold

$ 505,700 2-18

Exercise 2.10 (Continued) COGM: To find COGM, we need the cost of DM used, DL cost, and MOH cost. First, make a DM Inventory T-account and solve for cost of DM used. DM Inventory Beg. 8,500 Purchases 140,000 ? DM used End.

10,300

$8,500 + $140,000 − DM used = $10,300 $148,500 − DM used = $10,300 DM used = $138,200 Then, add up all the MOH costs: Production supervisor salary Utilities in production space Depreciation on manufacturing factory/equipment Indirect materials Indirect labor Total MOH costs

60,000 13,000 45,000 8,000 15,000 $ 141,000

Now, make a WIP Inventory T-account, enter what is known, and solve for COGM. WIP Inventory Beg. 20,000 DM used 138,200 DL 220,000 MOH 141,000 ? COGM End.

12,000

$20,000 + $138,200 + $220,000 + $141,000 − COGM = $12,000 $519,200 − COGM = $12,000 COGM = $507,200 COGS: Now, we can find COGS by setting up a FG Inv T-account, filling in what we have, and solving for it. FG Inventory Beg. 6,500 COGM 507,200 ? COGS End.

8,000

Exercise 2.10 (Continued) $6,500 + $507,200 − COGS = $8,000 $513,700 − COGS = $8,000 COGS = $505,700 b.

No; these schedules are for internal purposes only. They help identify product costs and provide the detail behind the calculations of COGM and COGS.

No; these costs are not part of the COGM or COGS. They are period costs, so they would only be shown on the income statement as part of the operating expense or SG&A section.

LO: 5, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Statement Preparation

Exercise 2.11 (10–15 minutes) a.

Create T-accounts and fill in the information you’re given. Then, solve for ending balances. DM Inventory 1

Beg. Purchases

4,000 35,000

? DM used 1

End.

2,700

$4,000 + $35,000 − DM used = $2,700 $39,000 − DM used = $2,700 DM used = $36,300 WIP Inventory Beg. DM used 3

DL MOH

6,000 36,300 29,000 16,000 ? COGM

given

End.

$6,000 + $36,300 + $29,000 + $16,000 − COGM = $0 $87,300 − COGM = $0 COGM = $87,300 FG Inventory 6

Beg. COGM

87,300 ? COGS

End.

2,400

$87,300 − COGS = $2,400 COGS = $87,300 − $2,400 = $84,900

Exercise 2.11 (Continued) The client used DM purchased, DL cost, and MOH cost to calculate COGS: $35,000 + $29,000 + $16,000 = $80,000 The correct COGS amount considers beginning and ending balances of each type of inventory in addition to new DM, DL, and MOH costs incurred. The client neglected to consider the effect of any inventory balance, beginning or ending. b.

GM would have been too high by $4,900. The client subtracted only $80,000 to reach GM while it should have subtracted $84,900 to reach GM.

It would be effective for Charlie to use a ledger or T-accounts to show the movement/transfer of costs from one inventory account to another, at the same time explaining the capitalization of these product costs in inventory, until the point that they are sold.

LO: 5, Bloom: AN, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: Customer Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Recordkeeping

Exercise 2.12 (5–10 minutes) a. Contribution Margin Income Statement Revenue ($20 × 2,400 units) $ 48,000 Less: Variable product costs ($8 × 2,400 units) 19,200 Less: Variable period costs ($1 × 2,400 units) 2,400 Contribution margin 26,400 Less: Fixed costs 13,000 Operating income $ 13,400 b. Traditional Income Statement Revenue ($20 × 2,400 units) Less: COGS ($8 × 2,400 units) Gross margin Less: Variable SG&A expenses ($1 × 2,400 units) Less: Fixed SG&A expenses Operating income c.

$ 48,000 19,200 28,800 2,400 13,000 $ 13,400

The contribution margin income statement organizes costs by behavior (variable vs. fixed) using CM as the key subtotal, while the traditional income statement organizes costs by function (product vs. period) and uses GM as the key subtotal. Both income statements recognize the same operating income, still. The CM income statement lends itself better to volume-based budgeting since the variable costs are clearly identifiable in this format (and since total variable costs will change if volume changes, even while total fixed costs will not change).

Exercise 2.12 (Continued) A traditional income statement is more challenging for estimating volume-based changes because the variable and fixed components of the product cost (and oftentimes the SG&A costs, too) are not identifiable. LO: 6, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Statement Preparation, Reporting & Control: Financial Statement Analysis

Exercise 2.13 (15–20 minutes) For both a) and b), split COGS and SG&A into their variable and fixed components. Use what you’re given (fixed manufacturing costs and the variable SG&A rate) and solve for the missing component. Traditional Income Statement Revenue $ 35,000,000 Less: COGS 22,950,000 Gross margin $ 12,050,000 Less: SG&A expenses 5,015,000 Operating income $ 7,035,000

a) Variable COGS: $22,950,000 − $8,450,000 = $14,500,000 $14,500,000 ÷ 50,000 units = $290/unit Fixed COGS: $8,450,000 b) Variable SG&A: $25 × 50,000 units = $1,250,000 Fixed SG&A: $5,015,000 − $1,250,000 = $3,765,000

c. Contribution Margin Income Statement Revenue $ Less: Variable costs ($14,500,000 + $1,250,000) Contribution margin $ Less: Fixed costs ($8,450,000 + $3,765,000) Operating income $

35,000,000 15,750,000 19,250,000 12,215,000 7,035,000

She would want to create this income statement for decision-making purposes, as it will allow her to budget for different revenue and total variable costs given different volumes and/or given a change in selling prices. Many different what-if scenarios could be quickly pulled together when using the contribution margin format. d.

GM/unit = $12,050,000 ÷ 50,000 units = $241/unit CM/unit = $19,250,000 ÷ 50,000 units = $385/unit GM/unit is the amount earned per unit that will go toward covering period/SG&A costs and generating a profit after manufacturing costs have been covered. CM/unit is the amount earned per unit that will go toward covering fixed costs and generating a profit after variable costs have been covered.

LO: 6, Bloom: AN, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Statement Preparation

Exercise 2.14 (10–15 minutes) a. (1)

Total Cost of Services = Variable Cost of services + Fixed Cost of services $220,000 + $148,000 = $368,000

(2)

Total SG&A costs = Variable SG&A + Fixed SG&A $33,000 + $73,000 = $106,000 2-22

Exercise 2.14 (Continued) b. Traditional Income Statement Revenue $550,000 Less: Cost of Services 368,000 Gross margin 182,000 Less: SG&A expenses 106,000 Operating income $ 76,000 c.

The income statement given in the exercise is a CM income statement, which means the costs are organized by behavior (variable vs. fixed), rather than by function (product vs. period), like they are in the traditional GM income statement. Still, both income statements determine operating income to be the same amount because the same costs are included in both statements, they are just presented differently in each.

The partners likely wanted the managers to do this exercise so they could see how the different categories of costs are presented differently on each income statement yet yield the same operating income. This knowledge could help them be more aware of how their own work—their efficiencies and inefficiencies—can impact the company’s bottom line.

LO: 6, Bloom: AN, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Statement Preparation

Exercise 2.15 (5–10 minutes) a. Cost of stone slabs MOH in fabrication process Labor costs of cutting, treating, and installation Total product costs

$26,400 3,500 18,700 $48,600

Commissions for salespeople Depreciation on sales and office space Marketing costs R&D costs Total SG&A costs

$3,150 2,800 900 1,300 $8,150

Full cost = product costs + SG&A costs Full cost = $48,600 + $8,150 = $56,750 Average full cost/project = full cost ÷ number of projects Average full cost/project = $56,750 ÷ 15 = $3,783.33

You should prefer to have the information from part (c) of this problem so you can base the selling price on the full cost of a project rather than just one type of cost. The company will only generate a profit if its selling price is higher than the product’s full cost.

LO: 6, Bloom: AN, Difficulty: Moderate, Time: 5-10, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Solutions to Problems Problem 2.1 a. Initial freight cost of getting product to lumber yard Marketing costs

$ 133,800 87,000

Total cost of product sold

1,534,000

Depreciation cost and utility cost for lumber yard

78,600

Cost of labor Other operating costs

495,000 20,600

(1) Cost of sales (2) SG&A (1) Cost of sales (3) Depreciation and amortization (2) SG&A (2) SG&A

Note: Labor isn’t a product cost for a merchandiser because the labor cost is not for making the product, it’s necessary for selling the product. Keep that key difference between manufacturers and merchandisers in mind! Traditional Income Statement Revenue

$2,620,000

Less: Cost of sales (freight [$133,800] + cost of products sold [$1,543,000])

1,676,800

Gross margin Less: Expenses SG&A (marketing [$87,000] + labor [$495,000] + other [$20,600]) Depreciation and amortization

602,600 78,600

Operating income

943,200

$ 262,000

When all merchandise inventory is sold, then all inventory costs move to Cost of Sales and are deducted to arrive at operating income. In this case, whether the freight cost was grouped in Cost of Sales or in SG&A, operating income would not have been different. However, if some of the inventory were unsold, and still on the balance sheet, a portion of freight costs would still be in inventory as well. That would cause operating income to differ between the treatment of freight as a product cost (grouped with cost of sales) versus SG&A (fully expensed when incurred.) Gross margin would have been different had Kenton classified the freight cost differently, as shown below. This would have affected Kenton’s evaluation of its performance, especially if there is a target gross margin ratio the company is expected to earn (GM% was 36% in part (a) ($943,200 ÷ $2,620,000); and it is 41% here ($1,077,000 ÷ $2,620,000)). Traditional Income Statement Revenue Less: Cost of sales (cost of products sold [$1,543,000]) Gross margin Less: Expenses SG&A (marketing [$87,000] + labor [$495,000] + other [$20,600] + freight [$133,800]) Depreciation and amortization Operating Income

$2,620,000 1,543,000 1,077,000

736,400 78,600 $ 262,000

Problem 2.1 (Continued) c.

Freight-in is the cost required to get the product to the company selling it, and it’s part of that company’s inventoriable cost. Delivery cost is the cost required to get the product to the customer after the sale. Therefore, freight-in would be the most appropriate term for the freight cost in this problem.

LO: 1, 2, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Statement Preparation

Problem 2.2 a.

Full cost = product costs + period costs Full cost = COGS + SG&A Full cost = $246,100 + $210,700 = $456,800 Product costs = $246,100 Period costs = $210,700 Average selling price = Sales ÷ number of units Average selling price = $533,500 ÷ 35,700 units = $14.94 Average full cost/unit = Full cost ÷ number of units Average full cost/unit = $456,800 ÷ 35,700 units = $12.80

Remember: sunk costs were incurred in the past, and they therefore should not influence our rational decision-making today. In this situation, the sunk costs would be all expenses, long-term assets, and a few current assets (including inventory and prepaid expenses). These are all “sunk” because we can’t undo these “investments.”

You would not find opportunity costs on the financial statements. They represent foregone benefits from choosing one path over another and are costs that aren’t actually incurred. Many possible opportunity costs could be given for Murray regarding a foregone benefit as a result of choosing a different option. One example of an opportunity cost for Murray could be foregone profit from selling in Australia if the company decided to sell only in North America.

LO: 1, 2, 3, 6, Bloom: AN, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Reporting & Control: Financial Statement Analysis

Problem 2.3 a. Description

Amount

Depreciation on factory Executive salaries Direct materials costs Administrative salaries Wages for factory workers Advertising expense Indirect materials Factory supervisor salaries Commissions to salespeople

$ 50,000 130,000 325,000 79,000 432,500 39,500 66,000 90,000 55,000

Product Period Product Period Product Period Product Period Product Product Period

or Variable Fixed Fixed Fixed Variable Fixed Variable Fixed Variable Fixed Variable

b. (1) Traditional Income Statement Revenue (32,000 × $46) Less: COGS DM cost $ 325,000 Factory wages 432,500 Factory supervisor salaries 90,000 Depreciation on factory 50,000 Indirect materials 66,000 Gross margin Less: SG&A expenses Executive salaries 130,000 Administrative salaries 79,000 Advertising expense 39,500 Commissions to salespeople 55,000 Operating income

1,472,000

963,500 508,500

303,500 205,000

Problem 2.3 (Continued) (2) Contribution Margin Income Statement Revenue (32,000 × $46) Less: Variable costs DM cost Factory wages Commissions to salespeople

$ 1,472,000 $ 325,000 432,500 55,000

Indirect materials

66,000

Contribution margin Less: Fixed costs Depreciation on factory Executive salaries Administrative salaries Advertising expense

878,500 593,500

50,000 130,000 79,000 39,500

Factory supervisor salaries

90,000

388,500

Operating income

205,000

Operating income = $205,000 c.

Operating income is the same on each of the two income statement formats. Both income statements include the same costs, but they are presented differently (organized differently) in each.

The numbers in red have changed from part (b). Traditional Income Statement Revenue (32,000 × $46) Less: COGS DM cost Factory wages ($432,500 × 1.05) Factory supervisor salaries Depreciation on factory Indirect materials Gross margin Less: SG&A expenses Executive salaries Administrative salaries Advertising expense Commissions to salespeople ($55,000 × 1.05) Operating income

$ 1,472,000 $ 325,000 454,125 90,000 50,000 66,000

985,125 486,875

130,000 79,000 39,500 57,750 $

306,250 180,625

Problem 2.3 (Continued) Contribution Margin Income Statement Revenue (32,000 × $46) Less: Variable costs DM cost $ 325,000 Factory wages ($432,500 × 1.05) 454,125 Commissions to salespeople ($55,000 × 1.05) 57,750 Indirect materials 66,000 Contribution margin Less: Fixed costs Depreciation on factory 50,000 Executive salaries 130,000 Administrative salaries 79,000 Advertising expense 39,500 Factory supervisor salaries 90,000 Operating income

GM CM Operating income

Last Year $ 508,500 593,500

Next Year $ 486,875 569,125

205,000

180,625

$ 1,472,000

902,875 569,125

388,500 $ 180,625

Change $ 21,625 decrease 24,375 decrease 24,375

decrease

Expenses increased, so GM, CM, and operating income all decreased. Note that CM and operating income decreased by the same amount, because on the CM income statement, both of the changed expenses were variable costs, which are presented above CM. LO: 1, 3, 4, 6, Bloom: AN, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Statement Preparation

Problem 2.4 a., b. Initially an Asset or Expense (a) Expense Asset (DM inv) Asset (MOH → WIP Inv) Expense Asset (DL → WIP Inv) Expense Asset (MOH → WIP Inv) Asset Asset Asset (MOH → WIP Inv)

Transaction Description

Amount

Advertising Flour, eggs, sugar Depreciation on baking equipment and kitchen Delivery expense

$ 12,000 290,000

Wages (baking employees)

378,000

Research and development

5,600

Utilities on bakery space

24,000

Investment in mutual fund Cash proceeds from loan

60,000 50,000

Wages (indirect labor)

42,000

Salaries (executives and office staff)

130,000 Expense

45,000 8,700

Product Cost (b) Yes Yes Yes Yes Yes -

c. Schedule of COGM & COGS Beginning Direct Materials Inventory $ 46,000 Purchases of direct materials 290,000 Direct materials available for use 336,000 Less: Ending Direct Materials Inventory 32,000 Direct materials used Direct labor Manufacturing overhead Depreciation 45,000 Utilities 24,000 Wages 42,000 Total manufacturing costs Beginning WIP Inventory Less: Ending WIP Inventory Cost of goods manufactured Beginning Finished Goods Inventory Less: Ending Finished Goods Inventory Cost of Goods Sold d.

$ 304,000 378,000

111,000 $ 793,000 2,800 2,100 793,700 35,000 25,000 $ 803,700

Expected sales revenue = $803,700 × 1.4 = $1,125,180 GM% = (Sales − COGS) ÷ Sales GM% = ($1,125,180 − $803,700) ÷ $1,125,180 = 28.6%

Problem 2.4 (Continued) e.

GM% = (Sales − COGS) ÷ Sales GM% = ($1,080,000 − $803,700) ÷ $1,080,000 = 25.6% This GM ratio is less than the expected ratio found in part (d), so Frank may not be happy about that. This could have been a result of slightly higher product costs than normal and/or from setting a selling price slightly less than the typical 140% mark-up on product cost. Frank might expect an increase in sales next year due to a delayed reaction from this year’s sponsorship. He may want to consider sponsoring that event again if the leaders feel they can gain some traction in sales.

LO: 1, 3, 5, 6, Bloom: AN, Moderate, Time: 20-25, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Statement Preparation

Problem 2.5 a. Garden Center - Cost of plants, flowers, trees, etc. sold ($341,000) - Sales (65% = $519,025)

Landscaping - Landscaping labor cost ($145,000) - Landscaping supplies ($4,100) - Sales (35% = $279,475)

b. Traditional Income Statement Garden Center Landscaping $ 519,025 $ 279,475 341,000

Company $ 798,500 341,000

145,000 4,100 $ 130,375 ÷ $279,475 46.65%

145,000 4,100 $ 308,400 ÷ $798,499 38.62%

Yes

Revenue Less: COGS Cost of services: Less: Landscaping labor cost Less: Landscaping supplies Gross Margin ÷ Revenue GM%

Meets 40% GM% standard?

178,025 ÷ $519,025 34.30% No

c. Traditional Income Statement Revenue $ 798,500 Less: COGS 341,000 Less: Cost of services Landscaping labor cost 145,000 Landscaping supplies 4,100 Gross margin 308,400 Less: All other expenses General sales and labor cost 89,500 Administrative labor cost 38,500 Advertising expense 86,400 Depreciation on equipment 5,800 Fuel cost 2,700 Utilities 3,500 Plant food/fertilizer 1,700 Operating income $ 80,300

Problem 2.5 (Continued) d.

Dear Alisha, Overall company performance looks very good, with positive income and a profit margin of 10.06% ($80,300 ÷ $798,500). While the combined income statement is useful in presenting this overall view, the more detailed segment income statement is much more useful; from it we can see the higher profitability of the services arm of the business. Still, the product side of the business is doing very well too, just not quite up to the 40% GM% target. It would be useful going forward if the company could continue to track the performance of each business line separately for more targeted decision-making efforts. In the past, the company may not have separated this information due to the difficulty of breaking the different business lines’ revenue and expenses apart. This could especially be true for the landscaping side of the business, where a portion of the sales earned would likely be from the products they are planting. If that is indeed the case, the total COGS presented as a garden center cost may include some landscaping COGS. Without additional detail, we are unable to determine the portion, though. This could explain why the garden center is currently showing a slightly lower GM% than the landscaping side of the business. Hopefully going forward, a more concerted effort can be made to keep key revenue and expense items separate for each of these business lines.

LO: 2, 3, 6, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Statement Preparation

Problem 2.6 a.

New sewing machine ($2,500) Purchased thread, etc. ($300) Purchased jeans ($1,000) Paid friend ($1,800) Finished jackets, sold all but 1 Freight out ($400) Advertising expense ($300) Finished all but 1 Counted 40 jeans

Product or Inventory? Period? Product MOH (depreciation on sewing machine) Product

MOH (indirect materials)

Product

DM purchased

Product -

DL FG Inventory (Beg Bal = 0, End Bal = $80)

Period Period

WIP Inventory (Beg Bal = 0, End Bal = $40) DM Inventory (Beg Bal = $30, End Bal = $120)

b. DM Inventory Beg. 30 Purchases 1,000 ? DM used End. 120 $30 + $1,000 − DM used = $120 $1,030 − DM used = $120 DM used = $910

Beg. DM used DL MOH

WIP Inventory 910 1,800 ? ? COGM

End.

MOH = Depreciation on sewing machine + Indirect materials MOH = $500 + $300 = $800 $0 + $910 + $1,800 + $800 − COGM = $40 $3,510 − COGM = $40 COGM = $3,470

Problem 2.6 (Continued) FG Inventory Beg. 400 COGM 3,470 ? End.

COGS

$400 + $3,470 − COGS = $80 $3,870 − COGS = $80 COGS = $3,790 c.

Total manufacturing costs (TMC) = DM used + DL + MOH TMC = $910 + $1,800 + $800 = $3,510 Prime costs = DM used + DL Prime costs = $910 + $1,800 = $2,710 Conversion costs = DL + MOH Conversion costs = $1,800 + $800 = $2,600

COGM was $3,470, and COGS was $3,790. It is important for Dorothy to understand these costs so that she can set a selling price that will allow her to recover her cost (and possibly generate some margin). Without knowing these costs, she can’t determine whether or not an already-set selling price is generating any margin or a desired margin.

LO: 3, 5, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Recordkeeping

Problem 2.7 For a) and b), use what you’re given and solve for what you need using T-accounts and income statements. Follow along with the explanations in boxes. a.

Becca First, set up FG Inventory and WIP Inventory T-accounts, as well as a traditional income statement. Populate the three with as much as you can, based on what you’re given.

BECCA: FG Inventory (i) Beg. ____ COGM 450 ____ COGS End. 145

BECCA: Traditional Income Statement Revenue $ 1,370 Less: COGS ____ Gross margin (ii) ____ Less: SG&A expenses 470 Operating income $ 220 BECCA: WIP Inventory Beg. 285 DM used 215 (iii) DL ____ MOH 80 450 COGM (iv) End. ____

(i) You’re told that COGAFS is $825, so you can use that to solve for FG Beg Bal here: COGAFS = FG Inv Beg. Bal + COGM $825 = FG Inv Beg. Bal + $450 FG Inv Beg. Bal = $825 − $450 = $375.

(ii) With operating income and SG&A Expenses, you can solve for gross margin: $220 + $470 = $690.

(iii) Total Manufacturing Costs is $530, so use that to solve for DL: TMC = DM used + DL + MOH $530 = $215 + DL + $80 DL = $530 − $215 − $80 = $235. (iv) You now have all of the values in the WIP Inventory T-account but End Bal, so solve for that: $285 + $215 + $235 + $80 − $450 = $365.

(iv) You’re told that COGAFS is $425, so you can use that to solve for COGM here:

Sean SEAN: FG Inventory Beg. 130 (iv) COGM ____ 370 (iii) End. ____

COGAFS = FG Inv Beg. Bal + COGM $425 = $130 + COGM COGM = $425 − $130 = $295.

COGS

(iii) then solve for FG Inv. End Bal: $130 + $295 − $370 = $55.

Problem 2.7 (Continued) SEAN: Traditional Income Statement Revenue (i) $ ____ Less: COGS 370 Gross margin $ 620 Less: SG&A expenses ____ Operating income $ 195

(i) Solve for Sales by adding COGS back to GM: $620 + $370 = $990.

SEAN: WIP Inventory Beg. ____ (ii) DM used ____ DL 180 MOH 205 ____ COGM End. 280 c.

(ii) You’re told that Total Manufacturing Costs (DM used + DL + MOH) is $470, so use that to solve for DM used: TMC = DM used + DL + MOH $470 = DM used + $180 + $205 DM used = $470 − $180 − $205 = $85.

Conversion Costs = DL + MOH BECCA DL + MOH TMC SEAN DL + MOH TMC

$235 + $80 $530

59%

$180 + $205 $470

82%

Sean’s scenario reflects conversion costs that exceed 80% of its manufacturing costs. d.

GM ratio = GM ÷ Sales BECCA GM Sales SEAN GM Sales

$690 $1,370

50%

$620 $990

63%

Again, Sean’s scenario reflects a GM% that exceeds 60%. LO: 3, 5, 6, Bloom: AN, Difficulty: Complex, Time: 20-25, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: N/A, IMA: Reporting & Control: Financial Recordkeeping

Problem 2.8 a. i. ii. iii. iv.

Total costs = Red line (starts at $2,000 [FC] and increases at a slope of the VC/unit given) Fixed costs = Grey line (starts at $2,000 and doesn’t change) Total revenue = Blue line (starts at $0 and increases at a slope of the selling price/unit) Total variable costs = Orange line (starts at $0 and increases at a slope of the VC/unit given)

Looking at the graph we can see that no profit would be generated at a sales volume of 20 units (because the total cost line is higher than the total revenue line at this volume). The company would generate a profit at a volume of 40 units and 60 units, however, as the total revenue line is higher than the total cost line at both volumes. If we want to determine the amount of profit or loss earned at each of the above volumes, further analysis will reveal the details. Revenue: To find the selling price, pick a point on the blue line and divide the revenue at that point by the volume of units sold at that point: $2,000 ÷ 20 units = $100 per unit. Now multiply $100 by each sales volume to find the revenue. Variable costs: to find the variable cost per unit, pick a point on the orange line and divide the variable costs at that point by the volume of units sold at that point: $3,000 ÷ 100 units = $30 per unit. We can then combine the revenue, variable cost, and fixed cost information to calculate profit or loss at each volume: Contribution Margin Income Statement 20 units 40 units Revenue ($100 × volume of units) $ 2,000 $ 4,000 Less: Variable costs ($30 × volume of units) 600 1,200 Contribution margin $ 1,400 $ 2,800 Less: Fixed costs 2,000 2,000 Operating income (loss) $ (600) $ 800 Profit?

Yes

60 units $ 6,000

$ $

1,800 4,200 2,000 2,200 Yes

Note: Remember that fixed costs stay the same in total even as the volume of units changes. c.

Total Fixed Costs = $2,000

FC/unit = $2,000 ÷ 40 = $50

Total Fixed Costs = $2,000

FC/unit = $2,000 ÷ 60 = $33.33

The red and orange lines are parallel; red reflects total costs while orange reflects total variable costs. The slope of the two lines is the same, which is $30/unit, because total costs will increase at the variable rate (since fixed costs stay stable regardless of volume).

Problem 2.8 (Continued) f. Contribution Margin Income Statement Revenue ($100 × 80 units) $ 8,000 Less: Variable costs ($30 × 80 units) 2,400 Contribution margin $ 5,600 Less: Fixed costs 2,000 Operating income $ 3,600 The difference between the blue line (total revenue) and the red line (total costs) is profit. The orange shaded area in the graph below represents profit.

The CM income statement would allow LaVonne the ability to quickly transform the graphical information into different income statement scenarios because it organizes costs by behavior (variable vs. fixed), and this graph has them organized that way, as well.

Yes, presenting information graphically can be very useful for users, especially because the supervisors and managers specifically asked for her to show them things rather than telling them. This format might be easier for them to understand and remember the relationships as opposed to a traditional income statement.

LO: 4, 6, Bloom: AN, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Communication, Analytic, Technology, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Problem 2.9 a.

Yes, the intern is correct that the income statement categories are correctly identified in each income statement format. The types of costs that are typically included in each of the following categories are described below: (1) COGS: product costs for the units sold, including DM used, DL, and MOH. (2) SG&A: selling, general, and administrative expenses such as office rent, administrative/executive salaries, and advertising expense. (3) Variable costs: costs that vary based on the quantity of units sold, such as DM used, DL, and sales commissions. (4) Fixed costs: costs that do not change regardless of the volume of units sold, such as administrative/executive salaries, advertising expense, and depreciation.

Selling price = Sales ÷ volume of units sold = $960,000 ÷ 30,000 = $32 Solve for total CM, then, knowing the operating income from Format 1 is correct, use that and the total CM to solve for total fixed costs. Total CM = CM/unit × volume of units sold Total CM = $22 × 30,000 = $660,000 CM Less: Fixed costs Operating income

$ $

660,000 ________ 260,000

CM − fixed costs = operating income $660,000 − fixed costs = $260,000 Fixed costs = $400,000 c. Traditional Income Statement Revenue $ 960,000 Less: COGS 522,500 Gross margin $ 437,500 Less: SG&A expenses 177,500 Operating income $ 260,000 COGS: Variable COGS = $8.75 × 30,000 units = $262,500 Fixed COGS = 65% × $400,000 = $260,000 Total COGS = $262,500 + $260,000 = $522,500

Problem 2.9 (Continued) SG&A Expenses: Total Variable cost/unit = Selling price/unit − CM/unit Total VC/unit = $32 − $22 = $10 Variable SG&A/unit = Total VC/unit − Variable COGS/unit Variable SG&A/unit = $10.00 − $8.75 = $1.25 Variable SG&A = $1.25 × 30,000 units = $37,500 Fixed SG&A = Total fixed costs − fixed COGS Fixed SG&A = $400,000 − $260,000 = $140,000 Total SG&A = $37,500 + $140,000 = $177,500 [The same calculations are repeated below to show that the same costs are being represented in a different order.] Contribution Margin Income Statement Revenue $ 960,000 Less: Variable costs 300,000 Contribution margin 660,000 Less: Fixed costs 400,000 Operating income $ 260,000 Variable costs: Variable COGS = $8.75 × 30,000 units = $262,500 Variable SG&A = $1.25 × 30,000 units = $37,500 Total variable costs = $262,500 + $37,500 = $300,000 Fixed costs: Fixed COGS = 65% × $400,000 = $260,000 Fixed SG&A = Total fixed costs − fixed COGS Fixed SG&A = $400,000 − $260,000 = $140,000 Total fixed costs = $260,000 + $140,000 = $400,000 d.

It’s important to have this information formatted in a traditional income statement for the benefit of external users such as creditors, and also for comparison purposes when benchmarking performance. The subtotal of gross margin is useful when evaluating the margin earned just on the products sold, before considering other operating expenses. It’s very useful to have a contribution margin format income statement for internal use related to decision-making, resource management, pricing, and risk evaluation (i.e. breakeven, CVP analysis, etc.). The subtotal of contribution margin is useful when evaluating the margin earned after recognizing the variable costs associated with the products sold, before considering any fixed expenses.

LO: 4, 6, Bloom: E, Difficulty: Complex, Time: 20-25, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Statement Preparation

Problem 2.10 Use the information you’re given and work through the T-accounts. DM Inventory Beg. Purchases

500 ____

End.

1,200

____

Beg. DM used DL MOH End.

DM used

WIP Inventory 2,100 ____ ____ ____ ____ 4,300

COGM

FG Inventory Beg. COGM

8,700 ____ ____

End.

COGS

12,500 COGS 217,000

End. a.

COGS = $217,000 (given) Use the FG Inventory account to solve for COGM: Beg FG Inventory + COGM − COGS = End FG Inventory $8,700 + COGM − $217,000 = $12,500 COGM = $220,800 DM Inventory Beg. Purchases

500 ____

End.

1,200

Beg. DM used DL MOH

2,100 ____ ____ ____

____

DM used

WIP Inventory

220,800 End.

COGM

4,300

Problem 2.10 (Continued) Beg. COGM End.

FG Inventory 8,700 220,800 217,000 12,500

COGS

COGS 217,000 End. b.

Total manufacturing costs = DM used + DL + MOH Calculate DL from what was given: $88,000 × 0.5 = $44,000 Calculate MOH from what was given: Manufacturing supervisor salaries ($88,000 x 0.5) + manufacturing utilities ($4,000 × 0.75) + manufacturing depreciation ($19,000) + indirect materials and indirect labor ($3,000) = $69,000 Solve for DM used: Beg WIP Inventory + DM used + DL + MOH − COGM = End WIP Inventory $2,100 + DM used + $44,000 + $69,000 − $220,800 = $4,300 DM used = $110,000 Total manufacturing costs = $110,000 + $44,000 + $69,000 = $223,000

We’ve already solved for these in part (b). DM used = $110,000 DL = $44,000 MOH = $69,000 DM Inventory Beg. Purchases

500 ____ 110,000

End.

Beg. DM used DL MOH End.

DM used

1,200 WIP Inventory 2,100 110,000 44,000 69,000 220,800 4,300

Beg. COGM

COGM

FG Inventory 8,700 220,800 217,000

End.

COGS

12,500

Problem 2.10 (Continued) COGS 217,000 End. d.

Beg DM Inventory + DM Purchased − DM used = End DM Inventory $500 + DM Purchased − $110,000 = $1,200 DM Purchased = $110,700 DM Inventory Beg. Purchases

500 110,700

End.

1,200

110,000

Beg. DM used DL MOH End.

WIP Inventory 2,100 110,000 44,000 69,000 220,800 4,300

COGM

FG Inventory 8,700 220,800

Beg. COGM End.

DM used

217,000

COGS

WIP Inventory Beg. 2,100 DM used 110,000 DL 44,000 MOH 69,000 220,800

COGM

12,500 COGS 217,000

End. e.

Italicized amounts are what we solved for here. DM Inventory Beg. Purchases

500 110,700

End.

1,200

110,000

End.

DM used

4,300

Problem 2.10 (Continued) Beg. COGM End.

FG Inventory 8,700 220,800 217,000 12,500

COGS

COGS 217,000 End. LO: 5, Bloom: AN, Difficulty: Complex, Time: 20-25, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Solution to Analysis and Decision-Making Case Case a.

Yes, they both make excellent points—information from both a traditional and a contribution margin income statement format is very important and useful for different types of users. Gross margin on a traditional income statement is a very common and important measure of performance. Contribution margin on a contribution margin income statement is also a very important measure of performance.

GM:

1. For external users 2. Allows a company to be compared to others in the industry 3. A traditional income statement with GM as its key subtotal reflects costs that have been separated by function (product vs. period) to reveal the margin specifically earned on the products sold.

CM:

1. For internal users 2. Helps with day-to-day decision-making 3. A contribution margin income statement with CM as its key subtotal reflects costs that have been separate by behavior (variable vs. fixed) to reveal the margin specifically earned after variable costs are considered.

No; just because a company’s CM percentage is higher than its GM percentage does not mean that CM is a superior measure. In terms of gross margin: it means that the company’s margin after covering product costs is 35%, recognizing that the remaining 65% of the revenue will be used to cover the company’s non-product (operating expenses), hopefully with some left over to reflect a profit. In terms of contribution margin, it means that the company’s margin after covering variable costs is 45%, recognizing that the remaining 55% of the revenue will be used to cover the company’s fixed costs, hopefully with some left over to reflect a profit. Without additional information on what the company’s profit margin is or what its operating expenses or fixed costs are as a percentage of revenue, we cannot determine whether its cost structure consists of predominantly fixed or variable costs.

The company should explain to the two managers the benefits of both income statement formats and both key subtotals. Further, company leadership should recognize its full intention to utilize both income statements and key subtotals for their key advantages. If both managers can see that they were right—that their favored subtotal is in fact a crucial measure for the business—it could be a win-win situation. Both managers could be ambassadors for improving the culture of the company, pulling other managers in and helping them better understand the financial situation of the company. If all managers become more financially literate, just imagine where their ideas could take them!

LO: 1, 4, 6, Bloom: AN, Difficulty: Moderate, Time: 10-15, AACSB: Analytic, Communication, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Chapter 3 Cost Behavior and Cost Estimation Assignment Classification Table (By Learning Objective)

Learning Objectives

1. Describe the fundamentals of cost behavior. 2. Demonstrate two straightforward methods of estimating costs. 3. Utilize regression analysis to estimate costs. 4. Estimate nonlinear costs using the learning curve.

Questions 1, 2, 3, 4

Brief Exercises 1, 2, 3

4, 5, 6, 7, 8, 9

Exercises 1, 2, 3

Problems 1, 2, 3, 4, 5, 6, 7, 8

4, 5, 6, 7

4, 5, 6, 7, 8, 9

1, 2

9, 10, 11, 12

8, 9, 10

8, 9, 10, 11, 12

2, 3, 4, 5, 6, 8

13, 14

11, 12, 13

13, 14

7, 8

Assignment Characteristics Table

Item E3.1 E3.2 E3.3

E3.4 E3.5 E3.6 E3.7

E3.8 E3.9 E3.10 E3.11 E3.12 E3.13 E3.14 P3.1

P3.2 P3.3 P3.4 P3.5

Description

Evaluate the cost behavior of three production costs given three observations for each cost. Match cost drivers with costs to consider cause and effect relationships. Determine cost behavior information from the scatter plot for two different costs given the same cost driver. Use the high-low method to estimate a cost function. Use the high-low method to estimate a cost function and evaluate the fit of the high-low line. Use the high-low method to estimate a cost function and further evaluate the fit of the line. Apply the account analysis method and high-low method to determine cost behavior for a variety of costs. Distinguish the high-low line from the regression line and evaluate both cost functions. Generate high-low and regression models for a given set of data and compare the models. Generate a regression model and evaluate its validity.

Generate a regression model to explain revenues and additional considerations. Evaluate regression output to determine the most appropriate model. Calculate the effects of a learning curve plus additional considerations. Calculate the time and cost effects of a learning curve. Estimate administrative expenses using the account analysis method and the high-low method; compare. Generate a high-low model and regression model to explain one cost; compare the two models. Generate multiple regression analyses using one or more variables to determine the best model. Evaluate the viability of three possible cost drivers to explain one cost using regression analysis. Consider the viability of a multiple regression model to explain delivery cost.

Level of Difficulty Simple

Time (minutes)

Moderate

10–15

Moderate

10–15

Moderate

10–15

Moderate

10–15

Simple

15–20

Moderate

15–20

Moderate

10–15

Moderate

15–20

Moderate Moderate

20–25 20–25

Moderate

10–15

Moderate

10–15

Moderate

20–25

Moderate

15–20

Moderate

20–25

Complex

25–30

Complex

25–30

Complex

20–25

5–10

P3.6 P3.7 P3.8 Case

Considering multiple possible cost drivers, select the best regression model; explain your process. Utilize learning curve methodology to determine and evaluate production costs. Calculate the learning curve effect on labor cost plus additional considerations. Generate and evaluate regression models to best explain costs.

Complex

25–30

Moderate

15–20

Complex

20–25

Moderate

30–35

Answers to Questions 1.

Examples of overhead costs in a professional services firm (and their cost behavior) include indirect labor such as support staff, paralegals, executive assistants (variable or mixed), depreciation on equipment (fixed), amortization on software (fixed), utilities (mixed), rent or lease costs (fixed), and indirect materials such as paper for reports, staplers, ink, or that specific type of pen that the managing partner prefers (variable or mixed).

LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

The stated formula is a linear cost function because it has a stable or steady fixed cost ($20) and a stable or steady variable rate per unit ($75 per outfit). These two components are the defining features of a linear cost function. The other assumption in a linear cost function is that the past (X, Y) observations exhibit a linear relationship when plotted, and that linear relationship holds within the relevant range of activity.

LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

A relationship likely exists between HR department costs and number of employees, such that a larger number of employees would occur when the company has a larger amount of HR department costs. A cause-and-effect relationship would mean one variable causes the other, such that if a company has a larger number of employees, then it will have a larger amount of HR department costs. A cause-and-effect relationship would be more meaningful in a linear cost function because we are trying to explain one variable in relation to the other. Ideally, the X variable (independent variable) would be the cause, and the Y variable (dependent variable) would be the effect. In this case, the number of employees would most likely be the independent variable (X) and the cause of the HR department costs, which would be the dependent variable (Y) and the effect of having employees.

LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

You would want to gather the following information: • Total indirect (MOH) costs for each batch • Quantity of thread used in each batch (probably in feet) • Number of feet of shoelaces used in each batch • Indirect labor costs for each batch • Machine time in each batch • Indirect labor time in each batch • Quantity of glue or adhesive used in each batch (probably in gallons) We could plot each potential cost driver against the total indirect costs and visually inspect to see if a trend is present in the data. Alternatively, we could use either the high-low or regression method, with MOH cost as the dependent variable and the other variables as potential independent variables, and further evaluate the model to determine if any have a significant relationship.

LO: 1, 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: Process and Resource Management Perspectives, AICPA AC: Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

Questions Chapter 3 (Continued) 5.

Payroll expenses likely consist of the salaries of full and/or part time staff, benefits such as retirement contributions or insurance benefits, employer payroll taxes and employer insurance such as worker’s compensation and/or unemployment taxes. This could also include any amount the organization pays to a payroll service provider or software to assist with these calculations. Most of these costs are likely fixed, unless some individuals are paid based on hours worked, in which case the costs would be variable per hour. It would take a clear understanding of what each of the underlying cost components is, and what drives it, to accurately classify between variable and fixed costs in this account analysis method.

LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Recordkeeping

The account analysis method requires an individual’s knowledge of or interpretation of the cost behavior within a particular account or grouping of costs, where each component or account is deemed to be variable, fixed, or mixed. The high-low method uses quantitative data from past observations to estimate the variable and fixed components, and just two data points (the high and the low) are needed to use this method. The account analysis method is subjective, as it relies on an individual’s understanding of the cost and activity. The high-low method is an objective method, based solely off the data provided. That is, all individuals will generate the same cost function through the high-low method if they follow the process correctly. The same cannot be said for the account analysis method, since each person may interpret and understand the costs to behave differently, thus resulting in a different model than others might interpret and create.

LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

When estimating a cost function using the high-low method, the line needs to cross through two points so an estimate can be made for the variable rate and the fixed portion of the cost. The highlow method will provide a fairly accurate cost estimation model only if the high and low observations (or points) are representative points among all the observations.

LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

There is no definite winner or loser here, in terms of finding the most effective cost estimate in the least amount of time. The high-low method can be very effective (providing a well-fitting model) if the two end points of the data are representative points of the entire sample. It can be an efficient method for estimating the cost function, also, as only two data points are needed to estimate the slope and fixed portion of the cost. The regression method will always generate the best-fitting line, but to be efficient as well as effective, computer software is needed to generate the model. And while regression will always generate the best-fitting line, that line will only be accurate if the data is good. In the end, both methods can be both effective and efficient in generating a cost estimation model, we just need to keep their costs and benefits in mind.

LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

Questions Chapter 3 (Continued) 9.

The criteria that we use for the validity of regression and high-low models are the same but used differently. See the table below for the three main criteria, and how they differ between the models: Criteria Goodness of Fit Statistical significance of the slope Economic Plausibility

Basic Description How well the line fits the actual observations The slope of the line is different from a flat line

Regression Model Based on R-Square; must be above 0.30 Based on the pvalue; must be below 0.05

High-low Model Visual interpretation: how well does the line appear to fit the observations? Visual interpretation: does the slope look different from a flat line?

It is feasible that there is a cause-and-effect relationship

As you can see, the goodness of fit and statistical significance of the slope criteria are more subjective for the high-low method than for regression, as they are based on visual interpretations. The economic plausibility criterion is subjective under both methods. LO: 2, 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Data Analytics, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

10. A regression model will automatically generate the best-fitting line, or the best cost function, given the information provided—here, between number of items sold and direct labor hours. If the information provided is not good information, or if there is no real relationship between the two variables, the model will not have a good fit and/or the independent variable will not be statistically significant. Here, it is possible that Corrine hired enough employees so her shop could be open for certain hours, perhaps making sure there were always two or more employees working a given shift, even though the number of items sold did not relate to or explain the number of labor hours. Corrine’s labor cost may be more of a fixed cost than a variable one. If so, even if she ran a regression model using number of items sold as the independent variable with DL cost as the dependent variable, she still may not have found a significant relationship. If a cost is truly fixed and we try to force it into a mixed cost model, we are unlikely to get a result that is useful. A more statistically significant relationship would likely have been found between DL hours (as the independent variable) and DL cost (as the dependent variable). LO: 3, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Data Analytics, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

11. Regression analysis will generate the best-fitting line between all observations included in the analysis (number of items sold and profitability). If Yasmine includes all 12 months of data, her estimated cost function will be skewed by the last two months of data. She should only use the first 10 months of data since these observations reflected normal operating conditions and she plans to reopen for normal business next year. If Yasmine finds herself needing to stay in a restricted form of operation, however, then she should use the two months of the year during which the business was operating in this manner. LO: 3, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Data Analytics, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

Questions Chapter 3 (Continued) 12. If Kuerkow only has access to two potential variables along with the dependent variable, his options for modeling the relationship include: o A single regression model with number of production runs as the cost driver, o A single regression model with DL hours as the cost driver, or o A multiple regression model with both variables included. He would first run the single regression models described and evaluate the validity of each model (using the goodness of fit, statistical significance of the slope, and economic plausibility criteria). If both single regression models are valid, recognizing a significant relationship between the independent variable and the dependent variable, then he would be justified in running a multiple regression model with both DL hours and number of production runs as independent variables. If both independent variables remain significant in the multiple regression model, and the goodness of fit remains strong, the multiple regression model would be selected. LO: 3, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Data Analytics, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

13. Zelda is seeing a steeper learning curve than Thron. This means that Zelda’s group is quicker to increase its efficiency, leading to less time spent on each new batch of product, and therefore, less money spent on direct labor. Thron’s employees have a much flatter learning curve. Their time on task stays stable until, after a fair amount of time, they develop efficiencies (and subsequently decreases in cost). LO: 4, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: N/A

14. A 95% learning curve reflects a gradual learning curve. If the manager sets the learning curve at 95% it would mean that every time the intern doubles their output, it will take 95% of the amount of time it took them for the previous halved quantity (i.e., if the first audit took 10 hours, the second audit would take 9.5 hours [10 × 0.95], and the fourth audit would take 9.025 hours [9.5 × 0.95], and so on). A 5% learning curve would reflect a very steep learning curve. If a 5% learning curve was in place, she would be expecting the intern to finish the second audit in almost no time at all; if the first audit took 10 hours, the second audit would take just 0.5 hours (10 × 0.05). That would reflect an exceptionally large amount of learning and does not appear realistic in this situation. LO: 4, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: N/A

Solutions to Brief Exercises Brief Exercise 3.1 Given the cost function of total monthly overhead costs = ($1.25 × Number of machine hours) + $5,400; (a) the variable rate is $1.25, (b) the fixed cost is $5,400, (c) the cost driver is machine hours, and (d) these MOH costs exhibit a mixed cost behavior as there are both variable and fixed components to this linear cost function. LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Technology & Analytics: Data Analytics, Reporting & Control: Cost Accounting

Brief Exercise 3.2 The relevant range for the pottery shop is from 0 to 20 pots—the range in which the total fixed costs are constant, and the variable rate is constant. The cost driver is the number of pots. This cost function is linear as the function identifies one slope and one fixed cost Y = 25(X) + 125. We could alternatively plot the two observations (total cost on Y-axis and number of pots on X-axis) and see that the cost function reflects a straight line. LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Technology & Analytics: Data Analytics

Brief Exercise 3.3 Given the scatter plot, the activity does appear to be linear as the observations follow an upwardsloping path. Since we could imagine a straight line going through the data and crossing the Y-axis above the origin of (0, 0), we would consider this activity to reflect a mixed cost—it has both a fixed and variable component to it. The variable component is reflected in the slope of the line while the fixed component is reflected in the Y-intercept (the point where the line would extend across the Y-axis). While this activity reflects a linear relationship, we cannot tell if there is a cause-and-effect relationship between these variables. We cannot determine from this scatter plot if one variable occurs before the other; there may simply be a correlation between the two. LO: 1, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

Brief Exercise 3.4 Given Nina’s total cost model of Y = $4.50X + $4,500, (where X = number of units), she understood the MOH cost to be fixed and the pizza cost to be variable. ($13,500 ÷ 3,000 units) = $4.50 per unit. Given Ron’s total cost model of Y = $6 × Number of units, he understood both costs to be variable. $13,500 + $4,500 = $18,000 $18,000 ÷ 3,000 units = $6 per unit Since they only had one data point to describe each of the costs, they would have had to use the account analysis method to make their decisions. When employing the account analysis method, they use their understanding of how the costs behave to classify a cost as variable or fixed. It can be a subjective method, as the cost classifications are up to interpretation. The results here are a perfect example since they both generated very different equations to describe the same total cost. LO: 2, Bloom: AP, Difficulty: Moderate, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

Brief Exercise 3.5 The scatter plot for the data is shown below:

Number of new research project ideas

Scatter plot 14 12 10 8 6 4 2 0 0

Hours spent weeding the garden

The data does appear to reflect a linear relationship as the observations follow an upward sloping trend. There is a variable component to this relationship, as exhibited by the slope of the trend line. The variable component would give us an estimate for how many new research ideas Faith generates with each hour spent weeding. It is not obvious whether there is any fixed component to this relationship, though. The fixed component would be estimated by the point where the estimation line crosses the y-axis. Here, as we imagine a line going through the data, it appears the line would cross the y-axis at or very near the intercept. If there were a fixed component to this relationship, it would suggest that Faith would come up with a research idea or two even if she spent no time weeding. LO: 2, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Technology & Analytics: Data Analytics

Brief Exercise 3.6 Using the high-low method, the highest point based on labor hours is month 2 (95, $180), and month 1 is the low point (60, $125). We use the formula below to solve for slope (m): Y2 − Y1 m= X2 − X1 m=

$180 − $125 95 − 60

$55 35

m = $1.57 per labor hour Now we can use the equation of a line (Y = m(X) + b), either the high or the low data point, and the estimated slope of $1.57 to find b: Using the low point, the calculation is Y = m(X) + b $125 = ($1.57)(60) + b $125 = $94.20 + b b = $30.80 Using the high point, the calculation is Y = m(X) + b $180 = ($1.57)(95) + b $180 = $149.15 + b b = $30.85 These estimates for the fixed cost differ slightly due to the rounding of the variable rate per hour. Using the estimate for fixed cost per the low point, the full cost function is: Y = $1.57X + $30.80 Using the fixed cost estimate per the high point, the full cost function is: Y = $1.57X + $30.85 LO: 2, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Knowledge, Analytic, Technology, Data Analytics, AICPA BC: N/A, AICPA AC: Reporting, Technology and Tools, AICPA PC: N/A, IMA: Technology & Analytics: Data Analytics

Brief Exercise 3.7 Since we have the fixed cost and the high point for this cost function, we can insert the known values into the cost function to solve for the variable rate, or slope, (m). Y = m(X) + b $328 = (m × 35) + $97 $231 = (m × 35) m = $6.60 The full cost equation is: Where X = number of units

Y = $6.60X + $97

To estimate next month’s total cost, we insert 33 into the equation for number of units and calculate the total cost: Total cost = ($6.60 × 33) + $97 = $314.80. LO: 2, Bloom: AN, Difficulty: Moderate, Time: 5-10, AACSB: Knowledge, Analytic, Data Analytics, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Technology & Analytics: Data Analytics

Brief Exercise 3.8 Since the line of best fit is given, we can use it to predict the cafeteria costs next month if 14 employees use it: Y = $20.594(X) + $330.03 Y = $20.594(14) +$330.03 = $618.35 This prediction may be accurate because the quantity of 14 employees is only slightly outside of the current relevant range from which the cost function was estimated (which is between 4 and 13 employees). Since that quantity is very close to the current range of volume, the company may feel comfortable making that projection with this model. We can see from the scatter plot that the quantity of 4 employees, the lowest level of X, is pulling the regression line downward. That is, because the regression method uses all data points to find the best fitting line, it caused the line to be flatter. LO: 3, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Knowledge, Communication, Analytic, Data Analytics, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

Brief Exercise 3.9 By looking at the information given about the two variables, we can see that both independent variables—number of participants and outside temperature—have a statistically significant relationship with the cost of water bottles as evidenced by the p-values of each model. A p-value measures the probability that the statistical result found in a sample occurred by chance. A smaller p-value means it is less likely that the result occurred by chance. If a model generates a p-value for a given independent variable of less than 0.05, that independent variable is considered statistically significant. The p-value for the number of participants is 0.016 and the p-value for outside temperature is 0.004, which are both well below the 0.05 standard. We can also see from the information provided that both regression models generate a good fit with the cost being explained. (This goodness of fit consideration is not required in this exercise, but instructors may want to supplement the discussion with this component of validity). The R-Square (or the coefficient of determination) measures the percentage change in Y (total cost of water) that can be explained by X (either of our two independent variables). With a possible value of between zero and one, the higher the R-Square, the better the fit of the X variable in relation to the Y variable; in other words, the higher the R-Square, the greater the explanatory power of the model with X explaining the changes in Y. For the outside temperature model, the R-Square is 0.77 while the RSquare for the number of participants model is 0.64. Both models reflect a very good fit, particularly if we use a standard of 0.30 as a reasonable fitting model. If the Earth Day half-marathon organizers would like to use just one independent variable to estimate the water bottle cost, the outside temperature variable has a slightly stronger statistically significant relationship with total cost of water and a slightly better fit. Both variables exhibit strong relationships to the total cost of water, however, so organizers may consider generating a multiple regression model including both independent variables to see if they can improve their estimation model even further. Going forward, organizers should look at predicted and/or historical temperatures along with predicted and historical participant numbers to predict and budget for the amount they will spend on water bottles. LO: 3, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

Brief Exercise 3.10 Based on the output provided, Marinan and her colleagues should not accept this model as is. While the R-Square of 0.8624 reflects a good fit, not all independent variables are significant in this model according to their p-values. DL hours and (especially) machine hours are statistically significant, as their p-values are far below the set threshold of 0.05 at 0.000189 and 0.0000075, respectively. (Remember, that “E-06” means we move the decimal 6 places to the left; that’s a really small p-value!) However, number of supervisors as an independent variable is not statistically significant as the p-value is high at 0.893. Marinan and her colleague’s next steps should be to remove the one independent variable that was not significant (the number of supervisors) from the model and generate a new regression model with just DL hours and machine hours. They would then evaluate the validity of that multiple regression model and go from there. If both variables are significant in that model, they would specify the model and use it to budget for overhead costs. LO: 3, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Knowledge, Communication, Analytic, Data Analytics, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

Brief Exercise 3.11 Ingrid is experiencing a learning curve, as with each SWOT analysis she produces her time used decreases. Specifically, every time production (of SWOT analyses) doubles, the quantity of time expected for the doubled quantity (let’s say 2 SWOTs) can be calculated by multiplying the learning curve percentage by the quantity of time it took for the original quantity (the first learning curve, which took 60 minutes in this case). Therefore, using the learning curve percentage of 85%, we have the following results: SWOT Analysis Number 1 2 4 8

Time Taken 60.00 minutes 51.00 minutes 43.35 minutes 36.85 minutes

Calculation Given 60 × 0.85 51 × 0.85 43.35 × 0.85

LO: 4, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Knowledge, Analytic, Data Analytics, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Technology & Analytics: Data Analytics

Brief Exercise 3.12 Since we know the amount of time it took to make the first and second units, we can use our knowledge of learning curves to determine the learning curve percentage. Every time production doubles, the quantity of time expected for the doubled quantity (let’s say 2 units) can be calculated by multiplying the learning curve percentage by the quantity of time it took for the original quantity (1 in this case). Since we don’t know the learning curve percentage, but we do know the amount of time it took for both the first and second unit (i.e., the quantity doubled from 1 to 2 units), we can solve for the learning curve percentage: 84 minutes = Learning curve percentage × 120 minutes. Solving for the learning curve percentage, we determine a 70% learning curve in the given relationship. 84 ÷ 120 = 0.7 → 70% learning curve percentage We can then multiply that learning curve percentage by the time it took to make the second unit to estimate the time it will take to make the fourth unit (the fourth unit reflects the doubled quantity from the second unit): 84 × 0.7 = 58.8 minutes We can now create the new scatter plot. In Excel, create the following table, filling in the “Total cumulative time” column:

Brief Exercise 3.12 (Continued) Then, select the “Number of units produced” and “Total cumulative time” columns. Go the “Insert” tab, click the “Scatter” button in the “Charts” section, and select the first option (the basic scatter plot).

The new scatter plot created should look like this:

Total cumulative time

Total cumulative time 400.00 300.00 200.00 100.00 0.00 0

Number of units produced

A business might use this new plot to budget more accurately for DL costs in the future, seeing that it is becoming more efficient with increased experience. The plot also might be useful for estimating total costs when producing a certain number of units. A 70% learning curve percentage is assumed in this analysis, and yes, this is a steep learning curve. There is a significant drop in the amount of time needed between the first and second unit (Remember: a steep learning curve means that learning is happening quickly). LO: 4, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, Technology, Data Analytics, AICPA BC: N/A, AICPA AC: Reporting, Technology and Tools, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics, Technology & Analytics: Visualization

Brief Exercise 3.13 Since we know that a 90% learning curve is being assumed, we can use that percentage to solve for the time needed for the second unit, and then for the first unit. This is where we start:

A 90% learning curve means that the fourth unit requires 90% of the time the second unit required. In other words, Time for unit 4 = Time for unit 2 × Learning curve percentage 32.40 = Time for unit 2 × 0.90 So we can divide 32.40 by 90%: 32.40 ÷ 0.90 = 36 minutes for unit 2 We can do the same calculation to find the time needed for the first unit by dividing 36 by 90%: 36.00 ÷ 0.90 = 40 minutes for unit 1 We can then use these results to fill in the “Time per unit” column in our table.

From there, we can fill in the “Total cumulative time” column, which is a simple sum of the time per unit for all units to that point (i.e. Total cumulative time for 2 units = 40 minutes for the first unit + 36 minutes for the second unit).

LO: 4, Bloom: AN, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Analytic, Technology, Data Analytics, AICPA BC: N/A, AICPA AC: Reporting, Technology and Tools, AICPA PC: N/A, IMA: Technology & Analytics: Data Analytics, Technology & Analytics: Visualization

Solutions to Exercises Exercise 3.1 (5–10 minutes) a.

The utility cost is a mixed cost. We can quickly determine the cost is not entirely fixed because it varies in total from month to month. To determine if the cost is entirely variable, we can calculate the variable rate per unit for two of the months to see if it is stable. For the first month shown, the variable rate would be $600 ÷ 500 units = $1.20 per unit. For the second month shown, the variable rate would be $505 ÷ 380 units = $1.33 per unit. Since the calculated cost per unit is not stable for these months, the utility cost is a mixed cost—it has both fixed and variable components. The indirect material cost is a variable cost. We can quickly determine it is not entirely fixed because it varies in total from month to month. We can then calculate the variable rate per unit for two months to see if it’s stable, which it is: For the first month shown, $900 ÷ 500 units = $1.80 per unit. For the second month shown, $684 ÷ 380 units = $1.80 per unit. Therefore, the cost per unit is stable from month to month, which is a key characteristic of a variable cost. The depreciation cost is fixed. The total cost does not change even though production volume changes for those periods of time.

The relevant range would be from 380 units to 500 units.

The depreciation cost is a fixed cost. As such, we would expect it to stay stable within the company’s relevant range of activity. Given the range of activity depicted here, explained as their typical production, we would not be able to say the fixed cost would stay at $5,200 per month for a level of activity of 1,000 units, which is double the highest production quantity provided. With a jump of this size, it’s very likely the company will need to purchase more equipment that would then be depreciated, thus increasing the monthly depreciation cost.

LO: 1, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Exercise 3.2 (10–15 minutes) a.

The possible cost drivers for electricity are: • Number of machine hours, as machines require electricity. • Number of units produced, because producing these units require machines, which require power. Possible cost driver for natural gas is: • The outside temperature, as the gas is only used for heat, and more is needed when it is colder outside.

Exercise 3.2 (Continued) Possible cost drivers for water are: • Number of machine hours used, because as equipment is used, it will need to be cleaned. • Number of employees in the factory, because these employees use the equipment, the restroom facilities, and the breakroom. b.

Other cost drivers for electricity could be the size of the factory, or square feet being utilized. For water, other cost drivers could be the number of pieces of equipment used, or the number of employees on-site. For natural gas, other cost drivers could be the number of employees on-site, or square feet being occupied.

Most of these relationships appear to exhibit a cause-and-effect relationship. Using equipment causes power usage to increase, and therefore causes costs to increase. Producing units requires equipment (an assumption, but a safe assumption), which requires power usage, which then causes costs to increase. For natural gas, when the outside temperature decreases the use of natural gas increases so the cost increases. (This is a bit more of an indirect relationship, as the decrease in temperature does not automatically mean an increase in natural gas. However, it is safe to assume that the company wants a comfortable environment for its employees.) Regarding water, if more employees are present, it likely causes more water to be used (more people using the restroom and breakroom), so the cost increases. The one situation that is not clearly a cause-and-effect relationship is the use of equipment with increased water costs; the use of equipment does not necessarily cause water usage (i.e., the water cost). The usage of water here more likely depends on how many pieces of equipment are used, or how often it needs to be cleaned.

LO: 1, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Exercise 3.3 (10–15 minutes) a.

In plot (1), printing costs appear generally linear within the given range of activity, 40 to 90 clients. While there is some variation, it does follow a linear trend. Consider if all students were all to draw a line through the points, would everyone end up with a very similar straight line? In this case, probably yes.

In plot (2), travel costs generally appear linear within the relevant range of 4 to 12 clients. Again, this plot does reveal some variation, but it is mostly linear. If all students were to draw a straight line through the points, everyone would likely end up with a very similar straight line.

Other information we would want to know could include: • Are the customers satisfied thus far with the consulting service provided? This could determine whether current printing and travel activity per client is sufficient, or if more printing and travel will be needed to satisfy the clients. • Has the firm picked up more customers as time has gone by? This will affect the firm’s relevant range of activity. If they want to project printing costs for 150 clients, while the current function is based on only 40-90 clients, the given relationships may not hold at that higher level of activity.

Exercise 3.3 (Continued) • • • •

Does it look like there is room to grow within this market for the services this firm is providing? (A similar point as above regarding projecting beyond the current range of activity.) For printing costs, is this firm considering a more virtual offering versus providing written reports at the end of the project? Is the economy stable such that gasoline prices (for example) are expected to remain stable? How far away are the clients typically from the firm’s office?

LO: 1, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, Data Analytics, AICPA BC: Strategic Perspective, Customer Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics, Reporting & Control: Cost Accounting

Exercise 3.4 (10–15 minutes) a.

Since the high-low method will generate a straight-line equation, it is important for the data to exhibit a linear relationship for the resulting cost function to be reasonable. This data appears to be linear within the current range of activity. If we all imagined a straight line going through these points, we would each draw a very similar straight line.

To estimate the cost function using the high-low method, we first select the high and low points based on the cost driver, number of units produced in this case: Low point: month 2, with 210 units and $2,200 in overhead cost. High point: month 5, with 360 units and $3,100 in overhead cost. We use the formula below to calculate the slope (m): m=

Y2 − Y1 X2 − X1

$3,100 − $2,200 360 − 210

$900 150

m = $6 per unit produced Now we can use the equation of a line Y = m(X) + b, either the high or the low data point, and the slope of $6 to find b. Here is the calculation to find b using the low point. Y = m(X) + b $2,200 = $6(210) + b $2,200 = $1,260 + b b = $940 Alternatively, here is the calculation to find b using the high point. $3,100 = $6(360) + b $3,100 = $2,160 + b b = $940

Exercise 3.4 (Continued) Therefore, the full cost function is: Y = $6X + $940 Where X = number of units produced. c.

See scatter plot, below, with high-low line drawn in (manually, via inserting a line illustration in Excel):

The high-low line shown here correctly connects the low point and the high point with a straight line. It does not appear to fit the data well, however, since all other observations land above the line. This specific high-low cost estimation equation will almost always predict a lower overhead cost than what is likely to occur. LO: 2, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, Technology, Data Analytics, AICPA BC: N/A, AICPA AC: Reporting, Technology and Tools, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics, Technology & Analytics: Visualization

Exercise 3.5 (10–15 minutes) a.

The high-low cost function for the shipping data provided is: Y = $2.80X + $4,020 Where X = number of units shipped The high point based on number of units shipped comes from month 6 (600, $5,700) and the low from month 4 (350, $5,000), and then we use the formula below to solve for slope (m):

Exercise 3.5 (Continued) m=

Y2 − Y1 X2 − X1

$5,700 − $5,000 600 − 350

$700 250

m = $2.80 per unit shipped Reminder for students: be sure to select the high and low point based on the level of activity (X) and not based on the cost, itself (Y). Once the high and low observations are selected based on activity level (X), we must use the corresponding cost for each of those observations. Students must not separately find the high and low cost (Y), as that would provide inconsistent information in determining the slope. Remember: we hypothesize that the independent variable X causes the dependent variable Y, not the other way around. Then the fixed cost of $4,020 is calculated by solving for b in the Y=m(X) + b formula for either of the two points, also using the variable cost estimate of $2.80. Here is the calculation using the high point: $5,700 = $2.80(600) + b $5,700 − ($2.80 × 600) = b $5,700 − $1,680 = b b = $4,020 Here is the calculation using the low point: $5,000 = $2.80(350) + b $5,000 − ($2.80 × 350) = b $5,000 − $980 = b b = $4,020 b.

The assumptions at play are that there is a steady fixed cost amount and a steady slope, m, (or variable rate per unit) within the given range of activity (i.e., the relationship approximates a straight line). It does appear that these assumptions hold true for this relationship. If drawn in, the line would connect the furthest left point with the furthest right point.

Exercise 3.5 (Continued) c.

See scatter plot with high-low line manually drawn in, below:

Shipping Cost

Shipping Cost $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $0

100

200

300

400

500

600

700

Units shipped

We can visually inspect the scatter plot with the high-low line drawn in (or envisioned) to evaluate the goodness of fit and significance of slope. Goodness of fit: The high-low line is approximately in the middle of all points, meaning there are about as many points above the line as there are below it. It appears to be a very good fit within this dataset. Significance of the slope: We can both eyeball the line and consider the slope that we calculated earlier of $2.80 per unit shipped. The line visually appears upward sloping and is not a flat horizontal line. Economic plausibility: We consider the context. It makes sense that shipping costs would increase as more units are shipped. Overall, it is a well-fitting line. If we drew the best-fitting line into this scatter plot, it would likely have a slightly steeper slope and lower fixed cost but would be quite similar to the high-low line presented here. Given the good fit of the high-low line, Aletha should feel comfortable using this cost function to predict her shipping costs going forward, unless the context in which she operates changes. Regarding her confidence in using this function going forward, she may also want to consider other factors such as: if sales are growing, or if units shipped will increase, or as she establishes a stronger relationship with her shipping vendor, might she be able to negotiate better rates or terms? LO: 2, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, Technology, Data Analytics, AICPA BC: Strategic Perspective, AICPA AC: Reporting, Technology and Tools, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics, Technology & Analytics: Visualization

Exercise 3.6 (15–20 minutes) a.

The data does appear linear within the given range of activity. If all students drew their own line of best fit, all would likely draw reasonably similar lines.

Purchasing department cost

Purchasing Department Cost $40,000 $35,000 $30,000 $25,000 $20,000 $15,000 $10,000 $5,000 $-

500

1,000

1,500

2,000

2,500

Number of purchase orders

Using the high-low method, the variable rate is $12 per purchase order. The high point based on number of purchase orders comes from month 9 (2,210, $35,100) and the low point comes from month 2 (910, $19,500). Then use the formula below to solve for slope (m): Y2 − Y1 m= X2 − X1 m=

$35,100 − $19,500 2,210 − 910

$15,600 1,300

m = $12 per purchase order Now we can use the equation of a line Y = m(X) + b, either the high or the low data point, and the slope of $12 to find b. Here is the calculation using the high point. Y = m(x) + b $35,100 = ($12)(2,210) + b $35,100 − ($12 × 2,210) = b $35,100 − $26,520 = $8,580 Here is the calculation using the low point. $19,500 = $12(910) + b $19,500 − ($12 × 910) = b $19,500 − $10,920 = b b = $8,580

Exercise 3.6 (Continued) This would then enable the full cost function to be specified: Y = $12X + $8,580 Where X = number of purchase orders. c.

See high-low line embedded within the scatter plot below (manually drawn in Excel by inserting a line illustration):

The high-low line must utilize the high and low observations, regardless of whether they are representative points or not. The goodness of fit looks reasonable in that the line results in a similar number of observations both above and below the line. The slope appears flatter than what the overall trend in the observations suggests, however. In this case, the high-low line appears to generate too flat of a slope because the two points are not well representative of all observations. It seems clear from visual inspection of the line that the slope is significantly different from zero, still. It is also economically plausible that the number of purchase orders would help to explain the company’s purchasing department costs. d.

Edwin could use his high-low line to predict the company’s purchasing department costs going forward if he has an estimate for the number of purchase orders to be used. If the number of purchase orders is expected to fall within the range of activity seen here, he should feel reasonably comfortable with his estimate. If the number of purchase orders increases, particularly if it increases well beyond the level of activity seen here, he would be wise to use caution when projecting for levels that fall outside of the range used to estimate the model.

LO: 2 Bloom: AP, Difficulty: Simple, Time: 15-20, AACSB: Knowledge, Communication, Analytic, Technology, Data Analytics, AICPA BC: Strategic Perspective, AICPA AC: Reporting, Technology and Tools, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics, Technology & Analytics: Visualization

Exercise 3.7 (15–20 minutes) a.

The fixed costs include vehicle insurance, registration fees, and depreciation. These are all steady costs that don’t change in total despite changing mileage. The only variable cost is fuel. This cost is entirely dependent on miles driven; further, the fuel cost per mile stays constant for all four quarters. Q1: $3,220 ÷ 28,000 = $0.115 per mile Q2: $3,623 ÷ 31,500 = $0.115 per mile The only mixed cost is vehicle maintenance. This cost is clearly not an entirely fixed cost as the total changes each month, but it’s also not entirely a variable cost, dependent on miles driven, since the rate per mile differs each month. Q1: $2,700 ÷ 28,000 = $0.096 per mile Q2: $2,825 ÷ 31,500 = $0.090 per mile

We will use the high-low method to breakdown the total vehicle maintenance cost into its variable and fixed components. First, we select the high and the low points: the high point comes from Q4, with 33,000 miles driven and $2,965 of maintenance. The low point occurred in Q3, with 27,000 miles driven and $2,485 of maintenance. We use the formula below to solve for slope (m): m=

Y2 − Y1 X2 − X1

$2,965 − $2,485 33,000 − 27,000

$480 6,000

m = $0.08 per mile driven Then we can use the equation of a line (Y = m(X) + b) to calculate the fixed portion by using either the low or the high point in addition to the estimated variable rate of $0.08 per mile. Here we use the high point to solve for b as follows: $2,965 = ($0.08 × 33,000) + b $2,965 − ($0.08 × 33,000) = b $2,965 − $2,640 = b b = $325 This could also be done with the low point: $2,485 = ($0.08 × 27,000) + b $2,485 − ($0.08 × 27,000) = b $2,485 − $2,160 = b b = $325 Therefore, the full cost function would be: Y = $0.08X + $325 Where X = miles driven. 3-25 © 2022 John Wiley & Sons, Inc. or the author, All rights reserved. Farmer, Cost Accounting, 1e, Job Costing Visualized (For Instructor Use Only)

Exercise 3.7 (Continued) c.

To specify one complete cost equation for the company’s total fleet expenses, we need to combine all the fixed cost components together and combine all of the variable cost components together, since the same cost driver was used for both variable rates. The total variable rate = $0.115 per mile for fuel + $0.08 per mile for maintenance = $0.195 per mile. The total fixed costs = Vehicle insurance ($1,800) + Registration ($1,200) + Depreciation ($5,500) + Fixed portion of maintenance ($325) = $8,825 Thus, the Total fleet expense = $0.195X + $8,825 Where X = miles driven. If they purchase another vehicle, the cost function above would not be accurate, as the level of fixed cost would increase due to the additional vehicle insurance costs, registration fees, depreciation, and likely a portion of maintenance. However, we cannot estimate by how much it will increase because we don’t know how many vehicles the above information is related to. There is no reason to believe the variable rate per mile would differ, though, unless the new vehicle had much better or worse gas mileage than the existing vehicles in the fleet, or unless the additional vehicle required significantly more or less maintenance.

If Leon had not submitted his mileage, fuel expenses would not have consistently related to miles driven, so it would have looked like a mixed cost instead of a purely variable cost. Also, while maintenance cost would still have appeared mixed, the resulting variable and fixed breakdown would have been different.

LO: 2, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Communication, Analytic, Technology, Data Analytics, AICPA BC: N/A, AICPA AC: Reporting, Technology and Tools, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

Exercise 3.8 (10–15 minutes) a.

The blue dotted line is the regression equation, and the orange line is the high-low equation. The orange high-low line directly connects the highest and lowest observations based on units sold. The regression line does not necessarily connect any points, but rather reflects the best-fitting line among all observations.

The regression method generated the best-fitting line in this case, and it will always generate the best-fitting line. The powerful nature of regression mathematically finds the best-fitting line to minimize the distance between all points and the cost estimation line. If the high and low points are representative of the data set, the high-low method can also provide a well-fitting line, but regression will always generate the best-fitting line.

The validity of the regression equation would be based on three main criteria: Goodness of fit: We consider how well the line fits the observations. In a regression model, the benchmark is 0.3 or higher. Statistical significance of the slope: We consider how likely it is that the relationship is not a coincidence. Here we use the p-value to evaluate significance of slope, and the smaller the p-value the better. The standard benchmark for a significant slope is a pvalue of 0.05 or less. 3-26

Exercise 3.8 (Continued) Economic plausibility: We consider the feasibility of there being a relationship between the two variables. There is no benchmark here, but a more subjective evaluation is conducted. d.

The team will use the model going forward to estimate its shipping expense based on an estimated number of units to be sold. The full output of the regression model will specify the slope of the line as well as the intercept of the line so that the cost function can be expressed in Y = m(X) + b format, where Y represents the quarterly shipping expense and X represents the units sold in that quarter. Delaney Company should feel comfortable using the model to estimate shipping expenses as long as units sold falls within the relevant range of activity that was used to generate the regression or high-low model. We can see from the scatter plot that range is from 10,000 to 20,000 units. If the volume of units sold falls outside of that range, the company may still choose to use the given model to estimate shipping expense, but they should do so with caution as the relationship between X and Y could be very different outside of this range.

LO: 2, 3, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, Data Analytics, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics, Technology & Analytics: Visualization

Exercise 3.9 (15–20 minutes) a.

Recreate the given table in Excel.

To create the scatter plot, select the “Machine hours” and “Power cost” columns. Go the “Insert” tab, click the “Scatter” button in the “Charts” section, and select the first option (the basic scatter plot).

Exercise 3.9 (Continued)

The scatter plot created should look like this:

Power cost $70,000 $60,000 $50,000 $40,000 $30,000 $20,000

$10,000 $0 0

10,000

20,000

30,000

40,000

50,000

We can see by looking at the scatter plot that the distribution of points does exhibit a linear relationship within the given range of activity, which is between 25,200 and 42,000 machine hours. b.

The highest point based on machine hours occurs in quarter 3 (42,000, $59,500), and the lowest point based on machine hours occurs in quarter 6 (25,200, $40,600). We use the formula below to solve for slope (m):

Exercise 3.9 (Continued) m=

Y2 − Y1 X2 − X1

$59,500 − $40,600 42,000 − 25,200

$18,900 16,800

m = $1.125 per machine hour Now we can use the equation of a line Y = m(X) + b, either the high or the low data point, and the slope of $1.125 to find b. Here is the calculation using the low point: Y = m(X) + b $40,600 = ($1.125)(25,200) + b $40,600 = $28,350 + b $40,600 − $28,350 = b b = $12,250 Here is the calculation using the high point: $59,500 = $1.125(42,000) + b $59,500 − ($1.125 × 42,000) = b $59,500 − $47,250 = b b = $12,250 Therefore, the full cost function is: Y = $1.125X + $12,250. To add the high-low line to the scatter plot in Excel, go to the “Insert” tab, click “Shapes,” and select the line. Draw a line connecting the point at (25,200, $40,600) and the point at (42,000, $59,500). If we extend that line through the y-axis, it should look similar to this:

Exercise 3.9 (Continued) c.

Using the table we created in Excel, we’ll run a regression by following these steps: 1. Go to the “Data” tab. 2. On the right side of the toolbar, in the “Analysis” section, click on “Data Analysis.”

3. Scroll down, select “Regression,” then click “OK.”

4. Select the “Power cost” column (including header and data points) for Input Y Range, and select the “Machine hours” column (including header and data points) for Input X Range. 5. Check the box next to “Labels,” then click “OK.” The regression output will appear in a new worksheet.

Exercise 3.9 (Continued) The regression output should look like this:

From this output, we can see that the full cost function is: Y = 1.101(X) + 12,489.61 Where X = the number of machine hours. The values shown here are found in the bottom section of the output, in the column labeled “Coefficients,” here we show them inside a blue frame. The coefficient for the “Machine hours” row is the slope (m), also known as the variable cost. The coefficient for the “Intercept” row is just that—the Y-intercept (b), also referred to as our estimate of the fixed cost. d.

Looking at the high-low line we created on the scatter plot in part (b), we can see that it’s a fairly good fit to the data points. It splits the data points equally, and there are no significant outliers. The line also appears to have a slope that is different from zero, because the slope is clearly positive, following an upward trend. If the slope were zero, the line would be flat (horizontal). Looking at the regression output we created in part (c), we can evaluate the goodness of fit with the R-Square value. The higher the R-Square the better the fit, and an R-Square of >.30 is the threshold we will use to determine a reasonable fit. This R-Square (0.7445) is higher than the standard, suggesting a very good fit. We can evaluate the significance of slope by looking at the p-value. The lower the pvalue, the better. A p-value of less than 0.05 suggests a significant relationship between the independent variable and the dependent variable. The slope in this model is statistically significant because its p-value is very low (0.0013).

Exercise 3.9 (Continued) We could also visually inspect the regression line in the context of the scatter plot to better understand the fit and slope, as shown below.

Inspection of this line helps us compare the regression line with the previously created high-low line. We can see that the two lines are very similar in terms of their slope and their estimated intercept. Since the low and high data points were very representative of the overall dataset, the high-low model is very similar to the regression model. Both lines have a good fit, although the regression line is mathematically the best-fitting line. If we did not have access to Excel, we could use the high-low method to estimate this relationship and we would get a good estimate of the cost function. LO: 2, 3, Bloom: AN, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Communication, Analytic, Technology, Data Analytics, AICPA BC: N/A, AICPA AC: Reporting, Technology and Tools, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics, Technology & Analytics: Visualization

Exercise 3.10 (20–25 minutes) a.

Recreate the given table in Excel.

Exercise 3.10 (Continued) To create the scatter plot, select the “Number of nights in apartment” and “Food expense” columns. Go the “Insert” tab, click the “Scatter” button in the “Charts” section, and select the first option (the basic scatter plot).

The scatter plot created should look like this:

Upon visual inspection of the scatter plot, we can see that the observations do not clearly follow a linear pattern within the current range of activity, which is from 25 nights to 54 nights. If we were pressed to imagine a straight line fitting this data, we would likely draw a slightly upward-sloping line through the observations. But it would not fit the data very well. b.

To run a regression, we’ll follow these steps: 1. Go to the “Data” tab.

Exercise 3.10 (Continued) 2. On the right side of the toolbar, in the “Analysis” section, click on “Data Analysis.”

3. Scroll down, select “Regression,” then click “OK.”

4. Select the “Food expense” column (including header and data points) for Input Y Range, and select the “Number of nights in apartment” column (including header and data points) for Input X Range (column titles included). 5. Check the box next to “Labels,” then click “OK.”

Exercise 3.10 (Continued) The regression output should look like this:

From this output, we can specify the full cost function as follows: Y = $3.15(X) + $259.51 Where X = the number of nights in the apartment per month, and Y = monthly food expense. The values included in the equation above are found in the bottom section of the output, in the column labeled “Coefficients.” The coefficient in the “Number of nights in apartment” row is the slope (m), and the coefficient in the “Intercept” row is just that—the Y-intercept (b). The slope, m, is also referred to as the variable cost estimate. The intercept, b, is also referred to as the fixed cost estimate. c.

Goodness of fit: The very low R-Square value (found in the regression output) of 0.078 informs us that the line is not a good fit for the data. It is far below the general standard of being greater than or equal to 0.30. Even though regression analysis will create a line of best fit from the data, it doesn’t mean the line is actually going to be a good fitting line. Significance of the slope: This independent variable lacks statistical significance, given its high p-value of 0.468. A p-value of less than or equal to 0.05 informs us of a statistically significant relationship between X and Y; the p-value here is well outside of that range. (The lower the p-value, the less likely it is that this relationship is deemed to occur by chance.) Economic plausibility: While there could be some logic to relating the number of nights spent at the apartment with food cost, there are many other variables to consider, so it’s really not surprising that this relationship has a poor fit.

Exercise 3.10 (Continued) d.

There are many (other) variables that could affect the amount these two roommates spent on food in a given month, such as: 1. Did Alan’s parents bring food to the apartment sometimes, since they live nearby? 2. When they were tired from studying, did they order out instead of making their own meals? 3. If they had friends over, the food cost would probably be much higher, but this variable does not account for situations like that, because they would be considered “at the apartment” in that situation. 4. Did they stock up on pantry items and frozen food when only one person was in the apartment only to use that food in a subsequent month? 5. Did Alan eat three meals a day in the apartment only to spend the night at his parent’s house? These examples provide a few considerations; there are many other factors that could play into the roommates’ total food expense, as well.

LO: 3, Bloom: AN, Difficulty: Moderate, Time: 20-25, AACSB: Knowledge, Communication, Analytic, Technology, Data Analytics, AICPA BC: N/A, AICPA AC: Reporting, Technology and Tools, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics, Technology & Analytics: Visualization

Exercise 3.11 (20–25 minutes) a.

Recreate the given table in Excel.

To create the scatter plot, select the “Marketing cost” and “Revenues” columns. Go to the “Insert” tab, click the “Scatter” button in the “Charts” section, and select the first option (the basic scatter plot).

Exercise 3.11 (Continued)

The scatter plot created should look like this:

The scatter plot helps us to evaluate the assumption of linearity, and we can see by looking at the distribution of data points that they are clearly following an upward linear trend. Therefore, the assumption of linearity appears to be met. b.

To run a regression model, we’ll follow these steps: 1. Go to the “Data” tab.

Exercise 3.11 (Continued) 2. On the right side of the toolbar, in the “Analysis” section, click on “Data Analysis.”

3. Scroll down, select “Regression,” then click “OK.”

4. Select the “Revenues” column (including the header and data points) for Input Y Range, and select the “Marketing cost” column (including the header and data points) for Input X Range (column titles included). 5. Check the boxes next to “Labels,” then click “OK.”

Exercise 3.11 (Continued) The regression output should look like this:

Goodness of fit: The R-Square value is 0.713, which is high, showing a strong goodness of fit (we consider an R-Square value of >=0.30 a reasonably good fit). Significance of the independent variable (significance of the slope): The p-value of 0.0006 is very low, showing a highly significant independent variable/slope (generally an independent variable with a p-value of <0.05 is considered statistically significant). Economic plausibility: Conceptually, yes, the amount spent on marketing should relate to and partially explains revenues, so this relationship is economically plausible. The final model is Y = $21.18(X) + $73,135.96 Where X represents marketing cost. These values included in the above equation are found in the bottom section of the regression output, in the column labeled “Coefficients.” The coefficient in the “Marketing cost” row is the slope or variable cost (m), and the coefficient in the “Intercept” row is just that: the Y-intercept or the fixed cost (b). c.

To predict revenues when $24,000 is spent on marketing, we can insert $24,000 in for X in that model: Y = $21.18(X) + $73,135.96 Y = $21.18($24,000.00) + $73,135.96 Y = $508,320.00 + $73,135.96 Y = $581,455.96

Exercise 3.11 (Continued) If I were Nick, I would be cautious to put too much reliance on this projection, as the anticipated marketing cost of $24,000 is outside the current range of activity from which the model was estimated (that range was between $10,000 and $22,000 of marketing cost). Further, upon more careful visual interpretation of the scatter plot, it appears the slope may taper off at levels beyond the current activity range. This model may or may not be reliable for costs of $24,000. Because of these reasons, he should be cautious about anticipating projected revenues that far exceed what he has generated in any of the last twelve months. LO: 3, Bloom: AN, Difficulty: Moderate, Time: 20-25, AACSB: Knowledge, Communication, Analytic, Technology, Data Analytics, AICPA BC: Strategic Perspective, AICPA AC: Reporting, Technology and Tools, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics, Technology & Analytics: Visualization

Exercise 3.12 (10–15 minutes) a.

Marketing expenditures Number of units sold Number of salespeople

Goodness of Fit (evaluated with RSquare value; RSquare > 0.30 reflects a good fit)

Statistical significance (evaluated with pvalue; p-value <0.05 is statistically significant)

Economic Plausibility (is the relationship plausible, that X will help explain Y)

Very good; 0.5968

Very good; 0.0032

Plausible

Good; 0.3601

Very good; 0.039

Plausible

Poor; 0.011

Poor; 0.74

Plausible

The marketing expenditures and units sold variables produce valid models, while number of salespeople is not a valid cost driver based on the goodness of fit and statistical significance criteria. b.

She should not have used number of salespeople in any of the models, instead just focusing on marketing expenditures and units sold, as each of these two variables on their own produced valid models. The multiple-regression model using marketing expenditures and units sold is appropriate to consider, but unfortunately is not valid overall. The model has a good fit, given the high R-Square value of 0.61. One of the two variables, however, Units sold, lacks statistical significance given its high p-value (0.63). The other two models were not appropriate to run in the first place, given the Number of salespeople variable that is included in them. While these models also have strong RSquare values indicating goodness of fit, the Number of salespeople variable lacks statistical significance given their high p-values. We also note that the R-Square value does not increase noticeably when either additional variable is added to the model compared to the original model with Marketing Expenditures alone.

Based on the validity criteria, Ning should select the best single cost driver from her initial regression models, since none of the multiple regression models proved to be valid. The marketing expenditures model is the strongest model, given it generated the highest R-Square and most significant p-value. Its cost function is:

Exercise 3.12 (Continued) Y = $2.06(X) + $212,766.67 Where X = marketing expenditures. Remember, the slope is pulled from the coefficient for marketing expenditures, and the fixed cost from the coefficient of the intercept. If we insert budgeted marketing expenditures for next year of $90,000 for X, we find: Y = $2.06($90,000.00) + $212,766.67 Y = $185,400.00 + $212,766.67 Y = $398,166.67 Where Y = budgeted sales for next year. LO: 3, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, Technology, Data Analytics, AICPA BC: Strategic Perspective, AICPA AC: Reporting, Technology and Tools, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

Exercise 3.13 (10–15 minutes) a.

Since we know that both Jonas and his associate spend four hours on their first assessment, and that they operate on 90% and 95% learning curves, respectively, we can calculate the amount of time they’re expected to need on their fourth assessment. Every time output doubles, the amount of time for that doubled quantity is estimated to be the previous halved quantity × the learning curve percentage. Let’s start with Jonas. First assessment: 4.00 hours Then he doubles his output to two: Second assessment: 4.00 × 0.90 = 3.60 hours Then he doubles his output to four: Fourth assessment: 3.60 × 0.90 = 3.24 hours Jonas Unit Time per “Unit” Calculation 1 4.00 Given 2 3.60 = 4 × 0.90 4

3.24 = 3.6 × 0.90

The same idea is followed for Jonas’ Associate Unit Time per “Unit” Calculation 1 4.00 Given 2 3.80 = 4 × 0.95 4

3.61 = 3.8 × 0.95

Mr. Gallagher would expect Jonas to spend 3.24 hours on his fourth assessment while his associate would be expected to spend 3.61 hours on the fourth assessment. b.

For the first assessment, they each took four hours to complete the work. We can find the total billing amount for this first assessment session by multiplying each associate’s time by their respective billing rates and add them together: Jonas (4.00 hours × $200) = $ 800 Jonas’ associate (4.00 hours × $100) = 400 Total billing amount $1,200 3-41

Exercise 3.13 (Continued) For the second assessment, Jonas is expected to need 3.60 hours and his associate should require 3.80 hours (both quantities reflected above). Jonas (3.60 hours × $200) = $ 720 Jonas’ associate (3.80 hours × $100) = 380 Total billing amount $1,100 The billing amount for the second assessment would be $100 lower than the billing amount for the first assessment. The only reason for the difference is the lower amount of time they are each expected to spend on this second risk assessment compared to the first risk assessment. c.

Since it appears that these jobs essentially reflect the same work performed multiple times, it would be most fair to bill both clients the same amount and not charge the first client more just because that client was unfortunate enough to be the first client. It would make good business sense to use a more stable pricing model for this type of work. While Mr. Gallagher’s clients may not know each other and may not share information about their own consulting endeavors, it would be regrettable if a client felt they were charged an unfair price because their project helped to more or less “train in” the consulting firm’s staff.

LO: 4, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, Data Analytics, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

Exercise 3.14 (20–25 minutes) a.

The total cost of making the first cake would be $29.04: Cost Category Amount Calculation DM $ 9.00 Given DL preparation 10.00 = 60 min. ÷ 60 min. = 1 hour × $10 per hour DL cooking 6.70 = 40 min. ÷ 60 min. = 0.67 hours × $10 per hour MOH 3.34 = ($10.00 + $6.70) × 0.20 Total cost

$29.04

An 85% learning curve means that prep for her second cake would take 85% of the time it took to prep the first one. We can follow the same process as in part (a) to calculate the total cost for her second cake. Cost Category Amount Calculation DM $ 9.00 Given = (60 min. × 0.85) = 51 min. ÷ 60 min. = 0.85 hours × DL preparation 8.50 $10 per hour DL cooking 6.70 = 40 min. ÷ 60 min. = 0.67 hours × $10 per hour MOH 3.04 = ($8.50 + $6.70) × 0.20 Total cost

$27.24

Keep in mind the learning here only affects the prep time; it does not affect the cooking time, nor does it affect the DM cost. 3-42 © 2022 John Wiley & Sons, Inc. or the author, All rights reserved. Farmer, Cost Accounting, 1e, Job Costing Visualized (For Instructor Use Only)

Exercise 3.14 (Continued) c.

To determine the total cost for all four cakes, we can first use our learning curve knowledge and determine how much total prep time she will need for all four cakes (the time for the third cake was given): Unit Time per Unit Cumulative Total Time 1 60.00 60.00 2 51.00 111.00 3 46.37 157.37 4 *43.35 **200.72 *The time for the fourth cake = Time for the 2nd cake × Learning curve percentage, or 51 minutes × 0.85 = 43.35 minutes. **The cumulative total time is the sum of the individual units to that point. The total cumulative time for 4 units = 60 + 51 + 46.37 + 43.35 = 200.72 minutes. The total cost for all four cakes: Cost Category Amount Calculation DM $ 36.00 $9 per cake × 4 cakes = 200.72 min. ÷ 60 min. = 3.35 hours × $10 per DL preparation 33.50 hour = (40 min. per cake × 4 cakes) = 160 min. ÷ 60 DL cooking 26.70 min. = 2.67 hours × $10 per hour MOH 12.04 = ($33.50 + $26.70) × 0.20 Total cost

$108.24

To find her average cost per cake, we divide $108.24 by four: $108.24 ÷ 4 = $27.06 d. Time spent prepping her first cake 60.00 minutes Less: Time spent prepping her fourth cake 43.35 minutes Difference 16.65 minutes She saved over 16 minutes of prep time from her original cake under this learning curve assumption. If she continues to make this cake and believes the learning curve of 85% is still reasonable, she will estimate prep time of just 36.85 minutes for her eighth cake (estimated time spent prepping fourth cake 43.35 minutes × 0.85 = 36.85 minutes). Given the significant reduction in time from the first to this eighth cake, it may not be reasonable to expect prep time to continue to drop at this rate. Eventually Kathy will have the process down to a science, with no more efficiencies to gain. We can’t predict the number of cakes it will take for her to hit this plateau in terms of prep time, though. LO: 4, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Knowledge, Communication, Analytic, Data Analytics, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

Solutions to Problems Problem 3.1 a.

There was an average of 80 administrative labor hours needed per project last year. We come to this conclusion by dividing the administrative labor hours in Year 8 by the number of projects. 2,800 admin. labor hours ÷ 35 projects = 80 admin. labor hours/project If 34 projects are anticipated, we would have the following costs: Cost Type Cost Calculation 34 projects × 80 hours each = 2,720 hours × $15 per Labor cost $40,800 hour Supplies 6,000 10% of the total administrative expense of $60,000 Depreciation 12,000 20% of total administrative expense of $60,000 Total costs $58,800 Office supplies and depreciation are fixed costs. The problem notes they “remain steady,” so we can base these off the Year 8 total administrative expenses.

Using the high-low method to create the cost function for administrative expenses, we will take the following steps: The highest point based on administrative labor hours occurs in year 8 (2,800, $60,000), and the lowest point based on administrative labor hours occurs in year 1 (1,825, $42,000). We use the formula below to solve for slope (m): Y2 − Y1 m= X2 − X1 m=

$60,000 − $42,000 2,800 − 1,825

$18,000 975

m = $18.46 per admin. lab. hour Now we can use the equation of a line Y = m(X) + b, either the high or the low data point, and the slope of $18.46 to find b. Here is the calculation using the low point: Y = m(X) + b $42,000.00 = ($18.46)(1,825) + b $42,000.00 = $33,689.50 + b $42,000.00 − $33,689.50 = b b = $8,310.50

Problem 3.1 (Continued) Here is the calculation using the high point: $60,000 = $18.46(2,800) + b $60,000 = $51,688 + b $60,000 − $51,688 = b b = $8,312 The fixed cost estimates are slightly different due to rounding of the variable rate. The full cost function (using the fixed cost estimate from the low point): Y = $18.46X + $8,310.50 Where X = administrative labor hours. If we insert the expected 2,700 hours into the equation, we have: Y = ($18.46)(2,700) + $8,310.50 = $58,152.50 The full cost function (using the fixed cost estimate from the high point): Y = $18.46X + $8,312 Where X = administrative labor hours. If we insert the expected 2,700 hours into the equation, we have: Y = ($18.46 × 2,700) + $8,312 = $58,154 c. Account analysis model prediction $58,800.00 High-low model prediction* 58,152.50 Difference $ 647.50 *Using the fixed cost estimate from the low point; if the fixed cost estimate from the high point had been used, the difference would be $646 ($58,800 − $58,154). Both models have very similar predictions; they differ by only $647.50 as is. Looking into the details for each model a bit closer: the account analysis model predicted 2,720 administrative labor hours for the 34 anticipated projects, while the high-low model prediction was based on 2,700 anticipated administrative labor hours. If we were to use the same number of administrative labor hours in the high-low model as what was used in the account analysis model, the two projections would be even closer: Account analysis model prediction (as is) $58,800.00 Less: High-low model prediction (using 2,720 hours) 58,521.70 Difference $ 278.30 If new administrative equipment is purchased next year, the firm’s fixed assets will change, causing a change in depreciation. The account analysis method would explicitly allow for and recognize any change in depreciation cost. The projection under that method could be adjusted quite easily to reflect a higher depreciation cost.

Problem 3.1 (Continued) The high-low method, as based on prior years’ data and driven only by administrative labor hours, would not incorporate a change in fixed costs until new data were included in the analysis (that is, unless or until the model was estimated again after next year’s total administrative expense was known, along with next year’s total administrative labor hours). LO: 1, 2, Bloom: AN, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Communication, Analytic, Data Analytics, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

Problem 3.2 a.

See the scatter plot, below:

Dollars earned from mowing

$ Earned from Mowing $80.00 $70.00 $60.00 $50.00 $40.00 $30.00 $20.00 $10.00 $0

Inches of rain

The observations appear to follow a linear and upward-sloping pattern. If all students were asked to draw a line through the points, they would each likely draw a very similarlooking line. b.

The highest point based on inches of rain occurs in week 8 (4.1, $67.5), and the lowest point based on inches of rain occurs in week 5 (0.2, $35). We use the formula below to solve for slope (m): Y2 − Y1 m= X2 − X1 m=

$67.50 − $35 4.1 − 0.2

$32.50 3.9

m = $8.33 per inch of rain Now we can use the equation of a line (Y = m(X) + b), with either the high or the low data point, and the slope of $8.33 to find b, also referred to as the fixed cost estimate. Here we use the high point: Y = m(X) + b $67.50 = ($8.33)(4.1) + b $67.50 = $34.15 + b $67.50 − $34.15 = b b = $33.35 The estimate for the fixed cost using the low point is as follows: $35.00 = $8.33(0.2) + b $35.00 = $1.67 + b $35.00 − $1.67 = b b = $33.33 3-47 © 2022 John Wiley & Sons, Inc. or the author, All rights reserved. Farmer, Cost Accounting, 1e, Job Costing Visualized (For Instructor Use Only)

Problem 3.2 (Continued) The fixed cost estimates differ slightly because of rounding in the variable rate. The high-low cost function would be specified as follows (using the fixed cost estimate at the high point), where X = inches of rain: Y = $8.33X + $33.35 The high-low cost function would be specified as follows (using the fixed cost estimate at the low point): Y = $8.33X + $33.33

Upon visual inspection of the high-low line within the scatter plot, it appears the model fits the data quite well, with an almost equal number of points above and below the line. The slope of the line is also positive and upward sloping, suggesting a strong relationship between inches of rain and weekly mowing earnings. c.

If we create a regression model in Excel using the steps outlined in the Chapter Tutorial, using inches of rain as “X” and dollars earned as “Y,” we get the output, reproduced below.

Problem 3.2 (Continued) Goodness of fit: The regression model with a desirable high R-square (0.8266) suggests a strong goodness of fit, as it is above the standard of being greater than or equal to 0.30. Significance of the slope: this independent variable has a low p-value of 0.0017 suggesting a statistically significant independent variable. Economic plausibility: It is economically plausible that a relationship would exist between inches of rain and mowing earnings, since rain affects grass growth. The scatter plot with the embedded trend line is shown below. This visual evidence helps us see why the R-Square value was so high—clearly the model is a well-fitting model.

The formal cost function resulting from this model is: Y = $6.92X + $38.23 Where X = inches of rain. 6.92 is the coefficient for inches of rain, and 38.23 is the coefficient for the intercept. d.

The two scatter plots with the revenue lines presented in them help us see how similar the two models are. Both models have a strong goodness of fit and show a strong relationship between the independent and dependent variable. The results of the slope and fixed costs for the high-low and regression models are summarized in the table below. The high-low model has the highest variable rate, while the regression model has the highest fixed costs. Slope Fixed costs High-low $8.33 $33.35 Regression $6.92 $38.23

Problem 3.2 (Continued) e.

Either of these models would be appropriate for prediction since they are both good models overall. Since the regression method generated the best-fitting line, though, it would be the preferred model since it is available here. Using the regression equation, we insert the estimated inches of rain for next week into the equation as X to get Y, the weekly mowing earnings: Y = $6.92X + $38.23 Y = ($6.92 × 3.8) + $38.23 Y = $26.30 + $38.23 Y = $64.53

LO: 1, 2, 3, Bloom: AN, Difficulty: Moderate, Time: 20-25, AACSB: Knowledge, Communication, Analytic, Technology, Data Analytics, AICPA BC: Strategic Perspective, AICPA AC: Reporting, Technology and tools, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics, Technology & Analytics: Visualization

Problem 3.3 a.

The scatter plot below visually presents the relationship between inspection hours and inspection costs:

We can see a linear trend to the data, a general upward-sloping trend, so the assumption of linearity is met. When we run the regression using inspection hours as the independent variable, we get the following output (for step-by-step instructions on creating a regression model, see InChapter Tutorial for Learning Objective 3).

Problem 3.3 (Continued) This regression model looks good overall. In terms of validity: Goodness of fit: The very high R-Square value of 0.651 informs us that the line is a good fit for the data. We use a standard 0.30 or greater for an acceptable fit; this R-Square value exceeds that standard. Significance of slope: This independent variable is statistically significant given its very low p-value of 0.0015. A p-value of less than or equal to 0.05 informs us of a statistically significant relationship between X and Y; the p-value here is well within that range. (The lower the p-value, the less likely it is that this relationship occurred by chance). Economic plausibility: It is plausible to expect the number of inspection hours to relate to and possibly even to cause the inspection costs. The formal cost function for this regression model is: Inspection costs = ($129.29 × Inspection hours) + $25,474.53. The variable rate of $129.29 is the coefficient for inspection hours, while the $25,474.53 fixed cost is the coefficient from the Intercept term in the Excel output, above. b.

The scatter plot for the number of inspections against inspection costs is shown here:

A linear, upward-sloping trend is apparent in this scatter plot, as well. When we run the regression using number of inspections as the independent variable, we get the following output (for step-by-step instructions on creating a regression model, see In-Chapter Tutorial for Learning Objective 3).

Problem 3.3 (Continued)

This regression model looks good overall, too. In terms of validity: Goodness of fit: The very high R-Square value of 0.6028 informs us that the line is a good fit for the data. We use a standard 0.30 or greater for an acceptable fit; this RSquare value exceeds that standard. Significance of slope: This independent variable is statistically significant given its very low p-value of 0.0030. A p-value of less than or equal to 0.05 informs us of a statistically significant relationship between X and Y; the p-value here is well within that range. (The lower the p-value, the less likely it is that this relationship occurred by chance). Economic plausibility: It is plausible to expect the number of inspections to relate to the inspection costs. The formal cost function for this regression model is: Y = $458.08X + $7,893.10 Where X = number of inspections. The values included in the equation above are found in the bottom section of the Excel output, in the column labeled “Coefficients.” The variable rate of $458.08 is the coefficient for Inspection hours, while the $7,893.10 fixed cost is the coefficient from the Intercept term. c.

Based on the analysis in a and b, both models are valid. Both demonstrate a strong Rsquare and significant p-values, suggesting they both are viable independent variables. Since Hakika is looking to provide a strong model, she would be wise to consider a multiple regression model with both variables, since each proved valuable on its own.

To generate a multiple regression model in Excel, we need to include the consecutive columns for both independent variables, when identifying the “X” range: 3-53

Problem 3.3 (Continued)

This multiple regression model provides the following output (below).

This model is superior to both simple regression models based on our validity criteria: Goodness of fit: The strong R-square of 0.7812 shows an improvement over both individual regression R-square values.

Problem 3.3 (Continued) Significance of the slope: Both independent variables remain statistically significant in this multiple regression model, as well, according to their low p-values of 0.0241 and 0.0461, respectively. Economic plausibility: It is very plausible to expect the number of inspections and hours spent inspecting to relate to the inspection costs. This multiple regression model would be specified as follows: Y = ($85.15X1) + ($267.70X2) + $1,966.69 Where X1 = inspection hours, and X2 = number of inspections The values included in the equation above are found in the bottom section of the Excel output, in the column labeled “Coefficients.” e.

Hakika’s boss is likely to find this information very useful. Her boss can use this multiple regression model to predict their inspection costs going forward if they have an estimate for the number of inspections to be performed and the number of inspection hours expected. These two independent variables are very likely to be part of the company’s budgeting process and data collection process already. By including the budgeted amounts for each of these variables into the equation above, her boss can get a reasonable estimate for the company’s inspection costs going forward.

LO: 1, 3, Bloom: AN, Difficulty: Complex, Time: 25-30, AACSB: Knowledge, Communication, Analytic, Technology, Data Analytics, AICPA BC: Strategic Perspective, AICPA AC: Reporting, Technology and Tools, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics, Technology & Analytics: Visualization

Problem 3.4 a.

Below are the scatterplots for the three possible independent variables in comparison to weekly delivery costs: miles per week, packages per week, and locations per week. The first two scatter plots—for miles per week and packages per week—both seem to exhibit linearity. The third plot for locations per week lacks any distinguishable linearity and raises some concern about any meaningful relationship between these variables.

We ran separate regression models for each possible independent variable in Excel (for step-by-step instructions on creating a regression model, see In-Chapter Tutorial for Learning Objective 3).

Problem 3.4 (Continued) Miles per Week: The regression output for miles per week as the independent variable is reproduced below:

Goodness of fit: This model has a good fit as evidenced by its high R-Square value of 0.5987 (an R-Square of higher than 0.30 is considered a reasonable fitting model). Significance of independent variable (slope): This independent variable, Miles per week, has a statistically significant relationship to the dependent variable as evidenced by its very low p-value of 0.0002 (a p-value of less than 0.05 is considered statistically significant). Economic plausibility: It is plausible that the more miles the company drives for delivery the more its overall delivery costs would be. The formal cost function for this model would be specified as follows: Y = $3.48(X) + $21,926.18 Where Y= Weekly delivery costs, and X = number of delivery miles per week.

Problem 3.4 (Continued) Packages per Week: The regression output for packages per week as the independent variable is reproduced below:

Goodness of fit: This model has a good fit as evidenced by its high R-Square value of 0.6913 (an R-Square of higher than 0.30 is considered a reasonable fitting model). Significance of independent variable (slope): This independent variable, Packages per week, has a statistically significant relationship to the dependent variable as evidenced by its very low p-value of 0.00002 (notice the negative exponent, recognizing the decimal is actually located 5 places to the left). A p-value of less than 0.05 is considered statistically significant. Economic plausibility: It is plausible that the more packages the company delivers, the higher its delivery costs will be. The formal cost function for this model would be specified as follows: Y = $8.00(X) + $7,813.16 Where Y= Weekly delivery costs, and X = number of packages delivered per week.

Problem 3.4 (Continued) Locations per Week: The regression output for packages per week as the independent variable is reproduced below:

Goodness of fit: This model has a poor fit as evidenced by its low R-Square value of 0.0155 (an R-Square of higher than 0.30 is considered a reasonable fitting model). Significance of independent variable (slope): This independent variable, Locations per week, does not have a statistically significant relationship to the dependent variable as evidenced by its very high p-value of 0.622. A p-value of less than 0.05 is considered statistically significant. Economic plausibility: It is plausible that the more locations the company delivers to, the higher its delivery costs will be. The formal cost function for this model would be specified as follows: Y = $3.82(X) + $66,009.33 Where Y= Weekly delivery costs, and X = number of locations delivered to per week. c.

Since the first two variables meet all three validity criteria, Nathan should consider further analysis with those variables: miles per week and packages per week.

If he were to choose just one independent variable, he would likely choose the number of packages per week. This model has a better fit than the number of miles per week as evidenced by its higher R-Square value; this independent variable also has a more significant relationship with delivery costs (the dependent variable) than the number of miles per week, as evidenced by its lower p-value.

Problem 3.4 (Continued) This final model, if they decide to move forward with just one variable in the model, is as follows: The formal cost function for this model would be specified as follows: Y = $8.00(X) + $7,813.16 Where Y = Weekly delivery costs, and X = number of packages delivered per week. LO: 1, 3, Bloom: AN, Complex, Time: 25-30, AACSB: Knowledge, Communication, Analytic, Technology, Data Analytics, AICPA BC: Strategic Perspective, AICPA AC: Reporting, Technology and Tools, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

Problem 3.5 a.

From the analysis in problem 4, two of the three possible independent variables were considered for further analysis. The table below identifies the variables as well as key output as evidence for goodness of fit and significance of slope for each: Independent variable Miles per week Packages per week

R-Square 0.5987

P-value 0.0002

0.6913

<0.0001

The R-Square values, above, provide evidence for goodness of fit. Both variables have high R-Square values that exceed the 0.30 threshold. The p-values, above, provide evidence for statistical significance of the slope, or the statistical significance of the independent variable. Both show very low p-values, well below 0.05, which is preferred. b.

To run the multiple regression model with these two variables: 1. Go to the “Data” tab. 2. On the right side of the toolbar, in the “Analysis” section, click on “Data Analysis.”

3. Scroll down, select “Regression,” then click “OK.”

4. Select the “Weekly delivery cost” column (including the header and all data points) for Input Y Range, and both the “Miles per week” and “Packages per week” columns (including the headers and all data points) for Input X Range (column titles included).

Problem 3.5 (Continued) 5. Check the boxes next to “Labels,” then click “OK.”

The regression output should look like this:

Goodness of fit: This model has a very good fit as evidenced by its high R-Square value of 0.7871 (an R-Square of higher than 0.30 is considered a reasonable fitting model). Significance of independent variables (slopes): Both independent variables maintain statistical significance in this multiple regression model, with very low p-values: Miles per week: Its p-value is 0.0202. Packages per week: Its p-value is 0.0024. P-values below 0.05 signify a statistically significant relationship.

Problem 3.5 (Continued) Economic plausibility: It is plausible that both variables, together, would help explain the company’s delivery costs. The formal cost function for this multiple regression model would be specified as follows: Y = $1.83(X1) + $5.47(X2) + $1,275.13. Where Y= Weekly delivery costs, X1 = number of miles driven each week, and X2 = number of packages delivered each week. c.

Since the independent variables maintain statistical significance in all models, the main point of comparison will be the goodness of fit, as evidenced by the R-Square value for each of the following models: 1. Miles per week, individual regression model: R-Square 0.5987 2. Packages per week, individual regression model: R-Square 0.6913 3. Multiple regression, two independent variables: R-Square 0.7871 The multiple regression model reveals an R-Square that is higher than either of the single regression models, while maintaining statistical significance for both independent variables. Because of the improvement in fit while keep both variables significant, we can conclude that the multiple regression model is the best of these three models to explain the company’s delivery costs.

LO: 1, 3, Bloom: AN, Difficulty: Complex, Time: 20-25, AACSB: Knowledge, Communication, Analytic, Technology, Data Analytics, AICPA BC: Strategic Perspective, AICPA AC: Reporting, Technology and Tools, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics, Technology & Analytics: Visualization

Problem 3.6 a.

To determine the best cost formula, and particularly which of the available independent variables should be considered further, we will evaluate the key assumption of linearity and evaluate the validity of each independent variable on its own. Enter the data into Excel to recreate the table shown in the problem. Assumption of linearity: scatter plots are created for each potential cost driver as shown below, to evaluate the assumption of linearity.

Problem 3.6 (Continued)

The scatter plots for DL hours and DM costs reveal linear, upward sloping trends. There is no visible linear trend in the Machine hour plot, though, and while the Material moves scatter plot suggests a linear relationship, it appears to be a flat, horizontal trend. The following regression analysis will help determine the goodness of fit and significance of each of these relationships. Regression analysis for each individual variable on its own: We can now run a regression model individually for each independent variable, by following these steps: 1. Go to the “Data” tab. 2. On the right side of the toolbar, in the “Analysis” section, click on “Data Analysis.” 3. Scroll down, select “Regression,” then click “OK.” 4. Select the data and label in the “Overhead costs” column for Input Y Range, and the data and label of the independent variable you’re analyzing for Input X Range (column titles included). 5. Check the boxes next to “Labels,” then click “OK.” A screenshot is shown, below, for generating the DL hours regression model:

Problem 3.6 (Continued) DL hours regression output:

We conduct the same type of analysis for each of the remaining independent variables. Machine hours regression output:

Problem 3.6 (Continued) DM costs regression output:

Number of material moves regression output:

Now we can compare the validity of each model using select output. • DL hours • Goodness of fit: R-Square = 0.5548, which is good. It’s above the threshold of 0.30 signifying a reasonably good fit.

Problem 3.6 (Continued) •

•

Significance of independent variable: P-value = 0.0004, which is good. It is very low, and the lower the p-value the better (a p-value below 0.05 is considered statistically significant). • Economic plausibility: It is plausible that DL hours could explain the company’s overhead costs. Conclusion: DL hours is a viable cost driver for the company’s overhead costs and should be considered further. Machine hours • Goodness of fit: R-Square = 0.0117, which is poor. It’s far below the threshold of 0.30. • Significance of independent variable: P-value = 0.6694, which is poor. This variable is not statistically significant since the p-value is not <0.05. • Economic plausibility: It is plausible that Machine hours could explain the company’s overhead costs. Conclusion: Machine hours should not be considered further since it does not meet all validity criteria. DM cost • Goodness of fit: R-Square = 0.5769, which is good. It’s above the threshold of 0.30 signifying a reasonably good fit. • Significance of independent variable: P-value = 0.0003, which is good. It is very low, and the lower the p-value the better (a p-value below 0.05 is considered statistically significant). • Economic plausibility: It is plausible that DM costs could explain the company’s overhead costs. Conclusion: DM cost is a viable cost driver for the company’s overhead costs and should be considered further. Material moves • Goodness of fit: R-Square = 0.1288, which is poor. It’s far below the threshold of 0.30. • Significance of independent variable: P-value = 0.1436, which is poor. This variable is not statistically significant since the p-value is not <0.05. • Economic plausibility: It is plausible that the number of material moves could explain the company’s overhead costs. Conclusion: Number of material moves should not be considered further since it does not meet all validity criteria.

The two independent variables to be considered further are DL hours and DM cost according to the evaluation described, above. Therefore, both variables should be considered together in a multiple regression model. In preparation for running a multiple regression model, we need to create a new table in Excel for the selected independent variables. The regression tool will only allow a user to select multiple columns if they are directly next to each other and currently DL hours and DM cost data are not presented in consecutive columns. • Copy the columns of data for DL hours and DM cost to a new table, where the columns are right next to each other. • You may leave the Overhead cost column in its current location, or you may copy it to the new table. 3-69 © 2022 John Wiley & Sons, Inc. or the author, All rights reserved. Farmer, Cost Accounting, 1e, Job Costing Visualized (For Instructor Use Only)

Problem 3.6 (Continued) To generate the multiple regression model: 1. Go to the “Data” tab. 2. On the right side of the toolbar, in the “Analysis” section, click on “Data Analysis.” 3. Scroll down, select “Regression,” then click “OK.” 4. Select the “Overhead costs” column for Input Y Range, and both the “DL hours” and “DM costs” columns for Input X Range (column titles included). 5. Check the boxes next to “Labels,” then click “OK.”

The multiple regression output should look like this:

Problem 3.6 (Continued) We will consider the same validity criteria for this multiple regression model as we did for each of the individual regression models: • Goodness of fit: R-Square = 0.7033, which is very good. It’s well above the threshold of 0.30 signifying a reasonably good fit. • Significance of independent variables: o DL Hours: P-value = 0.0232, which is good. It is very low, and the lower the p-value the better (a p-value below 0.05 is considered statistically significant). o DM costs: P-value = 0.0152, which is also good. It is well below the threshold of 0.05. • Economic plausibility: It is plausible that both DL hours and DM costs could together explain the company’s overhead costs. Conclusion: This multiple regression model is better than either of the individual regression models that passed the validity criteria. This model shows an improved fit while also maintaining statistical significance for both independent variables. The cost formula Dawn would use to specify this multiple regression model would be: Y = ($20.37X1) + ($3.53X2) + $94,223.07 Where Y= overhead costs, X1 = DL hours, and X2 = DM costs. All the values included in the model, above, are found in the “Coefficients” column of the multiple regression output. b.

What follows is an example of a memo that Dawn could have sent to her team to explain her conclusion that the model found in part (a) is the one they should use to estimate overhead costs. DATE: January 6, 2026 TO: Meyer Grove Company Management Team FROM: Dawn SUBJECT: Overhead cost findings As you all know, we have been trying to better understand our overhead costs for quite some time. In an effort to specify a cost function that will help us both better understand and budget for these costs going forward, I collected data on four possible costs drivers over the past 18 months: DL hours, Machine hours, DM costs, and Number of material moves. After a thorough analysis of all the data, I have determined that the best model to explain and predict our overhead costs is a multiple regression model that includes two of the four considered variables: DL hours and DM costs. The model we should use is presented below: Y = ($20.37X1) + ($3.53X2) + $94,223.07 Where Y = overhead costs, X1 = DL hours, and X2 = DM costs. 3-71

Problem 3.6 (Continued) Here is a summary of my process for making the conclusion, above. I used regression analysis as it generates the line of best fit considering all observations for the given variable(s). Regression analysis is a straightforward tool to employ with Microsoft Excel, and we all have access to this software. Before running individual regression models for each possible cost driver, though, I had to evaluate the linearity of each relationship. Linearity is an important assumption when conducting regression analysis due to the powerful mathematic calculations taking place behind the scenes as the tool creates the best-fitting line (cost function). To evaluate the assumption of linearity, I created a separate scatter plot for each cost driver in relation to overhead costs. From these scatter plots, it was obvious that DL hours and DM costs had a linear relationship to overhead costs; the other two scatter plots (for machine hours and material moves) did not exhibit obvious linear trends. From there, I ran separate individual regression models for each possible cost driver as the independent variable against overhead costs, the dependent variable. For any of these variables to be considered further, I made sure its model met three key validity criteria for regression: •

•

Goodness of fit can be evaluated by the R-Square value from the regression analysis. If the R-Square value is 0.30 or higher, it signifies a reasonably wellfitting model. Both the DL hours model and the DM costs model met this criterion. The other two did not. Statistical significance of the independent variable can be evaluated by the pvalue from the regression analysis. If the p-value is 0.05 or less, the independent variable has a statistically significant relationship with the dependent variable (overhead costs, in our case). Again, both the DL hours model and the DM costs model met this criterion; the other two did not. Economic plausibility should be present in the modeled relationship as well, recognizing that the independent variable and dependent variable contextually relate to each. In other words, economic plausibility is present in our case if the cost driver can be expected to explain some of the overhead cost we are experiencing. All four of the considered variables have economic plausibility. Still, all of these validity criteria need to be met before considering a variable further.

If two or more cost drivers on their own meet the validity criteria, above, then we can consider including them in a multiple regression model. In our case, both direct labor hours and direct materials costs met or exceeded all validity criteria, so I took the analysis one step further and ran a multiple regression model. We cannot just assume that the multiple regression model will be better, however. We need to evaluate the same three validity criteria for the multiple regression model. The resulting goodness of fit for this multiple regression model was better than either of the individual regression models as evidenced by its higher R-Square value. Further, both independent variables maintained their statistical significance in this multiple regression model according to their very low p-values. The economic plausibility of this combined relationship also makes sense: DL hours and DM cost could both plausibly explain our overhead costs. 3-72 © 2022 John Wiley & Sons, Inc. or the author, All rights reserved. Farmer, Cost Accounting, 1e, Job Costing Visualized (For Instructor Use Only)

Problem 3.6 (Continued) The final model, as presented above, includes a variable rate of $20.37 per DL hour and a variable rate of $3.53 per DM cost, along with an estimated fixed cost $94,223.07. Going forward, we can insert our estimated DL hours and DM costs for a given month into this cost function to predict our overhead costs for that period. Please let me know if you have any questions about this process or about the final model. Thank you, Dawn c.

We will use the model we found in part (b) to solve for next month’s overhead costs. Overhead costs = ($20.37 × DL hours) + ($3.53 × DM costs) + $94,223.07 Overhead costs = ($20.37 × 4,000) + ($3.53 × $24,000) + $94,223.07 Overhead costs = $81,480.00 + $84,720.00 + $94,223.07 Overhead costs = $260,423.07

LO: 1, 3, Bloom: S, Difficulty: Complex, Time: 25-30, AACSB: Knowledge, Communication, Analytic, Technology, Data Analytics, AICPA BC: Strategic Perspective, AICPA AC: Reporting, Technology and Tools, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics, Technology & Analytics: Visualization

Problem 3.7 a. Total cost = Total cost = Total cost = Total cost =

DM + DL + MOH (10 pounds × $8/pound) + (1.5 DL hours × $20/hour) + (1.5 DL hours × $7/hour) $80.00 + $30.00 + $10.50 $120.50

To find the total cost of making four mats, we create the following table and use the 80% learning curve to calculate the time needed for each of the four units. The grey quantities were given. Keep in mind: When production doubles from one to two units, the time for the second unit will reflect the time for the first unit × the learning curve percentage, as shown below. The same idea follows for doubling production from two to four units.

Now we can calculate each of DM, DL, and MOH cost for four units: DM 10 pounds × $8/pound × 4 units = $320.00 DL 282.79 minutes ÷ 60 minutes × $20/hour = 94.26 MOH 282.79 minutes ÷ 60 minutes × $7/hour = 32.99 $447.25 Average cost/unit = Total cost for four mats ÷ 4 mats Average cost/unit = $447.25 ÷ 4 mats Average cost/unit = $111.81 c.

If no learning curve were assumed, Treadwell would have just multiplied the total cost of the first unit (found in part (a)) by four: $120.50 × 4 = $482

$482.00 − $447.25 = $34.75 difference $34.75 ÷ 4 = $8.69 difference/unit The per unit average cost under the learning curve ($111.81) is only $8.69 less than the cost with no learning curve. That is a pretty small difference. If we extend this to hundreds of units, though, and/or if the learning curve percentage were more significant (like 70% or 60%), the differences would be much more meaningful. In this situation, it may not be worth the extra time and effort needed to estimate the learning curve percentage and make the additional calculations. The company will need to weigh the costs of using this approach against the benefits of doing so.

LO: 1, 4, Bloom: AN, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Communication, Analytic, Data Analytics, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

Problem 3.8 a.

To find the time needed to make the second, fourth, and eighth cabinet, we can make the following table and use the 90% learning curve to calculate it. With a learning curve, every time output doubles, the quantity of time for the doubled unit is determined by multiplying the learning curve percentage by the previously halved unit.

We can use this table to create a scatter plot: 1. Select the “Units made” and “Time needed (hours)” columns. 2. Go the “Insert” tab, click the “Scatter” button in the “Charts” section, and select the first option (the basic scatter plot).

Problem 3.8 (Continued) The scatter plot created should look like this:

Scatter plot Time per unit

25.00 20.00 15.00 10.00 5.00 0.00 0

Unit made (in sequence)

As we can expect when a learning curve is being assumed, the scatter plot does not look linear. The slope gets progressively flatter as more units are made. His labor cost for the first and eighth units are shown below: First unit: Eighth unit:

20.00 hours × $100/hour = $2,000 14.58 hours × $100/hour = $1,458

Deakin most likely could not get away with charging different amounts for these otherwise identical products in the same geographic area—word would get out, and he could lose business going forward.

The DL time estimates for the first, second, fourth, and eighth units are presented in part (a), above. We are also given the cumulative time to produce three units and seven units. We can use these values to calculate the cumulative time for four units and eight units. Here’s what we know so far:

Problem 3.8 (Continued) Cumulative time needed for four units = Cumulative time needed for three units + Time needed for fourth unit; Cumulative time needed for four units = 54.92 + 16.20 = 71.12 Cumulative time needed for eight units = Cumulative time needed for seven units + Time needed for eighth unit; Cumulative time needed for eight units = 116.89 + 14.58 = 131.47 We can now create this table in Excel:

We can then create a scatter plot by selecting the “Units made” and “Cumulative time needed (hours)” columns and following the same steps as in part (a). The resulting scatter plot should look like this:

Cumulative time needed (hours) 140.00 120.00 100.00 80.00 60.00

40.00 20.00 0.00 0

Problem 3.8 (Continued) To display the regression line, its equation, and the R-Square value within the scatter plot: 1. Select the graph, and click on the plus sign in the top right corner.

2. Click on the arrow next to “Trendline,” and click on “More Options.” This will add the line of best fit to the scatter plot.

Problem 3.8 (Continued) 3. In the menu that pops up on the right side of the screen, check the boxes next to “Display Equation on chart” and “Display R-squared value on chart.”

We can tell by looking at the trendline and its extremely high R-Square value (0.9989) that this line fits the data very well. e.

The nonlinear model does an excellent job of capturing the reduced time Deakin expects to spend on each subsequent unit. It allows Deakin to predict the time more accurately on task for each of these cabinets, and that time can then be multiplied by the cost of his time to estimate his total labor cost for a certain number of units. This type of model does require important assumptions about learning, though—assumptions which may be difficult to make, and which may or may not hold over the long-term. The regression model clearly does an excellent job of explaining the cumulative DL time, as well. Keep in mind this dependent variable is meant to reflect total actual DL time to make a given volume of cabinets. From this data, the regression model specifies a steady slope per number of units plus a fixed amount of time from which Deakin (or his competitor) could quickly estimate the total time for a certain quantity of units. This equation would be easy to use to estimate total time on task as Deakin or his competitor would only need an estimate for how many units they were going to make. This total estimated time could then be multiplied by the cost of his time to estimate his total labor cost for the job.

LO: 1, 3, 4, Bloom: S, Difficulty: Complex, Time: 20-25, AACSB: Knowledge, Communication, Analytic, Technology, Data Analytics, AICPA BC: Strategic Perspective, AICPA AC: Reporting, Technology and Tools, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

Solution to Analysis and Decision-Making Case Case a.

Year 1 Considering the first year of data only, Marjorie would consider the linearity of each possible cost driver and run an individual regression model for each possible cost driver. The three scatter plots are shown below for year 1, plotting each potential cost driver on the x-axis and the landscaping cost on the y-axis.

Case (Continued) Of all three scatter plots, DL hours is the only one with a clear linear, slightly upwardslowing trend. We now generate the regression output for each cost driver in its own individual regression model. For equipment hours (Year 1):

Validity of equipment hours in year 1: Goodness of fit: There is a poor goodness of fit, given the R-Square value of 0.1126, which is less than the standard of 0.30. Significance of the slope: This variable is not statistically significant, given its poor pvalue of 0.2864, which is higher than the standard of 0.05 (to be significant, the p-value must be 0.05 or lower). Economic plausibility: It is reasonable to expect equipment hours would impact landscaping costs. Overall, this variable should not be considered in a cost function to explain landscaping costs for this one period.

Case (Continued) For number of large trees (Year 1):

Validity of Number of large trees in year 1: Goodness of fit: There is a poor goodness of fit, given the R-Square of 0.1387, which is less than the standard of 0.30. Significance of the slope: This variable is not statistically significant, given its poor pvalue of 0.233, which is greater than the standard of 0.05 (to be significant, the p-value must be 0.05 or lower). Economic plausibility: It is reasonable to expect the number of large trees to explain a portion of landscaping cost. Overall, this variable should not be considered in a cost function to explain landscaping costs for this one period.

Case (Continued) For DL hours (Year 1):

Validity of DL hours in year 1: Goodness of fit: There is a good fit here, as the R-Square of 0.4128 is greater than the standard of 0.30. Significance of the slope: There is statistical significance here, as the p-value of 0.0243 is less than the standard of 0.05 (to be significant, the p-value must be 0.05 or lower). Economic plausibility: It is reasonable to expect DL hours to explain landscaping costs. Overall, this variable should be considered in a cost function to explain landscaping costs for this one period. In year 1, the only variable to pass the linearity assumption as well as all three validity criteria is DL hours. Since only one variable is considered appropriate to include in a cost function for landscaping costs during this period, there is no need to run a multiple regression model at this time. b.

Years 1 & 2 By the end of the second year of business, Marjorie can evaluate the relationship between each possible cost driver and landscaping costs using two years of data.

Case (Continued) The scatter plots for each of the identified cost drivers against landscaping cost for the first two years are presented below:

Similar to the first year, only the DL hours scatter plot shows a linear and slightly upward-sloping trend. Linearity is not clear to exist for the other two variables. To explore each relationship further, we run individual regression models for each possible cost driver and evaluate the validity criteria for each:

Case (Continued) For equipment hours (Years 1 & 2):

Validity of equipment hours for years 1 & 2: Goodness of fit: The R-Square value of 0.018 is less than the standard of 0.30, so there is poor goodness of fit. Significance of the slope: The p-value of 0.527 is greater than the standard of 0.05, so this lacks statistical significance. Economic plausibility: It is reasonable to expect equipment hours to impact the landscaping costs. Overall, this variable should not be considered further in a cost function for landscaping costs for this two-year period.

Case (Continued) For number of large trees (Years 1 & 2):

Validity of number of large trees years 1 & 2: Goodness of fit: The R-Square of 0.1097 is less than the standard of 0.30, so this is not a good fit. Significance of the slope: This lacks statistical significance as the p-value of 0.1139 is greater than 0.05. Economic plausibility: It is reasonable to expect equipment hours to impact the landscaping costs. Overall, this variable should not be considered further in a cost function for landscaping costs for this two-year period.

Case (Continued) For DL hours (Years 1 & 2):

Validity of DL hours years 1 & 2: Goodness of fit: There is a good fit here, as the R-Square of 0.378 is greater than the standard of 0.30. Significance of the slope: There is statistical significance here, as the p-value of 0.001 is less than the standard of 0.05 Economic plausibility: It is reasonable to expect DL hours to explain landscaping costs. Overall, this variable should be considered further to explain landscaping costs for this two-year period. In years 1 & 2, the only variable to pass the linearity assumption as well as all three validity criteria is DL hours. Since only one variable is considered appropriate to include in a cost function for landscaping costs during this period, there is no need to run a multiple regression model at this time. c.

Years 1, 2 & 3 By the end of the third year of business, Marjorie can evaluate the relationship between each possible cost driver and landscaping costs using all three years of data.

Case (Continued) The scatter plots for each of the identified cost drivers against landscaping cost for the first three years are presented below:

For the three-year period, both the equipment hours and DL hours show linear and slightly upward-sloping trends, while the number of large trees relationship still lacks linearity. To explore each relationship further, we run individual regression models for each possible cost driver and evaluate the validity criteria for each:

Case (Continued) For equipment hours (Years 1, 2, & 3):

Validity of equipment hours for years 1, 2 & 3: Goodness of fit: The R-Square value of 0.33 is greater than the standard of 0.30, so there is goodness of fit. Significance of the slope: The p-value of 0.0002 is less than the standard of 0.05, so this has statistical significance. Economic plausibility: It is reasonable to expect equipment hours to impact the landscaping costs. Overall, this variable should be considered further to explain landscaping costs for this three-year period.

Case (Continued) For number of large trees (Years 1, 2, & 3):

Validity of number of large trees: Goodness of fit: The R-Square value of 0.0259 is less than the standard of 0.30, so this lacks goodness of fit. Significance of the slope: The p-value of 0.3480 is greater than the standard of 0.05, so this lacks statistical significance. Economic plausibility: It is reasonable to expect the number of large trees to impact the landscaping costs. Overall, this variable should not be considered further to explain landscaping costs for this three-year period.

Case (Continued) For DL hours (Years 1, 2, & 3):

Validity of DL hours: Goodness of fit: The R-Square value of 0.3525 is greater than the standard of 0.30, so there is goodness of fit. Significance of the slope: The p-value of 0.0001 is less than the standard of 0.05, so this has statistical significance. Economic plausibility: It is reasonable to expect DL hours to impact the landscaping costs. Overall, this variable should be considered further to explain landscaping cost for this three-year period. In years 1, 2, & 3, two variables pass the linearity assumption as well as all three validity criteria: Equipment hours and DL hours. Since two variables are considered appropriate to include in a cost function for landscaping costs during this period, we will further consider a multiple regression model at this time.

Case (Continued) Multiple regression model with equipment hours and DL hours (years 1-3):

Validity of multiple regression model in years 1, 2, & 3: Goodness of fit: The R-Square value of 0.5430 is greater than the standard of 0.30, so there is goodness of fit. Significance of the slope: Both independent variables are statistically significant: ▪ Equipment hours: P-value of 0.0008 is less than the 0.05 standard. ▪ DL hours: P-value of 0.0004 is less than the 0.05 standard. Economic plausibility: It is reasonable to expect that both equipment hours and DL hours would help explain landscaping costs together. Overall, this multiple regression model provides a meaningful cost function to explain landscaping costs over this three-year period of time.

Case (Continued) d.

A summary of model results for all three years is shown below:

When comparing the models over the years, only the DL hours model provided a good fit and showed a significant relationship with the landscaping cost for the first two years. By the end of the third year, however, both equipment hours and DL hours showed a good fit and a significant relationship with landscaping cost when all three years of data were included in the model. Since both individual regression models were valid, the multiple regression model considered both variables together in explaining landscaping cost. That multiple regression model has an even better fit than either of the individual regression models while both independent variables remain significant. For that reason, the multiple regression model would be selected for explaining and predicting Walter’s landscaping cost going into the next year. The multiple regression model would be specified as follows: Y = ($47.03 × Equipment hours) + ($19.44 × DL hours) + $2,337.12 e.

Given the above model, we enter the estimated equipment hours and estimated DL hours into the equation to predict Walter’s landscaping cost on this project: Y = ($47.03 × 200) + ($19.44 × 400) + $2,337.12 = $19,519.12. The bid price, with a 50% mark-up would be $19,519.12 × 1.50 = $29,278.68.

Walter should feel more comfortable knowing that his past data supports his cost estimation model, which can assist him in project pricing. If a customer pushes back, he should feel more comfortable sticking with his bid. Still, given a large-scale project such as the one proposed, he may also be willing to negotiate to let the customer feel that they gained a little bit, too.

LO: 1, 2, 3, 4, Bloom: AN, Difficulty: Moderate, Time: 30-35, AACSB: Knowledge, Communication, Analytic, Technology, Data Analytics, AICPA BC: Strategic Perspective, AICPA AC: Reporting, Technology and Tools, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics

Chapter 4 Cost-Volume-Profit Analysis Assignment Classification Table (By Learning Objective) Learning Objectives 1. Calculate the contribution margin and break-even sales point. 2. Describe CVP analysis, its assumptions, the relevant range, and the margin of safety. 3. Practice using the standard and modified break-even formulas, with and without target profit and taxes, in CVP calculations. 4. Modify the break-even formula for scenarios with multiple products. 5. Demonstrate how sensitivity analysis assists decisionmakers in answering “whatif” questions. 6. Apply CVP analysis for service and nonprofit organizations.

Questions 1, 2, 3

Brief Exercises 1, 2, 3, 4

Exercises 1, 2, 3, 4

Problems 1, 2, 3, 4, 5, 6, 7

4, 5, 6, 7

4, 5

1, 2, 5, 6

1, 2, 3, 4, 5, 6, 7

6, 7

7, 8, 9

9, 10

10, 11, 12

9, 10, 11

13, 14

7, 15, 16

Assignment Characteristics Table Item E4.1 E4.2 E4.3 E4.4 E4.5 E4.6 E4.7 E4.8 E4.9 E4.10 E4.11 E4.12 E4.13 E4.14 E4.15 E4.16 P4.1 P4.2 P4.3 P4.4 P4.5 P4.6 P4.7 Case

Description Determine the break-even point, income, and margin of safety. Create a graph to evaluate profitability and break-even point. Prepare and analyze traditional and contribution margin income statements. Prepare a contribution margin income statement from traditional income statement categories. Analyze relevant range and margin of safety. Modify CVP relationships to project income. Calculate target sales volume to earn profit under different circumstances. Fill in missing CVP information. Analyze costs given CVP assumptions. Apply CVP tools to a multi-product scenario. Incorporate a multi-product scenario into CVP analysis. Evaluate break-even point and profitability under different multi-product scenarios. Utilize degree of operating leverage to determine impact on income. Determine degree of operating leverage and its impact on income. Utilize CVP tools to analyze a nonprofit organization. Utilize CVP tools to analyze a nonprofit endeavor. Utilize CVP relationships to predict income under changing circumstances, plus additional considerations. Use a CVP graph to address profitability questions. Evaluate an income statement for accuracy. Comparing profitability using gross margin vs. contribution margin goals. Evaluate break-even point scenarios when multiple products are involved. Evaluate the impact of degree of operating leverage under changing conditions. Consider CVP relationships for a professional services firm. Evaluate the viability of three scenarios in order to generate a profit.

Level of Difficulty Simple

Time (minutes) 10–15

Simple

10–15

Moderate

10–15

Moderate

10–15

Simple Simple Simple

5–10 10–15 5–10

Moderate Moderate Moderate Moderate Moderate

20–25 10–15 10–15 20–25 15–20

Moderate

10–15

Moderate

15–20

Simple Simple Simple

5–10 5–10 10–15

Moderate Moderate Complex

10–15 10–15 20–25

Complex

15–20

Moderate

20–25

Moderate

15–20

Complex

20–25

Answers to Questions 1. Yes, if a company has no fixed costs, its contribution margin will be the same as its operating income. We can see this hold true via a contribution margin (CM) income statement: Contribution Margin Income Statement Sales $100 Less: Variable costs 20 Contribution margin 80 Less: Fixed costs Operating income $ 80

Note: If there are no fixed costs, contribution margin and operating income will be the same.

If a company did have fixed costs, it could quickly calculate its break-even point with the following formula: Sales in units to break-even = (Fixed costs ÷ Contribution margin per unit) Alternatively, it could set up a contribution margin income statement and work in reverse order, starting with zero operating income and working backwards to determine the number of units needed to generate a total contribution margin that is equal to total fixed costs. LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

If selling price increases but all else stays the same, the break-even point in units will decrease and its contribution margin ratio will increase. Here’s why: • A higher selling price with no corresponding change in variable cost per unit will result in a higher contribution margin per unit. • The formula for the break-even point in units uses fixed costs in the numerator and contribution margin per unit in the denominator. In this case, the same amount of fixed costs is being divided by a larger contribution margin per unit, resulting in fewer units needed to cover those fixed costs. • The contribution margin ratio will increase because the contribution margin per unit is larger and will reflect a larger percentage of the selling price than it did previously. o For example: original selling price of $10 and variable cost per unit of $6 gives a contribution margin per unit of $4 and contribution margin ratio of 40% ($4 ÷ $10). o If the new selling price is $11 with the same variable cost per unit of $6, we get a contribution margin per unit of $5 and a contribution margin ratio of 45.45% ($5 ÷ $11).

LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: Strategic Perspective, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

A traditional income statement groups its costs by function (product costs vs. period costs). A contribution margin income statement, which groups its costs by behavior (variable vs. fixed) is much more effective in analyzing a change in income when volume, variable cost per unit, or total fixed cost is changing. This is true because each of these components is carefully identified in a contribution margin income statement, whereas fixed and variable costs are often intermingled in a traditional income statement (for example, COGS and SG&A Expenses often include both variable and fixed components, and they are not easily identifiable just by looking at the income statement).

LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Reporting & Control: Financial Statement Preparation

Questions Chapter 4 (Continued) 4.

Contribution margin is equal to Sales less Variable costs. If total contribution margin (CM) increased but the variable cost per unit did not change, that could mean: • The company sold more units this month → Sales increased, and variable costs increased (but not at the rate sales increased) → total CM increased, and/or • The selling price increased this month → Sales increased → CM increased.

LO: 2, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

In the equation of a line, Y = m(X) + b, each letter represents the following: • Y = the dependent variable, or the total cost, or the mixed cost; it represents the variable we are trying to understand. • m = the slope, or the variable rate (per unit or per quantity of the cost driver) • X = the cost driver quantity (per unit or per hour, for example) • b = the intercept or the fixed cost. In the relationship described, the Y would be the shipping expense and the X would be the number of packages shipped.

LO: 2, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Technology & Analytics: Data Analytics

A company’s relevant range is the band of activity wherein fixed costs stay constant and variable cost per unit stays constant. Understanding this range of activity is crucial in CVP analysis because we assume the total fixed cost and variable rate per unit stay the same unless we are told differently. If a company is considering a change in volume that would take them outside its relevant range, these assumptions would no longer hold true. We could not assume total fixed costs would stay the same at a volume of activity above its relevant range because more capacity may be needed to support that higher level of activity; more capacity generally means higher fixed costs. We also couldn’t assume that the variable rate per unit would stay constant at a volume of activity above its relevant range because the company may be able to purchase resources at a reduced rate per unit due to quantity discounts; alternatively, it may be more expensive per unit to obtain certain resources if they are scarce.

LO: 2, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

A company’s margin of safety reflects the quantity of units it currently sells above its break-even point (or alternatively the amount of sales dollars in excess of its break-even sales dollars). If a company prefers a low-risk approach, it would be much more comfortable operating with a high margin of safety. In other words, it would strive to generate a large safety net between total actual (or budgeted) sales volume and the unit break-even point. If it had only a small margin of safety, the company would be operating at a level that would generate a very low profit, and that level of risk would make this company’s management uncomfortable.

LO: 2, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Questions Chapter 4 (Continued) 8.

Yes, the company’s target sales volume to generate an after-tax income will always be larger than its target sales volume to earn the same amount in before-tax income. Let’s use an example where the target profit is $10,000. A company would have to sell more units to first pay taxes and then be left with $10,000 in after-tax income, than to achieve $10,000 before-tax. For example: We can use the formula for sales in units to achieve target profit: Sales in units to achieve target profit= (Fixed costs + Target operating income) ÷ Contribution margin per unit If the company’s only product sells for $50, and the variable cost/unit is $35, contribution margin per unit = $50 − $35 = $15. (1) Target sales in units to earn $10,000 in before-tax profit = $10,000 ÷ $15 = 666.67 → 667 units If the company’s tax rate is 20%, we must calculate the profit the company would have to earn before-tax to still have $10,000 left after-tax: Equivalent before-tax operating income = target after-tax operating income ÷ (1 − tax rate) $10,000 ÷ (1 − 0.2) = $10,000 ÷ 0.8 = $12,500 Now, let’s find out how many units would need to be sold in the after-tax scenario. (2) Target sales in units to earn $10,000 in after-tax profit = $12,500 ÷ $15 = 833.33 → 834 units The volume for (2) will always be higher.

LO: 3, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

The weighted average contribution margin (WACM) per unit captures two important aspects of the company’s profitability: (1) the CM of each unit, which is often different for each product; and (2) the sales mix of products that the company normally sells. The WACM per unit is calculated by multiplying a product’s sales mix percentage by its individual CM per unit, and then repeating that calculation for each product. We then add these amounts together to get a total WACM per unit for the company. Without bringing these pieces together, the break-even point or target volume calculation will inaccurately project a volume of units based on either too high a CM (if the focus stays on high-margin products) or based on a CM that is too low (if the focus stays on low-margin products). By balancing these two components, we can accurately predict sales volumes while considering the typical sales patterns that occur in a company. In a company’s break-even calculation, the WACM per unit is used in place of CM per unit.

LO: 4, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

10. If a company raises the selling price on just one of its three products, the weighted average contribution margin (WACM) per unit will change; the WACM per unit will increase because the sales mix is assumed to have stayed the same and the contribution margin for all other products stayed the same, but the contribution margin for this one product increased which will result in a higher WACM per unit. If a company adds a new product to its sales mix, the WACM per unit may not automatically change, but it could change. If the new product’s contribution margin balances out the effect of the sales mix change, the WACM per unit could stay the same. More likely, though, the WACM per unit will change due to the addition of a new product into the mix. LO: 4, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Questions Chapter 4 (Continued) 11. The degree of operating leverage (DOL) determines the overall impact of a change in sales on a firm’s operating income. It is calculated as contribution margin divided by operating income. A company might make this calculation to see how its bottom line will be impacted by an increase or decrease in sales. The DOL is primarily used to help a company determine the extent to which a change in sales will impact operating income. With a high DOL, an increase in sales will cause greater profitability gains. However, the opposite is also true—with a high DOL, when sales decrease, the company will see a steeper decline in profits. LO: 5, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

12. The key output measure for a public accounting firm or law practice would be billable hours. This metric allows these firms to capture the time spent on task separately for each client, since not every client will take the same number of hours to serve. Service organizations often base their sales on the hours spent providing services, which makes tracking their time on task very important. LO: 6, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Solutions to Brief Exercises Brief Exercise 4.1 Fixed costs = Designing fee ($75) + Shipping fee ($25) = $100 Variable costs = $15/unit We can set up a contribution margin income statement, where costs are organized by behavior (variable vs. fixed). To break-even, the bottom-line operating income must equal zero. Contribution Margin Income Statement Sales $20X Less: Variable costs 15X Contribution margin $ ? Less: Fixed costs 100 Operating income $ -

2. Now solve for X: $20X − $15X = $100 $5X = $100 → X = $100 ÷ $5 → X = 20 1. If operating income is zero and fixed costs are $100, then contribution margin must be $100.

They would need to sell 20 shirts at a selling price of $20/shirt. Alternatively, they could use the break-even formula, where Sales in units to break even = Fixed costs ÷ Contribution margin per unit Sales in units to break even = $100 ÷ ($20 − $15) = $100 ÷ $5 = 20 units to break even LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

Brief Exercise 4.2 Fixed costs = Labor ($3,500) + Rent/insurance ($500) = $4,000/month Variable costs = Ice cream ($0.25) + Cone ($0.05) = $0.30/cone Contribution margin per unit is equal to selling price per unit − Variable costs per unit. CM per unit = $2.00 − $0.30 = $1.70/unit LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

Brief Exercise 4.3 CM ratio = CM ÷ Sales

CM per unit ÷ Selling price

40% = CM per unit ÷ $50 → CM per unit = $20 To find variable manufacturing cost/unit, we can set up part of a contribution margin income statement, let variable manufacturing cost/unit = X, and solve for X: Selling price − Variable cost/unit = CM/unit $50.00 − ($2.50 + X) = $20.00 $50.00 − $2.50 − X = $20.00 $47.50 − X = $20.00 X = $27.50. Since there aren’t any fixed manufacturing costs, the total manufacturing cost per unit is equal to the variable product cost per unit of $27.50. Gross margin/unit = Selling price − Manufacturing cost per unit GM/unit = $50.00 − $27.50 = $22.50/unit Gross margin percentage = Gross margin per unit ÷ Selling price Gross margin percentage = $22.50 ÷ $50 = 45% LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

Brief Exercise 4.4 Total sales = $50,000 Total variable costs = $20,000 Total contribution margin = $50,000 − $20,000 = $30,000 Volume of units sold = Total sales ÷ Selling price Volume of units sold = $50,000 ÷ $5/unit = 10,000 units Variable costs per unit = Total variable costs ÷ Volume of units sold Variable costs per unit = $20,000 ÷ 10,000 units = $2.00/unit Contribution margin per unit = Selling price − Variable cost per unit CM per unit = $5 − $2 = $3.00/unit LO:1, 2, Bloom: AN, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

Brief Exercise 4.5 Operating income = Sales − Variable costs − Fixed costs $1,100 = $6,750 − Variable costs − $1,900 $1,100 = $4,850 − Variable costs Variable costs = $3,750 Total variable costs = Variable cost per unit × Sales volume $3,750 = $5/unit × Sales volume Sales volume = 750 units The relevant range is 0 to 1,000 units, as the business can produce up to 1,000 units. To find the margin of safety, we first need to find the break-even point: Sales in units to break even = Fixed costs ÷ CM per unit Sales in units to break even = $1,900 ÷ ($9 − $5) = 475 units Sales in dollars to break even = 475 units × $9 = $4,275 The margin of safety is the difference between actual sales and the break-even point. Margin of safety in units = 750 units − 475 units = 275 units Margin of safety in dollars = $6,750 − $4,275 = $2,475 LO: 2, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

Brief Exercise 4.6 Total sales = $35,000 Operating income = $5,000 CM ratio = 60% To calculate total variable costs: CM ratio = CM ÷ Total sales 60% = CM ÷ $35,000 CM = 60% × $35,000 CM = $21,000 CM = Sales − Total variable costs $21,000 = $35,000 − Total variable costs Total variable costs = $14,000 To calculate fixed costs: Operating income = CM − Total fixed costs $5,000 = $21,000 − Total fixed costs Total fixed costs = $16,000 To calculate the change in income resulting from new Sales, we can use the CM ratio to determine additional CM that will be earned. Since no new fixed costs will be incurred, that additional CM will translate directly into additional operating income. Change in operating income = Change in Sales × CM% Change in operating income = $5,000 × 0.6 = $3,000 LO: 3, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

Brief Exercise 4.7 Sales in units to achieve target profit = (Fixed costs + Target operating income) ÷ Contribution margin Sales in units to achieve $10,000 target profit = ($20,000 + $10,000) ÷ (12 − 4) = $30,000 ÷ 8 = 3,750 units Sales in units to achieve target after-tax profit = (Fixed costs + [After-tax operating income ÷ (1 − Tax rate)]) ÷ Contribution margin Sales in units to achieve target after-tax profit of $12,000 = ($20,000 + [$12,000 ÷ (1 - 0.25)]) ÷ 8 = 4,500 units LO: 3, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Knowledge, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

Brief Exercise 4.8 Weighted average contribution margin (WACM) per unit: Mild Medium Flaming Total Contribution margin per unit $4.50 $4.20 $4.00 × Sales mix 0.20 0.25 0.55 Weighted average contribution margin per unit $0.90 $1.05 $2.20 $4.15 Sales in units to break even = Fixed costs ÷ Weighted average contribution margin per unit Sales in units to break even = $15,770 ÷ 4.15 = 3,800 orders of wings, of which 2,090 are flaming (3,800 × 0.55 sales mix). LO: 4, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

Brief Exercise 4.9 Degree of operating leverage (DOL) = CM ÷ Operating income Let’s say Company A and Company B both have a DOL of 1.5. The two companies’ contribution margin income statements look like this: Company A % Company B % 1.00 1.00 Sales $ 30,000 Sales $ 69,500 0.50 Less: Variable costs 15,000 Less: Variable costs 32,000 0.46 Contribution margin Less: Fixed costs

15,000 5,000

Operating income

$ 10,000

DOL ($15,000 ÷ $10,000)

0.50

Contribution margin Less: Fixed costs Operating income

1.5

DOL ($37,500 ÷ $25,000)

37,500 0.54 12,500 $ 25,000 1.5

Now, we present new contribution margin income statements with a 20% increase in Sales for both companies (and corresponding increased variable costs and contribution margin): Company A % Company B % Sales Less: Variable costs Contribution margin Less: Fixed costs

$36,000 18,000 18,000 5,000

Operating income

1.00 0.50 0.50

Sales Less: Variable costs Contribution margin Less: Fixed costs

$83,400 38,364 45,036 12,500

13,000

Operating income

32,536

Less: Old operating income

10,000

25,000

Additional operating income

$ 3,000

Less: Old operating income Additional operating income

1.00 0.46 0.54

$ 7,536

Company A change in income of $3,000: New Operating income = $13,000 Predicted new operating income using DOL: New Operating income = Original operating income × (1 + [DOL × Percentage change in Sales]) New Operating income = $10,000 × (1 + [1.5 × 0.20]) = $13,000 Company B change in income of $7,536 New Operating income = $32,536 Predicted new operating income using DOL (same formula as above): New operating income = $25,000 + (1 + [1.5 × 0.20]) = $32,500* *slightly different from actual due to rounding of variable costs Company A generated additional operating income of $3,000 from a 20% increase in sales, while Company B generated $7,536 of additional operating income from a 20% increase in Sales. In summary, no, the same percentage increase in sales won’t necessarily yield the same amount of new operating income for two companies even if they have the same DOL immediately prior to the sales increase. The only time both companies would end up with the same amount of new operating income would be if the companies both started with the same amount of Sales (while also keeping both the DOL and the percentage change in sales the same between both companies). LO: 5, Bloom: AN, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Brief Exercise 4.10 Contribution margin per unit $ 28 × Total units 14,000 Total contribution margin $392,000 Operating income = CM − Fixed costs $73,000 = $392,000 − Fixed costs Fixed costs = $319,000 Contribution margin = Sales − Variable costs $392,000 = Sales − $308,000 Sales = $700,000 Presented in contribution margin income statement format: Contribution Margin Income Statement Sales $700,000 Less: Variable costs 308,000 Contribution margin $392,000 Less: Fixed costs 319,000 Operating income $ 73,000 With an increase is selling price of 10% and a decrease in sales volume of 5%, we first determine the new sales volume, new Sales, and new Variable costs: Sales volume

14,000

× 95% New sales volume

0.95 13,300

Sales ÷ Units Selling price per unit × Increase New selling price per unit × New volume New Sales

$ 700,000 14,000 $

50 1.10

55 13,300 $ 731,500

Variable costs ÷ original volume Variable cost per unit × New volume New variable costs

$ 308,000 14,000 $

22 13,300

$ 292,600

Then we present the new CM income statement: Contribution Margin Income Statement Sales $731,500 Less: Variable costs 292,600 Contribution margin $438,900 Less: Fixed costs 319,000 Operating income $119,900 Since the company’s income increased from $73,000 to $119,900, yes, it achieved its goal of increasing profitability. LO: 5, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Knowledge, Reflective Thinking, AICPA BC: Strategic Perspective, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Brief Exercise 4.11 Last Year: Operating income = Contribution margin − Fixed costs $31,700 = CM − $281,500 CM = $313,200 Sales = Selling price × Sales volume Sales = $129/unit × 5,800 units = $748,200 Variable costs = Sales − CM Variable costs = $748,200 − $313,200 = $435,000 Variable cost per unit = Total variable costs ÷ Sales volume Variable cost per unit = $435,000 ÷ 5,800 units = $75/unit Presented in CM format: Volume

5,800

Sales Less: Variable costs Contribution margin Less: Fixed costs

Total $ 748,200 435,000 $ 313,200 281,500

Operating income

Per unit $ 129 75 $ 54

31,700

This Year: New sales volume = 5,800 × 1.05 = 6,090 New variable cost per unit = $75/unit × 1.05 = $78.75 Incorporating these new details into a new CM income statement: Volume

6,090

Sales Less: Variable costs Contribution margin

Total $785,610.00 479,587.50 $306,022.50

Less: Fixed costs

281,500.00

Operating income

$ 24,522.50

Per unit $ 129.00 78.75 $ 50.25

The company’s income decreased by $7,177.50 ($31,700.00 − $24,522.50) due to the increase in sales volume and increase in variable cost per unit. Despite an increase in sales volume, the higher variable cost per unit results in a lower CM per unit. The bump in Revenue due to the sales volume increase was not enough to cover the lost contribution margin due to the higher variable costs. LO: 5, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

Brief Exercise 4.12 We can set this up algebraically, using the profit equation, with the number of billable hours being equal to X, and then solve for X. Fixed costs = $100,000 + $50,000 = $150,000 Sales − Variable costs − Fixed costs = Operating income ($100X − $50X) − $150,000 = $120,000 $50X − $150,000 = $120,000 $50X = $270,000, X = 5,400 billable hours LO: 6, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

Solutions to Exercises Exercise 4.1 (10–15 minutes) a.

Fixed costs = License ($200) + Insurance ($1,190) + Depreciation ($5,000) = $6,390 We can use the profit equation to solve for X, volume, as follows: Sales − Variable costs − Fixed costs = 0 $8.00X − $3.50X − $6,390 = 0 $4.50X = $6,390 X = 1,420 units to break even Or, we can use the break-even point formula: Sales in units to break even = Fixed costs ÷ CM per unit Sales in units to break even = $6,390 ÷ $4.50/unit = 1,420 units

b. Contribution Margin Income Statement Sales $8.00 × 2,000 units $16,000 Less: Variable costs $3.50 × 2,000 units 7,000 Contribution margin $ 9,000 Less: Fixed costs 6,390 Operating income $ 2,610 c. Contribution Margin Income Statement Sales $8.00 × 3,500 units $28,000 Less: Variable costs $3.50 × 3,500 units 12,250 Contribution margin $15,750 Less: Fixed costs 6,390 Operating income $ 9,360 d.

The margin of safety in units is the number of units we have as a buffer between our current or target unit sales and break-even sales volume. The margin of safety in sales dollars is the difference between total sales in dollars and the break-even sales point in dollars. Margin of safety in units = 3,500 units − 1,420 units = 2,080 units Margin of safety in Sales dollars = $28,000 − $11,360 = $16,640 Or, the margin of safety in sales dollars = margin of safety in units × selling price. 2,080 units × $8.00/unit = $16,640

LO: 1, 2, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

Exercise 4.2 (10–15 minutes) a.

The total sales line (in orange) starts at (0, 0) and increases by the $125 selling price with every additional unit sold. The total costs line starts at (0, $1,000) because of the $1,000 of fixed costs, and increases by $75 (the variable cost/unit) with every additional unit sold. At the break-even point, we can use the operating income formula and solve for sales volume, X. At the break-even point, Sales − Variable costs − Fixed costs = 0. Sales in units to break even = $125X − $75X − $1,000 = 0 $50X = $1,000 X = 20 units Or, we can calculate the break-even point using the formula: Sales in units to break even = Fixed costs ÷ CM per unit Sales in units to break even = $1,000 ÷ $50/unit = 20 units b.

At a level of 18 units, last month the store operated below the break-even level of 20 units. Sales − Variable costs − Fixed costs = Income/(Loss) ($125 × 18) − ($75 × 18) − $1,000 = Income/(Loss) $2,250 − $1,350 − $1,000 = $(100) The store generated a $100 loss last month.

Exercise 4.2 (Continued) In a normal month, the store usually generates the following income: ($125 × 30) − ($75 × 30) − $1,000 = Income/(Loss) $3,750 − $2,250 − $1,000 = $500 The company usually makes $500 in income. c.

The store’s drop in sales could be due to people’s preferences changing, or perhaps boots are not in season at this time. Perhaps other substitute products are available for a lower price, or the boots the store sells may have received some bad reviews on social media. The lower sales volume could be due to lagging economic conditions in the community at the time. It may also be a month after a normally very busy month (such as the month after a holiday rush). Or, perhaps the business is not investing (enough) in marketing/advertising. Depending on why the sales dropped, Lucy could explore many options. Lucy could try investing (more) in some marketing and advertising for her business. She could also consider using different or new channels in which to promote her business. Other ideas include: expanding store hours, making online purchasing an option, encouraging satisfied customers to post positive social media comments, search for additional suppliers for higher quality boots. Some of these options would increase fixed costs, thereby decreasing operating income and increasing the number of units the store would have to sell in order to break-even.

LO: 1, 2, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Knowledge, Communication, Analytic, Technology, AICPA BC: Strategic Perspective, AICPA AC: Measurement Analysis and Interpretation, Reporting, Technology and Tools, AICPA PC: Communication, IMA: Technology & Analytics: Visualization, Reporting & Control: Cost Accounting

Exercise 4.3 (10–15 minutes) a. CM Format 2 4 4 2 2

Traditional Format 7 9 7 7 9

Costs: Fabric cost per quilt, $150 Website cost per year, $50 Depreciation on sewing machine, $200/yr. Machine-quilting fee per quilt, $50 Promotional gift per item sold, $20

b. Contribution Margin Income Statement Sales ($500 × 12)

$6,000

Less: Variable costs Fabric ($150 × 12)

Traditional Income Statement Sales ($500 × 12)

$6,000

Less: COGS 1,800

Fabric ($150 × 12)

1,800

Machine-quilting fee ($50 × 12)

600

Depreciation

200

Promotional gift ($20 × 12)

240

Machine-quilting fee ($50 × 12)

600

Total variable costs Contribution margin

2,640 3,360

Less: Fixed costs

Total COGS Gross margin

2,600 3,400

Less: SG&A expenses

Website

Depreciation

200

Promotional gift ($20 × 12)

240

250

Total SG&A expenses

290

Total fixed costs Operating income

$3,110

Operating income

$3,110

Exercise 4.3 (Continued) c.

The contribution margin format will provide much greater ease in preparing different cost, volume, and profit scenarios as costs are separated by behavior. If she considers changing her volume, she can appropriately recognize a change in total variable costs as a result with no corresponding change to fixed costs. If she decides to incorporate a selling price change along with a change to her variable costs, she can easily make the adjustments. It is much less efficient to incorporate such changes into a traditional income statement because there are typically both variable and fixed expenses included in COGS and SG&A Expenses without identifiers to distinguish the variable portions from the fixed portions.

LO: 1, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Statement Preparation

Exercise 4.4 (10–15 minutes) a.

We first need to Separate COGS and SG&A into their variable and fixed components. Sales ÷ Selling price = Volume of units sold $2,400,000 ÷ $150 = 16,000 units sold Variable COGS = Variable cost/unit × Volume of units Variable COGS = $40/unit × 16,000 units = $640,000 Fixed COGS = COGS − Variable COGS Fixed COGS = $880,000 − $640,000 = $240,000 Variable SG&A = SG&A − Fixed SG&A Variable SG&A = $685,000 − $525,000 = $160,000 Contribution Margin Income Statement Sales $2,400,000 Less: Variable costs Variable COGS 640,000 Variable SG&A 160,000 Total variable costs $ 800,000 Contribution margin $1,600,000 Less: Fixed costs Fixed COGS 240,000 Fixed SG&A 525,000 Total fixed costs $ 765,000 Operating income $ 835,000

The operating income is the same because the two formats of income statement incorporate the same costs, but group those costs differently. The traditional format groups costs by function (product versus period), while the contribution margin format group costs by behavior (variable versus fixed). With equal revenues and equal expenses, operating income is the same.

Exercise 4.4 (Continued) c.

Categories of cost used to reach each key subtotal: To Reach Contribution Margin To Reach Gross Margin Variable costs: increase with every COGS: includes all product costs— additional unit produced; includes both those related to producing the product; product and period variable costs includes both variable and fixed product costs

LO: 1, Bloom: AN, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Statement Preparation

Exercise 4.5 (5–10 minutes) a.

Margin of safety in units = Current unit sales − Break-even sales volume Total variable costs per unit = $30/unit + $5/unit = $35/unit Calculate the break-even point, in units: ($75X − $35X) − $2,000 = 0 $40X = $2,000 X = 50 units Or, use the break-even point formula directly: Sales in units to break even = Fixed costs ÷ CM per unit Sales in units to break even = $2,000 ÷ ($75 − $35) = $2,000 ÷ 40 = 50 units Since the company currently sells 60 units/month, the margin of safety is 10 units (60 − 50 = 10).

For margin of safety to be 30 units, the company would need to sell 30 units more than its break-even point, or 80 units. Break-even point in units + Margin of safety = Desired volume 50 units + 30 units = 80 units If the company sold 80 units, it would generate the following income: Sales − Variable costs − Fixed costs = Operating income ($75 × 80) − ($35 × 80) − $2,000 = $1,200

The relevant range is the volume of activity wherein fixed costs stay constant and the variable cost per unit is constant. This means that the relevant range is currently 0-100, with two salespeople. If the store hires another salesperson, the relevant range would increase to a likely maximum of 150 units (since the 0-100 range was for two salespeople, each salesperson appears to have a selling capacity of 50 units).

LO: 2, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Exercise 4.6 (10–15 minutes) a.

Create a contribution margin income statement to find operating income. Contribution Margin Income Statement Sales ($18 × 90) $1,620 Less: Variable costs Product costs ($7 × 90) 630 Shipping ($3 × 90) 270 Contribution margin $ 720 Less: Fixed costs Marketing 100 Administrative 200 Other 200 Operating income $ 220

Create a new contribution margin income statement to incorporate the new information. Contribution Margin Income Statement Sales ($18 × 100) $1,800 Less: Variable costs Product costs ($7 × 100) 700 Shipping ($2 × 100) 200 Contribution margin $ 900 Less: Fixed costs Marketing 250 Administrative 200 Other 200 Operating income $ 250

Create a new contribution margin income statement to reflect the new information. Contribution Margin Income Statement Sales ($17 × 90) $1,530 Less: Variable costs Product costs ($7 × 90) 630 Contribution margin $ 900 Less: Fixed costs Marketing 100 Administrative 200 Other 200 Operating income $ 400 The customer will separately pay for the shipping cost directly to the shipping vendor; Tea Company will not see any revenue or cost associated with the shipping activity.

The highest income is generated in scenario (c). In that scenario, the contribution margin per unit is the highest of any scenario, at $10 per unit; total fixed costs are also just as low as they were in the first scenario a), at just $500. Even though volume of sales is highest in scenario (b), the lower contribution margin per unit does not allow the company to generate any more total contribution margin than what was generated in scenario (c).

LO: 2, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Knowledge, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting

Exercise 4.7 (5–10 minutes) a.

We can use the profit equation and solve for X, volume. Sales − Variable costs − Fixed costs = Operating income(loss) (Selling price/unit(X) − Variable cost/unit(X)) − Fixed costs = Profit(Loss) $30X − $5X − $150 = $3,500 $25X = $3,650 X = 146 sessions Or, we can use the target sales in units formula: Sales in units to reach target profit = (Fixed costs + Target operating income) ÷ CM per unit Sales in units to reach target profit = ($150 + $3,500) ÷ ($30 − $5) Sales in units to reach target profit = $3,650 ÷ $25 = 146 sessions

$3,500 after-tax = Before-tax income × (1 − 0.3) $3,500 = X (0.7) X = $5,000 before-tax income Using the profit equation: Selling price/unit(X)−Variable cost/unit(X) − Fixed costs = Profit(Loss) $30X − $5X − $150 = $5,000 $25X = $5,150 X = 206 sessions Or, we can use the target sales in units to achieve profit after-tax: Sales in units to achieve target after-tax profit = (Fixed costs + [Operating income ÷ (1 − Tax rate)]) ÷ CM per unit Target sales volume = ($150 + [$3,500 ÷ 0.7]) ÷ ($30 − $5) Target sales volume = $5,150 ÷ $25 = 206 units

New fixed expense = $400 $400 ÷ $25 CM per session = 16 sessions Teegan would need to sell 16 additional sessions in order to cover that cost. His current target volume is 206 sessions if he takes taxes into consideration. Each session requires one hour of his time, in addition to travel time. The advertising cost may be worth it if he is currently having difficulty finding enough clients. He has an entire year, after all, during which his fixed costs stay the same. If he conducts 206 sessions, it will require 206 hours of his time over the course of a year, plus travel time. If word-of-mouth or other free media outlets are not bringing in enough clients to meet his target, then he may find this advertising worth it.

LO: 3, 6, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Exercise 4.8 (20–25 minutes) A

Selling price/unit Total fixed costs

$5 $12,000

$750 ? (4)

? (7) $420,000

Volume Variable costs/unit

30,000 ? (1)

2,500 $330

? (8) $36

Operating income Tax rate

$33,000 ? (2)

? (5) 25%

$255,000 35%

After-tax profit Contribution ratio

$23,100

$685,875

? (9)

? (3)

? (6)

0.6

Company A (1)

margin

We can set up a contribution margin income statement, fill in what is given, and set variable costs equal to 30,000X, where X is the variable cost/unit. Solve for X. Contribution Margin Income Statement 2. $150,000 − 30,000X = $45,000 Sales ($5 × 30,000) $150,000 $105,000 = 30,000X Less: Variable costs 30,000X X = $3.50 Contribution margin $ ? 1. If operating income is $33,000 Less: Fixed costs 12,000 and fixed costs are $12,000, then Operating income $ 33,000 contribution margin must be $45,000.

Variable cost per unit = $3.50 (2)

Using before-tax profit (operating income) and after-tax profit, solve for the tax rate. Before-tax profit × (1 − Tax rate) = After-tax profit $33,000 (1 − Tax rate) = $23,100 1 − Tax rate = 0.7 Tax rate = 0.3 → 30%

(3)

CM ratio = Contribution margin ÷ Sales CM ratio = $45,000 ÷ $150,000 = 0.3

Company B (4)

Use the after-tax profit and the tax rate to solve for operating income. Operating income × (1 − Tax rate) = After-tax profit Operating income × (1 − 0.25) = $685,875 Operating income × 0.75 = $685,875 Operating income = $914,500: This is the answer to (5). Now we can use that amount to set up a contribution margin income statement, to solve for total fixed costs: Contribution Margin Income Statement Sales ($750 × 2,500) $1,875,000 Less: Variable costs ($330 × 2,500) 825,000 Contribution margin $1,050,000 $1,050,000 − Fixed Less: Fixed costs ? costs = $914,500 Fixed costs = $135,500 Operating income $ 914,500 4-22

Exercise 4.8 (Continued) Fixed costs = $135,500 (5)

$914,500; solved in (4), above.

(6)

CM ratio = Contribution margin ÷ Sales $1,050,000 ÷ $1,875,000 = 0.56

Company C (7)

Make a contribution margin income statement and first solve for the contribution margin: Contribution Margin Income Statement Sales $ ? Less: Variable costs 36X Contribution margin $ ? CM − $420,000 = $255,000 Less: Fixed costs 420,000 CM = $675,000 Operating income $255,000 Combine the CM and the CM ratio to solve for total sales: CM ratio = Contribution margin ÷ Sales 0.6 = $675,000 ÷ Sales Sales = $1,125,000 Now we can use the contribution margin formula (Sales − Variable costs) to find the volume. Make the volume equal to X and solve for X. $125,000 − 36X = $675,000 $450,000 = 36X X = 12,500 units: This is the answer to (8). Then, divide total sales by the volume in units to find the selling price/unit. Selling price = $1,125,000 ÷ 12,500 = $90/unit. This is the answer to (7).

(8)

12,500 units; solved for in (7), above.

(9)

Multiply the operating income by (1 − Tax rate) to find after-tax profit: After-tax profit = $255,000 × (1 − 0.35) After-tax profit = $255,000 × 0.65 = $165,750

LO: 3, Bloom: AN, Difficulty: Moderate, Time: 20-25, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Reporting & Control: Cost Accounting, Reporting & Control: Financial Statement Analysis

Exercise 4.9 (10–15 minutes) a.

CM ratio = Contribution margin/unit ÷ Selling price/unit CM ratio = ($5.00 − $2.50) ÷ $5.00 CM ratio = $2.50 ÷ $5.00 = 50% The CM ratio under the current conditions is 50%, which does not meet the needed 60%. So, no, it would not be approved.

Exercise 4.9 (Continued) b.

Use the CM ratio goal of 60% and the $5.00 selling price to solve for the needed variable cost/unit. CM ratio = Contribution margin/unit ÷ Selling price/unit 60% = ($5.00 − Variable cost/unit) ÷ $5.00 $3.00 = $5.00 − Variable cost/unit Variable cost/unit = $2.00

Sales in dollars to break even = Fixed costs ÷ CM ratio Sales in dollars to break even = $1,920 ÷ 60% = $3,200 in sales Sales in dollars to achieve target profit = (Fixed costs + Desired Operating income) ÷ CM ratio ($1,920 + $4,980) ÷ 0.6 = $11,500 in sales At this level of target operating income, after-tax profit would be: After-tax profit = $4,980 × (1 − Tax rate) After-tax profit = $4,980 (1 − 0.3) = $3,486

Since the hardware store would need to sell $3,200 worth of these tools just to breakeven on this promotion, while normal sales for these products range from $500 to $2,000 in a similar time frame, it seems unlikely to expect this would pay off. Target sales to achieve the target profit is almost four times the break-even sales amount, at $11,500. This seems well out of reach. Unless the hardware store is incredibly successful at bringing in customers to take advantage of this deal, this promotion appears very risky.

LO: 3, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis, Reporting & Control: Cost Accounting

Exercise 4.10 (10–15 minutes) a.

First calculate each product’s share of the total weighted average contribution margin (WACM) per unit. Then sum those to get the company’s total WACM. Product CM per Unit × Sales Mix WACM/unit Books $10 − $3 = $7 0.4 $2.80 Movies $15 − $9 = $6 0.4 2.40 Magazines $6 − $2 = $4 0.2 0.80 Total WACM/unit $6.00

Calculate the break-even point in units, then use the sales mix percentages to find the number of units of each product that is needed. Sales in units to break even = Total fixed costs ÷ WACM/unit Sales in units to break even = $30,000 ÷ $6.00 = 5,000 units Product Calculation Books 40% × 5,000 units Movies 40% × 5,000 units Magazines 20% × 5,000 units Total units

Units 2,000 2,000 1,000 5,000

Exercise 4.10 (Continued) c.

Books typically comprise 40% of the company’s sales volume. If Books’n More sells 3,000 books, we can divide 3,000 by 0.4 to find the total sales volume. Total sales volume = 3,000 ÷ 0.4 = 7,500. The company sells the same number of books as it does movies. The remainder is magazines. 7,500 − (3,000 × 2) = 1,500 1,500 magazines, 3,000 books, and 3,000 movies

Magazines generate the smallest contribution margin per unit at $4 per unit. This product category, therefore, contributes the least toward covering the company’s fixed costs (and profit). This category also has the lowest sales mix percentage, so it is a very small contributor, overall, for covering the company’s fixed costs, and generating profit. From the information provided we cannot tell how much effort the company is putting toward selling products in this category. The company may need to carry magazines as part of offering a complete portfolio of products, strategically. But it likely focuses its sales efforts on its higher margin and higher volume products—books and movies.

LO: 4, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Exercise 4.11 (20–25 minutes) a.

If the sales mix for tablets is 25% and the break-even sales in units is 100, the breakeven number of tablets is 25 (100 × 25%). If the volume of accessories sold is 1.5 times the volume of phones sold, we can set up an algebraic equation where the number of phones is equal to X, and solve for X. Total units sold = Phones + Tablets + Accessories 100 = X + 25 + 1.5X 100 = 2.5X + 25 75 = 2.5X X = 30 phones (sales mix of 30%) Now subtract the number of phones (30) and the number of tablets (25) from 100 to find the number of accessories. 100 − 30 − 25 = 45 accessories (sales mix of 45%)

30 units. 30% × 100 units = 30 units (detailed calculation above)

Sales in units to achieve target profit = (Total fixed costs + Target Operating income) ÷ Weighted average contribution margin per unit Total fixed costs = 11,000 + 4,400 + 2,600 + 1,200 + 800 + 600 Total fixed costs = $20,600 Product CM per Unit × Sales Mix WACM/unit Phones $800 − $400 = $400 0.30 $120 Tablets $500 − $300 = $200 0.25 50 Accessories $100 − $20 = $80 0.45 36 Total WACM/unit $206

Exercise 4.11 (Continued) Sales in units to achieve target profit = ($20,600 + $12,360) ÷ $206 Sales in units to achieve target profit = $32,960 ÷ $206 = 160 units Now use the sales mix percentages on 160 total units to find the sales volume needed of each category of product. Product Calculation Units Phones 30% × 160 units 48 Tablets 25% × 160 units 40 Accessories 45% × 160 units 72 Total units 160 d.

In part (c), it was determined that the company needs to sell 48 phones each month in order to reach the target profit. Since the store typically sells more than that, yes—the company should be on track to reaching or exceeding its target profit of $12,360 from part (c) if it maintains its sales of tablets and accessories.

LO: 4, Bloom: AN, Difficulty: Moderate, Time: 20-25, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Strategy, Planning, & Performance: Budgeting and Forecasting

Exercise 4.12 (15–20 minutes) a.

Sales in units to break even = Total fixed costs ÷ Weighted average contribution margin/unit Product CM per Unit × Sales Mix WACM/unit Soda $6.00 − $0.50 = $5.50 0.3 $1.65 Hot dog $5.00 − $1.50 = $3.50 0.4 1.40 Peanuts $7.00 − $2.50 = $4.50 0.3 1.35 Total WACM/unit $4.40 Sales in units to break even = $11,000 ÷ $4.40/unit = 2,500 units Product Calculation Units Soda 30% × 2,500 units 750 Hot dog 40% × 2,500 units 1,000 Peanuts 30% × 2,500 units 750 Total units 2,500

Sales in units to break even = Total fixed costs ÷ WACM/unit Product CM per Unit × Sales Mix WACM/unit Soda $5.50 0.1 $0.55 Hot dog $3.50 0.5 1.75 Peanuts $4.50 0.4 1.80 Total WACM/unit $4.10 Sales in units to break even = $12,300 ÷ $4.10 = 3,000 units Product Calculation Units Soda 10% × 3,000 units 300 Hot dog 50% × 3,000 units 1,500 Peanuts 40% × 3,000 units 1,200 Total units 3,000

Exercise 4.12 (Continued) c.

The break-even point is different in parts (a) and (b) because the company’s sales mix shifted toward lower-margin-generating products and away from higher-margingenerating products. Specifically, • The sales mix for sodas, the product with the highest contribution margin per unit, decreased from 30% of unit sales to 10%, and • The sales mix for hot dogs, the product with the lowest contribution margin per unit, increased from 40% of unit sales to 50%. Additionally, the company’s total fixed costs increased, requiring more contribution margin from product sales to cover them.

Soda sales may have decreased due to health concerns over sugar levels in soda. In addition, budget-conscious families may also be trying to save money by avoiding beverage purchases entirely and bringing their own empty water bottle into the park, refilling it at a water fountain when necessary. In terms of a promotion, the company could consider a hot dog + soda combination that is less expensive than buying them separately in order to increase sales. CM would be lower than originally presented, though, if there was a “deal” for this combination. The company could also consider offering sugar-free sodas, bottled water, or real fruit juice in lieu of regular soda. Is it ethical for the ballpark to push soda sales while recognizing the high sugar levels they contain? As long as the ballpark is not encouraging excessively large serving sizes and/or repeated refills, it may be fine to promote a soda sale as kids enjoy a special experience at the ballpark. A “healthy kids” campaign could coincide with the ballpark experience, promoting physical activity (such as playing baseball) and healthy eating habits at the same time.

LO: 4, Bloom: AN, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Communication, Ethics, Analytic, AICPA BC: Strategic Perspective, Customer Perspective, AICPA AC: Reporting, AICPA PC: Ethical Conduct, Communication, IMA: Reporting & Control: Cost Accounting, Professional Ethics & Values: Recognizing and Resolving Unethical Behavior

Exercise 4.13 (10–15 minutes) a.

Degree of operating leverage (DOL) = Contribution margin ÷ Operating income DOL = $280,000 ÷ $80,000 = 3.50

We can multiply the DOL by the percentage change in Sales to predict the percentage change in income. From there, we can determine the new income amount. Percentage increase in income = 3.50 × 20% = 70% increase Current income = $80,000 New income = $80,000 × 1.70 = $136,000 new income That’s an increase in income of $56,000 ($136,000 − $80,000). See the income statement, below, for proof: Contribution Margin Income Statement Sales ($400,000 × 1.2) $480,000 Less: Variable costs ($120,000 × 1.2) 144,000 Contribution margin ($280,000 × 1.2) $336,000 Less: Fixed costs 200,000 Operating income $136,000

Exercise 4.13 (Continued) c.

Operating income = CM − Fixed costs $136,000 = CM − $300,000 CM = $436,000 Change in CM: New contribution margin − Old contribution margin (part b) Difference in CM

$436,000 336,000 $100,000

A $100,000 increase in CM reflects a 30% increase from the previous amount ($100,000 ÷ $336,000) = 0.2976 = 29.76%. In order to generate the same operating income, contribution margin must increase by approsimately 30%. For CM to increase by 30%, sales volume will accordingly need to increase by 30% (with Sales and Variable costs following suit). The company will need to sell 30% more lumber in order to cover its higher fixed costs and generate the same profit as before. LO: 5, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: N/A, IMA: Strategy, Planning, & Performance: Budgeting and Forecasting, Reporting & Control: Cost Accounting

Exercise 4.14 (15–20 minutes) a.

Degree of operating leverage (DOL) = Contribution margin ÷ Operating income DOL = Contribution margin ÷ (Contribution margin − Fixed costs) Contribution margin = (Selling price − Variable cost per unit) × Volume CM = (50 − 2) × 4 = $192 Now use DOL formula to find fixed costs: DOL = CM ÷ (CM − Fixed costs) 1.5 = $192 ÷ ($192 − Fixed costs) 1.5 × ($192 − Fixed costs) = $192 $288 − 1.5(Fixed costs) = $192 $96 = 1.5(Fixed costs) Fixed costs = $64/month

Percentage change in Operating income = DOL × % Change in sales Percentage change in Operating income = 1.5 × 50% Percentage change in Operating income = 1.5 × 50% = 75% Operating income will increase by 75% if sales increase by 50%. New operating income = Original operating income + 75% of original operating income Original operating income = Contribution margin − Fixed costs Original operating income = $192 − $64 = $128 New operating income = $128 × 1.75 = $224 Income statement presentation of both scenarios: Contribution Margin Income Statement Old New Sales $50 × 4 = $200 $50 × 6 = $300 Less: Variable costs $2 × 4 = 8 $2 × 6 = 12 Contribution margin $192 $288 Less: Fixed costs 64 64 Operating income $128 $224 4-28

Exercise 4.14 (Continued) Operating income increase = $224 − $128 = $96 increase Percentage change in operating income = $96 ÷ $128 = 75% increase c.

New selling price = $50 × 1.2 = $60 DOL = Contribution margin ÷ Operating income Contribution Margin Income Statement Sales ($60 × 4) $240 Less: Variable costs ($2 × 4) 8 Contribution margin $232 Less: Fixed costs 64 Operating income $168 DOL = $232 ÷ $168 = 1.38 This scenario has the effect of decreasing his DOL slightly, from 1.50 to 1.38; a reduction of 0.12. This means his operating income will be affected slightly less by a percentage change in sales (volume or price).

Sales volume = 4 − 1 = 3 units per month DOL = Contribution margin ÷ Operating income Contribution Margin Income Statement Sales ($60 × 3) $180 Less: Variable costs ($2 × 3) 6 Contribution margin $174 Less: Fixed costs 64 Operating income $110 DOL = $174 ÷ $110 = 1.58 This increases his DOL by 0.08 (from his original DOL of 1.5). This means his operating income will be affected slightly more by a percentage change in sales (volume or price).

LO: 5, Bloom: AN, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: N/A, IMA: Strategy, Planning, & Performance: Budgeting and Forecasting

Exercise 4.15 (5–10 minutes) a. Total costs = Variable costs + Fixed costs Total costs = ($8 × 50) + $500 = $400 + $500 = $900 The youth group will need to raise $900 in order to cover its costs. b. $2,000 − $900 = $1,100 surplus With the surplus generated, the youth group could purchase additional yard clean-up supplies or equipment to allow it to expand its reach in the following season. Alternatively, or additionally, the group could consider donating the additional funds to those in need in the community. LO: 6, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Exercise 4.16 (5–10 minutes) a.

Fixed costs = $150 per day Fixed cost per patient = $150 ÷ 60 patients = $2.50 per patient Variable cost per patient = $25 Total cost per patient = Fixed cost per patient + Variable cost per patient Total cost per patient = $2.50/patient + $25/patient = $27.50/patient

The most obvious cost that isn’t included is salaries and wages for the dentist and hygienist, because involvement in this campaign is on a volunteer basis. While the rent of the facility partially offsets the facility cost, other real operating costs of the facility are also not included (depreciation, utilities, taxes, etc.). Further, for this Smile campaign, the dentists are not charging a mark-up for their own practice’s profitability.

Community members who understand how costs work will likely recognize that the amount charged to them for dental care is justified. There will always be customers/patients who believe that they are being overcharged, though, regardless of the service being provided. Community members will likely recognize the very specialized training and skills needed of their dental professionals and will be appreciative to have these services available in their community.

LO: 6, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Knowledge, Communication, Analytic, AICPA BC: Customer Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Reporting & Control: Cost Accounting

Solutions to Problems Problem 4.1 a.

We can set up a contribution margin income statement, fill in the information given, and solve for the missing information. Contribution Margin Income Statement Sales $112,000 2. $112,000 − $77,000 = Less: Variable costs ? $35,000 VC Contribution margin $ ? Less: Fixed costs 10,000 1. $67,000 + $10,000 = $77,000 CM Operating income $ 67,000 Total variable costs = Variable cost/unit × Sales volume $35,000 = $25/unit × Sales volume Sales volume = $35,000 ÷ $25/unit = 1,400 units Total sales = Selling price × Sales volume $112,000 = Selling price × 1,400 units Selling price = $112,000 ÷ 1,400 units = $80/unit CM/unit = Contribution margin ÷ Sales volume CM/unit = $77,000 ÷ 1,400 units = $55/unit

Actual Variable cost/unit = $25 × 1.4 = $35 Contribution Margin Income Statement Sales $112,000 Less: Variable costs ($35 × 1,400) 49,000 Contribution margin $ 63,000 Less: Fixed costs 10,000 Operating income $ 53,000 Operating income decreased from $67,000 to $53,000, a $14,000 decrease.

Option 1: Ned could pull the hoodies off the shelves (donate them) and find a new/different supplier to reintroduce the hoodie item at a later date. This would create a sizable loss for his company, but it could prevent reputational damage that may be even more challenging to overcome. Option 2: He could discount the current hoodies while he builds inventory of a new/higher quality product. Option 3: He could leave the hoodies on the shelves and do nothing; however, if more customers complain, it could result in reputational damage to the store, overall. Option 4: He could leave the hoodies on the shelves but have salespeople suggest customers buy one size larger than normal (in case the previous issues were from hoodies that were too tight); there could still be quality concerns, though, if the bigger size doesn’t fix the issue.

LO: 1, 2, Bloom: AN, Difficulty: Simple, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, Customer Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis, Reporting & Control: Cost Accounting

Problem 4.2 a.

Two specific profitability relationships were identified in the problem: at 8,000 units, Operating income = $14,000. At 2,000 units, Operating income (loss) = ($10,000) Notice that neither of these relationships is a specific point on either line; the profit(loss) amount reflects the difference between the total revenue line and the total cost line. We can use the operating income formula to determine contribution margin: Sales − Variable costs − Fixed costs = Operating income, Or, a more simplified version of this formula: Contribution Margin − Fixed costs = Operating income State the formula using the two profitability relationships noted above: (CM per unit × 2,000 units) − Fixed costs = ($10,000) (CM per unit × 8,000 units) − Fixed costs = $14,000 Using the first formula, above, fixed costs can be expressed as: Fixed costs = 2,000(CM per unit) + $10,000 Substitute this formula into the second equation to solve for CM per unit: 8,000(CM per unit) − (2,000(CM per unit) + 10,000) = $14,000 8,000(CM per unit) − 2,000(CM per unit) − $10,000 = $14,000 6,000(CM per unit) = $24,000 CM per unit = $4 per unit Insert the CM per unit estimate back into the first formula to determine fixed costs: Fixed costs = 2,000($4 per unit) + $10,000 Fixed costs = $8,000 + $10,000 Fixed costs = $18,000 Note: this value of fixed cost looks reasonably given the starting point for the total cost line in the graph; it visually looks to cross the Y-axis at $18,000. Sales in units to break even = Fixed costs ÷ CM per unit Sales in units to break even = $18,000 ÷ $4 per unit = 4,500 units

Average sales = 6,000 units Use the simplified operating income formula to calculate income: Contribution margin − Fixed costs = Operating income Operating income = $4X − $18,000 Operating income = ($4 × 6,000) − $18,000 Operating income = $6,000

If the company’s sales volume drops below the current break-even point, the business would generate a loss under current selling price, variable cost, and fixed cost amounts. At that reduced volume, it would be very difficult to generate $6,000 in profit, given competition in the area that would limit much of a potential for a selling price increase. If volume goes down but not as drastically as dropping below 4,500 units, it may be possible for the store to generate the same income. To do so, it would have to either raise prices and/or reduce variable costs, and/or reduce fixed costs. Some increase in contribution margin per unit would be almost necessary, as reducing fixed costs significantly would hamper the capacity of the business. Quality of product would need to be an important consideration, however, before reducing variable cost/unit.

LO: 1, 2, Bloom: AN, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Technology & Analytics: Visualization, Reporting & Control: Cost Accounting

Problem 4.3 a. Given Contribution Margin Income Statement Sales $ 1,200 Less: Variable costs 20,000 Contribution margin (18,800) Less: Fixed costs 15

Correct Contribution Margin Income Statement Sales ($30 × 40) $1,200 Less: Variable costs ($15 × 40) 600 Contribution margin 600 Less: Fixed costs ($500) 500

Operating income (loss)

Operating income

$(18,815)

$ 100

The intern had the correct order/format of the income statement, and she calculated sales correctly. The corrected income statement is shown to the right of the intern’s work, above. b. 1.

2. 3. c.

Variable costs were incorrect—she took the $500/month fixed cost amount and multiplied it by the 40 units as if it were the variable cost/unit amount. She should have multiplied the true variable cost per unit of $15 by 40 units to get the correct total variable costs. Fixed costs were incorrect—she used the $15/cake variable cost amount instead of the $500/month fixed cost amount. The correct income statement is shown in part (a).

Adding these 40 cakes would produce an additional $100 in operating income every month, so yes—it looks like this product would be a good addition to the bakery’s current product offerings. The manager should also consider several additional factors before moving forward with this new product: • Will the assumption of selling 40 cakes/month continue to be accurate? Or will demand decrease to the point that the cakes are no longer profitable? Or will demand increase to the point that it exceeds current capacity? • Will the current variable cost of $15/cake stay at that level? • Will other bakeries start making this item available to their customers and thereby threaten the sales of this bakery? • What is the margin of safety? How far can sales fall before the bakery loses money on this product? • Will there be an opportunity to raise the selling price of these cakes to make it more profitable to continue providing this item?

LO: 1, 2, Bloom: AN, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Budgeting and Forecasting, Reporting & Control: Cost Accounting

Problem 4.4 a.

Gross margin ratio = Gross margin ÷ Sales 60% = Gross margin ÷ $625,000 Gross margin = 60% × $625,000 = $375,000 Gross margin = Sales − COGS $375,000 = $625,000 − COGS COGS = $625,000 − $375,000 = $250,000 Or, if Gross margin % is 60%, COGS % must be 40% (100 − 60%). COGS = 40% × $625,000 = $250,000 COGS cannot exceed $250,000 if the company is to meet its goal. COGS reflects the company’s total manufacturing costs for the period (including both variable and fixed manufacturing costs for the units sold).

From part (a), we know that total COGS can’t exceed $250,000 to meet its goal. We use this to solve for variable product cost/unit. Total COGS = (Variable manufacturing cost/unit × Unit sales) + Fixed manufacturing costs $250,000 = (Variable manufacturing cost/unit × 25,000) + $87,500 $162,500 = Variable manufacturing cost/unit × 25,000 Variable manufacturing cost/unit = $6.50 Now use the GM ratio formula to solve for the selling price (SP). GM ratio = (Sales − COGS) ÷ Sales 60% = ([25,000 × SP] − $250,000) ÷ (25,000 × SP) 60%(25,000 × SP) = 25,000 × SP − $250,000 15,000 × SP = (25,000 × SP) − $250,000 $250,000 = 10,000 × SP SP = $25 per unit

CM% = CM ÷ Sales = (Sales − Variable costs) ÷ Sales Variable selling cost/unit = $2.50/unit (given) Variable COGS/unit = $6.50/unit (solved for in (b)) Total variable cost/unit = Variable selling cost/unit + Variable COGS/unit = $2.50 + $6.50 = $9.00/unit CM% = ($25.00 − $9.00) ÷ $25.00 CM% = $16.00 ÷ $25.00 = 0.64 → 64% Yes, the company would meet the 60% CM ratio goal.

Adding a new plant supervisor would increase COGS, which would decrease gross margin, and therefore decrease the GM ratio. If gross margin decreases, so will operating income (profit). Employees involved in a profit-sharing plan will not likely be pleased with this turn of events. Some employees may be relieved at the additional presence of a supervisor, however, if they believe the additional supervisor will be able to curb some of the safety concerns. This would particularly be true if the safety concerns are serious in nature such that the employees feel in danger while in the workplace.

LO: 1, 2, Bloom: AN, Difficulty: Complex, Time: 20-25, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Budgeting and Forecasting

Problem 4.5 a. Product CM per Unit × Sales Mix WACM/unit Subs $5.00 0.2 $1.00 Pasta $9.00 0.3 2.70 Pizza $7.00 0.5 3.50 Total WACM/unit $7.20 The total sales mix reflects the portion of total sales volume each product comprises. Here: Subs comprise 2 ÷ (2 + 3 + 5) = 20% Pasta comprises 3 ÷ (2 + 3 + 5) = 30% Pizza comrises the remaining 50% = 5 ÷ (2 + 3 +5) Sales volume in units to break even = Total fixed costs ÷ WACM/unit Sales volume in units to break even = $2,880 ÷ $7.20 = 400 units The specific break-even volume for each product type is shown below: Product Calculation Units Subs 20% × 400 units 80 Pasta 30% × 400 units 120 Pizza 50% × 400 units 200 Total units 400 b.

New total fixed costs = $2,880 × 1.2 = $3,456 Sales volume in units to break even = Total fixed costs ÷ WACM/unit Sales volume in units to break even = $3,456 ÷ $7.20 = 480 units New sales volume by product to break even (and the difference compared to the previous period): Units to − Last Month Units Product Calculation = Difference Break Even to Break Even Subs 20% × 480 units 96 80 16 Pasta 30% × 480 units 144 120 24 Pizza 50% × 480 units 240 200 40 Total 480 units

c. Product Calculation New CM/unit × Sales mix WACM/unit Subs $5.00 × 1.2 = $ 6.00 0.2 $1.20 Pasta $9.00 × 1.2 = 10.80 0.3 3.24 Pizza $7.00 × 1.2 = 8.40 0.5 4.20 Total WACM/unit $8.64 Sales volume in units to break even = Total fixed costs ÷ WACM/unit Sales volume in units to break even = $3,456 ÷ $8.64 = 400 units

Problem 4.5 (Continued) New, higher contribution margins per unit are presented above for each product, along with the new WACM/unit calculation given these higher contribution margins per unit. The resulting break-even volumes would be exactly the same as what they were in part (a). The concern with this scenario is that in order to generate a higher contribution margin, the company will either need to raise selling prices, reduce variable costs per unit, or both. People may not be willing to buy these products in the same proportions as they had been, if they’re willing to buy them at all, if selling prices have increased and/or if there is a real or perceived reduction in quality (or quantity) due to reducing variable costs per unit. d.

This approach would allow Palo’s to increase profitability—variable cost/unit would decrease, which would increase contribution margin and operating income. Customers may notice the difference in portion size, however, and may be unhappy because they are getting less food for the same price. This is especially true because the restaurant is apparently known for its generous portions. If the portion size is only slightly decreased, customers may not even notice, and if they do, they may still find the value satisfying. Consumers are much more likely to notice an increase in price than a slight decrease in portion size, so it may be worth a try if reducing costs elsewhere is not a viable option.

LO: 1, 2, 4, Bloom: AN, Complex, Time: 15-20, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Budgeting and Forecasting, Reporting & Control: Cost Accounting

Problem 4.6 a.

Contribution margin income statements are presented for each company, along with a calculation of degree of operating leverage for each, as well. Degree of operating leverage, or DOL = Contribution margin ÷ Operating income Company X Sales ($50 × 10,000 units) Less: Variable costs ($20 × 10,000 units)

$500,000

200,000

Sales ($50 × 10,000 units) Less: Variable costs ($10 × 10,000 units)

Contribution margin Less: Fixed costs

300,000 100,000

Contribution margin Less: Fixed costs

400,000 200,000

Operating income

$200,000

Operating income

$200,000

DOL ($300,000 ÷ $200,000) b.

Company Y

1.5

100,000

DOL ($400,000 ÷ $200,000)

Percentage increase in Operating income = DOL × Percentage change in sales. Company X: 1.5 × 30% increase = 45% increase in Operating income Company X Operating income increase = $200,000 × 0.45 = $90,000 Company Y: 2.0 × 30% increase = 60% increase in Operating income Company Y Operating income increase = $200,000 × 0.60 = $120,000

Company X: 1.5 × 30% decrease = 45% decrease in Operating income Company X Operating income decrease = $200,000 × 0.45 = $90,000 Company Y: 2.0 × 30% decrease = 60% decrease in Operating income Company Y Operating income decrease = $200,000 × 0.60 = $120,000

d. With a sales volume increase of 30%: 10,000 × 1.3 = 13,000 units Company X

Company Y

Sales ($50 × 13,000 units) Less: Variable costs ($20 × 13,000 units)

$650,000

260,000

Sales ($50 × 13,000 units) Less: Variable costs ($10 × 13,000 units)

Contribution margin Less: Fixed costs

390,000 100,000

Contribution margin Less: Fixed costs

520,000 200,000

Operating income

$290,000

Operating income

$320,000

130,000

Company X: increase in income = $290,000 − $200,000 = $90,000 Company Y: increase in income = $320,000 − $200,000 = $120,000

Problem 4.6 (Continued) With a sales volume decrease of 30%: 10,000 × 0.7 = 7,000 units Company X

Company Y

Sales ($50 × 7,000 units) Less: Variable costs ($20 × 7,000 units)

$350,000

140,000

Sales ($50 × 7,000 units) Less: Variable costs ($10 × 7,000 units)

Contribution margin Less: Fixed costs

210,000 100,000

Contribution margin Less: Fixed costs

280,000 200,000

Operating income

$110,000

Operating income

$ 80,000

70,000

Company X: decrease in income = $200,000 − $110,000 = $90,000 Company Y: decrease in income = $200,000 − $80,000 = $120,000 e.

Companies with lower DOL’s will generate more stable profit amounts even in periods of fluctuating volume, while companies with higher DOL’s will generate a wide range of profit amounts as volume changes. Some businesses are willing to risk their profitability on proposed changing conditions in the marketplace; others prefer to play it a little safer, looking for more of a “guaranteed” income. The risk preferences of the owners as well as the capital-intensive needs of the industry will dictate how a company structures it costs.

They will need to consider what their risk tolerance is toward not only significant gains but also significant losses. The larger the swing they are comfortable with, the higher the DOL they may pursue. If they prefer a more stable profitability environment, they may pursue a lower DOL. The company can also benchmark against other companies in the industry to see how the majority of companies are structuring their employee compensation plans. Perhaps Maddie needs to stay in line with the majority of others in the industry to remain competitive; alternatively, perhaps she can “change the game” in the industry if she believes the industry could support a more concerted change in structure such as this.

LO: 1, 2, 5, Bloom: S, Difficulty: Moderate, Time: 20-25, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Measurement Analysis and Interpretation, Reporting, AICPA PC: Communication, IMA: Reporting & Control: Financial Statement Preparation, Strategy, Planning, & Performance: Decision Analysis

Problem 4.7 a.

Fixed cost examples: • Salaries for the professional staff • Rent (if building is rented) • Depreciation on building (if building is owned) • Depreciation on office equipment and furniture • Insurance & taxes • Amortization on software • Licenses • Employee training and certification • Marketing and advertising campaigns

Total billable hours = (5 × 1,200) + (7 × 1,200) + (8 × 1,800) + (20 × 1,800) Total billable hours = 6,000 + 8,400 + 14,400 + 36,000 = 64,800 hours Admin. Staff 64,800 hours × $25.00 = $1,620,000 Misc. supplies 64,800 hours × $5.00 = 324,000 Total variable costs $1,944,000 Total revenue for each role type = Number of individuals × Billable hours per person × Billable rate per hour. Number of Target Billable Billable Rate Total Revenue Level Individuals Hours per Person per Hour by Role Partner 5 1,200 $175 $1,050,000 Manager 7 1,200 125 1,050,000 Senior 8 1,800 100 1,440,000 Staff 20 1,800 75 2,700,000 Total revenue $6,240,000 Then create a contribution margin income statement to find operating income. Contribution Margin Income Statement Service revenue $6,240,000 Less: Variable costs 1,944,000 Contribution margin $4,296,000 Less: Fixed costs 3,500,000 Operating income $ 796,000

New partner hours = 1,200 hours × 1.2 = 1,440 hours Number of Target Billable Level Individuals Hours per Person Partner 5 1,440 Manager 7 1,200 Senior 8 1,800 Staff 20 1,800 Total revenue

Billable Rate per Hour $175 125 100 75

Total Revenue by Role $1,260,000 1,050,000 1,440,000 2,700,000 $6,450,000

New total billable hours = (5 × 1,440) + (7 × 1,200) + (8 × 1,800) + (20 × 1,800) New total hours = 7,200 + 8,400 + 14,400 + 36,000 = 66,000 hours

Problem 4.7 (Continued) Admin. staff 66,000 hours × $25.00 = $ 1,650,000 Misc. supplies 66,000 hours × $5.00 = 330,000 Total variable costs $1,980,000 Create a new contribution margin income statement. Contribution Margin Income Statement Service revenue $6,450,000 Less: Variable costs 1,980,000 Contribution margin $4,470,000 Less: Fixed costs 3,500,000 Operating income $ 970,000 LO: 1, 2, 6, Bloom: AN, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: Strategy, Planning, & Performance: Budgeting and Forecasting

Solution to Analysis and Decision-Making Case Case a.

Determine the volume at the current operating income level of $0. Total variable costs/unit Paper $0.75/unit Printing 0.90/unit Film 0.50/unit Total variable costs $2.15/unit CM/unit = Selling price/unit − Variable cost/unit CM/unit = $6.95 − $2.15 = $4.80 Operating income = Contribution margin − Fixed costs Solve for volume with operating income at zero. $4.80X − $59,040 = $0 $4.80X = $59,040 X = 12,300 units Alternatively, we can use the break-even point formula directly. Sales in units to break even = Fixed costs ÷ CM per unit Sales in units to break even = $59,040 ÷ 4.80 = 12,300 units 1.

New selling price = $6.95 × 0.9 = $6.26 New volume = 12,300 × 1.05 = 12,915 units Option 1 Contribution Margin Income Statement Sales ($6.26 × 12,915 units) $80,847.90 Less: Variable costs ($2.15 × 12,915 units) 27,767.25 Contribution margin $53,080.65 Less: Fixed costs 59,040.00 Operating income $(5,959.35)

New fixed costs = $59,040 + $1,000 = $60,040 New volume = 12,300 × 1.1 = 13,530 units Option 2 Contribution Margin Income Statement Sales ($6.95 × 13,530 units) $94,033.50 Less: Variable costs ($2.15 × 13,530 units) 29,089.50 Contribution margin $64,944.00 Less: Fixed costs 60,040.00 Operating income $ 4,904.00

Case (Continued)

Change paper cost from $0.75 to $0.60, and film cost from $0.50 to $0.40, Thus, new variable cost/unit = $0.60 + $0.90 + $0.40 = $1.90 Option 3 Contribution Margin Income Statement Sales ($6.95 × 12,300 units) $85,485.00 Less: Variable costs ($1.90 × 12,300 units) 23,370.00 Contribution margin $62,115.00 Less: Fixed costs 59,040.00 Operating income $ 3,075.00

Salary cost changes from $45,000 to $25,000, New fixed costs = $25,000 + $14,040 = $39,040 New variable cost per unit becomes $2.15 + $1.50 commission = $3.65 per unit New sales volume = 12,300 x 1.2 = 14,760 units Option 4 Contribution Margin Income Statement Sales ($6.95 × 14,760 units) $102,582.00 Less: Variable costs ($3.65 × 14,760 units) 53,874.00 Contribution margin $ 48,708.00 Less: Fixed costs 39,040.00 Operating income $ 9,668.00

Option 4 is the only one that comes close to the goal of $10,000 in operating income. The salespeople may not be happy with a new uncertainty about their paychecks if the company moves to a commission-based compensation plan. On the other hand, some might be happy that their own individual efforts can finally pay off for them. If salespeople end up successfully increasing the company’s sales volume, their efforts will generate not only higher sales for the company, but also higher compensation costs, which is an important consideration for management. While the other options don’t come close to the $10,000 income goal, here are a few summary comments about each. Option 1: This option generates a loss, leaving the company in a worse state than it is in currently. The drop in selling price significantly hampers the company’s ability to generate contribution margin. Unless there is a very significant increase in sales volume to offset the reduced contribution margin per unit, this option will not be viable. Option 2: This option nearly reaches 50% of the operating income goal. It does, at least, provide an improvement over the company’s current break-even status. Perhaps the estimated increase in sales volume is a conservative estimate; if a larger sales volume increase could be generated, the company may get closer to its goal that this estimate currently shows. Option 3: This option provides a small improvement over the company’s current breakeven status, but it is still far from its goal. Reducing variable costs per unit will allow the company to keep its costs down. Concerns over product quality may come into play, however, and if that lower quality is noticed by consumers, sales volume will almost certainly decline as a result.

Case (Continued) c.

None of the options will help the company reach $10,000 in operating income, before tax, so none of them will generate $10,000 in net income, after tax. The after-tax operating income (loss) amounts are shown here. 1. 2. 3. 4.

$(5,959.35) = 0 $4,904 × 0.75 = $3,678.00 $3,075 × 0.75 = $2,306.25 $9,668 × 0.75 = $7,251.00

Other suggestions that Leo could consider: 1. Leo could look at the $14,040 of “other operating costs,” since no further detail is provided for this category. Could any of these be reduced/removed? 2. Consider a different advertising effort where a larger increase in sales volume could be likely. The advertising plan in option (2) did create additional profit, just not enough. 3. Leo could consider implementing both options 2 and 4, with hopes to increase volume between 20-30%. Option 2 suggests a volume increase of 10% and option 4 suggests a volume increase of 20%. It may be unrealistic to think volume would increase by 30% due to these efforts, but if volume could increase by 25%, after implementing both of these efforts, operating income would exceed his $10,000 target. New volume = 12,300 units × 1.25 = 15,375 Variable cost/unit = $2.15 + $1.50 = $3.65/unit Option 4 Contribution Margin Income Statement Sales ($6.95 × 15,375 units) $106,856.25 Less: Variable costs ($3.65 × 15,375 units) 56,118.75 Contribution margin 50,737.50 Less: Fixed costs $59,040 - $20,000 + $1,000) 40,040.00 Operating income $ 10,697.50 4.

Another option is to possibly increase the selling price, depending on the market. If there are few to no substitutes, customers may be willing to pay more, and a higher price may even signal higher quality. Try to reduce variable costs even further, without affecting the quality—perhaps through better relationships with vendors or new available resources in the marketplace.

LO: 1, 2, 3, Bloom: AN, Difficulty: Complex, Time: 20-25, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Chapter 5 Relevant Costs for the Decision-Maker Assignment Classification Table (By Learning Objective) Learning Objectives

Brief Questions Exercises

Exercises

Problems

Develop a decision-making framework in a few simple steps.

1, 2

1, 2, 3, 4, 5, 6, 7

Identify relevant information, costs, and/or revenues for a given decision.

3, 4

Outline four types of management decisions within the context of relevant costing.

5, 6, 7, 8, 5, 6, 7, 8, 3, 4, 5, 6, 2, 3, 4, 5, 9 9, 10, 11, 7, 8, 9, 10, 6, 7 12 11, 12, 15

Explain how opportunity costs relate to decision-making.

10, 11

6, 13, 14

2, 3, 6

Describe how three types of fixed costs impact decision-making.

12, 13, 14, 12, 13 15

11, 15, 16

1, 2

1, 2, 3, 4, 5, 6, 7

Assignment Characteristics Table

Item E5.1 E5.2 E5.3 E5.4 E5.5 E5.6 E5.7 E5.8 E5.9 E5.10 E5.11 E5.12 E5.13 E5.14 E5.15 E5.16

P5.1 P5.2 P5.3 P5.4 P5.5 P5.6 P5.7

Case

Level of Difficulty Simple

Time (minutes) 10–15

Moderate

10–15

Simple

5–10

Simple

5–10

Simple

10–15

Simple

10–15

Simple Moderate

10–15 15–20

Moderate

10–15

Moderate Moderate

10–15 10–15

Moderate

10–15

Moderate

10–15

Moderate

15–20

Moderate

15–20

Moderate

15–20

Determine relevant information and follow the five-step decision process to make a decision. Evaluate relevant information for an insource or outsource decision plus additional considerations. Evaluate relevant information to make a keep or drop decision plus additional considerations. Evaluate relevant information for a keep or drop scenario plus additional considerations. Evaluate a special-order decision plus additional considerations. Evaluate relevant information to make a decision to outsource or not plus additional considerations. Evaluate a product mix decision given production and demand constraints with or without Solver add-in.

Moderate

10–15

Moderate

15–20

Moderate

15–20

Moderate

15–20

Moderate

15–20

Moderate

15–20

Complex

25–30

Evaluate relevant information to make a keep or drop decision plus additional considerations.

Moderate

15–20

Description Make a decision based on assessment of quantitative and qualitative information. Make a decision based on assessment of quantitative and qualitative information. Evaluate an insource or outsource decision considering quantitative and qualitative information. Evaluate an insource or outsource decision considering quantitative and qualitative information. Evaluate a keep or drop decision considering quantitative and qualitative information. Evaluate a keep or drop decision considering quantitative and qualitative information plus opportunity costs. Evaluate a product mix decision to maximize profitability. Evaluate a product mix decision considering a constrained resource with or without Solver add-in. Evaluate a product mix decision considering a constrained resource. Evaluate a special-order decision. Evaluate a keep or drop decision considering different types of fixed costs. Evaluate an insource or outsource decision considering different types of fixed costs. Evaluate a decision to keep or sell a vehicle considering opportunity costs plus use of Goal Seek function. Identify opportunity costs associated with different choices and explain their implications. Distinguish the relevance of different types of fixed costs in a keep or drop decision. Evaluate a keep or drop decision considering different types of fixed costs.

Answers to Questions 1. The five steps in the decision-making framework are: (1) Clearly outline the problem and its related unknowns. (2) Identify suitable options and gather relevant qualitative and quantitative information, making informed assumptions as needed. (3) Calculate the relevant quantitative and qualitative costs and benefits for each option. (4) Select the option that maximizes benefit to the organization and meets required qualitative criteria. (5) Implement your decision. An individual or company might not choose the option with the largest quantitative benefit because sometimes qualitative concerns are seen as more important. Some plausible situations include: • If the supplier for a potential new product is unreliable, the company may choose not to move forward with it even if it looks good quantitatively. • If a new venture will create difficulty/inconvenience for employees, it may choose not to move forward with it, despite quantitative measures. • If a new product line is seen as financially lucrative but it is not consistent with the company’s brand or image, it may choose not to move forward with that line. LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

The restaurant might still choose to implement this move if there aren’t currently any vegan options on the menu, but there is a demand for vegan options. If the restaurant offered at least one (or preferably more than one) vegan option, it could advertise its broad appeal, possibly making it more attractive to groups where one or more members of the party prefer a vegan option. If a relatively small percentage of the restaurant community’s population currently prefers vegan, the restaurant will likely only prepare a small number of these dishes, thus keeping a wide range of customers happy while the majority of its sales volume will stem from profitable menu items.

LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: Strategic Perspective, Customer Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Relevant information: • Directly matters to the particular decision we’re making, now. • Differs between the options being considered. • Is avoidable—it would happen in the future if we make a specific choice.

LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: N/A

The price of the existing copier is not relevant to the decision at hand. It occurred in the past, and it is therefore a sunk cost and should not be considered when making future decisions. The price of a new copier and the price of fixing the existing copier are both relevant to the decision because they directly matter in the decision of whether to replace or fix the copier, the amounts differ between the options, and they are avoidable—if Mitchell chooses to fix the copier, the price of the new copier is avoided; if Mitchell buys a new copier, the price to fix the existing copier is avoided.

LO: 2, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Questions Chapter 5 (Continued) 5.

The reliability of the potential supplier is a qualitative consideration and will definitely matter in terms of product quality as well as timeliness of delivery for the purchasing company. If a company works primarily with one supplier, reliability in terms of both timeliness and quality is of critical importance. If a company works with a variety of suppliers such that parts can be sourced from different suppliers based on the company’s discretion, reliability is still important, but less critical than if it was the company’s only source for its parts. Reliability as a qualitative consideration can definitely take priority over price (as a quantitative consideration).

LO: 3, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

No, the original cost of the chairs is not relevant to this decision. That cost is a sunk cost, so it should not affect her present-day decision making. Examples of quantitative information that would be relevant could include: (1) The amount of profit (or segment margin) she would give up if she drops the office chair product line. (2) The amount of additional profit (or segment margin) she would gain by focusing more on the custom shelving options—she would weigh these two factors and decide if it would be worth the change. (3) How much she could sell the chairs for if they are discontinued, even if they need to be significantly discounted.

LO: 3, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: Strategic Perspective, AICPA AC: Measurement, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Fixed costs cannot be changed in the short-run. In the short-run, a company manages its capacity to maximize profitability (while also managing its strategic goals, considering qualitative information, as well). In order to maximize profitability in the short-run, it’s best to select a product mix based on the highest contribution margin per unit for its different products since contribution margin captures the difference between a product’s selling price and its variable cost, both of which can potentially be influenced in the short term.

LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

In order to maximize profitability in the face of a constraint, the unit contribution margin per packaging hour should be used to determine the most attractive product mix. Since there is limited capacity in the packaging department of this company at this time, profitability will be maximized when producing and selling those products that bring in the most contribution margin per packaging hour. Simply selecting a product for its contribution margin per unit will not necessarily provide the best information in this case because the high contribution margin per unit product may require substantially more packaging hours than another slightly lower contribution margin per unit product.

Questions Chapter 5 (Continued) 9.

The relevant quantitative information for a special order would include: • the special-order price, • whether production has available capacity to make units in the special order, as existing fixed costs are irrelevant if there is sufficient capacity, • the incremental variable costs to make the special order, • any new incremental fixed costs required to take on that special order, such as if additional capacity or new equipment is needed. If there is not sufficient capacity for the order, then the special-order price should be compared to the lost contribution margin on any regular sale. Allocated or other fixed costs are irrelevant to special order decisions as they will be incurred whether the company takes on the special order or not. Relevant qualitative information could include whether the special-order price will affect the regular unit sales or the channels where regular sales occur, or whether the special-order client will expect a special deal on subsequent orders.

LO: 3, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: N/A, IMA: Strategy, Planning, & Performance: Decision Analysis

10. The opportunity cost of buying the high-end bird feed is the inability to buy the salt lick to attract the deer. Apparently the higher-end bird feed attracts a wider range of birds, which qualitatively increases his enjoyment. But if he’s willing to give up that benefit to see deer, then yes, he could consider buying a lower quality bird feed so he can get the salt lick as well (qualitative consideration). Jurgen’s dad will have to decide whether he enjoys watching a larger variety of birds with fewer deer more than he enjoys seeing a moderate variety of birds and more deer. LO: 4, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

11. No—opportunity costs are not the same as sunk costs. Opportunity costs are the costs and benefits of paths not taken. Sunk costs are costs that have already been incurred, cannot be changed, and therefore should not affect future decision-making. Opportunity costs can and should affect decision-making because they allow the decision maker to consider other alternatives, as in: what would you be missing out on if you chose option A instead of option B? LO: 4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: N/A

12. Common fixed costs will still be incurred when a given product line is dropped because they are incurred to keep the company itself or the factory in operation. They are not avoidable, so they are not usually relevant in an insource versus outsource (or keep vs. drop) decision. Common fixed costs would only be avoidable if the company was considering closing down its entire factory, for example. Allocated fixed costs are assigned to divisions or segments of a company despite the costs being incurred by parties outside of the division or segment. The division or segment still bears the burden of covering the costs within its operations, but it also enjoys the benefits of the service whose cost is being allocated. An example of allocated fixed costs could be for corporate HR costs as divisions benefit from their support and therefore are allocated a portion of the cost. LO: 5, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Strategic Cost Management

Questions Chapter 5 (Continued) 13. Companies incur fixed costs for a variety of different reasons and for a variety of different activities. Some of its fixed costs are incurred in divisions that generate sales from products the division itself produces and sells; their sales can cover their fixed costs (and variable costs, too). Other fixed costs are incurred in divisions or functional areas that have no sales-generating ability by which to cover their costs. It is often these types of fixed costs that are allocated to the divisions of a company. By allocating the fixed costs, the company can get a better idea of the total costs it needs to cover by the products or services it sells. LO: 5, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Strategic Cost Management

Solutions to Brief Exercises Brief Exercise 5.1 1. Step 1: Clearly outline the problem and its related unknowns. I need new barstools. 2. Step 2: Identify suitable options and gather relevant qualitative and quantitative information, making informed assumptions as needed. I can buy the barstools online, or I can buy them instore. 3. Step 3: Calculate the relevant quantitative and qualitative costs and benefits for each option. The barstools are $50 online and $65 in-store. (I have already ruled out the most expensive ones.) 4. Step 4: Select the option that maximizes benefit to the organization and meets required qualitative criteria. It is less expensive to buy the barstools online, but if I’m in a hurry, or want to make sure they’re comfortable, I may be willing to pay the higher price to avoid having to potentially return them later if purchased online. This may also depend on how many I need. If I’m buying 2 barstools, it might not be as much of an issue as if I’m buying 4. I might also consider whether buying in-store includes a warranty. 5. Step 5: Implement your decision. Since I only need 2 barstools, I think I’ll buy in store and give my business to a local company, while also making sure they’re reasonably comfortable. (Student responses here could vary.) LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Brief Exercise 5.2 The five steps in the decision-making framework are: 1. Step 1: Clearly outline the problem and its related unknowns. The question is whether to add new fridge capacity for pet food. 2. Step 2: Identify suitable options and gather relevant qualitative and quantitative information, making informed assumptions as needed. He can buy a new fridge, buy a used fridge, or do nothing and pass on the opportunity. 3. Step 3: Calculate the relevant quantitative and qualitative costs and benefits for each option. Relevant costs include the purchase price of the new or used fridge, additional operating costs, new contribution margin to be earned, and the opportunity cost of the current use of that space if this fridge would require him to eliminate other products from his offerings. Relevant costs/benefits for a new fridge: New contribution margin Less: Cost to purchase new fridge Less: Additional labor and utilities Relevant (cost)/benefit for new fridge

$4,000 2,500 1,900 $(400)

Relevant costs/benefits for a used fridge: Additional contribution margin Less: Cost to purchase used fridge Less: Additional labor and utilities Relevant (cost)/benefit for used fridge

$4,000 800 1,900 $1,300

As for the opportunity costs and the option of doing nothing, there is no known information for what that opportunity cost would be for the reduced space. 4. Step 4: Select the option that maximizes benefit to the organization and meets required qualitative criteria. He should weigh the options to maximize benefits and minimize costs. While buying new initially looks like a bad option, he would recognize the fridge cost could be spread over many years, particularly if it is new. The net benefit of the used fridge shows that he should be able to recoup the original cost of the fridge in that first year, and even a used fridge should last more than one year. Doing nothing is a safe option, but if enough customers are asking for these refrigerated pet food products, he might lose these customers to a different store if the customers are serious about those products. 5. Step 5: Implement your decision. The quantitative analysis supports purchasing the used fridge as its entire cost will be more than covered in the first year with additional contribution margin to help boost his store’s overall profitability. It is also a fairly safe option, as he doesn’t have as much to lose should his additional margin estimates not be realized. If sales of this pet food go well, he may consider upgrading the fridge to a new one soon. If sales don’t go quite as well as planned, he doesn’t have as much to lose. LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, Research, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Brief Exercise 5.3 a) Relevant—if he doesn’t drive home, he wouldn’t spend any money on gas. b) Irrelevant if he’s planning to get pizza with friends whether at school or at home (unless there’s a difference in how much the pizza would cost). Relevant if he’s not planning to get pizza when at home. c) Irrelevant—he’s paying for car insurance whether or not he chooses to drive home this weekend. d) Irrelevant if he would purchase breakfast while at school as well. Relevant if he is on a meal plan and he would use his meal plan coverage for breakfast while at school. LO: 2, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, N/A, IMA: Strategy, Planning, & Performance: Decision Analysis

Brief Exercise 5.4 a) Irrelevant—lunch is provided either way. b) Relevant—travel costs will only be incurred if reps physically travel to the clinics. c) Irrelevant—salary will be incurred regardless; the bonus is contingent on sales, which is not dependent on physical presence at the clinic. d) Relevant—shipping costs will only occur under the remote option. LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Brief Exercise 5.5 The relevant costs to make is equal to the costs that would be avoided if the company chooses not to make the part. Relevant Costs to Make Relevant Cost to Buy DM $2.80 DL 1.70 Variable-MOH 0.50 Fixed-MOH* 0.40 Total cost $5.40 $6.25 *20% × $2.00 = $0.40 is avoidable, therefore relevant. The company is better off making the part as the relevant cost to make is less than the relevant cost to buy. Key qualitative factors may include the opportunity cost of the space currently used to make the part. If it could earn enough contribution margin on the available space to cover the additional cost to buy, it might consider the switch more seriously. Even then, it would depend on the quality of the part and the reliability of the supplier. LO: 3, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Brief Exercise 5.6 Keep Drop Contribution margin $ 80,000 $ 0 Less: Fixed costs 90,000 *20,000 Operating income $(10,000) $(20,000) *$90,000 total fixed costs − $70,000 avoidable fixed costs = $20,000 unavoidable fixed costs that will continue even if the marker line is dropped. No, Albertson’s should not drop the marker product line. The company will be worse off by $10,000 if it drops the product line. Currently the markers generate $80,000 of contribution margin with $90,000 of fixed costs leading to its $10,000 operating loss. If the company saves $70,000 in fixed costs from dropping the line, but loses $80,000 in contribution margin from dropping the product line, the company will be worse off by $10,000. Since the company is already recognizing a $10,000 loss on the marker product line, it will instead recognize a $20,000 loss from dropping this product line—a loss that other product lines in the company will have to cover. LO: 3, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Brief Exercise 5.7 Selling price Less: Cost of yarn Contribution margin per unit ÷ Time (minutes)

Hat $15.00 4.00 $11.00 20

Scarf $15.00 6.00 $ 9.00 30

Mittens $15.00 4.00 $11.00 40

CM/minute

$ 0.55

$ 0.30

$ 0.28

She should focus on hats because that product has the highest contribution margin per minute. LO: 3, Bloom: C, Difficulty: Simple, Time: 5-10, AACSB: Knowledge, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: N/A, IMA: Strategy, Planning, & Performance: Decision Analysis

Brief Exercise 5.8 To solve this problem, we will use the Solver add-in in Excel. To add the Solver, go to File, then Options, then Add-Ins, and then select Excel Add-Ins, and “Go.” From there select the Solver Add-In, and click “OK.”

To start, we have the data set up like this:

• •

• • •

Cells B6:D6 start with zero quantities entered in them. Cells B7:D7 each include a formula to calculate total contribution margin for each respective product: o B7=B6*B4 o C7=C6*C4 o D7=D6*D4 Cell E7 includes a formula to calculate the total contribution margin of all products sold: E7=SUM(B7:D7) Cells B10:D10 identify the number of minutes it takes Rachel to knit each product. Cell E10 includes a formula to calculate the total number of minutes used for the volume of products specified: E10=(B10*B6)+(C10*C6)+(D10*D6)

Brief Exercise 5.8 (Continued) Then, with the Solver add-in installed, we click on the solver here in the Data tab:

And enter the following parameters:

Solver gives us the following solution (we added the highlighting to emphasize the solution):

Given only the constraint of time and no constraint regarding the demand of any one type of product, Rachel will maximize her contribution margin if she makes and sells as many hats as possible with her 20 hours, or 1,200 minutes (20 hours × 60 minutes per hour), of available knitting time. Under this scenario, she will make no scarves and no mittens. Her maximum profit will occur at a production and sales volume of 60 hats, which will require 1,200 minutes of knitting time (60 hats × 20 minutes per hat). This volume of sales will generate $660 in contribution margin (60 hats × $11 contribution margin per hat). LO: 3, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Analytic, Technology, AICPA BC: Strategic Perspective, AICPA AC: Reporting, Technology and Tools, AICPA PC: N/A, IMA: Technology & Analytics: Data Analytics, Strategy, Planning, & Performance: Decision Analysis

Brief Exercise 5.9 We need to consider the relevant costs of producing the helmet. The relevant costs in this example include all the variable costs: Variable Costs DM cost $2.00 DL cost 4.00 Variable-MOH 3.00 Total variable costs $9.00 The Fixed-MOH of $4 is irrelevant in this example, because the company already has the capacity to produce the entire special order, and these costs will be incurred regardless of whether the special order is accepted or not. Elqenna should have accepted the special order as long as qualitative factors do not raise major concerns. If Elqenna had accepted the special order: Special order price $ 10.50 Less: Relevant cost per unit 9.00 Additional contribution margin per unit $ 1.50 × Volume 100 Total additional contribution margin $150.00 The company would be better off financially if it takes on this one-time order. LO: 3, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Brief Exercise 5.10 Relevant Information Relevant Information to Make to Buy Contribution margin $5,000 $2,500 New contribution margin due to available capacity 4,000 Total

$5,000

$6,500

Recognizing the opportunity cost of making the sleeping bags, Tarr is quantitatively better off by $1,500 if he buys the items from a supplier than if he makes them. Tarr is financially better off buying, assuming qualitative components of the decision are in line with company expectations. LO: 3, 4, Bloom: AN, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Brief Exercise 5.11 To solve this problem, we will use the Goal Seek function within Excel. First, we enter the data in Excel as follows:

Cells B4 and C4 include formulas to calculate total contribution margin (sum of the 2 cells above). The data in the other cells was given in the problem. We will use Goal Seek to determine how small the new contribution margin amount can be while keeping the total contribution margin for the “buy” option the same as for the “make” option. We find Goal Seek under “What-If Analysis” in the Data tab (highlighted in the picture below).

And then enter the following specifications:

After clicking on OK, Excel produces a status report for the Goal Seek function, as follows:

After clicking OK to clear the status box, the following result appears within the same Excel spreadsheet (highlight added to emphasize solution):

Brief Exercise 5.11 (Continued) This shows us that as little as $2,500 of new contribution margin related to use of the newly available space would still make the “buy” option just as appealing, quantitatively, as the “make” option. LO: 3, 4, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Knowledge, Analytic, Technology, AICPA BC: Strategic Perspective, AICPA AC: Reporting, Technology and Tools, AICPA PC: N/A, IMA: Technology & Analytics: Data Analytics, Strategy, Planning, & Performance: Decision Analysis

Brief Exercise 5.12 Of the Wild division’s total fixed costs of $45,000, $15,000 are direct (the supervisor salaries that would be eliminated), and $30,000 are allocated (the amount that will continue whether the division is dropped or not). To decide whether to close the division, we find the segment margin: Sales Less: Variable costs Contribution margin Less: Direct fixed costs Segment margin

$80,000 50,000 $30,000 15,000 $15,000

Bullseye should not close the Wild division as it still generates positive segment margin, which helps to cover the allocated fixed costs. LO: 3, 5, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Knowledge, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: N/A, IMA: Strategy, Planning, & Performance: Decision Analysis

Brief Exercise 5.13 1. 2. 3. 4. 5. 6.

A B, C B, C B, C A A

LO: 5, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: N/A, IMA: N/A

Solutions to Exercises Exercise 5.1 (10–15 Minutes) a.

What is relevant? Here are several qualitative issues that would be relevant to his decision. This is not an exhaustive list. • Number of miles from home to school, if commuting • Cost of fuel • Does he already have a reliable vehicle? • Does he need a vehicle if he lives on campus or if he rents an apartment off campus? • Vehicle efficiency (miles per gallon) • To what degree does he want or not want to live at home? • How good is his parents’ cooking? • How much is rent for a house near campus? • How many roommates would he need in the house? • What’s the length of the potential lease? Is there a way out of the lease? • How much is the parking permit for school? • How much is an on-campus apartment? • How many roommates would he need in the on-campus apartment?

Student assumptions for specific costs (outside of the given rent amounts) may vary. Quantitative Considerations Rent per month Rent per year Assuming 12 mo. lease for house, 9 mo. lease for on-campus apartment Gas per semester Miles driven (15 mi × 2 ways × 4 days/week × 12 weeks) ÷ Miles per gallon (25 mpg) × Cost of gas/gallon ($3.00) Gas (per year = per semester × 2) (rough estimate if rent house near school) Parking per year on campus (estimate) Assuming will need to pay for parking sometimes if rent house near school (estimate) Food per year (estimate) Net yearly cost

Commute From Home $ $ -

Rent House Near School $ 400.00 $4,800.00

Rent OnCampus Apartment $ 600.00 $5,400.00

1,440 57.6 $ 172.80 $ 345.60 $ 300.00

$ 50.00 $ 100.00

$ 500.00 $1,145.60

$2,500.00 $7,450.00

$3,500.00 $8,900.00

Additional qualitative considerations (for class discussion purposes; this is not an exhaustive list): • Can he find enough roommates for the house? • Will he be able to study properly at a rented house near campus? • Staying with his parents longer could be a positive or a negative in terms of his relationship with them. • Does he like to cook, or know how to cook?

Exercise 5.1 (Continued) c.

Quantitatively, he is best off if he commutes to school from home. That option presents the largest amount spent on gas and parking, but the amounts saved on rent and food more than make up for those expenses. Of course, Anh would have to weigh the qualitative considerations as well, depending on what’s most important to him.

No, the quantitative analysis does not overrule the qualitative analysis every time. Anh might not want to move back in with his parents if he’s already lived out of the house for three years, so he may not be willing to choose that option even though it’s the most affordable option. Additionally, living at his parents’ house 15 miles away from campus would make it more difficult to see his friends who live near school, and he might decide that barrier isn’t worth the money saved.

LO: 2, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Exercise 5.2 (10–15 minutes) a.

Relevant costs of each option Net monthly cost

Buy New

Payment

$500.00

Buy Used $350.00

Lease Midnight Blue SUV $300.00

((15,000 − 10,000) × $2) ÷ 12

833.33 150.00 250.00

200.00

Operating (15,000 miles × $0.20/mile) ÷ 12

200.00 250.00

Total average monthly cost

$950.00

$750.00

$1,583.33

Insurance

250.00

If she bases her decision solely on cost, she will buy used. It is $200 cheaper each month to buy used compared to buying new ($950 − $750), and is approximately half the estimated cost of leasing.

Maren might have had her current car for a long time and be excited about the opportunity to have a new car, so she might not want to buy another used car even though it is less costly. If it’s true that the used car would last four years, with the expected mileage per year of 15,000 miles, that means the warranty would run out before the end of the four years (4 years × 15,000 miles = 60,000 miles). That may be concerning to Maren, because repairs could be costly (and she has not factored that into her decision, above). She also may have a desire to be able to trade in this different vehicle in 2 to 4 years for a different vehicle at that time. If she leases, she will not have any trade-in value to barter with. If she buys a used vehicle, it will have a lower trade-in value than if she buys new. So, the length of time she intends to keep this vehicle would also be a relevant qualitative factor for her, as would her goal for subsequent trade-in value. Students will likely respond differently in regard to their own choice.

LO: 2, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: N/A, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Exercise 5.3 (5–10 minutes) a.

Relevant cost to make one gallon DM for one batch DL for one batch Variable-MOH for one batch Total for one batch ÷ 12 gallons per batch

Make $25 20 5 $50 $12

Cost per gallon $4.17/gallon Relevant cost to buy one gallon: $3.50/gallon None of the Fixed-MOH cost is relevant for making one gallon of sauce as none of it can be avoided if the company chooses to buy the sauce instead of making it. b.

It would be most cost-effective for Gino’s to buy the sauce from the outside supplier. Gino’s would have to decide if the decrease in cost is worth sacrificing the current reputation of its made-from-scratch sauce. Given the information about the importance of this sauce to its brand image, most will argue the small cost savings associated with buying the sauce is not worth it.

Other considerations not explicitly outlined in the information include: • The availability of the purchased sauce • The reputation of the supplier • The quality/taste of the purchased sauce • Will Gino’s require fewer employees in the kitchen if the restaurant is no longer making sauce from scratch? How much will this save the company? Or how much push-back will Gino’s receive from its current employees that they are not being scheduled for as many hours as they used to get? • Customer perception of the made-from-scratch sauce currently: (Are customers commenting on how much they love the current sauce? Or is the made-fromscratch specification something that was a big deal a number of years ago but is no longer a point of differentiation?) • Will it have to change its existing signage/billboards to remove any “made from scratch daily” reference? How costly would this be?

LO: 3, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Exercise 5.4 (5–10 minutes) a. Relevant Costs Per Cycle to Make: DM $10,000 DL 5,000 Variable-MOH 3,000 Fixed-MOH (avoidable)* 15,000 Total avoidable costs $33,000 ÷ Number of phone cases per cycle 1,200 Relevant cost per phone case $ 27.50 *Avoidable fixed costs = $75,000 − $60,000 = $15,000 Considering quantitative factors only, X Factor would be indifferent about making its own phone cases as compared to buying them from a supplier if the purchase price were $27.50 per case. b.

Qualitative factors to consider would include: • Whether the purchased cases have the same “unique, signature designs” that X Factor is known for. • Whether there is a difference in quality between the company’s own manufactured cases and the purchased cases. • The reliability of the supplier.

If the target cost is $24 per case, the total cost for 1,200 cases is $28,800. This is $4,200 less than the total avoidable costs of $33,000, so it would need to lower total costs by $4,200 for the option of making the cases themselves to be equally as attractive as buying the cases at this price.

LO: 3, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Knowledge, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: N/A, IMA: Strategy, Planning, & Performance: Decision Analysis

Exercise 5.5 (10–15 minutes) a.

Sudsy would be worse off by $30,000 if it drops the men’s line. By dropping the men’s line, it saves $30,000 in avoidable fixed costs, but it loses $60,000 in contribution margin. Dropping Men's Shower Products Lost contribution margin $(60,000) 30,000 Saved fixed costs Net effect

$(30,000)

Since Sudsy would be losing $60,000 in contribution margin by dropping the men’s line, it would need to save $60,000 in fixed costs in order to reach a $0 net effect from the action. At $60,000 in avoidable fixed costs, Sudsy would be indifferent to keeping or dropping the line (considering quantitative factors only).

Exercise 5.5 (Continued) c.

Additional factors Sudsy should consider before dropping the line include: • Is there an opportunity to save money in any of the men’s products variable costs? • Is there room to raise the selling price of any of these items? • Could Sudsy change the items it is selling within this product line? If so, would that have the potential to increase sales? • Would additional spending on marketing increase sales? • Are the current customers loyal to these products, and would they be disappointed if the line is discontinued? • Are any of the customers currently purchasing men’s, women’s, and children’s products from Sudsy? If Sudsy dropped the men’s line, would it lose any of these customers in its women’s and/or children’s lines as well? • Is the product line relatively new, and/or does it have the potential to grow with time?

If the quantitative analysis supports dropping the men’s line, Sudsy may still decide to keep it if the answers to any of the questions in part c) seemed promising. Sudsy also might decide to retain it if the line presents a key part of the company’s mission, vision, and strategic plan.

LO: 3, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, Customer Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Exercise 5.6 (10–15 minutes) a.

The company could have dropped the fabric chair line because: • It was no longer profitable. • One of the company’s suppliers stopped producing a key component of the chairs. • There was a flaw in the design that could not be remedied in a feasible and costeffective way. • It noticed that customers’ preferences had changed.

No—given the information, the company is financially worse off after dropping the fabric lawn chairs line. By dropping the line, the company is losing $50,000 in positive contribution margin and is only saving $40,000 in fixed costs, leaving the company worse off by $10,000. Dropping Fabric Lawn Chairs Lost contribution margin $(50,000) 40,000 Saved fixed costs Net effect

$(10,000)

In this situation, the company would be indifferent to dropping the fabric lawn chair line if based only on quantitative factors. The additional rent received offsets the remaining lost contribution margin after considering the saved fixed costs, so the company’s decision would have to be based on qualitative considerations.

Exercise 5.6 (Continued) Dropping Fabric Lawn Chairs + Renting Space $(50,000) Lost contribution margin 30,000 Saved fixed costs 20,000 Additional rent revenue $

Net effect

Qualitative considerations would include: • How important this particular line is to the company’s overall product portfolio? • Does the company have a suitable substitute product for customers who would otherwise select these fabric chairs? • What are the trending customer preferences? Is there hope for a rebound in sales for this line? LO: 3, 4, Bloom: AN, Difficulty: Simple, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, Customer Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Exercise 5.7 (10–15 minutes) a.

Wowza would focus on breath mints because they have the highest contribution margin per unit of the three products. The contribution margin per unit of the breath mints is actually equal to the contribution margin per unit of the other two products combined, so the company might consider producing solely breath mints. Such a move might disengage customers that only come to Wowza for its gum or candy, however. Breath Mints Gum Candy Selling price $2.50 $1.80 $1.25 Less: Variable cost per unit 0.75 0.80 0.50 Contribution margin per unit $1.75 $1.00 $0.75

Even with an increase in the cost of mint, the breath mints product line would still generate the largest contribution margin per unit of all three products. So, if the desire is to increase profitability, the company should focus on the breath mints despite the increasing costs. As noted for part a), also, the company may not want to exclusively produce breath mints, however, as customers for its other products might switch to a different brand. Breath Mints Gum Candy Selling price $2.50 $1.80 $1.25 Less: Variable cost per unit *1.31 **1.40 0.50 Contribution margin per unit $1.19 $0.40 $0.75 *$0.75 × 1.75 = $1.31 **$0.80 × 1.75 = $1.40

The approach to solving parts a) and b) required a straightforward calculation of contribution margin per unit for each of the products. No additional information was given to allow for a more thorough or detailed view into these products. In addition to the quantitative information provided, Wowza may want to consider also using contribution margin ratio as a metric for determining preference of production. Here, considering the scenario with the increased cost of mint, candy has the highest contribution margin ratio of the three products, even though its contribution margin per unit isn’t the highest. 5-22

Exercise 5.7 (Continued) Breath Mints Gum Candy Selling price $ 2.50 $ 1.80 $1.25 Less: Variable cost per unit 1.31 1.40 0.50 Contribution margin per unit $ 1.19 $ 0.40 $0.75 ÷ Selling price 2.50 1.80 1.25 Contribution margin ratio $0.476 $0.222 $0.60 The company should also consider customer preferences and current sales mixes as focusing on solely one of its products may result in permanently losing customers for its other products. Additionally, the company may want to consider a more in-depth view of the profitability of each of its products by considering production constraints such as labor time or machine time for these products. If it produces at capacity, could it produce enough packages of candy to more than offset the total contribution margin generated by a maximum capacity of breath mints? LO: 3, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, Customer Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Exercise 5.8 (15–20 minutes) a.

Considering the constrained resource, ripe bananas, Veda will maximize her profitability by producing and selling banana squares—they have the highest contribution margin per pound of banana used. Bread Muffins Squares (per dozen) (per dozen) (per dozen) Selling price $4.00 $5.00 $4.00 Less: Variable costs 2.00 2.50 1.50 Contribution margin $2.00 $2.50 $2.50 ÷ Pounds of banana 1.25 1.00 0.75 Contribution margin/pound $1.60 $2.50 $3.33

Since we know from part a) that the squares maximize her profitability, she should start by making as many squares as she can sell. The convenience stores can sell 20 dozen squares and muffins combined, so she should make 20 dozen squares to maximize profitability. 20 dozen squares × 0.75 pounds of banana = 15 pounds of banana. She will make 0 muffins since the combined muffin and square sales stop after 20 dozen. She’ll then use the remaining 10 pounds of banana (25 pounds available − 15 pounds used for squares) to make loaves of bread. 10 pounds of banana ÷ 1.25 pounds/loaf = 8 loaves of banana bread

Exercise 5.8 (Continued) c.

If Veda sells the quantities specified in part (b), she will generate the following total contribution margin: Bread Muffins Squares Total Selling price $ 4.00 $5.00 $ 4.00 × Quantity 8 20 Sales $32.00 $ $80.00 Less: Variable costs 16.00 30.00 Contribution margin $16.00 $ $50.00 $66.00

We will use the Solver in Excel to solve this problem. To add the Solver, go to File, then Options, then Add-Ins, and then select Excel Add-Ins, and “Go.” From there select the Solver Add-In, and click “OK.”

Then we set up the data in Excel as follows (the subsequent formulas and cell references are specific to this data format):

Exercise 5.8 (Continued) • •

• • •

•

Cells B6:D6 start with zero quantities in them. Cells B7:D7 each include a formula to calculate total contribution margin for each respective product: o B7=B6*B4 o C7=C6*C4 o D7=D6*D4 Cell E7 includes a formula to calculate the total contribution margin of all products sold: E7=SUM(B7:D7) Cells B9:D9 identify the pounds of banana needed for each type of product. Cells B10:D10 each include a formula to calculate the total pounds of banana used in each category of product: o B10=B9*B6 o C10=C9*C6 o D10=D9*D6 Cell E10 includes a formula to calculate the total pounds of banana used across all products: E10=SUM(B10:D10)

We then go to the Solver add-in:

And enter the following specifications:

And then click “Solve.” It might take the processor a few seconds to find a solution, but when it is found, the following results box will appear:

Exercise 5.8 (Continued)

Click “OK,” and then the answers will be visible in the Changing Variable Cells of B6:D6, with the total contribution margin as a result of the specified product mix shown in cell E7 as follows (highlighting added to emphasize the solution):

From the results, we can see that the solution is the same as what we determined by hand. Total contribution margin will be maximized by selling 8 loaves of bread and 20 dozen squares, given the constraints of 25 pounds of banana available and a maximum of 20 combined muffin and square items. The total contribution margin at these volumes is $66. Other constraints to consider would include labor time to make each type of item compared to time available, and oven space and baking time for each item compared to space and baking time available. LO: 3, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Analytic, Technology, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Technology and Tools, IMA: Technology & Analytics: Data Analytics, Strategy, Planning, & Performance: Decision Analysis

Exercise 5.9 (10–15 minutes) a.

Jomo should focus on medium jobs to maximize his profitability—they have the highest contribution margin per hour. Large Job Medium Job Small Job Average service fees $5,000 $2,500 $1,000 Less: Average variable costs 1,500 1,200 750 Contribution margin ÷ Time on task (hours)

$3,500 100

$1,300 35

$250 30

Contribution margin per hour

$35.00

$37.14

$8.33

Exercise 5.9 (Continued) b.

Jomo should first maximize the number of medium jobs he can do, since they are the most profitable. Therefore, he should take on 50 medium jobs (the maximum number of medium projects available). 50 medium jobs × 35 hours per job = 1,750 hours used There are 3,750 hours left to fill (5,500 hours available − 1,750 used). The next most profitable job is large jobs, so he should next maximize the number of large jobs he should take on, which is 37. 3,750 hours remaining ÷ 100 hours/job = 37.5 → 37 large jobs 37 large jobs × 100 hours per job = 3,700 hours used He would have to round down to 37 large jobs since there are not enough hours to fully complete 38 large jobs, and he cannot commit to half of a job given. There are now only 50 hours remaining (3,750 hours available − 3,700 hours used). With the remaining 50 hours, he could commit to 1 small job requiring 30 hours, leaving 20 hours available. Since no job described here can be completed within 20 hours, that time will remain unassigned for now. Jomo would have to forego 3 large jobs (40 available − 37 accepted) and 39 small jobs (40 available − 1 accepted).

If Jomo opts to heavily weigh his business with large and medium jobs, he may become known only for the larger-scale projects and could miss out on the opportunity to complete small projects going forward. This may be exactly what Jomo’s goal was, though; he may have gotten into this business with a goal of primarily focusing on largerscale projects. This could be his chance to establish his position in this segment of the market. Given the high demand for these larger jobs now, this may work to his advantage. There could come a time when larger jobs become less plentiful, however, and he might really appreciate having built a reputation for amazing small spaces, as well. He should weigh these qualitative considerations very carefully against his profit-motivated goal. His decision could impact the extent to which his services appeal to the broader market.

Yes—Jomo has some options for meeting the unmet demand for his services. He could hire more designers, which would increase the number of hours available, allowing him to accept more jobs. Jomo is already managing as much as he can, however, and the addition of more designers might be too much for him. If he wants to hire additional designers, he may also need to hire another manager or project manager to help him with the additional workload. This would require another careful quantitative and qualitative analysis to determine if it would be worth it. Jomo could also consider paying overtime to his existing designers if they are at all interested in adding hours to their schedule. This would increase the cost of providing the service, so Jomo would have to determine if the reduced profit on that additional time is worth it. Alternatively, he could outsource some of the work to a design vendor if he were able to establish a good relationship with one or more in this space. There would be many additional qualitative factors to consider there as he would lose much control over the details of the project. However, he does have some options to consider.

LO: 3, Bloom: AN, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, Customer Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Exercise 5.10 (10–15 minutes) a.

If Lansbury takes on the order, it will have the following incremental benefits and costs: Incremental benefit $ 250 Per unit Incremental costs: DM $55 Per unit DL 40 Per unit Variable-MOH 22 $ 117 Per unit Contribution margin earned $ 133 Per unit × Volume 50 units Total new contribution margin $6,650 Under these circumstances, Lansbury should take on the special order, as additional contribution margin is earned on the order. Since there is available capacity to take on the order and there isn’t an opportunity cost to consider, the company would be better off by $133 per unit, or $6,650 in total.

In this situation, we also need to consider Lansbury’s contribution margin from regular sales: Regular sales $325 Regular variable costs DM $55 DL 40 Variable-MOH 22 Variable selling costs 5 122 Contribution margin earned on regular sales $203

Per unit Per unit Per unit Per unit Per unit Per unit

If Lansbury takes on the special order under these circumstances, it will lose out on $70 of contribution margin per unit as each special-order item will have to replace a regular sale item. This is calculated as: Regular sales contribution margin of $203 − Special order contribution margin of $133 = $70. Lansbury’s total contribution margin would be worse off by $3,500 ($70 × 50 units) if it accepts the special order in lieu of regular sales. c.

Qualitative factors include: • Whether the customer will expect the same discounted price going forward. • Whether the discounted price will impact the current selling price for all other regular customers. • Whether the special-order customer has the potential to become a long-term customer.

Exercise 5.11 (10–15 minutes) a.

Lights On Broadway will be better off by $5,000 if it drops the Crystal line. We can quickly determine the impact of this decision by preparing a segment margin income statement for the Crystal line. Since the Crystal line is currently generating negative segment margin, quantitatively the company would be better off by $5,000 if it drops this product line. 5-28

Exercise 5.11 (Continued)

Sales Less: Variable costs Contribution margin Less: Direct (avoidable) fixed costs

Crystal $425,000 300,000 $125,000 130,000

Segment margin

$ (5,000)

Payton’s expected bonus = 5% × Chrome budgeted operating income Payton’s expected bonus = 5% × $195,000 = $9,750 If the Crystal line is dropped, the remaining fixed costs will be split evenly between the remaining two product lines: Original total fixed costs = $225,000 + $225,000 + $225,000 = $675,000 Remaining fixed costs if Crystal line is dropped = $675,000 − $130,000 = $545,000 An adjusted income statement is presented below. Chrome Crystal Iron Total Sales $1,200,000 $$780,000 $1,980,000 Less: Variable costs 780,000 325,000 1,105,000 Contribution margin $ 420,000 $455,000 $ 875,000 Less: Fixed costs* 272,500 272,500 545,000 Operating income $ 147,500 $$182,500 $ 330,000 *Assuming the fixed costs are again assigned evenly to the divisions. Payton’s actual bonus = 5% × Chrome actual operating income Payton’s actual bonus = 5% × $147,500 = $7,375

Payton finds herself in a difficult situation. Her bonus will be smaller as a result of the company making a difficult but likely appropriate decision to drop one of its product lines (assuming the qualitative considerations do not outweigh the quantitative factors). Payton would be worse off by $2,375 as a result of her segment having to absorb some of the fixed costs that were previously assigned to the Crystal division. Still, Payton should not try to sway the company in a direction that could turn out poorly for her or for the company as a whole. She is still employed at the end of the day and is receiving a bonus, as well.

LO: 3, 5, Bloom: S, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Ethics, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Ethical Conduct, Communication, IMA: Strategy, Planning, & Performance: Decision Analysis, Professional Ethics & Values: Professional Ethical Behavior

Exercise 5.12 (10–15 minutes) Projected Income Statement (Making)

Projected Income Statement (Buying)

Sales Less: Variable costs Contribution margin Less: Fixed costs

$4,675,000 1,890,000 $2,785,000 1,400,000

Sales Less: Variable costs Contribution margin Less: Fixed costs

$5,150,000 2,245,000 $2,905,000 1,400,000

Operating income ÷ Contribution margin

$1,385,000 2,785,000

Operating income ÷ Contribution margin

$1,505,000 2,905,000

Contribution margin ratio

59.57%

Contribution margin ratio

56.41%

Possible explanations for differences in income statement amounts comparing the original scenario where the company makes the cardstock to the scenario where the company buys the cardstock from a supplier: (1) Sales: increased • Since buying cardstock allows Poker Face to print more, it is predicting an increase in sales volume. • Since buying cardstock increases variable costs, Poker Face decided to raise the selling price. (2) Variable Costs: increased • The cardstock is more expensive to buy than to make, so variable costs have increased in total even if volume stayed the same. • Direct labor hours and/or cost has increased in the printing area. (3) Contribution margin: increased • Because the increase in sales was greater than the increase in variable costs, contribution margin has increased. (4) Fixed Costs: the total fixed cost amount hasn’t changed. (5) Operating Income: increased • Same explanation as for contribution margin—the increase in sales was greater than the increase in variable costs, and there was no change in fixed costs, so that increase in contribution margin carried down to an increase in operating income.

The manager is upset because the contribution margin ratio under the ‘buying cardstock’ option is 3.16 percentage points (59.57% − 56.41%) below the projection under the ‘make cardstock’ option. This reveals that buying the cardstock will negatively affect the bonus he receives. Upper management could remind lower managers that this move will be in the best interest of the company in the long-term, ensuring the company’s ability to give managers any bonuses at all.

The contribution margin ratio is still less than it was initially projected to be under the ‘make cardstock’ option, but it is very near the original projection. Here it is only 1.09 percentage points off from the original projection (59.57% − 58.48%) instead of being 3.16 percentage points off the mark.

Exercise 5.12 (Continued) The contribution margin ratio for this scenario is trending upward, however, suggesting that the following year it could potentially exceed the initial contribution margin ratio. New Projected Income Statement (Buying) Sales ($5,150,000 × 1.05) $5,407,500 Less: Variable costs 2,245,000 Contribution margin $3,162,500 Less: Fixed costs ($1,400,000 × 1.02) 1,428,000 Operating income $1,734,500 ÷ Contribution margin 3,162,500 Contribution margin ratio

58.48%

LO: 3, Bloom: S, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Leadership: Change Management, Reporting & Control: Financial Statement Preparation

Exercise 5.13 (10–15 minutes) a.

Regan would be better off by $4,900 if she sells her van and leases one instead. Since the cost of the delivery driver is the same under both options, it is not relevant to this decision. Relevant Cost Analysis for One Year Own Lease Cost of lease ($500 × 12) $ 6,000 Sales value of van (500) Cost to sell van 500 Maintenance ($75 × 12) $900 New profit due to freed up space (10,000) Total relevant costs/(benefits) $900 $(4,000) Better off to lease; results in a net benefit of: $(4,900)

Qualitative considerations would include: (1) Is the company she’d lease the van from reputable and reliable? (2) Does the van she would lease have the same/better/worse features than her current van? Would it be an upgrade? (3) Is there a dedicated parking space in the alley for a delivery van, or will it be challenging to secure parking near the floral shop? (4) Since her van is fully depreciated and carries a modest sales value, it is plausible that it is reaching the end of its useful life. If Regan is going to need a different van in the near future, would she rather handle this important transaction now, or delay it, potentially putting her driver at risk if the vehicle breaks down during a delivery? (5) The information lists own or lease as the only options. Has she considered purchasing a different van, or hiring a delivery company that uses its own vehicle?

Given the additional information Regan discovered, the quantitative analysis still supports moving forward with the lease, but the net benefit for leasing is much smaller than in part (a). She will be wise to carefully weigh the qualitative factors described in part (b), along with the quantitative analysis shown here, before making a final decision. 5-31

Exercise 5.13 (Continued) Relevant Cost Analysis for One Year Own Lease Cost of lease ($500 × 12) $ 6,000 Sales value of van (500) Cost to sell van 500 Maintenance ($75 × 12) $900 Higher fuel cost ($0.04 × 2,500 × 12) 1,200 Higher insurance cost ($200 × 12) 2,400 New profit due to freed up space (10,000) Total relevant costs/(benefits) $900 $ (400) Better off to lease; results in a net benefit of: $(1,300) d.

To use the Goal Seek function, first we enter the data in Excel as follows (this is one way to organize the information; subsequent formulas and cell references are based on this format):

The data shown here reflects one way to organize the information; other formats are acceptable as well. • Cell C8 reflects the formula to determine the higher fuel cost for the leased vehicle: C8=D8*E8*F8 • Since we want to determine the additional cost per mile, we broke down the formula for the higher fuel cost so the additional cost per mile can be targeted (in cell D8). • Formulas are entered in cells B11:C11 to reflect the sum of the amounts above, while cell C12 reflects the difference between those two sums. Then we find Goal Seek in the Data tab:

Exercise 5.13 (Continued) And enter the following specifications:

And then click “OK.” Once the function finds a solution, the following screen will appear:

Click “OK” to clear the status screen, and then the solution appears (we added the highlighting to emphasize the solution). The solution is in the identified variable cell, in this case D8. According to the solution, Regan can incur an additional cost per mile of as much as $0.083 and still be just as well off financially as she would have been keeping her existing van.

LO: 4, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, Technology, AICPA BC: Strategic Perspective, AICPA AC: Reporting, Technology and Tools, AICPA PC: Communication, IMA: Technology & Analytics: Data Analytics, Strategy, Planning, & Performance: Decision Analysis

Exercise 5.14 (15–20 minutes) a.

Your company makes a component part that is used in the assembly of a microwave oven. (Two possible opportunity costs are provided; the list included here is not exhaustive.) (1) Opportunity cost: if the company outsources the part instead, it could use the space to make something else. The company might change its mind because of the following quantitative and/or qualitative aspects of the opportunity cost. • Quantitative effects: would offset the contribution margin of the new product against the purchase price of the component part. This net effect would be compared to the current relevant cost of making the part. • Qualitative considerations would also come into play before purchasing the part externally (quality and availability of utmost concern). (2) Opportunity cost: if the company outsources the part instead, it could rent out the space. The company might change its mind because of the following quantitative and/or qualitative aspects of the opportunity cost. • Quantitative effects: would offset the rent earned from the available space against the purchase price of the component part. This net effect would be compared to the current relevant cost of making the component part. • Qualitative considerations would also come into play before purchasing the part externally (quality and availability of utmost concern).

You come home from class and rest for a while. (Two possible opportunity costs are provided; the list included here is not exhaustive.) (1) Opportunity cost: You could instead use that time to study (either while still on campus or once home). You might change your mind because of the following quantitative and/or qualitative aspects of the opportunity cost. • Quantitative: potentially no quantitative impact here unless you used transportation to get home and will have to turn around and go back to campus later for another class. • Qualitative: Can you study tonight instead? Have you been keeping up in all of your classes or are you falling behind? How are your grades so far? Are you exhausted from the day and really need a rest? (2) Opportunity cost: You could instead get a part-time job to generate income during that available time. You might change your mind because of the following quantitative and/or qualitative aspects of the opportunity cost. • Quantitative: hourly wage that could be earned (less any transportation costs to get to the job, if appropriate). • Qualitative: do you need this down-time in order to stay healthy?

Exercise 5.14 (Continued) c.

Next semester, instead of taking a full load of classes, you will be interning for a local company full-time. (Two possible opportunity costs are provided; the list included here is not exhaustive.) (1) Opportunity cost: You could instead take a full load of classes. You might change your mind because of the following quantitative and/or qualitative aspects of the opportunity cost. • Quantitative: Income lost from not doing the internship; tuition cost for more classes; difference in transportation cost if stay at school. • Qualitative: Would you rather finish school faster than do this internship? Is the internship a potential game changer for your career? Will the internship experience be valuable even if it doesn’t lead to a full-time position? (2) Opportunity cost: You could instead spend that time getting involved on campus. You might change your mind because of the following quantitative and/or qualitative aspects of the opportunity cost. • Quantitative: Income lost from not doing the internship; difference in transportation cost if staying on campus. • Qualitative: Is there an organization you’ve been wanting to get involved with, but you haven’t had the time with a full load of classes? The experiential benefit of the internship compared to the benefit of being more involved on campus; the time commitment of the internship compared to the time commitment of other on campus involvement.

LO: 4, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Communication, Analytic, Reflective Thinking, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Exercise 5.15 (15–20 minutes) a.

If the company drops the champagne line which, at first glance, appears to be unprofitable, the answer to the question is “No”—the company will not automatically be more profitable. The financial effect of dropping that product line depends on how much of the fixed cost could be saved.

The company would be better off (quantitatively) keeping the champagne line. The most efficient way to evaluate this keep or drop decision is to determine the segment margin of the targeted product line: Champagne Sales Less: Variable costs Contribution margin Less: Direct fixed costs

$125,000 45,000 $ 80,000 50,000

Segment margin

$ 30,000

Since the Champagne line is generating positive segment margin, the product line is contributing to the company’s overall common fixed costs and to its operating income. If this product line is dropped, the company will lose out on that $30,000 of segment margin. In other words, the company would be worse off by $30,000 if it drops this line of business. 5-35 © 2022 John Wiley & Sons, Inc. or the author, All rights reserved. Farmer, Cost Accounting, 1e, Job Costing Visualized (For Instructor Use Only)

Exercise 5.15 (Continued) Qualitatively, the company would want to always reevaluate its product offerings to make sure they are still in line with customer preferences. Still, since this line is generating positive margin, it would be difficult to justify dropping it unless the product is clearly at odds with the company’s mission or vision, or unless there is a more profitable use of resources being proposed. A different way of looking at a keep or drop decision is by conducting a total company profitability comparison as shown below. Total operating income before dropping the champagne glass line is $185,000, shown below: Red

White

Champagne

Total

Sales Less: Variable costs

$400,000 170,000

$325,000 150,000

$125,000 45,000

$850,000 365,000

Contribution margin Less: Fixed costs

$230,000 110,000

$175,000 100,000

$ 80,000 90,000

$485,000 300,000

Operating income (loss)

$120,000

$ 75,000

$(10,000)

$185,000

If the champagne glass line is dropped, $50,000 in direct fixed costs of the division will be saved. The $40,000 of common fixed cost that had been allocated to the Champagne line would still continue, and would need to be reallocated between the remaining two divisions. Since the original common fixed costs were spread evenly between the three division, we will assume the reallocated fixed costs here will be split evenly between the remaining two divisions. The new total operating income for Clear Leigh would be $155,000, shown below. That’s a decrease in company income of $30,000 ($185,000 − $155,000). Red White Total Sales $400,000 $325,000 $725,000 Less: Variable costs 170,000 150,000 320,000 Contribution margin $230,000 $175,000 $405,000 Less: Fixed costs *130,000 **120,000 250,000 Operating income $100,000 $ 55,000 $155,000 *$110,000 of original fixed costs + (0.5 × $40,000) **$100,000 of original fixed costs + (0.5 × $40,000) Another consideration could be whether the company could use the space used for champagne flutes to (1) produce larger quantities of the two more profitable product lines, (2) produce a different profitable product, or (3) rent the space to a different entity. c.

Looking at either format of analysis considered in part (b), the loss of income from dropping the champagne line was $30,000. If the company can make up that lost margin through increased sales of its other two products, then the company’s income overall will stay the same. $185,000 − $155,000 = $30,000 of additional margin needed

LO: 3, 5, Bloom: AN, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, Customer Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Exercise 5.16 (15–20 minutes) a.

Gen Y and Gen Z generated positive income last year, while the Boomer segment generated a loss. Gen Y Gen Z Boomers Total Contribution margin Less: Fixed costs Salaries for dedicated staff Depreciation of office assets Operating costs Executive salaries

$450,000

$625,000

$ 195,000

$1,270,000

80,000 30,000 15,000 150,000

90,000 30,000 15,000 150,000

120,000 30,000 15,000 150,000

290,000 90,000 45,000 450,000

Operating income (loss)

$175,000

$340,000

$(120,000)

$ 395,000

Direct and avoidable fixed costs include salaries for dedicated staff. That is the only direct fixed cost. All other fixed costs listed are common fixed costs that are allocated to all market segments and are not avoidable. Depreciation is not relevant, nor are operating costs (unless utility costs go down as a result of fewer computers operating, for example). Executive salaries also won’t decrease if a segment is dropped. Executives should not consider dropping any of the segments—they are all generating a positive segment margin. Gen Y Gen Z Boomers Total

Contribution margin Less: Direct fixed costs Salaries for dedicated staff

$450,000

$625,000

$195,000

$1,270,000

80,000

90,000

120,000

290,000

Operating Income

$370,000

$535,000

$ 75,000

$ 980,000

The segment margin for the Boomers segment per part (b) is $75,000. If the company drops this segment, it will be worse off by $75,000. We can also see this impact by comparing the operating income in the company’s current state from part (a), $395,000, to the operating income if it were to drop the Boomer segment, $320,000, shown below. That’s a decrease of $75,000. It is better off keeping that line. Since the original allocated fixed costs for depreciation of office assets, operating costs, and executive salaries were assigned equally between the three market segments, we assume that the same total common fixed costs will now be assigned equally between the remaining two market segments.

Exercise 5.16 (Continued) Gen Y $450,000

Gen Z $625,000

Total $1,075,000

80,000 45,000 22,500 225,000

90,000 45,000 22,500 225,000

170,000 90,000 45,000 450,000

$ 77,500 $242,500 Operating Income *Total depreciation of office assets $90,000 × 0.5 **Total operating costs of $45,000 × 0.5 ***Total executive salaries of $450,000 × 0.5

$ 320,000

Contribution margin Less: Fixed costs Salaries for dedicated staff Depreciation of office assets* Operating costs** Executive salaries***

The quantitative analysis supports keeping the Boomers market segment. One qualitative consideration that might push the company to drop that line anyway is if the client companies start producing products that are geared heavily toward Gen Y and Gen Z’ers, and as a result there is less of a need for a Boomer-centric marketing project. LO: 5, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, Customer Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Solutions to Problems Problem 5.1 a.

[Step 1: Clearly outline the problem and its related unknowns.] Kensington & Associates’ CPA’s need to complete training so they are up to date on recent tax law changes and revised financial reporting standards. [Step 2: Identify suitable options and gather relevant qualitative and quantitative information, making informed assumptions as needed.] Option 1: Hire an outside trainer to come into the firm to provide training for all appropriate professionals. Option 2: Send the professionals off-site to complete dedicated training.

[Step 3: Calculate the relevant quantitative and qualitative costs and benefits for each option.] The relevant costs for each option as well as the qualitative benefits for each option are provided below. The off-site conference is far more expensive than in-house training. The relevant costs include the cost to hire the in-house trainer, lunch for participants, travel/lodging for trainers, the cost of the off-site conference, and mileage/lodging for participants in the off-site conference. Relevant Costs

Cost of in-house training ($5,000 + $6,000 + $500 +$2,000) Conference fees (tax & audit) ($400 × 40) + ($600 × 30)

In-house Off-site Training Training $13,500 $34,000

Mileage/travel/lodging for tax & audit participants ($150 × 40) + ($300 × 30) Total cost

• • • •

15,000 $13,500

$49,000

Qualitative Benefits of Each Option In-house training Send staff to off-site conference Employees wouldn’t have to leave their • Getting away from the office can be a families. (Making other arrangements for welcome change of pace. childcare/house duties can be stressful). • Being away from the office may help participants focus on the training. The training would take place in a comfortable and familiar environment. • The conference may provide an opportunity to network with other Employees wouldn’t have to travel. (Traveling can be tiring for some). professionals. Questions regarding firm-specific client issues could be addressed that may not be appropriate to ask in an off-site training situation.

[Step 4: Select the option that maximizes benefit to the organization and meets required qualitative criteria.]

Problem 5.1 (Continued) Given the quantitative and qualitative considerations above, the firm will likely select the in-house training option as it is significantly less expensive while still generates some qualitative benefits for the employees. Could the firm ever justify selecting the off-site training option given the information above? It would be difficult to justify the additional $35,500 cost ($49,000 − $13,500) unless the travel experience was meant to be a travel bonus of sorts where the company covered the additional cost as an added benefit to its employees. Alternatively, if the firm decided that the qualitative benefits of the off-site conference are worth the financial investment (for instance, if the firm believes the conference will result in greater learning or networking opportunities that could allow the company to expand), then it may decide to go that route. d.

Yes, it would be wise for the firm to fully consider other options as viable ways to train its CPAs. Another option that could be considered is for the professionals to complete their training via on-line, remote training sessions. The cost of this option may be even less expensive than the in-house training option and could provide a qualitative benefit of allowing professionals to complete it from home if appropriate. Students may suggest other training options, as well.

LO: 1, 2, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, Research, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Problem 5.2 a.

Fixed-MOH for handlebar kits = $15,000 Avoidable Fixed-MOH = $15,000 ÷ 3 = $5,000 The relevant cost to make one unit is $300, as shown below. This cost reflects the cost the company would avoid by not making one of these handlebar units. Make $12,000 16,000 3,000 5,000 $36,000 120 $ 300

DM DL Variable-MOH Avoidable Fixed-MOH Total relevant costs ÷ Number of units produced Relevant cost/unit b.

Since the relevant cost to make one unit is $300, the company would not be willing to purchase them for $400 each from this supplier. Jeff’s response would be ‘No.’

Quantitatively, Jeff’s response would be ‘Yes’ to this supplier, but before committing to the purchase, the company would need to consider several qualitative factors of the arrangement. Qualitatively, the company would have to consider whether this is a reliable supplier and if the quality of the handlebar kits is comparable to its own. It would also consider how any loss of control over this production aspect would impact the remaining processes at all. It may consider the location of the supplier and if there are any social or environmental concerns with the suppliers’ practices. If the company could use the handlebar manufacturing space for something else, the benefits to be received in that scenario would also be relevant to the decision.

Given this new information, the relevant cost to buy the handlebar kits would be reduced by the new income that the freed-up space would generate (the opportunity cost of making the handlebar kits). This would bring down the relevant cost of buying the kits externally. This new information doesn’t change the answer to part (b) because the relevant cost to buy of $316.67 is still greater than the $300 relevant cost to make one unit. In terms of the purchase price presented in part (c), however, the new relevant cost to buy of $166.67 is even more appealing than the $250 purchase price, as this new cost is just over one-half of the $300 relevant cost to make one kit. Qualitative considerations would still need to be considered before jumping at this offer, including quality and reliability of the product and supplier, in particular. Relevant Cost to Buy (Using $400 purchase price) Cost to purchase 120 units $48,000.00 ($400 × 120) Less: Opportunity cost 10,000.00 Net cost to buy $38,000.00 ÷ Number of units produced 120

Relevant Cost to Buy (Using $250 purchase price) Cost to purchase 120 units $30,000.00 ($250 × 120) Less: Opportunity cost 10,000.00 Net cost to buy $20,000.00 ÷ Number of units produced 120

Net cost per unit to buy

316.67

166.67

Problem 5.2 (Continued) Note: the opportunity cost can either be treated as a reduction of the cost to buy (as shown here) or as an additional cost to make the kits. The same conclusion will be reached regardless of which approach is taken for opportunity costs. LO: 1, 2, 3, 4, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Problem 5.3 a.

We can evaluate this question by preparing a segment margin income statement for the sedan line. To determine segment margin for the sedan line, we present the income statement through contribution margin and then subtract the avoidable direct fixed costs to determine its segment margin.

Sales Less: Variable costs Contribution margin Less: Direct fixed costs

Sedan $1,200,000 700,000 $ 500,000 600,000

Segment margin

$(100,000)

Since its segment margin is negative, the company would be better off by $100,000 financially if it drops the sedan line. In other words, the sedan line is costing the company more than the contribution margin it is bringing in, since those direct fixed costs are exclusively for the sedan line. b.

Dryvz knows that the sedan line is very important to its brand image and was pivotal to its growth. Company leaders will need to carefully weigh the nostalgic benefit of the sedan segment alongside the improved operating income from dropping the line.

c. Sales

Sedan

SUV

Truck

Van

Total

$1,200,000

$4,200,000

$3,900,000

$2,000,000

$11,300,000

Less: Variable costs

700,000

2,000,000

1,800,000

1,100,000

5,600,000

Contribution margin

$ 500,000

$2,200,000

$2,100,000

$ 900,000

$ 5,700,000

600,000

675,000

900,000

600,000

2,775,000

$ (100,000)

$1,525,000

$1,200,000

$ 300,000

$ 2,925,000

200,000

225,000

300,000

200,000

925,000

$ (300,000)

$1,300,000

$ 900,000

$ 100,000

$ 2,000,000

Less: Direct fixed costs Segment margin Less: Allocated fixed costs Operating income

The direct fixed costs for each product line reflect 75% of the original fixed costs; the allocated fixed costs for each line reflect the difference between the original fixed costs and the direct fixed costs just determined. For the sedan line: Direct fixed costs = $800,000 of original fixed costs × 0.75 = $600,000 Allocated fixed costs = $800,000 of original fixed costs − $600,000 Direct fixed costs = $200,000.

Problem 5.3 (Continued) d.

If the sedans are dropped, the $200,000 of fixed costs currently allocated to the sedans must now be shared among the other three lines. Since the allocated fixed costs are assigned to product lines according to their sales volumes, we first determine the proportion that would be used for each remaining product line (based on each of their originally allocated fixed cost amounts). Then we can assign the new total allocated fixed costs of $925,000 ($725,000 + $200,000) to each of these product lines using those proportions: Previously × Total New Allocated Total Allocated Allocated FC Proportion Fixed Costs Fixed Costs Amounts $ 925,000 $287,027.50 SUV $225,000 0.3103 925,000 382,765.00 Truck 300,000 0.4138 925,000 255,207.50 Van 200,000 0.2759 Total

$725,000

$2,775,000

$925,000.00

Segment margin income statements resulting for each of the remaining product lines is shown below. SUV

Truck

Van

Total

Sales

$4,200,000.00

$3,900,000.00

$2,000,000.00

$10,100,000.00

Less: Variable costs

2,000,000.00

1,800,000.00

1,100,000.00

4,900,000.00

Contribution margin

$2,200,000.00

$2,100,000.00

$ 900,000.00

$ 5,200,000.00

675,000.00

900,000.00

600,000.00

2,175,000.00

$1,525,000.00

$1,200,000.00

$ 300,000.00

$ 3,025,000.00

287,027.50

382,765.00

255,207.50

925,000.00

$1,237,972.50

$ 817,235.00

44,792.50

$ 2,100,000.00

Less: Direct fixed costs Segment margin Less: Allocated fixed costs Operating income

Operating income is $2,100,000, up $100,000 from the current $2,000,000, and consistent with the original projection from part (a) of the problem. The report above shows that even if the sedan line is dropped, all remaining product categories are still profitable—both in terms of segment margin and overall operating income after the allocated fixed costs. The van line is reporting less than half of the operating income it reported before the sedan line was dropped, however, and the amount of its positive income is quite low. Its income is particularly small when compared to the income of the SUV and Truck lines. Still, its segment margin remains strong, recognizing its ability to contribute to the company’s fixed costs and income. LO: 1, 2, 3, 4, 5, Bloom: AN, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, Customer Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis, Reporting & Control: Financial Statement Preparation

Problem 5.4 a.

Projected income with profit margin if three geographic areas are presented. South West East Total Sales Less: Variable costs Contribution margin Less: Fixed costs Operating income ÷ Sales Profit margin

$800,000 450,000 $350,000 300,000 $ 50,000 800,000

$650,000 320,000 $330,000 200,000 $130,000 650,000

$1,100,000 500,000 $ 600,000 350,000 $ 250,000 1,100,000

$2,550,000 1,270,000 $1,280,000 850,000 $ 430,000 2,550,000

6.25%

20.00%

22.73%

16.86%

Projected income with profit margin if two geographic areas are presented: West East Total Sales Less: Variable costs Contribution margin Less: Fixed costs Operating income ÷ Sales Profit margin b.

$650,000 320,000 $330,000 200,000 $130,000 650,000

$1,100,000 500,000 $ 600,000 350,000 $ 250,000 1,100,000

$1,750,000 820,000 $ 930,000 550,000 $ 380,000 1,750,000

20.00%

22.73%

21.71%

The decision of which of these projections to present to potential investors depends on a number of factors: • How important a broad geographic coverage is for this business. • The likelihood that the south region will generate a loss in the near term. • The reason why sales in the south region are expected to decline while sales in the west are expected to increase; and can anything be done to prevent that from happening. • The relative importance to investors regarding operating income amount and/or operating income percentage. • If it would hurt to show investors both scenarios and get their feedback as to which might be more appropriate. If you have reliable information to suggest the south region will likely turn into a loss scenario, it would be unethical not to share that information with investors. As a potential investor, you wouldn’t be impressed with a proposal that shows a loss occurring in the near future, so potential investors will turn away at that, as well.

Problem 5.4 (Continued) c.

Since the company has been operating in the south region for three years now, it will be difficult to leave just that region if the company intends to continue working the east and west regions. Total sales in the southern region have dropped to only 25% of what they were originally ($200,000 ÷ $800,000), however, so the volume of affected customers may not be significant if the company leaves that region. The main issue lies in how significant this company’s products/services are to the customers that have stuck with it for this three-year period of time. If they have become reliant on this company for a key product/service, it will cause significant disruption to their business while they try to find an appropriate substitute. Before getting out of the southern region, considerations must be made for such factors as: how much of the south region’s fixed costs will remain and therefore need to be absorbed by the west and east regions? How much of its fixed costs are avoidable by leaving that region? If we analyze the results at this point in the company’s life cycle more closely, we note the following:

Sales Less: Variable costs Contribution margin Less: Fixed costs Operating income ÷ Sales Profit margin

South

West

East

Total

$ 200,000 125,000 $ 75,000 200,000 $(125,000) 200,000

$1,200,000 600,000 $ 600,000 300,000 $ 300,000 1,200,000

$1,100,000 500,000 $ 600,000 350,000 $ 250,000 1,100,000

$2,500,000 1,225,000 $1,275,000 850,000 $ 425,000 2,500,000

(62.50)%

25.00%

22.73%

17.00%

Fixed costs are equal to sales in the south, and variable costs are 62.5% of sales in that region. Profit margin percentages remain strong in the west and east with the west increasing its percentage by five percentage points compared to the first year. If demand for the company’s products/services in the south region is clearly going to continue to decline, then yes, the company likely would have been better off starting its operations in just the east and west regions. The operating loss from this third year, alone, likely more than offsets the income generated in the south region during the first two years combined. If it had started operating in just two regions, it could have used the resources directed to the south region to specifically generate business in the east and west, which could have allowed those regions to grow even more. We cannot say for certain this would have been the case, though. LO: 1, 2, 3, Bloom: E, Moderate, Time: 15-20, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, Customer Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis, Reporting & Control: Financial Statement Analysis

Problem 5.5 a.

If Mohamed Industries accepts the special order, it will need to consider the incremental sales (i.e., benefits) and costs: Incremental sales $ 50 Per unit Less: Incremental costs DM ($45,000 ÷ 3,000 units) 15 Per unit DL ($30,000 ÷ 3,000 units) 10 Per unit Variable-MOH ($9,000 ÷ 3,000 units) 3 Per unit New contribution margin $ 22 Per unit × Volume 200 units Total new contribution margin $4,400 The company would be better off by $4,400 by accepting this order.

Incremental benefit and cost analysis: Incremental sales $ 40 Per unit Less: Incremental costs DM ($45,000 ÷ 3,000 units) 15 Per unit DL ($30,000 ÷ 3,000 units) 10 Per unit Variable-MOH ($9,000 ÷ 3,000 units) 3 Per unit Variable selling ($6,000 ÷ 3,000 units) 2 Per unit New contribution margin per unit $ 10 Per unit × Volume 100 units Total new contribution margin $1,000 In this situation, Mohamed Industries would be overall better off by $1,000 by accepting the order.

Incremental benefit and cost analysis: Incremental sales $ 45 Per unit Less: Incremental costs DM ($45,000 ÷ 3,000 units) 15 Per unit DL ($30,000 ÷ 3,000 units) 10 Per unit Variable-MOH ($9,000 ÷ 3,000 units) 3 Per unit New contribution margin per unit $ 17 Per unit × Volume 150 units Total new contribution margin $2,550 Less: Additional fixed cost 3,200 Total new/(lost) contribution margin $(650) The company would be worse off by $650 if it took on the special order under these conditions.

For options (a) and (b) the company would need to consider whether the discounted price will hurt other external sales and if the customer will return and expect this deal again.

Problem 5.5 (Continued) For option (c), even though it shows a loss, if this customer returned, the company might be able to leverage the equipment, or it could potentially convert the customer into a long-term customer at its regular selling price of $85/unit ($255,000 ÷ 3,000 units). The customer may sense some goodwill from the company for helping with the initial order, which can be an important factor in establishing a longer-term relationship. LO: 1, 2, 3, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis, Reporting & Control: Financial Statement Analysis

Problem 5.6 a.

Outsource A is the most cost-effective option. Keep Existing Relevant Cost Analysis HR Staff Salaries and benefits (2 employees) $100,000 Direct (avoidable) fixed costs 10,000 Annual contract to outsource Savings due to employee engagement activities Net cost $110,000

Outsource A

Outsource B

$ 75,000

$100,000

(10,000)

(20,000)

$ 65,000

$ 80,000

Westin will most likely select Outsource B. Why? It is less expensive than keeping the existing HR staff, and has a lot of positive qualitative aspects to it (highly reputable company, has served in many different industries, and will be hands-off for the remaining HR professional). While Outsource A is the low-cost option, the additional nonquantifiable costs (qualitative costs) of selecting that outsource provider could outweigh the benefits. It has been in operation for 10 years, but it appears that it will require a lot of time and energy from the remaining HR professional, and that may completely negate the reason for hiring an outsource provider for these activities. Outsource B may be a safer bet and it isn’t too much more expensive than Outsource A.

In this situation, Westin would be even more likely to choose Outsource B, because now it is quantitatively the least costly option, and it still retains the favorable qualitative factors previously described. Keep Existing Outsource Outsource Relevant Cost Analysis HR Staff A B Salaries and benefits (2 employees) $100,000 Direct (avoidable) fixed costs 10,000 Annual contract to outsource $ 75,000 $100,000 Savings due to employee (10,000) (20,000) engagement activities New contribution margin or savings *(6,000) **(35,000) due to productivity gains Net cost $110,000 $ 59,000 $ 45,000 *2,000 new units × $3 CM/unit **(10,000 new units × $3 CM/unit) + (10,000 new units × $0.50/unit savings)

If the transition to Outsource A could be almost guaranteed to be a smooth one, Westin may more seriously consider that provider. If Westin could generate $14,000 more in cost savings from Outsource A, it would be quantitatively equal in preference to Outsource B. Westin still may prefer to see even slightly more savings than the $14,000 in order to justify any lingering uncertainty ($59,000 − $45,000 = $14,000).

LO: 1, 2, 3, 4, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis

Problem 5.7 a.

It’s not explicitly stated in the information, but one possible reason for the difficulty in reaching the production goal could be that the cost of the glass bottle is higher than the plastic bottle used before. Partially because of this reason, they may likely be more careful with the bottles as glass bottles will be more costly to replace. Also, because glass breaks much more easily than plastic, the bottling process may take longer than it did before. It is also possible that the size of the bottle opening is different in the glass bottles compared to the plastic bottles, which could also add time to the bottling process.

Variable cost = 0.25 × Selling price Selling price = Variable cost ÷ 0.25 Ketchup Mustard Relish Selling price (Variable cost/unit ÷ 0.25) $ 4.00 $ 3.00 $ 3.80 Less: Variable cost/unit 1.00 0.75 0.95 Contribution margin/unit $ 3.00 $ 2.25 $ 2.85 ÷ Bottling time/unit (in hours) 0.01 0.005 0.02 Contribution margin/bottling hour $300.00 $450.00 $142.50 New priority rank 2 1 3 The product with the highest CM per bottling hour is ranked first, mustard, followed by the next highest (ketchup) and the next highest (relish).

The total capacity for bottling hours in one month is 504 hours (18 hours/day × 28 days/month). The company should first prioritize meeting the demand for mustard, since it is the most profitable per bottling hour. Meeting the demand for mustard requires 125 hours (demand of 25,000 units × 0.005 hours per unit). That leaves with 379 hours remaining (504 − 125). The second priority product is ketchup, which would require 400 hours to meet all of its demand (demand of 40,000 units × 0.01 hours per unit). Since the company only has 379 hours available, it should spend all of those hours on ketchup. With 379 available hours, the company can produce 37,900 units of ketchup (379 ÷ 0.01 hours per unit). Total contribution margin under this priority ranking is $169,950. Ketchup Mustard Relish Demand 40,000 25,000 10,000 × Bottling time/unit 0.01 0.005 0.02 Hours needed to meet demand 400 125 200 Hours dedicated to product ÷ Bottling time/unit Units produced within the 504-hour capacity × Contribution margin/unit Contribution margin

379 0.01

125 0.005

0.02

37,900

25,000

$ 3.00 $ 2.25 $113,700.00 $56,250.00

Total

725 504

$2.85 $ - $169,950.00

Problem 5.7 (Continued) If the company instead produced up to demand and up to capacity, based on its original priority rankings with ketchup first, relish second, and mustard third, the following contribution margin would be generated: Under Prior Ranking Hours needed to meet demand Hours dedicated to product ÷ Bottling time/unit Units produced within this time × Contribution margin/unit Contribution margin

Ketchup Mustard 400 125 400 0.01 40,000 $ 3.00 $120,000.00

Relish 200

Total 725

104 504 0.005 0.02 5,200 $2.25 $2.85 $ - $14,820.00 $134,820.00

Profit is $35,130 higher under the new rankings ($169,950 − $134,820). The old rankings appear to have been based on each product’s contribution margin per unit, but did not consider the bottling time constraint. The new rankings consider the constraint and maximize the most profitable products based on their use of that constraint, bottling time. To install the Solver add-in, go to File, then Options, then Add-Ins, and then select Excel Add-Ins, and “Go.” From there select the Solver Add-In, and click “OK.”

Problem 5.7 (Continued) To use the Solver add-in, we first set up the data in Excel (we chose this format, with the subsequent cell references and formulas consistent with this data placement):

• •

Cells B6:D6 start with zero quantities entered in them. Cells B7:D7 each include a formula to calculate total contribution margin for each respective product: o B7=B6*B4 o C7=C6*C4 o D7=D6*D4

•

Cell E7 includes a formula to calculate the total contribution margin of all products sold: E7=SUM(B7:D7) Cells B9:D9 identify the number of hours it takes to bottle one unit of each type of product.

• •

Cell E10 includes a formula to calculate the total number of hours used for the volume of products specified: E10=SUM(B10:D10)

Then we find the Solver in the Data tab

Problem 5.7 (Continued) And enter the following specifications:

Click solve, and give the processor some time to find a solution. Then the following screen will appear:

Click OK, and the solution will be visible in the original variable cells of B6:D6, where total contribution margin is maximized, as presented in cell E7 (see figure below):

Problem 5.7 (Continued) The solution is identical to the solution generated in part (c) without the assistance of the Solver add-in. With some organized data entry and just a few clicks within the Solver add-in to specify the desired effects, Excel is able to generate a solution very quickly and with minimal user effort. The most profitable product mix given the constraint of bottling time is to produce as much mustard as can be sold, followed by as much ketchup as can be made, leaving no time to produce any relish. Relish could be some customers’ favorite product, so if the company doesn’t make any relish, it could potentially lose these customers permanently. It would be particularly problematic if customers tended to purchase the company’s products in a bundle (purchasing ketchup, mustard, and relish all at once), and if there is no relish available, they decide to go with a different brand for all three of these condiments. Even though it’s the least profitable product in terms of the constraint (bottling time), there is still significant demand for this product, so some customers and vendors could end up unhappy if these products are not available. LO: 1, 2, 3, Bloom: AN, Difficulty: Complex, Time: 25-30, AACSB: Knowledge, Communication, Analytic, Technology, AICPA BC: Strategic Perspective, Customer Perspective, AICPA AC: Reporting, AICPA PC: Communication, Technology and Tools, IMA: Technology & Analytics: Data Analytics, Strategy, Planning, & Performance: Decision Analysis

Solution to Analysis and Decision-Making Case Case a.

Relevant factors in the decision to keep or drop an intercollegiate sport could include: • Number of athletes affected • Number of other students that attend this school because their athlete friends attend • Options for students to transfer and the likelihood that they will transfer for athletic pursuits • Lost tuition, fees, room and board, etc. paid by these affected students who leave • Lost admission fees to these sporting events • Avoidable costs of sports programs being cut (coaches, facility costs, equipment costs, travel costs) This is not an exhaustive list; there could be many other relevant qualitative and quantitative factors that were not referred to in the problem, including any impact on existing/future donors, alumni, community, etc.

Initially, it looks like the school will save money if it drops these athletic programs, given the assumptions made. Under these assumptions, student tuition and fees, and room and board are not relevant as it is assumed all students will stay at the university to complete their degree. The athletic director’s salary is also not relevant because there are still other team sports that must be managed. Relevant Cost Analysis Lost event admissions fees $(19,200) Saved coaches’ salaries 320,000 Net annual cost savings $300,800

Given these more reasonable assumptions, the university is much worse off financially by dropping these athletic programs. The impact reflected here compared to the impact presented in part (b) are two completely different views of how this decision could affect the university financially. And neither of these analyses has considered any qualitative factors yet. Relevant Cost Analysis Lost event admissions fees Saved coaches’ salaries Lost tuition, fees, room, & board from athletes (120 students × 0.50 × $220,000/year) Lost tuition, fees, room, & board from athletes’ friends (150 students × 0.25 × $22,000/year) Net loss

(19,200) 320,000

(1,320,000) (825,000) $(1,844,200)

Case (Continued) d.

Qualitative considerations would include (but are not limited to): • The importance of the soccer program (and the importance of the other team sports that were cut) to the university. • The reputation of the school going forward and its ability to attract quality high school students not only for its remaining athletic programs, but for the university overall. • Possible Title IX issues if it doesn’t maintain its required ratio of male athletic opportunities to female athletic opportunities. • The ability to attract donors to the school for other athletics and for academic and other purposes. • If the university’s relationship with the community would be harmed • The relationship between alumni and the university • Whether any employers will become disengaged with the university because of this decision The university could look for cost savings in a number of other areas: • Using existing space more efficiently. • Implementing a hiring freeze or limiting new hires to emergency hires only. • Offering early retirement options for faculty/staff/administrators • Reducing number of faculty/staff/administrators and/or reducing their salaries • One-time funds could be generated from selling unused land or buildings • Temporary savings could be generated from offering unpaid leaves of absence for one year (for positions where there is currently excess capacity)

LO: 1, 2, 3, 4, 5, Bloom: AN, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, Communication, Analytic, AICPA BC: Strategic Perspective, Customer Perspective, AICPA AC: Reporting, AICPA PC: Communication, IMA: Strategy, Planning, & Performance: Decision Analysis