SOLUTIONS MANUAL for Managerial Accounting, 13th Canadian Edition by Ray Garrison, Theresa Libby, Al by StudyGuide

SOLUTION MANUAL: Managerial Accounting 13th Canadian Edition by Ray H. Garrison, Theresa Libby, Alan Webb Complete Chapters 1-14 Plus Appendix Chapter 1 Managerial Accounting and the Business Environment Solution to Discussion Case Benefits to employees of having a code of conduct: • Creates clarity as to how all employees are expected to behave. This should help employees avoid behaviours that the company prohibits. • Provides protection for employees when dealing with superiors given the guidelines related to protection from discrimination and harassment. • Establishes guidelines for workplace safety, which should help protect the health of employees. • Provides information on the consequences of code violations, which will help understand employees understand the outcomes of prohibited behaviours, if detected. • Provides guidance as to what employees should do if they witness a violation of the code and protects those employees who do report an incident. Disadvantages to CIBC of having a code of conduct: • May create the impression among employees that they are not trusted by senior management to act appropriately. • The obligation to report violations could create a culture of suspicion and mistrust among employees. • Enforcing the code may be costly and time consuming in large organizations such as CIBC. For example, investigations of possible violations could take weeks. • CIBC may be at a competitive disadvantage versus firms that have a less ‗restrictive‘ code of behaviour. Solutions to Questions 1-1 Given rapid changes to the competitive environment in many industries, having information on a timely basis to make decisions is critical. For example, getting timely information on customer reactions to product changes, price changes, new marketing campaigns, and so on, is necessary to allow managers to decide if fur-

ther changes are needed and to make plans for those changes. 1-2 Directing activities involve mobilizing people to carry out plans and run routine operations on a day-to-day basis. Controlling activities involve ensuring that the plan is actually carried out and is appropriately modified as circum© McGraw Hill Ltd. 2024. All rights reserved.

Solutions Manual, Chapter 1

stances change. As such, controlling is an ‗after the fact‘ test versus plan. 1-3 A budget is a detailed quantitative plan for the acquisition and use of financial and other resources over a specified future time period. 1-4 Predictive analytics could be used to estimate any number of metrics such as sales volumes, customer returns, customer satisfaction, warranty returns, product defects and so on. 1-5 A performance reports compares actual results to expected or budgeted results and is prepared on a periodic basis (e.g., monthly). Because it allows managers to see if actual results have departed from the plan, it can allow them to take corrective action where necessary. Performance reports can also be used to evaluate the performance of employees or business segments such as product lines. As such, performance reports can be a very important part of the control process in any organization. 1-6 The Royal Bank of Canada could segment its companywide performance by individual customer, by geographic area (e.g., province or country), and by product line (e.g. asset management, personal loans, mortgages, etc.). Procter & Gamble could segment its performance by product category (e.g., beauty and grooming, household care, and health and wellbeing), product line (e.g., Crest, Tide, and Bounty), and stock keeping units (e.g., Crest Cavity Protection toothpaste, Crest Extra Whitening toothpaste, and Crest Sensitivity toothpaste). 1-7 Managerial accounting plays an important role in strategic management by providing information to allow managers to effectively implement strategy and to monitor progress towards achieving strategic objectives. For example, performance measurement systems usually contain metrics related to the organization‘s target customers (e.g., customer satisfaction) to whom the value proposition is being delivered. 1-8 Planning, controlling, directing and motivating, and decision making must be performed within the context of a company‘s strategy. For example, if a company that competes as a product leader plans to grow too quickly, it may diminish quality and threaten the compa-

ny‘s customer value proposition. A company that competes in terms of operational excellence would select control measures that focus on time-based performance, convenience, and cost. A company that competes in terms of customer intimacy may decide against outsourcing employee training to cut costs because it might diminish the quality of customer service. 1-9 The six business functions that make the value chain are: (1) research and development; (2) product design; (3) manufacturing; (4) marketing; (5) distribution; and (6) customer service. 1-10 Examples of things socially responsible organizations should provide for their employees include: (1) safe and comfortable working conditions; (2) fair compensation; (3) job-training and opportunities for advancement; and (4) nondiscriminatory treatment and the right to file grievances; 1-11 Airlines face the risk that large spikes in fuel prices will lower their profitability. Therefore, they need to estimate future fuel prices and create a business plan based on these estimates. Monitoring actual fuel prices as compared to plan may lead to decisions to change ticket prices, for example. Further, exposure to fuel price spikes may lead to the decision to reduce this risk by spending money on hedging contracts that enable them to lock-in future fuel prices that will not change even if the market price increases. Steel manufacturers face major risks related to employee safety, so they create and monitor control measures related to occupational safety compliance and performance. Restaurants face the risk that an economic downturn will reduce customer traffic and lower sales. They reduce this risk by choosing to create menus during economic downturns that offer more low-priced entrees. 1-12 Having a good ethical reputation is important to companies in maintaining good relations with suppliers, employees and customers. Companies with a poor ethical reputation will likely have trouble finding suppliers for their raw materials, will have difficulty attracting and retaining employees, and will not be attractive to potential customers. Thus, in the long-run hav-

Managerial Accounting, 13th Canadian Edition

ing good relations with stakeholder groups is critical to a company‘s survival. 1-13 Companies prepare a code of conduct to demonstrate their morals and values system, often in part to demonstrate corporate social responsibility. The code of ethics indicates what is expected of all employees and directors in their dealings with various stakeholders.

1- 14 Organizations are managed by people that have their own personal interests, insecurities, beliefs, and data-supported conclusions that ensure unanimous support for a given course of action is the exception rather than the rule. Therefore, managers must possess strong leadership skills if they wish to channel their coworkers‘ efforts towards achieving organizational goals. 1-15 The company could use emissions metrics and tests to monitor whether pollution (e.g., greenhouse gas emission) is within allowable limits. 1-16 Intrinsic motivation comes from within whereby individuals are motivated to succeed at something because they take personal pride and enjoyment in doing so. Extrinsic incentives are provided by someone else (e.g., an employer) and are usually in the form of monetary compensation for work done or goals achieved.

Exercise 1-2 (15 minutes) i.

Primarily financial accounting since it involves the preparation of an income statement for use by the tax authorities (Canada Revenue Agency), an outside body.

ii.

Primarily managerial accounting since it involves the use of information for specific internal purposes related to resource allocations, marketing and production scheduling.

iii.

Primarily financial accounting since the information is being used to develop an account balance (allowance for doubtful accounts) for use in the year-end financial statements.

iv.

Primarily management accounting since the information is being used to evaluate customer satisfaction. Preparing this information is not a financial reporting requirement but it could be useful for internal decision-making purposes regarding pricing of products, product enhancements, etc.

Primarily management accounting since the information will be used to determine possible changes to credit terms offered to major customers. Note that essentially the same information is being used in item iii above but in this case the use is entirely for internal decision-making purposes, not for purposes of preparing the financial statements.

Managerial Accounting, 13th Canadian Edition

Exercise 1-3 (15 minutes) These examples are for illustrative purposes only. There are likely many more risks in each industry that students might identify and several reasonable ways to control those risks.

Industry

Type of Risk

Control

Air travel

A plane may experience a mechanical failure. Bad weather reduces chance of on time deliveries

Implement a preventive maintenance program. Build in time buffers in predicted delivery times, especially in seasons where bad weather poses a bigger risk. Implement monitoring systems, maintain network failsafes and secondary back-up systems. Implement a barcode system to use on tickets for all events. Implement multi-factor identification systems to keep unwarranted users out; ensure the integrity of firewalls; create regulate off site backups

Trucking

Wireless services

Systems failures may cause networks to go down.

Sports and entertainment

Fake tickets may be used to attempt entry to events.

Academic institutions

Cyber attacks may lock users out of needed online access (e.g., learning management systems) and students academic records (e.g., courses credited toward graduation). The company‘s website might be hacked resulting in unauthorized access to customer data like credit card details.

Software as a service

Develop firewalls and other security protocols to reduce the threat of hacking.

Problem 1-4 (15 minutes) The type of cognitive bias revealed by this data is called confirmation bias. This bias occurs when people search for and place greater weight on data that confirms their preexisting beliefs while underweighting and down-playing data that does not. Knowing the CEO‘s preferences, the market research team in this example might unwittingly place greater weight on evidence that supports the CEO‘s preferred outcome (i.e., that the company should invest in developing the new product) while underweighting or ignoring data that does not support this outcome. To avoid confirmation bias, it is important for the CEO to be relatively neutral when providing instructions to the market research team. This would help to ensure the team was not inadvertently developing survey or interview questions that could lead to biased responses. Managers can also help reduce the potential adverse consequences of confirmation bias by establishing a ―devil‘s advocate‖ team of independent managers that are charged with challenging proposed courses of action.

Problem 1-5 (20 minutes) Some possible examples for each activity:

Planning activities: 1. Estimating the advertising revenues for a future period. 2. Scheduling the designated broadcast time slot for games, special programming, news shows, etc. 3. Estimating total expenses for future periods including salaries of news desk anchors, play-by-play analysts, researchers, camera crew personnel, etc.

Directing and motivating activities: 1. Scheduling news desk anchors for each day‘s news broadcasts. 2. Assigning camera crew employees to cover specific events (e.g., games, press conferences, etc.). 3. Reviewing scripts used by news desk anchors for accuracy, clarity, etc. 4. Providing performance incentives for news anchors based on viewership numbers.

Controlling activities: 1. Contrasting the actual number of viewers for each show or game with its viewership projections. 2. Comparing the actual costs of producing a broadcast of a sporting event (e.g., hockey game) to its budget. © McGraw Hill Ltd. 2024. All rights reserved. 6

Managerial Accounting, 13th Canadian Edition

3. Comparing the advertising revenues earned from broadcasting a sporting event to the costs incurred to broadcast that event.

Decision-making activities: 1. Determining which news anchor personnel to sign to contracts. 2. Identifying and evaluating a new product line to complement the network‘s offering, such as a sport popular in foreign markets but not covered in North America. 3. Determining which specific games to broadcast in each sport carried by the network. Problem 1-6 (20 minutes) The purpose of this exercise is to present students with an opportunity to debate the ethicality of competing courses of action. Some students may argue that the ethical choice is to tell the truth when speaking with the professor from B.C. University. Other students may argue that it is okay to be untruthful with the professor from B.C. University because it serves a ―greater good‖ from the standpoint of future Central Manitoba University students that will be able to avoid Dr. Smith. The power of rationalization is a very important topic when discussing ethics and decision-making. When students are asked a generic question about the ethicality of breaking the law or lying, they quickly condemn these actions as unethical. However, when given specific contexts, such as the one presented in this problem, many students will rationalize unlawful or dishonest conduct. It is important to emphasize the long-term survival nature of ethical decision making. A culture of treating stakeholders, which includes other universities in this case, honestly and with integrity will provide the school with both the support of the community but also supports a culture that makes it an organization to which people want to belong. Problem 1-7 (20 minutes) 1. Companies face numerous potential incentives to engage in greenwashing or overstatement of claims about being socially responsible. For example:  Doing so can improve access to investment capital as some investors will only invest in companies that demonstrate good environmental and social performance.  Doing so can have a positive impact on the company‘s ability to attract and retain talent since some individuals will only work for companies with good environmental and social performance.  Doing so can bolster sales since some customers will only purchase products or services from companies with good environmental and social performance.

2. Numerous controls could be put in place to increase the likelihood that a company actually engages in environmentally and socially responsible activities such as:  Establishing financial incentives for achieving targets related to objective measures of environmental performance (e.g., reduction in water consumption or reduction in electricity usage).  Implementing mandatory health and safety training and regulary conducting compliance reviews.  Establishing and disclosing non-discriminatory hiring policies and conducting regular reviews for compliance.  Conducting periodic reviews of labour practices by suppliers operating in developing countries.  Having environmental and social responsibility reports audited, even though doing so is not mandatory.  Establishing financial guidelines (e.g., budgets) for financially supporting local charities, schools or municipalities and periodically reviewing actual spending against such guidelines.  Establishing an independent management team, responsible directly to the board of directors, charged with assessing the organization‘s CSR program and performance. Problem 1-8 (30 minutes) 1.

Possible unintended consequences: 

Example 1: o The manager could improve profits by reducing discretionary spending on value chain activities such as research and development, employee training or marketing. These actions could help improve profits in the shortterm but longer-term may have a negative impact on company performance. o The manager could improve profits by reducing manufacturing costs through the use of lower quality materials or by using less-experienced workers. Either of these actions could reduce product quality, which longer-term could negatively impact the company‘s reputation.



Example 2: o Sales staff could engage in aggressive sales tactics such as pressuring customers to make a purchase, or providing misleading product information, which could reduce the customers‘ willingness to purchase from

Managerial Accounting, 13th Canadian Edition

the company in the future. o Sales staff could offer price discounts too readily in an effort to secure a sale, which would reduce the profit margin on each sale. 2.

Controls that could be put in place to reduce the likelihood that the unintended consequences identified in requirement 1 will occur. 

Example 1: o Establish non-financial performance measures for key value chain activities such as research and development (e.g., number of new product features), employee training (e.g., number of training hours per employee) and customer service (e.g., customer satisfaction). Hold managers accountable for meeting expected levels of performance on such metrics. o Establish measures for product quality (e.g., number of defects, number of product returns, etc.) and hold managers accountable for meeting expected levels of performance.

Problem 1-8 (continued) o Establish policies for the use of specific suppliers that meet stringent requirements regarding material quality and periodically conduct compliance reviews. o Change the extrinsic rewards such that they contain a component of longterm performance. An example would be a bonus based on three-year rolling average of profitability rather than rewarding performance for a single year. 

Example 2: o Periodically measure customer satisfaction regarding their experience with sales staff. Hold sale staff accountable for unacceptable levels of customer satisfaction. o Do not allow sales staff any discretion to offer sales discounts. o Establish a mix of fixed pay (e.g., hourly wages) and commissions that results in less incentive to engage in aggressive sales tactics.

Problem 1-9 (30 minutes) 1. Benefits and challenges of performing value chain analysis: Benefits:  Provides a complete picture of product profitability since it incorporates all major functions of the value chain involved in developing, manufacturing and servicing products.  Can lead to the identification of the most and least profitable products. This could result in actions taken to improve less profitable products such as reducing manufacturing costs, increasing advertising or improving customer service.  Could lead companies to allocate resources to more profitable products (e.g., increased marketing or customer service) to further enhance their performance.  Could lead to the discontinuation of unprofitable products if management concludes that cost reductions across the value chain are not possible or feasible. Challenges:  Some costs may be difficult to separately track for each major product line. For example, marketing costs often relate to advertising campaigns for a company‘s products as a whole rather than for individual products (e.g., BMW advertisements are often for the brand rather than a specific model).  The timing of some value chain costs will occur in different periods than the related product revenues. For example, research and development costs will be incurred before a product is brought to market and customer service costs will be incurred after the product has been sold. Therefore to accurately assess product profitability using value chain analysis, managers will have to conduct the analysis on a long-term basis over multiple reporting periods (years) to fully match revenues with the related costs.  Could lead managers to reduce costs in certain areas such as customer support that could improve product profitability in the short-run but would have negative consequences longer-term if product quality or customer service levels suffer as a result. Note, a good control system would mitigate this behavior by rewarding managers in part based on the longer-term performance of the company.  Longer term success depends on having a constant supply of new products to fill the lost sales that eventually occur as older products lose their appeal with consumers. However, analysis will often show that older products are relatively more profitable. Long term success, however, depends on having products at all stages of the product life cycle and therefore care must be taken with decision making based on value chain analysis alone.

Managerial Accounting, 13th Canadian Edition

Problem 1-9 (continued) 2. Change in value chain costs over the life of a product:  



Research and development costs are primarily incurred before a product is brought to market and so will be low or non-existent for more mature products. Product design costs will be considerably lower as a product matures but some may continue to be incurred such as design changes aimed at improving quality or functionality. Manufacturing costs may decline on a per unit basis for more mature products as a result of improvements to production activities or because higher volumes are produced allowing for greater economies of scale (e.g., lower unit costs for raw materials). Marketing costs will likely be higher for new products but decrease as products mature since customers will be aware of their existence and features. Marketing costs could also increase as a product matures in response to increased competition. Distribution costs may increase as a product matures as managers seek new markets in which to increase sales.

Problem 1-10 (30 minutes) 1. While the numerical answers will differ among students, they should understand that if the company used the sales budget for the sole purpose of matching supply with demand, then the boss and the sales manager would both be inclined to focus on forecast accuracy. They would strive for accuracy because if they overestimate sales it is likely to result in bloated inventories and if they underestimate sales it is likely to result in lost sales. 2. While the numerical answers will differ among students, they should see a conflict arise because the budget is now being used for two purposes—deploying resources in a manner that matches supply with demand and motivating employees. If students choose an answer such as $1,200,000, it may motivate employees to strive for optimal sales, but it also may result in bloated inventories if the ―stretch‖ goal is not achieved. Conversely, if students choose an answer such as $1,000,000, it may do a good job of matching production with sales, but it also may sacrifice sales that could have been realized by challenging the sales team to strive for superior results. 3. While the numerical answers will differ among students, they should see a conflict arise because the budget is now being used for three purposes—deploying resources in a manner that matches supply with demand, motivating employees, and rewarding employees. In this scenario, it is quite likely that students will choose a sales forecast that creates budgetary slack, thereby increasing their chances of attaining a large pay raise, a bonus, and a promotion. Of course, creating budgetary slack increases the likelihood that production will be insufficient to meet customer demand, thereby resulting in lost sales. This scenario highlights an important management challenge, namely designing employee compensation systems that align employee incentives with the desires of the company. 4. Most students‘ answers to the first three questions will differ from one another. The differences in their answers highlight the complications that arise when budgets are used for multiple purposes. Students will come to understand that the gamesmanship increases when they need to account for the fact that their boss usually adds 510% to their forecast.

Managerial Accounting, 13th Canadian Edition

Problem 1-10 (continued) 5. Having the boss unilaterally impose a sales budget on the sales manager is a bad idea for three reasons. First, the boss may not have access to information possessed by the sales manager that would result in a more accurate forecast. Second, the sales manager is unlikely to be committed to achieving a budget that she did not help create. For example, if the sales manager fails to achieve actual results that meet or exceed the budget, it would be easy for the sales manager to justify this outcome on the grounds that she had no input in creating the budget. 6. The company would probably not be comfortable with having the sales manager create the budget with no input from her boss. First, the boss is likely to possess a broad understanding of strategic issues that should be incorporated into the budgeting process. Second, the sales manager may be inclined to purposely underestimate future sales to increase her chances of producing actual results that exceed the budget. If she can produce actual results that exceed the budget it is likely to increase her pay raise and bonus as well as her chances for promotion.

Chapter 2 Cost Terms, Concepts, and Classifications Solution to Discussion Case Possible reasons for disagreeing with the statement:  Distinguishing between product and period costs will still be important, even for small single-product companies. For companies in competitive markets knowing product costs will help them manage profitability more successfully. Knowing product costs is also important for companies that are able to set their own prices as it will provide an indication of the price needed to cover the costs of production.  Understanding how costs behave (variable versus fixed) is still important even for small companies as it will help them predict how costs will change in response to changes in activity levels. This knowledge will be helpful when developing budgets (more on this in chapter 9), which based on the authors‘ research, is a tool used by a large majority of companies, small and large.  Evaluating business opportunities requires an understanding of concepts such as opportunity costs and sunk cost regardless of the size of the company. For example a company that devotes its production equipment to producing one product is still incurring an opportunity cost that is equal to the benefits that would arise from using the invested capital in something else. Periodically owners of small companies should still evaluate whether the benefits of the status quo exceed the opportunity costs being incurred related to the next best alternative for using the company‘s resources. Sunk costs also arise in small companies and should be ignored. Possible reasons for agreeing with the statement:  Students who agree will likely take the view that, as per the question wording, many of the concepts in Chapter 2 take on more importance as the complexity of operations increases. For example, understanding product versus period costs is arguably more important in a multi-product setting where managers have to allocate resources across multiple products in an effort to maximize profitability.

Managerial Accounting, 13th Canadian Edition

Solutions 2-1 No. Only costs related to operating the production facilities are included as manufacturing overhead. Costs related to the administrative building would be an administrative expense. 2-2 The three categories are: (a) direct materials; (b) direct labour; and (c) manufacturing overhead. 2-3 Not always. Product costs are expensed in the same period in which the related products are sold. For example, if product costs were incurred in December but the products weren‘t sold until January, the costs would not be expensed as part of cost of goods sold until January. In this example, the product costs would be included on the December balance sheet as work in process or finished goods inventory. 2-4 Administrative costs are those costs with the general management of the company such as accounting, legal, human resources, executive compensation, etc. They are always treated as period costs on the income statement. As a result, they are expensed in the period incurred. 2-5 Raw materials inventory includes direct and indirect materials that have not yet been placed into production. Conversely work in process inventory includes costs related to direct and materials, direct labour and manufacturing overhead that have been placed into production but the goods are not yet complete. Both raw materials and work in process inventories are included on the balance sheet. Only when goods are finished and sold do the associated costs get transferred from the balance sheet inventory account(s) to cost of goods sold on the income statement. 2-6 Automation is likely to decrease prime costs. The reason is that automation reduces the need for employees to perform tasks, thereby reducing direct labour, one of the components of prime costs. 2-7 Total manufacturing costs are the total costs of direct materials, direct labour and manufacturing overhead incurred in the current period for products that are both complete and partially complete at the end of the period. Cost of

Questions goods manufactured represents the direct materials, direct labour and manufacturing overhead costs for goods completed during the period. Cost of goods manufactured = Total manufacturing costs + beginning WIP – ending WIP. 2-8 A manufacturing company will have raw materials inventory and work-in-process inventory. Because neither merchandising nor service companies have manufacturing activities, they will not have these two classes of inventory accounts. 2-9 Wages are a mixed cost for this company since it contains both a fixed portion (weekly salary based on 40 hours) and a variable portion based on overtime hours at $20 per hour. 2-10 As activity levels increase, variable costs per unit do not change within the relevant range. However, as activity levels increase, fixed costs per unit decrease. This decrease happens because total fixed costs remain unchanged (the numerator in the calculation of fixed costs per unit) even though the activity levels are increasing (the denominator in the calculation of fixed costs per unit). 2-11 It is a mixed cost. There is a fixed component, $50 for 5 GB of data, and a variable component, $5 for every 200 MB of data used in excess of 5 GB. 2-12 Manufacturing overhead is an indirect cost since these costs cannot be easily and conveniently traced to particular units of products. 2-13 No. The original cost of the existing machine is a sunk cost that is not relevant to the decision as to whether the new machine should be purchased. The original cost has already been incurred and cannot be undone at this point. Thus it is irrelevant for decision-making purposes. 2-14 There is an opportunity cost, the amount you could have received by selling your iPhone 14. Since you are foregoing this amount by signing up for a bring your own phone plan, it is an opportunity cost. © McGraw Hill Ltd. 2024. All rights reserved.

Solutions Manual, Chapter 2

2-15 Typically when overtime can be isolated to a particular job or product, it should be treated as direct labour rather than included as overhead and charged to all jobs and products. The rationale is that treating it as direct labour results in a more accurate picture of the total cost of completing jobs on a rush-order basis.

2-16 It is possible if the company had $100,000 in beginning finished goods inventory and sold it all during the period, but did not complete the production of any new units.

Managerial Accounting, 13th Canadian Edition

Foundational Exercises 1. Direct materials .................................................................... $ 6.00 Direct labor ..........................................................................3.50 Variable manufacturing overhead ...........................................1.50 Variable manufacturing cost per unit ...................................... $11.00 Variable manufacturing cost per unit (a) ................................ $11.00 Number of units produced (b) ............................................... 10,000 Total variable manufacturing cost (a) × (b) ............................ Average fixed manufacturing overhead per unit (c) ................. $4.00 Number of units produced (d) ............................................... 10,000 Total fixed manufacturing cost (c) × (d) ................................. Total product (manufacturing) cost ........................................

$110,000

40,000 $150,000

Note: The average fixed manufacturing overhead cost per unit of $4.00 is valid for only one level of activity—10,000 units produced. 2. Sales commissions ................................................................ $1.00 Variable administrative expense .............................................0.50 Variable selling and administrative per unit ............................. $1.50 Variable selling and admin. per unit (a) .................................. $1.50 Number of units sold (b) ....................................................... 10,000 Total variable selling and admin. expense (a) × (b) ........................................................................ Average fixed selling and administrative expense per unit ($3 fixed selling + $2 fixed admin.) (c) ................... $5.00 Number of units sold (d) ....................................................... 10,000 Total fixed selling and administrative expense (c) × (d) .................................................................................... Total period (nonmanufacturing) cost .....................................

$15,000

50,000 $65,000

Note: The average fixed selling and administrative expense per unit of $5.00 is valid for only one level of activity—10,000 units sold.

Foundational Exercises (continued) 3.

Direct materials .................................................................... $ 6.00 Direct labor .......................................................................... 3.50 Variable manufacturing overhead ........................................... 1.50 Sales commissions ................................................................ 1.00 Variable administrative expense ............................................. 0.50 $12.50 Variable cost per unit sold ..................................................... 4.* Direct materials .................................................................... $ 6.00 Direct labor .......................................................................... 3.50 Variable manufacturing overhead ........................................... 1.50 Sales commissions ................................................................ 1.00 Variable administrative expense ............................................. 0.50 Variable cost per unit sold ..................................................... $12.50 *Should be the same as part 3 since variable costs per unit don‘t differ within the relevant range of activity. 5. Variable cost per unit sold (a) ................................................ $12.50 Number of units sold (b) ....................................................... 8,000 Total variable costs (a) × (b) ................................................. $100,000 6.

Variable cost per unit sold (a) ................................................ $12.50 Number of units sold (b) ....................................................... 12,500 Total variable costs (a) × (b) ................................................. $156,250

Total fixed manufacturing cost (see requirement 1) (a)...................................................... $40,000 Number of units produced (b) ............................................... 8,000 Average fixed manufacturing cost per unit produced (a) ÷ (b) ................................................................. $5.00

Total fixed manufacturing cost (see requirement 1) (a)...................................................... $40,000 Number of units produced (b) ............................................... 12,500 Average fixed manufacturing cost per unit produced (a) ÷ (b) ................................................................. $3.20

Total fixed manufacturing cost (see requirement 1) ........................................................... $40,000

Managerial Accounting, 13th Canadian Edition

Foundational Exercises (continued) 10. Total fixed manufacturing cost $40,000 (see requirement 1) ........................................................... 11. Variable overhead per unit (a) ............................................... $1.50 Number of units produced (b) ............................................... 8,000 Total variable overhead cost (a) × (b) .................................... Total fixed overhead (see requirement 1) ............................... Total manufacturing overhead cost ........................................ Total manufacturing overhead cost (a) ............................. Number of units produced (b) ......................................... Manufacturing overhead per unit (a) ÷ (b) .......................

$12,000 40,000 $52,000 $52,000 8,000 $6.50

12. Variable overhead per unit (a) ............................................... $1.50 Number of units produced (b) ............................................... 12,500 Total variable overhead cost (a) × (b) .................................... Total fixed overhead (see requirement 1) ............................... Total manufacturing overhead cost ........................................ Total manufacturing overhead cost (a) ............................. Number of units produced (b) ......................................... Manufacturing overhead per unit (a) ÷ (b) .......................

$18,750 40,000 $58,750 $58,750 12,500 $4.70

13. Direct materials per unit ........................................................ $6.00 Direct labor per unit .............................................................. 3.50 Direct manufacturing cost per unit (a) ................................... $9.50 Number of units produced (b) ............................................... 11,000 Total direct manufacturing cost (a) × (b) ............................... $104,500 Variable overhead per unit (a) ......................................... $1.50 Number of units produced (b) ......................................... 11,000 Total variable overhead cost (a) × (b) .............................. Total fixed overhead (see requirement 1) ......................... Total indirect manufacturing cost .....................................

$16,500 40,000 $56,500

Foundational Exercises (continued) 14. Direct materials per unit ........................................................ $6.00 Direct labor per unit .............................................................. 3.50 Variable manufacturing overhead per unit .............................. 1.50 Incremental cost per unit produced ....................................... $11.00 Note: Variable selling and administrative expenses are variable with respect to the number of units sold, not the number of units produced.

Managerial Accounting, 13th Canadian Edition

Exercise 2-1 (10 minutes) 1. The cost of a hard drive installed in a computer: direct materials. 2. The cost of advertising in the Puget Sound Computer User newspaper: selling. 3. The wages of employees who assemble computers from components: direct labor. 4. Sales commissions paid to the company‘s salespeople: selling. 5. The salary of the assembly shop‘s supervisor: manufacturing overhead. 6. The salary of the company‘s accountant: administrative. 7. Depreciation on equipment used to test assembled computers before release to customers: manufacturing overhead. 8. Rent on the facility in the industrial park: a combination of manufacturing overhead, selling, and administrative. The rent would most likely be prorated on the basis of the amount of space occupied by manufacturing, selling, and administrative operations.

Exercise 2-2 (15 minutes) Product (Inventoriable) Cost

Period Cost

Components used in the devices

Factory heating costs

Factory equipment maintenance costs………

Training costs for new administrative staff…

Solder used to assemble the devices…………

Travel costs for Chief Financial Officer

Wages and salary costs of factory security personnel

Utility costs for administrative building

Wages and salaries for customer billing department

10.

Depreciation on fitness equipment used by factory employees

11.

Telephone expenses for manager of the production facility

12.

Costs of shipping devices to customers

13.

Wages of employees who assemble devices

14.

CEO salary

15.

Overtime paid to administrative staff in the accounts payable department

X X X X

X X

Managerial Accounting, 13th Canadian Edition

Exercise 2-3 (15 minutes) Pampering You Co. Income Statement For the month ended June Sales ......................................................................... Cost of goods sold: Beginning merchandise inventory ............................. Add: Purchases ....................................................... Goods available for sale ........................................... Deduct: Ending merchandise inventory..................... Gross margin ............................................................. Selling and administrative expenses: Selling expense ....................................................... Administrative expense............................................ Operating income ......................................................

$150,000 $ 12,000 90,000 102,000 22,000

40,000 25,000

80,000 70,000

65,000 $ 5,000

Exercise 2-4 (15 minutes) 1. Devon Manufacturing Schedule of Cost of Goods Manufactured For the year ended xxx Direct materials: Beginning raw materials inventory ..................... Add: Purchases of raw materials ........................ Raw materials available for use .......................... Deduct: Ending raw materials inventory .............. Raw materials used in production ...................... Direct labour ........................................................ Manufacturing overhead ....................................... Total manufacturing costs .................................... Add: Beginning work in process inventory ............... Deduct: Ending work in process inventory .............. Cost of goods manufactured ...............................

$ 0 200,000 200,000 100,000 $ 100,000 160,000 120,000 380,000 0 380,000 20,000 $360,000

Exercise 2-5 (30 minutes) 1. Per unit amounts: Item Variable expenses: Direct materials Direct labour Indirect materials

Amount $50,000 $ 5,000 $500

January Activity 100 100 100

Fixed expenses: Installation supervisor‘s wages Equipment depreciation Insurance and utilities for garage

$8,000 $1,000 $700

100 100 100

Per Unit $500 $50 $5 $80 $10 $7

2. a & b Item Variable expenses: Direct materials Direct labour Indirect materials

(1)

(2)

February Activity 80 80 80

January Per Unit $500 $ 50 $ 5

(3) February Total Cost $40,000 $ 4,000 $ 400

(3) ÷ (1) February Per Unit $500 $ 50 $5

Fixed expenses: Installation supervisor‘s wages 80 $80 $8,000 $100.00 Equipment depreciation 80 $10 $1,000 $ 12.50 Insurance and utilities for garage 80 $7 $700 $ 8.75  Variable expenses per unit do not change within the relevant range of activity so the January and February amounts do not differ.  Fixed expenses per unit increase in February because the same total fixed expenses are being spread over a lower activity base (80 installations versus 100). 3. The depreciation costs are sunk because they related to the cost of equipment already purchased. Nothing can be done in the future to avoid the incurrence of these costs, unless Mike decides to sell the equipment.

Managerial Accounting, 13th Canadian Edition

Exercise 2-6 (15 minutes)

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

Direct Cost

Cost Object

The wages of pediatric The pediatric department nurses Prescription drugs A particular patient Heating the hospital The pediatric department The salary of the head of The pediatric department pediatrics The salary of the head of A particular pediatric patient pediatrics Hospital chaplain‘s salary A particular patient Lab tests by outside conA particular patient tractor Lab tests by outside conA particular department tractor *Assuming allocated based on m2

Indirect Cost

X X X* X X X X X

Exercise 2-7 (15 minutes)

Item

Differential Revenue

Ex. Cost of electricity for the warehouse .................................. 1. Sublet revenue for the new warehouse ........................... X 2. Lease payments for the new warehouse ........................... 3. Net book value of the existing warehouse .......................... 4. Sales proceeds from selling the existing warehouse .......................................... X 5. Warehouse maintenance costs ........................................... 6. Warehouse staff wages ................... 7. Paving costs for the parking lot at existing warehouse .......................................... 8. Parking lot revenues for existing warehouse* X

Differential Cost

Opportunity Cost

Sunk Cost

X X

*The revenue foregone by moving to the new warehouse can be considered either differential revenue or an opportunity cost.

Managerial Accounting, 13th Canadian Edition

Exercise 2-8 (15 minutes)

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

Cost of x-ray film used in old machine ...................................... X Cost to purchase old x-ray machine ........................................... Cost of electricity to run x-ray machine ...................................... X Reduction in staff due to new CBC machine .............................. Cost of maintaining x-ray machine ........................................... X Cost to install shielding in x-ray room ........................................... Salary of radiology department manager ...................................... NA Benefit of providing faster, more accurate blood test results to patients

Opportunity

Sunk

Exercise 2-9 (30 minutes) 1. a. Medallions purchased Medallions drawn from inventory used for advertising Medallions remaining in inventory Cost per medallion Cost in Raw Materials Inventory at February 28 b. Medallions used in production (200-20) Units completed and transferred to Finished Goods (75% × 180) Units still in Work in Process at February 28 Cost per medallion Cost in Work in Process Inventory at February 28

1,000 200 800 × $2 $1,600 180 135 45 × $2 $ 90

c. Units completed and transferred to Finished Goods (above) Units sold during the month (60% × 135) Units still in Finished Goods at February 28 Cost per medallion Cost in Finished Goods Inventory at February 28

135 81 54 × $2.50 $135

d. Units sold during the month (above) Cost per medallion Cost in Cost of Goods Sold at February 28

81 x $2.50 $202.50

e. Medallions used in advertising Cost per medallion Cost in Advertising Expense for February

20 × $2 $ 40

2. Raw Materials Inventory—balance sheet Work in Process Inventory—balance sheet Finished Goods Inventory—balance sheet Cost of Goods Sold—income statement Advertising Expense—income statement

$1,600.00 90.00 135.00 202.50 40.00 $2,067.50

Note: the $2,000 above reconciles to the total amount spent on the Medallions in February: 1,000 x $2 per unit + 135 medallions inscribed x $0.50 = $2,067.50.

Managerial Accounting, 13th Canadian Edition

Exercise 2-10 (30 minutes) 1. Gulf Shore Limited Schedule of Cost of Goods Manufactured For the year ended April 30 Direct materials: Raw materials inventory, beginning ..................... $ 7,000 Add: Purchases of raw materials ............................. 118,000 Raw materials available for use ............................... 125,000 Deduct: Raw materials inventory, ending ................ 15,000 Raw materials used in production ........................... Direct labour............................................................. Manufacturing overhead: Rent, factory facilities ............................................. $ 20,000 Indirect labour ....................................................... 30,000 Maintenance, factory equipment ............................. 6,000 Insurance, factory equipment ................................. 800 Supplies, factory .................................................... 4,200 Depreciation, factory equipment ............................. 19,000 Total manufacturing overhead costs ........................ Total manufacturing costs ......................................... Add: Work in process, beginning................................ Deduct: Work in process, ending ............................... Cost of goods manufactured ......................................

$110,000 70,000

80,000 260,000 10,000 270,000 5,000 $265,000

2. The cost of goods sold section would be: Finished goods inventory, beginning .......................... Add: Cost of goods manufactured .............................. Goods available for sale ............................................ Deduct: Finished goods inventory, ending .................. Cost of goods sold ....................................................

$ 20,000 265,000 285,000 35,000 $250,000

Exercise 2-10 (continued) 3. Cost of goods sold is $15,000 lower than the cost of goods manufactured because finished goods inventory increased by that amount during the year from opening balance of $20,000 to an ending balance of $35,000. That is, of the total manufacturing costs incurred in the most recent year, $35,000 ended up on the balance sheet in the form of incremental finished goods inventory and the opening inventory balance $20,000 was sold and therefore transferred to the income statement as part of cost of goods sold. Exercise 2-11 (15 minutes)

Cost Item 1. 2. 3. 4. 5. 6. 7. 8. 9.

Small glass plates used for lab tests in a hospital. Straight-line depreciation of a building. Senior management salaries. Advertising of products and services. Electrical costs of operating production equipment. Batteries used in motorcycle manufacturing. Commissions paid to sales staff. Liability insurance paid by a dentist. Subscription fee paid for use of cloud-based analytics software.

Cost Behaviour Variable Fixed X X X X X X X X X

Managerial Accounting, 13th Canadian Edition

Exercise 2-12 (20 minutes) Marwick‘s Pianos, Inc. Traditional Income Statement For the Month of August Sales (40 pianos × $3,125 per piano)........................... Cost of goods sold (40 pianos × $2,450 per piano) ................................ Gross margin .............................................................. Selling and administrative expenses: Selling expenses: Advertising ........................................................... Sales salaries and commissions [$950 + (8% × $125,000)] ................................ Delivery of pianos (40 pianos × $30 per piano) ............................... Utilities ................................................................. Depreciation of sales facilities ................................ Total selling expenses .............................................. Administrative expenses: Executive salaries.................................................. Insurance ............................................................. Clerical [$1,000 + (40 pianos × $20 per piano)] .............. Depreciation of office equipment ........................... Total administrative expenses ................................... Total selling and administrative expenses ..................... Net operating income ..................................................

$125,000 98,000 27,000

700

10,950 1,200 350 800 14,000 2,500 400 1,800 300 5,000 19,000 $ 8,000

Problem 2-13 (30 minutes) 1. The direct costs of the Apparel Department are as follows: Apparel Department cost of sales—Evendale Store ................. $ 90,000 Apparel Department sales commission—Evendale Store .......... 7,000 Apparel Department manager‘s salary—Evendale Store ........... 8,000 Total direct costs for the Apparel Department ......................... $105,000 2. The direct costs of the Evendale Store are as follows: Apparel Department cost of sales—Evendale Store ................. $ 90,000 Store manager‘s salary—Evendale Store ................................. 12,000 Apparel Department sales commission—Evendale Store .......... 7,000 Store utilities—Evendale Store ............................................... 11,000 Apparel Department manager‘s salary—Evendale Store ........... 8,000 Janitorial costs—Evendale Store............................................. 9,000 Total direct costs for the Evendale Store ................................. $137,000 3. The direct costs in the Apparel Department that are also variable with respect to departmental sales is computed as follows: Apparel Department cost of sales—Evendale Store ................. Apparel Department sales commission—Evendale Store .......... Total direct costs for the Apparel Department that are also variable costs ....................................................................

$90,000 7,000 $97,000

Managerial Accounting, 13th Canadian Edition

Problem 2-14 (25 minutes) 1. The logistic manager‘s salary can be classified in several different ways. For example: a. It is a fixed rather than a variable cost since it does not change with volume of production b. It is an indirect rather than direct cost since it cannot be easily and conveniently traced to a particular cost object (i.e., a unit of product). c. Finally, depending on the context, it could be classified as a product (i.e., manufacturing cost) or a period (i.e., selling cost). 2. The President is correct that all costs hit the bottom line eventually. When a cost hits that bottom line differs depending on whether it is classified as a product or a period cost. If the salary is classified as a product cost, then that cost moves through Work-inProcess and Cost of Goods Sold as goods are produced and sold. At the end of the period, it is likely some of the logistics manager‘s salary would be attached to products still in process and would end up in the Work-in-Process Inventory account appearing on the Balance Sheet. The rest would be recognized on the Income Statement through Cost of Goods Sold. If the salary is classified as a period cost, then the full amount is included in the Selling and Administrative expense balance on the Income Statement for the current year. Thus, Net Income will be lower in the current year if the salary is classified as a period rather than a product cost. However, the classification decision should not be made based on its effect on Net Income. Rather, the classification should depend on the way the logistics manager spends most of their time. While this is a judgment call, the President might ask the logistics manager to keep track of the proportion of their time spent on issues related to manufacturing versus selling over a representative period of time to allow for a more accurate classification decision to be made.

Problem 2-15 (30 minutes) 1. Cost classification:

Product Cost Name of the Cost $5,000 salary at tech company foregone ................................... Garage rental, $300 per month ........ Equipment rental, $1,000 .............. Material cost, $.60 per unit ............ Labour cost, $1.00 per unit ........... Room rental for sales office, $150 per month ................................. Voicemail plan for cell phone, $5 per month ................................. Foregone interest on savings account, $2,000 per year ............... Advertising, $400 per month ......... Sales staff commission, $0.20 per unit ........................................... Legal fees to incorporate, $1,000…………………………………

Variable Cost

Fixed Cost

Direct Direct Materials Labour

Period Mfg. (Selling and Opportunity Sunk Overhead Admin.) Cost Cost Cost X

X X X X

X X

2. Because the legal fees have already been incurred, they are a sunk cost.

Managerial Accounting, 13th Canadian Edition

Problem 2-16 (20 minutes) Note to the Instructor: There may be some exceptions to the answers below. The purpose of this problem is to get the student to start thinking about cost behavior and cost purposes; try to avoid lengthy discussions about how a particular cost is classified.

Cost Item 1. Property taxes, factory ........................................... 2. Boxes used for packaging detergent produced by the company ....................................................... 3. Salespersons‘ commissions ..................................... 4. Supervisor‘s salary, factory ..................................... 5. Depreciation, executive autos ................................. 6. Wages of workers assembling computers ................ 7. Insurance, finished goods warehouses .................... 8. Lubricants for production equipment ....................... 9. Advertising costs .................................................... 10. Microchips used in producing calculators ................. 11. Shipping costs on merchandise sold ........................ 12. Magazine subscriptions, factory lunchroom .............. 13. Thread in a garment factory ................................... 14. Executive life insurance .......................................... 15. Ink used in textbook production .............................. 16. Fringe benefits, materials handling workers ............. 17. Yarn used in sweater production ............................. 18. Wages of receptionist, executive offices...................

Variable or Fixed

Selling Cost

Administrative Cost

Manufacturing (Product) Cost Direct Indirect

F V V F F V F V F V V F V F V V V F

Solutions Manual, Chapter 2

Problem 2-17 (60 minutes) 1. Precious Production Schedule of Cost of Goods Manufactured For the quarter ended xxxx Direct materials: Raw materials inventory, beginning............................ Add: Purchases of raw materials ................................ Raw materials available for use .................................. Deduct: Raw materials inventory, ending ................... Raw materials used in production .............................. Direct labour................................................................ Manufacturing overhead: Depreciation, factory ................................................. Insurance, factory ..................................................... Maintenance, factory ................................................. Utilities, factory......................................................... Supplies, factory ....................................................... Indirect labour .......................................................... Total overhead costs .................................................... Total manufacturing costs ............................................ Add: Work in process inventory, beginning .................... Deduct: Work in process inventory, ending .................... Cost of goods manufactured .........................................

$ 40,000 360,000 400,000 68,000 $ 332,000 240,000 168,000 20,000 120,000 108,000 4,000 260,000 680,000 1,252,000 28,000 1,280,000 120,000 $1,160,000

Managerial Accounting, 13th Canadian Edition

Problem 2-17 (continued) 2. Precious Production Limited Income Statement For the quarter ended xxxx Sales ................................................................................ Cost of goods sold: Finished goods inventory, beginning ............................... Add: Cost of goods manufactured ................................... Goods available for sale ................................................. Deduct: Finished goods inventory, ending ....................... Gross margin .................................................................... Selling and administrative expenses: Selling expenses ............................................................ Administrative expenses ................................................. Operating income .............................................................

$1,800,000 $ 40,000 1,160,000 1,200,000 160,000

320,000 280,000

1,040,000 760,000

600,000 $ 160,000

3. Direct labour: $240,000 ÷ 10,000 units = $24.00 per unit. Insurance: $20,000 ÷ 10,000 units = $2.00 per unit. 4. Direct materials: Unit cost: 332,000/10000= $33.20 Total cost: 12,000 units × $33.20 per unit = $398,400. Insurance: Unit cost: $20,000 ÷ 12,000 units = $1.67 per unit (rounded). Total cost: $20,000 (unchanged) 5. Unit cost for insurance dropped from $2.00 to $1.67, because of the increase in production between the two years. Since fixed costs do not change in total as the activity level changes, they will decrease on a unit basis as the activity level rises. 6. If the company produced 20,000 units then the following costs would appear in inventory: Direct materials ($332,000/20,000)*4,000 units = $ 66,400 Direct labour ($240,000/20,000)* 4,000 units = 48,000 Manufacturing overhead ($680,000/20,000) * 4,000 units = 136,000 Total $ 250,400

Problem 2-18 (15 minutes) 1. You are correct! Although for financial reporting purposes the supervisor is correct that there will be a net loss of $1,500 (salvage process less the net book value (NBV) to be written off), the $4,000 is still a sunk cost. As such, it is not relevant to the analysis. There is nothing the company can do to get that $4,000 NBV back. Another way of looking at it is regardless of whether or not the new computers are purchased, the $4,000 NBV will be written off. If the new computers are purchased it will be written off immediately. If the new computers are not purchased, it will be written off as depreciation in the next year as year three of the three-year useful life of the computers. You are both correct that the $2,500 in salvage proceeds for the old computer is relevant to include in the analysis. 2. You are correct! Although the foregone salvage value is not, as the supervisor says, an ―out-of-pocket‖ expense that will be incurred if the old computers are kept, it is an opportunity cost. By definition, an opportunity cost is a ―potential benefit that is given up when one alternative is selected over another.‖ The software cost, on the other hand, is ―out of pocket‖ in that is a current cost, and therefore a differential cost savings if the new computers are purchased and should be included in the analysis. Therefore, both items should be included in the analysis.

Managerial Accounting, 13th Canadian Edition

Problem 2-19 (30 minutes)

(Selling and

Product Cost Name of the Cost

To Units of Variable Fixed Direct Direct Mfg. Admin.) Product Opportunity Sunk Cost Cost Materials Labour Overhead Cost Direct Indirect Cost Cost

Metal used in frets and knobs ($10 per guitar) .................... X Employee wages to handcraft guitars ($175 per guitar) ............................................ X Insurance on manufacturing facilities ($5,000 per year) .............................................. Glue used in assembly process ............................................... X Depreciation on machines used to produce guitars ($15,000 per year) .......................... Marketing VP salary ($125,000 per year) ........................ Manufacturing operations manager salary ($130,000 per year) ........................ Discontinued ad campaign ($75,000) ....................................... Operating income foregone on manufacturing facili-

X X

Solutions Manual, Chapter 2

ties ($100,000 per year) .................. Overtime premiums ($1,000) ......................................... X

Managerial Accounting, 13th Canadian Edition

Problem 2-20 (45 minutes) 1.

Cost Item Direct labour ...................................... Advertising ........................................ Factory supervision ............................ Property taxes, factory building........... Sales commissions ............................. Insurance, factory .............................. Depreciation, administrative office equipment ...................................... Lease cost, factory equipment ............ Indirect materials, factory................... Depreciation, factory building ............. Administrative office supplies .............. Direct materials used ......................... Utilities, factory .................................. Total costs .........................................

Cost Behavior Variable Fixed

Selling or Administrative Cost

$118,000

Product Cost Direct Indirect $118,000

$50,000 40,000 3,500 80,000

$50,000 $40,000 3,500 80,000

2,500 4,000 12,000

2,500 4,000 12,000 6,000 10,000

6,000 10,000 3,000 94,000 20,000 $321,000

3,000 94,000 $122000

$137000

$212,000

20,000 $94,000

Problem 2-20 (continued) 2. Only the product costs will be included in the cost of a patio set. The cost per set will be: Direct product costs .................... Indirect product costs ................. Total product costs .....................

$212,000 94,000 $306,000

$306,000 ÷ 2,000 sets = $153 per set 3. The cost per set would increase. This is because the fixed costs would be spread over fewer units, causing the cost per unit to rise. 4. a. Yes, there probably would be a disagreement. The president is likely to want a price of at least $153, which is the average cost per unit to manufacture 2,000 patio sets. He may expect an even higher price than this to cover a portion of the administrative costs as well. His sister will probably be thinking of cost as including only materials used, or perhaps materials and direct labour. b. The term is opportunity cost. Since the company is operating at full capacity, the president must give up the full, regular price of a set to sell a patio set to his sister. Therefore, the president‘s cost is really the full, regular price of a set.

Managerial Accounting, 13th Canadian Edition

Problem 2-21 (15 minutes)

Item

Description

a. b.

The cost of leasing the Meals-On-Wheels van..... The cost of incidental supplies such as salt, pepper, napkins, and so on ................................. The cost of gasoline consumed by the Meals-OnWheels van ................................................... The rent on the facility that houses Madison Seniors Care Center, including the Meals-OnWheels program ............................................ The salary of the part-time manager of the Meals-On-Wheels program ............................. Depreciation on the kitchen equipment used in the Meals-On-Wheels program ....................... The hourly wages of the caregiver who drives the van and delivers the meals ....................... The costs of complying with health safety regulations in the kitchen ..................................... The costs of mailing letters soliciting donations to the Meals-On-Wheels program ...................

c. d.

e. f. g. h. i.

Direct or Indirect Cost of the MealsOn-Wheels Program Direct Indirect

Direct or Indirect Cost of Particular Seniors Served by the Meals-OnWheels Program Direct Indirect

Variable or Fixed with Respect to the Number of Seniors Served by the Meals-On-Wheels Program Variable Fixed

Problem 2-22 (60 minutes) 1. Wallace River Company Schedule of Cost of Goods Manufactured For the Year Ended December 31 Direct materials: Raw materials inventory, January 1 ............................ Add: Purchases of raw materials ................................ Raw materials available for use .................................. Deduct: Raw materials inventory, December 31 .......... Raw materials used in production .............................. Direct labour................................................................ Manufacturing overhead: Depreciation, factory ................................................ Insurance, factory ..................................................... Maintenance, factory ................................................. Utilities, factory......................................................... Supplies, factory……………………………. Indirect labour .......................................................... Total overhead costs .................................................... Total manufacturing costs ............................................ Add: Work in process inventory, Jan. 1 ......................... Deduct: Work in process inventory, Dec. 31 .................. Cost of goods manufactured .........................................

$ 10,000 90,000 100,000 17,000 $83,000 60,000 42,000 5,000 30,000 27,000 1,000 65,000 170,000 313,000 7,000 320,000 30,000 $290,000

Managerial Accounting, 13th Canadian Edition

Problem 2-22 (continued) 2. Wallace River Company Income Statement For the Year Ended December 31 Sales .......................................................................... Cost of goods sold: Finished goods inventory, Jan. 1 ............................... Add: Cost of goods manufactured ............................. Goods available for sale ........................................... Deduct: Finished goods inventory, Dec 31 ................. Gross margin .............................................................. Selling and administrative expenses: Administrative.......................................................... Selling expense ........................................................ Advertising .............................................................. Operating income .......................................................

$450,000 $ 10,000 290,000 300,000 40,000

70,000 80,000 20,000

260,000 190,000

170,000 $ 20,000

3. Costs per unit at a 10,000-unit activity level: Total Activity Cost Cost Level Per Unit Direct materials $83,000* 10,000 $8.30 Factory depreciation $42,000 10,000 $4.20 *As per the schedule of cost of goods manufactured in requirement 1. 4. Costs per unit at a 15,000-unit activity level: Total Activity Cost Cost Level Per Unit Direct materials $124,500* 15,000 $8.30 Factory depreciation $42,000 15,000 $2.80* *15,000 x $8.30 per unit **$42,000  15,000

Problem 2-22 (continued) 5. Although direct material costs increase in total as the activity-level increases from 10,000 units to 15,000 units, the cost per unit stays the same. This is a fundamental characteristic of variable costs. The total cost will change in direct proportion to a change in the activity level, but the cost per unit remains constant over a relevant range of activity, assuming input costs (e.g., prices charged by suppliers) do not change. The fixed cost per unit for factory depreciation decreases to $2.80 from $4.20 because while the total cost remains unchanged at $42,000, the activity level increases by 5,000 units. This is a fundamental characteristic of fixed costs. The total cost does not change in response to a change in the activity level, the cost per unit is inversely related to a change in activity levels.

Managerial Accounting, 13th Canadian Edition

Problem 2-23 (30 minutes) 1. A cost that is classified as a period cost will be recognized on the income statement as an expense in the current period. A cost that is classified as a product cost will be recognized on the income statement as an expense (i.e., cost of goods sold) only when the associated units of product are sold. If some units are unsold at the end of the period, the costs of those unsold units are treated as assets. Therefore, by reclassifying period costs as product costs, the company is able to carry some costs forward in inventories that would have been treated as current expenses. 2. The discussion below is divided into two parts—Gallant‘s actions to postpone expenditures and the actions to reclassify period costs as product costs. The decision to postpone expenditures is questionable. It is one thing to postpone expenditures due to a cash bind; it is quite another to postpone expenditures in order to hit a profit target. Postponing these expenditures may have the effect of ultimately increasing future costs and reducing future profits. If orders to the company‘s suppliers are changed, it may disrupt the suppliers‘ operations. The additional costs may be passed on to Gallant‘s company and may create ill will and a feeling of mistrust. Postponing maintenance on equipment is particularly questionable. The result may be breakdowns, inefficient and/or unsafe operations, and a shortened life for the machinery. Gallant‘s decision to reclassify period costs is not ethical—assuming that there is no intention of disclosing in the financial reports this reclassification. Such a reclassification would be a violation of the principle of consistency in financial reporting and is a clear attempt to mislead readers of the financial reports. Although some may argue that the overall effect of Gallant‘s action will be a ―wash‖—that is, profits gained in this period will simply be taken from the next period—the trend of earnings will be affected. Hopefully, the auditors would discover any such attempt to manipulate annual earnings and would refuse to issue an unqualified opinion due to the lack of consistency. However, recent accounting scandals may lead to some skepticism about how forceful auditors have been in enforcing tight accounting standards.

Problem 2-24 (60 minutes) 1. Carlton Manufacturing Schedule of Cost of Goods Manufactured Direct materials: Raw materials inventory, beginning..................... Add: Purchases of raw materials ......................... Raw materials available for use ........................... Deduct: Raw materials inventory, ending ............ Raw materials used in production ....................... Direct labour......................................................... Manufacturing overhead: Insurance, factory .............................................. Rent, factory building ......................................... Utilities, factory.................................................. Indirect materials, factory .................................. Depreciation, factory equipment ......................... Maintenance, factory .......................................... Total overhead costs ............................................. Total manufacturing costs ..................................... Add: Work in process inventory, beginning .............

$ 25,000 130,000 155,000 20,000 * $135,000 (given) 32,500 4,000 45,000 * 26,000 3,000 55,000 37,000 170,000 (given) 337,500 24,000 361,500 16,500 * $345,000 **

Deduct: Work in process inventory, ending... Cost of goods manufactured .................................. ** computed in Cost of Goods Sold The cost of goods sold section of the income statement follows: Finished goods inventory, beginning .................................. Add: Cost of goods manufactured ...................................... Goods available for sale .................................................... Deduct: Finished goods inventory, ending .......................... Cost of goods sold ............................................................

$ 15,000 345,000 360,000 42,500 $317,500

* (given) * (given)

*These items must be computed by working backwards up through the statements. An effective way of doing this is to place the form and known balances on the paper, and then work toward the un-known figures.

Managerial Accounting, 13th Canadian Edition

Problem 2-24 (continued) 2. Direct materials: $135,000 ÷ 15,000 units = $9.00 per unit. Rent, factory building: $45,000 ÷ 15,000 units = $3.00 per unit. 3. Direct materials: Per unit: $9.00 (unchanged) Total: 20,000 units × $9.00 per unit = $180,000. Rent, factory building: Per unit: $45,000 ÷ 20,000 units = $2.25 per unit. Total: $45,000 (unchanged). 4. The average cost per unit for rent dropped from $3.00 to $2.25, because of the increase in production between the two months. Since fixed costs do not change in total as the activity level changes, the average unit cost will decrease as the activity level rises.

Problem 2-25 (60 minutes) 1a. The total product cost is computed as follows: Direct materials .................................................................... Direct labour ........................................................................ Total manufacturing overhead (variable + fixed) ..................... Total product cost .................................................................

$ 69,000 35,000 43,000 $147,000

1b. The total period cost is computed as follows: Total selling expense (variable + fixed) .................................. Total administrative expense (variable + fixed) ....................... Total period cost ...................................................................

$30,000 29,000 $59,000

2a. The total direct manufacturing cost is computed as follows: Direct materials .................................................................... $ 69,000 Direct labour ........................................................................ 35,000 Total direct manufacturing cost .............................................. $104,000 2b. The total indirect manufacturing cost is computed as follows: Variable manufacturing overhead ........................................... Fixed manufacturing overhead ............................................... Total indirect manufacturing cost ...........................................

$15,000 28,000 $43,000

3a. The total manufacturing cost is computed as follows: Direct materials .................................................................... Direct labour ........................................................................ Total manufacturing overhead ............................................... Total manufacturing cost .......................................................

$ 69,000 35,000 43,000 $147,000

3b. The total nonmanufacturing cost is computed as follows: Total selling expense ............................................................ Total administrative expense ................................................. Total nonmanufacturing cost .................................................

$30,000 29,000 $59,000

Managerial Accounting, 13th Canadian Edition

Problem 2-25 (continued) 3c. The total conversion cost is computed as follows: Direct labour ........................................................................ Total manufacturing overhead ............................................... Total conversion cost ............................................................

$35,000 43,000 $78,000

The total prime cost is computed as follows: Direct materials .................................................................... Direct labour ........................................................................ Total prime cost ....................................................................

$ 69,000 35,000 $104,000

4a. The total variable manufacturing cost is computed as follows: Direct materials .................................................................... Direct labour ........................................................................ Variable manufacturing overhead ........................................... Total variable manufacturing cost ..........................................

$ 69,000 35,000 15,000 $119,000

4b. The total amount of fixed cost for the company as a whole is computed as follows: Fixed manufacturing overhead ............................................... Fixed selling expense ............................................................ Fixed administrative expense ................................................. Total fixed cost .....................................................................

$28,000 18,000 25,000 $71,000

4c. The variable cost per unit produced and sold is computed as follows: Direct materials .................................................................... $ 69,000 Direct labour ........................................................................ 35,000 Total variable manufacturing overhead ................................... 15,000 Variable selling expense ........................................................ 12,000 Variable administrative expense ............................................. 4,000 Total variable cost (a) ........................................................... $135,000 Number of units produced and sold (b) .................................. 1,000 Variable cost per unit produced and sold (a) ÷ (b) .................. $135

Problem 2-25 (continued) 5.

The incremental manufacturing cost is computed as follows: Total variable manufacturing cost (see 4a) (a) ........................ Number of units produced and sold (b) .................................. Variable manufacturing cost per unit produced (a) ÷ (b) ......... Incremental cost of producing an additional 100 units: 100 x $119…………………………………………

$119,000 1,000 $119 $11,900

Managerial Accounting, 13th Canadian Edition

Problem 2-26 (40 minutes) 1. 1a.

The total product cost is computed as follows:

Direct materials .................................................................... $ 750,000 Direct labour ........................................................................ 150,000 Total manufacturing overhead*.............................................. 640,000 Total product cost ................................................................. $1,540,000 1b. The total period cost is computed as follows: Selling expense..................................................................... Administrative expense ......................................................... Total period cost ...................................................................

$140,000 270,000 $410,000

2a. The total direct manufacturing cost is computed as follows: Direct materials .................................................................... $ 750,000 Direct labour ........................................................................ 150,000 Total direct manufacturing cost .............................................. $900,000 2b. The total indirect manufacturing cost is computed as follows: Utilities (factory) ................................................................... Depreciation (factory equipment)........................................... Insurance (factory) ............................................................... Supplies (factory) ................................................................. Indirect labour ...................................................................... Maintenance (factory equipment) .......................................... Total indirect manufacturing cost ...........................................

$36,000 162,000 40,000 15,000 300,000 87,000 $640,000

3a. The total manufacturing cost is computed as follows: Direct materials .................................................................... $ 750,000 Direct labour ........................................................................ 150,000 Total manufacturing overhead ............................................... 640,000 Total manufacturing cost ....................................................... $1,540,000

Problem 2-26 (continued) 3b. The total nonmanufacturing cost is computed as follows: Selling expense..................................................................... Administrative expense ......................................................... Total nonmanufacturing cost .................................................

$140,000 270,000 $410,000

*Manufacturing overhead is made up of Utilities (factory), Depreciation (factory equipment), Insurance (factory), Supplies (factory), Indirect labour and Maintenance (factory equipment)

Managerial Accounting, 13th Edition

Problem 2-27 (30 minutes) 1. Keep Old Mowers $0

Lease New Mowers $400

Difference ($400)

$25

($ 25)

$200

Foregone revenue

$75

($75)

Salvage value – old mowers (2 x $40)

$80

Gas expense savings*

$240

$360

Lease costs (2 x $200) Lease administration fee Oil change changes & blade sharpening (2 x $100)

Net difference

$140

*(2,400 x $1 x 7.5%) x 2 = $360 The above analysis shows that Lilly will be $140 better off by selling her old mowers and leasing the two new mowers for the fifth-year of operations. The biggest factor driving the advantage of leasing the mowers is the gas savings of $360. It would be worthwhile to point out to students that if Lilly‘s estimate of the efficiency gains is off by as little as 2.5% (i.e., only 5% savings are achieved) then the differential savings are only about $20. 2. Items excluded from the analysis and rationale:  Cost ($1,000) and net book value ($240) of existing mowers since these are sunk costs.  Wage increase of $1,200 for Lilly‘s brother since it does not differ under the keep versus replace alternatives.  Total repair costs of $300 per year as they are not estimated to differ under the two alternatives.  Total costs of $200 ($100 x 2) to replace the wheels and starter cords at the end of the fourth season since this is a sunk cost.  Additional revenue of $2,400 since it will not differ between the two alternatives.

Case 2-28 (30 minutes) 1. The error made by Ranton when calculating the 2024 expected operating income was to treat all expenses as if they were variable. This is incorrect since the case indicates that advertising and the salaries of the website administrator and the bookkeeper are fixed costs. By including these costs in the calculation of 2023 operating expenses on a per unit basis ($13.50), Ranton is effectively treating them as if they will vary in direct proportion with unit activity. This will lead to an overstatement of the expected amount of these expenses because they will not increase proportionately with sales activity. 2. The expected results for 2024, along with the 2023 actual results for comparison, are shown below. Actual 2023 Sales (units) .................................................. 8,000

Expected 2024 10,000

Sales ............................................................. $800,000

$1,000,000

Cost of goods sold: .........................................

640,000

800,000

Gross margin ..................................................

160,000

200,000

Advertising ..................................................

8,000

Salaries .......................................................

92,000

Commissions* .............................................

8,000

10,000

Total operating expenses .............................

108,000

110,000

Operating income ...........................................

$52,000

$90,000

Operating expenses

The above shows that expected results for 2024 should have been $90,000. This assumes, as per the case, that advertising and salaries remain fixed at respectively, $8,000 and $92,000 per year. *The only variable operating expense is the commission paid to the website designer/administrator based on 1% of total sales. Compared to the recalculated expected 2024 results, the actual operating income of $75,000 no longer looks as good since it is $15,000 below the anticipated level.

Managerial Accounting, 13th Edition

Case 2-28 (continued) 3. Comparison of expected and actual operating expenses in 2024: Expected expenses (per part 2 above) Actual expenses Difference

$110,000 $125,000 $ 15,000

Assuming no mistakes were made by the bookkeeper in preparing the 2024 financial statements Ranton needs to focus on the only variable operating expense – sales commissions paid to the website designer. If salaries ($92,000) and advertising ($8,000) truly are both fixed costs and did not change in 2024, the $15,000 difference between expected and actual operating expenses must be attributable to an increase in the amount of commissions actually paid. Perhaps a mistake was made in calculating the amount of the sales commissions but Ranton will want to get an answer.

Case 2-29 (30 minutes) 1.

Differential revenues:  The rental revenue that will be received from sub-letting 15% of the new warehouse.  Sales proceeds (less real estate commissions, legal fees, etc.) received from selling old warehouse.  Revenues from existing parking lot. Differential costs:  Monthly lease payments for the new warehouse.  Utility costs (expected to be lower at new warehouse).  Property taxes (none paid at new building).  Building insurance (none paid at new building).  Maintenance and repair costs (likely lower at new building).  Salary of current maintenance manager (won‘t be needed if PE moves to the new building).  Cost of maintaining the existing parking lot. Note: some students may want to also include the inventory insurance costs and the security personnel costs as differential costs. However, the facts of the case indicate that Reg does not believe these costs will change if the new warehouse is rented. As a result, these are not differential costs.

An opportunity cost is a potential benefit given up when one alternative is chosen over another. If PE sells the old warehouse they will incur an opportunity cost equal to the operating income currently being earned on the small parking lot set up on one corner of the property.

The depreciation expense represents a sunk cost because it represents the allocation to reporting periods of the original depreciable cost of the old warehouse. It should not be considered in deciding whether to lease the new warehouse. Because that original cost cannot be changed it is a sunk cost, and thus so too is the depreciation of that original cost.

Managerial Accounting, 13th Edition

Discussion Case 3-1 The relevant range in this example is 1,000 admissions to 2,000 admissions. Management could use this information to predict costs in the follow way:  If the number of patient admissions is expected to exceed 2,000 per month on a regular basis then an additional staff member would need to be hired. If that individual is paid the same as the existing staff members, this would result in fixed costs increasing by $4,750 per month. The actual amount would depend on factors such as the experience or education of the new staff member.  If the number of patient admissions is expected to fall below 1,000 on a regular basis, then one staff member would need to be let go. This would have the effect of reducing costs by $4,750.  Note that there is no information provided to suggest that the $3 per admission variable costs would change if admissions exceed 2,000 or fall below 1,000 per month. This suggests that if only 900 patients were admitted per month on a regular basis, the variable cost per admission would still be $3, or $2,700 in total per month.

Solutions to Questions 3-1 Examples of variable costs in a restaurant include food and beverages, some types of labour (e.g., employees paid an hourly wage), cleaning supplies such as dishwasher soap, and a portion of utility costs. 3-2 a. Unit fixed costs decrease as volume increases. b. Unit variable costs remain constant as volume increases. c. Total fixed costs remain constant as volume increases. d. Total variable costs increase as volume increases. 3-3 The activity base is what causes a variable cost to be incurred. The activity base would likely either be sales dollars or unit sales achieved by the salesperson. It would depend on whether the commission is bases on revenues or unit sales. 3-4 A non-linear variable cost is one where the cost per unit amount increases or decreases at some point as the activity level changes. Acquiring materials at a lower cost per unit when the amount purchased exceeds a pre-defined threshold is an example of a non-linear variable cost. 3-5 A true variable cost change in direct proportion to the activity level. Conversely, a step-variable cost only changes in response to fairly wide changes in the activity level. Maintenance staff expenses at a hospital or cleaning staff expenses at a hotel would be examples of step-variable expenses.

with a base amount of data plus overage charges. 3-8 a. Committed b. Committed c. Discretionary

d. Discretionary e. Committed f. Discretionary

3-9 Knowing the relevant range will help managers more accurately predict fixed costs when activity levels are expected to fall above or below that range. For example, if the activity level is expected to exceed the maximum amount in the relevant range for an extended period, fixed costs will likely increase. This is because more of the resources represented by the fixed cost (e.g., plant capacity) will be needed to meet demand. The opposite is true if activity levels are expected to fall below the minimum amount in the relevant range. As such, understanding the relevant range is very important when estimating fixed costs. 3-10 One advantage is that it likely doesn‘t take much time to use since managers are employing their knowledge to estimate cost behavior. As such, it is likely a low-cost approach. A disadvantage is that it may not be accurate if the manager‘s knowledge is limited or if something related to how the costs being estimated are incurred has changed and the manager is unaware of this. 3-11 The purpose of preparing a scattergraph is to allow managers to evaluate whether or not the relationship between two variables (independent and dependent) is linear.

3-6 A non-linear variable cost is one where the per unit amount changes as volume increases or decreases. An example is direct materials where the per unit purchase price decreases as a higher volume of materials is purchased.

3-12 It is problematic because the high and low levels of activity employed by the high-low method may not be representative of normal activity levels. As such, the cost function may be inaccurate. The scattergraph should visually show this potential problem.

3-7 A mixed cost has both variable and fixed elements. Examples include some types of wages such as sales employees paid a fixed wage plus commissions, utilities, and internet plans

3-13 The formula for a mixed cost is Y = a + bX. In cost analysis, the ―a‖ term represents the fixed cost, and the ―b‖ term represents the variable cost per unit of activity.

Managerial Accounting, 13th Edition

3-14 The gross margin is the difference between sales and the cost of goods sold (CGS) where CGS includes both variable and fixed manufacturing costs. The contribution margin is the difference between sales and total variable costs including manufacturing and nonmanufacturing costs (see Exhibit 3-11).

Foundational Exercises 1.

Units Shipped

Shipping Expense

8 2

$3,600 1,500

July (High activity level) ......... April (Low activity level) ......... 2. Variable cost element: Change in cost Change in activity

$2,100 6 units

=$350 per unit

3. Fixed cost element: Shipping expense at the high activity level ................................. Less variable cost element ($350 per unit × 8 units) .................. Total fixed cost .........................................................................

$3,600 2,800 $ 800

4. The cost formula is $800 per month plus $350 per unit shipped or Y = $800 + $350X, 5. Total shipping expense = $800 + $350(7) = $3,250 6. Fixed expense is $800. 7. Variable expense = $350(10) = $3,500 8. Price per unit Less variable costs: Variable manufacturing Variable overhead Variable selling & admin. Variable shipping expense Contribution margin per unit

$5,000 $2,500 500 200 350

3,550 $1,450

9. Total contribution margin = 7 x $1,450 per unit = $10,150.

Managerial Accounting, 13th Canadian Edition

Foundational Exercises (continued) 10. Operating income = Contribution margin – fixed costs = $10,150 - $3,000 - $800 (shipping) = $6,350 11. Contribution margin would decrease by: $5,000 x 5% x 7 = $1,750 12. Operating income would decrease by the same $1,750 as per part 11. 13. Variable shipping expenses for 12 units: ($350 x 10) + [($350 x 90%) x 2] $3,500 + $630 = $4,130 14. Total shipping expenses for 12 units: $4,130 (per part 13) + $800 = $4,930 15. Non-linear because variable shipping expenses per unit are decreasing as the volume shipped increases.

Exercise 3-1 (15 minutes)

Smoothies Served in a Week 2,100 2,800

3,500

Fixed cost .................................................................................... $2,500 $2,500 Variable cost ($0.75 per cup) ........................................................ 1,575 2,100 Total cost ..................................................................................... $4,075 $4,600 Cost per smoothie served * ........................................................... $1.94 $1.64

$2,500 2,625 $5,125 $1.46

* Total cost ÷ smoothies served in a week 2. The average cost of a smoothie declines as the number of smoothies served increases because the fixed cost is spread over more units.

Managerial Accounting, 13th Canadian Edition

Exercise 3-2 (30 minutes) 1. The completed scattergraph is presented below: $6,000

Shipping Expense

$5,000

$4,000

$3,000

$2,000

$1,000

$0 0

Units Shipped

2. It appears that shipping expenses are linearly related to the number of units shipped. As the number of units shipped increases there is a very linear increase in shipping expenses. 3. Based on a visual inspection of the scattergraph it seems that shipping expenses are a mixed cost. This is because it appears that if a straight line was drawn through the plotted points it would intersect the vertical axis at a cost above $0 (likely less than $1,000). This indicates that there must be some fixed shipping expenses along with some variable expenses since the total shipping expenses increase as the number of units shipped increases.

Exercise 3-3 (20 minutes) 1.

Month High activity level (June) ............. Low activity level (August) .......... Change ......................................

Units Shipped

Shipping Expenses

8 1 7

$5,400 $1,200 $4,200

Variable cost = Change in cost ÷ Change in activity = $4,200 ÷ 7 units shipped = $600 per unit shipped Total cost (June) ..................................................................... Variable cost element ($600 per unit shipped × 8 units) .......................................... Fixed cost element ...................................................................

$5,400 4,800 $600

2. The cost formula is Y = $600 + $600X Where Y = total shipping expenses and X = the number of units shipped. 3. I would not feel comfortable estimating shipping costs using the cost formula from part 2 because it appears that 20 units would likely be outside the relevant range for expenses. That is, 20 units is 150% more than the highest level of activity used to estimate the cost formula.

Managerial Accounting, 13th Canadian Edition

Exercise 3-4 (20 minutes) Crazy Canucks Income Statement—Ski Department For the Month Ended January 31

1 .

Sales ............................................................................ Variable expenses: Cost of goods sold ($900 per pair of skis × 200 $180,000 pairs*) .................................................................... Selling expenses ($150 per pair × 200 pairs) ............... 30,000 Administrative expenses (20% × $20,000) .................. 4,000 Contribution margin....................................................... Fixed expenses: Selling expenses (60,000-30,000)................................ 30,000 Administrative expenses(80% x 20,000) ...................... 16,000 Operating income ..........................................................

$300,000

214,000 86,000

46,000 $ 40,000

*$300,000 sales ÷ $1,500 per pair of skis = 200 pairs. 2. Since 200 pairs of skis were sold and the contribution margin totaled $86,000 for the month, the contribution of each pair of skis toward fixed expenses and profits was $430 ($86,000 ÷ 200 pairs). Another way to compute the $430 is: Selling price per pair of skis .......................... Less variable expenses: Cost per pair of skis................................... Selling expenses ....................................... Administrative expenses ($4,000 ÷ 200 pairs) .............................. Contribution margin per pair .........................

$1,500 $900 150 20

1,070 $430

3. If 150 pairs of skis were sold in a month then the total contribution margin would be: 150 x $430 = $64,500.

Exercise 3-5 (25 minutes) 1. Supplies* Onsite and telephone support** Administrative expenses*** Total

Fixed $12,400 $70,175 $33,500 $116,075

Variable $18,225 $24,718 $34,225 77,168

Total $30,625 $94,893 $67,725 $193,243

* Total supplies ......................................... Less: Variable portion ............................. Fixed portion .........................................

$30,625 18,225 $12,400

** Total costs ............................................. Less total Supplies ................................. Less total Administrative expenses Total Onsite and telephone support

$193,243 (30,625) (67,725) $94,893

Total Onsite and telephone support Less fixed portion Variable portion

$94,893 (70,175) $24,718

*** Total fixed costs (from cost formula) Less fixed portion of supplies Less fixed portion of Onsite and telephone support Fixed portion of Administrative expenses Total Administrative expenses Less fixed portion Variable portion

$116,075 (12,400) (70,175) $33,500 $67,725 (33,500) $34,225

2. Using the cost formula, we can calculate the number of billable hours as follows: Total cost ............................................................................. Less fixed portion from cost formula ...................................... Variable portion .................................................................... Divided by variable cost per unit per the cost formula Total billable hours in the month

$193,243 116,075 $77,168 ÷ $7.28 10,600

Managerial Accounting, 13th Canadian Edition

Exercise 3-6 (15 minutes)

1. Account Utilities1 Sales staff wages2 Delivery costs3

Fixed Cost $7,200 $34,000 $18,000

Variable Cost $5,760 $7,200 $2,400

Total $12,960 $41,200 $20,400

Fixed: $12,000 x .6; Variable [($12,000 x .4)/2,500] x 3000 Fixed: $40,000 x .85; Variable [($40,000 x .15)/2,500] x 3,000 3 Fixed: $20,000 x .9; Variable [($20,000 x .10)/(2,500] x 3,000 2

2. Contribution margin: Sales (3000 x $80) Variable Costs: Direct materials (3,000 x $14 per box) Direct labour (20 hrs x $15 x 50 weeks) Utilities Sales staff wages Delivery costs Contribution margin

$240,000

$42,000 15,000 5,760 7,200 2,400

72,360 $167,640

Exercise 3-7 (20 minutes)

Average # room nights rented per month

High level of activity................................... Low level of activity ................................... Change .....................................................

Total Monthly Cost

144 108 36

$9,360 7,650 $ 1,710

(80% occupancy × 6 rooms x 30 days) = 144 X $65 = $9,360 (60% occupancy × 6 rooms x 30 days) = 108 Variable cost per room occupied: Change in cost $1,710 = =$47.50 per room Change in activity 36 rooms Fixed cost per year: Total cost at 80% occupancy ..................................... Less variable portion: 144 room nights × $47.40 .................................... Fixed cost per year ....................................................

$9,360 6,840 $ 2,520

2. Y = $2,520 + $47.50X 3. Fixed cost...................................................................... Variable cost: 90% x 6 x 30 × $47.50 per room................................. Total annual cost ...........................................................

$ 2,520 7,695 $10,215

Managerial Accounting, 13th Canadian Edition

Exercise 3-8 (20 minutes) 1.

Blood Tests

Costs

3,500 1,500 2,000

$14,500 8,500 $ 6,000

High activity level (February) ................. Low activity level (June) ........................ Change ................................................ Variable cost per blood test:

Change in cost $6,000 = =$3 per blood test Change in activity 2,000 blood tests Fixed cost per month: Blood test cost at the high activity level ............................. Less variable cost element: 3,500 blood tests × $3.00 per test ................................. Total fixed cost .................................................................

$14,500 10,500 $ 4,000

The cost formula is $4,000 per month plus $3.00 per blood test performed or, in terms of the equation for a straight line: Y = $4,000 + $3.00X where X is the number of blood tests performed. 2. Expected blood test costs when 2,300 tests are performed: Variable cost: 2,300 blood tests × $3.00 per test .................... Fixed cost ............................................................................. Total cost .............................................................................

$6,900 4,000 $10,900

Exercise 3-9 (30 minutes) 1. The scattergraph appears below. 16,000 14,000

Cost of Blood tests

12,000 10,000

8,000 6,000 4,000 2,000 0 0

1,000

2,000

3,000

4,000

Number of Blood Tests Performed

2. The high-low method would not provide an accurate cost formula in this situation, since a line drawn through the high and low points would have a slope that is too flat. Consequently, the high-low method would overestimate the fixed cost and underestimate the variable cost per unit. Note the Y axis intercept in the chart, representing fixed costs, is approximately $3,000, whereas the high-low method estimated fixed costs of $4,000.

Managerial Accounting, 13th Canadian Edition

Exercise 3-10 (2 minutes) 1.

Total Utility Costs High: 4,000 sq. ft. × 90% = 3,600 sq. ft.....................................$10,900 Low: 4,000 sq. ft x 50% = 2,000 sq. ft. ............................ $8,500 Change in cost ................................................................. $2,400 Change in space occupied (3,600 – 2,000) 1,600 Change in cost $2,400 2 = =$1.50 per ft Change in activity 1,600 ft2

2. Total utility cost at high (above) ............................................ Less variable costs: 3,600 sq. ft. x $1.50 .......................................................... Fixed portion of monthly utility cost .......................................

$10,900 5,400 $5,500

3. Assuming 3,000 sq. ft. will be occupied in December: Fixed costs ........................................................................... Variable costs: $1.50 x 3,000 .................................................................... Total expected utilities costs ..................................................

$5,500 4,500 $10,000

Problem 3-11 (45 minutes) 1. To determine the manufacturing costs incurred in March and June recall from Chapter 2 that: Cost of goods manufactured = Direct materials + direct labour + manufacturing overhead + beginning work in process inventory – ending work in process inventory For March manufacturing overhead cost is: $168,000 = $36,000 (6,000 x $6) + $60,000 (6,000 x $10) + X + $9,000 $15,000 X = $78,000 For June manufacturing overhead cost is: $257,000 = $54,000 (9,000 x $6) + $90,000 (9,000 x $10) + X + $32,000 $21,000 X = $102,000

2. High activity level (June) ....................... Low activity level (March) ...................... Change ................................................

Units

Overhead Costs

9,000 6,000 3,000

$102,000 78,000 $ 24,000

Variable cost per unit: Change in cost $24,000 = =$8 per unit Change in activity 3,000 units Fixed cost per month: Total overhead cost at the high activity level ...................... Less variable cost element: 9,000 units × $8.00 per unit .......................................... Total fixed cost .................................................................

$102,000 72,000 $ 30,000

The cost formula is Y = $30,000 + $8.00X where X is the number of units produced.

Managerial Accounting, 13th Canadian Edition

Problem 3-11 (continued) 3. Cost of goods manufactured if 7,000 units are produced: Direct materials:7,000 x $6…………………… Direct labour: 7,000 x $10 .................................... Manufacturing overhead ....................................... Variable: 7,000 x $8....................................... Fixed............................................................. Cost of goods manufactured* .............................

$42,000 70,000 56,000 30,000 $198,000

*Work in process is ignored because the requirements indicated that it did not change in the month.

Problem 3-12 (45 minutes) 1.

Whitman Company Contribution Format Income Statement For the year ended December 31 Sales (40,000 units × $25 per unit) ........................... Variable expenses: Variable cost of goods sold (40,000 units × $12 per unit*) ............................ Variable selling and administrative expenses (40,000 units × $2 per unit) ................................ Contribution margin .................................................. Fixed expenses: Fixed manufacturing overhead ................................ Fixed selling and administrative expenses................ Net operating income ................................................

* Direct materials ...................................... Direct labor ............................................ Variable manufacturing overhead ............. Total variable manufacturing cost ............. 2. Contribution margin per unit:

$1,000,000

$480,000 80,000

160,000 210,000

560,000 440,000

370,000 $ 70,000

$5 6 1 $12

Selling price $25 – $14 variable costs = $11 CM per unit 3. If only 32,000 units are sold then operating income would decline from the $70,000 determined in part 1 by: (40,000 – 32,000) x $11 per unit contribution margin (from part 2) = $88,000. Therefore, operating income (loss) would be: $70,000 - $88,000 = $(18,000)

Managerial Accounting, 13th Canadian Edition

Problem 3-13 (30 minutes) 1.

a. b. c. d. e. f. g. h. i.

5 1 4 2 9 3 6 8 7

2. Knowledge of the underlying cost behaviour patterns will allow a manager to properly analyze the firm‘s cost structure. The reason is that all costs don‘t behave in the same way. One cost might move in one direction as a result of a particular action, and another cost might move in an opposite direction. If the behaviour pattern of each cost is clearly understood, the impact of a firm‘s activities on its costs can be estimated before the activity has occurred.

Problem 3-14 (45 minutes) 1. The completed scattergraph follows: $7,000 $6,000

Power Costs

$5,000 $4,000 $3,000 $2,000 $1,000 $0 0

100

120

140

Ignots Processed

Power costs appear to be closely related to the number of ignots processed each month. The data points all fall quite close to the trend line added to the plot and suggest the relationship between power costs and ignots processed is approximately linear.

Managerial Accounting, 13th Canadian Edition

Problem 3-14 (continued) 2. High-low method:

High activity level ..................... Low activity level ..................... Change ...................................

Number of Ignots

PowerCosts

130 40 90

$6,000 2,400 $3,600

Variable cost per ingot: Change in cost $3,600 = =$40 per ingot Change in activity 90 ingots Fixed cost:

Total power cost at high activity level .................. Less variable element: 130 ingots × $40 per ingot .............................. Fixed cost element .............................................

$6,000 5,200 $ 800

Therefore, the cost formula is: Y = $800 + $40X. 3. Using the cost formula determined in part 2, when the number of ingots processed is 140, the prediction of total costs is: $800 + ($40 x 140) = $6,400.

Problem 3-15 (45 minutes) 1. Maintenance cost at the 90,000 machine-hour level of activity can be isolated as follows:

Level of Activity 60,000 MHs 90,000 MHs Total factory overhead cost ................. Deduct: Utilities cost @ $0.80 per MH* ......... Supervisory salaries ........................ Maintenance cost ...............................

$174,000

$246,000

48,000 21,000 $105,000

72,000 21,000 $153,000

*$48,000 ÷ 60,000 MHs = $0.80 per MH 2. High-low analysis of maintenance cost:

High activity level ............................. Low activity level ............................. Change ...........................................

MachineHours

Maintenance Cost

90,000 60,000 30,000

$153,000 105,000 $ 48,000

Variable rate: Change in cost $48,000 = = $1.60 per MH Change in activity 30,000 MHs Total fixed cost: Total maintenance cost at the high activity level ............... Less variable cost element (90,000 MHs × $1.60 per MH) ..................................... Fixed cost element .........................................................

$153,000 144,000 $ 9,000

Therefore, the cost formula for maintenance is $9,000 per month plus $1.60 per machine-hour or Y = $9,000 + $1.60X.

Managerial Accounting, 13th Canadian Edition

Problem 3-15 (continued)

Variable Cost per Machine-Hour

3. Utilities cost........................... Supervisory salaries cost ........ Maintenance cost ................... Total overhead cost................

Fixed Cost

$0.80 $21,000 9,000 $30,000

1.60 $2.40

Thus, the cost formula would be: Y = $30,000 + $2.40X. 4. Total overhead cost at an activity level of 75,000 machine-hours: Fixed costs ............................................................ Variable costs: 75,000 MHs × $2.40 per MH ............ Total overhead costs ..............................................

$ 30,000 180,000 $210,000

Problem 3-16 (30 minutes) 1. Maintenance cost at the 45,000 billable hours level of activity can be isolated as follows:

Level of Activity 17,000 hrs 25,000 hrs Total overhead cost ...................................... Deduct: Office supplies @ $1.09 per hr* ................. Rent ......................................................... Vehicle costs ................................................

$308,530

$352,450

18,530 175,000 $ 115,000

27,250 175,000 $150,200

* $18,530 ÷ 17,000 hrs = $1.09 per billable hr 2. High-low analysis of vehicle cost: High level of activity ............... Low level of activity ............... Change .................................

Billable hours

Vehicle Costs

25,000 17,000 8,000

$150,200 115,000 $ 35,200

Variable cost element: Change in cost $35,200 = =$4.40 per billable hr Change in activity 8,000 hrs Fixed cost element: Total vehicle cost at the high level of activity ................... Less variable cost element (25,000 hrs × $4.40 per hr) ........................................ Fixed cost element .........................................................

$150,200 110,000 $40,200

Therefore, the cost formula for vehicle costs is $40,200 per year plus $4.40 per billable hour or Y = $40,200+ $4.40 X

Managerial Accounting, 13th Canadian Edition

Problem 3-16 (continued) 3. Total overhead cost at 35,000 billable hrs is: Office supplies (35,000 hrs × $1.09 per hr) ........................... Rent ................................................................ Vehicle costs: Variable cost element (35,000 hrs × $4.40 per hr) ........................ Fixed cost element......................................... Total overhead cost ..........................................

$38,150 175,000

$154,000 40,200

194,200 $407,350

Problem 3-17 (30 minutes) 1. Maintenance cost at the 75,000 machine-hour level of activity can be isolated as follows:

Level of Activity 50,000 MHs 75,000 MHs Total factory overhead cost ........................... Deduct: Indirect materials @ $100 per MH* ............ Rent ......................................................... Maintenance cost .........................................

$14,250,000

$17,625,000

5,000,000 6,000,000 $ 3,250,000

7,500,000 6,000,000 $ 4,125,000

* $5,000,000 ÷ 50,000 MHs = $100 per MH 2. High-low analysis of maintenance cost: High level of activity ............... Low level of activity ............... Change .................................

MachineHours

Maintenance Cost

75,000 50,000 25,000

$4,125,000 3,250,000 $ 875,000

Variable cost element: Change in cost $875,000 = =$35 per MH Change in activity 25,000 MH Fixed cost element: Total cost at the high level of activity .............................. Less variable cost element (75,000 MHs × $35 per MH) ........................................ Fixed cost element .........................................................

$4,125,000 2,625,000 $1,500,000

Therefore, the cost formula for maintenance is $1,500,000 per year plus $35 per direct labor-hour or Y = $1,500,000 + $35X

Managerial Accounting, 13th Canadian Edition

Problem 3-17 (continued) 3. Total factory overhead cost at 70,000 machine-hours is: Indirect materials (70,000 MHs × $100 per MH)......................... Rent ................................................................ Maintenance: Variable cost element (70,000 MHs × $35 per MH) ....................... Fixed cost element......................................... Total factory overhead cost ...............................

$ 7,000,000 6,000,000

$2,450,000 1,500,000

3,950,000 $16,950,000

Problem 3-18 (45 minutes) 1. Sales staff wages are a mixed cost with both fixed ($80,000 salary) and variable components (commissions). However the variable component is non-linear since the commission rate increases as sales dollar volume increases. 2. Total wages will be as follows for a salesperson who sells $210,00 of the company‘s service: Cumulative Sales Fixed salary Commissions: First $100,000 in sales Next $50,000 in sales Next $50,000 in sales Final $10,000 in sales Total wages

$100,000 $150,000 $200,000 $210,000

Wages $80,000

$ 5,000 $ 3,500 $ 4,500 $ 1,500 $94,500

3. A potential negative behavioural consequence of the commission structure used by Learn Fast is that sales staff may use high-pressure sales tactics to increase sales and the related commissions. While this may be good for the company in the short term (i.e., sales will grow) it may be off-putting to clients to have to deal with aggressive sales staff. This could hurt the company‘s ability to do business with that client in the future and or result in a negative reputation for the company. Alternatively, the relative high portion of the sales staff compensation that is fixed means that there may not be enough incentive, in the form of commission, to provide the extra motivation it is designed to achieve. 4. Customer support staff wages are a mixed cost with both fixed ($75,000 salary) and variable components ($60 per hour). These wages are also step-variable in the sense that as Learn Fast grows more customer support staff will need to be hired to keep up with the demand for technical support services. 5. Cost formula for weekly support staff wages: Y = $1,500 + $60 (X–35)1 1

$1,500 = $75,000/50; X = number of hours worked in excess of 35- hour standard work-week.

Managerial Accounting, 13th Canadian Edition

Problem 3-18 continued 6. Total customer support staff wages for most recent annual period: ($75,000 x 2) + (1,000 x $60) = $210,000 Total annual customer support staff wages if new staff member is hired: ($75,000 x 2) + $70,000 = $220,000 The benefit of hiring the new support staff member is that will ease the workload of the existing employees who are working nearly 10 hours per week of overtime. It will also allow Learn Fast to better service the expected growth in the customer-base since they will have an additional capacity of 1,750 service hours (50 x 35 hours per week). The key disadvantage is that the new staff member may not have enough work to keep him or her busy until more customers are acquired. Assuming a similar level of customer service activity as last year for existing customers, the new employee will only be working 20 hours per week (1,000/50). This will increase as new customers are attained but this will take time. This is a key issue with step-variable cost such as wages whereby additional capacity to serve customers comes in large ‗chunks‘ (i.e., 35 hours per week).

Case 3-19 (30 minutes) 1. The completed scattergraph for the number of direct labour hours as the activity base is presented below: 90,000 81,000

Overhead Cost

72,000 63,000 54,000 45,000 36,000 27,000 18,000 9,000 0 0

900

1,800

2,700

3,600

4,500

5,400

6,300

Direct Labour Hours

Managerial Accounting, 13th Canadian Edition

Case 3-19 (continued) 2. The completed scattergraph for the number of jobs as the activity base is presented below: 90,000 81,000

Overhead Cost

72,000 63,000 54,000 45,000 36,000 27,000 18,000 9,000 0 0

100

200

300

400

500

600

700

Number of jobs

Case 3-19 (continued) 3. For several reasons, the number of direct labour-hours should be used as the activity base for predicting overhead costs. First, the scattergraphs suggest that it is easier to approximate the relationship between labour-hours and overhead costs with a straight line than it is for total number of jobs completed in a month. Although both activity measures appear to have linear relationship with overhead costs, direct labour-hours appears to a better fit. Second, jobs differ with respect to complexity with more complex jobs requiring more direct labour-hours since they take longer to complete. Thus more complex jobs would likely result in the incurrence of more variable overhead costs such as electricity. Evidence of the differing mix of job complexity is indicated by the fact that during several months, around 500 jobs were completed (January, July, September, and December) but overhead ranged from $75,045 to $83,434 across those months. Third, management has the flexibility to change the mix of welders used across jobs. More experienced welders are more efficient and waste less indirect materials suggesting labour-hours may be a better predictor of overhead costs. 4.

Direct LabourHours August—High level of activity ..................... May—Low level of activity .......................... Change .....................................................

Overhead Costs

6,114 1,914 4,200

$81,582 60,162 $ 21,420

Variable cost per unit of activity: Change in cost $21,420 = =$5.10 per DLH Change in activity 4,200 DLHs Total cost at the high level of activity .............................. Less variable cost element ($5.10 per unit × 6,114 hours) Fixed cost element .........................................................

$81,582.00 31,181.40 $ 50,400.60

Therefore, the cost formula is: $ Y = $50,400.60 + $5.10X, where X represents the number of direct labour-hours.

Managerial Accounting, 13th Canadian Edition

Case 3-20 (60 minutes) 1. High-low method: High level of activity .............. Low level of activity ............... Change.................................

Hours

Cost

25,000 10,000 15,000

$99,000 64,500 $34,500

Variable element: $34,500 ÷ 15,000 DLH = $2.30 per DLH Fixed element: Total cost—25,000 DLH .................................. Less variable element: 25,000 DLH × $2.30 per DLH ...................... Fixed element ................................................

$99,000 57,500 $41,500

Therefore, the cost formula is: Y = $41,500 + $2.30X. 2. The scattergraph is shown below: Y $100,000 $95,000 $90,000

Overhead Costs

$85,000 $80,000 $75,000 $70,000 $65,000 $60,000 8,000

10,000

12,000

14,000

16,000

18,000

20,000

22,000

24,000

X 26,000

Direct Labor-Hours

Case 3-20 (continued) 2. The scattergraph shows that there are two relevant ranges—one below 19,500 DLH and one above 19,500 DLH. The change in equipment lease cost from a fixed fee to an hourly rate causes the slope of the regression line to be steeper above 19,500 DLH, and to be discontinuous between the fixed fee and hourly rate points. 3. The cost formula computed with the high-low method is faulty since it is based on the assumption that a single straight line provides the best fit to the data. Creating two data sets related to the two relevant ranges will enable more accurate cost estimates. 4. High-low method: High level of activity .............. Low level of activity* ............. Change.................................

Hours

Cost

25,000 20,000 5,000

$99,000 80,000 $19,000

*Note: this is the next highest data point after 19,500 hours (i.e. the second ‗relevant range‘) Variable element: $19,000 ÷ 5,000 DLH = $3.80 per DLH Fixed element: Total cost—25,000 DLH .................................. Less variable element: 25,000 DLH × $3.80 per DLH ...................... Fixed element ................................................

$99,000 95,000 $4,000

Expected overhead costs when 22,500 machine-hours are used: Variable cost: 22,500 hours × $3.80 per hour ......................... Fixed cost ............................................................................. Total cost .............................................................................

$85,500 4,000 $89,500

Managerial Accounting, 13th Edition

Appendix 3A Solutions Exercise 3A-1 (30 minutes) 1. The scattergraph plot is shown below: $5,000 $4,500 $4,000

Utility Costs

$3,500 $3,000 $2,500 $2,000 $1,500 $1,000 $500 $0 0

100

120

140

160

180

Number of Scans

The scattergraph shows that the number of scans and total utility costs are closely related and the relationship appears to be linear over the range of 50 to 160 scans. 2. A spreadsheet application such as Microsoft® Excel or a statistical software package can be used to compute the slope and intercept of the least-squares regression line. The results are: Intercept (fixed cost) ........................ Slope (variable cost per scan) ........... R2 ....................................................

$924 $20.69 0.96

Therefore, the cost formula for monthly utility costs is: Y = $924 + $20.69X Note that the R2 is 0.96, which means that 96% of the variation in monthly utility costs is explained by the number of scans. This is a very high R2 and indicates a very good fit.

Solutions Manual, Chapter 4

Exercise 3A-2 (30 minutes) 1. and 2. The scattergraph plot and least-squares regression estimates of fixed and variable costs using Microsoft Excel are shown below: $30,000

Car Wash Costs

$25,000 $20,000

y = 4.0392x + 1378 R² = 0.8981

$15,000 $10,000 $5,000 $-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

Rental Returns

The intercept provides the estimate of the fixed cost element, $1,378 per month, and the slope provides the estimate of the variable cost element, $4.04 per rental return. Expressed as an equation in the form Y = a + bX, the relation between car wash costs and rental returns is Y = $1,378 + $4.04X where X is the number of rental returns. 3. I would feel confident using the cost prediction model from part 2 because the R2 is approximately 0.90, which is quite high, and indicates a strong linear relationship between car wash costs and rental returns.

Managerial Accounting, 13th Edition

Exercise 3A-3 (30 minutes) 1. A spreadsheet application such as Microsoft® Excel or a statistical software package can be used to compute the slope and intercept of the least-squares regression line. The results are: Intercept (fixed cost) ........................ Slope (variable cost per unit) ............ R2 ....................................................

$206 $14.08 0.98

Therefore, the cost formula is $206 per week plus $14.08 per unit. Note that the R2 is 0.98, which means that 98% of the variation in quality control costs is explained by the number of units produced. This is a very high R2 and indicates a very good fit. 2. Total expected quality control costs if 20 units are produced: Variable cost: 20 units × $14.08 per unit ........................... Fixed cost ........................................................................ Total expected cost ..........................................................

$281.60 206.00 $487.60

3. It seems very plausible that as more units are produced, quality control costs would increase since each unit produced goes through a quality control process.

Solutions Manual, Chapter 4

Problem 3A-4 (45 minutes) 1. A spreadsheet application such as Excel or a statistical software package can be used to compute the slope and intercept of the least-squares regression line for the above data. The results are: Intercept (fixed cost) .......................... Slope (variable cost per direct labour hour) .............................................. 2 R ......................................................

$38,501 $5.27 96%

Therefore, the variable cost per direct labour hour is $5.27 and the fixed cost is $38,501 per month. Note that the R2 is very high with 96% of the variation in total overhead cost explained by direct labour hours. This is a very high R2 and indicates a very good fit. 2. Y = $38,501 + $5.27X, where Y is total manufacturing overhead and X is the number of direct labour hours. 3. The estimated total overhead cost in a month with 3,900 labour hours would be: Fixed cost ...................................................................... Variable cost (3,900 labour hours × $5.27 per hour) ........ Total cost ......................................................................

$ 38,501 20,553 $59,054

The estimate differs from the $58,400 incurred in December because a regression model is based on fitting the regression line as close to the actual data points as possible. It is almost always the case that the line cannot be perfectly fit so there will be a difference ―error‖ between the estimated amount and the actual amount for any given level of the independent variable. However, if the regression line is a good fit with the data these errors are generally small. In this case the difference between the estimated and actual amounts at 3,900 labour hours is only $654 or about 1% above the actual. This difference would be considered tolerable by managers.

Managerial Accounting, 13th Edition

Problem 3A-5 (45 minutes) 1. The scattergraph is shown below.

$60,000

Guiding Expense

$50,000

$40,000

$30,000

$20,000

$10,000

$0 0

1,000

2,000

3,000

4,000

5,000

Customers

The scattergraph reveals several interesting points about the behavior of guiding expenses: • The relation between guiding expenses and number of customers is approximated reasonably well by a straight line. (However, there appears to be a slight downward bend in the plot as the customers increase—evidence of increasing returns to scale. This could relate to Chief Adventures getting quantity discounts on drinks and snacks above certain volume levels.

Solutions Manual, Chapter 4

Problem 3A-5 (continued) • The data points are all fairly close to the straight line. This indicates that most of the variation in guiding expenses is explained by the number of customers. As a consequence, there probably wouldn‘t be much benefit to investigating other possible cost drivers for the guiding expenses. • Most of the guiding expenses appear to be fixed. This seems reasonable given the information in the problem about the numerous fixed expenses related to operating Chief Adventures. 2. It does seem economically plausible that the variable guiding expenses would be related to the number of customers. For example, costs such as drinks and snacks for the customers would likely be highly related to the number of customers taken on tours in a given month. Thus, using number of customers to predict guiding expenses makes sense. 3. Using Microsoft® Excel, the least-squares regression method yields estimates of $5.25 per customer for the variable cost and $38,601 per month for the fixed cost. The R2 is 96%. The high R2 is not surprising given the scattergraph results in part 1 and the fact that it is economically plausible that guiding expenses and number of customers would be highly related. 4. Total variable costs for the tour: Guide labour (2 guides x 3 hours each x $20 per hour) .................................................... Variable expenses (6 customers x $5.25 each from part 3 regression model)...................... Total variable cost per guest ...........................

$120.00 31.50 $151.50

The minimum amount Chief Adventures should charge for the tour is $151.50 to ensure the variable costs (including guide wages) are covered. Any amount charged above that will contribute towards recovering some of the fixed costs of approximately $38,601 incurred each month (per requirement 3 above).

Managerial Accounting, 13th Edition

Problem 3A-6 (90 minutes) 1a.

Units Produced (X) 60,000 44,000 84,000 48,000 72,000 100,000 120,000 112,000

Utilities Cost (Y) $200,000 $180,000 $240,000 $300,000 $400,000 $420,000 $340,000 $480,000

A spreadsheet application such as Excel or a statistical software package can be used to compute the slope and intercept of the least-squares regression line for the above data. The results are: Intercept (fixed cost) ........................ Slope (variable cost per unit) ............. R2 ....................................................

$113,407 $2.58 0.47

Therefore, the cost formula using units produced as the activity base is $113,407 per month plus $2.58 per unit produced, or Y = $113,407 + $2.58X. Note that the R2 is 0.47, which means that only 47% of the variation in utility costs is explained by the number of units produced.

Solutions Manual, Chapter 4

Case 3A-6 (continued) b. The scattergraph plot of utility costs versus units produced appears below:

500 450 400

Utilities Cost (000s)

350 300 250 200 150 100 50 0 0

100

120

140

Units Produced (000s)

Managerial Accounting, 13th Edition

Case 3A-6 (continued) 2a.

DLHs (X) 15,000 9,000 12,000 18,000 30,000 27,000 24,000 33,000

Utilities Cost (Y) $200,000 $180,000 $240,000 $300,000 $400,000 $420,000 $340,000 $480,000

$68,000 $12 0.93

Therefore, the cost formula using direct labour-hours as the activity base is $68,000 per quarter plus $12 direct labour-hour, or Y = $68,000 + $12X. Note that the R2 is 0.93, which means that 93% of the variation in utility costs is explained by the number of direct labour-hours. This is a very high R2 and is an indication of a good fit.

Solutions Manual, Chapter 4

Case 3A-6 (continued) b. The scattergraph plot of utility costs versus direct labour-hours appears below:

500 450 400

Utilities Cost (000s)

350 300

250 200 150 100 50 0 0

Direct Labour-Hours (000s)

3. The company should probably use direct labour-hours as the activity base since the fit of the regression line to the data is much tighter than it is with units produced. The R2 for the regression using direct labour hours as the activity base is twice as large as for the regression using units produced as the activity base. However, managers should look more closely at the costs and try to determine why utility costs are more closely tied to direct labour-hours than to the number of units produced.

Managerial Accounting, 13th Edition

Case 3A-6 (continued) 4. It is plausible that both units produced and direct labour hours would be related to utility costs. However, because different models require different amounts of direct labour, it seems more plausible to expect a strong association between labour hours and utility costs. Using units produced as the independent variable assumes no difference in labour hour requirements across the various models. Not surprisingly, the results of the regression analysis are consistent with the qualitative assessment of economic plausibility with a much higher R2 value for the model using direct labour hours.

Chapter 4 Cost-Volume-Profit Relationships Discussion Case 4-1 The point of this case is to illustrate that even when competition is high, CVP analysis can easily cope with changing assumptions and estimates. Some possible reasons for disagreeing:  Even when competition is high, selling prices, unit costs and cost behavior patterns are unlikely to change by large amounts in the short-run or to change so quickly that CVP analysis will be of limited use.  When competition is high, some values used in CVP analysis such as selling prices will likely be based on the current price offerings by key competitors. This will make these estimates quite accurate since selling prices that customers are willing to pay are easily observable and given their importance to CVP analysis, will make the resultant estimates (e.g., break-even points) more reliable.  Managers can use sensitivity analysis to improve their decision-making when competition is high. For example, break-even levels, targeted profit levels, and so on can all be calculated under differing assumptions about selling prices and unit costs. Indeed this is one of the strengths of CVP analysis is that it allows for the use of ―what if‖ assumptions to produce estimates of key metrics such as the break-even point. This idea is noted in the chapter. So, for example, even if prices do change quickly in the short-run CVP analysis can easily be updated to reflect any estimated or actual changes. Some possible reasons for agreeing:  If competition causes selling prices, unit costs or cost behavior to change by large amounts over the short-run then CVP analysis may have limited value.  Sales mix may change quickly as the result of competitors‘ actions such as price changes or the introduction of new models. To the extent these actions are unforeseen, the sales mix assumption used in multi-product CVP analysis may inacSolutions Manual, Chapter 4

curate.

Managerial Accounting, 13th Edition

Solutions to Questions 4-1 The contribution margin ratio is the ratio of the contribution margin to sales. It can be calculated using either the sales and contribution margin amounts per unit or using the total dollar amounts for these items for a given sales volume. It can be used in a variety of ways. For example a change in the sales a company expects to generate can be multiplied by the contribution margin ratio to estimate the impact on the total contribution margin in dollars. If fixed costs do not change, then the change in total contribution margin will also represent the change in operating income. The CM ratio can also be used in break-even analysis to determine the total sales revenue that must be generated to earn exactly $0 in operating income. Therefore, knowledge of a product‘s CM ratio is extremely helpful in forecasting contribution margin and operating income. 4-2 The slope of a variable expense line is determined by the variable cost per unit. The higher the variable costs per unit, the steeper the slope. 4-3 Incremental analysis focuses only on the changes in revenues, costs and volumes that will result from a particular decision. The main advantage of the incremental approach is that it is simpler because it ignores any factors (e.g., fixed costs) that do not change under the alternatives being considered. As such, the approach takes less time to utilize and reduces the chances for making an error because it only uses amounts expected to change. 4-4 All other things equal, Company B, with its higher fixed costs and lower variable costs, will have a higher contribution margin ratio than Company A. Therefore, it will tend to realize a larger decrease in contribution margin and in profits when sales decrease. 4-5 A margin of safety of 20% means that the break-even level of sales dollars is 20% below the current level of sales dollars. To put it another way, it means that if sales drop by 20% from the current level the company will be at the break-even level of total sales.

Solutions Manual, Chapter 4

4-6 If a company‘s contribution margin per unit increases, then its break-even level of sales will decrease, assuming no change to fixed expenses. An increase in the CM per unit means that each dollar of sales revenue is generating more contribution margin to cover fixed expenses. As a result, the level of sales required to break-even will decrease. 4-7 Target profit analysis and break-even analysis are very similar. The only difference is that in target profit analysis the desired level of profit is added to fixed expenses in the numerator of the equation used to determine the units or sales dollars needed to generate the desired profit. In break-even analysis the objective is to determine the level of sales (units or dollars) required to generate $0 in profit so the numerator in the equation only includes the total fixed expenses. 4-8 A flatter profit line means that profit changes by a smaller amount for each unit change in sales volume. So, a flatter profit line means that the contribution margin per unit has decreased. This decrease in the contribution margin per unit will cause the break-even level of unit sales to increase as more units will need to be sold to cover fixed costs. If the slope of the profit line stays the same but the line moves up to intersect the vertical axis closer to $0, this means that fixed costs have decreased. This is because the point where the profit line intersects the vertical axis represents total fixed costs. So, if the intersection of the profit line with the vertical axis is closer to $0, fixed costs must be decreasing. If fixed costs are decreasing and the slope of the profit line stays the same, the break-even point will decrease. Importantly, the fact that the slope of the profit line stays the same, means that the contribution margin per unit has not changed. 4-9 A 5% increase in the income tax rate would have no impact on the break-even point since at a $0 level of profit, there is no income tax. 4-10 The degree of operating leverage can be calculated for any level of sales by dividing the contribution margin at that level of sales by op© McGraw Hill Ltd. 2024. All rights reserved. 105

erating income. The degree of operating leverage can be used to determine the percentage change in operating income that will be realized for any percentage change in sales from the sales level used to determine the degree of operating leverage. For example, if a company has a degree of operating leverage of 4 for sales of $500,000, a 10% increase in sales to $550,000 will result in a 40% increase in operating income (4 x 10%). 4-11 Because Company X is highly automated it, will likely have higher fixed costs and lower variable costs, and thus have a higher contribution margin per unit than Company Y. Therefore, Company X would also have the lower margin of safety because a drop in sales would result in a larger relative decrease in operating income compared to Company Y.

products by the total number of units sold for all products, which results in a weighted average contribution margin per unit. For example, if a company has a total contribution margin of $1,200,000 for total unit sales of 30,000 across all product lines, the weighted average contribution margin will be $40 per unit. 4-13 A higher break-even point would result if the sales mix shifted from the high contribution margin product to the low contribution margin product. Such a shift would cause the weighted average contribution margin per unit in the company to decrease. With a lower weighted average contribution margin per unit, the break-even point would be higher because more total unit sales would be required to cover the same amount of fixed costs.

4-12 The simplest approach is to divide the total contribution margin from the sales of all

Managerial Accounting, 13th Canadian Edition

Foundational Exercises 1. The contribution margin per unit is calculated as follows: Total contribution margin (a) ......................... Total units sold (b) ............. ......... ............... Contribution margin per unit (a) ÷ (b) ...........

$25,000 2,500 units $10.00 per unit

The contribution margin per unit ($10) can also be derived by calculating the selling price per unit of $40 ($100,000 ÷ 2,500 units) and deducting the variable expense per unit of $30 ($75,000 ÷ 2,500 units). 2. The contribution margin ratio is calculated as follows: Total contribution margin (a) ......................... Total sales (b) .................... ......... ............... Contribution margin ratio (a) ÷ (b) ................

$25,000 $100,000 25%

3. The variable expense ratio is calculated as follows: Total variable expenses (a) . Total sales (b) .................... ......... ............... Variable expense ratio (a) ÷ (b) ....................

$75,000 $100,000 75%

4. The increase in operating income is calculated as follows: Contribution margin per unit (a) ................................ Increase in unit sales (b) ..... Increase in operating income (a) × (b) ..........

$10. per unit 10 units $100

5. If sales decline to 2,000 units, operating income would be computed as follows: Sales (900 units) ................. Variable expenses ............... Contribution margin ............ Fixed expenses ................... Operating income................

Solutions Manual, Chapter 4

Total

Per Unit

$80,000 60,000 20,000 15,000 $ 5,000

$40.00 30.00 $ 10.00

Foundational Exercises (continued) 6. The new operating income would be computed as follows: Sales (2,300 units) .............. Variable expenses ............... Contribution margin ............ Fixed expenses ................... Operating income................

Total

Per Unit

$101,200 69,000 32,200 15,000 $ 17,200

$44.00 30.00 $14.00

7. The new operating income would be computed as follows: Sales (2,7000 units) ............ Variable expenses ............... Contribution margin ............ Fixed expenses ................... Operating income (loss) ......

Total

Per Unit

$108,000 91,800 16,200 17,000 $( 800)

$40.00 34.00 $ 6.00

8. The break-even point in unit sales is as follows: Fixed expenses $15,000 = =1,500 units CM per unit $10 9. The dollar sales to break-even is as follows: Fixed expenses $15,000 = =$60,000 CM ratio .25 The dollar sales to break-even ($60,000) can also be computed by multiplying the selling price per unit ($40) by the unit sales to break-even (1,500 units). 10. The number of units that must be sold to achieve the target profit of $5,000 is as follows: Fixed expenses+Target profit $15,000+$20,000 = =3,500 CM per unit $10

Managerial Accounting, 13th Canadian Edition

Foundational Exercises (continued) 11. The margin of safety in dollars is calculated as follows: Sales.......................................................................... Break-even sales (at 1,500 units) ................................ Margin of safety (in dollars).........................................

$100,000 60,000 $ 40,000

The margin of safety as a percentage of sales is calculated as follows: Margin of safety (in dollars) (a) ............................ Sales (b) ............................................................. Margin of safety percentage (a) ÷ (b) ...................

$40,000 $100,000 40%

12. The degree of operating leverage is calculated as follows: Contribution margin (a) ....... ........................... Operating income (b) ...................................... Degree of operating leverage (a) ÷ (b) ............

$25,000 $10,000 2.5

13. A 10% increase in sales should result in a 25% increase in operating income, computed as follows: Degree of operating leverage (a) ........................................... Percent increase in sales (b) .................................................. Percent increase in operating income (a) × (b).......................

2.5 10% 25%

14. The degree of operating leverage is calculated as follows: Contribution margin (a) ...... ........................... Operating income (b) ..................................... Degree of operating leverage (a) ÷ (b)............ 15.

$85,000 $10,000 8.5

A 10% increase in sales should result in an 85% increase in operating income, computed as follows: Degree of operating leverage (a) ........................................... Percent increase in sales (b) .................................................. Percent increase in operating income (a) × (b) .......................

Solutions Manual, Chapter 4

8.5 10% 85%

Exercise 4-1 (20 minutes) 1. The revised operating income per month is: Original operating income ................ Change in contribution margin (100 units × $15.00 per unit) ........ New operating income .....................

$15,000 1,500 $16,500

2. The revised operating income per month is: Original operating income ............................ Change in contribution margin (–200 units × $15.00 per unit) .................. New operating income .................................

$15,000 (3,000) $ 12,000

3. The revised operating income is:

Total Contribution margin ............ 9,000 × $15 Fixed expenses…………….(no change) Operating income ...............

$135,000 135,000 $ 0

Note: This is the company‘s break-even point.

Managerial Accounting, 13th Canadian Edition

Exercise 4-2 (20 minutes) 1. The CVP graph is shown below. The slope of the total expense line is determined by the variable costs per unit of $10. The amounts plotted for the total expense line are determined as follows: (units x $10) + $10,000. For example, at 3,000 units sold total expenses will be $40,000 ($10,000 + (3,000 x $10)). The slope of the total revenue line is determined by the selling price of $15 per unit. $100,000 $90,000 $80,000 $70,000 $60,000 $50,000 $40,000 $30,000 $20,000 $10,000 $0 0

1000

2000

3000

4000

5000

6000

Volume of units sold Fixed Expenses

Total Expenses

Total Revenues

2. Looking at the graph, the break-even point appears to be 2,000 units. This can be verified as follows: Fixed expenses $10,000 = =2,000 units CM per unit $5

Solutions Manual, Chapter 4

Exercise 4-3 (10 minutes) 1. The company‘s contribution margin (CM) ratio is: Total sales (25,000 units) .............. Total variable expenses ................. = Total contribution margin........... ÷ Total sales ................................ = CM ratio ...................................

$2,500,000 1,500,000 $ 1,000,000 $2,500,000 40%

2. The break-even level of sales dollars is: Fixed expenses $800,000 = =$2,000,000 CM ratio .40

3. The break-even level of unit sales is: Sales price per unit = $2,500,000 ÷ 25,000 units = $100 Breakeven unit sales = $2,000,000 (break-even sales dollars) ÷ $100 = 20,000 units Alternatively: Contribution margin per unit = $1,000,000 ÷ 25,000 units = $40 Break-even units: Fixed expenses $800,000 = =20,000 units CM per unit $40 4. The change in operating income from an increase in total sales of $600,000 can be estimated by using the CM ratio as follows: Change in total sales ............................... × CM ratio ............................................. = Estimated change in operating income ..................................................

$600,000 40% $ 240,000

Managerial Accounting, 13th Canadian Edition

Exercise 4-4 (20 minutes) 1. The following table shows the effect of the proposed change in the monthly advertising budget: Solution Approach 1 Expected total contribution margin: $25 × 360 ................................................... Present total contribution margin: $25 × 300 ................................................... Incremental contribution margin ...................... Change in fixed expenses: Less incremental advertising expense ........... Change in operating income ............................

$9,000 7,500 1,500 1,000 $500

Solution Approach 2 Incremental contribution margin: $25 × 60 units ........................................... Less incremental advertising expense .............. Change in operating income ............................

$ 1,500 1,000 $ 500

2. The $5 increase in variable costs will cause the unit contribution margin to decrease from $25 to $20 with the following impact on operating income: Expected total contribution margin with the higherquality components: 330* units × $20 per unit ........................................... Present total contribution margin: 300 units × $25 per unit ............................................. Change in total contribution margin ................................

$6,600 7,500 $ (900)

*300 × 110% Assuming no change in fixed costs and all other factors remain the same, the higher-quality organic components should not be used. However, the owner might also want to consider other factors in making the decision. For example, using environmentally ‗friendlier‘ organic shampoo might simply be the right thing to do, even though the financial consequences are negative as shown above.

Solutions Manual, Chapter 4

Exercise 4-5 (10 minutes) 1. Using the formula method: Break-even point in units sold

= Fixed expenses ÷ Unit CM = $4,200 ÷ $3 per scarf = 1,400 scarfs

2. Using the formula method: Break-even point in sales dollars

= Fixed expenses ÷ CM ratio = $4,200 ÷ 0.20 = $21,000

3. Break-even point in units sold

= Fixed expenses ÷ Unit CM = $4,200 ÷ $2 per scarf = 2,100 scarfs

Managerial Accounting, 13th Canadian Edition

Exercise 4-6 (10 minutes) 1. Unit sales required to earn before-tax target profit of $20,000: Fixed expenses + Target profit $200,000+$20,000 = =4,400 units CM per unit $50* *$200 - $150 2. The formula approach yields the dollar sales required to attain a target profit of $60,000 (before tax) as follows: Fixed expenses + Target profit $200,000+$60,000 = =$1,040,000 CM ratio .25* *$50  $200 3. Unit sales required to earn target after-tax income of $120,000 given a tax rate of 25%. after-tax profit Fixed expenses+ Target1-Tax Rate = Unit Contribution Margin $200,000+ $120,000 1-.25 = $50 =

$200,000+$160,000 $50 =7,200 units

Solutions Manual, Chapter 4

Exercise 4-7 (15 minutes) 1. Break-even hours for residential clients: Fixed expenses $500 = =50 hours CM per unit $10 Break-even hours for commercial clients: Fixed expenses $825 = =55 hours CM per unit $15 2. Revenue at 120 hours per month* ............................... Break-even revenue (at 55 hours)** ............................ Margin of safety (in dollars).........................................

$4,200 1,925 $ 2,275

*$35 x 120; **$35 x 55 The margin of safety as a percentage of sales is as follows: Margin of safety (in dollars).................................. ÷ Sales ............................................................... Margin of safety as a percentage of sales ..............

$2,275 $4,200 54.2%

Managerial Accounting, 13th Canadian Edition

Exercise 4-8 (20 minutes) 1. The company‘s degree of operating leverage would be computed as follows: Contribution margin ...................... ÷ Operating income ...................... Degree of operating leverage ........

$48,000 $10,000 4.8

2. A 5% increase in sales should result in a 24% increase in operating income, computed as follows: Degree of operating leverage ................................................ × Percent increase in sales .................................................... Estimated percent increase in operating income .....................

4.8 5% 24%

3. The new income statement reflecting the change in sales would be:

Amount Sales.................................. Variable expenses ............... Contribution margin ............ Fixed expenses ................... Operating income ...............

$84,000 33,600 50,400 38,000 $ 12,400

Percent of Sales 100% 40% 60%

Operating income reflecting change in sales ......................... Original operating income ................................................... Change – income ................................................................ Percent change in operating income (2,400/12,400) .............

Solutions Manual, Chapter 4

$12,400 10,000 $2,400 24%

Exercise 4-9 (30 minutes) 1. The overall contribution margin ratio can be computed as follows: Total contribution margin $132,000 = =55 Total sales $240,000 2. The overall break-even point in sales dollars can be computed as follows: Total fixed expenses $110,000 = =$200,000 Overall CM ratio 55 3. The weighted average contribution margin per hour can be computed as follows: Total contribution margin $132,000 = =$22 per hour Total hours 4,000+2,000 4. The total break-even point in hours can be computed as follows: Total fixed expenses $110,000 = =5,000 hours Weighted average CM per hour $22 per hour 5. The hours of each service that must be provided to break-even is calculated as follows: Lawn care: 5,000 hours x 2/3 = 3,333 hours (rounded) Pool maintenance: 5,000 hours x 1/3 = 1,667 hours (rounded) 6. Overall sales required to generate an after-tax target profit: =

after-tax profit Fixed expenses+ Target1-Tax Rate Overall Contribution Margin Ratio

$110,000+$28,000 1-.3 = .55 $110,000+$40,000 =$272,727 (rounded) .55

Managerial Accounting, 13th Canadian Edition

Exercise 4-10 (30 minutes) 1. Variable expense ratio: 1 – 50% (CM) = 50%. 2.

Selling price.................................. Variable expenses* ....................... Contribution margin ......................

a. Unit sales to break even=

$120 60 $60

100% 50% 50%

Fixed expenses $720,000 = =12,000 units Unit contribution margin $60

Dollar sales to break even=

Fixed expenses CM ratio = $720,000 ÷ 0.50 = $1,440,000

Sales dollars to attain target profit=

Target profit +Fixed expenses CM ratio

= ($100,000 + $720,000) ÷ .50 = $1,640,000 c.

Unit sales require to earn an after-tax profit of $60,000 if tax rate is 25%. after-tax profit Fixed expenses+ Target1-Tax Rate = Unit Contribution Margin 0,000 $720,000+$ 1-.25 = $60

= 14,000 units

Solutions Manual, Chapter 4

Exercise 4-10 (continued) d.

Unit sales to break even=

Fixed expenses Unit contribution margin = $1,040,000 ÷ $80 per unit = 13,000 units

Break–even point in sales dollars=

Fixed expenses CM ratio

= $1,040,000 ÷ 0.667* = $1,559,220 (rounded) *$80 ÷ $120

Managerial Accounting, 13th Canadian Edition

Exercise 4-11 (30 minutes) 1. The contribution margin per person would be: Price per ticket ............................................................... Variable expenses: Dinner ........................................................................ Program ..................................................................... Contribution margin per person .......................................

$35 $18 2

20 $15

The fixed expenses of the dinner-dance total $6,000 ($2,800 + $900 + $1,000 + $1,300); therefore, the break-even point would be computed as follows: $6,000 =400 attendees $15 2. Variable cost per person ($18 + $2).................................. Fixed cost per person ($6,000 ÷ 300 people) .................... Ticket price per person to break even ...............................

$20 20 $40

Check: Operating income if 300 people attend at $40 per ticket: Contribution margin: 300 x ($40 - $20) = $6,000 Fixed expenses: 6,000 Operating income: $ 0

Solutions Manual, Chapter 4

Exercise 4-11 (continued) 3. Cost-volume-profit graph: $20,000

Total Sales

$18,000

Break-even point: 400 people, or $14,000 in sales

$16,000 $14,000

Dollars

$12,000

Total Expenses

$10,000 $8,000 $6,000

Fixed Expenses

$4,000

$2,000 $0 0

100

200

300

400

500

600

Number of Persons

Managerial Accounting, 13th Canadian Edition

Exercise 4-12 (20 minutes)

Total

Per Unit

1. Sales (20,000 units × 1.15 = 23,000 units) ............. Variable expenses .................................................. Contribution margin ............................................... Fixed expenses ...................................................... Operating income ..................................................

$345,000 207,000 138,000 70,000 $ 68,000

$15.00 9.00 $6.00

2. Sales (20,000 units × 1.25 = 25,000 units) ............. Variable expenses .................................................. Contribution margin ............................................... Fixed expenses ...................................................... Operating income ..................................................

$337,500 225,000 112,500 70,000 $ 42,500

$13.50 9.00 $4.50

3. Sales (20,000 units × 0.95 = 19,000 units) ............. Variable expenses .................................................. Contribution margin ............................................... Fixed expenses ($100,000 + $20,000) .................... Operating income ..................................................

$313,500 171,000 142,500 90,000 $ 52,500

$16.50 9.00 $7.50

4. Sales (20,000 units × 0.90 = 18,000 units) ............. Variable expenses .................................................. Contribution margin ............................................... Fixed expenses ...................................................... Operating income ..................................................

$302,400 172,800 129,600 70,000 $ 59,600

$16.80 9.60 $7.20

Solutions Manual, Chapter 4

Exercise 4-13 (20 minutes)

Case #1

a. Number of units sold ......... Sales ................................ Variable expenses ............. Contribution margin .......... Fixed expenses ................. Operating income..............

15,000 * $180,000 * 120,000 * 60,000 50,000 * $ 10,000

Case #2 $12 8 $4

4,000 $100,000 * 60,000 40,000 32,000 * $ 8,000 *

Case #3 Number of units sold ......... Sales ................................ Variable expenses ............. Contribution margin .......... Fixed expenses ................. Operating income (loss).. ..

10,000 * $200,000 70,000 * 130,000 118,000 $ 12,000 *

Case #4 $20 7 $13 *

6,000 * $300,000 * 210,000 90,000 100,000 * $ (10,000) *

Case #1

b. Sales ................................ Variable expenses ............. Contribution margin ........... Fixed expenses ................. Operating income ..............

$500,000 * 400,000 100,000 93,000 $ 7,000 *

$250,000 100,000 150,000 130,000 * $ 20,000 *

$50 35 $15

Case #2 100% 80% 20% *

Case #3 Sales ................................ Variable expenses ............. Contribution margin .......... Fixed expenses ................. Operating income (loss).

$25 15 $10 *

$400,000 * 260,000 * 140,000 100,000 * $ 40,000

100% 65% 35%

Case #4 100% 40% 60% *

$600,000 * 420,000 * 180,000 185,000 $ (5,000) *

100% 70% 30%

*Given

Managerial Accounting, 13th Canadian Edition

Exercise 4-14 (30 minutes) 1. Variable expenses: $30 × (100% – 50%) = $15. 2. Break-even point in units and sales dollars: In units: $450,000  ($30 - $15) = 30,000 units In sales dollars: $450,000  .50 = $900,000 3. Sales in units and dollars to achieve a target operating income of $150,000 In units: ($450,000 + $150,000)  ($30 - $15) = 40,000 units In dollars: ($450,000 + $150,000)  .5 = $1,200,000 4. New break-even point in units: ($450,000 + $54,000)  ($30 - $12) = 28,000 units 5. Sales in dollars to achieve a target after-tax profit of $100,000 with a tax rate of 20%. ($450,000 + ($100,000  1-.2)  .5 = $1,150,000

Solutions Manual, Chapter 4

Exercise 4-15 (15 minutes) 1.

Total Sales (15,000 games) ................ Variable expenses ...................... Contribution margin ................... Fixed expenses .......................... Operating income ......................

$300,000 90,000 210,000 182,000 $ 28,000

Per Unit $20 6 $14

The degree of operating leverage is: Degree of operating leverage=

Contribution margin Operating income =

$210,000 =7.5 $28,000

2. a. Sales of 18,000 games represent a 20 increase over last year‘s sales. Because the degree of operating leverage is 7.5, operating income should increase by 7.5 times as much, or by 150% (7.5 × 20%). b. The expected total dollar amount of operating income for next year would be: Last year‘s operating income........................................ Expected increase in operating income next year (150% × $28,000) ................................................... Total expected operating income..................................

$28,000 42,000 $70,000

Managerial Accounting, 13th Canadian Edition

Exercise 4-16 (30 minutes) 1. Break-even point in units and sales dollars: In units: $108,000  ($50 - $32) = 6,000 units In sales dollars: $108,000  .36* = $300,000 *($50 - $32)  $50 2. An increase in the variable expenses as a percentage of the selling price would result in a higher break-even point. The reason is that if variable expenses increase as a percentage of sales, then the contribution margin will decrease as a percentage of sales. A lower CM ratio would mean that more tackle boxes would have to be sold to generate enough contribution margin to cover the fixed costs.

3. Increase in unit sales…………………. (a) New selling price........................ Variable cost per unit ................. New contribution margin ...... (b) Incremental operating income: (a) x (b) (a) 8,000 x .25 * $50 – ($50 x .1)

2,000 $45* 32 $13 $ 26,000

Loss of operating income due to sales price reduction of $5 on the base unit sales of 8,000 X $5 = $40,000 Therefore: Incremental operating income per the above $26,000 Loss due to sale price reduction ($40,000) Net decrease in operating income ($14,000) 4. Number of stoves to achieve a target profit of $35,000 per month: ($108,000 + $35,000)  ($13) = 11,000 stoves

Solutions Manual, Chapter 4

Exercise 4-17 (30 minutes)

Regular Amount %

1. Sales ................... Variable expenses .................... Contribution margin ............. Fixed expenses .... Operating income

Delicio Amount %

Total Company Amount %

$40,000 100

$60,000

100

$100,000 100

20,000

36,000

56,000

$20,000

$24,000

44,000 22,000 $ 22,000

44 *

*$44,000 ÷ $100,000 = 44%. 2. The break-even point in sales dollars for the company as a whole would be: Fixed expenses $22,000 = =$50,000 CM ratio 44 3. The break-even point in units for the company as a whole would be: 9,800 bags of coffee are being sold at the current level of operations: Regular: $4  .5 (1 - .5) = $8 per bag selling price. $40,000  $8 = 5,000 bags Delicio:

$5  .4 (1 - .6) = $12.50 per bag selling price $60,000  $12.50 = 4,800 bags

Weighted average CM = Total contribution  total bags of coffee sold = $44,000  9,800 = $4.49 (rounded)

Managerial Accounting, 13th Canadian Edition

Exercise 4-17 (continued) Breakeven units = Total fixed expenses $22,000 = =4,900 (rounded) Weighted average CM per unit $4.49 per unit 4. The additional contribution margin from additional sales of $10,000 can be computed as follows: $10,000 × 44% CM ratio = $4,400 This answer assumes no change in selling prices, variable costs per unit, fixed expenses, or sales mix. 5. The additional contribution margin from additional sales of 1,000 units can be computed as follows: 1,000 × $4.49* per unit = $4,490 *weighted average contribution margin from part 3 above. This answer assumes no change in selling prices, variable costs per unit, fixed expenses, or sales mix.

Solutions Manual, Chapter 4

Problem 4-18 (60 minutes) 1. The CM ratio is 60%: Selling price ............................. Variable expenses .................... Contribution margin .................

$20 8 $12

100% 40% 60%

2. Break-even point in sales dollars: $180,000  .60 = $300,000 3. $75,000 increased sales × 60% CM ratio = $45,000 increased contribution margin. Since fixed costs will not change, operating income should also increase by $45,000. 4. a. Operating leverage = Contribution margin  operating income $240,000  $60,000 = 4 b. 4 × 20% = 80% increase in operating income. In dollars, this increase would be 80% × $60,000 = $48,000.

Sales.................................. Variable expenses ............... Contribution margin ............ Fixed expenses ................... Operating income ...............

Last Year: 20,000 units Total Per Unit

Proposed: 25,000 units* Total Per Unit

$400,000 160,000 240,000 180,000 $ 60,000

$450,000 200,000 250,000 210,000 $40,000

$20.00 8.00 $12.00

$18.00 ** 8.00 $10.00

* 20,000 units × 1.25 = 25,000 units ** $20 per unit × (1 – 0.10) = $18 per unit No, the changes should not be made since operating income decreases.

Managerial Accounting, 13th Canadian Edition

Problem 4-18 (continued) 6. Expected total contribution margin: 25,000 units × $11 per unit* ......................................... Present total contribution margin: 20,000 units × $12 per unit........................................... Incremental contribution margin, and the amount by which advertising can be increased with operating income remaining unchanged .........................

$275,000 240,000

$ 35,000

*$20 – ($8 + $1) = $11

Solutions Manual, Chapter 4

Problem 4-19 (45 minutes)

1. Sales (15,000 units × $70 per unit) .................................. Variable expenses (15,000 units × $40 per unit) ................ Contribution margin ......................................................... Fixed expenses ................................................................ Operating loss ................................................................. 2.

Unit sales to break even=

$1,050,000 600,000 450,000 540,000 $ (90,000)

Fixed expenses Unit contribution margin =

$540,000 $30 per unit

= 18,000 units 18,000 units × $70 per unit = $1,260,000 to break even 3. See the next page. 4. At a selling price of $58 per unit, the contribution margin is $18 per unit. Therefore: Unit sales to break even=

Fixed expenses Unit contribution margin =

$540,000 $18

= 30,000 units 30,000 units × $58 per unit = $1,740,000 to break even This break-even point is different from the break-even point in part (2) because of the change in selling price. With the change in selling price, the unit contribution margin drops from $30 to $18, resulting in an increase in the break-even point.

Managerial Accounting, 13th Canadian Edition

Problem 4-19 (continued) 3.

Unit Selling Price

Unit Variable Expense

Unit Contribution Margin

Volume (Units)

Total Contribution Margin

Fixed Expenses

Operating income (loss)

$70 $68 $66 $64 $62 $60 $58 $56

$40 $40 $40 $40 $40 $40 $40 $40

$30 $28 $26 $24 $22 $20 $18 $16

15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000

$450,000 $560,000 $650,000 $720,000 $770,000 $800,000 $810,000 $800,000

$540,000 $540,000 $540,000 $540,000 $540,000 $540,000 $540,000 $540,000

$ (90,000) $ 20,000 $110,000 $180,000 $230,000 $260,000 $270,000 $260,000

The maximum profit is $270,000. This level of profit can be earned by selling 45,000 units at a price of $58 each.

133

Problem 4-20 (30 minutes)

Product Fragrant

White Percentage of total sales ..... Sales .................................. Variable expenses ............... Contribution margin ............ Fixed expenses ................... Operating income (loss) ......

40% $300,000 100 % 216,000 72 % $84,000 28 %

24% $180,000 36,000 $144,000

100 % 20 % 80 %

Loonzain

Total

36% $270,000 100 % 108,000 40 % $162,000 60 %

100% $750,000 100 % 360,000 48 % 390,000 52 %* 449,280 $( 59,280)

*$390,000 ÷ $750,000 = 52% 2. Break-even sales: Total fixed expenses $449,280 = =$864,000 Contribution margin ratio .52

Managerial Accounting, 13th Canadian Edition

Problem 4-20 (continued) 3. Memo to the president: Although the company met its sales budget of $750,000 for the month, the mix of products changed substantially compared to the budgeted mix. This is the reason the budgeted operating income was not met, and the reason break-even sales were greater than budgeted. The company‘s sales mix was to be 20 White, 52 Fragrant, and 28% Loonzain. The actual sales mix was 40% White, 24% Fragrant, and 36% Loonazin. As shown by these data, sales shifted away from Fragrant, which provides the highest contribution per dollar of sales, toward White Rice, which provides the lowest contribution per dollar of sales. Although the company met its budgeted level of sales, doing so provided less contribution margin than planned, with a resulting decrease in operating income. Notice in the statements that the company‘s overall CM ratio was only 52 compared to the planned ratio of 64%. This also explains why the break-even point was higher than planned. With less average contribution margin per dollar of sales, a greater level of sales had to be achieved to cover the fixed expenses.

Solutions Manual, Chapter 4

Problem 4-21 (60 minutes) 1. a. Selling price ............................ Variable expenses ................... Contribution margin ................

$25 15 $10

100% 60% 40%

Break-even units: Unit sales to break even=

Fixed expenses Unit contribution margin =

$210,000 $10

= 21,000 balls b. The degree of operating leverage is: Degree of operating leverage= =

Contribution margin Operating income

$300,000 =3.33 (rounded) $90,000

2. The new CM ratio will be: Selling price ........................... Variable expenses .................. Contribution margin ...............

$25 18 $7

100% 72% 28%

The new break-even point will be: Unit sales to break even=

Fixed expenses Unit contribution margin =

$210,000 $7

= 30,000 balls

Managerial Accounting, 13th Canadian Edition

Problem 4-21 (continued) 3. Units sales to attain target profit: Units sales to attain target profit=

Target profit+Fixed expenses Unit contribution margin =

$90,000+ $210,000 =42,857 balls $7

Thus, sales will have to increase by 12,857 balls (42,857 balls, less 30,000 balls currently being sold) to earn the same amount of operating income as last year. The computations above and in part (2) show the dramatic effect that increases in variable costs can have on an organization. The effects on Northwood Company are summarized below:

Break-even point (in balls).............................................. Sales (in balls) needed to earn a $90,000 profit ...............

Present

Expected

21,000 30,000

30,000 42,857

Note that if variable costs do increase next year, then the company will just break even if it sells the same number of balls (30,000) as it did last year. 4. The contribution margin ratio last year was 40%. If we let P equal the new selling price, then: P = $18 + 0.40P 0.60P = $18 P = $18 ÷ 0.60 P = $30 To verify: Selling price .......................... Variable expenses ................. Contribution margin ..............

$30 18 $12

100% 60% 40%

Therefore, to maintain a 40% CM ratio, a $3 increase in variable costs would require a $5 increase in the selling price.

Solutions Manual, Chapter 4

Problem 4-21 (continued) 5. The new CM ratio would be: Selling price ................................ Variable expenses ....................... Contribution margin.....................

$25 9* $16

100% 36% 64%

*$15 – ($15 × 40%) = $9 The new break-even point would be: Unit sales to break even=

Fixed expenses Unit contribution margin =

$420,000 =26,250 balls $16

Although this new break-even is greater than the company‘s present break-even of 21,000 balls [see Part (1) above], it is less than the break-even point will be if the company does not automate and variable labor costs rise next year [see Part (2) above].

6a. Unit sales to attain target profit: Unit sales to attain target profit=

Target profit+Fixed expenses Unit contribution margin =

$90,000+ $420,000 $16

=31,875 balls Thus, the company will have to sell 1,875 more balls (31,875 – 30,000 = 1,875) than now being sold to earn a profit of $90,000 per year. However, this is still less than the 42,857 balls that would have to be sold to earn a $90,000 profit if the plant is not automated and variable labor costs rise next year [see Part (3) above].

Managerial Accounting, 13th Canadian Edition

Problem 4-21 (continued) b. The contribution income statement would be: Sales (30,000 balls × $25 per ball) ................................ Variable expenses (30,000 balls × $9 per ball) ................ Contribution margin ...................................................... Fixed expenses ............................................................. Operating income .........................................................

Degree of operating leverage=

$750,000 270,000 480,000 420,000 $ 60,000

Contribution margin Operating income =

$480,000 =8 $60,000

c. This problem illustrates the difficulty faced by some companies. When variable labor costs increase, it is often difficult to pass these cost increases along to customers in the form of higher prices. Thus, companies are forced to automate resulting in higher operating leverage, often a higher break-even point, and greater risk for the company. There is no clear answer as to whether one should have been in favor of constructing the new plant.

Solutions Manual, Chapter 4

Problem 4-22 (30 minutes) 1. Unit sales to break-even: Unit sales to break even=

Fixed expenses Unit contribution margin =

$216,000 =12,000 units $18

or at $30 per unit, $360,000 2. The contribution margin is $216,000 because the contribution margin is equal to the fixed expenses at the break-even point. 3.

Target profit+Fixed expenses Unit contribution margin $90,000 + $216,000 = $18

Units sold to attain target profit=

=17,000 units Sales (17,000 units × $30 per unit) ................. Variable expenses (17,000 units × $12 per unit) ....................... Contribution margin ........................................ Fixed expenses ............................................... Operating income ...........................................

Total

Unit

$510,000

$30

204,000 306,000 216,000 $ 90,000

12 $18

4. Unit sales required to earn an after-tax profit of $90,000 after-tax profit Fixed expenses+ Target1-Tax Rate = Unit Contribution Margin

$216,000+$90,000 1-.3 = $18 =19,143 units (rounded)

Managerial Accounting, 13th Canadian Edition

Problem 4-22 (continued)

5. Margin of safety in dollar terms: Margin of safety in dollars = Total sales - Break-even sales = $450,000 - $360,000 = $90,000 Margin of safety in percentage terms: Margin of safety in percentage=

Margin of safety in dollars Total sales =

$90,000 =20 $450,000

6. The CM ratio is 60%. Expected total contribution margin: ($500,000 × 60%) ................ Present total contribution margin: ($450,000 × 60%) .................. Increased contribution margin ....................................................

$300,000 270,000 $ 30,000

Alternative solution: $50,000 incremental sales × 60% CM ratio = $30,000 Given that the company‘s fixed expenses will not change, monthly operating income will also increase by $30,000.

Solutions Manual, Chapter 4

Problem 4-23 (60 minutes) 1. Break-even points: Break even unit sales =

Fixed expenses $300,000 = = 12,500 pairs CM per unit $60 – $36

Break even unit sales dollars = Fixed expenses $300,000 = = $750,000 CM ratio .40* *$24  $60 2. See the graph on the following page. 3. Operating income (loss) if 12,000 pairs are sold: (12,000 × $24) – $300,000 = ($12,000) Note: since unit sales are below the break-even point of 12,500 calculated in Part 1 above, we know an operating loss will be incurred. 4. The new break-even point will be: Break even unit sales =

Fixed expenses $300,000 = = 15,000 pairs CM per unit $60 – $40

5. Operating income (loss) if 15,000 pairs are sold: At 12,500 unit sales (break-even point) operating income is $0. Incremental contribution margin and contribution margin for the additional 2,500 units is: 2,500 × ($60 – $36 – $4) = $50,000 6. The new break-even point in sales dollars will be: Fixed expenses $300,000 + $60,000 = = $654,545 CM ratio .55* *($60 – $27)  $60

Managerial Accounting, 13th Canadian Edition

Problem 4-23 (continued) 2. Cost-volume-profit graph:

$1,200,000 $1,100,000 Total Sales

$1,000,000

Break-even point: 12,500 pairs, or $750,000 in sales

$900,000

Dollars

$800,000 Total Expenses

$700,000 $600,000 $500,000 $400,000

Fixed Expenses

$300,000 $200,000 $100,000

$0 0

Solutions Manual, Chapter 4

2,500

5,000

7,500 10,000 12,500 15,000 17,500 20,000 Number of Pairs

Problem 4-24 (30 minutes) 1. The contribution margin per sweatshirt would be: Selling price ........................................................... Variable expenses: Purchase cost of the sweatshirts ........................... Commission to the student salespersons ............... Contribution margin ................................................

$30.00 $12.00 3.00

15.00 $ 15.00

CM ratio = $15  $30 = 50% Fixed expenses are $9,000: $3,000 salary per month x 3 months The number of unit sales needed to yield the desired $9,000 in profits can be obtained as follows: Fixed expenses+ Target profit $9,000+$9,000 = =1,200 pairs Unit CM $15.00 The dollar sales needed to yield the desired $9,000 in profits can be obtained as follows: Fixed expenses+ Target profit $9,000+$9,000 = =$36,000 CM ratio 50 2. Since an order has been placed, there is now a ―fixed‖ cost associated with the purchase price of the gloves since they can‘t be returned. An order of 200 pairs requires a ―fixed‖ cost (investment) of $2,400 (200 pairs × $12 per pair). For purposes of the break-even analysis for the first month, the variable cost drops to only $3.00 per pair, and the new contribution margin per pair is: Selling price .................................................... Variable expenses (commissions only) .............. Contribution margin ........................................

$30.00 3.00 $27.00

Since the ―fixed‖ cost of $2,400 must be recovered before Abenaki shows any profit, the break-even computation would be: Fixed expenses $3,000+$2,400 = =200 pairs Unit CM $27

Managerial Accounting, 13th Canadian Edition

Problem 4-24 (continued) The break-even level of sales would be: Fixed expenses $3,000+$2,400 = =$6,000 CM ratio 90 Thus, all the gloves ordered in the initial batch must be sold for Abenaki to break-even. 3. The unit sales now required to reach the target profit of $9,000 would be: Fixed expenses+ Target profit $10,800+$9,000 = =1,100 pairs CM ratio $18 CM per unit = $30 - $12 Fixed expenses = $3,600 salary per month x 3 months 4. The risk to Abenaki of eliminating the sales commission and increasing the monthly salary to $3,600 is that the student might not be as motivated to sell gloves. If the student‘s motivation to sell gloves decreases enough to reduce sales below 1,100 pairs, Abenaki might be better off retaining the original plan to pay the $3 commission per pair and a monthly salary of $3,000. Unfortunately, this is the type of decision that is very difficult to make given the challenges of determining how different pay schemes will affect effort. However, CVP analysis at least provides managers with information about the potential consequences of changes such as that contemplated in requirement 3.

Solutions Manual, Chapter 4

Problem 4-25 (45 minutes)

1. a. Sales ................................ Variable expenses ......... Contribution margin .......... Fixed expenses ................. Operating income ............. b. Break-even sales dollars =

Warm 500 pairs $ %

Super Warm 400 pairs $ %

$7,000 100.0 3,000 42.9 $4,000 57.1

$8,000 100 4,800 60 $3,200 40

Total $

$15,000 7,800 7,200 4,500 $2,700

100 52 48

Fixed expenses $4,500 = = $9,375 (rounded) CM ratio 48

Margin of safety = Actual sales – break-even sales Dollars: $15,000 – $9,375 = $5,625 Percentage: $5,625 ÷ $15,000 = 37.5% c. Break-even units =

Fixed expenses $4,500 = = Weighted average CM per unit $8*

units ( u

*$7,200  900 Margin of safety = Actual sales – break-even sales Units: 900 – 563 = 337 Percentage: 337 ÷ 900 = 37.4% d. Sales in units required to achieve an after-tax target profit: after-tax profit Fixed expenses+ Target1-Tax Rate = Weighted average contribution margin per unit

$4,500+$6,000 1-.25 = $8 $4,500+$8,000 =1,562.5 pairs $8

Managerial Accounting, 13th Canadian Edition

)

Problem 4-25 (continued)

2. a. Sales ..................................... Variable expenses .................. Contribution margin ............... Fixed expenses ...................... Operating income .................. b. Break-even sales

Warm 500 pairs $ %

Super Warm 400 pairs $ %

Regular 300 pairs $ %

Total 1,200 pairs $ %

$7,000 100.0 3,000 42.9 $4,000 57.1

$8,000 100 4,800 60 $3,200 40

$3,000 1,200 $1,800

$18,000 100 9,000 50 $ 9,000 50 4,500 $ 4,500

100 40 60

= Fixed expenses ÷ CM ratio = $4,500 ÷ 0.50 = $9,000

3. The reason for the increase in the break-even point can be traced to the increase in the company‘s average contribution margin ratio when the third product is added. Note from the income statements above that this ratio improves from 48% to 50% with the addition of the third product. Regular socks have a CM ratio of 60%, which causes the overall average contribution margin ratio to improve, since both of the other products have a lower ratio.

147

Problem 4-26 (60 minutes) 1. Operating income: November Basic Unit sales ...................................................... 2,000 Contribution margin per unit ........................... $40.00 Total contribution margin ............................... $80,000 Total fixed expenses ....................................... Operating income ..........................................

Advanced

Elite

2,000 $108.00 $216,000

4,000 $198.00 $792,000

December Basic Unit sales ...................................................... 6,000 Contribution margin per unit ........................... $40.00 Total contribution margin ............................... $240,000 Total fixed expenses ....................................... Operating income ..........................................

Advanced

Elite

2,000 $108.00 $216,000

2,000 $198.00 $396,000

Total 8,000 $1,088,000 408,000 $680,000

Total 10,000 $852,000 418,000 $434,000

2. Operating income in December is lower despite the higher unit sales because the sales mix has changed. In November, 50% of the total unit sales came from the Elite model, which has the highest contribution margin per unit. However, in December the Elite model represents only 20% of total unit sales while the Basic model, the least profitable, made up 60% of total unit sales. This is likely the result of the advertising campaign which appears to have shifted some sales from the Elite model to the Basic model. Although the advertising campaign does appear to have increased total unit sales it was not a success because it changed the sales mix such that a higher proportion of total unit sales came from the least profitable product. 3. The break-even in unit sales can be computed as follows: Fixed expenses $408,000 = =3,000 units Weighted average CM per unit $136* *$1,088,000  8,000 units 4. December‘s break-even point has gone up. The reason is that the division‘s sales mix has changed whereby there was a higher proportion of the least profitable model being sold as part of the overall mix, and there are $10,000 more fixed costs to ‗cover‘. © McGraw Hill Ltd. 2024. All rights reserved. 148

Managerial Accounting, 13th Canadian Edition

Problem 4-26 (continued) 5. If the mix stays the same in January as it was in December, then the weighted average CM per unit will also be the same in the two months. It can be calculated most easily as follows: $852,000  10,000 = $85.20 Therefore, the total contribution margin in January will be: 12,000 × $85.20 = $1,022,400

Solutions Manual, Chapter 4

Problem 4-27 (45 minutes) 1. The income statements would be:

Amount Sales ..................................... Variable expenses .................. Contribution margin ............... Fixed expenses ...................... Operating income ..................

$800,000 560,000 240,000 192,000 $ 48,000

Amount Sales ..................................... Variable expenses* ................ Contribution margin ............... Fixed expenses** .................. Operating income ..................

$800,000 320,000 480,000 432,000 $ 48,000

Present Per Unit

$20 14 $6

100% 70% 30%

Proposed Per Unit

$20 8 $12

100% 40% 60%

*$14 – $6 = $8 **$192,000 + $240,000 2. a. Degree of operating leverage: Present: Degree of operating leverage=

Contribution margin Operating income =

Proposed: Degree of operating leverage=

Contribution margin Operating income =

$480,000 =10 $48,000

Managerial Accounting, 13th Canadian Edition

Problem 4-27 (continued) b. Dollar sales to break even: Present: Dollar sales to break even=

Fixed expenses CM ratio =

$192,000 =$640,000 0.30

Proposed: Dollar sales to break even=

Fixed expenses CM ratio =

$432,000 =$720,000 0.60

c. Margin of safety: Present: Margin of safety = Actual sales - Break-even sales = $800,000 - $640,000 = $160,000 Margin of safety percentage=

Margin of safety in dollars Actual sales =

$160,000 =20 $800,000

Proposed: Margin of safety = Actual sales - Break-even sales = $800,000 - $720,000 = $80,000 Margin of safety percentage=

Margin of safety in dollars Actual sales =

Solutions Manual, Chapter 4

$80,000 =10 $800,000

Problem 4-27 (continued) 3. Frieden will be indifferent between performing or not performing the major upgrade at the volume (X) where total costs are equal. Solve for X as the number of units where: Total costs with upgrade = Total costs without upgrade $8X + $432,000 = $14X + $192,000 $6X = $240,000 X = 40,000 units Or: Change in Fixed costs  Change in Contribution Margin $240,000  $6 = 40,000 units Or: From the perspective of maintaining the current level of operating income, the major upgrade must provide the current operating income for management to be indifferent. Therefore: (Fixed Costs + Target Operating Income)/CM Unit ($432,000 + $48,000)/$12=40,000 Interestingly, the indifference point equals the current level of sales. So, unless sales are expected to increase, it may not be in Frieden‘s best interest to proceed with the upgrade since it will have no impact on operating income as shown in the answer above to requirement 1. 4.

If the expected increase in monthly contribution margin exceeds the increase in monthly fixed expenses, Frieden should proceed with the new advertising campaign. Expected contribution margin increase: (40,000 x 10%) x $6 per unit = Increase in fixed costs per month Benefit of proceeding with the campaign:

$24,000 20,000 $ 4,000

Frieden should go ahead with the new advertising campaign since it will increase operating income by $4,000 per month if unit sales increase 10% per month as expected.

Managerial Accounting, 13th Canadian Edition

Problem 4-28 (30 minutes) 1.

Profit $0 $0 $24Q Q Q

= Unit CM × Q − Fixed expenses = ($40 − $16) × Q − $60,000 = ($24) × Q − $60,000 = $60,000 = $60,000 ÷ $24 = 2,500 pairs, or at $40 scarfs, $100,000 in sales

Alternative solution: Fixed expenses

Unit sales to break even= Unit contribution margin = Dollar sales to break even=

$60,000 $24

=2,500 scarfs

Fixed expenses $60,000 = =$100,000 CM ratio .60

2. See the CVP graph at the end of this solution 3.

Profit = Unit CM × Q − Fixed expenses $18,000 = $24 × Q − $60,000 $24Q = $18,000 + $60,000 Q = $78,000 ÷ $24 Q = 3,250 scarfs

Alternative solution: Fixed expenses+target profit $60,000+$18,000 = =3,250 scarfs Unit contribution margin $24 4. Incremental contribution margin: $25,000 increased sales × 60% CM ratio ................ Incremental fixed salary cost ..................................... Increased operating income ......................................

$15,000 8,000 $ 7,000

Yes, the position should be converted to a full-time basis.

Solutions Manual, Chapter 4

Problem 4-28 (continued) 5a. Degree of operating leverage=

Contribution margin $72,000 = =6 Operating income $12,000

6. 6 x 50% sales increase = 300% increase in operating income. Thus, operating income next year would be: $12,000 + ($12,000 x 300%) = $48,000.

Managerial Accounting, 13th Canadian Edition

Problem 4-29 (30 minutes) 1. The contribution margin per unit on the first 16,000 units is:

Per Unit Sales price .................................. Variable expenses ....................... Contribution margin.....................

$3.00 1.25 $1.75

The contribution margin per unit on anything over 16,000 units is:

Per Unit Sales price .................................. Variable expenses ....................... Contribution margin.....................

$3.00 1.40 $1.60

Thus, for the first 16,000 units sold, the total amount of contribution margin generated would be: 16,000 units × $1.75 per unit = $28,000 Since the fixed costs on the first 16,000 units total $35,000, the $28,000 contribution margin above is not enough to permit the company to break even. Therefore, in order to break even, more than 16,000 units would have to be sold. The fixed costs that will have to be covered by the additional sales are: Fixed costs on the first 16,000 units ......................................... Less contribution margin from the first 16,000 units .................. Remaining unrecovered fixed costs ........................................... Add monthly rental cost of the additional space needed to produce more than 16,000 units ........................................... Total fixed costs to be covered by remaining sales.....................

Solutions Manual, Chapter 4

$35,000 28,000 7,000 1,000 $ 8,000

Problem 4-29 (continued) The additional sales of units required to cover these fixed costs would be: Total remaining fixed costs $8,000 = =5,000 units Unit CM on added units $1.60 Therefore, a total of 21,000 units (16,000 + 5,000) must be sold in order for the company to break even. This number of units would equal total sales of: 21,000 units × $3.00 per unit = $63,000 in total sales Target profit $12,000 = =7,500 units Unit CM $1.60

Thus, the company must sell 7,500 units above the break-even point to earn a profit of $12,000 each month. These units, added to the 21,000 units required to break even, equal total sales of 28,500 units each month to reach the target profit. 3. If a bonus of $0.10 per unit is paid for each unit sold in excess of the break-even point, then the contribution margin on these units would drop from $1.60 to $1.50 per unit. The desired monthly profit would be: 25% × ($35,000 + $1,000) = $9,000 Thus, Target profit $9,000 = =6,000 units Unit CM $1.50 Therefore, the company must sell 6,000 units above the break-even point to earn a profit of $9,000 each month. These units, added to the 21,000 units required to break even, would equal total sales of 27,000 units each month.

Managerial Accounting, 13th Canadian Edition

Problem 4-30 (60 minutes) 1. The income statements would be:

Present Per Amount Unit Sales ............................. Variable expenses .......... Contribution margin ....... Fixed expenses .............. Operating income ..........

$450,000 315,000 135,000 90,000 $ 45,000

$30 21 $9

% 100 70 30

Proposed Per Amount Unit $450,000 180,000 270,000 225,000 $ 45,000

$30 100 12 * 40 $18 60

*$21 – $9 = $12 2. a. Present Proposed Degree of operating leverage ........................................................ $135,000  45,000 = 3 $270,000  45,000 = 6 b. Break-even point in dollars

c. Margin of safety = Total sales – Break-even sales: $450,000 – $300,000 ....... $450,000 – $375,000 ....... Margin of safety percentage = Margin of safety ÷ Total sales: $150,000 ÷ $450,000 ...... $75,000 ÷ $450,000 ........

Solutions Manual, Chapter 4

$90,000  .30 = $300,000

$225,000  .60 = $375,000

$150,000 $75,000

33 1/3% 16 2/3%

Problem 4-30 (continued) 3. The major factor would be the sensitivity of the company‘s operations to changes in the operating environment. In years of strong economic activity, the company will be better off with the new equipment. The new equipment will increase the CM ratio and, as a consequence, profits would rise more rapidly in years with strong sales. However, the company will be worse off with the new equipment in years in which sales drop. The greater fixed costs of the new equipment will result in losses being incurred more quickly and they will be deeper. Thus, management must decide whether the potential greater profits in good years is worth the risk of deeper losses in bad years. 4. No information is given in the problem concerning the new variable expenses or the new contribution margin ratio. Both of these items must be determined before the new break-even point can be computed. The computations are: New variable expenses: Sales = Variable expenses + Fixed expenses + Profits $585,000* = Variable expenses + $180,000 + $54,000** $351,000 = Variable expenses * New level of sales: $450,000 × 1.3 = $585,000 ** New level of operating income: $45,000 × 1.2 = $54,000 New CM ratio: Sales ............................................ Variable expenses ......................... Contribution margin.......................

$585,000 351,000 $ 234,000

100% 60% 40%

With the above data, the new break-even point in sales dollars can be computed as: $180,000  .40 = $450,000 The greatest risk is that the marketing manager‘s estimates of increases in sales and operating income will not materialize and that sales will remain at their present level. Note that the company generates a profit of $45,000 at the present level of sales of $450,000, which is the break-even level of sales under the new marketing method.

Managerial Accounting, 13th Canadian Edition

Problem 4-30 (continued) 5. The level of sales needed under the new marketing strategy to generate $45,000 in operating income can be calculated as follows: ($180,000 + $45,000)  .40 = $562,500 Thus, sales would have to increase by more than 25% ($562,500 is 25% higher than $450,000) in order to make the company better off with the new marketing strategy than with the current situation. This appears to be extremely risky.

Solutions Manual, Chapter 4

Problem 4-31 (20 minutes) 1. The CM ratio is 50%: Selling price ............................. Variable expenses .................... Contribution margin .................

$40 20 $20

100% 50% 50%

2. Break-even point in sales dollars: $120,000  .50 = $240,000 3. $50,000 decreased sales × 50% CM ratio = $25,000 decreased contribution margin. Since fixed costs will not change, operating income should also decrease by $25,000. 4. Operating leverage = Contribution margin  operating income $200,000  $80,000 = 2.5 5. 2.5 × 20% = 50% decrease in operating income. 6.

Sales.................................. Variable expenses ............... Contribution margin ............ Fixed expenses ................... Operating income ...............

Last Year: 10,000 units Total Per Unit

Proposed: 14,000 units* Total Per Unit

$400,000 200,000 200,000 120,000 $ 80,000

$504,000 280,000 224,000 140,000 $84,000

$40.00 20.00 $20.00

$36.00 ** 20.00 $16.00

* 10,000 units × 1.4 = 14,000 units ** $40 per unit × (1 – 0.10) = $36 per unit Yes, the changes should be made since operating income increases and the margin of safety increases.

Managerial Accounting, 13th Canadian Edition

Problem 4-32 (20 minutes) 1. Break-even points: Pre-Solar panels Break-even units=

Fixed expenses $300,000 = =2,500 putters Contribution margin per unit $120

Post-Solar panels

Break-even units=

Fixed expenses $490,000 = =3,500 putters Contribution margin per unit $140

2. Margin of safety in units: Pre-Solar Panels: (4,000 – 2,500)  4,000 = 37.5% Post-Solar Panels: (4,000 – 3,500)  4,000 = 12.5% 3. Current operating income: $400(4,000) - $280(4,000) - $300,000 = $180,000 Unit sales required post-solar panels to earn $180,000: Units=

Fixed expenses + targe profit $490,000+$180,000 = =4,786 putters (rounded) Contribution margin per unit $140

4. $400(4,000) - $x(4,000) - $490,000 = $180,000 x = $232.50 per unit Thus, variables costs would need to decrease by $47.50 per unit ($280- $232.50) for Pro Putters to earn $180,000 if unit sales remain at 4,000 putters. 5. $400(4,000) - $260(4,000) - $x = $180,000 x = $380,000. The green energy incentive would need to be $110,000 ($490,000 - $380,000).

Solutions Manual, Chapter 4

Problem 4-33 (60 minutes) 1. The CM ratio is 30%. Sales (19,500 units) ............... Variable expenses .................. Contribution margin ...............

Total

Per Unit

Percent of Sales

$585,000 409,500 $175,500

$30.00 21.00 $ 9.00

100% 70% 30%

Break-even point in units and dollar sales: Unit sales to break even=

Fixed expenses Unit contribution margin =

Dollar sales to break even=

$180,000 =20,000 units $9.00

Fixed expenses CM ratio =

$180,000 =$600,000 in sales 0.30

2. Incremental contribution margin: $80,000 increased sales × 0.30 CM ratio ........................ Less increased advertising cost ......................................... Increase in monthly operating income...............................

$24,000 16,000 $ 8,000

Since the company is now showing a loss of $4,500 per month, if the changes are adopted, the loss will turn into a profit of $3,500 each month ($8,000 less $4,500 = $3,500). 3. Sales (39,000 units @ $27.00 per unit*) .................... Variable expenses (39,000 units @ $21.00 per unit) ............................ Contribution margin .................................................. Fixed expenses ($180,000 + $60,000) ....................... Operating loss ..........................................................

$1,053,000

819,000 234,000 240,000 (6,000)

*$30.00 – ($30.00 × 0.10) = $27.00

Managerial Accounting, 13th Canadian Edition

Problem 4-33 (continued) 4. Unit sales required to achieve target profit: Unit sales to attain target profit=

Target profit + Fixed expenses CM per unit =

$9,750 + $180,000 * $8.25

= 23,000 units *$30.00 – $21.75** = $8.25; **$21.00 + $0.75 5. a. The new CM ratio would be: Sales.................................. Variable expenses ............... Contribution margin ............

Per Unit

Percent of Sales

$30.00 18.00 $12.00

100% 60% 40%

The new break-even point would be: Unit sales to break even=

Fixed expenses Unit contribution margin =

$180,000 + $72,000 $12.00

= 21,000 units Dollar sales to break even=

Fixed expenses CM ratio =

$180,000 + $72,000 0.40

= $630,000

Solutions Manual, Chapter 4

Problem 4-33 (continued) b. Comparative income statements follow:

Sales (26,000 units) Variable expenses ... Contribution margin Fixed expenses ....... Operating income ...

Not Automated Per Total Unit %

Total

Per Unit

$780,000 $30.00 546,000 21.00 234,000 $ 9.00 180,000 $ 54,000

$780,000 468,000 312,000 252,000 $ 60,000

$30.00 18.00 $12.00

100 60 40

100 70 30

Automated

3. Indifference point: Let Q = Point of indifference in units sold $9.00Q - $180,000 = $12.00Q - $252,000 $3.00Q = $72,000 Q = $72,000 ÷ $3.00 Q = 24,000 units If more than 24,000 units are sold in a month, the proposed plan will yield the greater profits; if less than 24,000 units are sold in a month, the present plan will yield the greater profits (or the least loss). Whether or not the company should automate its operations depends on how much risk the company is willing to take and on prospects for future sales. The proposed changes would increase the company‘s fixed costs and its break-even point. However, the changes would also increase the company‘s CM ratio (from 0.30 to 0.40). The higher CM ratio means that once the break-even point is reached, profits will increase more rapidly than at present. If 26,000 units are sold next month, for example, the higher CM ratio will generate $6,000 more in profits than if no changes are made. The greatest risk of automating is that future sales may drop back down to present levels (only 19,500 units per month), and as a result, losses will be even larger than at present due to the company‘s greater fixed costs. (Note the problem states that sales are erratic from month to month.) In sum, the proposed changes will help the company if sales continue to trend upward in future months; the changes will hurt the company if sales drop back down to or near present levels.

Managerial Accounting, 13th Canadian Edition

CASE 4-34 (75 minutes) Before proceeding with the solution, it is helpful first to restructure the data into contribution format for each of the three alternatives. (The data in the statements below are in thousands.)

Sales.................................................... Variable expenses: Manufacturing ................................... Commissions (15%, 20% 7.5%) ......... Total variable expenses ......................... Contribution margin .............................. Fixed expenses: Manufacturing overhead..................... Marketing .......................................... Administrative ................................... Interest............................................. Total fixed expenses ............................. Income before income taxes ................. Income taxes (30%) ............................. Net income ..........................................

15% Commission

20% Commission

$16,000

100%

$16,000

60% 40%

7,200 3,200 10,400 5,600

7,200 2,400 9,600 6,400 2,340 120 1,800 540 4,800 1,600 480 $ 1,120

Own Sales Force

100%

$16,000.00

100.0%

65% 35%

7,200.00 1,200.00 8,400.00 7,600.00

52.5% 47.5%

2,340 120 1,800 540 4,800 800 240 $ 560

2,340.00 2,520.00 * 1,725.00 ** 540.00 7,125.00 475.00 142.50 $ 332.50

*$120,000 + $2,400,000 = $2,520,000 **$1,800,000 – $75,000 = $1,725,000

165

CASE 4-34 (continued) 1. When the income before taxes is zero, income taxes will also be zero and net income will be zero. Therefore, the break-even calculations can be based on the income before taxes. a. Break-even point in dollar sales if the commission remains 15%: Dollar sales to break even=

Fixed expenses $4,800,000 = =$12,000,000 CM ratio 0.40

b. Break-even point in dollar sales if the commission increases to 20%: Dollar sales to break even=

Fixed expenses $4,800,000 = =$13,714,286 CM ratio 0.35

c. Break-even point in dollar sales if the company employs its own sales force: Dollar sales to break even=

Fixed expenses $7,125,000 = =$15,000,000 CM ratio 0.475

2. In order to generate a $1,120,000 net income, the company must generate $1,600,000 in income before taxes. Therefore, Dollar sales to attain target=

Target income before taxes + Fixed expenses CM ratio

$1,600,000 + $4,800,000 0.35

$6,400,000 =$18,285,714 0.35

3. To determine the volume of sales at which net income would be equal under either the 20% commission plan or the company sales force plan, we find the volume of sales where costs before income taxes under the two plans are equal. See the next page for the solution.

Managerial Accounting, 13th Edition

CASE 4-34 (continued) X = Total sales revenue 0.65X + $4,800,000 = 0.525X + $7,125,000 0.125X = $2,325,000 X = $2,325,000 ÷ 0.125 X = $18,600,000 Thus, at a sales level of $18,600,000 either plan would yield the same income before taxes and net income. Below this sales level, the commission plan would yield the largest net income; above this sales level, the sales force plan would yield the largest net income. 4. a., b., and c.

Contribution margin (Part 1) (a).............. Income before taxes (Part 1) (b)............. Degree of operating leverage: (a) ÷ (b) ............................................

15% Commission

20% Commission

Own Sales Force

$6,400,000 $1,600,000

$5,600,000 $800,000

$7,600,000 $475,000

5. We would continue to use the sales agents for at least one more year, and possibly for two more years. The reasons are as follows: First, use of the sales agents would have a less dramatic effect on net income. Second, use of the sales agents for at least one more year would give the company more time to hire competent people and get the sales group organized. Third, the sales force plan doesn‘t become more desirable than the use of sales agents until the company reaches sales of $18,600,000 a year. This level probably won‘t be reached for at least one more year, and possibly two years. Fourth, the sales force plan will be highly leveraged since it will increase fixed costs (and decrease variable costs). One or two years from now, when sales have reached the $18,600,000 level, the company can benefit greatly from this leverage. For the moment, profits will be greater and risks will be less by staying with the agents, even at the higher 20% commission rate.

167

CASE 4-35 (60 minutes) 1. The overall break-even sales can be determined using the CM ratio.

Basic Sales................................ Variable expenses ............. Contribution margin .......... Fixed expenses ................. Operating income .............

$60,000 36,000 $ 24,000

Advanced

Audiophile

Total

$80,000 40,000 $40,000

$60,000 22,000 $ 38,000

$200,000 98,000 102,000 71,400 $ 31,200

Contribution margin ratio: Contribution margin $102,000 = =51 Sales $200,000 Overall break-even level of sales: Fixed expenses $71,400 = =$140,000 Contribution margin ratio .51 2. a. The break-even points for each product can be computed using the contribution margin approach as follows:

Basic Unit selling price........................ Variable cost per unit ................. Unit contribution margin (a) ....... Product fixed expenses (b) ......... Unit sales to break even* (b) ÷ (a) ...............................

$20.00 12.00 $8.00 $32,200 4,025

Advanced

Audiophile

$40.00 20.00 $20.00 $21,400 1,070

$60.00 22.00 $38.00 $7,600 200

*4,025 + 1,070 + 200 = 5,295 b. If the company were to sell exactly the break-even quantities computed above, the company would lose $10,200 — the amount of the common fixed cost. This occurs because the common fixed costs have been ignored in the calculations of the break-evens.

Managerial Accounting, 13th Edition

Case 4-35 (continued) The fact that the company loses $10,200 if it operates at the level of sales indicated by the break-evens for the individual products can be verified as follows:

Basic Unit sales ...................... CM per unit ................... Contribution margin ....... Fixed expenses .............. Operating loss ...............

4,025 $8 $32,200

Advanced

Audiophile

1,070 $20 $ 21,000

200 $38 $ 7,600

Total

$61,200 71,400 $(10,200)

c. The overall break-even sales units can be determined by calculating the weightedaverage contribution margin per unit as shown below: Total contribution margin  total unit sales $102,000  6,000 = $17 per unit Overall break-even units: Fixed expenses $71,400 = =4,200 units Weighted average CM per unit $17 Units of each product that must be sold at overall break-even level: Basic: Advanced: Audiophile:

4,200 x 50% = 2,100 4,200 x 33.33% = 1,400 4,200 x 16.67% = 700

Using the weighted average contribution margin per unit approach yields a much lower overall level of break-even units compared to calculating the break-even level individual for each model. However, note the much higher level of sales required for the Audiophile model compared to results in part 2a. This is driven by the relatively low amount of fixed costs directly related to the Audiophile model ($7,600) used in calculating the break-even on an individual product basis. However, as shown above, a company must cover all of its fixed costs to break-even, not just those costs directly related to individual products.

169

Case 4-35 (continued) Importantly, note in the response to part 2a. that the break-even sales mix resulting from calculating the break-even units individually for each product differs considerably from the actual mix of sales that is used in determining the response to part 2c. In particular, in part 2a. the Audiophile model represents just 3.8% of total sales at the breakeven level while the actual mix used in part 2c. is 16.67%. This distortion in sales mix for the most profitable model in terms of contribution margin per unit is a potential problem with calculating break-even individually for each product in multi-product companies when common fixed costs exist. Accordingly, incorporating all fixed costs, direct and common, yields the appropriate level of unit sales that must be achieved to ensure the company breaks even.

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Connecting Concepts: Section 1 (40 minutes) 1. The first step is to determine the cost-behaviour pattern for the Marketing Department costs as follows:

Month High activity level (November) Low activity level (May) .............. Change .....................................

Follow-up Activities

Total Costs

625 305 320

$211,250 $118,450 $92,800

Variable cost = Change in cost ÷ Change in activity = $92,800 ÷ 320 follow-up activities = $290 per follow-up activity Total cost (November) ............................................................. Variable cost element ($290 per activity × 625 activities) ........................................ Monthly fixed cost element .......................................................

$211,250 181,250 $30,000

The cost formula for total annual marketing costs is: Y = $360,0001 + $290x 1

$30,000 x 12

The next step is to estimate the total number of follow-up activities required to acquire 40 new customers assuming a conversion ratio of 0.35%: = 40 ÷ 0.0035 = 11,429 follow-up activities (rounded) The estimated cost of conducting 11,429 follow-up activities is as follows: Total costs = $360,000 + $290x = $360,000 + $290(11,429) = $3,674,410

171

Connecting Concepts: Section 1 (continued) 2. Jackson is likely to approve of the estimated spending for the Marketing Department since it is less than the $4 million ARR for one-year from the new customers: 40 x $100,000 = $4,000,000 3. The revised cost estimate for the Marketing Department given the proposed changes is calculated as follows: Number of follow-up activities given the improved conversion ratio: = 40 ÷ 0.004 = 10,000 follow-up activities The estimated cost of conducting 10,000 follow-up activities is as follows: Total costs = $360,000 + $400,000* + $350x = $760,000 + $350(10,000) = $4,260,000 *bonus of $10,000 x 40=$400,000 Jackson is unlikely to approve these increases since they will result in estimated total costs that exceed the one-year ARR for the 40 new customers of $4 million. 4. Since Jackson believes that the Marketing Department should spend no more than $4 million on its activities (i.e., 40 x $100,000 per new customer) that will be her indifference point since it effectively represents a break-even level of spending. So, the new conversion rate can be calculated as follows: $4,000,000 = $760,000 + $350(x) Where x = the number of follow-up activities x = 9,257 (rounded) The new conversion rate = 0.0043* (rounded) *40/9,257=.0043 So, only a small improvement in the conversion rate is needed.

Chapter 5 Systems Design: Job-Order Costing © McGraw Hill Ltd., 2024 172

Managerial Accounting, 13th Edition

Solution to Discussion Case Students will likely generate wide variety of products and related costs, some of them will likely be similar to the following: Products

Cost Types

Audits Reviews Compilations Personal Tax Returns Corporate Tax Returns Consulting projects Valuations Bankruptcy advice

Professional staff salaries Office staff salaries Equipment Lease costs Utilities Supplies IT costs Software

Direct or Indirect? Direct Indirect Indirect Indirect Indirect Indirect Indirect

Cost driver Hours worked by project % of total revenues These would likely be amalgamated into an overhead charge out rate applied to each job in proportion to hours worked or % of total revenues

It is important to note that when providing services rather than manufacturing products, most costs will be indirect and management needs to give careful thought to what drives each type of cost. Understanding what drives costs is key to developing good cost estimates which often serve as the basis for pricing in such industries.

173

Solutions to Questions 5-1 By definition, manufacturing overhead consists of product costs that cannot be practically traced to products or jobs. Therefore, if these costs are to be assigned to products or jobs, they must be allocated rather than traced. 5-2 Job-order costing is used in situations where many different products or services that require separate costing are produced each period. Process costing is used in situations where a single, homogeneous product, such as cement, bricks, or gasoline, is produced for long periods. 5-3 The job cost sheet is used to record all costs that are assigned to a particular job. These costs include direct materials costs traced to the job, direct labour costs traced to the job, and manufacturing overhead costs applied to the job. When a job is completed, the job cost sheet is used to compute the unit product cost. 5-4 A predetermined overhead rate is the rate used to apply overhead to jobs. It is computed before a period begins by dividing the period‘s estimated total manufacturing overhead by the period‘s estimated total amount of the allocation base. Thereafter, overhead is applied to jobs by multiplying the predetermined overhead rate by the actual amount of the allocation base that is incurred for each job. The most common allocation base is direct labour-hours. 5-5 A sales order is issued after an agreement has been reached with a customer on quantities, prices, and shipment dates for goods. The sales order forms the basis for the production order. The production order specifies what is to be produced and forms the basis for the job cost sheet. The job cost sheet, in turn, is used to summarize the various production costs incurred to complete the job. These costs are entered on the job cost sheet from materials requisition forms, labour time tickets, and by applying overhead. 5-6 The measure of activity used as the allocation base should drive the overhead cost; that is, the allocation base should cause ‗or drive‘ the overhead cost. If the allocation base does not really cause the overhead, then costs will be in-

correctly attributed to products and jobs and product costs will be distorted. 5-7 A cost driver is a factor that causes overhead costs. The measure of activity used as the allocation base should drive the overhead cost; that is, the base should cause the overhead cost. Cost drivers are used to allocate indirect costs to units of product in a job-order costing system. 5-8 Assigning manufacturing overhead costs to jobs does not ensure a profit. The units produced may not be sold and if they are sold, they may not be sold at prices sufficient to cover all costs. It is a myth that assigning costs to products or jobs ensures that those costs will be recovered. Costs are recovered only by selling to customers—not by allocating costs. 5-9 The Manufacturing Overhead account is credited when overhead cost is applied to Work in Process. Generally, the amount of overhead applied will not be the same as the amount of actual cost incurred, since the predetermined overhead rate is based on estimates. This is because the application of overhead involves estimates (of the costs and the base for allocation) and the actual may vary from the estimates. 5-10 Underapplied overhead occurs when the actual overhead cost exceeds the amount of overhead cost applied to Work in Process inventory during the period. Overapplied overhead occurs when the actual overhead cost is less than the amount of overhead cost applied to Work in Process inventory during the period. Underapplied overhead is disposed of by closing out the amount to Cost of Goods Sold. Overapplied overhead is disposed of by allocating the amount among Cost of Goods Sold and ending inventories in proportion to the applied overhead in each account. The adjustment for underapplied overhead increases Cost of Goods Sold whereas the adjustment for overapplied overhead decreases Cost of Goods Sold and inventories. 5-11 Manufacturing overhead may be underapplied for several reasons. For example, control over overhead spending may be poor and actual costs may exceed the estimates. Or, some of the overhead may be fixed and the actual

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amount of the allocation base was less than estimated at the beginning of the period. In this situation, the amount of overhead applied to inventory will be less than the actual overhead cost incurred. If production is less than estimated this may also result in overhead being underapplied. 5-12 Underapplied overhead implies that not enough overhead was assigned to jobs during the period and therefore cost of goods sold was understated. Therefore, underapplied overhead is added to cost of goods sold while overapplied overhead is deducted from cost of goods sold and inventory accounts. 5-13 Yes, overhead should be applied to value the Work in Process inventory at year-end. Since $7,500 of overhead was applied to Job A on the basis of $15,000 of direct labour cost, the company‘s predetermined overhead rate must be 50% of direct labour cost. Thus, $2,000 of overhead should be applied to Job B at year-end: $4,000 direct labour cost × 50% = $2,000 applied overhead cost. 5-14 Direct material ................................... $12,000 Direct labour...................................... 16,000 Manufacturing overhead: $16,000 × 150% ............................ 24,000 Total manufacturing cost .................... $52,000 Unit product cost: $52,000  750 units ....................... $69.33

5-17 Yes, predetermined overhead rates in general smooth product costs when costs change during a year or where production volume varies. The predetermined overhead rate is computed by using the yearly estimated total overhead divided by the estimated base for the year. This rate is used to calculate the product cost for each period. The product cost becomes an average cost rather than an actual cost which would include the fluctuations. 5-18 Since predetermined overhead is supposed to average out fluctuations during a year, it is logical that when actual overhead turns out to be less than estimated (i.e., overhead is overapplied), this amount should not all be charged to income this period since inventory will be overvalued on the balance sheet Those actual costs, if allocated to WIP and Finished Goods inventory, will then be charged against income with the related goods are sold which better satisfies the matching principle. 5-19 Opening inventories for work in process and finished goods contain overhead costs from previous periods. These amounts are contained in the cost of goods sold for the current period. If cost of goods sold for the current period was not reduced by the opening inventories then there would be a double charge made for the inventory variance, one for this period and one for last period.

5-15 A plantwide overhead rate is a single overhead rate used throughout all production departments in a plant. Some companies use multiple overhead rates rather than plantwide rates to more appropriately allocate overhead costs among products. Multiple overhead rates should be used, for example, in situations where one department is machine intensive and another department is labour intensive. 5-16 When automated equipment replaces direct labour, overhead increases and direct labour decreases. This results in an increase in the predetermined overhead rate—particularly if it is based on direct labour. Direct labour should be replaced by another cost driver such as machine hours, when a company has automated. Machine hours, it could be argued, would be what causes the overhead in this case. © McGraw Hill Ltd., 2024. All rights reserved. Solutions Manual, Chapter 5

175

Foundational Exercises 1. Moulding: Using the equation Y = a + bX, the estimated total manufacturing overhead cost is computed as follows: Y = $10,000 + ($1.40 per MH)(2,500 MHs) Estimated fixed manufacturing overhead ................................ Estimated variable manufacturing overhead: $1.40 per MH × 2,500 MHs ................................................ Estimated total manufacturing overhead cost .........................

$10,000 3,500 $13,500

The predetermined overhead rate in Molding is computed as follows: Estimated total manufacturing overhead (a) ............... Estimated total machine-hours (MHs) (b) .................. Predetermined overhead rate (a) ÷ (b) ......................

$13,500 2,500 MHs $5.40 per MH

Fabrication: Using the equation Y = a + bX, the estimated total manufacturing overhead cost is computed as follows: Y = $15,000 + ($2.20 per MH)(1,500 MHs) Estimated fixed manufacturing overhead ................................ Estimated variable manufacturing overhead: $2.20 per MH × 1,500 MHs ................................................ Estimated total manufacturing overhead cost .........................

$15,000 3,300 $18,300

The predetermined overhead rate in Fabrication is computed as follows: Estimated total manufacturing overhead (a) ............... Estimated total machine-hours (MHs) (b) .................. Predetermined overhead rate (a) ÷ (b) ......................

$18,300 1,500 MHs $12.20 per MH

2. The applied overhead from Molding is computed as follows:

Machine-hours worked on job (a)............................... Molding overhead rate (b) ......................................... Manufacturing overhead applied (a) × (b) ..................

Job P

Job Q

1,700 $5.40 $9,180

800 $5.40 $4,320

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Foundational Exercises (continued) 3. The applied overhead from Fabrication is computed as follows:

Machine-hours worked on job (a)............................... Fabrication overhead rate (b) ..................................... Manufacturing overhead applied (a) × (b) ..................

Job P

Job Q

600 $12.20 $7,320

900 $12.20 $10,980

4. The total manufacturing cost assigned to Job P is computed as follows:

Job P Direct materials ........................................................................ Direct labor .............................................................................. Manufacturing overhead applied ($9,180 + $7,320) .................. Total manufacturing cost .........................................................

$13,000 21,000 16,500 $50,500

5. The unit product cost for Job P is computed as follows: Total manufacturing cost (a) .................................. Number of units in the job (b) ................................ Unit product cost (a) ÷ (b) .....................................

$50,500 20 $2,525

6.The total manufacturing cost assigned to Job Q is computed as follows:

Job Q Direct materials ....................................................................... Direct labor ............................................................................. Manufacturing overhead applied ($4,320 + $10,980) ................ Total manufacturing cost .........................................................

$ 8,000 7,500 15,300 $30,800

7. The unit product cost for Job Q is computed as follows: Total manufacturing cost (a) .................................. Number of units in the job (b) ................................ Unit product cost (rounded) (a) ÷ (b) .....................

$30,800 30 $1,027

177

Foundational Exercises (continued) 8. The selling prices are calculated as follows:

Total manufacturing cost ........................................... Markup (based on 80%) ............................................ Total price for the job (a) .......................................... Number of units in the job (b) ................................... Selling price per unit (a) ÷ (b) ...................................

Job P

Job Q

$50,500 40,400 $90,900 20 $4,545

$30,800 24,640 $55,440 30 $1,848

9. The cost of goods sold is the sum of the manufacturing costs assigned to Jobs P and Q: Total manufacturing cost assigned to Job P ................ Total manufacturing cost assigned to Job Q ................ Cost of goods sold ....................................................

$50,500 30,800 $81,300

10. The plantwide overhead rate of $7.95 per machine-hour is calculated by combining the estimated manufacturing overhead costs computed in requirement 1 for Molding and Fabrication ($13,500 + $18,300 = $31,800) and then dividing by the estimated total machine-hours: Estimated total manufacturing overhead (a) ............... Estimated total machine-hours (MHs) (b) .................. Predetermined overhead rate (a) ÷ (b) ......................

$31,800 4,000 MHs $7.95 per MH

11. The manufacturing overhead applied to Jobs P and Q is computed as follows:

Actual machine-hours worked (a) ............................... Predetermined overhead rate per MH (b) ................... Manufacturing overhead applied (a) × (b) ..................

Job P

Job Q

2,300 $7.95 $18,285

1,700 $7.95 $13,515

Managerial Accounting, 13th Canadian Edition

Foundational Exercises (continued) 12. Job P‘s unit product cost is computed as follows: Direct materials ..................................................... Direct labor ........................................................... Manufacturing overhead applied ............................. Total manufacturing cost (a) .................................. Number of units in the job (b) ................................ Unit product cost (rounded) (a) ÷ (b) .....................

$13,000 21,000 18,285 $52,285 20 $2,614

13. Job Q‘s unit product cost is computed as follows: Direct materials ..................................................... Direct labor ........................................................... Manufacturing overhead applied ............................. Total manufacturing cost (a) .................................. Number of units in the job (b) ................................ Unit product cost (rounded) (a) ÷ (b) .....................

$8,000 7,500 13,515 $29,015 30 $967

14. The selling prices are calculated as follows:

Job P

Job Q

$52,285 41,828 $94,113 20 $4,706

$29,015 23,212 $52,227 30 $1,741

15. The cost of goods sold is the sum of the manufacturing costs assigned to Jobs P and Q: Total manufacturing cost assigned to Job P ................ Total manufacturing cost assigned to Job Q ................ Cost of goods sold ....................................................

$52,285 29,015 $81,300

179

Exercise 5-1 (10 minutes) a.

Job-order costing

Process costing

Job-order costing

Process costing

Job-order costing

Process costing

Job-order costing

Process costing

Job-order costing

Process costing

Managerial Accounting, 13th Canadian Edition

Exercise 5-2 (10 minutes) 1. Total direct labour-hours required for Job A-200: Direct labour cost ...................................... ÷ Direct labour wage rate per hour ............ = Total direct labour hours ........................

$150 $15 10

Total manufacturing cost assigned to Job A-200: Direct materials ......................................... Direct labour ............................................. Manufacturing overhead applied ($20 per DLH × 10 DLHs) ....................... Total manufacturing cost............................

$200 150 200 $550

2. Unit product cost for Job A-200: Total manufacturing cost .......................... ÷ Number of units in the job .................... = Unit product cost ..................................

$550 50 $11

Exercise 5-3 (10 minutes) The predetermined overhead rate is computed as follows: Estimated total overhead cost .................................. ÷ Estimated total direct labour hours (DLHs) ............ = Predetermined overhead rate................................

$172,500 7,500 DLHs $23 per DLH

Note that the information about actual overhead costs is irrelevant to the calculation of the predetermined overhead rate.

181

Exercise 5-4 (15 minutes) a. Raw Materials ............................... Accounts Payable ................

45,000

b. Work in Process ............................ Manufacturing Overhead ............... Raw Materials .....................

70,000 55,000

45,000

125,000

c. Work in Process ............................ 183,000 Manufacturing Overhead ............... 29,000 Wages Payable ................... 212,000 d. Manufacturing Overhead ............... 189,000 Accounts Payable ................ 189,000 Exercise 5-5 (15 minutes) 1. Estimated total manufacturing overhead (a). Estimated total direct labour hours (b) ................. Predetermined overhead rate (a÷b) ....................

$270,000 27,000 $10

Overhead applied to jobs: Job 101 (8,000 DLH x $10) Job 102 (4,000 DLH x $10) Job 103 (3,000 X $10)

$80,000 $40,000 $30,000

2. Predetermined overhead rate (a) ....................... $10 Actual total direct labour hours (b) .................... 25,000 Manufacturing overhead applied (a x b) $250,000 Less: Actual total manufacturing overhead incurred in the year (230,000) Over-applied overhead $20,000

Managerial Accounting, 13th Canadian Edition

Exercise 5-6 (15 minutes) Calculate the predetermined overhead rate: Estimated overhead costs (a).................................. Estimated direct labour hours (b) ............................ Predetermined overhead rate (a÷b) .......................

$257,400 11,000 $23.40

Manufacturing overhead applied: Estimated overhead costs ....................................... Less: Underapplied overhead .................................. Manufacturing overhead applied (c) ........................

$257,400 (17,550) $239,850

Direct labour hours worked: Manufacturing overhead applied (c) ........................ Predetermined overhead rate (d) ............................ Direct labour hours worked in year (c) ÷ (d) ...........

$239,850 $23.40 10,250 DLH

183

Exercise 5-7 (20 minutes) 1. Schedule of Cost of Goods Manufactured: Direct materials: Beginning raw materials inventory ............................ Add: Purchases of raw materials ............................... Total raw materials available .................................... Deduct: Ending raw materials inventory .................... Raw materials used in production ............................. Less indirect materials included in manufacturing overhead ..................................................................... Direct labour ................................................................ Manufacturing overhead applied to work in process ........ Total manufacturing costs ............................................. Add: Beginning work in process inventory ......................

$12,000 30,000 42,000 18,000 24,000 5,000

Deduct: Ending work in process inventory ...................... Cost of goods manufactured..........................................

$ 19,000 58,000 87,000 164,000 56,000 220,000 65,000 $155,000

2. Schedule of Cost of Goods Sold: Beginning finished goods inventory ................................ Add: Cost of goods manufactured .................................. Cost of goods available for sale ..................................... Deduct: Ending finished goods inventory ........................ Unadjusted cost of goods sold ....................................... Add: Underapplied overhead ......................................... Adjusted cost of goods sold ...........................................

$ 35,000 155,000 190,000 42,000 148,000 4,000 $152,000

Managerial Accounting, 13th Canadian Edition

Exercise 5-8 (20 minutes) Parts 1 and 2. Cash

Raw Materials

(a)

75,000

(c)

152,000

(d)

126,000

(a)

Work in Process (b)

67,000

(c)

134,000

(e)

178,000 379,000 (f)

6,000 (e)

(c)

18,000

(d)

126,000

(g)*

28,000

73,000

Finished Goods (f)

379,000 379,000 (f)

379,000

Manufacturing Overhead (b)

75,000 (b)

178,000

Cost of Goods Sold (f)

379,000 (g)

28,000

351,000 28,000

* The company had no beginning or ending inventories, so overapplied overhead was written off completely to cost of goods sold since the balance related completely to current period's costs. This entry corrects the cost of goods sold to actual.

185

Exercise 5-9 (10 minutes) 1. Actual machine hours ......................................... × Predetermined overhead rate .......................... = Manufacturing overhead applied...................... Less: Manufacturing overhead incurred ............... Manufacturing overhead underapplied

18,500 $3.00 $55,500 64,500 $ 9,000

2. Because manufacturing overhead is underapplied and there were no beginning or ending inventories, the cost of goods sold would increase by $9,000 and the gross margin would decrease by $9,000.

Managerial Accounting, 13th Canadian Edition

Exercise 5-10 (30 minutes) 1.

Cost of Goods Manufactured Direct materials: Raw materials inventory, beginning .......................... Add: Purchases of raw materials .............................. Total raw materials available .................................... Deduct: Raw materials inventory, ending .................. Raw materials used in production ............................. Direct labour ................................................................ Manufacturing overhead applied to work in process inventory ..................................................................... Total manufacturing costs............................................. Add: Beginning work in process inventory......................

$ 8,000 132,000 140,000 10,000 130,000 90,000 210,000 430,000 5,000 435,000 20,000 $415,000

Deduct: Ending work in process inventory ..................... Cost of goods manufactured ......................................... 2.

Cost of Goods Sold Finished goods inventory, beginning .............................. Add: Cost of goods manufactured ................................. Cost of goods available for sale ..................................... Deduct: Finished goods inventory, ending...................... Unadjusted cost of goods sold ...................................... Add: Underapplied overhead ......................................... Adjusted cost of goods sold ..........................................

$ 70,000 415,000 485,000 25,000 460,000 10,000 $470,000

187

Exercise 5-11 (30 minutes) Note to the instructor: This exercise is a good vehicle for introducing the concept of predetermined overhead rates. This exercise can also be used as a launching pad for a discussion of the appendix to the chapter. 1. As suggested, the costing problem does indeed lie with manufacturing overhead cost. Since manufacturing overhead is mostly fixed, the cost per unit increases as the level of production decreases. The problem can be ―solved‖ by using a predetermined overhead rate, which should be based on expected activity for the entire year. Many students will use units of product in computing the predetermined overhead rate, as follows:

Predetermined = Estimated total manufacturing overhead cost overhead rate Estimated total amount of the allocation base =

$840,000* 200,000 units

=$4.20 per unit. * $228,000 + $204,000 + $192,000 + $216,000 = $840,000 The predetermined overhead rate could also be set on the basis of direct labour cost or direct materials cost. The computations are: Predetermined = Estimated total manufacturing overhead cost Overhead rate Estimated total amount of the allocation base =

$840,000 $240,000* direct labour cost

= 350% of direct labour cost * $96,000 + $48,000 + $24,000 + $72,000 = $240,000

Managerial Accounting, 13th Canadian Edition

Exercise 5-11 (continued)

Predetermined = Estimated total manufacturing overhead cost overhead rate Estimated total amount of the allocation base =

$840,000** $600,000* direct materials cost

=140% of direct materials cost. * $240,000 + $120,000 + $60,000 + $180,000 = $600,000 ** $228,000 + $204,000 + $192,000 + $216,000 = $840,000 2. Using a predetermined overhead rate, the unit costs would be:

Direct materials ....................... Direct labour ........................... Manufacturing overhead: Applied at $4.20 per unit, 350% of direct labour cost, or 140% of direct materials cost ..................................... Total cost ................................ Number of units produced ........ Estimated unit product cost ......

First

Quarter Second Third

Fourth

$240,000 96,000

$120,000 48,000

$ 60,000 24,000

$180,000 72,000

336,000 $672,000 80,000 $8.40

168,000 $336,000 40,000 $8.40

84,000 $168,000 20,000 $8.40

252,000 $504,000 60,000 $8.40

Note: Overhead is calculated using $4.20 per unit in the first quarter, 350% in the second quarter, 140% in the third and fourth quarters to provide illustrations of the possible answers.

189

Exercise 5-12 (15 minutes) 1. Stamping Department:

Predetermined = Estimated total manufacturing overhead cost overhead rate Estimated total amount of the allocation base =

$2,550,000 =$8.50 per machine-hour 300,000 machine-hours

Assembly Department: Predetermined = Estimated total manufacturing overhead cost Overhead rate Estimated total amount of the allocation base =

$4,000,000 $3,200,000 direct labour cost = 125% Direct labour cost

Overhead Applied

2. Stamping Department: 450 MHs × $8.50 per MH ....... Assembly Department: $800 × 125% ........................ Total overhead cost applied ......................................

$3,825 1,000 $4,825

3. Yes; if some jobs require a large amount of machine time and little labour cost, they would be charged substantially less overhead cost if a plantwide rate based on direct labour cost were used. It appears, for example, that this would be true of Job 407 which required considerable machine time to complete, but required only a small amount of labour cost.

Managerial Accounting, 13th Canadian Edition

Exercise 5-13 (30 minutes) 1. Overhead application rate for each department: Assembly $11,900/(.40 x 1,000+.40 x 750)MH Finishing $8,500/(.40 x 1,000+.60 x 750)DLH

$17 per MH $10 per DLH

2. Total cost per unit of each product Standard $8.50 4.00

Heavy Duty $12.00 5.00

Direct material Direct labour Overhead applied Assembly (based on MH)* 6.80 Finishing (based on DL$)** 4.00 Total cost per unit $23.30 *Standard: $17 per MH x 0.40; Heavy Duty: $17 per MH x 0.40

6.80 6.00 $29.80

**Standard: $10 per DLH x .40; Heavy Duty: $10 per DLH x .60

191

Problem 5-14 (20 minutes) 1. The predetermined plantwide overhead rate is computed as follows: Estimated manufacturing overhead (a) ..................... Estimated total direct labour-hours (b)...................... Predetermined overhead rate (a) ÷ (b) .....................

$1,400,000 80,000 DLHs $17.50 per DLH

The overhead applied to Job Bravo is computed as follows: Direct labour-hours worked on Bravo (a) .................. Predetermined overhead rate (b).............................. Overhead applied to Bravo (a) × (b) .........................

14 $17.50 per DLH $245

2. The predetermined overhead rate in Assembly is computed as follows: Estimated manufacturing overhead (a) ..................... Estimated total direct labour-hours (b)...................... Predetermined overhead rate (a) ÷ (b) .....................

$600,000 50,000 DLHs $12.00 per DLH

The predetermined overhead rate in Fabrication is computed as follows: Estimated manufacturing overhead (a) ..................... Estimated total machine-hours (b) ............................ Predetermined overhead rate (a) ÷ (b) .....................

$800,000 100,000 MHs $8.00 per MH

The overhead applied to Job Bravo is computed as follows: Assembly Quantity of allocation base used (a) ......................... 11 Predetermined overhead rate (b) ............................. $12.00 Overhead applied to Bravo (a) × (b) ........................$132

Fabrication 6 $8.00 $48

Total

$180

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Problem 5-15 (30 minutes) 1. Since $250,000 of studio overhead cost was applied to Work in Process on the basis of $125,000 of direct staff costs, the apparent predetermined overhead rate was $250,000/ $125,000 = 200%: 2. The XYZ Corporation Headquarters project is the only job remaining in Work in Process at the end of the month; therefore, the entire $75,000* balance in the Work in Process account at that point must apply to it. Recognizing that the predetermined overhead rate is 200% of direct staff costs, the following computation can be made: * $50,000 + $125,000 + $250,000 - $350,000 = $75,000 Total cost added to the XYZ Corporation Headquarters project .............. Less: Direct staff costs .......................................... $20,800 Studio overhead cost ($20,800 × 200%) .................................... 41,600 Costs of subcontracted work .........................

$75,000

62,400 $ 12,600

With this information, we can now complete the job cost sheet for the XYZ Corporation Headquarters project: Costs of subcontracted work .................... $ 12,600 Direct staff costs ..................................... 20,800 Studio overhead ...................................... 41,600 Total cost to January 31 .......................... $75,000

193

Problem 5-16 (20 minutes) 1. Estimated fixed overhead ...................................................... Estimated variable overhead: $1.00 per DLH × 20,000 DLHs ... Estimated total overhead cost ................................................

$350,000 20,000 $370,000

The predetermined overhead rate is computed as follows: Estimated total overhead (a) ................................... Estimated total direct labour-hours (b) ..................... Predetermined overhead rate (a) ÷ (b) ....................

$370,000 20,000 DLHs $18.50 per DLH

2. Total manufacturing cost assigned to Mr. Wilkes: Direct materials .................................................................... Direct labour......................................................................... Overhead applied ($18.50 per DLH × 4 DLH) ......................... Total cost assigned to Mr. Wilkes ............................................

$1,090 140 74 $1,304

3. The price charged to Mr. Wilkes is computed as follows:

Job 550 Total manufacturing cost ....................................................... Markup (40%) (rounded) ...................................................... Selling price ..........................................................................

$ 1,304 522 $1,826

Managerial Accounting, 13th Canadian Edition

Problem 5-17 (20 minutes) 1. Item (a): Actual manufacturing overhead costs for the year. Item (b): Overhead cost applied to work in process for the year. Item (c): Cost of goods manufactured for the year. Item (d): Cost of goods sold for the year. 2. The overapplied overhead will be allocated to the other accounts on the basis of the amount of overhead applied during the year in the ending balance of each account: Work in process .......................................... Finished goods ........................................... Cost of goods sold ...................................... Total cost ...................................................

$ 32,800 41,000 336,200 $410,000

8% 10 82 100 %

Using these percentages, the journal entry would be as follows: Manufacturing Overhead ...................................... Work in Process (8% × $30,000) .................... Finished Goods (10% × $30,000) ................... Cost of Goods Sold (82% × $30,000)..............

30,000 2,400 3,000 24,600

195

Problem 5-18 (60 minutes) 1.

The predetermined overhead rate is computed as follows:

Predetermined = Estimated total manufacturing overhead cost overhead rate Estimated total amount of the allocation base =

$800,000 =160% $500,000 direct materials cost

Before the underapplied or overapplied overhead can be computed, we must determine the cost of direct materials used in production for the year. Beginning raw materials inventory.................................... Add: Purchases of raw materials ...................................... Total raw materials available............................................ Deduct: Ending raw materials inventory ........................... Raw materials used in production .....................................

$ 20,000 510,000 530,000 80,000 $450,000

Next, compare the actual manufacturing overhead costs incurred to the manufacturing overhead costs applied. Actual manufacturing overhead costs: Indirect labor ............................................................... Property taxes ............................................................. Depreciation of equipment ............................................ Maintenance ................................................................ Insurance .................................................................... Rent, building .............................................................. Total actual costs ............................................................ Manufacturing overhead applied to work in process based on cost of raw materials used in production ($450,000 × 160%) ......................................................................... Underapplied overhead....................................................

$170,000 48,000 260,000 95,000 7,000 180,000 760,000

720,000 $ 40,000

Managerial Accounting, 13th Canadian Edition

Problem 5-18 (continued) 3. Schedule of Cost of Goods Manufactured:

Direct materials: Beginning raw materials inventory ................................... $ 20,000 Add: Purchases of raw materials...................................... 510,000 Total raw materials available ........................................... 530,000 Deduct: Ending raw materials inventory ........................... 80,000 Direct materials used in production ....................................... Direct labor ......................................................................... Manufacturing overhead applied to work in process (from part 2) ............................................................. Total manufacturing costs .................................................... Add: Beginning work in process inventory ............................. Deduct: Ending work in process inventory ............................. Cost of goods manufactured ................................................ 4. Unadjusted cost of goods sold: Beginning finished goods inventory ................................ Add: Cost of goods manufactured .................................. Cost of goods available for sale ..................................... Deduct: Ending finished goods inventory ........................ Unadjusted cost of goods sold .......................................

450,000 90,000 720,000 1,260,000 150,000 1,410,000 70,000 $1,340,000

$ 260,000 1,340,000 1,600,000 400,000 $1,200,000

4. The journal entry to dispose of underapplied overhead is as follows: Cost of Goods Sold ......................................... Manufacturing Overhead ...........................

40,000 40,000

197

Problem 5-19 (60 minutes) 1. The predetermined overhead rate is computed as follows: Estimated total manufacturing overhead (a) ............. Estimated total computer hours (b) .......................... Predetermined overhead rate (a) ÷ (b).....................

$1,275,000 75,000 hours 17.00 per hour

2. Actual manufacturing overhead cost ................................... Manufacturing overhead applied to Work in Process during the year: 60,000 actual MHs × $17 per MH ...................... Overapplied overhead cost .................................................

$850,000 1,020,000 $170,000

3. The overapplied overhead would be allocated using the following percentages: Overhead applied during the year in: Work in process ........................................... Finished goods ............................................. Cost of goods sold ........................................ Total ..............................................................

$ 51,000 255,000 714,000 $1,020,000

5% 25 % 70 % 100 %

The entry to record the allocation of the overapplied overhead would be: Manufacturing Overhead Work in Process (5% X $170,000) Finished Goods Inventory (25% X $170,000) Cost of Goods Sold (70% X $170,000)

170,000 8,500 42,500 119,000

Managerial Accounting, 13th Canadian Edition

Problem 5-20 (60 minutes) 1. and 2.

Bal. (k) Bal.

Cash 8,000 (l) 197,000 15,000

Bal. (a) Bal.

Raw Materials 7,000 (b) 45,000 12,000

Bal. (i) Bal.

Finished Goods 20,000 (j) 130,000 30,000

Bal.

Plant and Equipment 230,000

(b) (c) (d) (e) (f) Bal.

190,000

40,000

120,000

Manufacturing Overhead 8,000 (h)* 60,000 14,600 21,000 18,000 2,400 4,000 (m) 4,000

Bal. (j) Bal.

Accounts Receivable 13,000 (k) 197,000 200,000 16,000

Bal. (b) (e) (h) Bal.

Work in Process 18,000 (i) 32,000 40,000 60,000 20,000

Bal.

Prepaid Insurance 4,000 (f)

Bal.

130,000

3,000

1,000 Accumulated Depreciation Bal. 42,000 (d) 28,000 Bal. 70,000

(l)

Accounts Payable 100,000 Bal. (a) (c) (g)

30,000 45,000 14,600 18,000

Bal.

7,600

Retained Earnings Bal.

78,000

*$40,000 × 150% = $60,000.

(l)

Salaries & Wages Payable 90,000 (e) 93,400 Bal. 3,400

199

Problem 5-20 (continued) Capital Stock Bal.

150,000

Administrative Salaries Expense (e) 25,000

(e)

Sales Commissions Expense 10,400

(d)

Depreciation Expense 7,000

(g)

Miscellaneous Selling and Administrative Expense 18,000

Insurance Expense (f)

600

(j) (m)

Cost of Goods Sold 120,000 4,000

Sales (j)

200,000

3. Overhead is underapplied by $4,000. Entry (m) above records the closing of this underapplied overhead balance to Cost of Goods Sold. 4. Durham Company Income Statement For the Year Ended December 31 Sales ........................................................................ Cost of goods sold ($120,000 + $4,000) .................... Gross margin ............................................................ Selling and administrative expenses: Depreciation expense ............................................. Sales commissions expense .................................... Administrative salaries expense .............................. Insurance expense ................................................. Miscellaneous expense ........................................... Operating income .....................................................

$200,000 124,000 76,000 $ 7,000 10,400 25,000 600 18,000

61,000 $ 15,000

Managerial Accounting, 13th Canadian Edition

Problem 5-21 (60 minutes) 1. and 2.

Bal. (l) Bal.

Cash 15,000 (c) 445,000 (m) 85,000

Bal. (a)

Raw Materials 25,000 (b) 80,000

Bal.

15,000

Bal. (j) Bal.

Finished Goods 45,000 (k) 310,000 55,000

Bal.

Buildings & Equipment 500,000

(b) (c) (d) (e) (f) (h)

225,000 150,000

90,000

300,000

Retained Earnings Bal.

Bal. (b) (c) (i) Bal.

Work in Process 30,000 (j) 85,000 120,000 96,000 21,000

Bal.

Prepaid Insurance 5,000 (f)

Bal.

445,000

310,000

4,800

200 Accumulated Depreciation Bal. 210,000 (e) 30,000 Bal. 240,000

Manufacturing Overhead 5,000 (i)* 96,000 30,000 12,000 25,000 4,000 17,000 Bal. 3,000 $80,000 = 80 $100,000

Bal. (k) Bal.

Accounts Receivable 40,000 (l) 450,000 45,000

(m)

Accounts Payable 150,000 Bal. (a) (d) (g) (h)

75,000 80,000 12,000 40,000 17,000

Bal.

74,000

of direct labour cost; $120,000 × 0.80 = $96,000.

125,000

Capital Stock Bal.

250,000

201

Problem 5-21 (continued) (c)

Salaries Expense 75,000

(f)

Insurance Expense 800

(k)

Cost of Goods Sold 300,000

(e)

Depreciation Expense 5,000

(g)

Shipping Expense 40,000 Sales (k)

450,000

3. Manufacturing overhead was overapplied by $3,000 for the year. This balance would be allocated between Work in Process, Finished Goods, and Cost of Goods Sold in proportion to the ending balances in these accounts. The allocation would be: Work in Process, 12/31......................... Finished Goods, 12/31 .......................... Cost of Goods Sold, 12/31 ....................

$ 21,000 55,000 300,000 $376,000

Manufacturing Overhead ......................................... Work in Process (5.6% × $3,000) ...................... Finished Goods (14.6% × $3,000) ..................... Cost of Goods Sold (79.8% × $3,000) ................

5.6 % 14.6 79.8 100.0 % 3,000 168 438 2,394

4. PQB Inc. Income Statement For the Year Ended December 31 Sales ........................................................................ Cost of goods sold ($300,000 – $2,394) ..................... Gross margin ............................................................ Selling and administrative expenses: Salaries expense .................................................... Depreciation expense ............................................. Insurance expense ................................................. Shipping expense ................................................... Operating income .....................................................

$450,000 297,606 152,394 $75,000 5,000 800 40,000

120,800 $ 31,594

Managerial Accounting, 13th Canadian Edition

Problem 5-22 (60 minutes) 1. Bal.

Raw Materials 40,000 (a)

Bal. (e)

Finished Goods 85,000 60,700

33,500

Work in Process 77,800* (e) 29,500 20,000 32,000 98,600

Bal. (a) (b) (d) Bal.

(a) (b) (c)

60,700

Manufacturing Overhead 4,000 (d) 32,000 8,000 19,000

Salaries & Wages Payable (b) 28,000

Accounts Payable (c)

* Job 105 materials, labour, and overhead at November 30 ............... Job 106 materials, labour, and overhead at November 30 ............... Total Work in Process inventory at November 30 ........................... 2. a. Work in Process ................................................... Manufacturing Overhead ...................................... Raw Materials ................................................ *$8,200 + $21,300 = $29,500.

19,000 $50,300 27,500 $77,800

29,500 * 4,000 33,500

This entry is posted to the T-accounts as entry (a) above. b. Work in Process .................................................. Manufacturing Overhead ..................................... Salaries and Wages Payable ........................... *$4,000 + $6,000 + $10,000 = $20,000.

20,000 * 8,000 28,000

This entry is posted to the T-accounts as entry (b) above. c. Manufacturing Overhead .................................... Accounts Payable .........................................

19,000 19,000

This entry is posted to the T-accounts as entry (c) above.

203

Problem 5-22 (continued) 3. Apparently, the company uses a predetermined overhead rate of 160% of direct labour cost. This figure can be determined by relating the November applied overhead cost on the job cost sheets to the November direct labour cost shown on these sheets. For example, in the case of Job 105: November overhead cost $20,800 = =160 November direct labour cost $13,000

of direct labour cost

The overhead cost applied to each job during December was: Job 105: $4,000 × 160% .................... Job 106: $6,000 × 160% .................... Job 107: $10,000 × 160% .................. Total applied overhead .......................

$ 6,400 9,600 16,000 $32,000

The entry to record the application of overhead cost to jobs would be as follows: Work in Process ....................................... Manufacturing Overhead ....................

32,000 32,000

The entry is posted to the T-accounts as entry (d) above. 4. The total cost of Job 105 was: Direct materials ........................................................................... Direct labour ($13,000 + $4,000) ................................................. Manufacturing overhead applied ($17,000 × 160%) ...................... Total cost ...................................................................................

$16,500 17,000 27,200 $60,700

The entry to record the transfer of the completed job would be as follows: Finished Goods ...................................................... Work in Process ...............................................

60,700 60,700

This entry is posted to the T-accounts as entry (e) above. 5. As shown in the above T-accounts, the balance in Work in Process at December 31 was $98,600. The breakdown of this amount between Jobs 106 and 107 is: Direct materials .................................. Direct labour ...................................... Manufacturing overhead ..................... Total cost ..........................................

Job 106

Job 107

Total

$17,500 13,000 20,800 $51,300

$21,300 10,000 16,000 $47,300

$38,800 23,000 36,800 $98,600

Managerial Accounting, 13th Canadian Edition

Problem 5-23 (45 minutes) 1a. The first step is to calculate the total estimated overhead costs in ICU and Other: ICU: Estimated fixed overhead ...................................................... $3,200,000 Estimated variable overhead: $236 per patient-day × 2,000 patient-days.......................... 472,000 Estimated total overhead cost ............................................... $3,672,000 Other: Estimated fixed overhead ...................................................... $14,000,000 Estimated variable overhead: $96 per patient-day × 18,000 patient-days.......................... 1,728,000 Estimated total overhead cost ............................................... $15,728,000 The second step is to combine the estimated overhead costs in ICU and Other ($3,672,000 + $15,728,000 = $19,400,000) to enable calculating the predetermined overhead rate as follows: Estimated total overhead (a) ..................................$19,400,000 Estimated total patient-days (b) .............................. 20,000 patient-days Predetermined overhead rate (a) ÷ (b) ................... $970 per patient-day 1b. The total cost assign to Patients A and B is computed as follows:

Direct materials ................................................ Direct labour .................................................... Overhead applied ($970 per patient-day × 14 patient days; ($970 per patient-day × 21 patient days) .................................................... Total cost .........................................................

Patient A

Patient B

$ 4,500 25,000

$ 6,200 36,000

13,580 $43,080

20,370 $62,570

205

Problem 5-23 (continued) 2a. The overhead rate in ICU is computed as follows: Estimated fixed overhead ...................................................... $3,200,000 Estimated variable overhead: $236 per patient-day × 2,000 patient-days.......................... 472,000 Estimated total overhead cost ............................................... $3,672,000 The predetermined overhead rate is computed as follows: Estimated total overhead (a) .................................. $3,672,000 Estimated total patient-days (b) ............................. 2,000 patient-days Predetermined overhead rate (a) ÷ (b) ................... $1,836 per patient-day The overhead rate in Other is computed as follows: Estimated fixed overhead ...................................................... $14,000,000 Estimated variable overhead: $96 per patient-day × 18,000 patient-days.......................... 1,728,000 Estimated total overhead cost ............................................... $15,728,000 The predetermined overhead rate is computed as follows: Estimated total overhead (a) .................................. $15,728,000 Estimated total patient-days (b) ............................. 18,000 patient-days Predetermined overhead rate (rounded) (a) ÷ (b) ..................................................................... $873.78 per patient-day

Managerial Accounting, 13th Canadian Edition

Problem 5-23 (continued) 2b. The total cost assigned to Patient A: Direct materials ........................................................... Direct labour ............................................................... ICU ($1,836 per patient-day × 0 patient-days) .............. Other ($873.78 per patient day × 14 patient-days) (rounded to nearest dollar) ....................................... Total cost assigned to Patient A ....................................

$ 4,500 25,000 $

12,233

12,233 $41,733

The total cost assigned to Patient B: Direct materials ........................................................... Direct labour ............................................................... ICU ($1,836 per patient-day × 7 patient-days) .............. Other ($873.78 per patient day × 14 patient-days) (rounded to nearest dollar) ....................................... Total cost assigned to Patient B ....................................

$ 6,200 36,000 $12,852 12,233

25,085 $67,285

3. Relying on just one predetermined overhead rate overlooks the fact that some departments are more intensive users of overhead resources than others. As the name implies, patients in the ICU require more intensive (and expensive) care than other patients in other departments. Broadly, speaking, relying on only one overhead rate, will most likely overcost patients with less severe illnesses and undercost patients with more severe illnesses.

207

Problem 5-24 (30 minutes) Income statement: Sales ..................................................................... Cost of goods sold ($660,000 + $15,000)................ Gross margin ......................................................... Selling and administrative expenses: Selling expenses* ............................................... Administrative expense* ...................................... Net operating income* ...........................................

$945,000 675,000 270,000 $140,000 100,000

240,000 $ 30,000

* Given in the problem Schedule of cost of goods sold: Beginning finished goods inventory* ........................ Add: Cost of goods manufactured ............................ Cost of goods available for sale* ............................. Deduct: Ending finished goods inventory .................. Unadjusted cost of goods sold* ............................... Add: Underapplied overhead ($285,000 ‒ $270,000) Adjusted cost of goods sold** .................................

$ 50,000 690,000 740,000 80,000 660,000 15,000 $675,000

* Given in the problem **From Income Statement

Managerial Accounting, 13th Canadian Edition

Problem 5-24 (continued) Schedule of cost of goods manufactured: Beginning work in process inventory ..................................... Direct materials: Beginning raw materials inventory* ................................. Add: Purchases of raw materials* ................................... Total raw materials available ........................................... Deduct: Ending raw materials inventory* Direct materials used in production ...................................... Direct labor ......................................................................... Manufacturing overhead applied to work in process* Total manufacturing costs added to production* ................... Total manufacturing costs to account for .............................. Deduct: Ending work in process inventory* ........................... Cost of goods manufactured ................................................

$ 42,000 $ 40,000 290,000 330,000 10,000 320,000 78,000 270,000 683,000 725,000 35,000 $690,000

209

Problem 5-25 (30 minutes) 1. Preparation Department predetermined overhead rate:

Predetermined = Estimated total manufacturing overhead cost overhead rate Estimated total amount of the allocation base =

$416,000 =$5.20 per machine-hour 80,000 machine-hours

Fabrication Department predetermined overhead rate:

Predetermined = Estimated total manufacturing overhead cost overhead rate Estimated total amount of the allocation base =

$720,000 =180% of materials cost $400,000 materials cost

2. Preparation Department overhead applied: 350 machine-hours × $5.20 per machine-hour .................. $1,820 Fabrication Department overhead applied: $1,200 direct materials cost × 180% ................................ 2,160 Total overhead cost ............................................................ $3,980 3. Total cost of Job 127: Direct materials ...................... Direct labour .......................... Manufacturing overhead ......... Total cost ..............................

Preparation

Fabrication

Total

$ 940 710 1,820 $3,470

$1,200 980 2,160 $4,340

$2,140 1,690 3,980 $7,810

Unit product cost for Job 127: Average cost per unit =

$7,810 = $312.40 per unit 25 units

Managerial Accounting, 13th Canadian Edition

Problem 5-25 (continued) 4. Manufacturing overhead cost incurred ............... Manufacturing overhead cost applied: 73,000 machine-hours × $5.20 per machinehour .......................................................... $420,000 direct materials cost × 180% .......... Underapplied (or overapplied) overhead ............

Preparation

Fabrication

$390,000

$740,000

379,600 $ 10,400

756,000 $(16,000)

211

Problem 5-26 (45 minutes) 1. The cost of raw materials put into production was: Raw materials inventory, 1/1 ................................... Debits (purchases of materials) ............................... Materials available for use ....................................... Raw materials inventory, 12/31 ............................... Materials requisitioned for production .......................

$ 30,000 420,000 450,000 60,000 $390,000

2. Of the $390,000 in materials requisitioned for production, $320,000 was debited to Work in Process as direct materials. Therefore, the difference of $70,000 ($390,000 – $320,000 = $70,000) would have been debited to Manufacturing Overhead as indirect materials. 3. Total factory wages accrued during the year (credits to the Factory Wages Payable account) ................. Less direct labour cost (from Work in Process) ..................... Indirect labour cost .............................................................

$175,000 110,000 $ 65,000

4. The cost of goods manufactured for the year was $810,000—the credits to Work in Process. 5. The Cost of Goods Sold for the year was: Finished goods inventory, 1/1 ............................................. Add: Cost of goods manufactured (from Work in Process) .... Goods available for sale ..................................................... Finished goods inventory, 12/31 ......................................... Cost of goods sold .............................................................

$ 40,000 810,000 850,000 130,000 $720,000

6. The predetermined overhead rate was:

Predetermined = Manufacturing overhead cost applied overhead rate Direct materials cost =

$400,000 =125% of direct materials cost $320,000

Managerial Accounting, 13th Canadian Edition

Problem 5-26 (continued) 7. Manufacturing overhead was overapplied by $15,000, computed as follows: Actual manufacturing overhead cost for the year (debits) ..................................................................................... Applied manufacturing overhead cost (from Work in Process—this would be the credits to the Manufacturing Overhead account) ...... Overapplied overhead ...................................................................

$385,000 400,000 $(15,000)

8. The ending balance in Work in Process is $90,000. Direct labour makes up $18,000 of this balance, and manufacturing overhead makes up $40,000. The computations are: Balance, Work in Process, 12/31 ............................................... Less: Direct materials cost (given) ............................................. Manufacturing overhead cost ($32,000 × 125%) ............. Direct labour cost (remainder) ..................................................

$90,000 (32,000) (40,000) $18,000

213

Problem 5-27 (60 minutes) 1. a. Predetermined = Estimated total manufacturing overhead cost Overhead rate Estimated total amount of the allocation base =

$248,000 40,000 MH = $6.20 per MH

b. Actual manufacturing overhead costs: Applied manufacturing overhead costs: 42,000 MH × $6.20 ............................................... Underapplied overhead.............................................

264,000 260,400 $ 3,600

Underapplied overhead would be closed directly to Cost of Goods Sold. 2. Calgary Injection Molding Schedule of Cost of Goods Manufactured Direct materials: Raw materials inventory, beginning............................ Add purchases of raw materials ................................. Total raw materials available ..................................... Deduct raw materials inventory, ending ..................... Raw materials used in production .............................. Direct labour................................................................ Manufacturing overhead applied to work in process ....... Total manufacturing cost .............................................. Add: Work in process, beginning................................... Deduct: Work in process, ending .................................. Cost of goods manufactured .........................................

$ 21,000 133,000 154,000 16,000 $138,000 80,000 260,400 478,400 44,000 522,400 40,000 $482,400

Managerial Accounting, 13th Canadian Edition

Problem 5-27 (continued) 3. Cost of goods sold: Finished good inventory, beginning ................................... Add: Cost of goods manufactured ..................................... Goods available for sale ................................................... Deduct: Finished goods inventory, ending ......................... Cost of goods sold ...........................................................

$ 68,000 482,400 550,400 60,000 $490,400

4. Direct materials .................................................................. Direct labour ...................................................................... Overhead applied ($6.20 × 350 MH) .................................... Total manufacturing cost.....................................................

$ 3,200 4,200 2,170 $9,570

$9,570 job cost × 140% = $13,398 price to customer. 5. The amount of overhead cost in Work in Process was: 2,050 MH × $6.20 =$12,710 The amount of direct materials cost in Work in Process was: Total ending work in process ................................ Deduct: Direct labour ..................................................... Manufacturing overhead .................................... Direct materials ....................................................

$40,000 $ 8,000 12,710

20,710 $19,290

The completed schedule of costs in Work in Process was: Direct materials .................................................... $19,290 Direct labour ........................................................ 8,000 Manufacturing overhead ....................................... 12,710 Work in process inventory..................................... $40,000

215

Problem 5-28 (45 minutes) 1. The predetermined overhead rate was calculated as follows: Predetermined rate = $230,000/4,000 machine hours = $57.50 per hr 2. Actual manufacturing overhead cost .................................... Manufacturing overhead cost applied to Work in Process during the year: 3,150 actual machine hours × $57.50 per hour .......................................................................... Underapplied overhead cost ................................................ 3. Cost of Goods Sold ................................................ Manufacturing Overhead ..................................

$228,000

181,125 $ 46,875

46,875 46,875

4. The unexpected economic recession means that the forecasted machine time is well above the time actually used. At the same time, most of the manufacturing overhead cost is fixed so the forecasted dollars of manufacturing overhead stay roughly the same even though the amount of actual machine time has gone down. Thus, the predetermined overhead rate is not accurate and manufacturing overhead is underapplied by a significant amount during the year. Once the Cost of Goods Sold is adjusted for underapplied overhead, profit will be much lower than forecasted as well.

Managerial Accounting, 13th Canadian Edition

Problem 5-29 (45 minutes) 1. a. Raw Materials .................................................. Accounts Payable .......................................

275,000

b. Work in Process ............................................... Manufacturing Overhead ................................... Raw Materials ............................................

220,000 60,000

c. Work in Process ............................................... Manufacturing Overhead ................................... Sales Commissions Expense .............................. Salaries Expense .............................................. Salaries and Wages Payable ........................

180,000 72,000 63,000 90,000

d. Manufacturing Overhead ................................... Rent Expense ................................................... Accounts Payable .......................................

60,000 15,000

e. Manufacturing Overhead ................................... Accounts Payable .......................................

57,000

f. Advertising Expense ......................................... Accounts Payable .......................................

14,000

g. Manufacturing Overhead ................................... Depreciation Expense ....................................... Accumulated Depreciation ...........................

88,000 12,000

h. Work in Process ............................................... Manufacturing Overhead* ...........................

297,000

275,000

280,000

405,000

75,000 57,000 14,000

100,000 297,000

*Predetermined OH rate = $330,000 budget overhead cost/$200,000 DL$ = $1.65 per DL$ (can also be expressed as 165% of direct labour cost) $180,000 DL × $1.65 per DL$ = $297,000 overhead applied.

217

Problem 5-29 (continued) i. Finished Goods ............................................ Work in Process .....................................

675,000

j. Accounts Receivable .................................... Sales ..................................................... Cost of Goods Sold ...................................... Finished Goods ......................................

1,250,000

675,000 1,250,000 700,000 700,000

2. Bal. (a)

Raw Materials 25,000 (b) 275,000

Bal.

20,000

Bal. (i)

Bal.

(j)

Finished Goods 40,000 (j) 675,000

280,000

700,000

15,000

Bal. (b) (c) (h) Bal.

(b) (c) (d) (e) (g) Bal.

Work in Process 10,000 (i) 220,000 180,000 297,000 32,000

675,000

Manufacturing Overhead 60,000 (h) 297,000 72,000 60,000 57,000 88,000 40,000

Cost of Goods Sold 700,000

3. Manufacturing overhead is underapplied by $40,000 for the year. To dispose of underapplied inventory, we need to this amount must be closed out to Cost of Goods Sold.

Managerial Accounting, 13th Canadian Edition

Problem 5-29 (continued) 4. Gold Nest Company Income Statement For the Year Ended June 30 Sales .......................................................................... Cost of goods sold ($700,000 +40,000 ......................... Gross Margin ………………………………………….. Selling and administrative expenses: Sales commissions ................................................... $63,000 Administrative salaries.............................................. 90,000 Rent expense .......................................................... 15,000 Advertising expenses ............................................... 14,000 Depreciation expense ............................................... 12,000 Operating income .......................................................

$1,250,000 740,000 510,000

194,000 $316,000

Additional Notes: You may wish to have the student prepare a statement of Cost of Goods manufactured as follows: Raw Materials, B.I. Purchase of RM R.M. Available Less: Raw Material, E.I. Raw Materials Used Less: Indirect Material Direct Material Used Direct Labour Manufacturing Overhead Applied Manufacturing Costs for the year Add: WIP B.I. Less: WIP E.I. Cost of Goods Manufactured

$ 25,000 275,000 300,000 20,000 280,000 60,000 $ 220,000 180,000 297,000 697,000 10,000 32,000 $675,000

Remind the students that this statement is just a detailed explanation of what is in the WIP t-account.

219

Problem 5-30 (120 minutes) 1. a. Raw Materials ................................................ Accounts Payable .....................................

200,000

b. Work in Process ............................................. Raw Materials ..........................................

185,000

c. Manufacturing Overhead................................. Utilities expense Accounts Payable .....................................

63,000 7,000

d. Work in Process ............................................. Manufacturing Overhead................................. Selling and Admin Expense ............................. Salaries and Wages Payable ......................

230,000 90,000 110,000

e. Manufacturing Overhead................................. Accounts Payable .....................................

54,000

Advertising Expense ....................................... Accounts Payable .....................................

136,000

g. Manufacturing Overhead................................. Depreciation Expense ..................................... Accumulated Depreciation.........................

76,000 19,000

h. Manufacturing Overhead................................. Rent Expense ................................................. Accounts Payable .....................................

102,000 18,000

390,000

Work in Process ............................................. Manufacturing Overhead...........................

200,000 185,000

70,000

430,000 54,000 136,000

95,000

120,000 390,000

*Estimated total manufacturing overhead cost = $360,000 Estimated direct labour hours = 900 hours Predetermined overhead rate = $360,000/900 hrs = $400 per DLH Actual direct labour hours = 975 Manufacturing overhead applied = $400 x 975 DLH = $390,000

Managerial Accounting, 13th Canadian Edition

Problem 5-30 (continued) j. Finished Goods .............................................. Work in Process .......................................

770,000

k. Accounts Receivable ...................................... Sales ....................................................... Cost of Goods Sold ........................................ Finished Goods ........................................

1,200,000

770,000 1,200,000 800,000 800,000

2. (l)

Accounts Receivable 1,200,000

Bal. (b) (d) (i) Bal.

Work in Process 21,000 (j) 185,000 230,000 390,000 56,000

770,000

Bal. (j)

Finished Goods 60,000 (k) 770,000

Bal.

30,000

185,000

800,000

Manufacturing Overhead 63,000 (i) 390,000 90,000 54,000 76,000 102,000 5,000

Accounts Payable (a) (c) (e) (f) (h)

Accumulated Depreciation (g) 95,000

(g)

Depreciation Expense 19,000

(d)

Selling and Admin Expense 110,000

(f)

Advertising Expense 136,000

Salaries & Wages Payable (d) 430,000

(c)

Bal. (a) Bal.

Raw Materials 30,000 (b) 200,000 45,000

Utilities Expense 7,000

200,000 70,000 54,000 136,000 120,000

221

Problem 5-30 (continued) (h)

Rent Expense 18,000 Sales (k)

(k)

Cost of Goods Sold 800,000

1,200,000

3. Oil Field Equipment Company Schedule of Cost of Goods Manufactured Direct materials: Raw materials inventory, beginning................................ Purchases of raw materials ............................................ Materials available for use ............................................. Raw materials inventory, ending .................................... Materials used in production .......................................... Direct labour.................................................................... Manufacturing overhead applied to work in process ........................................................................ Total manufacturing cost .................................................. Add: Work in process, beginning....................................... Deduct: Work in process, ending ...................................... Cost of goods manufactured .............................................

$ 30,000 200,000 230,000 45,000 $185,000 230,000 390,000 805,000 21,000 826,000 56,000 $770,000

4. The t-account analysis indicates manufacturing overhead was over-applied by $5,000 Since we aren‘t told how many units are in ending work in process, finished goods or cost of goods sold, we will use the entire cost of manufacturing in each account to determine how to allocate over-applied overhead.

Managerial Accounting, 13th Canadian Edition

Problem 5-30 (continued) Work in Process inventory at year end Finished goods inventory at year end Cost of Goods Sold Less: Work in process inventory, beg. Less: Finished goods inventory, beg. Total

$800,000 21,000 60,000

$56,000 $30,000

7% 4%

719,000 $805,000

89% 100%

The entry to dispose of this balance would be: Manufacturing Overhead……………………… Work in Process Inventory (7% x $5,000) Finished Goods Inventory (4% x $5,000) Cost of Goods Sold (89% x $5,000)

5,000 350 200 4,450

Schedule of cost of goods sold: Finished goods inventory, beginning .......................... Add: Cost of goods manufactured ............................. Goods available for sale ............................................ Finished goods inventory, ending .............................. Unadjusted cost of goods sold .................................. Deduct allocated overapplied overhead...................... Adjusted cost of goods sold ......................................

$ 60,000 770,000 830,000 30,000 800,000 4,450 $795,550

223

Problem 5-30 (continued) 5. Oil Field Equipment Company Income Statement For the year ended xxx Sales...................................................................... Cost of goods sold .................................................. Gross margin .......................................................... Selling and administrative expenses: Selling and Admin expense ................................... Advertising expense ............................................. Depreciation expense ........................................... Rent expense ...................................................... Utilities expense .................................................. Operating income ...................................................

$1,200,000 795,550 404,450 $110,000 136,000 19,000 18,000 7,000 $

290,000 114,450

6. Direct materials .......................................................................... Direct labour ............................................................................. Manufacturing overhead cost applied ($400 × 39) ........................ Total manufacturing cost............................................................. Units produced Cost per unit

$ 8,000 9,200 15,600 $32,800 ÷4 $8,200

Price is 60% above unit product cost Price = 160% x $8,200 = $13,120 per unit

Managerial Accounting, 13th Canadian Edition

Problem 5-31 (60 minutes) 1. a. Predetermined = Estimated total manufacturing overhead cost Overhead rate Estimated total amount of the allocation base =

$1,440,000 $900,000 direct labour cost = 160% Direct labour cost

b. $21,200 × 160% = $33,920 2. a.

Estimated manufacturing overhead cost (a) ................ Estimated direct labour cost (b) ...................................... Predetermined overhead rate (a) ÷ (b) .............................

Cutting Department

Machining Department

Assembly Department

$540,000

$800,000

$100,000

$300,000

$200,000

$400,000

180%

400%

25%

b. Cutting Department: $6,500 × 180% ............................................ Machining Department: $1,700 × 400% ............................................ Assembly Department: $13,000 × 25% ............................................ Total applied overhead .....................................

$11,700 6,800 3,250 $21,750

3. The bulk of the labour cost on the Hastings job is in the Assembly Department, which incurs very little overhead cost. The department has an overhead rate of only 25% of direct labour cost as compared to much higher rates in the other two departments. Therefore, as shown above, use of departmental overhead rates results in a relatively small amount of overhead cost charged to the job.

225

Problem 5-31 (continued) However, use of a plantwide overhead rate in effect redistributes overhead costs proportionately between the three departments (at 160% of direct labour cost) and results in a large amount of overhead cost being charged to the Hastings job, as shown in Part 1. This may explain why the company bid too high and lost the job. Too much overhead cost was assigned to the job for the kind of work being done on the job in the plant. If a plantwide overhead rate is being used, the company will tend to charge too little overhead cost to jobs that require a large amount of labour in the Cutting or Machining Departments. The reason is that the plantwide overhead rate (160%) is much lower than the rates if these departments were considered separately. 4. The company‘s bid price was: Direct materials .......................................................... Direct labour .............................................................. Manufacturing overhead applied (above) ..................... Total manufacturing cost ............................................ Bidding rate ............................................................... Total bid price ............................................................

$ 18,500 21,200 33,920 73,620 × 1.5 $110,430

If departmental overhead rates had been used, the bid price would have been: Direct materials .......................................................... Direct labour .............................................................. Manufacturing overhead applied (above) ..................... Total manufacturing cost ............................................ Bidding rate ............................................................... Total bid price ............................................................

$ 18,500 21,200 21,750 61,450 × 1.5 $ 92,175

Note that if departmental overhead rates had been used, Prime Products would have been the low bidder on the Hastings job since the competitor underbid Prime Products by only $10,000.

Managerial Accounting, 13th Canadian Edition

Problem 5-31 (continued) 5. a. Actual overhead cost ................................................... Applied overhead cost ($870,000 × 160%) .................. Underapplied overhead cost ........................................

$1,482,000 1,392,000 $ 90,000

Actual overhead cost ................... Applied overhead cost: $320,000 × 180% ................... $210,000 × 400% ................... $340,000 × 25% ..................... Underapplied (overapplied) overhead cost ..........................

Cutting

Department Machining

Assembly

Total Plant

$560,000

$830,000

$92,000

$1,482,000

85,000

1,501,000

$ 7,000

$ (19,000)

576,000 840,000

$(16,000)

$(10,000)

227

Problem 5-32 (45 minutes) 1. a. Raw Materials .................................................. Accounts Payable .......................................

30,000 30,000

b. Work in Process ............................................... Manufacturing Overhead ................................... Raw Materials ............................................

25,000 10,000

c. Work in Process ............................................... Manufacturing Overhead ................................... Salaries and Wages Payable ........................

32,000 2,000

d. Manufacturing Overhead ................................... Accounts Payable .......................................

17,900

e. Manufacturing Overhead ................................... Accumulated Depreciation ...........................

10,000

f. Work in Process ............................................... Manufacturing Overhead* ...........................

48,000

g. Salaries expense………………………………… Salaries and wages payable…………….

30,000

h. Selling expenses………………………………… Accounts payable…………………………..

6,000

i. Finished Goods ……………………………….. Work in Process …………………………

34,500

j. Accounts Receivable……………………………. Sales ………………………………………… Cost of Goods Sold ………………………… Finished Goods ………………………..

48,300

35,000

34,000 17,900 10,000 48,000 30,000 6,000 34,500 48,300 34,500 34,500

*Predetermined OH rate = $576,000 budget overhead cost/19,200 DLH = $30 per DLH 1,600 DLH × $30 per DLH = $48,000 overhead applied.

Managerial Accounting, 13th Canadian Edition

Problem 5-32 (continued) 2. (j)

Accounts Receivable 48,300

Bal. (b) (c) (f) Bal.

Work in Process 12,000 (i) 25,000 32,000 48,000 82,500

34,500

(b) (c) (d) (e)

Manufacturing Overhead 10,000 (f) 48,000 2,000 17,900 10,000

Bal.

8,100 Salaries & Wages Payable (c) 34,000 (g) 30,000 Sales (j)

48,300

Accumulated Depreciation (e) 10,000

Bal. (a) Bal.

Raw Materials 15,000 (b) 30,000 10,000

Bal. (i)

Finished Goods 10,000 (j) 34,500

Bal.

10,000 Accounts Payable (a) (c) (d) (h)

(g)

Admin Expense 30,000

(j)

Cost of Goods Sold 34,500

(h)

35,000

34,500

30,000 34,000 17,900 6,000

Selling Expenses 6,000

229

Problem 5-32 (continued) 3. Mountain Manufacturing Company Schedule of Cost of Goods Manufactured Direct materials: Raw materials inventory, beginning................................ Purchases of raw materials ............................................ Materials available for use ............................................. Raw materials inventory, ending .................................... Materials used in production .......................................... Less: Indirect materials included in manufacturing overhead…………………………………………… Direct labour.................................................................... Manufacturing overhead applied to work in process ........................................................................ Total manufacturing cost .................................................. Add: Work in process, beginning.......................................

$ 15,000 30,000 45,000 10,000 35,000 10,000

$25,000 32,000

Deduct: Work in process, ending ...................................... Cost of goods manufactured .............................................

48,000 105,000 12,000 117,000 82,500 $34,500

Cost of Goods Sold Finished goods inventory, beginning………………… Add: Cost of Goods Manufactured……………………. Goods available for Sale…………………………………. Deduct Finished Goods Inventory, ending………… Unadjusted Cost of Goods Sold

$10,000 34,500 44,500 10,000 34,500

4. The t-account for Manufacturing Overhead indicates that overhead was overapplied by $8,100. We first need to determine how much overhead is included in each of the inventory accounts and in Cost of Goods Sold for the month of January as follows:

Managerial Accounting, 13th Canadian Edition

Problem 5-32 (continued) Overhead applied to Finished goods in January ............................ $0 * Overhead applied to Work in Process Inventory, January Job B DLH of 1,250 x $30 per DLH ……. $37,500 78% Overhead included in Cost of Goods Sold, January Job A 350 DLH x $30 per DLH………………………… 10,500 22% Total Overhead applied ...............................................................$48,000 100% *We know that the only sales during January were for Job A so the same finished goods costing $10,000 that were in Finished Goods inventory at the beginning of the month are still there at the end of the month. No overhead costs for January were applied to those units. Using the percentages calculated above, the journal entry to dispose of $8,100 of overapplied inventory is as follows:** Manufacturing Overhead ................................... Work in Process Inventory ($8,100 x .78) Cost of Good Sold ($8,100 x .22)

8,100 6,318 1,782

Therefore, the adjusted Cost of Goods Sold = $34,500 – 1,782 = $32,718 ** Instructors may wish to clarify with the students that this journal entry to correct the manufacturing overhead balance is not typically made until the end of the fiscal year, but adding this required in a problem that deals with manufacturing during one month allows them to practice the calculations to allocate overapplied inventory in a relatively simple setting.

231

Problem 5-32 (continued) 5. Mountain Manufacturing Company Income Statement For the Month ended January 31 Sales ........................................................................ Cost of goods sold ................................................... Gross margin ............................................................ Selling and administrative expenses: Admin expense ...................................................... Selling expense ...................................................... Operating loss ..........................................................

$48,300 32,718 15,582 $30,000 6,000

36,000 ($20,418)

Managerial Accounting, 13th Canadian Edition

Case 5-33 (45 minutes) 1. The revised predetermined overhead rate is determined as follows: Original estimated total manufacturing overhead ................ Plus: Lease cost of the new machine ................................. Plus: Cost of new technician/programmer .......................... Estimated total manufacturing overhead ............................

$3,402,000 348,000 50,000 $3,800,000

Original estimated total direct labour-hours ........................ Less: Estimated reduction in direct labour-hours................. Estimated total direct labour-hours ....................................

63,000 6,000 57,000

Predetetermined = Estimated total manufacturing overhead overhead rate Estimated total amount of the allocation base =

$3,800,000 57,000 DLHs

=$66.67 per DLH The revised predetermined overhead rate is higher than the original rate because the automated milling machine will increase the overhead for the year (the numerator in the rate) and will decrease the direct labour-hours (the denominator in the rate). This double-whammy effect increases the predetermined overhead rate. 2. Acquisition of the automated milling machine will increase the apparent costs of all jobs—not just those that use the new facility. This is because the company uses a plantwide overhead rate. If there were a different overhead rate for each department, this would not happen. 3. The predetermined overhead rate is now considerably higher than it was. This will penalize products that continue to use the same amount of direct labour-hours. Such products will now appear to be less profita-ble and the managers of these products will appear to be doing a poorer job. There may be pressure to increase the prices of these products even though there has in fact been no increase in their real costs.

233

Case 5-33 (continued) 4. While it may have been a good idea to acquire the new equipment because of its greater capabilities, the calculations of the cost savings were in error. The original calculations implicitly assumed that overhead would decrease because of the reduction in direct labour-hours. In reality, the overhead increased because of the additional costs of the new equipment. A differential cost analysis would reveal that the automated equipment would increase total cost by about $316,000 a year if the labour reduction is only 2,000 hours. Cost consequences of leasing the automated equipment: Increase in manufacturing overhead cost: Lease cost of the new machine ............................................... Cost of new technician/programmer ........................................ Less: labour cost savings (2,000 hours × $41 per hour)............... Net increase in annual costs .......................................................

$348,000 50,000 398,000 82,000 $316,000

Even if the entire 6,000-hour reduction in direct labour-hours occurred, that would have added only $164,000 (4,000 hours × $41 per hour) in cost savings. The net increase in annual costs would have been $152,000 and the machine would still be an unattractive proposal. The entire 6,000-hour reduction may ultimately be realized as workers retire or quit. However, this is by no means automatic. There are two morals to this tale. First, predetermined overhead rates should not be misinterpreted as variable costs. They are not. Second, a reduction in direct labour requirements does not necessarily lead to a reduction in direct labour hours paid. It is often very difficult to actually reduce the direct labour force and may be virtually impossible in some countries except through natural attrition.

Managerial Accounting, 13th Canadian Edition

Case 5-34 (30 minutes) 1. Calculation of shop-wide overhead application rate Salaries of skilled repair personnel (4 x $50,000) Salaries of repair technicians (2 x $38,000) Other budgeted indirect support costs Total indirect costs

$200,000 76,000 178,450 $454,450

Total estimated hours worked (6 x 1,750)

10,500

Shop rate (Total indirect costs/ estimated total hours)

$43.28

2. Calculation of shop rates for simple and complex work Total indirect costs 65% due to complex repairs Time spent on complex repairs (50% of 10,500)

$454,450.00 $295,392.50 5,250

Shop rate for complex repairs

$56.27

35% of indirect cost due to simple repairs Time spent on simple repairs (50% of 10,500) Shop rate for simple repairs

$159,057.50 5,250.00 $ 30.30

3. a. Price of Job 1246 using shop-wide rate Price for Job 1246 using shop wide rate: Direct materials cost 6 hours x $43.28 for support costs Total cost Price to customer after mark up of 10%

$115.00 259.68 $374.68 $412.15

b. Price of Job 1246 using separate rates for simple and complex repairs: Price for Job 1246 using complex and simple shop rates: Direct materials cost Support costs for complex work (2 hrs x $56.27) Support costs for simple work (4 hrs x $30.30) Total cost Price after mark up of 10%

$115.00 112.54 121.20 $348.74 $383.61

235

Case 5-34 (continued) 4. For jobs with more simple than complex elements like Job 1246, Foster can charge a lower overall price (e.g., $383.61 versus $412.15 using the single shop-wide rate). Given there is a new competing shop in the neighbourhood, setting a more accurate price becomes even more important. The decision to use two different rates comes down to the issue of costs versus benefits. While it is more costly to gather and analyze information using two different overhead application rates, Foster may derive significant benefits due to more accurate pricing. In addition, by using a shop-wide average rate, Foster may actually be under-pricing more complex repairs which would also have a negative effect on company profitability. Improved decision making resulting from more accurate information can justify the additional costs of gathering separate information for each type of repair.

Managerial Accounting, 13th Canadian Edition

Appendix 5A Solutions Question 5A-1 When the predetermined overhead rate is based on the amount of the allocation base at capacity and the plant is operated at less than capacity, overhead will ordinarily be underapplied. This occurs because actual activity is less than the activity the predetermined overhead rate is based on. Question 5A-2 Critics of current practice advocate disclosing underapplied overhead on the income statement as Cost of Unused Capacity—a period expense. This would highlight the amount rather than burying it in other accounts.

237

Exercise 5A-1 (30 minutes) 1. The overhead applied to Ms. Miyami‘s account would be computed as follows: Estimated overhead cost (a).......................................... Estimated professional staff hours (b) ............................ Predetermined overhead rate (a) ÷ (b) .......................... Professional staff hours charged to Ms. Miyami‘s account ................................................. Overhead applied to Ms. Miyami‘s account .....................

20X1

20X2

$144,000 2,400 $60

$144,000 2,250 $64

×5 $300

×5 $320

2. If the actual overhead cost and the actual professional hours charged turn out to be exactly as estimated there would be no underapplied or overapplied overhead. Predetermined overhead rate (see above)...................... Actual professional staff hours charged to clients‘ accounts (by assumption) ............................... Overhead applied ......................................................... Actual overhead cost incurred (by assumption) .............. Under- or overapplied overhead ....................................

20X1

20X2

$60

$64

× 2,400 $144,000 144,000 $ 0

× 2,250 $144,000 144,000 $ 0

Managerial Accounting, 13th Canadian Edition

Exercise 5A-1 (continued) 3. If the predetermined overhead rate is based on the professional staff hours available, the computations would be:

Estimated overhead cost (a) ........................................... Professional staff hours available (b) ............................... Predetermined overhead rate (a) ÷ (b) ........................... Professional staff hours charged to Ms. Miyami‘s account . Overhead applied to Ms. Miyami‘s account .......................

20X1

20X2

$144,000 3,000 $48 ×5 $240

4. If the actual overhead cost and the actual professional staff hours charged to clients‘ accounts turn out to be exactly as estimated overhead would be underapplied as shown below. Predetermined overhead rate (see 3 above) (a) ............... Actual professional staff hours charged to clients‘ accounts (by assumption) (b) ........................... Overhead applied (a) × (b) ............................................. Actual overhead cost incurred (by assumption) ................ Underapplied overhead ...................................................

20X1

20X2

$48

× 2,400 $115,200 144,000 $ 28,800

× 2,250 $108,000 144,000 $ 36,000

The underapplied overhead is best interpreted in this situation as the cost of idle capacity. Proponents of this method of computing predetermined overhead rates suggest that the underapplied overhead be treated as a period expense that would be separately disclosed on the income statement as Cost of Unused Capacity.

239

Problem 5A-2 (60 minutes) 1. The overhead applied to the Fire job would be computed as follows: Estimated studio overhead cost (a) ................................ Estimated hours of studio service (b) ............................. Predetermined overhead rate (a) ÷ (b) .......................... Fire job‘s studio hours .................................................. Overhead applied to the Fire job ..................................

20X1

20X2

$90,000 1,000 $90 × 30 $2,700

$90,000 750 $120 × 30 $3,600

Overhead is underapplied for both years as computed below: Predetermined overhead rate (see above) (a) ................ Actual hours of studio service provided (b) .................... Overhead applied (a) × (b) ........................................... Actual studio cost incurred ............................................ Underapplied overhead .................................................

20X1

20X2

$90 900 $81,000 90,000 $ 9,000

$120 600 $72,000 90,000 $18,000

2. If the predetermined overhead rate is based on the hours of studio service at capacity, the computations would be: Estimated studio overhead cost (a) ................................ Hours of studio service at capacity (b) ........................... Predetermined overhead rate (a) ÷ (b) .......................... Fire job‘s studio hours .................................................. Overhead applied to the Fire job ..................................

20X1

20X2

$90,000 1,800 $50 × 30 $1,500

Overhead is underapplied for both years under this method as well: Predetermined overhead rate (see above) (a) ................... Actual hours of studio service provided (b) ....................... Overhead applied (a) × (b) .............................................. Actual studio cost incurred ............................................... Underapplied overhead ....................................................

20X1

20X2

$50 900 $45,000 90,000 $45,000

$50 600 $30,000 90,000 $60,000

3. When the predetermined overhead rate is based on capacity, underapplied overhead is interpreted as the cost of idle capacity. Indeed, proponents of this method suggest that underapplied overhead be treated as a period expense that would be separately disclosed on the income statement as Cost of Unused Capacity. © McGraw Hill Ltd., 2024. All rights reserved. 240

Managerial Accounting, 13th Canadian Edition

Problem 5A-2 (continued) 4. Alderberry Recording‘s fundamental problem is the competition that is drawing customers away. The competition is able to offer the latest equipment, excellent service, and attractive prices. The company must do something to counter this threat or it will ultimately face failure. Under the conventional approach in which the predetermined overhead rate is based on the estimated studio hours, the apparent cost of the Fire job has increased between 20X1 and 20X2. That happens because the company is losing business to competitors and therefore the company‘s fixed overhead costs are being spread over a smaller base. This results in costs that seem to increase as the volume declines. Alderberry Recording‘s managers may be misled into thinking that the problem is rising costs and they may be tempted to raise prices to recover their apparently increasing costs. This would almost surely accelerate the company‘s decline. Under the alternative approach, the overhead cost of the Fire job is stable at $1,500 and lower than the costs reported under the conventional method. Under the conventional method, managers may be misled into thinking that they are actually losing money on the Fire job and they might refuse such jobs in the future—another sure road to disaster. This is much less likely to happen if the lower cost of $1,500 is reported. It is true that the underapplied overhead under the alternative approach is much larger than under the conventional approach and is growing. However, if it is properly labeled as the cost of idle capacity, management is much more likely to draw the appropriate conclusion that the real problem is the loss of business (and therefore more idle capacity) rather than an increase in costs. While basing the predetermined rate on capacity rather than on estimated activity will not solve the company‘s basic problems, at least this method will be less likely to send managers misleading signals.

241

Case 5A-3 (120 minutes) 1. Traditional approach: Actual total manufacturing overhead cost incurred (assumed to equal the original estimate) ................................. Manufacturing overhead applied (80,000 units × $25 per unit) ................................................. Overhead underapplied or overapplied .......................................

$2,000,000 2,000,000 $ 0

PowerDrives, Inc. Income Statement: Traditional Approach Revenue (75,000 units × $70 per unit) ...................... Cost of goods sold: Variable manufacturing (75,000 units × $18 per unit) .............................. Manufacturing overhead applied (75,000 units × $25 per unit) .............................. Gross margin ........................................................... Selling and administrative expenses .......................... Operating income .....................................................

$5,250,000

$1,350,000 1,875,000

3,225,000 2,025,000 1,950,000 $ 75,000

New approach: PowerDrives, Inc. Income Statement: New Approach Revenue (75,000 units × $70 per unit) ...................... Cost of goods sold: Variable manufacturing (75,000 units × $18 per unit) .............................. Manufacturing overhead applied (75,000 units × $20 per unit) .............................. Gross margin ........................................................... Cost of unused capacity [(100,000 units  80,000 units) × $20 per unit] ............................................ Selling and administrative expenses .......................... Operating income .....................................................

$5,250,000

$1,350,000 1,500,000

2,850,000 2,400,000 400,000 1,950,000 $ 50,000

Managerial Accounting, 13th Canadian Edition

Case 5A-3 (continued) 2. Traditional approach: Under the traditional approach, the reported operating income can be increased by increasing the production level, which then results in overapplied overhead that is deducted from Cost of Goods Sold. Additional operating income required to attain target operating income ($210,000 - $75,000) (a)...................... Overhead applied per unit of output (b) ....................................... Additional output required to attain target operating income (a) ÷ (b) ....................................................... Actual total manufacturing overhead cost incurred ........................ Manufacturing overhead applied [(80,000 units + 5,400 units) × $25 per unit] ............................ Overhead overapplied..................................................................

$135,000 $25 per unit 5,400 units $2,000,000 2,135,000 $ 135,000

PowerDrives, Inc. Income Statement: Traditional Approach Revenue (75,000 units × $70 per unit) ..................... Cost of goods sold: Variable manufacturing (75,000 units × $18 per unit) ............................. Manufacturing overhead applied (75,000 units × $25 per unit) ............................. Less: Manufacturing overhead overapplied ............. Gross margin ........................................................... Selling and administrative expenses .......................... Operating income ....................................................

$5,250,000

$1,350,000 1,875,000 135,000

3,090,000 2,160,000 1,950,000 $ 210,000

Note: If the overapplied manufacturing overhead were prorated between ending inventories and Cost of Goods Sold, more units would have to be produced to attain the target operating income of $210,000.

243

Case 5A-3 (continued) New approach: Under the new approach, the reported operating income can be increased by increasing the production level which then results in less of a deduction on the income statement for the Cost of Unused Capacity. Additional operating income required to attain target operating income ($210,000 - $50,000) (a) ............................................. Overhead applied per unit of output (b) ...................................... Additional output required to attain target operating income (a) ÷ (b) ..................................................................................... Estimated number of units produced .......................................... Actual number of units to be produced .......................................

$160,000 $20 per unit 8,000 units 80,000 units 88,000 units

PowerDrives, Inc. Income Statement: New Approach Revenue (75,000 units × $70 per unit).............................. Cost of goods sold: Variable manufacturing (75,000 units × $18 per unit) ..................................... Manufacturing overhead applied (75,000 units × $20 per unit) ..................................... Gross margin ................................................................... Cost of unused capacity [(100,000 units - 88,000 units) × $20 per unit] .............. Selling and administrative expenses .................................. Operating income ............................................................

$5,250,000

$1,350,000 1,500,000

2,850,000 2,400,000 240,000 1,950,000 $ 210,000

3. Operating income is more volatile under the new method than under the old method. The reason for this is that the reported profit per unit sold is higher under the new method by $5, the difference in the predetermined overhead rates. As a consequence, swings in sales in either direction will have a more dramatic impact on reported profits under the new method.

Managerial Accounting, 13th Canadian Edition

Case 5A-3 (continued) 4. As the computations in part (2) above show, the ―hat trick‖ is a bit harder to perform under the new method. Under the old method, the target operating income can be attained by producing an additional 5,400 units. Under the new method, the production would have to be increased by 8,000 units. This is a consequence of the difference in predetermined overhead rates. The drop in sales has had a more dramatic effect on operating income under the new method as noted above in part (3). In addition, since the predetermined overhead rate is lower under the new method, producing excess inventories has less of an effect per unit on operating income than under the traditional method and hence more excess production is required. 5. One can argue that whether the ―hat trick‖ is unethical depends on the level of sophistication of the owners of the company and others who read the financial statements. If they understand the effects of excess production on operating income and are not misled, it can be argued that the hat trick is ethical. However, if that were the case, there does not seem to be any reason to use the hat trick. Why would the owners want to tie up working capital in inventories just to artificially attain a target operating income for the period? Also increasing the rate of production toward the end of the year is likely to increase overhead costs due to overtime and other costs. Building up inventories all at once is very likely to be much more expensive than increasing the rate of production uniformly throughout the year. In the case, we assumed that there would not be an increase in overhead costs due to the additional production, but that is likely not to be true. In our opinion the hat trick is unethical unless there is a good reason for increasing production other than to artificially boost the current period‘s operating income. It is certainly unethical if the purpose is to fool users of financial reports such as owners and creditors or if the purpose is to meet targets so that bonuses will be paid to top managers.

Chapter 6 Systems Design: Process Costing

Solution to Discussion Case

245

Estimating percentage of completion of products requires a judgment call. As with all areas where judgment comes to play, managers will tend to be more or less conservative depending on several factors including the degree to which they inherently tend toward conservative estimates and forecasts. From the perspective of the organization, the objective is to provide as accurate an estimate of percentage of completion as possible in order to better understand and control costs and to ensure the integrity of the costing system. Even so, managers also have incentives to improve profit, both for the shareholder's sake as well as to meet performance evaluation and bonus targets each year. Managers could, for example, overestimate WIP thereby reducing Cost of Goods Sold and falsely increase profits. But ―misestimating‖ is likely of only short term benefit since the Board will quite quickly fail to trust the manager's estimated percentage of completion if they prove to be wrong over several periods. Once this happens, the company would be foolish to continue to provide incentives to base bonuses on divisional profit figures if these figures cannot be trusted. In the end, the benefit of subverting the integrity of the accounting system is likely much lower than the potential long-term reputational cost.

Managerial Accounting, 13th Canadian Edition

Solutions to Questions 6-1 A process costing system should be used in situations where a homogeneous products or services are produced on a continuous basis. 6-2 1. In job-order costing many different jobs are worked on during each period each with its own production requirements. In process costing, a single product is produced on a continuous basis and all units are identical. 2. The job cost sheet is the key document in job-order costing while the department production report is the key document in process costing. 3. Unit costs are computed by job in job-order costing while unit costs are computed by department in process costing. 6-3 Cost accumulation is simpler under process costing because costs only need to be assigned to departments—not separate jobs. A company usually has a small number of processing departments, whereas a job-order costing system often must keep track of the costs of hundreds or even thousands of jobs. 6-4 In a process costing system, a Work in Process account is maintained for each processing department.

to the next department (or to finished goods) during the period plus the equivalent units in the department‘s ending work in process inventory. 6-8 Disagree. In fact, flexible manufacturing systems may actually increase the use of process costing over time. These systems can have a major impact on costing since they allow for an easy switch from producing one type of product to another. The systems‘ flexibility means product switching results in little time lost and relatively low setup costs. Therefore, companies are able to move between products with about the same speed as they would if they were working in a continuous processing environment. As the use of flexible manufacturing systems grows, so should the application of process costing techniques. 6-9 Advantages of the weighted average method include: computations are simpler; the managers does not need information at too fine a level of detail so the average is informative enough; there is little change in cost from period to period; in cases where ending inventories are typically low each period when compared to current production, the average ends up being quite accurate.

6-5 The journal entry would be: Work in Process, Firing...................................... XXXX Work in Process, Mixing ... XXXX 6-6 The costs that might be added to the Firing Department‘s Work in Process account during the period are, (1) transferred-in costs from the Mixing Department; (2) direct materials costs; (3) direct labour costs; and (4) manufacturing overhead costs added in the Firing Department. 6-7 Since there are inevitably incomplete units in inventory at the end of an accounting period, ‗equivalent units‘ are calculated to arrive and the mathematical equivalent of fully completed units these incomplete units represent. Under the weighted-average method, equivalent units of production consist of units transferred © McGraw Hill Ltd., 2024. All rights reserved. Solutions Manual, Chapter 6

247

Foundational Exercises 1. The journal entries would be recorded as follows: Work in Process—Mixing ............................................................... 120,000 Raw Materials Inventory .........................................................

120,000

Work in Process—Mixing ............................................................... 79,500 Wages Payable....................................................................... 79,500 2. The journal entry would be recorded as follows: Work in Process—Mixing ............................................................... 97,000 Manufacturing Overhead......................................................... 97,000 3. The ―units completed and transferred to finished goods‖ is computed as follows:

Pounds Work in process, June 1 ........................................................ Started into production during the month ............................... Total pounds in process ......................................................... Deduct work in process, June 30 ............................................ Completed and transferred out during the month .................... 4. and 5.

5,000 37,500 42,500 8,000 34,500

The equivalent units of production for materials and conversion are computed as follows:

Equivalent Units Materials Conversion Units transferred out ............................................... Work in process, ending: 8,000 units × 100% .............................................. 8,000 units × 40% ................................................ Equivalent units of production ...................................

34,500

8,000 42,500

3,200 37,700

Managerial Accounting, 13th Canadian Edition

Foundational Exercises (continued) 6. and 7.

Materials Cost of beginning work in process ............................ Cost added during the period ................................... Total cost ................................................................

Conversion

$ 16,000 120,000 $136,000

$ 12,000 176,500* $188,500

* $79,500 + $97,000 = $176,500 8. and 9. The cost per equivalent unit for materials and conversion is computed as follows: Total cost (a) .................................................... Equivalent units of production (b) ...................... Cost per equivalent unit (a) ÷ (b)....................... 10. and 11.

$136,000 42,500 $3.20

$188,500 37,700 $5.00

The cost of ending work in process inventory for materials and conversion is computed as follows:

Materials Conversion

Equivalent units of production (a) ............ 8,000 Cost per equivalent unit (b) ..................... $3.20 Cost of ending work in process inventory (a) × (b)............................. $25,600

3,200 $5.00

Total

$16,000 $41,600*

* $41,600 is the June 30 balance in the Work in Process—Mixing Department Taccount. 12. and 13. The cost of materials and conversion transferred to finished goods is computed as follows:

Materials Conversion

Units transferred out (a) .................................. 34,500 Cost per equivalent unit (b) .............................$3.20 Cost of units transferred to finished goods (a) × (b) ......................................... $110,400

34,500 $5.00

Total

$172,500 $282,900

249

Foundational Exercises (continued) 14. The journal entry to record the transfer of costs from Work in Process—Mixing to Finished Goods would be recorded as follows: Finished Goods ..................................... 282,900 Work in Process—Mixing ................ 282,900 15. The total cost to be accounted for and the total cost accounted for is: Costs to be accounted for: Cost of beginning work in process inventory .................... $ 28,000 Costs added to production during the period ................... 296,500 Total cost to be accounted for ........................................ $324,500 Costs accounted for: Cost of ending work in process inventory ........................ Cost of units completed and transferred out .................... Total cost accounted for .................................................

$ 41,600 282,900 $324,500

Managerial Accounting, 13th Canadian Edition

Exercise 6-1 (20 minutes) a. To record issuing raw materials for use in production: Work in Process—Moulding Department . 28,000 Work in Process—Firing Department ...... 5,000 Raw Materials................................ 33,000 b. To record direct labour costs incurred: Work in Process—Moulding Department . 18,000 Work in Process—Firing Department ...... 5,000 Wages Payable .............................. 23,000 c. To record applying manufacturing overhead: Work in Process—Moulding Department . 24,000 Work in Process—Firing Department ...... 37,000 Manufacturing Overhead ................ 61,000 d. To record transfer of unfired, molded bricks from the Molding Department to the Firing Department: Work in Process—Firing Department ...... 67,000 Work in Process—Moulding Department 67,000 e. To record transfer of finished bricks from the Firing Department to the finished goods warehouse: Finished Goods ..................................... 108,000 Work in Process—Firing Department 108,000 f. To record Cost of Goods Sold: Cost of Goods Sold ................................ 106,000 Finished Goods .............................. 106,000

251

Exercise 6-2 (10 minutes) Weighted-Average Method 1. Units completed and transferred out in June: Work in process, June 1 Units started into production Less: Work in process, June 31 Units completed and transferred out

20,000 190,000 (30,000) 180,000

Equivalent Units Materials Conversion Units completed and transferred out .......................... 180,000 Ending work in process: Materials: 30,000 units × 60% complete ................. 30,000 Conversion: 30,000 units × 40% complete .................................................................. Equivalent units of production ................................... 210,000

180,000

18,000

198,000

12,000 192,000

Managerial Accounting, 13th Canadian Edition

Exercise 6-3 (10 minutes) Weighted-Average Method Baking Department Cost Reconciliation Costs to be accounted for: Cost of beginning work in process inventory ............. Costs added to production during the period ............ Total cost to be accounted for .................................

$ 3,570 43,120 $46,690

Costs accounted for as follows: Cost of ending work in process inventory ................. Cost of units completed and transferred out ............. Total cost accounted for ..........................................

$ 2,860 43,830 * $46,690

* Beginning WIP $3,570 + Costs added to production $43,120 – Ending WIP $2,860

253

Exercise 6-4 (10 minutes) Weighted-Average Method 1.

Materials

Conversion

Total

Ending work in process inventory: Equivalent units ..................................... Cost per equivalent unit .........................

2,000 $13.86

800 $4.43

Cost of ending work in process inventory

$27,720

$3,544

$31,264

Materials

Conversion

Total

Units completed and transferred out: Units transferred to next department ...... Cost per equivalent unit .........................

20,100 $13.86

20,100 $4.43

Cost of units transferred out ...................

$278,586

$89,043

$367,629

Managerial Accounting, 13th Canadian Edition

Exercise 6-5 (10 minutes) Work in Process—Mixing ............................................................... 25,000 Raw Materials Inventory ..........................................................

25,000

Work in Process—Mixing ............................................................... 15,000 Work in Process—Baking ............................................................... 12,000 Wages Payable .......................................................................

27,000

Work in Process—Mixing ............................................................... 20,000 Work in Process—Baking ............................................................... 30,000 Manufacturing Overhead .........................................................

50,000

Work in Process—Baking ............................................................... 60,000 Work in Process—Mixing .........................................................

60,000

Finished Goods ............................................................................. 100,000 Work in Process—Baking .........................................................

100,000

255

Exercise 6-6 (20 minutes) Weighted-Average Method 1. Equivalent Units (EU) Units transferred to the next department during October Work in process, October 31: Materials: 40,000 units × 40% complete ........................... Labour and overhead: 40,000 units × 20% complete ......... Equivalent units of production..............................................

Cost per Equivalent Unit: Cost of beginning work in process ................ Costs added during June ............................. Total cost (a) .............................................. Equivalent units of production (b) ................. Cost per equivalent unit (a) ÷ (b) .................

Materials $ 68,000 427,000 $495,000 596,000 $0.83

Materials

Conversion

580,000

16,000 8,000 588,000

596,000

Conversion $ 30,000 170,000 $200,000 588,000 $0.34

Exercise 6-7 (10 minutes) Weighted-Average Method Equivalent Units (EU)

Materials Litres transferred to the Bottling Department during April* .... Work in process, April 30: Materials: 2,000 litres × 100% complete ........................... Labour and overhead: 2,000 litres × 20% complete ........... Equivalent units of production..............................................

Labour & Overhead

43,000

2,000 45,000

400 43,400

* Beginning WIP 25,000 + Started 20,000 – Ending WIP 2,000 = 43,000 litres.

Managerial Accounting, 13th Canadian Edition

Exercise 6-8 (30 minutes) Weighted-Average Method

Equivalent Units:

Materials

Conversion

Units transferred to the next process .......................... 320,000 Ending work in process: Materials: 60,000 units × 45% complete .................. 27,000 Conversion: 60,000 units × 20% complete ................... Equivalent units of production .................................... 347,000

320,000

Costs per Equivalent Unit:

12,000 332,000

Materials

Conversion

Cost of beginning work in process .............................. $ 76,600 Cost added during the period..................................... 410,000 Total cost (a) ............................................................ $486,600 Equivalent units of production (b) .............................. 347,000 Cost per equivalent unit (a) ÷ (b) .............................. $1.40

$ 34,900 234,500 $269,400 332,000 $0.81*

Ending work in process inventory:

Equivalent units of production (see above) ....................................... Cost per equivalent unit (see above). Cost of ending work in process inventory ...................................

Materials

Conversion

27,000 $1.40

12,000 $0.81

$37,800

$9,720

320,000

$1.40

$0.81

$448,000

$259,200

Total

$47,520

Units completed and transferred out:

Units transferred to the next department.................................... Cost per equivalent unit (see above)................................ Cost of units completed and transferred out………………….

$707,200

*rounded

257

Exercise 6-9 (20 minutes) Cost Reconciliation Cost to account for: Work in process Incurred in March Total Costs to Account for Cost accounted for as follow: Transferred to Processing Dept: 3,500 claims x $1.75 Work in process, March 31: Conversion, $1.75 per EU Total cost accounted for

6,913 6,913 Total Cost

Conversion EU

$6,125

3,500

$788* $6,913

450

(500 x 90%)

*rounded to nearest dollar

Managerial Accounting, 13th Canadian Edition

Problem 6-10 (45 minutes) Weighted-Average Method 1. Equivalent Units of Production

Materials Transferred to next department ................................... Ending work in process: Materials: 100,000 units × 60% complete ................. Conversion: 100,000 units × 40% complete .............. Equivalent units of production ..................................... 2.

Conversion

380,000

60,000 40,000 420,000

440,000

Cost per Equivalent Unit

Materials Cost of beginning work in process ............................ Cost added during the period ................................... Total cost (a) .......................................................... Equivalent units of production (b) ............................ Cost per equivalent unit, (a) ÷ (b) ........................... *rounded

Conversion

$ 45,500 425,500 $471,000 440,000 $1.07

$ 25,000 145,000 $170,000 420,000 $0.405*

Applying Costs to Units 3.

Materials

Conversion Total

Ending work in process inventory: Equivalent units of production (materials: 100,000 units × 60% complete; conversion: 100,000 units × 40% complete) ......................... Cost per equivalent unit ............... Cost of ending work in process inventory ..................................... Units completed and transferred out: Units transferred to the next department .................................. Cost per equivalent unit ............... Cost of units completed and transferred out .................................

60,000 $1.07

40,000 $0.405

$64,200 $16,200$80,400

380,000 380,000 $1.07 $0.405 $406,600 $153,900 $560,500

259

Problem 6-10 (continued) 4.

Cost Reconciliation Costs to be accounted for: Cost of beginning work in process inventory ($45,500 + $25,000) ............................................ Costs added to production during the period ($425,500 + $145,000) ......................................... Total cost to be accounted for .................................. Costs accounted for as follows: Transferred to next department: 380,000 units x $1.475................................................. Work in process June 30 Materials at $1.07 per EU ........................................ Conversion at $0.405 per EU ................................... Total cost accounted for ..........................................

$ 70,500 570,500 $641,000

$560,500 64,200 16,200 80,400 $640,900*

*off $100 due to rounding

Managerial Accounting, 13th Canadian Edition

Problem 6-11 (45 minutes) Weighted-Average Method 1. The equivalent units are: Units to be accounted for: Work in process, January 1 (100% complete for materials; 80% complete for conversion) Units started into production Less: Finished goods inventory, January 31 Total units

2,000 10,000 (2,000) 10,000

Equivalent units Materials Conversion

Units accounted for as follows: Work in process, January 31 Materials: 3,000 units x 100 complete…. Conversion: 3,000 units x 60% complete Units completed and sold in the month*

3,000 7,000

7,000

1,800 7,000

Total units accounted for and EU of production

10,000

8,800

3,000

*9,000 units completed – 2,000 units in finished goods inventory on January 31

261

Problem 6-11 (continued) The costs per equivalent unit are:

Materials

Conversion

Work in process, January 1 ....................................... $ 20,000 $31,500 Cost added during the year ....................................... 130,000 188,500 Total cost (a) ........................................................... $150,000 $220,000 Equivalent units of production (b) ............................. 10,000 8,800 Cost per equivalent unit (a) ÷ (b).............................. $15 $25 2. The amount of cost that should be assigned to the ending work in process inventory is:

Materials Ending work in process inventory: Equivalent units of production (100% complete for materials; 60% complete for conversion) Cost per equivalent unit (see above) Cost of ending work in process inventory Finished goods inventory: 2,000 units x ($15+$25)

Conversion

3,000 $15

1,800 $25

$45,000

Total

$90,000 $80,000

3. 1.

Finished Goods Inventory ....................................... Cost of Goods Sold .......................................... Work in Process Inventory ...............................

$5,000 30,000 $35,000

Managerial Accounting, 13th Canadian Edition

Problem 6-12 (30 minutes) Weighted-Average Method 1. Total units transferred to the next department ............... Less units in the May 1 inventory .................................. Units started and completed in May............................... 2.

28,000 8,000 20,000

The equivalent units were:

Materials Transferred to next department ............................. Ending work in process: Materials: 6,000 units × 75% complete............... Conversion: 6,000 units × 50% complete............ Equivalent units of production ............................... 3.

Conversion

28,000

4,500 3,000 31,000

32,500

The costs per equivalent unit were:

Conversion

£ 9,000 56,000 £65,000 32,500 £2.00

£ 4,400 31,250 £35,650 31,000 £1.15

4. The ending work in process figure is verified as follows:

Materials

Conversion

Total

Ending work in process inventory: Equivalent units of production (see above) .......................................... 4,500 3,000 Cost per equivalent unit........................... £2.00 £1.15 Cost of ending work in process inventory .............................................. £9,000 £3,450 £12,450 5. Multiplying the total unit cost figure of £3.15 per unit by 1,000 units does not provide a valid estimate of the incremental cost of processing an additional 1,000 units through the department. If there is sufficient idle capacity to process an additional 1,000 units, the incremental cost per unit is almost certainly less than £3.1 per unit because the conversion costs are likely to include fixed costs.

263

Problem 6-13 (45 minutes) Weighted-Average Method 1. Computation of equivalent units of production:

Mixing

Materials

Units transferred to the next department ................... 50.0 Equivalent units in ending work in process inventory: Mixing: 1 unit × 100% complete ......................... 1.0 Materials: 1 unit × 80% complete ........................ Conversion: 1 unit × 70% complete..................... Equivalent units of production ................................... 51.0 2. Costs per equivalent unit:

50.0

Mixing

Materials

Cost of beginning work in process inventory .............. Cost added during the period .................................... Total cost (a) ........................................................... Equivalent units of production (b) ............................. Cost per equivalent unit (a) ÷ (b) .............................

$ 1,670 81,460 $83,130 51.0 $1,630

Conversion 50.0

0.8 0.7 50.7

50.8

Conversion

$ 90 6,006 $6,096 50.8 $120

Managerial Accounting, 13th Canadian Edition

$ 605 42,490 $43,095 50.7 $850

Problem 6-13 (continued) 3. and 4. Costs of ending work in process inventory and units transferred out:

Mixing Ending work in process inventory: Equivalent units ................................................... Cost per equivalent unit ....................................... Cost of ending work in process inventory .............. Units completed and transferred out: Units transferred to the next department .............. Cost per equivalent unit ....................................... Cost of units transferred out................................. 5. Cost reconciliation: Cost to be accounted for: Cost of beginning work in process inventory ($1,670 + $90 + $605) ........................................ Cost added to production during the period ($81,460 + $6,006 + $42,490) ............................. Total cost to be accounted for ................................. Costs accounted for as follows: Cost of ending work in process inventory ................. Cost of units transferred out ................................... Total cost accounted for..........................................

Materials

Conversion

Total

1.0 $1,630 $1,630

0.8 $120 $96

0.7 $850 $595

$2,321

50.0 $1,630 $81,500

50.0 $120 $6,000

50.0 $850 $42,500

$130,000

$ 2,365 129,956 $132,321 $ 2,321 130,000 $132,321

265

Problem 6-14 (30 minutes) Weighted-Average Method 1. The equivalent units are: Units transferred to the next production department .. Work in process, May 31: Materials: 10,000 units × 100% complete............... Conversion: 10,000 units × 30% complete ............. Equivalent units of production ................................... 2. The costs per equivalent unit are:

Materials

Conversion

175,000

10,000 185,000

3,000 178,500

Materials

Conversion

Work in process, May 1 ............................................ $ 1,500 $ 4,000 Cost added during the year ....................................... 54,000 352,000 Total cost (a) ........................................................... $55,500 $356,000 Equivalent units of production (b) ............................. 185,000 178,500 Cost per equivalent unit (a) ÷ (b).............................. $0.30 $2.00 3. The amount of cost that should be assigned to the ending work in process inventory is:

Materials

Conversion

Ending work in process inventory: Equivalent units of production (see above) ..................................... Cost per equivalent unit ............... Cost of ending work in process inventory ..........................................

10,000 $0.30

3,000 $2.00

$3,000

$6,000

Units completed and transferred out: Units transferred to the next department ........................................ Cost per equivalent unit (see above) Cost of units completed and transferred out .................................

175,000 $0.30

175,000 $2.00

$52,500

$350,000

Total

$9,000

$402,500

Managerial Accounting, 13th Canadian Edition

Problem 6-15 (30 minutes) Weighted-Average Method 1. a.

495,000 Work in Process—Blending ............................................................ 115,000 Work in Process—Bottling 610,000 Raw Materials ........................................................................

Work in Process—Blending ............................................................ 72,000 Work in Process—Bottling ............................................................. 18,000 Salaries and Wages Payable ....................................................90,000

Manufacturing Overhead ............................................................... 225,000 Accounts Payable ................................................................... 225,000

Work in Process—Blending ............................................................ 181,000 Manufacturing Overhead ......................................................... 181,000 Work in Process—Bottling ............................................................. 42,000 Manufacturing Overhead .........................................................42,000

Finished Goods ............................................................................. 950,000 Work in Process—Bottling ....................................................... 950,000

Accounts Receivable ..................................................................... 1,500,000 Sales ..................................................................................... 1,500,000 Cost of Goods Sold ....................................................................... 890,000 Finished Goods ....................................................................... 890,000

267

Problem 6-15 (continued) 2.

(a)

115,000

Work in Process—Blending Bal. 38,000 Part 740,000 4 (a) 495,000

(b)

18,000

(b)

72,000

(d)

42,000

(d)

181,000

Part 4 Bal.

740,000 30,000

Bal.

Part 3 46,000

Bal.

Work in Process—Bottling 65,000 (e) 950,000

(c)

Bal.

Manufacturing Overhead 225,000 (d) 181,000

Bal.

Finished Goods 20,000 (f)

(d)

(e)

950,000

Bal.

80,000

42,000

2,000

Bal.

Raw Materials 681,000 (a)

Bal.

71,000

890,000

Accounts Payable (c) 225,000

610,000

Sales Salaries and Wages Payable (b) 90,000

(f)

Accounts Receivable 1,500,000

(f)

1,500,000

Cost of Goods Sold 890,000

Managerial Accounting, 13th Canadian Edition

Problem 6-15 (continued) 3. Production Report – Blending Department Quantity Schedule Units to be accounted for: Work in process, March 1

20,000

Started into production

390,000

Total Units

410,000 Equivalent Units (EU) Material

Labour

Overhead

Units accounted for as follows: Transferred to Bottling

370,000

Work in process March 31

40,000

30,000

10,000

Total units and equivalent units of production

410,000

400,000

380,000

Material

Labour

Overhead

Costs per Equivalent Unit: Total cost Cost to be accounted for: Work in process, March 1

$38,000

$25,000

$4,000

$9,000

Cost added by the Blending Department

748,000

495,000

72,000

181,000

Total Cost

$786,000

$520,000

$76,000

$190,000

400,000

380,000

$1.30

$0.20

$0.50

Equivalent units of production Cost per equivalent unit

269

Problem 6-15 (continued) Costs accounted for: Completed

370,000 x $2

$740,000

Work in process – end

30,000 x $1.30

39,000

10,000 x $0.20

2,000

10,000 x $0.50

5,000

Total

$746,000

4. Units transferred to bottling 370,000 x ($1.30 + $0.20 +$0.50) Work in Process—Bottling ...................................................... 740,000 Work in Process—Blending ...............................................

740,000

Managerial Accounting, 13th Canadian Edition

Problem 6-16 (30 minutes) Weighted-Average Method 1. Equivalent units of production

Materials Transferred to next department ................................... Ending work in process: Materials: 40,000 units x 75% complete.................... Conversion: 40,000 units x 60% complete................. Equivalent units of production ..................................... 2.

190,000

30,000 220,000

24,000 214,000

Cost per equivalent unit

Materials

Conversion

Cost of beginning work in process ............................ Cost added during the period ................................... Total cost (a) .......................................................... Equivalent units of production (b) ............................ Cost per equivalent unit, (a) ÷ (b) ...........................

$ 67,800 579,000 $646,800 220,000 $2.94

Total units transferred ............................................ Less units in the beginning inventory ....................... Units started and completed during April .................

190,000 30,000 160,000

Conversion $ 30,200 248,000 $278,200 214,000 $1.30

Note: This answer assumes that the units in the beginning inventory are completed before any other units are completed. 4. No, the manager should not be rewarded for good cost control. The Mixing Department’s low unit cost for April occurred because the costs of the prior month have been averaged in with April’s costs. This is a major criticism of the weighted-average method. Costs computed for product costing purposes should not be used to evaluate cost control or to measure performance for the current period.

271

Problem 6-17 (45 minutes) Weighted-Average Method 1. Equivalent units of production:

Materials Transferred to next department ................................... Ending work in process: Materials: 40,000 units x 100% complete .................. Conversion: 40,000 units x 25% complete................. Equivalent units of production ..................................... 2.

Conversion

160,000

40,000 10,000 170,000

200,000

Cost per Equivalent Unit

Conversion

$ 25,200 334,800 $360,000 200,000 $1.80

$ 24,800 238,700 $263,500 170,000 $1.55

Conversion

Total

Applying costs to units:

Materials Ending work in process inventory: Equivalent units of production ...... Cost per equivalent unit ............... Cost of ending work in process inventory .......................................... Units completed and transferred out: Units transferred to the next department ........................................ Cost per equivalent unit ............... Cost of units completed and transferred out .................................

40,000 $1.80

10,000 $1.55

$72,000

$15,500

160,000 $1.80

160,000 $1.55

$288,000

$248,000

$87,500

$536,000

Managerial Accounting, 13th Canadian Edition

Problem 6-17 (continued) 4. Cost reconciliation: Costs to be accounted for: Cost of beginning work in process inventory ($25,200 + $24,800)............................................. Costs added to production during the period ($334,800 + $238,700) ......................................... Total cost to be accounted for .................................. Costs accounted for as follows: Cost of ending work in process inventory .................. Cost of units completed and transferred out.............. Total cost accounted for...........................................

$ 50,000 573,500 $623,500 $ 87,500 536,000 $623,500

273

Problem 6-18 (30 minutes) Weighted-Average Method Computation of equivalent units in ending inventory:

Materials

Labor

Units in ending work in process inventory 3,000 3,000 Percent completed ........................... 80% 60% Equivalent units ............................... 2,400 1,800 2. and 3. Cost of ending work in process inventory and units transferred out:

Materials Ending work in process inventory: Equivalent units .................. Cost per equivalent unit....... Cost of ending work in process inventory ..................

Labor

Overhead 3,000 60% 1,800

Overhead

2,400 $12.50

1,800 $3.20

1,800 $6.40

$30,000

$5,760

$11,520

Units completed and transferred out: Units transferred to the next department ...................... 25,000 25,000 25,000 Cost per equivalent unit....... $12.50 $3.20 $6.40 Cost of units completed and transferred out ................. $312,500 $80,000 $160,000 4. Cost reconciliation: Total cost to be accounted for ....................................... $599,780 Costs accounted for as follows: Cost of ending work in process inventory .................. $ 47,280 Cost of units completed and transferred out.............. 552,500 Total cost accounted for........................................... $599,780

Total

$47,280

$552,500

Managerial Accounting, 13th Canadian Edition

Problem 6-19 (30 minutes) Weighted-Average Method 1. Equivalent units of production

Pulping Transferred to next department ................................... Equivalent units in ending work in process inventory: Pulping: 8,000 units x 100% complete ...................... Conversion: 8,000 units x 25% complete .................. Equivalent units of production ..................................... 2. Cost per equivalent unit

Conversion

157,000

8,000 2,000 159,000

165,000

Pulping

Conversion

Cost of beginning work in process ............................ $ 4,800 Cost added during the period ................................... 102,450 Total cost (a) .......................................................... $107,250 Equivalent units of production (b) ............................ 165,000 Cost per equivalent unit (a) ÷ (b) ............................ $0.65 3. and 4. Cost of ending work in process inventory and units transferred out

Pulping Ending work in process inventory: Equivalent units .............................. Cost per equivalent unit ................... Cost of ending work in process inventory .............................................. Units completed and transferred out: Units transferred to the next department ............................................ Cost per equivalent unit ................... Cost of units completed and transferred out .....................................

Conversion

8,000 $0.65

2,000 $0.20

$5,200

$400

157,000 $0.65

157,000 $0.20

$102,050

$31,400

500 31,300 $31,800 159,000 $0.20

Total

$5,600

$133,450

275

Problem 6-19 (continued) 5. Cost reconciliation Costs to be accounted for: Cost of beginning work in process inventory ($4,800 + $500) ................................................... Costs added to production during the period ($102,450 + $31,300) ........................................... Total cost to be accounted for .................................. Costs accounted for as follows: Cost of ending work in process inventory .................. Cost of units completed and transferred out.............. Total cost accounted for...........................................

$ 5,300 133,750 $139,050 $ 5,600 133,450 $139,050

Managerial Accounting, 13th Canadian Edition

Case 6-20 (45 minutes) Weighted-Average Method 1. The revised computations follow:

Quantity Schedule and Equivalent Units of Production Transferred to next department ................................... Ending work in process: Transferred in: 5,000 units × 100% complete............ Materials: 5,000 units × 0% complete ...................... Conversion: 5,000 units × 2/5 complete ..................... Equivalent units of production .....................................

Costs per equivalent unit Cost of beginning work in process .............................. Cost added during the period ..................................... Total cost (a) ............................................................ Equivalent units of production (b) .............................. Cost per equivalent unit, (a) ÷ (b) .............................

Transferred In 100,000

Materials

Conversion

100,000

5,000 0 105,000

Transferred In $ 8,820 81,480 $90,300 105,000 $0.86

100,000

Materials $ 3,400 27,600 $31,000 100,000 $0.31

2,000 102,000

Conversion $ 10,200 96,900 $107,100 102,000 $1.05

277

Case 6-20 (continued)

Cost reconciliation Units completed and transferred out: Units transferred to the next department .................... Cost per equivalent unit ............................................. Cost of units completed and transferred out................ Ending work in process inventory: Equivalent units of production (see above) ...... Cost per equivalent unit ........................................ Cost of ending work in process inventory .........

Transferred In

Materials

Conversion

100,000 $0.86 $86,000

100,000 $0.31 $31,000

100,000 $1.05 $105,000

5,000 $0.86 $4,300

0 $0.31 $0

2,000 $1.05 $2,100

Total

$2.22 $222,000

$6,400 $228,400

2. The unit cost computed above is $2.22 (= $0.86 + $0.31 + $1.05) versus $2.284 on the original report. The unit cost on the report prepared by the accountant is high because none of the cost incurred during the month was assigned to the units in the ending work in process inventory.

Managerial Accounting, 13th Canadian Edition

Case 6-21 (60 minutes) MEMORANDUM TO: FROM: SUBJECT:

Rachel Archer Ed Switzer Ending Work in Process and Finished Goods Inventory Balances

As agreed, I have calculated the ending inventory balances to be included in the Balance Sheet of Rachel‘s Real Root Beer as at August 30. The calculations assume process costing using the weighted average method. My calculations indicate an addition to Finished Goods Inventory of $6,456 and an ending Work in Process balance of $1,944. Details of my calculations are presented in the attached Production Report for the month of August.

279

Case 6-21 (continued) Rachel’s Real Root Beer Production Report for August (weighted average method) Quantity Schedule and Equivalent Units Quantity Units to be accounted for: Work in process, August 1 (75% complete for material, 60% for conversion)

550

Started into production

3,000

Total units

3,550 Equivalent Units Materials

Conversion

Units accounted for as follows: Transferred to Finished Goods

2,400

Work in process, August 30 (75% complete for material, 50% for conversion)

1,150

863

575

Total units and equivalent units

3,550

3,263

2,975

Cost per Equivalent Unit

Total Cost

Materials

Conversion

Cost to be accounted for: Work in process, August 1

$1,080

$650

$430

Cost added during the month

7,320

3,840

3,480

Total cost

$8,400

$4,490

$3,910

Equivalent units of production

3,263

2,975

Cost per equivalent unit

$1.38

$1.31

Total cost per equivalent unit

$2.69

Managerial Accounting, 13th Canadian Edition

Case 6-21 (continued) Cost reconciliation:

Total Cost

Materials

Conversion

Cost accounted for as follows: Transferred to Finished Goods 2,400 units x $2.69

$6,456

2,400

Work in process, August 30: Materials at $1.38 per EU

1,191

863

Conversion at $1.31 per EU

753

Total Work in process, Aug 30

1,944

Total cost accounted for:

$8,400

2,400

575

281

Appendix 6A Solutions Questions 6A-1 Under the weighted-average method, each unit transferred out of the department is counted as one equivalent unit—regardless of in what period the work was done to complete the units. Under the FIFO method, only the work done in the current period is counted. Units transferred out are divided into two parts. One part consists of the units transferred out from beginning inventory. Only the work needed to complete these units is shown as part of the equivalent units for the current period. The other part of the units transferred out consists of the units started and completed during the current period.

6A-2 The weighted-average method mixes costs from the current period with costs from the prior period. Thus, under the weightedaverage method, the department‘s apparent performance in the current period is influenced to some extent by what happened in a prior period. In contrast, the FIFO method cleanly separates the costs and work of the current period from those of the prior period. This makes the FIFO method superior to the weighted-average method for cost control because current performance should be measured in relation to costs of the current period only.

Exercise 6A-1 (10 minutes) FIFO Method

Materials Conversion To complete beginning work in process: Materials: 400 units × (100% – 75%) ............................ Conversion: 400 units × (100% – 25%) ......................... Units started and completed during the period (42,600 units started – 500 units in ending inventory)..................................................................... Ending work in process Materials: 500 units × 80% complete ............................. Conversion: 500 units × 30% complete .......................... Equivalent units of production.............................................

100 300

42,100

400 42,600

150 42,550

Managerial Accounting, 13th Canadian Edition

Exercise 6A-2 (10 minutes) FIFO method

Materials Cost added during May (a) ............ Equivalent units of production (b) .......................... Cost per equivalent unit (a) ÷ (b) ...................................

Labour

Overhead

Total

$41,280

$26,460

$66,150

8,000

7,000

$5.16

$3.78

$9.45

$18.39

Materials

Conversion

Total

800 $4.40 $3,520

200 $1.30 $260

$3,780

$2,700

$380

$3,080

400 $4.40

700 $1.30

$1,760

$910

7,000 $4.40

7,000 $1.30

$30,800

$9,100

Exercise 6A-3 (15 minutes) FIFO Method

Ending work in process inventory: Equivalent units of production ......................... Cost per equivalent unit .................................. Cost of ending work in process inventory .........

Units transferred out: Cost in beginning work in process inventory ..................................................

Cost to complete the units in beginning work in process inventory: Equivalent units of production required to complete the beginning inventory ............ Cost per equivalent unit ............................... Cost to complete the units in beginning inventory ..................................................

2,670

Cost of units started and completed this period: Units started and completed this period (8,000 units completed and transferred to the next department–1,000 units in beginning work in process inventory) ........... Cost per equivalent unit ............................... Cost of units started and completed this period .......................................................... Total cost of units transferred out....................

39,900 $45,650

283

Exercise 6A-4 (20 minutes) FIFO Method

Materials

1. To complete beginning work in process: Materials: 60,000 units × (100 − 60 ) .......................................... Conversion: 60,000 units × (100 − 80 ) .......................................... Units started and completed during the period (560,000 started – 40,000 in end wip) ............... Ending work in process: Materials 40,000 units × 40% ........................ Conversion: 40,000 units × 20% .................... Equivalent units of production ...........................

24,000 12,000 520,000

520,000

16,000 560,000

Materials

Conversion

8,000 540,000

Conversion

Cost added during the period (a) .......................$427,000

$170,000

Equivalent units of production (b)...................... 560,000 Cost per equivalent unit (a) ÷ (b) ....................$0.76* ` *rounded

540,000 $0.31*

Managerial Accounting, 13th Canadian Edition

Exercise 6A-5 (45 minutes) FIFO method 1. Computation of the total cost per equivalent unit of production: Cost per equivalent unit of production for material ........................... Cost per equivalent unit of production for conversion ....................... Total cost per equivalent unit of production ..................................... 2. Computation of equivalent units in ending inventory:

Materials

$18.20 23.25 $41.45

Conversion

Units in ending inventory ................. 300 300 Percentage completed ..................... 80 % 40 % Equivalent units of production .......... 240 120 3. Computation of equivalent units required to complete the beginning inventory:

Materials Units in beginning inventory ............. Percentage uncompleted.................. Equivalent units of production .......... 4.

Conversion

400 30 % 120

400 70 % 280

Units transferred to the next department ......................... Less units from the beginning inventory ........................... Units started and completed during the period .................

4,400 400 4,000

285

Exercise 6A-5 (continued)

Materials Conversion

5. Ending work in process inventory: Equivalent units of production .................................................................. Cost per equivalent unit ........................................................................... Cost of ending work in process inventory .................................................. Units transferred out: Cost from the beginning work in process inventory .................................... Cost to complete the units in beginning work in process inventory: Equivalent units of production required to complete the units in beginning inventory .......................................................................................... Cost per equivalent unit ...................................................................... Cost to complete the units in beginning inventory ................................. Cost of units started and completed this period: Units started and completed this period ............................................... Cost per equivalent unit ...................................................................... Cost of units started and completed this period .................................... Total cost of units transferred out .............................................................

Managerial Accounting, 13th Canadian Edition

Total

240 $18.20 $4,368

120 $23.25 $2,790

$7,158

$4,897

$2,989

$7,886

120 $18.20 $2,184

280 $23.25 $6,510

8,694

4,000 $18.20 $72,800

4,000 $23.25 $93,000

165,800 $182,380

Exercise 6A-6 (15 minutes) FIFO Method

Labour & Overhead

Materials To complete the beginning work in process: Materials: 25,000 litres × (100 − 100 ) ........................ Labour and overhead: 25,000 litres × (100 − 80 ) ...................................... Litres started and completed during April (20,000 litres started − 2,000 litres in ending inventory) ......................... Ending work in process: Materials: 2,000 litres × 100% complete ........................... Labour and overhead: 2,000 litres × 20% complete ........... Equivalent units of production..............................................

0 5,000 18,000

18,000

2,000 20,000

400 23,400

287

Problem 6A-7 (45 minutes) FIFO method 1. Equivalent Units of Production

Materials To complete beginning work in process: Materials: 50,000 units × (100% − 75%) ................ Conversion: 50,000 units × (100% − 30%) ............. Units started and completed during the period (430,000 units started − 100,000 units in ending inventory) ..... Ending work in process: Materials: 100,000 units × 60% complete ................ Conversion: 100,000 units × 40% complete ............. Equivalent units of production ...................................... 2. Cost per Equivalent Unit

Conversion

12,500 35,000 330,000

330,000

60,000 402,500

Materials Cost added during the period (a)......................... $425,500 Equivalent units of production (b) ....................... 402,500 Cost per equivalent unit (a) ÷ (b)........................ $1.057 3. See the next page. 4. Cost Reconciliation Costs to be accounted for: Cost of beginning work in process inventory ($45,500 + $25,000) ...................................................... Costs added to production during the period ($425,500 + $145,000)................................................... Total cost to be accounted for ............................................. Costs accounted for as follows: Cost of ending work in process inventory ............................. Costs of units transferred out .............................................. Total cost accounted for...................................................... *Off $67 due to rounding.

40,000 405,000

Conversion $145,000 405,000 $0.358

$ 70,500 570,500 $641,000 $ 77,740 563,193 *$640,933

Managerial Accounting, 13th Canadian Edition

Problem 6A-7 (continued) 3.

Costs of Ending Work in Process Inventory and Units Transferred Out

Materials Ending work in process inventory: Equivalent units of production ................................................................ Cost per equivalent unit ......................................................................... Cost of ending work in process inventory ................................................ Units transferred out: Cost in beginning work in process inventory ............................................ Cost to complete the units in beginning work in process inventory: Equivalent units of production required to complete the beginning inventory ........................................................................................ Cost per equivalent unit .................................................................... Cost to complete the units in beginning inventory ............................... Cost of units started and completed this period: Units started and completed this period ............................................. Cost per equivalent unit .................................................................... Cost of units started and completed this period .................................. Cost of units transferred out ...................................................................

Conversion

Total

60,000 $1.057 $63,420

40,000 $0.358 $14,320

$77,740

$45,500

$25,000

$70,500

12,500 $1.057 $13,213

35,000 $0.358 $12,530

25,743

330,000 $1.057 $348,810

330,000 $0.358 $118,140

466,950 $563,193

289

Problem 6A-8 (45 minutes) FIFO Method 1. Equivalent Units of Production

Materials Conversion To complete beginning work in process: Materials: 50,000 units × (100% − 60%) ................. Conversion: 50,000 units × (100% − 30%) .............. Units started and completed during the period (500,000 units started − 60,000 units in ending inventory) ....... Ending work in process: Materials: 60,000 units × 80% complete .................. Conversion: 60,000 units × 40% complete ............... Equivalent units of production ....................................... 2.

20,000 35,000 440,000 48,000 508,000

24,000 499,000

Cost per Equivalent Unit

Materials Cost added during the period (a) ......................... Equivalent units of production (b) ........................ Cost per equivalent unit (a) ÷ (b) ........................ 3. See the next page. 4.

440,000

$457,200 508,000 $0.90

Cost Reconciliation Costs to be accounted for: Cost of beginning work in process inventory ($17,000 + $3,000) ......................................................... Costs added to production during the period ($457,200+ $349,300) .................................................... Total cost to be accounted for ............................................. Costs accounted for as follows: Cost of ending work in process inventory ............................. Costs of units transferred out .............................................. Total cost accounted for ......................................................

Conversion $349,300 499,000 $0.70

$ 20,000 806,500 $826,500 $ 60,000 766,500 $826,500

Managerial Accounting, 13th Canadian Edition

Problem 6A-8 (continued) 3.

Costs of Ending Work in Process Inventory and Units Transferred Out

Conversion

Total

48,000 $0.90 $43,200

24,000 $0.70 $16,800

$60,000

$17,000

$3,000

$20,000

20,000 $0.90 $18,000

35,000 $0.70 $24,500

42,500

440,000 $0.90 $396,000

440,000 $0.70 $308,000

704,000 $766,500

291

Problem 6A-9 (45 minutes) FIFO method 1. Equivalent Units of Production

Materials Conversion To complete beginning work in process: Materials: 20,000 units x (100% − 100%) ................ Conversion: 20,000 units x (100% − 75%) ............... Units started and completed during the period (180,000 units started − 40,000 units in ending inventory) ....... Ending work in process: Materials: 40,000 units x 100% complete ................. Conversion: 40,000 units x 25% complete ................ Equivalent units of production ....................................... 2.

0 5,000 140,000

140,000

40,000 180,000

10,000 155,000

Cost per Equivalent Unit

Materials

Conversion

Cost added during the period (a) ......................... $334,800 $238,700 Equivalent units of production (b) ........................ 180,000 155,000 Cost per equivalent unit (a) ÷ (b) ........................ $1.86 $1.54 3. See the next page. 4. Cost Reconciliation Costs to be accounted for: Cost of beginning work in process inventory ($25,200 + $24,800)....................................................... $ 50,000 Costs added to production during the period ($334,800 + $238,700) ................................................... 573,500 Total cost to be accounted for ............................................. $623,500 Costs accounted for as follows: Cost of ending work in process inventory ............................. $ 89,800 Costs of units transferred out .............................................. 533,700 Total cost accounted for ...................................................... $623,500

Managerial Accounting, 13th Canadian Edition

Problem 6A-9 (continued) 3.

Costs of Ending Work in Process Inventory and Units Transferred Out

Conversion

Total

40,000 $1.86 $74,400

10,000 $1.54 $15,400

$89,800

$25,200

$24,800

$50,000

0 $1.86 $0

5,000 $1.54 $7,700

$7,700

140,000 $1.86 $260,400

140,000 $1.54 $215,600

$476,000 $533,700

293

Case 6A-10 (60 minutes) FIFO Method 1.

Transferred In To complete beginning work in process: Transferred in: 8,000 units × 0% ................................................ Materials: 8,000 units × 0% ....................................................... Conversion: 8,000 units × (1 − 7/8) ........................................... Units completed during the period (100,000 units started − 8,000 units in beginning inventory) ....................................................... Ending work in process: Transferred in: 5,000 units x 100% complete Materials: 5,000 units × 0% complete ........................................ Conversion: 5,000 units × 2/5 complete...................................... Equivalent units of production .........................................................

Cost added during the period (a) ..................................................... Equivalent units of production (b) .................................................... Cost per equivalent unit (a) ÷ (b) ....................................................

Conversion

0 0 1,000 92,000

92,000

5,000 0 97,000

92,000

2,000 95,000

Transferred In

Materials

Conversion

$81,480 97,000 $0.84

$27,600 92,000 $0.30

$96,900 95,000 $1.02

Materials

Managerial Accounting, 13th Canadian Edition

Case 6A-10 (continued)

Transferred In Ending work in process inventory: Equivalent units of production ..................................... Cost per equivalent unit .............................................. Cost of ending work in process inventory ..................... Units transferred out: Cost in beginning work in process inventory ................. Cost to complete units in beginning work in process inventory: Equivalent units of production required to complete the beginning inventory (see above) ....................................................... Cost per equivalent unit ......................................... Cost to complete units in beginning inventory.......... Cost of units started and completed this period: Units started and completed this period .................. Cost per equivalent unit ......................................... Cost of units started and completed this period ....... Cost of units transferred out ........................................

Materials

5,000 $0.84 $4,200

0 $0.30 $0

Conversion 2,000 $1.02 $2,040

Total

$6,240 $22,420

0 $0.84 $0

0 $0.30 $0

1,000 $1.02 $1,020

92,000 $0.84 $77,280

92,000 $0.30 $27,600

92,000 $1.02 $93,840

$1,020

$198,720 $222,160

2. The effects of the cost-cutting will tend to show up more under the FIFO method. The reason is that the FIFO method keeps the costs of the current period separate from the costs of the prior period. Thus, under the FIFO method, the company will be able to compare unit costs of the current period to those of the prior period to see how effective the cost-cutting program has been. Under the weighted-average method, however, costs carried over from the prior period are averaged in with costs of the current period, which will tend to mask somewhat the effects of the cost-cutting effort.

295

Case 6A-11 (60 minutes) MEMORANDUM TO: FROM: SUBJECT:

Rachel Archer Ed Switzer Ending Work in Process and Finished Goods Inventory Balances

As agreed, I have calculated the ending inventory balances to be included in the Balance Sheet of Rachel‘s Real Root Beer as at August 30. The calculations assume process costing using the FIFO method. My calculations indicate an transfer t0 Finished Goods Inventory of $6,513 and an ending Work in Process balance of $1,919. Details of my calculations are presented in the attached Production Report for the month of August.

Managerial Accounting, 13th Canadian Edition

Case 6A-11 (continued) Rachel’s Real Root Beer Production Report for August (FIFO Method) Quantity Schedule and Equivalent Units Quantity Units to be accounted for: Work in process, August 1 (75% complete for material, 60% for conversion)

550

Started into production

3,000

Total units

3,550 Equivalent Units Materials

Conversion

Units accounted for as follows: Transferred to Finished Good: From Beg. inventory (Aug 1) Materials (550 x (100%-75%) Conversion (550 x (100%-60%)

550 138

220

Started and completed in period (3,000 started - ending inv 1,150)

1,850

Work in process, August 30 (1,150 units 75% complete for material, 50% for conversion)

1,150

863

575

Total and Equivalent units

3,550

2,851

2,645

Total Cost

Materials

Conversion

Cost per Equivalent Unit Cost to be accounted for: Costs in beginning inventory

$1,080

Cost added during the month

7,320

3,840

3,480

Total cost

$8,400

$3,840

$3,480

Equivalent units of production

2,851

2,645

Cost per equivalent unit

$1.347

$1.316

297

Case 6A-11 (continued) Total cost per equivalent unit

$2.663 Equivalent Units

Cost reconciliation:

Total Cost

Materials

Conversion

Cost accounted for as follows: Costs in Beginning inventory

$1080

Costs to complete these units Materials at $1.347 per EU Conversion at $1.316 per EU

$186 $290

Total costs from beg. inventory

$1,556

Started and completed this period 1,850 units x $2.663

$4,957

Work in process, August 30: Materials at $1.347 per EU

$1,162

Conversion at $1.316 per EU

757

Total Work in process, Aug 30

1,919

Total cost accounted for:

138 220

863 575

$8,432*

* $32 difference due to rounding

Chapter 8 Variable Costing: A Tool for Management

Discussion Case (30 minutes) Discussion of this issue should include many of the following points: 1. The main benefit of absorption costing is that it better adheres to the ―matching principle‖ than variable costing making it appropriate for external financial reporting. The matching principle argues that revenues generated in a period should be matched with related costs incurred to generate those revenues (i.e., the unit cost © McGraw Hill Ltd. 2024. All rights reserved. 298

Managerial Accounting, 13th Canadian Edition

of products produced should only be recognized in the income statement when those units of product are actually sold). In addition, proponents of absorption costing would argue that product costs should include ALL costs related to manufacturing, whether they are variable or fixed. Fixed costs must be ‗covered‘ in the long run to ensure profitability and absorption costing reinforces this principle. 2. Profits can be generated when a company produces more product than they expect to sell in order to boost operating income under absorption costing. These profits are ―illusory‖ in that they are not sustainable, nor are they generated by productive means. They are purely an artefact of the accounting system. Specifically, fixed manufacturing overhead costs can be deferred to finished goods inventory by producing more goods than needed in any given period under absorption costing. Conversely, variable costing treats fixed manufacturing costs as period expenses and as such, does not offer managers the opportunity to manipulate profits visà-vis production decisions. 3. Building up inventory does have negative consequences. One is the actual costs of carrying inventory such as insurance and the costs associated with storage facilities (rent if not owned, insurance, utilities, maintenance, etc.). Another cost is the opportunity cost of the capital tied up in inventory. Such capital could productively be used elsewhere (e.g., pay down debt, invest in other projects, etc.) and thus has a cost. A final cost is the risk of inventory becoming damaged, obsolete or stolen. While these risks are difficult to quantify, they are nonetheless real and represent a cost of carrying inventory.

299

Solutions to Questions 8-1 Absorption and variable costing differ in how they handle fixed manufacturing overhead. Under absorption costing, fixed manufacturing overhead is treated as a product cost and hence is an asset until products are sold. Under variable costing, fixed manufacturing overhead is treated as a period cost and is expensed on the current period‘s income statement.

trast, all of the fixed manufacturing overhead cost of the current period is immediately expensed under variable costing.

8-2 Under absorption costing, fixed manufacturing overhead costs are included in product costs, along with direct materials, direct labor, and variable manufacturing overhead. If some of the units are not sold by the end of the period, then they are carried into the next period as inventory. When the units are finally sold, the fixed manufacturing overhead cost that has been carried over with the units is included as part of that period‘s cost of goods sold.

8-6 Under absorption costing operating income can be increased by simply increasing the level of production without any increase in sales. If production exceeds sales, units of product are added to inventory. These units carry a portion of the current period‘s fixed manufacturing overhead costs into the inventory account, reducing the current period‘s reported expenses and causing operating income to increase.

8-3 If production and sales are equal, operating income should be the same under absorption and variable costing. When production equals sales, inventories do not increase or decrease and therefore under absorption costing fixed manufacturing overhead cost cannot be deferred in inventory or released from inventory. 8-4 If production exceeds sales, absorption costing will usually show higher operating income than variable costing. When production exceeds sales, inventories increase and under absorption costing part of the fixed manufacturing overhead cost of the current period is deferred in inventory to the next period. In con-

8-5 If fixed manufacturing overhead cost is released from inventory, then inventory levels must have decreased and therefore production must have been less than sales.

8-7 Selling and administrative expenses are treated as period costs under both variable costing and absorption costing. 8-8 Differences in reported operating income between absorption and variable costing arise because of changing levels of inventory. In lean production, goods are produced strictly to customers‘ orders. With production geared to sales, inventories are largely (or entirely) eliminated. If inventories are completely eliminated, they cannot change from one period to another and absorption costing and variable costing will report the same operating income.

Managerial Accounting, 13th Canadian Edition

Foundational Exercises 1. and 2. The unit product costs under variable costing and absorption costing are computed as follows:

Direct materials ...................................... Direct labor ............................................ Variable manufacturing overhead ............. Fixed manufacturing overhead ($400,000 ÷ 40,000 units) ................... Unit product cost ....................................

Variable Costing

Absorption Costing

$12 7 1

— $20

10 $30

3. and 4. The total contribution margin and net operating income under variable costing are computed as follows: Sales ........................................................... Variable expenses: Variable cost of goods sold (35,000 units × $20 per unit) ................. Variable selling and administrative (35,000 units × $2 per unit) ................... Contribution margin ..................................... Fixed expenses: Fixed manufacturing overhead ................... Fixed selling and administrative ................. Net operating loss ........................................

$1,400,000

$700,000 70,000

400,000 248,000

770,000 630,000

648,000 $ (18,000)

301

Foundational Exercises (continued) 5. and 6. The total gross margin and operating income under absorption costing are computed as follows: Sales (35,000 units × $40 per unit) ....................................... Cost of goods sold (35,000 units × $30 per unit) .................... Gross margin ........................................................................ Selling and administrative expenses [(35,000 units × $2 per unit) + $248,000] .......................... Operating income .................................................................

$1,400,000 1,050,000 350,000 318,000 $ 32,000

7. The difference between the absorption and variable costing operating incomes is explained as follows: Manufacturing overhead deferred in (released from) inventory = Fixed manufacturing overhead in ending inventory – Fixed manufacturing overhead in beginning inventory = ($10 per unit × 5,000 units) − $0 = $50,000 Variable costing net operating loss ........................................ Add fixed manufacturing overhead cost deferred in inventory under absorption costing ................................................... Absorption costing net operating income ...............................

$(18,000) 50,000 $ 32,000

8. The break-even point in units is computed as follows: Target Profit = Unit CM × Q − Fixed expenses $32,000 = ($40 − $22) × Q − $648,000 $680,000 = ($18) × Q Q = $680,000 ÷ $18 Q = 37,778 units (rounded) Under absorption costing $32,000 of operating income was generated with only 35,000 units sold. The inconsistency between the results of CVP analysis and the income generated using absorption costing is due to the deferral of fixed manufacturing overhead costs when production exceeds sales as it did for Kitmat Company.

Managerial Accounting, 13th Canadian Edition

Foundational Exercises (continued) 9. and 10. The variable costing operating income would be the same as the answer to question 4 as shown below: Sales ........................................................... Variable expenses: Variable cost of goods sold (35,000 units × $20 per unit) ................. Variable selling and administrative (35,000 units × $2 per unit) ................... Contribution margin ..................................... Fixed expenses: Fixed manufacturing overhead ................... Fixed selling and administrative ................. Operating loss .............................................

$1,400,000

$700,000 70,000

400,000 248,000

770,000 630,000

648,000 $ (18,000)

When the number of units produced equals the number of units sold, absorption costing operating income equals the variable costing net operating income. Therefore, the answer to question 11 is that the absorption costing operating loss would also be $18,000. Note that this is because cost of goods sold will increase if production and sales both equal 35,000 units. In part 2 above, fixed manufacturing overhead cost per unit is only $10 when production is 40,000 units. However, if production is only 35,000 units then fixed manufacturing overhead per unit would be $11.43 per unit (rounded) calculated as $400,000 ÷ 35,000. 11. Absorption costing income will be lower than variable costing income. The variable costing income statement will only include the fixed manufacturing overhead costs incurred during the second year of operations, whereas the absorption costing cost of goods sold will include all of the fixed manufacturing overhead costs incurred during the second year of operations plus some of the fixed manufacturing overhead costs that were deferred in inventory at the end of the prior year.

303

Exercise 8-1 (15 minutes) 1. Under absorption costing, all manufacturing costs (variable and fixed) are included in product costs. Direct materials ......................................................................... Direct labor ............................................................................... Variable manufacturing overhead ................................................ Fixed manufacturing overhead ($120,000 ÷ 500 units) ................ Absorption costing unit product cost ...........................................

$150 270 40 240 $700

2. Under variable costing, only the variable manufacturing costs are included in product costs. Direct materials ......................................................................... Direct labor ............................................................................... Variable manufacturing overhead ................................................ Variable costing unit product cost ...............................................

$150 270 40 $460

Note that selling and administrative expenses are not treated as product costs under either absorption or variable costing. These expenses are always treated as period costs and are charged against the current period‘s revenue.

Managerial Accounting, 13th Canadian Edition

Exercise 8-2 (20 minutes) 1. 50 units in ending inventory × $240 per unit fixed manufacturing overhead per unit = $12,000 2. The variable costing income statement appears below: Sales........................................................................ Variable expenses: Variable cost of goods sold (450 units sold × $460 per unit) .......................... Variable selling and administrative expenses (450 units × $25 per unit) .......................................... Contribution margin .................................................. Fixed expenses: Fixed manufacturing overhead ................................ Fixed selling and administrative expenses................ Net operating income ................................................

$382,500

$207,000 11,250

120,000 40,000

218,250 164,250

160,000 $ 4,250

The difference in net operating income between variable and absorption costing can be explained by the deferral of fixed manufacturing overhead cost in inventory that has taken place under the absorption costing approach. Note from part (1) that $12,000 ($240 x 50 units) of fixed manufacturing overhead cost has been deferred in inventory to the next period. Thus, net operating income under the absorption costing approach is $12,000 higher than it is under variable costing.

305

Exercise 8-3 (20 minutes) 1. Beginning inventories Ending inventories Change in inventories

Year 1 200 170 (30)

Fixed manufacturing overhead in ending inventories (@$560 per unit) $ 95,200 Fixed manufacturing overhead in beginning inventories (@$560 per unit) 112,000 Fixed manufacturing overhead deferred in (released from) inventories (@$560 per unit) $(16,800) Variable costing operating income $1,080,400 Add (deduct) fixed manufacturing overhead cost deferred in (released from) inventory under absorption costing (16,800) Absorption costing operating income $1,063,600

Year 2 170 180 10

Year 3 180 220 40

$100,800

$123,200

95,200

100,800

$ 5,600

$ 22,400

$1,032,400

$ 996,400

5,600

22,400

$1,038,000

$1,018,800

2. Because absorption costing operating income was greater than variable costing operating income in Year 4, inventories must have increased during the year and, hence, fixed manufacturing overhead was deferred in inventories. The amount of the deferral is the difference between the two operating incomes, or $28,000 = $1,012,400 – $984,400.

Managerial Accounting, 13th Canadian Edition

Exercise 8-4 (30 minutes) 1. a. By assumption, the unit selling price, unit variable costs, and total fixed costs are constant from year to year. Consequently, operating income will vary with sales using variable costing. If sales increase, variable costing operating income will increase. If sales decrease, variable costing operating income will decrease. If sales are constant, variable costing operating income will be constant. Because variable costing operating income declined over the three years, unit sales must have also declined. The same is not true of absorption costing operating income. Sales and absorption costing operating income do not necessarily move in the same direction because changes in inventories also affect absorption costing operating income. As such, we cannot determine whether unit sales differed across the three years based on the absorption costing operating income data provided for scenario A. b. When variable costing operating income exceeds absorption costing operating income, sales exceeds production. Inventories shrink and fixed manufacturing overhead costs are released from inventories. In contrast, when variable costing operating income is less than absorption costing operating income, production exceeds sales. Inventories grow and fixed manufacturing overhead costs are deferred in inventories. The year-by-year effects are shown below.

Year 1

Year 2

Year 3

Variable costing OI > Absorption costing OI Production < Sales

Variable costing OI = Absorption costing OI Production = Sales Inventories remain the same

Variable costing OI < Absorption costing OI Production > Sales

Inventories decline

Inventories grow

307

Exercise 8-4 (continued) 2. a. As discussed in part (1 a) above, unit sales and variable costing operating income move in the same direction when unit selling prices and the cost structure are constant. Because variable costing operating income was the same each year, unit sales must have also been the same. This is true even though the absorption costing operating income was different each year. How can that be? By manipulating production (and inventories) it may be possible to maintain or change the level of absorption costing operating income even though unit sales are constant. b. The year-by-year effects are shown below.

Year 1

Year 2

Year 3

Variable costing OI < Absorption costing OI Production > Sales

Variable costing OI > Absorption costing OI Production < Sales

Inventories grow

Inventories decline

Variable costing OI = Absorption costing OI Production = Sales Inventories remain the same

Variable costing appears to provide a much better picture of economic reality than absorption costing in the examples above. In the first case, absorption costing operating income increases from year to year even though unit sales decline. In the second case, absorption costing operating income fluctuates even though unit sales are the same each year and unit selling prices, unit variable costs, and total fixed costs remain the same. Absorption costing operating income is potentially more subject to manipulation than variable costing. Simply by changing production levels (and thereby deferring or releasing costs from inventory) absorption costing operating income can be manipulated upward or downward.

Managerial Accounting, 13th Canadian Edition

Exercise 8-5 (30 minutes) 1. Under variable costing, only the variable manufacturing costs are included in product costs. Direct materials ............................................... Direct labour ................................................... Variable manufacturing overhead ..................... Unit product cost .............................................

$ 8 10 2 $20

Note that selling and administrative expenses are not treated as product costs; that is, they are not included in the costs that are inventoried. These expenses are always treated as period costs and are charged against the current period‘s revenue. 2. The variable costing income statement appears below: Sales (21,500 × $35) ................................... Variable expenses: Variable cost of goods sold: Beginning inventory ............................... Add variable manufacturing costs (25,000 units × $20 per unit) .............. Goods available for sale .......................... Less ending inventory (3,500 units × $20 per unit) ............................................. Variable cost of goods sold* ...................... Variable selling and administrative (21,500 units × $4 per unit) ............................... Contribution margin ..................................... Fixed expenses: Fixed manufacturing overhead ................... Fixed selling and administrative ................. Operating profit ...........................................

$752,500

0 500,000 500,000 70,000 430,000 86,000

75,000 110,000

516,000 236,500

185,000 $51,500

* The variable cost of goods sold could be computed more simply as: 21,500 units sold × $20 per unit = $430,000.

309

Exercise 8-5 (continued) 3. The break-even point in units sold can be computed using the contribution margin per unit as follows: Selling price per unit.............................. Variable product cost per unit ................ Variable selling and admin cost per unit……………………………………….. Contribution margin per unit .................. Break-even unit sales = =

$35 20 4 $ 11

Fixed expenses Unit contribution margin $185,000 $11 per unit

= 16,819 units

Managerial Accounting, 13th Canadian Edition

Exercise 8-6 (20 minutes) 1. Under absorption costing, all manufacturing costs (variable and fixed) are included in product costs. Direct materials ............................................... Direct labour ................................................... Variable manufacturing overhead ..................... Fixed manufacturing overhead ($75,000 ÷ 25,000 units).............................. Unit product cost .............................................

$ 8 10 2 3 $23

2. The absorption costing income statement appears below: Sales (21,500 units × $35 per unit).................... Cost of goods sold: Beginning inventory ....................................... Add cost of goods manufactured (25,000 units × $23 per unit) ...................... Goods available for sale .................................. Less ending inventory (3,500 units × $23 per unit) ........................ Gross margin .................................................... Selling and administrative expenses: Variable selling and administrative (21,500 units × $4 per unit) .................................... Fixed selling and administrative ...................... Operating income .............................................

$752,500 $

0 575,000 575,000 80,500

86,000 110,000

494,500 258,000

196,000 $ 62,000

Note: Operating income is larger under absorption costing because the company defers $10,500 ($3 x 3,500 units) worth of fixed costs in ending inventory.

311

Exercise 8-7 (30 minutes) 1. a. The unit product cost under absorption costing would be: Direct materials ............................................................................ Direct labour ................................................................................ Variable manufacturing overhead ................................................... Total variable costs ....................................................................... Fixed manufacturing overhead ($300,000 ÷ 25,000 units)............... Absorption costing unit product cost ..............................................

$ 6 9 3 18 12 $30

b. The absorption costing income statement: Sales (20,000 units × $50 per unit) ....................................... Cost of goods sold (20,000 units × $30 per unit) .................... Gross margin ........................................................................ Selling and administrative expenses [(20,000 units × $4 per unit) + $190,000] .......................... Operating income .................................................................

$1,000,000 600,000 400,000 270,000 $ 130,000

2. a. The unit product cost under variable costing would be: Direct materials .................................... Direct labour ........................................ Variable manufacturing overhead ........... Variable costing unit product cost ..........

$ 6 9 3 $18

b. The variable costing income statement: Sales (20,000 units × $50 per unit) ...................... Variable expenses: Variable cost of goods sold (20,000 units × $18 per unit) ......................... Variable selling expense (20,000 units × $4 per unit) ........................... Contribution margin ............................................. Fixed expenses: Fixed manufacturing overhead ........................... Fixed selling and administrative expense ............ Operating income ................................................

$1,000,000

$360,000 80,000

300,000 190,000

440,000 560,000

490,000 $ 70,000

Managerial Accounting, 13th Canadian Edition

Exercise 8-8 (20 minutes) 1. The company is using variable costing. The computations are:

Direct materials ....................................... Direct labour ........................................... Variable manufacturing overhead ............. Fixed manufacturing overhead ($180,000 ÷ 30,000 units) .................... Unit product cost ..................................... Total cost, 2,500 units .............................

Variable Costing

Absorption Costing

$20 10 4

— $34 $85,000

6 $40 $100,000

2. a. The total cost based on variable costing of $85,000 would be acceptable for tax purposes, but not for external reporting. b. The finished goods inventory account should be stated at $100,000, which represents the absorption cost of the 2,500 unsold units. Thus, the account should be increased by $15,000 for external reporting purposes. This $15,000 consists of the amount of fixed manufacturing overhead cost that is allocated to the 2,500 unsold units under absorption costing: 2,500 units × $6 per unit fixed manufacturing overhead cost = $15,000

313

Exercise 8-9 (20 minutes) 1. Sales (40,000 units × $33.75 per unit)………… Variable expenses: Variable cost of goods sold (40,000 units × $16 per unit*)………………….. Variable selling and administrative expenses (40,000 units × $3 per unit) ……………………… Contribution margin………………………………….. Fixed expenses: Fixed manufacturing overhead……………………. Fixed selling and administrative expenses…….. Operating income……………………………………… * Direct materials…………………………. Direct labour……………………………… Variable manufacturing overhead… Total variable manufacturing cost..

$1,350,000

$640,000 120,000

250,000 300,000

760,000 590,000

550,000 $ 40,000

$10 4 2 $16

2. The difference in operating income can be explained by the $50,000 in fixed manufacturing overhead deferred in inventory under the absorption costing method: Variable costing operating income ………………………… $40,000 Add: Fixed manufacturing overhead cost deferred in inventory under absorption costing: 10,000 units × $5 per unit in fixed manufacturing overhead cost………………. 50,000 Absorption costing operating income……………………… $90,000

Managerial Accounting, 13th Canadian Edition

Exercise 8-10 (10 minutes) 1. Sales were below the company‘s break-even sales and yet the company generated positive operating income. The apparent contradiction is explained by the fact that the CVP analysis is based on variable costing, whereas the income reported to shareholders is prepared using absorption costing. Because sales were below the break-even point, the variable costing operating income would have been negative (i.e., a loss would have been incurred). However, the absorption costing operating income was positive. Ordinarily, this would only happen if inventories increased and fixed manufacturing overhead in the current period was deferred to finished goods inventories under absorption costing. This deferral of fixed manufacturing overhead cost resulted in positive operating income on an absorption costing basis even though the company fell short of its break-even point on a variable costing basis. 2. Given that absorption costing resulted in $0 operating income with $4.9 million in sales, inventory levels must have remained the same during the year (i.e., sales = production). This is because variable costing and absorption costing will result in the same level of operating income (or loss) when production equal sales, assuming unit costs and fixed costs do not change between periods. Since $4.9 million is the break-even level of sales and $0 operating income was reported using absorption costing at that level of sales, production equaled sales for the year.

315

Problem 8-11 (30 minutes) 1. The unit product cost under the absorption costing approach would be computed as follows: Direct materials ............................................... Direct labour ................................................... Variable manufacturing overhead ..................... Fixed manufacturing overhead ($350,000 ÷ 25,000 units) .............................................. Unit product cost .............................................

$ 8 10 2 14 $34

With this figure, the absorption costing income statements can be prepared:

Year 1

Year 2

Sales ..................................................................... Cost of goods sold: Beginning inventory ............................................ Add cost of goods manufactured @$34 per unit.... Goods available for sale ....................................... Less ending inventory@$34 per unit .................... Cost of goods sold ................................................. Gross margin ......................................................... Selling and administrative expenses* ...................... Operating income (loss) ......................................... *$3 per unit variable; $250,000 fixed each year

$1,000,000

$1,500,000

0 850,000 850,000 170,000 680,000 320,000 310,000 $ 10,000

170,000 850,000 1,020,000 0 1,020,000 480,000 340,000 $ 140,000

2. Variable costing operating income (loss) ................. Add: Fixed manufacturing overhead cost deferred in inventory under absorption costing (5,000 units × $14 per unit) .......................................... Deduct: Fixed manufacturing overhead cost released from inventory under absorption costing (5,000 units × $14 per unit) ................................ Absorption costing operating income.......................

$ (60,000)

$ 210,000

70,000

10,000

(70,000) $ 140,000

Managerial Accounting, 13th Canadian Edition

Problem 8-12 (45 minutes) 1. a. The unit product cost under absorption costing: Direct materials ............................................... Direct labour ................................................... Variable manufacturing overhead ..................... Fixed manufacturing overhead (600,000 ÷ 20,000 units).............................. Unit product cost .............................................

$12 9 5 30 $56

b. The absorption costing income statement follows: Sales (15,000 units × $80 per unit) .................... Cost of goods sold: Beginning inventory ....................................... Add cost of goods manufactured (20,000 units × $56 per unit) ...................... Goods available for sale .................................. Less ending inventory (5,000 units × $56 per unit) ........................ Gross margin .................................................... Selling and administrative expenses* ................. Operating loss...................................................

$1,200,000 $

1,120,000 1,120,000 280,000

840,000 360,000 565,000 $ (205,000)

*(15,000 units × $6 per unit) + $475,000 = $565,000. 2. a. The unit product cost under variable costing: Direct materials ............................................... Direct labour ................................................... Variable manufacturing overhead ..................... Unit product cost.............................................

$12 9 5 $26

317

Problem 8-12 (continued) b. The variable costing income statement follows: Sales (15,000 units × $80 per unit) ......................... Variable expenses: Variable cost of goods sold: Beginning inventory.......................................... Add variable manufacturing costs (20,000 units × $26 per unit)......................... Goods available for sale .................................... Less ending inventory (5,000 units × $26 per unit) .......................... Variable cost of goods sold .................................. Variable selling expense (15,000 units × $6 per unit) ............................. Contribution margin................................................ Fixed expenses: Fixed manufacturing overhead ............................. Fixed selling and administrative expense............... Operating loss ........................................................

$1,200,000

520,000 520,000 130,000 390,000 90,000

600,000 475,000

480,000 720,000

1,075,000 $ (355,000)

3. The difference in the ending inventory relates to a difference in the handling of fixed manufacturing overhead costs. Under variable costing, these costs have been expensed in full as period costs. Under absorption costing, these costs have been added to units of product at the rate of $30 per unit ($600,000 ÷ 20,000 units produced = $30 per unit). Thus, under absorption costing a portion of the $600,000 fixed manufacturing overhead cost of the month has been added to the inventory account rather than expensed on the income statement: Added to the ending inventory (5,000 units × $30 per unit) .................................................... Expensed as part of cost of goods sold (15,000 units × $30 per unit)................................................... Total fixed manufacturing overhead cost for the month ................

$ 150,000 450,000 $600,000

Because $150,000 of fixed manufacturing overhead cost has been deferred in inventory under absorption costing, the operating income reported under that costing method is $150,000 higher than the operating income under variable costing, as shown in parts (1) and (2) above. © McGraw Hill Ltd., 2024. All rights reserved. 318

Managerial Accounting, 13th Canadian Edition

Problem 8-13 (45 minutes) 1. The unit product cost under variable costing is computed as follows: Direct materials ................................... Direct labour ....................................... Variable manufacturing overhead ......... Variable costing unit product cost .........

$ 4 7 1 $12

2. With this figure, the variable costing income statements can be prepared: Sales (@ $25 per unit) ........................................... Variable expenses: Variable cost of goods sold (@ $12 per unit) .............................................. Variable selling and administrative expenses (@ $2 per unit) ..................................................... Total variable expenses .......................................... Contribution margin ............................................... Fixed expenses: Fixed manufacturing overhead ............................. Fixed selling and administrative expenses ............. Total fixed expenses ............................................... Operating income ..................................................

Year 1

Year 2

$1,000,000

$1,250,000

480,000

600,000

80,000 560,000 440,000

100,000 700,000 550,000

270,000 130,000 400,000 $ 40,000

270,000 130,000 400,000 $ 150,000

319

Problem 8-13 (continued) 3. The reconciliation of absorption and variable costing follows:

Year 1 Units in beginning inventory ................................... + Units produced .................................................. − Units sold .......................................................... = Units in ending inventory ....................................

0 45,000 40,000 5,000

Year 1 Fixed manufacturing overhead in ending inventory (5,000 units × $6 per unit) ................................. Deduct: Fixed manufacturing overhead in beginning inventory (5,000 units × $6 per unit) ........... Manufacturing overhead deferred in (released from) inventory ..................................................

$30,000

5,000 45,000 50,000 0

Year 2 $

0 30,000

$30,000

Year 1 Variable costing net operating income (loss) ............ Add: Fixed manufacturing overhead cost deferred in inventory under absorption costing .................. Deduct: Fixed manufacturing overhead cost released from inventory under absorption costing .... Absorption costing operating income ......................

Year 2

$40,000

$(30,000)

Year 2 $150,000

30,000

$70,000

(30,000) $120,000

Managerial Accounting, 13th Canadian Edition

Problem 8-14 (60 minutes) 1. a. Direct materials ..................................................... Direct labour ......................................................... Variable manufacturing overhead ............................ Fixed manufacturing overhead ($75,000 ÷ 50,000 units) .................................... Unit product cost ................................................... b. Sales (40,000 units) ............................................. Cost of goods sold: Beginning inventory .......................................... Add cost of goods manufactured (50,000 units × $3.50 per unit) ...................... Goods available for sale..................................... Less ending inventory (10,000 units × $3.50 per unit) ...................... Gross margin ....................................................... Selling and administrative expenses* .................... Operating income ................................................

$1.00 0.80 0.20 1.50 $3.50 $200,000 $

175,000 175,000 35,000

140,000 60,000 50,000 $ 10,000

c. Variable costing operating loss ............................................... Add: Fixed manufacturing overhead cost deferred in inventory under absorption costing (10,000 units × $1.50 per unit) .......................................... Absorption costing operating income ......................................

$ (5,000)

*$30,000 variable plus $20,000 fixed = $50,000.

15,000 $ 10,000

321

Problem 8-14 (continued) 2. Under absorption costing, the company did earn a profit for the month. However, before the question can really be answered, one must first define what is meant by a ―profit.‖ The central issue here relates to timing of the release of fixed manufacturing overhead costs to expense. Advocates of variable costing would argue that all such costs should be expensed immediately, and that no profit is earned unless the revenues of a period are sufficient to cover the fixed manufacturing overhead costs in full. From this point of view, then, no profit was earned during the month, because the fixed costs were not fully covered. Advocates of absorption costing would argue, however, that fixed manufacturing overhead costs attach to units of product as they are produced, and that such costs do not become expense until the units are sold. Therefore, if the selling price of a unit is greater than the unit cost (including a proportionate amount of fixed manufacturing overhead), then a profit is earned even if some units produced are unsold and carry some fixed manufacturing overhead with them to the following period. A difficulty with this argument is that ―profits‖ will vary under absorption costing depending on how many units are added to or taken out of inventory. That is, profits will depend not only on sales, but on what happens to inventories. In particular, profits can be consciously manipulated by increasing or decreasing a company‘s inventories.

Managerial Accounting, 13th Canadian Edition

Problem 8-14 (continued) 3. a. Sales (60,000 units × $5 per unit) ............................. Variable expenses: Variable cost of goods sold (60,000 units × $2 per unit) ................................ Variable selling and administrative expenses (60,000 units × $0.75 per unit) ........................... Contribution margin .................................................. Fixed expenses: Fixed manufacturing overhead ................................ Fixed selling and administrative expense ................. Operating income .....................................................

$300,000

$120,000 45,000

75,000 20,000

165,000 135,000

95,000 $ 40,000

b. The absorption costing unit product cost will remain at $3.50, the same as in part (1). Sales (60,000 units × $5 per unit) .......................... Cost of goods sold: Beginning inventory (10,000 units × $3.50 per unit) ........................ Add cost of goods manufactured (50,000 units × $3.50 per unit) ........................ Goods available for sale....................................... Less ending inventory ......................................... Gross margin ......................................................... Selling and administrative expenses (60,000 units × $0.75 per unit + $20,000) ................................... Operating income ..................................................

$300,000

$ 35,000 175,000 210,000 0

c. Variable costing operating income ............................................... Deduct: Fixed manufacturing overhead cost released from inventory under absorption costing (10,000 units × $1.50 per unit) ... Absorption costing operating income ...........................................

210,000 90,000 65,000 $ 25,000 $ 40,000 15,000 $ 25,000

323

Problem 8-15 (45 minutes) 1. a. and b.

Absorption Costing

Variable Costing

$ 36 72 24

16 $148

— $132

Direct materials .............................................. Direct labour .................................................. Variable manufacturing overhead ..................... Fixed manufacturing overhead ($720,000 ÷ 45,000 units) ........................... Unit product cost ............................................ 2. Sales (39,000 units, 51,000 units) .......................... Less Variable expenses: Variable cost of goods sold: Beginning inventory ............................................ Add variable production costs @ $132 per unit Good available for sale ....................................... Less ending inventory ......................................... Variable cost of goods sold Variable selling and administrative @ $18 per unit ... Total variable expenses .......................................... Contribution margin ............................................... Fixed expenses: Fixed manufacturing overhead ............................ Fixed selling and administrative ........................... Total fixed expenses .............................................. Operating income (loss) .........................................

October

November

$9,360,000

$12,240,000

0 5,940,000 5,940,000 792,000 5,148,000 702,000 5,850,000 3,510,000

792,000 5,940,000 6,732,000 0 6,732,000 918,000 7,650,000 4,590,000

720,000 540,000 1,260,000 $ 2,250,000

720,000 540,000 1,260,000 $ 3,330,000

Managerial Accounting, 13th Canadian Edition

Problem 8-15 (continued) 3.

October Variable costing operating income (loss) ........................................ $2,250,000 Add: Cost deferred in inventory under absorption costing (6,000 units × $16 per unit) ........................................... 96,000 Deduct: Cost released from inventory under absorption costing (6,000 units × $16 per unit) ..................................... Absorption costing operating income.............................................. $ 2,346,000

November $3,330,000

(96,000) $ 3,234,000

4. The CVP analysis was not in error. The issue is that it was prepared, correctly, based on variable costing which does not include fixed manufacturing costs in ending inventory. As shown by the variable costing income statement prepared for requirement 2 above, at sales of 39,000 units variable costing operating income is indeed $2,250,000 for October. However, as shown in the reconciliation between variable costing and absorption costing, $96,000 of fixed manufacturing overhead was deferred to the balance sheet under absorption costing. This resulted in operating income of $2,346,000 rather than $2,250,000 based on variable costing when unit sales hit 39,000. This highlights one of the key problems with absorption costing in that it makes it more complicated to predict operating income at different levels of activity since the level of production relative to the number of units sold also impacts profits. As such, variable costing is the superior approach for planning purposes. 5. a. Variable costing operating income Contribution margin: $90 x 60,000 units Less fixed costs: Fixed manufacturing overhead Fixed selling and administrative expenses Operating income

$5,400,000 (720,000) (540,000) $4,140,000

b. Because production is expected to equal sales in December, absorption costing operating income will also be $4,140,000.

325

Problem 8-16 (30 minutes) 1. Because of soft demand for the New Zealand Division‘s product, the inventory should be drawn down to the minimum level of 1,500 units. Drawing inventory down to the minimum level would require production as follows during the last quarter: Desired inventory, December 31 ....................... Expected sales, last quarter ............................. Total needs ..................................................... Less inventory, September 30 .......................... Required production ........................................

1,500 units 18,000 units 19,500 units 12,000 units 7,500 units

Drawing inventory down to the minimum level would save inventory carrying costs such as storage (rent, insurance), interest, and obsolescence. The number of units scheduled for production will not affect the reported operating income or loss for the year if variable costing is in use. All fixed manufacturing overhead cost will be treated as an expense of the period regardless of the number of units produced. Thus, no fixed manufacturing overhead cost will be shifted between periods through the inventory account and income will be a function of the number of units sold, rather than a function of the number of units produced. 2. To maximize the New Zealand Division‘s operating income, Ms. Hartley could produce as many units as storage facilities will allow. By building inventory to the maximum level, Ms. Hartley will be able to defer a portion of the year‘s fixed manufacturing overhead costs to future years through the inventory account, rather than having all of these costs appear as charges on the current year‘s income statement. Building inventory to the maximum level of 30,000 units would require production as follows during the last quarter: Desired inventory, December 31 ....................... Expected sales, last quarter ............................. Total needs ..................................................... Less inventory, September 30 .......................... Required production ........................................

30,000 units 18,000 units 48,000 units 12,000 units 36,000 units

Thus, by producing enough units to build inventory to the maximum level that storage facilities will allow, Ms. Hartley could relieve the current year of fixed manufacturing overhead cost and thereby maximize the current year‘s operating income.

Managerial Accounting, 13th Canadian Edition

Problem 8-16 (continued) 3. By setting a production schedule that will maximize her division‘s operating income— and maximize her own bonus— Ms. Hartley will be acting against the best interests of the company as a whole. The extra units aren‘t needed and will be expensive to carry in inventory. Moreover, there is no indication that demand will be any better next year than it has been in the current year, so the company may be required to carry the extra units in inventory a long time before they are ultimately sold. The company‘s bonus plan undoubtedly is intended to increase the company‘s profits by increasing sales and controlling expenses. If Ms. Hartley sets a production schedule as shown in part (2) above, she will obtain her bonus as a result of producing rather than as a result of selling. Moreover, she will obtain it by creating greater expenses—rather than fewer expenses—for the company as a whole. Further, the following year the fixed costs will release from inventory and the profit will fall dramatically but Ms. Hart will not have to ‗pay back‘ the bonus that the inventory build created. In summary, producing as much as possible so as to maximize the division‘s operating income and the manager‘s bonus would be unethical because it subverts the goals of the overall organization.

327

Problem 8-17 (45 minutes) 1. The break-even point in units sold can be computed using the contribution margin per unit as follows: Selling price per unit.............................. Variable cost per unit ............................. Contribution margin per unit ..................

$87 57 $30

Break-even unit sales = Fixed expenses ÷ Unit contribution margin = $1,200,000 ÷ $30 per unit = 40,000 units 2 a. Under variable costing, only the variable manufacturing costs are included in product costs. Direct materials ............................................... Direct labor ..................................................... Variable manufacturing overhead ..................... Variable costing unit product cost .....................

Year 1

Year 2

Year 3

$30 18 6 $54

Note that selling and administrative expenses are not treated as product costs; that is, they are not included in the costs that are inventoried. These expenses are always treated as period costs.

Managerial Accounting, 13th Canadian Edition

Problem 8-17 (continued) 2 b. The variable costing income statements appear below: Sales ..................................................................................... Variable expenses: Variable cost of goods sold @ $54 per unit ........................... Variable selling and administrative @ $3 per unit .................. Total variable expenses .......................................................... Contribution margin ............................................................... Fixed expenses: Fixed manufacturing overhead ............................................. Fixed selling and administrative ........................................... Total fixed expenses............................................................... Net operating income (loss)....................................................

Year 1

Year 2

Year 3

$5,220,000

$4,350,000

$5,655,000

3,240,000 180,000 3,420,000 1,800,000

2,700,000 150,000 2,850,000 1,500,000

3,510,000 195,000 3,705,000 1,950,000

960,000 240,000 1,200,000 $ 600,000

960,000 240,000 1,200,000 $ 300,000

960,000 240,000 1,200,000 $ 750,000

3 a. The unit product costs under absorption costing: Direct materials ............................................... Direct labor ..................................................... Variable manufacturing overhead ..................... Fixed manufacturing overhead ......................... Absorption costing unit product cost ................. * $960,000 ÷ 60,000 units = $16 per unit. ** $960,000 ÷ 75,000 units = $12.80 per unit. *** $960,000 ÷ 40,000 units = $24 per unit.

Year 1

Year 2

$30 18 6 *16 $70

$30 18 6 **12.80 $66.80

Year 3 $30 18 6 ***24 $78

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Problem 8-17 (continued) 3 b. The absorption costing income statements appears below: Sales ................................................................ Cost of goods sold* .......................................... Gross margin .................................................... Selling and administrative expenses**......................................... Net operating income (loss)...............................

Year 1

Year 2

Year 3

$5,220,000 4,200,000 1,020,000

$4,350,000 3,340,000 1,010,000

$5,655,000 4,790,000 865,000

420,000 $ 600,000

390,000 $ 620,000

435,000 $ 430,000

*Cost of goods sold computations: Year 1: 60,000 units × $70 per unit = $4,200,000 Year 2: 50,000 units × $66.80 per unit = $3,340,000 Year 3: (25,000 × $66.80 per unit) + (40,000 × $78 per unit) = $4,790,000 ** $240,000 fixed expenses + $3 per unit variable expenses 4.

Year 1

Year 2

Year 3

Units sold ........................................................................ Break-even point in units .................................................. Units above (below) break-even point ...............................

60,000 40,000 20,000

50,000 40,000 10,000

65,000 40,000 25,000

Variable costing net operating income ............................... Absorption costing net operating income ...........................

$600,000 $600,000

$300,000 $620,000

$ 750,000 $430,000

The absorption costing net operating incomes in year 2 and 3 are counter-intuitive. In year 2, the number of units sold is lower than in year 1, yet absorption costing reports higher net operating income in year 2. In addition, more units were sold in year 3 than in year 2, yet absorption costing reports a lower net operating income in year 3 than in year 2. © McGraw Hill Ltd., 2024. All rights reserved. 330

Managerial Accounting, 13th Canadian Edition

Problem 8-18 (75 minutes) 1. Sales.................................................... Variable expenses: Variable cost of goods sold @ $4 per unit................................................ Variable selling and administrative @ $2 per unit ..................................... Total variable expenses ......................... Contribution margin .............................. Fixed expenses: Fixed manufacturing overhead ............ Fixed selling and administrative .......... Total fixed expenses ............................. Operating income (loss) ........................

Year 1

Year 2

Year 3

$1,000,000

$ 800,000

$1,000,000

200,000

160,000

200,000

100,000 300,000 700,000

80,000 240,000 560,000

100,000 300,000 700,000

600,000 70,000 670,000 $ 30,000

600,000 70,000 670,000 $(110,000)

600,000 70,000 670,000 $ 30,000

Year 1

Year 2

Year 3

$ 4

2. a. Variable manufacturing cost .................... Fixed manufacturing cost: $600,000 ÷ 50,000 units ...................... $600,000 ÷ 60,000 units ...................... $600,000 ÷ 40,000 units ...................... Unit product cost ....................................

12 10 $16

b. Variable costing operating income (loss) .......................................... $30,000 Add (Deduct): Fixed manufacturing overhead cost deferred in inventory from Year 2 to Year 3 under absorption costing (20,000 units × $10 per unit)............. Add: Fixed manufacturing overhead cost deferred in inventory from Year 3 to the future under absorption costing (10,000 units × $15 per unit)............................... Absorption costing operating income (loss) .......................................... $30,000

$14

15 $19

$(110,000)

$ 30,000

200,000

(200,000)

150,000 $ 90,000

$(20,000)

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Problem 8-18 (continued) 3. Production went up sharply in Year 2 thereby reducing the unit product cost, as shown in (2a). This reduction in cost, combined with the large amount of fixed manufacturing overhead cost deferred in inventory for the year, more than offset the loss of revenue. The net result is that the company‘s operating income rose even though sales were down. 4. The fixed manufacturing overhead cost deferred in inventory from Year 2 was charged against Year 3 operations, as shown in the reconciliation in (2b). This added charge against Year 3 operations was offset somewhat by the fact that part of Year 3‘s fixed manufacturing overhead costs was deferred in inventory to future years [again see (2b)]. Overall, the added costs charged against Year 3 were greater than the costs deferred to future years (i.e. there was an inventory reduction), so the company reported less income for the year even though the same number of units was sold as in Year 1. 5. a. With lean production, production would have been geared to sales in each year so that little or no inventory of finished goods would have been built up in either Year 2 or Year 3. b. If lean production had been in use, the operating income under absorption costing would have been the same as under variable costing in all three years. With production geared to sales, there would have been no ending inventory on hand, and therefore there would have been no fixed manufacturing overhead costs deferred in inventory to other years. Assuming that the company expected to sell 50,000 units in each year and that unit product costs were set on the basis of that level of expected activity, the income statements under absorption costing would have appeared as shown on the next page.

Managerial Accounting, 13th Canadian Edition

Problem 8-18 (continued)

Sales ................................................. Cost of goods sold: Cost of goods manufactured @ $16 per unit ....................................... Add underapplied overhead ............. Cost of goods sold ....................... Gross margin ..................................... Selling and administrative expenses .... Operating income (loss) .....................

Year 1

Year 2

Year 3

$1,000,000

$ 800,000

$1,000,000

800,000 800,000 200,000 170,000 $ 30,000

640,000 * 120,000 ** 760,000 40,000 150,000 $(110,000)

800,000 800,000 200,000 170,000 $ 30,000

* 40,000 units × $16 per unit = $640,000. ** 10,000 units not produced × $12 per unit fixed manufacturing overhead cost = $120,000 fixed manufacturing overhead cost not applied to products.

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Case 8-19 (45 minutes) 1. Because of soft demand for the Brazilian Division‘s product, the inventory should be drawn down to the minimum level of 50 units. Drawing inventory down to the minimum level would require production as follows during the last quarter: Desired inventory, December 31 .................... Expected sales, last quarter .......................... Total needs .................................................. Less inventory, September 30 ....................... Required production .....................................

50 units 600 units 650 units 400 units 250 units

This plan would save inventory carrying costs such as storage (rent, insurance), interest, and obsolescence. The number of units scheduled for production will not affect the reported operating income or loss for the year if variable costing is in use. All fixed manufacturing overhead cost will be treated as an expense of the period regardless of the number of units produced. Thus, no fixed manufacturing overhead cost would be shifted between periods through the inventory account and income would be a function of the number of units sold, rather than a function of the number of units produced. 2. To maximize the Brazilian Division‘s operating income, Mr. Cavalas could produce as many units as storage facilities will allow. By building inventory to the maximum level, Mr. Cavalas would be able to defer a portion of the year‘s fixed manufacturing overhead costs to future years through the inventory account, rather than having all of these costs appear as charges on the current year‘s income statement. Building inventory to the maximum level of 1,000 units would require production as follows during the last quarter: Desired inventory, December 31 ............. Expected sales, last quarter ................... Total needs ........................................... Less inventory, September 30 ................ Required production ..............................

1,000 units 600 units 1,600 units 400 units 1,200 units

Managerial Accounting, 13th Canadian Edition

Case 8-19 (continued) Thus, by producing enough units to build inventory to the maximum level that storage facilities would allow, Mr. Cavalas could relieve the current year of fixed manufacturing overhead cost and thereby maximize the current year‘s operating income. 3. By setting a production schedule that will maximize his division‘s operating income— and maximize his own bonus—Mr. Cavalas would be acting against the best interests of the company as a whole. The extra units aren‘t needed and would be expensive to carry in inventory. Moreover, there is no indication that demand will be any better next year than it has been in the current year, so the company may be required to carry the extra units in inventory a long time before they are ultimately sold. The company‘s bonus plan undoubtedly is intended to increase the company‘s profits by increasing sales and controlling expenses. If Mr. Cavalas sets a production schedule as shown in part (2) above, he would obtain his bonus as a result of producing rather than as a result of selling. Moreover, he would obtain it by creating greater expenses—rather than fewer expenses—for the company as a whole. Note that the carrying costs of inventory will largely be reflected in the next period‘s operating income and not the current period. As such, longer-term the decision to maximize the amount of overhead deferred to ending inventory will be harmful to the company. In sum, producing as much as possible so as to maximize the division‘s operating income and the manager‘s bonus would be unethical because it subverts the goals of the overall organization.

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Case 8-20 (40 minutes) Memo To: Ms. Jane Jones, Plant Manager From: Plant Accountant, Acme Electric Fan Co. RE: Production beyond the planned 20,000 fans this year I have prepared this memo in response to your question concerning the effect of producing an extra 500 fans this year. As indicated at our recent meeting, the obvious issue when producing units beyond what can be sold is the cost of holding the extra units in inventory. We have determined that the extra inventory holding costs related to the 500 fans would be negligible so let‘s move on to the effect of incurring the extra production costs without also realizing sales revenues related to these units before the end of the year. You expressed concern that this decision might have a negative effect on plant profitability. To help you to make this decision, I provide the following analysis:

Assume you decided to make the extra 500 fans: Sales (20,000 units x $12) Cost of goods sold: Beginning inventory

$240,000 -0-

Add cost of goods manufactured: 20,500 units x ($3+2+1+ 3*) Less: Ending inventory (500 x $9) Cost of goods sold Gross margin Less Variable selling costs ($1 x 20,000) Net income

184,500 (4,500) 180,000 60,000 20,000 $40,000

*$3 = $61,500 fixed costs ÷ 20,500 units produced

Managerial Accounting, 13th Canadian Edition

Case 8-20 (continued) Without the additional 500 fans, net income would be as follows: Sales (20,000 units x $12) Cost of goods sold: Beginning inventory

$240,000 -0-

Add cost of goods manufactured: Variable manufacturing costs: 20,000 units x ($3+2+1) Fixed manufacturing costs Less: Ending inventory Cost of goods sold Gross margin Less Variable selling costs ($1 x 20,000) Net income

$120,000 61,500 -0181,500 58,500 20,000 $38,500

* Note the $61,500 fixed costs are spread over fewer units in this scenario so that the cost per unit increases to $3.08 ($61,500 ÷ 20,000 units produced) As you can see from this analysis, profits are actually higher when the extra 500 fans are produced. This can be explained by our use of an absorption costing system. This system is designed to match costs with revenues generated; therefore, the $1500 in fixed costs related to producing the extra fans is held back in the Ending Inventory account (an asset on the Balance Sheet) until next period when the fans are sold. At that point, the costs will move out of ending inventory and will be included in cost of goods sold. Based on my analysis of the effect on profits, the fact that holding costs are negligible and that unexpected orders that would otherwise upset the production schedule are sometimes issued by customers, I would recommend that you produce and hold in inventory the additional 500 fans.

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Connecting Concepts: Section 2 (30 minutes) 1. Cost of each job using traditional overhead allocation method:

Cost of subcontracted work Direct in-house staff costs Overhead* Total cost per job

Smith and Valens $45,000 12,500 85,000 $142,500

Walker and Chen $85,000 5,000 30,000 $120,000

*Overhead application rate = $115,000/575 hrs = $200/hr Smith and Valens: $200 x 425 hrs = $85,000 Walker and Chen: $200 x 150 hrs = $30,000 Cost of each job using ABC to allocate overhead costs

Cost of subcontracted work Direct in-house staff costs Technical support* Administration** Total cost per job

Smith and Valens $45,000 12,500 22,500 36,125 $116,125

Walker and Chen $85,000 5,000 42,500 12,750 $145,250

*Smith and Valens: $0.50 x $45,000 Walker and Chen: $0.50 x $85,000 **Smith and Valens: $85 x 425 hrs Walker and Chen: $85 x 150 hrs

Managerial Accounting, 13th Canadian Edition

Connecting Concepts: Section 2 (continued) The cost of the two jobs differ under different cost allocation methods because, under the traditional method, overhead costs are allocated based on the number of direct inhouse staff hours worked, whether these activities drive the overhead costs or not. Every direct in-staff hour attracts an equal portion of the overhead costs. The ABC system recognizes that jobs that require more subcontracted labour cause more technical support costs to be generated. Therefore, more of the total overhead incurred is allocated to the Walker and Chen job than to the Smith and Valens job given the Walker and Chen job requires more subcontracted work. In addition, the ABC system recognizes that more administrative activity is likely needed to oversee a greater number of inhouse hours worked. Thus, more of this type of overhead cost is allocated to the Smith and Valens job than to the Walker and Chen job since more in-house direct hours are required there. Note that using ABC results in $1,125 of overhead costs not being applied to the jobs in total. These costs must have been determined by management to be those that would be incurred regardless of the level of technical support and administration required to service clients. 2. The CEO should be aware that some jobs may have been over-costed while others were likely under-costed under the old system. This suggests that rolling out the ABC system to other departments where several different activities drive overhead costs could improve the company‘s ability to estimate cost more accurately. This would allow the company to better understand and manage those costs as well as to set prices with more confidence. Even so, performing initial and continuing activity analyses is costly and the firm must ensure to only implement an ABC system in areas where the benefits exceed the cost of implementation.

Chapter 9 Budgeting Solution to Discussion Case Budgets should not be used to lay blame or attribute ―fault‖ to managers when actual results differ significantly from static budget levels. There are several reasons for this: 

Budgets are based on assumptions and estimates and are often prepared well in advance of when actual results are known. As such, some of these assumptions and estimates may turn out to be inaccurate simply because economic conditions change between the time the budget was prepared and when actual results are realized (e.g., interest rates increase, inflation increases, etc.). As such, variances from © McGraw Hill Ltd. 2024. All rights reserved.

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budget may not be anyone‘s fault and laying blame would be inappropriate. 

Related to the preceding point, actual results can be influenced by competitors‘ actions, which often cannot be foreseen with any degree of accuracy. For example, if a competitor introduces a new product or service, or drops prices on existing products or services, this may have the effect of reducing demand for a company‘s product or service offerings. This could lead to an unfavourable revenue variance but that would hardly be the fault of the managers responsible for sales.



Actual results may also be negatively affected by supply chain problems whereby a company cannot acquire the inputs needed for their products or services. Alternatively, the inputs might still be available, but prices may have risen leading to unfavourable cost variances. Both issues were present during the recent pandemic and had a negative impact on the operating results of many companies. However, it would be unfair to blame managers for the negative revenue or expense variances that might arise because of such issues because they likely had little ability to control them.

Instead of using budgets to lay blame or attribute fault, a more constructive approach is to use them to identify corrective actions necessary when revenues or expenses differ significantly from budget levels. While it is certainly appropriate to hold managers accountable for attaining budgeted revenues and expenses, it would be demoralizing to use budgets as a way of blaming them when things go wrong. Moreover, the use of flexible budgets, as described in the chapter, may be better for control purposes than a static budget when activity levels are difficult to budget or are subject to significant variation due to factors outside the control of managers.

Managerial Accounting, 13th Canadian Edition

Solutions to Questions 9-1 By quantifying how many units must be produced, the budget will require management to plan how many employees will be needed to meet production needs. In periods of growing demand, more employees may need to be hired while in periods of decreasing demand, fewer employees may be needed. Planning for the number of employees needed to meet the production budget will of course depend on the level of automation in any given company. The more automated the production process is, the less impact a given change in demand will have on staffing needs. 9-2 As part of the control system, budgets are compared to actual results in order to: (a) improve the efficiency and effectiveness of operations; and (b) evaluate and reward employees. 9-3 A perpetual or continuous budget is a 12-month budget that rolls forward one-month (or one quarter) as the current month (quarter) is completed. The objective of using a perpetual budget is to encourage managers to always be focusing at least one-year ahead in terms of operating results. 9-4 Benchmarking is the comparison of revenue, cost or process performance to high performing competitors in the same industry, to best-in-class companies, or to other successful business units in the same company. 9-5 Agree. The sales forecast impacts just about every other aspect of the master budget from estimating production needs to developing the selling and administrative budget. As such, an inaccurate sales forecast can‘t help but cause other elements of the master budget to also be inaccurate. Hence the need for accurate sales forecasts as the starting point in the master budget. 9-6 Managers will use a variety of information sources in developing the master budget estimates and assumptions. Examples would include: (a) prior period‘s results; (b) an analysis of the operating environment including expected actions by competitors; (c) macro-economic forecasts (e.g., inflation, interest rates, ex-

change rates) by outside entities such as the Bank of Canada or consulting firms; (d) senior management‘s goals and objectives (e.g., for revenue growth); and (e) the research and development department‘s plans for introducing new products or services. 9-7 Depreciation is not included in the cash budget because it is a non-cash expense. 9-8 No, with participative budgeting, although lower-level managers have significant influence in setting the budget, the budget must still be reviewed and approved by higher-level managers. One reason for this review and approval requirement is that lower-level managers might be tempted to introduce budget slack into the budget. Another reason is that higher-level managers may have information about the operating environment or macro-economic conditions that are not necessarily known by lowerlevel managers. 9-9 Budget slack is the difference between the revenues and expenses a manager believes can be achieved and the amounts included in the budget. Managers create slack in an attempt to increase the likelihood of receiving bonuses contingent upon meeting or beating budget. They may also create slack so that they do not have to work as hard to attain their budget. 9-10 A challenging but attainable budget is one that attained by exerting a reasonable effort. 9-11 The cash budget allows managers to estimate how much cash will be on hand at various points (e.g., quarters) during the year. By preparing the cash budget they can estimate the amount of borrowing that may be necessary to meet shortages in cash. Conversely, the cash budget also allows managers to see if there will be a cash surplus during the budgeting period and make plans for how to best use that excess cash (e.g., pay down debt, make short-term investments). 9-12 The largest proportion of the total expense budget at a professional services company, such as a law firm would likely be the sala© McGraw Hill Ltd. 2024. All rights reserved.

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ries of the employees. That is because such companies provide a service based on the specialized knowledge and expertise of their employees. Such companies would have other types of expenses in their budget such as administrative costs since such costs are still necessary in running their business. For example, larger law firms would have a billing department, a human resources department, an accounting department, and so on.

9-15 A forecast is an estimate of revenues and expenses that is prepared after the fiscal period has begun. A static budget is prepared before the fiscal period begins. Forecasts are valuable because they incorporate changes to a company‘s operating environment compared to when the static budget was prepared. Forecasts are used for planning purposes.

9-13 Flexible budgets incorporate changes in revenues and expenses expected to occur as a consequence of changes in actual activity. Static budgets are fixed before the start of the period and are not adjusted for changes in activity levels during the period. 9-14 The sales volume variance for revenue will be favourable since the actual number of units sold exceeds the budget by 1,000 units. Whether the flexible budget variance for revenue is favourable or unfavourable depends on the actual selling price. If the actual selling price is lower than that used for the master (static) budget then the flexible budget variance for revenue will be unfavourable. If the opposite is true, then the flexible budget variance will be favourable.

Managerial Accounting, 13th Canadian Edition

Foundational Exercises 1.

The budgeted sales for July are computed as follows: Unit sales (a) ...................................... Selling price per unit (b) ...................... Total sales (a) × (b) ............................

10,000 $70 $700,000

The expected cash collections for July are computed as follows:

July June sales: $588,000 × 60% ........................... July sales: $700,000 × 40% ........................... Total cash collections ........................ 3.

280,000 $632,800

The accounts receivable balance at the end of July is: July sales (a)....................................... Percent uncollected (b) ........................ Accounts receivable (a) × (b) ...............

$352,800

$700,000 60% $420,000

The required production for July is computed as follows:

July Budgeted sales in units .......................... Add desired ending inventory* ............... Total needs ........................................... Less beginning inventory** .................... Required production ..............................

10,000 2,400 12,400 2,000 10,400

*August sales of 12,000 units × 20% = 2,400 units. **July sales of 10,000 units × 20% = 2,000 units.

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Foundational Exercises (continued) 5.

The raw material purchases for July are computed as follows:

July Required production in units of finished goods ............................... Units of raw materials needed per unit of finished goods ................ Units of raw materials needed to meet production .......................... Add desired units of ending raw materials inventory* ..................... Total units of raw materials needed ............................................... Less units of beginning raw materials inventory** .......................... Units of raw materials to be purchased ..........................................

10,400 5 52,000 6,100 58,100 5,200 52,900

*61,000 kilograms × 10% = 6,100 kilograms. **52,000 kilograms × 10% = 5,200 kilograms. 6.

The cost of raw material purchases for July is computed as follows: Units of raw materials to be purchased (a)..................... Unit cost of raw materials (b) ........................................ Cost of raw materials to be purchased (a) × (b) .............

52,900 $2.00 $105,800

The estimated cash disbursements for materials purchases in July is computed as follows:

July June purchases: $88,880 × 70% .............................. July purchases: $105,800 × 30% ............................. Total cash disbursements .................... 8.

$62,216 31,740 $93,956

The accounts payable balance at the end of July is: July purchases (a) ............................... Percent unpaid (b) .............................. Accounts payable (a) × (b) ..................

$105,800 70% $74,060

Managerial Accounting, 13th Canadian Edition

Foundational Exercises (continued) 9.

The estimated raw materials inventory balance at the end of July is computed as follows: Ending raw materials inventory (kilograms) (a) .............. Cost per kilograms (b) .................................................. Raw material inventory balance (a) × (b) ......................

6,100 $2.00 $12,200

10. The estimated direct labor cost for July is computed as follows:

July Required production in units ....................... 10,400 Direct labor hours per unit .......................... × 2.0 Total direct labor-hours needed (a).............. 20,800 Direct labor cost per hour (b) ...................... $15 Total direct labor cost (a) × (b) ................... $312,000 11. The estimated unit product cost is computed as follows:

Quantity Direct materials ............................... 5 kilograms Direct labor ..................................... 2 hours Manufacturing overhead .................. 2 hours Unit product cost .............................

Cost $2 per kilogram $15 per hour $10 per hour

Total $10.00 30.00 20.00 $60.00

12. The estimated finished goods inventory balance at the end of July is computed as follows: Ending finished goods inventory in units (a) ................... Unit product cost (b) .................................................... Ending finished goods inventory (a) × (b) ......................

2,400 $60.00 $144,000

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Foundational Exercises (continued) 13. The estimated cost of goods sold for July is computed as follows: Unit sales (a) ............................................................... Unit product cost (b) .................................................... Estimated cost of goods sold (a) × (b) ..........................

10,000 $60.00 $600,000

The estimated gross margin for July is computed as follows: Total sales (a) .............................................................. Cost of goods sold (b) .................................................. Estimated gross margin (a) – (b)...................................

$700,000 600,000 $100,000

14. The estimated selling and administrative expense for July is computed as follows:

July Budgeted unit sales ............................................. Variable selling and administrative ........................ expense per unit .............................................. Total variable expense ......................................... Fixed selling and administrative expenses ............. Total selling and administrative expenses .............

10,000 × $1.80 $18,000 60,000 $78,000

15. The estimated operating income for July is computed as follows: Gross margin (a) .......................................................... Selling and administrative expenses (b) ......................... Operating income (a) – (b) ...........................................

$100,000 78,000 $ 22,000

Managerial Accounting, 13th Canadian Edition

Exercise 9-1 (20 minutes) 1.

July May sales: $190,000 × 10% June sales: $250,000 × 40%, 10%....................... July sales: $150,000 × 50%, 40%, 10%.............. August sales: $200,000 × 50%, 40%....................... September sales: $300,000 × 50% ............................ Total cash collections ..........

August

September

$ 19,000

Total $

19,000

100,000

$ 25,000

75,000

60,000

$ 15,000

150,000

100,000

80,000

180,000

$185,000

150,000 $245,000

150,000 $624,000

$194,000

125,000

2. Accounts receivable at September 30: From August sales: $200,000 × 10% ................................ From September sales: $300,000 × (40% + 10%) ............ Total accounts receivable at June 30 .................................

$ 20,000 150,000 $170,000

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Exercise 9-2 (30 minutes) Fortin Limited Sales Budget

1st Quarter Budgeted unit sales ...................... Selling price per unit ..................... Total sales....................................

24,000 × $40.00 $960,000

2nd Quarter 3rd Quarter 4th Quarter 22,500 × $40.00 $900,000

21,000 × $40.00 $840,000

Year

22,000 × $40.00 $880,000

89,500 × $40.00 $3,580,000

$ 210,000 660,000 $870,000

$ 184,000 960,000 900,000 840,000 660,000 $3,544,000

Schedule of Expected Cash Collections Accounts receivable, beginning balance ..................................... st 1 Quarter sales* ......................... 2nd Quarter sales .......................... 3rd Quarter sales ........................... 4th Quarter sales ........................... Total cash collections .................... *

$ 184,000 720,000

$904,000

$ 240,000 675,000

$915,000

$ 225,000 630,000 $855,000

75% collected in the month of sale, 25% in the following month.

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Managerial Accounting, 13th Canadian Edition

Exercise 9-2 (continued) 2.

Fortin Limited Production Budget

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Budgeted unit sales ...................... Add desired ending inventory* ....... Total units needed ........................ Less beginning inventory ............... Required production ..................... *

24,000 2,250 26,250 2,400 23,850

22,500 2,100 24,600 2,250 22,350

21,000 2,200 23,200 2,100 21,100

22,000 2,200 24,200 2,200 22,000

Year 89,500 2,200 91,700 2,400 89,300

of the following month‘s sales

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Exercise 9-3 (15 minutes)

First Required production of lights ............................. Number of bulbs per light .................................. Total production needs—bulbs ...........................

23,850 × 2 47,700

Quarter Second Third 22,350 × 2 44,700

21,100 × 2 42,200

Fourth

Year

22,000 × 2 44,000

89,300 × 2 178,600

Quarter

First Production needs—bulbs ................................... Add desired ending inventory—bulbs* Total needs—bulbs ............................................ Less beginning inventory—bulbs ........................ Required purchases—bulbs ................................ Cost of purchases at $2 per bulb........................ *

47,700 4,470 52,170 4,800 47,370 $94,740

Second 44,700 4,220 48,920 4,470 44,450 $88,900

Third 42,200 4,400 46,600 4,220 42,380 $84,760

Fourth

Year

44,000 4,400 48,400 4,400 44,000 $88,000

178,600 4,400 183,000 4,800 178,200 $356,400

10% of the following month‘s production.

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Exercise 9-4 (20 minutes) 1. Assuming that the direct labour workforce is adjusted each quarter, the direct labour budget would be:

Units to be produced ............................ Direct labour time per unit (hours)......... Total direct labour hours needed ........... Direct labour cost per hour .................... Total direct labour cost .........................

1st Quarter

2nd Quarter

3rd Quarter

4th Quarter

Year

23,850 ×0.75 17,887 ×$20.00 $357,740

22,350 ×0.75 16,763 ×$20.00 $335,260

21,100 ×0.75 15,825 ×$20.00 $316,500

22,000 ×0.75 16,500 ×$20.00 $330,000

89,300 ×0.75 66,975 ×$20.00 $1,339,500

351

Exercise 9-5 (30 minutes) 1.

Hruska Corporation Direct Labour Budget 1st Quarter 2nd Quarter

3rd Quarter

4th Quarter

13,000 0.2 2,600 $16.00 $41,600

14,000 0.2 2,800 $16.00 $44,800

Hruska Corporation Manufacturing Overhead Budget 1st Quarter 2nd Quarter 3rd Quarter

4th Quarter

Required production in units .................. Direct labour time per unit (hours)......... Total direct labour-hours needed ........... Direct labour cost per hour .................... Total direct labour cost .........................

12,000 0.2 2,400 $16.00 $38,400

10,000 0.2 2,000 $16.00 $32,000

Year 49,000 0.2 9,800 $16.00 $156,800

2 and 3.

Budgeted direct labour-hours ................ Variable manufacturing overhead rate .... Variable manufacturing overhead .......... Fixed manufacturing overhead .............. Total manufacturing overhead ............... Less depreciation .................................. Cash disbursements for manufacturing overhead ....................

Year

2,400 $1.75 $ 4,200 86,000 90,200 23,000

2,000 $1.75 $ 3,500 86,000 89,500 23,000

2,600 $1.75 $ 4,550 86,000 90,550 23,000

2,800 $1.75 $ 4,900 86,000 90,900 23,000

9,800 $1.75 $ 17,150 344,000 361,150 92,000

$67,200

$66,500

$67,550

$67,900

$269,150

352

Managerial Accounting, 13th Canadian Edition

Exercise 9-6 (15 minutes) 1. Used Bikes Selling and Administrative Expense Budget

Budgeted sales .............................................................. Variable selling and administrative expense 5% of sales ... Variable selling and administrative expense ..................... Fixed selling and administrative expenses: Advertising ................................................................. Employee salaries ....................................................... Rent ........................................................................... Insurance ................................................................... Depreciation ............................................................... Total fixed selling and administrative expenses ................ Total selling and administrative expenses ........................ Less depreciation ........................................................... Cash disbursements for selling and administrative expenses .......................................................................

1st Quar- 2nd Quar- 3rd Quar- 4th Quarter ter ter ter

Year

$150,000 × 5% $ 7,500

$160,000 × 5% $ 8,000

$140,000 × 5% $ 7,000

$130,000 × 5% $ 6,500

$580,000 × 5% $29,000

1,000 40,000 6,000

5,000 52,000 59,500 5,000

1,000 40,000 6,000 2,000 5,000 54,000 62,000 5,000

5,000 52,000 59,000 5,000

1,000 40,000 6,000 2,000 5,000 54,000 60,500 5,000

4,000 160,000 24,000 4,000 20,000 212,000 241,000 20,000

$ 54,500

$ 57,000

$ 54,000

$ 55,500

$221,000

2. The only change is that there would be additional depreciation of $250 in each of quarters three and four: ($2,000  2 years)  4 quarters per year. Since depreciation is a non-cash expense, total cash disbursements would not change from the amounts calculated in requirement 1.

353

Exercise 9-7 (20 minutes)

Cash balance, beginning................... Add collections from customers......... Total cash available .......................... Less disbursements: Purchase of inventory.................... Operating expenses ...................... Equipment purchases .................... Dividends ..................................... Total disbursements ......................... Excess (deficiency) of cash available over disbursements ....................... Financing: Borrowings ................................... Repayments ................................ Total financing ................................. Cash balance, ending .......................

Quarter (000 omitted) 3 4 2

Year

$ 6 * 65 71 *

$ 5 70 75

$ 6 323 * 329

$ 5 96 * 101

$ 5 92 97

35 * 28 8 * 2 * 73

45 * 30 * 8 * 2 * 85 *

48 30 * 10 * 2 * 90

35 * 25 10 2 * 72

163 113 * 36 * 8 320

(2) *

(10)

11 *

7 0 7 $5

15 * 0 15 $ 5

0 (6) (6) $ 5

0 (16) * (16) $ 9

22 (22) 0 $ 9

*Given.

Managerial Accounting, 13th Canadian Edition

Exercise 9-8 (20 minutes) Halifax Harbour Divers Flexible Budget For the Month Ended May 31 Actual diving-hours ................................................

105

Revenue ($365.00q)............................................... Expenses: Wages and salaries ($8,000 + $125.00q) ............. Supplies ($3.00q)................................................ Insurance ($3,400) ............................................. Miscellaneous ($630 + $1.80q) ............................ Total expenses ....................................................... Operating income...................................................

$38,325 21,125 315 3,400 819 25,659 $12,666

355

Exercise 9-9 (30 minutes) Quilcene Oysteria Flexible Budget Performance Report For the Month Ended August 31

Actual Results

Flexible Budget

Flexible Budget Variance

Kilograms ............................................

8,000

Revenue ($4.00q) ................................ Expenses: Packing supplies ($0.50q) .................. Oyster bed maintenance ($3,200) ...... Wages and salaries ($2,900 + $0.30q) ......................................... Shipping ($0.80q) ............................. Utilities ($830) .................................. Other ($450 + $0.05q) ...................... Total expenses .................................... Operating income ................................

$35,200

$32,000

$3,200

4,200 3,100 5,640

4,000 3,200 5,300

200 100 340

U F U

6,950 810 980 21,680 $13,520

6,400 830 850 20,580 $11,420

550 20 130 1,100 $2,100

U F U U F

Managerial Accounting, 13th Canadian Edition

Exercise 9-10 (30 minutes) Vision and Audio Comprehensive Performance Report For the Month Ended October 31

Flexible Budget Variance

Actual Jobs ...............................................................

Revenue ......................................................... Variable Expenses: Selling and administrative expenses .............. Office expenses ........................................... Miscellaneous expenses ................................ Total variable expenses ................................ Contribution margin Less fixed expenses: Technician wages ..................................... Selling and administrative expenses ............ Office expenses ......................................... Marketing expenses ................................... Insurance ................................................. Miscellaneous ............................................ Total fixed expenses ................................... Operating income ...........................................

$52,250

1,500 304 171 1,975 50,275

75 19 19 75 75

16,900 1,304 5,112 3,300 300 538 27,454 $ 22,821

300 79 288 140 0 12 381 $306

Sales Volume Variance

Flexible Budget

Static Budget

100

$52,250

2,750

$55,000

U U F U U

1,425 285 190 1,900 50,350

75 15 10 100 2,650

F F F F U

1,500 300 200 2,000 53,000

F U F U

17,200 1,225 5,400 3,160 300 550 27,835 $ 22,515

0 0 0 0 0 0 0 $2,650

17,200 1,225 5,400 3,160 300 550 27,835 25,165

F F F

357

Problem 9-11 (60 minutes) 1. 1. The estimated sales for the third quarter:

Budgeted unit sales ............ Selling price per unit ........... Budgeted sales ...................

July

Month August

September

Quarter

30,000 × $12 $360,000

70,000 × $12 $840,000

50,000 × $12 $600,000

150,000 × $12 $1,800,000

2. The expected cash collections from sales for the third quarter: Accounts receivable, June 30: $300,000 × 65% ........... July sales: $360,000 × 30%, 65% .. August sales: $840,000 × 30%, 65% .. September sales: $600,000 × 30% ........... Total cash collections ........

$195,000 108,000

$303,000

$ 195,000 $234,000

342,000

252,000

$546,000

798,000

$486,000

180,000 $726,000

180,000 $1,515,000

3. The production budget (quantity of beach umbrellas) for July-October:

July Budgeted unit sales ...................... Add desired units of ending finished goods inventory ................ Total needs................................... Less units of beginning finished goods inventory ......................... Required production in units ..........

August

September

October

30,000

70,000

50,000

20,000

10,500 40,500

7,500 77,500

3,000 53,000

1,500 21,500

4,500 36,000

10,500 67,000

7,500 45,500

3,000 18,500

Managerial Accounting, 13th Canadian Edition

Problem 9-11 (continued) 4 and 5. The direct materials budget for the third quarter: July Required production in units of finished goods .................................................. Units of raw materials needed per unit of finished goods ................................. Units of raw materials needed to meet production ........................................... Add desired units of ending raw materials inventory* ...................................... Total units of raw materials needed .......... Less units of beginning raw materials inventory ............................................. Units of raw materials to be purchased .... Unit cost of raw materials ........................ Cost of raw materials to be purchased......

August

September

Quarter

36,000

67,000

45,500

148,500

×1

36,000

67,000

45,500

148,500

33,500 69,500

22,750 89,750

9,250 54,750

9,250 157,750

18,000 51,500 × $3.20 $164,800

33,500 56,250 × $3.20 $180,000

22,750 32,000 × $3.20 $102,400

18,000 139,750 × $3.20 $447,200

* September 30: 18,500 units (October) × 1 metre per unit = 18,500 metre 18,500 feet × ½ = 9,250 metre

359

Problem 9-11 (continued) 6. The expected cash disbursements for materials purchases for the third quarter:

July Accounts payable, June 30 .............................. July purchases: $164,800 × 50%, 50% ....... August purchases: $180,000 × 50%, 50% ...................... September purchases: $102,400 × 50% ................ Total cash disbursements .......

August

September

$ 76,000 82,400

$158,400

Quarter $ 76,000

$ 82,400

164,800

90,000

$ 90,000

180,000

$172,400

51,200 $141,200

51,200 $472,000

Managerial Accounting, 13th Canadian Edition

Problem 9-12 (30 minutes) 1. September cash sales ............................................ Collections on account: July sales: $200,000 × 20% ................................ August sales: $260,000 × 60% ........................... September sales: $300,000 × 20% ...................... Total cash collections ..........................................

$ 42,000 40,000 156,000 60,000 $298,000

2. Payments to suppliers: August purchases (accounts payable) .................. September purchases: $140,000 × 40% .............. Total cash payments ........................................... 3.

$80,000 56,000 $136,000

Country Quilts Cash Budget For the Month of September Beginning cash balance ............................................... Add collections from customers.................................... Total cash available ..................................................... Less cash disbursements: Payments to suppliers for inventory .......................... Selling and administrative expenses* ........................ Property taxes paid .................................................. Total cash disbursements ............................................ Excess (deficiency) of cash available over disbursements ......................................................... Financing: Borrowings .............................................................. Repayments ............................................................ Interest ................................................................... Total financing ............................................................ Ending cash balance ...................................................

$ 20,000 298,000 318,000 $136,000 189,600 4,800 330,400 (12,400) 22,400 0 0 22,400 $ 10,000

*$215,000 – $25,000 - $400 = $189,600.

361

Problem 9-12 (continued) 4. Beginning cash balance ............................................... Add collections from customers.................................... Total cash available ..................................................... Less total cash disbursements: Total cash disbursements ............................................ Excess (deficiency) of cash available over disbursements ......................................................... Financing: Borrowings* ............................................................ Repayments ............................................................ Interest** ............................................................... Total financing ............................................................ Ending cash balance ...................................................

$ 10,000 298,000 308,000 330,400 (22,400) 32,512 0 (112) 32,400 $ 10,000

* Borrowing - $22,400 - $112 (interest due October 1) = $10,000 Borrowing = $32,512 **September loan of $22,400 * .5%

Managerial Accounting, 13th Canadian Edition

Problem 9-13 (45 minutes) 1. The budget at Springfield is an imposed ―top-down‖ budget that fails to consider both the need for realistic data and the human interaction essential to an effective budgeting/control process. The President has not given any basis for his goals, so one cannot know whether they are realistic for the company. True participation of company employees in preparation of the budget is minimal and limited to mechanical gathering and manipulation of data. This suggests there will be little enthusiasm for implementing the budget. The sales by product line should be based on an accurate sales forecast of the potential market. Therefore, the sales by product line should have been developed first to derive the sales target rather than the reverse. The initial meeting between the Vice President of Finance, Executive Vice President, Marketing Manager, and Production Manager should have been held earlier. This meeting was held too late in the budget process. 2. Springfield should consider adopting a ―bottom-up‖ budget process. This means that the people responsible for performance under the budget would participate in the decisions by which the budget is established. In addition, this approach requires initial and continuing involvement of sales, financial, and production personnel to define sales and profit goals that are realistic within the constraints under which the company operates. Although time consuming, the approach should produce a more acceptable, honest, and workable goal-control mechanism. The sales forecast should be developed considering internal sales-forecasts as well as external factors. Costs within departments should be divided into fixed and variable, controllable and non-controllable, discretionary and nondiscretionary. Flexible budgeting techniques could then allow departments to identify costs that can be modified in the planning process.

363

Problem 9-13 (continued) 3. The functional areas should not necessarily be expected to cut costs when sales volume falls below budget. The time frame of the budget (one year) is short enough so that many costs are relatively fixed. For costs that are fixed, there is little hope for a reduction as a consequence of short-run changes in volume. However, the functional areas should be expected to cut costs should sales volume fall below target when: a. control is exercised over the costs within their function. b. budgeted costs were more than adequate for the originally targeted sales, i.e., slack was present. c. budgeted costs vary to some extent with changes in sales. d. there are discretionary costs that can be delayed or omitted with no serious effect on the department. (Adapted unofficial CPA Canada Solution)

Managerial Accounting, 13th Canadian Edition

Problem 9-14 (45 minutes) 1.

Production budget:

April

May

June

July

Budgeted sales (units) .................. 120,000 150,000 210,000 106,000 * Add desired ending inventory 31,000 37,000 26,600 22,000 Total needs ................................... 151,000 187,000 236,600 128,000 Less beginning inventory ............... 28,000 31,000 37,000 26,600 Required production ...................... 123,000 156,000 199,600 101,400 * April E.I. = 16,000 units + 150,000 (next month‘s sales) x 10%; July E.I. = 16,000 units + 60,000 x 10% 2. Direct materials budget:

Required production (units) ......... XL 12 components needed per unit ......................................... Production needs ........................ Add desired ending inventory ...... Total XL 12 needs ....................... Less beginning inventory ............. Material XL 12 purchases .............

Second Quarter

April

May

June

123,000

156,000

199,600

478,600

x4 492,000 124,800 616,800 98,400 518,400

x4 624,000 159,680 783,680 124,800 658,880

x4 798,400 81,120 * 879,520 159,680 719,840

x4 1,914,400 81,120 1,995,520 98,400 1,897,120

* 101,400 units (July production) × 4 components per unit = 405,600 components; 405,600 × 0.2 = 81,120 components.

365

Problem 9-15 (30 minutes) 1.

Zan Corporation Direct Materials Budget

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Required production in units of finished goods ....................................................... Units of raw materials needed per unit of finished goods ........................................... Units of raw materials needed to meet production ..................................................... Add desired units of ending raw materials inventory................................................... Total units of raw materials needed ............... Less units of beginning raw materials inventory .......................................................... Units of raw materials to be purchased .......... Unit cost of raw materials ............................. Cost of raw materials to be purchased .................................................

Year

5,000

8,000

7,000

6,000

26,000

×8

40,000

64,000

56,000

48,000

208,000

16,000 56,000

14,000 78,000

12,000 68,000

8,000 56,000

8,000 216,000

6,000 50,000 × $1.20

16,000 62,000 × $1.20

14,000 54,000 × $1.20

12,000 44,000 × $1.20

6,000 210,000 × $1.20

$60,000

$74,400

$64,800

$52,800

$252,000

366

Managerial Accounting, 13th Canadian Edition

Problem 9-15 (continued) Schedule of Expected Cash Disbursements for Materials Beginning accounts payable .................. 1st Quarter purchases ........................... 2nd Quarter purchases.......................... 3rd Quarter purchases .......................... 4th Quarter purchases .......................... Total cash disbursements for materials .. 2. 1. Required production in units .................. Direct labor-hours per unit .................... Total direct labor-hours needed ............. Direct labor cost per hour...................... Total direct labor cost ...........................

$ 2,880 36,000

$38,880

$24,000 44,640

$68,640

$29,760 38,880 $68,640

$25,920 31,680 $57,600

$ 2,880 60,000 74,400 64,800 31,680 $233,760

Zan Corporation Direct Labor Budget

1st Quarter

2nd Quarter

5,000 × 0.20 1,000 × $11.50 $ 11,500

8,000 × 0.20 1,600 × $11.50 $ 18,400

3rd Quarter 4th Quarter 7,000 × 0.20 1,400 × $11.50 $ 16,100

6,000 × 0.20 1,200 × $11.50 $ 13,800

Year 26,000 × 0.20 5,200 × $11.50 $ 59,800

367

Problem 9-16 (30 minutes) 1.

Specialty James Direct Labour Budget

1. 1.

Jars to be produced .............................. Direct labour time per unit (hours)......... Total direct labour-hours needed ........... Direct labour cost per hour .................... Total direct labour cost .........................

1st Quarter

2nd Quarter

3rd Quarter

4th Quarter

Year

4,000 0.50 2,000 $15 $30,000

5,000 0.50 2,500 $15 $37,500

4,500 0.50 2,250 $15 $33,750

7,000 0.50 3,500 $15 $52,500

20,500 0.50 10,250 $15 $153,750

368

Managerial Accounting, 13th Canadian Edition

Problem 9-16 (continued) 2. 1. 1.

Specialty Jams Manufacturing Overhead Budget

1st Quarter Budgeted direct labour-hours ................ Variable overhead rate .......................... Variable manufacturing overhead .......... Fixed manufacturing overhead .............. Total manufacturing overhead ............... Less depreciation .................................. Cash disbursements for manufacturing overhead...........................................

2nd Quarter

3rd Quarter

4th Quarter

Year

2,000 $1.00 $ 2,000 12,000 14,000 3,000

2,500 $1.00 $ 2,500 12,000 14,500 3,000

2,250 $1.00 $ 2,250 12,000 14,250 3,000

3,500 $1.00 $ 3,500 12,000 15,500 3,000

10,250 $1.00 $10,250 48,000 58,250 12,000

$11,000

$11,500

$11,250

$12,500

$46,250

369

Problem 9-17 (45 minutes) The expected cash collections are calculated as follows:

Cash sales .......................... March credit sales collected . April credit sales collected: $40,000 × 20%, 80% ...... May credit sales collected: $44,000 × 20%, 80% ...... June credit sales collected: $52,000 × 20% ............... Total cash collections ..........

April

May

June

Total

$ 60,000 36,000

$ 66,000

$ 78,000

$204,000 36,000

8,000

32,000

$104,000

40,000

8,800

35,200

44,000

$106,800

10,400 $123,600

10,400 $334,400

2. The budgeted merchandise purchases are calculated as follows:

Cost of goods sold .............. Add: desired ending merchandise inventory* ......... Total needs ......................... Less: beginning merchandise inventory .................. Required purchases.............

April

May

June

Total

$ 60,000

$ 66,000

$ 78,000

$204,000

43,000 103,000

49,000 115,000

52,000 130,000

52,000 256,000

40,000 $ 63,000

43,000 $ 72,000

49,000 $ 81,000

40,000 $216,000

* April: $66,000 × 50% + $10,000 = $43,000 May: $78,000 × 50% + $10,000 = $49,000 June: $140,000 × 60% × 50% + $10,000 = $52,000

Managerial Accounting, 13th Edition

Problem 9-17 (continued) 3. The budgeted cash disbursements for merchandise purchases are calculated as follows:

Cash purchases................... March purchases paid ......... April credit purchases paid: $63,000 × 90% ............... May credit purchases paid: $72,000 × 90% ............... Total cash disbursed............

April

May

June

Total

$ 6,300 51,300

$ 7,200

$ 8,100

$21,600 51,300

56,700

$57,600

$63,900

56,700 64,800 $72,900

64,800 $194,400

4. The budgeted balance sheet is calculated as follows: Deacon Company Balance Sheet June 30 Assets Cash ($55,000 + $334,400 – $194,400 – $48,000) ......................... Accounts receivable ($130,000 × 40% × 80%) .............................. Inventory (see requirement 2) ....................................................... Buildings and equipment, (net) ($100,000 – $3,000)....................... Total assets .................................................................................. Liabilities and Stockholders’ Equity Accounts payable ($81,000 – $8,100) ............................................ Common shares Retained earnings ($109,700 + $25,000 + $27,500 + $32,500) ...... Total liabilities and stockholders‘ equity ..........................................

$147,000 41,600 52,000 97,000 $337,600 $ 72,900 70,000 194,700 $337,600

371

Problem 9-18 (45 minutes) 1. Schedule of cash receipts: Cash sales—May ............................................................ Collections on account receivable: April 30 balance .......................................................... May sales (50% × $140,000) ...................................... Total cash receipts ......................................................... Schedule of cash payments for purchases: April 30 accounts payable balance ................................... May purchases (40% × $120,000) .................................. Total cash payments ......................................................

$ 60,000 54,000 70,000 $184,000

$ 63,000 48,000 $111,000

Minden Company Cash Budget For the Month of May Beginning cash balance .................................................. Add collections from customers (above) .......................... Total cash available ........................................................ Less cash disbursements: Purchase of inventory (above) ..................................... Selling and administrative expenses ............................. Purchases of equipment .............................................. Total cash disbursements ............................................... Excess of cash available over disbursements .................... Financing: Borrowing—note ......................................................... Repayments—note ...................................................... Interest ...................................................................... Total financing ............................................................... Ending cash balance ......................................................

$ 9,000 184,000 193,000 111,000 72,000 6,500 189,500 3,500 20,000 (14,500) (100) 5,400 $ 8,900

Managerial Accounting, 13th Edition

Problem 9-18 (continued) 2. Minden Company Budgeted Income Statement For the Month of May Sales ................................................................... Cost of goods sold: Beginning inventory .......................................... Add purchases .................................................. Goods available for sale ..................................... Ending inventory ............................................... Cost of goods sold ............................................... Gross margin ....................................................... Selling and administrative expenses ($72,000 + $2,000) ............................................................ Net operating income ........................................... Interest expense .................................................. Net income ..........................................................

$200,000 $ 30,000 120,000 150,000 40,000 110,000 90,000 74,000 16,000 100 $ 15,900

3. Minden Company Budgeted Balance Sheet May 31

Assets Cash ....................................................................................... Accounts receivable (50% × $140,000) ..................................... Inventory ................................................................................ Buildings and equipment, net of depreciation ($207,000 + $6,500 – $2,000) .................................................................. Total assets .............................................................................

$ 8,900 70,000 40,000 211,500 $330,400

Liabilities and Shareholders‘ Equity Accounts payable (60% × 120,000) .......................................... Note payable ........................................................................... Common stock ......................................................................... Retained earnings ($42,500 + $15,900) .................................... Total liabilities and stockholders‘ equity .....................................

$ 72,000 20,000 180,000 58,400 $330,400

373

Problem 9-19 (60 minutes) 1. The sales budget for the third quarter: Budgeted sales (units) ........... Selling price per unit .............. Total budgeted sales ..............

July

Aug.

Sept.

Quarter

6,500 x $60 $390,000

5,000 x $60 $300,000

4,000 x $60 $240,000

15,500 x $60 $930,000

Sept.

Quarter

The schedule of expected cash collections from sales:

July Accounts receivable, beginning balance ....................... July sales: $390,000 × 50%, 45% ....... August sales: $300,000 × 50%, 45% ....... September sales: $240,000 × 50% ................ Total cash collections .............

Aug.

$160,000 195,000

$355,000

$160,000 $175,500

370,500

150,000

$135,000

285,000

$325,500

120,000 $255,000

120,000 $935,500

2. The production budget for July through October: Budgeted sales (units) ............................... Add desired ending inventory ..................... Total needs ................................................ Less beginning inventory ............................ Required production (units) ........................

July

Aug.

Sept.

Oct.

6,500 1,000 7,500 1,300 6,200

5,000 800 5,800 1,000 4,800

4,000 600 4,600 800 3,800

3,000 500 3,500 600 2,900

Managerial Accounting, 13th Edition

Problem 9-19 (continued) 3. The direct materials purchases budget for the third quarter: Required production—units (above) ................................... Raw materials needs per unit....... Production needs (kgs.) ............... Add desired ending inventory ...... Total needs ................................. Less beginning inventory Raw materials to be purchased .... Cost of raw materials to be purchased at $3.50 per kg.............

July

Aug.

Sept.

Quarter

6,200 x 3 kgs. 18,600 2,880 21,480 3,720 17,760

4,800 x 3 kgs. 14,400 2,280 16,680 2,880 13,800

3,800 x 3 kgs. 11,400 1,740 * 13,140 2,280 10,860

14,800 x 3 kgs. 44,400 1,740 46,140 3,720 42,420

$62,160

$48,300

$38,010

$148,470

Sept.

Quarter

*2,900 units (October) × 3 kgs. per unit = 8,700 kgs.; 8,700 kgs. × 20% = 1,740 kgs. The schedule of expected cash disbursements:

July Accounts payable, beginning balance July purchases: $62,160 × 70%, 30% ................... August purchases: $48,300 × 70%, 30% ................... September purchases: $38,010 × 70% ............................ Total cash disbursements .................

Aug.

$11,400 43,512

$54,912

$11,400 $18,648

62,160

33,810

$14,490

48,300

$52,458

26,607 $41,097

26,607 $148,467

375

Problem 9-20 (120 minutes) 1. Sales Budget March April May June July Total sales $60,000 $70,000 $85,000 $90,000 $50,000 12,000 Cash 14,000 17,000 18,000 10,000 Credit $48,000 $56,000 $68,000 $72,000 $40,000 1. Schedule of Expected Cash Collections April May June Quarter Cash sales 14,000 17,000 18,000 $49,000 Credit sales 48,000 56,000 68,000 172,000 Total collections $62,000 $73,000 $86,000 $221,000 2. Inventory Purchases Budget

April $42,000

May $51,000

June $54,000

Quarter $147,000

Budgeted cost of goods sold* Add desired ending inven15,300 16,200 9,000 9,000 ‡ tory Total needs 57,300 67,200 63,000 156,000 Less beginning inventory 12,600 15,300 16,200 12,600 Required purchases $44,700 $51,900 $46,800 $143,400 *For April sales: $70,000 sales  60% cost ratio ‡ At April 30: $51,000  30% At June 30: July sales $50,000  60% cost ratio  30% Schedule of Expected Cash Disbursements—Purchases April May June March purchases $18,300 April purchases 22,350 $22,350 May purchases 25,950 $25,950 June purchases 23,400 Total disbursements $40,650 $48,300 $49,350

Quarter $ 18,300 44,700 51,900 23,400 $138,300

Managerial Accounting, 13th Edition

Problem 9-20 (continued) 3. Schedule of Expected Cash Disbursements—Selling and Administrative Expenses April May June Quarter Salaries and wages $ 7,500 $ 7,500 $7,500 $22,500 Shipping (6% of sales) 4,200 5,100 5,400 14,700 Advertising 6,000 6,000 6,000 18,000 ,800 Other (4% of sales) 2 3,400 3,600 9,800 Total disbursements $20,500 $22,000 $22,500 $65,000 4. Cash Budget

April $ 9,000

May $ 8,000

June $ 8,000

Quarter $ 9,000

Cash balance, beginning Add cash collections 62,000 73,000 86,000 221,000 Total cash available 71,000 81,000 94,000 230,000 Less disbursement For inventory 40,650 48,300 49,350 138,300 For expenses 20,500 22,000 22,500 65,000 For equipment 11,500 3,000 0 14,500 For dividends 0 0 3,500 3,500 Total disbursements 72,650 73,300 75,350 221,300 Excess (deficiency) of (1,650) 7,700 18,650 8,700 cash Financing: Borrowings* 9,747 401 0 10,148 Repayments (10,148) (10,148) Interest** (97) (101) (101) (299) Total financing 9,650 300 (10,249) (299) Cash balance, end $ 8,000 $ 8,000 $ 8,401 $ 8,401 **April: ($1,650) + X - .01X = $8,000, X = $9,747 (rounded) May: $7,700 + X - .01X - $97 = $8,000, X = $401 (rounded) ***April: $9,747 x 1% = $97; May & June: ($9,747 + $401) x 1% = $101

377

Problem 9-20 (continued) 5. LEISURE SPORTS Income Statement For the Quarter Ended June 30 Sales Less cost of goods sold: Beginning inventory (Given) Add purchases (Part 2) Goods available for sale Ending inventory (Part 2) Gross margin Less operating expenses: Salaries and wages (Part 3) Shipping (Part 3) Advertising (Part 3) Depreciation Other expenses (Part 3) Operating income Less interest expense (Part 4) Net income *A simpler computation would be $245,000  60%

$245,000 $ 12,600 143,400 156,000 9,000

147,000* 98,000

22,500 14,700 18,000 6,000 9,800 $

71,000 27,000 299 26,701

Managerial Accounting, 13th Edition

Problem 9-20 (continued) 6. LEISURE SPORTS Balance Sheet June 30 Assets Current assets: Cash (Part 4) Accounts receivable ($90,000  80%) Inventory (Part 2) Total current assets Building and equipment—net ($214,100 + $14,500 – $6,000) Total assets Liabilities and Shareholders‘ Equity Accounts payable (Part 2: $46,800  50%) Shareholders‘ equity: Common shares (Given) $190,000 Retained earnings* 98,601 Total liabilities and shareholders‘ equity *Retained earnings, beginning $ 75,400 Add net income 26,701 Total 102,101 Less dividends 3,500 Retained earnings, ending $ 98,601

8,401 72,000 9,000 89,401 222,600

$312,001 $ 23,400 288,601 $312,001

379

Problem 9-21 (60 minutes) 1. Collections on sales: Cash sales (@ 20%) ............... Sales on account: February: $200,000 × 80% × 20% ............................ March: $300,000 × 80% × 70%, 20% ....................... April: $600,000 × 80% × 10%, 70%, 20% .............. May: $900,000 × 80% × 10%, 70% ....................... June: $500,000 × 80% × 10% ................................ Total cash collections ..............

April

May

June

Quarter

$120,000

$180,000

$100,000

$ 400,000

32,000

168,000

48,000

336,000

96,000

480,000

72,000

504,000

576,000

$636,000

40,000 $740,000

40,000 $1,744,000

May

June

July

$630,000

$350,000

$280,000

70,000 700,000

56,000 406,000

126,000 $574,000

70,000 $336,000

$368,000

216,000

2. a. Merchandise purchases budget:

April Budgeted cost of goods sold ............. $420,000 Add desired ending merchandise inventory* .................................... 126,000 Total needs ...................................... 546,000 Less beginning merchandise inventory .............................................. 84,000 Required inventory purchases ........... $462,000

*20% of the next month‘s budgeted cost of goods sold. b. Schedule of expected cash disbursements for merchandise purchases:

April Beginning accounts payable .................... April purchases ............ May purchases ............. June purchases ............ Total cash disbursements ..........

$126,000 231,000

$357,000

May

$231,000 287,000

$518,000

June

Quarter

$287,000 168,000

$ 126,000 462,000 574,000 168,000

$455,000

$1,330,000

Managerial Accounting, 13th Edition

Problem 9-21 (continued) 3. Garden Sales, Inc. Cash Budget For the Quarter Ended June 30

April Beginning cash balance ............... $ 52,000 Add collections from customers.... 368,000 Total cash available ..................... 420,000 Less cash disbursements: Purchases for inventory ............ 357,000 Selling expenses ...................... 79,000 Administrative expenses* ......... 25,000 Land purchases........................ — Dividends paid ......................... 49,000 Total cash disbursements ......... 510,000 Excess (deficiency) of cash available over disbursements .... (90,000) Financing: Borrowings .............................. 130,000 Repayments ............................ 0 Interest ($130,000 × 1% × 3 + $50,000 × 1% × 2) .............. 0 Total financing ............................ 130,000 Ending cash balance ................... $ 40,000 *Excludes $20,000 depreciation per month.

May

June

Quarter

$ 40,000 636,000 676,000

$ 40,000 740,000 780,000

$ 52,000 1,744,000 1,796,000

518,000 120,000 32,000 16,000 — 686,000

455,000 62,000 21,000 — — 538,000

1,330,000 261,000 78,000 16,000 49,000 1,734,000

(10,000)

242,000

62,000

50,000 0

0 (180,000)

180,000 (180,000)

0 50,000 $ 40,000

(4,900) (184,900) $ 57,100

(4,900) (4,900) 57,100

381

Problem 9-22 (60 minutes) 1. Collections on sales: Cash sales ............................. Sales on account: February: $200,000 × 80% × 20% ............................ March: $300,000 × 80% × 70%, 20% ....................... April: $600,000 × 80% × 25%, 65%, 10% .............. May: $900,000 × 80% × 25%, 65% ....................... June: $500,000 × 80% × 25% ................................ Total cash collections ..............

April

May

June

Quarter

$120,000

$180,000

$100,000

$ 400,000

32,000

168,000

48,000

120,000

312,000

48,000

480,000

180,000

468,000

648,000

$720,000

100,000 $716,000

100,000 $1,876,000

May

June

July

$630,000

$350,000

$280,000

52,500 682,500

42,000 392,000

94,500 $588,000

52,500 $339,500

$440,000

216,000

2. a. Merchandise purchases budget:

April Budgeted cost of goods sold ............. $420,000 Add desired ending merchandise inventory* .................................... 94,500 Total needs ...................................... 514,500 Less beginning merchandise inventory .............................................. 84,000 Required inventory purchases ........... $430,500

*15% of the next month‘s budgeted cost of goods sold. b. Schedule of expected cash disbursements for merchandise purchases:

April Beginning accounts payable .................... April purchases ............ May purchases ............. June purchases ............ Total cash disbursements ..........

$126,000 215,250

$341,250

May

$215,250 294,000

$509,250

June

Quarter

$294,000 169,750

$ 126,000 430,500 588,000 169,750

$463,750

$1,314,250

Managerial Accounting, 13th Edition

Problem 9-22 (continued) 3. Garden Sales, Inc. Cash Budget For the Quarter Ended June 30

April Beginning cash balance ............... $ 52,000 Add collections from customers.... 440,000 Total cash available ..................... 492,000 Less cash disbursements: Purchases for inventory ............ 341,250 Selling expenses ...................... 79,000 Administrative expenses* ......... 25,000 Land purchases........................ — Dividends paid ......................... 49,000 Total cash disbursements ......... 494,250 Excess (deficiency) of cash available over disbursements .... (2,250) Financing: Borrowings .............................. 43,000 Repayments ............................ 0 Interest ($43,000 × 1% × 3) ............. 0 Total financing ............................ 43,000 Ending cash balance ................... $ 40,750 *Excludes $20,000 depreciation per month.

May

June

Quarter

$ 40,750 720,000 760,750

$ 83,500 716,000 799,500

$ 52,000 1,876,000 1,928,000

509,250 120,000 32,000 16,000 — 677,250

463,750 62,000 21,000 — — 546,750

1,314,250 261,000 78,000 16,000 49,000 1,718,250

83,500

252,750

209,750

0 0

0 (43,000)

43,000 (43,000)

0 0 $ 83,500

(1,290) (44,290) $ 208,460

(1,290) (1,290) $ 208,460

4. Collecting accounts receivable sooner and reducing inventory levels reduces the company‘s borrowing from $180,000 to $43,000. It also reduces the company‘s interest expense from $4,900 to $1,290.

383

Problem 9-23 (90 minutes) 1. Budgeted sales ........................... Add desired ending inventory* .... Total needs ................................ Less beginning inventory ............. Required production....................

April

May

June

Quarter

30,000 10,600 40,600 6,000 34,600

53,000 15,000 68,000 10,600 57,400

75,000 13,600 88,600 15,000 73,600

158,000 13,600 171,600 6,000 165,600

*20% of the next month‘s sales. 2. Material #226: Required production—units .... Material #226 per unit ........... Production needs—kilograms .. Add desired ending inventory*..................................... Total needs—kilograms .......... Less beginning inventory ........ Required purchases— kilograms ........................... Required purchases at $4.00 per kilogram .......................

April

May

June

Quarter

34,600 × 2 kgs. 69,200

57,400 × 2 kgs. 114,800

73,600 × 2 kgs. 147,200

165,600 × 2 kgs. 331,200

68,880 138,080 23,000

88,320 203,120 68,880

76,080 223,280 88,320

76,080 407,280 23,000

115,080

134,240

134,960

384,280

$460,320

$536,960

$539,840

$1,537,120

* 60 of the following month‘s production needs. For June: July production 68,000 + 9,000 – 13,600 = 63,400 units; 63,400 units × 2 kgs. per unit = 126,800 kgs.; 126,800 kgs. × 60% = 76,080 kgs.

Managerial Accounting, 13th Edition

Problem 9-23 (continued) Material #301: Required production—units .... Material #301 per unit ........... Production needs—metres...... Add desired ending inventory* .................................... Total needs—metres .............. Less beginning inventory........ Required purchases—metres .. Required purchases at $1.50 per metre...........................

April

May

June

Quarter

34,600 × 5 mt. 173,000

57,400 × 5 mt. 287,000

73,600 × 5 mt. 368,000

165,600 × 5 mt. 828,000

86,100 259,100 35,000 224,100

110,400 397,400 86,100 311,300

95,100 463,100 110,400 352,700

95,100 923,100 35,000 888,100

$336,150

$466,950

$529,050

$1,332,150

* 30 of the following month‘s production needs. For June: July production 68,000 + 9,000 – 13,600 = 63,400 units; 63,400 units × 5 mt. per unit = 317,000 mt.; 317,000 mt. × 30% = 95,100 mt. 3. Direct labour budget:

Units Produced Cutting ........... Assembly........ Finishing ........

165,600 165,600 165,600

Direct Labour Hours Per Unit Total 0.15 0.60 0.10

24,840 99,360 16,560 140,760

Cost per DLH $16.00 $14.00 $18.00

Total Cost $ 397,440 1,391,040 298,080 $2,086,560

385

Problem 9-23 (continued) 4. Manufacturing overhead budget: Expected production for the year ........................................... Actual production through March 31....................................... Expected production, April through December ........................ Variable manufacturing overhead rate per unit ($124,800 ÷ 48,000 units) ................................................. Variable manufacturing overhead ........................................... Fixed manufacturing overhead ($4,166,000 × 9/12) ............... Total manufacturing overhead ............................................... Less depreciation ($2,619,000 × 9/12)................................... Cash disbursement for manufacturing overhead......................

380,000 48,000 332,000 × $2.60 $ 863,200 3,124,500 3,987,700 1,964,250 $2,023,450

(CPA Canada Solution, adapted)

Managerial Accounting, 13th Edition

Problem 9-24 (45 minutes) 1. a. The benefits that Marge Atkins and Pete Granger may realize by using budgetary slack include the following: • They are both hedging against the possibility that events beyond their control will lead to negative consequences. For example, a rapid increase in inflation might reduce sales of ‗luxury‘ items such as virtual gaming equipment, which in turn would likely negatively impact software sales. Or, an unexpected spike in software demand might put pressure on Granger to pay his programmers overtime wages to keep up with development needs. Creating a cushion using budgetary slack reduces the risk of these types of events negatively impacting performance versus budget. • The use of budgetary slack allows employees to exceed expectations and/or show consistent performance against budget. This is particularly important when performance is evaluated on the basis of actual results versus budget, which is the case at VG. • Atkins and Granger can increase the likelihood of attaining personal goals using budgetary slack as good performance leads to larger bonuses for both. 

Atkins and Granger can use budgetary slack to keep their employees happier through larger bonuses (Atkins) and lower workloads (Granger).

b. The use of budgetary slack can adversely affect Atkins and Granger by: • Limiting the usefulness of the budget to motivate their employees to top performance. If budget slack is excessive, the budgets will no longer represent challenging but attainable targets. Rather, they will be easily attainable. • Affecting their ability to identify issues that should be addressed throughout the year and take appropriate corrective action. For example, if actual revenues are somewhat better than a budget containing slack, but well below what they should be had the budget been set at realistic levels, Atkins may fail to recognize that there is a problem. As such, she may not follow-up to determine why sales performance is worse than it should be relative to a realistic budget. • Reducing their credibility in the eyes of management. At some point, senior managers are likely to question whether Atkins and Granger‘s favourable performance relative to budget is because they are great managers, or because they are padding their budgets. 2. The use of budgetary slack, particularly if it has a detrimental effect on the company, may be unethical.2. The creation of budgetary slack in this company is clearly © McGraw Hill Ltd. 2024. All rights reserved. Solutions Manual, Chapter 9

387

unethical and appears to be driven by the self-interested behaviour of Atkins and Granger. Per the discussion of ethics in Chapter 1 (LO 4), intentionally misstating the budget for potential personal gain is dishonest and may negatively impact the organization‘s ability to meet its objectives. Indeed, Atkins admits to padding her revenue budget by 10%-15% and Granger over-estimates staffing needs by 10%. These seem like material amounts of budgetary slack, which in turn result in both managers receiving much larger bonuses than they likely deserve. Moreover, being dishonest in budgeting may represent a more widespread pattern or culture of undesirable behaviour in an organization. While creating budgetary slack may seem innocuous as an isolated behaviour, employees who feel it is acceptable to do so and get away with it, may engage in other unethical practices, which could also negatively impact the organization and its stakeholders. A particularly troubling aspect of Atkins‘ rationale for creating budgetary slack in this case is that she sees it as a means of creating more equitable compensation. Managers who feel they are underpaid should not engage in dishonest behaviour as a means of addressing the problem. This would be akin to going grocery shopping and upon having to pay a high price for milk, deciding to ‗offset‘ that cost by stealing another product! Atkins should approach senior management with her concerns in an effort to work out an acceptable solution regarding compensation. 3. The incentive scheme used to reward Atkins creates a strong incentive for creating budgetary slack. Every dollar of slack she can create will potentially yield an extra return of 1%. If the entirely of the $500,000 she beat budget by last year was budgetary slack, she received an extra $5,000 relative to submitting an honest budget. Some possible changes to the incentive scheme to weaken the incentive for slack:  Limit (cap) the amount of sales above budget that will be rewarded. For example, had there been a cap of $250,000 Atkins‘ additional bonus of $5,000 last year would have been reduced to $2,500.  Reduce or eliminate the bonus percentage for sales above budget.  Provide a reduced lump-sum bonus for actual sales that are less than budget, but close. For example, Atkins could be paid a $20,000 bonus if actual sales are 80% of budget. This creates less incentive to pad the budget since bonuses aren‘t as strongly linked to budget attainment.  Base the bonus on actual sales growth relative to the prior period instead of using the budget to determine bonus amounts. This would likely have the effect of considerably reducing the motivation to create budget slack since the budget would no longer be used for determining rewards. © McGraw Hill Ltd. 2024. All rights reserved. 388

Managerial Accounting, 13th Edition

Problem 9-25 (30 minutes) 1. The cost control report compares the static budget, which was prepared for 35,000 machine-hours, to actual results for 38,000 machine-hours. This is like comparing apples to oranges. Costs that are variable or mixed should be higher when the activity level is 38,000 rather than 35,000 machine-hours. Direct comparisons of budgeted to actual costs are valid only if the costs are fixed. The cost control report prepared by the company should not be used to evaluate how well costs were controlled.

389

Problem 9-25 (continued) 2. A report that would be helpful in assessing how well costs were controlled appears below: Freemont Corporation—Machining Department Comprehensive Performance Report For the Month Ended June 30

Actual Results Machine-hours (q) ................................

38,000

Direct labour wages* ($2.30q) .............. Supplies* ($0.60q) ............................... Maintenance** ($92,000 + $1.20q) ....... Utilities** ($11,700 + $0.10q)............... Supervision ($38,000) ........................... Depreciation ($80,000) ......................... Total ....................................................

$ 86,100 23,100 137,300 15,700 38,000 80,000 $380,200

* **

Flexible Budget Variance

Flexible Budget

Volume Variance

38,000 $ 1,300 300 300 200 0 0 $ 1,100

F U F U

$ 87,400 22,800 137,600 15,500 38,000 80,000 $381,300

Static Budget 35,000

$6,900 1,800 3,600 300 0 0 $12,600

U U U U

$ 80,500 21,000 134,000 15,200 38,000 80,000 $368,700

The variable cost per machine-hour is obtained by dividing the total variable cost from the planning budget by 35,000 machine-hours. The variable cost per machine-hour is obtained by subtracting the fixed cost (given) from the planning budget and then dividing the result by 35,000 machine-hours.

Note that in this new report the overall spending variance is favourable—indicating that costs were most likely under control.

Managerial Accounting, 13th Edition

Problem 9-26 (45 minutes) 1. The variance report should not be used to evaluate how well costs were controlled. In July, the static budget was based on 150 lessons, but the actual results are for 155 lessons—an increase of more than 3% over budget. Consequently, the actual revenues and many of the actual costs should have been different from what was budgeted at the beginning of the period. For example, instructor wages, a variable cost, should have increased by more than 3% because of the increase in activity, but the variance report assumes that they should not have increased at all. This results in a spurious unfavorable variance for instructor wages. Direct comparisons of budgeted to actual costs are valid only if the costs are fixed. 2. See the following page. 3. The overall sales volume variance for operating income was $435 F (favourable). That means that as a consequence of the increase in activity from 150 lessons to 155 lessons, the operating income should have been up $435 over budget. However, it wasn‘t. The budgeted operating income was $8,030 and the actual operating income was $8,080, so the profit was up by only $50—not $435 as it should have been. There are many reasons for this—as shown in the flexible budget variances. Perhaps most importantly, fuel costs were much higher than expected. The flexible budget variance variance for fuel was $425 U (unfavourable) and may have been due to an increase in the price of fuel that is beyond the owner/manager‘s control. Most of the other flexible budget variances were favourable, so with the exception of this item, costs seem to have been adequately controlled. In addition, the unfavourable revenue variance of $200 indicates that revenue was slightly less than they should have been. This variance is very small relative to the size of the revenue, so it may not justify investigation.

391

Problem 9-26 (continued) TipTop Flight School Comprehensive Performance Report For the Month Ended July 31

Actual Results

Flexible Budget Variance

Flexible Budget

Sales Volume Variances

155

Static Budget

Lessons (q)................................................

155

150

Revenue ($220q) ....................................... Expenses: Instructor wages ($65q) .......................... Aircraft depreciation ($38q) ..................... Fuel ($15q)............................................. Maintenance ($530 + $12q) .................... Ground facility expenses ($1,250 + $2q) .................................... Administration ($3,240 + $1q) ................. Total expense ............................................ Operating income ......................................

$33,900

$200

$34,100

$1,100

$33,000

9,870 5,890 2,750 2,450

205 0 425 60

F U U

10,075 5,890 2,325 2,390

325 190 75 60

U U U U

9,750 5,700 2,250 2,330

1,540 3,320 25,820 $ 8,080

20 75 185 $385

F F U U

1,560 3,395 25,635 $ 8,465

10 5 665 $ 435

U U U F

1,550 3,390 24,970 $ 8,030

Managerial Accounting, 13th Edition

Case 9-27 (120 minutes) 1. Schedule of expected cash collections: Cash sales .......................... Credit sales1 ....................... Total collections ..................

April

May

June

Quarter

$36,000 * 20,000 * $56,000 *

$43,200 24,000 $67,200

$54,000 28,800 $82,800

$133,200 72,800 $206,000

May

June

Quarter

$45,000 * $ 54,000 *

$67,500

$166,500

43,200 * 88,200 *

28,800 * 96,300

28,800 195,300

54,000 $42,300

36,000 $159,300

40% of the preceding month‘s sales. * Given. 2. Merchandise purchases budget:

April 1

Budgeted cost of goods sold . Add desired ending merchandise inventory2 .......................... Total needs ........................... Less beginning merchandise inventory ........................... Required purchases ...............

54,000 108,000

36,000 * 43,200 $52,200 * $ 64,800

For April sales: $60,000 sales × 75% cost ratio = $45,000. At April 30: $54,000 × 80% = $43,200. At June 30: July sales $48,000 × 75% cost ratio × 80% = $28,800. * Given. 2

Schedule of expected cash disbursements—merchandise purchases

April March purchases ................... April purchases ...................... May purchases ...................... June purchases .....................

$21,750 * 26,100 *

Total disbursements ...............

$47,850 *

May $26,100 * 32,400 $58,500

June

Quarter

$32,400 21,150

$ 21,750 * 52,200 * 64,800 21,150

$53,550

$159,900

* Given.

393

Case 9-27 (continued) 3. Cash budget: Beginning cash balance ..... Add collections from customers ............................. Total cash available .............. Less cash disbursements: For inventory .................... For expenses .................... For equipment .................. Total cash disbursements ..... Excess (deficiency) of cash available over disbursements .............................. Financing: Borrowings ....................... Repayments ..................... Interest ($3,000 × 1% × 3 + $7,000 × 1% × 2) ... Total financing ..................... Ending cash balance ............

April

May

June

Quarter

$ 8,000 *

$ 4,350

$ 4,590

$ 8,000

56,000 * 64,000 *

67,200 71,550

82,800 87,390

206,000 214,000

47,850 * 13,300 * 1,500 * 62,650 *

58,500 15,460 0 73,960

53,550 18,700 0 72,250

159,900 47,460 1,500 208,860

1,350 *

(2,410)

15,140

5,140

3,000 0

7,000 0

0 (10,000)

10,000 (10,000)

0 3,000 $ 4,350

0 7,000 $ 4,590

(230) (10,230) $ 4,910

(230) (230) $ 4,910

* Given.

Managerial Accounting, 13th Canadian Edition

Case 9-27 (continued) 4. Shilow Company Income Statement For the Quarter Ended June 30 Sales ($60,000 + $72,000 + $90,000) .................. Cost of goods sold: Beginning inventory (Given) .............................. Add purchases (see requirement 2).................... Goods available for sale ..................................... Ending inventory (see requirement 2) ................ Gross margin ....................................................... Selling and administrative expenses: Commissions (12% of sales) .............................. Rent ($2,500 × 3)............................................. Depreciation ($900 × 3) .................................... Other expenses (6% of sales) ............................ Net operating income ........................................... Interest expense (see requirement 3) ................... Net income ..........................................................

$222,000 $ 36,000 159,300 195,300 28,800

26,640 7,500 2,700 13,320

166,500 * 55,500

50,160 5,340 230 $ 5,110

* A simpler computation would be: $222,000 × 75% = $166,500.

395

Case 9-27 (continued) 5. Shilow Company Balance Sheet June 30 Assets Current assets: Cash (see requirement 3) ........................................................... Accounts receivable ($90,000 × 40%)......................................... Inventory (see requirement 2) .................................................... Total current assets ....................................................................... Building and equipment—net ($120,000 + $1,500 – $2,700).................................................... Total assets .................................................................................. Liabilities and Stockholders’ Equity Accounts payable (Part 2: $42,300 × 50%) ............. Stockholders‘ equity: Common stock (Given) ........................................ Retained earnings* ............................................. Total liabilities and shareholders‘ equity ................... * Beginning retained earnings ............................... Add net income (see requirement 4) ................... Ending retained earnings ....................................

$ 4,910 36,000 28,800 69,710 118,800 $188,510

$ 21,150 $150,000 17,360

167,360 $188,510

$12,250 5,110 $17,360

Managerial Accounting, 13th Canadian Edition

Case 9-28 (45 minutes) 1.

The flexible budget can be prepared using the following cost formulas: o o o o o o

Gasoline: $0.16 per kilometre. Given. Oil, minor repairs, parts: $0.05 per kilometre. Given Outside repairs: $40 per auto per month. $40 = $480/12 Insurance: $75 per auto per month. $75 = $900/12 Salaries and benefits: $8,610 per month. Given Vehicle depreciation: $200 per auto per month. $200 = $2,400/12 Farrar University Motor Pool Spending Variances For the Month Ended March 31

Flexible Budget

Actual Results

Kilometres (q1) ......................................... Autos (q2) ................................................

58,000 21

Gasoline ($0.16q1) .................................... Oil, minor repairs, parts ($0.05q1) ............. Outside repairs ($40q2) ............................. Insurance ($75q2)..................................... Salaries and benefits ($8,610) ................... Vehicle depreciation ($200q2) .................... Total ........................................................

$ 9,280 2,900 840 1,575 8,610 4,200 $27,405

$ 8,970 2,840 980 1,625 8,610 4,200 $27,225

Spending Variances

$310 60 140 50 0 0 $180

F F U U

2. The original report is based on a static budget approach that does not allow for variations in the number of kilometres driven from month to month, or for variations in the number of automobiles used. As a result, the ―monthly budget‖ figures are unrealistic benchmarks. For example, actual variable costs such as gasoline can‘t be compared to the ―budgeted‖ cost, because the monthly budget is based on only 50,000 kilometres rather than the 58,000 kilometres actually driven during the month. The performance report in part (1) above is more realistic because the flexible budget benchmark is based on the actual kilometres driven and on the actual number of automobiles used during the month.

397

Case 9-29 (45 minutes) 1. The budgetary control system has several important shortcomings that reduce its effectiveness and may cause it to interfere with good performance. Some of the shortcomings are explained below. a. Lack of Coordinated Goals. Emory had been led to believe high-quality output is the goal; it now appears low cost is the goal. Employees do not know what the goals are and thus cannot make decisions that further the goals. b. Influence of Uncontrollable Factors. Actual performance relative to budget is greatly influenced by uncontrollable factors (i.e., rush orders, lack of prompt maintenance). Thus, the variance reports serve little purpose for performance evaluation or for locating controllable factors to improve performance. As a result, the system does not encourage coordination among departments. c. The Short-Run Perspectives. Monthly evaluations and budget tightening on a monthly basis results in a very short-run perspective. This results in inappropriate decisions (i.e., inspect forklift trucks rather than repair inoperative equipment, fail to report supplies usage). d. System Does Not Motivate. The budgetary system appears to focus on performance evaluation even though most of the essential factors for that purpose are missing. The focus on evaluation and the weaknesses take away an important benefit of the budgetary system—employee motivation. 2. The improvements in the budgetary control system should correct the deficiencies described above. The system should: a. more clearly define the company‘s objectives. b. develop an accounting reporting system that better matches controllable factors with supervisor responsibility and authority. c. establish budgets for appropriate time periods that do not change monthly simply as a result of a change in the prior month‘s performance. The entire company from top management down should be educated in sound budgetary procedures.

Chapter 10 Standard Costs and Overhead Analysis

Managerial Accounting, 13th Canadian Edition

Discussion Case (20 minutes) While standard cost systems have many advantages, disadvantages can include the following:  Disagreement between managers over whether the standard should be set at practical, ideal, or current levels  Difficulty when adjusting for seasonality of costs or for periods of inflation when using standard cost systems  Timeliness of evaluation may suffer because management needs to wait until the end of each accounting period to compare actual to standard. By that point, problems may have gone unresolved for several weeks  Favorable variances may actually mean employees have not devoted enough time or resources to ensuring the quality of the product.  Companies often fail to update standards on a timely basis which reduces the overall integrity of the standard costing system.

399

Solutions to Questions 10-1 A quantity standard indicates how much of an input should be used to make a unit of output. A price standard indicates how much the input should cost. 10-2 Ideal standards assume perfection and do not allow for any inefficiency. Thus, ideal standards are rarely, if ever, attained. Practical standards can be attained by employees working at a reasonable, though efficient pace and allow for normal breaks and work interruptions. 10-3 The materials price variance can be computed when materials are purchased or when they are placed into production. It is usually better to compute the variance when materials are purchased because that is when the purchasing manager, who has responsibility for this variance, has completed his work. In addition, recording the price variance when materials are purchased allows the company to carry its raw materials inventory at standard cost, which simplifies bookkeeping. 10-4 If standards are used to find who to blame for problems, they can breed resentment and undermine morale. Standards should not be used to find someone to blame for problems. 10-5 The standard rate per hour for direct labour would typically include the wages paid per hour plus employee benefits such as employment insurance, extended medical insurance and other labour costs. 10-6 Separating an overall variance into a price variance and a quantity variance provides more information for decision-making purposes. Moreover, price and quantity variances are usually the responsibilities of different managers. 10-7 The materials price variance is usually the responsibility of the purchasing manager. The materials quantity and labour efficiency variances are usually the responsibility of production managers and supervisors. 10-8 An unfavourable labour rate variance could be caused by using more experienced (skilled) workers that planned when setting the

standard. It could also be caused by paying employees overtime to fill rushed orders. 10-9 If poor quality materials create production problems, a result could be excessive labor time and therefore an unfavorable labor efficiency variance. Poor quality materials would not ordinarily affect the labor rate variance. 10-10 The two factors that can cause an overhead spending variance are: (a) the actual purchase price of the variable overhead items differs from the standard or (b) the actual quantity of variable overhead items used differs from the standard. 10-11 The denominator level of activity is the denominator in the predetermined overhead rate. It is based on managers‘ estimate of the total activity (e.g., labour hours, machine hours, etc.) for the period the rate will be used. 10-12 In Chapter 5 we were dealing with a normal cost system, whereas in Chapter 10 we are dealing with a standard cost system. Standard costing ensures that each unit of product bears the same amount of overhead cost regardless of any variations in efficiency of the use of the application base or price of inputs. 10-13 A budget variance and a volume variance are computed for fixed manufacturing overhead cost in a standard cost system. 10-14 The fixed overhead budget variance compares actual to budgeted costs for fixed overhead items. If actual costs exceed budgeted costs, the variance is labelled unfavourable. 10-15 The volume variance is favourable when the activity for a period, at standard, is greater than the denominator activity level. Conversely, if the activity level, at standard, is less than the denominator level of activity, the volume variance is unfavourable. The variance does not measure deviations in spending. It measures deviations in actual activity from the denominator level of activity.

Managerial Accounting, 13th Canadian Edition

10-16 The volume variance can also be measured in physical units, such as direct labour hours or machine hours. 10-17 The under- or overapplied overhead can be factored into variable overhead spending and efficiency variances and the fixed overhead budget and volume variances. 10-18 Overapplied overhead means that actual overhead is less than the amount applied to products during the period. A favourable overhead variance in total means that the actual overhead costs are less than the standard cost of overhead allowed for the period. Since in a standard costing system overhead applied is equal to the standard amount of overhead allowed, overapplied overhead is synonymous with a favourable overhead variance. 10-19 While managers are likely to investigate the cause of significant unfavourable variances there may also be value in investigating significant favourable variances. One reason for doing so is that large favourable variances may indicate that the current standards are too easily attainable and need to be revised. Another reason for doing so is that if the favourable variances are being caused by using inferior quality materials or less experienced workers, this could have longer-term effects on the quality of the products being produced or service being delivered. In such cases, management would want to take corrective action to ensure that any short-

term favourable variances are not jeopardizing the long-term success of the organization. 10-20 If labour is a fixed cost and standards are tight, then the only way to generate favourable labour efficiency variances is for every workstation to produce at capacity. However, the output of the entire system is limited by the capacity of the bottleneck. If workstations before the bottleneck in the production process produce at capacity, the bottleneck will be unable to process all of the work in process. In general, if every workstation is attempting to produce at capacity, then work in process inventory will build up in front of the workstations with the least capacity. 10-21 Capacity analysis allows managers to assess the financial implications of not fully utilizing productive capacity. For example, if demand exceeds the current utilization of productive capacity, finding ways to increase output would have a positive effect on operating income. Alternatively, if the actual utilization of productive capacity is well below practical capacity and demand for the company‘s products is unlikely to increase, management may want to reduce capacity over time. Doing so would have the effect of decreasing fixed costs associated with under-utilized capacity and thus improving operating income.

401

Foundational Exercises 1, 2. Actual Quantity of Input, at Actual Price (AQ × AP) 46,000 kg × $15 per kg = $690,000

Actual Quantity of Input, at Standard Price (AQ × SP) 46,000 kg × $16.00 per kg = $736,000

Materials price variance = $46,000 F

Standard Quantity Allowed for Actual Output, at Standard Price (SQ × SP) 45,000 kg* × $16.00 per kg = $720,000

Materials quantity variance = $16,000 U

*4,500 units × 10 kg per unit = 45,000 kg Alternatively, the variances can be computed using the formulas: Materials price variance = AQ (AP – SP) = 46,000 kg ($15 per kg – $16 per kg) = $46,000 F Materials quantity variance = SP (AQ – SQ) = $16 per kg (46,000 kg – 45,000 kg) = $16,000 U

Managerial Accounting, 13th Canadian Edition

Foundational Exercises (continued) 3. and 4. Actual Quantity of Input, at Actual Price (AQ × AP) 50,000 kg × $15 per kg = $750,000

Actual Quantity of Input, at Standard Price (AQ × SP) 50,000 kg × $16 per kg = $800,000

Standard Quantity Allowed for Actual Output, at Standard Price (SQ × SP) 45,000 kg* × $16 per kg = $720,000

Materials price variance = $50,000 F 46,000 kg × $16 per kg = $736,000 Materials quantity variance = $16,000 U *4,500 units × 10 kg per unit = 45,000 units Alternatively, the variances can be computed using the formulas: Materials price variance = AQ (AP – SP) = 50,000 kg ($15 per kg – $16 per kg) = $50,000 F Materials quantity variance = SP (AQ – SQ) = $16 per kg (46,000 kg – 45,000 kg) = $16,000 U Note that the magerials quantity variance remains the same as in requirement 10-2 because it is based on the number of actually used in production (46,000), not the quantity purchased in July (50,000).

403

Foundational Exercises (continued) 5 and 6. Actual Hours of Input, at Actual Rate (AH × AR) 8,800 hours × $29 per hour = $255,200

Actual Hours of Input, at Standard Rate (AH × SR) 8,800 hours × $28 per hour = $246,400

Labor rate variance = $8,800 U

Standard Hours Allowed for Actual Output, at Standard Rate (SH × SR) 9,000 hours* × $28 per hour = $252,000

Labor efficiency variance = $5,600 F

*4,500 units × 2.0 hours per unit = 9,000 hours Alternatively, the variances can be computed using the formulas: Labor rate variance = AH (AR – SR) = 8,800 hours ($29 per hour – $28 per hour) = $8,800 U Labor efficiency variance = SR (AH – SH) = $28 per hour (8,800 hours – 9,000 hours) = $5,600 F

Managerial Accounting, 13th Canadian Edition

Foundational Exercises (continued) 7. and 8. Actual Hours of Input, at Actual Rate (AH × AR) 8,800 hours × $3.21 per hour = $28,210

Actual Hours of Input, at Standard Rate (AH × SR) 8,800 hours × $3.00 per hour = $26,400

Variable overhead spending variance = $1,810 U

Standard Hours Allowed for Actual Output, at Standard Rate (SH × SR) 9,000 hours* × $3.00 per hour = $27,000

Variable overhead efficiency variance = $600 F

*4,500 units × 2.0 hours per unit = 9,000 machine hours ** $28,210 ÷ 8,800 hours = $3.21 per machine hour (rounded) Alternatively, the variances can be computed using the formulas: Variable overhead spending variance = AH (AR* – SR) = 8,800 hours ($3.21 per hour – $3.00 per hour) = $1,848 U (note this differs from the $1,810 above because $3.21 is rounded) *28,210 ÷ 8,800 hours = $3.21 per machine hour (rounded) Variable overhead efficiency variance = SR (AH – SH) = $3.00 per machine hour (8,800 hours – 9,000 hours) = $600 F

405

Foundational Exercises (continued) 9. and 10. Actual Fixed Overhead Cost $52,000



Budgeted Fixed Overhead Cost $50,000*

Budget Variance, $2,000 U



Fixed Overhead Cost Applied to Work in Process 9,000 standard MHs × $5 per MH = $45,000

Volume Variance, $5,000 U



Total Variance, $7,000 U *10,000 denominator MHs × $5 per MH = $50,000.

11. Fixed manufacturing overhead was underapplied by $7,000 in July: $52,000 (actual) - $45,000 applied.

Managerial Accounting, 13th Canadian Edition

Exercise 10-1 (20 minutes) 1. Cost per 50 kilogram container ......................................... Less: 2% cash discount.................................................... Net cost .......................................................................... Add freight cost per 50 kilogram container ($250 ÷ 10 containers) ................................................. Total cost per 50 kilogram container ................................. Standard cost per kilogram purchased .............................. Standard cost per gram

$6,250.00 125.00 6,125.00 25.00 $6,150.00 $123 $.123

2. X43 required per pouch as per bill of materials ............................ Add allowance for material rejected as unsuitable (480 grams ÷ 0.96 = 500 grams; 500 grams – 480 grams = 20 grams) ......................................

480

grams

Standard quantity of X43 per saleable pouch ...............................

500

grams

Item X43

Standard Quantity per pouch

Standard Price per gram

Standard Cost per pouch

500 grams

$.123

$61.50

407

Exercise 10-2 (20 minutes) 1. Number of bird feeders .................................................... Number of plastic metres per feeder ................................. Standard plastic metres allowed ....................................... Standard cost per metre................................................... Total standard cost ..........................................................

600 × 0.5 300 × $6.00 $1,800

Actual cost incurred ......................................................... Standard cost above ........................................................ Total variance—unfavourable ............................................

$1,856 1,800 $ 56

Actual Quantity of Inputs, at Actual Price (AQ × AP) $1,856

Actual Quantity of Inputs, at Standard Price (AQ × SP) 320 plastic metres × $6 per metre = $1,920



Price Variance, $64 F

Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 300 plastic metres × $6 per metre = $1,800

Quantity Variance, $120 U



Total Variance, $56 U Alternatively: Materials Price Variance = AQ (AP – SP) 320 plastic metres ($5.80 per metre* – $6.00 per metre) = $64 F *$1,856 ÷ 320 plastic metres = $5.80 per metre. Materials Quantity Variance = SP (AQ – SQ) $6 per metre (320 plastic metres – 300 plastic metres) = $120 U

Managerial Accounting, 13th Canadian Edition

Exercise 10-3 (20 minutes) 1.

Number of meals prepared ................................ Standard direct labour-hours per meal ................ Total direct labour-hours allowed ....................... Standard direct labour cost per hour .................. Total standard direct labour cost ........................

6,000 × 0.20 1,200 × $14 $16,800

Actual cost incurred ........................................... $17,250 Total standard direct labour cost (from above) .... 16,800 Total direct labour variance ............................... $ 450U 2. Actual Hours of Input, at the Actual Rate (AH×AR) 1,150 hours × $15.00 per hour = $17,250

Actual Hours of Input, at the Standard Rate (AH×SR) 1,150 hours × $14 per hour = $16,100

Standard Hours Allowed for Output, at the Standard Rate (SH×SR) 1,200 hours × $14 per hour = $16,800



Rate Variance, $1,150 U

Efficiency Variance, 700 F

Total Variance, $450 U Alternatively, the variances can be computed using the formulas: Labour rate variance

= AH (AR – SR) = 1,150 hours ($15.00 per hour – $14 per hour) = $1,150 U

Labour efficiency variance

= SR (AH – SH) = $14 per hour (1,150 hours – 1,200 hours) = 700 F

409

Exercise 10-4 (20 minutes) 1.

Number of items shipped (a) Standard labour-hours per item (b) Standard quantity of labour-hours allowed (a) × (b)

120,000 0.02 2,400

Standard quantity of labour-hours allowed (a) Standard variable overhead cost per hour (b) Standard variable overhead cost allowed (a) × (b)

2,400 $3.25 $7,800

4 Actual Hours of . Input, at the Actual Rate

Actual Hours of Input, at the Standard Rate

Standard Hours Allowed for Output, at the Standard Rate

(AH×AR)

(AH×SR)

(SH×SR)

2,300 hours × $3.20 per hour*

2,300 hours × $3.25 per hour

2,400 hours** × $3.25 per hour

= $7,360

= $7,475

= $7,800

   Variable overhead spending Variable overhead variance, $115 F efficiency variance, $325 F *$7,360 ÷ 2,300 hours = $3.20 per hour ** 120,000 items × 0.02 hours per unit = 2,400 hours

Exercise 10-4 (continued) Alternatively, the variances can be computed using the formulas: Variable overhead spending variance: AH(AR – SR) = 2,300 hours ($3.20 per hour – $3.25 per hour) = $115 F Variable overhead efficiency variance: SR(AH – SH) = $3.25 per hour (2,300 hours – 2,400 hours) = $325 F

Managerial Accounting, 13th Canadian Edition

Exercise 10-5 (45 minutes) 1.Fixed portion of the predetermined overhead rate: Fixed overhead  Denominator level of activity $20,000/10,000 MHs = $2.00 per MHs 2.Budget variance = Actual fixed overhead cost – Flexible budget fixed overhead cost = $19,000 - $20,000 = -$1,000 F

Volume variance = Fixed portion of × (denominator hours – standard predetermined rate hours) = $2.00 per MH (10,000 MHs – 9,900 MHs) = $200 U 3. Actual fixed overhead

$ 19,000

Applied fixed overhead

19,800

Overapplied overhead

$ 800

Budget variance

$ 1,000 F

Volume variance

200 U

Net

(9,900 hours × $2 per hour)

$ 800 F

Recall from the chapter that overapplied overhead relates to favourable variances.

411

Exercise 10-6 (20 minutes) Arden Inc. Variable Overhead Performance Report For the Year Ended March 31 Budgeted direct labour-hours .................................... Actual direct labour-hours ......................................... Standard direct labour-hours allowed .........................

Overhead Costs Indirect labour.................. Supplies ........................... Electricity ......................... Total variable overhead cost ..............................

Cost Formula (per DLH)

21,000 22,000 22,500

(2) (1) Flexible Actual Costs Budget Incurred Based on 22,000 DLHs 22,000 DLHs (AH × AR) (AH × SR)

(3) Flexible Budget Based on 22,500 DLHs (SH × SR)

(4) Total Variance (1)-(3)

Spending Variance (1)-(2)

Efficiency Variance (2)-(3)

$0.90 0.15 0.05

$21,000 3,450 900

$19,800 3,300 1,100

$20,250 3,375 1,125

$750 U 75 U 225 F

$1,200 U 150 U 200 F

$ 450 F 75 F 25 F

$1.10

$25,350

$24,200

$24,750

$600 U

$1,150 U

$550 F

Managerial Accounting, 13th Canadian Edition

Exercise 10-7 (20 minutes) 1.The standard price of a kilogram of white chocolate is determined as follows: Purchase price, finest grade white chocolate ....................................... £9.00 Less purchase discount, 5% of the purchase price of £9.00 ................. (0.45) Shipping cost from the supplier in Belgium .......................................... 0.20 Receiving and handling cost ............................................................... 0.05 Standard price per kilogram of white chocolate ................................... £8.80 2.The standard quantity, in kilograms, of white chocolate in a dozen truffles is computed as follows: Material requirements ....................................... 0.80 Allowance for waste ......................................... 0.02 Allowance for rejects ........................................ 0.03 Standard quantity of white chocolate ................. 0.85 3.The standard price of the white chocolate in a dozen truffles is determined as follows: Standard quantity of white chocolate (a) ................ Standard price of white chocolate (b) ..................... Standard price of white chocolate (a) × (b) ............

0.85 kilogram £8.80 per kilogram £7.48

413

Exercise 10-8 (30 minutes) 1.a. Notice in the solution below that the materials price variance is computed on the entire amount of materials purchased, whereas the materials quantity variance is computed only on the amount of materials used in production. Actual Quantity of Inputs, at Actual Price (AQ × AP) 12,000 cells × $0.45 per cell = $5,400 

Actual Quantity of Inputs, at Standard Price (AQ × SP) 12,000 cells × $0.50 per cell = $6,000

Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 8,000 cell* × $0.50 per cell = $4,000

 Price Variance, $600 F 6,500 cells × $0.50 per cell = $3,250 



Quantity Variance, $750 F

*4,000 lamps × 2 cells per lamp = 8,000 solar cells Alternative Solution: Materials Price Variance = AQ (AP – SP) 12,000 cells ($0.45 per cell – $0.50 per cell) = $600 F Materials Quantity Variance = SP (AQ – SQ) $0.50 per cell (6,500 cells – 8,000 cells) = $750 F

Managerial Accounting, 13th Canadian Edition

Exercise 10-8 (continued) b.Direct labour variances: Actual Hours of Input, at the Actual Rate (AH × AR) $25,600



Actual Hours of Input, at the Standard Rate (AH × SR) 1,600 hours × $15 per hour = $24,000

Rate Variance, $1,600 U



Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 2,000 hours* × $15 per hour = $30,000

Efficiency Variance, $6,000F



Total Variance, $4,600F *4,000 lamps × 0.50 hours per lamp = 2,000 hours Alternative Solution: Labour Rate Variance = AH (AR – SR) 1,600 hours ($16* per hour – $15 per hour) = $1,600 U *$25,600 ÷ 1,600 hours = $16 per hour Labour Efficiency Variance = SR (AH – SH) $15 per hour (1,600 hours – 2,000 hours) = $6,000F

415

Exercise 10-8 (continued) 2.A variance usually has many possible explanations. In particular, we should always keep in mind that the standards themselves may be incorrect. Some of the other possible explanations for the variances observed appear below:

Materials Price Variance Since this variance is unfavourable, the actual price paid per unit for the material was more than the standard price. This could occur for a variety of reasons including an unanticipated change in the market price of the material, loss of bargaining power with a major supplier, or purchases in smaller quantities than usual causing the supplier to raise the per unit price.

Materials Quantity Variance Since this variance is favourable, less materials were

used to produce the actual output than were called for by the standard. This could also occur for a variety of reasons. Some of the possibilities include well trained or supervised workers, properly adjusted machines, and superior materials.

Labour Rate Variance Since this variance is favourable, the actual average wage

rate was lower than the standard wage rate. Some of the possible explanations include hiring more than the usual number of new employees at wages less than the standard wage rate bringing down the average wage rate and less than the expected amount of overtime.

Labour Efficiency Variance Since this variance is favourable, the actual number of

labour hours was less than the standard labour hours allowed for the actual output. As with the other variances, this variance could have been caused by any of a number of factors. Some of the possible explanations include excellent supervision, well trained workers, high-quality materials requiring less labour time to process, and few machine breakdowns. In addition, if the direct labour force is essentially fixed, a favourable labour efficiency variance could be caused by a reduction in output due to increased demand for the company‘s products.

Managerial Accounting, 13th Canadian Edition

Exercise 10-9 (20 minutes) 1. Actual Quantity of Inputs, at Actual Price (AQ × AP) 20,000 ml × $0.25 per ml = $5,000 

Actual Quantity of Inputs, at Standard Price (AQ × SP) 20,000 ml × $0.20 per ml = $4,000

Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 18,000 ml* × $0.20 per ml = $3,600



Price Variance, $1,000 U

Quantity Variance, $400 U

Total Variance, $1,400 U *3,000 units × 6 ml per unit = 18,000 ml Alternatively: Materials Price Variance = AQ (AP – SP) 20,000 ml ($0.25 per ml – $0.20 per ml) =$1,000 U Materials Quantity Variance = SP (AQ – SQ) $0.20 per ml (20,000 ml – 18,000 ml) = $400 U

417

Exercise 10-9 (continued) 2.

Actual Hours of Input, at the Actual Rate (AH × AR) $10,000

Actual Hours of Input, at the Standard Rate (AH × SR) 625 hours × $15 per hour = $9,375



Rate Variance, $625 U

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 600 hours* × $15 per hour = $9,000

Efficiency Variance, $375 U



Total Variance, $1,000 U *3,000 units × 0.2 hours per unit = 600 hours Alternatively: Labour Rate Variance = AH (AR – SR) 625 hours ($16 per hour* – $15 per hour) = $625 U *$10,000 ÷ 625 hours = $16 per hour Labour Efficiency Variance = SR (AH – SH) $15 per hour (625 hours – 600 hours) = $375 U

Managerial Accounting, 13th Canadian Edition

Exercise 10-10 (15 minutes) Notice in the solution below that the materials price variance is computed on the entire amount of materials purchased, whereas the materials quantity variance is computed only on the amount of materials used in production. Actual Quantity of Inputs, at Actual Price (AQ × AP) 20,000 ml × $0.250 per ml = $5,000 

Actual Quantity of Inputs, at Standard Price (AQ × SP) 20,000 ml × $0.20 per ml = $4,000

Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 12,000 ml* × $0.20 per ml = $2,400

 Price Variance, $1,000 U 16,000 ml × $0.20 per gram = $3,200 



Quantity Variance, $800 U

*2,000 bottles × 6 ml per bottle = 12,000 ml Alternatively: Materials Price Variance = AQ (AP – SP) 20,000 grams ($0.25 per ml – $0.20 per ml) = $1,000 U Materials Quantity Variance = SP (AQ – SQ) $0.20 per ml (16,000 ml – 12,000 ml) = $800 U

419

Exercise 10-11 (30 minutes) 1.

Number of units manufactured ......................................... Standard labour time per unit (15 minutes ÷ 60 minutes per hour) ..................................................................... Total standard hours of labour time allowed ...................... Standard direct labour rate per hour ................................. Total standard direct labour cost.......................................

0.25 4,000 × $16 $64,000

Actual direct labour cost .................................................. Standard direct labour cost .............................................. Total variance—favourable ...............................................

$61,600 64,000 $ 2,400

Actual Hours of Input, at the Actual Rate (AH × AR) $61,600

Actual Hours of Input, at the Standard Rate (AH × SR) 3,850 hours × $16 per hour = $61,600



Rate Variance, -$0-

16,000 ×

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 4,000 hours* × $16 per hour = $64,000

Efficiency Variance, $2,400 F



Total Variance, $2,400 F *16,000 units × 0.25 hour per unit = 4,000 hours Alternative Solution: Labour Rate Variance = AH (AR – SR) 3,850 hours ($16 per hour* – $16.00 per hour) = $0 *$61,600 ÷ 3,850 hours = $16 per hour Labour Efficiency Variance = SR (AH – SH) $16 per hour (3,850 hours – 4,000 hours) = $2,400 F

Managerial Accounting, 13th Canadian Edition

Exercise 10-11 (continued) 3.

Actual Hours of Input, at the Actual Rate (AH × AR) $13,475

Actual Hours of Input, at the Standard Rate (AH × SR) 3,850 hours × $3 per hour = $11,550



Spending Variance, $1,925 U

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 4,000 hours × $3 per hour = $12,000

Efficiency Variance, $450 F



Total Variance, $1,475 U Alternative Solution: Variable Overhead Spending Variance = AH (AR – SR) 3,850 hours ($3.50 per hour* – $4.00 per hour) = $1,925 U *$13,475 ÷ 3,850 hours = $3.50 per hour Variable Overhead Efficiency Variance = SR (AH – SH) $3 per hour (3,850 hours – 4,000 hours) = $450 F

421

Exercise 10-12 (30 minutes) 1.While on the surface, investigating favourable variances might seem like a waste of management‘s time (i.e., why question good news!) there are valid reasons for doing so, including: 

A favourable variance might indicate that the standards for prices or quantities are too easy to achieve or have become outdated. If so, an investigation could lead to a revision of standards to ensure they better motivate managers to control costs.



A favourable variance might also indicate that managers are taking actions to ‗beat‘ the standard that are not necessarily in the best interests of the company longer-term. For example, purchasing lower quality and less costly materials could lead to a favourable materials price variance but might reduce the overall quality of the company‘s products. Similarly, using lessexperienced employees might reduce labour costs but doing so could increase product defects or could negatively impact service delivery for nonmanufacturing companies.



Investigating favourable variances could also enhance organizational learning if the underlying cause is an innovation to the production processes or service delivery processes. For example, if managers are able to find ways to reduce material wastage or speed up service delivery for a particular product or service, these innovations might be transferrable to other products and services offered by the company.

2.Although more details would be needed to determine whether the possible relationships among variances discussed below are indeed valid, it could be that: 

If the favourable materials price variance is because lower quality materials were purchased, this could lead to the observed unfavourable materials quantity variance vis-à-vis wastage. Lower quality materials could also lead to rework, which could account for the unfavourable labour efficiency variance.



If the favourable labour efficiency variance is due to the utilization of less experienced employees, this could be contributing to the unfavourable labour efficiency variance if these employees are working more slowly than would more experienced employees. Using less experienced employees could also result in material wastage, which might explain the unfavourable materials quantity variance.

Managerial Accounting, 13th Canadian Edition

Exercise 10-13 (20 minutes) 1.Overall rate = $58,000 / 4,000 DLHs = $14.50 per DLH Variable rate = $8,400 / 4,000 DLHs = $2.10 per DLH Fixed rate = $49,600 / 4,000 DLHs = $12.40 per DLH 2.The standard hours per unit of product are: 4,000 DLHs ÷ 1,600 units = 2.5 DLHs per unit The standard hours allowed for the actual production would be: 1,750 units × 2.5 DLHs per unit = 4,375 DLHs 3.Variable overhead spending variance

Variable overhead efficiency variance

= (AH × AR) – (AH × SR) = ($9,860) – (4,250 DLHs x $2.10 per DLH) = ($9,860) – ($8,925) = $935 U = SR (AH – SH) = $2.10 per DLH (4,250 DLHs – 4,375 MHs) = $262.50 F

423

Exercise 10-13 (continued) Fixed overhead budget and volume variances: Actual Fixed Overhead Cost $50,200



Budgeted Fixed Overhead Cost $49,600*

Budget Variance, $600 U



Fixed Overhead Cost Applied to Work in Process 4,375 standard DLHs × $12.40 per DLH = $54,250

Volume Variance, $4,650 F



Total Variance, $4,050 F *4,000 denominator MHs × $12.40 per DLH = $49,600. Alternative approach to the budget variance: Budget variance = Actual fixed overhead cost – budgeted fixed overhead cost = $50,200 – $49,600 = $600 U Alternative approach to the volume variance: Volume variance = Fixed portionof the predetermined × (Denominator hours - rate standard hours allowed) = $12.40 per DLH (4,000 DLHs – 4,375 DLHs) = -$4,650 F Reconciliation of overhead variances to overapplied overhead: Variable OH spending variance $935.00 U Variable OH efficiency variance 262.50 F Fixed OH budget variance 600.00 U Fixed OH volume variance 4,650.00 F Total $3,377.50 F Actual OH (variable + fixed) Applied OH (variable + fixed) Overapplied OH

$60,060.00 ($9,860 + $50,200) 63,437.50 ($9,187.50 + $54,250) $ 3,377.50

Managerial Accounting, 13th Canadian Edition

Exercise 10-14 (15 minutes) 1. 6,800 units × 0.5 DLH per unit = 3,400 DLHs. 2. and 3. Actual Fixed Overhead Cost $27,310*



Budgeted Fixed Overhead Cost $26,800**

Budget Variance, $510 U



Fixed Overhead Cost Applied to Work in Process 3,400 standard DLHs × $8 per DLH* = $27,200

Volume Variance, $400 F*



*Given. **$27,200 – 400 4.Fixed cost element of the predetermined overhead rate

Budgeted fixed overhead cost Denominator activity = $26,800 = $8 per DLH Denominator activity Denominator Activity= $26,800/$8 = 3,350 direct labour hours Therefore, the denominator activity was 3,350 direct labour hours.

425

Exercise 10-15 (10 minutes) Company A:

This company has a favourable volume variance since the standard direct labour-hours allowed for the actual output are more than the denominator activity. This indicates that more units were produced than planned per the denominator level of activity. Hence productive capacity was used less than expected.

Company B:

This company has neither an unfavourable nor favourable volume variance since the standard direct labour-hours allowed for the actual output is equal to the denominator activity. This indicates that the number of units produced is the same as the denominator level of activity.

Company C:

This company has an unfavourable volume variance since the standard direct labour-hours allowed for the actual output are less than the denominator activity. This indicates that few units were produced than planned per the denominator level of activity. Hence productive capacity was used more than expected.

Managerial Accounting, 13th Canadian Edition

Exercise 10-16 (20 minutes) Pay Loans Company Overhead Performance Report For the Month Ended October 31 Budgeted labour-hours ................................................................................................... Actual labour-hours ........................................................................................................ Standard labour-hours allowed for the actual number of checks processed ........................

Overhead costs Variable overhead costs: Office supplies ................. Staff coffee lounge ........... Indirect labour ................. Total variable overhead cost .............................. Fixed overhead costs: Supervisory salaries. Total overhead cost

Cost Formula (per labourhour)

(1) (2) (3) Actual Costs Flexible Flexible Incurred for Budget Based Budget Based 1,290 La- on 1,290 La- on 1,320 Labour-Hours bour-Hours bour-Hours Total Variance (AH × AR) (AH × SR) (SH × SR) (1) – (3)

Breakdown of the Total Variance Spending (Budget) Variance (1) – (2)

Efficiency Variance (2) – (3)

$0.30 0.10 3.90

$ 219 186 3,348

$ 387 129 5,031

$ 396 132 5,148

$177 F 54 U 1,800 F

$168 F 57 U 1,683 F

$ 9F 3F 117 F

$4.30

3,753

5,547

5,676

1,923 F

1,794 F

129 F

6,300 $10,053

6,000 $11,547

6,000 $11,676

300 U $1,623 F

300 U $1,494 F

$129 F

1,300 1,290 1,320

427

Exercise 10-16 (continued) NOTE: In the solution above students may get confused with the fact that the fixed overhead flexible budget amount is $6,000 for both columns (2) and (3). An explanation can be found on page 430 and in exhibit 10-13. This fixed amount is not the same thing as fixed overhead applied at standard as you would compute in your variance analysis. The volume variance is not part of the measurement of performance.

Managerial Accounting, 13th Canadian Edition

Exercise 10-17 (30 minutes) 1.Theoretical capacity = Practical capacity = Denominator = Actual =

15,000  .60 = 15,000  .80 =

15,000 hours 14,000 hours

25,000 hours 18,750 hours (7,000 pairs × 2 hours per pair*)

*for purposes of capacity analysis, standard hours are used. Total overhead cost at each level of capacity utilization: Theoretical: (25,000 × $6) + $150,000*=$300,000 Practical: (18,750 × $6) + $150,000 = $262,500 Denominator: (15,000 × $6) + $150,000 = $240,000 Actual: (14,000 × $6) + $150,000 = $234,000 *Fixed overhead rate = Total estimated fixed overhead Denominator activity $10 = Total estimated fixed overhead 15,000 hours Fixed overhead is therefore $150,000 2.Operating income at each level of activity is as follows: Theoretical: Practical: Denominator: Actual:

12,500 pairs* × ($200 - $100) - $300,000 = $950,000 9,375 pairs × ($200 - $100) - $262,500 = $675,000 7,500 pairs × ($200 - $100) - $240,000 = $510,000 7,000 pairs × ($200 - $100) - $234,000 = $466,000

*25,000 hours  2 direct labours per pair The opportunity loss of producing 7,000 pairs instead of one of the other capacity utilization alternatives is calculated as follows: Theoretical: Practical: Denominator:

$950,000 - $466,000 = $484,000 $675,000 - $466,000 = $209,000 $510,000 - $466,000 = $44,000

429

Exercise 10-18 (15 minutes) 1.Predetermined overhead rate = (Total overhead at denominator activity) (Denominator activity) = ($2 per DLH x 30,000 DLH) + $168,000 30,000 DLH = $228,000/30,000 DLH = $7.60 per DLH Variable element: $2.00 per DLH Fixed element: $168,000 ÷ 30,000 DLHs = $5.60 per DLH 2.

Direct materials, 2.5 metres × $17.20 per metre ............................... Direct labor, 2.5 DLHs* × $15.00 per DLH ........................................

$43.00 37.50

Variable manufacturing overhead, 2.5 DLHs × $2 per DLH.................

5.00

Fixed manufacturing overhead, 2.5 DLHs × $5.60 per DLH ................

14.00

Total standard cost per unit .............................................................

$99.50

*30,000 DLHs ÷ 12,000 units = 2.5 DLHs per unit.

Managerial Accounting, 13th Canadian Edition

Problem 10-19 (45 minutes) 1.Each kilogram of fresh mushrooms yields 150 grams of dried mushrooms suitable for packing: One kilogram of fresh mushrooms ............................. Less: unacceptable mushrooms (1/4 of total) ............. Acceptable mushrooms ............................................. Less 80% shrinkage during drying ............................. Acceptable dried mushrooms ....................................

1,000 grams 250 750 600 150 grams

Since 1,000 grams of fresh mushrooms yield 150 grams of dried mushrooms, 100 grams (or, 0.1 kilogram) of fresh mushrooms should yield the 15 grams of acceptable dried mushrooms that are packed in each jar. The direct labour standards are determined as follows:

Sorting and Inspecting Direct labour time per kilogram of fresh mushrooms .............................................................. Grams of dried mushrooms per kilogram of fresh mushrooms ...................................................... Direct labour time per gram of dried mushrooms ... Grams of dried mushrooms per jar ....................... Direct labour time per jar .....................................

15 minutes ÷ 150 grams 0.10 minute per gram × 15 grams 1.5 minutes

Drying Direct labour time per kilogram of acceptable sorted fresh mushrooms ................................... Grams of dried mushrooms per kilogram of acceptable sorted fresh mushrooms ...................... Direct labour time per gram of dried mushrooms ... Grams of dried mushrooms per jar ....................... Direct labour time per jar ..................................... *Rounded

10 minutes ÷ 150 grams 0.07 minute per gram* × 15 grams 1.05 minute

431

Problem 10-19 (continued) Standard cost per jar of dried chanterelle mushrooms: Direct material: Fresh mushrooms (0.1 kilogram per jar × €60.00 per kilogram) ....................... Jars, lids, and labels (€10.00 ÷ 100 jars) ............................... Direct labour: Sorting and inspecting (1.5 minutes per jar × €0.20 per minute*) .......................... Drying (1.05 minute per jar × €0.20 per minute*) .................. Packing (0.10 minute per jar** × €0.20 per minute*) ...................... Standard cost per jar ...............................................................

€6.00 0.10

€6.10

0.30 0.21 0.02

0.53 €6.63

*€12.00 per hour is €0.20 per minute. **10 minutes per 100 jars is 0.10 minute per jar. 2.a. Ordinarily, the purchasing manager has more influence over the prices of purchased materials than anyone else in the organization. Therefore, the purchasing manager is usually held responsible for material price variances. b. The production manager is usually held responsible for materials quantity variances. However, this situation is a bit unusual. The quantity variance will be heavily influenced by the quality of the mushrooms acquired from gatherers by the purchasing manager. If the mushrooms have an unusually large proportion of unacceptable mushrooms, the quantity variance will be unfavourable. The production process itself is likely to have less effect on the amount of wastage and spoilage. On the other hand, if the production manager is not held responsible for the quantity variance, the production workers may not take sufficient care in their handling of the mushrooms. A partial solution to this problem would be to make the sorting and inspection process part of the purchasing manager‘s responsibility. The purchasing manager would then be held responsible for any wastage in excess of the 100 grams expected for each 300 grams of acceptable fresh mushrooms. The production manager would be held responsible for any wastage after that point. This is only a partial solution, however, because the purchasing manager may pass on at least 300 grams of every 400 grams of fresh mushrooms, whether they are acceptable or not.

Managerial Accounting, 13th Canadian Edition

Problem 10-20 (45 minutes) 1. a. Notice in the solution below that the materials price variance is computed on the entire amount of materials purchased, whereas the materials quantity variance is computed only on the amount of materials used in production. Actual Quantity of Input, at Actual Price (AQ × AP) 25,000 microns × $1.48 per micron = $37,000 

Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 18,000 microns* × $1.50 per micron = $27,000

Actual Quantity of Input, at Standard Price (AQ × SP) 25,000 microns × $1.50 per micron = $37,500

 Materials price variance, $500 F 20,000 microns × $1.50 per micron = $30,000



 Materials quantity variance, $3,000 U *3,000 toys × 6 microns per toy = 18,000 microns Alternatively, the variances can be computed using the formulas: Materials price variance = AQ (AP – SP) 25,000 microns ($1.48 per micron – $1.50 per micron) = $500 F Materials quantity variance = SP (AQ – SQ) $1.50 per micron (20,000 microns – 18,000 microns) = $3,000 U

433

Problem 10-20 (continued) b. Direct labour variances: Actual Hours of Input, at the Actual Rate (AH × AR)

$88,000

Actual Hours of Input, at the Standard Rate (AH × SR) 4,000 hours × $21.00 per hour = $84,000



 Labor rate variance, $4,000 U

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 3,900 hours* × $21.00 per hour = $81,900

Labor efficiency variance, $2,100 U



*3,000 toys × 1.3 hours per toy = 3,900 hours Alternatively, the variances can be computed using the formulas: Labour rate variance = AH (AR – SR) 4,000 hours ($22.00 per hour* – $21.00 per hour) = $4,000 U *$88,000 ÷ 4,000 hours = $22.00 per hour Labour efficiency variance = SR (AH – SH) $21.00 per hour (4,000 hours – 3,900 hours) = $2,100 U

Managerial Accounting, 13th Canadian Edition

Problem 10-20 (continued) 2. A variance usually has many possible explanations. In particular, we should always keep in mind that the standards themselves may be incorrect. Some of the other possible explanations for the variances observed at Dawson Toys appear below:

Materials Price Variance Since this variance is favourable, the actual price paid per

unit for the material was less than the standard price. This could occur for a variety of reasons including the purchase of a lower grade material at a discount, buying in an unusually large quantity to take advantage of quantity discounts, a change in the market price of the material, or particularly effective bargaining by the purchasing department.

Materials Quantity Variance Since this variance is unfavorable, more materials were

used to produce the actual output than were called for by the standard. Some possible reasons include poorly trained or supervised workers, improperly adjusted machines, and defective materials.

Labour Rate Variance Since this variance is unfavorable, the actual average wage rate

was higher than the standard wage rate. Some of the possible explanations include an increase in wages that has not been reflected in the standards, unanticipated overtime, and a shift toward more highly experienced workers.

Labour Efficiency Variance Since this variance is unfavorable, the actual number of la-

bour hours was greater than the standard labor hours allowed for the actual output. As with the other variances, this variance could have been caused by any of a number of factors. Some of the possible explanations include poor supervision, poorly trained workers, low-quality materials requiring more labor time to process, and machine breakdowns. In addition, if the direct labor force is essentially fixed, an unfavorable labor efficiency variance could be caused by a reduction in output due to decreased demand for the company‘s products.

435

Problem 10-21 (45 minutes) 1.a. In the solution below, the materials price variance is computed on the entire amount of materials purchased, whereas the materials quantity variance is computed only on the amount of materials used in production: Actual Quantity of Inputs, at Actual Price (AQ × AP) $19,800



Actual Quantity of Inputs, at Standard Price (AQ × SP) 1,800 kgs. × $12.00 per kg. = $21,600

Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 1,400 kgs.* × $12.00 per kg. = $16,800

 Price Variance, -$1,800 F 1,500 kgs. × $12.00 per kg. = $18,000 



Quantity Variance, $1,200U

*4,000 pkgs × 350 grams per pkg = 1,400 kgs. Alternatively: Materials Price Variance = AQ (AP – SP) 1,800 kgs. ($11.00 per kg.* – $12.00 per kg.) = $1,800 F *$19,800 ÷ 1,800 kgs. = $11.00 per kg. Materials Quantity Variance = SP (AQ – SQ) $12.00 per kg. (1,500 kgs. – 1,400 kgs.) = $1,200U b. No, the contract should probably not be signed. Although the new supplier is offering the material at only $11.00 per kg., it does not seem to hold up well in production as shown by the large materials quantity variance. Moreover, the company still has 300 kgs. of unused material in the warehouse; if these materials do as poorly in production as the 1,500 kgs. already used, the total quantity variance on the 1,800 kgs. of materials purchased will be large.

Managerial Accounting, 13th Canadian Edition

Problem 10-21 (continued) 2. a. Actual Hours of Input, at the Actual Rate (AH × AR) 925 hours* × $14.00 per hour = $12,950

Actual Hours of Input, at the Standard Rate (AH × SR) 925 hours × $13.00 per hour = $12,025



Rate Variance, $925 U

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 1,000 hours** × $13.00 per hour = $13,000

Efficiency Variance, $975 F



Total Variance, $50 F * 5 workers × 185 hours per worker ** 4,000 units × 0.25 hours per pkg

= 925 hours = 1,000 hours

Alternatively: Labour Rate Variance = AH (AR – SR) 1,200 hours ($14.00 per hour – $13.00 per hour) = $925 U Labour Efficiency Variance = SR (AH – SH) $13.00 per hour (925 hours – 1,000 hours) = $975 F b. Yes, the new labour mix should probably be continued. Although it increases the average hourly labour cost from $13.00 to $14.00, thereby causing a $925 unfavourable labour rate variance, this is more than offset by greater efficiency of labour time. Notice that the labour efficiency variance is $975 favourable. Thus, the new labour mix reduces overall labour costs.

437

Problem 10-21 (continued) 3.

Actual Hours of Input, at the Actual Rate (AH × AR) $1,850

Actual Hours of Input, at the Standard Rate (AH × SR) 925 hours × $1.60 per hour = $1,480



Spending Variance, $370 U

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 1,000 hours × $1.60 per hour = $1,600

Efficiency Variance, $120 F



Total Variance, $250 U Alternatively: Variable Overhead Spending Variance = AH (AR – SR) 925 hours ($ 2.00 per hour* – $1.60 per hour) = $370 U *$1,850 ÷ 925 hours = $2.00 per hour Variable Overhead Efficiency Variance = SR (AH – SH) $1.60 per hour (925 hours – 1,000 hours) = -$120 F Both the labour efficiency variance and the variable overhead efficiency variance are computed by comparing actual labour-hours to standard labour-hours. Thus, if the labour efficiency variance is favourable, then the variable overhead efficiency variance will be favourable as well.

Managerial Accounting, 13th Canadian Edition

Problem 10-22 (45 minutes) 1.a. Labour Rate Variance = AH (AR – SR) 425 hrs. ($14 per hr.* – SR) = $425F $5,950 – 425 SR =- $425** Or $5,950 + 425 = 425 SR** SR = $15 per hr. * $5,950 ÷ 425 hrs. = $14 per hr. ** When used with the formula, unfavourable variances are positive and favourable variances are negative. b. Labour Efficiency Variance = SR (AH – SR) = $15 per hr. (425 hrs. – SR) Total labour variance= Labour efficiency variance + Labour rate variance Therefore, $350 F = 425 F + Labour rate variance Labour efficiency variance = 425F - 350 F = $75 F $75 F = $15 per hr (425hrs – SH) $75F = $6,375 - $15 SH SH = ($6,375 - $75**)/$15 = 420 hrs **When used with the formula, unfavourable variances are positive and favourable variances are negative. c. 420 hrs / 966 units = .435 hrs. per unit. 2.a. Actual direct materials cost per kg = $6,375 ÷ 1,500 kg = $4.25 per kg b. Materials Price Variance = AQ (AP – SP) =1,500 kgs. ($4.25 per kg – $4 per kg) = $375 U Note: The materials quantity variance can be proven as follows Materials quantity variance = SP (AQ-SQ) = $4 (1,500 kg – 1,449 kg) = $204 U *966 units x 1.5 kg SQ

439

Problem 10-23 (45 minutes) 1.

Alpha6: Direct materials—X442 ...... Direct materials—Y661 ...... Direct labour—Sintering ..... Direct labour—Finishing ..... Total ................................ Zeta7: Direct materials—X442 ...... Direct materials—Y661 ...... Direct labor—Sintering....... Direct labor—Finishing ....... Total ................................

Standard Quantity or Hours

Standard Price or Rate

Standard Cost

1.8 kgs 2.0 litres 0.20 hours 0.80 hours

$3.50 per kg $1.40 per litre $19.80 per hour $19.20 per hour

$ 6.30 2.80 3.96 15.36 $28.42

3.0 kgs 4.5 litres 0.35 hours 0.90 hours

$3.50 per kg $1.40 per litre $19.80 per hour $19.20 per hour

$10.50 6.30 6.93 17.28 $41.01

Managerial Accounting, 13th Canadian Edition

Problem 10-23 (continued) 2.The computations to follow will require the standard quantities allowed for the actual output for each material.

Standard Quantity Allowed

Material X442: Production of Alpha6 (1.8 kgs per unit × 1,500 units) ....... Production of Zeta7 (3.0 kgs per unit × 2,000 units) ......... Total ..............................................................................

2,700 kg 6,000 kg 8,700 kg

Material Y661: Production of Alpha6 (2.0 litres per unit × 1,500 units) ..... 3,000 litres Production of Zeta7 (4.5 litres per unit × 2,000 units) ....... 9,000 litres Total .............................................................................. 12,000 litres Direct Materials Variances—Material X442: Materials quantity variance = SP (AQ – SQ) = $3.50 per kg (8,500 kgs – 8,700 kgs) = $700 F Materials price variance = AQ (AP – SP) = 14,500 kilos ($3.60 per kg* – $3.50 per kg) = $1,450 U *$52,200 ÷ 14,500 kgs = $3.60 per kg Direct Materials Variances—Material Y661: Materials quantity variance = SP (AQ – SQ) = $1.40 per litre (13,000 litres – 12,000 litres) = $1,400 U Materials price variance = AQ (AP – SP) = 15,500 liters ($1.35 per litre* – $1.40 per litre) = $775 F *$20,925 ÷ 15,500 liters = $1.35 per litre

441

Problem 10-23 (continued) 3.The computations to follow will require the standard quantities allowed for the actual output for direct labor in each department.

Standard Hours Allowed

Sintering: Production of Alpha6 (0.20 hours per unit × 1,500 units) .. 300 hours Production of Zeta7 (0.35 hours per unit × 2,000 units).... 700 hours Total .............................................................................. 1,000 hours Finishing: Production of Alpha6 (0.80 hours per unit × 1,500 units) .. 1,200 hours Production of Zeta7 (0.90 hours per unit × 2,000 units).... 1,800 hours Total .............................................................................. 3,000 hours Direct Labor Variances—Sintering: Labor efficiency variance = SR (AH – SH) = $19.80 per hour (1,200 hours – 1,000 hours) = $3,960 U Labor rate variance = AH (AR – SR) = 1,200 hours ($22.50 per hour* – $19.80 per hour) = $3,240 U *$27,000 ÷ 1,200 hours = $22.50 per hour Direct Labor Variances—Finishing: Labor efficiency variance = SR (AH – SH) = $19.20 per hour (2,850 hours – 3,000 hours) = $2,880 F Labor rate variance = AH (AR – SR) = 2,850 hours ($21.00 per hour* – $19.20 per hour) = $5,130 U *$59,850 ÷ 2,850 hours = $21.00 per hour

Managerial Accounting, 13th Canadian Edition

Problem 10-24 (45 minutes) 1.a. Actual Quantity of Input, at Actual Price (AQ × AP) 39,200 kgs** × $4.40 per kg = $172,480

Actual Quantity of Input, at Standard Price (AQ × SP) 39,200 kgs** × $4.00 per kg = $156,800

Standard Quantity Allowed for Actual Output, at Standard Price (SQ × SP) 38,400 kgs* × $4.00 per kg = $153,600

Materials price variance = Materials quantity vari$15,680 U ance = $3,200 U Total flexible budget variance = $18,880 U * 16,000 units × 2.40 kgs per unit = 38,400 kgs ** 16,000 units × 2.45 kgs per unit = 39,200 kgs Alternatively, the variances can be computed using the formulas: Materials price variance = AQ (AP – SP) = 39,200 kgs ($4.40 per kg – $4.00 per kg) = $15,680 U Materials quantity variance = SP (AQ – SQ) = $4.00 per kg (39,200 kgs – 38,400 kgs) = $3,200 U

443

Problem 10-24 (continued) 1.b. Actual Hours of Input, at Actual Rate (AH × AR) 19,520 hours** × $23.50 per hour = $458,720

Actual Hours of Input, at Standard Rate (AH × SR) 19,520 hours** × $24.00 per hour = $468,480

Standard Hours Allowed for Actual Output, at Standard Rate (SH × SR) 19,200 hours* × $24.00 per hour = $460,800

Labour efficiency variance = $7,680 U

Labour rate variance = $9,760 F Total flexible budget variance = $2,080 F * 16,000 units × 1.20 hours per unit = 19,200 hours ** 16,000 units × 1.22 hours per unit = 19,520 hours

Alternatively, the variances can be computed using the formulas: Labour rate variance = AH (AR – SR) = 19,520 hours ($23.50 per hour – $24.00 per hour) = $9,760 F Labour efficiency variance = SR (AH – SH) = $24.00 per hour (19,520 hours – 19,200 hours) = $7,680 U

Managerial Accounting, 13th Canadian Edition

Problem 10-24 (continued) 1.c. Actual Hours of Input, at Actual Rate (AH × AR) 19,520 hours** × $8.00 per hour = $156,160

Actual Hours of Input, at Standard Rate (AH × SR) 19,520 hours** × $8.00 per hour = $156,160

Standard Hours Allowed for Actual Output, at Standard Rate (SH × SR) 19,200 hours* × $8.00 per hour = $153,600

Variable overhead spending variance = $0

Variable overhead efficiency variance = $2,560 U Total flexible budget variance = $2,560 U

* 16,000 units × 1.20 hours per unit = 19,200 hours ** 16,000 units × 1.22 hours per unit = 19,520 hours Alternatively, the variances can be computed using the formulas: Variable overhead spending variance = AH (AR – SR) = 19,520 hours ($8.00 per hour – $8.00 per hour) = $0 Variable overhead efficiency variance = SR (AH – SH) = $8.00 per hour (19,520 hours – 19,200 hours) = $2,560 U 2. Materials: Price variance ($15,680 ÷ 16,000 units) ..................... $0.98 U Quantity variance ($3,200 ÷ 16,000 units) ................. 0.20 U Labour: Rate variance ($9,760 ÷ 16,000 units) ....................... 0.61 F Efficiency variance ($7,680 ÷ 16,000 units) ................ 0.48 U Variable overhead: Spending variance ($0 ÷ 16,000 units)....................... 0.00 Efficiency variance ($2,560 ÷ 16,000 units) ................ 0.16 U Excess of actual over standard cost per unit ....................

$1.18 U

0.13 F

0.16 U $1.21 U

445

Problem 10-24 (continued) 3.Both the labour efficiency and variable overhead efficiency variances are affected by inefficient use of labour time. Excess of actual over standard cost per unit ................... $1.21 U Less portion attributable to labor inefficiency: Labour efficiency variance .............................................. 0.48 U Variable overhead efficiency variance ............................. 0.16 U 0.64 U Portion due to other variances ....................................... $0.57 U 4.Although the excess of actual cost over standard cost is only $1.21 per unit, the details of the variances are quite large in some cases. The materials price variance is $15,680 U and it warrants further investigation. The labour rate variance at $9,760 is also large and merits investigation. Moreover, the labour efficiency variance is $7,680 U and the variable overhead efficiency variance is $2,560 U, which indicate the workforce is not performing as well as expected. Taken together, these latter two variances highlight an opportunity for the company to pursue process improvement opportunities that would improve efficiency or possibly to change the mix of labour if the reason for the favourable labour rate variance is the use of less experienced employees.

Managerial Accounting, 13th Canadian Edition

Problem 10-25 (60 minutes) 1.The number of units produced can be computed by using the total standard cost applied for the period for any input (materials, labour, or overhead), or it can be computed by using the total standard cost applied for all inputs together. Using only the standard cost applied for materials, we have: Total standard cost applied for the period Standard cost per unit = $202,500/$27 = 7,500 units The same answer can be obtained by using any other cost input. 2.69,000 kilograms; see below for a detailed analysis. 3.$2.95 per kilogram; see below for a detailed analysis. 4.9,700 direct labour-hours; see below for a detailed analysis. 5.$15.75 per direct labour-hour; see below for a detailed analysis. 6.

Standard variable overhead cost applied ............ Add: Overhead efficiency variance ..................... Deduct: Overhead spending variance ................. Actual variable overhead cost incurred ...............

$ 27,000 2,100 U 650 F $28,450

Standard fixed overhead cost applied ................ Add: Unfavourable volume variance ................... Budgeted fixed overhead cost ...........................

$63,000 7,000 U $70,000

(see below)

8. Budgeted fixed overhead cost $70,000 = =10,000 DLHs Fixed portion of the overhead rate $7

447

Problem 10-25 (continued) Direct materials analysis: Actual Quantity of Inputs, at Actual Price (AQ × AP) 69,000 kilograms × $2.95 per kilogram*** = $203,550 

Actual Quantity of Inputs, at Standard Price (AQ × SP) 69,000 kilograms** × $3 per kilogram

Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 67,500 kilograms* × $3 per kilogram

= $207,000

= $202,500

 Price Variance, Quantity Variance, $3,450 F $4,500 U Total Variance, $1,050 U



* 7,500 units × 9 kilograms per unit = 67,500 kilograms ** $207,000 ÷ $3 per kilogram = 69,000 kilograms *** $203,550 ÷ 69,000 kilograms = $2.95 per kilogram Direct labour analysis: Actual Hours of Input, at the Actual Rate (AH × AR) 9,700 DLHs × $15.75 per DLH*** = $152,775 

Actual Hours of Input, at the Standard Rate (AH × SR) 9,700 DLHs** × $15 per DLH = $145,500

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 9,000 DLHs* × $15 per DLH = $135,000

 Rate Variance, Efficiency Variance, $7,275 U $10,500 U Total Variance, $17,775 U



* 7,500 units × 1.2 DLHs per unit = 9,000 DLHs ** $145,500 ÷ $15 per DLH = 9,700 DLHs *** $152,775 ÷ 9,700 DLHs = $15.75 per DLH

Managerial Accounting, 13th Canadian Edition

Problem 10-25 (continued) Variable overhead analysis: Actual Hours of Input, at the Standard Rate (AH × SR) 9,700 DLHs × $3 per DLH = $29,100

Actual Hours of Input, at the Actual Rate (AH × AR) $28,450**



Spending Variance, $650 F

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 9,000 DLHs × $3 per DLH = $27,000 

Efficiency Variance, $2,100 U*

* Computed using 9,700 actual DLHs at the $3 per DLH standard rate. ** $29,100 – $650 = $28,450. Fixed overhead analysis: Actual Fixed Overhead Cost $69,750** 

Budgeted Fixed Overhead Cost $70,000*

Budget Variance, $250 F



Fixed Overhead Cost Applied to Work in Process 9,000 hours × $7 per hour = $63,000 Volume Variance, $7,000 U



* $63,000 + $7,000 = $70,000. ** $70,000 – $250 = $69,750.

449

Problem 10-26 (45 minutes) 1. Direct materials price and quantity variances: Materials price variance = AQ (AP – SP) 64,000 metres ($8.55 per metre – $8.45 per metre) = $6,400 U Materials quantity variance = SP (AQ – SQ) $8.45 per metre (64,000 metres – 60,000 metres*) = $33,800 U *30,000 units × 2 metres per unit = 60,000 metres 2. Direct labour rate and efficiency variances: Labour rate variance = AH (AR – SR) 43,500 DLHs ($31.60 per DLH – $32.00 per DLH) = $17,400 F Labour efficiency variance = SR (AH – SH) $32.00 per DLH (43,500 DLHs – 42,000 DLHs*) = $48,000 U *30,000 units × 1.4 DLHs per unit = 42,000 DLHs 3. Variable overhead spending and efficiency variances: Actual Hours of Input, at the Actual Rate (AH × AR) $108,000

Actual Hours of Input, at the Standard Rate (AH × SR) 43,500 DLHs × $2.50 per DLH = $108,750

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 42,000 DLHs × $2.50 per DLH = $105,000

   Variable overhead spending Variable overhead efficiency variance, variance, $750 F $3,750 U Alternative solution: Variable overhead rate variance = (AH × AR) – (AH × SR) ($108,000) – (43,500 DLHs × $2.50 per DLH) = $750 F Variable overhead efficiency variance = SR (AH – SH) $2.50 per DLH (43,500 DLHs – 42,000 DLHs) = $3,750 U

Managerial Accounting, 13th Canadian Edition

Problem 10-26 (continued) 4. Fixed overhead budget and volume variances: Actual Fixed Overhead $211,800 

Budgeted Fixed Overhead $210,000*

Budget variance, $1,800 U



Fixed Overhead Applied to Work in Process 42,000 DLHs × $6 per DLH = $252,000 Volume variance, $42,000 F



*As originally budgeted. This figure can also be expressed as: 35,000 denominator DLHs × $6 per DLH = $210,000. Alternative solution: Budge Variance = Actual fixed overhead – budgeted fixed overhead = $211,800 - $210,000 = $1,800 U Volume variance = Fixed OH rate (Denominator hours – Standard hours allowed) = $6 (35,000 – 42,000) = $42,000 F

451

Problem 10-26 (continued) 5. The total of the variances would be: Direct materials variances: Price variance ........................................................ Quantity variance ................................................... Direct labor variances: Rate variance ......................................................... Efficiency variance .................................................. Variable manufacturing overhead variances: Rate variance ......................................................... Efficiency variance .................................................. Fixed manufacturing overhead variances: Budget variance ..................................................... Volume variance ..................................................... Total of variances ......................................................

$ 6,400 U 33,800 U 17,400 F 48,000 U 750 F 3,750 U 1,800 U 42,000 F $33,600 U

Note that the total of the variances agrees with the $33,600 variance mentioned by the president. It appears that not everyone should be given a bonus for good cost control. The materials quantity variance and the labour efficiency variance are 6.7% and 3.6%, respectively, of the standard cost allowed and thus would warrant investigation. The company‘s large unfavorable variances (for materials quantity and labor efficiency) do not show up more clearly because they are offset by the favorable volume variance. This favorable volume variance is a result of the company operating at an activity level that is well above the denominator activity level used to set predetermined overhead rates. (The company operated at an activity level of 42,000 standard hours; the denominator activity level set at the beginning of the year was 35,000 hours.) As a result of the large favorable volume variance, the unfavorable quantity and efficiency variances have been concealed in a small ―net‖ figure. The large favorable volume variance may have been achieved by building up inventories.

Managerial Accounting, 13th Canadian Edition

Problem 10-27 (45 minutes)

Per Direct Labour-Hour Variable Fixed Total

1. and 2. Denominator of 40,000 DLHs: $100,000 ÷ 40,000 DLHs .......................... $320,000 ÷ 40,000 DLHs .......................... Total predetermined rate .............................. Denominator of 50,000 DLHs: $125,000 ÷ 50,000 DLHs .......................... $320,000 ÷ 50,000 DLHs .......................... Total predetermined rate ..............................

Denominator Activity: 40,000 DLHs

Direct materials, 3 metres @ $5.00 per yard .................... Direct labour, 2.5 DLHs @ $20.00 per DLH .................. Variable overhead, 2.5 DLHs @ $2.50 per DLH ................ Fixed overhead, 2.5 DLHs @ $8.00 per DLH .................... Total standard cost per unit ....

$2.50 $8.00

$ 2.50 8.00 $10.50

$6.40

$ 2.50 6.40 $ 8.90

$2.50

Denominator Activity: 50,000 DLHs $15.00 Same ......................................

$15.00

50.00 Same ......................................

50.00

6.25 Same ...................................... Fixed overhead, 2.5 DLHs @ 20.00 $6.40 per DLH...................... $91.25 Total standard cost per unit .....

6.25 16.00 $87.25

4. a. 18,500 units × 2.5 DLHs per unit = 46,250 standard DLHs b. Actual costs

Manufacturing Overhead 446,500 Applied costs (46,250 standard DLHs × $10.50 per DLH) Overapplied overhead

485,625 39,125

453

Problem 10-27 (continued) c. Variable Overhead Spending Variance = (AH × AR) – (AH × SR) ($124,800) – (48,000 DLHs × $2.50 per DLH) = $4,800 U Variable Overhead Efficiency Variance = SR (AH – SH) $2.50 per DLH (48,000 DLHs – 46,250 DLHs) = $4,375 U Fixed overhead variances: Actual Fixed Overhead Cost $321,700



Budgeted Fixed Overhead Cost $320,000*

Budget Variance, $1,700 U



Fixed Overhead Cost Applied to Work in Process 46,250 standard DLHs × $8.00 per DLH = $370,000

Volume Variance, $50,000 F



*40,000 denominator DLHs × $8 per DLH = $320,000. Alternative approach to the budget and volume variances: Budget Variance: Budget variance = Actual fixed overhead – Flexible budget fixed overhead $321,700 – $320,000 = $1,700 U Volume Variance: Fixed Overhead Rate (Denominator hours – standard hours allowed) $8.00 per DLH (40,000 DLHs – 46,250 DLHs) = -$50,000 F

Managerial Accounting, 13th Canadian Edition

Problem 10-27 (continued) Summary of variances: Variable overhead spending ................ $ 4,800 U Variable overhead efficiency ............... 4,375 U Fixed overhead budget ....................... 1,700 U Fixed overhead volume ...................... 50,000 F Overapplied overhead ........................ $39,125 5.The major disadvantage of using normal activity as the denominator in the predetermined rate is the large volume variance that ordinarily results. This occurs because the denominator activity used to compute the predetermined overhead rate is different from the activity level that is anticipated for the period. In the case at hand, the company has used the normal activity of 40,000 direct labour-hours to compute the predetermined overhead rate, whereas activity for the period was expected to be 50,000 DLHs. This has resulted in a huge favourable volume variance that may be difficult for management to interpret. In addition, the large favourable volume variance in this case has masked the fact that the company did not achieve the budgeted level of activity for the period. The company had planned to work 50,000 DLHs, but managed to work only 46,250 DLHs (at standard). This unfavourable result is concealed due to using a denominator figure that is out of step with current activity. On the other hand, by using normal activity as the denominator unit costs are stable from year to year. Thus, management‘s decisions are not clouded by unit costs that jump up and down as the activity level rises and falls.

455

Problem 10-28 (45 minutes) 1. Actual Quantity of Inputs, at Actual Price (AQ × AP) 25,000 components × $0.48 each = $12,000 

Actual Quantity of Inputs, at Standard Price (AQ × SP) 25,000 components × $0.50 each = $12,500

Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 18,000 components* × $0.50 each = $9,000

 Price Variance, $500 F 20,000 components × $0.50 each = $10,000



Quantity Variance, $1,000 U * 3,000 cameras x 6 components each = 18,000 components Alternative Solution: Materials Price Variance = AQ (AP – SP) 25,000 components ($0.48 each – $0.50 each) = $500 F Materials Quantity Variance = SP (AQ – SQ) $0.50 per component (20,000 components – 18,000 components) = $1,000 U

Managerial Accounting, 13th Canadian Edition

Problem 10-28 (continued) 2. Actual Hours of Input, at the Actual Rate (AH × AR) $128,000

Actual Hours of Input, at the Standard Rate (AH × SR) 4,000 hours × $30 per hour = $120,000

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 3,900 hours* × $30 per hour = $117,000



Rate Variance, $8,000 U

Efficiency Variance, $3,000 U

Total Variance, $11,000 U * 3,000 cameras x 1.3 hours each = 3,900 hours. Alternative Solution: Labour Rate Variance = AH (AR – SR) 4,000 hours ($32 per hour* – $30 per hour) = $8,000 U *$128,000 ÷ 4,000 hours = $32 per hour Labour Efficiency Variance = SR (AH – SH) $30 per hour (4,000 hours – 3,900 hours) = $3,000 U

457

Problem 10-28 (continued) 3. Actual Hours of Input, at the Actual Rate (AH × AR) $17,000

Actual Hours of Input, at the Standard Rate (AH × SR) 4,000 hours × $4 per hour = $16,000

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 3,900 hours* × $4 per hour = $15,600



Spending Variance, $1,000 U

Efficiency Variance, $400 U

Total Variance, $1,400 U * 3,000 cameras x 1.3 hours each = 3,900 hours. Alternative Solution: Variable Overhead Spending Variance = AH (AR – SR) 4,000 hours ($4.25 per hour* – $4 per hour) = $1,000 U *$17,000 ÷ 4,000 hours = $4.25 per hour Variable Overhead Efficiency Variance = SR (AH – SH) $4 per hour (4,000 hours – 3,900 hours) = $400 U

Managerial Accounting, 13th Canadian Edition

Problem 10-28 (continued) 4.Fixed overhead variances: Actual Fixed Overhead Cost $25,000



Budgeted Fixed Overhead Cost $24,180

Budget Variance, $820 F



Fixed Overhead Cost Applied to Work in Process 3,900 standard DLHs × $6.00 per DLH = $23,400

Volume Variance, $780 U



Alternative approach to the volume variance: Volume Variance: Fixed Overhead Rate (Denominator hours – standard hours allowed) $6.00 per DLH (4,030 DLHs – 3,900 DLHs) = $780 U 5. Actual overhead costs incurred: Variable: $17,000 Fixed: 25,000 Total $42,000 Overhead costs applied: Variable: $15,600 Fixed: 23,400 Total $39,000 Overhead is underapplied by $3,000: $42,000 - $39,000

459

Problem 10-29 (45 minutes) 1.Total rate: $105,000/15,000 DLHs = $7.00 per DLH Variable rate: $30,000/15,000 DLHs = $2.00 per DLH Fixed rate: $75,000/15,000 DLHs = $5.00 per DLH 2.a. 11,000 units × 1.5 DLHs per unit = 16,500 standard DLHs. b.

Manufacturing Overhead Applied costs (16,500 Actual costs 108,000 standard DLHs × $7 per DLH) Overapplied overhead 3.Variable overhead variances: Actual Hours of Input, at the Actual Rate (AH × AR) $31,500

Actual Hours of Input, at the Standard Rate (AH × SR) 17,500 DLHs × $2 per DLH = $35,000



Spending Variance, $3,500 F

115,500 7,500

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 16,500 DLHs × $2 per DLH = $33,000

Efficiency Variance, $2,000 U



Managerial Accounting, 13th Canadian Edition

Problem 10-29 (continued) Alternative solution: Variable Overhead Spending Variance = (AH × AR) – (AH × SR) ($31,500) – (17,500 DLHs × $2 per DLH) = $3,500 F Variable Overhead Efficiency Variance = SR (AH – SH) $2 per DLH (17,500 DLHs – 16,500 DLHs) = $2,000 U Fixed overhead variances: Actual Fixed Overhead Cost $76,500



Budgeted Fixed Overhead Cost $75,000

Budget Variance, $1,500 U



Fixed Overhead Cost Applied to Work in Process 16,500 DLHs × $5 per DLH = $82,500

Volume Variance, $7,500 F



Alternative approach to the volume variance: Volume variance = Fixed Overhead Rate (Denominator hours – standard hours allowed) $5 per DLH (15,000 DLHs – 16,500 DLHs) = $7,500 F Summary of variances: Variable overhead spending variance .............................. $ 3,500 F Variable overhead efficiency variance ............................. 2,000 U Fixed overhead budget variance..................................... 1,500 U Fixed overhead volume variance .................................... 7,500 F Overapplied overhead—see part 2.................................. $ 7,500 F 4.Only the volume variance would have changed. It would have been unfavourable, since the standard DLHs allowed for the year‘s production (16,500 DLHs) would have been less than the denominator DLHs (18,000 DLHs).

461

Problem 10-30 (45 minutes) 1.Total rate: (£27,000 + £54,000)/18,000 MHs = £4.50 per MH Variable rate: £27,000/18,000 MHs = £1.50 per MH Fixed rate: £54,000/18,000 MHs = £3.00 per MH 2.16,000 standard MHs × £4.50 per MH = £72,000 3.Variable manufacturing overhead variances: Actual Hours of Input, at the Actual Rate (AH × AR) £24,000

Actual Hours of Input, at the Standard Rate (AH × SR) 15,000 MHs × £1.50 per MH = £22,500

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 16,000 MHs × £1.50 per MH = £24,000



Spending Variance, £1,500 U

Efficiency Variance, £1,500 F

Alternative solution: Variable Overhead Spending Variance = (AH × AR) – (AH × SR) (£24,000) – (15,000 MHs × £1.50 per MH) = £1,500 U Variable Overhead Efficiency Variance = SR (AH – SH) £1.50 per MH (15,000 MHs – 16,000 MHs) = £1,500 F

Managerial Accounting, 13th Canadian Edition

Problem 10-30 (continued) Fixed overhead variances: Actual Fixed Overhead Cost £52,000



Budgeted Fixed Overhead Cost £54,000

Fixed Overhead Cost Applied to Work in Process 16,000 MHs × £3 per MH = £48,000



Budget Variance, Volume Variance, £2,000 F £6,000 U Alternative approach to the budget variance: Budget variance = Actual fixed overhead – Flexible budget fixed overhead £52,000 – £54,000 = £2,000 F Alternative approach to the volume variance: Volume variance = Fixed Overhead Rate (Denominator hours – standard hours allowed) £3 per MH (18,000 MHs – 16,000 MHs) = £6,000 U Verification of variances: Variable overhead spending variance ............................ Variable overhead efficiency variance ........................... Fixed overhead budget variance................................... Fixed overhead volume variance .................................. Underapplied overhead ...............................................

£ 1,500 U 1,500 F 2,000 F 6,000 U £4,000

463

Problem 10-30 (continued) 4.Variable overhead

Spending variance: This variance includes both price and quantity elements. The

overhead spending variance reflects differences between actual and standard prices for variable overhead items. It also reflects differences between the amounts of variable overhead inputs that were actually used and the amounts that should have been used for the actual output of the period. Since the variable overhead spending variance is unfavourable, either too much was paid for variable overhead items or too many of them were used.

Efficiency variance: The term ―variable overhead efficiency variance‖ is a misno-

mer, since the variance does not measure efficiency in the use of overhead items. It measures the indirect effect on variable overhead of the efficiency or inefficiency with which the activity base is utilized. In this company, machine-hours is the activity base. If variable overhead is really proportional to machine-hours, then more effective use of machine-hours has the indirect effect of reducing variable overhead. Since 1,000 fewer machine-hours were required than indicated by the standards, the indirect effect was presumably to reduce variable overhead spending by about £1,750 (£1.75 per machine-hour × 1,000 machine-hours). Fixed overhead

Budget variance: This variance is simply the difference between the budgeted

fixed cost and the actual fixed cost. In this case, the variance is favourable, which indicates that actual fixed costs were lower than anticipated in the budget.

Volume variance: This variance occurs as a result of actual activity being different

from the denominator activity that was used in the predetermined overhead rate. In this case, the variance is unfavourable, so actual activity was less than the denominator activity. It is difficult to place much of a meaningful economic interpretation on this variance. It tends to be large, so it often swamps the other, more meaningful variances if they are simply netted against each other.

Managerial Accounting, 13th Canadian Edition

Problem 10-31 (45 minutes) 1.a. Actual Quantity of Inputs, at Actual Price (AQ × AP) 6,300 kgs. × $1.50 per kg. = $9,450 

Actual Quantity of Inputs, at Standard Price (AQ × SP) 6,300 kgs. × $1.25 per kg. = $7,875

Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 5,000 kgs.* × $1.25 per kg. = $6,250

 Price Variance, $1,575 U 4,900 kgs. × $1.25 per kg. = $6,125 



Quantity Variance, $125 F

*2,500 units × 2.0 kgs. per unit = 5,000 kgs. Alternatively: Materials Price Variance = AQ (AP – SP) 6,300 kgs. ($1.50 per kg. – $1.25 per kg.) = $1,575 U Materials Quantity Variance = SP (AQ – SQ) $1.25 per kg. (4,900 kgs. – 5,000 kgs.) = $125 F

465

Problem 10-31 (continued) b. Actual Hours of Input, at the Actual Rate (AH × AR) 1,800 hours × $9.50 per hour = $17,100

Actual Hours of Input, at the Standard Rate (AH × SR) 1,800 hours × $10.00 per hour = $18,000



Rate Variance, $900 F

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 1,350 hours* × $10.00 per hour = $13,500

Efficiency Variance, $4,500 U



Total Variance, $3,600 U *2,500 units × 0.54 hour per unit = 1,350 hours Alternatively: Labour Rate Variance = AH (AR – SR) 1,800 hours ($9.50 per hour – $10.00 per hour) = $900 F Labour Efficiency Variance = SR (AH – SH) $10.00 per hour (1,800 hours – 1,350 hours) = $4,500 U

Managerial Accounting, 13th Canadian Edition

Problem 10-31 (continued) c. Actual Hours of Input, at the Actual Rate (AH × AR) $1,080

Actual Hours of Input, at the Standard Rate (AH × SR) 900 hours × $1.00 per hour = $900



Spending Variance, $180 U

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 675 hours* × $1.00 per hour = $675

Efficiency Variance, $225 U



Total Variance, $405 U *2,500 units × 0.27 hours per unit = 675 hours Alternatively: Variable Overhead Spending Variance = AH (AR – SR) 900 hours ($1.20 per hour* – $1.00 per hour) = $180 U *$1,080 ÷ 900 hours = $1.20 per hour Variable Overhead Efficiency Variance = SR (AH – SH) $1.00 per hour (900 hours – 675 hours) = $225 U

467

Problem 10-31 (continued) 2.Summary of variances: Material price variance ..................................... Material quantity variance ................................ Labour rate variance ........................................ Labour efficiency variance ................................ Variable overhead spending variance ................ Variable overhead efficiency variance ................ Net variance ....................................................

$1,575 125 900 4,500 180 225 $5,455

U F F U U U U

The net unfavourable variance of $5,455 for the month caused the plant‘s variable cost of goods sold to increase from the budgeted level of $40,000 to $45,455: Budgeted cost of goods sold at $16 per unit ..................... Add the net unfavourable variance (as above) .................. Actual cost of goods sold .................................................

$40,000 5,455 $45,455

This $5,455 net unfavourable variance also accounts for the difference between the budgeted net operating income and the actual net loss for the month. Budgeted net operating income....................................... $7,500 Deduct the net unfavourable variance added to cost of goods sold for the month (5,455) Add favourable variance on fixed overhead ...................... 500 Actual operating income (loss)............................ $ 2,545 3.The two most significant variances are the materials price variance and the labour efficiency variance. Possible causes of the variances include: Materials Price Variance:

Outdated standards, uneconomical quantity purchased, higher quality materials, high-cost method of transport.

Labour Efficiency Variance:

Poorly trained workers, faulty equipment, work interruptions, inaccurate standards, and insufficient demand.

Managerial Accounting, 13th Canadian Edition

Problem 10-32 (45 minutes) 1.The standard quantity of plates allowed for tests performed during the month would be: Smears ......................................... Blood tests.................................... Total ............................................. Plates per test ............................... Standard quantity allowed .............

2,700 900 3,600 × 3 10,800

The variance analysis for plates would be: Actual Quantity of Inputs, at Actual Price (AQ × AP) $38,400



Actual Quantity of Inputs, at Standard Price (AQ × SP) 16,000 plates × $2.50 per plate = $40,000

Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 10,800 plates × $2.50 per plate = $27,000

 Price Variance, $1,600 F 14,000 plates × $2.50 per plate = $35,000 



Quantity Variance, $8,000 U

Alternative Solution: Materials Price Variance = AQ (AP – SP) 16,000 plates ($2.40 per plate* – $2.50 per plate) = -$1,600 F *$38,400 ÷ 16,000 plates = $2.40 per plate. Materials Quantity Variance = SP (AQ – SQ) $2.50 per plate (14,000 plates – 10,800 plates) = $8,000 U

Note that all of the price variance is due to the hospital‘s 4 quantity discount. Also note that the $8,000 quantity variance for the month is equal to nearly 30% of the standard cost allowed for plates. This variance may be the result of using too many assistants in the lab. © McGraw Hill Ltd. 2024. All rights reserved. Solutions Manual, Chapter 10

469

Problem 10-32 (continued) 2.a. The standard hours allowed for tests performed during the month would be: Smears: 0.3 hour per test × 2,700 tests ................ Blood tests: 0.6 hour per test × 900 tests ............. Total standard hours allowed ................................

810 540 1,350

The variance analysis of labour would be: Actual Hours of Input, at the Actual Rate (AH × AR) $18,450

Actual Hours of Input, at the Standard Rate (AH × SR) 1,800 hours × $12 per hour = $21,600

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 1,350 hours × $12 per hour = $16,200



Rate Variance, $3,150 F

Efficiency Variance, $5,400 U

Total Variance, $2,250 U Alternative Solution: Labour Rate Variance = AH (AR – SR) 1,800 hours ($10.25 per hour* – $12.00 per hour) = -$3,150 F *$18,450 ÷ 1,800 hours = $10.25 per hour Labour Efficiency Variance = SR (AH – SH) $12 per hour (1,800 hours – 1,350 hours) = $5,400 U

b. The policy probably should not be continued. Although the hospital is saving $1.75 per hour by employing more assistants relative to the number of senior technicians than other hospitals, this savings is more than offset by other factors. Too much time is being taken in performing lab tests, as indicated by the large unfavourable labour efficiency variance. And, it may be that much of the hospital‘s unfavourable quantity variance for plates is traceable to inadequate supervision of assistants in the lab.

Managerial Accounting, 13th Canadian Edition

Problem 10-32 (continued) 3.The variable overhead variances follow: Actual Hours of Input, at the Actual Rate (AH × AR) $11,700

Actual Hours of Input, at the Standard Rate (AH × SR) 1,800 hours × $6 per hour = $10,800



Spending Variance, $900 U

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 1,350 hours × $6 per hour = $8,100

Efficiency Variance, $2,700 U



Total Variance, $3,600 U Alternative Solution: Variable Overhead Spending Variance = AH (AR – SR) 1,800 hours ($6.50 per hour* – $6.00 per hour) = $900 U *$11,700 ÷ 1,800 hours = $6.50 per hour Variable Overhead Efficiency Variance = SR (AH – SH) $6 per hour (1,800 hours – 1,350 hours) = $2,700 U Yes, the two efficiency variances are related. Both are computed by comparing actual labour time to the standard hours allowed for the output of the period. Thus, if there is an unfavourable labour efficiency variance, there will also be an unfavourable variable overhead efficiency variance.

471

Problem 10-32 (continued) 4.Fixed overhead budget and volume variances: Actual Fixed Overhead Cost $10,400



Budgeted Fixed Overhead Cost $10,000*

Budget Variance, $400 U



Fixed Overhead Cost Applied to Work in Process 1,350 standard hours × $8.00 per hour = $10,800

Volume Variance, $800 F



Total Variance, $400 F *1,250 denominator hours × $8.00 per hour = $10,000. Alternative approach to the budget variance: Budget variance = Actual fixed overhead – Flexible budget fixed overhead $10,400 - $10,000 = $400 U Alternative approach to the volume variance: Volume variance = Fixed Overhead Rate (Denominator hours – standard hours allowed) $8(1,250 – 1,350) = $800 F

Managerial Accounting, 13th Canadian Edition

Problem 10-33 (45 minutes) 1.Direct materials price and quantity variances: Direct Materials Price Variance = AQ (AP – SP) 78,000 metres ($3.25 per metre – $3.00 per metre) = $19,500 U Direct Materials Quantity Variance = SP (AQ – SQ) $3.00 per metre (78,000 metres – 80,000 metres*) = $6,000 F *20,000 units × 4 metres per unit = 80,000 metres 2.Direct labour rate and efficiency variances: Direct Labour Rate Variance = AH (AR – SR) 32,500 DLHs ($15.00 per DLH – $16.00 per DLH) = $32,500 F Direct Labour Efficiency Variance = SR (AH – SH) $16.00 per DLH (32,500 DLHs – 30,000 DLHs*) = $40,000 U *20,000 units × 1.5 DLHs per unit = 30,000 DLHs 3.a. Variable manufacturing overhead spending and efficiency variances: Actual Hours of Input, at the Actual Rate (AH × AR) $123,500

Actual Hours of Input, at the Standard Rate (AH × SR) 32,500 DLHs × $4 per DLH = $130,000



Spending Variance, $6,500 F

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 30,000 DLHs × $4 per DLH = $120,000

Efficiency Variance, $10,000 U



Alternative solution: Variable Overhead Spending Variance = (AH × AR) – (AH × SR) ($123,500) – (32,500 DLHs × $4.00 per DLH) = $6,500 F Variable Overhead Efficiency Variance = SR (AH – SH) $4.00 per DLH (32,500 DLHs – 30,000 DLHs) = $10,000 U

473

Problem 10-33 (continued) b. Fixed overhead budget and volume variances: Actual Fixed Overhead Cost $148,000



Budgeted Fixed Overhead Cost $150,000

Budget Variance, $2,000 F



Fixed Overhead Cost Applied to Work in Process 30,000 DLHs × $6 per DLH = $180,000

Volume Variance, $30,000 F



Alternative approach to the budget variance: Budget variance = Actual fixed overhead – Flexible budget fixed overhead $148,000 – $150,000 = $2,000 F Alternative approach to the volume variance: Volume variance = Fixed Overhead Rate (Denominator hours – standard hours allowed) $6.00 per DLH (25,000 DLHs – 30,000 DLHs) = $30,000 F

Managerial Accounting, 13th Canadian Edition

Problem 10-33 (continued) 4.The total of the variances would be: Direct materials variances: Price variance .......................................................... Quantity variance ..................................................... Direct labour variances: Rate variance ........................................................... Efficiency variance .................................................... Variable manufacturing overhead variances: Spending variance .................................................... Efficiency variance .................................................... Fixed manufacturing overhead variances: Budget variance ....................................................... Volume variance ....................................................... Total of variance ..........................................................

$19,500 U 6,000 F 32,500 F 40,000 U 6,500 F 10,000 U 2,000 F 30,000 F $7,500 F

Notice that the total of the variances disagrees with the $18,500 unfavourable variance mentioned by the vice president. The reason the company‘s large unfavourable variances (for materials price and labour efficiency) do not show up more clearly is that they are offset for the most part by the company‘s favourable volume variance for the year. This favourable volume variance is the result of the company operating at an activity level that is well above the denominator activity level used to set predetermined overhead rates. (The company operated at an activity level of 30,000 standard DLHs; the denominator activity level set at the beginning of the year was 25,000 DLHs.) As a result of the large favourable volume variance, the unfavourable price and efficiency variances have been concealed in a small ―net‖ figure. Finally, the large favourable volume variance may have been achieved by building up inventories.

475

Problem 10-34 (45 minutes) The cost formulas for each overhead item with a variable cost component can be developed from the data in the problem using the simple high-low method. The calculations are as follows*: Utilities:

($49,000 - $41,000)/(50,000 – 40,000) = $0.80 per hour Fixed: $49,000 – (50,000 × $0.80) = $9,000

Supplies:

($5,000 - $4,000)/(50,000 – 40,000) = $0.10 per hour Fixed: $5,000 – (50,000 × $0.10) = $0

Indirect labour:

($10,000 - $8,000)/(50,000 – 40,000) = $0.20 per hour Fixed: $10,000 – (50,000 × $0.20) = $0

Maintenance:

($41,000 - $37,000)/(50,000 – 40,000) = $0.40 per hour Fixed: $41,000 – (50,000 × $0.40) = $21,000

Supervision:

All fixed at $10,000 since the cost does not vary with the percentage of capacity used.

*Fixed costs could also have been calculated using the low-point (40,000 machine hours) in each case. 2.The cost formula for all overhead costs would be: Y = $40,000 + $1.50x Where x = machine hours. Overhead Item

Variable Component

Fixed Component

Utilities

$0.80

$9,000

Supplies

0.10

Indirect labour

0.20

Maintenance

0.40

21,000

Supervision

10,000

$1.50

$40,000

Totals

Managerial Accounting, 13th Canadian Edition

Problem 10-34 (continued) 3.

As per Company Performance Report For the Month of May Budgeted machine-hours ...................... Standard machine-hours allowed ........... Actual machine-hours ...........................

40,000 41,000 43,000 *

Flexible Budget 43,000 MH

Spending Variance

$ 33,540 ** 6,450 9,890 14,190 **

$ 34,400 4,300 8,600 17,200

$ 860 F 2,150 U 1,290 U 3,010 F

64,070

64,500

430 F

Fixed overhead costs: Utilities ......................... Maintenance ................. Supervision ................... Total fixed overhead cost ..

9,000 21,000 10,000 40,000

0 0 0 0

Total overhead cost ..........

$104,070

$104,500

$ 430 F

Overhead Costs Variable overhead costs: Utilities ......................... Supplies ........................ Indirect labour .............. Maintenance ................. Total variable overhead cost ..............................

Cost Formula per MH

Actual Cost 43,000 MH

$0.80 0.10 0.20 0.40 $1.50

* 86% of 50,000 MHs = 43,000 MHs ** $42,540 – $9,000 fixed = $33,540 $35,190 – $21,000 fixed = $14,190 4.Assuming that variable overhead should be proportional to actual machine-hours, the unfavourable spending variance could be the result either of price increases or of waste. Unlike the price variance for materials and the rate variance for labour, the spending variance for variable overhead measures both price and waste elements. This is why the variance is called a ―spending‖ variance.

477

Problem 10-35 (30 minutes) 1.

Pike Limited Overhead Performance Report—Machining Department For the Month of June Budgeted machine-hours ............ Actual machine-hours .................

Overhead Costs

Cost Formula per MH

Variable: Utilities ...................... Lubricants .................. Machine setup ............ Indirect labour ........... Total variable cost .........

$0.35 0.50 0.10 0.30 $1.25

10,000 9,000

Flexible Budget 9,000 MHs

Spending Variance

$ 3,000 4,000 * 1,200 3,000 11,200

$ 3,150 4,500 900 2,700 11,250

$ 150 F 500 F 300 U 300 U 50 F

Fixed: Lubricants .................. Indirect labour ........... Depreciation............... Total fixed cost ..............

4,000 60,000 16,000 80,000

0 0 0 0

Total overhead cost .......

$91,200

$91,250

$ 50 F

Actual 9,000 MHs

* $8,000 total lubricants – $4,000 fixed lubricants = $4,000 variable lubricants. The variable element of other costs is computed in the same way.

Managerial Accounting, 13th Canadian Edition

Problem 10-35 (continued) 2.

Pike Limited Overhead Performance Report—Machining Department For the Month of June

Overhead Costs Variable costs: Utilities ...................... Lubricants .................. Machine setup ............ Indirect labour............ Total variable cost .......... Fixed costs: Lubricants .................. Indirect labour............ Depreciation ............... Total fixed cost .............. Total overhead cost .......

Cost Formula (per MH) $0.35 0.50 0.10 0.30 $1.25

(2) Flexible Budget Based on Actual 9,000 MHs

(3) Flexible Budget Based on Standard 8,800 MHs

Total Variance (1) – (3)

Spending Variance (1) – (2)

Efficiency Variance (2) – (3)

$ 3,000 4,000 1,200 3,000 11,200

$ 3,150 4,500 900 2,700 11,250

$ 3,080 4,400 880 2,640 11,000

$ 80 F 400 F 320 U 360 U 200 U

$ 150 F 500 F 300 U 300 U 50 F

$ 70 U 100 U 20 U 60 U $250 U

4,000 60,000 16,000 80,000 $91,200

4,000 60,000 16,000 80,000 $91,250

4,000 60,000 16,000 80,000 $91,000

0 0 0 0 $200 U

0 0 0 0 $50 F

0 0 0 0 $250 U

(1) Actual Costs Incurred

479

Problem 10-36 (30 minutes) 1.The company is using a static budget approach, and is comparing budgeted performance at one level of activity to actual performance at a lower level of activity. This mismatching of activity levels causes the variances to be favourable. The report in this format is not useful for measuring either operating efficiency or cost control. All it tells Mr. Lockhart is that the budgeted activity level of 26,250 machine-hours was not achieved. It does not tell whether the actual output of the period was produced efficiently, nor does it tell whether overhead spending has been controlled during the month.

Managerial Accounting, 13th Canadian Edition

Problem 10-36 (continued) 2.

Kal-Tubing Company Performance Report—Machining Department Budgeted machine-hours ............................. Actual machine-hours ..................................

Overhead Costs

Cost Formula (per MH)

(1) Actual Costs Incurred

26,250 22,500

Standard machine-hours allowed………15,750*

(2) Flexible Budget Based on Actual 22,500 MHs

Variable costs: Indirect labour ............ $ 2.40 $ 59,100 $ 54,000 Utilities ...................... 6.80 152,400 153,000 Supplies ..................... 1.60 37,800 36,000 Maintenance ............... 3.20 74,700 72,000 Total variable cost .......... $14.00 324,000 315,000 Fixed costs: Maintenance ............... 117,000 117,000 Supervision ................ 247,500 247,500 Depreciation ............... 180,000 180,000 Total fixed cost .............. 544,500 544,500 Total overhead cost........ $868,500 $859,500 *5,250 units × 3 MHs per unit = 15,750 MHs allowed

(3) Flexible Budget Based on Standard 15,750 MHs

Total Variance (1) – (3)

Spending Variance (1) – (2)

Efficiency Variance (2) – (3)

$ 37,800 107,100 25,200 50,400 220,500

$ 21,300 U 45,300 U 12,600 U 24,300 U 103,500 U

$5,100 U 600 F 1,800 U 2,700 U $9,000 U

$16,200 U 45,900 U 10,800 U 21,600 U $94,500 U

117,000 247,500 180,000 544,500 $765,000

0 0 0 0 $103,500 U

481

Problem 10-37 (25 minutes) Budgeted machine-hours .............................. Actual machine-hours................................... Standard machine-hours allowed ..................

5,600 4,700 4,900 *

*24,500 units × 0.2 MH per unit = 4,900 MHs

Overhead Item Supplies .............. Power ................. Lubrication .......... Wearing tools ...... Total overhead cost Fixed costs: Depreciation ............... Supervision................. Maintenance ............... Total fixed cost .............. Total overhead cost

Cost Formula (per MH)

(1) Actual Costs Incurred, 4,700 MHs

(2) Flexible Budget Based on 4,700 MHs

$1.20 2.10 0.90 5.40 $9.60

$ 5,593 10,199 4,512 24,863 45,167

$ 5,640 9,870 4,230 25,380 45,120

$ 5,880 10,290 4,410 26,460 47,040

$287 F 91 F 102 U 1,597 F 1,873 F

$ 47 F 329 U 282 U 517 F 47 U

$ 240 F 420 F 180 F 1,080 F 1,920 F

17,500 25,550 4,375 47,425 $92,592

17,500 24,500 5,250 47,250 $92,370

17,500 24,500 5,250 47,250 $94,290

0 1,050 U 875 F 175 U $1,698 F

0 1,050 U 875 F 175 U $222 U

0 0 0 0 $1,920 F

Total Variance (1) – (3)

Breakdown of the Total Variance Spending (Budget) Efficiency VariVariance ance (1) – (2) (2) – (3)

(3) Flexible Budget Based on Standard 4,900 MHs

Managerial Accounting, 13th Canadian Edition

Problem 10-38 (40 minutes) Fixed overhead = denominator activity times fixed overhead per hour = 60,000 hours × $5.00 per hour = $300,000 Capacity Expected Annual Denominator Practical Sales Quantity* ............................................................................ 27,500 30,000 37,500 Sales Price** ................................................................................ $80 $80 $72 Total Sales ................................................................................... $2,200,000 $2,400,000 $2,700,000

Theoretical 50,000 $64 $3,200,000

Cost of Sales Material $24 ................................................................................. 660,000 720,000 900,000 1,200,000 Direct labour $30 .......................................................................... 825,000 900,000 1,125,000 1,500,000 Variable overhead $6 .................................................................... 165,000 180,000 225,000 300,000 Fixed overhead $10 ...................................................................... 300,000 300,000 300,000 300,000 1,950,000 2,100,000 2,550,000 3,300,000 Gross profit .................................................................................. 250,000 $ 300,000 $ 150,000 $ (100,000) The need to reduce the selling price to achieve demand equal to either the practical or theoretical capacity levels yields a decline in gross profit because the increase in revenue is more than offset by the increase in variable costs. Also, the additional costs of the expansion of crews, the reduction of scheduled maintenance and the change in set ups has not been added beyond the change in variable costs indicated by the analysis above. Adding these costs to the analysis above would further increase the gross profit decrease when moving from practical to theoretical capacity. *55,000 hours ÷ 2 hours per unit = 27,500 units **$80 × .90 = $72; $80 × .80 = $64

483

Case 10-39 (30 minutes) 1.Some students will argue that Roth is simply responding in a rational and ethical manner to the incentive scheme used at Road Gear. Since the product line managers have the autonomy to make operational decisions related to purchasing direct materials and the mix of labour to use, Roth is free to manage these items as she sees fit. However, others will argue that because she is taking actions that she is likely aware are not in the best interests of the company for her own personal gain (i.e., to increase the likelihood of a merit pay increase and bonus) she is behaving unethically. In particular: 

Deliberately using inferior quality direct materials for the Speed Tracker, which is described as a ―high quality‖ cycle computer.



Using a mix of labour that favours less experienced employees, which likely runs the risk of inferior craftsmanship thus reducing product quality.

Because Roth has experience in the industry, she is likely well aware that these deliberate actions will hurt product quality, which can certainly be described as unethical. 2.Longer term consequences of Roth‘s behaviour include: 

Damage to the company‘s reputation with respect to the quality of the Speed Tracker. This will likely lead to a loss of sales for this product.



Damage to the company‘s reputation on one product/model can lead to lost sales on other products offered by the company.



Increased warranty costs related to repairing defective Speed Trackers because of the poorer quality direct materials and the use of less experienced employees. This already appears to be happening.



Other managers may copy Roth‘s behaviour since merit pay increases and bonuses are often awarded on the basis of relative performance.

Managerial Accounting, 13th Canadian Edition

Case 10-39 (continued) 3.There are a number of things Road Gear can do to reduce the type of behaviour exhibited by Roth: 

Require explanations for favourable and unfavourable variances. If Roth had to explain how she was achieving the favourable price variance for direct materials and the favourable rate variance for direct labour, this may have constrained her opportunistic behaviour since senior management would likely not be in favour of using lower quality inputs and less skilled production employees. Of course she could lie about the drivers of favourable variances but this is more difficult to perpetrate over an extended period.



Evaluate the product-line managers on a broader set of metrics including non-financial measure such as product quality, number of repairs made under warranty, number of product returns, etc. The incentive scheme seems very focused on financial performance (cost management) so inclusion of key non-financial measures could reduce some of the gaming behaviour displayed by Roth. The use of NFM is taken up in greater detail in Chapter 11 and many companies use a balanced set of metrics for precisely the reasons illustrated in this case.



Require product-line managers to deal only with suppliers that satisfy certain quality thresholds. Companies that compete on the basis of quality have stringent requirements regarding quality levels for key inputs. Road Gear could centralize control over this aspect of their production process to ensure quality standards are met across the various products they offer.



Senior management could use a more subjective approach to evaluating product-line managers whereby uncontrollable factors such as those Roth felt hurt her performance in her first year are taken into account. If managers know that their superiors will consider the effects of events outside their control when evaluating performance, they are less likely to engage in the type of behaviour illustrated in this case.

485

Case 10-40 (45 minutes) 1. Direct materials, 3 metres × $4.40 per metre ........................................ Direct labour, 1 DLH × $24.00 per DLH ................................................. Variable manufacturing overhead, 1 DLH × $5.00 per DLH* ................... Fixed manufacturing overhead, 1 DLH × $11.80 per DLH** ................... Standard cost per unit.......................................................................... * $25,000 ÷ 5,000 DLHs = $5.00 per DLH ** $59,000 ÷ 5,000 DLHs = $11.80 per DLH

$13.20 24.00 5.00 11.80 $54.00

2. Materials variances: Materials price variance = AQ (AP – SP) 24,000 metres ($4.80 per metre – $4.40 per metre) = $9,600 U Materials quantity variance = SP (AQ – SQ) $4.40 per metre (17,500 metres – 18,000 metres*) = -$2,200 F *6,000 units × 3 metres per unit = 18,000 metres Labour variances: Labour rate variance = AH (AR – SR) 5,800 DLHs ($26.00 per DLH – $24.00 per DLH) = $11,600 U Labour efficiency variance = SR (AH – SH) $24.00 per DLH (5,800 DLHs – 6,000 DLHs*) = -$4,800 F *6,000 units × 1 DLH per unit = 6,000 DLHs 3. Some possible relationships among the materials and labour variances:  The materials price variance could be due to purchasing higher quality direct materials. If so, that could have lead to the favourable materials quantity variance vis-à-vis less wastage of materials.  The use of better-quality materials could also have contributed to the favourable labour efficiency variance by reducing the amount of rework needed.  The labour rate variance may have been caused by the use of more experienced employees. If so, this could have contributed to the favourable efficiency variance vis-à-vis working more quickly. Using more experienced workers may also have reduced the wastage of materials contributing to the favourable quantity variance.

Managerial Accounting, 13th Canadian Edition

Case 10-40 (continued) 4. Variable overhead variances: Actual DLHs of Input, at the Actual Rate (AH × AR) $29,580

Actual DLHs of Input, at the Standard Rate (AH × SR) 5,800 DLHs × $5.00 per DLH = $29,000

Standard DLHs Allowed for Output, at the Standard Rate (SH × SR) 6,000 DLHs × $5.00 per DLH = $30,000

   Variable overhead spending Variable overhead efficienvariance, cy variance, $580 U $1,000 F Total variance, $420 F Alternative solution for the variable overhead variances: Variable overhead rate variance = (AH × AR) – (AH × SR) ($29,580) – (5,800 DLHs × $5.00 per DLH) = $580 U Variable overhead efficiency variance = SR (AH – SH) $5.00 per DLH (5,800 DLHs – 6,000 DLHs) = $1,000 F Fixed overhead variances: Actual Fixed Overhead $60,400



Budgeted Fixed Overhead $59,000

Budget variance, $1,400 U



Fixed Overhead Applied to Work in Process 6,000 DLHs × $11.80 per DLH = $70,800 Volume variance, $11,800 F



487

Case 10-40 (continued) Alternative approach to the volume variance: Volume Variance: Fixed Overhead Rate (Denominator hours – standard hours allowed) $11.80 per DLH (5,000 DLHs – 6,000 DLHs) = -$11,800 F 5. The choice of a denominator activity level affects standard unit costs in that the higher the denominator activity level chosen, the lower standard unit costs will be. The reason is that the fixed portion of overhead costs is spread over more units as the denominator activity rises. The volume variance cannot be controlled by controlling spending. The volume variance simply reflects whether actual activity was greater than or less than the denominator activity. Thus, the volume variance is controllable only through activity.

Managerial Accounting, 13th Canadian Edition

Appendix 10A Solutions Exercise 10A-1 (30 minutes) Material Variances Equivalent units To complete beginning WIP (5,000 units × 0%) = .......................... 0 Started and completed (18,000 – 6,000) ............................... 12,000 Ending WIP (6,000 × 100%) ..................................... 6,000 Total equivalent units ............................................................ 18,000 Standard Cost of Materials Issued A B

28,000 12,000 40,000

× ×

0.80 2.00

Actual material used at standard mix A 1.5 30,000 × 0.80 2.0 B

0.5 2.0

10,000 40,000

2.00

Standard materials for actual production A (18,000 × 1.5) × 0.80 B

(18,000 × 0.5)

2.00

$22,400 24,000 $46,400

$24,000

Mix Variance $ 1,600 F A 4,000 U B $ 2,400 U

20,000 $44,000

Yield Variance

$21,600

$ 2,400 U A 2,000 U B $ 4,400 U

18,000 $39,600

Labour Variances Equivalent units To complete beginning WIP (5,000 × .75) ............................... 3,750 Started and completed (18,000 – 6,000) ............................... 12,000 End WIP (6,000 × .60) .......................................................... 3,600 Total equivalent units ............................................................ 19,350

489

Exercise 10A-1 (continued) Actual labour costs

$50,000

Std. Cost of actual hours 4,800 × $10

$2,000 U Rate var.

48,000

$375 F Effic. Var.

Cost of actual production (standards) 19,350 × 0.25 × $10 48,375

It may be helpful to see the summary for the material variance analysis as it would appear per Exhibit 10-3. NOTE: Standard Quantity Allowed for 18,000 equivalent units produced: Material A = 18,000 x 1.5 L = 27,000 L Material B = 18,000 x 0.5 L = 9,000 L Actual Quantity of Inputs, at Actual Price (AQ × AP) N/A

Actual Quantity of Inputs, at Standard Price (AQ × SP) Material A + B: 28,000 x $0.80 +12,000 x $2.00 = $46,400

Price Variance, N/A

Standard Quantity Allowed for Output, at Standard Price (SQ × SP) Material A + B: 27,000 x $0.80 + 9,000 x $2.00 = $39,600

Quantity Variance, $6,800 U

Total Variance, N/A The total Material Quantity Variance of $6,800 is explained by the following: Mix Variance $2,400 U and the Yield Variance $4,400 U = Quantity Variance of $6,800 U.

Managerial Accounting, 13th Canadian Edition

Exercise 10A-2 (30 minutes) a.

(1) Material

(2)

(1 – 2) Price Variance

Actual Cost Standard Cost × Actual Quantity

$68,040

($2 × 32,400)

$ 3,240 U

$110,000

($10 × 10,800)

2,000 U $ 5,240 U

(2)

(1) Standard Cost × Actual Quantity

Material R1 T2

($2 × 32,400) = $64,800 ($10 × 10,800) = 108,000 43,200

*Standard quantity at standard mix: R1 160/200 × 36,000 T2 40/200× 36,000

(1 – 2)

Standard Usage × Standard Mix* × Standard Cost

Quantity Variance

28,800 × $2 7,200× $10 36,000

$7,200 U 36,000 U $43,200 U

= 28,800 = 7,200

491

Problem 10A-2 (continued) c.

(1)

(2)

(3)

(4)

(3 × 4)

Actual Quantity

Actual Quantity at Standard Proportions

(1 – 2)

Standard Cost

Mix Variance

Difference

32,400 34,560 (160/200)

2,160 F

$4,320 F

10,800

8,640 (40/200)

2,160 U

21,600 U

43,200

$ 17,280 U

Alternatively: Mix variance = (AQA – MA)SPA R1: (32,400 – 160/200(43,200) x $2 = $ 4,320 F T2: (32,400 – 40/200(43,200) x $10 = $21,600 U Total mix variance $17,280 U d. Yield variance = (MA – SQA)SPA R1: [160/200(32,400+10,800)-28,800*] x $2 = $11,520 U T2: [400/200(32,400+10,800)-7,200*] x $10 = $14,400 U Total yield variance $25,920 U *See solution to part b. above. Check:

Mix variance Yield variance Quantity variance

$ 17,280 U 25,920 U $43,200 U

Managerial Accounting, 13th Canadian Edition

Appendix 10B Solutions Exercise 10B-1 (20 minutes) 1.The general ledger entry to record the purchase of materials for the month is: Raw Materials (5,000 metres at $10.00 per metre) ............................... 50,000 Materials Price Variance (5,000 metres at $0.10 per metre F ............................... Accounts Payable (5,000 metres at $9.90 per metre) .......................... 2.The general ledger entry to record the use of materials for the month is: Work in Process (4,000* metres at $10 per metre) ................................. Materials Quantity Variance (200 metres at $10 per metre U) ............................. Raw Materials (4,200 metres at $10 per metre) .............................

500 49,500

40,000 2,000 42,000

*2,000 units × 2 metres per unit 3.The general ledger entry to record the incurrence of direct labour cost for the month is: Work in Process (1,000* hours at $30.00 per hour) ........... Labour Rate Variance (975 hours at $1 per hour U)......................................... Labour Efficiency Variance (25 hours at $30.00 per hour F) .............................. Wages Payable (975 hours at $31.00 per hour) ...............................

30,000 975 750 30,225

*2,000 units × 0.50 hours per unit

493

Exercise 10B-2 (45 minutes) 1.a. Actual Quantity of Inputs, at Actual Price (AQ × AP) 7,000 metres × $5.75 per metre = $40,250 

Actual Quantity of Inputs, at Standard Price (AQ × SP) 7,000 metres × $6.00 per metre = $42,000

Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 5,250 metres* × $6.00 per metre = $31,500

 Price Variance, -$1,750 F 6,000 metres × $6.00 per metre = $36,000



 Quantity Variance, $4,500 U *1,500 units × 3.5 metres per unit = 5,250 metres Alternatively: Materials Price Variance = AQ (AP – SP) 7,000 metres ($5.75 per metre – $6.00 per metre) = -$1,750 F Materials Quantity Variance = SP (AQ – SQ) $6.00 per metre (6,000 metres – 5,250 metres) = $4,500 U

Managerial Accounting, 13th Canadian Edition

Exercise 10B-2 (continued) b. The journal entries would be: Raw Materials (7,000 metres × $6 per metre) .................. Materials Price Variance (7,000 metres × $0.25 F per metre) ....................... Accounts Payable (7,000 metres × $5.75 per metre) ..........................

42,000

Work in Process (5,250 metres × $6 per metre) ............... Materials Quantity Variance (750 metres U × $6 per metre) .................................... Raw Materials (6,000 metres × $6 per metre)..............

31,500

1,750 40,250

4,500 36,000

2.a. Actual Hours of Input, at the Actual Rate (AH × AR) $8,120

Actual Hours of Input, at the Standard Rate (AH × SR) 725 hours × $10 per hour = $7,250



Rate Variance, $870 U

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 600 hours* × $10 per hour = $6,000

Efficiency Variance, $1,250 U



Total Variance, $2,120 U *1,500 units × 0.4 hour per unit = 600 hours Alternatively: Labour Rate Variance = AH (AR – SR) 725 hours ($11.20 per hour* – $10.00 per hour) = $870 U *$8,120 ÷ 725 hours = $11.20 per hour Labour Efficiency Variance = SR (AH – SH) $10 per hour (725 hours – 600 hours) = $1,250 U

495

Exercise 10B-2 (continued) b. The journal entry would be: Work in Process (600 hours × $10 per hour) ....................... 6,000 Labour Rate Variance (725 hours × $1.20 U per hour) ....................................... 870 Labour Efficiency Variance (125 U hours × $10 per hour).......................................... 1,250 Wages Payable (725 hours × $11.20 per hour) .............. 8,120 3.The entries are: (a) purchase of materials; (b) issue of materials to production; and (c) incurrence of direct labour cost. (a) Bal.

Raw Materials 42,000 (b) 1 6,000

36,000

Accounts Payable (a)

40,250

Materials Price Variance (a) 1,750

Wages Payable (c)

8,120

(b)

Materials Quantity Variance 4,500

(b) (c)

Work in Process 31,5002 6,0003

(c)

Labour Rate Variance 870

(c)

Labour Efficiency Variance 1,250

1,000 metres of material at a standard cost of $6.00 per metre Materials used 3 Labour cost 2

Managerial Accounting, 13th Canadian Edition

Problem 10B-3 (60 minutes) 1.a. Actual Quantity of Inputs, at Actual Price (AQ × AP) 21,120 metres × $3.35 per metre = $70,752

Actual Quantity of Inputs, at Standard Price (AQ × SP) 21,120 metres × $3.60 per metre = $76,032

Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 19,200 metres* × $3.60 per metre = $69,120



Price Variance, -$5,280 F

Quantity Variance, $6,912 U

Total Variance, $1,632 U *4,800 units × 4.0 metres per unit = 19,200 metres Alternatively: Materials Price Variance = AQ (AP – SP) 21,120 metres ($3.35 per metre – $3.60 per metre) = -$5,280 F Materials Quantity Variance = SP (AQ – SQ) $3.60 per metre (21,120 metres – 19,200 metres) = $6,912 U b.

Raw Materials (21,120 metres @ $3.60 per metre) ............... Materials Price Variance (21,120 metres @ $0.25 per metre F) ........................ Accounts Payable (21,120 metres @ $3.35 per metre) ...........................

76,032

Work in Process (19,200 metres @ $3.60 per metre) ............ Materials Quantity Variance (1,920 metres U @ $3.60 per metre) ................................ Raw Materials (21,120 metres @ $3.60 per metre) .........

69,120

5,280 70,752

6,912 76,032

497

Problem 10B-3 (continued) 2.a. Actual Hours of Input, at the Actual Rate (AH × AR) 6,720 hours* × $4.85 per hour = $32,592

Actual Hours of Input, at the Standard Rate (AH × SR) 6,720 hours × $4.50 per hour = $30,240



Rate Variance, $2,352 U

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 7,680 hours** × $4.50 per hour = $34,560

Efficiency Variance, -$4,320 F



Total Variance, $1,968 F * 4,800 units × 1.4 hours per unit = 6,720 hours ** 4,800 units × 1.6 hours per unit = 7,680 hours Alternatively: Labour Rate Variance = AH (AR – SR) 6,720 hours ($4.85 per hour – $4.50 per hour) = $2,352 U Labour Efficiency Variance = SR (AH – SH) $4.50 per hour (6,720 hours – 7,680 hours) = -$4,320 F b.

Work in Process (7,680 hours @ $4.50 per hour) ................. Labour Rate Variance (6,720 hours @ $0.35 per hour U) ................................... Labour Efficiency Variance (960 hours F @ $4.50 per hour) ................................. Wages Payable (6,720 hours @ $4.85 per hour) ..............

34,560 2,352 4,320 32,592

Managerial Accounting, 13th Canadian Edition

Problem 10B-3 (continued) 3.

Actual Hours of Input, at the Actual Rate (AH × AR) 6,720 hours × $2.15 per hour = $14,448

Actual Hours of Input, at the Standard Rate (AH × SR) 6,720 hours × $1.80 per hour = $12,096

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 7,680 hours × $1.80 per hour = $13,824



Spending Variance, $2,352 U

Efficiency Variance, -$1,728 F

Total Variance, $624 U Alternatively: Variable Overhead Spending Variance = AH (AR – SR) 6,720 hours ($2.15 per hour – $1.80 per hour) = $2,352 U Variable Overhead Efficiency Variance = SR (AH – SH) $1.80 per hour (6,720 hours – 7,680 hours) = -$1,728 F

499

Problem 10B-3 (continued) 4.

Fixed overhead variances: Actual Fixed Overhead Cost 6,720 hours × $3.05 per hour = $20,496 

Fixed Overhead Cost Applied to Work in Process 7,680 × $3 per hour = $23,040

Budgeted Fixed Overhead Cost 6,860 hours × $3.00 per hour = $20,580

Budget Variance, -$84 F



Volume Variance, -$2,460 F



Alternative approach to the budget variance: Budget variance = Actual fixed overhead – Flexible budget fixed overhead $20,496 - $20,580 = -$84 F Alternative approach to the volume variance: Volume variance = Fixed Overhead Rate (Denominator hours – standard hours allowed) $3 per hour (6,860 hours – 7,680 hours) = -$2,460 F 5.No. This total variance is made up of several quite large individual variances, some of which may warrant investigation. A summary of variances is given below: Materials: Price variance ........................................... Quantity variance ...................................... Labour: Rate variance ............................................ Efficiency variance ..................................... Variable overhead: Spending variance ..................................... Efficiency variance ..................................... Fixed overhead Budget variance ........................................ Volume variance ........................................ Net favourable variance ................................

$5,280 F 6,912 U

$1,632 U

2,352 U 4,320 F

1,968 F

2,352 U 1,728 F

624 U

84 F 2,460 F

2,544 F $ 2,256 F

Managerial Accounting, 13th Canadian Edition

Problem 10B-3 (continued) 6.The variances have many possible causes. Some of the more likely causes include:

Materials variances: Favourable price variance: Good price, inaccurate standards, inferior quality materials, unusual discount due to quantity purchased, drop in market price. Unfavourable quantity variance: Carelessness, poorly adjusted machines, unskilled workers, inferior quality materials, and inaccurate standards.

Labour variances: Unfavourable rate variance: Use of highly skilled workers, change in wage rates, inaccurate standards, and overtime. Favourable efficiency variance: Use of highly skilled workers, high-quality materials, new equipment, and inaccurate standards.

Variable overhead variances: Unfavourable spending variance: Increase in costs, inaccurate standards, waste, theft, spillage, and purchases in uneconomical lots. Favourable efficiency variance: Same as for labour efficiency variance.

Fixed overhead variances: Favourable budget variance: Decreases in costs such as insurance, taxes, salaries, and maintenance that were not anticipated when the budget was set for fixed overhead. Favourable volume variance: greater use of available capacity than planned.

501

Problem 10B-4 (75 minutes) 1.a. Actual Quantity of Inputs, at Actual Price (AQ × AP) 20,000 metres × $2.85 per metre = $57,000

Actual Quantity of Inputs, at Standard Price (AQ × SP) 20,000 metres × $3.00 per metre = $60,000

Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 12,000 metres* × $3.00 per metre = $36,000



Price Variance, -$3,000 F 12,650 metres × $3.00 per metre = $37,950

 Quantity Variance, $1,950 U *6,000 units × 2.0 metres per unit = 12,000 metres Alternative approach: Materials Price Variance = AQ (AP – SP) 20,000 metres ($2.85 per metre – $3.00 per metre) = -$3,000 F Materials Quantity Variance = SP (AQ – SQ) $3.00 per metre (12,650 metres – 12,000 metres) = $1,950 U b.

Raw Materials (20,000 metres @ $3.00 per metre) ............. Materials Price Variance (20,000 metres @ $0.15 per metre F) ...................... Accounts Payable (20,000 metres @ $2.85 per metre) ......................... Work in Process (12,000 metres @ $3.00 per metre) .......................................................................... Materials Quantity Variance (650 metres U @ $3.00 per metre)................................. Raw Materials (12,650 metres @ $3.00 per metre) ....................................................................

60,000 3,000 57,000 36,000 1,950 37,950

Managerial Accounting, 13th Canadian Edition

Problem 10B-4 (continued) 2.a. Actual Hours of Input, at the Actual Rate (AH × AR) $27,950

Actual Hours of Input, at the Standard Rate (AH × SR) 6,500 hours* × $4.50 per hour = $29,250



Rate Variance, -$1,300 F

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 6,000 hours** × $4.50 per hour = $27,000

Efficiency Variance, $2,250 U



Total Variance, $950 U * The actual hours worked during the period can be computed through the variable overhead efficiency variance, as follows: SR (AH – SH) = Efficiency Variance $3 per hour (AH – 6,000 hours**) = $1,500 U $3 per hour × AH – $18,000 = $1,500*** $3 per hour × AH = $19,500 AH = 6,500 hours ** 6,000 units × 1.0 hour per unit = 6,000 hours *** When used with the formula, unfavourable variances are positive and favourable variances are negative. Alternative approach: Labour Rate Variance = AH × (AR – SR) 6,500 hours ($4.30 per hour* – $4.50 per hour) = -$1,300 F *$27,950 ÷ 6,500 hours = $4.30 per hour Labour Efficiency Variance = SR (AH – SH) $4.50 per hour (6,500 hours – 6,000 hours) = $2,250 U

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Problem 10B-4 (continued) b.

Work in Process (6,000 hours @ $4.50 per hour)................................ Labour Efficiency Variance (500 hours U @ $4.50 per hour) ............................... Labour Rate Variance (6,500 hours @ $0.20 per hour F) ....................... Wages Payable (6,500 hours @ $4.30 per hour) ..........................

27,000 2,250 1,300 27,950

3.a. Actual Hours of Input, at the Actual Rate (AH × AR) $20,475

Actual Hours of Input, at the Standard Rate (AH × SR) 6,500 hours × $3.00 per hour = $19,500



Spending Variance, $975 U

Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 6,000 hours × $3.00 per hour = $18,000

Efficiency Variance, $1,500 U



Total Variance, $2,475 U Alternative approach: Variable Overhead Spending Variance = AH × (AR – SR) 6,500 hours ($3.15 per hour* – $3.00 per hour) = $975 U *$20,475 ÷ 6,500 hours = $3.15 per hour Variable Overhead Efficiency Variance = SR (AH – SH) $3.00 per hour (6,500 hours – 6,000 hours) = $1,500 U

Managerial Accounting, 13th Canadian Edition

Problem 10B-4 (continued) b. No. When variable manufacturing overhead is applied on the basis of direct labourhours, it is impossible to have an unfavourable variable manufacturing overhead efficiency variance when the direct labour efficiency variance is favourable. The variable manufacturing overhead efficiency variance is the same as the direct labour efficiency variance except that the difference between actual hours and the standard hours allowed for the output is multiplied by a different rate. If the direct labour efficiency variance is favourable, the variable manufacturing overhead efficiency variance must also be favourable. 4.a. The volume variance for fixed overhead is calculated as follows: Fixed Overhead Rate (Denominator hours – standard hours allowed) $5(6,200 – 6,000) = $1,000 U b. The budget variance for fixed overhead is calculated as follows: Budget variance = Actual fixed overhead – Flexible budget fixed overhead $1,000 U = Actual fixed overhead – $31,000* Therefore actual fixed overhead = $32,000 *Fixed overhead rate = Budgeted Fixed Overhead  denominator hours Therefore budgeted fixed overhead = $31,000 5.For materials: Favourable price variance: Decrease in outside purchase prices, fortunate buy, inferior quality materials, unusual discounts due to quantity purchased, inaccurate standards. Unfavourable quantity variance: Inferior quality materials, carelessness, poorly adjusted machines, unskilled workers, and inaccurate standards.

505

Problem 10B-4 (continued)

For labour: Favourable rate variance: Unskilled workers (paid lower rates), piece work, and inaccurate standards. Unfavourable efficiency variance: Poorly trained workers, poor quality materials, faulty equipment, work interruptions, fixed labour with insufficient demand to keep them all busy, inaccurate standards.

For variable overhead: Unfavourable spending variance: Increase in supplier prices, inaccurate standards, waste, and theft of supplies. Unfavourable efficiency variance: See comments under direct labour efficiency variance.

For fixed overhead: Unfavourable budget variance: increases in the costs of insurance, taxes, maintenance, salaries, not anticipated in the budget. Unfavourable volume variance: utilized less capacity than the denominator level (6,000 versus 6,200)

Managerial Accounting, 13th Canadian Edition

Appendix 10C Solutions Solutions to Questions 10C-1 The market share variance represents the effect on total contribution margin of the actual sales volume differing from the anticipated share of the actual market volume. The variance is, to some extent, controllable by managers. For example, introducing an effective advertising campaign or making product/service enhancements can increase market share leading to a favourable variance. Increasing selling price can lead to decreased demand and an unfavourable market share variance. 10C-2 The sales mix variance represents the total contribution margin effect of the actual mix of products sold differing from the budgeted mix. The budgeted mix is calculated by taking the total actual sales quantity of all products and multiplying it by the anticipated sales mix for each product. To some extent, the sales mix variance can be controllable by managers. For example, an advertising campaign could be implemented that promotes one product more heavily than others. The result could be increased sales for that product, relative to the others in the product line.

507

Exercise 10C-1 (30 minutes) 1. Budgeted Contribution Margin: Mountain Selling price ............................................................. $2,400 Variable costs .......................................................... 1,936 Budgeted contribution margin per unit ...................... $ 464 2. Sales volume variance: Mountain (9,000 – 6,300) x $464 = $1,252,800 F Road (27,000 – 25,500) x $684 = $1,026,000 F Total $2,278,800 F 3. a. Sales Price Variance: Mountain ($2,480 – $2,400) 9,000 = $ 720,000 F Road ($3,150 – $3,200) 27,000 = $1,350,000 U Total $ 630,000 U

Road $3,200 2,516 $ 684

b. Market Volume Variance: Mountain (90,000 – 72,000) × (6,300/72,000) × $464 = $ 730,800 F Road(150,000 – 127,500) × (25,500/127,500) × $684 = $3,078,000 F Total $3,808,800 F

Managerial Accounting, 13th Canadian Edition

Exercise 10C-1 (continued) c. Market Share Variance: Mountain [9,000 – [90,000( 6,300/72,000)] × $464] = $ 522,000 F Road [27,000 – [150,000(25,500/127,500)] × $684] = $2,052,000 U Total $1,530,000 U d. Sales Mix Variance: Mountain [9,000 – [36,000*(6,300/31,800)] × $464] = $ 866,752 F Road [27,000 – [36,000*(25,500/31,800)] × $684] = $1,277,712 U Total $410,960 U *9,000 + 27,000 = 36,000 e. Sales Quantity Variance: Mountain [36,000*(6,300/31,800)] – 6,300 × $464] = $ 386,048 F Road [36,000*(25,500/31,800)] – 25,500 × $684] = $2,303,712 F Total $2,689,760 F *9,000 + 27,000 = 36,000 Note that the total of the market volume variance and the market share variance is $2,278,800, which equals the total sales volume variance from requirement 2. Similarly, the total of the sales mix variance and the sales quantity varirance is also $2,278,800. As discussed in the appendix this is because there are two different ways to decompose the sales volume variance, both of which can help managers understand the factors that affected sales performance during the period.

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Problem 10C-2 (30 minutes) Budgeted Contribution Margin: Selling price .................................................... Variable costs ................................................. Budgeted contribution margin per unit .............

Regular $300 220 $ 80

Heavenly $800 590 $210

1. a.

Sales Price Variance: Regular ($325 – $300) × 7,200 Heavenly ($700 – $800) × 4,800 Total

= =

$180,000 F $480,000 U $300,000 U

Market Volume Variance: Regular (444,444 – 300,000) × (4,500/300,000) × $ 80 = $173,333 F Heavenly (222,223 – 200,000) × (5,500/200,000) × $210 = $128,338 F Total $301,671 F

Market Share Variance: Regular 7,200 – [444,444 (4,500/300,000)] × $ 80 = $ 42,640 F Heavenly 4,800 – [222,223(5,500/200,000)] × $210 = $275,310 U Total $232,670 U

Sales Mix Variance: Regular 7,200 – [12,000*(4,500/10,000)] × $ 80 = $144,000 F Heavenly 4,800 – [12,000*(5,500/10,000)] × $210 = $378,000 U Total $234,000 U *7,200 + 4,800 = 12,000

Sales Quantity Variance: Regular [12,000 (4,500/10,000)] – 4,500 × $ 80 = $ 72,000 F Heavenly [12,000 (5,500/10,000)] – 5,500 × $210 = $231,000 F Total $303,000 F

Managerial Accounting, 13th Canadian Edition

Problem 10C-2 (continued) 2.The decision to drop the price on the Heavenly model does not appear to have been a good decision based on the variance analysis conducted in part 1. The sales price variance for the Heavenly model is $480,000 unfavourable, a direct result of dropping the price from $800 to $700 per unit. The unfavourable sales mix variance of $378,000 indicates that the price drop did not result in a greater proportion of Heavenly beds being sold as part of the overall product mix. In fact, the actual mix of 40% Heavenly beds (4,800/12,000) is considerably lower than the planned mix of 55% (5,500/10,000). Since Heavenly beds have a higher contribution margin than Regular beds, this had a negative effect on the total contribution margin as shown by the unfavourable sales mix variance. The unfavourable market share variance of $275,310 for Heavenly beds confirms that the price drop did not have the desired effect. The actual market share of 2.2% (4,800/222,223) is lower than the planned share of 2.75% (5,500/200,000). Collectively these variances indicate that Rest Easy‘s approach of simply dropping prices without changing their marketing approach did not have the desired effect.

Chapter 11 Reporting for Control Discussion Case (30 minutes) Although both businesses are in the same industry (food service), they serve very different markets and target customers that have very different expectations. Consequently, there are likely to be more differences than similarities between measures on the balanced scorecards of these two restaurants. Some examples (although not comprehensive) of the types of measures that might be included are as follows: Sam's Pita Place Number of orders processed per hour

Classic Steakhouse Number of special occasion dining reservations taken per week

Number of sandwiches sent back - different ingredients than ordered

Number of orders sent back as over/under-cooked or due to poor taste.

Explanation Sam's is focused on speed of service while Classic is focused on special occasion dining offerings; larger dining parties that spend more money per visit. Sam's allows customers to customize their sandwiches. Getting something different than ordered with © McGraw Hill Ltd. 2024. All rights reserved.

Solutions Manual, Chapter 11

511

reduce the probability the customer will return to the restaurant. Classic serves food at a higher price point and customers dine-in. They expect their food to be tasty and cooked to order.

Managerial Accounting, 13th Canadian Edition

Discussion Case (continued) Sam's Pita Place Customer satisfaction scores received via social media sources. Survey would include measures such as speed of service and variety of food offerings at low prices.

Classic Steakhouse Customer satisfaction scores provided at the end of the meal. Survey would include measures of server attentiveness and the quality of the overall dining experience.

Number of sandwich offerings below $6

Number of menu items that are priced at or slightly above competitors

Explanation While both restaurants would likely collect customer satisfaction survey data, each restaurant must collect this data from different sources considering differences in their target markets. The scores collected should reflect differences in these target markets and overall strategies Sam's is concerned with offering enough low-priced menu items while Classic is concerned about ensuring their higher priced items are still price-competitive.

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Solutions to Questions 11-1 There are a number of possible disadvantages including decision-making by individuals who don‘t necessarily understand the company‘s strategy. Also, independent decisionmaking by managers as part of decentralization may lead to coordination problems, lack of information sharing and possible self-interested behaviour that is not aligned with the organization‘s objectives. 11-2 A segment is any part or activity of an organization about which a manager seeks cost, revenue, or profit data. Examples of segments include departments, operations, sales territories, divisions, product lines, and so forth. 11-3 A common fixed cost is one that supports the operations or activities of more than one segment but is not traceable in whole or in part to any one segment. 11-4 The contribution margin is the difference between sales revenue and variable expenses. The segment margin is calculated by deducting traceable fixed expenses from the contribution margin. The contribution margin is useful as a planning tool for many decisions, including those in which fixed costs don‘t change. The segment margin is useful in assessing the overall profitability of a segment. 11-5 If common costs were allocated to segments, then the costs directly attributable to segments would be overstated and their margins would be understated. As a consequence, some segments could appear to be unprofitable and managers may be tempted to eliminate them. If a segment were eliminated because of the existence of arbitrarily allocated common costs, the overall profit of the company would decline by the amount of the segment margin because the common cost would remain. The common cost that had been allocated to the segment would then be reallocated to the remaining segments—making them appear less profitable. 11-6 A traceable fixed cost is one that can be identified with a particular segment and that only arises because a segment exists.

11-7 Three inappropriate methods for assigning traceable costs are: treating traceable fixed costs as indirect, using the wrong allocation base and arbitrarily dividing common costs among segments. Each of these practices is inappropriate because they can lead to distorted segment costs and consequently, distorted segment margins. 11-8 A cost center manager has control over cost, but not revenue or the use of investment funds. A profit center manager has control over both cost and revenue. An investment center manager has control over cost and revenue and the use of investment funds. To evaluate cost centre performance, standard cost variances and flexible budget variances are often used. Profit centre managers are often evaluated by comparing actual profit to targeted or budgeted profit. Investment centre managers are usually evaluated using return on investment or residual income measures. 11-9 The net book value (NBV) approach is in keeping with how plant and equipment are reported on the balance sheet. Also, the NBV approach is consistent with the determination of operating income, which includes depreciation as an expense. 11-10 Return on investment (ROI) can be improved by increasing sales, reducing operating expenses or reducing operating assets. 11-11 Residual income is the operating income an investment center earns above the company‘s minimum required rate of return on operating assets. 11-12 If ROI is used to evaluate performance, a manager of an investment center may reject a profitable investment opportunity whose rate of return exceeds the company‘s required rate of return but is less than the investment center‘s current ROI. The residual income approach overcomes this problem since any project whose rate of return exceeds the company‘s minimum required rate of return will result in an increase in residual income. A positive change in residual income will be viewed favourably by management.

Managerial Accounting, 13th Canadian Edition

11-13 No, residual income should not be used to compare the performance of divisions of different sizes. The reason is that larger divisions should, other factors held constant, produce more residual income since they have a larger asset base with which to generate profits. However, it is appropriate to compare the percentage growth in residual income (e.g., year-overyear) for divisions of different sizes.

whether improvements in leading indicators such (e.g., service delivery) are resulting in predicted or expected changed in outcome measures (e.g., customer satisfaction, revenue growth, etc.). A strategy is not likely to be working if the predicted effects of changes in leading indicators are not being observed within a reasonable period of time.

11-14 A balanced scorecard can be used to test management‘s strategy by assessing

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Foundational Exercises 1.

Last year‘s margin is: Margin = Operating Income  Sales = $500,000  $2,000,000 = 25%

Last year‘s turnover ratio is: Turnover Ratio = Sales  Average Operating Assets = $2,000,000  $2,000,000 =1

Last year‘s return on investment (ROI) is: ROI = Margin x Turnover Ratio = 25% x 1 = 25%

The margin for this year‘s investment opportunity is: $50,000*  $150,000 = 33.3% (rounded) *($150,000 x .5) - $25,000

The turnover ratio for this year‘s investment opportunity is: $150,000  $250,000 = 0.6

The ROI for this year‘s investment opportunity is: 33.3% x .6 = 20% (rounded)

Managerial Accounting, 13th Canadian Edition

Foundational Exercises (continued) 7, 8, and 9. If the company pursues the investment opportunity, this year‘s margin, turnover ratio, and ROI would be: Margin = Operating Income  Sales = ($500,000 + $50,000)  ($2,000,000 + $150,000) = 25.6% (rounded) Turnover Ratio = Sales  Average Operating Assets = ($2,000,000 + $150,000)  ($2,000,000 + $250,000) = 0.96 (rounded) ROI = Margin x Turnover Ratio = 25.6% x 0.96 = 24.6% (rounded) 10. The CEO would not pursue the investment opportunity because it lowers her ROI from 25% to 24.6%. The shareholders of the company would want the CEO to pursue the investment opportunity because its ROI of 20 exceeds the company‘s minimum required rate of return of 10%. 11. Last year‘s residual income is: Average operating assets ................................ Operating income ........................................... Minimum required return: 10% × $2,000,000 ...................................... Residual income .............................................

$2,000,000 $500,000 200,000 $300,000

12. The residual income for this year‘s investment opportunity is: Average operating assets ................................ Operating income ........................................... Minimum required return: 10% × $250,000 ......................................... Residual income .............................................

$250,000 $50,000 25,000 $25,000

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Foundational Exercises (continued) 13. If the company pursues the investment opportunity, this year‘s residual income will be: Average operating assets ................................ Operating income ........................................... Minimum required return: 10% × $2,250,000 ...................................... Residual income .............................................

$2,250,000 $550,000 225,000 $325,000

14. The CEO would pursue the investment opportunity because it would raise her residual income by $25,000. 15. The CEO and the company would not want to pursue this investment opportunity because at a 30% contribution margin ratio it does not exceed the minimum required return and would result in residual income dropping by $5,000 as shown below: Average operating assets ................................ Operating income* ......................................... Minimum required return: 10% × $250,000 ......................................... Residual income .............................................

$250,000 $20,000 25,000 $ (5,000)

*($150,000 x .3) - $25,000

Managerial Accounting, 13th Canadian Edition

Exercise 11-1 (10 minutes)

Revenues ..................................... Variable expenses ......................... Contribution margin ...................... Traceable fixed expenses ............... Segment margin ........................... Common fixed expenses ................ Operating income .........................

Total Company

Family Law

Commercial Law

$1,000,000 220,000 780,000 670,000 110,000 60,000 $ 50,000

$400,000 100,000 300,000 280,000 $ 20,000

$600,000 120,000 480,000 390,000 $ 90,000

The firm would not be better off financially if the family law practice were dropped. The family law segment is covering all of its own costs and contributing $20,000 per month to covering the common fixed expenses of the firm. While the segment margin for family law is much lower than for commercial law, it is still profitable as shown in the revised income statement above.

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Exercise 11-2 (20 minutes) 1.

Total

Geographic Market

Company

South

Central

North

Sales .......................................

$1,000,000

$300,000

$400,000

$300,000

Variable expenses (52%, 30%, 40%) ................

396,000

156,000

120,000

Contribution margin .................

604,000

144,000

280,000

180,000

Traceable fixed expenses ..........

575,000

160,000

265,000

150,000

Geographic market segment margin .................................

29,000

$(16,000)

$ 15,000

$30,000

Common fixed expenses not traceable to geographic markets*....................................

77,000

Operating income (loss) ...........

$ (48,000)

*$652,000 – $575,000 = $77,000 2.

Incremental sales ($400,000 × 15%) ............................... Contribution margin ratio 70% ......................................... Incremental contribution margin....................................... Less incremental advertising expense ............................... Incremental operating income ..........................................

$60,000 × 70% 42,000 13,000 $ 29,000

Yes, the advertising program should be initiated.

Managerial Accounting, 13th Canadian Edition

Exercise 11-3 (20 minutes) 1.

$75,000 × 40% CM ratio = $30,000 increased contribution margin in Vancouver. Since the fixed costs in the office and in the company as a whole will not change, the entire $30,000 would result in increased operating income for the company. It is incorrect to multiply the $75,000 increase in sales by Vancouver‘s 25 segment margin ratio. This approach assumes that the segment‘s traceable fixed expenses increase in proportion to sales, but if they did, they would not be fixed.

a. The segmented income statement follows:

Segments Total Company Amount % Sales ............................. $800,000 Variable expenses .................... 420,000 Contribution margin ............................. 380,000 Traceable fixed expenses .................... 168,000 Office segment margin ........................ 212,000 Common fixed expenses not traceable to segments .................... 120,000 Operating income .................. $ 92,000

100.0

Toronto Amount %

Vancouver Amount %

$200,000 100

$600,000 100

52.5

60,000

360,000

47.5

140,000

240,000

21.0

78,000

90,000

26.5

$ 62,000

$150,000

15.0 11.5

b. The segment margin ratio rises and falls as sales rise and fall due to the presence of fixed costs. The fixed expenses are spread over a larger base as sales increase. In contrast to the segment ratio, the contribution margin ratio is stable so long as there is no change in either variable expenses or the selling price of a unit of service.

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Exercise 11-4 (15 minutes) 1.

The company should focus its campaign on Construction Clients. The computations are:

Increased sales ............................................ Market CM ratio............................................ Incremental contribution margin ................... Less cost of the campaign............................. Increased segment margin and operating income for the company as a whole ................................................ 2.

Construction Clients

Landscaping Clients

$50,000 × 50% $25,000 10,000

$80,000 × 20% $16,000 10,000

$15,000

$6,000

The $90,000 in traceable fixed expenses in the previous exercise is now partly traceable and partly common. When we segment Vancouver by market, only $72,000 remains a traceable fixed expense. This amount represents costs such as advertising and salaries that only arise because of the existence of the construction and landscaping market segments. The remaining $18,000 ($90,000 – $72,000) is a common cost when Vancouver is segmented by market. This amount would include such costs as the salary of the manager of the Vancouver office that could not be avoided by eliminating either of the two market segments.

Managerial Accounting, 13th Canadian Edition

Exercise 11-5 (10 minutes) The completed segmented income statement should appear as follows:

Divisions

Sales ........................................................ Variable expenses ..................................... Contribution margin .................................. Traceable fixed expenses ........................... Territorial segment margin......................... Common fixed expenses ............................ Net operating income ................................

Total Company Amount %

North Amount

South Amount %

$500,000 270,000 230,000 130,000 100,000 90,000 $ 10,000

$300,000 150,000 150,000 80,000 $ 70,000

100.0 50.0 50.0 26.7 23.3

$200,000 120,000 80,000 50,000 $30,000

100.0 54.0 46.0 26.0 20.0 18.0 2.0

100.0 60.0 40.0 25.0 15.0

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Exercise 11-6 (15 minutes) Responsibility Centre Food services

Building maintenance Printing and copying services

Technology support Campus expansion

Type

Profit Centre: the department generates

revenue, and the manager is responsible for the related costs. The manager is not responsible for making investment decisions in the restaurant equipment/facilities. Cost Centre: there are no revenues generated by the department so the manager would only have responsibility for costs. Profit Centre: the department generates revenue, and the manager is responsible for the related costs. The manager is not responsible for investment decisions in printing or copying equipment. Cost centre: there are no revenues generated by the department so the manager would only have responsibility for costs. Investment centre: the manager appears to have responsibilitiy for revenues, costs and investments.

Managerial Accounting, 13th Canadian Edition

Exercise 11-7 (15 minutes) 1.

ROI computations: ROI = Operating Income × Sales

Sales__________ Average operating assets

Western Division: ($91,000/$1,040,000) × ($1,040,000/$400,000) 8.75% × 2.6 = 22.75% Eastern Division: ($96,000/$2,400,000) × ($2,400,000/$400,000) 4.0% × 6.0 = 24% 2.

The manager of the Eastern Division seems to be doing the better job. Although her margin is lower than the margin of the Western Division, her turnover is higher (a turnover of 6, as compared to a turnover of 2.67for the Eastern Division). The greater turnover more than offsets the lower margin, resulting in a 24% ROI, as compared to a 22.75% ROI for the other division. Notice that if you look at margin alone, then the Western Division appears to be the strongest division. This fact underscores the importance of looking at turnover as well as at margin in evaluating performance in an investment center.

525

Exercise 11-8 (15 minutes) 1.

ROI computations: ROI = Operating Income × Sales

Sales Average operating assets

Fort McMurray: ($180,000/$2,000,000) × ($2,000,000/$1,250,000) 9% × 1.6 = 14.4% Nunavut: ($63,000/$900,000) × ($900,000/$360,000) 7% × 2.5 = 17.5%

Fort McMurray

2. Average operating assets (a) ........................ Operating income ........................................ Minimum required return on average operating assets—10% × (a).............................. Residual income .......................................... 3.

Nunavut

$1,250,000 $180,000

$360,000 $63,000

125,000 $55,000

36,000 $ 27,000

It appears that the Nunavut division is better managed as it is generating a 17.5% ROI compared to the 14.4% ROI for the Fort McMurray division. Note that the larger residual income earned by the Fort McMurray division is to be expected since it is over twice as large as the Nunavut division based on sales and over three times as large based on average operating assets. Given this size difference, the Fort McMurray division should be generating more residual income, all else equal.

Managerial Accounting, 13th Canadian Edition

Exercise 11-9 (15 minutes)

Company A Sales (a) ............................................$9,000,000 * Operating income (b) ......................... $540,000 Average operating assets (c) ...............$3,000,000 * Return on investment (ROI) (b) ÷ (c).................................................. 18% * Minimum required rate of return: Percentage (d) ................................ 16% * Dollar amount (c) x (d).................... $480,000 Residual income (b) –[(c) x (d)] ..........

Company B

Company C

$7,000,000 * $280,000 * $2,000,000

$4,500,000 * $360,000 $1,800,000 *

14% *

20%

16% $320,000 *

15% * $270,000

$60,000

$(40,000)

$90,000 *

Fab

Division Consulting

$800,000 * 72,000 * 400,000 9% 2.0 18% *

$650,000 26,000 130,000 * 4% * 5.0 * 20%

$500,000 40,000 * 200,000 8% * 2.5 20% *

*Given. Exercise 11-10 (15 minutes)

Sales .............................................. Operating income ............................ Average operating assets ................. Margin ............................................ Turnover ......................................... Return on investment (ROI) ............. *Given.

Note that the Consulting and IT Divisions apparently have different strategies to obtain the same 20% return. The Consulting Division has a low margin and a high turnover, whereas the IT Division has just the opposite.

527

Exercise 11-11 (30 minutes) 1.

Margin

= =

Operating income  Sales $26,250/$750,000 = 3.5%

Turnover

= =

Sales  Average operating assets $750,000/$80,000 = 9.375

ROI

= =

Margin × Turnover 3.5% × 9.375 = 32.81%

Margin

= Operating income  Sales = ($26,250 + $6,000)/($750,000 + $80,000) = 3.89%

Turnover

= Sales  Average operating assets = ($750,000 + $80,000)/$80,000 = 10.38

ROI

= Margin × Turnover = 3.89% × 10.38 = 40.38%

Margin

= Operating income  Sales = ($26,250 + $3,200)/$750,000 = 3.93%

Turnover

= Sales  Average operating assets = $750,000/$80,000 = 9.375

ROI

= Margin × Turnover = 3.93% × 9.375 = 36.84%

Margin

= Operating income  Sales = $26,250/$750,000 = 3.5%

Turnover

= Sales  Average operating assets = $750,000/($80,000-$20,000) = 12.5

ROI

= Margin × Turnover = 3.5% × 12.5 = 43.75%

Managerial Accounting, 13th Canadian Edition

Exercise 11-12 (30 minutes) 1.

Computation of ROI (margin x turnover ratio). Tours :

$12,000 × $200,000 $200,000

Dining: Wellness:

5% × 2 = 10%

5% × 3 = 15%

$150,000

$18,750 × $375,000 $375,000

$125,000

Tours

2. Actual operating income (a) ........ Average operating assets ............ Required rate of return ............... Required operating income (b) Residual income (a) – (b) ........... 3.

6% × 4 = 24%

$50,000

$15,000 × $300,000 $300,000

a. and b. Return on investment (ROI) .......... Therefore, if the division is presented with an investment opportunity yielding 12%, it probably would.. Minimum required return for computing residual income................... Therefore, if the division is presented with an investment opportunity yielding 12%, it probably would..

Dining

Wellness

$12,000 $50,000 × 8% $ 4,000 $ 8,000

$ 15,000 $150,000 × 8% $ 12,000 $ 3,000

$ 18,750 $125,000 × 8% $ 10,000 $ 8,750

Tours

Dining

Wellness

24%

10%

15%

Reject

529

Exercise 11-12 (continued) If performance is being measured by ROI, the Tours and Wellness divisions probably would both reject the 12% investment opportunity. The reason is that both divisions are presently earning a return greater than 12%; thus, the new investment would reduce the overall rate of return and place the divisional managers in a less favourable light. The Dining division probably would accept the 12% investment opportunity, since its acceptance would increase these division‘s overall rate of return above the current level of 10%. If performance is being measured by residual income, all three divisions would accept the 12% investment opportunity. The 12% rate of return promised by the new investment is greater than their required rates of return of 8% and would therefore add to the total amount of their residual income.

Exercise 11-13 1. $150,000/$750,000=20% 2. $300,000/$750,000=40% 3.

$350,000/$1,000,000=35%

Managerial Accounting, 13th Canadian Edition

Exercise 11-14 (10 minutes)

1. 2. 3. 4. 5. 6. 7. 8. 9.

10. 11. 12. 13. 14. 15.

Item Sales from new customers Customer defection rate Average number of workplace accidents per employee Delivery cycle time Average training hours per employee Number of job applicants from under-represented groups Percent of customers that strongly agree with the statement ―Your employees treated me courteously.‖ Return on assets Percent of customers that strongly agree with the statement ―Your company has a superior commitment to product safety.‖ Number of modular product designs Lost sales due to out-of-stock merchandise Kilograms of waste produced Number of customer referrals Residual income Average mentorship hours per employee

Learning & Growth

Internal Business Process

Customer

Financial √

√ √ √ √ √ √ √ √ √ √ √ √ √ √

531

Exercise 11-15 (30 minutes) 1. Brainstorming Comment

Plausible Performance Measure

Learning & Growth "To many customer service employees leave our company to work for other employers."

Employee turnover percentage

"We are not providing enough training to our employees."

Average training hours per employee

"Our employees are not generating enough ideas to help improve what we do."

Number of process improvement suggestions per employee

Internal Business Process "Customers are returning too many defective products."

Defect-free units as a percentage of completed units

―It is taking too long to make products and ship them to customers."

Throughput time

"Customers have to call us repeatedly to get problems solved."

Percent of customer complaints settled on first contact

Customer "The number of customers we are serving seems to be shrinking."

Customer defection rate

"Customers are complaining about excessive delays with respect to receiving what they ordered."

Percent of customers that strongly agree with the statement ―my order was delivered on time

"We are acquiring fewer new customers from our current customers' word-ofmouth"

Number of customer referrals

Financial "Wall Street is becoming very concerned about our future."

Price-earnings ratio

"Sales are decreasing instead of increasing"

Sales growth rate

"It takes too long to convert customer orders into cash."

Net cash flow from operating activities

Managerial Accounting, 13th Canadian Edition

Exercise 11-15 (continued) 2.

One approach for defining the company‘s strategy is as follows: The concerns raised during the brainstorming session seem to share a common theme—the company‘s operational performance is faltering. It is having problems providing customers with defect-free products. It is unable to deliver products to customers in a timely manner. Finally, the company‘s post-sales customer service is unsatisfactory. These operational weaknesses suggest that the company is failing to execute an operational excellence strategy. A total of nine plausible causal connections are shown in the diagram on the next page.

533

Exercise 11-15 (continued)

Financial Price-earnings ratio (+)

Sales growth rate (+)

Net cash flow from operating activities (+)

Customer

Customer defection rate (-)

Number of customer referrals (+)

Internal Business Processes

Percent of customers that strongly agree with the statement ―My order was delivered on time.‖ (+)

Defect-free units as a percentage of completed units (+)

Percent of customer complaints settled on first contact (+)

Learning and Growth

Employee turnover percentage (-)

Throughput time (-)

Average training hours per employee (+)

Number of process improvement suggestions per employee (+)

Managerial Accounting, 13th Canadian Edition

Problem 11-16 (60 minutes) 1.

The disadvantages or weaknesses of the company‘s version of a segmented income statement are as follows: a. The company should include a column showing the combined results of the three territories taken together. b. The territorial expenses should be segregated into variable and fixed categories to permit the computation of both a contribution margin and a territorial segment margin. c. The corporate expenses are probably common to the territories and should not be allocated.

Corporate advertising expenses have apparently been allocated on the basis of sales dollars; the general administrative expenses have apparently been allocated evenly among the three territories. Such allocations can be misleading to management because they seem to imply that these expenses are caused by the segments to which they have been allocated. The segment margin—which only includes costs that are actually caused by the segments—should be used to measure the performance of a segment. An operating income or loss after allocating common expenses should not be used to judge the performance of a segment.

535

Problem 11-16 (continued) 3.

Sales ............................................. Variable expenses: Cost of goods sold ....................... Shipping expense ........................ Total variable expenses ................... Contribution margin ........................ Traceable fixed expenses: Salaries ....................................... Insurance ................................... Advertising .................................. Depreciation................................ Total traceable fixed expenses ......... Territorial segment margin .............. Common fixed expenses: Advertising (general) ................... General administration ................. Total common fixed expense ........... Operating loss ................................

Total Amount in €s

Southern Europe Amount in €s %

Middle Europe Amount in €s %

Northern Europe Amount in €s %

1,800,000

100.0

300,000 100

800,000

100

700,000

100

648,000 89,000 737,000 1,063,000

36.0 4.9 40.9 59.1

93,000 15,000 108,000 192,000

31 5 36 64

240,000 32,000 272,000 528,000

30 4 34 66

315,000 42,000 357,000 343,000

45 6 51 49

222,000 39,000 590,000 81,000 932,000 131,000

12.3 2.2 32.8 4.5 51.8 7.3

54,000 9,000 105,000 21,000 189,000 3,000

18 3 35 7 63 1

56,000 16,000 240,000 32,000 344,000 184,000

7 2 30 4 43 23

112,000 14,000 245,000 28,000 399,000 (56,000)

16 2 35 4 57 (8)

90,000 60,000 150,000 (19,000)

5.0 3.3 8.3 ( 1.1)

Note: Columns may not total due to rounding.

Managerial Accounting, 13th Canadian Edition

Problem 11-16 (continued) 4.

The following points should be brought to the attention of management: a. Sales in Southern Europe are much lower than in the other two territories. This is not due to lack of salespeople—salaries in Southern Europe are about the same as in Middle Europe, which has the highest sales of the three territories. b. Southern Europe is spending less than half as much for advertising as Middle Europe. Perhaps this is the reason for Southern Europe‘s lower sales. c.

Northern Europe has a poor sales mix; apparently it is selling a large amount of low-margin items. Note that its contribution margin ratio is only 49%, as compared to 64% or more for the other two territories.

d. Northern Europe may be overstaffed. Its total salaries are much higher than in either of the other two territories. e. Northern Europe is not covering its own traceable costs. Attention should be given to changing the sales mix and reducing expenses in this territory. f.

If the Northern Europe operations were discontinued, the total margin from the remaining two segments would more than cover the common fixed expenses of $150,000 and indeed the company would be more profitable by $56,000.

537

Problem 11-17 (30 minutes) 1.

Total Company Amount % Sales......................................................... Variable expenses ...................................... Contribution margin ................................... Traceable fixed expenses............................ Territorial segment margin ......................... Common fixed expenses*........................... Operating income ...................................... *465,000 – $290,000 = $175,000.

$900,000 408,000 492,000 290,000 202,000 175,000 $ 27,000

100.0 45.3 54.7 32.2 22.4 19.4 3.0

Sales Territory Central Eastern Amount % Amount % $400,000 208,000 192,000 160,000 $ 32,000

100 52 48 40 8

$500,000 100 200,000 40 300,000 60 130,000 26 $170,000 34

Product Line

Sales......................................................... Variable expenses ...................................... Contribution margin ................................... Traceable fixed expenses............................ Product line segment margin ...................... Common fixed expenses*........................... Sales territory segment margin ................... *$160,000 – $114,000 = $46,000.

Central Territory Amount %

Kiks Amount

Dows Amount

$400,000 208,000 192,000 114,000 78,000 46,000 $ 32,000

$100,000 25,000 75,000 60,000 $ 15,000

100 25 75 60 15

$300,000 100 183,000 61 117,000 39 54,000 18 $ 63,000 21

100.0 52.0 48.0 28.5 19.5 11.5 8.0

Managerial Accounting, 13th Canadian Edition

Problem 11-17 (continued) 2.

Two points should be brought to the attention of management. First, compared to the Eastern territory, the Central territory has a low contribution margin ratio. Second, the Central territory has high traceable fixed expenses. Overall, compared to the Eastern territory, the Central territory is very weak.

Again, two points should be brought to the attention of management. First, the Central territory has a poor sales mix. Note that the territory sells very little of the Kiks product, which has a high contribution margin ratio. It is this poor sales mix that accounts for the low overall contribution margin ratio in the Central territory mentioned in part (2) above. Second, the traceable fixed expenses of the Kiks product seem very high in relation to sales. These high fixed expenses may simply mean that the Kiks product is highly leveraged; if so, then an increase in sales of this product line would greatly enhance profits in the Central territory and in the company as a whole.

539

Problem 11-18 (45 minutes) 1.

The segmented income statement follows:

Sales ....................................... Variable expenses: Materials, labour & other ....... Sales commissions................. Total variable expenses ............. Contribution margin.................. Traceable fixed expenses: Advertising............................ Salaries ................................ Equipment depreciation* ....... Storage facility rent**............ Total traceable fixed expenses ... Product line segment margin .................................. Common fixed expenses: General administration ........... Operating income .....................

Total Company

Basic

Advanced

Pro

$300,000

$100,000

$150,000

$50,000

102,000 30,000 132,000 168,000

30,000 10,000 40,000 60,000

63,000 15,000 78,000 72,000

9,000 5,000 14,000 36,000

61,500 33,000 15,000 6,000 115,500

21,500 14,500 6,000 2,000 44,000

27,500 8,000 7,500 3,500 46,500

12,500 10,500 1,500 500 25,000

52,500

$ 16,000

$ 25,500

$ 11,000

45,000 $ 7,500

* $15,000 × 40%, 50%, and 10% respectively ** $0.50 per square metre × 4,000 square metres, 7,000 square metres, and 1,000 square metres respectively 2.

No, the Pro Model should not be eliminated. It is covering all of its own costs and is generating a $11,000 segment margin toward covering the company‘s common costs and toward profits.

3. The incremental contribution margin generated by the expected sales increase of $20,000 will be $12,000 ($20,000 x 60%*). *$60,000/$100,000 (see solution to Part 1). Since the incremental contribution margin exceeds the $10,000 cost of the advertising campaign, the company should proceed.

Managerial Accounting, 13th Canadian Edition

Problem 11-19 (45 minutes) 1.

Segments defined as product lines:

Product Line

Sales ................................................. Variable expenses............................... Contribution margin............................ Traceable fixed expenses: Advertising...................................... Administration ................................. Depreciation ................................... Total traceable fixed expenses ............. Product line segment margin............... Common fixed expenses: Administrative* ............................... Divisional segment margin ..................

Leather Division

Garments

Shoes

R1,500,000 761,000 739,000

R500,000 325,000 175,000

R700,000 280,000 420,000

R300,000 156,000 144,000

312,000 107,000 114,000 533,000 206,000

80,000 30,000 25,000 135,000 R 40,000

112,000 35,000 56,000 203,000 R217,000

120,000 42,000 33,000 195,000 R (51,000)

Handbags

110,000 R 96,000

*R217,000 – R107,000 = R110,000.

541

Problem 11-19 (continued) 2.

Segments defined as markets for the handbag product line:

Sales Market Domestic Foreign

Handbags Sales ................................................. Variable expenses............................... Contribution margin............................ Traceable fixed expenses: Advertising...................................... Market segment margin ...................... Common fixed expenses: Administrative ................................. Depreciation ................................... Total common fixed expenses ............. Product line segment margin...............

R300,000 156,000 144,000

R200,000 86,000 114,000

R100,000 70,000 30,000

120,000 24,000

40,000 R 74,000

80,000 R(50,000)

42,000 33,000 75,000 R(51,000)

Garments

3. Contribution margin (a) ....................................... Sales (b) ............................................................. Contribution margin ratio (a) ÷ (b) ....................... Incremental contribution margin: 35% × R200,000 increased sales ...................... 60% × R145,000 increased sales ...................... Less cost of the promotional campaign ................. Increased operating income .................................

R175,000 R500,000 35%

Shoes R420,000 R700,000 60%

R70,000 30,000 R40,000

R87,000 30,000 R57,000

Based on these data, the campaign should be directed toward the shoes product line. Notice that the analysis uses the contribution margin ratio rather than the segment margin ratio because fixed expenses do not change.

Managerial Accounting, 13th Canadian Edition

Problem 11-20 (30 minutes) 1.

Breaking the ROI computation into two separate elements helps the manager to see important relationships that might remain hidden. First, the importance of turnover of assets as a key element to overall profitability is emphasized. Prior to use of the ROI formula, managers tended to allow operating assets to swell to excessive levels. Second, the importance of sales volume in profit computations is stressed and explicitly recognized. Third, breaking the ROI computation into margin and turnover elements stresses the possibility of trading one off for the other in attempts to improve the overall profit picture. That is, a company may shave its margins slightly hoping for a large enough increase in turnover to increase the overall rate of return. Fourth, it permits a manager to reduce important profitability elements to ratio form, which enhances comparisons between units (divisions, etc.) of the organization.

Companies in the Same Industry A B C

2. Sales ......................................... Operating income ....................... Average operating assets ............ Margin ....................................... Turnover .................................... Return on investment (ROI) ........

$500,000 * $70,000 * $250,000 * 14% 2.0 28%

$150,000 * $21,000 * $300,000 14% 0.5 7% *

$600,000 $24,000 $300,000 * 4% * 2.0 * 8%

*Given. Company B does as well as Company A in terms of profit margin, for both companies earn 14% on sales. But Company B has a much lower turnover of capital than does Company A. Whereas a dollar of investment in Company A supports two dollars in sales each period, a dollar investment in Company B supports only 50 cents in sales each period. This suggests that the analyst should look carefully at Company B‘s investment. Is the company keeping an inventory larger than necessary for its sales volume? Are receivables being collected promptly? Or did Company A acquire its fixed assets at a price level, which was much lower than that at which Company B purchased its plant? Or company A might have older, more fully depreciated assets, as compared to B.

543

Problem 11-20 (continued) Thus, by including sales specifically in ROI computations the manager is able to discover possible problems, as well as reasons underlying a strong or a weak performance. Looking at Company A compared to Company C, notice that C‘s turnover is the same as A‘s, but C‘s margin on sales is much lower. Why would C have such a low margin? Is it due to inefficiency, is it due to geographical location (thereby requiring higher salaries or transportation charges), is it due to excessive materials costs, or is it due to still other factors? ROI computations raise questions such as these, which form the basis for managerial action. To summarize, in order to bring B‘s ROI into line with A‘s, it seems obvious that B‘s management will have to concentrate its efforts on increasing turnover, either by increasing sales or by reducing assets. It seems unlikely that B can appreciably increase its ROI by improving its margin on sales. On the other hand, C‘s management should concentrate its efforts on the margin element by trying to pare down its operating expenses.

Managerial Accounting, 13th Canadian Edition

Problem 11-21 (30 minutes) 1. (1) Sales ............................... (2) Operating income ............ (3) Operating assets .............. (4) Margin (2) ÷ (1) .............. (5) Turnover (1) ÷ (3) ........... (6) ROI (4) × (5) ..................

Present

New Line

Total

$21,000,000 $1,680,000 $5,250,000 8.0% 4.00 32%

$9,000,000 $630,000 * $3,000,000 7.0% 3.00 21%

$30,000,000 $2,310,000 $8,250,000 7.7% 3.64 28%

* Sales......................................................................... Variable expenses (65% x $9,000,000) ....................... Contribution margin ................................................... Fixed expenses .......................................................... Operating income ......................................................

$9,000,000 5,850,000 3,150,000 2,520,000 $ 630,000

Grenier will be inclined to reject the new product line, since accepting it would reduce her division‘s overall rate of return.

The new product line promises an ROI of 21 , whereas the company‘s overall ROI last year was only 18%. Thus, adding the new line would increase the company‘s overall ROI.

a. Operating assets ............................. Minimum required return ................. Minimum operating income .............. Actual operating income .................. Minimum net operating income (above) ....................................... Residual income ..............................

Present

New Line

Total

$5,250,000 × 18% $945,000 $1,680,000

$3,000,000 × 18% $540,000 $ 630,000

$8,250,000 × 18% $1,485,000 $2,310,000

945,000 $ 735,000

540,000 $ 90,000

1,485,000 $825,000

b. Under the residual income approach, Grenier would be inclined to accept the new product line, since adding the product line would increase the total amount of her division‘s residual income, as shown above.

545

Problem 11-22 (20 minutes) 1.

Operating assets do not include investments in other companies or in undeveloped land.

Cash ............................................... Accounts receivable ......................... Inventory ........................................ Plant and equipment (net) ............... Total operating assets ......................

Average operating assets=

Ending Balances

Beginning Balances

$ 150,000 500,000 510,000 840,000 $2,000,000

$ 145,000 360,000 590,000 865,000 $1,960,000

$1,960,000+$2,000,000 =$1,980,000 2

Margin = Operating income ÷ Sales = $313,500/$2,090,000 = 15% Turnover = Sales  Average operating assets = $2,090,000/$1,980,000 = 1.06 ROI = Margin x Turnover = 15% × 1.06 = 15.9% 2.

Operating income .......................................................... Minimum required return (14% × $1,980,000) ................ Residual income ............................................................

$313,500 277,200 $36,300

Managerial Accounting, 13th Canadian Edition

Problem 11-23 (30 minutes) 1.

Residual income last year: Residual income = Operating income – (Average operating assets x Minimum required rate of return) = [10,000($250 - $150) - $500,000] – ($2,000,000 x 15%) = $500,000 - $300,000 = $200,000 ROI = Operating Income × Sales

Sales__________ Average operating assets

($500,000/$2,500,000) × ($2,500,000/$2,000,000) 20%

1.25

= 25%

2. Target residual income will be $300,000: $200,000 + $100,000 Operating income - $300,000 ($2,000,000 x 15%) = $300,000 Operating income = $600,000 Unit sales required to achieve target operating income of $600,000: x($250 - $150) – $500,000 = $600,000 x = 11,000 units ROI = Operating Income × Sales

Sales__________ Average operating assets

($600,000/$2,750,000) × ($2,750,000/$2,000,000) 21.8%

1.375

= 30% (rounded)

547

Problem 11-23 (continued) 3. A 15% return on assets translates into operating income of $300,000: $2,000,000 x 15% Unit sales required to achieve target operating income of $300,000: x($250 - $150) – $500,000 = $300,000 x = 8,000 units 4. The ROI on the new drone model would be: ROI = Operating Income × Sales

Sales__________ Average operating assets

($75,000*/$325,000**) × ($325,000/$400,000) 23.1%

0.81

= 18.7% (rounded)

*1,000($325-$200) - $50,000 **1,000 x $325 The manager of the Drone Division would reject the proposal because it generates ROI of 18.7%, which is lower than the 25% being earned from the existing model. From the company‘s perspective the new model should be introduced since doing so will generate additional residual income of $15,000 calculated as follows: $75,000 – ($400,000 x 15%) = $15,000

Managerial Accounting, 13th Canadian Edition

Problem 11-24 (30 minutes) 1.

ROI = Operating Income × Sales__________ Sales Average operating assets ($360,000/$4,000,000) × ($4,000,000/$2,000,000) 9%

ROI = ($392,000/$4,000,000) × ($4,000,000/$2,000,000) 9.8%

(increase) 3.

= 19.6%

(unchanged)

(increase)

ROI = ($360,000/$4,000,000) × ($4,000,000/$1,600,000) 9%

2.5

(unchanged)

= 18%

= 22.5%

(increase)

ROI = ($380,000/$4,000,000) × ($4,000,000/$2,500,000) 9.5%

1.6

(increase)

= 15.2%

(decrease)

5. The company has a contribution margin ratio of 30% ($24 CM per unit, divided by the $80 selling price per unit). Therefore, a 20% increase in sales would result in a new operating income of: Sales (1.20 × $4,000,000) ............. Variable expenses ......................... Contribution margin....................... Fixed expenses ............................. Operating income ..........................

$4,800,000 3,360,000 1,440,000 840,000 $ 600,000

100 % 70 * 30 %

* $56 ÷ $80 = 70% ROI = ($600,000/$4,800,000) × ($4,800,000/2,000,000) 12.5% (increase)

2.4 = 30%

(increase)

Solutions Manual, Chapter 12

549

Problem 11-24 (continued) 6.

ROI = ($320,000/$4,000,000) × ($4,000,000/$1,960,000) 8%

(decrease) 7.

2.04

= 16.3%

(increase)

(decrease)

ROI = ($360,000/$4,000,000) × ($4,000,000/$1,800,000) 9% (unchanged)

2.22 (increase)

= 20% (increase)

Managerial Accounting, 13th Canadian Edition

Problem 11-25 (60 minutes) 1. Students‘ answers may differ in some details from this solution.

Financial

Profit margin +

Revenue per employee Customer

Internal Business Processes Ratio of billable hours to total hours

Sales

Number of new customers acquired

Customer satisfaction with effectiveness

Customer satisfaction with efficiency

+ Customer satisfaction with ser- + vice quality

Average number of errors per tax return

–

Average time needed to prepare a return

–

Learning And Growth Percentage of job offers accepted

Employee morale

Amount of compensation paid above industry average

Average number of years to be promoted

–

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Problem 11-25 (continued) 2. The hypotheses underlying the balanced scorecard are indicated by the arrows in the diagram. Reading from the bottom of the balanced scorecard, the hypotheses are: ° If the amount of compensation paid above the industry average increases, then the percentage of job offers accepted and the level of employee morale will increase. ° If the average number of years to be promoted decreases, then the percentage of job offers accepted and the level of employee morale will increase. ° If the percentage of job offers accepted increases, then the ratio of billable hours to total hours should increase while the average number of errors per tax return and the average time needed to prepare a return should decrease. ° If employee morale increases, then the ratio of billable hours to total hours should increase while the average number of errors per tax return and the average time needed to prepare a return should decrease. ° If employee morale increases, then the customer satisfaction with service quality should increase. ° If the ratio of billable hours to total hours increases, then the revenue per employee should increase. ° If the average number of errors per tax return decreases, then the customer satisfaction with effectiveness should increase. ° If the average time needed to prepare a return decreases, then the customer satisfaction with efficiency should increase. ° If the customer satisfaction with effectiveness, efficiency, and service quality increases, then the number of new customers acquired should increase. ° If the number of new customers acquired increases, then sales should increase. ° If revenue per employee and sales increase, then the profit margin should increase.

Managerial Accounting, 13th Canadian Edition

Problem 11-25 (continued) Each of these hypotheses can be questioned. For example, Ariel‘s customers may define effectiveness as minimizing their tax liability which is not necessarily the same as minimizing the number of errors in a tax return. If some of Ariel‘s customers became aware that Ariel overlooked legal tax minimizing opportunities, it is likely that the ―customer satisfaction with effectiveness‖ measure would decline. This decline would probably puzzle Ariel because, although the firm prepared what it believed to be error-free returns, it overlooked opportunities to minimize customers‘ taxes. In this example, Ariel‘s internal business process measure of the average number of errors per tax return does not fully capture the factors that drive the customer satisfaction. The fact that each of the hypotheses mentioned above can be questioned does not invalidate the balanced scorecard. If the scorecard is used correctly, management will be able to identify which, if any, of the hypotheses are invalid and then modify the balanced scorecard accordingly. 3. The performance measure ―total dollar amount of tax refunds generated‖ would motivate Ariel‘s employees to aggressively search for tax minimization opportunities for its clients. However, employees may be too aggressive and recommend questionable or illegal tax practices to clients. This undesirable behavior could generate unfavorable publicity and lead to major problems for the company as well as its customers. Overall, it would probably be unwise to use this performance measure in Ariel‘s scorecard. However, if Ariel wanted to create a scorecard measure to capture this aspect of its client service responsibilities, it may make sense to focus the performance measure on its training process. Properly trained employees are more likely to recognize viable tax minimization opportunities. 4. Each office‘s individual performance should be based on the scorecard measures only if the measures are controllable by those employed at the branch offices. In other words, it would not make sense to attempt to hold branch office managers responsible for measures such as the percent of job offers accepted or the amount of compensation paid above industry average. Recruiting and compensation decisions are not typically made at the branch offices. On the other hand, it would make sense to measure the branch offices with respect to internal business process, customer, and financial performance. Gathering this type of data would be useful for evaluating the performance of employees at each office.

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Problem 11-26 (30 minutes) Target

Actual

Return on assets employed by department

14%

15%

Proportion of repeat customers

60%

57%

Sales generated by new product lines as a percent of total departmental sales

65%

64%

Average discount on goods sold

10%

18%

Based on the balanced scorecard results above, it appears that John's new strategy is beginning to reap benefits, but he may need to persist a little longer to be able to meet all of the targets the board has set for him. While return on assets employed in the Women's Wear department exceeded target, the department experienced less repeat customers than targeted. Even so, taken together with the positive results in terms of satisfaction scores from new customers, the lower proportion of repeat customers might indicate fewer traditional customers are returning, while the return rate of new customers could be much higher. Results also indicate that sales by new product lines as a percent of total sales was quite close to target, although the average discount on goods sold was higher than expected (18%). This may indicate that John needs to further refine his merchandise choices based on his experience with new customers over the past year and be careful about the proportion of very high priced he carries each season.

Managerial Accounting, 13th Canadian Edition

Problem 11-27 (45 minutes) The answers below are not the only possible answers. Ingenious people can figure out many different ways of making performance look better even though it really isn‘t. This is one of the reasons for a balanced scorecard. By having a number of different measures that ultimately are linked to overall financial goals, ―gaming‖ the system is more difficult. 1.

Speed-to-market can be improved by taking on less ambitious projects. Instead of working on major product innovations that require a great deal of time and effort, R&D may choose to work on small, incremental improvements in existing products. There is also a danger that in the rush to push products out the door, the products will be inadequately tested and developed.

In this case, the ground crews raced from one arriving airplane to another in an effort to unload luggage from these airplanes as soon as possible. However, once the luggage was unloaded from the airplane it was being left on the tarmac rather than being delivered in a timely manner to carousels or appropriate connecting flights. Another flaw of the CEO‘s bonus system is that ground crews would probably ―smooth‖ their rate of improvement to earn as many monthly bonuses as possible. They would not perform at their highest level during the first month of the new bonus scheme because it would diminish their chances of earning bonuses in subsequent months.

In real life, the production manager simply added several weeks to the delivery cycle time. In other words, instead of promising to deliver an order in four weeks, the manager promised to deliver in six weeks. This increase in delivery cycle time did not, of course, please customers and drove some business away, but it dramatically improved the percentage of orders delivered on time.

555

Problem 11-28 (45 minutes) 1.

Students‘ answers may differ in some details from this solution.

Financial

Weekly profit

Weekly sales

Customer Customer satisfaction with service

Internal Business Processes

Dining area cleanliness

Customer satisfaction with menu choices

Average time to prepare an order

–

Average time to take an order Learning and Growth

Percentage of dining room staff completing hospitality course

–

Number of menu items

Percentage of kitchen staff com- + pleting cooking course

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Problem 11-28 (continued) 2.

The hypotheses underlying the balanced scorecard are indicated by the arrows in the diagram. Reading from the bottom of the balanced scorecard, the hypotheses are: o If the percentage of dining room staff that complete the basic hospitality course increases, then the average time to take an order will decrease. o If the percentage of dining room staff that complete the basic hospitality course increases, then dining room cleanliness will improve. o If the percentage of kitchen staff that complete the basic cooking course increase es, then the average time to prepare an order will decrease. o If the percentage of kitchen staff that complete the basic cooking course increases, then the number of menu items will increase. o If the dining room cleanliness improves, then customer satisfaction with service will increase. o If the average time to take an order decreases, then customer satisfaction with service will increase. o If the average time to prepare an order decreases, then customer satisfaction with service will increase. o If the number of menu items increases, then customer satisfaction with menu choices will increase. o If customer satisfaction with service increases, weekly sales will increase. o If customer satisfaction with menu choices increases, weekly sales will increase. o If sales increase, weekly profits for the Lodge will increase. Each of these hypotheses can be questioned. For example, the items added to the menu may not appeal to customers. So even if the number of menu items increases, customer satisfaction with the menu choices may not increase. The fact that each of the hypotheses can be questioned does not, however, invalidate the balanced scorecard. If the scorecard is used correctly, management will be able to identify which, if any, of the hypotheses are incorrect.

Management will be able to tell if a hypothesis is false if an improvement in a performance measure at the bottom of an arrow does not, in fact, lead to improvement in the performance measure at the tip of the arrow. For example, if the number of menu items is increased, but customer satisfaction with the menu choices does not increase, management will immediately know that something was wrong with that particular hypothesis.

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Case 11-29 (60 minutes) 1. MPC‘s previous manufacturing strategy was focused on high-volume production of a limited range of paper grades. The goal of this strategy was to keep the machines running constantly to maximize the number of tons produced. Changeovers were avoided because they lowered equipment utilization. Maximizing tons produced and minimizing changeovers helped spread the high fixed costs of paper manufacturing across more units of output. The new manufacturing strategy is focused on lowvolume production of a wide range of products. The goals of this strategy are to increase the number of paper grades manufactured, decrease changeover times, and increase yields across non-standard grades. While MPC realizes that its new strategy will decrease its equipment utilization, it will still strive to optimize the utilization of its high fixed cost resources within the confines of flexible production. In an economist‘s terms, the old strategy focused on economies of scale while the new strategy focuses on economies of scope. 2. Employees focus on improving those measures that are used to evaluate their performance. Therefore, strategically-aligned performance measures will channel employee effort towards improving those aspects of performance that are most important to obtaining strategic objectives. If a company changes its strategy but continues to evaluate employee performance using measures that do not support the new strategy, it will be motivating its employees to make decisions that promote the old strategy, not the new strategy. And if employees make decisions that promote the new strategy, their performance measures will suffer. Some performance measures that would be appropriate for MPC‘s old strategy include: equipment utilization percentage, number of tons of paper produced, and cost per ton produced. These performance measures would not support MPC‘s new strategy because they would discourage increasing the range of paper grades produced, increasing the number of changeovers performed, and decreasing the batch size produced per run.

Managerial Accounting, 13th Canadian Edition

Case 11-29 (continued) 3. Students‘ answers may differ in some details from this solution.

Financial

Sales

Customer

Number of new customers acquired

Time to fill an order

Number of different paper grades produced

Average changeover time

Customer satisfaction with breadth of product offerings

–

Internal Business Processes

Learning and Growth

Contribution margin per ton

–

Average manufacturing yield

Number of employees trained to support the flexibility strategy

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Case 11-29 (continued) 4. The hypotheses underlying the balanced scorecard are indicated by the arrows in the diagram. Reading from the bottom of the balanced scorecard, the hypotheses are: ° If the number of employees trained to support the flexibility strategy increases, then the average changeover time will decrease and the number of different paper grades produced and the average manufacturing yield will increase. ° If the average changeover time decreases, then the time to fill an order will decrease. ° If the number of different paper grades produced increases, then the customer satisfaction with breadth of product offerings will increase. ° If the average manufacturing yield increases, then the contribution margin per ton will increase. ° If the time to fill an order decreases, then the number of new customers acquired, sales, and the contribution margin per ton will increase. ° If the customer satisfaction with breadth of product offerings increases, then the number of new customers acquired, sales, and the contribution margin per ton will increase. ° If the number of new customers acquired increases, then sales will increase. Each of these hypotheses can be questioned. For example, the time to fill an order is a function of additional factors above and beyond changeover times. Thus, MPC‘s average changeover time could decrease while its time to fill an order increases if, for example, the shipping department proves to be incapable of efficiently handling greater product diversity, smaller batch sizes, and more frequent shipments. The fact that each of the hypotheses mentioned above can be questioned does not invalidate the balanced scorecard. If the scorecard is used correctly, management will be able to identify which, if any, of the hypotheses are invalid and modify the balanced scorecard accordingly.

Managerial Accounting, 13th Canadian Edition

Case 11-30 (60 minutes) To: CFO, Convenience Food Markets From: Internal auditor RE: Indicators of the effectiveness of the performance evaluation system for CFM district managers Earlier this year, I was asked to evaluate the effectiveness of our performance evaluation system for district managers at CFM and to examine whether John Nicholson, one of our district managers, should open a new store in a new development in the suburbs. John and I have prepared the following analysis based on the actual operating results for the original store and the forecast for the new store. This analysis is summarized in the table below: Original store (actual)

New store (forecast)

Operating Income less depreciation

$75,000

$145,000

Net book value of operating assets

$195,000

$475,000

38.5%

30.5%

Operating income less depreciation

$75,000

$145,000

Less: capital charge at 22%

(42,900)

(104,500)

Residual income

$32,100

$40,500

ROI Residual Income:

As you can see, the original store is generating a quite strong return on investment. The new store is forecasted to provide a relatively strong ROI, but this return is still below the ROI generated by the original store. This result puzzled me so I decided to examine the issue in more detail.

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Case 11-29 (continued) Although the numbers indicate ROI will be higher for the original store, we all are aware that strategically, new stores with better layouts and modern display areas and in locations with a growing population base should yield better returns than stores in less popular locations. A closer look at the calculations indicates both the operating income and the residual income of the new store are higher than for the original store. The key then appears to be in the asset base used to calculate ROI. We use the net book value of operating assets as the denominator in the ROI calculation. The net book value of operating assets of the original store will therefore be much lower than that of the new store since those assets are almost fully depreciated. Due to this quirk of our system, the ROI of older stores will always be higher than the ROI of newer stores. Based on this analysis, it is unlikely that John will decide open a store in the newer neighbourhood even though a strategic analysis indicates he should since this will have a negative effect on John‘s performance evaluation. Specifically, by closing a higher ROI store and replacing it with a lower ROI store, the average ROI in John‘s district will necessarily go down and thus, his bonus will also be lower than if he keeps the original store open. Since he is five years from retirement, John will probably want to maximize the bonuses he receives in the next several years. It appears the structure of our performance evaluation system for district managers is sending signals that are contrary to good business strategy. It appears we need to change the way we evaluate managers or at minimum, the way we calculate ROI so the signal coming from the ROI calculation leads to appropriate managerial decisions. Suggestions for change include: • Basing district managers‘ bonuses on residual income, not ROI (downside is that residual income is not really comparable across districts of different sizes and/or scales) • Change the calculation of ROI for district managers to operating income BEFORE depreciation (downside is they may then overinvest in leasehold improvements) • Make corporate managers, not district managers responsible for making store opening and closing decisions assuming they may have a longer term focus (i.e., maximizing long run ROI as opposed to short-run ROI) than district managers.

Managerial Accounting, 13th Canadian Edition

Connecting Concepts: Section 3 (30 minutes) 1.

A segment report indicating the profitability of each of the company‘s divisions is presented below:

Total

Geographic Market

Company

Canada

Europe

South America

Sales .......................................

$8,250,000

$6,950,000

$825,000

$475,000

Variable expenses (52%, 40%, 40%) ................

4,134,000

3,614,000

330,000

190,000

Contribution margin..................

4,116,000

3,336,000

495,000

285,000

Traceable fixed expenses ..........

4,267,000

3,622,000

375,000

270,000

Geographic market segment margin ..................................

(151,000)

$(286,000) $ 120,000

$15,000

Common fixed expenses not traceable to geographic markets* ..............................

145,000

Operating income (loss) ............

$ (296,000)

*$4,412,000 – $4,267,000 = $145,000 As it turns out, the losses are occurring in the long-standing Canadian segment while the new European and South American segments are actually generating a profit. Thus, the CEO may want to consider ways to better manage costs and ensure accurate cost estimation processes so that prices bid for new jobs are sufficient to cover costs and generate the expected profit margin (see recommendations from Section 2 Connecting Concepts analysis). 2.

The divisional ROI for the European division is 12% ($120,000/$1,000,000). The divisional ROI for the South American division is 3.1% ($15,000/$485,000). The European divisional manager is eligible for a bonus, but the South American divisional manager is not.

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Connecting Concepts: Section 3 (continued) Recommendations to increase ROI over the next year include the following: •

Attempt to generate more sales without any increase in operating assets. This may be possible for the new divisions given they have likely only just begun to explore the markets and build a reputation as a high-quality vendor. Perhaps the initial investment in operating assets has not yet been used to full capacity.

•

Better control operating expenses with no change in sales or operating assets. Generating a good understanding of the activities that drive costs is important as it will allow the division managers to target cost control activities to the places where they could make a significant difference. In addition, much of this company‘s work is done by subcontractors. Better cost control over the subcontractor‘s work is also likely to yield benefits in terms of additional profit margin.

•

Invest in operating assets to increase sales. The CEO should determine if jobs are being turned away due to lack of capacity in terms of either people or operating assets. Although less likely than underutilization of operating assets for these new divisions, if growth is outpacing investment, the divisions are leaving money on the table and should be encouraged to request additional capital investments from head office.

Chapter 12 Relevant Costs for Decision Making

Discussion Case (20 minutes) The main benefit of using overtime to alleviate the labour constraint is that it allows the firm to meet client demand in a timelier manner without needing to hire more employees. This in turn will keep the clients happy and reduces the risk they will take their business elsewhere. However, the use of overtime, particularly significant amounts for an extended period of time, can have negative consequences such as: 

Employee stress or burnout if the hours are excessive for prolonged periods of time. This can be bad for the health of employees and may lead to higher turnover at the firm if employees become dissatisfied with their job.

Managerial Accounting, 13th Canadian Edition



Employee stress associated with tight deadlines. If the overtime is needed to meet a client‘s demand for services by a specified date, there will be pressure on employees to work quickly and this can induce stress.



The quality of the work may suffer if employees are working extended hours and feel pressure to work quickly. For jobs where attention to detail and cognitive focus is important, working long hours raises the risk that mistakes will happen. If serious mistakes are made by employees, this could affect the firm‘s relationship with the client. Serious mistakes could also lead to poor performance evaluations for the employee.



Firms that have a culture of expecting employees to work significant amounts of overtime may face challenges hiring new employees who are looking for better work-life balance.

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Solutions to Questions 12-1 A relevant cost in a decision is a cost that differs between alternatives under consideration and one that will be incurred in the future.

the line is less than the fixed costs that can be avoided. Even then there may be arguments in favour of retaining the product line, if its presence promotes the sale of other products.

12-2 An incremental cost is the change in cost that will result from some proposed action. An opportunity cost is the benefit that is lost or sacrificed in rejecting some course of action. A sunk cost is a cost that has already been incurred, and which cannot be changed by any future decision.

12-9 If a company decides to make a part internally, rather than to buy it from an outside supplier, then a portion of the company‘s facilities have to be turned over to the production of the part. The company‘s opportunity cost is measured by the benefits that could be derived from the best alternative use of the facilities.

12-3 By definition, an avoidable cost is one that can be eliminated by choosing one alternative over another. This means that it is a cost that will differ between the alternatives under consideration. Therefore, avoidable costs will always be relevant costs.

12-10 The relevant costs in a special order decision are: incremental costs of making the product, opportunity costs of utilizing space to make the product and the outside purchase price that would be paid to an external supplier.

12-4 Depreciation is an allocation of the original cost of a depreciable asset across reporting periods. Since it is an allocation of a sunk cost (the original cost), it is irrelevant. 12-5 No. Only those future costs that differ between the alternatives are relevant. 12-6 Variable costs will not necessarily always be relevant to a decision. Only if the variable cost differs among the alternatives under consideration should it be considered relevant. For example, sales commissions, a variable cost, will likely not differ between the alternatives of making a product or buying it from an outside supplier. As such, although a variable cost, sales commissions would not be relevant to this make or buy decision. 12-7 Allocations of common fixed costs can make a product (or other segment) appear to be unprofitable, whereas in fact it may be profitable. 12-8 No. If a product line shows a net loss it may be the result of allocated common costs, or of sunk costs, which will continue even in the absence of the product line itself. A product line should be discontinued only if the contribution margin that will be lost as a result of dropping

12-11 The profitability index is the contribution margin per unit of a constrained resource such as labour hours, shelf space, or machine hours. It is calculated by dividing the contribution margin per unit by the quantity of the constrained resource required per unit. 12-12 Four ways to increase capacity at bottlenecks: work overtime on the bottleneck; subcontract some of the work that would otherwise be done at the bottleneck; transfer works from other activities or processes that are not bottlenecks to the bottleneck activity; and reduce the number of defective units. 12-13Joint products are two or more products that are produced from a common input. Joint product costs are those manufacturing costs that are incurred in processing joint products up to the split-off point. The split-off point is that point in the manufacturing process where joint products can be recognized as individual products, and are ready either to be sold individually, or to be processed separately in preparation for sale. 12-14 Common costs are irrelevant in decisions relating to joint products after the split-off point has been reached. If common costs are allocated among the joint products, then the manager may come to view them as direct costs

Managerial Accounting, 13th Canadian Edition

of the end products. This may lead to incorrect decisions as to further processing, product emphasis, relative profitability of product lines, and so forth. 12-15 No. The product with the highest contribution margin per machine hour should be prioritized in this situation. Profits will be maximized by using the available machine hours to produce the product with the highest profitability index, which may not be the product that also has the highest contribution margin per unit.

would be concerned about the third-party‘s ability to provide timely, courteous and competent delivery service to their customers. If the managers had serious concerns about the thirdparty‘s ability to meet these criteria they may opt to have the hardware store continue to provide the service even if doing so is not the best alternative financially. This is because the store would risk losing customers because of poor delivery service, which eventually would have a negative financial impact on the company.

12-16 No. Non-financial factors will often be important to consider. In this case the managers

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Foundational Exercises 1. The total traceable fixed manufacturing overhead for Deluxe and Regular is computed as follows: Traceable fixed overhead per unit (a) .................... Level of activity in units (b) .................................. Total traceable fixed overhead (a) × (b) ................

Deluxe

Regular

$8 50,000 $400,000

$9 50,000 $450,000

2. The total common fixed expenses is computed as follows: Common fixed expenses per unit (a) ..................... Level of activity in units (b) .................................. Total common fixed expenses (a) × (b).................

Deluxe

Regular

$7.50 50,000 $375,000

$5 50,000 $250,000

The company‘s total common fixed expenses would be $625,000. 3. The profit impact is computed as follows:

Per Unit Incremental revenue ...................................... Incremental costs: Variable costs: Direct materials ........................................ Direct labor .............................................. Variable manufacturing overhead .............. Variable selling expenses .......................... Total variable cost ....................................... Incremental operating income .........................

Total 5,000 units

$40

$200,000

15 10 3.50 6 $34.50

75,000 50,000 17,500 30,000 172,500 $27,500

Managerial Accounting, 13th Canadian Edition

Foundational Exercises (continued) 4. The profit impact is computed as follows:

Total 2,500 units

$20

$50,000

6 7.50 2.50 4 $20

15,000 18,750 6,250 10,000 50,000 $ 0

5. The profit impact is computed as follows: Incremental revenue (5,000 units × $40) (a) ......................................................... Incremental variable costs: Direct materials (2,500 units × $15) ................................... $37,500 Direct labor (2,500 units × $10) ......................................... 25,000 Variable manufacturing overhead (2,500 units × $3.50) ..................................................... 8,750 Variable selling expenses (2,500 units × $6) .......................................................... 15,000 Total incremental variable cost (b) ........................................ Foregone sales to regular customers (2,500 units × $60) (c).................................................................... Incremental operating income (a) − (b) – (c) ......................................................................

$200,000

86,250 150,000 $(36,250)

Note to instructors: Emphasize to students that the variable costs related to 2,500 units of production are irrelevant to the decision because they will be incurred whether the special order is accepted or rejected.

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Foundational Exercises (continued) 6. The profit impact of dropping the Regular product line is computed as follows: Contribution margin lost if the Regular product line is dropped* ... Traceable fixed manufacturing overhead ..................................... Decrease in operating income if Regular is dropped ...........

$(900,000) 450,000 $(450,000)

* Regular‘s contribution margin per unit is $20 ($40 − $20). Therefore, the decrease in contribution margin if Regular is dropped would be $900,000 (45,000 units × $20). Note to instructors: Emphasize that the traceable fixed manufacturing overhead is avoidable and the common fixed expenses are not. 7. The profit impact of dropping the Regular product line is computed as follows: Contribution margin lost if the Regular product line is dropped* .... Traceable fixed manufacturing overhead ...................................... Increase in operating income if Beta is dropped .................

$(400,000) 450,000 $ 50,000

* Regular‘s contribution margin per unit is $20 ($40 − $20). Therefore, the decrease in contribution margin if Regular is dropped would be $400,000 (20,000 units × $20). 8. The profit impact of dropping the Regular product line is computed as follows: Contribution margin lost if the Regular product line is dropped ...... Traceable fixed manufacturing overhead ...................................... Contribution margin on additional Deluxe sales* ......................... Increase in operating income if Regular is dropped ............

$(600,000) 450,000 191,250 $ 41,250

* Deluxe‘s contribution margin per unit is $25.50 ($60 − $34.50). Therefore, the increase in Deluxe‘s contribution margin if Regular is dropped would be $765,000 (7,500 units × $25.50).

Managerial Accounting, 13th Canadian Edition

Foundational Exercises (continued) 9. The profit impact of buying 40,000 Deluxe units from a supplier rather than making them is computed as follows:

Make Cost of purchasing (40,000 units × $40) ................... Direct materials (40,000 units × $15) ....................... Direct labor (40,000 units × $10) ............................. Variable manufacturing overhead (40,000 units × $3.50).......................................... Traceable fixed manufacturing overhead ................... Total costs ...............................................................

Buy $1,600,000

$600,000 400,000 140,000 400,000 $1,540,000

Difference in favour of continuing to make the Deluxe units .......................

$1,600,000

$60,000

Note to instructors: Emphasize that the variable selling expenses are irrelevant to this decision because they will be incurred regardless of whether the company makes or buys its Deluxe units. 10. The profit impact of buying 50,000 Alphas from a supplier rather than making them is computed as follows:

Make Cost of purchasing (25,000 units × $40) ................... Direct materials (25,000 units × $15) ....................... Direct labor (25,000 units × $10) ............................. Variable manufacturing overhead (25,000 units × $3.50).......................................... Traceable fixed manufacturing overhead ................... Total costs ............................................................... Difference in favour of buying Deluxe from the supplier ....................

Buy $1,000,000

$375,000 250,000 87,500 400,000 $1,112,500

$1,000,000

$112,500

Note to instructors: Emphasize that the variable selling expenses are irrelevant to this decision because they will be incurred regardless of whether the company makes or buys Deluxe units.

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Foundational Exercises (continued) 11. The kilograms of raw material per unit are computed as follows:

Deluxe

Regular

$15 $3 5

$6 $3 2

Direct material cost per unit (a) ......................................... Cost per kilogram of direct materials (b) ............................. Kilograms of direct materials per unit (a) ÷ (b) ...................

12. The contribution margins per kilogram of raw materials are computed as follows: Selling price per unit.......................................... Variable cost per unit......................................... Contribution margin per unit (a) ......................... Kilograms of direct material required to produce one unit (b) ................................................... Contribution margin per kg (a) ÷ (b) ..................

Deluxe

Regular

$60.00 34.50 $25.50

$40 20 $20

5 kgs $5.10

2 kgs $10.00

13. The optimal number of units to produce would be computed as follows:

Product Regular ...................................... Deluxe ....................................... Total kilograms available .............

Kilograms Per Unit

Units Produced

Total Kilograms

2 5

30,000 4,000

60,000 20,000 80,000

The company should produce Regular first because it earns the highest contribution margin per kilogram of raw materials. After customer demand for Regular has been satisfied by producing 30,000 units, there are 20,000 kilograms of raw materials remaining to use for making Deluxe units. Since each Deluxe requires 5 kilograms of raw materials, the company would be able to produce 4,000 Deluxe units (20,000 kilograms ÷ 5 kilograms per unit) before running out of raw materials.

Managerial Accounting, 13th Canadian Edition

Foundational Exercises (continued) 14. The total contribution margin would be computed as follows:

Deluxe

Regular

Number of units produced (a) ............................................4,000 Contribution margin per unit (b) ......................................... $25.50 Total contribution margin (a) × (b) ..................................... $102,000

30,000 $20 $600,000

The company‘s total contribution margin would be $702,000 ($102,000 + $600,000). 15. The maximum price per kilogram is computed as follows:

Deluxe Regular direct material cost per kilogram ........................................ Contribution margin per kilogram of direct materials ........................ Maximum price to be paid per kilogram ..........................................

$ 3.00 5.10 $8.10

Because the company has satisfied all demand for Regular, it would use additional raw materials to produce Deluxe. Note to instructors: emphasize to students that if Abel pays $8.10 per kg. for the extra raw materials, the contribution margin per unit on the additional sales of Deluxe will be $0 ($60 - $40.50* - $10 - $3.50 - $6). Thus, $8.10 is indeed the maximum price that can be paid for the additional raw materials without negatively impacting operating income. *$8.10 x 5 kgs. per unit.

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Exercise 12-1 (15 minutes)

Item a. b. c. d. e. f. g. h. i. j. k. l.

Sales revenue ....................... Direct materials ..................... Direct labour ......................... Variable manufacturing overhead ........................... Book value—Model A3000 machine ............................ Disposal value—Model A3000 machine .................. Depreciation—Model A3000 machine ............................ Market value—Model B3800 machine (cost) ................... Fixed manufacturing overhead (general) ................... Variable selling expense......... Fixed selling expense............. General administrative overhead .................................

Case 1 Not ReleRelevant vant X X X

Case 2 Not ReleRelevant vant X X X

X X X

X X

X X X

Managerial Accounting, 13th Canadian Edition

Exercise 12-2 (30 minutes) 1. The financial (disadvantage) of discontinuing the road bikes is computed as follows: Lost contribution margin............................................ Fixed costs that can be avoided: Advertising, traceable ............................................. Salary of the product-line manager ......................... Financial (disadvantage) of discontinuing the road bikes .....................................................................

$(27,000) $ 6,000 10,000

16,000 $(11,000)

The depreciation of the special equipment is a sunk cost and is not relevant to the decision. The common costs are allocated and will continue regardless of whether or not the road bikes are discontinued; thus, they are not relevant to the decision. Alternative Solution:

Total If Road Bikes Are Dropped

Difference: Operating Income Increase or (Decrease)

$300,000 120,000 180,000

$240,000 87,000 153,000

$(60,000) 33,000 (27,000)

30,000

24,000

6,000

23,000 35,000 60,000 148,000 $ 32,000

23,000 25,000 60,000 132,000 $ 21,000

0 10,000 0 16,000 $ (11,000)

Current Total Sales.................................................... Variable expenses ................................. Contribution margin .............................. Fixed expenses: Advertising, traceable ........................ Depreciation on special equipment* .................................... Salaries of product-line managers ....... Common allocated costs .................... Total fixed expenses ............................. Operating income .................................

*Includes pro-rated loss on the special equipment if it is disposed of. 2. No, production and sale of the road bikes should not be discontinued.

575

Exercise 12-2 (continued) 3. The segmented report can be improved by eliminating the allocation of the common fixed expenses. A better report would be:

Sales........................................... Variable manufacturing and selling expenses.................................. Contribution margin ..................... Traceable fixed expenses: Advertising ............................... Depreciation of special equipment ..................................... Salaries of the product-line managers .............................. Total traceable fixed expenses.................................. Product line segment margin ........ Common fixed expenses .............. Operating income ........................

Total

Dirt Bikes

Mountain Bikes

Road Bikes

$300,000

$90,000

$150,000

$60,000

120,000 180,000

27,000 63,000

60,000 90,000

33,000 27,000

30,000

10,000

14,000

6,000

23,000

6,000

9,000

8,000

35,000

12,000

13,000

10,000

88,000 92,000 60,000 $ 32,000

28,000 $35,000

36,000 $ 54,000

24,000 $ 3,000

Managerial Accounting, 13th Canadian Edition

Exercise 12-3 (30 minutes)

Per Unit Differential Costs Make Buy

Cost of purchasing ................................ Direct materials .................................... Direct labour ........................................ Variable manufacturing overhead ........... Fixed manufacturing overhead, traceable1 ................................................. Fixed manufacturing overhead, common .................................................. Total costs ............................................ Difference in favour of continuing to make the parts .................................. 1

12,000 units Make Buy

$32

$384,000

$ 12 10 3

$144,000 120,000 36,000

24,000

0 $27

0 $32

0 $324,000

0 $384,000

$60,000

Only the supervisory salaries can be avoided if the switches are purchased. The remaining book value of the special equipment is a sunk cost; hence, the $6 ($8 x 75%) per unit depreciation expense is not relevant to this decision. Based on these data, the company should reject the offer and should continue to produce the parts internally.

Make

2. Cost of purchasing (part 1) .................................... Cost of making (part 1) .......................................... Opportunity cost—segment margin forgone on a potential new product line....................................... Total cost .............................................................. Difference in favour of purchasing from the outside supplier ..............................................................

Buy $384,000

$324,000 78,000 $402,000

$384,000

$18,000

Thus, the company should accept the offer and purchase the parts from the outside supplier.

577

Exercise 12-4 (15 minutes) Only the incremental costs and benefits are relevant. In particular, only the variable manufacturing overhead and the cost of the special tool are relevant overhead costs in this situation. The other manufacturing overhead costs are fixed and are not affected by the decision.

Per Unit Incremental revenue ....................................... Incremental costs: Less Variable costs: Direct materials ........................................ Direct labour ............................................ Variable manufacturing overhead .............. Special logo .............................................. Total variable cost ....................................... Fixed costs: Purchase of special tool ............................ Total incremental cost ..................................... Incremental operating income .........................

Total 10 trophies

$199.95

$1,999.50

93.00 56.00 7.00 6.00 $162.00

930.00 560.00 70.00 60.00 1,620.00 195.00 1,815.00 $ 184.50

Even though the price for the special order is below the company's regular price for such an item, the special order would add to the company‘s operating income and should be accepted. This conclusion would not necessarily follow if the special order affected the regular selling price of bracelets or if it required the use of a constrained resource.

Managerial Accounting, 13th Canadian Edition

Exercise 12-5 (30 minutes)

1. (1) Contribution margin per unit .............................................. (2) Direct labour cost per unit.................................................. (3) Direct labour rate per hour ................................................. (4) Direct labour-hours required per unit (2) ÷ (3) .................... Contribution margin per direct labour-hour (1) ÷ (4) ...........

$36 $90 $24 $48 16 16 1.5 3.0 $24 $ 30

$40 $32 16 2.0 $20

2. The company should concentrate its labour time on producing product D2: Contribution margin per direct labour-hour ............ Direct labour-hours available ................................ Total contribution margin......................................

$24 × 3,000 $72,000

$30 × 3,000 $90,000

$20 × 3,000 $60,000

It turns out that D2 has both the highest contribution margin per unit and the highest profitability index (contribution margin per direct labour hour). Since labour time seems to be the company‘s constraint, this measure should guide management in its production decisions. 3. The amount Davidson Company should be willing to pay in overtime wages for additional direct labour time depends on how the time would be used. If there are unfilled orders for all of the products, Davidson would presumably use the additional time to make more of product D2. Each hour of direct labour time generates $30 of contribution margin over and above the usual direct labour cost. Therefore, Davidson should be willing to pay up to $46 per hour (the $16 usual wage plus the contribution margin per hour of $30 for additional labour time, but would of course prefer to pay far less. The upper limit of $46 per direct labour hour signals to managers how valuable additional labour hours are to the company. If all the demand for D2 has been satisfied, Davidson Company would then use any additional direct labour-hours to manufacture product D1. In that case, the company should be willing to pay up to $40 per hour (the $16 usual wage plus the $24 contribution margin per hour for D1) to manufacture more D1. Likewise, if all the demand for both products D2 and D1 has been satisfied, additional labour hours would be used to make product D3. In that case, the company should be willing to pay up to $36 ($16 + $20) per hour to manufacture more D3.

579

Exercise 12-6 (10 minutes)

Sales value after further processing............ Less sales value at split-off point ................ Incremental revenue ................................. Less cost of further processing................... Incremental profit (loss) ............................

Raw Sugar

Brown Sugar

White Sugar

$40,000 20,000 20,000 21,000 $(1,000)

$35,000 20,000 15,000 14,000 $1,000

$41,000 21,000 20,000 6,000 $ 14,000

Brown sugar and white sugar should be processed further

Exercise 12-7 (20 minutes) 1. Average fixed cost per kilometre ($3,300* ÷ 10,000 kms) ............. Variable operating cost per mile ................................................... Average cost per mile ................................................................. * Depreciation ...................................... Insurance.......................................... Garage rent....................................... Automobile registration ...................... Total .................................................

$0.33 0.20 $0.53

$1,600 1,200 435 65 $3,300

2. The variable operating cost is relevant in this situation. The depreciation is not relevant because it is a sunk cost. However, any decrease in the resale value of the car due to its use is relevant. The automobile registration costs would be incurred whether Kristen decides to drive her own car or rent a car for the trip during spring break and therefore are irrelevant. It is unlikely that her insurance costs would increase as a result of the trip, so they are irrelevant as well. The garage rent is relevant only if she could avoid paying part of it if she drives her own car. 3. When analyzing the incremental cost of the electric car, the relevant costs include the purchase price of the new car (net of the resale value of the old car) and the increases in the fixed costs of insurance. Kristen will also need to estimate the electricity cost for the new car as that will replace the cost of gas and oil for her current internal combustion engine vehicle. She will also need to estimate the repair costs for the electric car as they are expected to be lower, but tire costs can be ignored since they will be about the same. The original purchase price of the old car is a sunk cost and therefore is irrelevant. © McGraw Hill Ltd, 2024. All rights reserved. 580

Managerial Accounting, 13th Canadian Edition

Exercise 12-8 (20 minutes) 1. The most profitable use of the constrained resource is determined by the contribution margin per unit of the constrained resource. In part 1, the constrained resource is time on the plastic injection molding machine. Therefore, the analysis would proceed as follows:

Ski Guard Selling price per unit .......................... Variable cost per unit ......................... Contribution margin per unit (a) ......... Plastic injection molding machine processing time required to produce one unit (b) .......................................... Contribution margin per unit of the constrained resource (a) ÷ (b) ........................................

Golf Guard

Fishing Guard

$200 60 $140

$300 140 $160

$255 55 $200

2 minutes

5 minutes

4 minutes

$70 per minute

$32 per minute

$50 per minute

Production of the Ski Guard product would be the most profitable use of the constrained resource which is, in this case, time on the plastic injection molding machine. The contribution margin per minute is $70 for this product, which is larger than for the other two products. 2. In this part, the constraint is the available pounds of plastic pellets.

Ski Guard Selling price per unit .......................... Variable cost per unit ......................... Contribution margin per unit (a) Kgs of plastic pellets required to produce one unit (b) ............................ Contribution margin per unit of the constrained resource (a) ÷ (b) ........................................

Golf Guard

Fishing Guard

$200 60 $140

$300 140 $160

$255 55 $200

7 kgs

4 kgs

8 kgs

$20/kg

$40/ kg

$25/ kg

In this case, production of the Golf Guard would be the most profitable use of the constrained resource. The contribution margin per unit of the constrained resource for this product is $40, which is larger than for the other two products.

581

Exercise 12-8 (continued) 3. The Fishing Guard product has the largest unit contribution margin, but it is not the most profitable use of the constrained resource in either case above. This happens because the Fishing Guard uses more of the constrained resources in proportion to its contribution margin than the other two products. In other words, more of the other products can be produced for a given amount of the constrained resource and this more than makes up for their lower contribution margins.

Exercise 12-9 (15 minutes) 1. Annual profits will decrease by $6,000:

Per Unit Incremental sales .......................................... Incremental costs: Direct materials .......................................... Direct labor ................................................ Variable manufacturing overhead ................ Variable selling and administrative ............... Total incremental costs .................................. Incremental loss ............................................

15,000 Units

$14.00

$210,000

6.10 4.80 2.00 1.50 14.40 $ (0.40)

91,500 72,000 30,000 22,500 216,000 $ (6,000)

The fixed costs are not relevant to the decision because they will be incurred regardless of whether the special order is accepted or rejected. 2. The relevant cost is $1.50 (the variable selling and administrative expenses). All other variable costs are sunk because the units have already been produced. The fixed costs are not relevant because they will not change in total as a consequence of the price charged for the left-over units.

Managerial Accounting, 13th Canadian Edition

Exercise 12-10 (15 minutes) 1. Yes, the special order should be accepted. The relevant costs are shown below.

Per Unit Incremental costs: Variable costs: Direct materials .................................................... Direct labour ........................................................ Variable manufacturing overhead........................... Total variable cost ....................................................

$10.00 12.00 0.50 $ 22.50

Since the incremental costs of filling the order are less than $25, Wood Group should accept the offer. 2. Monthly profits would be increased by $250:

Incremental revenue ................................................... Incremental costs: Variable costs: Direct materials .................................................... Direct labour ........................................................ Variable manufacturing overhead........................... Total variable cost .................................................... Fixed costs: None affected by the special order ........................ Total incremental cost ................................................. Incremental operating income .....................................

Per Unit

Total for 100 Units

$25.00

$2,500

10.00 12.00 0.50 $ 22.50

1,000 1,200 50 2,250 0 2,250 $ 250

3. Since the Wood Group is now at capacity, the opportunity cost of foregoing the sale of 100 feeders at regular prices needs to be included in the determination of relevant costs. The opportunity cost would be the contribution margin per unit foregone on regular sales, calculated below:

583

Exercise 12-10 (continued)

Per Unit Regular selling price Incremental costs: Variable costs: Direct materials .................................................... Direct labour ........................................................ Variable manufacturing overhead........................... Variable selling and administrative Total variable cost .................................................... Contribution margin

$35.00

10.00 12.00 0.50 1.50 24.00 $11.00

The total relevant cost for purposes of evaluating the special order is: $22.50 (see part 1 above) + $11.00 = $33.50. The offer of $25 per feeder should be declined since it is less than the relevant cost of $33.50 per unit of filling the order given that Wood Group is operating at capacity.

Managerial Accounting, 13th Canadian Edition

Exercise 12-11 (15 minutes) The company should accept orders first for Beta, second for Alpha, and third for Omega. The computations are:

Alpha (a) (b) (c) (d)

Direct materials required per unit .............. Cost per kilogram ..................................... Kilograms required per unit (a) ÷ (b) ........ Contribution margin per unit ..................... Contribution margin per kilogram of materials used (d) ÷ (c) .............................

Proof: Units that could be produced using 10,000kg 1,250 Profit (CM/unit x production) $80,000

Omega

Beta

$48.00 $6.00 8 $64.00

$30.00 $6.00 5 $28.00

$18.00 $6.00 3 $42.00

$8.00

$5.60

$14.00

2,000 $56,000

3,333 $139,986

Since Beta uses the least amount of material per unit of the three products, and since it is the most profitable of the three in terms of its use of this constrained resource, some students will immediately assume that this is an infallible relationship. That is, they will assume that the way to spot the most profitable product is to find the one using the least amount of the constrained resource. The way to dispel this notion is to point out that Alpha uses more material (the constrained resource) than Omega, but yet it is more profitable per unit of the constrained resource.

The key factor is not how much of a constrained resource a product uses, but rather how much contribution margin the product generates per unit of the constrained resource.

585

Exercise 12-12 (10 minutes)

Selling price after further processing ............. Selling price at the split-off point .................. Incremental revenue per kg or litre ............... Total quarterly output in kgs or litres ............ Total incremental revenue ............................ Total incremental processing costs ................ Total incremental profit or loss .....................

$20 16 $4 ×15,000 $60,000 63,000 $(3,000)

$13 8 $5 ×20,000 $100,000 80,000 $ 20,000

$32 25 $7 ×4,000 $28,000 36,000 $(8,000)

Therefore, only product B should be processed further.

Managerial Accounting, 13th Canadian Edition

Exercise 12-13 (20 minutes) 1. The value of relaxing the constraint can be determined by computing the contribution margin per unit of the constrained resource:

Sofa Selling price per unit ................................................................. Variable cost per unit ................................................................ Contribution margin per unit (a) ................................................ Upholstery shop time required to produce one unit (b) ............... Contribution margin per unit of the constrained resource (a) ÷ (b) ........................................................................................

$1,800 1,200 $ 600 10 hours $60 per hour

The company should be willing to pay up to $60 per hour to keep the upholstery shop open after normal working hours. 2. To answer this question, it is desirable to compute the contribution margin per unit of the constrained resource for all three products: Selling price per unit .......................... Variable cost per unit ......................... Contribution margin per unit (a) ......... Upholstery shop time required to produce one unit (b) ............................ Contribution margin per unit of the constrained resource (a) ÷ (b) ........................................

Recliner

Sofa

$1,400 800 $ 600

$1,800 1,200 $ 600

Loveseat $1,500 1,000 $ 500

8 hours

10 hours

5 hours

$75 per hour

$60 per hour

$100 per hour

The offer to upholster furniture for $45 per hour should be accepted. The time would be used to upholster Loveseats. If this increases the total production and sales of furniture, the time would be worth $100 per hour—a net gain of $55 per hour. If Loveseats are already being produced up to demand, then having Loveseats upholstered at the other company would free up capacity to produce more of the other furniture. In both cases, the additional time is worth more than $45 per hour.

587

Exercise 12-14 (30 minutes) 1. The relevant costs of a bird watching trip would be: Travel expense (400 kilometres @ $0.45 per kilometre) Park camping fees...................................................... Insect repellant .......................................................... Total .........................................................................

$180 60 20 $260

Jane will need to eat even if she does not make a bird watching trip so those costs are not relevant. The above also assumes that the resale value of the tent, camping equipment, camera equipment and car are unaffected by taking the next trip. All of the other costs are sunk at the point at which the decision is made to go on another bird watching trip. 2. If Jane gave up bird watching she would avoid the costs of:  Gas, oil, and tires  Park camping fees  Insect repellant  Jane would be able to sell the tent and possibly the camping equipment and camera equipment. The proceeds of which would be considered relevant in this decision. The original costs of these items are not relevant, but their resale values are relevant. 3. The incremental cost of taking the additional four pictures would be zero since there are no variable costs per picture taken. That is, at the point of taking the additional four photos, all the costs itemized by Jane‘s mother would be considered sunk.

Managerial Accounting, 13th Canadian Edition

Exercise 12-15 (30 minutes) No, the school knapsacks should not be discontinued. The computations are: Contribution margin lost if the knapsacks are discontinued ..................................................................... Less fixed costs that can be avoided if the knapsacks are discontinued: Salary of the product line manager ........................ Advertising ........................................................... Insurance on inventories ....................................... Net disadvantage of dropping the knapsacks ................

$(130,000)

$ 10,500 55,000 4,500

70,000 $ (60,000)

The same solution can be obtained by preparing comparative income statements:

Keep School Knapsack Sales ..................................................... Variable expenses: Variable manufacturing expenses ......... Sales commissions .............................. Shipping ............................................. Total variable expenses .......................... Contribution margin ............................... Fixed expenses: Salary of line manager ........................ General factory overhead .................... Depreciation of equipment .................. Advertising—traceable ......................... Insurance on inventories ..................... Purchasing department ....................... Total fixed expenses ............................... Operating loss .......................................

$225,000

Difference: Operating Income Drop School Increase or (DeKnapsack crease) $

$(225,000)

65,000 24,000 6,000 95,000 130,000

0 0 0 0 0

65,000 24,000 6,000 95,000 (130,000)

10,500 52,000 18,000 55,000 4,500 25,000 165,000 $ (35,000)

0 52,000 18,000 0 0 25,000 95,000 $(95,000)

10,500 0 0 55,000 4,500 0 70,000 $(60,000)

589

Exercise 12-16 (20 minutes) The costs that are relevant in a make-or-buy decision are those costs that can be avoided as a result of purchasing from the outside. The analysis for this exercise is:

Per Unit Differential Costs Make Buy Cost of purchasing ................................ $54.00 Cost of making: Direct materials ................................. $ 14.40 Direct labour...................................... 21.00 Variable manufacturing overhead ........ 9.60 Fixed manufacturing overhead ............ 10.00 * Total cost .......................................... $55.00 $54.00

10,000 Units Make Buy $540,000 $ 144,000 210,000 96,000 100,000 $550,000

$540,000

* The remaining $15 of fixed manufacturing overhead cost would not be relevant, since it will continue regardless of whether the company makes or buys the parts. The $150,000 rental value of the space being used to produce part R-3 represents an opportunity cost of continuing to produce the part internally. Thus, the completed analysis would be: Total cost, as above ....................................................... Rental value of the space (opportunity cost) .................... Total cost, including opportunity cost .............................. Net advantage in favour of buying ..................................

Make

Buy

$550,000 150,000 $700,000

$540,000 $540,000

$160,000

Profits would increase by $160,000 if the outside supplier‘s offer is accepted.

Managerial Accounting, 13th Canadian Edition

Exercise 12-17 (20 minutes) 1. The financial advantage of further processing X15 is computed as follows: Sales value after further processing (7,000 units × $12 per unit) ..................................... Sales value at the split-off point (7,000 units × $9 per unit) ....................................... Incremental revenue from further processing ............... Cost of further processing ........................................... Financial advantage of further processing .....................

$84,000 63,000 21,000 9,500 $11,500

The $60,000 cost incurred up to the split-off point is not relevant in a sell or process further analysis. 2. Yes, the company should process product X15 beyond the split-off point.

Exercise 12-18 (10 minutes) Contribution margin lost if the Linens Department is dropped: Lost from the Linens Department .......................................................... $(600,000) Lost from the Hardware Department (10% × $2,100,000) ..................... (210,000) Total lost contribution margin .................................................................. (810,000) Fixed costs that can be avoided ($800,000 – $340,000) ............................ 460,000 Financial (disadvantage) of discontinuing the Linens Department ............... $(350,000)

591

Exercise 12-19 (15 minutes)

Current cost to purchase each headlight

$14.00

Less incremental cost to produce headlights in-house: Incremental direct materials and labour ($4 + $3) Variable portion of plant overhead* Incremental profit from making headlights

7.00 3.60 $3.40

This analysis indicates the headlights should be produced in house rather than purchased from outside. The plant manager should remember that this decision only holds given excess capacity (so no incremental fixed costs) and assuming there is no opportunity cost from choosing to put this excess capacity to this rather than another use. *150% of $3 = $4.50 x (1-20%) = $3.60

Managerial Accounting, 13th Canadian Edition

Exercise 12-20 (15 minutes) 1. The donut shop should promote the product with the highest contribution margin since fixed costs are unavoidable. Chocolate filled

Cream filled

Jam filled

Sales price per dozen

$4.00

$3.00

$2.50

Direct cost per dozen

(2.10)

(0.90)

(2.00)

CM per dozen

$1.90

$2.10

0.50

In this case, the cream filled donuts have the highest contribution margin so they should be promoted. This will result in $2.10 x 50 dozen = $105 in additional contribution to cover fixed costs. 2. The jam-filled donuts contribute $0.50 per dozen to covering the fixed costs so they should not be dropped unless the shop has the opportunity to add a more profitable product or to put the equipment used to make jam-filled donuts to an alternative, more profitable use. 3. If the shop is currently operating at capacity, it is likely they could put the equipment currently used to produce jam-filled donuts to an alternative profitable use, specifically producing more of the other two types of donuts. If the shop can produce and sell enough of the other two types of donuts to make a profit using the equipment currently devoted to making jam-filled donuts, then dropping the jamfilled line would be a good idea.

593

Problem 12-21 (30 minutes) 1. Contribution margin lost if the flight is discontinued ................................................................. Flight costs that can be avoided if the flight is discontinued: Flight promotion ........................................................... Fuel for aircraft ............................................................. Liability insurance (1/3 × $4,200) .................................. Salaries, flight assistants ............................................... Overnight costs for flight crew and assistants ................. Net decrease in profits if the flight is discontinued .............

$(12,950)

$ 750 5,800 1,400 1,500 300

9,750 $ (3,200)

The following costs are not relevant to the decision:

Cost Salaries, flight crew Depreciation of aircraft Liability insurance (two-thirds) Baggage loading and flight preparation

Reason Fixed annual salaries, which will not change. Sunk cost. Two-thirds of the liability insurance is unaffected by this decision. This is an allocated cost that will continue even if the flight is discontinued.

Managerial Accounting, 13th Canadian Edition

Problem 12-21 (continued) Alternative Solution:

Ticket revenue ................................................. Variable expenses ............................................ Contribution margin ......................................... Less flight expenses: Salaries, flight crew ....................................... Flight promotion ........................................... Depreciation of aircraft .................................. Fuel for aircraft ............................................. Liability insurance ......................................... Salaries, flight assistants ............................... Baggage loading and flight preparation .......... Overnight costs for flight crew and assistants at destination ............................. Total flight expenses ........................................ Net operating loss ............................................

Keep the Flight

Drop the Flight

$14,000 1,050 12,950

Difference: Net Operating Income Increase or (Decrease)

0 0 0

$(14,000) 1,050 (12,950)

1,800 750 1,550 5,800 4,200 1,500 1,700

1,800 0 1,550 0 2,800 0 1,700

0 750 0 5,800 1,400 1,500 0

300 17,600 $ (4,650)

0 7,850 $ (7,850)

300 9,750 $ (3,200)

2. The goal of increasing the seat occupancy could be obtained by eliminating flights with a lower-than-average seat occupancy. By eliminating these flights and keeping the flights with a higher-than-average seat occupancy, the overall average seat occupancy for the company as a whole would be improved. This could reduce profits in at least two ways. First, the flights that are eliminated could have contribution margins that exceed their avoidable costs (such as in the case of flight 482 in part 1). If so, then eliminating these flights would reduce the company‘s total contribution margin more than it would reduce total costs, and profits would decline. Second, these flights might be acting as ―feeder‖ flights, bringing passengers to cities where connections to more profitable flights are made.

595

Problem 12-22 (60 minutes) 1. Direct labour cost per unit (a) .......... Direct labour rate per hour (b) ......... Direct labour hours per unit (a) ÷ (b) ..............................................

Dani

Trish

Satya

Max

Sewing Kit

$6.40 $16.00

$4.00 $16.00

$11.20 $16.00

$8.00 $16.00

$3.20 $16.00

0.40

0.25

0.70

0.50

0.20

Variable overhead per hour (a) ........ Direct labour hours per unit (b) ........ Variable overhead per unit (a) × (b) ..............................................

Dani

Trish

Satya

Max

Sewing Kit

$2.00 0.40

$2.00 0.25

$2.00 0.70

$2.00 0.50

$2.00 0.20

$0.80

$0.50

$1.40

$1.00

$0.40

Selling price .................................... Variable costs: Direct materials ............................ Direct labour ................................ Variable overhead ........................ Total variable costs .......................... Contribution margin (a) ................... Direct labour hours per unit (b) ........ Contribution margin per DLH (a) ÷ (b) ..............................................

Dani

Trish

Satya

Max

Sewing Kit

$16.70

$7.50

$26.60

$14.00

$ 9.60

4.30 6.40 0.80 11.50 $ 5.20 0.40

1.10 4.00 0.50 5.60 $1.90 0.25

6.44 11.20 1.40 19.04 $ 7.56 0.70

2.00 8.00 1.00 11.00 $ 3.00 0.50

3.20 3.20 0.40 6.80 $ 2.80 0.20

$13.00

$7.60

$10.80

$ 6.00

$14.00

Managerial Accounting, 13th Canadian Edition

Problem 12-22 (continued) 4. The first step is to compute how many direct labour-hours would be committed to each of the five products as follows: Amount of constrained resource available .............................. Less: Hours required for production of 325,000 units of the Sewing Kit @ 0.20 hours per unit ..................................... Remaining constrained resource available .............................. Less: Hours required for production of 50,000 units of the Dani doll @ 0.40 hours per unit ....................................... Remaining constrained resource available .............................. Less: Hours required for production of 35,000 units of the Satya doll @ 0.70 hours per unit ...................................... Remaining constrained resource available .............................. Less: Hours required for production of 42,000 units of the Trish doll @ 0.25 hours per unit ....................................... Remaining constrained resource available .............................. Less: Hours required for production of 20,000 units of the Max doll @ 0.50 hours per unit ........................................ Remaining constrained resource available ..............................

130,000 hours 65,000 hours 65,000 hours 20,000 hours 45,000 hours 24,500 hours 20,500 hours 10,500 hours 10,000 hours 10,000 hours 0 hours

The second step is to multiple the direct labour-hours committed to each product by its respective contribution margin per direct labour-hour as shown below:

Sewing Kit Contribution margin per DLH (a) ............. DLH committed to each product (b) ...... Total contribution margin (a) × (b) ......

Dani

Satya

Trish

Max

$14.00

$13.00

$10.80

$7.60

$6.00

65,000

20,000

24,500

10,500

10,000

$910,000

$260,000

$264,600

$79,800

$60,000

The highest total contribution margin that the company can earn is $1,574,400 (= $910,000 + $260,000 + $264,600 + $79,800 + $60,000).

597

Problem 12-22 (continued) 5. Because the additional capacity would be used to produce the Max doll, the company should be willing to pay up to $22 per hour ($16 per hour usual rate plus $6 contribution margin per hour) for added labor time. 6. Additional output could be obtained in a number of ways including working overtime, adding another shift, expanding the workforce, contracting out some work to outside suppliers, and eliminating wasted labor time in the production process. The first four methods are costly, but the last method can add capacity at very low cost. Note: Some would argue that direct labour is a fixed cost in this situation and should be excluded when computing the contribution margin per unit. However, when deciding which products to emphasize, no harm is done by misclassifying a fixed cost as a variable cost—providing that the fixed cost is the constraint. If direct labour were removed from the variable cost category, the net effect would be to bump up the contribution margin per direct labour-hour by $8 for each of the products. The products will be ranked exactly the same—in terms of the contribution margin per unit of the constrained resource—whether direct labour is considered variable or fixed. However, this only works when the fixed cost is the cost of the constraint itself.

Managerial Accounting, 13th Canadian Edition

Problem 12-23 (60 minutes) 1. The starting point for answering requirement 1 is separating the manufacturing overhead per unit of $1.40 into its variable and fixed components. The variable manufacturing overhead per box of Chap-Off would be $0.50, as shown below: Total manufacturing overhead cost per box of Chap-Off ................ Less fixed portion ($90,000 ÷ 100,000 boxes) ............................. Variable overhead cost per box ...................................................

$1.40 0.90 $0.50

The avoidable manufacturing cost per box of Chap-Off is computed as follows: Cost avoided by purchasing the tubes: Direct materials ($3.60 × 25%) ........................................ Direct labour ($2.00 × 10%)............................................. Variable manufacturing overhead ($0.50 × 10%) ............... Avoidable manufacturing cost per box of Chap-Off ................

$0.90 0.20 0.05 $1.15

2. The financial (disadvantage) per box of Chap-Off is computed as follows: Avoidable manufacturing cost per box of Chap-Off ....................... Less price paid to supplier .......................................................... Financial (disadvantage) per box of Chap-Off ...............................

$ 1.15 1.35 $(0.20)

3. The financial (disadvantage) of outsourcing 100,000 boxes of Chap-Off is computed as follows: Number of boxes (a) .................................................................. Financial (disadvantage) per box of Chap-Off (b) ......................... Financial (disadvantage) in total (a) × (b)....................................

100,000 $(0.20) $(20,000)

4. Silven should make the tubes because the price paid to the supplier ($1.35) exceeds the avoidable manufacturing cost per unit ($1.15). 5. The maximum purchase price would be $1.15 per box. The company would not be willing to pay more than this amount because the $1.15 represents the cost of producing one box of tubes internally. To make purchasing the tubes attractive, however, the purchase price should be less than $1.15 per box.

599

Problem 12-23 (continued) 6. At a volume of 120,000 boxes, the company should buy the tubes. The computations are: Cost of making 120,000 boxes of tubes: 120,000 boxes × $1.15 per box .............................. Rental cost of equipment ........................................ Total cost ..................................................................

$138,000 40,000 $178,000

Cost of buying 120,000 boxes of tubes: 120,000 boxes × $1.35 per box ..............................

$162,000

Thus, buying the tubes provides a financial advantage of $16,000 (= $178,000 – $162,000) per year. 7. Under these circumstances, the company should make 100,000 boxes of tubes and purchase the remaining 20,000 boxes of tubes from the outside supplier. The costs would be as follows: Cost of making: 100,000 boxes × $1.15 per box ................... Cost of buying: 20,000 boxes × $1.35 per box ...................... Total cost ............................................................................

$115,000 27,000 $142,000

8. Management should take into account at least the following additional factors:  The ability of the supplier to meet required delivery schedules.  The quality of the tubes purchased from the supplier.  Alternative uses of the capacity that would be used to make the tubes.  The ability of the supplier to supply tubes if volume increases in future years.  The problem of finding an alternative source of supply if the supplier proves to be undependable.

Managerial Accounting, 13th Canadian Edition

Problem 12-24 (45 minutes) 1. As much yarn as possible should be processed into sweaters. Products should be processed further so long as the added revenues from further processing are greater than the added costs. In this case, the added revenues and costs are:

Per Sweater Added revenue ($30.00 – $20.00) ................. Added costs: Buttons, thread, lining ............................... Direct labor ............................................... Added contribution margin ............................

$10.00 $2.00 5.80

7.80 $ 2.20

Thus, the company will gain $2.20 in contribution margin for each spindle of yarn that is further processed into a sweater. The fixed manufacturing overhead costs are not relevant to the decision because they will be the same regardless of whether the yarn is sold or processed further. In addition, we must omit the $16.00 cost of manufacturing the yarn because this cost will be incurred whether the yarn is sold as is or is used in sweaters. 2. The lowest price the company should accept is $27.80 per sweater. The simplest approach to this answer is: Present selling price per sweater ................... Less added contribution margin being realized on each sweater sold .......................... Minimum selling price per sweater.................

$30.00 2.20 $27.80

A more involved approach to the same answer is to reason as follows: If the wool yarn is sold outright, then the company will realize a contribution margin of $9.40 per spindle:

Per Spindle Selling price .................................. Variable expenses: Raw wool ................................... Direct labor ................................ Contribution margin.......................

$20.00 $7.00 3.60

10.60 $ 9.40

601

Problem 12-24 (continued) This $9.40 is an opportunity cost. The price of the sweaters must be high enough to cover this opportunity cost. In addition, the company must be able to cover all of its variable costs from the time the raw wool is purchased until the sweater is completed. Therefore, the minimum price is: Variable costs of producing a spindle of yarn: Raw wool ............................................................... Direct labor ............................................................ Added variable costs of producing a sweater: Buttons, etc. .......................................................... Direct labor ............................................................ Total variable costs .................................................... Opportunity cost—contribution margin if the yarn is sold outright .......................................................... Minimum selling price per sweater..............................

$7.00 3.60 2.00 5.80

$10.60

7.80 18.40 9.40 $27.80

Managerial Accounting, 13th Canadian Edition

Problem 12-25 (45 minutes) 1. Selling price per unit ........................................................... Less variable expenses per unit ........................................... Contribution margin per unit................................................

$32 18 * $14

*$10.00 + $4.50 + $2.30 + $1.20 = $18.00 Increased sales in units (60,000 units × 25%) ...................... Contribution margin per unit ................................................ Incremental contribution margin .......................................... Less added fixed selling expenses ........................................ Incremental operating income .............................................

15,000 × $14 $210,000 80,000 $130,000

Yes, the increase in fixed selling expenses would be justified. 2. Variable manufacturing cost per unit .................................... $16.80 * Import duties per unit ......................................................... 1.70 Permits and licenses ($9,000 ÷ 20,000 units) ....................... 0.45 Shipping cost per unit ......................................................... 3.20 Break-even price per unit .................................................... $22.15 *$10 + $4.50 + $2.30 = $16.80. 3. The relevant cost is $1.20 per unit, which is the variable selling expense per Bit. Since the irregular units have already been produced, all production costs (including the variable production costs) are sunk. The fixed selling expenses are not relevant since they will be incurred whether or not the irregular units are sold. Depending on how the irregular units are sold, the variable expense of $1.20 per unit may not even be relevant. For example, the units may be disposed of through a liquidator without incurring the normal variable selling expense. 4. If the plant operates at 30% of normal levels, then only 3,000 units will be produced and sold during the two-month period: 60,000 units per year × 2/12 = 10,000 units. 10,000 units × 30% = 3,000 units produced and sold.

603

Problem 12-25 (continued) Given this information, the simplest approach to the solution is: Contribution margin lost if the plant is closed (3,000 units × $14 per unit*) ................................................... Fixed costs that can be avoided if the plant is closed: Fixed manufacturing overhead cost ($300,000 × 2/12 = $50,000; $50,000 × 40%) ...................................... Fixed selling cost ($210,000 × 2/12 = $35,000; $35,000 × 20%) ........................................................ Net disadvantage of closing the plant ................................

$(42,000)

$20,000 7,000

27,000 $(15,000)

*$32.00 – ($10.00 + $4.50 + $2.30 + $1.20) = $14.00 Some students will take a longer approach such as that shown below:

Continue to Operate Sales (3,000 units × $32 per unit) ............................. Less variable expenses (3,000 units × $18 per unit) ... Contribution margin .................................................. Less fixed expenses: Fixed manufacturing overhead cost: $300,000 × 2/12 ................................................ $300,000 × 2/12 × 60% ..................................... Fixed selling expense: $210,000 × 2/12 ................................................ $210,000 × 2/12 × 80% ..................................... Total fixed expenses .................................................. Operating income (loss) ............................................

$ 96,000 54,000 42,000

Close the Plant $

0 0 0

50,000 30,000 35,000 85,000 $(43,000)

28,000 58,000 $(58,000)

Managerial Accounting, 13th Canadian Edition

Problem 12-25 (continued) 5. The relevant costs are those that can be avoided by purchasing from the outside manufacturer. These costs are: Variable manufacturing costs ...................................................... Fixed manufacturing overhead cost ($300,000 × 75% = $225,000; $225,000 ÷ 60,000 units) ........................................ Variable selling expense ($1.20 × 1/3) ........................................ Total costs avoided .....................................................................

$16.80 3.75 0.40 $20.95

To be acceptable, the outside manufacturer‘s quotation must be less than $20.95 per unit. Alternative: Costs were ………………………………………………………………………….………… $26.50 Less costs remaining if purchased: Fixed overhead $5 * 25% (1.25) Variable selling 2/3 $1.20 ( .80) Fixed selling (3.50) Total costs avoided $20.95

605

Problem 12-26 (45 minutes) 1. GoGrow yields a contribution margin of $7 per litre ($18 – $11). If the plant closes, this contribution margin will be lost on the entire 12,000 litres (6,000 litres per month × 2 = 12,000 litres) that could have been sold during the two-month period. However, the company will be able to avoid certain fixed costs as a result of closing down. The full analysis is as follows: Contribution margin lost by closing the plant for two months ($7 per litre × 12,000 litres) ............................ Costs avoided by closing the plant for two months: Fixed manufacturing overhead cost ($30,000 × 2 months = $60,000) ............................. Fixed selling costs ($155,000 × 10% × 2 months) ................................ Net advantage of closing, before start-up costs ............... Add start-up costs ......................................................... Advantage of closing the plant........................................

$(84,000)

$60,000 31,000

91,000 7,000 (3,500) $3,500

Alternative Solution:

Plant Kept Open Sales (6,000 litres × $18 per litre × 2) ...... $ 216,000 Less variable expenses (6,000 litres × $11 per litre × 2) ..................... 132,000 Contribution margin ................................ 84,000 Less fixed costs: Fixed manufacturing overhead cost ($115,000 × 2; $85,000 × 2) ................................... 230,000 Fixed selling cost ($155,000 × 2; $155,000 × 90% × 2) ....................... 310,000 Total fixed cost ....................................... 540,000 Operating loss before start-up costs ......... (456,000) Start-up costs ......................................... Operating loss ........................................ $ (456,000) The company is better off financially closing the plant.

Difference— Operating Income Increase (DePlant Closed crease) $

$(216,000)

0 0

132,000 (84,000)

170,000

60,000

279,000 449,000 (449,000) (3,500) $(452,500)

31,000 91,000 7,000 (3,500) $3,500

Managerial Accounting, 13th Canadian Edition

Problem 12-26 (continued) 2. Non-financial factors management would likely consider:  The employees who are laid-off might find work elsewhere and not return to the Green Garden Group after the two-month period is over. To the extent employees are difficult to hire or train, this could cause significant problems for the company when they try to start-up the business again in two months.  Customers currently purchasing GoGrow will have to find another fertilizer product for two months and may be permanently lost if they find a suitable alternative at a comparable price. 3. The Green Garden Group should be indifferent between closing down or continuing to operate if the level of sales total 12,500 litres (6,250 litres per month) over the two-month period. The indifference point computations are: Cost avoided by closing the plant for two months (see above) ............................................................................. Less start-up costs .............................................................. Net avoidable costs .............................................................

$91,000 3,500 $87,500

Indifference point = Net avoidable costs ÷ Per unit contribution margin = $87,500 ÷ ($18 - $11) = 12,500 litres

Verification: Sales (12,500 litres × $18 per litre)......................... Less variable expenses (12,500 litres × $11 per litre)................................................................... Contribution margin ............................................... Less fixed expenses: Manufacturing overhead ($115,000 and $85,000 × 2 months) ....................................................... Selling ($155,000 and $139,500 × 2 months) ....... Total fixed expenses ............................................... Start-up costs ........................................................ Total costs ............................................................. Operating loss .......................................................

Operate at 12,500 Litres for Two Months $ 225,000

Close for Two Months $

137,500 87,500

0 0

230,000 310,000 540,000 0 540,000 $ (452,500)

170,000 279,000 449,000 3,500 452,500 $(452,500)

607

Problem 12-27 (60 minutes) 1. The $4.00 per unit general overhead cost is not relevant to the decision, since the total general company overhead cost will be the same regardless of whether the company decides to make or buy the oil drums. Also, the depreciation on the old equipment is not a relevant cost since it represents a sunk cost and the old equipment is worn out and must be replaced. The cost of supervision is relevant since this cost can be avoided by buying the oil drums.

Outside supplier‘s price ............... Direct materials .......................... Direct labour ($8.00 × 0.75)........ Variable overhead ($1.20 × 0.75) ....................... Supervision ................................ Equipment rental* ...................... Total ..........................................

Differential Costs Per Unit Make Buy

Total Differential Costs for 40,000 Units Make Buy

$16.00

$640,000

$5.50 6.00

$220,000 240,000

0.90 1.50 3.00 $16.90

36,000 60,000 120,000 $676,000

$16.00

$640,000

Difference in favour of buying ........................................................ $0.90 $36,000 * $120,000 per year ÷ 40,000 units per year = $3.00 per unit

Managerial Accounting, 13th Canadian Edition

Problem 12-27 (continued) 2. a. Note that unit costs for both supervision and equipment rental will change if the company needs 50,000 carburetors each year. These fixed costs will be spread over a larger number of units, thereby decreasing the cost per unit.

Differential Costs Per Unit Make Buy

Total Differential Costs— 50,000 Units Make Buy

Outside supplier‘s price ................. Direct materials ............................ $5.50 Direct labour ................................ 6.00 Variable overhead ......................... 0.90 Supervision ($60,000 ÷ 50,000 units) ........... 1.20 Equipment rental ($120,000 ÷ 50,000 units) ......... 2.40 Total ............................................ $16.00

$16.00

Difference ....................................

$800,000 $275,000 300,000 45,000 60,000

$16.00

120,000 $800,000

$800,000 $0

The company would be indifferent between the two alternatives if 50,000 oil drums were needed each year.

609

Problem 12-27 (continued) b. Again, notice that the unit costs for both supervision and equipment rental decrease with the greater volume of units.

Differential Costs Per Unit Make Buy Outside supplier‘s price ................. Direct materials ............................ $5.50 Direct labour ................................ 6.00 Variable overhead ......................... 0.90 Supervision ($60,000 ÷ 60,000 units) ........... 1.00 Equipment rental ($120,000 ÷ 60,000 units) ......... 2.00 Total ............................................$15.40

Total Differential Costs— 60,000 Units Make Buy

$16.00

$960,000 $330,000 360,000 54,000 60,000

$16.00

120,000 $924,000

$960,000

Difference in favour of making ....................................................... $0.60 $36,000 The company should rent the new equipment and make the oil drums if 60,000 units per year are needed.

Managerial Accounting, 13th Canadian Edition

Problem 12-27 (continued) 3. Other factors that the company should consider include: a. Will volume in future years be increasing, or will it remain constant at 40,000 units per year? (If volume increases, then renting the new equipment becomes more desirable, as shown in the computations above.) b. Can quality control be maintained if the oil drums are purchased from the outside supplier? c. Does the company have some other profitable use for the space now being used to produce the oil drums? Does production of the oil drums require use of a constrained resource? d. Will the outside supplier be dependable in meeting shipping schedules and continuing to supply at this price? e. Can the company begin making the oil drums again if the supplier proves to be undependable, or are there alternative suppliers? f. If the outside supplier‘s offer is accepted and the need for oil drums increases in future years, will the supplier have the capacity to provide more than 40,000 oil drums per year? g. Will the rental cost of the equipment change in the future?

611

Problem 12-28 (30 minutes) 1. Since the fixed costs will not change as a result of the order, they are not relevant to the decision. The cost of the new machine is relevant, and this cost will have to be recovered by the current order since there is no assurance of future business from the retail chain.

Unit

Total—5,000 units

Revenue from the order ($50 × 84%)................................ $42 Less costs associated with the order: Direct materials ............................................................. 15 Direct labour ................................................................. 8 Variable manufacturing overhead .................................... 3 Variable selling expense ($4 × 25%) .............................. 1 Special machine ($10,000 ÷ 5,000 units) ........................ 2 Total costs ........................................................................ 29 Net increase in profits ....................................................... $13 2. Revenue from the order: Reimbursement for costs of production (variable production costs of $26, plus fixed manufacturing overhead cost of $9 = $35 per unit; $35 per unit × 5,000 units) .......................... Fixed fee ($1.80 per unit × 5,000 units) .................................. Total revenue ............................................................................ Less incremental costs—variable production costs ($26 per unit × 5,000 units).................................................... Net increase in profits ................................................................ 3. Sales revenue: From the provincial government (above) .................................. From regular channels ($50 per unit × 5,000 units) .................. Net decrease in revenue ............................................................ Less variable selling expenses avoided if the provincial government‘s order is accepted ($4 per unit × 5,000 units) ................ Net decrease in profits if the provincial government‘s order is accepted ................................................................................

$210,000 75,000 40,000 15,000 5,000 10,000 145,000 $ 65,000

$175,000 9,000 184,000 130,000 $ 54,000

$184,000 250,000 (66,000) 20,000 $(46,000)

Managerial Accounting, 13th Canadian Edition

Problem 12-28 (continued) ALTERNATE SOLUTION: Net Increase in Profits as above in part 2............................... $54,000 Less: Opportunity Cost (CM LOST on regular sales 5,000 units x $20/unit...........................................................(100,000) Net Decrease in profits if order accepted................................($46,000)

Problem 12-29 (45 minutes) 1. A product should be processed further so long as the incremental revenue from the further processing exceeds the incremental costs. The incremental revenue from further processing of the Clean 236 is: Selling price of the silver polish, per jar ................................ Selling price of 1/2 kilogram of Clean 236 ($4.00 ÷ 2)...................................................................... Incremental revenue per jar.................................................

$8.00 2.00 $6.00

The incremental variable costs are: Other ingredients ................................................................ Direct labour ....................................................................... Variable manufacturing overhead (25% × $2.96) .................. Variable selling costs (7.5% × $8) ........................................ Incremental variable cost per jar ..........................................

$1.30 2.96 0.74 0.60 $5.60

Therefore, the incremental contribution margin is $0.40 per jar ($6.00 – $5.60). The $3.20 cost per kilogram ($1.60 per 1/2 kilogram) required to produce the Clean 236 would not be relevant in this computation, since it is incurred regardless of whether the Clean 236 is further processed into silver polish or sold outright.

613

Problem 12-29 (continued) 2. Only the cost of advertising and the cost of the production supervisor are avoidable if production of the silver polish is discontinued. Therefore, the number of jars of silver polish that must be sold each month to justify continued processing of the Clean 236 into silver polish is: Production supervisor ................................................................... $6,000 Advertising—direct ....................................................................... 8,000 Avoidable fixed costs .................................................................... $14,000 Avoidable fixed costs Incremental CM per jar

$14,000 $0.40 per jar

=35,000 jars per month

Therefore, if 35,000 jars of silver polish can be sold each month, the company would be indifferent between selling it and selling all of the Clean 236 as a cleaning powder. If the sales of the silver polish are greater than 35,000 jars per month, then continued processing of the Clean 236 into silver polish would be advisable since the company‘s total profits will be increased. If the company can‘t sell at least 35,000 jars of silver polish each month, then production of the silver polish should be discontinued. To verify this, we show on the next page the total contribution to profits of sales of 34,000, 35,000 and 36,000 jars of silver polish, contrasted to sales of equivalent amounts of Clean 236 sold outright (i.e., 35,000 jars of silver polish would require the use of 17,500 kilograms of Clean 236 that otherwise could be sold outright as cleaning powder, etc.):

Managerial Accounting, 13th Canadian Edition

Problem 12-29 (continued)

34,000 Jars of Polish; or 17,000 kilograms of Clean 236

35,000 Jars of Polish; or 17,500 kilograms of Clean 236

Sales of Silver Polish: Sales @ $8.00 per jar ....................................$272,000 $280,000 Less variable expenses: Production cost of Clean 236 @ $3.20 per kilogram .................................................... 54,400 * 56,000 * Further processing and selling costs of the polish @ $5.60 per jar .......................... 190,400 196,000 Total variable expenses .................................... 244,800 252,000 Contribution margin ......................................... 27,200 28,000 Less avoidable fixed costs: Production supervisor .................................... 6,000 6,000 Advertising ................................................... 8,000 8,000 Total avoidable fixed costs ................................ 14,000 14,000 Total contribution to common fixed costs and to profits ................................................ $ 13,200 $ 14,000 Sales of Clean 236: Sales @ $4.00 per kilogram ........................... $68,000 Less variable expenses: Production cost of Clean 236 @ $3.20 per kilogram .................................................... 54,400 * Contribution to common fixed costs and to profits .......................................................... $13,600

36,000 Jars of Polish; or 18,000 kilograms of Clean 236 $288,000

57,600 * 201,600 259,200 28,800 6,000 8,000 14,000 $ 14,800

$70,000

$72,000

56,000 *

57,600 *

$14,000

$14,400

* This cost will be incurred regardless of whether the Clean 236 is further processed into silver polish or sold outright as cleaning powder; therefore, it is not relevant to the decision, as stated earlier. It is included in the computation above for the specific purpose of showing that it will be incurred under either alternative. The same thing could have been done with the depreciation on the mixing equipment.

615

Case 12-30 (90 minutes) 1. The lowest price Alanco could bid for the one-time special order of 25,000 kilograms (25 lots) without losing money would be $34,750—the relevant cost of the order, as shown below. Direct materials: CW-3: 400 kilograms per lot × 25 lots = 10,000 kilograms. Substitute CN-5 on a one-for-one basis to its total of 5,500 kilograms. If CN-5 is not used in this order, it will be salvaged for $500. Therefore, the relevant cost is ............................................................................... The remaining 4,500 kilograms would be CW-3 at a cost of $0.90 per kilogram ........................................................................................ JX-6: 300 kilograms per lot × 25 lots = 7,500 kilograms at $0.60 per kilogram ........................................................................................ MZ-8: 200 kilograms per lot × 25 lots = 5,000 kilograms at $1.60 per kilogram ........................................................................................ BE-7: 100 kilograms per lot × 25 lots = 2,500 kilograms at $0.55 per kilogram, the amount Alanco could realize by selling BE-7 [$0.65 market price – $0.10 handling charge] ............................................ Total direct materials cost ..................................................................

$ 500 4,050 4,500 8,000

1,375 18,425

Direct labour: 30 DLHs per lot × 25 lots = 750 DLHs. Because only 400 hours can be scheduled during regular time this month, overtime would have to be used for the remaining 350 hours. 400 DLHs × $14.00 per DLH .............................................................. 350 DLHs × $21.00 per DLH .............................................................. Total direct labour cost ......................................................................

5,600 7,350 12,950

Overhead: This special order will not increase fixed overhead costs. Therefore, only the variable overhead is relevant. 750 DLHs × $4.50 per DLH ................................................................

3,375

Total relevant cost of the special order................................................

$34,750

Managerial Accounting, 13th Canadian Edition

Case 12-30 (continued) 2. In this part, we calculate the price for recurring orders of 25,000 kilograms (25 lots) using the company‘s rule of marking up its full manufacturing cost. This is probably not the best pricing policy to follow, but is a common practice in business. Direct materials: Because of the possibility that future orders would exhaust existing inventories of CN-5 and BE-7 and new supplies would have to be purchased, all raw materials should be charged at their expected future cost, which is the current market price. CW-3: 10,000 kilograms × $0.90 per kilogram ........................ JX-6: 7,500 kilograms × $0.60 per kilogram ............................ MZ-8: 5,000 kilograms × $1.60 per kilogram........................... BE-7: 2,500 kilograms × $0.65 per kilogram ........................... Total direct materials cost ......................................................

$ 9,000 4,500 8,000 1,625 $23,125

Direct labour: 60% (i.e., 450 DLHs) of the production of a batch can be done on regular time; but the remaining production (i.e., 300 DLHs) must be done on overtime. Regular time 450 DLHs × $14.00 per DLH .............................. Overtime premium 300 DLHs × $21.00 per DLH ..................... Total direct labour cost ..........................................................

$ 6,300 6,300 $12,600

Overhead: The full manufacturing cost includes both fixed and variable manufacturing overhead. Manufacturing overhead applied: 750 DLHs × $12.00 per DLH ...............................................

$ 9,000

Full manufacturing cost......................................................... Mark-up (40% × $44,725) .................................................... Selling price (full manufacturing cost plus mark-up) ................

$44,725 17,890 $62,615

617

Case 12-31 (60 minutes) 1.

Davis‘s approach to calculating the opportunity cost with respect to the number of physical units involved is correct. Since ECD is currently operating at less than full capacity (90%) part of the order (250 units) from Jay Limited can be filled without having to forego any sales to regular customers given the existing orders. So, she is correct in that the way to proceed is to first calculate how many units can be produced given the amount of capacity currently not being utilized (10%). This amount would then be subtracted from the 250 units to arrive at the number of units that ECD would have to forego selling to regular customers in order to meet the needs of Jay Limited.

Number of units that can be produced given remaining monthly capacity of 10%: Laser Imaging Equipment Equipment Total capacity (hours) 4,000 1,000 Unutilized (10%) 400 100 Hours to produce 1 PVR* 4 1 Units that can be produced 100 100 *Laser direct labour cost of $60 per unit ÷ $15 per hour = 4 hours; Imaging direct labour cost of $20 per unit ÷ $20 per hour = 1 hour. Therefore, ECD will have to forego selling 150 units (250 – 100) to existing customers in order to fill the special order from Jay Limited.

The opportunity cost of filling the special order will be the contribution margin foregone by having to reduce sales to existing customers by 150 units. The calculation is as follows: Sales – direct materials – direct labour laser process – direct labour image process – variable overhead – variable selling costs = contribution margin. $320 - $50 - $60 - $20 - $40 - $20 = $130 per unit 150 units x $130 = $19,500.

Managerial Accounting, 13th Canadian Edition

Case 12-31 (continued) Note that the fixed overhead costs of $50 per unit are excluded from the analysis since they will be incurred whether or not the special order is accepted. Also note that the opportunity cost of $130 is considerably higher than the $40 per unit ($320 - $280) since it incorporates the incremental profit foregone by filling the special order, not just the difference in the selling price per unit. 4.

The net effect on profit of accepting the special order will be the contribution margin earned on the 250 units sold to Jay Limited less the opportunity cost of foregoing sales of 150 units. Contribution margin earned on the 250 units: ($280 - $50 - $60 - $20 - $40) x 250 = $27,500 Less opportunity cost (part 3. Above) 19,500 Net effect of accepting the offer $ 8,000

Number of units that can be produced given remaining monthly capacity of 25%: Laser Imaging Equipment Equipment Total capacity (hours) 4,000 1,000 Unutilized (25%) 1,000 250 Hours to produce 1 PVR* 4 1 Units that can be produced 250 250 *Laser direct labour cost of $60 per unit ÷ $15 per hour = 4 hours; Imaging direct labour cost of $20 per unit ÷ $20 per hour = 1 hour. Therefore, ECD will not have to forego selling any units to existing customers in order to fill the special order from Jay Limited because they have enough capacity to produce all 250 units. Accordingly, there will not be any opportunity cost incurred if they accept the order.

619

Case 12-31 (continued) The minimum price ECD should be willing to accept is the total incremental costs that will be incurred to fill the order: Direct materials Direct labour – laser Direct labour – image Variable overhead Total incremental costs

$ 50 60 20 40 $170

6. When accepting a special order such as that proposed by Jay Limited, issues to consider would include:  The reaction of existing customers if they learn of the special price being offered.  The potential for repeat business with the new customer (seems reasonably likely in this case).  The ability to utilize more of the existing production capacity to avoid layoffs.

Managerial Accounting, 13th Canadian Edition

Case 12-32 (45 minutes) 1. Yes, processing of jelly should be discontinued if the price remains at $3.90, but not for the reason given by the sales manager. The reason it should be discontinued is that the added contribution margin that can be obtained from processing a kilogram of blueberries into jelly is less than the contribution margin that can be obtained from using the labour capacity to produce another kilogram of blueberries and selling them unprocessed. The analysis is: Selling price per kilogram of blueberries ................................................ Less variable expenses ($2.45 materials and $0.20 labour) .................... Contribution margin per kilogram of blueberries ....................................

$3.15 2.65 $0.50

Added revenue from further processing of blueberries into jelly ($3.90 – $3.15).............................................................................................. Less costs of further processing ($0.50 materials and $0.20 labour)*...... Contribution margin per kilogram of jelly ...............................................

$0.75 0.70 $0.05

* The overhead costs are not relevant, since they are fixed and will remain the same whether the labour and processing capacity is used to produce tomatoes or salsa. Therefore, the company makes more money using its labour and processing capacity to produce blueberries than jelly. 2. Since the demand for the two products is unlimited and both require the same amount of labour and processing time, the company should process the blueberries into jelly only if the contribution margin from processing blueberries into jelly is at least as large as the contribution margin for unprocessed blueberries. x = price per kilogram of jelly at which Westchester Blueberries will be indifferent between selling unprocessed blueberries at $3.15 per kilogram or processing it further into jelly. (x - $3.15) - $0.70 = $0.50. x = $4.35 The above formulation subtracts the incremental costs of further processing blueberries into jelly ($0.50 materials + $0.20 labour) from the incremental revenue (i.e., above then $3.15 per kg. from blueberries) that would need to be received per kilogram of jelly, to produce a contribution margin of at least $0.50 per kilogram, i.e., what is currently earned from selling blueberries.

621

Case 12-32 (continued) An alternative formulation for x is as follows: x = $3.90 + $0.45 $3.90 per kilogram is the current price of jelly and $0.45 is the current difference in the per kilogram contribution margins from selling jelly versus blueberries from part 1 above ($0.50 - $0.05). Thus, the sum of these two amounts is the price that would be needed per kilogram of jelly to generate a contribution margin of $0.50 per kilogram. Using either formulation, the selling price of jelly should be at least $4.35 per kilogram; otherwise, the labour and processing time should be used to produce and sell unprocessed blueberries.

Managerial Accounting, 13th Canadian Edition

Case 12-32 (continued)

3. x = price per kilogram of unprocessed blueberries at which Westchester Blueberries will be indifferent between selling unprocessed blueberries or processing them further into jelly with a selling price of $3.90 per kilogram. x - $2.65 = $3.90 – x - $0.70 x = $2.925 At a selling price of $2.925 per kilogram of unprocessed blueberries Westchester Blueberries will be indifferent between processing them further into jelly versus selling them unprocessed. Proof using the unrounded selling prices for blueberries to show that it is the exact price at which the company will be indifferent: Selling price per kilogram of blueberries ................................................ Less variable expenses ($2.45 materials and $0.20 labour) .................... Contribution margin per kilogram of blueberries ....................................

$2.925 2.650 $0.275

Added revenue from further processing of blueberries into jelly ($3.90 – $2.925) ............................................................................................ Less costs of further processing ($0.50 materials and $0.20 labour) ....... Contribution margin per kilogram of jelly ...............................................

$0.975 0.700 $0.275

623

Case 12-33 (120 minutes) 1. The product margins computed by the accounting department for the drums and park benches should not be used in the decision of which product to make. The product margins are lower than they should be due to the presence of allocated fixed common costs that are irrelevant in this decision. Moreover, even after the irrelevant costs have been removed, what matters is the profitability of the two products in relation to the amount of the constrained resource—welding time—that they use. A product with a very low margin may be desirable if it uses very little of the constrained resource. In short, the financial data provided by the accounting department are useless and potentially misleading for making this decision. 2. Students may have answered this question assuming that direct labour is a variable cost, even though the case strongly hints that direct labour is a fixed cost. The solution is shown here assuming that direct labour is fixed. The solution assuming that direct labour is variable will be shown in part (4).

Solution assuming direct labour is fixed Purchased STR Drums Selling price .............................................. Less variable costs: Materials ................................................ Variable manufacturing overhead ............. Variable selling and administrative ........... Total variable cost ...................................... Contribution margin ...................................

Manufactured STR Park BenchDrums es

$225.00

$360.00

207.00 0.00 1.15 208.15 $ 16.85

78.15 2.00 1.15 81.30 $143.70

149.10 2.85 1.95 153.90 $206.10

Managerial Accounting, 13th Canadian Edition

Case 12-33 (continued) 3. Since the demand for the welding machine exceeds the 3,000 hours that are available, products that use the machine should be prioritized based on their contribution margin per welding hour. The computations are carried out below under the assumption that direct labour is a fixed cost and then under the assumption that it is a variable cost.

Solution assuming direct labour is fixed Manufactured Park STR Drums Benches Contribution margin per unit (above) (a) ......................... Welding hours per unit (b) ............................................. Contribution margin per welding hour (a) ÷ (b) ...............

$143.70 0.6 hour $239.50 per hour

$206.10 0.75 hour $274.80 per hour

625

Case 12-33 (continued) Since the contribution margin per unit of the constrained resource (i.e., welding time) is larger for the park benches than for the STR drums, the benches make the most profitable use of the welding machine. Consequently, the company should manufacture as many park benches as possible up to demand and then use any leftover capacity to produce STR drums. Buying the drums from the outside supplier can fill any remaining unsatisfied demand for STR drums. The necessary calculations are carried out below.

Analysis assuming direct labour is a fixed cost (a) Quantity Total hours available............................. Park benches produced ........................ STR Drums—make ............................... STR Drums—buy .................................. Total contribution margin ......................

2,400 4,500 4,500

(b) Unit Contri-bution Margin $206.10 $143.70 $16.85

(a) × (c) Total Welding Time

Balance of Welding Time

1,800 2,700

4,500 2,700 0

Less: Contribution margin from present operations: 7,500 drums × $143.70 CM per drum........................ Increased contribution margin and operating income ..............................

Total Contri-bution $494,640 646,650 75,825 1,217,115

1,077,750 $ 139,365

(a) × (b)

Managerial Accounting, 13th Canadian Edition

Case 12-33 (continued) 4. The computation of the contribution margins and the analysis of the best product mix are repeated here under the assumption that direct labour costs are variable.

Solution assuming direct labour is a variable cost Purchased STR Drums Selling price .............................................. Less variable costs: Materials ................................................ Direct labour .......................................... Variable manufacturing overhead ............. Variable selling and administrative ........... Total variable cost ...................................... Contribution margin ...................................

Manufactured STR Park BenchDrums es

$225.00

$360.00

207.00 0.00 0.00 1.15 208.15 $ 16.85

78.15 5.40 2.00 1.15 86.70 $138.30

149.10 43.20 2.85 1.95 197.10 $162.90

Solution assuming direct labour is a variable cost Manufactured Park STR Drums Benches Contribution margin per unit (above) (a) ......................... Welding hours per unit (b) ............................................. Contribution margin per welding hour (a) ÷ (b) ...............

$138.30 0.6 hour $230.50 per hour

$162.90 0.75 hour $217.20 per hour

When direct labour is assumed to be a variable cost, the conclusion is reversed from the case in which direct labour is assumed to be a fixed cost—the STR drums appear to be a better use of the constraint than the park benches. The assumption about the behaviour of direct labour really does matter.

Case 12-33 (continued)

Solution assuming direct labour is a variable cost (a) Quantity Total hours available............................. STR Drums—make ............................... Park benches produced ........................ STR Drums—buy .................................. Total contribution margin ...................... Less: Contribution margin from present operations: 7,500 drums × $138.30 CM per drum ....................... Increased contribution margin and operating income ..............................

7,500 0 1,500

(b) Unit Contri-bution Margin $138.30 $162.90 $16.85

(a) × (c) Total Welding Time

Balance of Welding Time

4,500 0

4,500 0 0

(a) × (b) Total Contribution $1,037,250 0 25,275 1,062,525

1,037,250 $ 25,275

Case 12-33 (continued) 5. The case strongly suggests that direct labour is fixed: ―The park benches could be produced with existing equipment and personnel.‖ Nevertheless, it would be a good idea to examine how much labour time is really needed under the two opposing plans.

Production

Direct Labour-Hours Per Unit

Total Direct Labour-Hours

Plan 1: Park benches ..................... STR drums .........................

2,400 4,500

1.6* 0.2**

3,840 900 4,740

Plan 2: STR drums .........................

7,500

0.2**

1,500

* $43.20 ÷ $27.00 per hour = 1.6 hours ** $5.40 ÷ $27.00 per hour = 0.2 hours Some caution is advised. Plan 1 assumes that direct labour is a fixed cost. However, this plan requires 3,240 more direct labour-hours than Plan 2 and the present situation. At 40 hours per week a typical full-time employee works about 2,000 hours a year, so the added workload is equivalent to more than one full-time employee (the full-time equivalent would be 3,240 hours ÷ 2,000 hours = 1.6 FTE employees). Does the plant really have that much idle time at present? If so, and if shifting workers over to making park benches would not jeopardize operations elsewhere, then Plan 1 is indeed the better plan. However, if taking on the park benches as a new product would lead to pressure to hire another worker, more analysis is in order. It is still best to view direct labour as a fixed cost, but taking on the park benches as a new product could lead to a jump in fixed costs of about $54,000 (2,000 hours × $27 per hour)—assuming that only one new full-time employee is required and the remaining 1,340 hours could be made up using otherwise idle time. See the additional analysis on the next page.

629

Case 12-33 (continued) Contribution margin from Plan 1: Park benches produced (2,400 × $206.10) ................................... STR Drums—make (4,500 × $143.70) .......................................... STR Drums—buy (4,500 × $16.85) .............................................. Total contribution margin ............................................................. Less: Additional fixed labour costs ................................................... Net effect of Plan 1 on operating income .........................................

494,640 646,650 75,825 1,217,115 54,000 $1,163,115

Contribution margin from Plan 2: .................................................... STR Drums—make (7,500 × $143.70) .......................................... STR Drums—buy (1,500 × $16.85) .............................................. Net effect of Plan 2 on operating income .........................................

$1,077,750 25,275 $1,103,025

If an additional direct labour employee would have to be hired, Plan 1 is still optimal.

Managerial Accounting, 13th Canadian Edition

Appendix 12A Solutions Exercise 12A-1 (15 minutes) 1.

Mark-up percentage based on absorption cost: = [(12% × $750,000) + $50,000] ÷ (14,000 × $25) = $140,000 ÷ $350,000 = 40%

Mark-up percentage based on total variable costs: = [(12% × $750,000) + $36,000 + $70,000*] ÷ (14,000 × $21**) = $196,000 ÷ $294,000 = 66.67% *Fixed manufacturing overhead: $5 × 14,000 = $70,000 ** Total variable costs per unit: ($25–$5) + ($50,000–$36,000)/14,000 = $21

3. Target selling price under absorption costing: Unit product cost.......................................................................... $25.00 Mark-up: 40% × $25 .................................................................... 10.00 Target selling price per unit........................................................... $35.00

Target selling price under total variable costing: Unit product cost.......................................................................... $21.00 Mark-up: 66.67% × $21.00 .......................................................... 14.00 * Target selling price per unit........................................................... $35.00

*rounded to the nearest cent.

631

Exercise 12A-2 (10 minutes) Sales (500 mowers × $6,000 per mower) ...................................... Less desired profit (20% × $3,000,000) ........................................ Target cost for 500 mowers .......................................................... Target cost per mower

$3,000,000 600,000 $2,400,000

= ($2,400,000 ÷ 500 mowers) = $4,800 per mower

Exercise 12A-3 (15 minutes) 1. Time rate to be used: Mechanics‘ wages and fringe benefits ($900,000 ÷ 50,000 hours) ........................................................ $18 Other repair costs ($450,000 ÷ 50,000 hours)................................9 Desired profit per hour of mechanic time .......................................8 Total charging rate per hour for service .......................................... $35 Material loading charge: Ordering, handling, and storage cost ............................................. 40% of invoice cost Desired profit on parts .................................................................. 40% of invoice cost Material loading charge ................................................................. 80% of invoice cost 2. Time charge: 12 hours × $35 per hour .......................................... $ 420 Material charge: Invoice cost of parts .................................................................. $100 Material loading charge (80% × $100) ....................................... 80 180 Bill for the job .............................................................................. $600

Managerial Accounting, 13th Canadian Edition

Exercise 12A-4 (10 minutes) 1. Maria‘s profit during the first week is computed as follows: Profit = (P – V) × Q − Fixed expenses Profit = ($3.50 − $0.80) × 1,800 − $2,675 Profit = $2.70 × 1,800 − $2,675 Profit = $4,860 − $2,675 Profit = $2,185 2. The percentage increase in the selling price and the percentage decrease in unit sales are computed as follows:

Price

Volume

Revised price/volume ........................................................... $4.00 Original price/volume (a) ...................................................... 3.50 Change (b) .......................................................................... $0.50 Percentage increase/(decrease) (b) ÷ (a) .............................. 14.3%

1,400 1,800 (400) (22.2%)

3. Maria‘s profit during the second week is computed as follows: Profit = (P – V) × Q − Fixed expenses Profit = ($4.00 − $0.80) × 1,400 − $2,675 Profit = $3.20 × 1,400 − $2,675 Profit = $4,480 − $2,675 Profit = $1,805 4. The decrease in profits is computed as follows: Net operating income in the second week ...................................... $1,805 Net operating income in the first week ........................................... 2,185 Decrease in net operating income .................................................. $ (380)

633

Exercise 12A-5 (20 minutes) 1. The reference value is the price of the competing alternative, which is $40,000. 2. The differentiation value has two components. First, customers who purchase an RT-1 rather than the competing alternative would avoid the need to buy a second component part for $40,000 to achieve 52,000 hours of usage. Second, customers who purchase the RT-1 rather than the competing component would realize software upgrade savings of $1,000 over a 52,000-hour period, computed as follows:

Competing Equipment Software upgrade costs for 52,000 hours: $2,000 × (52,000 hours ÷ 26,000 hours) ................. $3,000 × (52,000 hours ÷ 52,000 hours) ................. Differentiation value ...................................................

RT-1

$4,000 $3,000 $1,000

Thus, the total differentiation value is $40,000 + $1,000 = $41,000. 3. The economic value to the customer (EVC) is computed as follows: EVC = Reference value + Differentiation value EVC = $40,000 + $41,000 EVC = $81,000 4. The range of possible prices is as follows: Reference value ≤ Value-based price ≤ EVC $40,000 ≤ Value-based price ≤ $81,000

Managerial Accounting, 13th Canadian Edition

Problem 12A-6 (45 minutes) 1. a. Supporting computations: Number of suits manufactured each year: 10,000 labour-hours ÷ 1.0 labour-hour per suit = 10,000 suits. Selling, general, and administrative expenses: Variable (10,000 suits × $4 per suit) ............................................. $ 40,000 Fixed ........................................................................................... 245,000 Total ............................................................................................ $285,000 2. Mark-up percentage based on absorption cost: = [(20% × $500,000) + $285,000] ÷ (10,000 × $77) = $385,000 ÷ $770,000 = 50% b. Direct materials ............................................................................ $25.00 Direct labour ................................................................................ 28.00 Manufacturing overhead ............................................................... 24.00 Unit product cost .......................................................................... 77.00 Add mark-up: 50% of unit product cost ......................................... 38.50 Target selling price ....................................................................... $115.50 c. The income statement would be: Sales (10,000 suits × $115.50 per suit) ......................................... $1,155,000 Less cost of goods sold (10,000 suits × $77 per suit) ......................................................................................... 770,000 Gross margin ............................................................................... 385,000 Less selling, general, and administrative expenses: Shipping ($4.00 × 10,000 suits) ................................................. $ 40,000 Salaries .................................................................................... 45,000 Advertising and other ................................................................ 200,000 Total selling, general, and administrative expense .......................... 285,000 Operating income ......................................................................... $ 100,000

635

Problem 12A-6 (continued) The company‘s ROI computation for the suits would be: ROI = =

Operating income Sales x Sales Average operating assets $100,000 $1,155,000 x = 8.66% x 2.31 = 20% $1,155,000 $500,000

a. Mark-up percentage based on total variable costs: = [(20% × $500,000) + $245,000 + $200,000*] ÷ (10,000 × $61**) = $545,000 ÷ $610,000 = 89.3%

*($24 × 5/6) × 10,000 suits = $200,000 ** $25 + $28 + ($24 × 1/6) + $4 = $61 b. Direct materials ............................................................................ $25.00 Direct labour ................................................................................ 28.00 Variable manufacturing overhead ...................................................4.00 Variable selling, general and administrative……… 4.00 Unit product cost .......................................................................... 61.00 Add mark-up: 89.3% of unit product cost ....................................... 54.47 Target selling price........................................................................ $115.47 * *Differs from absorption costing target selling price by $0.03 due to rounding. 3. If the company has idle capacity and sales to the retail outlet would not affect the company‘s regular sales, any price above the variable cost of $61 per suit (see part 2.) would add to profits. The company should aggressively bargain for more than this price; $61 is simply the minimum acceptable price.

Managerial Accounting, 13th Canadian Edition

Problem 12A-7 (45 minutes) 1. Projected sales (200 scooters × $4,000 per machine) ..................... $800,000 Less desired ROI (20% × $200,000).............................................. 40,000 Target cost for 200 machines ........................................................ $760,000 Target cost per machine ($760,000 ÷ 200 machines) ..................... Less Free Rider‘s variable selling cost per machine ......................... Maximum allowable purchase price per machine ............................

$3,800 1,000 $2,800

2. A number of options are available in addition to simply giving up on adding the new scooters to the company‘s product lines. These options include: • Check the projected unit sales figures. Perhaps more units could be sold at the $4,000 price. However, management should be careful not to indulge in wishful thinking just to make the numbers come out right. • Modify the selling price. This does not necessarily mean increasing the projected selling price. Decreasing the selling price may generate enough additional unit sales to make carrying the scooters more profitable. • Improve the selling process to decrease the variable selling costs. • Rethink the investment that would be required to carry this new product. Can the size of the inventory be reduced? Are the new warehouse fixtures really necessary? • Does the company really need a 20% ROI? Does it cost the company this much to acquire more funds?

Note to instructors: students may raise additional valid options.

637

Problem 12A-8 (45 minutes) 1. a. and b.

Parts: Material Loading Charge

Repairs Total Cost of repair technician time: Repair technicians—wages.......................... $480,000 Retirement benefits (20% of wages) ........... 96,000 Health insurance (5% of wages) ................. 24,000 Total cost .................................................. 600,000 For repairs–other costs of repair service. For parts–costs of ordering, handling and storing parts: Repair service manager—salary ............. 56,000 Parts manager—salary ........................... 0 Repairs & parts assistant—salary............ 28,800 Retirement benefits (20% of salaries) ............................... 16,960 Health insurance (5% of salaries) .......... 4,240 Utilities ................................................. 120,000 Truck operating costs ............................ 19,200 Property taxes ...................................... 9,280 Liability and fire insurance ..................... 6,720 Supplies ............................................... 1,200 Rent—building ...................................... 38,400 Depreciation—trucks and equip. ............. 59,200 Total cost .................................................. 360,000 Desired profit: 20,000 hours × $10.00 per hour ............ 200,000 $600,000 × 40% .................................. Total amount to be billed ............$1,160,000

Per Hour*

Total

%**

$30.00

$0 60,000 7,500

18.00

13,500 3,375 24,000 0 5,400 3,000 225 33,000 0 150,000

25%

240,000 $390,000

40% 65%

10.00 $58.00

* Based on 20,000 hours per year of service time. ** Based on $600,000 invoice costs of parts used.

Managerial Accounting, 13th Canadian Edition

Problem 12A-8 (continued) 2. Time charge: 6 hours × $58.00 per hour .......................... Parts charge: Invoice cost of parts .................................................. Material loading charge: 65% × $500.00 .................... Total price of the job ......................................................

$348.00 $500.00 325.00

825.00 $1,173.00

3. The new rates are higher than the old rates. The impact of the new rates on the company‘s profit will depend entirely on what happens to the volume of unit sales. In other words, whether the new rates will result in an increase or decrease in profit depends on the price elasticity of demand. Without this information, it is impossible to know what will happen to the company‘s profit. If unit sales drop enough, the company will be worse off with the new, higher rates.

639

Problem 12A-9 (30 minutes) 1. The reference value is the price of a full-page ad in Trophy Whitetails magazine of $4,000 per month. 2. The differentiation value offered by a full-page ad in Midwest Whitetails magazine is computed as follows:

Midwest Whitetails

Trophy Whitetails

Sales per reader who buys products (a) ....................... Contribution margin ratio (b) ....................................... Contribution margin per buyer (a) × (b) .......................

$120 40% $48

$100 40% $40

Number of readers buying products (a) ........................ Contribution margin per buyer (b) ................................ Contribution margin provided by ad (a) × (b) ...............

910 $48 $43,680

1,000 $40 $40,000

Number of readers (a)................................................. Percent of readers who buy products (b) ...................... Number of readers who buy products (a) × (b) ............

130,000 0.7% 910

Differentiation value ....................................................

200,000 0.5% 1,000

$3,680

3. The economic value to the customer (EVC) is computed as follows: EVC = Reference value + Differentiation value EVC = $4,000 + $3,680 EVC = $7,680 4. The range of possible prices is as follows: Reference value ≤ Value-based price ≤ EVC $4,000 ≤ Value-based price ≤ $7,680

Chapter 13

Capital Budgeting Decisions Solution to Discussion Case 1.

While it is true that net present value (NPV) analysis does require estimates of cash inflows and outflows, it is still a highly useful technique for several reasons:  Best practice in using such techniques requires the use of conservative esti-

Managerial Accounting, 13th Canadian Edition



mates of inflows and outflows, especially those that are more uncertain. The use of conservatism can greatly enhance the usefulness of NPV analysis for decision-making purposes as it recognizes the uncertainty inherent to some estimates, especially those occurring several years in the future. Because of the use of discounted cash flows, the estimates furthest into the future for inflows and outflows have the smallest impact on the decision. That is, the discount factors are smaller for years further into the future, resulting in the related cash inflows and outflows having a smaller impact on the NPV. Sensitivity analysis can be prepared whereby different assumptions are made for cash inflows and outflows to determine the impact on a project‘s NPV. For example conservative estimates of inflows (outflows) can be decreased (increased) by a certain percentage to determine how this affects the NPV. This approach can give management an idea of how much the estimates can vary before the project becomes unattractive financially.

Factors that might reduce managers‘ tendency to manipulate estimates of cash inflows or outflows to improve a project‘s NPV:  Knowing that a post-audit will be performed after a project has been implemented can deter opportunistic behavior. For example, a post-audit that shows managers were highly optimistic in estimating cash inflows would not look good for the managers‘ reputation. As such, knowing that such audits will occur can be an effective means of encouraging realistic estimates when using NPV analysis. That said, a manager could always try to explain away actual inflows (outflows) falling short of (exceeding) their estimates as being due to the uncertainty inherent to such estimates. While this might be accepted as a one-off explanation, a repeated pattern of such unrealistic estimates would look bad for the manager.  Most companies have a code of conduct that specifies unacceptable (unethical) behaviour. Intentionally manipulating estimates of cash inflows and outflows would be unethical and if detected, could have serious implications for the offending managers, such as dismissal. Knowing this can deter managers from engaging in behaviour such as overstating (understating) cash inflows for a capital project.

Solutions to Questions 13-1 Agree. In the case of screening decision, capital is the constrained resource and the manager‘s task is to analyze how best to utilize that resource to maximize the company‘s profits. Projects with the highest profitability index are those that offer the best return on the capital available for projects and should thus be prioritized. Although screening decisions involve more complex analysis than the constrained resource

decisions examined in Chapter 12, conceptually they are very similar. 13-2 Discounting is the process of computing the present value of a future cash flow. Discounting gives recognition to the time value of money and makes it possible to meaningfully add together cash flows that occur at different times. © McGraw Hill Ltd. 2024. All rights reserved.

Solutions Manual, Chapter 13

641

13-3 The time value of money simply means that a dollar to be received at some future point in time (e.g., a year) is worth less than a dollar right now. This is an important concept in capital budgeting because all else equal, projects that provide returns sooner in time are worth more than those that provide returns further in the future. 13-4 No. The net book value of the old equipment is a sunk cost that should be ignored when calculating the NPV or IRR. Because it is not an incremental cash inflow of the new project, it is not relevant to the decision. 13-5 The main criticism of the simple rate of return method is that it ignores the time value of money. This means it treats a dollar received five years from now the same as a dollar received tomorrow for purposes of calculating the return. 13-6 One assumption is that all cash flows occur at the end of a period. Another is that all cash inflows are immediately reinvested at a rate of return equal to the discount rate. 13-7 Not necessarily. It is important to remember that estimates used to calculate a project‘s net present value (or IRR) are typically based on the information available to managers at the time the project was originally being considered. If conditions change after the project is implemented, actual cash inflows may well come in lower than estimated. For example, estimated sales for a project related to a new product introduction may be higher than the actual amounts realized because of actions a competitor took such as dropping prices or making product enhancements. Or, economic conditions may have changed since the original estimates were prepared causing demand to drop (e.g., a rise in interest rates). 13-8 Disagree. As with any financial investment, the higher a project‘s risk the higher the return needs to be to justify the capital spending. As such, for projects assessed to have higher risk, a higher discount rate should be used to calculate the NPV. For example, if a company typically uses its WACC to evaluate capital projects, riskier projects should use a discount rate higher than the WACC.

13-9 If the internal rate of return is equal to or greater than the required rate of return, the project is acceptable, otherwise it is not. 13-10 If both projects have the same useful life, then the one with the shorter cash payback period is typically preferable. However, if the projects do not have the same useful life, it is not necessarily the case that the one with the shorter payback period is preferable. When the useful lives of the alternatives under consideration differ, the analysis becomes more complicated. The best approach for doing the analysis in this case is to determine the cash flows for the alternatives over the same length of service. 13-11 No. As the discount rate decreases, the present value of a given future cash flow increases. For example, the present value factor for a discount rate of 14% for cash to be received ten years from now is 0.270, whereas the present value factor for a discount rate of 12% over the same period is 0.322. If the cash to be received in ten years is $10,000, the present value in the first case is $2,700, but increases to $3,220 in the second case. Thus, as the discount rate decreases, the present value of a given future cash flow increases. 13-12 These factors will vary from one company. Some examples include the project‘s impact on the environment, which may not be quantifiable. Similarly, a project‘s impact on employees‘ sense of well-being might be considered, which is also difficult to quantify. Further, in companies with multiple business divisions, senior management may feel the need to approve less profitable projects to maintain a sense of fairness among managers. 13-13 The project profitability index represents the profitability of a capital project (net present value) relative to the capital investment required. When comparing competing projects, those with higher project profitability indices should be considered more desirable, other factors held constant. The result is that those projects with lower initial investments are favoured,

Managerial Accounting, 13th Canadian Edition

13-14 By definition, the payback period is the length of time that it takes for a project to recover its initial cost from the net cash inflows that it generates. Because depreciation expense is not a cash outflow, it is not included in the calculation of the payback period. 13-15 The simple rate of return is more like an accounting rate of return (e.g., ROI) than the other methods covered in Chapter 13. As such, it includes accounting-based non-cash expenses such as depreciation in the numerator whereas the other methods covered in the chapter exclude non-cash items and focus only on incremental cash flows.

643

Foundational Exercises 1.

The depreciation expense of $300,000 is the only non-cash expense.

The annual net cash inflows are computed as follows: Operating income ................................................. Add: Noncash deduction for depreciation ............... Annual net cash inflow .........................................

$400,000 300,000 $700,000

The present value of the annual net cash inflows is computed as follows:

Item

Year(s)

Cash Flow

Present Value of Cash Flows*

1-5

$700,000

$2,523,343

Annual net cash inflows

*Calculated using the PV function in Excel using a 12% discount rate. 3. Net present value:

Item

Year(s)

Cash Flow

1-5 0

$700,000 $(2,400,000)

Annual net cash inflows Initial investment Net present value 4.

Present Value of Cash Flows $2,523,343 (2,400,000) $ 123,343

The project profitability index for the project is:

Item

Present Value of Cash Inflows (a)

Investment Required (b)

Project Profitability Index (a) ÷ (b)

Project

$2,523,343

$2,400,000

1.05

The project‘s internal rate of return using the IRR formula in Excel is 14.05%.

Managerial Accounting, 13th Canadian Edition

Foundational Exercises (continued) 6.

The payback period is determined as follows: Payback period=

Investment required Annual net cash flows

3.4 years= 7.

$2,400,000 $700,000

The simple rate of return is computed as follows: Return=

Incremental operating income Initial investment 16.7 =

$400,000 $2,400,000

If the discount rate was 10%, instead of 12 , the project‘s net present value would be higher because the discount or present value factors would be larger. (See Exhibit 13A-4 for the discount factors when the interest rate is 10% vs. 12%)

The payback period would be the same because the initial investment was recovered at the end of three years. The salvage value at the end of five years is irrelevant to the payback calculation.

10. The net present value would be higher because a $300,000 salvage value translates into a larger cash inflow in the fifth year. Although the salvage value would need to be translated to its lesser present value, it would still increase the project‘s net present value. 11. The simple rate of return would be higher. The salvage value would lower the annual depreciation expense by $60,000 ($300,000 ÷ 5 years), which in turn would raise the annual operating income and the simple rate of return. In addition, the salvage value would reduce the investment amount in the denominator thereby increasing the rate of return as well. 12. The new annual variable expense would be $1,600,000 ($3,200,000 × 50%), which is $200,000 lower than the original estimate. This means that the annual net cash inflows are $900,000 instead of $700,000 as originally estimated. Therefore the project‘s actual net present value would be computed as follows:

645

Foundational Exercises (continued)

Item Annual net cash inflows Initial investment Net present value

Year(s)

Cash Flow

1-5 0

$ 900,000 $(2,400,000)

Present Value of Cash Flows* $3,244,299 (2,400,000) $1,244,299

13. The project‘s internal rate of return using the IRR formula in Excel is 25.4%. 14. The actual payback period: 2.67 years=

$2,400,000 $900,000

15. Net present value:

Item Annual net cash inflows* Maintenance* Initial investment Net present value

Year(s)

Cash Flow

1-5 3 0

$700,000 (100,000) $(2,400,000)

Present Value of Cash Flows $2,523,343 $(71,178) $(2,400,000) $ 52,165

*Calculated using Microsoft Excel

Managerial Accounting, 13th Canadian Edition

Exercise 13-1 (10 minutes) 1.

Item

Year(s)

Cash Flow

Present Value of Cash Flows*

Annual cost savings ....... 1-5 $25,000 $99,818 Initial investment ........... Now $(80,000) (80,000) Net present value .......... $19,818 *Calculated using NPV formula in Microsoft Excel and an 8% required return. 2. Using the IRR formula in Microsoft Excel the printer‘s return is 17 . This can be proven by calculating the NPV using 17% as the discount rate. As the table below shows, this results in a NPV of $(16), which differs from $0 only because of rounding.

Item

Year(s)

Cash Flow

Annual cost savings ....... Initial investment ........... Net present value ..........

1-5 Now

$25,000 $(80,000)

Present Value of Cash Flows* $79,984 (80,000) $(16)

*Calculated using NPV formula in Microsoft Excel and a 17% required return. Exercise 13-2 (30 minutes) 1. Annual savings over present vehicle ....................................... Additional cash inflows from new customers ........................... Annual cash inflows ..............................................................

$6,000 4,000 $10,000

2. Using the IRR formula in Microsoft Excel the answer is 5.8%.

647

Exercise 13-3 (15 minutes) 1.

The solar panel‘s net present value without considering the intangible benefits would be:

Item

Year(s)

Amount of Cash Flows

Cost of the equipment ........ Annual cash savings............ Net present value ...............

Now 1-15

$(2,000,000) $200,000

Present Value of Cash Flows* $(2,000,000) 1,521,216 $(478,784)

*Calculated using NPV formula in Microsoft Excel and a 10% required return. 2. The annual value of the intangible benefits would have to be large enough to offset the $478,784 negative present value for the equipment. Using the PMT formula in Microsoft Excel, the required increase in annual cash flows to offset the negative NPV of $478,784 is approximately $62,948. In other words, the goodwill created among customers from investing in solar panels would need to generate an incremental contribution margin of nearly $63,000 ignoring taxes.

Managerial Accounting, 13th Canadian Edition

Exercise 13-4 (10 minutes) 1. The project profitability index for each proposal is:

Project

Present Value of Cash Inflows (a)

Investment Required (b)

Project Profitability Index (a) ÷ (b)

A B C D

$535,000 $590,000 $670,000 $730,000

$350,000 $390,000 $450,000 $480,000

1.53 1.51 1.49 1.52

2. The ranking would be:

Project

Project Profitability Index

A D B C

1.53 1.52 1.51 1.49

Note that project A has the lowest net present value of the four projects, but it is ranked first in terms of the project profitability index.

649

Exercise 13-5 (10 minutes) 1. The payback period is determined as follows:

Year

Investment

Cash Inflow

Unrecovered Investment

1 2 3 4 5 6 7 8 9 10

$15,000 $8,000

$1,000 $2,000 $2,500 $4,000 $5,000 $6,000 $5,000 $4,000 $3,000 $2,000

$14,000 $20,000 $17,500 $13,500 $8,500 $2,500 $0 $0 $0 $0

The investment in the project is fully recovered in the 7th year. To be more exact, the payback period is approximately 6.5 years. 2. Since the investment is recovered prior to the last year, the amount of the cash inflow in the last year has no effect on the payback period.

Managerial Accounting, 13th Canadian Edition

Exercise 13-6 (10 minutes) The annual incremental operating income is shown below along with the initial and net investment cost: Incremental contribution margin per year ................. Less annual depreciation on the drone ($10,000 $2,000) ÷ 4 years) ............................................... Annual incremental operating income .......................

$3,000 (2,000) $1,000

Initial investment..................................................... Less salvage value ................................................... Net initial investment ...............................................

$10,000 (2,000) $ 8,000

The simple rate of return is $1,000 ÷ $8,000 = 12.5%.

Exercise 13-7 (10 minutes)

Item

Year(s)

Amount of Cash Flows

Present Value of Cash Flows*

Green Future: Investment required....... Annual cash inflows ....... Net present value...........

Now 1-8

$(600,000) $150,000

$(600,000) 800,239 $ 200,239

Wharf Development: Investment .................... Cash inflow.................... Net present value...........

Now 8

$(600,000) $1,700,000

$(600,000) 793,063 $ 193,063

*Calculated using NPV formula in Microsoft Excel and an 10% required return. The Green Future investment should be selected since it provides a higher net present value.

651

Exercise 13-8 (10 minutes)

Purchase of the stand .......... Salvage value of old stand. Cost savings ........................ Salvage value of new stand**.... Net present value.................

Year(s)

Amount of Cash Flows

Present Value of Cash Flows*

Now Now 1-10 10

$(30,000) $1,000 $5,000 $2,500

$(30,000) 1,000 35,118 1,271 $7,389

*Calculated using NPV formula in Microsoft Excel and a 7% required return. **Note that the formula used in Microsoft Excel to calculate the present value of a single lump sum payment is: =PV(0.07,10,,-2500). Alternatively it is easier to add the salvage value of $2,500 in year 10 to the $5,000 cost saving resulting in a total inflow of $7,500 in year 10. This approach allows use of the NPV formula without needing a separate calculation for the present value of the salvage value in year 10. Exercise 13-9 (30 minutes) 1. Using the IRR formula in Microsoft Excel, the internal rate of return is 6.2%. 2. The revised IRR is 5.6%. It only decreased a small amount because the reduction in salvage value occurs 15 years hence. Thus, the impact on the IRR will be very small. Exercise 13-10 (10 minutes) The solution to this exercise requires a trial-and-error approach using the IRR function in Excel. Using this approach results in an estimate of $18,200 as the annual cost savings necessary to produce an IRR of 10%. Proof of the 10% is shown below.

System costs ....................... Recognition program costs…… Required cost savings........... Net present value.................

Year(s)

Amount of Cash Flows

Present Value of Cash Flows*

Now 1-5 1-5

$(50,000) $(5,000) $18,200

$(50,000) (18,954) 68,992 $38

Managerial Accounting, 13th Canadian Edition

Exercise 13-11 (15 minutes) 1. The payback period would be: Investment required Net annual cash inflow $210,000 4.2 years= $50,000

Payback period=

Yes, the boat would be purchased, since the 4.2-year payback period is less than the company‘s maximum 5-year payback period. 2. The simple rate of return would be computed as follows: Annual net cash inflows ...................................................... Less annual depreciation ($210,000 - $10,000 ÷ 10 years).... Annual incremental operating income .................................. Simple rate of return=

$50,000 20,000 $30,000

Incremental operating income Initial investment-salvage value

15 =

$30,000 $200,000

The boat would be purchased since its 15% rate of return is greater than the company‘s 12 required rate of return.

653

Exercise 13-12 (10 minutes) 1. The owner of Johnston Farms should first calculate the present value of the stream of cost savings estimated for the next five years. Amount Present Value $50,000 $44,643 $60,000 $47,832 $65,000 $46,266 $70,000 $44,486 $70,000 $39,720 $222,947

Year 1 Year 2 Year 3 Year 4 Year 5 Total

The most the owner should be willing to pay should be $222,947. At that price she will exactly earn a 12% return on her initial investment. 2. At a price of $245,242 ($222,947 x 1.10) the farm equipment will yield an internal rate of return of only 8.46%. 3. At a price of $245,242 and a salvage value of $40,000, the farm equipment will yield and internal rate of return of 12.06%. Since the return exceeds the minimum return required by the owner of Johnston Farms, she should purchase the equipment.

Exercise 13-13 (30 minutes) 1. 2.

Using the IRR formula in Microsoft Excel, the internal rate of return is 14%.

Item

Year(s)

Amount of Cash Flows

Initial investment ........... Annual cash inflows ....... Net present value ..........

Now 1-5

$(137,280) $40,000

Present Value of Cash Flows* $(137,280) 137,323 $ 43

*Calculated using NPV formula in Microsoft Excel and a 14% required return. The reason the net present value is so close to zero is that 14% (the discount rate we have used) represents the machine‘s internal rate of return. The internal rate of return is the discount rate that results in a zero net present value. 3. Using the IRR formula in Microsoft Excel results in an internal rate of return of only 11% if the annual cash inflows are only $37,150. © McGraw Hill Ltd. 2024. All rights reserved. 654

Managerial Accounting, 13th Canadian Edition

Exercise 13-14 (15 minutes)

Item

Year(s)

Amount of Cash Flows

Present Value of Cash Flows*

Project A: Cost of the equipment ....................... Annual cash inflows........................... Salvage value of the equipment** Net present value ..............................

Now 1-7 7

$(750,000) $210,000 $50,000

$(750,000) 756,964 13,954 $ 20,918

Project B: Working capital investment ................ Annual cash inflows........................... Working capital released .................... Net present value ..............................

Now 1-7 7

$(750,000) $150,000 $750,000

$(750,000) 540,689 209,311 $ 0

*Calculated using NPV formula in Microsoft Excel and a 20% required return. **Note that the formula used in Microsoft Excel to calculate the present value of a single lump sum cash inflow is: =PV(0.20,7,,-50000). Alternatively, it is easier to add the salvage value of $50,000 in year 7 to the other year 7 cash inflows. This approach allows use of the NPV formula without needing a separate calculation for the present value of the salvage value in year 7. The $750,000 should be invested in Project A rather than in Project B. Project B has a zero net present value, which means that it promises exact-ly a 20% rate of return. However, Project A has a positive net present value of nearly $21,000 and therefore is preferable over Project B.

655

Exercise 13-15 (15 minutes) 1. Computation of the annual cash inflow associated with the new go-cart track: Operating income ................................................. Add: Noncash deduction for depreciation ............... Net annual cash inflow .........................................

$14,000 19,750 $33,750

The payback computation would be: Investment required

Payback period =

Net annual cash inflow

$170,000 $33,750

5 years

2. The simple rate of return would be: Simple rate of return=

Incremental operating income Initial investment-salvage value $14,000 $158,000

= 8.9%

Managerial Accounting, 13th Canadian Edition

Problem 13-16 (15 minutes)

Item

Year(s)

Amount of Cash Flows

Cost of equipment required.............. Working capital required .................. Net annual cash receipts.................. Cost of road construction** ............. Salvage value of equipment** ......... Working capital released** .............. Net present value ............................

Now Now 1-4 3 4 4

$(275,000) $(100,000) $120,000 $(40,000) $65,000 $100,000

Present Value of Cash Flows $(275,000) (100,000) 310,648 (23,148) 31,346 48,225 $ (7,929)

*Calculated using NPV formula in Microsoft Excel and a 20% required return. **Note that the formula used in Microsoft Excel to calculate the present value of a single lump sum cash outflow is: =PV(0.20,3,,40000). Alternatively, it is easier to add the outflow of $40,000 in year 3 to the other year 3 cash inflows. This approach allows use of the NPV formula without needing a separate calculation for the present value of the salvage value in year 3. Either approach to dealing with lump sum inflows or outflows can be applied to the salvage value and working capital release in year 4. No, the project should not be accepted; it has a negative net present value. This means that the rate of return on the investment is less than the company‘s required rate of return of 20%.

657

Problem 13-17 (20 minutes) 1. The annual cash inflows would be: Reduction in annual operating costs: Operating costs, present hand method ............... Less operating costs, new machine .................... Total annual cash inflows ...................................... 2.

Item

Year(s)

Amount of Cash Flows

$68,000 (28,000) $40,000

Present Value of Cash Flows*

Cost of the machine .......... Now $(200,000) $(200,000) Overhaul required** ......... 5 $(10,000) (5,674) Annual cash inflows .......... 1-10 $40,000 226,009 Salvage value**................ 10 $18,000 5,795 Net present value ............. $ 26,130 *Calculated using NPV formula in Microsoft Excel and a 12% required return. **Note that the formula used in Microsoft Excel to calculate the present value of a single lump sum cash outflow is: =PV(0.12,5,,10000). Alternatively, it is easier to add the outflow of $10,000 in year 5 to the other year 5 cash inflows. This approach allows use of the NPV formula without needing a separate calculation for the present value of the overhaul required in year 5. Either approach to dealing with lump sum inflows or outflows can be applied to the salvage value in year 10. 3. Using the IRR formula in Microsoft Excel, the project has a 15% rate of return.

Managerial Accounting, 13th Canadian Edition

Problem 13-18 (30 minutes) 1. The net annual cost savings is computed as follows: Reduction in labour costs ................................................ Less increased costs ....................................................... Net annual cost savings ..................................................

$84,000 (10,000) $74,000

2. Using this cost savings figure, and other data provided in the text, the net present value analysis is:

Year(s) Cost of the system ...................... Installation and software ............. Severance payments ................... Annual cost savings .................... Net present value .......................

Now Now Now 1-5

Amount of Cash Flows $(225,000) $(162,500) $(20,000) $74,000

Present Value of Cash Flows* $ (225,000) (162,500) (20,000) 248,059 $ (159,441)

*Calculated using NPV formula in Microsoft Excel and a 15% required return. No, the new system should not be implemented since it has a negative NPV. 3. Using the PMT formula in Microsoft Excel, the intangible benefits would have to be worth at least $47,564 per year to offset the negative NPV of $159,441 calculated in part using a required return of 15%. Thus, the new system should be implemented if management believes that the intangible benefits are worth at least $47,564 per year to the company.

659

Problem 13-19 (20 minutes) 1. The formula for the project profitability index is: Present value of net cash inflows

Profitability index= Investment required by the project The index for the projects under consideration would be: Project 1: $336,140 ÷ $270,000 = 1.24 Project 2: $522,970 ÷ $450,000 = 1.16 Project 3: $433,400 ÷ $360,000 = 1.20 Project 4: $567,270 ÷ $480,000 = 1.18 2. a., b., and c.

Project 1 ....................... Project 2 ....................... Project 3 ....................... Project 4 .......................

Net Present Value

Rankings Project Profitability Index

Internal Rate of Return

4 3 2 1

1 4 2 3

2 1 4 3

3. The ―preferred‖ ranking depends on Revco‘s opportunities for reinvesting funds as they are released from the project. The IRR method assumes that any released funds are reinvested at the project‘s IRR. This means that funds released from project #2 would have to be reinvested in another project yielding a rate of return of 19%. Another project yielding such a high rate of return might be difficult to find. The profitability index approach assumes that funds released from a project are reinvested in other projects at a rate of return equal to the discount rate, which in this case is 10%. On balance, the profitability index is the most dependable method of ranking competing projects. Further, this method rewards lower investment cost projects. The net present value is inferior to the profitability index as a ranking device because it looks only at the total amount of net present value from a project and does not consider the amount of investment required. For example, it ranks project #1 as fourth in terms of preference because of its low net present value; yet this project is the best available in terms of the amount of cash inflow generated for each dollar of investment (as shown by the profitability index).

Managerial Accounting, 13th Canadian Edition

Problem 13-20 (30 minutes) 1. The annual incremental operating income can be determined as follows: Ticket revenue (50,000 × $3.60) ........................... Selling and administrative expenses: Salaries ............................................................ Insurance ......................................................... Utilities ............................................................. Depreciation*.................................................... Maintenance ..................................................... Total selling and administrative expenses ............... Operating income .................................................

$180,000 $85,000 4,200 13,000 27,500 9,800 139,500 $ 40,500

*$330,000 ÷ 12 years = $27,500 per year. 2. The formula for the simple rate of return is:

Annual incremental net operating income Simple rate = of return Initial investment (net of salvage from old equipment) =

$40,500 $40,500 = = 15% $330,000 - $60,000 $270,000

Yes, the water slide would be constructed. Its return is greater than the specified hurdle rate of 14%. 3. The formula for the payback period is: Payback = Investment required (net of salvage from old equipment) period Annual net cash inflow =

$330,000 - $60,000 $270,000 = = 3.97 years (rounded) $68,000* $68,000*

*Net operating income + Depreciation = Annual net cash flow $40,500 + $27,500 = $68,000. Yes, the water slide would be constructed. The payback period is within the 5 year payback required by Mr. Sharkey.

661

Problem 13-21 (30 minutes) The annual net cash inflow from rental of the property would be: Operating income ....................... Add back depreciation ................. Annual net cash inflow ................

$16,000 8,000 $24,000

Given this figure, the present value analysis would be as follows:

Amount of Cash Flows

Present Value of Cash Flows**

Item

Year(s)

Keep the property: Annual loan payment ............ Annual net cash inflow .......... Resale value of the property .. Present value of cash flows ...

1-9 1-15 15

$(6,300) $24,000 $66,000 *

$ (36,282) 182,546 15,800 $162,064

Sell the property: Payoff of mortgage ............... Down payment received ........ Annual payments received ..... Present value of cash flows ...

Now Now 1-15

$(35,500) $75,000 $11,500

$ (35,500) 75,000 87,470 $126,970

Net present value in favor of keeping the property .............

$ 35,094

*Land: $26,000 × 2 = $52,000; Building: $14,000; Total: $66,000. **Calculated using NPV formula in Microsoft Excel and a 10% required return. Thus, Ross should be advised to keep the property.

Managerial Accounting, 13th Canadian Edition

Problem 13-22 (45 minutes) 1. Present cost of temporary workers Less out-of-pocket costs to operate the cherry picker: Cost of an operator and assistant Insurance Fuel Maintenance contract Annual savings in cash operating costs

$40,000

$14,000 200 1,800 3,000

19,000 $21,000

2. The first step is to determine the annual incremental operating income: Annual savings in cash operating costs......................... Less annual depreciation ($94,500 ÷ 12 years) ............ Annual incremental operating income .......................... Simple rate of return= 13.9 =

$21,000 7,875 $13,125

Incremental operating income Initial investment

$13,125 (rounded) $94,500

No, the cherry picker would not be purchased. The expected return is less than the 16% return required by the farm. 3. The formula for the payback period is: Payback period=

Investment required Annual net cash inflow

4.5 years=

$94,500 $21,000

* In this case, the cash inflow is measured by the annual savings in cash operating costs. Yes, the cherry picker would be purchased. The payback period is less than 5 years. Note that this conclusion conflicts with the answer in Part 2.

663

Problem 13-22 (continued) 4. Using the IRR formula in Microsoft Excel, the internal rate of return is 19.6% based on an initial investment of $94,500 and annual cash inflows of $21,000 for 12 years. Note that the payback and internal rate of return methods would indicate that the investment should be made. The simple rate of return method indicates the opposite since the simple rate of return is less than 16%. The simple rate of return method generally is not an accurate guide in investment decisions as it ignores the time value of money.

Managerial Accounting, 13th Canadian Edition

Problem 13-23 (60 minutes) 1. Computation of the net annual cost savings: Savings in labour costs ($20 per hour × 20,000 hours) ............. Savings in inventory carrying costs .......................................... Total ...................................................................................... Less increased power and maintenance cost ($4,500 per month × 12 months) ......................................... Net annual cost savings .......................................................... 2. Cost of the module .................. Software and installation .......... Cash released from inventory ... Net annual cost savings ........... Salvage value**....................... Net present value ....................

Year(s)

Amount of Cash Flows

Now Now Now 1-15 15

$(2,400,000) $(1,050,000) $450,000 $546,000 $180,000

$400,000 200,000 600,000 (54,000) $546,000

Present Value of Cash Flows* $(2,400,000) (1,050,000) 450,000 3,192,664 22,121 $ 214,785

*Calculated using NPV formula in Microsoft Excel and a 15% required return. **Note that the formula used in Microsoft Excel to calculate the present value of a single lump sum cash inflow is: =PV(0.15,15,,-180000). Alternatively, it is easier to add the inflow of $180,000 in year 15 to the other year 15 cash inflows. This approach allows use of the NPV formula without needing a separate calculation for the present value of the salvage value in year 15. Yes, the module should be purchased. It has a positive net present value at a 15% discount rate. 3. Recomputation of the annual cost savings: Savings in labour costs ($20 per hour × 17,500 hours) ............. Savings in inventory carrying costs .......................................... Total ...................................................................................... Less increased power and maintenance cost ($4,500 per month × 12 months) ......................................... Net annual cost savings ..........................................................

$350,000 200,000 550,000 (54,000) $496,000

665

Problem 13-23 (continued) Recalculation of the net present value of the project:

Cost of the module ................ Software and installation ........ Cash released from inventory .. Net annual cost savings ......... Salvage value ........................ Net present value ..................

Year(s)

Amount of Cash Flows

Now Now Now 1-15 15

$(2,400,000) $(1,250,000) $450,000 $496,000 $180,000

Present Value of Cash Flows* $(2,400,000) (1,250,000) 450,000 2,900,296 22,121 $ (277,583)

*Calculated using NPV formula in Microsoft Excel and a 15% required return. It appears that the company did not make a wise investment because the rate of return that will be earned by the module is less than 15%. However, see part 4 below. This illustrates the difficulty in estimating data, and also shows what a heavy impact even seemingly small changes in the data can have on net present value. To mitigate these problems, some companies analyze several scenarios showing the ―most likely‖ results, the ―best case‖ results, and the ―worst case‖ results. Probability analysis can also be used when probabilities can be attached to the various possible outcomes. 4.

Using the PMT formula in Microsoft Excel, the additional annual cash inflows would have to be $47,471 per year to offset the negative NPV of $277,583 calculated in part using a required return of 15%. As a check, the NPV of annual cash inflows of $47,741 for 15 years using a discount rate of 15%, is $277,581.

Managerial Accounting, 13th Canadian Edition

Problem 13-24 (60 minutes) 1. Using the IRR formula in Microsoft Excel result in a 15.6% internal rate of return. Verification of the 16% rate of return:

Item

Year(s)

Amount of Cash Flows

Present Value of Cash Flows*

Investment in equipment ............ Now $(286,000) $(286,000) Annual cash inflows ................... 1-7 $70,000 286,062 Net present value....................... $ 62 ** *Calculated using NPV formula in Microsoft Excel and a 15.6% required return. **Difference due to rounding 2. Using the PMT formula in Microsoft Excel, we can determine the annual cash inflows for seven years that will provide a NPV of $286,000 and a rate of return of 14%. The result is $66,693.

667

Problem 13-24 (continued) 3. a. 5-year life for the equipment: Using the IRR formula in Microsoft Excel result in a 7.1% internal rate of return, rounded to nearest whole percentage. b. 9-year life for the equipment: Using the IRR formula in Microsoft Excel result in a 19.6% internal rate of return, rounded to nearest whole percentage. The 7.1% return in part (a) is less than the 14% minimum return that Boothe wants to earn on the project. Of equal or even greater importance, the following diagram should be pointed out to Boothe: 2 years shorter 5 years 7.1%

2 years longer 7 years 15.6%

A reduction of 8.5%

9 years 19.6% An increase of only 4%

As this illustration shows, a decrease in years has a much greater impact on the rate of return than an increase in years. This is because of the time value of money; added cash inflows further into the future do little to enhance the rate of return, but loss of cash inflows in the near term can do much to reduce it. Therefore, Boothe should be very concerned about any potential decrease in the life of the equipment, while at the same time realizing that any increase in the life of the equipment will do little to enhance her rate of return, which is unlikely anyway due to the nature of technology.

Managerial Accounting, 13th Canadian Edition

Problem 13-24 (continued) 4. a. The expected annual cash inflow would be: $70,000 x 115% = $80,500. Using the IRR formula in Microsoft Excel result in a 20.5% internal rate of return, rounded to one decimal place. b. The expected annual cash inflow would be: $70,000 x 85% = $59,500. Using the IRR formula in Microsoft Excel result in a 10.4% internal rate of return, rounded to one decimal place. Unlike changes in time, increases and decreases in cash flows at a given point in time have basically the same impact on the rate of return, as shown below: 15% decrease in cash flow $59,500 cash inflow 10.4%

$70,000 cash inflow 15.6% A decrease of 5.2%

15% increase in cash flow $80,500 cash inflow 20.5% An increase of 4.9%

Using the IRR formula in Microsoft Excel result in a 11.8% internal rate of return. Note that in year 5, the total cash inflows are $180,000 ($60,000 + $120,000).

669

Problem 13-25 (30 minutes) 1. The present value of the purchase alternative is computed as follows: Purchase Alternative:

Year(s)

Amount of Cash Flows

Present Value of Cash Flows*

Cost of the fleet ....................... Now $(170,000) $(170,000) Annual service costs ................. 1-3 $(3,000) (6,523) Repairs* .................................. 1 $(1,500) (1,271) Repairs .................................... 2 $(4,000) (2,873) Repairs .................................... 3 $(6,000) (3,652) Salvage value .......................... 3 $85,000 51,733 Net present value ..................... $(132,586) *Calculated using NPV formula in Microsoft Excel and a 18% required return. **Note that the formula used in Microsoft Excel to calculate the present value of a single lump sum cash outflow is: =PV(0.18,1,,1,500). Alternatively, it is easier to add the outflow of $1,500 in year 1 to the other year 1 cash outflows. This approach allows use of the NPV formula without needing a separate calculation for the present value of the salvage value in year 15. The other lump sum outflows and inflows in years 2 and 3 can also be handled using either of these two approaches. 2. The present value of the lease alternative is computed as follows: Lease Alternative:

Year(s)

Amount of Cash Flows

Present Value of Cash Flows*

Security deposit ....................... Now $(10,000) $(10,000) Annual lease payments............. 1-3 $(55,000) (119,585) Deposit refund** ..................... 3 $10,000 6,086 Net present value ..................... $(123,499) *Calculated using NPV formula in Microsoft Excel and a 18% required return. **See the footnote in part 1 above for an alternative approach to calculating the present value of the lump sum deposit refund. 3. The company should lease the cars because this alternative has the lowest present value of total costs.

Managerial Accounting, 13th Canadian Edition

Problem 13-26 (30 minutes) 1. The formula for the project profitability index is: Present value of cash inflows

Profitability index= Investment required by the project The project profitability index for each project is: Project 1: Project 2: Project 3: Project 4:

$2,457,621 ÷ $1,960,000 = 1.25 $2,126,250 ÷ $1,653,750 = 1.29 $1,619,144 ÷ $1,225,000 = 1.32 $2,058,224 ÷ $1,715,000 = 1.20

2. a., b., and c.

Net Present Value Project 1 .......................... Project 2 .......................... Project 3 .......................... Project 4 ..........................

1 2 3 4

Rankings Project Profit- Internal Rate of ability Index Return 3 2 1 4

4 1 3 2

3. Which ranking is best depends on Riley and Tanner Limited‘s opportunities for reinvesting funds as they are released from a project. The internal rate of return method assumes that released funds are reinvested at the internal rate of return. For example, funds released from project 2 would have to be reinvested in another project yielding a rate of return of 23%. It might be difficult to find another project yielding such a high rate of return. The project profitability index assumes that funds released from a project are r einvested at a rate of return that is equal to the discount rate, which in this case is only 10%. On balance, the project profitability index is generally regarded as being the most dependable method of ranking competing projects. The net present value is inferior to the project profitability index as a ranking device because it does not consider the amount of investment required.

671

Problem 13-27 (45 minutes) 1. The payback period for Products A and B are calculated as follows: Product A $250,000

Sales revenues

Product B $350,000

Variable expenses (120,000) (170,000) Fixed out-of-pocket operating costs (70,000) (50,000) Annual net cash inflows $ 60,000 $130,000 Product A Cash Payback period: Payback=

Investment Annual net cash inflows

2.83 years=

$170,000 $60,000

Product B Cash Payback period: Payback=

Investment Annual net cash inflows

2.92 years=

$380,000 $130,000

2. Net present value for Products A and B: Present Product A Year(s) Cash Flow Value Equipment purchase Now $(170,000) $(170,000) Sales Variable expenses Fixed expenses Net cash inflow Net present value

1-5 1-5 1-5 1-5

$250,000 (120,000) (70,000) $60,000

$196,458 $26,458

Managerial Accounting, 13th Canadian Edition

Problem 13-27 (continued) 2. Present Product B Year(s) Cash Flow Value Equipment purchase Now $(380,000) $(380,000) Sales Variable expenses Fixed expenses Net cash inflow Net present value

1-5 1-5 1-5 1-5

$350,000 (170,000) (50,000) $130,000

$425,658 $45,658

3. The internal rate of return for Products A and B calculated using Microsoft Excel are: Product A: 22.5% Product B: 21.05% 4. The profitability index for each product is calculated below: Product A Product B Present value of cash inflows (a) $196,458 $425,658 Investment required (b) Profitability index (a)  (b)

$170,000 1.16

$380,000 1.12

5. Simple rate of return for Product A and Product B Product A: Simple return=

Annual p ati g i c m aft Initial investment 15.3 =

Product B: 14.2 =

p ciati

$26,000 $170,000

$54,000 $380,000

6. The net present value calculations suggest that Product B is preferable to Product A. However, the profitability index reveals that Product A is the preferred choice. The payback period, internal rate of return, and simple rate of return all favor Product A over Product B. However, it bears emphasizing that Lou Barlow may be inclined to reject both products because the simple rate of return for each product is lower than his division‘s historical return on investment of 18 . © McGraw Hill Ltd. 2024. All rights reserved. Solutions Manual, Chapter 13

673

Problem 13-28 (60 minutes) 1. The net cash inflow from sales of the detectors for each year would be:

Year 1 Sales in units ......................... Contribution margin: $60 per unit ($135-$75) .................. Less fixed expenses: Advertising ......................... Other fixed expenses* ........ Total fixed expenses .............. Net cash inflow (outflow) .......

4-12

4,000

7,000

10,000

12,000

240,000

420,000

600,000

720,000

210,000 360,000 570,000 $(330,000)

210,000 360,000 570,000 $ (150,000)

150,000 360,000 510,000 $ 90,000

120,000 360,000 480,000 $ 240,000

* Depreciation is not a cash outflow and therefore must be eliminated when determining the net cash flow. The analysis is: Cost of the equipment .................... Less salvage value (10%) ............... Net depreciable cost .......................

$300,000 30,000 $ 270,000

$ 270,000 ÷ 12 years = $22,500 per year depreciation $382,500 – $22,500 depreciation = $360,000 cash fixed expenses

Managerial Accounting, 13th Canadian Edition

Problem 13-28 (continued) 2. The net present value of the proposed investment would be:

Item Investment in equipment.......... Working capital investment ....... Yearly cash flows** .................. " " " ...................... " " " ...................... " " " ...................... Salvage value of equipment ...... Release of working capital ........ Net present value.....................

Year(s) Now Now 1 2 3 4-12 12 12

Present Value Amount of Cash of Cash Flows Flows* $(300,000) $(120,000) $(330,000) $(150,000) $90,000 $240,000 $30,000 $120,000

$(300,000) (120,000) (286,957) (113,422) 59,176 752,975 5,607 22,429 $ 19,808

*Calculated using NPV formula in Microsoft Excel and a 15% required return. **Note that the formula used in Microsoft Excel to calculate the present value of a single lump sum cash outflow is: =PV(0.15,1,,330,000). Alternatively, it is easier to add the inflow of $150,000 in year 12 to the other year 12 cash flows. This approach allows use of the NPV formula without needing a separate calculation for the present value of the lump sum amounts in any particular year. The other single lump sum outflows and inflows in this problem can also be handled using either of these two approaches. Since the net present value is positive, the company should accept the smart-home monitoring system as a new product. 3. Using the IRR formula in Microsoft Excel, the IRR is 15.4%. Note that the fact that the IRR is just above the required return of 15% is consistent with the relatively small NPV determined in part 2 above.

675

Problem 13-29 (30 minutes) 1. The total-cost approach:

Year(s)

Amount of Cash Present Value of Flows Cash Flows*

Purchase the new units: Cost of the new units ...................... Salvage of the old units ................... Annual cash operating costs ............ Salvage of the new units ................. Present value of the net cash outflows

Now Now 1-10 10

$(6,000) $500 $(1,100) $1,000

$(6,000) 500 (7,381) 463 $(12,481)

Keep the old units: Repairs needed now ......................... Annual cash operating costs .............. Salvage of the old units ..................... Present value of the net cash outflows

Now 1-10 10

$(2,000) $(1,500) $0

$ (2,000) (10,065) 0 $(12,065)

Net present value in favour of keeping the old units.................................... $ 353 *Calculated using NPV formula in Microsoft Excel and an 8% required return. Jackie should repair the old units since that option has the lowest present value of total cost.

Managerial Accounting, 13th Canadian Edition

Problem 13-29 (continued) 2.

The incremental-cost approach:

Year(s) Incremental investment—new units* ... Salvage of the old units....................... Savings in annual cash operating costs Difference in salvage value in 10 years. Net present value in favour of keeping the old units ..................................

Now Now 1-10 10

Amount of Cash Present Value of Flows Cash Flows** $(4,000) $500 $400 $1,000

$(4,000) 500 2,684 463 $ 353

*$6,000 – $2,000 = $4,000. **Calculated using NPV formula in Microsoft Excel and an 8% required return.

3. A key non-financial factor Jackie should consider is that the new washer and dryer are more environmentally friendly since they both will use less electricity and the washer uses less water. Even though the analysis slightly favours keeping the old equipment, Jackie might decide that the environmental advantage of the new washer and dryer outweighs the financial disadvantage of purchasing them.

677

Problem 13-30 (30 minutes) 1. Average weekly use of the auto wash and the vacuum will be:

Auto wash:

$1,350 = 675 uses $2.00

Vacuum: 675 × 60% = 405 uses The expected annual net cash flow from operations would be: Auto wash cash receipts ($1,350 × 52) ...................... Vacuum cash receipts (405 × $1.00 × 52) .................. Total cash receipts.................................................. Less cash disbursements: Water (675 × $0.20 × 52) ...................................... Electricity (405 × $0.10 × 52) ................................. Rent ($1,700 × 12) ................................................ Cleaning ($450 × 12) ............................................. Insurance ($75 × 12) ............................................. Maintenance ($500 × 12) ....................................... Total cash disbursements ........................................... Annual net cash flow from operations .........................

$70,200 21,060 91,260 $ 7,020 2,106 20,400 5,400 900 6,000 41,826 $49,434

Year(s)

Amount of Cash Flows

Present Value of Cash Flows*

Cost of the equipment ........... Working capital ...................... Net annual cash inflows .........

Now Now 1-5

$(175,000) $(2,000) $49,434

$(175,000) (2,000) 187,394

Working capital release Salvage value ........................ Net present value ..................

5 5

$2,000 $17,500

1,242 10,866 $ 22,502

Yes, the carwash should be opened since it generates a positive net present value.

Managerial Accounting, 13th Canadian Edition

Case 13-31 (45 minutes) 1. It is worth pointing out that the CPA Ontario Code of Professional Conduct applies to ―all members and firms, irrespective of the type of professional services being provided‖ (p. 1). Therefore, even though Scott is in a management position at a financial institution, the code still applies to her. Given what Scott knows about the capital budgeting process at the Bank of Ontario, doing nothing could be a violation of several of the principles identified in the Code of Conduct on pages 2-4, most notably:  Professional behaviour: this principle states that CPAs should always conduct themselves in a way that will maintain the ―good reputation of the profession and serve the public interest.‖ Doing nothing would involve ignoring the unethical behaviour the divisional controllers are engaging in. Doing nothing would also not be in the best interest of the bank‘s shareholders since projects may be approved that aren‘t meritorious.  Integrity and due care: this principle requires CPAs to act diligently in performing their duties and to act ―carefully, thoroughly, and on a timely basis.‖ Doing nothing while knowing that the capital budgeting estimates are clearly biased would be a violation of this principle.  Objectivity: this principle requires CPAs to exercise their professional judgment without being compromised by ―bias, conflict of interest or the undue influence of others.‖ Doing nothing would be in violation of this principle as Scott would be acquiescing to the pressure of the divisional controllers not to do anything.  Professional competence: this principle requires a CPA to both maintain professional skills as well as complying with developments related to their role. As such, doing nothing could be viewed as incompetence since it is reasonable to expect that a CPA would understand the appropriate approach to analyzing capital projects does not involve significant bias.

679

Case 13-31 (continued) 2. So what to do? Although she could try insisting that the divisional controllers revise their proposals to provide reasonable estimates, this probably won‘t be successful given what appears to be a pervasive and ingrained problem at the Bank. Scott‘s best bet would be to speak with the controller and perhaps the CFO together and fill them in on what she has learned. Hopefully they are not part of the problem but if they refuse to take action, Scott may need to speak with the V.P. Finance or a senior Human Resources manager to get advice on how to proceed. A more effective longterm solution, as will be discussed in part 3 below will be to implement a thorough and independent post-audit process.

3. The potential benefits of a thorough and independent post-audit process are twofold. First, if the divisional controllers know that approved projects will be subjected to a post-audit review to evaluate whether the estimated benefits of the project are being realized, they will be more likely to develop realistic projections for the cash inflows and outflows. The accountability to provide cash flow estimates based on reasonable assumptions created by the existence of a post-audit process can reduce the type of game-playing currently on-going at the Bank of Ontario. Second, the results of the post-audit review can be used to help preparers understand the causes of inaccurate estimates included in the original proposal. For example, the review may reveal that the original proposal inadvertently omitted or understated certain cash outflows (e.g., maintenance costs on equipment). In some cases this may help improve the accuracy of future proposals for capital expenditures of a similar nature. Moreover, if the post-audit review reveals that projects had unreasonable cash flow projections suggestive of intentional bias, and senior management follows-up with the preparer(s) of the proposal, any negative consequences that result may serve as a deterrent for those tempted to inflate benefits included in future proposals.

Managerial Accounting, 13th Canadian Edition

Case 13-31 (continued) 4. It is important to recognize that there will always be uncertainty regarding some of the cash flow estimates (e.g., cost reductions, revenue increases, etc.) included in a capital budget proposal. As such, the existence of a thorough post-audit process cannot be expected to result in proposals that are entirely free of optimism or inaccuracies. Moreover, hindsight may make it appear that some projections were unreasonably optimistic but they may have been fair given the information available to the preparer at the time of the proposal was developed. Thus, it is critical that the process not be used as a blame-laying exercise that assumes bias exists in the projections. Even wellintentioned estimates can appear biased with the benefit of hindsight. Although a thorough post-audit can never completely eliminate optimism in capital budget proposals, the accountability that is established by the existence of the process can certainly make a difference in the reasonableness of the estimates.

681

Case 13-32 (60 minutes) 1. A net present value computation for each investment follows:

Amount of Cash Flows

Present Value of Cash Flows*

Item

Year(s)

Common stock: Purchase of the stock ............... Sale of the stock ...................... Net present value.....................

Now 3

$(95,000) $160,000

$(95,000) 102,505 $ 7,505

Preferred stock: Purchase of the stock ............... Annual cash dividend (6%)....... Sale of the stock ...................... Net present value.....................

Now 1-3 3

$(30,000) $1,800 $27,000

$(30,000) 4,043 17,298 $(8,659)

Bonds: Purchase of the bonds.............. Semiannual interest received .... Sale of the bonds ..................... Net present value.....................

Now 1-3 3

$(50,000) $6,000 $52,700

$(50,000) 13,475 33,763 $ (2,762)

Linda earned a 16% rate of return on the common stock but not on the preferred stock or the bonds.

Managerial Accounting, 13th Canadian Edition

Case 13-32 (continued) 2. Considering all three investments together, Linda did not earn a 16% rate of return. The computation is:

Net Present Value Common stock ................................. Preferred stock ................................ Bonds ............................................. Overall net present value ..................

$ 7,560 (8,650) (2,743) $(3,833)

The problem with the broker‘s computation is that it does not consider the time value of money and therefore has overstated the rate of return earned. 3. Using the PMT formula in Microsoft Excel shows that the $239,700 investment in the retail store must generate at least $42,348 in net cash inflows each year for 12 years to generate a return of 14%.

683

Connecting Concepts: Section 4 (75 minutes) 1. The analysis below indicates that the new marketing specialist should be hired since the net present value over the five-year period exceeds that of the alternative to discontinue the operations by over $48,000. Note to instructors: the analysis illustrated below assumes students have read Appendix 13B and therefore understand how to incorporate income tax effects in their analysis. (1) × (2) (1)

(2)

Amount

Tax Effect

After-Tax Cash Flows

Present Value of Cash Flows*

Items and Computations

Year(s)

Discontinue South American operations: Salvage proceeds ................................... Severance pay ....................................... Contribution margin foregone*

Now Now 1-5

$15,000 $(50,000) $(220,000)

— 1 – 0.35 1 – 0.35

$15,000 $(32,500) $(143,000)

$15,000 $(32,500) $(515,483)

1-5

$270,000

1 – 0.35

$175,500

$632,638 $ 99,655

Fixed costs avoided** ............................ Net present value ...................................

*$400,000 - $180,000 **$310,000 - $40,000 of allocated computer support costs since these will be incurred even if the South American division is discontinued. As such, they are irrelevant to the decision.

Managerial Accounting, 13th Canadian Edition

Connecting Concepts: Section 4 (continued) (1) Items and Computations Hire a new marketing specialist: Investment in office furniture Net annual cash flows Operating income (loss)1 Operating income (loss)2 Operating income (loss)3 Operating income (loss)4 Operating income (loss)5 CCA tax shield: Cdt d +k =5,000 × .1 × .35 .10 + .12 Net present value ...................................

Year(s)

Amount

(2) Tax Effect

(1) × (2) After-Tax Cash Flows

Present Value of Cash Flows

Now

$(5,000)

—

$(5,000)

$ (5,000)

1 2 3 4 5

$(70,000) $40,000 $105,000 $160,000 $215,000

1 – 0.35 1 – 0.35 1 – 0.35 1 – 0.35

$(70,000) $26,000 $68,250 $104,000 $139,750

$(62,500) $ 20,727 $ 48,579 $ 66,094 $ 79,298

$ 795 $147,993

$600,000 ($400,000 + $200,000) - $270,000 - $20,000 ($200,000 x 10%) - $380,000 ($310,000 - $40,000* + $110,000) 2 $800,000 ($600,000 + $200,000) - $360,000 - $20,000 ($200,000 x 10%) - $380,000 ($310,000 - $40,000 + $110,000) 3 $900,000 ($800,000 + $100,000) - $405,000 - $10,000 ($100,000 x 10%) - $380,000 ($310,000 - $40,000 + $110,000) 4 $1,000,000 ($900,000 + $100,000) - $450,000 - $10,000 ($100,000 x 10%) - $380,000 ($310,000 - $40,000 +$110,000) 5 $1,100,000 ($1,000,000 + $100,000) - $495,000 - $10,000 ($100,000 x 10%) - $380,000 ($310,000 - $40,000 +$110,000) *$40,000 fixed expense allocation is irrelevant to the decision since it will be incurred with or without the South American division. © McGraw Hill Ltd. 2024. All rights reserved. Solutions Manual, Chapter 13

685

Connecting Concepts: Section 4 (continued) 2. Qualitative factors that should be considered when deciding whether to discontinue operations:  

 

Discontinuing operations in SA could be harmful to EL‘s reputation, which could affect its relationships with existing or prospective customers in other locations. The success of the option to hire a new marketing specialist relies on retention of all existing and new customers acquired over the next five years, which may be very optimistic. Losing any customer will have a negative impact on the NPV of this option. If the marketing specialist is unable to acquire as many new customers as anticipated, the NPV will be negatively affected. If the other employees in the Argentina office find out that the marketing specialist is being paid a high salary plus commission on revenues from new customers, this could cause resentment, which could lead to employee dissatisfaction or turnover.

Managerial Accounting, 13th Canadian Edition

Connecting Concepts: Section 4 (continued) 3. Revised analysis given the new assumption about acquiring new customers: (1) (2) Tax Items and Computations Year(s) Amount Effect Hire a new marketing specialist: Investment in office furniture Now $(5,000) — Net annual cash flows Operating income (loss)1 1 $(70,000) Operating income (loss)2 2 $(5,000) 3 Operating income (loss) 3 $50,000 1 – 0.35 4 Operating income (loss) 4 $105,000 1 – 0.35 Operating income (loss)5 5 $160,000 1 – 0.35 CCA tax shield: Cdt d +k =5,000 × .1 × .35 .10 + .12 Net present value ...................................

(1) × (2) After-Tax Cash Flows

Present Value of Cash Flows

$(5,000)

$ (5,000)

$(70,000) $(5,000) $32,500 $68,250 $104,000

$(62,500) $ (3,986) $ 23,133 $ 43,374 $ 59,012

$ 795 $54,828

$600,000 ($400,000 + $200,000) - $270,000 - $20,000 ($200,000 x 10%) - $380,000 ($310,000 - $40,000* + $110,000) $700,000 ($600,000 + $100,000) - $315,000 - $10,000 ($100,000 x 10%) - $380,000 ($310,000 - $40,000 + $110,000) 3 $800,000 ($700,000 + $100,000) - $360,000 - $10,000 ($100,000 x 10%) - $380,000 ($310,000 - $40,000 + $110,000) 4 $900,000 ($800,000 + $100,000) - $405,000 - $10,000 ($100,000 x 10%) - $380,000 ($310,000 - $40,000 +$110,000) 5 $1,000,000 ($900,000 + $100,000) - $450,000 - $10,000 ($100,000 x 10%) - $380,000 ($310,000 - $40,000 +$110,000) 2

*$40,000 fixed expense allocation is irrelevant to the decision since it will be incurred with or without the South American division.

687

Connecting Concepts: Section 4 (continued) 3. (continued) The net present value of the option to hire a new marketing specialist is now only $54,828, which makes it more attractive to discontinue the South American operations since this alternative has a net present value of $99,655. 4. The recommendation in this case is highly sensitive to the assumption about the number of new customers the marketing specialist will be able to acquire. Assuming that only one new customer instead of two is acquired in the second year is enough to make this alternative less attractive than discontinuing operations. This suggests that risk inherent to this alternative is quite high. An argument could be made that the required return should be significantly higher than 12% to reflect the additional operating risk of this alternative. Although EL requires an average return of 12% across its capital investments, options with higher operating risk, such as hiring the new marketing specialist should likely be analyzed using a higher required rate of return. There is no ‗right‘ answer regarding the return to use in the analysis but sensitivity analysis could be prepared whereby the NPV is calculated using different rates such as 14%, 16%, 18% and so on.

Managerial Accounting, 13th Canadian Edition

Appendix 13A Solutions Note to instructors: for illustrative purposes we use the formulas presented in Appendix 13A to calculate all amounts and also show the solutions for Exercise 13A-1 using the discount factors from Exhibits 13A-4 and 13A-5. Students can of course use Microsoft Excel or a financial calculator to arrive at the same (similar) answers. Exercise 13A-1 (15 minutes) 1. a. Using formula A3: =$250,000(1+.05)-5 =$195,882 Or using the discount factor for 5% and 5 periods from Exhibit 13A-4: = $250,000 x 0.784 = $196,000 (difference due to rounding) b. $ Using formula A3: =$250,000(1+.09)-5 =$162,483 Or using the discount factor for 9% and 5 periods from Exhibit 13A-4: = $250,000 x 0.650 = $162,500 (difference due to rounding) 2. a. Using formula A4: 1-(1+0.12)-20 = x $3,000 0.12 = $22,408

Or using the discount factor for 12% and 20 periods from Exhibit 13A-5: = $3,000 x 7.469 = $22,407 (difference due to rounding)

689

Exercise 13A-1 (continued) 3. Using formula A4: 1-(1+0.08)-25 = x $40,000 0.08 = $426,991 Or using the discount factor for 8% and 25 periods from Exhibit 13A-5: = $40,000 x 10.675 = $427,000 (difference due to rounding) Whether or not Dan really won a million dollars depends on your point of view. He will receive a million dollars over the next 25 years ($40,000 × 25 years); however, in terms of its value today he won much less than a million dollars as shown by the present value computation above.

Managerial Accounting, 13th Canadian Edition

Exercise 13A-2 (30 minutes) 1.

Present Value of Cash Flows*

Amount of Cash Flows Year(s)

$3,000

$12,000

$ 2,500

$10,000

$6,000

$9,000

4,167

6,250

$9,000

$6,000

5,208

3,472

$12,000

$3,000

5,787

1,447

$17,662

$21,169

*Present values are calculated using formula A3: P=Fn(1+r)-n 2. a. Using formula A3, the present value of the required investment is: =$10,000(1+.06)-4 = $7,921 b. Using formula A3, the present value of the required investment is: =$10,000(1+.12)-4 = $6,355 3.

Option

Year(s)

A B

Now 1-8 8

Amount of Cash Present Value of Flows Cash Flows $250,000 $30,000 $100,000

$250,000 $210,591 78,941 $289,532

* **

*Calculated using formula A4; **Calculated using formula A3 Mark should accept option B.

691

Exercise 13A-2 (continued) 4. You should prefer option b since it has the largest present value: Option a: $100,000 × 1.000 = $100,000. Option b (formula A3): =$150,000(1+.08)-5 = $102,087 Option c (formula A4): =

1-(1+0.08)-5 x $24,000 0.08

= $95,825

Managerial Accounting, 13th Canadian Edition

Appendix 13B Solutions Note to Instructors: Solutions for 13B-2 through 13B-6 reflect use of the 150% accelerated investment incentive rule for purposes of calculating the present value of the CCA tax shield since that rule was still in place at the time the 13th Edition was finalized. However, notes have been added to each solution indicating the impact on the present value of the CCA tax shield and the project‘s overall NPV, assuming the asset was acquired during the 2024-2027 transition period. During that period 100% of normal CCA (not 150%) will be permitted in the year of acquisition. For examples of the application of the accelerated investment incentive rule before and during the transition period click here.

Exercise 13B-1 (10 minutes) 1. Consulting fees ................................. Multiply by 1 – 0.40........................... After-tax cost ....................................

$100,000 × 0.60 $ 60,000

2. Increased revenues ........................... Multiply by 1 – 0.30........................... After-tax cash flow (benefit) ..............

$500,000 × 0.70 $350,000

Undepreciated Capital Cost $800,000 440,000 308,000

Tax Savings 90,000 33,000 23,100

PV of 3. CCA Tax Savings* 1 ................ 360,000 $81,818 2 ................ 132,000 27,273 3 ................ 92,400 17,355 Total $126,446 *Calculated using the NPV formula in Microsoft Excel and a 12% required rate of return.

693

Exercise 13B-2 (20 minutes)

Items and Computations

Year(s)

Investment 1: Investment in robotics equipment Now Net annual cash flows 1-12 Salvage value of the equipment 12 CCA tax shield: Cdt × 1+ 1.5k – Sdt × (1+k)-n d+k 1+k d+k

(1)

(2)

Amount

Tax Effect

$(400,000) $100,000 $75,000

(1) × (2) After-Tax Cash Flows

— 1 – 0.30

$(400,000) $70,000 $75,000

— 1 – 0.30

$(400,000 $70,000

=400,000 × .3 × .3 × 1.18 – 75,000 × .3 × .3 × .257 .3 + .12 1.12 .3+.12 = ($85,714 × 1.0536) – ($16,071 × 0.257)= $86,178** Net present value ................................... Investment 2: Investment in working capital ................. Net annual cash flows ............................

Now 1-12

$(400,000) $100,000

Release of working capital ...................... 12 $400,000 — Net present value ................................... *Calculated using the NPV formula in Microsoft Excel and a required return of 12%. **Per Appendix 13B if the asset is acquired during the 2024-2027 period, the PV of the CCA tax shield will only be $85,714 since the 150% rule will no longer be in effect; 100% of normal CCA is allowed in the year of acquisition during that period. This would have the effect of reducing the Investment 1 NPV by $4,594 and would make Investment 2 the better option. Given the results of the analysis, Courtney Limited should invest in Investment 1.

Managerial Accounting, 13th Canadian Edition

$400,000

Exercise 13B-3 (20 minutes) 1. Annual reduction in part-time wages .......................... Annual cost of the new machine ................................. Net annual cost savings (cash inflow)..........................

$50,000 4,000 $46,000

2. The net present value analysis follows:

(2) Tax Effect

(1) × (2) After-Tax Cash Flows $(300,000) $34,500 $(6,000) $50,000

Items and Computations

Year(s)

(1) Amount

Cost of the new checkout machine .............. Net annual cost savings (above) ................. Cost of the maintenance ............................ Salvage value of the new machine .............. Tax shield: Cdt × 1+ 1.5k – Sdt × (1+k)-n d+k 1+k d+k

Now 1-12 6 12

$(300,000) $46,000 1 – 0.25 $(8,000) 1 – 0.25 $50,000

300,000 × .3 × .25 × 1.12 – 50,000 × .3 × .25 × .397 .3 + .08 1.08 .3+.08 = ($59,211 × 1.0370) – ($9,868 × .397) =$57,486** Net present value....................................... *Calculated using the NPV formula in Microsoft Excel and a required return of 8%. **Per Appendix 13B if the asset is acquired during the 2024-2027 period, the PV of the CCA tax shield will only be $59,211 since the 150% rule will no longer be in effect; 100% of normal CCA is allowed in the year of acquisition during that period. This would have the effect of reducing the NPV by $2,191. Yes, the new checkout machine should not be purchased.

695

Pre of C

Problem 13B-4 (20 minutes)

Items and Computations

Year(s)

Net investment in new equipment** ........... Working capital required ............................. Net annual cash receipts ............................ Maintenance year 3 .................................... Maintenance year 4 Working capital release .............................. CCA tax shield: PV =Cdt × 1+ 1.5k d+k 1+k

Now Now 1-5 3 4 5

(420,000 -80,000) × .2 × .3 × .2 + .12

(1) Amount

(2) Tax Effect

$(340,000) $(65,000) $135,000 1 – 0.30 $(20,000) 1 – 0.30 $(20,000) 1 – 0.30 $65,000

(1) × (2) Af- Pres ter-Tax Cash o Flows F $(340,000) $(65,000) $94,500 $(14,000) $(14,000) $65,000

1.18 1.12

= ($63,750 × 1.0536)*** = Net present value....................................... *Calculated using the NPV formula in Microsoft Excel and a required return of 12%. **$420,000 - $80,000 ***Per Appendix 13B if the asset is acquired during the 2024-2027 period, the PV of the CCA tax shield will only be $63,750 since the 150% rule will no longer be in effect; 100% of normal CCA is allowed in the year of acquisition during that period. This would have the effect of reducing the NPV by $3,417. Since the project has a positive net present value, the contract should be accepted.

Managerial Accounting, 13th Canadian Edition

Problem 13B-5 (30 minutes)

Items and Computations

Year(s)

(1) Amount

(2) Tax Effect

Investment in the business ........................ Now $(160,000) — Net annual cash receipts ($325,000 – $295,000 = $30,000) .......... 1-15 $30,000 1 – 0.40 CCA tax shield: Cdt × 1+ 1.5k D +k 1+k (note there is no salvage value so no adjustment is needed)

(1) × (2) After-Tax Cash Pre Flows C $(160,000) $18,000

= $64,000 × .2 × .40 × 1.15 .2 + .10 1.10 = ($17,067 × 1.0454) =$17,842**

Recovery of working capital ($160,000 – $64,000 = $96,000) ............ 15 $96,000 — $96,000 Net present value...................................... *Calculated using the NPV formula in Microsoft Excel and a required return of 10%. **Per Appendix 13B if the asset is acquired during the 2024-2027 period, the PV of the CCA tax shield will only be $17,067 since the 150% rule will no longer be in effect; 100% of normal CCA is allowed in the year of acquisition during that period. This would have the effect of reducing the NPV by $775. Yes, Huang should purchase the perfume shop since it has a positive net present value.

697

Problem 13B-6 (30 minutes) 1. The net present value analysis would be:

(2) Tax Effect

Items and Computations

Year(s)

(1) Amount

Investment in equipment....................... Net annual cash receipts* ..................... Salvage value of the equipment .............. CCA tax shield:

Now 1-5 5

$(130,000) $50,000 1 – 0.30 $10,000

(1) × (2) After-Tax Cash Present Flows Cash F $(130,000) $35,000 $10,000

Cdt × 1+ 1.5k – Sdt × (1+k)-n d+k 1+k d+k 130,000 × .3 × .3 × 1.15 – 10,000 × .3 × .3 × .621 .3 + .10 1.10 .3+.10 = ($29,250 × 1.0454) – ($2,250 × .621) =$29,181*** Net present value *$250,000 - $130,000 - $70,000 **Calculated using the NPV formula in Microsoft Excel and a required return of 12%. **Per Appendix 13B if the asset is acquired during the 2024-2027 period, the PV of the CCA tax shield will only be $29,250 since the 150% rule will no longer be in effect; 100% of normal CCA is allowed in the year of acquisition during that period. This would have the effect of reducing the NPV by $1,328. 2. Yes, the investment project should not be undertaken. It has a positive net present value.

Chapter 14 “How Well Am I Doing?” Financial Statement Analysis Solution to Discussion Case Reasons for agreeing:  Past performance is not necessarily indicative of future performance or trends in performance. In some industries (e.g., high tech) changes in the operating environment happen very quickly making historical financial results even less predictive of future performance.

Managerial Accounting, 13th Canadian Edition



Other changes internal to the company (e.g., management changes) may render historical results of limited value in forecasting future trends and ratios. These changes can of course have positive or negative effects on future performance.

Reasons for disagreeing:  Trend and ratio analysis, particularly for the most recent periods, can be very informative in forecasting future performance. Although past trends are not guaranteed to continue, they can be indicative of where a company is headed with respect to financial performance.  The stability (or lack thereof) of recent trends can be indicative of future performance. That is, there is a higher likelihood that past trends in key ratios will continue in the future if they have been consistent over several periods in the past.  Trend and ratio analysis can be very useful in combination with other publicly available information in forecasting future amounts. For example, the management discussion and analysis section of annual reports often provides insights into management‘s major plans, which can be helpful in estimating future sales and profits. Management also often discloses other key information in press releases. As an example, Chrysler‘s decision to upgrade manufacturing equipment in its Ontario plants was the subject of several articles in the financial press in early 2014. This information can be useful in predicting future profitability vis-àvis the impact on operating efficient and cost management.

699

Solutions to Questions 14-1 Horizontal analysis involves examining how a particular item on a financial statement such as sales revenues behaves over time. Vertical analysis involves analysis of items on an income statement or balance sheet for a single year. In vertical analysis, all the items on the financial statement are stated as a percentage of a single item such as sales revenues or total assets. 14-2 By looking at trends, an analyst hopes to get some idea of whether a situation is improving, remaining the same, or deteriorating. Such analyses can provide insight into what is likely to happen in the future. Rather than looking at trends, an analyst may compare one company to another or to industry averages using common-size financial statements. 14-3 Price-earnings ratios are determined by how investors see a firm‘s future prospects. Current reported earnings are generally considered to be useful only so far as they can assist investors in judging what will happen in the future. For this reason, two firms might have the same current earnings, but one might have a much higher price-earnings ratio if investors believe it has superior future prospects. In some cases, firms with very small current earnings enjoy very high price-earnings ratios. This is simply because investors view these firms as having very favourable prospects for earnings in future years. By definition, a share with current earnings of $4 and a price-earnings ratio of 20 would be selling for $80 per share. 14-4 A firm in a rapidly growing technological industry probably would have many opportunities to invest its earnings at a high rate of return; thus, one would expect it to have a low dividend payout ratio. 14-5 The dividend yield is the return on an investment from simply collecting dividends. The other source of return on an investment is increases in market value. The dividend yield is computed by dividing the dividend per share by the current market price per common share.

14-6 How a shareholder would feel would depend in large part on the stability of the firm and its industry. If the firm is in an industry that experiences wide fluctuations in earnings, then shareholders might be very pleased that no interest-paying debt exists in the firm‘s capital structure. In hard times, interest payments might be very difficult to meet, or earnings might be so poor that negative leverage would result. On the other hand, firms with stable earnings that do not take on interest-paying debt may be shortchanging their shareholders. If the assets in which debt sources of funds are invested can earn at a rate greater than the cost of the debt, then the shareholders can enjoy the benefits of positive leverage. In rapidly expanding industries, profits are often very good, thereby minimizing the possibility of negative leverage. A company with reasonable prospects for good earnings that will not take on interest-bearing debt also places heavy limitations on its own ability to grow, due to the fact that its sources of new investment funds will be limited to current earnings and new issues of shares. 14-7 No, the shares are not necessarily overpriced. Book value represents the cumulative effects on the balance sheet of past activities evaluated using historical prices. The market value of the share reflects investors‘ beliefs about the company‘s future earning prospects. For most companies, market value exceeds book value because investors anticipate future growth in earnings. 14-8 A 2-to-1 current ratio might not be adequate for several reasons. First, the composition of the current assets may be heavily weighted toward slow-turning inventory. Second, the receivables may be large or the receivables may be turning very slowly due to poor collection procedures. Third, a 2-to-1 current ratio may not be considered adequate in the firm‘s industry.

Managerial Accounting, 13th Canadian Edition

Foundational Exercises 1.

The earnings per share is computed as follows:

Earnings per share =

= 2.

Net income Average number of common shares outstanding $92,400 = $0.77 per share 120,000 shares

The price-earnings ratio is computed as follows:

Price-earnings ratio = = 3.

Market price per share Earnings per share $2.75 = 3.57 (rounded) $0.77

The dividend payout ratio is computed as follows:

Dividend payout ratio = =

Dividends per share Earnings per share $0.55 = 71% (rounded) $0.77

The dividend yield ratio is computed as follows:

Dividend yield ratio = = 4.

Dividends per share Market price per share $0.55 = 20% $2.75

The return on total assets is computed as follows:

Net income + [Interest expense × (1 - Tax rate)] Return on total assets = Average total assets =

$92,400 + [$8,000 × (1 - 0.30)] =21.5% ($450,000 + $460,000) /2

701

Foundational Exercises (continued) 5.

The return on equity is computed as follows:

Return on equity

Net income Average shareholders' equity

$92,400 = 28% ($320,000 + $340,000)/2

The book value per share is computed as follows:

Book value per share = = 7.

Total shareholders' equity Number of common shares outstanding $320,000 = $2.67 per share (rounded) 120,000 shares

The working capital and current ratio are computed as follows:

Working capital = Current assets - Current liabilities = $150,000 - $60,000 = $90,000 Current assets Current liabilities $150,000 = = 2.50 $60,000

Current ratio =

The acid-test ratio is computed as follows:

Cash + Marketable securities + Accounts receivable + Short-term notes Acid-test ratio = Current liabilities $35,000 + $0 + $60,000 + $0 = = 1.58 (rounded) $60,000

Managerial Accounting, 6th Canadian Edition

Foundational Exercises (continued) 9.

The accounts receivable turnover is calculated as follows:

Sales on account Accounts receivable = turnover Average accounts receivable balance =

$700,000 = 12.73 (rounded) ($60,000 + $50,000)/2

The average collection period is computed as follows:

365 days Accounts receivable turnover 365 days = = 28.67 days (rounded) 12.73

Average collection period =

10. The inventory turnover is computed as follows:

Inventory turnover = =

Cost of goods sold Average inventory balance $400,000 = 6.96 (rounded) ($55,000 + $60,000)/2

11. The average sale period is computed as follows:

Average sale period = =

365 days Inventory turnover 365 days = 52.44 days (rounded) 6.96

12. The total asset turnover is computed as follows:

Total asset turnover = =

Sales Average total assets $700,000 = 1.54 (rounded) ($450,000 + $460,000)/2

703

Foundational Exercises (continued) 13. The times interest earned ratio is computed as follows:

Earnings before interest Times interest = expense and income taxes earned ratio Interest expense =

$140,000 = 17.5 $8,000

14. The debt-to-equity ratio is computed as follows:

Debt-to-equity ratio = =

Total liabilities Shareholders' equity $130,000 = 0.41 (rounded) $320,000

Managerial Accounting, 6th Canadian Edition

Exercise 14-1 (15 minutes) 1. Sales ............................................................... Cost of goods sold ........................................... Gross margin ................................................... Selling and administrative expenses: Selling expenses ........................................... Administrative expenses ................................ Total selling and administrative expenses .......... Net operating income ....................................... Interest expense .............................................. Net income before taxes...................................

This Year

Last Year

100.0 % 62.3 37.7

100.0% 58.6 41.4

18.5 8.9 27.4 10.3 1.2 9.1 %

18.2 10.3 28.5 12.9 1.4 11.5%

2. The company‘s major problem seems to be the increase in cost of goods sold, which increased from 58.6% of sales last year to 62.3% of sales this year. This suggests that the company is not passing the increases in costs of its products on to its customers. As a result, cost of goods sold as a percentage of sales has increased and gross margin has decreased. This change has been offset somewhat by reduction in administrative expenses as a percentage of sales. Note that administrative expenses decreased from 10.3% to only 8.9% of sales over the two years. However, this decrease was not enough to completely offset the increased cost of goods sold, so the company‘s net income decreased as a percentage of sales this year.

705

Exercise 14-2 (30 minutes) 1. Calculation of the gross margin percentage: Gross margin percentage=

Gross margin Sales

$69,000 $198,000 = 34.8%

2. Calculation of the earnings per share: Earnings per share=

Net income-Preferred dividends Average number of common shares outstanding $8,050-$180 600 = $13.12 per share

Earnings per share=

3. Calculation of the price-earnings ratio: Price-earnings ratio=

Market price per share Earnings per share

$150 $13.12 = 11.4

4. Calculation of the dividend payout ratio: Dividend payout ratio=

Dividends per share* Earnings per share

$.75 $13.12 = 5.7% =

*$450,000/600,000 = $.75 per share 5. Calculation of the dividend yield ratio: Dividend yield ratio= =

Dividends per share Market price per share $.75 $150

Managerial Accounting, 6th Canadian Edition

Exercise 14-2 (continued) 6.

Calculation of the return on total assets: Return on total assets= =

Net income+[Interest expense x (1-tax rate) Average total assets $8,050+[$800 x (1-.3) ($136,960+$127,140)/2 = 6.5%

7. Calculation of the return on common shareholders‘ equity: Beginning balance, shareholders‘ equity (a)............. Ending balance, shareholders‘ equity (b) ................. Average shareholders‘ equity [(a) + (b) /2 .............. Average preferred shares ....................................... Average common shareholders‘ equity ....................

Return on common shareholders equity= =

$74,740 82,160 78,450 2,000 $76,450

Net income-preferred dividends Average common shareholders equity

$8,050-$180 $76,450 = 10.3%

8. Calculation of the book value per share: Book value per share= =

Total shareholders equity-Preferred shares Number of common shares outstanding $82,160-$2,000 600 = $133.60

707

Exercise 14-3 (30 minutes) 1. Calculation of working capital: Working capital = Current assets – Current liabilities $45,360 - $38,800 = $6,560 2. Calculation of the current ratio: Current assets Current liabilities $45,360 = $38,800 = 1.17

Current ratio=

3. Calculation of the acid-test ratio: Cash+temporary investments+current receivables* Current liabilities $2,160+$18,000 = $38,800 = 0.52 *Includes accounts receivable and short-term notes receivable. Acid-test ratio=

4. Calculation of accounts receivable turnover: Accounts receivable turnover=

Sales on account Average accounts receivable balance

$198,000

= $18,000+$11,000 2

= 13.66

5. Calculation of the average collection period: 365 days Accounts receivable turnover 365 = 13.66 = 26.7 days

Average collection period=

Managerial Accounting, 6th Canadian Edition

Exercise 14-3 (continued) 6. Calculation of inventory turnover: Inventory turnover= =

Cost of goods sold Average inventory balance

$129,000 ($24,000+$18,720)/2 = 6.04

7. Calculation of the average sale period: Average sale period= =

365 days Inventory turnover

365 6.04

= 60.4 days

709

Exercise 14-4 (15 minutes) 1. Calculation of the times interest earned ratio: Times interest earned=

Earnings before interest expense and income taxes Interest expense =

$12,300 $800

= 15.4 2. Calculation of the debt-to-equity ratio: Debt-to-equity ratio= =

Total liabilities Shareholders equity

$54,800 $82,160

= 0.67 to 1

Managerial Accounting, 6th Canadian Edition

Exercise 14-5 (15 minutes) 1. The trend percentages are:

Year 1

Year 2

Year 3

Year 4

Year 5

Sales .......................................

100.0

110.0

115.0

120.0

125.0

Current assets: Cash .................................... Accounts receivable .............. Inventory ............................. Total current assets ..................

100.0 100.0 100.0 100.0

130.0 115.0 110.0 112.6

96.0 135.0 115.0 120.3

80.0 170.0 120.0 133.7

60.0 190.0 125.0 142.1

Current liabilities ......................

100.0

110.0

130.0

145.0

160.0

2. Sales: Assets:

Liabilities:

The sales are increasing at a steady and consistent rate. The most noticeable thing about the assets is that the accounts receivable have been increasing at a rapid rate—far outstripping the increase in sales. This disproportionate increase in receivables is probably the chief cause of the decrease in cash over the five-year period. The inventory seems to be growing at a well-balanced rate in comparison with sales. The current liabilities are growing more rapidly than the total current assets. The reason is probably traceable to the rapid buildup in receivables in that the company doesn‘t have the cash needed to pay bills as they come due.

711

Exercise 14-6 (20 minutes) 1. Return on total assets: Return on total assets= =

Net income+[Interest expense x (1-tax rate) Average total assets

$952,000+[$40,000 x (1-.3) ($10,000,000+$9,600,000)/2 = 10%

2. Return on common shareholders‘ equity: Net income ......................................................................... Preferred dividends: $12 × 7,000 .........................................

$952,000 $84,000

Average shareholders‘ equity ($6,000,000 + $5,700,000)/2 ............................................ Average preferred shares ($1,200,000 + $1,200,000)/2 Average common shareholders‘ equity (b) ............................

$5,850,000 1,200,000 $4,650,000

Return on common shareholders equity=

Net income-preferred dividends Average common shareholders equity

$952,000-$84,00 $4,650,000

= 18.7% 3. The company has positive financial leverage, since the return on common shareholders‘ equity (18.7 ) is greater than the return on total assets (10 ). This positive leverage arises from the long-term debt, which has an after-tax interest cost of only 2.8% [4% interest rate × (1 – 0.30)], and the preferred shares, which carries a dividend rate of only 7% {($12 × 7,000) ÷ $1,200,000}. Both of these figures are smaller than the return that the company is earning on its total assets; thus, the difference goes to the common shareholders.

Managerial Accounting, 6th Canadian Edition

Exercise 14-7 (15 minutes) 1. Current assets ($90,000 + $260,000 + $490,000 + $10,000) .......................... Current liabilities ($850,000 ÷ 2.5) ............................................. Working capital ..........................................................................

$850,000 340,000 $510,000

Cash + Marketable securities + Accounts receivable 2. Acid-test = ratio Current liabilities =

$90,000 + $0 + $260,000 = 1.03 (rounded) $340,000

3. a. Working capital would not be affected by a $40,000 payment on accounts payable: Current assets ($850,000 – $40,000) ........................ Current liabilities ($340,000 – $40,000) ..................... Working capital ........................................................

$810,000 300,000 $510,000

b. The current ratio would increase if the company makes a $40,000 payment on accounts payable: Current assets Current ratio = Current liabilities =

$810,000 = 2.7 $300,000

713

Exercise 14-8 (30 minutes) 1. Gross margin percentage:

Gross margin percentage=

Gross margin $840,000 = =40% Sales $2,100,000

2. Current ratio: Current ratio=

Current assets $490,000 = =2.45 Current liabilities $200,000

3. Acid-test ratio:

Cash + Temporary investments + Accounts receivable + Short-term notes Acid test ratio= Current liabilities =

$21,000 + $0 + $160,000 + $0 =0.91 (rounded) $200,000

4. Average collection period:

Accounts receivable turnover=

Sales on account Average accounts receivable

$2,100,000 =14 ($160,000 + $140,000)/2

Average collection period =

365 days Accounts receivable turnover

365 days =26.1 days (rounded) 14

Managerial Accounting, 6th Canadian Edition

Exercise 14-8 (continued) 5. Average sale period:

Inventory turnover=

Cost of goods sold Average inventory

$1,260,000 =4.5 ($300,000 + $260,000)/2

Average sale period=

365 days =81.1 days (rounded) 4.5

6. Debt-to-equity ratio:

Debt-equity ratio= =

Total liabilities Shareholders' equity $500,000 =0.63 (rounded) $800,000

7. Times interest earned:

Earnings before interest and income taxes Times interest earned= Interest expense =

$180,000 = 6.0 $30,000

8. Book value per share:

Book value per share= =

Total shareholders' equity - Preferred shares Common shares outstanding $800,000 - $0 =$40 per share 20,000 shares

715

Exercise 14-9 (20 minutes) 1. Earnings per share:

Earnings per share= =

Net income - Preferred dividends Average common shares outstanding $105,000 - $0 =$5.25 per share 20,000 shares

2. Dividend payout ratio:

Dividend payout ratio=

Dividends per share $3.15 = =60% Earnings per share $5.25

3. Dividend yield ratio:

Dividend yield ratio=

Dividends per share $3.15 = =5% Market price per share $63.00

4. Price-earnings ratio:

Price-earnings ratio=

Market price per share $63.00 = =12.0 Earnings per share $5.25

Managerial Accounting, 6th Canadian Edition

Exercise 14-10 (20 minutes) 1. Return on total assets: Return on total assets=

Net income + {Interest expense × (1-Tax rate)} Average total assets

$105,000 + {$30,000 × (1 - 0.30)} ($1,100,000 + $1,300,000) / 2

$126,000 =10.5% $1,200,000

2. Return on common shareholders‘ equity:

Return on common = Net income - Preferred dividends shareholders' equity Average total shareholders' equity - Average preferred shares =

$105,000 - $0 {($725,000 + $800,000) /2} - $0

$105,000 =13.8% (rounded) $762,500

3. Financial leverage was positive because the rate of return to the common shareholders (13.8%) was greater than the rate of return on total assets (10.5%). This positive leverage is traceable in part to the company‘s current liabilities, which may carry no interest cost, and to the bonds payable, which have an after-tax interest cost of only 7%. 10% interest rate × (1 – 0.30) = 7% after-tax cost.

717

Problem 14-11 (60 minutes)

This Year

Last Year

1. a. Current assets (a) ............................................. Current liabilities (b) ......................................... Working capital (a) − (b)...................................

$2,060,000 1,100,000 $ 960,000

$1,470,000 600,000 $ 870,000

b. Current assets (a) ............................................. Current liabilities (b) ......................................... Current ratio (a) ÷ (b).......................................

$2,060,000 $1,100,000 1.87

$1,470,000 $600,000 2.45

c. Cash + temporary investments + accounts receivable + short-term notes (a) ...................... Current liabilities (b) ......................................... Acid-test ratio (a) ÷ (b) .....................................

$740,000 $1,100,000 0.67

$650,000 $600,000 1.08

d. Sales on account (a) ......................................... Average receivables (b) ..................................... Accounts receivable turnover (a) ÷ (b) ...............

$7,000,000 $525,000 13.3

$6,000,000 $375,000 16.0

Average collection period: 365 days ÷ accounts receivable turnover ........................................

27.4 days

22.8 days

e. Cost of goods sold (a) ....................................... Average inventory (b) ....................................... Inventory turnover ratio (a) ÷ (b) ......................

$5,400,000 $1,050,000 5.1

$4,800,000 $760,000 6.3

Average sale period: 365 days ÷ inventory turnover........................

71.6 days

57.9 days

f. Total liabilities (a) ............................................. Shareholders‘ equity (b) .................................... Debt-to-equity ratio (a) ÷ (b) ............................

$1,850,000 $2,150,000 0.86

$1,350,000 $1,950,000 0.69

g. Net income before interest and taxes (a) ............ Interest expense (b) ......................................... Times interest earned (a) ÷ (b) .........................

$630,000 $90,000 7.0

$490,000 $90,000 5.4

Managerial Accounting, 6th Canadian Edition

Problem 14-11 (continued) 2. a.

Modern Building Supply Common-Size Balance Sheets Current assets: Cash ............................................ Temporary Investments................. Accounts receivable, net................ Inventory ..................................... Prepaid expenses .......................... Total current assets ......................... Plant and equipment, net ................. Total assets ..................................... Liabilities: Current liabilities ........................... Bonds payable, 12% ..................... Total liabilities.................................. Shareholders‘ equity: Preferred shares, 4000, $4 no par, Common shares, 50,000 .............. Retained earnings ......................... Total shareholders‘ equity ................. Total liabilities and equity .................

This Year

Last Year

2.3% 0.0% 16.3% 32.5% 0.5% 51.5% 48.5% 100.0%

6.1% 1.5% 12.1% 24.2% 0.6% 44.5% 55.5% 100.0%

27.5% 18.8% 46.3%

18.2% 22.7% 40.9%

5.0% 12.5% 36.3% 53.8% 100.0%

6.1% 15.2% 37.9% 59.1% 100.0%

Note: Columns may not total down due to rounding.

719

Problem 14-11 (continued) b.

Modern Building Supply Common-Size Income Statements Sales ......................................................... Cost of goods sold ..................................... Gross margin ............................................. Selling and administrative expenses ............ Operating income....................................... Interest expense ........................................ Net income before taxes ............................. Income taxes ............................................. Net income ................................................

This Year

Last Year

100.0% 77.1% 22.9% 13.9% 9.0% 1.3% 7.7% 3.1% 4.6%

100.0% 80.0% 20.0% 11.8% 8.2% 1.5% 6.7% 2.7% 4.0%

3. The following points can be made from the analytical work in parts (1) and (2) above: The company has improved its profit margin from last year. This is attributable to an increase in gross margin, which is offset somewhat by an increase in operating expenses. In both years the company‘s net income as a percentage of sales equals or exceeds the industry average of 4%. Although the company‘s working capital has increased, its current position actua lly has deteriorated significantly since last year. Both the current ratio and the acid-test ratio are well below the industry average, and both are trending downward. (This shows the importance of not just looking at the working capital in assessing the financial strength of a company.) Given the present trend, it soon will be impossible for the company to pay its bills as they come due. The drain on the cash account seems to be a result mostly of a large buildup in accounts receivable and inventory. This is evident both from the common-size balance sheet and from the financial ratios. Notice that the average collection period has increased by 4.6 days since last year, and that it is now 9 days over the industry average. Many of the company‘s customers are not taking their discounts, since the average collection period is 27 days and collection terms are 2/10, n/30. This suggests financial weakness on the part of these customers, or sales to customers who are poor credit risks. Perhaps the company has been too aggressive in expanding its sales.

Managerial Accounting, 6th Canadian Edition

Problem 14-11 (continued) The inventory turnover was only 5 times this year as compared to over 6 times last year. It takes three weeks longer for the company to turn its inventory than the average for the industry (71 days as compared to 50 days for the industry). This suggests that inventory quantities are higher than they need to be. The loan should be approved on the condition that the company take immediate steps to get its accounts receivable and inventory back under control. This would mean more rigorous checks of creditworthiness before sales are made and perhaps declining credit to slow paying customers. It would also mean a sharp reduction of inventory levels to a more manageable size. If these steps are taken, it appears that sufficient funds could be generated to repay the loan in a reasonable period of time. Further, the ‗times interest earned ratio‘ has improved and is above industry standard; showing an ability to service a loan.

721

Problem 14-12 (60 minutes)

This Year

1. a.

Last Year

Net income ..................................................... Less preferred dividends .................................. Net income remaining for common (a) .............. Average number of common shares (b) ............ Earnings per share (a) ÷ (b) ............................

$324,000 16,000 $308,000 50,000 $6.16

$240,000 16,000 $224,000 50,000 $4.48

b. Dividends per share (a)*.................................. Market price per share (b) ............................... Dividend yield ratio (a) ÷ (b) ...........................

$2.16 $45.00 4.8%

$1.20 $36.00 3.33%

c. Dividends per share (a) ................................... Earnings per share (b) .................................... Dividend payout ratio (a) ÷ (b) ........................

$2.16 $6.16 35.1%

$1.20 $4.48 26.8%

d. Market price per share (a) ............................... Earnings per share (b) .................................... Price-earnings ratio (a) ÷ (b) ...........................

$45.00 $6.16 7.3

$36.00 $4.48 8.0

*$108,000 ÷ 50,000 shares = $2.16; $60,000 ÷ 50,000 shares = $1.20

Investors regard Modern Building Supply less favourably than other companies in the industry. This is evidenced by the fact that they are willing to pay only 7.3 times current earnings for a share of the company, as compared to 9 times current earnings for other companies in the industry. If investors were willing to pay 9 times current earnings for Modern Building Supply‘s shares, then it would be selling for about $55 per share (9 × $6.16), rather than for only $45 per share.

This Year

Last Year

Total shareholders‘ equity ............................. Less preferred shares ................................... Common shareholders‘ equity (a) .................

$2,150,000 200,000 $1,950,000

$1,950,000 200,000 $1,750,000

Number of common shares outstand-ing (b) . Book value per share (a) ÷ (b) .....................

50,000 $39.00

50,000 $35.00

Managerial Accounting, 6th Canadian Edition

Problem 14-12 (continued) A market price in excess of book value does not mean that the price of a shares is too high. Market value is an indication of investors‘ perceptions of future earnings and/or dividends, whereas book value is a result of already completed transactions. 2. a.

This Year

Last Year

Net income .................................................. Add after-tax cost of interest paid: [$90,000 × (1 – 0.40)].............................. Total (a) ......................................................

$ 324,000

$ 240,000

54,000 $ 378,000

54,000 $ 294,000

Average total assets (b) ............................... Return on total assets (a) ÷ (b) ....................

$3,650,000 10.4%

$3,000,000 9.8%

This Year

Last Year

Net income .................................................. Less preferred dividends............................... Net income remaining for common (a) ..........

$ 324,000 16,000 $ 308,000

$ 240,000 16,000 $ 224,000

Average total shareholders‘ equity* ............... Less average preferred shares ...................... Average common shareholders‘ equity (b) .....

$2,050,000 200,000 $1,850,000

$1,868,000 200,000 $1,668,000

*1/2($2,150,000 + $1,950,000); 1/2($1,950,000 + $1,786,000). Return on common shareholders‘ equity (a) ÷ (b) ........................................

16.6%

13.4%

c. Financial leverage is positive in both years, since the return on common shareholders‘ equity is greater than the return on total assets. This positive financial leverage is due to three factors: the preferred shares, which has a dividend of only $4 per share (8% return); the bonds, which have an after-tax interest cost of only 7.2% [12% interest rate × (1 – 0.40) = 7.2%]; and the accounts payable, which may bear no interest cost.

723

Problem 14-12 (continued) 3. We would recommend keeping the shares. The downside risk of the shares seems small, since it is selling for only 7.3 times current earnings as compared to 9 times earnings for other companies in the industry. In addition, its earnings are strong and trending upward, and its return on common equity (16.6%) is extremely good. Its return on total assets (10.4%) compares favourably with that of the industry. However, the dividend yield must be compared to other investment options, both within the industry and outside. For example, if GIC‘s are earning 5%, this investment might be questionable. The risk, of course, is whether the company can get its cash problem under control. Conceivably, the cash problem could worsen, leading to an eventual reduction in profits through inability to operate, a reduction in dividends, and a precipitous drop in the market price of the company‘s shares. This does not seem likely, however, since the company can easily control its cash problem through more careful management of accounts receivable and inventory. If this problem is brought under control, the price of the shares could rise sharply over the next few years, making it an excellent investment.

Managerial Accounting, 6th Canadian Edition

Problem 14-13 (30 minutes) 1. a. Computation of working capital: Current assets: Cash ............................................... Marketable securities........................ Accounts receivable, net ................... Inventory ........................................ Prepaid expenses ............................. Total current assets (a) .......................

$ 50,000 30,000 200,000 210,000 10,000 500,000

Current liabilities: Accounts payable ............................. Notes due in one year ...................... Accrued liabilities ............................. Total current liabilities (b) ....................

150,000 30,000 20,000 200,000

Working capital (a) – (b) .....................

$300,000

b. Computation of the current ratio:

Current assets $500,000 = = 2.5 Current liabilities $200,000 c. Computation of the acid-test ratio: Cash + Marketable securities + Accounts receivable $280,000 = = 1.4 Current liabilities $200,000

725

Problem 14-13 (continued) 2.

Transaction (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l)

Issued capital stock for cash .................. Sold inventory at a gain ......................... Wrote off uncollectible accounts ............. Declared a cash dividend ....................... Paid accounts payable ............................ Borrowed on a short-term note .............. Sold inventory at a loss .......................... Purchased inventory on account ............. Paid short-term notes ............................ Purchased equipment for cash ................ Sold marketable securities at a loss ........ Collected accounts receivable .................

The Effect on Working Current Acid-Test Capital Ratio Ratio Increase Increase None Decrease None None Decrease None None Decrease Decrease None

Increase Increase None Decrease Increase Decrease Decrease Decrease Increase Decrease Decrease None

Increase Increase None Decrease Increase Decrease Increase Decrease Increase Decrease Decrease None

Managerial Accounting, 6th Canadian Edition

Problem 14-14 (90 minutes)

This Year

Last Year

Net income ..................................................... Add after-tax cost of interest: $90,000 × (1 – 0.30) ................................... $75,000 × (1 – 0.30) ................................... Total (a) .........................................................

$ 210,000

$ 126,000

$ 273,000

52,500 $ 178,500

Average total assets (b) .................................. Return on total assets (a) ÷ (b) .......................

$3,997,500 6.8%

$3,480,000 5.1%

b. Net income ..................................................... Less preferred dividends.................................. Net income remaining for common (a) .............

$ 210,000 36,000 $ 174,000

$ 126,000 36,000 $ 90,000

Average total shareholders‘ equity ................... Less average preferred shares ......................... Average common equity (b) ............................

$2,340,000 450,000 $1,890,000

$2,248,500 450,000 $1,798,500

Return on common shareholders‘ equity (a) ’ (b) ..............................................................

9.2%

5.0%

1. a.

63,000

c. Leverage is positive for this year because the return on common equity (9.2%) is greater than the return on total assets (6.8%). For last year, leverage is slightly negative because the return on the common equity (5.0%) is less than the return on total assets (5.1%). 2. a. Net income remaining for common [see above] (a) .............................................................. Average number of common shares outstanding (b) ........................................................ Earnings per share (a) ÷ (b)............................ b. Dividends per share (a) ................................... Market price per share (b) ............................... Dividend yield ratio (a) ÷ (b) ...........................

$174,000

$90,000

50,000 $3.48

50,000 $1.80

$1.08 $27.00 4.0%

$0.54 $15.00 3.6%

727

Problem 14-14 (continued)

This Year

Last Year

c. Dividends per share (a) ................................... Earnings per share (b) .................................... Dividend payout ratio (a) ÷ (b) ........................

$1.08 $3.48 31.0%

$0.54 $1.80 30.0%

d. Market price per share (a) ................................. Earnings per share (b) ...................................... Price-earnings ratio (a) ÷ (b) ............................

$27.00 $3.48 7.8

$15.00 $1.80 8.3

Notice from the data given in the problem that the typical P/E ratio for companies in Hill‘s industry is 10. Hill Company presently has a P/E ratio of only 7.8, so investors appear to regard it less well than they do other companies in the industry. That is, investors are willing to pay only 7.8 times current earnings for a share of Hill Company, as compared to 10 times current earnings for a share of a typical company in the industry. e. Shareholders‘ equity........................................ Less preferred shares ...................................... Common shareholders‘ equity (a) ....................

$2,400,000 450,000 $1,950,000

$2,280,000 450,000 $1,830,000

Number of common shares outstanding (b) ...... Book value per share (a) ÷ (b) ........................

50,000 $39.00

50,000 $36.60

Note that the book value of Hill Company‘s shares is greater than its market value for both years. This does not necessarily indicate that the shares are selling at a bargain price. Market value is an indication of investors‘ perceptions of future earnings and/or dividends, whereas book value is a result of already completed transactions. f. Gross margin (a)............................................. Sales (b) ........................................................ Gross margin percentage (a) ÷ (b) ..................

$787,500 $3,937,500 20.0%

$645,000 $3,120,000 20.7%

Managerial Accounting, 6th Canadian Edition

Problem 14-14 (continued) 3. a.

This Year

Last Year

Current assets (a) ............................................. Current liabilities (b) ......................................... Working capital (a) − (b) ..................................

$1,950,000 975,000 $975,000

$1,485,000 690,000 $795,000

b. Current assets (a) ............................................. Current liabilities (b) ......................................... Current ratio (a) ÷ (b) ......................................

$1,950,000 $975,000 2.0

$1,485,000 $690,000 2.15

c. Cash + temporary investments + accounts receivable + short-term notes (a) ........................

$915,000

$840,000

Current liabilities (b) ......................................... Acid-test ratio (a) ÷ (b) ....................................

$975,000 0.94

$690,000 1.22

d. Sales on account (a) ......................................... Average receivables (b) ..................................... Accounts receivable turnover (a) ÷ (b) ..............

$3,937,500 $562,500 7.0

$3,120,000 $420,000 7.4

Average collection period: 365 days ÷ accounts receivable turnover ........................................

52 days

49 days

e. Cost of goods sold (a) ....................................... Average inventory balance (b) ........................... Inventory turnover ratio (a) ÷ (b) ......................

$3,150,000 $787,500 4.0

$2,475,000 $540,000 4.6

Average sales period: 365 days ÷ inventory turnover ratio ......................................................

91 days

79 days

f. Total liabilities (a) ............................................. Shareholders‘ equity (b) .................................... Debt-to-equity ratio (a) ÷ (b) ............................

$1,875,000 $2,400,000 0.78

$1,440,000 $2,280,000 0.63

$390,000 $90,000 4.3

$255,000 $75,000 3.4

Net income before interest and income taxes (a) Interest expense (b) ......................................... Times interest earned (a) ÷ (b) .........................

729

Problem 14-14 (continued) 4. As stated by Pat Smith, both net income and sales are up from last year. The return on total assets has improved from 5.1% last year to 6.8% this year, and the return on common equity is up to 9.2% from 5.0% the year before. But this appears to be the only bright spot. Virtually all other ratios are below what is typical for the industry, and, more important, they are trending downward. The deterioration in the gross margin percentage, while not large, is worrisome. Sales and inventories have increased substantially, which should ordinarily result in an improvement in the gross margin percentage as fixed costs are spread over more units. However, the gross margin percentage has declined. Notice particularly that the average collection period has lengthened to 52 days— about three weeks over the industry—and that the inventory turnover is 50% longer than the industry. The increase in sales may have been obtained at least in part by extending credit to high-risk customers. Also notice that the debt-to-equity ratio is rising rapidly. If the $750,000 loan is granted, the ratio will rise further to 1.09. Further, a $2,000,000 loan would require interest payments of, say, 10% (note the bond rate) resulting in $200,000 interest. Looking at the ‗times interest earned‘ analysis the company would have a hard time covering the interest payment initially. In our opinion, what the company needs is more equity—not more debt. Therefore, the loan should not be approved. The company should be encouraged to issue more common shares.

Managerial Accounting, 6th Canadian Edition

Problem 14-15 (30 minutes) 1.

Hill Company Comparative Balance Sheets Current assets: Cash ...................................................... Temporary investments ........................... Accounts receivable, net .......................... Inventory ............................................... Prepaid expenses .................................... Total current assets .................................... Plant and equipment, net ........................... Total assets ............................................... Current liabilities ........................................ Bonds payable, 10% .................................. Total liabilities ............................................ Shareholders‘ equity: Preferred shares, 20,000, $2.40, no par value ................................................... Common shares, 50,000 ......................... Retained earnings ................................... Total shareholders‘ equity ........................... Total liabilities and equity ...........................

This Year

Last Year

5.6% 0.0% 15.8% 22.8% 1.4% 45.6% 54.4% 100.0%

8.5% 2.0% 12.1% 16.1% 1.2% 39.9% 60.1% 100.0%

22.8% 21.1% 43.9%

18.5% 20.2% 38.7%

10.5% 35.1% 10.5% 56.1% 100.0%

12.1% 40.3% 8.9% 61.3% 100.0%

Note: Columns may not total down due to rounding.

731

Problem 14-15 (continued) 2.

Hill Company Comparative Income Statements

This Year Sales ......................................................... Cost of goods sold ....................................... Gross margin ............................................... Selling and administrative expenses .............. Operating income ........................................ Interest expense .......................................... Net income before taxes .............................. Income taxes (30%) .................................... Net income ..................................................

100.0% 80.0% 20.0% 10.1% 9.9% 2.3% 7.6% 2.3% 5.3%

Last Year 100.0% 79.3% 20.7% 12.5% 8.2% 2.4% 5.8% 1.7% 4.0%

Note: Columns may not total down due to rounding. 3. The company‘s current position has declined substantially between the two years. Cash this year represents only 5.6% of total assets, whereas it represented 10.5% last year (Cash + Temporary investments). In addition, both accounts receivable and inventory are up from last year, which helps to explain the decrease in the Cash account. The company is building inventories, but not collecting from customers. (See Problem 14-14 for a ratio analysis of the current assets.) Apparently part of the financing required to build inventories was supplied by short-term creditors, as evidenced by the increase in current liabilities. Looking at the income statement, the gross margin percentage has deteriorated. Ordinarily, the increase in sales (and in inventories) should have resulted in an increase in the gross margin percentage since fixed manufacturing costs would be spread across more units. Note that the other operating expenses are down as a percentage of sales—possibly because of the existence of fixed expenses.

Managerial Accounting, 6th Canadian Edition

Problem 14-16 (45 minutes) 1. Decrease

Sale of inventory at a profit will be reflected in an increase in retained earnings, which is part of shareholders‘ equity. An increase in shareholders‘ equity will result in a decrease in the ratio of assets provided by creditors as compared to assets provided by owners.

2. No effect

Purchasing land for cash has no effect on earnings or on the number of common shares outstanding. One asset is exchanged for another.

3. Increase

A sale of inventory on account will increase the quick assets (cash, accounts receivable, temporary investments) but have no effect on the current liabilities. For this reason, the acid-test ratio will increase.

4. No effect

Payments on account reduce cash and accounts payable by equal amounts; thus, the net amount of working capital is not affected.

5. Decrease

When a customer pays a bill, the accounts receivable balance is reduced. This increases the accounts receivable turnover, which in turn decreases the average collection period.

6. Decrease

Declaring a cash dividend will increase current liabilities, but have no effect on current assets. Therefore, the current ratio will decrease.

7. Increase

Payment of a previously declared cash dividend will reduce both current assets and current liabilities by the same amount. An equal reduction in both current assets and current liabilities will always result in an increase in the current ratio, so long as the current assets exceed the current liabilities.

8. No effect

Book value per share is not affected by the current market price of the company‘s shares.

9. Decrease

The dividend yield ratio is obtained by dividing the dividend per share by the market price per share. If the dividend per share remains unchanged and the market price goes up, then the yield will decrease.

10. Increase

Selling property for a profit would increase net income and therefore the return on total assets would increase.

11. Increase

A write-off of inventory will reduce the inventory balance, thereby increasing the turnover in relation to a given level of cost of goods sold.

733

Problem 14-16 (continued) 12. Increase

Assuming the company‘s assets earn at a rate that is higher (if not why borrow the money) than the rate paid on the bonds, leverage is positive, increasing the return to the common shareholders.

13. No effect

Changes in the market price of a share has no direct effect on the dividends paid or on the earnings per share and therefore have no effect on this ratio.

14. Decrease

A decrease in net income would mean less income availa-ble to cover interest payments. Therefore, the times-interest-earned ratio would decrease.

15. No effect

Write-off of an uncollectible account against the Allowance for Bad Debts will have no effect on total current assets. For this reason, the current ratio will remain unchanged.

16. Decrease

A purchase of inventory on account will increase current liabilities, but will not increase the quick assets (cash, accounts receivable, temporary investments). Therefore, the ratio of quick assets to current liabilities will decrease.

17. Increase

The price-earnings ratio is obtained by dividing the market price per share by the earnings per share. If the earnings per share remains unchanged, and the market price goes up, then the price-earnings ratio will increase.

18. Decrease

Payments to creditors will reduce the total liabilities of a company, thereby decreasing the ratio of total debt to total equity.

Managerial Accounting, 6th Canadian Edition

Problem 14-17 (30 minutes) a. It is becoming more difficult for the company to pay its bills as they come due. Although the current ratio has improved over the three years, the acid-test ratio is down. Also notice that the accounts receivable and inventory are both turning more slowly, indicating that an increasing portion of the current assets is being made up of these items, from which bills cannot be paid. b. Customers are paying their bills more slowly in Year 3 than in Year 1. This is evidenced by the decline in accounts receivable turnover. In year 3 customer payments are received in 39 (365  9.4) days vs 29 (365  9.4) days in year 1. c. The total of accounts receivable is increasing. This is evidenced both by a slowdown in turnover and in an increase in total sales. d. The level of inventory undoubtedly is increasing. Notice that the inventory turnover is decreasing. Even if sales (and cost of goods sold) just remained constant, this would be evidence of a larger average inventory on hand. However, sales are not constant, but rather are increasing. With sales increasing (and undoubtedly cost of goods sold also increasing), the average level of inventory must be increasing as well to service the larger volume of sales. e. The market price is going down. The dividends paid per share over the three-year period are unchanged, but the dividend yield is going up. Therefore, the market price per share of stock must be decreasing. f. The amount of earnings per share is increasing. Again, the dividends paid per share have remained constant. However, the dividend payout ratio is decreasing. In order for the dividend payout ratio to be decreasing, the earnings per share must be increasing. g. The price-earnings ratio is going down. If the market price of the stock is going down [see Part (e) above], and the earnings per share are going up [see Part (f) above], then the price-earnings ratio must be decreasing. h. In Year 1 and in Year 2 there was negative leverage because in both years the return on total assets exceeded the return on common equity. In Year 3 there was positive leverage because in that year the return on common equity exceeded the return on total assets employed. As a result, the company has, in year 3, clearly made returns on the funds in excess of borrowing costs.

735

Problem 14-18 (45 minutes) 1. The loan officer stipulated that the current ratio prior to obtaining the loan must be higher than 2.0, the acid-test ratio must be higher than 1.0, and the times interest earned be at least 5. These ratios are computed below: Current ratio= =

Current assets Current liabilities

$870,000 =1.8 (rounded) $492,000

Cash+Accounts receivable Current liabilities $210,000+$150,000 = = .7 (rounded) $492,000

Acid-test ratio=

Times interest earned=

Earnings before interest expense and income taxes Interest expense =

$60,000 =7.5 $8,000*

*$200,000 x 4% The company would not qualify for the loan because both its current ratio and its acid-test ratio are too low. The times interest earned of 7.5 does exceed the minimum of 5 required by the bank. 2. By reclassifying the $136,000 net book value of the old equipment as inventory, the current ratio would improve, but the acid-test ratio would be unaffected. Inventory is considered a current asset for purposes of computing the current ratio, but is not included in the numerator when computing the acid-test ratio. Therefore the acidtest ratio would remain at .7 as per part 1. The revised current ratio would be as follows: =

$870,000+$136,000 =2.0 (rounded) $492,000

Managerial Accounting, 6th Canadian Edition

Problem 14-18 (continued) Even if this tactic had succeeded in qualifying the company for the loan, it is not advisable. Inventories are assets the company has acquired to sell to customers in the normal course of business. Used production equipment is not inventory—even if there is a clear intention to sell it in the near future. The loan officer would not expect used equipment to be included in inventories; doing so would be intentionally misleading. Nevertheless, the old equipment is an asset that could be turned into cash. If this were done, the company would satisfy two of the banks requirements for the loan since the $136,000 in cash would be included in the numerator in both the current ratio and in the acid-test ratio. Revised current ratio (as per above): =

$870,000+$136,000 =2.0 (rounded) $492,000

Revised acid-test ratio: =

$210,000+$150,000+ $136,000 =1.0 (rounded) $492,000

The third criterion, times interest earned, would be unaffected by the sale. A sale of the asset for proceeds that equal book value would have no income statement effect in the current period as there would be no gain or loss on the transaction. However, other options may be available. The old equipment is being used to relieve bottlenecks in the heat-treating process and it would be desirable to keep this standby capacity and Thomas could explain this to the loan officer. The loan officer might insist that the equipment be sold before any loan is approved, but might instead grant a waiver of the current ratio and acid-test ratio requirements on the basis that they could be satisfied by selling the old equipment. Or the officer may approve the loan on the condition that the equipment is pledged as collateral. In that case, Thomas would only have to sell the equipment if he would otherwise be unable to pay back the loan.

737

Problem 14-19 (60 minutes or longer) Pepper Industries Income Statement For the Year Ended March 31

Key to Computation Sales ......................................................... Cost of goods sold ..................................... Gross margin ............................................. Selling and administrative expenses ............ Operating income ...................................... Interest expense ........................................ Net income before taxes............................. Income taxes (30%) .................................. Net income ................................................

$4,200,000 2,730,000 1,470,000 930,000 540,000 80,000 460,000 138,000 $ 322,000

(h) (i) (j) (a) (b) (c) (d)

Pepper Industries Balance Sheet March 31 Current assets: Cash ...................................................... Accounts receivable, net .......................... Inventory ............................................... Total current assets .................................... Plant and equipment .................................. Total assets ............................................... Current liabilities ........................................ Bonds payable, 10% .................................. Total liabilities ............................................ Shareholders‘ equity: Common shareholders‘ equity .................. Retained earnings ................................... Total shareholders‘ equity ........................... Total liabilities and equity ...........................

70,000 330,000 480,000 880,000 1,520,000 $2,400,000

(f) (e) (g) (g) (q) (p)

$ 320,000 800,000 1,120,000

(k) (l)

700,000 580,000 1,280,000 $2,400,000

(n) (m) (o)

Managerial Accounting, 6th Canadian Edition

Problem 14-19 (continued) Computation of missing amounts: a.

Times interest earned =

Earnings before interest and taxes Interest expense

Earnings before interest and taxes $80,000

= 6.75 Therefore, the earnings before interest and taxes for the year must be $540,000. b. Net income before taxes = $540,000 – $80,000 = $460,000 c. Income taxes = $460,000 × 30% tax rate = $138,000 d. Net income = $460,000 – $138,000 = $322,000 e.

Sales on account Accounts receivable = turnover Average accounts receivable balance =

$4,200,000 Average accounts receivable balance

= 14.0 Therefore, the average accounts receivable balance for the year must have been $300,000. Since the beginning balance was $270,000, the ending balance must have been $330,000. f.

Acid-test ratio=

Cash + Marketable securities + Current receivables Current liabilities

Cash + Marketable securities + Current receivables $320,000

= 1.25

739

Problem 14-19 (continued) Therefore, the total quick assets must be $400,000. Because there are no marketable securities and the accounts receivable are $330,000, the cash must be $70,000. g.

Current ratio = =

Current assets Current liabilities Current assets $320,000

= 2.75 Therefore, the current assets must total $880,000. Because the quick assets (cash and accounts receivable) total $400,000 of this amount, the inventory must be $480,000. h.

Inventory turnover =

Cost of goods sold Average inventory

Cost of goods sold ($360,000 + $480,000)/2

Cost of goods sold $420,000

= 6.5 Therefore, the cost of goods sold for the year must be $2,730,000. i. Gross margin = $4,200,000 – $2,730,000 = $1,470,000. j.

Operating income = Gross margin - Operating expenses Operating expenses = Gross margin - Operating income = $1,470,000 - $540,000 = $930,000

Managerial Accounting, 6th Canadian Edition

Problem 14-19 (continued) k. The interest expense for the year was $80,000 and the interest rate was 10%, the bonds payable must total $800,000. l. Total liabilities = $320,000 + $800,000 = $1,120,000 m.

Debt-to-equity ratio =

Total liabilities Shareholders' equity

$1,120,000 Shareholders' equity

= 0.875 Therefore, the total stockholders‘ equity must be $1,280,000. n.

Total shareholders' equity = Common stock + Retained earnings Retained earnings = Total shareholders' equity - Common Stock = $1,280,000 - $700,000 = $580,000

741

Problem 14-19 (continued) o.

Total assets = Liabilities + Shareholders' equity = $1,120,000 + $1,280,000 = $2,400,000 This answer can also be obtained using the return on total assets:

Return on = Net income + [Interest expense × (1 - Tax rate)] total assets Average total assets =

$322,000 + [$80,000 × (1 - 0.30)] Average total assets

$378,000 Average total assets

= 18.0% Therefore the average total assets must be $2,100,000. Since the total assets at the beginning of the year were $1,800,000, the total assets at the end of the year must have been $2,400,000 (which would also equal the total of the liabilities and the stockholders‘ equity). p.

Total assets = Current assets + Plant and equipment $2,400,000 = $880,000 + Plant and equipment Plant and equipment = $2,400,000 - $880,000 = $1,520,000

Appendix 4A Cost–Volume–Profit Analysis with Uncertainty Problem 4A-1 (20 minutes) 1. Decision tree:

Managerial Accounting, 6th Canadian Edition

A Campaign B

Minor (.2) Modest (.5) All Out (.3) Minor (.2) Modest (.5) All Out (.3)

$100,000 $400,000 $1,600,000 $80,000 $300,000 $1,800,000

2. Calculate expected profits. Campaign A: .2($100,000) + .5($400,000) + .3($1,600,000) $20,000 + $200,000 + $480,000 = $700,000 Campaign B: .2($80,000) + .5($300,000) + .3($1,800,000) $16,000 + $150,000 + $540,000 = $706,000 The marketing manager should choose Campaign B because it has a slightly higher expected profit.

743

Problem 4A-2 (20 minutes) (a) Decision Tree

East Expansion West

High (.2) Medium (.5) Low (.3) High (.2) Medium (.5) Low (.3)

$300,000 $180,000 $5,000 $210,000 $190,000 $30,000

(b) For the East coast alternative: Expected profits = (.2 × $300,000) + (.5 × $180,000) + (.3 × $5,000) = $60,000 + $90,000 + $1,500 = $151,500 For the West coast alternative: Expected profits = (.2 × $210,000) + (.5 × $190,000) + (.3 × $30,000) = $42,000 + $95,000 + $9,000 = $146,000 The company should expand to the East coast because it has a higher expected operating profit.

Managerial Accounting, 6th Canadian Edition

Problem 4A-3 (20 minutes) IF Win Proposals 1

Revenue $500,000

500,000

IF Lose 1

Costs $200,0 00 80,000

0 420,000

200,00 0

Net $300,00

(200,000

Tax 25% ($75,000 ) (105,000 )

After Tax $ 225,000 315,000

50,000

(150,000

) 80,000

) (80,000)

20,000

Win (.5)

$225,000

Lose (.5)

$(150,000)

Win (.3)

$315,000

Lose (.7)

$(60,000)

(60,000)

1 Proposals 2

Expected profits: Proposal A: ($225,000 x .5) + (-$150,000 x .5) .............................................. $112,500 -$75,000 = $37,500 Proposal B: ($315,000 x .3) + (-$60,000 x .7) ................................................ $94,500 -$42,000 = $52,500 Since Proposal 2 has the higher expected value, it should be submitted to the city. However, the reputation of the firm for quality and originality might be more important than the narrow evaluation of just this proposal; management needs to consider all elements of a decision.

745

Appendix 6B Shrinkage and Lost Units Solutions to Questions 6B-1 Normal losses can either be assigned to all production by dropping their equivalent units from the calculation, or normal losses can be costed, disclosed and charged to the appropriate completed units.

6B-2 The second method is usually preferred if managers seek to control losses. Costing normal losses makes such costs visible and therefore managers can take appropriate cost control actions.

Managerial Accounting, 6th Canadian Edition

Problem 6B-1 (45 minutes) Lanyard Home Paint Company Production Report – Base Fab Department For the Month ended April 30 Quantity Schedule Units to be accounted for: Work in process, April 1(100% complete materials; 60% complete for conversion) Started into production Total units to be accounted for

2,000 420,000 450,000 Equivalent Units Materials Conversion Costs

Units accounted for as follows: Transferred to Finishing Dept Units lost – normal Work in process, April 30 (50% complete for materials; 25% complete for conversion) Total units accounted for

Cost per Equivalent unit Costs to be accounted for: Work in process, April 1 Costs added by the Base Fab Dept Total cost (a) Equivalent units (b) Cost per equivalent unit (a÷b)

365,000 5,000

365,000 0

40,000 405,000

20,000 385,000

Total

Materials

Conversion costs

$150,000 1,846,000 $1,996,000

$92,000 851,000 $ 943,000 405,000 $2.328

$58,000 995,000 $1,053,000 385,000 $2.735

80,000 450,000

$5.063* =

*Note that total cost is $5.063 rather than $5.00 in Review Problem 1 without spoilage. The cost per EU is higher in this case as the cost of spoilage is spread over the lower quantity of good output using this method.

747

Problem 6B-1 (continued) Cost Reconciliation Cost accounted for as follows: Transferred to Finishing Dept (365,000 × $5.063) Work in Process, April 30: Materials at $2.328 per unit Conversion costs at $2.735 Total costs accounted for † Difference of $185 due to rounding

Total Cost

Equivalent Units Materials Conversion

$1,847,995

365,000

93,120 54,700 $1,995,815†

40,000

365,000

20,000

Managerial Accounting, 6th Canadian Edition

Problem 6B-2 (45 minutes) Power Company Production Report – Finishing Department For the month ended June 30 Equivalent Units: Materials Conversion Units accounted for: Transferred out 467,500 467,500 467,500 Normal spoilage (100% materials; 80% conversion) 7,500 7,500 6,000 Work in process, ending (25% materials; 30% conversion) 225,000 56,250 67,500 Equivalent units (b) 700,000 531,250 541,000

Cost per EU Costs to be accounted for (a) Cost per EU (a÷b)

Total $1,565,625 $2.91 =

Materials $616,250 $1.16*

Conversion Costs $949,375 $1.754*

Cost accounted for: Good units transferred out (467,500 x $2.914) $1,362,295 Normal spoilage (7,500 × $1.16) + (6,000 x $1.754) 19,224 Work in process, ending (56,250 × $1.16) + (67,500 × $1.754) 183,645 Total cost accounted for $1,565,164 Difference of $461 due to rounding *Note the cost per EU is the same as in Review Problem 2 under this method (used 3 decimal places for conversion costs to reduce rounding error above) Journal Entry for Normal Spoilage: Manufacturing Overhead 19,224 WIP

19,224

Appendix 8A Super-Variable Costing

Problem 8A-1 (10 minutes)

749

1. a. The unit product cost under super-variable costing would only include direct materials of $18. b. The super-variable costing income statement would be: Sales (20,000 units × $50 per unit) ...................... Variable cost of goods sold (20,000 units × $18 per unit) ......................... Contribution margin ............................................. Fixed expenses: Direct labour .................................................... Fixed manufacturing overhead ........................... Fixed selling and administrative expense ............ Operating income ................................................

$1,000,000 360,000 640,000 $200,000 250,000 80,000

530,000 $ 110,000

Managerial Accounting, 6th Canadian Edition

Exercise 8A-2 (20 minutes) 1. a. The unit product cost under super-variable costing would only include direct materials of $13. b. The super-variable costing income statement would be: Sales (52,000 units × $40 per unit) ...................... Variable cost of goods sold (52,000 units × $13 per unit) ......................... Contribution margin ............................................. Fixed expenses: Direct labor ...................................................... Fixed manufacturing overhead ........................... Fixed selling and administrative expense ............ Operating income ................................................

$2,080,000 676,000 1,404,000 $750,000 420,000 110,000

1,280,000 $ 124,000

2. a. The unit product cost under variable costing would be: Direct materials ............................................................................ Direct labour ($750,000 ÷ 60,000 units) ........................................ Variable costing unit product cost ..................................................

$13.00 12.50 $25.50

b. The variable costing income statement would be: Sales (52,000 units × $40 per unit) ..................... Variable cost of goods sold (52,000 units × $25.50 per unit) ................... Contribution margin ............................................ Fixed expenses: Fixed manufacturing overhead .......................... Fixed selling and administrative expense ........... Operating income ...............................................

$2,080,000 1,326,000 754,000 $420,000 110,000

530,000 $ 224,000

751

Exercise 8A-2 (continued) 3. The difference between the super-variable costing and variable costing operating incomes is explained as follows: Units in ending inventory = Units in beginning inventory + Units produced – Units sold = 0 units + 60,000 units – 52,000 units = 8,000 units Direct labour cost deferred in (released from) inventory = Direct labour cost ending inventory – Direct labour cost in beginning inventory = (8,000 units × $12.50 per unit) − $0 = $100,000 Super-variable costing operating income ..................................... Add direct labor cost deferred in inventory under variable costing . Variable costing operating income ...............................................

$124,000 100,000 $224,000

Managerial Accounting, 6th Canadian Edition

Problem 8A-3 (45 minutes) 1. a. The unit product cost under super-variable costing would include direct materials of $19. b. The super-variable costing income statement would be: Sales (18,000 units × $55 per unit) ...................... Variable cost of goods sold (18,000 units × $19 per unit) ......................... Contribution margin ............................................. Fixed expenses: Direct labour .................................................... Fixed manufacturing overhead ........................... Fixed selling and administrative expense ............ Operating income ................................................

$990,000 342,000 648,000 $250,000 300,000 90,000

640,000 $ 8,000

2. a. The unit product cost under variable costing would be: Direct materials ............................................................................ Direct labour ($250,000 ÷ 20,000 units) ........................................ Variable costing unit product cost ..................................................

$19.00 12.50 $31.50

b. The variable costing income statement would be: Sales (18,000 units × $55 per unit) ...................... Variable cost of goods sold (18,000 units × $31.50 per unit) .................... Contribution margin ............................................. Fixed expenses: Fixed manufacturing overhead ........................... Fixed selling and administrative expense ............ Operating income ................................................

$990,000 567,000 423,000 $300,000 90,000

390,000 $ 33,000

753

Problem 8A-3 (continued) 3. a. The unit product cost under absorption costing would be: Direct materials ............................................................................ Direct labour ($250,000 ÷ 20,000 units) ........................................ Fixed manufacturing overhead ($300,000 ÷ 20,000 units)............... Absorption costing unit product cost ..............................................

$19.00 12.50 15.00 $46.50

b. The absorption costing income statement would be: Sales (18,000 units × $55 per unit) ....................................... Cost of goods sold (18,000 units × $46.50 per unit) ............... Gross margin ........................................................................ Selling and administrative expenses ....................................... Operating income .................................................................

$990,000 837,000 153,000 90,000 $ 63,000

4. The difference between the super-variable costing and variable costing operating incomes is the direct labour deferred in (or released from) inventory during the period, which is determined as follows: Units in ending inventory = Units in beginning inventory + Units produced – Units sold = 0 units + 20,000 units – 18,000 units = 2,000 units Direct labour cost deferred in (released from) inventory = Direct labour cost in ending inventory – Direct labour cost in beginning inventory = (2,000 units × $12.50 per unit) – $0 = $25,000 Super-variable costing operating income ............................... Add direct labour cost deferred in inventory under variable costing ............................................................................. Variable costing operating income .........................................

$ 8,000 25,000 $33,000

Managerial Accounting, 6th Canadian Edition

Problem 8A-3 (continued) 4. The difference between the super-variable costing and absorption costing operating incomes is explained as follows: Direct labour and fixed manufacturing overhead cost deferred in (released from) inventory = Direct labour and fixed manufacturing overhead cost in ending inventory – Direct labour and fixed manufacturing overhead cost in beginning inventory = [2,000 units × ($12.50 per unit + $15.00 per unit)] – $0 = $55,000 Super-variable costing operating income ............................... Add direct labour and fixed manufacturing overhead cost deferred in inventory under absorption costing ....................... Absorption costing operating income .....................................

$ 8,000 55,000 $63,000

Appendix 9A Inventory Decisions Solutions to Questions 9A-1 Inventory ordering costs are those costs associated with acquiring inventory such as clerical costs and transportation costs.

9A-5 The reorder point depends on the: economic order quantity; lead time; and the rate of usage during the lead time.

9A-2 In determining the economic order quantity, a company seeks to trade off costs of carrying inventory against the costs of ordering inventory.

9A-6 If some setup costs are fixed, then reducing the number of set-ups will not necessarily lead to a reduction in set-up costs. For example, if set-up costs include depreciation on equipment used in the set-up activity, this will be unaffected by changing the number of setups. Generally, however, less setups results in lower costs.

9A-3 The reorder point is the point in time when an order must be made to replenish depleted stocks. It is determined by multiplying the lead time by the average daily or weekly usage. 9A-4 Costs associated with the inventory that do not appear as expenses on the income statement include the following: quantity discounts foregone; irregular production; inefficiency of production runs; and lost sales due to customer dissatisfaction.

755

9A-7 Variable usage during the lead time can be accommodated by calculating safety stock using the maximum expected usage per week. Alternatively variable usage can be accommodated by: (a) computing the various inventory quantities that the demand probabilities indicate could be satisfied by the safety stock; and (b) computing the stockout costs caused when expected demand exceeds the safety stock. The optimal level of safety stock is the one that minimizes the cost of carrying the safety stock plus the expected stockout costs. 9A-8 There are two costs associated with perishable products. If excess inventory is ordered the cost of the excess (net of any recoveries) is similar to a carrying charge. If inventory is too low an opportunity cost is incurred equivalent to the contribution on lost sales.

Managerial Accounting, 6th Canadian Edition

Exercise 9A-1 (10 minutes)

1. E= √

QP x = √ C

2. Total inventory costs per year:*

Setup cost: (2,000 components ÷ 400 (E) drones = 5 production runs per year; 5 runs × $400 per run) ........................................................ Cost of carrying inventory: Economic production lot size ............................... 400 drones Percentage on hand ............................................ × 50% Average inventory............................................... 200 drones Carrying cost per drone....................................... × $10 Total inventory cost ...............................................

$2,000

$2,000 $4,000

*Note that at a production lot size of 400 units, the setup costs exactly equal the carrying costs. At lot sizes above or below 400 units, the total inventory costs will exceed $4,000. 3. E= √

QP x = √ C

s( u

)

757

Exercise 9A-2 (15 minutes)

1. Average weekly usage ......................................... 520 units Lead time ........................................................... × 3 weeks Reorder point...................................................... 1,560 units The company should reorder when inventory has been depleted to 1,560 units remaining. 2. a.

Maximum weekly usage ....................................... 600 units Average weekly usage ......................................... 520 units Difference ...................................................... 80 units Lead time............................................................ × 3 weeks Safety stock ........................................................ 240 units Reorder point from part (1) above ........................ 1,560 units Add the safety stock from (2a) above ................... 240 units Reorder point ...................................................... 1,800 units The company should reorder when the inventory has been depleted to 1,800 units remaining.

Managerial Accounting, 9th Canadian Edition

Exercise 9A-3 (15 minutes) 1. E= √

QP x1 = √ C

x 1 1

u its

2. A decrease in the cost to place an order will cause the economic order quantity to decrease: E= √

QP x1 = √ C

x 1 1

7 u its ( u

)

3. An decrease in the cost to carry a part in inventory will cause an increase in the economic order quantity.

E= √

QP x1 = √ C

x 1 .

= 71 u its ( u

)

4. If the cost to place an order decreases (as in part 2), then the company will want to purchase more frequently and in smaller amounts. Thus, the economic order quantity will decrease. On the other hand, if the cost to carry a part in stock decreases (as in part 3), then the company will want to carry more stock and therefore purchase less frequently and in larger amounts. Thus, the economic order quantity will increase. Exercise 9A-4 (5 minutes) 1. 2.

b. a.

3. a. 4. a.

5. b. 6. b.

7. b. 8. a.

9. b. 10. a.

759

Problem 9A-5 (30 minutes) 1. E= √

QP x = √ C

x 1

=√

c mp

2. A 10% stock-out risk would mean providing for a maximum delivery time of 4 days, or a safety stock of only 2 days (4 days minus 2 days average delivery time).

Usage during the lead time (5,000 components  360 days = 14 components per day rounded) × 2 days ................................................................ Safety stock (2 days only) .................................. Reorder point ....................................................

28 components 28 components 56 components

A new order should be placed when the inventory drops to 56 components on hand. The safety stock would be 28 components. 3. A 5% stockout risk would mean providing for a maximum delivery time of five days, or a safety stock of 3 days (5 days minus 2 days average delivery time).

Usage during the lead time (above).................... Safety stock (3 days × 14 components per day usage) .............................................................. Reorder point ....................................................

28 components components 42 70 components

A new order should be placed when the inventory drops to 70 components on hand. The safety stock would be 42 components.

Purchase order cost: (5,000 components ÷ 50 components EOQ = 100 orders per year; 100 orders × $10 per order) ................................................... Carrying cost of safety stock: (42 components × $40 each) .............................. Carrying cost of other inventory: Economic order quantity ..................................... 50 components Percentage on hand ............................................ × 50% Average inventory............................................... 25 components Carrying cost per component............................... × $40

$1,000 $1,680

$1,000

Managerial Accounting, 9th Canadian Edition

Total cost ..............................................................

$3,680

761

Problem 9A-5 (continued) Note from this computation that the purchase order cost ($1,000) is equal to the carrying cost of ―other‖ inventory ($1,000), which proves that 50 components is the EOQ. 5. E= √

QP x = √ C

=√

c mp

Managerial Accounting, 9th Canadian Edition

Problem 9A-6 (45 minutes) 1.

Computation of the EOQ 1

Gross Ordered 2 3 1.0 1.5

Average inventory in units

0.5

Number of purchase orders

Delivered cost per gross*

$ 500

Value of average inventory

5 2.0

2.5

$ 500

$ 250

$ 500

$ 750

$ 1,000

$ 1,250

$18,000

Annual carrying cost at 20% of line d (above)

100

150

200

250

Annual storage cost at $24 x line a (above)

Annual ordering cost at $30 x line b (above)

1,080

540

360

270

240

$19,142

$18,664

$18,546

$18,518

$18,550

Delivered cost of inventory

Total annual cost The EAQ would be 4 gross.

* Delivered cost = purchase cost plus cost of freight = $800 × .6 + $20 = $500

763

Problem 9A-6 (continued) 2. Average daily usage =

5,184 * annual usage = 20 units per day 259 working days

Normal lead time = 20 working days Average lead-period usage: 20 × 20 =

400

Maximum daily usage................................................ 28 Less average daily usage ........................................... 20 Excess above average ............................................... 8 Times normal lead time ............................................. 20 Safety stock required ................................................ 160

units units per day units per day units per day days units

Average lead-period usage (above) ............................ 400 units Safety stock required ................................................ 160 units Minimum stock reorder point ..................................... 560 units Note:

The computed minimum stock requirements would increase the carrying and storage costs calculated in part 1. However, the increased costs would be equal for all lot sizes and, therefore, would not affect the EOQ of 4 gross.

*36 gross @ 144 units/gross= 5,184 units per year. (CPA Canada Solution, adapted)

Managerial Accounting, 9th Canadian Edition

Problem 9A-7 (25 minutes) 1. E= √

QP x7 = √ C

x .

=√

u its

2. The basic question is whether the company should provide for a 3-day safety stock, or a 5-day safety stock. The problem is structured so that there is no ―right‖ answer to this question. However, the following points should be considered: First, since the company places only 16 orders a year (7,200 units  450 units EOQ), a 12-day delivery period would occur only every 3.1 years. (2% of the time would equal one order out of 50; 50  16 orders = 3.1 years.) This seems far too infrequent to make a provision for a safety stock, unless interruptions in production simply can‘t be tolerated at all. Second, a 5-day safety stock would be more costly compared to a 3-day safety stock

(7,200  360 = 20 units per day) × 5 days ..... (7,200  360 = 20 units per day) × 3 days ..... Difference ................................................... Carrying cost per unit .................................. Additional annual carrying cost ..................... Frequency needed—once each 3.1 years ....................................................... Total cost of added safety stock for the 3.1 year period ..............................................

100 units safety stock 60 units safety stock 40 units × $3.20 $ 128 × 3.1 $ 396.80

Note: the $396.80 would need to be compared to expected stock-out costs in making a final decision on the level of safety stock to carry.

765

Problem 9A-7 (continued)

Reorder Point 3-day 5-day Safety Safety stock Stock Daily usage rate (Part 2.) ..................................... 20 units 20 units Lead time in days ................................................ ×7 ×7 Total ............................................................... 140 units 140 units Safety stock (above)............................................ 60 units 100 units Reorder point ...................................................... 200 units 240 units 3-day Safety stock $ 720

5-day Safety Stock $ 720

Purchase order cost (16 orders × $45) Carrying cost of the safety stock (60 units and 100 units, @ $3.20 each) .................. 192 Carrying cost of the other inventory: Economic order quantity 450 units Percentage on hand × 50% Average inventory 225 units Carrying cost × $3.20 720 Total annual cost. ................................................$1,632

320

720 $1,760

Note from the computations above that the purchase order cost ($720) is equal to the carrying cost of ―other‖ inventory ($720), which proves that 450 units is the EOQ. 5. a. E= √

QP x7 = √ C

=√

= 1 u its ( u

)

b. Under the old purchasing policy, the company was placing a new order every 22.5 days (450 units EOQ  20 units per day = 22.5 days). Under the new policy, they would be placing a new order every 10.9 days (219 units EOQ  20 units per day = 10.9 days).

Managerial Accounting, 9th Canadian Edition

Problem 9A-8 (30 minutes) 1. Projected raw materials issues:

AD-5 (8,000 units) FX-3 (6,000 units) Projected raw material issues

Plastic 16,000 kg 6,000 kg 22,000 kg

Brass 4,000 kg — 4,000 kg

Aluminum — 9,000 kg 9,000 kg

Plastic

Brass3

Aluminum

1,100 kg 16,000 kg

200 kg 9,000 kg

450 kg 14,000 kg

15,0001 kg 15,0002 kg 46,000 kg 22,000 kg 24,000 kg

— — 9,000 kg 4,000 kg 5,000 kg

10,0004 kg — 24,000 kg 9,000 kg 15,000 kg

2. and 3. Projected inventory activity and ending balance:

Average daily usage (issues  20 working days) Beginning inventory Orders received: Ordered in 7th period Ordered in 8th period Subtotal Issues (from part 1. above) Projected ending inventory balance 1

Order for 15,000 kilograms of plastic ordered during seventh period will be received on tenth working day of eighth period. 2 Order for 15,000 kilograms of plastic placed on fourth working day of eighth period will be received on the fourteenth working day of the eighth period (i.e., 10 days later). By end of the fourth working day inventory will be just below the reorder point of 12,000 kilograms: 16,000 – (4 x 1,100 per day) = 11,600. 3 Ordered 5,000 kilograms of brass on eighth working day but it won‘t be received until 30 days later. By the end of the eighth working day inventory will be just below the reorder point of 7,500 kilograms: 9,000 – (8 x 200 per day) = 7,400. 4 Order for 10,000 kilograms of aluminum ordered during seventh period received on fourth working day. Inventory for aluminum will not fall below the reorder point at any point during the 8th period so no new orders will be placed.

767

Problem 9A-8 (continued) 4. Projected payments for raw material purchases:

Raw Material Plastic Aluminum Plastic Brass

Day/ Period Ordered 20th/ Seventh 4th/ Seventh 4th/Eighth

Day/ Period Quantity Amount Period Received Ordered Due Due 1 10th/Eighth 15,000 kg $6,000 Eighth 4th/Eighth

10,000 kg

$5,5002 Eighth

14th/Eighth

15,000 kg

$6,0003 Eighth

Due Ninth

5,000 kg

4,7504 Ninth

8th/Eighth

15,000 x $.40 10,000 x $.55 3 15,000 x $.40 4 5,000 x $.95 2

(CPA Canada Solution, adapted)

Managerial Accounting, 9th Canadian Edition

Problem 9A-9 (30 minutes) 1. The economic order quantity of inventory considers order costs and carrying costs. The formula is:

E= Where:

2QP C Q = Annual quantity used = 6,000 dozen P = Cost per purchase order = $16.50, with Data entry cost (1/4 × $16) ............................ Receiving cost (1/3 × $21) .............................. Opportunity cost of manager‘s time spent on ordering (1/6 × $301) ....................

= =

$ 4.00 7.00 5.00 $16.00

C = Annual cost of carrying one unit in stock for one year $4.00 ($1.00 + $3.00). The carrying costs per unit include $1.00 per dozen balls plus the desired 10% return on the price per dozen ($30 × .10 = $3). 1

$1,200/40 = $30 per hour; 10 minutes (1/6 hour) spent on each order.

E= √

QP x = √ C

x 1 .

= 1

( u

)

2. The total inventory expenses include order costs, inventory carrying costs, and the desired return on the inventory. The order cost is the number of orders per year (30 = 6,000 needed/200 per order) times the cost per order ($16.00). The inventory carrying costs are the average number on hand (200/2) times the carrying cost per dozen ($4.00). The desired return on the inventory is the average number on hand (200/2) times the desired return per dozen ($30 × .10). Order costs ($16.00 × 30) ............................................................ $ 480.00 Carrying costs ($1.00 × 200/2) ..................................................... 100.00 Return ($3 × 200/2) ..................................................................... 300.00 $880.00

769

Problem 9A-9 (continued) 3. The New EOQ =

E= √ Number of orders

QP x = √ C

x 1 .

( u

)

6,000 ÷ 190 = 32 (rounded)

If Links Unlimited wants to minimize the cost of inventory for the year, it should order 190 dozen per order. This means 32 orders per year, i.e., annual costs of $764* Order costs ($12 × 32).................................................... $384.00 Carrying costs ($1 × 190/2) ................................................ 95.00 Return ($3 × 190/2) ................................................ 285.00 Total annual inventory costs $764.00 *Total order costs of $384 do not equal total carrying costs $380 ($95 + $285) because of rounding. (CPA Canada Solution, adapted)

Managerial Accounting, 9th Canadian Edition

Problem 9A-10 (50 minutes) 1a. Economic order quantity:

2QP C

E = order size in units Q = annual quantity used in units P = cost of placing one order C = annual cost of carrying one unit in stock Q = 400 * 250 = 100,000 units P = $20 C = $0.30

2x100,000x $20  13,333,333  3,651 $.30 1b. Safety stock Maximum expected usage per day Average usage per day ................ Excess ........................................ Lead time ................................... Safety stock ................................

600 400 200 8 1,600

1c. Reorder point: Reorder point = (lead time * avg. daily usage) + safety stock Reorder point = (8 × 400) + 1,600 = 4,800 1d.

Normal maximum inventory: Normal maximum inventory = EOQ + safety stock 3,651 + 1,600 = 5,251 units

1e. Absolute maximum inventory: (EOQ + Safety Stock) + [(Normal use – minimum use) x lead time] (3,651 + 1,600) + [(400 – 100) x 8] = 7,651 units 1f. Average inventory = Safety stock + (1/2 x EOQ) 1,600 + (1/2 x 3,651) = 3,426 units

771

Problem 9A-10 (continued) 2. Safety stock that minimizes expected costs. Normal demand = 3,200 units (8 days x 400 units per day) (1)

(2)

Possible Normal Demand Demand (units) (units)

(3)

(4)

Safety Stock (units)1

Carrying Cost Per Year

(5) (1)-(2)(3) Stock-out (units)

(6) (5) x .05 Stock-out Cost per Order

(7)

(8)

Orders Per Year2

Prob. of Stockout

(9) Expected Stockout Cost Per

(10) Total Cost Per Year4

-0400 800 1,200 1,600

$0.00 20.00 40.00 60.00 80.00

28 28 28 28 28

0.40 0.30 0.20 0.05 0.05

Year3 $0.00 168.00 224.00 84.00 112.00

-0400 800 1,200

0.00 20.00 40.00 60.00

28 28 28 28

0.30 0.20 0.05 0.05

0.00 112.00 56.00 84.00

372.00

-0400 800

0.00 20.00 40.00

28 28 28

0.20 0.05 0.05

0.00 28.00 56.00

324.00

$360

-0400

0.00 20.00

28 28

0.05 0.05

0.00 28.00

388.00

$480

-0-

0.00

0.05

0.00

480.00

3,200 3,600 4,000 4,400 4,800

3,200 3,200 3,200 3,200 3,200

0 0 0 0 0

$-0-

3,600 4,000 4,400 4,800

3,200 3,200 3,200 3,200

400 400 400 400

$120

4,000 4,400 4,800

3,200 3,200 3,200

800 800 800

$240

4,400 4,800

3,200 3,200

1,200 1,200

4,800

3,200

1,600

$588.00

It appears that safety stock of 800 units should be maintained to minimize the costs associated with carrying excess inventory and the costs associated with stock-outs. © McGraw-Hill Ryerson Ltd. 2011. All rights reserved. 772

Managerial Accounting, 9th Canadian Edition

Problem 9A-10 (continued) 1

Safety stock alternatives = Possible demand – normal demand.

3,200 - 3,200 = 0 3,600 – 3,200 = 400 4,000 – 3,200 = 800 4,400 – 3,200 = 1,200 4,800 – 3,200 = 1,600 2

Orders per year = Annual demand/EOQ = 100,000/3,651 = 28 orders per year (rounded up)

Expected stock-out cost per year: Stock-out cost per order x number of orders x probability of stock-out Example - If safety stock is 0 and actual demand is 3,600 then cost is: $20 x 28 x 0.30 = $168

Total cost per year = Carrying cost of safety stock + Expected total costs of stock-out for given level of safety stock Example- If safety stock = 0, then total cost per year is: $0 + ($168 + $224 + $84 + $112) = $588 (CPA Canada Solution, adapted)

773

Problem 9A-11 (20 minutes) 1.

Demand Probabilities A1: Stock 7 copies (7 × $3.00 – 7 × $1.80) A2: Stock 8 copies A3: Stock 9 copies A4: Stock 10 copies EMV (A1) = 8.40 (.3) + 6.00(.4) + 3.60(.2) + 1.20(.1) = EMV (A2) = 7.80 (.3) + 9.60(.4) + 7.20(.2) + 4.80(.1) = EMV (A3) = 7.20 (.3) + 9.00(.4) + 10.80(.2) + 8.40(.1) = EMV (A4) = 6.60 (.3) + 8.40(.4) + 10.20(.2) + 12.00(.1) =

Demand Number of Copies 7 8 9 10 .30 .40 .20 .10 $8.40 $6.00* $3.60 $1.20 7.80** 9.60 7.20 4.80 7.20 9.00 10.80 8.40 6.60 8.40 10.20 12.00

$5.76 $8.10 $8.76 *** $8.58

*[7($3-$1.80) – (1 x $2.40)] = $6 (1 = the number of number dissatisfied customers when demand is 8 and inventory is 7) **$8.40 when stock = 7 less net cost of $0.60 ($1.80 - $1.20) of excess inventory of 1 unit. *** The newsstand should stock 9 copies of the magazine. The expected profit is $8.76 per week. Each lost sale reduced profit by $2.40. Each unsold unit reduced profit by $0.60 ($1.80 - $1.20).

Managerial Accounting, 9th Canadian Edition

Problem 9A-11 (continued)

Demand Copies 8 9

Opportunity Loss A1: (Stock 7 copies) 0 $3.60* $7.20** $10.80*** EOL (A1) = 0 + 3.60(.4) + 7.20(.2) + 10.80(.1) = $3.96 Opportunity loss = Profit if ―best‖ alternative selected – profit of chosen alternative. Note that ―best‖ alternative is to stock enough copies to exactly meet demand. In this case, the chosen alternative is to stock 7 copies. _____________________ *[8 × (3.00 – 1.80)] – 6.00 (Profit from part 1 if demand = 8 units) **[9 × (3.00 – 1.80)] – 3.60 (Profit from part 1 if demand = 9 units) **[10 × (3.00 – 1.80)] – 1.20 (Profit from part 1 if demand = 10 units) (CPA Canada Solution, adapted)

775

Problem 9A-12 (20 minutes)

Demand Possibilities (Probability of Occurrence) Quantity 75 80 85 90 95 Expected Stocked (.10) (.20) (.30) (.30) (.10) Value*** 75 75($30*) $2,250 $2,250 $2,250 $2,250 $2,250 = $2,250 80 75($30) – 80($30) = $2,400 $2,400 $2,400 $2,395 $50**= $2,400 $2,200 85 75($30) – 80($30) –$50= 85($30) = $2,550 $2,550 $2,470 $100 = $2,350 $2,550 $2,150 90 75($30) – 80($30) – 85($30) – 90($30) = $2,700 $2,500 $150 = $100= $2,300 $50= $2,500 $2,700 $2,100 95 75($30) – 80($30) – 85($30) – 90($30) – 95($30) = $2,470 $200 = $150 = $2,250 $100 = $50 = $2,850 $2,050 $2,450 $2,650 *Contribution margin per bouquet: $60 - $30 = $30 **Loss per bouquet when inventory < demand = $10 ($20-$30); Bouquets overstocked = 5 (80 – 75); Total loss = $50 ($10 x 5) ***EV(stock 75) = $2,250 EV(stock 80) = .1(2,350) + .9(2,400) = $2,395 EV(stock 85) = .1(2,150) + .2(2,350) + .7(2,550) = $2,470 EV(stock 90) = .1(2,100) + .2(2,300) + .3(2,500) + .4(2,700) = $2,500 EV(stock 95) = .1(2,050) + .2(2,250) + .3(2,450) + .3(2,650) + .1(2,850) = $1,615 *Janet‘s Bouquets should purchase 90 bouqets each week to maximize earnings. (CPA Canada, Solution adapted)

Managerial Accounting, 6th Canadian Edition

Problem 9A-13 (60 minutes) 1. The value for ordering cost is composed of the following items: Shipping fee per order .................................................................. Direct labour per order—receiving clerk (8 hours × $17.50 per hour) ...................................................... Processing cost per order1 ............................................................ Total ordering cost per order ........................................................ 1

Processing cost per order

$ 104.00 140.00 6.00 $250.00

Change in ordering cost Change in number of orders

= $35,560 – $34,440 280-56 = $1,120 224 = $5.00 processing cost per order Recognition of 20% cost increase

= $5.00 × 1.20 = $6.00

2. The value for storage cost is composed of the following items: Variable warehouse rent per windshield (fixed fee not relevant) .............................................................. Breakage cost per windshield ($200 × .10) .................................... Taxes and fire insurance per windshield ........................................ Desired rate of return on inventory investment per windshield ($200 × .15) ...................................................... Total storage cost per windshield ..................................................

$ 5.00 20.00 5.00 30.00 $60.00

777

Problem 9A-13 (continued) 3. The economic order quantity (EOQ) is calculated as follows:

E= √

QP x = √ C

=√

u its

*100 × 300 4. The minimum annual cost at the economic order quantity is calculated as follows: Costmin.

= Order cost + Storage cost

[(30,000/500) × $250)] + [(500/2 × $60)] $15,000 + $15,000 = $30,000 Note: this proves that 500 is the economic order quantity since the costs of ordering exactly equal the storage costs.

5. The reorder point in units is calculated as follows: Usage per day × Lead time in days = 100 units × 5 days = 500 windshields

(CPA Canada Solution, adapted)

Appendix 10D Prediction of Labour Time: Learning Curve Solutions to Questions

Managerial Accounting, 6th Canadian Edition

10D-1 A learning curve is a cost function that shows that the average cost per unit of output declines systematically as cumulative production increases. This learning effect occurs during the early stages of production and demonstrates that less time is needed to perform a task as workers gain experience.

10D-3 The average time required to complete the next 100 units will be 7.2 minutes (.90 x 8)

10D-2 Workers performing according to an 80 percent learning curve would show a declining pattern of average time to learn a task. The pattern would drop from a high of 1 unit to a low, nearly flat curve at about 32 units (see exhibit 10-D1)

779

Problem 10D-1 (30 minutes) 1. Cost of component: Set-up ............................................................................................ $ 100.00 Material 8 × $40.00 ........................................................................ 320.00 Labour 27.44* × $20.00 ................................................................. 548.80 Variable overhead 1.50 × $548.80 ................................................. 823.20 Total for 8 units .............................................................................. $1,792.00 Per unit $224.00 * Cumulative Quantity 1 2 4 8

Average Hours Per Unit 10 7 4.9 3.43*

Total Hours 10 14 19.6 27.44

*Or y = aQb y = 10 x 8Log.70/Log2 = 10 x 8-.51457 = 3.43 hours per unit 2. Lot size to equal $310/unit: Set-up ............................................................................................ $ 100.00 Material 4 × $40.00 ........................................................................ 160.00 Labour 19.6 (see above) × $20.00 ................................................. 392.00 Variable overhead 1.50 × $392.00 ................................................. 588.00 Total for 4 units .............................................................................. $ 1,240.00 Per unit $310.00 ($1,240 ÷ 4) The indifference level of production is 4 units. Producing less than 4 units, the unit cost would exceed $310.00 so it would be cheaper to buy from the external supplier. However, if Walker Limited produces more than 4 units, it will be cheaper to produce the component internally.

Problem 10D-2 (10 minutes) The formula for the incremental unit time learning model is y  aQb where b = log(% learning) ÷ log 2 b = log(.90) ÷ log2 b = -0.0457 ÷ .30103 b = -.1520 y = 6 x 16-.1520 y = 3.9 hours to produce the 16th unit.

781

Problem 10D-3 (40 minutes) 1. The total hours for 1,600 units (1.344* × .80) x 1,600 = 1,720.32 or 1,720 hours *1.344 is average hours per unit required to produce 800 units. This is based on needing 1.68 hours per unit to produce 400 units. Therefore, the average hours per unit to produce 1,600 units = 1.344 x .80. This is all based 80% learning curve as implied in the case facts. 2. The incremental assembly costs would be 1,720 × $15 .............. Less: (800 × 1.344) × $15 ........................................................... Incremental cost of 800 ............................................................... 3. High Low

Y 1075.2 420.

Log Y 3.0315 2.6232

Q 800 200

Log Q 2.9031 2.3010

Formula for Linear Form Log Y = Log a + (b + 1) Log Q (b + 1) = (diff. In Log Y)/(diff. In Log Q) = (3.0315 – 2.6232)/(2.9031 – 2.3010) = .4083/.6021 = .6781 Log a = Log Y – (b + 1) Log Q = 3.0315 – .6781(2.9031) = 3.0315 – 1.9686 = 1.0629 a = 101.0629 = 11.5585 Formula is Y = (11.5585)Q0.6781

= = =

$25,800 16,128 $ 9,672

Problem 10D-3 (continued) 4. Total hours to produce 1,600 Y = 11.5585(1,600)0.6781 = 1,720.34 Total hours to produce 1,700 Y = 11.5585(1,700)0.6781 = 1,792.54 Time to produce additional 100 1,792.54 – 1,720.34 = 72.20 hours or .7220 per unit The actual time was .90 per unit while the curve suggests .7220 per unit for the last 100 units. The deviation could result from inefficiency by the work force that is approaching the end of the contract. The deviation could result because of deficient materials or poorly maintained equipment. The difference could also be caused of inaccuracies in the estimates.

Appendix 11A Additional Control Topics Solutions to Question 11A-1 The maximum they will pay is the market price being currently charged by the alternative supplier.

nificant time and effort and may result in an impasse that needs to be settled by head office in any case.

11A-2 Negotiated transfer prices preserve the autonomy of the divisions and are in keeping with decentralization. Also, the managers of the divisions tend to have much better information than head office about potential costs and benefits of the transfer so they are in a better position to determine the best final transfer price. Disadvantages of negotiated transfer prices include the risk of divisional managers acting in their own interests instead of in the interest of the company. Also, negotiation can involve sig-

11A-3 When a market price is available it is usually the best transfer price because it provides an objective yardstick with which to measure what the internal cost/price should be. Neither manager gains or loses if the transfer is made a market price since neither manager could buy/sell to the outside at a better price/cost. 11A-4 Quality costs can be broken down into prevention costs, appraisal costs, internal failure © McGraw Hill Ltd. 2024. All rights reserved.

Solutions Manual, Appendix 11A

783

costs, and external failure costs. Prevention costs are incurred in an effort to keep defects from occurring. Appraisal costs are incurred to detect defects before they can create further problems. Internal and external failure costs are incurred as a result of producing defective units.

ed, costs are not reallocated back to it under the step-down method.

11A-5 No, total quality costs are usually minimized by increasing prevention and appraisal costs in order to reduce internal and external failure costs. Total quality costs usually decrease as prevention and appraisal costs increase. 11A-6 Lost sales arising from a reputation for poor or declining quality is the most difficult to quantify. This is because the company would need to estimate what sales would have been if not for poor or declining quality. Given the number of factors (including quality) that can negatively impact product sales, simply comparing current period sales to prior period sales is at best a crude proxy for determining the effects of reputation loss. 11A-7 Service department costs are allocated to products and services in two stages. Service department costs are first allocated to the operating departments. These allocated costs are then included in the operating departments‘ overhead rates, which are used to cost products and services. 11A-8 There are many reasons for allocating service department costs to operating departments including to: encourage operating departments to efficient use of service department resources; provide operating departments with complete cost information for making decisions; allow the assessment of operating department profits; and create an incentive for service departments to operate efficiently. 11A-9 Under the direct method, interdepartmental services are ignored; service department costs are allocated directly to operating departments. Under the step-down method, the costs of the service department performing the greatest amount of service for the other service departments are allocated first, the costs of the service department performing the next greatest amount of service are allocated next, and so forth through all the service departments. Once a service department‘s costs have been allocat© McGraw-Hill Ryerson Ltd. 2012. All rights reserved. 784

Managerial Accounting, 9th Canadian Edition

Exercise 11A-1 (30 minutes) 1. Since the Valve Division has idle capacity, it does not have to give up any outside sales to take on the Pump Division‘s business. Applying the formula for the lowest acceptable transfer price from the viewpoint of the selling division, we get: Total contribution margin on lost sales Number of units transferred $0 Transfer price $8+ =$8 10,000 The Pump Division would be unwilling to pay more than $14, the price it is currently paying an outside supplier for its valves. Therefore, the transfer price must fall within the range: Transfer price

Variable cost per unit+

$8 ≤Transfer price ≤$14 2. Since the Valve Division is selling all that it can produce on the intermediate market, it would have to give up some of these outside sales to take on the Pump Division‘s business. Thus, the Valve Division has an opportunity cost that is the total contribution margin on lost sales: Transfer price

$8+

($15-$8)10,000

=$8+$7=$15 10,000 Since the Pump Division can purchase valves from an outside supplier at only $14 per unit, no transfers will be made between the two divisions. 3. Applying the formula for the lowest acceptable price from the viewpoint of the selling division, we get: Transfer price

($8-$2)+

($15-$8)10,000

=$6+$7=$13 10,000 In this case, the transfer price must fall within the range: $13 ≤Transfer price ≤$14 4. To produce the 20,000 special valves, the Valve Division will have to give up sales to outside customers of 30,000 regular valves. Applying the formula for the lowest acceptable price from the viewpoint of the selling division, we get Transfer price

$10+

($15-$8) 30,000 =$10+$10.50=$20.50 20,000

785

Exercise 11A-2 (20 minutes) 1. The lowest acceptable transfer price from the perspective of the selling division is given by the following formula: Total contribution margin on lost sales Transfer price Variable cost per unit+ Number of units transferred There is no idle capacity, so each of the 10,000 units transferred from Alpha Division to Beta Division reduces sales to outsiders by one unit. The contribution margin per unit on outside sales is $10 (= $25 – $15). Transfer price  ($15 - $1) + ($10 × 10,000)/10,000 = $14 + $10 - $24 The buying division, Beta Division, can purchase a similar unit from an outside supplier for $23.50. Therefore, Beta would be unwilling to pay more than $23.50 per unit. Transfer price  Cost of buying from outside supplier = $23.50 The requirements of the two divisions are incompatible and no transfer will take place. 2. In this case, Alpha Division has enough idle capacity to satisfy Beta Division demand. Therefore, there are no lost sales and the lowest acceptable price as far as the selling division is concerned is the variable cost of $10 per unit. Transfer price  $10 + ($0/10,000) = $10 The buying division, Beta Division, can purchase a similar unit from an outside supplier for $17. Therefore, Beta Division would be unwilling to pay more than $17 per unit. Transfer price  Cost of buying from outside supplier = $17 In this case, the requirements of the two divisions are compatible and a transfer will hopefully take place at a transfer price within the range: $10  Transfer price  $17

Managerial Accounting, 13th Canadian Edition

Exercise 11A-3 (20 minutes) 1. Sales.................................. Expenses: Added by the division ....... Transfer price paid ........... Total expenses.................... Net operating income ..........

Component Division

Watch Division

Total Company

100,000

60,000 50,000 110,000 $ 90,000

160,000

$250,0001

100,000 $ 150,000

$200,0002

$400,0003

160,000 $240,000

10,000 units × $25 per unit = $250,000. 2,000 units × $100 per unit = $200,000. 3 Components Division outside sales (8,000 units × $25 per unit) ................................... Watch Division outside sales (2,000 units × $100 per unit) ................................. Total outside sales ................................................... 2

$200,000 200,000 $400,000

Note that the $50,000 in intracompany sales have been eliminated as have the $50,000 in intracompany expenses. However, this does not affect the net operating income for the company as a whole, which is still $240,000. 2. The Components Division should transfer the 1,000 additional components to the Watch Division. Note that the Watch Division‘s processing adds $75 to each unit‘s selling price ($100 - $25), but it adds only $30 in cost. Therefore, each component transferred to the Watch Division ultimately yields $45 more in contribution margin ($75 – $30 ) to the company than can be obtained from selling to outside customers. Thus, the company as a whole will be better off if the Component Division transfers the 1,000 additional components to the Watch Division.

787

Exercise 11A-4 (15 minutes) 1. The total cost of quality last year and this year is computed as follows:

Last Year Prevention costs ................................ $ 357,000 Appraisal costs ................................... 445,000 Internal failure costs .......................... 790,000 External failure costs .......................... 1,100,000 Total cost of quality ............................ $2,692,000

This Year $ 650,000 545,000 500,000 680,000 $2,375,000

2. The appropriate percentages (rounded) are computed as follows:

Last Year Prevention costs ................................ Appraisal costs ................................... Internal failure costs .......................... External failure costs .......................... Total cost of quality ............................

Percent

$ 357,000 13.3% 445,000 16.5% 790,000 29.3% 1,100,000 40.9% $2,692,000 100.0%

3. The appropriate percentages (rounded) are computed as follows:

This Year Prevention costs ................................ Appraisal costs ................................... Internal failure costs .......................... External failure costs .......................... Total cost of quality ............................

Percent

$ 650,000 27.4% 545,000 22.9% 500,000 21.1% 680,000 28.6% $2,375,000 100.0%

4. Performance is trending in a favorable direction. The total cost of quality has decreased by $317,000. The company invested an additional $393,000 in prevention and appraisal activities [($650,000 + $545,000) – ($357,000 + $445,000)]. This enabled a $710,000 reduction in internal and external failure costs [($790,000 + $1,100,000) – ($500,000 + $680,000)].

Managerial Accounting, 13th Canadian Edition

Exercise 11A-5 (15 minutes) 1.

Prevention Cost a. b. c. d. e. f. g.

Quality improvement initiatives ... Cost of spoilage ......................... Inspecting raw materials ............ Lawsuit from defective products . Handling customer complaints .... Reprogramming software ........... Training finished goods quality inspectors ................................. h. Repairs to quality testing equipment ...................................... i. Disposal of scrap material .......... j. Training instructors of quality programs .................................... k. Lost sales because of product quality problems ........................... l. Insurance on quality testing equipment .............................. m. Training final product testers ...... n. Installing software for statistical process control ....................... o. Shipping costs for product returns from customers ...................... p. Overtime paid for a rush order caused by quality problems with raw materials

Appraisal Internal FailCost ure Cost

External Failure Cost

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

2. Prevention costs and appraisal costs are incurred in an effort to keep poor quality of conformance from occurring. Internal and external failure costs are incurred because poor quality of conformance has occurred.

789

Exercise 11A-6 (15 minutes)

Departmental costs before allocations ................................ Allocations: Administration costs (40/50, 10/50) .................. Physical Plant costs (25/30, 5/30)* .................. Total costs after allocation .........

Service Departments AdminiPhysical Plant stration Services $1,500,000

$654,000

(1,500,000) $

(654,000) $ 0

Operating Departments Undergraduate Graduate ProPrograms grams $32,650,000

$1,890,000

1,200,000

300,000

545,000 $34,395,000

109,000 $2,299,000

*Based on the space occupied by the two operating departments, which is 30,000 square metres.

Managerial Accounting, 13th Canadian Edition

Total $36,694,000

$36,694,000

Exercise 11A-7 (15 minutes)

Departmental costs before allocations ............... Allocations: Administration costs (320/8,000, 6,200/8,000, 1,480/8,000)* .... Cleaning costs (4,000/5,000, 1,000/5,000)† ..................... Total costs after allocation ................................

Service Departments Administration Cleaning

Operating Departments Book Store

Coffee Shop

$300,000

$80,000

(300,000)

12,000

232,500

55,500

(92,000) $ 0

73,600 $4,946,100

18,400 $1,973,900

$4,640,000

$1,900,000

Total

$6,920,000

*Based on employee hours in the other three departments: 320 + 6,200 + 1,480 = 8,000. †Based on space occupied by the two operating departments: 4,000 + 1,000 = 5,000. Both the Cleaning Department costs of $80,000 and the Administration costs of $12,000 that have been allocated to the Cleaning Department are allocated to the two operating departments.

791

Exercise 11A-8 (20 minutes)

Service Departments

Costs before allocation .................................... Allocation: Personnel: (30/600; 120/600; 300/600; 150/600) .................................................. Cleaning: (500/5,000; 1,000/5,000; 3,500/5,000) ............................................ Maintenance & Tech Suport: (5,000/20,000; 15,000/20,000)......................................... Total cost after allocations ...............................

Operating Departments

Personnel

Maintenance & Tech SupCleaning port

Forming

Assembly

Total

$42,000

$33,900

$18,000

$128,050

$249,300

$471,250

(42,000)

2,100

8,400

21,000

10,500

(36,000)

3,600

7,200

25,200

(30,000) $ 0

7,500 $163,750

22,500 $307,500

Managerial Accounting, 13th Canadian Edition

$471,250

Exercise 11A-9 (20 minutes)

Service Departments

Costs before allocation ............................... Allocation: Personnel: (300/450; 150/450) ................ Cleaning: (1,000/4,500; 3,500/4,500) .................. Maintenance & Tech Support: (5,000/20,000; 15,000/20,000) ............ Total cost after allocations ..........................

Operating Departments

Personnel

Cleaning

Maintenance & Tech Support

$42,000

$33,900

$18,000

(42,000)

Forming

Assembly

Total

$128,050

$249,300

$471,250

28,000

14,000

7,533

26,367

4,500 $168,083

13,500 $303,167

(33,900)

(18,000) $ 0

$471,250

793

Problem 11A-10 (60 minutes) 1. From the standpoint of the selling division, Division A: Transfer price

Variable cost per unit+

Total contribution margin on lost sales Number of units transferred

Transfer price  ($63 - $5) +[($100 - $63) × 10,000]/10,000  $58 + $37 = 95 But, from the standpoint of the buying division, Division B: Transfer price  Cost of buying from outside supplier = $92 Division B won‘t pay more than $92 and Division A will not accept less than $95, so no deal is possible. There will be no transfer. 2. a. From the standpoint of the selling division, Division A: Transfer price

Variable cost per unit+

Total contribution margin on lost sales Number of units transferred

Transfer price  ($19 - $4) +[($40 - $19) × 70,000]/70,000  $15 + $21 = 36 From the standpoint of the buying division, Division B: Transfer price  Cost of buying from outside supplier = $39 In this instance, an agreement is possible within the range: $36  Transfer price  $39 Even though both managers would be better off with any transfer price within this range, they may disagree about the exact amount of the transfer price. It would not be surprising to hear the buying division arguing strenuously for $36 while the selling division argues just as strongly for $39.

Managerial Accounting, 13th Canadian Edition

Problem 11A-10 (continued) b. The loss in potential profits to the company as a whole will be: Division B‘s outside purchase price ........................................... Division A‘s variable cost on the internal transfer ....................... Potential added contribution margin lost to the company as a whole .................................................................................. Number of units ...................................................................... Potential added contribution margin and company profits forgone ...................................................................................

$39 36 $3 ×70,000 $210,000

Another way to derive the same answer is to look at the loss in potential profits for each division and then total the losses for the impact on the company as a whole. The loss in potential profits in Division A will be: Suggested selling price per unit ............................................... Division A‘s variable cost on the internal transfer ....................... Potential added contribution margin per unit............................. Number of units ...................................................................... Potential added contribution margin and divisional profits forgone ...................................................................................

$38 36 $2 ×70,000 $140,000

The loss in potential profits in Division B will be: Outside purchase price per unit................................................ Suggested price per unit inside ................................................ Potential cost avoided per unit ................................................. Number of units ...................................................................... Potential added contribution margin and divisional profits forgone ...................................................................................

$39 38 $1 ×70,000 $70,000

The total of these two amounts ($140,000 + $70,000) equals the $210,000 loss in potential profits for the company as a whole.

795

Problem 11A-10 (continued) 3. a. From the standpoint of the selling division, Division A: Transfer price

Variable cost per unit+

Total contribution margin on lost sales Number of units transferred

Transfer price  $35 + ($0/20,000) = $35 From the standpoint of the buying division, Division B: Transfer price  Cost of buying from outside supplier = $57 Transfer price  $60 – (0.05 × $60) = $57 In this case, an agreement is possible within the range: $35  Transfer price  $57 If the managers understand what they are doing and are reasonably cooperative, they should be able to come to an agreement with a transfer price within this range. b. Division A‘s ROI should increase. The division has idle capacity, so selling 20,000 units a year to Division B should require no increase in operating assets. Therefore, Division A‘s turnover should increase. The division‘s margin should also increase, because its contribution margin will increase by $340,000 as a result of the new sales, with no offsetting increase in fixed costs: Selling price ............................... Variable costs ............................ Contribution margin ................... Number of units ......................... Added contribution margin..........

$52 35 $17 ×20,000 $340,000

Thus, with both the margin and the turnover increasing, the division‘s ROI would also increase.

Managerial Accounting, 13th Canadian Edition

Problem 11A-10 (continued) 4. From the standpoint of the selling division, Division A: Transfer price

Variable cost per unit+

Total contribution margin on lost sales Number of units transferred

Transfer price  $25 +[($45- $30) × 30,000]/60,000  $25 + $7.50 = $32.50

797

Problem 11A-11 (45 minutes) 1. The lowest acceptable transfer price from the perspective of the selling division is given by the following formula: Transfer price

Total contribution margin on lost sales Variable cost + per unit Number of units transferred

The Pulp Division has no idle capacity, so transfers from the Pulp Division to the Carton Division would cut directly into normal sales of pulp to outsiders. The costs are the same whether the pulp is transferred internally or sold to outsiders, so the only relevant cost is the lost revenue of $70 per ton from the pulp that could be sold to outsiders. This is confirmed below: Transfer price $42 +

($70 - $42) × 5,000 = $42 + ($70 - $42) = $70 5,000

Therefore, the Pulp Division will refuse to transfer at a price less than $70 a ton. The Carton Division can buy pulp from an outside supplier for $63 a ton. Therefore, the Division would be unwilling to pay more than $63 per ton. Transfer price ≤ Cost of buying from outside supplier = $63 The requirements of the two divisions are incompatible. The Carton Division won‘t pay more than $63 and the Pulp Division will not accept less than $70. Thus, there can be no mutually agreeable transfer price and no transfer will take place. 2. The price being paid to the outside supplier is only $63. If the Pulp Division meets this price, then profits in the Pulp Division and in the company as a whole will drop by $35,000 per year: Lost revenue per ton ....................................... Outside supplier‘s price .................................... Loss in contribution margin per ton .................. Number of tons per year .................................. Total loss in profits ..........................................

$70 $63 $7 × 5,000 $35,000

Managerial Accounting, 13th Canadian Edition

Problem 11A-11 (continued) Profits in the Carton Division will remain unchanged because it will be paying the same price internally as it is now paying externally. 3. The Pulp Division has idle capacity, so transfers from the Pulp Division to the Carton Division do not cut into normal sales of pulp to outsiders. In this case, the minimum price as far as the Carton Division is concerned is the variable cost per ton of $42. This is confirmed in the following calculation: Transfer price $42 +

$0 = $42 5,000

The Carton Division can buy pulp from an outside supplier for $63 a ton and would be unwilling to pay more than that for pulp in an internal transfer. If the managers understand their own businesses and are cooperative, they should agree to a transfer and should settle on a transfer price within the range: $42 ≤ Transfer price ≤ $63 4. Yes, $59 is a bona fide outside price. Even though $59 is less than the Pulp Division‘s $60 ―full cost‖ per unit, it is within the range given in Part 3 and therefore will provide some contribution to the Pulp Division. If the Pulp Division does not meet the $59 price, it will lose $85,000 in potential profits: Price per ton ..................................................... Variable costs .................................................... Contribution margin per ton ...............................

$59 42 $17

5,000 tons × $17 per ton = $85,000 potential increased profits This $85,000 in potential profits applies to the Pulp Division and to the company as a whole. 5. No, the Carton Division should be free to go outside and get the best price it can. Even though this would result in lower profits for the company as a whole, the buying division should not be forced to buy inside if better prices are available outside.

799

Problem 11A-11 (continued) 6. The Pulp Division will have an increase in profits: Selling price ........................................................ Variable costs ...................................................... Contribution margin per ton .................................

$70 42 $28

5,000 tons × $28 per ton = $140,000 increased profits The Carton Division will have a decrease in profits: Inside purchase price .......................................... Outside purchase price ........................................ Increased cost per ton .........................................

$70 59 $11

5,000 tons × $11 per ton = $55,000 decreased profits The company as a whole will have an increase in profits: Increased contribution margin in the Pulp Division ....................... Decreased contribution margin in the Carton Division ................... Increased contribution margin per ton .........................................

$28 11 $17

5,000 tons × $17 per ton = $85,000 increased profits So long as the selling division has idle capacity, profits in the company as a whole will increase if internal transfers are made. However, there is a question of fairness as to how these profits should be split between the selling and buying divisions. The inflexibility of management in this situation damages the profits of the Carton Division and greatly enhances the profits of the Pulp Division.

Managerial Accounting, 13th Canadian Edition

Problem 11A-12 (45 minutes) 1. The Quark Division will probably reject the $340 price because it is below the division‘s variable cost of $350 per set. This variable cost includes the $140 transfer price from the Screen Division, which in turn includes $30 per unit in fixed costs. Nevertheless, from the perspective of the Quark Division, the entire $140 transfer price from the Screen Division is a variable cost. Thus, it will reject the offered $340 price. 2. If both the Screen Division and the Quark Division have idle capacity, then from the perspective of the entire company the $340 offer should be accepted. By rejecting the $340 price, the company will lose $60 in potential contribution margin per set: Foregone revenue offered per set....................... Foregone variable costs per set: Screen Division .............................................. Quark Division................................................ Foregone contribution margin per set .................

$(340) $ 70 210

280 $ (60)

3. If the Screen Division is operating at capacity, any screens transferred to the Quark Division to fill the overseas order will have to be diverted from outside customers. Whether a screen is sold to outside customers or is transferred to the Quark Division, its production cost is the same. However, if a set is diverted from outside sales, the Screen Division (and the entire company) loses the $140 in revenue. As a consequence, as shown below, there would be a net loss of $10 on each TV set sold for $340. Price offered per set .......................................................... Less: Lost revenue from sales of screens to outsiders ................ Variable cost of Quark Division ........................................ Net loss per TV..................................................................

$340 $140 210

350 $( 10)

801

Problem 11A-12 (continued) 4. When the selling division has no idle capacity, as in part (3), market price works very well as a transfer price. The cost to the company of a transfer when there is no idle capacity is the lost revenue from sales to outsiders. If the market price is used as the transfer price, the buying division will view the market price of the transferred item as its cost—which is appropriate because that is the cost to the company. As a consequence, the manager of the buying division should be motivated to make decisions that are in the best interests of the company. When the selling division has idle capacity, the cost to the company of the transfer is just the variable cost of producing the item. If the market price is used as the transfer price, the manager of the buying division will view that as his/her cost rather than the real cost to the company, which is just variable cost. Hence, the manager will have the wrong cost information for making decisions as we observed in parts (1) and (2) above.

Managerial Accounting, 13th Canadian Edition

Problem 11A-13 (20 minutes) 1. If the transfer price is set at $15 per unit, the profit per unit of the two divisions is: Parts Division Revenue per unit Cost per unit Profit per unit

$15 12 $ 3

Assembly Division Revenue per unit Parts cost per unit Assembly costs Profit per unit

$25 15 6 $ 4

2. If the transfer price is set at $12 per unit, the profit per unit of the two divisions is: Parts Division Revenue per unit Cost per unit Profit per unit

$12 12 $ 0

Assembly Division Revenue per unit Parts cost per unit Assembly costs Profit per unit

$25 12 6 $ 7

By setting the transfer price at Parts division cost, profits are shifted to the Assembly division from the Parts division. The Parts division manager would be unlikely to agree to this transfer price since he/she is evaluated based on divisional profit. 3. If the transfer price is set at the $13 cost per unit, the profit of the two divisions is: Parts Division Revenue per unit Cost per unit Profit per unit

$13 13 $ 0

Assembly Division Revenue per unit Parts cost per unit Assembly costs Profit per unit

$25 13 6 $ 6

4. By setting the transfer price at $13, the inefficiencies of the Parts division get passed on to the Assembly division. As the Assembly division manager, I would be unhappy with this transfer price since it would reduce my profit by $1 per unit. It is unfair that I have to be penalized in my performance evaluation for inefficiencies due to poor management by the Parts division manager.

803

Problem 11A-13 (continued) 5. The best transfer price from the perspective of the company as a whole would be $15 per unit. This price allows for a reasonable profit per unit for in each division. In addition, by setting the transfer price at $12, the Parts division manager, if inefficient, would have to hold back the extra cost in his/her division and it would affect his/her own division‘s profit. Thus, the Assembly division manager would not be penalized for poor management in the Parts division. In addition, if the Parts division manager can actually become more efficient and can actually produce the parts for less than $12, he/she can increase the profit per unit of the Parts division.

Managerial Accounting, 13th Canadian Edition

Problem 11A-14 (60 minutes) 1. An analysis of the company‘s quality cost report is presented below (dollar amounts are in thousands):

Last Year This Year Amount Percent* Amount Percent* Prevention costs: Machine maintenance ........ Training suppliers .............. Quality circles.................... Total prevention costs ..........

$ 70 0 0 70

(1) 1.7 0.0 0.0 1.7

(2) 10.4 $ 120 0.0 10 0.0 20 10.4 150

(1) 2.5 0.2 0.4 3.1

(2) 20.3 1.7 3.4 25.4

Appraisal costs: Incoming inspection .......... Final testing ......................

20 80

0.5 1.9

3.0 11.9

40 90

0.8 1.9

6.8 15.3

Total appraisal costs .............

100

2.4

14.9

130

2.7

22.0

Rework .............................

1.2

7.5

130

2.7

22.0

Scrap ................................

1.0

6.0

1.5

11.9

Total internal failure costs .....

2.1

13.4

200

4.2

33.9

Warranty repairs ...............

2.1

13.4

0.6

5.1

Customer returns ..............

320

7.6

47.8

1.7

13.6

Total external failure costs ....

410

9.8

61.2

110

2.3

18.6

Internal failure costs:

External failure costs:

Total quality cost ..................

$ 670 16.0 100.0 $ 590 12.3 100.0

Total production cost

$4,200

$4,800

* Percentage figures may not add down due to rounding. (1) As a percentage of total production costs. (2) As a percentage of total quality costs.

805

Problem 11A-14 (continued) From the above analysis it would appear that Mercury, Inc.‘s program has been successful. 

Total quality costs have declined from 16.0% to 12.3% as a percentage of total production cost. In dollar amount, total quality costs went from $670,000 last year to $590,000 this year.



External failure costs, those costs signaling customer dissatisfaction, have declined from 9.8% of total production costs to 2.3%. These declines in warranty repairs and customer returns should result in increased sales in the future.



Appraisal costs have increased from 2.4% to 2.7% of total production cost.



Internal failure costs have increased from 2.1% to 4.2% of production costs. This increase has probably resulted from the increase in appraisal activities. Defective units are now being spotted more frequently before they are shipped to customers.



Prevention costs have increased from 1.7% of total production cost to 3.1% and from 10.4% of total quality costs to 25.4%. The $80,000 increase is more than offset by decreases in other quality costs.

2. The initial effect of emphasizing prevention and appraisal was to reduce external failure costs and increase internal failure costs. The increase in appraisal activities resulted in catching more defective units before they were shipped to customers. As a consequence, rework and scrap costs increased. In the future, an increased emphasis on prevention should result in a decrease in internal failure costs. And as defect rates are reduced, resources devoted to appraisal can be reduced. 3. To measure the cost of not implementing the quality program, management could assume that sales and market share would continue to decline and then calculate the lost profit. Or, management might assume that the company will have to cut its prices to hang on to its market share. The impact on profits of lowering prices could be estimated.

Managerial Accounting, 13th Canadian Edition

Problem 11A-15 (45 minutes)

Food Services

Admin. Services

X-Ray Services

Variable costs ............................................................................... $73,150 $ 6,800 $38,100 Food Services allocation: $1.90 per meal × 1,000 meals ................................................... (1,900) 1,900 $1.90 per meal × 500 meals ...................................................... (950) 950 $1.90 per meal × 7,000 meals ................................................... (13,300) $1.90 per meal × 30,000 meals ................................................. (57,000) Admin. Services allocation: $0.50 per file × 1,500 files ........................................................ (750) $0.50 per file × 3,000 files ........................................................ (1,500) $0.50 per file × 900 files ........................................................... (450) $0.50 per file × 12,000 files ...................................................... (6,000) X-Ray Services allocation: $4 per X-ray × 1,200 X-rays ...................................................... $4 per X-ray × 350 X-rays ......................................................... $4 per X-ray × 8,400 X-rays ...................................................... Total variable costs ....................................................................... $ 0 $ 0

Outpatient Clinic

OB Care

General Clinic

$11,700

$ 14,850

$ 53,400

13,300 57,000

750 1,500 450 6,000 (4,800) (1,400) (33,600) $ 0

4,800 1,400 $18,000

$ 30,000

33,600 $150,000

807

Problem 11A-15 (continued)

Food Services

Admin. Services

X-Ray Services

Fixed costs ................................................................................... $48,000 $33,040 $59,520 Food Services allocation: 2% × $48,000 ........................................................................ (960) 960 1% × $48,000 ........................................................................ (480) 17% × $48,000 ........................................................................ (8,160) 80% × $48,000 ........................................................................ (38,400) Admin. Services allocation: 10% × $34,000 ......................................................................... (3,400) 20% × $34,000 ......................................................................... (6,800) 30% × $34,000 ......................................................................... (10,200) 40% × $34,000 ......................................................................... (13,600) X-Ray Services allocation: 13% × $63,400 ......................................................................... 3% × $63,400 ......................................................................... 84% × $63,400 ......................................................................... Total fixed costs ............................................................................ $ 0 $ 0 Total overhead costs ..................................................................... $ 0 $ 0

Outpatient Clinic

OB Care

General Clinic

$26,958

$ 99,738

$344,744

8,160

480 38,400 3,400 6,800 10,200 13,600 (8,242) (1,902) (53,256) $ 0 $ 0

8,242 1,902 $42,000 $60,000

Managerial Accounting, 13th Canadian Edition

$120,000 $150,000

53,256 $450,000 $600,000

Problem 11A-15 (continued) Computation of allocation rates: Variable Food Services: Variable food service cost $73,150 = =$1.90 per meal Total meals served 38,500 meals Variable Admin. Services: Variable administrative cost $6,800+$1,900 = =$0.50 per file Files processed 17,400 files Variable X-Ray Services: Variable X-ray cost $38,100+$950+$750 = =$4.00 per X-ray X-rays taken 9,950 X-rays

809

Problem 11A-16 (30 minutes) 1. Direct Method

Departmental costs before allocations ............... Allocations: Personnel department costs To RC: ($60,000 x .625)*; To AIC: ($60,000 x .375)*..................................... Legal department costs To DC: ($90,000 x .5)†; To EC: ($90,000 x .5)† ......................................................... Total costs after allocation ................................

Service Departments Personnel Admin $60,000

Consulting Departments RC AIC

$90,000

(60,000)

(90,000) $ 0

$37,500

$ 22,500

45,000 $82,500

45,000 $67,500

*.625 = (.5 /(.5 + .3)); .375 = (.3 /(.5 + .3)) † .5 = (.35 /(.35 + .35)); .5 = (.35 /(.35 + .35)) Income Statements Income Statements Robotics

Consulting

Revenue ..........................................................................$240,000 Costs RC = 60% × $120,000 AIC = 40% × $120,000

$153,000

(72,000)

(48,000)

Allocated from Personnel and Admin ................................. (82,500)

(67,500)

Operating income............................................................. $85,500

$37,500

Managerial Accounting, 13th Canadian Edition

811

Problem 11A-16 (continued) 2.

Step-down Method

Service Departments Personnel Admin

Consulting Departments RC AIC

Departmental costs before allocations ............... $60,000 $90,000 Allocations: Personnel department costs To RC: ($87,000 x .625)*; To AIC: ($87,000 x .375)* ................................................... (87,000) $54,375 Admin department costs To Personnel: ($90,000 x .3); To RC: ($90,000 x .35); To AIC: ($90,000 x .35) 27,000 (90,000) 31,500 Total costs after allocation ................................ $ 0 $ 0 $85,875 *.625 = (.5 /(.5 + .3)); .375 = (.3 /(.5 + .3)); $87,000 = $60,000 + $27,000 allocated from Admin. Income Statements Robotics

Consulting

Revenue ..........................................................................$240,000 Costs RC = 60% × $120,000 AIC = 40% × $120,000

$153,000

(72,000)

(48,000)

Allocated from Personnel and Admin

(85,875)

(64,125)

Operating income/(loss)

$82,125

$40,875

Managerial Accounting, 13th Canadian Edition

$ 32,625 31,500 $64,125

813

Case 11A-17 (90 minutes) 1. Step-down method:

Total costs before allocations ........................ Allocations: Cafeteria (40/500; 60/500; 100/500; 300/500)1 .............................................. Custodial Services (10,000/70,000; 40,000/70,000; 20,000/70,000)2............. Machinery Maintenance (160,000/200,000; 40,000/200,000)3................................... Total overhead after allocations ....................

Cafeteria

Custodial Services

Machinery Maintenance

Milling

Finishing

$320,000

$65,400

$ 93,600

$416,000

$166,000

(320,000)

25,600

38,400

64,000

192,000

(91,000)

13,000

52,000

26,000

(145,000) $ 0

116,000 $648,000

29,000 $413,000

Based on 40+60+100+300=500 employees Based on 10,000+40,000+20,000=70,000 square metres 3 Based on 160,000+ 40,000 = 200,000 machine-hours 2

Milling predetermined overhead rate

$648,000 160,000 machine hr.

Finishing predetermined overhead rate

$413,000 70,000 direct labour hr.

$4.05 per machine hr. = $5.90 per DLH

Managerial Accounting, 13th Canadian Edition

Case 11A-17 (continued) 2. Direct method:

Total costs before allocations ........................... Allocations: Cafeteria (100/400; 300/400)1 ...................... Custodial Services (40,000/60,000; 20,000/60,000)2 ....................................... Machinery Maintenance (160,000/200,000; 40,000/200,000)3 ........... Total overhead after allocations ....................... Divide by machine-hours ................................. Divide by direct labour-hours ........................... Predetermined overhead rate ..........................

Cafeteria

Custodial Services

Machinery Maintenance

Milling

Finishing

$320,000

$65,400

$93,600

$416,000

$166,000

80,000

240,000

43,600

21,800

74,880 $ 614,480 ÷160,000

18,720 $446,520

(320,000) (65,400)

(93,600) $ 0

3.84

÷70,000 $ 6.38

Based on 100 + 300 = 400 employees. Based on 40,000 + 20,000 = 60,000 square metres. 3 Based on 160,000 + 40,000 = 200,000 machine-hours. 2

815

Case 11A-17 (continued) 3. a. The amount of overhead cost assigned to the job would be:

Step-down method: Milling Department: 2,000 machine-hours × $4.05 per machine-hour .................... Finishing Department: 13,000 DLHs × $5.90 per DLH .............................................. Total overhead cost .................................................................

$ 8,100 76,700 $84,800

Direct method: Milling Department: 2,000 machine-hours × $3.84 per machine-hour .................... Finishing Department: 13,000 DLHs × $6.38 per DLH .............................................. Total overhead cost .................................................................

$ 7,680 82,940 $90,620

b. The step-down method provides a better basis for computing predetermined overhead rates than the direct method because it gives recognition to services provided between service departments. If this interdepartmental service is not recognized, then either too much or too little of a service department‘s costs may be allocated to a producing department. The result will be an inaccuracy in the producing department‘s predetermined overhead rate. For example, notice from the computations in (2) above that using the direct method and ignoring interdepartmental services causes the predetermined overhead rate in the Milling Department to fall to $3.84 per machine-hour (from $4.05 per machine-hour when the step-down method is used), and causes the predetermined overhead rate in the Finishing Department to rise to $6.38 per direct labour-hour (from $5.90 per direct labour-hour when the step-down method is used). These inaccuracies in the predetermined overhead rate affect bids for jobs. Since the direct method in this case understates the rate in the Milling Department and overstates the rate in the Finishing Department, it is not surprising that the company tends to bid low on jobs requiring a lot of milling work and tends to bid too high on jobs that require a lot of finishing work.

Managerial Accounting, 13th Canadian Edition

817

SOLUTION MANUAL: Managerial Accounting 13th Canadian Edition by Ray H. Garrison, Theresa Libby, Alan Webb Complete Chapters 1-14 Plus Appendix